red petrol station in USA

NAFTA Refueled: What’s Next for North American Energy Trade?

This article is based on a recent CSIS panel titled, “Renegotiating NAFTA: Energy Opportunities and Challenges.” The full recording of the event can be found HERE

Discussions of the more than 20-year legacy of NAFTA typically focus on the agreement’s role in expanding North American trade and integrating markets for agricultural and manufactured goods and services. One area that has received less attention until recently is the historical and growing importance of energy trade between the three nations. As the leaders from Washington, Ottawa and Mexico City look to the future of their trading regime, energy is poised to play a larger role than it did in the original NAFTA negotiations.

Why is North American Energy Trade so Important?

The short answer: because it powers everything else. We use energy for everything from transportation to heating and lighting our homes and offices, to a wide variety of industrial production. The energy industry features heavily in geopolitics and corresponds closely to growth in the economy. Shocks and shifts in energy markets reverberate throughout our economy. Recall the oil crises of the 1970s and the spike in gas prices around the Iraq War. Responses in oil producing nations like Venezuela, Russia, and Saudi Arabia to falling petroleum prices will affect consumers in countries whose economies depend on purchases from them.

The United States is fortunate to have mutually-beneficial trade relationships in energy products with its peaceful neighbors to the north and south. The volume of trade within North America of energy resources – crude petroleum and natural gas – and “energy goods” like petroleum products and even electricity has increased significantly from 1995 to the present and are strikingly reciprocal. Deep integration has occurred not as a result of NAFTA but supported by the overall framework for relations that NAFTA provides. While the American, Canadian, and Mexican energy markets are interdependent, as a region, North America is positioned to achieve independence from the vagaries of global energy markets.

North American Energy Trade 1995 v 2016

What Does NAFTA Say About Energy?

The short answer: less than meets the eye, even though there’s an entire chapter dedicated to it. NAFTA was negotiated following a period of heavy government interventions in the flows of energy. In the General Agreement on Tariffs and Trade, these interventions were seen as exceptions to trade disciplines in the name of conserving natural resources or out of national security considerations.

Chapter 6 of the NAFTA covering “Energy and Basic Petrochemicals” applies the principle of National Treatment. It includes general commitments against restrictions on energy trade but parties retain the ability to avail themselves of exceptions. The general approach taken in NAFTA was not to eliminate exceptions, but rather to place greater limitations on their use so as to further the objective of securing energy supplies from within the region. Also, when NAFTA was negotiated, Mexico’s constitution prohibited foreign participation in hydrocarbons production and development. The Mexican government preserved its constitutional right to own and control oil resources and production in Annex III of NAFTA (entitled “Activities Reserved for the State”).

Many important developments in the region’s energy market have reshaped the industry. In 2013, Mexico achieved public approval to change its constitution, generating the opportunity to reform its energy sector and permit foreign participation, an opportunity American companies are well suited to pursue. Unconventional energy production has brought to market large volumes of U.S.-produced oil and gas, as has oil sands development in Canada. The renewable energy market has also evolved considerably since NAFTA was negotiated. All three NAFTA partners have promoted development of wind and solar power, but each country’s standards and subsidy programs were adopted to promote domestic interests – for example, offering subsidies for adopting solar panels contingent on those panels being produced domestically.

Will the NAFTA Negotiation Produce a Regular or High Octane Outcome on Energy?

The short answer: who knows? In the run-up to renegotiations, the Trump administration released a set of negotiating objectives. According to Scott Miller of CSIS, these objectives are designed to achieve three types of outcomes: 1) deficit reduction and Trump-style “America First” promotion, 2) resolve lingering “commercial irritants” in North American trade, and 3) update NAFTA to reflect changes to the North American economy since 1994. Enhancing energy trade would fall into the third category.

NAFTA renegotiation may be the chance to move closer to the goal of free trade and investment in the North American energy sector. This could include commitments to “lock in” important reforms and market opening in Mexican energy production and services. Similarly, it could establish a framework for harmonizing green technology standards to create a thriving North American market for renewable energy. The industry is also interested in greater regulatory coherence in areas such as safety and environmental protection.

These outcomes are far from certain, however. With the explicit objectives of reducing the trade deficit, Trump administration negotiators may focus less on integrating markets and more on managing trade flows, which could lead to less trade in energy, not more. If “Buy American” policies are prioritized, the prospects of a comprehensive North American approach to green innovation may breakdown, further fragmenting these markets and programs at the expense of greater cooperation.

While the results remain uncertain, there is no doubt that NAFTA’s energy commitments could use a recharge and energy will play a major role in the coming talks.