Analysis: Canadian Energy Could Be Collateral Damage To A NAFTA Failure

President Donald Trump’s negative outlook for the North American Free Trade Agreement (NAFTA) as expressed during his Arizona rally on Tuesday should have come as no big shock. The U.S. had already thrown down the gauntlet on August 16, the first day of the first round of NAFTA renegotiations with Canada and Mexico. Robert Lighthizer, Trump’s top trade advisor, said the U.S. is not interested in “a mere tweaking” of the 23-year-old trade pact.

Instead, the U.S. is demanding major concessions from its North American trading partners to slash the country’s trade deficit, and has set an end of the year deadline to do so. On the surface, energy trade between the three countries appears to be relatively safe, but potentially could become collateral damage if the Canadian government decides to use energy as a bargaining chip and the NAFTA renegotiation ultimately fails.

Canadian and Mexican trade negotiators should not be surprised by the hardline the Americans are taking on NAFTA, even if the leaders of the two countries have attempted to make the best of a bad situation — referring to the renegotiation as a “modernization” and similar such nonsense.

It was debatable whether there would even be a renegotiation when President Trump took office this past January. On the campaign trail, candidate Trump referred to NAFTA as “a disaster” and the “worst trade deal maybe ever signed anywhere,” and on numerous occasions said he would simply “tear up” the treaty. NAFTA played an integral part in his “America First” rhetoric, given the treaty’s supposed role in the U.S. trade deficit and job losses in America’s manufacturing heartland.

In addition, President Trump prides himself on being a tough bargainer, and seems to think the U.S. holds most of the chips. Canada and Mexico are significantly more reliant on the huge American market for their exports than the U.S. is on them. In 2015, the U.S. accounted for roughly three-quarters of Canada and Mexico’s total exports of goods. In contrast, Canada made up only 18 per cent of U.S total exports and Mexico accounted for 16 per cent.

On July 17, the U.S. Trade Representative (USTR) released a report containing its key objectives for the NAFTA renegotiation. At the top of the list is a reduction in the country’s merchandise trade deficit. Mexico is much more in the crosshairs for this key objective than Canada, given each country’s relative trade position with the U.S., but Canada could still be caught in the crossfire.

In 2016, Mexico had a substantial US$55.6 billion bilateral goods and services trade surplus with the U.S., whereas Canada had a trade deficit of US$12.5 billion. In addition, since NAFTA was enacted in 1994, manufacturing jobs have been moving to low cost Mexico, not relatively high cost Canada. Canada continues to primarily be “hewers of wood and drawers of water” for the U.S. market.

In terms of North American energy trade, the USTR report was relatively brief, despite expansion of trade in energy and energy services being one of its key objectives. In its sole reference to energy trade, the USTR called for an agreement to “reserve and strengthen investment, market access, and state-owned enterprise disciplines benefitting energy production and transmission and support North American energy security and independence, while promoting continuing energy market-opening reforms.”

In the lead up to NAFTA renegotiations, the Trump administration also made it abundantly clear that it considers energy an integral component of NAFTA. At the beginning of “Energy Week” in Washington, D.C. in late June, U.S. Energy Secretary Rick Perry said, in reference to the NAFTA renegotiation, that the U.S. has a unique opportunity to create a “North American Energy Strategy” with Canada and Mexico.

Mexico appears to be the primary target of the USTR’s energy related goal as well, despite Canada being the largest exporter of energy to the U.S. Mexico embarked on a series of reforms in 2013 to end its state monopoly over energy, creating market opportunities for American energy companies in both the petroleum and electricity sectors. At the same time, U.S. exports of light oil, natural gas and electricity to Mexico have been rising rapidly in recent years, with Mexico now America’s number one energy export market. The Trump administration needs export markets if it is to achieve its goal of U.S. “energy dominance.”

Under these circumstances, it’s not surprising that energy has been mentioned as an important bargaining chip for Canada and Mexico. For example, Derek Burney — former Canadian ambassador to the U.S. and one of Prime Minister Justin Trudeau’s key trade advisors  — is on record as saying “there will be no surrender” if the U.S. plays hardball on the NAFTA renegotiation and that Canada is willing to use its oil and gas as a  “trump card,” if need be.

If the Trump administration is to achieve North American energy strategy, security and independence, as well as U.S. energy dominance, it needs to import Canadian oil — especially heavy oil — natural gas and electricity and to export light oil, natural gas and electricity to Mexico.

At the same time, there is at least one issue that could lead to the outright failure of the NAFTA renegotiation — the status of the binational trade dispute settlement mechanism in Chapter 19 of the treaty. The elimination of this trade dispute mechanism was mentioned as one of America’s key objectives in the USTR report. The Trump administration views this provision as an infringement on U.S. sovereignty as it curtails its ability to unilaterally impose anti-dumping and countervailing duties on “offending” industries in Canada and Mexico.

On August 14, in a speech at the University of Ottawa, Foreign Affairs Minister Chrystia Freeland suggested that Canada would be willing to walk away from the NAFTA renegotiation if the U.S. does not back down on its desire to dump Chapter 19.

To conclude, President Trump appears to have set a very high bar for his NAFTA renegotiating team, including an incredibly short deadline compared to the norm. As a result, a successful renegotiation of the treaty probably is less likely than an unsuccessful one. Canada’s energy industry should benefit modestly from a successful renegotiation of NAFTA, given the importance the Trump administration is placing on North American energy strategy, security and independence.

In contrast, the impact of an unsuccessful NAFTA renegotiation on Canada’s energy industry is more difficult to gauge. If the Canadian trade team resorts to the energy trump card and the renegotiation still fails, it potentially could backfire against the industry — for example, through revisiting a border adjustment tax — especially given President Trump’s vindictive nature. If the NAFTA split is more amicable, and due more to Mexican than Canadian intransigence, it appears the Canada-U.S Free Trade Agreement (CUSFTA) would kick back in, contributing to minimal or no negative impact on Canada’s energy industry.