Canada—Petroleum Superpower or Super-slave?

Our economy is anchored in the North American marketplace by our Free Trade Agreement with the United States and Mexico. It gives Canadians – and investors in the Canadian economy – secure access to the huge U.S. market. But again, our trading relationships are not quite as one dimensional as people tend to think. Our links to the Asia-Pacific region are growing, and we’re upgrading our West Coast port and highway infrastructure to make it the primary Gateway for Asia-Pacific trade with North America. As a share of our total trade, our commerce with the U.S. has actually declined nearly 10% since the turn of the century. During the same period our trade with other parts of the world, including the E.U., has been increasing. However, despite the growing diversity of our economy, it remains true that natural resources and the U.S. market are our strongest economic assets. Indeed, it is no exaggeration to call Canada an “emerging energy superpower” and a “global mining giant.”
from a speech by Steven Harper, PM of Canada June 2007 BERLIN, GERMANY 

This is an addendum to my earlier article, Trends in Canadian Petroleum Production and Consumption, to explain why I have amended Figures 4 and 5 and corresponding discussion in that article to account for additional Canadian export obligations to the USA that I was not aware of when I originally published that article on November 7, 2010.

Canada’s obligation to the USA under NAFTA

What kind of bone-headed banana-republic politician would obligate their country, in perpetuity, to supply oil to another country, regardless of what that country’s own internal domestic oil consumption needs are?  Only in Canada you say?

Yes indeed, Canada, in signing the NAFTA agreement, obligated itself to never reduce its proportion of petroleum exports to the USA.  The specific provision is in Chapter 6, Article 605(a) reads in-part as follows:

Article 605: Other Export Measures

Subject to Annex 605, a Party may adopt or maintain a restriction otherwise justified under Article XI:2(a) or XX(g), (i) or (j) of the GATT with respect to the export of an energy or basic petrochemical good to the territory of another Party, only if:

(a) the restriction does not reduce the proportion of the total export shipments of the specific energy or basic petrochemical good made available to that other Party relative to the total supply of that good of the Party maintaining the restriction as compared to the proportion prevailing in the most recent 36-month period for which data are available prior to the imposition of the measure, or in such other representative period on which the Parties may agree;

That is, Canada can only restrict petroleum (or natural gas) exports to the extent “the restriction does not reduce the proportion .... as compared to the proportion prevailing in the most recent 36-month period for which data are available prior to the imposition of the measure.”  This basically means that Canada can never restrict its proportion of exports to the USA below the most recent 3-year average proportion. 

Interestingly, this provision was not agreed to by Mexico, nor did the USA agree to this with respect to Mexico.  

The Parkland Institute in Canada, who advocates ending this “proportionality clause” have noted that NAFTA Article 605 really has put Canada over a barrel: 

Proportionality is an obscure sounding clause which requires Canada to maintain its current share of energy exports to the United States, even if Canadians experience shortages. It effectively guarantees the U.S. access to Canada's energy resources in perpetuity, or until NAFTA and the FTA are renegotiated or ended, or the resources run out.

This clause is unique in all of the world’s treaties. Even Canada’s fellow NAFTA partner and major oil exporter, Mexico, is exempt.

.....

Both conventional oil and gas have already peaked in Canada. Canada imports about 49% of its oil needs, with almost half its imports coming from very insecure sources ' OPEC countries. Unlike all other IEA member countries, Canada has no Strategic Petroleum Reserves.

Meanwhile, Canada is obligated by NAFTA's proportionality clause to make two-thirds of its domestic oil production and 60% of its current natural gas production available for export to the U.S., even if Canadians experience shortages.

Most Canadians assume that Canadian energy supplies will be there when they need them. It hasn't dawned on most Canadians that their governments have signed away their right to have first access to their own energy supplies.

At the time the NAFTA agreement was signed in 1994, Canada did have a terrible trade balance problem, which it eventually turned around quite nicely, as recently discussed by Mauldin. So maybe this didn’t seem like such a bone-headed thing to agree to, at the time.  Nevertheless, the result is that Canada is obligated to export major fractions (the majority) of its total oil and gas production to the USA—forever or until it runs out.  Wow.

One implication of this “proportionality clause” is that, although as shown in Trends in Canadian Petroleum Production and Consumption, Canada is a net petroleum exporter, it still has to import petroleum to cover the excess (i.e., the excess over net production minus domestic consumption) petroleum it sends to the USA.  Up till now, that had not been a problem, because importing petroleum from Europe, the Middle East and from the USA, has been cheaper than shipping oil from Western Canada (mostly Alberta and more recently Saskatchewan) to Eastern Canada (mostly Ontario, Quebec and the Maritime Provinces): 

Canadian energy imports, mostly crude oil, are widely dispersed geographically. After rising rapidly during the late 1990s, they declined, only to shoot up again in 2003. But at $20 billion they still account for just 6% of all imports in 2003. The import price of oil over this time period was very volatile, dropping 25% in 1998 before recovering. Canada exports three times the amount of energy it imports; at 15% of all exports, it was our fourth largest export last year.

Regionally, despite a recent dip, almost 40% of our energy imports originate in Western Europe, mostly Norway and the UK. The US has maintained a fairly steady share in the low 20s. Imports from the Middle East have fluctuated from 13% in 1993 to just 6% in the late 1990s, but have climbed back to 11% in recent years. Algeria dominates imports from Africa, with 72% of Africa’s energy exports to Canada in 2003, up from just 9% in 1990. South American imports have tapered off from their peak near 10% in the late 1990s (when they picked up the slack from the Middle East) to just 4% in 2003.

By country, our largest source of oil is the US at $4.7 billion, up from $1.9 billion in 1990. This is a reflection of the reason we import oil: despite our overall surplus in meeting domestic demand, refineries on the East Coast find it easier to import crude from the US and Europe than to have it piped from Western Canada. As well, refiners find the oil from some regions easier to process than others.

Table 1: Energy Imports in 2003

From	$000,000	%
Europe	8,405	41.8
United States	4,735	23.5
Africa	3,310	16.5
Middle East	2,265	11.3
Latin America	1,301	6.5
Asia	104	0.5

Other sources in 2003 include Norway at $3.9 billion, Algeria at $2.4 billion and Iraq at $1.1 billion. Oil is virtually the only commodity these countries ship to Canada.

From: Canada’s Imports by Country, by C. Bloskie

But what will happen to Canada if (when) the oil from these foreign sources dries up?  It would seem that Eastern Canadians are just supposed to freeze in the dark because, by gosh, NAFTA says that the USA has to get its proportionate share of Canadian production.  The Council of Canadians has expressed this very concern:

Can Canada replace the oil it imports with resources from its own territory if our suppliers become unreliable, or if an oil crisis becomes a reality? The answer is a resounding NO! Under NAFTA, we must keep sending the same proportion of our oil to the United States no matter what happens on the world stage. Article 605 of NAFTA only allows us to reduce exports to the U.S. if we cut our domestic supplies by the same proportion. Furthermore, we can’t charge the U.S. a higher price than the one in Canada and we can’t disrupt or restrict the normal channels of supply. What are those normal channels? A huge network of 16,000 km of pipelines sends Canadian oil south, mainly to the American mid-west. At the moment, no pipeline takes Alberta’s oil to eastern Canada.

To be balanced, I should note that others, such as Michael Holden, do not interpret NAFTA Art. 605 as restricting Canada’s ability to export to the USA but rather to limit the government’s ability to enable export controls: 

Article 605 of NAFTA has been interpreted by some to mean that Canada is required to sell a certain percentage of its energy output to the United States, even in the face of a severe domestic shortage.  Moreover, they argue that NAFTA prevents this percentage from falling over time.

Neither of these statements is hue. Canadian producers are free to sell as much oil as they wish to whomever they wish, including, for example, overseas customers. As a result, the share of total output exported to the United States can rise or fall according to the normal forces of supply and demand.

The only condition that NAFTA imposes on Canadian energy products is that all buyers in North America must have equal rights to buy those products.

Article 605 does stipulate that energy exports to the United States as a percentage of total output cannot fall. However, this does not refer to the day-to-day, operation of the Canadian energy sector. It is valid only as a limitation on the extent to which the Canadian government can interfere in energy markets.

NAFTA prohibits the Canadian government from imposing (under normal conditions) any restriction that causes U.S. imports of Canadian energy to fall.  In essence, therefore, NAFTA does prevent the Canadian government from imposing a policy like the National Energy Program in the 1980s.

However, as even Holden had to admit Art. 605 stipulates that exports as a percentage cannot fall.  Moreover, Holden seems to be oblivious to the potential impact of peak oil, where oil could not be bought on the global market at any price, or at least at a much higher price than it would take to ship oil from western to eastern Canada. 

Estimating the proportion of petroleum shipped from Canada to the USA

Figure 1 shows a plot of the annual percentage of Canada’s total petroleum exports to the USA relative Canada’s total petroleum production from 1980 to 2008.  The data is from the EIA’s energy page for Canada  The historic data for total exports to the USA was particularly hard to extract: it only appears in a pop-window when the graph corresponding to “Total Oil Exports to the USA” is clicked, and I hover my mouse over each individual data points. 

It is not quite a straight line (r²=0.97; linear regression analysis of the slope) but the overall trend is for the proportion of petroleum from Canada to the USA to linearly increase by 1.66 percent per year.  This trend has slowed down to 1.15 %/yr over the last 9 years (regression slope from 2000-2008), but still, if this recent trend were to continue, then in about 21 years, Canada would be shipping all of its petroleum to the USA. 

For instance, for 2008, the last year with complete data, Canada shipped a whopping 75% of its total production (about 2.5 mbd) to the USA.  This is despite the fact that Canada’s net exports (production minus domestic consumption) was only about 1.1 mbd.  These numbers are fairly consistent with the EIA’s Country Report for Canada:

In 2008, Canada exported 2.5 million bbl/d of crude oil and refined products to the U.S., the single-largest source of U.S. oil imports and representing almost all of Canada’s total oil exports. The largest share of U.S.-bound Canadian oil exports go to the Midwest (PAD District II), followed by the Rocky Mountains (PAD District IV). The bulk of Canadian exports to the U.S. have traditionally gone to PAD Districts II and IV, because these areas are well connected to Alberta by oil pipelines and not well served by coastal import terminals.

....

Even though Canada is a net oil exporter, it imports sizable quantities of crude oil and refined products. According to the International Energy Agency (IEA), Canada imported around 1.2 million bbl/d of crude oil and refined products in 2008. Canada’s major population centers in the eastern part of the country are not well connected to its principle production facilities in the western interior, meaning that it is often easier to import oil along the coastlines rather than transport it domestically. Most oil imports come from Algeria (crude oil), Norway (crude oil) and the U.S. (refined products).

No mention of NAFTA Art 605 here! 

Application to Export-Land model Considerations

Based the data shown in Figure 1, the last three-year average of the proportion of Canada’s production shipped to the USA equals 73 percent.  We know from NAFTA Art. 605 that the proportion to the USA cannot be decreased below this number. 

Canada does make some of this back, because as shown in the above cited Table 1, about 23.5 percent (as of 2003) of its petroleum imports came from the USA.  Therefore of the 1.2 mbd that Canada imported in 2008, about 0.28 mbd came from the USA.  This corresponds to about 12% of Canada’s consumption in 2008.  Presumably the USA is also obligated not to reduce this percentage under the NAFTA “proportionality clause.”

Therefore, to account for this in my export analsysis, the net petroleum exports from Canada to the USA should equal total petroleum production (TPP) times 0.73, minus total petroleum consumption (TPC) times 0.12:

Canadian exports = TPP*0.73 – TPC*0.12

I have revised my previously published graphs showing Canada’s predicted future net exports to the USA in accordance with this formula as applied to the numbers extracted from the BP statistical review.

For instance, FIG. 4 in Trends in Canadian Petroleum Production and Consumption, is now revised from this:

 To this:

 And, FIG. 5 in Trends in Canadian Petroleum Production and Consumption, is now revised from this:

To this:

I have also applied these corrections to the final figures and pertinent discussion points in the two subsequent articles, Trends in Mexican Petroleum Production and Consumption, published Nov 20, 2010, and Trends in Venezuelan Petroleum Production and Consumption, published Nov.25, 2010.

Implications for the USA and Canada

As a result of these corrections the petroleum exported to the USA from Canada shown on the revised graph is more than double as compared to the original graph because Canada ships more than double of its net exports to the USA even after accounting for the petroleum products shipped back from the USA to Canada. 

Just how long would this agreement last if, for example, there was a global petroleum shortage, and Canada was no longer able to import petroleum to make up for the excess petroleum it sends to the USA that is over its net production over consumption?  If a situation arises where Canada is unable to import petroleum from the Middle East or Europe, then I think that it is safe to assume that the USA would also be unable to import from these locations as well.  Would Canada just keep its own oil just for its own use? 

This would appear to violate NAFTA article 605, but even if we were to set aside the NAFTA proportionality clause, Canada keeping its own oil for its own domestic use is probably not possible.  At present, there is no pipeline that goes from western to eastern Canada and plans to build such a pipeline is only the dream of a few (see e.g, Canada: an oil importer??   and Canada’s national pipeline dream ).  As such, Canada has no practical means to ship its oil, produced mostly in western Canada, to eastern Canada without using the pipelines that go to the USA.  Therefore if there was an oil crunch, Canada would seem to have no choice but to send its oil south to the USA, in exchange for the roughly order-of-magnitude lower amount of petroleum products that the USA ships back to Canada.