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. The U.S. Department of Commerce, Bureau of Industry & Security (“BIS”) has indeed authorized such a “swap,” involving 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 exporters need to know about crude oil swap licenses:
1. Do not confuse the two different types of swap licenses. BIS has 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 non-adjacent country (hereafter “non-adjacent country swap”). For reasons explained below, BIS has yet to authorize a non-adjacent 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 non-adjacent 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 non-adjacent 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 non-adjacent 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 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 non-adjacent country swaps face a high hurdle. As noted above, the BIS has yet to approve a non-adjacent 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.” 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 experience, BIS is more likely to authorize a non-adjacent 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 that the government will grant the required license, BIS has, in the past, provided a contingent license approval. If an applicant presents a proposal to BIS that outlines an overall transaction that satisfies federal requirements, 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, BIS will review the details (no later than 30 days prior to the first shipment) and, if acceptable, will issue a license authorizing a swap that must be concluded within one year.
Despite on-going legislative efforts to repeal the U.S. ban on crude oil exports, the export restrictions remain firmly in place, making it difficult for producers and traders to reach foreign buyers for the large supply of light crude produced in the United States. BIS frequently issues licenses to export Canadian crude out of the United States 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. Now, U.S. exporters and foreign refiners are beginning to realize that the two swap licenses discussed above offer unique opportunities.
Not surprisingly, industry interest in the potential for swaps licenses has risen considerably because of 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.
Client Alert 2015-285