Why the energy sector can withstand NAFTA

NAFTA negotiations took a more positive tone recently, but if the trade agreement were to go sideways, the Canadian energy sector would see little impact, says a commodity note from Scotiabank. In fact, the sector might see a benefit.

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To explain why, the authors first note that a NAFTA withdrawal would be a long, gradual process, potentially fraught with constitutional legalities.

And, beyond legal challenges, “a wholesale, across-the-board change in U.S. tariffs […] would require Congressional action, which may not be forthcoming. NAFTA tariff preferences would still remain in place until Congress acts to change them,” says the note.

What happens after withdrawal

If the U.S. were to withdraw from NAFTA, one of two likely scenarios would be expected to unfold for the Canadian energy sector.

One scenario, which the bank deems has only a 10% probability, is a move to most favoured nation (MFN) tariff rates.

At those rates, crude oil exports are subject to a tariff of US$0.0525-0.21 per barrel, paid by the U.S. entity importing oil.

“The economic burden of the tariff would depend on the extent to which there are easy substitutes for Canadian crude,” says the note. “Mexican and Venezuelan production—the other two sources of U.S. heavy crude imports—are in decline, which limits the extent to which substitutes […] could be easily found.”

The more likely scenario: Because of U.S. refineries’ demand for Canadian crude, a special exemption would likely be created for Canadian petroleum products to ensure the U.S. effective tariff rate remains at or near 0% (the current rate) for these goods.

“This would represent a continuation of current market conditions,” says Scotiabank.

A NAFTA withdrawal would be accompanied by an initial depreciation of the loonie “that would see it initially overshoot below fair value,” which the bank estimates to be around US$0.81, says the bank.

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That result would benefit the energy sector, which would see revenues increase in Canadian dollar terms, though equipment imports would cost more.

“The net result would likely be positive—at least until CAD corrected over time back to fair value,” says the bank, which estimates this overall scenario has a 90% probability.

Trump talk takes a turn

Earlier this week in his State of the Union address, President Trump notably didn’t mention NAFTA. He simply vowed to improve old agreements.

His party has also showed support for the trade agreement: a clear majority of Republicans in the Senate recently released a letter urging the president to remain in the agreement. It was signed by 36 members, who represent about 70% of the 51-seat Republican contingent in the Senate.

Read the full Scotiabank commodity note.

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2018 could be ‘record-setting’ for U.S. oil: IEA