Looming trade wars have made frequent headlines since the election of U.S. president Donald J. Trump. His view on the U.S.’ position in global trade is that for too long the country has been the “piggy bank” of the world.
Obviously, this has put some strain on relations with trading partners. Trump’s belligerent language and willingness to make use of the U.S.’ disproportionate influence in global economics through its financial and monetary system, has upset markets and partners. One area of attention is NAFTA. Although partners Canada and Mexico have been startled by the change of attitude of the U.S. towards the trade agreement, the negotiations could also provide an opportunity.
While China is the largest trading partner of the U.S. when measured in value, the total economic activity between NAFTA’s members is far greater. Trade between Canada and the U.S. reached a total of $647 billion in 2017, with a small surplus of $8 billion for the U.S. Regardless of these numbers, an unprecedented clash occurred between the partners, during and after the G7 summit of 8 and 9 June concerning the planned tariffs on Canadian products.
Spurred by president Trump’s strong language, Canada, Mexico and the U.S. have been renegotiating NAFTA. In the case of Canada, these talks are an opportunity to change certain aspects of the agreement concerning the crucial hydrocarbons sector. More specifically, the preferential access of the U.S. to the energy resources of its northern neighbour, which is a major impediment for Canadian policy and energy security. Canadian export faces strategic restrictions as the overwhelming amount of oil is produced in landlocked Alberta. The absence of sufficient infrastructure to either the east or west coast, and existing pipelines to the south mean that the majority of produced oil is sent to the U.S. Related: OPEC Meeting Could End Without Decision
According to the ‘proportionality clause’, article 605, Canada has to reserve a fixed ratio of its hydrocarbons production for export to U.S. customers regardless of domestic needs or federal policy. This effectively gives American companies considerable control over Canada’s resources. Under the deal, 75 percent of all oil produced and imported, and 50 percent of gas needs to be exported to the U.S.
This means that even under exceptional circumstances, such as the boycott of 1973 by Arab countries, Canadian oil earmarked for export could not be diverted for domestic purposes. Due to a lack of transportation options between east and west and the proportionality clause, most of the oil in Eastern Canada is imported. In 2016 around 900.000 barrels a day came from several sources costing around $14,4 billion per year.
The U.S. currently is the destination for 99 percent of Canada’s oil exports. This gives Washington and American producers a major strategic advantage as producers do not have many options. The price of West Canadian Select usually trades for $14 to $16 dollars a barrel less than the New York traded West Texas Intermediary due to quality differences and transportation costs. Earlier this year that had risen to $30 a barrel, but the difference has somewhat decrease recently.
The need for additional markets has increased due to two reasons. First, the shale revolution has dramatically increased the production of oil in the U.S., which hit 7 million bpd in April. Next to that, Canadian oil production is expected to rise with an additional 1.4 million bpd from currently to 5.6 million bpd in 2035. A combination of decreasing demand, rising U.S. production and increased domestic output requires additional destination markets.
Some politicians and other stakeholders have been lobbying to revitalize the Energy East pipeline that would transport oil from Alberta to the eastern shores of Canada. It would greatly reduce the dependency on the international markets and increase the share of domestic consumption. Obviously, the latter has consequences for the preferential access of U.S. companies to Canadian oil as the share of export to the south would decrease.
To the west, as early as 2013, Houston based Kinder Morgan started with the planning and construction of a second part of the Trans Mountain pipeline to triple capacity from Alberta to the shores of British Columbia for transpacific export. However, the decentralized political system, British Colombia’s strong disapproval of the construction of the pipeline, and the uncertain regulatory environment led to the withdrawal of the U.S. company and the (temporary) nationalization of the pipeline.
Although the government of Justin Trudeau has received a lot of criticism for bailing out the U.S. company and its unfinished multibillion dollar project, the pipeline could significantly improve Canada’s position on the negotiating table. By providing producers alternative options and markets (at least in part), negative developments for the Canadian energy sector can be mitigated by supplementing supply and demand of different regions. Furthermore, extra capacity is a bargaining chip in the hand of Canada’s negotiators vis-à-vis the U.S.’ as the proportionality clause is a serious impediment for the oil industry.
By Vanand Meliksetian for Oilprice.com
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