CALGARY — A little-known tariff is costing Canadian oil companies $60 million a year and though it predates Donald Trump’s presidency, it’s likely to persist even if the new North American free trade agreement comes into force.
Oil might be the last export category that traders would expect to pay tariffs on — after all, Canadian oil supplies have been touted as a pillar of U.S. “energy security” by multiple U.S. presidents — but Global Affairs Canada, which manages the country’s diplomatic relations, said companies sending crude over the border in recent years are annually spending a total of amount $60 million in tariffs and duties, an amount that has remained more or less steady through the industry’s ups and downs.
Those payments may not sound like much on a per-barrel basis — about 10.5 cents each — but traders say it makes a big difference at the margins, especially since oil prices have fallen and Canadian oil prices have remained persistently low. Western Canada Select heavy oil averaged US$41.77 per barrel on Friday, or US$10 per barrel less than West Texas Intermediate.
We all know in our hearts, and most of us in our minds, that oil coming down from Canada to the U.S. is NAFTA-originatingTrade lawyer Teresa Polino
Despite the need down south for Canadian oil, the U.S. Customs and Border Protection (CPB) has carried out an increasing number of audits on shipments, demanding proof of origin for the crude moving between the North American Free Trade Agreement’s partners, and applying those aggravating duties to Canada’s largest export category.
The size of the levies began to grow in 2006 after EnCana Corp. (before it split into natural gas-focused Encana Corp. and oilsands-focused Cenovus Energy Inc.) imported batches of a lightweight hydrocarbon called condensate from Peru, Bolivia and Pakistan to mix as a diluent with its oilsands bitumen, which has the consistency of peanut butter, so it could flow through a pipeline.
EnCana imported 28 cargoes of condensate from Peru, another two cargoes from Bolivia and one from Pakistan through the port of Kitimat, B.C., according to a 2010 customs ruling, before transporting the products to Redwater, Alta., where they were stored in tanks alongside diluents sourced within North America.
After a lengthy investigation, U.S. customs determined the foreign diluent did not contaminate the NAFTA-originating status of the other diluent in the tanks. The ruling also determined that EnCana’s oil blended with foreign diluent would be subject to duties determined by a specific formula and, in the future, EnCana would be required to provide documentation and an inventory management system of its diluent blends that could be subject to verification by the CPB.
Cenovus, which owns the oilsands facility that imported the non-originating diluent, declined to comment on the case and whether the company has imported diluent from abroad since the case closed.
The company also declined to comment on whether new rules under the United States-Mexico-Canada Agreement (USMCA) would make it easier to export diluted bitumen to the U.S.
Oil traders say the EnCana case was a turning point and the CPB has carried out an increasing number of audits on shipments of Canadian oil since that time.
Despite attempts by the Canadian government to eliminate those tariffs under the USMCA trade deal, lawyers and oil traders say there are still avenues for the CBP to apply those tariffs to Canadian light and heavy oil shipments by demanding full compliance on niggling details about origination, which in many cases are difficult or impossible to provide.
“We all know in our hearts, and most of us in our minds, that oil coming down from Canada to the U.S. is NAFTA-originating,” said Teresa Polino, a Washington, D.C.-based trade lawyer who represents U.S. oil importers and Canadian exporters as a partner at law firm Arent Fox LLP. “There is no economic sense to bring in third-country crude oil to Canada and endure handling fees and transportation fees to bring it into the U.S. just to avoid the five or 10 cents per barrel tariff.”
Since EnCana imported the foreign condensate, Canadian condensate production has more than doubled to over 400,000 barrels per day, according to the National Energy Board. In addition, Enbridge Inc.’s Southern Lights pipeline was built in 2010 to bring 180,000 bpd of condensate into Canada from the U.S., helping alleviate the need for product outside the NAFTA zone.
There is now so much diluent and condensate being produced from Canadian shale gas plays like the Montney and the rapidly expanding Duvernay that Enbridge has even proposed reversing the Southern Lights pipeline to export oil rather than import diluent.
But even with multiple U.S. condensate pipelines and ballooning Canadian condensate production, companies are still paying duties on Canadian oil shipments as if the product originated outside North America.
“It’s just the most ludicrous thing and it drives me crazy,” Polino said, adding that auditing Canadian oil shipments for NAFTA origination hurts the energy industry’s ability on both sides of the border to spend money on drilling and research and development.
The federal government last November announced the terms of the new trade deal to replace the 25-year-old NAFTA, and said it would resolve “a technical issue related to diluents that had previously added upwards of $60 million a year in duties and other fees, which served as an unnecessary and burdensome cost to Canadian businesses.”
The Canadian government does not have historic figures for duties and fees on crude oil exports, but it is confident the $60 million in annual duties will drop under the new agreement.
“In the new NAFTA, we eased regulations that make it more difficult for Canada to competitively get our resources to market,” Global Affairs Canada spokesperson Sylvain Leclerc said in an email.
But as Canada, the U.S. and Mexico move to ratify the USMCA this summer, oil traders and lawyers such as Polino say some of the technical issues in NAFTA will persist under the new deal.
The new deal allows oil producers to blend heavy crude with up to 40-per-cent diluent tariff-free, but they will still need to provide “minimum data elements” for the oilsands product.
“This is a modernization of the agreement,” said George Reid, a trade and investment lawyer at Bennett Jones LLP in Toronto, adding the scrutiny on diluents added a tariff cost to Canadian exports as well as a “compliance cost” since companies spend millions proving their diluent originated in Canada.
Reid is confident the new rules are a win for oil companies, but Polino and oil traders don’t believe the USMCA will make life easier for oil traded through online platforms such as Alberta-based ICE NGX.
Since NAFTA came into force in 1994 (and the Canada/U.S. agreement in 1988), oil trading has moved to highly efficient online systems, where barrels can trade hands multiple times before being exported, making it very difficult for oil traders or U.S. refineries to prove the origin of every single barrel of Canadian oil.
“The rules of origin developed under NAFTA are difficult to apply in the context of a highly liquid commodity market place with electronic bulletin board trading, multiple trades and commingling of goods in pipeline transport,” said the American Petroleum Institute, the Canadian Association of Petroleum Producers and Asociación Mexicana de Empresas de Hidrocarburos in a joint submission to the negotiating teams of the USMCA.
As a result, the three associations asked the negotiating teams to “rely on and accept general information and representations that crude oil or natural gas is originating” from the three countries inside the agreement.
That request was granted. Now, exporters of crude oil within the USMCA no longer need a certificate of origin as they did under NAFTA to claim duty-free status.
But lawyers and traders say that won’t resolve the issue. Any company selling its oil through an intermediary — such as a merchant trading house or hedge fund — could still be subject to duties.
“I have concerns that where oil is being sold through the platforms like NGX, that there’s still an issue with traceability that is going to give customs heartburn,” Polino said.
Part of the issue is that most Canadian oil producers are unwilling to declare after the fact that a barrel of oil bought on an online trading board originated from their own operations, because doing so could expose them to a potential customs audit.
“I’ve talked to people at customs who have said that until this (the USMCA trade deal) becomes a done deal, they are not going to be putting (any clarifications) out on this,” Polino said.
U.S. Customs and Border Protection confirmed as much to the Financial Post.
“Until something is signed and finalized, we wouldn’t say either way,” CBP spokesperson Kelly Cahalan said.
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