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How the drive for North American energy independence could save NAFTA

Current negotiations between Canada, Mexico and the United States to revise and modernize the North American Free Trade Agreement (NAFTA) have been characterized by notable disagreements and heavy demands across parties, as well as threats from US President Donald Trump to exit the current agreement altogether. However, the energy sector – and North American energy independence specifically – is a potential area of cooperation that might save NAFTA in the long-term.

The original 1993 agreement excluded rules and regulations for the energy sector largely because Mexico still had a nationalized energy industry. However, current President Enrique Peña Nieto enacted sweeping reforms in 2014 that opened up the industry to private and foreign investment. The renegotiation of NAFTA therefore presents an opportune time to harmonize the three countries’ large and diversified energy industries. Theoretically, this would create an entire region of energy independence and affordable and reliable access to fuel.

Cross-border energy commerce already strong

Canada, Mexico and the United States possess more than enough natural energy reserves to achieve full energy independence if a free trade agreement induces affordable prices and accessibility. The US Energy Information Administration projected in its 2017 Annual Energy Outlook that the three NAFTA countries’ combined production of petroleum and other liquid fuel sources is on track to very soon surpass consumption. The US also now ranks as the world’s largest joint producer of oil and natural gas.

The North American energy industry also already boasts a significant level of trade in oil and refined products, gas, and electricity, even without a specific provision in NAFTA. According to the US Department of Energy, as of 2012-2013, the United States had $140 billion and $65 billion in trade of energy products with Canada and Mexico, respectively. Canada is the United States’ largest source of trade in energy products, and Mexico already purchases around 60-65 percent of US gasoline and natural gas exports. The approval of the Keystone XL Pipeline earlier this year, while highly controversial from an environmental standpoint, now enables 108,000 barrels daily of refined petroleum to flow from the US to Mexico. The US already manages 17 pipelines that carry over four billion cubic feet of natural gas a day to Mexico. These statistics indicate a fast-growing market for US energy products.

Furthermore, while NAFTA energy integration would be dominated by fossil fuels in the near future, North America’s diverse range of climates and topography make the region poised to become a major player in cleaner, renewable energies, particularly solar, wind and ethanol. Mexico has grown significantly under NAFTA to become a competitive, middle income country. This growth has translated into a rapid increase in demand for electricity; Forbes estimates that, in the next 25 years, Mexico’s power use will double.

Approximately two-thirds of Mexico’s energy growth will come from natural gas, but the remainder is expected to come from renewables. Accordingly, Mexico has rapidly expanded its capacity for wind energy, with a 400% increase expected from 2014 to 2018 and the US has witnessed a similar level of growth in wind energy capacity. This has already created major demand for turbine equipment from US companies such asGeneral Electric, with considerable space for additional growth.

Political commitment to North American energy independence

Encouragingly, all three NAFTA leaders have signaled that they view North American energy independence as a major priority, demonstrating a potential major area of consensus in the midst of otherwise tense negotiations. In 2016, Presidents Obama, Peña Nieto and Trudeau stated a joint goal to make renewable energies constitute 50 percentof North America’s electricity by 2025, up from 37 percent in 2015. This goal may be deprioritized under Donald Trump, but his administration is most certainly focused on energy independence in general. In a June speech at the US Department of Energy, Trump announced his desire for “US energy dominance.” Moreover, the US Trade Representative’s NAFTA renegotiation objectives, released July 17, emphasized support for North American energy independence, indicating buy in from the US in this arena.

Leading industry associations in all three countries have echoed these goals. Earlier this year, the American Petroleum Institute, Asociación Méxicana de Empresas de Hidrocarburos and the Canadian Association of Petroleum Producers issued a joint proposal urging reforms that liberalize trade of energy goods and integration of North American energy supply chains. These commitments provide an opportunity to integrate a new export sector into NAFTA that could help eliminate the United States’ trade deficit with Mexico, a particular point of contention regularly raised by Trump. They also provide an opening to create a holistic set of common cross-border standards around energy production and usage for both traditional and renewable fuel sources.

Political risks to energy sector integration

The biggest political risk to achieving these energy integration goals will be Mexico’s leading candidate for the presidency in 2018, Andres Manuel Lopez Obrador (AMLO), a leftist populist whose platform has been elevated, largely in response to harsh rhetoric from Donald Trump towards Mexico. AMLO has threatened to reverse the 2014 reformsthat opened up Mexico’s energy sector to more private investment.

Second, the investor-state dispute settlement mechanism (ISDS) will be critical to keeping the three countries’ energy policies and regulations in harmony, but the Trump administration has proposed scrapping this vehicle from NAFTA. For example, each country currently provides different levels of subsidies and standards for what exactly qualifies as renewable energy. These disparities could theoretically lead to conflicts between foreign companies and the state with regard to tax breaks and fair competition. Consequently, the ISDS provides a critical independent judicial body and risk management mechanism to protect their international investments.

Energy sector integration across North America is a lofty goal to achieve, especially amongst three heads of state with vastly different political philosophies and political headwinds in 2018, indicating potential for further polarization. However, current trends in cross-border commerce and domestic economic objectives make NAFTA renegotiations an appropriate forum to address the issue.

 

This article first ran on Global Risk Insights, and was written by Samuel Schofield