Time for a North American Energy Initiative

This blog regularly focuses on the foreign policy reverberations of the U.S. energy boom.  As discussed in earlier posts (here and here), these include the gradual paring back of U.S. strategic commitments in the Persian Gulf*, the diminution of Russia’s great power aspirations**,  as well as a boost to America’s soft-power prospects and global standing.  But it’s time to add another upshot to the list: The shale revolution will redraw the North American energy landscape, prompting in turn a renewed U.S. emphasis on its immediate neighbors.

President Obama was right to focus on enhancing cross-border commercial ties during last week’s visit to Mexico, Latin America’s second largest economy that has become a darling of foreign investors.  Important changes over the past few years in the global production process – including rising labor rates in China, higher shipping costs, and a growing desire by companies to locate manufacturing centers closer to the consumer markets they serve – have led to a manufacturing resurgence in Mexico.  The country now exports more manufacturing products than the rest of Latin America combined and HSBC predicts that it is poised to eclipse China and Canada as the chief supplier of merchandise goods to the United States by 2018.

And despite fears among U.S. military planners just four years ago that Mexico was fast becoming a failed state, a flourishing middle class has instead taken hold.  According to a World Bank report, Mexico’s middle class has grown faster than in most of Latin America over the past 15 years, with the result that over half of the population can now be considered in that socio-economic category.  This development helped expand U.S. exports to Mexico by some $50 billion over the last two years.

So it was a fine idea when Mr. Obama and Enrique Pena Nieto, Mexico’s new president, established last week a high-level bilateral group focused on bolstering economic cooperation.  But Obama missed a shining opportunity while in Mexico City to do something even more visionary and consequential: Setting in motion the creation of a truly integrated North American energy market.

Such an effort would capitalize on two significant trends.  First and foremost among these is the shale energy revolution that is transforming the U.S. and Canadian economies and which promises to do the same for Mexico’s.  The shale bonanza has already helped propel the US pass Saudi Arabia as the world’s biggest fuel producer and the International Energy Agency forecasts that it will enable the U.S. to overtake Russia as the world’s largest producer of natural gas by 2015 and come to rival Saudi Arabia in oil output by the end of the decade.

And in Canada, the world’s third-largest producer of natural gas, a new study forecasts that the gas sector will add nearly C$1 trillion to the economy over the next quarter century and create an additional 260,000 jobs.  And while surging U.S. gas production is closing out a traditionally lucrative export market, Canadian producers should be able to profit from new opportunities in energy-starved Asia, where gas prices are much higher than in North America.

The United States and Canada, which already have a tightly-knitted energy relationship (here and here), have so far emerged as the shale revolution’s biggest winners.  But the benefits could soon extend to Mexico as well.  Mr. Pena Nieto is moving to end the country’s protectionist energy policy by introducing more private-sector and foreign involvement in Petroleos Mexicanos (PEMEX), the elephantine state-owned oil monopoly that is the world’s seventh largest oil producer.   If this reform comes to pass, it would open up new avenues of prosperity and cooperation among the NAFTA countries.

Mexico possesses energy reserves so large that they rival Kuwait’s and it is the third-largest oil supplier (following Canada and Saudi Arabia) to the United States.  Sitting on top of what may be the world’s fourth-largest reserves of shale gas, it is also well positioned to benefit from the shale revolution.  Yet due to nationalistic restrictions that shut out foreign capital and technology, PEMEX has experienced sharp production declines in recent years and is unable to exploit deep-water reserves in the Gulf of Mexico or onshore resources that require hydraulic fracturing (“fracking”) to extract.  Indeed, a Baker Institute report two years ago warned that without major new investments in exploration and production the company could lose its entire capacity to export crude oil within a decade.  PEMEX’s new head sees shale development as a key to the country’s economic future but acknowledges that foreign partnerships are a critical factor.

The regional payoff would be profound if Mexico is able to replicate the energy renaissance now unfolding in the other NAFTA countries and act in concert with them to maximize its benefits.  A recent Citigroup report argues that surging oil and natural gas output in the three countries “will eventually turn the global geopolitics of energy on its head” and that “the growing continental surplus of hydrocarbons points to North America effectively becoming the new Middle East by the next decade.”  A study by the Manhattan Institute concurs, noting that “the total North American hydrocarbon resource base is more than four times greater than all the resources extant in the Middle East.”  It also estimates that a NAFTA-style collaboration in the hydrocarbon sector could yield as much as $7 trillion in value to the North American economy over 20 years.

Prospective gains like these should start policymakers in Washington, Ottawa and Mexico City thinking in imaginative and cooperative directions.  A first step is the implementation of the U.S.-Mexico Transboundary Hydrocarbons Agreement (TBHA), signed a year ago and quickly ratified by Mexico but now awaiting passage by the U.S. Congress.***  The accord will foster joint cooperation in the exploration and development of oil and gas fields sitting astride the maritime border.  But an even more important consequence might be symbolic – sending a concrete message about the advantages of bilateral partnership just as Mexico begins to debate the Pena Nieto energy reforms.

Beyond this, the three NAFTA partners should set out to construct a highly-integrated energy market that would allow consumers and businesses through North America to benefit from the new era of energy abundance.  Such an initiative would include the promulgation of mutually-advantageous policies for developing oil and gas resources in each country; building cross-border infrastructure (such as pipeline networks and other transportation facilities) to serve not only the continental market but also beckoning export opportunities in Asia and elsewhere; trilateral cooperation in managing the safety and environmental challenges of shale development; and promoting collaboration in developing green-energy sources.  To give impetus to this effort, the leaders of the NAFTA countries should announce this initiative at their forthcoming summit meeting and direct their bureaucracies to put together a formal accord expeditiously.  Signing a North American energy trade agreement in 2014 would be a splendid way to commemorate the 20^th anniversary of NAFTA’s enactment.

In this year’s State of the Union address, President Obama announced his commitment to wrap up work on the Trans-Pacific Partnership, an ambitious trade and investment pact in Asia, and to launch negotiations for a free trade agreement between the United States and the European Union.  Both are worthy undertakings in view of their economic and strategic impact.  But significant opportunities are also stirring right on America’s borders and Mr. Obama would be wise to focus on them as well.

*The perceived waning of America’s strategic presence in the Persian Gulf may prompt the United Kingdom to restore a military presence there that it closed down five decades ago.   Saudi leaders also appear to be worried about the possibility of U.S. disengagement.

** For recent analysis on this point, see here, here and here.

***The House Subcommittee on Energy & Mineral Resources held a hearing on the THBA two weeks ago – statements and testimony are located here.  The Subcommittee on Western Hemisphere Affairs heard testimony in March on the TBHA and other ways to enhance energy cooperation with Mexico and Canada – details here.

This commentary is cross-posted on Monsters Abroad.  I invite you to connect with me via Facebook and Twitter.