NAFTA; fungible materials; Inventory Management Method; Average Method; Crude Oil; diluent/condensate

HQ H012415 August 3, 2010 OT:RR:CTF:VS H012415 KSG CATEGORY: Classification Port Director U.S. Customs & Border Protection 610 South Canal Street Chicago, Il 60607 Re: NAFTA; fungible materials; Inventory Management Method; Average Method; Crude Oil; diluent/condensate Dear Director: This case was initiated in a letter dated May 29, 2007, by counsel for EnCana Marketing (USA) Inc. (“EMUS”), the importer in this case. Counsel requested a binding ruling concerning the eligibility of certain crude oil produced and/or exported from Canada by a related party, EnCana Oil & Gas Partnership (“EnCana”) now known as Cenovus for preferential tariff treatment pursuant to the North American Free Trade Agreement (“NAFTA”). Since this case relates to entries dating back to July 1, 2006, which were current transactions when the request was submitted, we are treating it as a Request for Internal Advice. The file is supplemented by letters dated November 16, 2007, November 26, 2007, November 27, 2007, March 18, 2008, April 22, 2008, June 2, 2008, June 25, 2008, October 16, 2008, April 27, 2009, March 12, 2010, and July 12, 2010. In addition, we note that Customs & Border Protection (“CBP”) also received letters from Canadian Natural Resources Limited, dated March 24, 2010, from Valero Energy Corporation, dated March 26, 2010, and from other oil companies dealing with the issue of the fungibility of diluent/condensates. At the request of counsel, a meeting, which included representatives of the Office of Regulatory Audit, was held on this matter at Headquarters on March 18, 2008. A second meeting with representatives of audit and OLSS was held at Headquarters on July 12, 2010. In the letter dated November 16, 2007, counsel asked to withdraw without prejudice, issues that were raised with regard to treatment of non-originating condensate as either a packing material or an indirect material. Therefore, these issues will not be addressed in this Request for Internal Advice. FACTS: The imported product and materials This case relates to shipments of certain crude petroleum oil blends obtained from bituminous minerals blended with diluent/condensate that were imported into the U.S. from Canada by EMUS via pipeline from June 1, 2006, through October 1, 2009. More specifically, this case deals with two heavy oil blends of bitumen and diluent/condensate: 1) Cold Lake Blend (“CLB”), and (2) Western Canadian Select (“WCS”) which is a mixture of crude blends that includes CLB as one of its components. The importer states that the blend imported into the U.S. is classified in subheading 2709.00.10.00 of the Harmonized Tariff Schedule of the United States (“HTSUS”) covering petroleum oils and oils obtained from bituminous minerals, crude: testing under 25 degrees A.P.I. EnCana recovers bitumen from “oil sands” which are concentrated primarily in northeast Alberta. “Oil sands” refer to the extremely heavy crude oil, or bitumen (a semi-solid, highly viscous form of crude oil) that is trapped in sands. For both of the heavy blends involved in this case, a “condensate” or diluent must be added to the bitumen in order to “lighten” or “lower the viscosity” so that the heavier crude oil is able to flow through a pipeline. Once the blend reaches the refinery, the diluent/condensate is extracted and the bitumen is used by the refiners. The classic dictionary definition of Condensate is a liquid formed by the condensation of a vapor (gas). However, in this case, Encana uses the term condensate to refer to a number of light hydrocarbon liquids produced either from natural gas or through refined oil production. According to counsel, a number of different diluent/condensates were used by EnCana, including pentanes plus, refinery naphtha or a blend of synthetic crude oil and pure compound pentane. Counsel for EMUS states that until June 2006, it solely used Canadian-origin condensates. Since then, EnCana states that it has been increasingly difficult to obtain sufficient originating diluent/condensate. In June 2006, EnCana states that it began using non-originating diluent/condensate along with originating diluent/condensate in its CLB and WCS. The originating condensate/diluent that Encana used includes the following five materials: 1) U.S. and Canadian Lease condensate extracted as a liquid from natural gas at the well head and composed mainly of pentanes and heavier hydrocarbons (one analysis submitted showed a composition mainly of pentane, hexanes plus and trace amounts of methane, ethane, and butane, although it is stated that the chemical composition is not collected for the condensates used in the normal course of business). 2) Originating Pentanes Plus with a chemical composition from C4 through C12, produced by distillation sourced from field condensate and natural gas liquids (“NGL’s”). Commercially it is known as Pentanes Plus, Gas Plant Condensate, Fractionator Condensate or Naphtha. 3) Originating Upgrader Naphtha with a chemical composition of C5 through C12, produced by carbon rejection or hydrogen addition and distillation. It is sourced from bitumen or heavy oil. Commercially it is known as Suncor Naphtha. 4) Originating Refinery Naphtha with a chemical composition of C5 through C12, produced by distillation. It is sourced from crude oil and commercially known as Naphtha. 5) Originating Blended Condensate with a chemical composition of C4 through C14, produced by blending synthetic crude oil and pure compound pentanes. It is sourced from synthetic crude oil and pentanes. It is not commercially marketed, but internally known as blended condensate. In the March 12, 2010 submission, EnCana also provided information on the non-originating diluent/condensate used by it during the relevant time period of June 2006 to October 1, 2009. There were three different sources claimed: 28 cargoes from Pisco, Peru; two cargos from Bolivia; and one cargo from Karachi, Pakistan. According to counsel, the Peruvian diluent/condensate, which was the primary type of non-originating material used, was processed at the Natural Gas Liquids fractionation plant at Pisco, Peru through fractionator distillation which processes natural gas liquids from the San Martin, Cashiriari and Pagoreni fields located in La Convenction Province, Peru. EnCana states that this product is commercially known as Naphtha and the majority has a chemical composition of C4 through C10. The Bolivian diluent/condensate known as Reconstituted Top Crude was obtained from the Guillermo Elder Bell refinery at Cochabamba through distillation and recombination. The chemical composition of the majority of the Bolivian reconstituted top crude is C5 through C14. The Pakistani Naphtha was obtained from the National Refinery in Karachi, Pakistan and was distilled crude oil. The chemical composition of the majority of the Pakistani Naphtha is C4 through C10. To ensure flow within a pipeline, pipeline companies mandate viscosity standards for the condensate and will not accept condensate that does not meet such standards. As part of its submission, EMUS provided the pipeline quality standards for diluents/condensates for the Enbridge Pipeline. The standards allow a range of density, viscosity, sulfur content, olefins, reid vapour pressure (“RVP”), and organic chloride required by the National Energy Board which must fall within a specific American Petroleum Industry (“API”) group. The density range for the Enbridge Pipeline is from 600kg/m3 (104.3 API) up to but not including 800kg/m3 (45.3 API) and a viscosity of 0.4 cSt up to but not including 2 cSt. EnCana states that all the condensates (and as specified in its contracts for the purchase of diluent/condensate) used by it during the relevant time period met the following specifications: viscosity less than 2.0cSt at 7.5 C RVP less than 103 kPa density range between 650 and 770 kg/m3@ 15 C total sulfur less than 0.5 wt% mercaptan sulfur less than 50 wppm no olefins no organic chlorides total aromatics greater than 2.5 vol% propane less than 0.25 vol% butane less than 5 vol% sediment and water less than Se, P less than 1 wppm arsenic less than 20 wppm, and Hg less than 10 wppb In Table 2 of the March 12, 2010 submission, EnCana provided a representative sample of the range of characteristics for the non-originating diluent/condensate for density, RVP, viscosity, sulfur, butane and aromatics. The range for density was 688.9 kg/m3-735.1 kg/m3. The range for viscosity was 0.575 to 1.571 cSt. According to counsel in its March 12, 2010 submission (Table 7), the following Canadian condensates were used in the Enbridge diluent/condensate stream or pool (“CRW”) for 2008: DENSITY VISCOSITY/20C SULFUR Amoco condensate 703.6 .55 .03 Bonnie Glen condensate 708.3 .63 .24 Federated condensate 710.7 .56 .07 Fort Saskatechewan condensate 672.3 .47 .03 Gibson condensate 739.8 .74 .28 PetroCanada condensate 690.9 .53 .01 Pembina condensate 753.6 1.00 .20 Peace Pipe condensate 739.3 .95 .14 Rainbow condensate 746.8 1.00 .12 Rimbey condensate 692.6 .52 .12 Suncor-N 725.9 .70 .01 CRW blend 715.3 .66 .12 EnCana states that in general, the amount of diluent/condensate that is required to blend with the bitumen in order to bring it to pipeline specifications is in the range of 25% diluent/condensate and 75% bitumen (1:3 ratio). However, it states that this ratio will vary somewhat based on a number of factors, including the density of the bitumen, the density of the diluent/condensate, and the temperatures of the bitumen and diluent/condensate at the time of blending. Journey of the diluent/condensate and crude oil Diluent/Condensate EnCana states that it receives all its non-originating diluent/condensate through a Canadian west coast port facility at Kitimat, British Columbia (sample documentation was submitted, including an invoice, Canadian customs documents, quantity certificate, and bill of lading). The non-originating diluent/condensate is transported by rail to the Provident Energy Ltd. facility, at Redwater, near Edmonton, Alberta (see the sample load ticket). The Provident facility is operated by an unrelated third party (see the sample rail deposit report/offloading ticket prepared by Provident and the sample record management system printout). Counsel states that in addition to EnCana, other shippers also deliver diluent/condensate to the Provident facility. At the Provident facility, the originating and non-originating diluent/condensate of EnCana is commingled in operational tankage (short term storage) with the diluent/condensate of the other shippers (see the sample Delivery ticket and the sample final shipper’s balance). Commingled diluent/condensate from the Provident facility is injected into Inter Pipeline Fund’s (“IPF”) Cold Lake Pipeline where it is transported north to the Cold Lake region and is delivered to EnCana’s Foster Creek facility in Bonnyville, Alberta. The Foster Creek facility only produces CLB. Crude oil product At EnCana’s Foster Creek facility, the commingled diluent/condensate is blended with bitumen to produce CLB. As described below, it moves from the Cold Lake Pipeline onto either the Express or Enbridge Pipeline from which it is imported into the United States. At Foster Creek, the diluent/condensate is delivered either directly into operational storage for immediate blending with EnCana bitumen or may be delivered into a storage cavern at the Foster Creek facility for future use. The shipment of non-originating diluent/condensate to the Foster Creek plant generally requires a one-month transit time. For example, the diluent/condensate received at Kitimat in June will be used at Foster Creek Plant in July. At Foster Creek the bitumen is processed through “treaters” (vessels which remove water and sediment from bitumen). Some commingled diluent/ condensate is added to the bitumen at the treaters to facilitate water removal. The partially blended treated bitumen is injected into a limited amount of operational tankage and then further blended with more of the commingled diluent/condensate to meet pipeline specifications. The precise blending proportion (or percentage of condensate required) is determined by the density of the condensate. Encana states that the higher the density of the diluent/condensate, the higher proportion of diluent/condensate required for blending. The Cold Lake Pipeline measures the density (or quality) of the condensate being injected into its pipeline. As discussed below, shippers delivering a lower density condensate to the pipeline are paid an equalization amount which reflects the increased value of their condensate. Shippers who deliver condensates with higher densities are charged an equalization amount to reflect the lesser value of their condensate stream. Condensate Equalization The Canadian Crude and Condensate equalization procedures and penalty scales are governed by the Industry's "Equalization Steering Committee." According to counsel, this independent Industry committee has been in existence since 1994. In addition, condensate was first equalized for density in 1997. The Canadian condensate equalization process is based on the concept that the difference in value of a condensate can be determined from the density (expressed in kg/m3), sulfur (expressed in liquid volume percent) and butane (expressed in liquid volume percent) content of each condensate. By establishing a value for each of these three variables, the value of any condensate delivered to a mixed stream can be determined. The guide notes that most condensates contain some butane and it sets forth how the butane content influences the value of the condensate for purposes of equalization. In comparing the value of various condensates, the guide provides that the density of the condensate is the most critical because it is the most significant influence in how much condensate must be added, which also depends on the reference temperature. The guide states that the sulfur adjustment is equal to that used for the industry accepted equalization process for light and medium crude oil. Counsel provided a summary of the equalization adjustment applied to the Kitimat condensate delivered to EnCana's Foster Creek facility via the Interpipeline Fund's Cold Lake Pipeline for the period June 2008 to July 2009 (March 12, 2010 submission, Table 8). The equalization adjustment over this period has not exceeded $6.00/m3 and averages less than 0.75% of the condensate value. Counsel states that this equalization adjustment shows that the Kitimat condensate (i.e., the imported condensate) has a similar value to other condensate streams. Pipeline A batch is a measured amount of oil or refined product in a pipeline or tank; a shipment of oil or product by pipeline. Batches on pipelines are owned by the shippers and are identifiable through an assigned batch number. Not all pipelines are batch systems. The Cold Lake Pipeline is not a batch system. The pipeline operator, IPF, monitors the volume injected by each of its shippers, maintains legal title separation and delivers back to each shipper an equivalent volume of product. The Enbridge pipeline and Express pipeline are batch systems and the CLB and WCS are batched on these pipelines for transportation to U.S. pipelines. There is no direct commingling of these blends with other crude oil blends on either of these pipeline systems; the integrity of the batch is maintained during shipment. There are four producers (EnCana and three other producers) and five injection points on the Cold Lake Pipeline. EnCana’s Foster Creek production is commingled on the Cold Lake Pipeline with the blended bitumen production from the other three producers. CLB goes from the Foster Creek facility via the Cold Lake Pipeline. The Cold Lake Pipeline goes in two directions, either west to Edmonton, Canada or south to Hardesty, Canada. If the CLB goes west to Edmonton, it is then batched and goes via the Enbridge Pipeline. If the CLB goes south to Hardesty, it is batched and goes to the U.S., either via the Enbridge Pipeline or via the Express Pipeline. The end destination of the imported good is a U.S. refinery, where it is held in refinery crude holding tanks. After the bitumen/diluent blend is imported into the U.S., the diluent is removed and the bitumen is sold separately. The paper trail Examples of the following documents related to acquisition and delivery of condensate were provided by EnCana: An Invoice prepared by a seller of non-originating condensate. This document reflects the sale terms and provides information stating the quantity of the imported non-originating condensate sold to EnCana. Canadian Customs documents filed in Canada with the entry of the non-originating condensate. These documents include information regarding the tariff classification, volume, price and country of origin of the non-originating condensate. A Quantity Certificate provided by unrelated third party that shows the name of the product and the volume purchased of non-originating condensate that was loaded onto the vessel. A Bill of Lading identifies the shipper, the consignee, description of the cargo and the volume of non-originating condensate being shipped to Canada. A Load Ticket records the loading of the non-originating condensate at the non-related third-party operated Terminal in Kitimat, B.C. onto railcars for transport to the non-related third party operated Provident Terminal in Redwater, Alberta, Canada. The operator provides EnCana with an offloading and terminalling service. The load ticket provides the shipping instructions which identify the shipper, the consignee, the destination of the non-originating condensate and its weight in kilograms of the volumes loaded. It also shows the unique identifier for the shipment and the railcar number. The Load Ticket is for one railcar. It takes approximately 450 railcars and five days to transport the non-originating condensate delivered by one ship from Kitimat, B.C. to Redwater, Alberta. A Rail Deposit Report/Offloading ticket, from the unrelated third party operating the Provident Terminal, documents the delivery of the non-originating condensate to the Provident Terminal. It references the railcar number, original ID number, reports the volume in each railcar by liters, and identifies Provident as the final destination. An Offload ticket is prepared for each railcar. A Record Management System printout prepared by the unrelated third party operating the Provident Terminal lists all the railcars that delivered non-originating condensate for the month. EnCana receives a copy of this report. A Delivery Ticket prepared by the unrelated third party operating the Cold Lake Pipeline, Inter Pipeline, is a document based on meter readings. It measures the total amount of both originating and non-originating condensate received and delivered into the Foster Creek plant by EnCana. The meters are operated in accordance with the directives of the Energy Resources Conservation Board, an Alberta government agency, which specifies how volume should be measured in the pipeline industry. The meters are solely owned and operated by Inter Pipeline. A Final Shipper’s Balance prepared by Inter Pipeline provides the total amount of EnCana’s condensate (originating and non-originating) injected into the diluent line of the Cold Lake Pipeline system at the Provident facility. Within this diluent pipeline, EnCana’s condensate (originating and non-originating) is commingled with other shipper’s condensates. The import documents for the CLB or WCS were filed with CBP upon receipt of the delivery ticket from the cross border pipeline ope