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(John Kemp is a Reuters market analyst. The views expressed are his own)
By John Kemp
LONDON, June 26 (Reuters) - The U.S. Commerce Department's decision to allow two companies to begin exporting ultra-light condensate after only minimal refining marks the beginning of the end of the ban on American crude oil exports.
The ban, which applies to crude but not refined products, has never made much sense economically or in terms of fuel chemistry, but now the department's rulings show it may be impossible to enforce in practice.
The Commerce Department and the White House insist there has been "no change in policy on crude oil exports".
But these administrative decisions show how hard it will be to prevent enterprising crude and condensate producers from circumventing the ban by processing raw oil just enough to ensure it no longer counts as crude.
The statutory authority for the ban stems from the 1975 Energy Policy and Conservation Act and the 1979 Export Administration Act. But enforcement is left to the Export Administration Regulations, the relevant section of which is set out in Chapter 15, Part 754 of the Code of Federal Regulations.
To export crude a shipper must first obtain a license from the Bureau of Industry and Security (BIS), which also enforces restrictions on a range of other products, including items with dual military and civilian uses, nuclear technology, law enforcement products and execution equipment.
Crude turns out to be surprisingly hard to categorise. There is no chemical way to define it. Raw oil is a mixture of thousands of different molecules, mostly made up of carbon and hydrogen in widely varying proportions, but with small amounts of oxygen, nitrogen, sulphur, nickel and vanadium mixed in too.
Raw oil is heterogeneous. Crudes range from dark black to brown or greenish in colour, from ultra-heavy oils denser than water to ultra-light ones virtually indistinguishable from the gasoline used in motor vehicles (or at least the ones in use in the mid-20th century before motor fuels became more advanced).
To enforce the ban, BIS needs a legal definition of what is crude oil and what is not. The bureau could adopt a stance similar to Justice Potter Stewart's approach to pornography ("I know it when I see it") but that might be held unlawful by the courts if deemed "arbitrary and capricious", in the words of the Administrative Procedure Act.
So BIS employs a two-part test: "Crude oil is defined 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" (15 CFR 754.2(a)).
The liquid part of the test is designed to distinguish oil from gas, while the distillation part is intended to differentiate crude from refined products. It is the distillation which lies at the heart of the current controversy.
Distillation separates the hydrocarbons in crude based on their different boiling and condensation points.
In principle, crude can be separated into dozens or even hundreds of fractions based on their slightly different boiling points. Even then, separation may not be perfect because the boiling points of many molecules are close together and the process is fairly rough when used on an industrial scale.
Most refineries separate crude into about six broad "cuts", each of which contains a range of molecules, and the streams are then sent for further processing. Cuts range from refinery gases and light naphtha, which come off at the top of the distillation tower, to kerosene, heavy gas oil and residuum lower down.
The number of cuts is a matter of practical convenience and commercial practice. It is possible to distil crude into more or fewer fractions.
Distillation processes are not confined to oil refineries. Some distillation units are much more complex than others. For example, oilfields have simple units known as stabilisers which, to meet safety specifications, distil raw crude just enough to remove the most volatile components such as propane and butane before it is put into pipelines or loaded onto tank cars.
The BIS regulations state hydrocarbons are no longer to be considered crude oil once they have been processed through a "crude oil distillation tower". But they are silent on how complete that distillation must be. Nowhere do they say into how many cuts the oil must be separated.
According to the Wall Street Journal, Enterprise Products Partners and Pioneer Natural Resources approached the Bureau of Industry and Security to ask whether lightly processed condensates from the Eagle Ford shale would count as crude under the Export Administration Regulations ("Rulings on oil exports roil industry", June 25).
From the moment BIS said lightly processed condensates would not be defined as crude oil, they could be exported just as easily as gasoline, diesel or jet fuel.
Crucially, there is no change in the law or policy, just an interpretation of how existing laws and policies apply to a specific set of circumstances.
There are established procedures under which corporations and individuals can write to various government agencies and ask them for a ruling on how the law applies to a certain situation.
Formally, these "private letter rulings" are advisory opinions and apply only to the specific facts in the case concerned. However, PLRs are valuable because they provide the requesters with assurance that they will not subsequently face criminal or civil prosecution by the government as long as they have outlined their circumstances accurately.
BIS and the Internal Revenue Service issue many private letter rulings on issues linked to export controls and taxation. Some PLRs are published, with identifying details redacted. PLRs interpret rather than make law but the process can set or modify important precedents.
The gap between PLRs and policymaking is blurred. For example, PLRs from the IRS explain how U.S. mutual funds were able to pour more than $50 billion into commodity derivatives, even though before 2006 it was generally thought the law prohibited them from generating more than 10 percent of their income from commodities and other alternative investments ("U.S. tax ruling threatens commodity mutual funds", Sept. 14, 2012).
Precisely what BIS told Enterprise and Pioneer remains unclear because the PLRs in this case have not yet been published, though they might be at a later date.
Crucially, we still do not know exactly how much distillation Enterprise and Pioneer told BIS they would be carrying out before exporting the condensate.
The amount of distillation is variously described in the Wall Street Journal as "minimal processing", "minimally processed oil" and "stabilised and distilled" ("U.S. ruling loosens four-decade ban on oil exports", June 27).
"Stabilisation (is) a process that heats up oil to boil off some of the most volatile gases," the Journal says. "Distillation is an increased step ... but far short of refining or turning condensate into finished fuels."
The crucial point is that condensate does not have to be fully refined or distilled before it can be exported.
Once that principle is established, it is not easy to see where BIS can draw a new line. The PLRs obtained by Enterprise and Pioneer apparently relate to condensates from Eagle Ford. But the approach could just as easily be used for medium or heavy crude oils that are stabilised and minimally distilled to make them export-ready. Wherever BIS tries to draw a new line, it must be able to satisfy the courts that it has some rational basis and is not arbitrary and capricious.
News of the private letter rulings appears to have caught the White House and the rest of the administration off-guard, which is not surprising because government agencies issue many such determinations each month.
It has also upset the careful political choreography in which the White House, the Department of Energy, the Department of Commerce and Congress have been intensively "studying" the impact of easing or lifting the export ban.
Washington had been edging towards lifting the ban, but very slowly, and now the PLRs threaten to accelerate the administrative process before the political groundwork has been laid.
"We are closely studying the economic, environmental and security opportunities and challenges posed by growing (oil) production and we'll evaluate policy options as needed going forward," the White House told the Wall Street Journal.
Until the contents of the PLRs are known, the practical significance of the determinations is impossible to assess, but the political symbolism is enormous. Supporters of lifting the ban have greeted the news with delight, while opponents reacted with fury.
But the PLRs reveal a more fundamental problem. It is almost impossible to make a rational distinction between crude, condensate and refined products based on their chemical composition or use. The only practical distinction is based on processing (the distillation test). But that leads the government into the question of how much processing is enough.
Some U.S. oil refiners will complain bitterly about any move to lift the crude export ban since its main effect is to boost their profitability at the expense of domestic oil producers. There are already complaints that oil producers are trying to arbitrage around the regulations.
However, refiners already conduct their own form of arbitrage, buying domestic crude, which is artificially cheap because of the export ban, and then turning it into gasoline and diesel that can be exported.
How much processing the refiners carry out before exporting the oil is largely a matter of choice. The rules are clear. Refiners do not have to completely refine the crude before sending it overseas. "Topped crude oil, residual oil and other finished and unfinished products" are not considered crude, according to the Export Administration Regulations.
In an ideal world, the administration would recognise that trying to distinguish between crude oil and refined products is futile and lift the ban, explaining that it was introduced in response to 1970s oil shortages and is no longer necessary.
In practice, it may be politically expedient for the White House to create a new definition based on a minimally acceptable amount of distillation. Doing so would help contain the controversy and buy more time for refiners and voters to become accustomed to the idea of oil exports. (Editing by Dale Hudson)