INTERNATIONAL

For all its economic importance in North America, what sets the energy sector apart from others is political sensitivity. Whenever prices spike in the United States, investigations are launched to find the culprit. In Canada, the energy sector is perhaps even more sensitive than that. In the 1980s, Canadian opponents of North American integration frequently cited sovereign control over energy resources as a reason for opposing the Canada-United States Free Trade Agreement (CUSFTA). Lingering sovereignty sentiments make the Canadian government reluctant to embrace the concept of a continental energy policy.

In Mexico, sovereignty issues are even more extreme, stemming from President Cardenas' nationalization of oil in the 1930s. The Mexican Constitution was amended to establish a state monopoly on energy production and distribution, creating barriers to both energy integration and market-oriented reforms.

Political sensitivities notwithstanding, economic forces are slowly integrating the North American energy sector. Faster integration—aided by cooperative policies—would bring considerable benefits. But while CUSFTA and the North American Free Trade Agreement (NAFTA) pointed in the right direction, energy policies and prices are still set within national borders.

The policy question is whether NAFTA can be extended to make the energy sector as integrated as the auto sector—widely considered the most integrated sector in North America. Integration in the auto sector has a long history, starting in 1965 with the bilateral Auto Pact between the United States and Canada. Energy integration did not really get going until the 1990s, and efforts to create a North American energy market will take time, especially considering political sensitivities. Still, over the next few years, forward steps are possible.

Canada & Mexico
Canadian and Mexican trade with the United States is the heart of North American commerce in the energy sector. (See Table 1.)

TABLE 1 ENERGY IMPORTS TO THE UNITED STATES, 1995-2001 (including coal, crude and refined oil, liquid propane and butane, natural gas, and electricity) Exporter 1995 1996 1997 1998 1999 2000 2001 Canada 13,228 16,189 17,385 14,716 17,318 31,261 34,190 Mexico 6,158 7,784 7,403 4,563 5,943 10,918 8,832 World 60,332 72,116 68,504 51,994 63,010 111,183 106,129

Energy trade between Canada and Mexico is very small, as is Mexican and Canadian energy trade with the rest of the world. Since energy prices are volatile, to get a handle on underlying trends, we find it is useful to focus on the volume of energy trade in North America rather than the value. While the volume of U.S. energy imports from Canada doubled in many areas since 1989, the free-trade agreements are not responsible for most of the growth. U.S. energy imports from Mexico have increased in some areas but not in others. Natural gas is the only area where U.S. exports have grown substantially to both Canada and Mexico.

In 2001, on a global basis, the United States produced 71.7 quadrillion (thousands of trillions) British thermal units (BTUs) of energy, exported 3.9 quadrillion BTUs, and imported 29.9 quadrillion BTUs, according to data from the U.S. Department of Energy. The nation's energy exports plus imports thus totaled about 47 percent of U.S. production.

By contrast, the U.S. manufacturing sector shipped $4.22 billion in 2000, while exporting $640 million and importing $1.04 billion, according to U.S. Customs and the International Trade Commission. Manufactured exports plus imports thus amounted to about 40 percent of U.S. production.

These figures suggest a comparable extent of international involvement by the U.S. energy and manufacturing sectors. However, behind-the-border barriers to energy trade are more severe than for manufacturing. Free trade is practically the norm for manufactured goods within North America, but the same cannot be said of energy. Policy liberalization within North America would likely stimulate substantially more trade in oil, natural gas, and electricity, and sharply boost the trade-to-production ratio.

U.S. Cabinet Group or NAFTA Group?
A couple years ago, the United States Energy Association (USEA) made several useful recommendations to liberalize North American energy trade. One recommendation was that a U.S. cabinet group be formed to "accelerate the development of an open and integrated energy market in North America." The result, the current North American Energy Working Group, has produced some moderately useful reports, but its influence pales in comparison to national levers of power in the energy sector. The Bush administration's energy policy has, rightly or wrongly, come under tremendous scrutiny due to the Enron scandal and the recent dispute (since dropped) with the General Accounting Office over the disclosure of energy-related documents. If the United States were to create another ad hoc energy group, its recommendations would be tainted with guilt by association. Moreover, North American energy policy is a trilateral issue and should be approached in that fashion. Unless Mexico and Canada are equal partners at the planning stage, they will not gladly participate when it comes to implementation.

The USEA recommended that the Federal Energy Regulatory Commission (FERC) be authorized to enforce the decisions of the North American Electric Reliability Council (NERC). This suggestion is a good idea, although it has limitations. Currently, the U.S. system of electricity regulation operates by voluntary compliance. As the sector has been deregulated, more firms are using electricity grids to compete against each other in providing power to customers. In this setting, firms tend to ignore voluntary standards. The standards need to be put on a mandatory footing, enforced by FERC.

A major obstacle is that FERC does not have jurisdiction over one-third of U.S. transmission facilities—that is, cooperatively owned and government-owned facilities. Legislation is needed both to ensure mandatory standards and to give FERC jurisdiction over all U.S. transmission lines. USEA does not address parallel enforcement issues in Canada and Mexico. However, if FERC is given the power to enforce NERC decisions in the United States, that could provide a model for Canada and even more so for Mexico.

Clean Energy Technology
The USEA also recommended that the United States and Mexico cooperate to promote U.S. exports of clean energy technology and equipment to the Mexican market. This has its pros and cons.

Encouraging the use of environmentally friendly energy is a noble goal, but Mexico is primarily concerned with obtaining enough energy to meet its needs. For Mexico, "state-of-the-art" environmental standards are a secondary concern. An aggressive attempt to promote U.S. clean energy exports might be perceived by Mexican nationalists as a covert attempt to undermine PEMEX and CFE, particularly if less stringent rules are applied in the United States. To avoid this sort of backlash, the United States should not deny Mexico electricity generated in accordance with U.S. environmental standards, nor should it ask Mexico to meet state-of-the-art environmental standards beyond those already enforced in the United States.

Meanwhile, the North American Energy Working Group should study the ways of advancing clean energy technology trade in North America. The voice of Canada, which is an international leader in environmentally friendly energy, would be prominent. Addressing these issues in a trilateral forum would put the focus on the shared goal of environmental protection rather than the narrower one of promoting U.S. clean energy exports.

Protectionist States?
Many states have renewable portfolio standards (RPS) that either require the use of renewable energy or give incentives to use renewable energy. Different states, however, have different definitions of renewable energy. Some definitions exclude hydroelectric power in general or hydroelectric power from dams above a threshold capacity. Also, some states have potentially discriminatory licensing requirements for establishing renewable energy plants or requirements that the renewable energy be generated in-state.

One goal of NAFTA is to ensure that legitimate environmental objectives are not achieved by arbitrary or protectionist restrictions. In-state production requirements are often viewed as a thinly disguised form of protection and deserve to be challenged by Canada and Mexico. Other licensing requirements may not obviously violate NAFTA, but they could be used arbitrarily to discriminate against applications from Canadian or Mexican firms.

The definition of renewable energy is a tougher case. For example, New Jersey considers hydroelectric power that is generated by facilities with less than 30 megawatts of capacity to be renewable, but 96 percent of Canadian hydroelectric power is produced by facilities with more than 30 megawatts of capacity. Under these circumstances, the 30-megawatt requirement could well operate as a disguised form of protection, especially if most of New Jersey's hydroelectric power generators are below the capacity limit.

The USEA asks that the National Association of Regulatory Utility Commissioners (NARUC), the National Governors Association, NERC, and FERC reconcile differing definitions of renewable energy. While this recommendation is well intentioned, it will be next to impossible for the governors and regulators to reach an agreement and then convince their respective legislatures to harmonize state laws. Since the definition of renewable energy affects both international and interstate commerce, which are matters assigned to Congress, the U.S. government should assert jurisdiction. A federal definition of renewable energy should reflect a trilateral consensus, reached in the North American Energy Working Group. States can make their own decisions as to the required proportion or incentives for the use of renewable energy in regional consumption, but the federal definition—insofar as it affects cross-border trade—should preempt conflicting state definitions. [Look for a feature story on RPS in EP's July/August issue.]

Infrastructure Security
As one of its last recommendations, the USEA proposes a coordinated approach towards protecting the security of energy infrastructure. The USEA is not specific when it comes to appropriate incentives for adequate security measures. Mexico and Canada seem less likely to be terrorist targets than the United States—and therefore the countries are less willing to spend serious money on protecting powerplants, oil and gas fields, and distribution networks. As an incentive, the United States might insist on security measures for facilities that sell substantial energy volumes to the U.S. market.

Pipelines
The construction of pipelines to transport oil and natural gas from Alaskan and Canadian fields to the lower 48 states is a matter of huge importance. It is no exaggeration to say that the resolution of the pipeline route issue will set the tone of Canada-U.S. energy cooperation for at least a decade.



In 2002, the U.S. Senate included in its failed version of an energy bill various incentives to build a pipeline from northern Alaska to Chicago via the "southern route"—a route that would run south across Alaska and then cut east through British Columbia and Alberta on its way to the Chicago hub. The alternative "northern route" would run southeast from Alaska underwater into the Canadian Northwest territories and then pass through northern British Columbia and Alberta before heading south on its way to Chicago. The northern route is more direct and might cost $2 billion less to build than the southern one. More important, it would better enable vast amounts of Canadian oil and natural gas to reach the U.S. market. The Senate preferred the southern route on the argument that it is more environmentally friendly and the political argument that a greater percentage of the line would pass through the United States, thus creating more jobs for union workers both in producing the pipe and constructing the pipeline.

Neither route is deemed economically viable by the private sector for the time being. However, a jointly subsidized pipeline makes sense in the context of a vision of energy independence for North America. What doesn't make sense is for the United States to act alone in subsidizing a more expensive pipeline that frays relations with Canada. Not surprisingly, in response to the Senate's proposed subsidies, Canada has threatened noncooperation on the Canadian portion of a southern route. Canada is rightly concerned that the southern route would adversely affect the development of Canadian oil and gas fields.

As a key element of energy cooperation, the North American Energy Working Group needs to negotiate a mutually acceptable pipeline route, with an agreement on shared public subsidies, rules for sourcing the purchase of pipe, temporary visas for Canadian and U.S. construction workers, and ultimate operation of the pipeline.

An agreement on the Alaska/Canadian pipeline could serve as the foundation and inspiration for energy integration, echoing the historic role played by the bilateral Auto Pact of 1965.

© 2008 Edison Electric Institute