melgar energy security

8/2/2019 Melgar Energy Security

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Energy Security:A North AmericanApproach

by Lourdes Melgar, Ph.D.

Independent Energy AnalystMexico

Paper presented at the

Forging North American Energy Security

Conference, Monterrey, MexicoApril 1-2, 2004


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ENERGY SECURITY:A NORTH AMERICAN APPROACH

Lourdes Melgar, Ph.D.Independent Energy Analyst

Mexico

nergy has become a key issue in the relationship of NAFTA partners. Afterthe failed attempts to include the energy sector of the three countries in arelevant manner as part of the North American Free Trade Agreement,1 the

subject was rarely approached from a trilateral perspective. Yet, imminent energyconcerns in the United States and Mexico, and Canadian interest in advancing itsinternational energy policies brought back the subject to the table in 2001.

ESince the oil shock of 1973, diversifying and guaranteeing its energy supply

has been a priority for the United States. Despite efforts to increase energyefficiency and develop alternative energy sources, energy security has continued tobe equated with uninterrupted oil supply at reasonable price levels.

The oil crisis of 1998-2000, brought into question the concept of energysecurity. For the first time, two North-American partners found themselves at thecenter of the debate. The sense of urgency heightened as an electricity crisis hitCalifornia and tensions between the U.S. and the Middle East increased. Early intheir Administrations, Presidents Bush and Fox found similar answers: NAFTApartners should be North-American energy partners.

The proposal was welcome in energy circles that had long been waiting for atrilateral energy agreement; but soon became under fire. The nationalistic wings inMexico and in Canada viewed it as if the U.S. wanted to ensure its supply of oil, gasand electricity at the expense of their countries own national interest. It seemedas if, once again, the subject would be banned. Yet, the need to find solutions tothe existing energy crisis and avert foreseen ones provided the grounds forreflection and the insight to find productive ways to address the issue.

Ensuring the availability of adequate, reliable and affordable supply of energy

is essential to the three countries. In addition, energy security is, to the U.S., apriority of its trade and foreign policy; to Canada, it is a matter intimately relatedto environmental protection; to Mexico, it is also a sovereignty issue. AfterSeptember 11th, for the three countries the concept has become broader,encompassing the integrity of critical infrastructure.

Is it possible to consider energy security from a North American perspective?This paper will argue that a trilateral concept of energy security is feasible and

can lead to policies that promote the actual energy integration of the region. Yet,the perspectives of such integration ought to be assessed taking into account theexisting resources of the region and their potential, as well as the political,economic and legal possibilities of each country.

Considering the energy map of North America --including supply and demand,reserves, existing interconnections, physical and legal limitations--, the paper will

address how to further energy integration and guarantee energy security in NorthAmerica by taking advantage of existing opportunities. Moreover, it will argue thatNorth American energy markets can be rendered more dynamic through mutualunderstanding and minor physical and regulatory changes. Finally, an attempt willbe made to imagine the future, and arrive at a NAFTA definition, taking intoaccount that energy security is a strategic factor in ensuring the economicdevelopment and stability of North America.


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I.-ENERGY SECURITY:EVOLUTION OF THE CONCEPT AND CURRENT UNDERSTANDING

Energy security is essential to ensuring the sustained development of nations.Energy, it is said, is the motor of the economy. Yet, its availability in adequate,affordable and reliable form is not a given. Few countries can claim to be energyself-reliant. To most, energy security represents an important policy challenge.

Energy security became a household concept in the 1970s, as a result of the oilshocks of the period. At the time, it was equated with reliable availability of oil ataffordable prices. This understanding of energy security led to the establishment,within the Organization for Economic Cooperation and Development (OECD), ofthe International Energy Agency (IEA) in 1974, a consumers club with sharedpolicies aimed at ensuring a rapid response to oil supply disruptions.

The U.S. designed and promoted the establishment of the IEA2 and of itsCoordinated Emergency Response Program. This mechanism commits membercountries to hold oil stocks equivalent to 90 days of net oil imports and to takeeffective cooperative measures in case of supply disruption. The United Statesestablished its Strategic Petroleum Reserve. The IEA has never operated itsEmergency Response Program, although it oversees the continuous fulfillment ofthis commitment. Nonetheless, the organization has been useful to its members in

promoting the latest policies derived from their understanding of energysecurity. It has become also the advocate of consumers views in the debate withoil producing countries over the stability of the international oil market.

Since the 1990s, energy security as a concept has evolved, becoming broaderand taking into account technological advances and rising concerns aboutenvironmental protection, both at the local and global levels. Energy security doesnot stop at national borders and does not solely refer to oil availability.

Today, energy security is thought of in terms of: a) external factors(geopolitics); b) internal factors (operational and investment); c) temporal factors(short-term; long-term).3 The causes of disruptions in energy supply are no longerlimited to oil shortages in the international market. In addition to politicalintervention in energy markets other factors such as systemic failures, under-investment, technical failure of components of highly bundled energy flows, and

even sabotage have to be taken into account. The impact of such breakdowns is fargreater than in the past, due to the increase rigidity in energy supply and demand.

To ensure energy supply a multi-dimensional policy approach is needed, whichincludes promoting energy efficiency and conservation; diversify sources of fuelsand their origins; and maintaining adequate margins of reserves. This policy holdsas a precondition the protection of the environment, in particular the mitigation ofgreenhouse gas emissions.

The United States has been at the forefront of the definition of energysecurity and the policies derived from its conception of the term. In addition tothe adoption of national policies that meet this understanding, the United Statespromotes its views and policies internationally, both at the bilateral andmultilateral levels.

During his campaign, George W. Bush stressed that energy issues would be a

priority of his Administration. Both he and Vice-President Cheney had experienceand significant interests in the oil sector. The California crisis, which began a fewdays before the Presidential Inauguration, forced the issue to the forefront. Withina week of taking office, President Bush established the National Energy PolicyDevelopment Group. By May 2001, this Presidential task-force produced theNational Energy Policy Report. In the words of the chairman of the Group, Vice-President Cheney, the report

Forging North American Energy Security 4


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envisions a comprehensive long-term strategy that uses leadingedge technology to produce an integrated energy, environmentaland economic policy. To achieve a 21st century quality of lifeenhanced by reliable energy and clean environment we mustmodernize conservation, modernize our infrastructure, increaseour energy supplies, including renewables, accelerate the protectionand improvement of our environment, and increase our energy

security.4

This comprehensive document presents an assessment of the energy challengesfaced by the United States, establishes five specific national goals5and proposes aseries of recommendations to achieve them. The analysis and conclusions of theReport are driven by an all-encompassing understanding of the meaning of energysecurity. As in the past, the U.S. approach to the subject holds an importantinternational component. It stressed that energy security must be a priority ofU.S. trade and foreign policy6. Yet, it emphasizes a new approach in which aNorth

American Energy Framework is a key element in ensuring energy security.The Report urges to

Support a North American Energy Framework to expand and

accelerate cross-border energy investment, oil and gas pipelines,and electricity grid connections by streamlining and expediting

permitting procedures with Mexico and Canada.7

This proposal concurred with President Vicente Foxs views on solving Mexicosenergy challenges. During his electoral campaign, Mr. Fox vowed to reformMexicos energy sector and to open it up to foreign investment. His initial positionhad to be amended and clarified through out the campaign, given the politicalopposition to the privatization of Mexican energy assets and to foreignparticipation in the oil sector.

In spite of the increasing susceptibilities over his plans for the energy sector,Mr. Fox sustained his views on advancing some sort of North American energycooperation. For the first time, since the NAFTA negotiations, two incoming

presidents in Mexico and in the United States were seeing eye to eye on an issue,which would have significant implications domestically and regionally.

President Foxs energy agenda derived also from concerns about energysecurity. Yet, the Mexican position had a different origin. No impending energycrisis was looming over the horizon, at least in the short-run. Mexicos challengehad been assessed clearly by Mr. Foxs predecessor: to achieve energy security andsustain it over time, Mexico requires significant investments.8 The naturalresources are currently available in the country, but the financial ones are quitelimited and in high demand. Opening up the energy sector to foreign investmentand fostering energy markets within the region seemed the logical solution.

Yet, Mexicos concept of energy security has a distinctive economic andpolitical dimension. Even though the economy is not oil dependent, cruderevenues represent close to 40% of the Federal Budget. A drop in state revenues

could seriously jeopardize the stability of the economy in the short-run and put atrisk future petroleum production due to a fall in investments. This reality pushedMexico to the forefront of the debate on energy security and oil markets 9. Inaddition, for historical reasons, Mexicans have equated petroleum and byextension energywith national sovereignty, rendering any discussion on thesubject highly political and controversial.

The shared vision of the U.S. and the Mexican Presidents of furthering energymarkets in North America to achieve energy security in the region requires, asprecondition for success, Canadian participation. Given the sovereignty issue, a



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trilateral approach renders the proposal politically viable for Mexico. Given itswealth in resources and the intense energy exchange between the two northernneighbors, Canadas participation is crucial in a regional approach to energysecurity.

Canadas concerns over energy security are different from those of Mexico oreven the United States. Canada is blessed with abundant and varied sources of

energy and has the economic potential to produce them in quantities that meet theinternal demand and allow for exports. Canadian energy policy reflects this reality.The accent is put on sustainable development. Energy must be produced and usedrespecting the environment and for the benefit of present and future generations.Meeting the greenhouse gas emission challenge is central to Canadian concerns. Inaddition, Canadian energy policy is market-based, as this orientation is consideredessential to achieve long-term security.

Canadas understanding of energy security translates into internationalpolicies that encourage open energy markets, promote Canadian industry accessto foreign markets, advocate environmental stewardship, and promotetechnological cooperation.10

Canada has an additional particularity. The Federal government provides ageneral framework for energy policy, centering on trade regulation, inter-

provincial and international commercialization, and conservation andadministration of non renewable Federal resources. The Provincial governmentsare responsible for the exploration, production, conservation and administrationof non-renewable resources, and decide over power generation within theirterritory. Thus, some provinces --such as Alberta or Quebec-- have been moreactive than the Federal government in developing energy relations with the UnitedStates and Mexico.

In early 2001, Mexico and the United States promoted with Canada the idea offostering energy security through North American integration. Despite thedifferences in the understanding of the concept, Canada became an interestedpartner in this dialogue as it offered an opportunity to advance its positions onenergy affairs.

In addition, as in the case of Mexico, Canada found that it would be easier to

respond to U.S. demands from a trilateral perspective. The initial solution of theBush Administration to its domestic energy crisis included using at liberty the wideavailability of Canadian and Mexican resources to alleviate U.S. needs. Thebluntness of the proposal seemed unpalatable to either neighbors.

In March 2001, Mexico proposed the creation of a commission to addresstrilateral energy issues. The United States embraced this idea to the point ofmaking it its own.11 Canada was more cautious and insisted on keeping discussionsdown to a technical level. Thus was established theNorth American Energy WorkingGroup.12 An important step was given in addressing energy issues from a regionalperspective.

The timing of this initiative could not have been better. The events ofSeptember 11th, 2001, added yet another dimension to energy security, whichbecame relevant to the three countries. The protection of critical infrastructure

has become essential to the energy security and national security of Canada,Mexico and the United States. The energy interdependency within the regionrenders the subject a priority for cooperation. At the same time, the risks derivedfrom potential terrorist attempts on energy infrastructure and flows renders theidea of North American Energy Security strategic in ensuring the sustaineddevelopment and stability of the region.



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II. FURTHERING ENERGY INTEGRATIONAS A MEANS TO ENSURE ENERGY SECURITY

In order to further energy integration and achieve energy security in NorthAmerica, it is necessary to consider the energy map of the region --including supplyand demand, reserves, existing interconnections, and physical and legallimitations. This has to be the point of departure in the design of viable proposals

to achieve energy security from a North American perspective.13

North America is blessed with abundant and varied energy resources. With only 7percent of the world population, the region produces around 25 percent of theworld energy supply and consumes about 30 percent.14 In 1999, it generated 19 %of the worlds oil supply, 31% of natural gas, 25% of coal and 32% of electricity; itconsumed 31% of world oil, 31% of natural gas; 24% coal, and 30% of powergenerated. It is foreseen that by 2010, the region will show a decline in oil, gas andcoal production to 17%, 28%, and 24% while power generation will remain even. Itwill also show a slight decline in oil, gas, coal, and power consumption to 28%,29%, 23% and 29% respectively.15

(Source:North America- The Energy Picture)

North America has significant reserves of coal, meaningful reserves of oil and gas,considerable refining capacity, and substantial power generation capacity fromdiverse sources.16



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North America. Energy Supply(Source:North America-The Energy Picture)

Due to the dynamism of its economy and to the high level of industrialization anddevelopment, North America is the most energy intensive region in the world. It isnot energy completely self-sufficient and relies on foreign trade to supplement itsenergy requirements. Taken separately, each country presents a different picture.

Canada is a net exporter of energy, exporting 5 quadrillion British thermal

snits (quads). It sells to the United States about fifty percent of its natural gasproduction, over fifty percent of its crude production and a significant amount of



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electricity.17 Canadian concerns are not in supply and demand issues, but inmeeting its environmental objectives, locally and globally and in securing itsresources for future generations. In the Kyoto Protocol, Canada agreed to reduceits greenhouse gas emissions to six percent below 1990 levels by the period 2008 to2012.18 It is a priority of the Canadian government to fulfill this commitment,which it ratified in December 2002. This represents a significant challenge for its

energy sector, and its policies are designed to reach this goal.Mexico is a net exporter of energy, exporting 3 quads a year. 19 But, in order

to meet its energy demand, it has to import natural gas and refined products.

The United States is one of the worlds largest energy producers and

consumers. It produces 72 of the 99 quads it consumes.20 Yet its imports havealmost doubled over the past decade. Whereas in 1980 U.S. energy imports wereequivalent to 12 quads and in 1990 to 14 quads, by the year 2000 they reached 25quads, and are growing.21

Given its energy balance, the United States is the main importer of energyfrom Canada and Mexico. About 36 percent of its needs come from NorthAmerica, 27% from Canada in the form of natural gas, oil and electricity; and 9%from Mexico mostly in the form of crude oil. Canada provides 15% of the naturalgas the U.S. consumes, about 15% of its oil imports and 1% of its electric

consumption. Mexico supplies around 15% of the U.S. oil imports, buys from itnatural gas and refined petroleum products and trades electricity.22

United States Imports from Canada and Mexico in the year 2000

(Source:North America The Energy Picture)

The mapping of energy resources shows the wealth of the region. Yet, it does notpoint to the challenges North America faces in securing an adequate and sustainedenergy supply. Solely looking at existing resources and reserves can easily lead tosimplistic solutions that might not take into account relevant factors such asinvestment needs, regulatory and physical limitations, technological requirements,and legal or even constitutional constraints.

The snap-shot of resources might hide the complexities of ensuring security ofsupply over time. Thus, resources have to be analyzed in terms of their access,

production cost, processing requirements and even marketing to reveal thefeasibility of policies designed to furthering energy integration in the region.The energy balance of the region shows that oil and gas supply are two of the

challenges North America faces in the short-run. Guaranteeing the availability ofthese two fuels is a precondition to the viability of the regions energy sector andthus to the dynamism of its economy.



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Oil

Despite technological advances and efforts to diversify sources of energy, since1985, there have been no improvements in moderating oil dependenceworldwide.23Oil is, and will remain at least until 2030, the dominant fuel inprimary energy mix. Thus, the availability of an adequate supply of oil atreasonable price levels continues to be central to energy security and to the

stability of the world economy.The United States is the third world oil producer after Saudi Arabia and Russia,

with a production of 8.1 million barrels a day (mmb/d). Yet, it imports 52% of itsnet oil requirements, of which about 27% come from Canada and Mexico.24 Overthe past few years, over fifty percent of U.S. oil imports have come from fourcountries: Canada, Mexico, Saudi Arabia and Venezuela, each representing about15% of total exports, and shifting slightly in position month after month.

The United States25 is the most mature oil producing region in the world.Thus, oil production has been declining since the 1970s. Important investmentsand technological innovation have allowed to slow-down the rate of decline inproduction. Yet, there are fewer areas for exploration, and the cost of productionin most fields is climbing. One of the solutions advanced by the BushAdministration is to exploit oil and gas in Alaskas Artic National Wildlife Refuge.

The proposal has received wide opposition due to environmental concerns. Inaddition, there are cost considerations derived from harsh climatic conditions,distance to market points and limited infrastructure that have to be taken intoaccount. Efforts are already underway to further explore Alaskan oil and to updatethe Trans-Alaskan Pipeline System.

In this scenario, the North American Energy Framework proposed in theNational Energy Policy provides a realistic approach to enhance oil security for theUnited States in the short and long-run.

Indeed, Canada produces 3.1 mmb/d of conventional oil and oil sands, ofwhich it exports 1.9 mmb/d.26 In addition to its current reserves, Canada owns2,500 billion barrels of oil sands of which 300 could be recoverable. The IEAconsiders that this much oil would satisfy global oil demand, at current rates, forover 10 years.27 Increasingly, oil sands production is offsetting the rapid decline

in crude oil production. The prospects are such that, taking into account oil sands,Canada is placed second worldwide in total proven oil reserves after Saudi Arabia.Yet, some companies have delayed production due to environmental concerns, highdevelopment costs and the rising prices of natural gas, a prime material in bitumenextraction.

Mexico, for its part, produces around 3.8 mmb/d of crude oil, and exports 1.8mmb/d, mostly to the United States (around 80%).28 It has reserves of 22.3 billionbarrels of oil and LNG and an estimated 23 billion barrels of undiscoveredrecoverable oil resources in Mexico.29 In 2003, Mexico ranked fourth-largest oilproducer in the world, behind Saudi Arabia, Russia and the United States.

Unlike its northern neighbor, Mexico has oil fields that are quite accessible.Whereas the U.S. exploited most of its resources in the Gulf of Mexico, leaving onlyfields in deep water, Mexico is producing close to its shore. The Cantarell field

produces a significant amount ofMaya crude oil, and through a process of nitrogeninjection oil recovery is boosted. PEMEX is also developing a field in the state ofTabasco of light and ultralight crude which has a high oil and gas ratio. Productionof 1.5 mmb/d of light crude and 1.5 billion cubic feet (Bcf) of natural gas isexpected to begin in 2006. With this project, Mexico will increase the quality of itsoil basket, which today is mostly composed of Maya, high density crude withsignificant sulfur content.

Mexicos challenge in its oil sector lies in the lack of investments. Between1981 and 2000, investments in this sector have gone down by two-thirds. The



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Secretara de Energa of Mexico has estimated that Mexico requires 140 billiondollars in investments between 2000 and 2010, of which 50 billion should beallocated to gas and oil exploration and production.30 Even the past three years ofhigh oil prices have not contributed to increase investments in the oil sector, asmost oil revenues go straight to the Federal Treasury and are allocated to otherprograms. The upstream oil industry also needs significant upgrading.

The prospects for returns in the Mexican oil sector are so good that manyforeign investors have their eyes on it. Yet, it is unlikely that for many years tocome, Mexico will open up exploration and production to foreign investment. Thisis the core of the sovereignty challenge. Today, Mexico is probably the mostclosed country in terms of foreign participation in its oil industry. For historicalreasons, Mexicans have equated petroleum with national sovereignty. The debatesof the past few years over the opening of the power sector and the furthering ofprivate participation in the gas sector have sealed even more the currentexploration and production regime.

Respecting the Constitutional rule that oil exploration and production shouldbe done by the Mexican State through PEMEX, there is still significant space forNorth American integration. The U.S. oil market offers good prospects for Canadaand Mexico. Geographic location is an advantage, as is political closeness. In

addition, most Mexican oil and some Canadian are heavy crudes, requiring for theirprocessing high conversion refineries, most of which are located in the UnitedStates. This fact reduces the market destination of the product. Increasing oiltrading within the region becomes then a win-win situation for all parties andfavors the security of oil supply in North America.

Natural Gas

Natural gas supply is critical to North American energy security. This is the mosturgent and major challenge facing the sustainability of the regions energy sector.Interestingly enough, in this sector integration between NAFTA partners is quiteadvanced. Thus, a trilateral approach to the problem is likely to produce the mostbeneficial response.

When NAFTA entered into force, natural gas had not the predominance it has

today as a primary source of energy. Through the 1990s, natural gas became thefuel of preference, due to its wide availability, cost competitiveness and itsenvironmental friendliness. Countries turned to the cutting-edge technology ofcombined-cycle power generation which allows for highest fuel efficiency, usingnatural gas and steam. At the same time, industrial and residential use of the so-called clean fuel expanded rapidly.

With in a decade, in a region with some of the highest reserves and productioncapacity, the enthusiasm with natural gas consumption surpassed the rate ofproduction. The limits to domestic supply became evident in 1999, the year bothMexico and the United States had to boost their imports of natural gas.

In the year 2000, the average monthly wellhead prices of natural gas becamehighly volatile and skyrocketed, reaching a new equilibrium point around US $4.5per thousand cubic feet (mcf), from the average US $1.98 per mcf in the

1990s.31The behavior of natural gas prices over the past few years, led FederalReserve Chairman Alan Greenspan, on June 10, 2003, to warn that

...if we stay at these very elevated prices we're going to see someerosion in a number of macroeconomic variables which are notevident at this stage. A very significant amount of natural gas usinginfrastructure in the American economy was based on $2 [per mcf]gas. That means a lot of noncompetitive structures are sitting out

there.32



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Some analysts argued that the variations in average monthly wellhead prices ofnatural gas were the result of a shift in domestic market practices in the UnitedStates, where a regulatory framework was replaced by a competitive one,introducing vulnerability to severe high prices peaks. The market was supposed totake care of these deviations. Yet, despite some readjustments in 2001, prices in

2004 have oscillated around $4.5 per mcf.The paradox is that, given its competitiveness in comparison to other fuels,sizeable investments were made in natural gas fueled infrastructure in theproduction, industrial and residential sectors, that now has to be sustained. Thechallenge for the region is to meet natural gas demand at affordable prices.

Taken as a region, North America is largely self-sufficient and highlyintegrated with a vastly interconnected natural gas grid. The United States is theworlds leading natural gas producer, Canada is the third world producer, andMexico is also a significant player. 33 All three countries have important reserves.Yet given their patterns of consumption, the United States and Mexico importabout 15% of their respective internal needs. Canada, the second world exporter ofnatural gas after Russia, exports over 50% of its production to the U.S. covering94% of its neighbors imports requirements. In the three countries, demand is

expected to grow on a yearly basis. Thus, a strong increase in natural gasproduction and net imports are needed over the next two decades to fill demand.The natural gas industry will require significant investments in downstream andupstream to meet this challenge.

In the three countries, ambitious projects are being undertaken to increasedomestic supply of natural gas. New fields, which will come to fruition around2010, are being developed in the artic region of Canada (MacKenzie gas project)and in Alaska. In Mexico, were demand is expected to grow at a yearly rate of 6.8%,PEMEX has established an innovative scheme (multiple service contracts) toexploit dry gas in Burgos, with private sector participation, but respecting theConstitutional framework.34 High natural gas prices render these projectsinteresting to investors. In the case of Mexico, the incentive for the governmentlies in that --given current price levelsproducing gas is cheaper than importing it,

generating important savings and employment.Increasing domestic production is essential to securing the supply of natural

gas in the region. Yet, it is not sufficient. Imports are needed to maintain at alltimes an adequate supply and demand balance. Given cost differentials, imports inthe form of liquid natural gas (LNG) can provide an injection into the system tobring natural gas prices back to levels that support the dynamism of the economy.

North America is thinking in terms of LNG. There are currently four LNGfacilities in the U.S., and twelve others are under consideration: two in Canada,four in Mexico and the rest in the United States. Importing LNG into the regionwould confer supply flexibility. More interestingly, it would provide a means tofurther energy integration among the three countries, by boosting the regional gasmarket.

The natural gas security challenge offers an opportunity to design a NAFTA

response that would benefit all parties. By furthering energy integration throughthe enhancement of the natural gas market, North American energy security wouldbe increased.

Electricity

Ensuring a secure power supply is essential to the functioning of modern societies,since there are limits to electricity substitution. Given that the disruptive impactof power failure is costly and spreads through the economy, governments have twobasic objectives: (1) in the short-run, to guarantee system reliability, i.e. the ability



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of the power industry to cover demand at all times; and (2) in the long-run, tosecure the adequacy for generating and transmitting electricity. Industrializednations invest in generating capacity to cover demand at peak hours, whiledeveloping countries are mostly concerned with extending coverage.

The power intensive nature of modern life has led to a sustained increase inelectricity demand. Adequate and timely investments in generating and network

infrastructure are a prerequisite to ensure a secure power supply. Yet, the levels ofcapital investment required represent a major challenge for financing.Traditionally governments have undertaken the responsibility of carrying out

those investments. Currently, the power industry is undergoing a paradigm shift,from government regulation to market competition. Privatization, deregulationand setting electricity markets are carried out in several countries. The extent ofprivate participation varies, but the tendency is growing, since this is a viablemeans to obtain the much needed financial resources to sustain power security.

The outcomes of recent reforms have brought up questions about theadequacy of the market to provide incentives to carry out the investments requiredto support reliability. In some cases the market has been effective, but the failureshave been tremendously noticeable, as in California and the Northeast. Theelectricity industry is in a transition period and it might be too soon to evaluate the

outcome.North America reflects the diversity of the debate. The United States hasundertaken a wide deregulation process; while in Canada Provincial governmentsrun their power industry, with the exception of Alberta and Ontario; and, inMexico, governments attempts to liberalize the electricity sector have met withstaunch opposition. Both Canada and Mexico have accepted private participationthrough independent power producers schemes.

Regardless of the structure of the power sector in NAFTA countries, thechallenge is basically the same: meeting the growing demand of electricity. Thereliability of the system is derived from the generation of electricity as well as fromthe possibility to transmit and distribute it to consumers. Major investments areneeded to update the transmission grid of the region in addition to the opening ofnew power plants. On the generation side, the region has a healthy diversity of

energy sources, with a growing emphasis on cleaner fuels and renewables.35

However, each type of energy source for electricity production has its own limits,which have to be taken into account.

Given the nature of the product, electricity markets remain local. Thus, NorthAmerican electricity security can be enhanced through the furthering of powerexchange within the region.

III.- RENDERING NORTH AMERICANENERGY MARKETS MORE DYNAMIC

Geographical proximity, the energy mix of each country and cross-border regionalbalance have facilitated an intense energy exchange within North America.Debates about the benefits of regional energy integration are surpassed by reality.The natural market of each country is within the region. North American energy

integration started many years ago, with the trade of oil. Through the years, themarket has expanded. Today the region is interconnected by an importantinfrastructure that facilitates an intense exchange of oil, gas and electricity.

North America has a dense natural gas grid that reflects the intensity offlows within the region. Multiple links exist between the United States andCanada, although the degree of interconnection varies among states and provinces.The level of exchange between these two neighbors has almost turned theirsystems into a single network. In a smaller proportion, Mexico is alsointerconnected with the United States. The increasing consumption of natural gas



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in the three countries will require further developing the infrastructure to sustainan intensive exchange within the region. Significant investments will be needed inthe years to come to ensure the density and capacity of pipelines and storagefacilities to facilitate transportation and trade of this fuel.

Main Canadian Natural Gas Pipelines

(Source:North America-The Energy Picture)

Natural Gas Pipeline Interconnections between Mexico and the U.S.(Source:North America The Energy Picture)

Aprospects of establishing LNG facilities to complement North American supply, is

trilateral response to the natural gas challenge of the region, including the



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facilitated by the structure of the market. The three countries have modern andtransparent regulatory frameworks that allow for the competitive participation ofthe private sector in the upstream business (in Mexico, downstream activities in oiland natural gas are reserved to the State).36

In this context, the development of the market is driven by the appealingopp

llows for a better allocation ofreso

ctive trading, with adequate infrastructure, otherpos

ides a usefulinst

elopment of a North Americanelect

Canada- Major International Interconnections (kV) and Electricity Trade (GWh)

ortunities it can offer. Governments can help mobilize needed investments in a

timely fashion by lowering regulatory and market barriers. The dynamism of such amarket would write-off severe price imbalances.Moreover, cross-border natural gas trade aurces, as it bridges regional disparities. For instance, it might be more efficient

to import gas from Mexico to New Mexico, and sell gas to Baja California fromCalifornia, than for each country to transport the gas through long stretches oftheir respective territories.

In addition to cost-effesibilities may arise such as the Mexican purchase of Canadian natural gas or the

establishment of LNG facilities in Mexico to service the U.S. market.The furthering of the North American natural gas market provrument for enhancing the energy security of the region. It is viable and

provides rich opportunities to all participants.

A similar scenario is possible with the devricity market. The power grid between Canada and the United States is highlyinterconnected. The two countries have been trading electricity for over fortyyears. The exchange is particularly intense between neighboring Provinces andstates. Currently, Canada supplies 1% the U.S. electricity requirements, most of itfrom hydropower generated in Quebec to the Northeast.

1999. (Source:North America The Energy Picture)



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Mexico and the United States are interconnected at various points throughout theborder, trade is small. Mexico is a net importer of electricity from the UnitedStates. The U.S. provides emergency assistance to border towns.

Mexico-U.S. Border Power Interconnections(Source:North America The Energy Picture)

The California crisis unveiled, at the highest political level, the limits and

possibilities of cross-border electricity trade. In January 2001, Mexico initiated thesale of 50 megawatts (MW) of electricity to California, a small amount compared tothe required 4 000 MW, but sufficient to supply up to 5 000 households. Yet, thetransmission infrastructure proved to be insufficient to carry greater flows.

As newly inaugurated President Bush requested higher exports of power fromMexico to avert the crisis, several issues came to the surface: The transmissioninfrastructure is limited on both side of the border; attempts to expand it havebeen hindered by the slow pace of the process of Presidential Permitting. Strictenvironmental legislation in California recurrently blocks energy projects thatwould enhance regional integration.

The National Energy Policy recommends the revision of the PresidentialPermitting processes in order to render the regulatory regimes more compatiblewith cross-border trade.37 Streamlining these processes is a precondition to

rendering the North American electricity market more dynamic, as a highlyintegrated power grid needs to be developed and investments will not materializein due time otherwise.

There are several projects currently under consideration both at the Canadianborder and the Mexican border with the United States. Given the increasinginterrelationship between natural gas and electricity, interesting projects arearising which involve cross-border trade of both resources. For instance, acombined-cycle power plant in Mexico can be fueled with imported gas from theU.S. and export electricity back to California. Business opportunities will arisefrom the existence of a potential market, but also from the advantages derived



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from more expedient approval processes. Yet, trading will still need to befacilitated by the existence of appropriate infrastructure.

The interconnectivity of transmission is a key issue for North America whichhas

North American electricity market has to overcomesign

IV. IMAGINING THE FUTURE:NORTH AM REALITY

The develop ctricity will

re internal national codes will change in the nearfutu

ntry, it is possible to imagine afutu

tion forward. In the multi-dim

gram for energy efficient products in the U.S. andCan

hich the lack of capital investment couldbrin

development of energy infrastructure and trade.

to be addressed trilaterally in order to ensure the development of a dynamicregional electricity market. There are major electric power grids, but there is not acomprehensive one. In addition, there are interconnection compatibility issues,

particularly between Mexico and the United States. Canada has been workingclosely with the United States on these issues; yet, cross-grid interconnectioncapability remains limited.

In order to thrive, theificant challenges in terms of financing, regulation and interconnection

compatibility. Trilateral integration in this area is essential to secure electricitysupply throughout the region. Important gains can be derived from growing trade,including increase reserve margins, fuller coverage and greater reliability.

ERICAN ENERGY SECURITY AS A

ment of dynamic trilateral markets of oil, gas and eleaccelerate the process of North American energy integration. Imagining a future

without barriers to trade and investment within the region can be glamorous andexciting, but also unrealistic.

It is unforeseeable that core. Mexico is likely to maintain its sovereignty issue with regards to petroleum

exploration and production. Canada is unlikely to step down its efforts to mitigatethe impact of the energy sector on climate change. The U.S. is likely to strive toadvance the American way to energy security.

Keeping in mind the core issues of each coure where North American energy integration is a reality. This integration is

driven primarily by the existing exchange of oil, gas and electricity. The increase intrade will accelerate integration, as flows become more dynamic and reciprocal atmultiple cross-border points. The challenge lies in harmonizing rules andregulations to attract the levels of investments required to establish the

infrastructure needed to sustain these flows.Trade is just on element that pushed integraensional approach to energy security that NAFTA partners share, energy

efficiency and conservation are key policy objectives. In this realm, trilateralefforts have been undertaken to advance in the design of programs with commonpractices and standards. Such programs have a double impact as they favor energyefficiency and conservation while they promote the intraregional trade of goodsthat meet common standards.

Energy Star, the labeling proada, could become a regional trademark. Initial work has been conducted by

the North American Energy Working Group for refrigerators and air conditioningdevices, but other products could be included in this effort. One could imagine afuture in which all electrical appliances produced in North America meet the

highest standards of energy efficiency and conservation and are commercializedworld-wide with a North American seal.

One can also imagine a future in wg some flexibility to rigid positions. This could be the case in Mexico where the

costs of under investing in the energy sector could be much greater than the risksof opening up some aspects of the power industry or of the oil upstream industryto the private participation. This could also be the case in California where thestrictest environmental laws by international standards are hindering the



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In this scenario, Mexico, for instance, could design innovative schemes toovercome its limited capacity to refine its crude and become self-sufficient. Theprec

Thecurr

t to reduce greenhouse gas emissions could have a positive effect on

the

and

Can

ous and rising supply of energy. Meeting this demand is a centralcha

edent is already there with the joint-venture between PEMEX and Shell in arefinery in Deer Park, Texas. Given the countrys limited refining capacity, and thelack of financial resources, ventures could be established in Mexican territory toprocess oil to meet domestic consumption and become a participant in the

petroleum products market, getting the benefits of the value-added to theresource. In this case, a market for fuels could emerge within North America.The advantage of such strategy is that Mexico could be at the cutting-edge of

refining, producing products that met the highest environmental standards.ent risk for the country is that the revamping of its refineries might not

necessarily solve the double challenge of meeting internal demand and producingthe highest quality products. Lagging behind in this sector could seriously affectthe Mexican automobile industry, as cars for exports would have specifications forthe use of fuels that met more stringent environmental standards. The cost ofstaying out of the international automobile market would be high for the Mexicaneconomy.

Given North Americas concern with climate change mitigation, a strongcommitmen

acceptance of nuclear power production. Thermal generated electricityaccounts for over 30% of carbon dioxide emissions. The benefits of existingnuclear power plants in terms of global environmental protection and costcompetitiveness of the electricity produced could entice a reconsideration of theirsafety and other environmental concerns. NAFTA countries have vast experiencewith nuclear power plants, and the safety record is very good. The main issue forapprehension is radioactive waste management, which is one of the key elementsstirring public opposition to the nuclear option. In the medium-run, this could bean area of trilateral cooperation, leading to the establishment of a state-of the-artnuclear waste disposal facility for North America. Reviving the nuclear alternativeis an option that cannot be discarded in the efforts to achieve energy security.

Paradoxically, another approach to enhance electricity security in the regioncould be increasing the use of coal in power generation. The United States

ada have some of the worlds most important reserves of coal. Significant stepsare being undertaken in the development of clean-coal technologies, whichdiminish the impact of coal generation on the environment. Coal-fired plantscould have a comeback as an alternative to the thermal or hydropower generation.Maintaining a diverse source of fuels will continue to be essential to energysecurity.

Sustaining the sophisticated and dynamic North American economy demandsa continu

llenge for the region. Yet, North America is blessed with vast and diversesources of energy, with well developed and widely interconnected infrastructure,and with a transparent and legal framework to attract investments. The dynamicsof the existing energy markets are likely to push forward regional integration andbring about needed changes to secure investments. Energy security will greatly be

advanced by this integration. This is primary goal for NAFTA, since energy securityis a strategic factor in ensuring the economic development and stability of NorthAmerica.

the NAFTA refers to energy. In Annex 602.3 Mexico reserves theparticipation in most of the Mexican energy sector to the Mexican State. It could be saidthat in terms of energy NAFTA is a bilateral rather than a trilateral agreement.

1.-Chapter VI of



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es. National Energy Policy. Report of the National Energy Policy Development2001)

licy, p. xi.

nsure its, President Zedillo presented to Congress a proposal to openreign investment. The proposal was never discussed by

with

d

king Group are to

interest, and

nergy balance, trade, existing pipelines and

ves: 5%; natural gas: 6%; refining capacity: 25%;tico de Amrica del Norte, pp. 13-15

8.

ational Energy Agency, 2002), pp. 97 ff.n Agency,

2 . -Henry Kissinger, then Secretary of State of the United States, proposed the creation of

the IEA at his Pilgrim Society Speech in December 1973, leading to the Washington EnergyConference in February 1974. The United States and Canada are founding members of the

AIE. Mexico, despite being a member of OECD, has refused to join the IEA on the groundsthat its Constitution does not allow foreign entities to intervene in the design of Mexicanenergy policy.

3 .-Energy Security, International Energy Agency, www.iea.org4 .-Dick Cheney in National Energy Policy presentation letter addressed to the President ofthe United StatGroup. (Washington, D.C.: U.S. Government Printing Office, May5 .-These goals are 1) modernize conservation, 2) modernize our infrastructure, 3) increaseour energy supplies, including renewables, 4) accelerate the protection and improvement ofour environment, and 5) increase our energy security. National Energy Po6 .-National Energy Policy, p. xv.7 .-National Energy Policy, p. xv.8 .-Aware that Mexico needed 25 billion dollars invested over the next decade to epower supply, in February 1999up the electricity sector to foCongress. President Fox has promoted an all encompassing energy reform which has onceagain been blocked by Congress. His administration has estimated that the energy sector

requires investments in the amount of $140 billion dollars over the period 2001-2010.9 .-Since 1998, Mexico has been an active participant in the efforts of oil producing countriesto stabilize the international oil market. Mexico is not a member of OPEC. Yet, in order toavert a financial collapse of the Mexican economy in 1998-1999, it joined forcesanother independent producer, Norway, and with OPEC members, in particular Saudi Arabiaand Venezuela, to stabilize the market. The Fox Administration has continued this policy.10 .-Quoted from Natural Resources Canada home page, Energy sector section , MeetingInternational Priorities, www2.necan.gv.ca/es/es/international-e.cfm.11.-In a speech at the U.S. Department of Energy on June 28th, 2001, President Bush referreto the North American Energy Working Group as a Presidential Task Force.

12.-According to the agreed Guidelines, The goals of the Worfoster communication and cooperation among the governments and energysectors of the three countries on energy-related matters of commonto enhance North American energy trade and interconnections consistent with the

goal of sustainable development, for the benefit of all. This cooperation processwill fully respect the domestic policies, divisions of jurisdictional authority, andexisting trade obligations of each country.13.-This paper will not attempt to present a detailed energy map of the region. A usefuldocument was produced and published by the North American Energy Working Group.North America - -The Energy Picture presents the etransmission lines, regulations, and legal frameworks for the energy sector of Canada,Mexico and the United States. The document was published simultaneously in the threecountries. The reference used throughout this paper is Perfil Energtico de Amrica del Norte.(Mxico D.F.: Secretara de Energa, 2002).14.- Perfil Energtico de Amrica del Norte , p. 7.15.-Perfil Energtico de Amrica del Norte, p.12.16.-Coal reserves: 26% of the world; oil reserpower generation: 967 gigawatts. Perfil Energ17

.-Perfil Energtico de Amrica del Norte , p. 18.18 .-www2.nrcan.gc.ca/es/es/change_e.cfm19 .-Perfil Energtico de Amrica del Norte , p. 18.20 .-National Energy Policy, p. 8-1.21 .-Perfil Energtico de Amrica del Norte , p. 122 .-Perfil Energtico de Amrica del Norte , p. 19.23 .-Energy Security, International Energy Agency, www.iea.org24 .-National Energy Policy, pp. 8-3, 8-4.25 .-The United Status 2002 Review. (Paris: Intern26.-Canada Country Analysis as reviewed by the Energy Informatio



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html.

doe.gov.

is brief, www.eia.doe.gov/emeu/cabs/usa.htmlsis brief for Canada and the US, www.eia.doe.gov.

mand coal), 13% from

d 1.3% from other renewable sources. In 2003, the U.S. produced

ry. Only exploration, production and processing of natural gas are

ve technical studiesincluding

www.eia.doe.gov/emeu/cabs/canada/27 .-World Energy Outlook 2001. p. 34.28 - Data for 2004 . Pemex, Indicadores Petroleros, www.pemex.org.mx29 - World Energy Outlook 2001. p.125.30 .- World Energy Outlook 2001. p.125.31 .- Data taken from the Energy Information Agency web page. www.eia.

32 .- As quoted by EIA in country analys33 .- Data taken from EIA, country analy34.- For further information on PEMEX multiple services contracts see:www.csm.pemex.com35 .-In 2001, Canada generated 566.3 billion kilowatt hours (Bkwh) of electricity: 56% frohydropower, 28.3% from conventional thermal power (oil, natural gas,nuclear generation, an3,836 Bkwh: 52% from coal-fired plants, 21% from nuclear, 161% from natural gas, 7% fromhydroelectricity, 2% from oil 2%, and 1% from geothermal and "other" sources. In 2002,Mexico generated 198.6 Bkwh of electricity: 81% from thermal (oil, natural gas, and coal),12% hydropower, 4.5% nuclear, 2.5% and geothermal and 0.005% wind-generated, from awind plant in Oaxaca.36 .- The Mexican natural gas industry allows for the participation of private investors in thetransportation, storage, and distribution activities, including importing and marketing

within national territoactivities reserved to the Mexican State through PEMEX. The Mexican gas sector hasattracted the participation of foreign investors and is likely to become even more appealingwith the increase integration of the North American market.37.-The U.S. has three types of Presidential permits in the energy sector, related to thedevelopment of dross-border infrastructure in oil, gas and electricity. The procedure variesslightly for the different sources of energy. Yet, they all involfeasibility and environmental assessments-- and consultations at federal, state and locallevel. The approval process is delayed at the local level often on the grounds ofenvironmental considerations.

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