Monday, May 25, 2020

OPINION: Drowning in Oil, Regulatory Measures to Keep Prices Afloat

May 1, 2020

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These days history seems to be in the making on a daily basis. On April 20, 2020, the price of the NYMEX West Texas Intermediate Sweet Crude Oil (WTI) futures contract for May delivery plunged into the negative, forcing sellers to actually pay customers for taking the crude oil off the sellers’ hands. The historic drop came a little over a month after Russia and Saudi Arabia initiated crude oil price war, and it has left many wondering if certain regulatory measures are needed to help boost oil prices in the United States. Although the June and July WTI futures contracts remain in the positive, recent events and the price collapse of the May WTI futures contract may increase the probability that the Trump Administration will make efforts to assist a suffering US oil industry.

There are a handful of regulatory measures the President could seek to utilize in this regard, including waiving the Renewable Fuel Standard (RFS), waiving the Jones Act, and imposing crude oil and refined product import restrictions.

With national economies continuing to be shut down and the prospect that demand for crude oil and refined products will remain at historic lows, concerns over the US oil industry will likely continue for the foreseeable future, further increasing the likelihood that the Trump Administration may provide relief.

Waiving RFS Obligations
The Clean Air Act (CAA) permits the US Environmental Protection Agency (EPA) to waive the statutory renewable fuel mandates contained in the RFS under select circumstances, namely when the program’s requirements would severely harm the economy or environment of a state, region or the United States, or when EPA has determined that there is an inadequate domestic supply.

To date, a group of oil-producing states has already requested EPA exercise its waiver authority to dispense with the requirements, but there is significant debate regarding the extent to which the RFS is severely harming the economy. Each year, EPA establishes percentage-based Renewable Volume Obligations (RVOs), which refiners and importers must then apply to their gasoline and diesel production for the compliance year. This, in turn, determines the number of Renewable Identification Numbers (RINs) each refiner and/or importer must retire to comply with the RFS. Gasoline and diesel demand is projected to be down more than nine percent and six percent respectively from EPA’s original forecasts when it set RVOs, and it is expected to diverge even further—potentially by 20-30%—as significant cutbacks in domestic travel continue over the coming months. Therefore, assuming parallel declines in production, refiners would be required to retire 20-30% less RINs for the 2020 RFS compliance year.

However, most RINs are generated when the renewable fuel is produced, not when it is used as a transportation fuel, which means renewable fuel producers can continue to generate RINs and overtime may lead to a supply of RINs that exceeds demand. Accordingly, RIN prices could see a decline if gasoline and diesel demand continues to decline.

With the Trump Administration seemingly caught in between refiner and renewable fuel producer special interests, attempting to foresee how the President will respond to issues related to the RFS is challenging, to say the least. Furthermore, even in the event EPA adjusts the 2020 RVOs, it would do so under its general waiver authority, which requires notice and public comment, thereby preventing the Trump Administration from moving quickly on the matter and providing any immediate relief that may be needed.

Waiving Jones Act Restrictions
Under the Jones Act, merchandise that is shipped between two US points (i.e., ports) must be transported by US-flagged vessels that are built and operated by US citizens. The Jones Act may be waived in the interest of “national defense” when US-qualified vessels are unavailable. The phrase “national defense” has been broadly interpreted to include “national security interests” and “national interests,” with waivers having been granted due to supply constraints resulting from hurricanes damaging petroleum infrastructure.

By their nature, Jones Act vessels are more expensive to utilize, disadvantaging US crude oil and refined products from being sent to supply-constrained areas in the United States as crude oil and products coming from foreign locations can use cheaper, foreign vessels. By opening select domestic markets to US crude oil and refined products, some believe a waiver of the Jones Act has the potential to alleviate pressure on domestic petroleum prices.

However, the Jones Act is fervently defended by the US maritime industry, making such waivers rare, and to this day, a waiver has not yet been granted solely for logistical and economic reasons. Instead, waivers granted in the past two decades have only been in instances involving significant damage to oil infrastructure during hurricanes. That being said, if the Jones Act was ever to be waived for economic and logistical reasons, recent events would indicate now is the time.

Import Restrictions

According to some reports, the Trump Administration is contemplating imposing restrictions on the import of crude oil and potentially gasoline and diesel into the United States. In doing so, the President would seek to utilize his authority under the International Emergency Economic Powers Act, which permits the import restrictions to address: (1) “any unusual and extraordinary threat, which has its source in whole or substantial part outside the United States, to the national security, foreign policy or economy of the United States, if the President declares a national emergency with respect to such threat,” and (2) “an unusual and extraordinary threat with respect to which a national emergency has been declared for purposes of this chapter and may not be exercised for any other purpose.”

Import restrictions could be the least politically controversial of the three measures discussed in this article given that the RFS is defended by corn and soybean farmers and the Jones Act by US maritime interests. The most significant issue associated with imposing any such import restrictions would be the scope of the: (1) geographic region covered, and (2) hydrocarbons covered. Due to the integrated nature of the Canadian and American markets, a large amount of Canadian crude oil is imported into the US either as transshipments for export to other countries or for use in the US by US refiners. It is likely that those advocating for import restrictions would seek to carve out Canadian crude from those restrictions so as to more likely target Saudi-origin crude oil. There are also limited locations in the US where finished gasoline and diesel fuel are imported in significant quantities (e.g., the Northeast, Puerto Rico, Hawaii). It is foreseeable that certain petroleum interests argue that restrictions on gasoline and diesel imports into these areas (or the US generally) should be restricted as a means to support refined product prices.  

Conclusion
As social distancing and global economic shutdowns persist due to the spread of COVID-19, it is likely that the demand for crude oil and refined products will remain at historic lows for the foreseeable future. With the initial shock of negative oil prices fresh in mind, the prospect of such a prolonged collapse in global demand only seems to increase the likelihood that the President may implement regulatory measures like those detailed above, which may provide the industry with the relief it needs and keep prices of crude oil and refined products afloat.

The Authors
David McCullough is a partner, and Nicholas Hillman is an associate, in Eversheds Sutherland (US) LLP’s Energy & Infrastructure Practice Group.

David McCullough
Nicholas Hillman

(The opinions expressed here are those of the authors and not necessary of OEDigital.com)

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