NAFTA: The Biggest Economic Wild Card in 2018

Hand’s down: It’s the biggest economic question for Canada entering 2018.

Will current talks to update the North American Free Trade Agreement (NAFTA) involving Canada, the U.S. and Mexico — a central plank in U.S. President Donald Trump’s 2016 election campaign — end in a successful re-negotiation or will it conclude in failure?

Through five rounds of talks in 2017, observers say negotiators have made progress in several areas, including digital trade, telecommunications, anti-corruption and customs procedures.

But a number of stumbling blocks have emerged.

Canada and Mexico have rejected Washington’s demand that 50 percent of American autos and auto parts be made in the U.S. The parties also continue to argue on the mechanisms to resolve trade disputes, as well as U.S. demands for a sunset clause and a buy-American-first policy for U.S. government procurement.

The countries meet again Jan. 23 in Montreal for the sixth and penultimate round of negotiations, which some describe as make-or-break.

“At the end of the day, the bedrock question remains unanswered: do the Americans want a new deal on NAFTA or not,” L. Ian MacDonald, editor of Policy Magazine and formerly Minister of Public affairs at the Canadian Embassy in Washington, wrote this month for iPolitics.

“We may have a better idea after the last week of January in Montreal.”

North American Energy Industry Positions

The NAFTA agreement, which entered into force in 1994, affects all parts of the Canadian economy, but has also played a critical role supporting and growing North American energy integration, interdependence and energy security by eliminating tariffs for crude oil, gasoline, kerosene-type jet fuel and other refined products, and for energy-intensive manufactured goods.

NAFTA also has liberalized energy trade, provided investment protection and served as the foundation for recent access to Mexico’s hydrocarbon reserves.

In a jointly issued position paper released in 2017 by the American Petroleum Institute (API), Asociación Méxicana de Empresas de Hidrocarburos (AMEXHI), and Canadian Association of Petroleum Producers (CAPP), the organizations said negotiators need to adopt a “do no harm” perspective.

“… While there is an opportunity to update the agreement in some areas, any changes that disrupt energy trade across our North American borders, reduces investment protection, or reverts to high tariffs and trade barriers that preceded NAFTA, could put at risk the tens of millions of jobs that depend on North American trade and interdependent energy markets,” the groups said.

Energy firms also worry the end of NAFTA could eliminate investment protections, including the Investor-State Dispute Settlement (ISDS), which allows such conflicts to be settled via international arbitrators, overriding contractual clauses that only reference local courts.

Organizations such as API, AMEXHI and CAPP support preservation of NAFTA’s provisions for strong investment protections and ISDS, including rules that restrict expropriation of investments and that provide for prompt, adequate and effective compensation if expropriation does occur.

Business Uncertainty

There are already signs that NAFTA-related uncertainty is weighing on Canadian businesses, however.

A survey conducted by Export Development Canada (EDC), released in December, said nearly one-quarter of Canadian exporters reported feeling negatively impacted by the NAFTA negotiations and, among that number, 14 percent were delaying investments, 26 percent were contemplating moving some operations to the U.S., and 23 percent wanted to diversify outside North America.

Some survey respondents also indicated they were delaying or cutting their levels of investments and employment in response to concerns of the status of NAFTA.

“…While companies aren't necessarily panicking, we found that almost one-quarter of Canadian exporters said that the ongoing NAFTA renegotiation was having a negative impact on their Canadian operations and they already are or plan to implement strategies to mitigate this," said EDC chief economist Peter Hall.

In the context of elevated U.S. trade policy uncertainty, the EDC said the survey revealed a significant drop in the number of Canadian exporters planning to export to the U.S. market in the next two years.

Fight or move on?

Vincent Lauerman, president of Calgary-based energy consultancy Geopolitics Central, believes NAFTA is all but dead.  And there are many advantages for Canada in moving on.

The Trudeau government faces a choice, he wrote in a recent column for the Daily Oil Bulletin.

“It can accept this reality [of a failing NAFTA] and make the best of a bad situation or it can fight the inevitable and risk a Trump trade tantrum. The latter would likely have a far greater negative impact on the Canadian economy, and our oil and gas industry as well.”

A messy NAFTA divorce would substantially increase the cost to Canada if Trump decides to impose additional tariffs, quotas and other trade barriers.

On the relatively bright side, natural resources have become an increasingly large part of Canadian exports since the turn of the century, and Canada tends to be the preferred supplier for such products into the U.S. given our transportation cost advantage — NAFTA or no NAFTA.

If NAFTA does collapse, the Trudeau government should take this ‘opportunity’ to further deepen U.S.-Canada energy relations, Lauerman says. U.S. Energy Secretary Rick Perry made it clear in the months prior to the start of the NAFTA renegotiation he would like Canada and Mexico to forge a North American energy strategy with his country. Mexico is becoming an increasingly important market for U.S. natural gas and petroleum products, but Mexican Economy Minister Ildefonso Guajardo has indicated that his country’s ‘Plan B’ would intentionally avoid importing American goods in retaliation for a NAFTA collapse.

“In this case, Canada could easily appear the good neighbour while serving our own interests by ‘guaranteeing’ the export of our oil and gas to the U.S. market,” Lauerman says. “The Trudeau government could even offer to do so on a proportional basis in case of emergency — in line with NAFTA’s current ‘proportionality clause’ — in return for a guarantee to not tax or otherwise impede our energy exports, including electricity.”

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