• HQ H012415
• Aug 03, 2010

• Type : Classification • HTSUS :

OT:RR:CTF:VS H012415 KSG

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 operator. The delivery ticket was created by the pipeline operator and identifies the location, shipper, consignee, batch number, product type, temperature density, pressure, opening and closing dates of the pipeline and the amount of delivered volumes. The pipeline operator creates the delivery ticket at the point of entry, as there are no metering facilities at the border crossing. EMUS imported the bitumen and diluent/condensate blend into the U.S. at the following ports: Chicago, Illinois; Denver, Colorado; and Duluth, Minnesota.

Where EMUS agrees to sell a specific volume of CLB to a U.S. customer, EnCana supplies that volume to EMUS through an internal Crossborder Commodity Agreement. EMUS took title and delivery in the U.S. EMUS completed the sales transaction by filing the import documents for the volumes that were then sold to the third party. Delivery to the third party took place in the U.S. after the consumption entry was filed by EMUS. In some instances, EnCana sold a specific volume of originating CLB to a Canadian customer directly. The Canadian customer kept that amount in Canada, or sold it to its own U.S. affiliate or another Canadian or U.S. company.

Proposed Inventory Management methodology

EnCana has written procedures for its internal use which outline the objectives of its NAFTA inventory management strategy and provide an explanation of how it would apply the NAFTA Schedule X methodology.

EnCana asserts that the use of the average method as an Inventory method to identify originating and non-originating condensate as fungible materials is acceptable. EnCana determines the ratio of non-qualifying material by dividing the sum of:

the total units of non-originating fungible material that were in materials inventory at the beginning of the preceding three-month period plus the total units of non-originating fungible materials that were received in materials inventory during that preceding three month period,

by

the total units of originating and non-originating fungible materials that were in materials inventory at the beginning of the preceding three-month period plus the total units of originating and non-originating fungible materials that were received in materials inventory during that preceding three month period.

The above ratio is then applied to the fungible materials remaining in materials inventory at the end of the preceding three-month period to determine the total non-qualifying condensate in inventory at the end of this reference period.

EnCana states that overages and shortages with respect to the volume of product sent through the pipeline are reported by the Pipeline operator in an overages and shortages account for each shipper on a monthly basis. EnCana contends that this account ensures that the mathematical account of inventory matches the physical amount of inventory on the system. EnCana states that it assumes that its non-originating condensate is delivered off the pipeline first and is not subjected to overages and shortages. EnCana states that this ensures that all of the non-originating condensate is used in production and that the quantity of non-originating condensate is neither increased nor decreased by pipeline operations.

Certificate of Origin Procedures

In light of the complex arrangements regarding the movement and sale of its products, EnCana developed procedures for issuing its NAFTA certificates of origin for CLB and WCS crude oil. The determination of how much EnCana CLB and WCS is NAFTA originating is not finalized and confirmed until after the period of actual production and exportation. Therefore, when EnCana issues its

blanket certificate of origin to its only U.S. customer EMUS, for each year (usually issued in December of the preceding year), it excludes all CLB (and WCS) batches from the Certificate. After the end of the Inventory Management System (“IMS”) accounting period, EnCana states that it determines how many batches were non-originating and specifically identifies these batches to the sales/exports made to EMUS.

Once the IMS period review is finalized, EnCana states that it prepares a revised certificate of origin that will exclude all CLB except any CLB that has been determined to be originating under the IMS. This revised certificate will also include all WCS except those batches determined to be non-originating. To the extent there are batches of either CLB or WCS that were entered as non-originating pursuant to the initial blanket certificate of origin, but which as a result of the IMS are later determined to have been originating, and for which a revised certificate is issued covering such batches, a 520(d) post-importation NAFTA claim is filed.

Thus EnCana contends that the above described IMS allows it to accurately identify all non-originating batches of CLB and WCS and to allocate these specific batches to its sales to EMUS. EMUS then enters as non-originating, and pays duty, on all such specifically identified non-originating batches. EnCana asserts that this system allows it to properly issue NAFTA certificates of origin to other parties who purchase CLB or WCS in Canada. These parties may utilize the CLB or WCS in Canada or may choose to export it to the United States.

EnCana asserts that it continually reviews its production forecasts and the operation of its IMS system to ensure that the above-described process produces accurate results. EnCana states that if it were to determine that changes were needed to ensure the continued accuracy of its certificates of origin, such changes would promptly be made.

We assume for the purposes of this ruling that all the facts presented by counsel are correct and that materials designated as “originating” or “non-originating” are in fact originating or non-originating.

ISSUE: Whether the non-originating condensate/diluent is properly considered to be fungible with the originating diluent/condensate within the meaning of General Note 12(g) and Part 181, Customs Regulations.

Whether EnCana can use the average method, an inventory management method described in 19 CFR Part 181 App., to determine which shipments of imported crude oil are entitled to preferential tariff treatment under the NAFTA.

LAW AND ANALYSIS:

Pursuant to General Note (“GN”) 12, HTSUS, for an article to be eligible for NAFTA preference, two criteria must be satisfied. First, the article in question must be “originating” under the terms of GN 12 and second, the article must qualify to be marked as a good of a NAFTA country under the NAFTA Marking Rules contained in 19 CFR 102.20.

With regard to the first criteria, GN 12(b) provides, in pertinent part, as follows:

For purposes of this note, goods imported into the customs territory of the U.S. are eligible for the tariff treatment and quantitative limitations set forth in the tariff schedule as goods originating in the territory of a NAFTA party only if they are goods wholly obtained or produced in the territory of Canada, Mexico and/or the U.S.; or they have been transformed in the territory of Canada, Mexico, and/or the U.S. so that each of the non-originating material used in the production of such goods undergoes a change in tariff classification described in subdivisions (r), (s), and (t) of this note or the rules set forth therein, or the goods otherwise satisfy the applicable requirements of subdivisions (r), (s), and (t) where no change in tariff classification is required, and the goods satisfy all other requirements of this note; or they are goods produced entirely in the territory of Canada, Mexico and/or the U.S. exclusively from originating materials. With regard to entries made prior to October 1, 2009, the tariff shift rule set forth in GN 12(t) for goods of heading 2709 was “a change to headings 2705 through 2709 from any other chapter.” Assuming for the purposes of this ruling that diluent/condensate is classified either in 2709 or 2710, the non-originating diluent/condensate would not satisfy the tariff shift rule. General Note 12(g) provides as follows:

(g) Fungible goods and materials. For purposes of determining whether a good is an originating good—

(i) where originating and non-originating fungible materials are used in the production of a good, the determination of whether the materials are originating need not be made through the identification of any specific fungible material, but may be determined on the basis of any of the inventory management methods set out in regulations promulgated by the Secretary of the Treasury; and

(ii) where originating and non-originating fungible goods are commingled and exported in the same form, the determination may be made on the basis of any of the inventory management methods set out in regulations promulgated by the Secretary of the Treasury.

The term “fungible” means that the particular materials or goods are interchangeable for commercial purposes and have essentially identical properties.

The NAFTA Rules of Origin Regulations, 19 CFR Part 181 App. (“ROR”) for purposes of determining NAFTA preference eligibility provide for the use of inventory management methods. The various inventory management methods set out in ROR, Schedule X, section 2 include: a) specific identification method; b) FIFO method; c) LIFO method; and d) average method. Section 5 of Schedule X references the Average Method and states “where the producer or person referred to in section 3 chooses the average method, the origin of fungible materials withdrawn from materials inventory is determined on the basis of the ratio of originating materials and non-originating materials in materials inventory that is calculated under sections 6 through 8.”

The issue presented in this case is whether under the facts described above, the non-originating diluent/condensate is properly considered to be fungible with the originating diluent/condensate within the meaning of General Note 12 (G). If so, EnCana would be entitled to use an inventory management method to determine which shipments of imported crude oil are entitled to preferential tariff treatment under NAFTA.

Previous rulings have dealt with the question of the scope of the term fungible materials. In Headquarters Ruling Letter (“HRL”) 563062, dated October 13, 2004, CBP considered whether a blend of certain base oils used to manufacture lubricating motor oils could be treated as fungible materials for purposes of the NAFTA. CBP held that such a blend of originating and non-originating base oils, stored in common storage tanks, could be treated as fungible materials under a NAFTA authorized inventory management method. The API Guidelines allowed substitution of one base oil for another if certain standards were met so that engine performance tests could be satisfied. CBP determined that the base oils were commercially interchangeable and met certain standards for saturates level, viscosity index and sulfur content and were within the same API group. Counsel noted that there was an allowable range for viscosity, as well as parameters for the saturates and sulfur in this case.

In HRL 562344, dated September 9, 2002, CBP determined that commingled originating gold ore, slag, and non-originating waste and scrap, were fungible when commingled to produce refined gold bars and grain and it was proper to rely on an average inventory management system based on Refining Reports for purposes of determining NAFTA eligibility for the imported refined gold bars and grain. In HRL 562255, dated February 22, 2002, CBP determined that yarns that were used indiscriminately in the dyeing process were fungible materials.

The first requirement of the definition of fungible materials for purposes of NAFTA inventory management is that the materials be “interchangeable for commercial purposes.” This in turn requires an examination of how the materials are bought, sold, and used. The use of the material in the commercial marketplace must be examined in making this determination. CBP must examine whether a reasonable buyer in the marketplace would accept the non-originating diluent/condensates in lieu of the Canadian diluent/condensate for the purpose of assisting the movement of bitumen in the pipeline.

The factors to be examined in determining whether the material are “interchangeable for commercial purposes” are to be decided on a case-by-case basis and must take into account the nature of the material and the use to which it is put. In this case, it is apparent that the foreign diluent/condensate is fully capable of acting as a diluent for the bitumen. In the first place, the foreign condensate/diluent is fully within the pipeline standards and is capable of transporting the bitumen to its intended destination. In fact, the record shows that the foreign condensate/diluent is less dense than much of its Canadian counterparts. The difference between the foreign and Canadian diluent/condensates is less than some of the differences between the Canadian condensates themselves. We also take note of letters from other buyers in this marketplace stating that they consider the originating diluent/condensate to be interchangeable for commercial purposes with the non-originating diluent/condensate. This is also consistent with the equalization procedures discussed above. Moreover, we take into consideration the fact that the purpose of the material being considered is to act as a diluent in order to facilitate the movement of the bitumen. After the bitumen/diluent blend is imported into the U.S., the diluent is removed and the final product sold in the U.S. is the bitumen. The fungible material is not used in the final processing of the crude oil. It merely facilitates transportation of the bitumen in the pipeline.

The second test set forth in General Note 12(g), is that for fungible materials, its “properties of which are [to be] essentially identical”. EnCana states in its July 12, 2010, submission that the Peruvian condensate/diluent, which is the predominant non-originating diluent/condensate used for this time period, is chemically indistinguishable from the Canadian condensate/diluent produced in the PetroCanada refinery in Edmonton (one of the Canadian condensates used in the Enbridge stream in 2008). EnCana argues that the originating and non-originating diluent are chemically like products that meet the criteria listed in the July 12, 2010 submission, and range from C4-C12, mainly in the C5-C6 range, for the purposes of its use as a diluent to be used with the bitumen to allow it to flow through the pipeline.

In this case, determining whether the properties of the relevant materials are essentially identical also requires consideration of the specific role and purpose for which the condensate/diluent is used in the imported article. The condensate is being used as a carrier for the bitumen, rather than as an ingredient for the further processing or manufacture of the bitumen. In this case, it appears that the properties that are most significant for comparison purposes, given the role of the condensate/diluent, are density, viscosity and the sulfur content. It is these properties of the condensates that are essentially identical and measured and tracked with precision. It is clear that the note allows for some range of these properties within which the material can reasonably be used in the commercial market for the intended purposes. It is noteworthy that a range of Canadian diluent/condensate is used for purposes of moving the bitumen. Examining all the factors, we find that the originating Canadian diluent/condensate and non-originating diluent/condensates used by EnCana are interchangeable for commercial purposes and the properties are essentially identical with regard to their usage as diluent blended with bitumen in the Enbridge pipeline. Accordingly, we find that the non-originating diluent/condensate discussed in this case may be considered a fungible material for the purposes of NAFTA Inventory management.

Since the diluent/condensate is considered a fungible material, one of the four methods of NAFTA Inventory management method may be used in accordance with generally accepted accounting methods. The average method proposed by counsel based on a ratio over a three month period is consistent with Example 3 in Addendum B, Schedule X of the Appendix (19 CFR 181, App.) and therefore, we find it is an acceptable method to determine whether condensate is originating for purposes of the NAFTA, provided that sufficient records are maintained to support the calculations and origin determinations. Accordingly, based on the facts described in this case, we find that EnCana may use the average method as described in 19 CFR Part 181 App. to constructively segregate the commingled foreign and originating diluent/ condensate to calculate the dutiable and non-dutiable shipments of the imported crude oil.

Counsel also notes that in this case, its use of non-originating materials physically affects not only shipments for which it is responsible, but also shipments by other producers even where those producers do not inject any non-originating materials in the pipeline. Counsel contends that EnCana’s use of non-originating condensate in the pipeline should not affect the NAFTA eligibility of other products or materials owned by parties other than EnCana that may use the same pipeline or storage tanks.

In a case that interpreted a different legal provision but is instructive with regard to the question of the common storage of commingled crude oil, the Court of International Trade held in Marathon Oil Co. v. U.S., 93 F. Supp. 2d. 1277 (CIT 2000) that a claimant need not receive the actual molecules of petroleum product it placed into a common storage tank for the purposes of duty drawback. The court looked to the legislative history of the statute in question and stated that it “indicated Congress’ clear understanding of the business efficiency in commingling fuel in a common storage area and its intent to conform drawback law to that reality.”

While the legal framework in this case is different than in the Marathon Oil case, we believe that the rationale should be applied to this case. NAFTA provides for the use of inventory management methods to account for commingled fungible materials. We do not believe that the use of a shared storage facility should render what are otherwise originating materials and goods non-originating.

Counsel cited HRL 224628, dated January 10, 1994, as authority for CBP’s recognition of “title separation” of imported goods where products of different duty status by necessity shared the same storage or pipeline facilities. Counsel argues that each heavy crude oil producer using the same storage or pipeline facility maintains ownership of its volume and inputs, and accounts for its use, movement, withdrawal, and/or entry of such materials and product accordingly.

In HRL 224628, CBP considered an accounting and identification procedure for removal of jet fuel for use on foreign and domestic flights from foreign trade zones. The FTZ consisted of tanks and pipeline systems for the storage and delivery of jet fuel at an international airport. Privileged foreign, non-privileged foreign and domestic jet fuel were commingled in the tank and pipeline system. There were various records described and procedures for determining the inventory and reconciliation of the jet fuel. While the regulatory framework for inventory control and recordkeeping in a FTZ differ from the instant case, CBP allowed the different airlines to use the same storage and pipeline system for the jet fuel. See also HRL 228616 dated July 1, 2002.

Based on the above, we find that EnCana’s use of non-originating condensate in the pipeline does not affect the NAFTA eligibility of other products or materials that are themselves originating that share the same pipeline or storage tanks.

HOLDING: Based on the facts described in this case, we find that EnCana has shown that the non-originating diluent/condensate used in the June 2006-October 1, 2009 time period are fungible materials for the purposes of NAFTA Inventory Management.

Accordingly, Encana may employ the average method, an Inventory Management Method described in Schedule X, for the purposes of determining which materials are originating. However, the use of such a method is contingent upon Encana’s providing documentation which demonstrates to the satisfaction of CBP that claims based on the use of that method are fully supported. In addition, the methodology used to document the number of originating shipments of CLS and WCS are likewise subject to verification.

Further, we find that EnCana’s use of non-originating condensate in the pipeline does not affect the NAFTA eligibility of other products or materials that are originating that share the same pipeline or storage tanks.

This decision should be mailed by your office to the party requesting Internal Advice no later than 60 days from the date of this letter. On that date, the Office of Regulations and Rulings will make the decision available to CBP personnel, and to the public on the CBP Home Page on the World Wide Web at www.cbp.gov, by means of the Freedom of Information Act, and other methods of public distribution.

Sincerely,

Myles B. Harmon, Director
Commercial & Trade Facilitation Division