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S P O T L I G H T

How can a modernized NAFTA revolutionize North American energy?

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How can a modernized NAFTA improve North American energy market integration and the region’s global energy competitiveness?

With North American Free Trade Agreement (NAFTA) renegotiations now finishing their second round, one aspect of the agreement that has eluded greater attention is its enormous success in the energy space. All three signatory countries—the United States, Canada, and Mexico—have abandoned protectionist policies2 through NAFTA, and both the United States and Canada have committed to zero tariffs and open market access for a range of conventional and emerging energy products.

Mexico’s historic energy reforms in 20133 opened the country’s fast-growing market to imports of US natural gas, petroleum products, and electricity.4 The results have been phenomenal and particularly favorable to the United States. Although the US-Canada energy trade balance favored Canada by approximately $39 billion in 2016, the value of US energy exports to Mexico are now double that of US imports from Mexico.5 US-Mexico energy trade is poised to grow further, favoring greater US natural gas and product exports and increased investment in Mexico’s energy sector. Still, renegotiations create opportunities to make NAFTA work even better for our energy market.

The original NAFTA lacked a consolidated energy chapter that many in the industry would like to see added to a new agreement. The treaty currently covers energy trade under its investment and services clauses in Chapter 11. The Investor-State Dispute Settlement (ISDS) clauses in the same chapter have been criticized by the Trump administration in the renegotiations, but they are robustly supported by all three countries’ oil and gas industries.6 In the original NAFTA, Mexico required exemptions from allowing foreign investors into its domestic energy industry, as such investment was at the time banned by Mexico’s constitution. Mexico has since undertaken a set of historic energy reforms that have liberalized its oil and gas development and allowed for an influx of US and other foreign industry investors. A modernized NAFTA would remove those outdated exemptions, give Mexico’s reforms treaty status, and expand energy trade by covering digital services, which would harmonize standards for energy efficiency and renewable technology and allow for more efficient trade in energy services.

Since 1990, Mexican imports of gasoline and diesel (largely supplied from US refineries) have tripled, while imports of piped US natural gas have increased at an average of 26 percent annually over the past five years. Today, US imports meet around 40 percent of Mexico’s natural gas demand.7 Indeed, US natural gas piped exports—the catalyst behind the positive energy-related trade balance—doubled between 2009 and 2016 based on US Energy Information Administration (EIA) data; nearly all of these exports went to Mexico. Mexico’s Energy Ministry (SENER) has planned twelve new pipelines that will add nearly 3,200 miles of natural gas pipeline across the border and throughout Mexico, the largest of which will have a transport capacity of 2.6 billion cubic feet per day.8 The US border with Canada, on the other hand, is seamless, with mature two-way trade in crude oil, petroleum products, electricity, and a highly-integrated transmission network of multiple pipeline, road, and rail links.

This deep integration has maximized the comparative advantages of each country. The United States, with its highly efficient refining sector, exports products to Mexico and Canada, which are then refined with low-cost heavy crudes. US natural gas exports to Mexico continue to increase, providing it with lower-cost electricity, lower carbon emissions, and energy security. The United States exports light oil to Canada—the fifth largest oil producer in the world—for consumption by its refining system and blending with its native heavier crudes. Bilateral trade in electricity between the United States and its neighbors provides each with increased reliability.

For these reasons, the main message from the energy sector,9 experts,10 and policy makers11 in all three countries has been: “Do no harm.” But there are tremendous gains to be made in exports, investment, employment, new energy trade, and energy system reliability if NAFTA is modernized to foster deeper market integration and maximize the competitiveness of the North American energy economy.

Renegotiations create opportunities

to make NAFTA work even better for our energy market.

In this Spotlight, we ask: How can a modernized NAFTA improve North American energy market integration and the region’s global energy competitiveness?

1Deeper Integration = Increased Exports

The key to expanding US (and North American) exports of oil, gas, and power is sustaining the competitiveness of the energy industrial base and finding export markets. For the United States, Mexico is a major market for petroleum products and natural gas, largely due to low prices, proximity, and growing demand.

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Peru crime and security
Mexico is a key export market for US goods, and recent reforms now open the door to greater energy imports. [Reuters]

The key to the competitiveness of the US oil and gas sector has been its ability to access technology and fossil fuel-based feed stock at competitive prices—all advantages enhanced by NAFTA provisions that favor the free movement of products and services. A modernized NAFTA can improve or undermine this position depending on where it settles on tariffs, content rules, and investor protections.

Zero tariffs make North American energy trade more attractive. If this framework is sustained, the United States stands to dramatically increase exports of natural gas and petroleum products, while providing a steady market for Canadian and Mexican heavy crudes.

Protectionist policies, however, could have a dramatic and negative impact on US export markets. Enacting “Buy American” or “Hire American” policies, which would raise the cost of pipelines, liquefaction plants, and refineries, would put the broader cost structure at risk. The US industry does not make the gauge of pipe required for oil and gas pipelines and cannot quickly or easily retool. LNG gasification plants and petrochemical plants require specialized steel. Import restrictions could raise prices without providing competitive supply. Although the prospect of adding content rules (presumably favoring higher US content) is superficially appealing, it would quickly backfire if our neighbors adopted similar policies that could create new barriers to exports and efficiency.12

Investor protections are an equally sensitive issue; it has been suggested the Trump administration may seek to weaken the Chapter 11 Investor-State Dispute Settlement mechanisms by making them an optional component of the treaty out of which the US could opt. These protections are critical to the private sector’s investment strategies (and, historically, have never resulted in a US legal defeat). It is likely that Canada and Mexico would reject this asymmetry. The changes have not been made public. If the NAFTA Chapter 11 protections that undergird the willingness of foreign companies to invest in oil (or electricity) production in Canada and Mexico were to lapse or fail to assure investors of adequate recourse in the event of an arbitrary rescission of a major contract, cross-border investment could decline. This would undermine the economics of our refining system.

A major discontinuity in investment from lack of investor protections could also devastate the purchasing power of the United States’ two largest trading partners, wreaking havoc on US trade and export prerogatives as well as export-dependent US industries that employ tens of thousands of US workers. Higher tariffs or a hostile trade relationship could drive Mexico to inefficiently invest in national supply and infrastructure, to prioritize other suppliers13 of gas, or to insist on growing its own refining sector.

The 2015 Trade Promotion Authority (TPA)14 requires that US negotiators seek “to further strengthen the system of international trade and investment disciplines and procedures, including dispute settlement.”15 Chapter 11 should be improved to protect investors more fully against arbitrary state actions but still protect states from lawsuits over policy changes (e.g., tighter environmental standards and time-limited incentives for renewable energy). While all sides hope to codify the advantages of the recent Mexican energy reforms, reaping the benefits of these reforms should be done in a way that enhances the NAFTA protections that have been indispensable to its success. It is not clear that Mexico’s opening negotiating position meets this test.

Protectionist policies could

have a dramatic and negative impact on US export markets.

2 Greater NAFTA Labor Mobility = More Jobs and Higher Wages

Mexico’s energy reforms, with the prospect of greater oil and gas development in the Mexican Gulf, provide a tremendous opportunity for the US service sector and for US universities. As Mexico enjoys a renaissance of investment in its oil and gas sector, US geoscientists, engineers, and marine transportation companies will be called on to perform much of the work. The EIA estimates that Mexico has 545 trillion cubic feet of natural gas and 13.1 billion barrels of oil and condensate in its shale formations alone;16 these resources will demand technical and operative expertise to fully leverage.

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NAFTA renegotiations could offer the US a privileged role in Mexico's energy renaissance. [Reuters]

Mexico will require a new generation of scientists and engineers, and US universities are well positioned to provide the necessary education and training to boost Mexico’s technical capacities. To maximize these opportunities, the United States must be willing to provide Mexico the visa arrangements necessary for its citizens to come into the country, just as we hope Mexico will provide for US service-sector personnel seeking to work in Mexico.

Mutually flexible visa arrangements will allow for rapid and efficient energy development, increased employment, and higher wage levels for US workers, simultaneously bolstering human and intellectual capital development in Mexico.

Mutually flexible visa arrangements

will allow for rapid and efficient energy development.

3Free Trade in Clean Energy = Expanded Markets

North America’s geographic blessings enable the United States, Mexico, and Canada to lead in the global clean energy marketplace. But maintaining this advantage will require common standards, zero-tariff trade in clean energy technology, and a collaborative rather than competitive approach in areas like carbon capture and storage, battery technology, and smart grids.

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US wind farms stand to benefit immensely from opened markets in Mexico and Canada. [Reuters]

The recent explosion of renewable electricity generation market share in all three NAFTA countries, unimaginable in the early 1990s, offers its own unique set of challenges, such as if and how to harmonize renewables subsidies across the region.17 As digitization transforms the electricity sector, free trade in data—avoiding national restrictions on the location of data storage—and common standards on trade in electricity will be essential for maximizing innovation in this sector and for expanding markets.

In contrast, protectionist measures such as “Buy American” provisions for government procurement of these services will diminish US access to growing markets and impede the flow of foreign investment in these sectors.

While each country will need to take care not to overturn the clean energy incentives in place today at the national or subnational level, assuring open trade in clean energy could open markets for the increased sale of US wind-based power to Mexico and Canada, while opening southern California and the northeastern United States to low-cost wind, solar, and (from Canada) hydroelectricity. This could both lower electricity costs and carbon emissions in these regions, helping drive economic growth and competitiveness.

Common standards on trade in electricity

will be essential for maximizing innovation in this sector.

4 Greater Energy Resilience through NAFTA = Greater Competitiveness

The United States is seeing a revival in inward investment, based on lower feedstock and electricity costs from cheap natural gas. Over the next year, $50 billion in petrochemical manufacturing investment is expected in the United States alone, creating as many as 80,000 new jobs.18

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Alberto Fujimori
Harmonized standards and information-sharing can make the entire continent more energy-secure. [Reuters]

The reliability of the US energy system is indispensable to incentivizing investment flows across all sectors. Cyber risk, aging and outdated infrastructure, extreme weather events, and even insufficient transmission pose risks to that competitiveness.

Greater regional integration and a deliberate strategy to develop energy resilience in conjunction with our neighbors can enhance flexibility, and thus competitiveness. At the broadest level, North American self-sufficiency in oil and gas recycles economic rents into the trade relationship and reduces dependence on sea-borne heavy oil imports from Venezuela and the Middle East. The energy system could also enjoy enhanced reliability from rapid imports of fuel or equipment in the event of emergencies; greater and more efficient trade in electricity to enhance reliability; coordination of information-sharing on systemic threats and vulnerabilities; enhanced cooperation among local and regional authorities across shared borders; and harmonized standards on electricity security at the federal and municipal levels.19

North American self-sufficiency

in oil and gas recycles economic rents into the trade relationship.

Endnotes

1 The author would like to thank Andrea Clabough for research and editorial assistance with this Spotlight.

2 David L. Goldwyn, “Case Study: The Oil Trade Relationship Between the US and Canada CFR – Workshop on Oil and Political Relationships,” May 9, 2012. https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&ved=0ahUKEwjEx6Wqke7VAhULfiYKHUmJBokQFggoMAA&url=https%3A%2F%2Fwww.cfr.org%2Fcontent%2Fpublications%2Fattachments%2FGoldwyn_United%2520States-Canada.pdf&usg=AFQjCNHjzfb6RP-Xc35tz0_pcdKWdOG7BA.

3 See author’s prior studies, including: David L. Goldwyn, “Mexico Rising: Comprehensive Energy Reform at Last?,” Atlantic Council (2013), http://www.atlanticcouncil.org/images/publications/Mexico_Rising.pdf and David L. Goldwyn, Neil R. Brown, and Megan Reilly Cayten, “Mexico’s Energy Reform: Ready to Launch,” Atlantic Council (2014), http://www.atlanticcouncil.org/publications/reports/mexico-s-energy-reform-ready-to-launch.

4 “US energy trade with Mexico: US export value more than twice import value in 2016,” US Energy Information Agency, February 9, 2017, https://www.eia.gov/todayinenergy/detail.php?id=29892.

5 “US energy trade with Mexico: US export value more than twice import value in 2016.” EIA, February 9, 2017https://www.eia.gov/todayinenergy/detail.php?id=29892.

6 See the recent letter from API, AMEXHI and CAPP, “North American Oil & Natural Gas Industry Positions on NAFTA,” American Petroleum Industry, August 2, 2017 http://www.api.org/~/media/Files/News/Letters-Comments/2017/APIAMEXHICAPPJointPositionPaperonNAFTAV1002Aug2017.pdf.

7 “Mexico Energy Outlook,” International Energy Agency World Energy Outlook Special Report (2016), https://www.iea.org/publications/freepublications/publication/MexicoEnergyOutlook.pdf.

8 “US natural gas exports to Mexico continue to grow,” EIA, November 29, 2016, https://www.eia.gov/todayinenergy/detail.php?id=28932#.

9 “North American Oil & Natural Gas Industry Positions on NAFTA,” http://www.api.org/~/media/Files/News/Letters-Comments/2017/APIAMEXHICAPPJointPositionPaperonNAFTAV1002Aug2017.pdf.

10 We recommend the recent analyses by Gary Hufbauer and Euijin Jung with the Peterson Institute for International Economics on how to craft a positive renegotiation. See: Gary Hufbauer and Euijin Jung, “NAFTA and Energy,” Peterson Institute for International Economics, July 17, 2017, https://piie.com/system/files/documents/hufbauer20170717ppt.pdf.

11 A notable recent example from US policymakers is the June 8 letter (available here) from Senators Cornyn and Heitkamp (and six others) that notes: “NAFTA has played a key role in all North American energy markets, including electricity, renewable, oil and natural gas as each market remains highly integrated” and encourages the administration to maintain free flows of all energy products, zero tariffs, and open access to investors, among other priorities.

12 This is not to argue that the Rules of Origin (ROO) should be untouched in a renegotiation; there are multiple areas where strengthening or clarifying the ROO would in fact support energy trade, such as the overly cumbersome rules on diluent trade.

13 Mexico is actively considering options to develop its native natural gas resources, which the EIA estimates at 15.3 trillion cubic feet.

14 TPA sets the parameters of executive action during all trade negotiations for a set time period. From the USTR’s website: “Since 1974, Congress has enacted TPA legislation that defines US negotiating objectives and priorities for trade agreements and establishes consultation and notification requirements for the President to follow throughout the negotiation process. At the end of the negotiation and consultation process, Congress gives the agreement an up or down vote, without amendment. TPA reaffirms Congress’s overall constitutional role in the development and oversight of US trade policy.” For additional information, see: Trade Promotion Authority, https://ustr.gov/trade-topics/trade-promotion-authority, last accessed August 23, 2017.

15 The full text of S.995 from Congress.gov, https://www.congress.gov/bill/114th-congress/senate-bill/995/text.

16 “Technically Recoverable Shale Oil and Shale Gas Resources: Mexico,” EIA, September 2015, https://www.eia.gov/analysis/studies/worldshalegas/pdf/Mexico_2013.pdf.

17 We note that the issue of renewables in a NAFTA 2.0 is an important but less discussed aspect of a renegotiation. We again credit the scholars at the Peterson Institute for International Economics (PIIE) as thought leaders on this issue, and recommend the work of Melina Kolb and Cathleen Cimino-Issacs. See: Melina Kolb and Cathleen Cimino-Issacs, “A Guide to Renegotiating NAFTA,” Peterson Institute for International Economics, June 19, 2017, https://piie.com/blogs/trade-investment-policy-watch/guide-renegotiating-nafta.

18 Patti Domm, “The $160 billion US manufacturing boom that started before Trump,” CNBC, March 9, 2017, https://www.cnbc.com/2017/03/09/the-160-billion-us-manufacturing-boom-that-started-before-trump.html.

19 For further insights, we recommend the US Department of Energy’s Second Installment of the Quadrennial Energy Review (available here), which expands further on critical updates to US energy and electricity infrastructure.