This study deals with the thermal efficiency improvement of diesel engines operated by W/O (water-in-oil) type emulsified fuels. This paper focuses on the feasibility of W/O emulsions as fuels applied to small diesel engines from the view point of compatibility between lower fuel consumption and lower NOx emission. Effects of water content ratio and mean diameter of water scattered in gas oil on ignition, combustion and emission characteristics in a small DI diesel engine with progress of fuel injection timing were experimentally investigated. Results showed that water content ratio strongly influenced on ignition delay and associated combustion characteristics after auto-ignition, and mean diameter of dispersed water in gas oil was not sensitive parameter on ignition and combustion. Under the 60% load condition in 2000 rpm engine operating speed, for 20 volume percent water content W/O emulsified fuel, slight progress of fuel injection timing yielded approximately 5% improvement of thermal efficiency and 60% reduction of NOx emission compared with the base engine performance fueled by gas oil.