LITTLE U.S. BENEFIT SEEN IN NAFTA

Congressional Budget Office predicts the North American Free Trade Agreement will have little short term energy trade benefit for the U.S. But that could improve in time. CBO said the agreement is an improvement over the status quo. And almost as important as net trade gains is the likelihood that Nafta would not hurt any major U.S. energy industries or groups of energy consumers.

Aug. 30, 1993

9 min read

Congressional Budget Office predicts the North American Free Trade Agreement will have little short term energy trade benefit for the U.S.

But that could improve in time.

CBO said the agreement is an improvement over the status quo. And almost as important as net trade gains is the likelihood that Nafta would not hurt any major U.S. energy industries or groups of energy consumers.

Even so, U.S. oil and gas service firms and equipment suppliers should not be very optimistic about the prospects of significant new work with Pemex as a result of Nafta. The U.S. and Mexico are negotiating side agreements to supplement Nafta. Canada has approved the pact. The U.S. Congress is due to consider it this fall.

RESTRICTIONS REMAIN

CBO said, "For the most part, the energy chapter of Nafta sets out exceptions to the principles of free trade with Mexico that the rest of the agreement embraces. In particular, Nafta would do very little to increase U.S. access to Mexican oil resources, even though imports of crude oil account for over half of the total dollar value of U.S. imports from that country. "For trade in oil with Canada, however, Nafta generally reaffirms provisions of the Canada-U.S. Free Trade Agreement (CFTA) that promote access to Canadian oil and gas.

"Energy imports from Mexico would not be affected by Nafta. Those imports are already virtually unrestricted by the U.S. And the agreement does not address U.S. restrictions on the export of crude oil to Canada or Mexico beyond the small volume of Alaskan oil exports allowed in CFTA. But the agreement might help boost the relatively, low levels of U.S. energy and energy related exports to Mexico and U.S. investments in Mexico."

The CBO study, titled "Energy and Petrochemicals in the North American Free Trade Agreement," said the treaty would be more effective in promoting U.S. energy investment in Mexico than it would be in promoting U.S. exports of goods and services to Mexico.

It said the pact cuts Mexican tariffs on energy and energy related goods, but the goods that normally would benefit from lower tariffs could remain largely constrained by nontariff barriers, including important restrictions on the operation of free markets in Mexico.

"By addressing nontariff barriers, Nafta's specific provisions for energy, investment, government procurement, and competition point the way to new trade and investment opportunities with Mexico.

"Tangible evidence of new opportunities includes Mexico's commitments to ease restrictions on imports of natural gas and basic petrochemicals, allow investment in production of secondary petrochemicals, protect U.S. investments from discriminator treatment by Mexico, and open the market for contract services with the Mexican government's energy monopolies.

"The degree to which U.S. businesses could take advantage of new opportunities, however, would depend on a series of enforcement provisions--some of which are very weak--and ultimately on the good intentions of the Mexican government."

FUTURE TRADE

CBO said an important intangible benefit of Nafta is that it defines the rules of competition, even though those rules alone may not guarantee increased trade.

Mexico would have to follow principles of the General Agreement on Tariffs and Trade concerning energy trade, although most petroleum products are exempted, and it would restrict the anticompetitive practices of its state energy monopolies in commercial areas outside the officially monopolized markets.

Mexico also would revise and clarify its legal procedures for design and award of government procurement contracts.

"Future trade benefits might also derive from the current vagueness of some of the language in Nafta," CBO said.

"During the negotiation process, Mexico had pushed for more specific, more restrictive language on several of the energy provisions. The fact that the negotiators could settle on less specific language, which may be interpreted by different parties as more or less restrictive, means an agreed framework can be in place for further trade liberalization.

"For example, Nafta's provision for performance clauses in service contracts may ultimately be interpreted as allowing U.S. drilling firms to own part of the oil or gas then, discover in Mexico, even though Mexico does not accept that interpretation now."

CBO said what was omitted from the agreement was far more significant than what was included. It observed Mexico was unwilling to revise its ban against foreign ownership of energy resources, did not want to weaken the state oil and gas monopolies, and wanted to adhere to central planning for development and use of energy resources.

"These obstacles remain and underscore Nafta's accomplishment as only a first step toward free energy trade with Mexico.

"Mexico has recently taken several actions, however, that indicate a willingness to relax its constitutional restriction on foreign ownership and control of its domestic energy resources, even without the ratification of Nafta.

"For example, in August 1992 Mexico issued regulations that expanded the list of secondary petrochemicals in which limited foreign investment is allowed. In April 1993 a U.S. firm announced an agreement with Petroleos Mexicanos to build and jointly own a plant producing a gasoline additive for which foreign investment was otherwise prohibited. In May 1993, Pemex negotiated a bond issue with U.S. investors that would, for the first time, be guaranteed by future earnings from Mexican oil exports.

"Internal demand for lower cost and more reliable energy supplies, public concern with Pemex mismanagement, growing environmental problems, and difficulties in raising capital to finance future development are all adding pressure on the Mexican government to liberalize energy trade. "

CURRENT TRADE

CBO said the U.S. should not expect to buy more oil from Mexico or receive a lower price as a result of Nafta.

"Within these very tight restrictions, however, a limited number of opportunities would be created to sell energy and energy related products to Mexico. Of particular note are investment opportunities related to secondary petrochemicals and electricity, generation and export opportunities for natural gas, basic petrochemicals, oil and gas services and equipment, and road surfacing materials."

It said although Nafta would reduce Mexican tariffs on energy goods, the benefits to U.S. importers and exporters would be small, and the U.S. currently places little restriction on energy imports from Mexico.

"For U.S. goods moving south, the reductions in Mexican tariffs that would most benefit U.S. exporters of energy and energy related commodities would come about only slowly--after 5-10 years.

"Mexico's 10% tariff on natural gas would not be eliminated for 10 years. Mexico's tariffs of 10-15% on the most important categories of oil field equipment also would not be eliminated for 10 years.

"Only tariffs for selected petroleum products and a couple of high technology categories of oil and gas production equipment that Mexico already has difficulty supplying endogenously would be eliminated immediately."

CBO said exports to Mexico have been more constrained by nontariff barriers such as limits on commodity imports and exports, differential pricing of domestic and exported goods, restrictions on foreign access to government procurement, and restrictions on foreign investment.

It said Mexico would maintain its rights to set oil export limits and prices and would keep investment restrictions on most refined petroleum products, including nine of the most basic petrochemical feedstocks and blending components for gasoline.

"But Nafta would specifically allow unrestricted U.S. and Canadian investment for the first time in production, distribution, and foreign trade of a long list of secondary petrochemicals and a very short list of petroleum products used for nonenergy purposes."

CBO said the potential advantages of investing in Mexico come not from Nafta but from the inefficiencies of Mexico's current operations for refining crude oil and processing gas, inefficiencies in hauling crude from Mexico and finished product from the U.S. across the Gulf of Mexico and difficulties in siting petrochemical plants in the LT.S. and Canada.

Two uncertainties could undermine investments. One is how Pemex would give access to and price feedstocks needed to produce secondary petrochemicals. Another is whether Mexico's commitment to give foreign investments the same treatment as domestic investments is enforceable.

SERVICE, SUPPLY CONTRACTS

CBO said Nafta would require Pemex to open 50% of its large procurement contracts to U.S. and Canadian businesses, increasing to 100% by 2003, and to rewrite the procurement process to give them fair consideration.

"In a token exception to its prohibition on foreign ownership of energy resources, Mexico would allow contracts for oil and gas drilling services to include performance clauses.

"In the absence of such incentives, many U.S. firms consider Mexico's current contract requirements for drilling services to be prohibitive, especially requirements for fixed price bidding on tasks for which the contractor not only would have incomplete information on the overall project but also could not control the entire project, the timing, or, as a result, the costs.

"Under the most optimistic interpretation of this mention of performance clauses, drilling contractors could earn compensation based in part on how much oil or -as was found, a more common practice in other oil markets.

"Such performance clauses based on discovery are especially important for smaller contractors because the contracts represent marketable assets that firms can use in securing project financing.

"As with other opportunities presented by Nafta, the real gains here are at best uncertain. Nothing in the agreement would require Pemex to offer performance incentives in its drilling contracts. And Mexico probably would be unwilling to tie such incentives to the amount of oil or gas found, restricting, them instead to rewards for early or below budget completion."

CBO pointed out that the agreement applies only to procurement actions for goods and nonconstruction sen ices worth more than $250,000 and for construction services worth more than $8 million.

It said, "Mexico could easily circumvent the dollar thresholds in order to place even larger procurement actions outside the agreement."

The situation is better for U.S. suppliers of oil field equipment, as opposed to services, but the potential market for all services and equipment will be arbitrarily capped as long as Mexico adheres to central planning for development of its energy resources.