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HQ 955203

June 2, 1994

CLA-2 CO:R:I 955203 JLV

CATEGORY: CLASSIFICATION

TARIFF NO.: 2709; 2710

Michael D. Sherman, Esq.
Collier, Shannon, Rill & Scott
3050 K Street, N.W.
Suite 400
Washington, D.C. 20007

RE: Refinery feedstock; crude oil; residual; topped crude; mixture; inventory management; originating; non- originating; CFTA; NAFTA; opening inventory; commingling; fungible; reconstituted crude; GRI 3(b); essential character; volume criterion

Dear Mr. Sherman:

In a submission dated October 7, 1993, as supplemented by your submissions of October 21 and 29 and December 17, 1993, January 28, 1994, and May 11, 1994, you request a ruling, on behalf of a client, concerning the eligibility of imported refined petroleum products as originating goods under the United States-Canada Free-Trade Agreement ("CFTA"), approved and implemented by the United States-Canada Free-Trade Agreement Implementation Act, Public Law 100-449, 102 Stat. 1851 (September 28, 1998). In a submission dated January 28, 1994, you requested that your submission of October 7, as supplemented, be treated as a request for an advance ruling under the North American Free Trade Agreement ("NAFTA"), approved and implemented by the North American Free Trade Agreement Implementation Act, Public Law 103- 182, 107 Stat. 2057 (December 8, 1993). This ruling is our response to your request for an advance ruling under NAFTA. Furthermore, in view of the fact that there are outstanding entries of petroleum products under the CFTA, this ruling is also our response to the issues under the CFTA.

FACTS:

Various types of petroleum feedstock are shipped to a refinery in Canada. Under a master agreement, feedstock is processed to produce various finished products, including motor gasoline, jet fuel, home heating oil, and No. 6 fuel oil. Some of the finished products are imported into the United States. Two of the feedstocks are described as "topped crude" and as "reconstituted crude." Both terms are used in a general sense to describe the feedstocks. The topped crude feedstock consists of products which are the remaining fractions of crude oil after certain light ends have been removed through atmospheric distillation. The reconstituted crude feedstock is a mixture of different petroleum products and is said to yield the same range of products as does virgin crude oil.

The product called "topped crude" is described by you as a petroleum oil which contains the same chemical compounds that existed in that portion of the crude oil in its natural underground reservoir. A topped crude has a distillation curve (a curve plotted by temperature on one axis and the percentage of oil that vaporizes on the other axis) that is similar to the continuous distillation curve of a heavy crude oil. This type of curve indicates that it contains a wide range of hydrocarbons from which various types of petroleum products may be obtained. However, we note that the similarity of the distillation curve is only in the part of the curve that represents the complex hydrocarbons that distil at a temperature greater than 600o F. Topped crude, such as the topped crude in issue, does not have the same range of hydrocarbons which naturally occur in heavy crude because the light ends have been removed by processing. This topped crude is, in fact, a processed petroleum oil.

Topped crude is often used as feedstock in a refinery operation. The type of refinery operation depends on the quality of the topped crude. Topped crude may also be used as a fuel oil, provided it meets the viscosity requirements and other ASTM requirements for a specific fuel oil. In some cases it is necessary to add a distillate or lighter petroleum product to the topped crude in order to satisfy the viscosity requirement. Other terms used to describe the "topped crude" feedstock include "reduced crude," "straight run fuel oil," "residual fuel oil," "residual" or "resid." Based on the facts submitted, the "topped crude" used as feedstock is more generally described as residual fuel oil from an atmospheric distillation unit.

The product called "reconstituted crude" is a product that is mixed from available petroleum oils for specific refinery needs. The relative percentages of the petroleum products used in the mixture could range from a relatively low percentage of crude oil and high percentage of topped crude to the opposite. In fact, you state the topped crude is considered to be interchangeable with heavy crude as a feedstock. The usual mixture has consisted of approximately 45 percent light crude oil and 55 percent topped crude. However, the mixture could contain up to 70 to 80 percent topped crude. Based on the representations by counsel, it is assumed that the relative percentages of the wide range of hydrocarbons, especially those obtainable during an atmospheric distillation, will remain approximately the same regardless of the relative percentages in the mixture. Based on these representations, it is assumed that at least 25 percent of the mixture will separate out as a full range of light oils by a fractional distillation at approximately 600o F to 650o F. The crude oil used in this mixture is generally considered a "light" crude oil because of the percentage of light ends in the crude oil. The distillation curve of the mixture, on the other hand, is more similar to a heavy crude with regard to the percentage of light ends that is obtained during atmospheric distillation.

As used by counsel with regard to the facts of this case, the term "reconstituted crude" refers to a mixture that results from the combining of light crude oil, which is a virgin petroleum product, and a topped crude oil, which is a petroleum product processed by an atmospheric distillation. In effect, it is an artificial mixture usually performed only at a refinery for specific refinery requirements. As will be discussed later, the term does not refer to a crude oil resulting from the recombining of light oils and a topped crude from which the light oils were previously taken so as to reconstitute the crude.

You also state that the reconstituted crude may either be mixed in a separate tank prior to introduction into the refinery process or that the actual mixing may occur by pumping crude oil and topped crude from separate tanks directly into the heating unit in the refinery. Because of the nature of a refinery process and the constant movement of feedstock through the refinery, and your additional submission dated May 11, 1994, we assume that the crude oil and the topped crude, when pumped directly into the heating unit, are pumped simultaneously. You have claimed that the records have been and will be maintained so as to establish a verifiable percentage of light crude oil and topped crude oil in the mixture at any given time.

You state that the finished petroleum products, classifiable in heading 2710, HTS, qualify as originating goods under both the CFTA and NAFTA because the production of these finished products from non-originating "topped crude," which you claim is classifiable as petroleum oil, crude, in heading 2709, HTS, results in the required change in tariff classification to heading 2710 from any other heading outside headings 2710 through 2715. In the alternative, you state, that if the "topped crude" is not classifiable in heading 2709, then the reconstituted crude feedstock is classifiable as petroleum oil, crude, in heading 2709 and, therefore, the finished petroleum products derived from that feedstock are originating goods.

ISSUE:

Whether a residual petroleum product, which has been subjected to an atmospheric distillation process to remove light oils, is classifiable as a petroleum oil, crude, in heading 2709?

Whether a petroleum mixture, consisting of topped crude that is classifiable in heading 2710 and light crude oil classifiable in heading 2709, is classifiable as a petroleum oil, crude, in heading 2709?

Whether petroleum products from the distillation of such a feedstock mixture qualify as originating goods, if imported before January 1, 1994, for preferential tariff treatment under the United States-Canada Free-Trade Agreement?

Whether petroleum products from the distillation of such a feedstock mixture qualify as originating goods, if imported on or after January 1, 1994, for preferential tariff treatment under the North American Free Trade Agreement?

LAW AND ANALYSIS:

For petroleum goods imported from Canada prior to January 1, 1994, and classifiable in heading 2710, HTS, the applicable rule for determining whether the goods are eligible for tariff preference under the CFTA is found at General Note 3(c)(vii)(R)(5)(bb), HTS (1993), which requires a change to headings 2710 through 2715 from any other heading outside that group. (General Note 3(c), HTS (1993) has been redesignated as General Note 9, HTS (1994), which is suspended effective January 1, 1994, pursuant to Presidential Proclamation 6641, dated December 15, 1993 (58 FR 66867, December 20, 1993).) For such goods imported from Canada on or after January 1, 1994, the applicable rule under the NAFTA is found at General Note 12(t)/27, subdivision 4, HTS (1994), which requires a change to headings 2710 through 2715 from any heading outside that group. Therefore, the controlling issue in either case is the classification of the topped crude and the reconstituted crude.

The headings in issue are headings 2709 and 2710, HTS, which provide for certain petroleum oils. Neither of these headings is subdivided at the international level in the Harmonized Commodity Description and Coding System. In pertinent parts, heading 2709 provides for "petroleum oils * * *, crude" and heading 2710 provides for "petroleum oils * * *, other than crude; * * *." There are no section or chapter notes which define or otherwise direct the classification of these products.

1. Topped Crude

Headings 2709 and 2710 both use the term "petroleum oil" which is modified in heading 2709 by the additional term "crude" and in heading 2710 by the additional phrase "other than crude." These terms are not defined. However, it is well known rule of tariff construction that, when a tariff term is not defined, the correct meaning is the common meaning understood in trade or commerce. Sanwa Foods, Inc. v. United States, ____ Ct. Int'l Trade ___ (Slip Op. 93-169, Aug. 23, 1993); Schott Optical Glass Inc. v. United States, 67 CCPA 32, 612 F.2d 1283 (1979).

Concerning the meaning of the term "crude" as it is used to describe petroleum oil, we note that "unrefined petroleum is now usually termed crude oil." "Petroleum," McGraw-Hill Encyclopedia of Science and Technology, Vol. 13, page 284 (7th edition, 1992). The first step in a refining operation is the separation of crude oil into various fractions or streams in order to isolate the desired products. "Petroleum processing," McGraw-Hill Encyclopedia of Science and Technology, Vol. 13, page 293 (7th edition, 1992). "Topped crude," the term used by counsel to refer to a feedstock petroleum used by its client, is the product of the first step of a refining operation in which crude oil has been separated into specific streams of petroleum oils in an atmospheric distillation unit. In fact, the topped crude in this case is more generally described as the residual fuel oil stream (residual) from such a separation process. Although residual from an atmospheric distillation process is also considered a refinery feedstock for the recovery and further processing of heavy gas oils, it is not traded or known in the industry as crude oil. Therefore, it is reasonable to conclude that this "topped crude" feedstock is not a crude oil for purposes of heading 2709.

This conclusion is supported by the references in the Explanatory Notes to headings 2709 and 2710 which specifically describe the products of those headings. First, EN 27.09 describes the types of processes that are considered as not affecting the nature or character of an oil as a "petroleum oil, crude" for purposes of heading 2709. These processes are essentially processes which are performed on the naturally- occurring crude oil and which are incidental to the extraction and movement of the crude oil: (1) stabilization to normalize vapor pressure, (2) removal of very light fractions for use of such fractions in the oil extraction process, (3) the addition of only those hydrocarbons previously recovered by physical methods during one of the named physical processes are allowed, and (4) any other minor process that does not change the essential character of the product (emphasis is added). Explanatory Notes to the Harmonized Commodity Description and Coding System, page 217. A topped crude, which is a residual fuel oil from a atmospheric distillation, has been clearly processed beyond the limited types of processes identified in EN 27.09.

Second, EN 27.10(A) describes two categories of petroleum oils that are "other than crude:" topped crudes, and relatively broad fractions obtained by distillation or refining of crude petroleum oils. These are petroleum products which have undergone a type of separation process other than the processes specified in EN 27.09. Explanatory Notes to the Harmonized Commodity Description and Coding System, page 217 to 218. This reference to "topped crudes" as one of the processed petroleum products classified in heading 2710 is clear evidence as to the limited scope of the term "crude" when applied to petroleum oils of heading 2709. EN 27.10, which is the official interpretation at the international level for heading 2710 in the Harmonized System, provides clear direction as to the proper classification of the topped crude as a "processed" petroleum product in heading 2710.

In this case, the initial boiling point (IBP) and the chemical composition of the topped crude is a clear indication that the "topped crude" is a residual product of an atmospheric distillation process. Atmospheric distillation in a refinery is not a minor or simple process such as the processes described in EN 27.09. The term "topped crude" encompasses a broad range of residual products that vary significantly in quality. Generally, topped crude of the kind in issue is the bottom fraction of crude oil that cannot be economically further processed or refined in an atmospheric distillation unit. It is recognized that these topped crudes may contain some hydrocarbons that could be separated in an atmospheric distillation unit. However, the presence of these relatively small amounts of hydrocarbons, whether intentionally left in the topped crude or added to the topped crude for various reasons, does not affect the character of this product as a processed petroleum product.

Therefore, we conclude that the "topped crude" feedstocks are petroleum oils, other than crude, and are classifiable in heading 2710, HTS. The classification of topped crudes in heading 2710 must have been apparent when the draft text of the Harmonized Tariff Schedules of the United States was considered by the Congress and passed into law in order to implement the HS as the tariff nomenclature for the United States. Heading 2710 was subdivided in the HTS in order to address the many petroleum products that fall within the heading. The first subdivision is for "distillate and residual fuel oils (including blended fuel oils)" and separates these products for tariff purposes into subheading 2710.00.05, testing under 25 degrees A.P.I., subheading 2710.00.10, testing 25 degrees A.P.I. or more. One of the common terms for topped crude, of the type described in the facts of this case, is "residual fuel oil."

2. Reconstituted crude

As noted earlier, the term "reconstituted crude" as used in this case does not refer to a crude oil resulting from the recombining of light oils and a topped crude from which the light oils were previously taken. The term "reconstituted crude" refers, instead, to a feedstock mixture of petroleum products which approximates a chemical composition that will result in known percentages of various distillates and other products for specific stages or processing units in a refinery. This chemical composition of the mixture is based on the chemical analysis of each component and not on a chemical analysis of the mixture.

According to the facts in this case, the product described as reconstituted crude is a feedstock mixed at a refinery from different types of petroleum oils. The actual percentages of the constituents in the mixture will vary with the quality and chemical compositions of the individual feedstock products. The mixture contains petroleum products that are classifiable in heading 2710, as well as crude oil classifiable in heading 2709. The principal component from heading 2710 is residual oil from an atmospheric distillation process.

Counsel argues that the mixture is classifiable under the eo nomine provision for crude petroleum oils in heading 2709 because it is a product that exhibits characteristics that are essentially similar to naturally occurring crude oil. Rhone- Poulenc, Inc. v. United States, 11 Ct. Int'l Trade 466 (1987). Counsel states that the mixture is a petroleum mixture that is made to resemble crude oil in its chemical composition, and, as a refinery feedstock, the reconstituted crude is similar to a heavy crude oil because it has the full range of hydrocarbons that are normally found in crude oil before the initial separation in an atmospheric distillation unit. According to counsel's argument, the mixture is of the same class or kind of articles within the eo nomine provision for crude petroleum oils. This argument invokes the principle of classification set out in GRI 1, HTS.

In the alternative, counsel argues that the feedstock mixture is classifiable as a crude oil in heading 2709 on the basis of the principles set forth in GRI 2(b) and GRI 3 as they apply to mixtures of two or more materials. To the extent that the mixture has the essential character of the crude oil, counsel argues that the applicable classification is in heading 2709 because it has the same physical characteristics, chemical composition and uses as does naturally-occurring crude oil.

The Harmonized Tariff Schedule (HTS) provides no additional guidance concerning the description or classification of crude petroleum oils and other (than crude) petroleum oils. The term "reconstituted crude petroleum" is not used in the nomenclature at the international level. However, it does appear in the Harmonized Tariff Schedule. In Additional U.S. Note 1(a) to Chapter 27, HTS, the term "reconstituted crude petroleum" is used to identify a petroleum product that, if a product of Canada, may be admitted free of duty under certain conditions. The note does not define the term "reconstituted crude petroleum." However, the term was previously defined in Headnote 2(a) to Part 10 of Schedule 4, Tariff Schedules of the United States (TSUS), the predecessor to Additional U.S. Note 1(a), HTS:

Part 10 Headnotes:

2. For purposes of this part --

(a) "Reconstituted crude petroleum" (items 475.05 and 475.10) is a product which is essentially the equivalent of crude petroleum and which is made by adding fuel oil, naphtha, or other petroleum fractions to crude or topped crude petroleum;

(Headnote 2(a), Part 10, Schedule 4, TSUS (1987))

This definition was inserted into the TSUS after the hearings on the proposed draft for the TSUS. In opposing a proposed tariff item for mixtures of petroleum products, counsel for several oil companies briefly discussed "so-called reconstituted crude petroleum" as a topped crude in which very light ends were removed by a simple distillation for purposes of stabilization and transportation of the light ends and then were returned to the topped crude for processing at a refinery. This was compared with crude oil from which light ends had escaped at the wellhead, but were captured, condensed, stabilized and ultimately returned to the crude for processing. See Tariff Classification Study, Explanatory and Background Materials, Schedule 4, pages 291, 314 to 315 (November 15, 1960). The definition of "reconstituted crude petroleum" seems to have implemented this concern: that very lightly topped crudes, mixed with the light oils taken from the lightly topped crude, should remain classifiable as crude oils. Therefore, under the TSUS, the use of the term "reconstituted crude" was understood to refer to a product that had been processed in a far more limited way than is the case here.

It must be acknowledged that from the point of view of the use of the product as a feedstock, the mixture ("reconstituted crude") and crude oil appear to be similar. However, several points must be made in connection with these goods and the structure of the TSUS texts and the current HTS texts. First, it must be observed that, under the TSUS, reconstituted crude petroleum was classifiable under items 475.05 and 475.10, depending on specific gravity. The text of the superior language to those TSUS tariff items included an eo nomine designation for "crude petroleum oil (including reconstituted crude petroleum)," as well as eo nomine designations for "topped crude petroleum" and "distillate and residual fuel oils." The TSUS headnote merely defined what was already specifically identified in the tariff provisions. On the other hand, the text of the HTS heading 2709 does not include a reference to any petroleum oil other than "crude" petroleum oil. Furthermore, the Additional Note 1(a) to Chapter 27 does not, of itself, direct classification of the "reconstituted crude petroleum" to heading 2709, HTS. Because Note 1(a) to Chapter 27 is an additional U.S. note, we would assume that the intent was to extend the tariff treatment given under the TSUS and not to expand the scope of the term so as to affect the structure of the Harmonized System.

Secondly, crude oil mixed with a substantial amount of residual from an atmospheric distillation process is not known as crude oil, either in the industry or by name. Based on counsel's submission, the mixture may contain an overwhelming proportion by volume of topped crude which, as we have concluded, is classifiable in heading 2710. To refer to this mixture, which is essentially a refinery mixture, as crude oil, would be misleading in the industry, notwithstanding its use as a feedstock in a refinery. The residual oil in the mixture is itself used as a refinery feedstock in the same manner, as stated by counsel, as a heavy crude. However, because residual has already been processed through an atmospheric distillation, it is normally used as a feedstock for a vacuum distillation or cracking unit. Therefore, the use as a feedstock would not be a sufficient basis for determining whether or not a feedstock mixture is a crude petroleum oil.

In regard to counsel's first argument that the reconstituted crude has the essential character of a crude oil and is classifiable as a crude oil in heading 2709, we conclude that the mixture cannot be classifiable in heading 2709 under GRI 1, HTS. Our analysis of the terms in the heading and the Explanatory Notes to headings 2709 and 2710 leads us to conclude that the products of heading 2710 are distinguished from the crude petroleum oil of heading 2709 on the basis of the nature of the processing from which the petroleum product is obtained. Heading 2709, when read in light of EN 27.09, is limited to petroleum oils that have not been processed by a refinery operation. This is consistent with definitions of crude oil. See definition of crude oil at page 326, Oil: A practical guide to the economics of world petroleum, Peter Ellis Jones, Nichols Publishing, New York (1988); definition of crude oil at page 17-7, Petroleum Products Handbook, Virgil B. Guthrie, Editor, McGraw-Hill Book Company, Inc., New York (1960). To the extent that a crude petroleum oil is mixed with a petroleum oil that has been processed, then the mixture cannot be classifiable as a crude under GRI 1 unless the addition of an oil of heading 2710 is so minimal that it does not affect the unrefined character of the crude oil. GRI 1 and GRI 2(b), HTS.

However, it remains to consider counsel's second argument with respect to essential character of the feedstock as a mixture. If a good which consists of two or more materials is, prima facie, classifiable under two or more headings, and no one heading provides the most specific description because each refers in part only to the goods, then classification is based, in the first place, on the material or component that imparts the essential character to the good. GRI 3(b), HTS. If a mixture is not classifiable by reference to GRI 3(b), then the mixture is classifiable in the heading which occurs last in numerical order among the headings that equally merit consideration. GRI 3(c), HTS.

The Explanatory Notes to the Harmonized Commodity Description and Coding System set forth factors which, when applied to the individual materials or components of a mixture, may be used to determine the essential character of a product. EN (VIII) to the General Rules for the Interpretation of the Harmonized System (for GRI 3(b)) provides as follows:

(VIII) The factor which determines the essential character will vary as between different kinds of goods.
It may, for example, be determined by the nature of the material or component, its bulk, quantity, weight or value, or by the role of a constituent material in relation to the use of the goods.

EN (VIII) to GRI 3(b) at page 4 of the Explanatory Notes to the Harmonized Commodity Description and Coding System

An analysis under GRI 3(b) thus requires a comparison of the relative importance of the different materials that make up a product in order to determine which of them provides the essential character to the product. As applied to the mixture in this case, the analysis requires a comparison of the role of the topped crude of heading 2710 and the light crude oil of 2709.

The light crude oil component is commercially recognized as a material for use as refinery feedstock in the production of processed petroleum products. The topped crude component, although its physical and chemical characteristics make it suitable for use as a fuel oil, either directly or by cutting with a distillate, is also commercially recognized as a material for use as feedstock for a refinery because it contains many different complex hydrocarbons which can be further processed. As noted earlier in this ruling, the refinery processes are generally different for light crude oil and for topped crude (residual of an atmospheric distillation). Processing of light crude oil must be done initially in an atmospheric distillation unit. Processing of a topped crude (i.e., residual) in an atmospheric distillation unit will have little significant effect on that petroleum feedstock. Nevertheless, crude oil and topped crude are both used as feedstock for refinery operations. Therefore, the relative significance of the components to the use of the mixture is not, of itself, a distinguishing characteristic for the purpose of determining which of the components imparts the essential character of the mixture.

The changing demands in the market and in a refinery operation do not always allow for a constant or fixed percentage or ratio to be used in a feedstock mixture. Production requirements, storage capacities and refinery capacities (processing capability of the different units in a refinery) often will direct the actual percentages of feedstock materials in a mixture. Inasmuch as both components of the mixture are feedstocks with different characteristics for a refinery process, the percentage of a component which is greater than 50 percent by volume is a relatively constant factor that reflects which of the components imparts an essential character to the mixture. If the topped crude, for example, is greater than 50 percent by volume, the mixture would appear to have the essential character of a topped crude feedstock because such a large percentage of the product will be destined for the vacuum or cracking units. If the crude oil predominates by volume, the mixture would appear to have the essential character of a crude oil feedstock.

Another factor which must be considered is the effect of the value of the two components on the mixture. In this case, the comparative values of a light crude and a topped crude (residual) will affect the value of the mixture in proportion to the percentages of each component. For example, as the percentage of the topped crude increases, the value of the mixture decreases. Notwithstanding the argument that the light crude oil is responsible for imparting a value to the mixture, it is our conclusion that the criterion of "value" is a secondary consideration when compared with the criterion based on the actual percentages by volume of the two types of feedstock components. This is especially true in view of the fact that the mixture is not a product which is itself offered for sale as a feedstock.

In summary, the light crude oil component and the topped crude are both feedstocks for a refinery, and each has, in its own way, an effect on the character of a mixture with respect to the process by which petroleum products will be extracted. As previously noted, light crude oil is unprocessed petroleum that must first enter the separation process in an atmospheric tower. On the other hand, topped crude is a processed petroleum that is further processed in a vacuum tower or cracking unit. Therefore, the percentage by volume is the criterion which, when considered together with the nature and role of each component in a petroleum mixture of light crude and topped crude, lends the clearest indication as to the nature of the mixture as a feedstock. To the extent that the percentage of light crude oil is greater than 50 percent of the total volume of the feedstock, we determine that the light crude oil imparts the essential character of the feedstock mixture.

Therefore, we conclude that, provided that the mixture of light crude oil and topped crude (residual) contains more than 50 percent by volume of light crude oil, the mixture is classifiable in heading 2709 as a petroleum oil, crude.

3. Application of CFTA

The gasoline, home heating oil, No. 6 fuel oil and other petroleum products in issue that were produced in Canada from the topped crude or from the feedstock mixture are said to be petroleum products classifiable in heading 2710, HTS.

In view of our conclusion that topped crude itself is classifiable in heading 2710, any goods classifiable in heading 2710 that were produced in Canada from a non-originating topped crude do not qualify under the specific rules of origin for petroleum products of heading 2710, HTS. Under the CFTA, goods of heading 2710, if produced from non-originating materials, qualify as originating goods only if the non-originating materials used in their production were classifiable in a heading other than headings 2710 through 2715.

To the extent that the goods, other than a residual from an atmospheric distillation, were produced entirely in Canada from the feedstock that was a non-originating mixture of light crude oil and topped crude in which the light crude oil constitutes more than 50 percent of the mixture by volume, the goods qualify as originating goods under the specific rule for the CFTA because the non-originating mixture is classifiable in heading 2709, HTS. See General Note 3(c)(vii)(R)(5)(bb), HTS (1993). Provided that the other applicable requirements are satisfied, the petroleum goods produced from this feedstock mixture would be eligible for tariff preferences as originating goods.

Because classification of the feedstock mixture in heading 2709 is dependent upon the light crude oil constituting more than 50 percent by volume of the mixture, it is imperative that the production records be sufficient to demonstrate to Customs satisfaction that, on a daily basis, the mixture used in the refinery always consisted of at least more than 50 percent by volume of light crude oil. The use of a non-originating feedstock mixture that is classifiable in heading 2710 would have resulted in goods that fail to satisfy the specific change in tariff requirement.

4. Commingling of goods under the CFTA

Based on the representations made by counsel that the actual percentage of crude oil in a feedstock mixture may have been 50 percent or less by volume at any time during the 1992 and 1993 production years, we conclude that the product produced at the refinery consists of both originating and non-originating goods. Unless these goods were directed to separate tanks for originating and non-originating goods, they were commingled. Physical identification would have been impossible.

The CFTA addressed only one situation involving the identification of originating and non-originating articles which were used together. In Paragraph 6 to Annex 301.2 of the United States-Canada Free-Trade Agreement, it was required that the value of materials be directly attributed to goods under consideration in order to identify the value of originating and non-originating materials used in the production of a good which was subject to a regional value content requirement. Section 202(c)(5) of the United States-Canada Free-Trade Implementation Act of 1988, Public Law 100-449, 102 Stat. 1851 (September 28, 1988). If physical identification were not possible or practical, an inventory identification method (FIFO) was allowed to establish the requirement of "directly attributed" in that limited situation, i.e., the situation involving originating and non-originating materials used together in a good that was subject to a regional value content requirement. See HQ ruling 556346 of January 24, 1992. Thus, pursuant to the requirements in Paragraph 6 to Annex 301.2, Customs determined that an inventory management method could be used in place of physical identification to determine which materials were directly attributed to the goods. The normal requirement of physical identification was otherwise required.

The treatment of commingled goods was not addressed in either the CFTA or the implementing statute or regulations. Therefore, in the event that both originating and non-originating products were produced at the refinery during the period in question and were not put into separate tanks, the legal effect of the commingling of these goods needs to be addressed in order to determine whether any of the commingled product may be determined to be "originating" when some or all of the commingled product is exported under a claim for CFTA tariff preference.

General Note 5, HTS (1993) [formerly designated as General Headnote 7(a) under the TSUS (1987); redesignated as General Note 5 in 1988, effective January 1, 1989, and now currently designated as General Note 14 by Proclamation 6641 of December 15, 1993, 58 FR 66867, at 67032, December 20, 1993, effective January 1, 1994], addresses commingling of goods. In the absence of a specific statutory or regulatory provision under the CFTA, General Note 5 is applicable. It provides in pertinent part as follows:

General Note 5. Commingling of Goods.

(a) Whenever goods subject to different rates of duty are so packed together or mingled that the quantity or value of each class of goods cannot be readily ascertained by customs officers (without physical segregation of the shipment or the contents of any entire package thereof), by one or more of the following means:

(i) sampling

(ii) verification of packing lists or other documents filed at the time of entry, or
the commingled goods shall be subject to the highest rate of duty applicable to any part thereof unless the consignee or his agent segregates the goods pursuant to subparagraph (b) hereof.

General Note 5 provides that commingled goods shall be assessed the highest rate applicable to any one kind of goods included in the commingled goods, unless the quantity and value of each of the kinds of goods can be readily ascertained either by the usual method of Customs examination or by one of the methods specified in General Note 5. See Section 152.13 of the Customs Regulations (19 CFR 152.13).

In Coastal States Marketing v. the United States, 646 F.Supp. 255 (CIT 1986), aff'd 818 F.2d 860 (CAFC 1987), the issue before the court was the country of origin of a mixture of gas oil from the Soviet Union and fuel oil from Italy. Customs treated the goods as commingled goods and, based on documentation presented by plaintiff, assessed a higher rate for the part of the goods that were determined to be Soviet gas oil and a lower rate for the part of the commingled goods that were determined to be Italian fuel oil. In affirming Customs action in this regard the court concluded that Customs properly applied General Headnote 7(a), TSUS, for commingling of merchandise, to the oil mixture in question by segregating the components of the blend pursuant to available documentation.

The principle of the application of General Headnote 7(a) in Coastal States also applies to a situation involving commingled goods under the CFTA. For purposes of this discussion, General Note 5(a)(ii), HTS (1993) sets forth the method in General Note 5 that applies in this case. In the event that Customs cannot readily ascertain the quantity of each commingled good by verification of documents presented at entry, the applicable rate of duty is the highest rate applicable to any of the commingled goods. Clearly, Customs has the authority to determine what method or methods will be considered sufficient for this purpose and what information will be necessary to verify the documents filed at the time of entry.

Under our ruling the approved method for purposes of implementing Paragraph 6 of Annex 301.2, CFTA, was an inventory identification based on FIFO. In the case of originating and non-originating petroleum products which are commingled in a tank after production in a refinery, FIFO would also be an appropriate inventory method for identifying the originating and non- originating final goods because a refiner is able to follow a feedstock through the refinery process to its final products. A FIFO method would establish, for Customs purposes, any "layers" of originating and non-originating products that may result from a refinery operation. If adequate refinery operating records are maintained by the refiner, withdrawals of commingled product for export under the CFTA could, therefore, be readily ascertained as originating and non-originating goods when imported into the United States.

Customs has, in another context, set forth other methods which can be used for this purpose. Section 7(14) and Schedule X of the Appendix to Part 181, Title 19 Code of Federal Regulations (19 CFR Part 181, Appendix) implement Section 202(f) of the North American Free Trade Agreement Implementation Act and provide for inventory management methods which, if applicable, could be used, for example, in the event a producer uses fungible originating and non-originating materials or commingles fungible originating and non-originating goods. These inventory management methods are considered sufficient to ascertain the quantity of materials or goods that are "originating" for purposes of the NAFTA provisions related to fungible materials and goods. It is reasonable that such methods are also sufficient to ascertain the quantity of goods that are originating for purposes of applying General Note 5 to the CFTA.

For any acceptable inventory identification method, daily refinery operating records must be sufficiently specific for Customs to verify the percentages of light crude oil and topped crude in a feedstock mixture at any time during the production process, the nature of the light crude and the topped crude (i.e., chemical composition of each component) in the mixture, the output of the refinery as related to the feedstock input and any other information which is relevant to the verification of the claim for tariff preference under the CFTA. If the available records are not sufficient for Customs to readily ascertain, under the method employed, the quantity of CFTA originating goods in a shipment of commingled originating and non-originating goods, the entire shipment would be subject to the non-CFTA rate of duty.

5. Application of the NAFTA

In view of our conclusion that topped crude itself is classifiable in heading 2710, any goods classifiable in heading 2710 that were produced in Canada from a non-originating topped crude do not qualify under the specific rules of origin for petroleum products of heading 2710, HTS. Under the NAFTA, goods of heading 2710, if produced from non-originating materials, qualify as originating goods only if the non-originating materials used in their production are classifiable in a heading other than headings 2710 through 2715.

To the extent that the goods, other than a residual from an atmospheric distillation, are produced entirely in Canada from the feedstock that is a non-originating mixture of light crude oil and topped crude in which the light crude oil constitutes more than 50 percent of the mixture by volume, the goods qualify as originating goods under the specific rule for the NAFTA because the non-originating mixture is classifiable in heading 2709, HTS. See General Note 12(t)/27, subdivision 4, HTS (1994). Provided that the other applicable requirements are satisfied, the petroleum goods produced from this feedstock mixture would be eligible for tariff preferences as originating goods.

Because classification of the feedstock mixture in heading 2709 is dependent upon the light crude oil constituting more than 50 percent by volume of the mixture, it is imperative that the production records be sufficient to demonstrate to Customs satisfaction that, on a daily basis, the mixture used in the refinery always consists of at least more than 50 percent by volume of light crude oil. The use of a non-originating feedstock mixture that is classifiable in heading 2710 would result in goods that fail to satisfy the specific change in tariff requirement.

6. Opening inventory under the NAFTA

Opening inventory for fungible materials and for fungible and commingled goods is determined under one of the appropriate methods established in Section 9 or Section 15 to Schedule X of the Appendix to Part 181 of Title 19, Code of Federal Regulations (19 CFR Part 181), published as an interim regulation in the Federal Register, December 28, 1993 (58 FR 68520).

7. Commingling of fungible goods under NAFTA

Under the NAFTA, the treatment of commingled fungible goods is distinctly different from the treatment of such goods under the CFTA. Section 202(f)(2) of the North American Free Trade Agreement Implementation Act, Public Law 103-182, 107 Stat. 2057 (December 8, 1993), provides that the determination of whether a good is an originating good may be made on the basis of an inventory management method if originating and non-originating goods are fungible and commingled. Section 7(14) and Schedule X of the Appendix to Part 181, Title 19 Code of Federal Regulations (19 CFR Part 181, Appendix) implement Section 202(f) and provide for inventory management methods which, if applicable, could be used, for example, in the event the refinery uses a feedstock mixture that fails to be classified in heading 2709.

In any case, in order for preferential tariff treatment to be granted, daily records must be sufficient for Customs to verify the percentages of light crude oil and topped crude in a feedstock mixture, the nature of the light crude and the topped crude (chemical composition of each component) in the mixture, the output of the refinery as related to the feedstock input and any other information which is relevant to the verification of the claim for tariff preference under the NAFTA.

8. Circumvention

For purposes of the CFTA, under General Note 3(c)(vii)(C)(3), HTS (1993), a good shall not be considered originating if it undergoes a change in tariff classification merely by virtue of having undergone "any process * * * in respect of which the facts as ascertained clearly justify the presumption, that the sole object was to circumvent the provisions of subdivision (c)(vii) of this note." Similarly, for purposes of the NAFTA, under General Note 12(m)(ii), HTS, a good is not considered originating merely by reason of "any production or pricing practice with respect to which it may be demonstrated, on the basis of a preponderance of evidence, that the object was to circumvent this note." It is our position that the atmospheric distillation of a residual petroleum product is repetitive and commercially unnecessary to the extent that the product to be obtained from the atmospheric distillation is a residual petroleum product.

Whether characterized as "reverse processing" (see, for example, the Statement of Administrative Action for the CFTA, page 175 of House Document 100-216, July 26, 1988) or circumvention (see, for example, the Statement of Administrative Action for the NAFTA, pages 493 and 498 of House Document 103- 159, Vol. 1, November 4, 1993), the mixing of crude oil and topped crude (residual fuel oil), and the subsequent production of a "residual" from the atmospheric distillation of the mixture, in effect, achieves the return of the residual, used in making the mixture, to its original condition.

Therefore, to the extent that a residual from an atmospheric distillation is removed from the refining of a mixture of light crude oil and topped crude, classifiable in heading 2710 and is either exported or mixed with another petroleum product and exported to the United States, that product would not be considered an originating good under either the CFTA or the NAFTA. In effect, the residual merely constitutes a return of the non-originating topped crude to its condition at the time it was mixed with the light crude oil.

9. Other laws and regulations

This determination applies only to preferential tariff treatment under the CFTA and the NAFTA, and, therefore, does not affect the enforcement of other laws and regulations administered by the Office of Foreign Assets Control, this agency or any other agency of the United States Government.

HOLDING:

The "topped crude" or residual fuel oil is classifiable as a petroleum oil, other than crude, in heading 2710, HTS. The products produced in Canada from the topped crude do not qualify as originating goods under either the CFTA or the NAFTA.

The "reconstituted crude," consisting of a mixture of light crude oil and topped crude (residual fuel oil) in which the light crude oil constitutes by volume over 50 percent of the total mixture, is classifiable as a petroleum oil, crude, in heading 2709, HTS. The products produced in Canada from this mixture, other than a product which is a residual fuel oil from an atmospheric distillation, qualify as originating goods under both the CFTA and the NAFTA and may be eligible for tariff preferences under the provisions of each agreement, provided that the records are sufficient to establish that all the conditions outlined in this ruling have been met, and that all other applicable requirements are satisfied.
Sincerely,

John Durant, Director

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See also:

• Tariff No.: 2710.00.05 - Distillate and residual fuel oils (including blends) derived from bituminous minerals, testing under 25 degrees A.P.I.
• Tariff No.: 2710.00.10 - Distillate and residual fuel oils (including blends) derived from bituminous minerals, testing 25 degrees A.P.I. or more