North American Free Trade Agreement on world map with national borders

The North American Free Trade Agreement – Good for American Energy

The North American Free Trade Agreement (NAFTA) was negotiated in the early 1990s and came into effect on Jan. 1, 1994. NAFTA created one of the world’s largest and most successful free-trade zones in the world, broadly reducing or eliminating tariffs, duties and other restrictions on cross-border trade and investment between the United States, Canada and Mexico. By virtually any measure, NAFTA has been an unqualified success — raising trade, investment, economic activity and prosperity in the three countries.

NAFTA became an issue in the 2016 presidential elections, however, with Donald Trump calling it the “single worst trade deal ever approved” in the U.S. True to his leanings, after Trump was elected he announced his plans to rework the agreement, and those discussions commenced with Mexico and Canada in 2017.

Though many of the benefits of unfettered energy trade between the three countries could not have been foreseen in 1994 (simply because the U.S. “energy renaissance” and the explosion of U.S. onshore domestic oil and gas production could not have been predicted), NAFTA has proven to be an enormous success in terms of energy trade flows in North America. And the energy-related free trade success is, in many ways, in its infancy with dramatic increases in export volumes beginning only about eight years ago.

Just since 2010, natural gas exports to Mexico have increased by well over five times (445 percent), creating a sizable positive natural gas trade balance between the U.S. and Mexico that is only expected to continue to grow in the coming years. Canada produces a substantial amount of natural gas — more than enough to meet its domestic needs — and much of it is exported to the United States, though the net natural gas trade deficit with Canada has declined since the U.S. began to grow in natural gas production in 2003.

Thanks to the lower Canadian natural gas trade deficit and burgeoning natural gas exports to Mexico, the U.S. became a net exporter of natural gas in North America at year-end 2017. That newly created positive natural gas trade balance will do nothing but widen going forward, providing a critical market outlet for U.S.-and Texas-produced natural gas.

If not for NAFTA, exports of the gas itself would be hindered, and the investment necessary to establish the cross-border infrastructure as well as the Mexican in-country infrastructure needed to transport and process that gas, would be greatly diminished.

While little in the way of raw crude oil is exported to Mexico from the United States, exports of petroleum products from the U.S. to Mexico have increased by some 320 percent since 2010. The positive result on markets is the same, of course, as the rising demand and movement of petroleum products across the border raise the demand for the U.S.-and Texas-produced crude oil from which those products are processed and refined.

At first glance, the Canadian crude oil trade imbalance with the United States may appear to be a problem that needs to be corrected. Again, however, simply consider the size of the Canadian economy relative to the U.S. economy — more crude oil is produced in Canada than can be consumed domestically, and the surplus is going to go somewhere. Canada is the largest single-country source of crude oil imports into the U.S., and the net negative trade balance in crude oil has widened in recent years.

However, higher import volumes from Canada, along with rising U.S. production, have displaced crude oil imports into the U.S. from suppliers in more geopolitically volatile non-North American regions. Further, not all crude oil is the same, of course. The heavier grade of Canadian crude oil is necessary to supply refineries on the gulf coast and elsewhere that are tooled to handle that particular brand of crude. Any NAFTA rework that slows or interrupts that process will be costly and harmful to the U.S. domestic refining industry and the American consumers they supply.

Thanks to these developments — rising North American production (from the U.S. and Canada, primarily) and the ability to trade freely within the North American zone — the region is on the verge of something once thought impossible: market-achieved North American energy self-sufficiency. The results are positive all the way around: greater supplies at lower prices to U.S. household and business consumers, as well as growth in the domestic oil and gas production industry, producing tens of thousands of high-paying jobs along the way.

The other direct benefit of NAFTA to U.S. oil and gas companies is the lower cost of inputs as a direct result of the low/zero-tariff trade environment. For example, a sizable portion of oilfield steel comes into the U.S. from Canada and Mexico, and tossing out the agreement or altering it to raise barriers to trade oilfield goods and services will raise the cost of doing business for Texas and U.S. oil and gas companies. That cost increase comes straight off the bottom line, directly impacting future development investment, reducing activity and costing jobs.

The 40-year-old crude oil export ban in the United States was done away with in late 2015. Since then, crude oil exports have been growing impressively. Meanwhile, the pace of oil exports quickened in 2017. While altering or eliminating NAFTA would at present have little direct effect on energy trade within North America (again, very little raw crude oil is exported to Mexico, and some exports of crude oil to Canada were permitted under the ban), any heightened protectionist stance on the part of the United States with regard to NAFTA or other trade-related actions could easily threaten rapidly growing crude oil exports due to retaliation by other countries in a growing protectionist environment.

The threat to the Texas and U.S. oil and gas industry resulting from the elimination of NAFTA or a renegotiation that diminishes its effectiveness as a North American free trade vehicle is clear — the loss of critical markets for domestic oil and gas, higher costs of doing business for domestic oil and gas producers and the corresponding job loss, and pinched supplies to domestic refiners. If NAFTA were to be done away with tomorrow, the effects would be immediate — lower prices for domestically produced natural gas and crude oil; natural gas in particular (and natural gas prices are anything but spectacular as it is).

Recognizing this threat, the Texas Alliance of Energy Producers Board of Directors adopted a resolution on Feb. 1, 2018, to communicate to the administration and its office of the United States Trade Representative the importance of NAFTA to the recent and continued success of the domestic oil and gas industry. The resolution highlighted the positive outcomes under NAFTA and acknowledged that there are aspects of the nearly 25-year old agreement that may need to be modernized and updated.

The central message of that resolution is as follows: (1) a renegotiated NAFTA should maintain the low/zero-tariff trilateral trade environment, (2) the agreement should be re-enacted with no “sunset provision” (the administration has suggested that a reworked NAFTA should have to be renegotiated every five years, which does nothing but hang an ever-present cloud of uncertainty over these matters), and (3) if an agreement cannot be reached on revamping NAFTA as a result of the current negotiations, then NAFTA should be maintained in its current form.

With regard to energy, NAFTA is not broken and does not need to be fixed. “Fixing” it will cost American energy jobs and unnecessarily raise costs to American energy consumers.

 

About the author: Karr Ingham Is an Amarillo, Texas, economist, and is the owner and President of InghamEcon, LLC, an economic analysis and research firm specializing in statewide, regional and metro area economics, and oil and gas/energy economics.

 

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