Action Item: New policy guidance in the form of "Frequently Asked Questions" was published by the Commerce Department on December 20, 2014, with regard to crude oil export controls. Stakeholders interested in crude oil exports should review this new guidance to understand what factors are considered by export regulators to determine what petroleum commodities are, and are not, eligible for export under current rules.
On December 30, 2014, the Department of Commerce Bureau of Industry & Security ("BIS") published new policy guidance on crude oil export issues, in the form of Frequently Asked Questions published at http://www.bis.doc.gov/index.php/policy-guidance/ faqs. These FAQs set forth BIS' approach to technical issues that have been of concern to traders, including:
- what sort of processing (through a "distillation tower") is required to make crude oil and lease condensate exportable,
- and whether Canadian crude shipped through the U.S. can be exported if it has incidental mixing with U.S. crude in storage and pipeline facilities.
Some press reports have trumpeted this as "further easing the export ban," but that is not so. The FAQs largely restate existing rules, and give a somewhat fuller picture of what factors BIS considers relevant to determining if a processed commodity is considered "crude."
These FAQs have been under consideration since last summer, when BIS suspended action on several pending commodity classification requests for exporters seeking rulings on whether processed condensates are considered "crude oil" under the export ban. The pause reportedly was to allow BIS to consider additional information collected from applicants and to develop its internal policy regarding the types of processing sufficient to render crude exportable.
Unfortunately, while the FAQs provide some insights into BIS' thinking, they stop short of giving the industry transparent and objective technical specifications for determining what processed commodities fall within the crude ban. As a result, the limits on the scope of the crude ban will continue to have to be determined on a case-by-case basis, a process that hopefully now will resume after Commerce's lengthy hiatus.
Treatment of Condensate under the Crude Export Ban
"Crude oil" is defined in Commerce Department Export Administration Regulations (15 CFR Part 754) as a mixture of hydrocarbons that existed in liquid phase in underground reservoirs and remains liquid at atmospheric pressure after passing through surface separating facilities and which has not been processed through a crude oil distillation tower. The definition set forth in the rule includes reconstituted crude petroleum, and lease condensate, liquid hydrocarbons produced from tar sands, gilsonite, and oil shale. Drip gases are also included. Topped crude oil, residual oil, and other finished and unfinished oils are excluded. The newly issued FAQs recite those definitions, without much elaboration, in response to questions regarding about how to determine if a commodity is crude oil, and if lease condensate is considered crude oil.
There are a number of legal quirks in the application of the crude oil definition, but one of the most challenging is the application of the regulations to condensate, a mix of hydrocarbons lighter than crude oil (i.e., with a specific gravity above 45° API) that can be collected in liquid form at oil and gas wellheads. There is no formal regulatory specification for "condensate," and the term can be used to refer to different products. "Lease condensate" generally refers to liquids collected at the well site; it differs from "plant condensate" that is produced from the wellhead as gas but is converted to liquids once separated at a natural gas processing plant.
Although the current definition of crude oil has been in place for nearly two decades, little attention was paid in the past to fleshing out what was in and what was out of the regulation's imprecise wording until just this past year. Now, however, with the boom in domestic hydrocarbon production and corresponding push to export light petroleum products, BIS has had to grapple with the issue of what hydrocarbons are considered "crude oil and lease condensate" in the modern era of shale production, and what types of processing might open the door to export by triggering the exceptions for crude "processed through a crude oil distillation tower" and for "topped crude oil, residual oil, and other finished and unfinished oils."
BIS made surprise global headlines earlier this year when it issued rulings to two producers finding that certain condensates were sufficiently "processed through a crude oil distillation tower" to be exported. The agency then quickly applied the brakes and ceased responding to crude classification requests altogether, while the Administration gave the issue more thought.
FAQs Factors in Classifying Processed Crude and Lease Condensate
On the much-watched issue of how much processing is needed to export crude and condensate, BIS' new FAQs set forth six factors that it will weigh to determine whether the product has been "processed through a crude oil distillation tower."
While the FAQs give a window into BIS' analysis, the multi-factor test remains complex and subjective, since it requires BIS to weigh various details of the "distillation tower" equipment, the characteristics of the output streams, and the end use of the products. No objective or quantitative cut-offs are provided, so the new factors will not provide much certainty for exporters looking to"self-classify" new and unique products for export. The six factors are below (although Commerce states these factors are not exclusive; other unnamed factors may be considered as well):
- whether the distillation process materially transforms the crude oil by using heat (not just negative pressure) to induce evaporation and condensation, into liquid streams that are chemically distinct from the crude oil input;
- the change in API gravity between the input of the process and the output of the process;
- the change in percentage of different types of hydrocarbons between the input and output of the process;
- whether the streams resulting from distillation have purposes other than allowing the product to be classified as exportable petroleum products, such as use as petrochemical feedstock, diluent, and gasoline blendstock;
- whether the distillation process utilizes temperature gradients and has significant internal structures, such as trays or packing, and differentiated output streams; and
- whether the distillation uses towers with more mechanical complexity and heat, higher residence time, internal structures that promote condensation and better separation, and a consistent quality liquid streams (also called cuts or fractions) than equipment used to separate vapors and liquids for transportation needs.
Recent press reports have suggested that BIS has signaled approval of exporters using self-classification; that is, exporting commodities based on the exporter's determinations of commodity type, rather than formal BIS rulings. As a general matter of export compliance, proceeding with exports based on self-classification is a lawful way to operate; this practice represents the norm in most sectors, as commodity classification rulings are not required by BIS rules. The practical difficulty with self-classification arises when dealing when trading new and unique commodities and systems, because exporters, counterparties, and financing banks must assume the risk of not having total certainty that the cargo is legally exportable. As a result, while the new crude FAQs give a window into BIS' broad reasoning and will help with preparing commodity classification requests for submission to BIS, the FAQs do not set out clear, objective technical specifications that would help exporters to self-certify commodities with a high degree of certainty and minimal risk.
Treatment of Canadian Crude Transiting the U.S.
Over the past two years, the industry has examined various options for exporting Canadian crude via U.S. ports, after carriage through the states via rail or pipeline. According to BIS regulations, "foreign-origin" crude oil can be exported (with a valid license) as long as it is not "co-mingled" with domestic crude oil. There has been considerable uncertainty and concern regarding the extent to which even de minimus mixing of domestic crude in transit compromised the exportability of foreign crude.
In the FAQs, BIS signaled some flexibility on incidental mixing, but again leaves the details to be considered on a case-by-case basis, explaining:
What is the acceptable level of domestic crude that can be mixed with foreign crude and still be eligible for export?
The Regulations do not specify any de minimis amount of U.S.- origin oil that can be co-mingled with the foreign oil. However, BIS understands that a minimal amount of mixing may occur due to incidental contact in pipelines and/or storage tanks when foreign and U.S. origin-oil is sequentially transported or stored in the same pipeline or tank. We encourage those applying for export licenses for foreign-origin crude to include in their application an explanation of the precautions they are taking to ensure that U.S. crude oil is not mixed with the foreign-origin crude, other than incidental contact.
In conclusion, while the publication of the FAQs assists the public to better understand BIS' general policies with regard to exports under the current rules, it does not substantially advance the ball with regard to actually easing the export ban. The outer limits of the crude oil ban will continue to be determined on a case-by-case basis, at least until BIS has completed sufficient rulings to allow the market to "connect the dots" as to what regulators deem to be permitted under the current rules. The Administration's highly cautious approach in this matter reinforces the notion that any expectations for reform of the decades-old export restrictions are probably better focused on the new Congress, which has pledged to make energy, trade, and infrastructure gains a priority. Stakeholders are encouraged to confer with counsel to further assess the importance of this development.
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