of Proportional Sharing of Energy Products between the U.S. and Canada

NAFTA 2.00: The End of Proportional Sharing of Energy Products between the U.S. and Canada

Previous articles in this series on the new USMCA have touched on some of the unexpected benefits for Canada stemming from the projected replacement of NAFTA by the new agreement. Among the benefits mentioned have been the revision of rules of origin on trade in automotive products to create more incentives for investment in production facilities in the U.S. and Canada. A second benefit for Canada which only surfaced late in the negotiations, is the three- year phaseout of the investor state dispute settlement provisions as between the U.S. and Canada contained in NAFTA Chapter 11. In practice, Chapter 11 procedures have overwhelmingly favoured U.S. private sector investors at the expense of Canadian taxpayers and stymied non-discriminatory public policy initiatives in sensitive sectors such as environmental protection.

The third benefit flowing from the new USMCA agreement is the abrogation of the “proportional sharing” provisions of NAFTA Article 605. These provisions originated in the Canada-U.S. Free Trade Agreement in 1988 and were very much a product of the specific negotiating dynamics surrounding that agreement. Following the collapse of the negotiations in 1987 and the return of the Canadian Chief Negotiator Simon Reisman to Ottawa, the Canadian government made a policy decision to put energy trade up for negotiations with the U.S. as a means of enticing American negotiators back to the table. It is important to remember that in 1988, the U.S. was a very significant net importer of oil and gas products (around 47% of U.S. oil consumption came from imported sources in 1988) and Canadian supplies to U.S. refiners were becoming increasingly important to U.S. energy security. It is no exaggeration to say that the inclusion of energy in the negotiations likely tipped the balance in favour of the resumption of negotiations and ultimate conclusion of the 1988 free-trade agreement between Canada and the United States. It did so however at a high price to Canada in terms of the independence of Canadian regulatory authorities.

Regulation of export volumes of oil, gas and electricity to the United States which was, and remains far away the largest customer for Canadian energy, has been an integral part of the Canadian energy policy. The NAFTA “proportional sharing” clause (which ostensibly operates in both directions), was designed to prevent the Canadian government from reducing U.S. access to Canadian oil, natural gas, coal, electricity and refined petroleum products without a corresponding reduction in domestic Canadian access to those same products — in other words, the ratio of energy exports to the U.S. to total Canadian domestic supply must remain the same i.e. “ proportional”. As well, price discrimination as against the other party is prohibited (i.e. no more fixed export prices for energy exports higher than domestic prices) and there is also a prohibition on disruption of normal channels of supply or product mixes. In actual effect, the clause vastly reduced the role of the National Energy Board in the control of Canadian exports. It was well-received by many in Western Canada at the time as many in the energy industry saw it as an important impediment to reintroduction of export controls pursuant to a potentially reemergent National Energy Policy.

What was not widely publicized at the time was that the proportional sharing mechanism would, if triggered, work overwhelmingly in favour of the U.S. This is so because of the national security clause in NAFTA Article 2102 which preserves the ability of all three parties to take measures necessary to preserve what they judge to be their own national security interests. Canada, in essence, agreed to heavily constrain its prerogatives to impose regulatory measures for economic security considerations and made the quasi-totality of its energy supplies available to the U.S. The U.S. on the other hand, has maintained for many years, enormous supplies of oil in its Strategic Petroleum Reserve (over 700 million barrels). In the event of a major supply crisis, Canada would have no access to this reserve as the U.S. would be entitled to preserve such supplies for itself for reasons of national security.

So why has the U.S. agreed to the abrogation of a clause that guaranteed privileged access to the energy supplies of one of the largest energy suppliers in the world? The answer very probably lies at least in part in the re-emergence of the U.S. as a major oil and gas supplier as a result of its dynamic new shale oil industry. Imported oil accounted for around 35% of U.S. consumption before the 1973 oil crisis and steadily rose to a peak of 60% in 2005. Owing to the shale oil boom in the first decades of this century, imported crude oil fell once more to around 35% of total U.S. consumption by 2013. The 1970’s U.S. ban on exports of oil without a permit was lifted in 2015. Shale oil supplies are projected to continue to grow quickly. In 2014, the U.S. became the world’s third largest oil producer, after Saudi Arabia and Russia. In a word, Canada is no longer as important an energy supplier to the U.S. as it was.

As well, there is now an increasing possibility that the proportional sharing clause, which works in both directions as between the U.S. and Canada, might conceivably in some circumstances result in U.S. obligations not to reduce energy exports to Canada. Given the current U.S. Administration’s preoccupation with national sovereignty and the progressive dismembering of perceived international constraints on U.S. economic prerogatives, that prospect was likely not attractive to the U.S. Administration. Hence U.S. negotiators did not insist on the preservation of the provisions of NAFTA Article 605 in the new USMCA.

Canadians should be pleased with this result. If confirmed in the final text of the USMCA, the removal of proportional sharing will remove certain highly restrictive constraints on the development of Canadian energy policy in the 21st century. This does not suggest that the reintroduction of NEP-style export controls is desirable or feasible. However given the many challenges confronting Canada and other like-minded countries, regulatory flexibility will be needed for the Canadian government to deal effectively with emerging challenges, such as climate change and the transition to a carbon-neutral economy. The removal of proportional sharing obligations will assist significantly in that regard.

Mark Sills
Pilot Law LLP
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