Exports of Condensate Reflect Evolution, Not Revolution, In Crude Export Regulation

by Blank Rome LLP
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Maritime

On June 24, 2014, various news sources reported that the Department of Commerce (“DOC”) had allowed two companies to export processed condensate, suggesting a breakthrough in the 40-year ban on crude oil exports. The reality might not match the dramatic headlines, however. It appears that the Administration has not changed course or broken major ground in reforming the 1970s era crude export ban. Instead, it appears these developments are part of an ongoing process at the Commerce Department—largely shielded from view, on a case-by-case basis—to define and clarify what particular tight oils are deemed “crude oil” for the purposes of the ban.

Background

In response to the fuel and geopolitical crises of the 1970s, Congress passed the Energy Policy and Conservation Act, curbing exports of crude oil and natural gas. Limits on exports to Canada were relaxed during the Reagan administration, but exports to other destinations have remained virtually nil. Proponents of maintaining the current policy point to the need to maintain low domestic gas prices, national security factors, the goal of U.S. energy independence, and the unpredictable effects of altering the longstanding ban.

However, the boom in North Dakota and Texas shale oil production has altered the landscape for crude oil, and lifting the ban has been much discussed in Washington. Earlier this year, the Senate held its first hearing in decades to consider loosening the restrictions, and in recent weeks top White House and Energy Department officials have acknowledged that crude export reform is under consideration. Much of the debate is driven by the types of new oil being produced in North Dakota and Texas—light, sweet (low sulfur) oils—and the difficulties in shipping and refining this production with Midwest and Gulf refining infrastructure built to capitalize on heavy, sour feedstock imported from abroad. Allowing free trade could create trading opportunities to more efficiently balance crude supplies to our existing infrastructure.

Treatment of Condensate under the Crude Export Ban

There are a number of legal quirks in the application of the crude oil export regulations, but one of the most challenging is the application of the export laws 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.

The practical issues presented by condensate are immediate. Domestic condensate production has roughly doubled in the past three years to 1.2m b/d, and is forecasted to reach 1.6m b/d by the end of 2018 according to some estimates, threatening to soon overwhelm Gulf Coast refining and processing capabilities.

“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 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.

Although the rule text has been in place for nearly two decades, little attention was paid in the past to fleshing out the regulation’s imprecise wording. Now, however, with the boom in domestic production, it is suddenly critical for the industry and Commerce Department to work through the details of which hydrocarbons are considered “lease condensate” in the modern era of shale production, and what types of processing might trigger the exceptions for crude “processed through a crude oil distillation tower” and for “topped crude oil, residual oil, and other finished and unfinished oils.” (Topped crude, generally speaking, refers to crude that has had light ends removed through distillation.)

These issues are being worked out largely behind closed doors on a case-by-case basis, either through dialogue with relevant officials, or through commodity classification requests, which are requests for private rulings on the controls applicable to specific commodities. The rulings cited by the media this week likely represent part of this process. Unfortunately, most of this policymaking is shielded from the industry and public view. Unlike Customs rulings, export licenses and classification rulings generally are statutorily protected from disclosure, so decision-making can go on without notice or comment by industry players, even those potentially most impacted.

Conclusions and Recommendations

While these issues of defining condensate might seem technical and legal, they have major real-world consequences for investment, infrastructure, and trade. According to a recent FT report, new simple distillation and processing units—splitters and topping units—representing over 400,000 b/d of production are coming on line in and around Port Arthur, focused on making condensate exportable.

The Commerce Department rulings have already had an impact on the industry, but since the agency is operating on a case-by-case basis, companies that will profit the most are the ones who engage early with regulators. Companies looking for more certainty about the export restrictions on particular types of condensate or other products have little to gain from remaining on the sidelines; engaging with policymakers and seeking formal rulings where needed can minimize the regulatory risks of investing in new and untested commodities and infrastructure.

More broadly, it is clear that the industry, media, and public interest in the Administration’s policymaking in this area is growing quickly. Accordingly, the Commerce Department may be considering using more traditional policymaking tools, such as notice and comment rulemaking, to evolve U.S. energy policy in a more evenhanded and transparent way. Such a move could be beneficial, to the extent it would allow the Administration to seek comments from impacted parties. Interested parties should remain alert for opportunities to weigh in on what has quickly become one of the most significant trade issues of recent years

Notice: The purpose of this Maritime Developments Advisory is to identify select developments that may be of interest to readers. The information contained herein is abridged and summarized from various sources, the accuracy and completeness of which cannot be assured. The Advisory should not be construed as legal advice or opinion, and is not a substitute for the advice of counsel.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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