The governments of Mexico, Canada, and the U.S. have been in negotiations to draft a new and updated version of the North American Free Trade Agreement (NAFTA) for over a year now. And the talks have been bogged down by disagreements on many issues, including rules of origin, measures protecting agriculture, and opening government procurement.
The Energy sector was an apparent bright spot – the three countries agree that a new treaty should aid the growing energy trade. But the US government’s bid to drop a rulemeant to protect investors from government intervention is derailing progress even in this area.
The contentious issue is the Investor-State Dispute Settlement (ISDS) system. This system allows a firm to take legal action against a foreign government if it believes that the foreign government’s actions harmed its investments in that country. The U.S. Trade Representative Robert Lighthizer wants to scrap these NAFTA protections saying that they create an incentive for US companies to invest internationally and move jobs overseas. Energy companies, on the other hand, argue that dispute resolution provisions provide a critical safety net for US companies abroad. A senior at Sempra Energy was quoted in a recent articleas saying, “without that protection, you look at future investments in Mexico very differently and you may decide that because of that added risk you’re not willing to make those investments”.
To what extent do the actions of the energy industry match the rhetoric of their argument? My co-author, Robert Weiner, and I tested this argument in the context of the oil industry. Our study – published in the Journal of International Business Studiesin 2014 – examined detailed transaction-level data for sale of petroleum reserves in 45 countries. If firms really valued the dispute settlement option, we argued, then it should reflect in their valuation of the oil reserve and the price they pay for it. To test this argument, we compared two types of transactions. The first set of transactions offered firms access to treaty-based investor-state dispute settlement, i.e. the home country of the acquiring firm and the foreign country where the oil asset was located were party to an international agreement dealing with this issue. Other transactions did not have the same protections. We then examined if the price oil companies paid for each barrel of oil differed between the two. Because the price of oil reserves can also reflect other characteristics – such as depth of oil, type of oil, etc. – we account for these factors as well. We find that oil firms pay significantly higher amounts when buying petroleum reserves that are protected by international treaties than similar but unprotected assets. Moreover, the premium that firms pay for access to investor-state dispute settlement is higher for large firms than small; in other words, for firms that have the financial and managerial resources to undertake a long, expensive, and tedious legal process.
So, what does this mean for the NAFTA renegotiation? Given that any deal needs to be approved by the US Congress, the extent to which Representatives of Congress are sympathetic to energy firms concerns about access to international dispute settlement may determine the balance of the treaty, regardless of the views of the USTR.