Canada: Section 526 Of The U.S. Energy Independence And Security Act Remains Alive And Well – Effect On Alberta Oil Sands Still Unknown

Copyright 2008, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Energy–Oil & Gas, November 2008

The Energy Independence and Security Act (Energy Act) was signed into law by President Bush in December 2007 (see our analysis in the March 2008 Blakes Bulletin on Oil & Gas: U.S. Energy Independence and Security Act – A New Focus on Energy Conservation). Widely viewed as the largest single step since the 1970s that the United States has taken towards energy conservation, section 526 of the Energy Act is of particular interest to Canadian oil producers. This section prohibits U.S. Federal agencies from entering into any contract for the procurement of an alternative or synthetic fuel, including fuel produced from non-conventional petroleum sources, unless the contract specifies that the lifecycle greenhouse gas (GHG) emissions associated with such fuel are less than or equal to emissions from conventional petroleum sources.

Considerable discussion and debate with respect to the interpretation and application of section 526 has arisen both in Canada and the U.S. in the months since the Energy Act became law. The drafters of section 526 have acknowledged that the section was originally intended to prevent the U.S. Air Force from procuring coal-to-liquid fuels, which are estimated to produce almost double the GHG emissions of conventional fuels. They have further acknowledged that section 526 was not intended to apply to oil produced from the oil sands ("oil sands oil"). Despite the original intent, the wording of section 526 is of concern to oil sands producers since oil sands oil is often characterized, and referred to, as non-conventional petroleum. It is also generally understood that the production of oil sands oil currently results in GHG emissions that are greater than oil from non-oil sands sources. Unfortunately, no statement of purpose was included in the Energy Act to limit the scope of section 526 and preclude an expansive interpretation of the section. This has resulted in ongoing confusion on both sides of the U.S.–Canadian border.

The Government of Canada has taken the position that a narrow interpretation of section 526 ought to be adopted. In February 2008, Michael Wilson, Canada's Ambassador in Washington, wrote a letter to Robert Gates, the U.S. Secretary of Defense, in which Mr. Wilson stated that "Canada would not want to see an expansive interpretation of Section 526, which would then include commercially-available fuel made in part from oil derived from Canadian oil sands. "

In support of the position that oil sands oil is not an alternative fuel, he further stated: "Oil produced from the oil sands, like oil from other sources, is processed in conventional facilities. Oil sands production is commercial. The U.S. Administration has recognized the reality that oil sands oil is now part of the mainstream. Since 2003, 174 billion barrels of oil sands reserves have been recognized as proved reserves by the U.S. Department of Energy's Energy Information Agency."

Several U.S. congressmen and senators have voiced their concern regarding the potential impact that section 526 could have on the availability of a proximate, secure fuel supply. In March 2008, Texas congressmen Jeb Hensarling and Mike Conaway introduced legislation to repeal section 526, stating that "though short, this section – which raises concerns over national security, economic security and bureaucratic uncertainty – has powerful and harmful implications and needs to be repealed immediately."

An identical bill was introduced in the House of Representatives by Senator James Inhofe of Oklahoma in April 2008. Senator Inhofe stated his concern as follows: "I worked to include language in the Energy Policy Act of 2005 recognizing that unconventional fuels such as oil shale and tar sands developed in the U.S. and Canada are strategically important and necessary to develop to reduce the growing dependence of the U.S. on foreign oil imports. Section 526 of the 2007 energy bill, however, prohibits federal agencies from contracting for such fuels. This misguided provision was surreptitiously inserted into the 2007 energy bill shortly before final passage."

Neither of the bills repealing section 526 made it past their respective second readings in the House and the Senate. More recently, an attempt to ameliorate the effect of section 526 was included in the 2009 Defense Authorization Bill (Defense Bill), passed by the House of Representatives in May 2008. Section 335 (hereinafter referred to as the section 526 amendment), of the Defense Bill would have enabled U.S. federal agencies, including the U.S. military, to purchase blended fuels containing non-conventional petroleum that are generally available in the marketplace. Since oil sands oil is currently not segregated from other petroleum within the petroleum supply chain, the amendment would have essentially made oil sands oil available for use by all federal agencies. In late September 2008, the Defence Bill was passed by the Senate, however, it excluded the section 526 amendment. The Defense Act (excluding the section 526 amendment) was signed into law by President Bush on October 14, 2008.

In an unusual twist, both environmentalists and Alberta's representative in Washington, Mr. Gary Mar, have heralded the passage of the Defense Act as a victory. Environmentalists have asserted that the exclusion of the section 526 amendment confirms that U.S. federal departments are prohibited from using oil sands oil. Mr. Mar has been quoted as saying that the reason section 526 was not amended was because it was never intended to apply to oil sands oil in the first instance. Both interpretations cannot be correct, and it remains to be seen how the final chapter on the interpretation of section 526 will be written.

The significance of the passage of the Defence Bill by the president and the exclusion of the section 526 amendment appears to have been lost in the midst of the political frenzy leading up to the U.S. presidential election. Early indications are that the new U.S. President will support policies that will decrease the demand for oil sands oil. Senator Barack Obama has vowed that he will break the U.S.'s addiction to "dirty, dwindling, and dangerously expensive" oil if he is elected U.S. president. Senator Obama's senior energy advisor has stated that the U.S. shift away from carbon-intensive fossil fuels could include the oil sands if technologies are not developed to allow this resource to be recovered more efficiently, and with lower carbon emissions. Similarly, Senator John McCain has supported policies that could have a negative impact on the demand for oil derived from the Canadian oil sands in the U.S. At a press conference last year, Senator McCain voiced his support of expanding California's low carbon fuel standard, which measures the amount of greenhouse gases needed to produce fuel and punishes use of heavy crude oil in favour of conventional light crude or alternative fuels. Expanding that plan nationwide would force U.S. refiners to buy less American and Canadian oil and import more oil from the Middle East.

Interestingly, on October 21, 2008, U.S. Acting Deputy Secretary of State, Jeffrey Kupfer, visited Alberta in an effort to highlight U.S.-Canadian energy co-operation. After visiting the Syncrude oil sands project in Fort McMurray, Mr. Kupfer stated, "[the Energy Act] has not impacted our relationship with Canada and shouldn't do, going forward... and by relationship I mean our actual purchasing decisions and our imports from the oil sands". However, Mr. Kupfer also added that the U.S. Department of Energy was continuing to review the Energy Act, and that he was unable to comment on how the incoming administration will treat section 526. The significance of the visit and whether or not a secure, proximate supply of oil from Canada will outweigh concerns over GHG emissions, remains unclear.

In the event that section 526 is ultimately determined to apply to oil sands oil and therefore deleteriously impacts the demand for such oil, it raises the spectre of a NAFTA challenge. The basis of the challenge would presumably be predicated upon a U.S. law that is arguably domestic policy, having a harmful international impact in Canada on the development of the oil sands and demand for oil sands oil. Such a potential impact and the involvement of NAFTA is also on the mind of at least one of the U.S. presidential candidates. During the final presidential debate on October 15, 2008, Senator McCain touched on the issue of blocking the importation of oil sands oil into the U.S. During the debate, Senator McCain reminded viewers that Senator Obama has stated that he will "unilaterally" renegotiate NAFTA if elected president. Senator McCain stated, "and the Canadians said, 'Yes, and we'll sell our oil to China' ... You don't tell countries you're going to unilaterally renegotiate agreements with them."

Conclusion

Section 526 can potentially be interpreted in a manner that prohibits U.S. federal agencies from relying upon oil sands oil for their fuel supply. The impact of such an interpretation may not be that significant today due to the Energy Act only applying to U.S. federal departments and agencies, and the limited amount of oil sands oil that is presently processed into fuel. However, the impact will likely increase as the percentage of oil sands oil used as fuel increases. Oil sands production is projected to grow from the present 1.4 mbd to 3.0 mbd by 2015. Most of this increased production is destined for the U.S. market. There is also a concern that if the policy initiative as set out in section 526 becomes more widespread and is adopted in other U.S. enactments that apply more broadly to industry or the public, it could result in a significant curtailment on the U.S. demand for oil sands oil.

The potential impact of section 526 on the continued development of Alberta's oil sands is a matter of utmost concern to the oil sands industry, the Canadian government, the Alberta government and the U.S. government. The new U.S. president will need to quickly clarify section 526 to ensure that its scope and application is fully understood. If it is ultimately interpreted in a manner that prohibits the use of oil sands oil, it may result in the U.S. becoming more dependent on foreign, less-secure oil. It is ironic that an act entitled "Energy Independence and Security" could contain provisions that lead to the opposite result.

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