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US-EU Free Trade Is Good for the Economy and for the Climate (Trans-Atlantic Trade and Investment Partnership treaty deserves broad support)

By Carlo Stagnaro -- October 17, 2014

“The degree of trade integration between America and Europe is already fairly advanced…. In particular, the average level of tariffs is relatively low (around 3%). Therefore, unlike most previous and current discussions on trade treaties, the Trans-Atlantic Trade and Investment Partnership will focus much more on non-tariff barriers where a protectionist rationale advances an environmentalist or health regulatory agenda.”

“Free trade can be good for the economy, and for the environment too.”

The United States and the European Union are in the process of negotiating a new free trade agreement, the so-called Trans-Atlantic Trade and Investment Partnership (TTIP). The treaty has the potential of delivering significant benefits to both parties, because of increased trade, lower barriers, and better labor specialization.

Energy may be a significant part of the deal: according to a leaked “non paper”, trade in energy commodities and technologies between the EU and the US would be freed from most of the burdensome red tape that, until now, has significantly hampered the possibility of achieving a greater integration among the two world’s largest economies.

TTIP would be a landmark free trade agreement for several reasons. An obvious one is the size of the involved economies: together, the US and the EU account for about half of the world GDP. A second reason is that, in a moment of crisis of the multi-lateral negotiations, an EU-US accord might set what in fact would work as a global standard, reviving global trade.

A third reason is that the degree of trade integration between America and Europe is already fairly advanced, as compared with the trade links that each of them have with other regions. In particular, the average level of tariffs is relatively low (around 3%). Therefore, unlike most previous and current discussions on trade treaties, TTIP will focus much more on non-tariff barriers where a protectionist rationale advances an environmentalist or health regulatory agenda.

Energy provides a particular case of this kind of barriers, on both sides of the Atlantic. On the European side, environmental and health standards are often set to protect domestic industries. Moreover interventionist policies to promote renewable energy sources are frequently designed in a way that is inconsistent with market competition.

Greater international trade in the energy sector would force the EU to design its “green” policies in a less distortionary way – a target that the EU itself is well aware of, as shown by the recent guidelines on state aid in the energy sector. (See, for example, the loose decision by the EU Commission on the British subsidies to nuclear power.)

As far as the US is concerned, protectionist barriers are still in place when it comes to energy, as a legacy of the “energy independence” mantra that has been a milestone of America’s energy policy at least since the 1970s. Regardless to the underlying economic and logical fallacies (that have been effectively debunked, for example, by Robert Bryce), the unconventional revolution changed completely the landscape: today the US has no shortage of domestic oil and gas.

In fact, the supply is so abundant and prices are so low that long-run investments might be in danger. In other words, whatever the reasons that led the US to place a stigma on exporting domestic energy commodities, they are no longer valid. TTIP would bypass most obstacles by setting a default green light on energy exports to the EU.

Why Not Free Trade?

From an economic viewpoint this is clearly a win-win game. The consensus among professional economists about the benefits of free trade is so widespread that some even call for unilateral trade opening, if negotiations fail. So, where’s the problem?

Unfortunately, many stakeholders oppose free trade agreements, TTIP included. The opposition may be grounded on the mere defense of vested interests (for example those of the domestic industries that fear to be displaced by more competitive, foreign companies) or in anti-trade ideology (that seems to be the case for many trade unions, even more than the protection of workers in scarcely competitive industries).

A strong and growing opposition is also coming from the environmentalist movement. For example, the Sierra Club argued that TTIP would jeopardize the effectiveness of climate policies, by increasing the consumption of fossil fuels, lowering their price, and creating a stronger incentive for fracking in the US. Is that a credible argument?

I will not question the climate science, nor will I argue against regulations aimed at reducing greenhouse gas emissions. I will just counter the specific anti-trade argument, showing that TTIP (and free trade in general) would be very unlikely to result in increased emissions. It would rather possibly lead to reduced emissions, although that may imply a greater exploitation of unconventional resources in the US.

That should not be a problem, however: not just fracking can be performed in environment-friendly ways, but more fundamentally fracking – however problematic – cannot be a greater threat than climate change. Otherwise, it would mean that climate change is no longer the greatest threat to humankind ever, a thesis that the environmental movement has been pushing forward for the last few decades.

TTIP and CO2 Emissions

So, what are going to be the likely consequences of TTIP on CO2 emissions?

The Sierra Club’s Ilana Solomon develops an argument on both oil and gas. As far as oil is concerned, it doesn’t seem that TTIP can have relevant consequences, except perhaps on marginally changing Europe’s import mix. World oil markets – differently from natural gas markets – are “one great pool”, as the late Morris Adelman said. “The price is the same at every border [he went on]. Who exports the oil Americans consume is irrelevant”. In his seminal 1984 paper, Adelman argued that, given the nature of oil as a commodity, price shocks in any region are rapidly transferred to any other region.

Therefore the effect of selective treaties (particularly embargoes or cartels) is much less relevant than one would expect. That also applies to bilateral free trade agreements. Who exports oil to America is as irrelevant as who imports American oil. The effect of TTIP on global oil prices is likely to be negligible. But if the price does not change, all else being equal demand is not likely to increase either. True, there may be some relocation in production, with more drilling in the US and less drilling somewhere else, but that is likely to be a second-order effect, with little impact on total consumption, emissions, etc.

The issue of natural gas is trickier. On the one hand, a global market is developing that in this respect makes natural gas more similar to oil than ever before. Yet, the size of LNG trade – as compared to pipeline trade – is still too small to result in one global price for natural gas. Therefore there are still huge price differentials between regions, as is evident by looking at natural gas quotations at European and American hubs. For example, in 2013 the average price for natural gas was as low as 3.71 US$/MMBtu at Henry Hub, as compared to more than 10 US$/MMBtu in Europe. TTIP can make a difference, although not a substantial one in the short run.

What are the environmental implications? Contrary to what Ms. Solomon argues, they are likely to be positive for the climate. More LNG trade between the EU and the US is likely to result in two consequences. Since natural gas markets are mostly regional in size, the effects on the US and the EU should be looked at separately.

The basic assumption is that, by removing red tape on natural gas exports from the US, all else being equal the existing price differential will make it convenient for US producers to export some of their natural gas to Europe, even after transportation costs are taken into account. If the quantities involved are large enough there will be effects on prices. In Europe, an increase of LNG import will lower prices at the margin, making gas more competitive and its supply more secure, both in reality and in the operators’ and politicians’ perception.

At any rate, cheaper natural gas is unlikely to displace green energies, as Ms. Solomon fears: the demand for renewables is driven by and large by the available (although declining) subsidies and by regulatory mandates. It is substantially shielded from market risks. For example, if the EU adopts a 30% renewable target by 2030, the available natural gas from the US will only impact how the remaining 70% is provided. It will have no effect on the green 30%.

Even if such a target is not adopted, but a 40% reduction target for COis set, free trade in energy commodities with the US may or may not have an impact on renewable investments, but at the end of the day Europe’s energy mix will have to be such that carbon emissions decline by that amount. Therefore, even in the worst-case scenario more natural gas (and oil) imports from the US would have no impact on Europe’s ability to meet its target, provided that there is a credible commitment to do so.

Good News

The opposite is more likely. US natural gas might displace coal in the European Union, as much as coal displaced gas in the past few years. From a CO2 perspective, this is likely to result in less, not more, emissions. Climate activists should be happy and supportive of this development.

Alas, the opposite will happen in the US. If American natural gas is demanded in Europe, it will become relatively less abundant in America, driving prices up. This might in fact result in more coal becoming relatively more competitive, but that again seems quite unlikely.

There are several reasons behind this. First, there is still a large potential for unconventional gas in the US: the alleged additional demand will be covered, at least in part, by additional supply. Therefore the effect on prices would be less than proportional. Luckily, this is not a zero-sum game.

Secondly, natural gas in the US is so abundant and so cheap that it is very unlikely that its prices will increase enough to make it convenient for power generators to switch back to coal.

Thirdly, America’s generating fleet is also evolving towards a cleaner, natural gas- and renewables-based pattern: that involves large sunk costs that will have to be recovered, creating a strong incentive for generators to keep the existing CCGTs running despite a modest increase in domestic natural gas prices (and a correspondent reduction in their margins, if there is enough competition in the US electricity generation market).

Fourth, according to the US Congressional Research Service, “some initial estimates projected a modest rise in absolute terms in domestic natural gas prices if all the proposed export projects are built, premised on a relatively flat supply curve for natural gas”. If the impact on prices is low, all else being equal the impact on demand will be low, too, making it unlikely that there will be an incentive for energy-consumers to switch from gas to more carbon-intensive fuels.

All in all, it seems reasonable to expect that the environmental consequences of TTIP, if any, will be benign: lower emissions in the EU will more than offset higher US emissions, and it is likely that US emissions will not deviate from the baseline anyway.

Free trade can be good for the economy, and for the environment too.


Carlo Stagnaro (Ph.D) is Senior Fellow of Istituto Bruno Leoni. This article is based on a longer version that originally appeared on EnergyPost.eu.

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