Blended fuels allow biofuels (e.g., bio-oil, ethanol, and biodiesel) to be commercialized by mixing them with petroleum-based fuels and address their deficiencies, such as compatibility with existing engine systems. Traditional blends (e.g., B20, E15, and E85) rely on mechanical mixing and use of surfactants (stabilizing chemicals) to prevent mixture separation, however, in many cases bio-blends suffer from reduced performance. Bio-oil, a low-grade liquid biofuel, has high potential in blended fuels production and addresses its deficiencies, such as high upgrading cost due to high oxygen-carbon ratio and H2O content. Emulsion technology is a relatively immature process, which relies on microscopic H2O blended with fuel for increased performance and stability. This study explores how residual H2O in bio-oil may increase performance and compensate for its deficiencies by using bio-oil in diesel emulsion. Our research shows that (a) H2O emulsion fuel has received little attention yet, which can offer many benefits to reduce fuel consumption and emissions, (b) H2O content in bio-oil may be significant enough to impact performance in a diesel engine if stability concerns are addressed, and (c) the stability of bio-oil derived diesel emulsions may be increased over conventional practice, using ultrasonic cavitation. It is concluded that emulsified bio-oil in diesel is able to address common upgrading challenges by skipping H2O removing operation and using H2O in bio-oil to enhance blended fuel performance. Ultimately, bio-oil can be used to supplement diesel fuel and develop a commercial market similar to the strategy’s used earlier with ethanol production from corn.