Law360

Authors: Jeffrey Orenstein

Notwithstanding the recent momentum of congressional efforts to repeal the U.S. ban on crude oil exports, President Obama has vowed to veto any bill that would dismantle the current short supply regulations administered by the U.S. Department of Commerce's Bureau of Industry and Security. With the export ban still firmly in place, producers and traders have continued their search for ways to reach foreign markets for the large supply of light crude produced in the United States. BIS frequently issues licenses to export Canadian crude out of the U.S. and to export U.S. crude to Canada, but historically the option of exporting U.S.-origin crude to refineries in Europe, Asia and other foreign markets has been largely blocked. Recently, however, U.S. exporters and foreign refiners have taken a keen interest in the opportunities afforded by so-called swap licenses.

Recent reports that the Obama administration authorized exports of U.S. light crude oil in exchange for imports of Mexican heavy crude have caused a stir in the industry and a fair amount of confusion in the press. BIS has indeed authorized such a swap, involving Petroleos Mexicanos, or Pemex, the Mexican national oil company. But the legal context of the deal is frequently misunderstood. To provide some clarification, here are the top 10 things that exporters need to know about crude oil swap licenses.

1. Do Not Confuse the Two Different Types of Swap Licenses

The BIS has the authority to issue two distinct types of swap licenses under the Export Administration Regulations. The first type permits the export of U.S.-origin crude in exchange for the import of crude from an “adjacent” country (this means Mexico as a practical matter, although Canada and Panama are part of the definition too) (hereafter “adjacent country swap”). That is the type of license at-issue in the Pemex deal. The second type of swap license permits the exchange of U.S. crude oil for either crude or petroleum products from a nonadjacent country (hereafter “nonadjacent country swap”). For reasons explained below, the BIS has yet to authorize a nonadjacent country swap.

2. Crude Exported Under a Swap License Cannot Be Re-Exported

Under both types of licenses, all U.S. crude exported must be used and consumed (i.e., refined) in the authorized country of export.

3. Applicants Cannot Count Existing Commitments to Purchase and Import Crude or Products Toward the Volumes They Promise to Import Under a Swap License

Under both types of licenses, the commodities exchanged must be in addition to any commitments the transacting parties have under existing contracts. In other words, if a party already has a contract to import a certain quantity of Mexican heavy crude, it cannot count these volumes toward the quantity of crude it subsequently commits to import under an adjacent country swap.

4. The Relevant Contracts Must Provide for Termination in Case of an Oil Shortage

For national security purposes, under both types of licenses, the relevant contracts must allow for termination of the exchange in the event that U.S. petroleum supplies are interrupted or seriously threatened, as determined by the federal government.

5. Licenses for Adjacent Country Swaps Only Permit Crude-for-Crude Exchanges

Under an adjacent country swap license, one must import an equal or greater quantity of crude. By contrast, licenses for nonadjacent country swaps permit an exchange of U.S. crude for equal or greater quantities of either foreign crude or foreign petroleum products (i.e., refined products).

6. Equal "Quantity" Is Determined Differently for Petroleum Products Than It Is for Crude Oil

In a crude-for-crude swap, a simple barrel count will suffice to show that the quantity of imported crude is equal to the quantity exported. However, for an exchange of U.S. crude for petroleum products from a nonadjacent country, the applicant must demonstrate that the quantity of petroleum product to be imported is equal to the amount of product that would be derived from the refining of the crude to be exported.

7. Disparity in Commodity Values Can Be Addressed With Capital

While the monetary value of commodities exchanged may be substantially different, the transacting parties can address such disparities to make an exchange commercially feasible through additional capital or additional imports.

8. Quality Counts Too

For nonadjacent country swaps, the imported and exported commodities must not only be of equal quantity; they must also be of equal quality. Some have questioned how one can compare the quality of vastly different crude types, let alone compare the quality of crude oil and refined products. It is an apples-to-oranges comparison in some ways, but the BIS has indicated that this requirement is essentially a check against exchanges that would swap valuable U.S. crude for inferior commodities.

9. Applicants for Nonadjacent Country Swaps Face a High Hurdle

As noted above, the BIS has yet to approve a nonadjacent country swap. This is principally the result of one high hurdle in the regulations: an applicant must demonstrate that the U.S. crude “cannot reasonably be marketed in the United States” for “compelling economic or technological reasons beyond the control of the applicant.” The BIS has not defined this marketability standard, but it has rejected as insufficient arguments that rely essentially on the fact that exports would yield higher profit margins. Based on past experience, the BIS is more likely to authorize a nonadjacent country swap if the applicant can show either an absence of domestic refining capacity or a circumstance in which producers can no longer earn a return under domestic prices.

10. BIS Can Facilitate Complex Deal Negotiation Through a Contingent Approval

Because it is difficult to execute the contracts necessary for a complex swap transaction without an assurance the government will grant the required license, the BIS has, in the past, provided a contingent license approval. If an applicant presents a proposal to the BIS that outlines an overall transaction that satisfies federal requirements, the BIS can grant a contingent approval. This facilitates the applicant’s ability to negotiate the finer points of the deal with its counterparties. Once finalized, the BIS will review the details (no later than 30 days prior to the first shipment) and, if acceptable, the BIS will issue a license authorizing a swap that must be concluded within one year.

Conclusion

Not surprisingly, industry interest in the two swaps licenses discussed above has risen considerably due to imbalances caused by the shale oil boom, U.S. refining capacity and current crude oil prices. Parties wishing to explore the commercial prospects of exporting U.S. crude in exchange for foreign crude or petroleum products should seek the advice of counsel to discuss the available licensing options.

Republished from Law360.com