The National Energy Program:
Canada and the United States

Carman Neustaedter

POLI 437

March 2001

The National Energy Program:

Canada and the United States

Introduction

A high degree of interdependence exists between Canada and the United States making it essential to have effective management of the relationship. To effectively manage a relationship such as the one between Canada and the US, both procedure and substance must be maintained. Procedure requires good communication traits such as prior notification, consultation, and accommodation. Substance reflects a balance between national and joint interests. Both must be taken into account during policy formulation to solve problems of differing opinions. The "special relationship" that is often said to exist between Canada and the United States (US) was neglected by Canada in the early 1980's with the creation of the National Energy Program (NEP). Canada's policy was in the national interest of increasing Canadian control in the oil and gas industry. Little concern was taken over bilateral implications of the policy. Canada typically follows US energy policy, but in this instance Canada looked to increase the government's control of the industry, in direct contradiction to the US policy of free market forces. The problems that arose from the NEP between the US and Canada directly relate to the procedure and substance of the relationship at this point in time. Effective procedures were not fully used to provide good policy communication between Canada and the US and a balance between national and joint interests was not properly maintained.

Policy Reasoning and Formulation

Concern over Canada's oil and gas industry rose in the early 1980's, mainly as a result of changes in the world oil market. Oil prices had recently doubled and the federal government of Canada sought to gain more control over Canada's oil and gas industry. Western Canada produces a large amount of oil, however, the cost to transport this oil to Eastern Canada is expensive. As a result, large amounts of oil are still imported into Canada. A rise in international oil prices causes these imports to be expensive. The government's policy proposal was an attempt to shelter the Canadian economy from high import costs. The Department of Energy Mines and Resources stated their opinion that, "any country able to dissociate itself from the world oil market of the 1980s should do so, and quickly."¹ Canada's rushed attempt at this was the creation of the NEP.

A second factor behind the NEP's formulation was rooted in nationalist views within Canada and Canadianization. Concern over foreign ownership in Canada was not new and there was fear of losing Canadian control of the oil and gas industry.² Continued control of the industry by foreign owned companies would allow them to dictate the pace of growth for Canada's oil and gas industry while threatening Canada's sovereignty over the industry. Foreign-owned companies are also more apt to employ foreign managerial staff and use less Canadian products as opposed to foreign products. Two main methods exist to counter foreign control: increased regulation and greater Canadian ownership.³ Ottawa pushed for both in the National Energy Program. Increased domestication of the oil and gas industry could be met by increasing domestic oil production in places such as Western Canada and Atlantic Canada. Moreover, by increasing Canadian participation in the industry and lessening foreign ownership, Ottawa would begin to receive the benefits of higher oil and gas prices as opposed to foreign owned companies and gain direct control of the industry.

The federal government had been under negotiation with the provincial government of Alberta in initial attempts to solve Canada's oil and gas problems. Alberta sought to gain increased revenues with high domestic oil and gas prices reflecting the world market. The federal government had a contradictory view which called for a gradual rise in domestic oil and gas prices to ease the impact of rising world oil costs.⁴ Talks broke down between the two governments and as part of a fall budget, Ottawa acted unilaterally and introduced the National Energy Program. The NEP ultimately looked at giving more control of the oil and gas industry to the federal government. Little consideration was taken into realizing potential bilateral implications of the policy with the United States, along with the dissatisfaction from many of the western provinces. The problems surrounding the policy's formulation stemmed mainly from normal budget secrecy. Budget secrecy typically does not allow consultation with outside experts or the provinces. Furthermore, interdepartmental consultation was not allowed for the NEP's creation because the federal government wanted to avoid any complications that may be brought out between departments.⁵ Effective procedures to provide the US with prior notification of the policy, as well as proper consultation were not maintained.

Policy Goals and US Concerns

The National Energy Program was structured on three main policy goals: energy security, redistributing revenue, and Canadianization.⁶ All three policy goals encompass the broad incentive to place Canada back in control of its oil and gas industry. The United States was at a particularly awkward moment in time for such a policy to come on the agenda, leading to consultation and communication problems between Canada and the US. The US was familiar with the notion of domestication of industrial sectors because of prior proposals made by Canada, however, the introduction of the NEP caught them off-guard. The NEP was announced just days before the US election of Ronald Reagan, leaving any major response from the US slow in coming. Reagan's administration valued free market forces giving a view quite contrary to the regulations found in the NEP. Concerns from the US fostered around all three policy goals with an emphasis on foreign investment issues and the so-called Canadianization.

The first goal of the NEP was to have Canadian energy security by 1990, but focussed primarily on oil because Canada was self-sufficient in natural gas. Oil self-sufficiency would be accomplished through the expansion of domestic oil production, oil conservation, the use of alternate energy sources, and a reduction of oil imports. By making Canada completely self-sufficient in terms of oil, Canada would not have to rely on the world oil market and potentially high prices. The second goal was to redistribute revenue from the industry and lessen the cost of oil for Eastern Canada. Redistribution would move the federal government's revenue share from 10% to 25%, leaving the oil producing provinces with 43% and the industry with 33%.⁷ To lessen the oil cost for Eastern Canada, a blended pricing scheme would also be introduced.

The US argued that low domestic oil prices for Canada driven by regulated pricing would not lead Canada towards oil self-sufficiency.⁸ The view of the US was that it would make it more difficult for the Western World as a whole to maintain energy security because Canadian oil production and exploration would be restricted.⁹ Furthermore, they felt that by lowering domestic oil prices, Canada would effectively be subsidizing the Canadian industry which would only hurt Canada in the future by creating a dependence on the government. In regard to these two policy goals, it was clear that Canada was taking a domestic viewpoint while the US, although subject to question, had a wider, more regional standpoint. The differing positions on regulation are not surprising. Generally speaking, the US is more open to allowing market forces to control important industrial sectors with less government control than is Canada. The major problem, however, lay in the fact that Canada was not taking the interests of the US into account in the formation of these policy goals.

The third goal of Canadianization was the most controversial. Its primary purpose was to increase Canadian participation in the oil and gas industry by reducing foreign ownership and gaining Canadian control over large foreign owned firms.¹⁰ To do this, the NEP would restrict permits for production in Canada to only those companies with at least 50% Canadian ownership. Moreover, grants would be given out to Canadian firms in a program called the Petroleum Incentives Program (PIP). The PIP would give out subsidies to oil and gas firms based on their percentage of Canadian ownership. All firms would also be required to purchase Canadian goods and services for oil and gas production and exploration. This aspect of the National Energy Program would leave Ottawa in complete control over the industry. Crown corporations such as Petro Canada were labeled to take a more active role in this industry and a special tax was to be created to help Ottawa purchase foreign-owned firms. A Crown Interest provision was also introduced which calls for any company holding an oil or gas lease, whether Canadian or foreign owned, to pay 25% interest on the lease to Ottawa.¹¹ The controversial part of this interest provision was the fact that it applied to both future and current developments. Developments that were already discovered, but not in production would still be subject to the interest.

The US took its strongest stance against the third policy goal of the NEP, Canadianization. They felt not only did items such as the PIP grants and the purchasing of Canadian goods and services discriminate against US firms, but it more importantly violated international standards concerning foreign investment as set out in the General Agreement on Trade and Tariffs (GATT). Canadian suppliers of goods and services would be favored and the principle of national treatment would therefore not be applied. The US government regards "the principle of national treatment as an absolute prerequisite for a stable international investment regime."¹² Canada, it advocates, did not fully take into account its obligations under the GATT and the Organization for Economic Cooperation and Development (OECD) which clearly outline the role of national treatment. A fear existed that Canadianization may spill across the border into the US or set a precedent for discriminatory treatment of foreign investors in other Canadian industrial sectors. The US also strongly disagreed with the Crown Interest provision and its retroactive nature. Essentially, they felt that Canada was changing investment rules in the middle of the game.¹³ The US argued that this provision would lessen the value of holdings for existing shareholders and that it should not be applied to lands not yet in production. The Crown Interest itself could not be properly argued by the US because it applied to both Canadian and foreign firms. Once again, the NEP's third goal did not take into account the interests of the US and furthermore, in this instance failed to comply with previous international agreements. More emphasis was placed on the national interests of Canada than that of joint interests with the US.

US Actions

Actions from the US over the NEP came not only from two different levels of government, namely the Executive and Congress, but also two different administrations. With the announcement of the NEP days before the US presidential election, Canada consulted with the Carter Administration for just two months. Following Carter, the Reagan Administration began a slow start with high-level administration appointments leaving many senior officials unknowing of the policy initially. Moreover, the State Department was unaware of the new president's position on the energy issues because of early presidential relationship building strategies with Canada. It was not clear whether Reagan objected to the policy or whether he was for it.¹⁴ As a result, a clear presidential opposition did not arise until nearly six months after the policy was placed on the table when US oil company executives began complaining that their assets had been decreasing in Canada as a result of the NEP. Canadian take over attempts of foreign-owned oil and gas companies within Canada had also started to cause concern within Congress.¹⁵ The administration problems in the US clearly decreased the effectiveness of any communication between the two countries. Poor consultation between Canada and the US had become a consequence of a weak administration position.

The first main approach taken by the US in response to the NEP was through diplomacy and bilateral negotiations. The US attempted to broaden the agenda for the diplomatic talks by grouping objections to the NEP with previous objections to the Foreign Investment and Review Agency (FIRA).¹⁶ Unfortunately, this tactic only lead to confused negotiations because Canada was unsure of what to prepare to discuss and the actual intent of the negotiations was not clearly defined. As a result, Canada felt the US only wanted clarification on the policy and therefore sought to achieve this goal, rather than dealing with wavering concerns.¹⁷ Frustrated with poor negotiations, the US began expressing its concerns over the NEP with public pronouncements and diplomatic correspondence that not only outlined concerns, but addressed how Canada could alter its policy to align with US views.¹⁸ Once it was clear what the US concerns were, however, Canada took a contrasting role to its usual flexible nature by standing firm in its position showing its lack of willingness to accommodate.

The US also pursued a multi-lateral approach in hopes to alter the Canadian policy. Their claims that Canadianization deviated from the principle of national interest was brought before OECD committees. The US argued that Canada's failure to adhere to the principle would undermine the OECD and its future growth by lessening its acceptance by developing countries.¹⁹ The US also lodged a complaint with the International Energy Agency (IEA) over questions about the NEP's pricing, taxation, and production policies.²⁰ One of the fundamental principles of the IEA is a reliance on market forces in an effort to increase production in energy sectors. The US argued that regulations in the NEP violated the outlined market forces principles. Finally, the US asked for an international panel to give a binding decision on whether the NEP violated the principle of national treatment as outlined in the GATT articles. A decision was reached that in fact the NEP did contradict principles of national treatment leaving Canada with little choice but to modify the NEP to allow for Canadian goods and services to be assessed on a competitive basis with other suppliers first. Aside from this minor alteration of the NEP, the multi-lateral approach did little to alter the Canadian policy.

After strong Canadian resistance to change in the NEP in bilateral negotiations and multi-lateral disputes, the US resorted to unilateral retaliation threats. The administration's first threat was to rewrite the AutoPact that had been negotiated with Canada. Following this, the US stated that Canada was not living up to its international trade commitments and would not be allowed to participate in the International Trade Ministers meeting scheduled for January 1982.²¹ The administration's threats were never turned into action however and Canada was allowed to attend the meeting. The US Congress was the second body to threaten Canada when it felt the administration was having no effect on altering the NEP and Canadian takeover attempts began hurting US firms in Canada. Congress maintained the position that the administration was too weak and began issuing legislation aimed to aid US companies suffering from the NEP.²² In addition, Congress threatened to deny Canadian firms access to leases for oil and gas production on US federal lands with the establishment of a US agency replicating Canada's FIRA to screen foreign investment.²³ This issue rolled into a larger policy struggle between the executive and legislature because denying leases could be seen as being painful for the US as well. The feeling that retaliation would end up hurting US interests became eminent and no retaliatory actions stemmed from the various threats.

Conclusion

The problems that arose during the early 1980's between the United States and Canada over the National Energy Program stemmed not from a simple difference in opinion, but from ineffective management of the relationship. The two components of effective relationship management, process and substance, were not maintained. Principles of good communication like prior notification and consultation could not be achieved between the US and Canada because of a number of factors. First, budget secrecy caused Canada to provide little notification to the US of the new policy in formulation. Moreover, poor timing by Canada saw the policy presented amidst a change of presidents, leaving effective consultation difficult to achieve. Once the US was aware of the policy, accommodation was not sought by Canada during negotiations after the US was aware of the policy. Along with an ineffective process, the substance of the relationship was also not effectively managed. Canada failed to maintain a balance between national and joint interests by emphasizing its domestic view too heavily and not taking US interests into account in the NEP's formulation. As a result of ineffective relationship management, the special relationship between the US and Canada declined and problems arose over the NEP's creation.

Bibliography

Carmichael, Edward A. and Stewart, James K. Lessons from the National Energy Program. C.D. Howe Institute., 1983.

Clarkson, Stephen. Canada and the Reagen Challenge: Crisis in the Canadian-American Relationship. Canadian Institute for Economic Policy., 1982, pp. 55 -113.

Leyton-Brown, David. Weathering the Storm: Canadian-U.S. Relations, 1980-83. Canadian American Committee., 1985, pp. 23-42.

MacLaren, Roy. "Canadian Views on the US Government Reaction to the National Energy Program," Canadian Public Policy (1982).

Wonder, Edward. "The US Government Response to the Canadian National Energy Program," Canadian Public Policy (1982).

World Trade Organization, "Technical Barriers to Trade: Non-Discrimination and National Treatment", <http://www.wto.org/english/thewto_e/whatis_e/eol/e/wto03/wto3_11.htm> (March 16, 2001).