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Life after Nafta

With talks over the deal at loggerheads, Canada's oil industry is contemplating what comes next

The obituary for the North American Free Trade Agreement (Nafta) hasn't yet been written, but Canada is coming to the realisation that the 24-year-old trade deal is all but dead. Despite marathon efforts to resuscitate the patient in Montreal this January, the corpse is growing cold.

Most of the dispute has centred around Canada's automobile manufacturing sector and protected agricultural industries. Oil has hardly figured in the negotiations, even though it is central to the trade relationship. Canada supplies 43% of US imports—some 3.5m barrels a day—which in turn accounts for 98% of its own exports.

Obviously, Canada will continue to be an important supplier to the US in the immediate term even if Nafta is indeed doomed. What is less clear is the impact it would have on the two countries' future energy trade.

Under Article 605 of the trade deal, Canada is obligated to maintain energy exports to the US as a percentage of its total output. The Americans pushed hard for the so-called proportionality clause in the original Canada-US Free Trade Agreement (Fta) in the 1980s following the Arab oil embargo and price shocks of the 1970s.

At the time it was hugely controversial in Canada. Economic nationalists opposed the clause arguing it gave Americans too much control over a vital strategic resource. Alternatively, it was backed by oil producing provinces—particularly Alberta, which accounts for 80% of Canada's production.

Thrashing Nafta would remove the US' preferential access to Canada's oil and theoretically allow Canada to limit shipments to American refineries and sell oil to whoever and wherever—China, namely—it pleases.

3.5m b/d—Canada's oil exports to the US

In reality, the inability—if not impossibility—of building new pipelines from the oil sands to Canada's east and west coasts means the only viable outlet for Canadian crude off the North American continent is through the Gulf of Mexico.

However, thanks to unconventional technology, Lower 48 oil production is rising to historic highs and imports are falling fast. American investors are increasingly abandoning Canada's oil sands in favour of greener pastures in unconventional basins, such as the Permian. The vast amount of heavy oil refining capacity on the US' Gulf Coast is a beachhead for Canada, but America's oil trade dynamics are changing fast.

The US becoming a major exporter in its own right makes it both Canada's largest competitor, as well as its largest customer.

What's equally uncertain is the process this economic divorce will take. Some observers suggest the Trump administration's threats to rip up the deal are bluster, a negotiating tactic to wring concessions out of both Canada and Mexico. This sense that negotiations aren't being carried out in good faith hasn't been appreciated on either side of the US' borders, and both Canada and Mexico have said they're willing to walk away. "No deal might very well be better for Canada than a bad deal," Canada's Prime Minister Justin Trudeau told an audience at the University of Chicago in February.

If Trump does follow through on promises to shred Nafta, he would have to convince Congress to sign off on the decision. The whole process would likely take more than two years and it's not clear if Trump's Republicans will control either house by then. History suggests he won't. If negotiations drag on, Trump might want to keep the issue on the table as a campaign issue in 2020.

For now, the US has agreed to extend talks past the informal early March deadline and try to hammer out a new deal.

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