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Nafta 2.0: Dealing with the Devil

Despite being such a prominent component of the trade relationship, energy has hardly come up in Nafta talks. That could change

It's well known that Canada and the US share the longest undefended border in the world. What's less acknowledged is that they also share the world's largest bilateral trading relationship, amounting to almost $1 trillion a year, a partnership which has more than doubled since the North American Free Trade Agreement (Nafta) was implemented in 1993.

A substantial chunk of that trade is in oil. Energy alone accounted for a fifth of all Canadian exports to the US in 2016—and that was in a year when oil prices were down, according to the Energy Information Administration.

Now, President Donald Trump is threatening to upend a status quo that began with the Canada-US Free Trade Agreement in 1988 and ultimately culminated in Nafta, which brought Mexico into the fold. Since then, they have been dubbed the Three Amigos, but the relationship has been anything but friendly since Trump was elected to the White House last November.

That Trump is unhappy with the pact—which he has dubbed "the worst" trade deal of all time—isn't in doubt. When the renegotiations formally began in Washington DC in August, Canadians had every reason to believe the wrath of Donald Trump was squarely aimed at Mexico, a regular target of derision and scorn.

However, it's become increasingly apparent that Canada too is in the crosshairs. US trade representatives have made clear they intend for nothing less than a drastic overhaul of the 25-year old treatise.

To the dismay of Canadian officials, they are left wondering exactly what that means, with little more to go on than Trump's Twitter missives. "We are in the Nafta (worst trade deal ever made) renegotiation process with Mexico and Canada. Both being very difficult, may have to terminate?" he opined into the Twittersphere on 27 August.

The 128-character outburst failed to note that Canada is by far the largest source of US oil imports at 3.5m barrels a day.

Given the prominence of energy in the trade relationship, it's surprising how little it has been brought up. The only mention of energy in a July statement from the Trump administration on its Nafta objectives was a bland commitment to "North American energy security and strong markets."

That could change as negotiations move along. That is because of a relatively obscure clause in Nafta known as proportionality. The clause guarantees the ratio of Canadian exports of oil, natural gas, coal, electricity and refined products would remain consistent in the event of a corresponding reduction in domestic production due to a supply disruption at home. In other words, Canada can't cut off its US customers to divert supplies to the domestic market in an emergency.

'We are in the Nafta (worse trade deal ever made) renegotiation process with Mexico and Canada. Both being very difficult, may have to terminate?'

Given the US' reliance on Canadian oil, this has been a prized principle in the trade relationship.

It's considerably less popular north of the border. Nationalist groups, including the Council of Canadians, have long argued the clause gives the US too much control over Canadian oil production.

More recently, environmental groups complain the clause restricts Canada's ability to reduce oil sands output to meet greenhouse gas reduction targets in the Paris Treaty, which president Trump infamously pulled the US out of. The Canadians have proposed binding environmental standards in Nafta 2.0—code for a North American carbon tax—although American officials have made clear this is a non-starter. Canada's federal government has vowed to impose a carbon levy of C$50 ($40.50) per tonne of carbon dioxide starting in 2020.

The Conference Board of Canada, a non-partisan think tank, has complained the clause isn't fair because it doesn't apply to Mexico which retains tight government control over its own oil industry despite moves to open it up to foreign investment.

Even Canadian business groups have suggested the proportionality clause is outdated given that the US is now an oil exporter. It has never been invoked. But it's not clear that the US is willing to give it up, especially if it were to sanction Venezuela's oil imports.

Thus, Canadian officials hold a strong card in the negotiations. They'd do well to reread Trump's biography, The Art of the Deal, for clues on how to play it.

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