indicatorThe Twenty-Four

Follow the barrels

Why a U.S. tariff on Canadian energy is self-defeating

By Mark Parsons, ATB Economics 15 January 2025 5 min read

On January 20, President-elect Donald Trump will take office and, among other things, speculation is swirling on what he plans to do with tariffs.

In November, Trump threatened a 25% tariff on Mexico and Canada across all products, citing border security concerns. This month, the Washington Post reported a lighter touch on tariffs, only to be refuted by Trump days later. And after her meeting with the Trump team over the weekend, Alberta Premier Danielle Smith warned that tariffs are likely coming.

Even if this is a negotiating tactic, the persistence of the Trump tariff threat suggests it should be taken seriously. We have prepared different scenarios for the Alberta economy to account for the possibility of sweeping 25% tariffs, which in our estimation would lead to a recession. In the U.S., the Peterson Institute for International Economics estimates it will hurt economic growth and drive up inflation.

Amid the social media storm and political wrangling, it’s worth taking a step back to look at what Canada actually trades with the U.S.

A trade surplus with Canada, excluding oil and gas

Trump has been clear he doesn’t like running trade deficits with countries (that is, importing more than it sells), often calling it a ‘subsidy’.

According to the U.S. Census Bureau, the U.S. trade deficit (including both goods and services) with Canada was $US 40.6 billion in 2023.* There were nine other trading partners with which the U.S. had a larger trade deficit (see the chart below), and Canada accounted for only 5% of the total U.S. trade deficit of $US 785 billion in 2023.

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A closer look reveals a more nuanced picture.

-The U.S. runs a trade surplus with Canada in services. As of 2023, the service surplus was $US 31.7 billion.

-Excluding oil and gas from the trade picture, the U.S. runs an overall trade surplus with Canada.**

A tariff on Canadian oil and gas will raise U.S. prices and undermine energy security

So will oil and gas be the target of U.S. protectionist policy? That’s problematic from a number of angles.

First, the North American oil and gas market is highly integrated. Canada generates income from exporting oil and gas stateside, while the U.S. benefits from access to discounted barrels and secure supply. Far from being a subsidy to Canada, you could argue that the U.S. receives a subsidy from Canada’s relatively inexpensive feedstock, freeing up other more lucrative U.S. barrels for export. In other words, the U.S. trade deficit with Canada in oil and gas enables the U.S. to run an oil and gas trade surplus with other countries. Early this month, the U.S. was importing more than 4.4 million barrels per day from Canada, a record. In 2023, about a quarter of all crude refined in the U.S. came from Canada.

What about U.S. refiners swapping out Canadian barrels? There are limits to how much refineries could exchange heavy oil for light oil. The other heavy options include Mexico (also a target of 25% tariffs, but having greater ability to move barrels to alternative markets given seaborne access) and Venezuela (a less reliable supplier).

Second, tariffs on Canadian crude oil and natural gas will raise energy prices in the U.S.— which is directly at odds with Trump’s campaign pledges to slash prices. Refineries and natural gas importers have few options in the near term: The pipeline network sending these products is fixed and many U.S. refineries are equipped to process Canadian heavy barrels, particularly in the U.S. midwest.

U.S. industry groups have strongly cautioned against tariffs on imported crude.  According to the President of the American Fuel and Petrochemicals Manufacturers (AFPM), “American refiners depend on crude oil from Canada and Mexico to produce the affordable, reliable fuels consumers count on every day. Therefore, we would hope any future tariffs would exclude these critical feedstocks and refined products.”

To be sure, the reduction in demand for Canadian oil will also hit producers in Canada and government revenue via wider discounts on Canadian crude, including a wider light-heavy differential. It is a lose-lose for both countries.

Third, tariffs would come at a time of other energy affordability challenges for the Trump Administration. Oil prices have jumped in the last two weeks, closing at  $US 77.50 on January 14. This could be a double whammy—higher North American oil prices and higher import costs. Inflation expectations have risen, and the U.S. Federal Reserve is now leaning towards only one or two rate cuts this year, in part due to potential trade and fiscal policy.

Turning off the taps?

There has been some talk of the federal government considering export restrictions on Canadian energy as a retaliatory measure. There are at least three problems with that. First, many of the barrels flowing to the U.S. end up in refineries in central Canada via Enbridge’s Line 5 pipeline. The result would mean higher energy prices for Canadians. Second, there would be an economic hit from less energy production. Third, the Alberta government has been clear it will challenge any measure, arguing this infringes on provincial jurisdiction over energy production. Far from presenting a united front, this measure is opposed by the major energy-producing provinces of Saskatchewan and Alberta.

Summary

The U.S. runs a trade deficit with Canada that is driven by energy trade. But the U.S. does not ‘subsidize’ Canada.  Rather, it benefits from reliable flows of discounted crude and natural gas. In economics speak, each country specializes in what it does best (i.e. its comparative advantage) and gains from trade. A tariff, one way or another, will raise prices.

There is still hope the U.S. and Canada can preserve their mutually-beneficial trading relationship and avoid a tariff war (or at least keep it very temporary). We will know soon.

*Full-year data for 2024 are not available. In the first three-quarters of last year, the U.S. trade deficit with Canada was $US 28.7 billion.

**Using customs-based trade data by industry, the U.S. had a trade deficit in oil and gas trade with Canada of approximately $US 94 billion in 2023. Excluding oil and gas, we estimate the U.S. had a goods and services trade surplus with Canada of approximately $US 53 billion in 2023.

Answer to the previous trivia question: The University of Alberta was founded in 1908.

Today’s trivia question: In what year was the University of Calgary founded as a separate institution from the University of Alberta?

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