How would the Trump Administration Impact the U.S. Natural Gas Market? Part I: NAFTA

*This paper is the first part of a research conducted for the Bloomberg New Energy Finance under the capstone workshop program of the School of International and Public Affairs (SIPA) of Columbia University in Spring 2018 Semester.

Executive Summary

The Natural Gas trade in North America has boomed since the shale revolution. The cheap shale gas resources in the USA and the free trade agreement (NAFTA), enabled US companies to export gas to Mexico and to import even cheaper gas from Canada. The imported/exported gas is treated as a national commodity under the provisions of the Natural Gas Act. The volume of the gas trade between Mexico and the USA has further increased after Mexico liberalized its oil and gas sector in 2013. However, the Trump administration’s promise of “bringing the [manufacturing] jobs back” threatens this trade. In this paper, we shall discuss the possible effects of NAFTA’s cancellation or renegotiation on the natural gas trade in North America. 

?      The USA became a net natural gas exporter in 2017 for the first time in history. 

?      Around 50 percent of its export went to Mexico and 97 percent of its import originated from Canada via pipelines. 

?      The USA exported on average 4.2 Bcf natural gas per day to Mexico. The pipeline export capacity to Mexico was 7.3 Bcf per day.[1] Therefore, the pipeline utilization rate was on average sixty-one percent in 2017. 

?      The USA imported on average 8.07 Bcf per day from Canada in 2017. NG Pipeline import capacity from Canada 21 Bcf per day[2]. Therefore, the pipeline utilization rate was around 38% in 2017. 

?      Mexico and Canada are free to trade agreement (FTA) countries. Therefore, natural gas imported from them into the United States requires national treatment for its trade. [3]

?      Under NAFTA, US companies can start trading with FTA countries within a few weeks under the “blanket authorization” issued by the Department of Energy.[4]

?      Cancellation or renegotiation of NAFTA would increase the time required for obtaining permissions and the cost for the companies as they have to go through the public and environmental reviews. It would also lead to the imposition of new tariffs by 20%. 

?      The presidential elections in Mexico in July 2018 could also have an impact on the gas trade. If the leftist candidate is elected, the Mexican government could also impose new tariffs on foreign companies.[5]

?      However, cancelation of NAFTA would not impact the U.S. – Canada trade relations as much it would impact the U.S. – Mexico trade. 

1.      Current policy situation

Natural gas has been traded in North America under NAFTA since 1993. Because Canada and Mexico are Free-Trade Agreement countries (FTA), the USA has preferential treatment under the National Gas Act.[6] According to the Department of Energy (DOE), the import and export of natural gas (including LNG) from and to a nation with which there is in effect a free trade agreement require national treatment for trade in natural gas, and the authorization should be granted without modification or delay as the trades with FTA countries are considered to be in public interest.[7]

Under these provisions, US companies have two ways to export. The first procedure is called a two-year blanket authorization. According to Bordoff and Walsh, companies, after applying to DOE, receive the export permits in a couple of weeks under blanket authorization. Likewise, companies that have long term contracts can obtain their permits in a couple of months. In either case, the companies do not have to go through public interest or environmental reviews which would increase the time required to “start pumping”, and the cost, and it would create uncertainty. Yet, we know that since the natural gas production boom in the USA thanks to shale, companies have been obtaining permits to export to many non-FTA countries in Asia and Europe. Without an FTA, trade is still possible; however, considering all contracts and business plans in North America have been done under current policy, the NAFTA debate creates stress. 

Canada

The Congressional Research Service (CRS) report indicates that NAFTA facilitated the integration of the North American market, particularly the Canadian and U.S. natural gas markets so that they are viewed as one market by the industry. For example, rather than circulating the gas inside Canada, Canadian gas is usually imported to U.S. and U.S. exports it back to Canada because of transportation facilities and low cost.[8]  

Under these conditions in 2017, U.S. imported on average 8 Bcf/d natural gas from Canada which counts for 97% of U.S. total gas import. Under current policy conditions, EIA predicts that the gas trade will be around 8 Bcf/d until 2019 and then decline every year slightly. EIA expects that on the Western part of the continent U.S. imports of natural gas from Canada will remain relatively stable for the next few years before declining from historically high levels. U.S. exports of natural gas to Eastern Canada will continue to increase because of Eastern Canada’s proximity to U.S. natural gas resources in the Marcellus and Utica. 

However, the U.S. LNG export projects to the rest of the world may face competition from Canadian projects. CRS claims that projects to take Utica and Marcellus shale gas to world markets would be done through Canada as transportation costs would be even lower.  The graph below shows how Canada and U.S. gas markets are integrated and treated like one unified market.

Mexico 

Mexico signed the NAFTA in 1993, yet the gas trade between Mexico and the USA has increased only after Mexico’s energy reform in 2013. Sixty percent of the Mexican electricity generation depends on cheap natural gas from the U.S.[9] According to EIA, U.S. NG pipeline export capacity to Mexico was around 7.3 Bcf per day, and pipeline export to Mexico was around 4.2 Bcf per day which accounts for 55 percent of Mexican natural gas usage. At the end of 2017, with the completion of 3 new pipelines, the capacity increased to 10 Bcf per day. EIA claims that this number will be 14 Bcf per day by the end of 2018. Likewise, Mexico is expanding its domestic natural gas pipeline network with 12 additional gas pipelines which have a total additional capacity of 9.7 Bcf per day. EIA states that the increase in U.S. pipeline exports to Mexico is displacing Mexico’s LNG imports. For example, the Los Ramones Phase I pipeline in Mexico (2.1 Bcf/d capacity), which went into service in 2014, displaced LNG imports at the Altamira terminal with natural gas from Eagle Ford.[10]

According to EIA’s 2018 Annual Outlook where assumptions are based on current policy conditions, in the reference case, pipeline exports to Mexico increase until 2020. However, by late 2020s LNG export to the rest of the world is expected to exceed pipeline export to Mexico and become the main driver of U.S. natural gas export. Simultaneously, EIA expects Mexico to produce enough of its own natural gas by mid-2020s for its electricity generation and industry. The graph below shows the EIA’s projections on US gas import and export rates by 2050. 

Source: EIA 2018 Annual Energy Outlook[11]

2.      Policy Proposals: Cancellation or renegotiation of Trade Terms 

While NAFTA provided clear benefits for the U.S. domestic market and although the Trump administration would like to increase U.S. gas exports, Trump’s election campaign promises of “bringing the job back” makes the future uncertain. NAFTA’s cancellation or renegotiation would have several consequences affecting the national treatment of traded gas with FTA countries.  Firstly, the exporting companies would have to go through public interest and environmental reviews to start exporting, basically eliminating the two-year short-term blanket authorizations. This new procedure would potentially cause delays in trade and increase the operating expenses of midstream companies.  Secondly, the capacity factor (utilization rate) of the existing pipelines would decline and new pipeline investments would chill down. The pipeline utilization rate between the U.S. and Mexico is currently around 60 percent; whereas it is around 38 percent between the U.S. and Canada. The ongoing five pipeline expansions and one new pipeline project that is scheduled for 2018 with an additional 3.923 Bcf/d capacity would be at risk.[12] Thirdly and most importantly, as the cross-border traded natural gas is treated as a national commodity, there are no tariff imposed by any parties. However, President Trump has mentioned, “a 20 percent border tax to pay for a wall on the US-Mexico border, potentially to renegotiate NAFTA.”[13] Yet, the energy trade could be exempted from the aforementioned 20 percent border tax as Trump’s campaign promise was mostly about “bringing manufacturing jobs back”.

3.      Effect of the policy 

In case of cancellation or renegotiation of trade terms of NAFTA, a tariff imposition would be most harmful. The time delay would lead companies to change their behaviors i.e. applying to permits earlier. Besides, although this procedure increases the cost, it has not prevented some other companies to seek LNG export permits to trade with non-FTA countries. As long as U.S. Henry Hub gas prices are lower than the rest of the world, the trade will remain profitable and operating cost increases would be negligible when compared to profit margins. Therefore, a procedural change would not prevent companies from trading. However, a new tariff imposition would have much bigger impacts. We shall elaborate on the possible outcomes of a new tariff in each country. 

U.S. – Mexico Relations 

As we have said, 60 percent of the Mexican electricity generation mix depends on natural gas mostly imported from the U.S. This number is likely to increase considering there will be 3.9 Bcfd new capacity added by the end of this year. If the U.S. decides to impose a 20 percent tariff on natural gas export to Mexico, two possibilities emerge. First, if the Henry Hub prices are higher than Mexico's LNG import prices, Mexico would divert its import to LNG. Yet, the LNG import terminal constraints would be effective on how much to this diversion will be. Second, in the worst-case scenario, Mexico would choose to replace natural gas electricity generation with its own oil in the short run in order to absorb the shock. The graph below shows the natural gas price difference in Henry Hub and in Mexico. 

Source: Natural Gas Intelligence[14]

Moreover, Mexico is holding its presidential elections in July 2018. The leftist candidate Andres Manuel Lopez Obrador is the favorite candidate. Considering Trump administration’s right-wing nationalist rhetoric has already generated anti-American sentiments in Mexico, a move towards imposing a tariff would trigger the Mexican side to impose its own tariff as well and the natural gas prices in Mexico would further spike up.  The Mexican experts say that in this kind of scenario, it would be cheaper for Mexico to replace natural gas with its own oil for electricity generation. Therefore, the natural gas prices in Mexico would further increase if Mexico retaliates with tariffs on its own market and U.S. energy export would become much more expensive. As a result, U.S. producers would have to find other markets to sell their gas or scale back production.[15]

U.S. – Canada Relations

While the U.S. imposition of a new tariff on the natural gas trade could trigger the Mexican side to respond in the same way under the impulse of a new possible leftist nationalist government, the Canadian government’s reaction would be different. The Economist writes that the Canada-US Free Trade Agreement (CUSFTA) which predates NAFTA would remain in place even if NAFTA is cancelled and that tariff-free trade would continue between Canada and U.S.[16]However, there are a couple of differences between CUSFTA and NAFTA. According to Andre Plourde, NAFTA goes beyond previous FTA in two specific areas; firstly, the definition and treatment of energy regulatory measures and secondly, the treatment of contracts between buyers and sellers of energy goods. Firstly, while CUSFTA restricts coverage to a limited number of federal entities, NAFTA extends it to all federal and sub-federal entities. Secondly, there are better specifications of energy regulatory measures such as the national treatment of energy goods (Article 301), the absence of import and export restrictions and export taxes (Article 603 and 604). Most importantly, under both NAFTA and CUSFTA, if a tax is levied on export volumes, it has to be imposed on domestic sales as well. Yet under NAFTA, if any party imposes such taxes, it must do it without discriminating against the other party, whereas CUSFTA does not impose this.[17]

However, whatever happens with NAFTA or CUSFTA, we should also consider that the unified Canada-U.S. gas market was not the direct result of any free trade agreement. Andre Plourde, who wrote a paper in 1993 upon Mexico’s accession to NAFTA, asserts that the main reason for the increase in gas trade in North America was not the result of FTAs but of deregulation. FTAs have emerged to consolidate earlier policy initiatives and therefore, they have had only limited effect. By examining the trade patterns between Canada and U.S prior to any FTA, Plourde claimed that “Mexico would likely remain a relatively minor player in the North American natural gas market until an internally driven-deregulation process occurs.”[18] If we analyze the EIA’s data about the natural gas trade between the U.S. and Mexico, we see that the increase in trade started with Mexico’s deregulation and energy reform after 2013. After denationalization and opening of Mexican oil and gas sectors to foreign direct investment, the biggest jumped occurred in trade numbers. Before that, NAFTA’s impact was very small despite cheap shale natural gas that the U.S. had produced from 2010 onwards. 

The last important element we should consider is the hierarchy of federal, state jurisdictions and FTAs in Canada and USA. Plourde asserts that while in the U.S, an international agreement to which federal government is the party supersedes state authority (states have to abide by the International agreements); in Canada, it is the other way around. The federal jurisdiction or international agreement does not supersede the state jurisdictions in Canada.[19] Therefore, it is highly unlikely that Canadian states would impose a new tariff. 

In this respect, we can further claim that the NAFTA’s possible cancellation would not change the U.S.-Canada gas trade as much as U.S.-Mexico trade relations.  

4.      Variations of the policy proposal 

President Trump is known to fight to keep his campaign promises. However, considering that his promise was about “bringing manufacturing jobs back”, he could decide to keep the energy trade away from renegotiations or he could use it as a bargaining weapon for his other campaign promise “the wall”. Finally, any tariff or border tax in energy sector (which would harm U.S. companies mostly in Texas) could have a political impact on members of the Trump administration, such as Rex Tillerson former CEO of ExxonMobil, and Rick Perry, former governor of Texas. 

[1] EIA, “New U.S. border-crossing pipelines bring shale gas to more regions in Mexico” (Dec 1, 2016) Retrieved from https://bit.ly/2FevSKA

[2] Calculated from the North American Cooperation on Energy Information (NACEI) data https://nacei.org/#!/maps

[3] Natural Gas Act 15 U.S. Code § 717b - Exportation or importation of natural gas; LNG terminals Retrieved from https://bit.ly/2CYEMtG

[4] Bordoff, J. and Walsh S. (February 22, 2017) “How might a US-Mexico Trade Conflict Affect Trade in Natural Gas?” Columbia, SIPA, Center on Global Energy Policy. 

[5] The Economist. What if NAFTA Falls Apart? Retrieved from:  https://bit.ly/2CITuFd)

[6]  Congressional Research Service (January 30, 2017) Cross Border Energy Trade in North America: Present and Potential (p.18) Retrieved from https://fas.org/sgp/crs/misc/R44747.pdf  

[7]  Department of Energy, “How to Obtain Authorization to Import and/or Export Natural Gas and LNG?” Retrieved From https://bit.ly/2oNiExy    

[8]  Idem Congressional Research Service Paper (p.19)

[9]  Clemente, J. (February 12, 2018) Mexico’s Natural Gas Dilemma. Oilprice.com Retrieved from https://bit.ly/2Br3EgM

[10] EIA, Today in Energy (Dec 1, 2016) “New U.S. border-crossing pipelines bring shale gas to more regions in Mexico.” Retrieved from https://bit.ly/2FevSKA  

[11] EIA, Annual Energy Outlook 2018 https://www.eia.gov/outlooks/aeo/

[12] EIA, US Natural Gas Pipeline Projects. Updated as of February 9, 2018. Retrieved from https://bit.ly/2oHPdO7

[13] Goldberg, K. Energy Cos. (February 9, 2017) Unnerved by Trump’s Mexico Border Tax Talk. Law360. Retrieved from https://bit.ly/2FpImSW  

[14] Montmollin, Peter de (November 28, 2017) Mexico’s CRE Proposes Rule Updates for NatGas Trading Reports, New Price Indexes. Natural Gas Intelligence. Retrieved from https://bit.ly/2D4oYG3

[15]  Idem, Goldberg  

[16] The Economist (January 23, 2018) NAFTA: What if it falls apart? Retrieved from https://bit.ly/2CITuFd

[17]  Plourde, A. (1993). Natural Gas Trade in North America: Building Up to the NAFTA. The Energy Journal, Vol.14, No. 3, North American Energy Markets After Free Trade. (pp. 51-73). Retrieved from https://www.jstor.org/stable/i40059851

[18]  Idem, Plourde

[19] Idem, Plourde

References

·       Bordoff, J. and Walsh S. (February 22, 2017) “How might a US-Mexico Trade Conflict Affect Trade in Natural Gas?” Columbia, SIPA, Center on Global Energy Policy. Retrieved from https://bit.ly/2HbIW4c

·       Clemente, J. (February 12, 2018) Mexico’s Natural Gas Dilemma. Oilprice.com Retrieved from https://bit.ly/2Br3EgM

·       Congressional Research Service (January 30, 2017) Cross Border Energy Trade in North America: Present and Potential (p.18) Retrieved from https://fas.org/sgp/crs/misc/R44747.pdf

·       Department of Energy. How to Obtain Authorization to Import and/or Export Natural Gas and LNG? Retrieved From https://bit.ly/2oNiExy

·       EIA, Today in Energy (Dec 1, 2016) New U.S. border-crossing pipelines bring shale gas to more regions in Mexico. Retrieved from https://bit.ly/2FevSKA

·       EIA, Annual Energy Outlook 2018 https://www.eia.gov/outlooks/aeo/

·       EIA, US Natural Gas Pipeline Projects. Updated as of February 9, 2018. Retrieved from https://bit.ly/2oHPdO7

·       EIA (Dec 1, 2016) New U.S. border-crossing pipelines bring shale gas to more regions in Mexico (Retrieved from https://bit.ly/2FevSKA

·       Goldberg, K. Energy Cos. (February 9, 2017) Unnerved by Trump’s Mexico Border Tax Talk. Law360. Retrieved from https://bit.ly/2FpImSW

·       Montmollin, P. (November 28, 2017) Mexico’s CRE Proposes Rule Updates for NatGas Trading Reports. New Price Indexes. Natural Gas Intelligence. Retrieved from https://bit.ly/2D4oYG3

·       Natural Gas Act 15 U.S. Code § 717b - Exportation or importation of natural gas; LNG terminals Retrieved from https://bit.ly/2CYEMtG

·       North American Cooperation on Energy Information (NACEI) Retrieved from https://nacei.org/#!/maps

·       Plourde, A. (1993). Natural Gas Trade in North America: Building Up to the NAFTA. The Energy Journal, Vol.14, No. 3, North American Energy Markets After Free Trade. (pp. 51-73). Retrieved from https://www.jstor.org/stable/i40059851

·       The Economist (January 23, 2018) NAFTA: What if it falls apart? Retrieved from https://bit.ly/2CITuFd