THE POTENTIALThe United States imports more oil and oil products from Canada than from any other single source. It imports nearly two million barrels of oil per day, three quarters of which is crude oil, placing Canada marginally behind Saudi Arabia as a US crude supplier. Canada is the leading exporter to the US of both refined oil products and natural gas (Canada is the world's second largest exporter of natural gas, after Russia). All of Canada's natural gas exports go to the US, accounting for 87 percent of total US natural gas imports.1As oil and gas production fall in the lower 48 states, a decline matched across the border in the western Canadian sedimentary basin (WCSB), the source of most current Canadian oil and natural gas production, both countries have turned their attention to the vast potential of the Albertan tar sands. These tar sands, covering an area equivalent to both Ireland and Scotland, are located predominantly in the Cold Lake, Peace River, and Athabasca regions of Alberta. While proven conventional oil resources in Canada are estimated at a paltry 4.5 billion barrels, proven tar sands reserves are estimated at some 174 to 178 billion barrels. This places Canada second only to Saudi Arabia in terms of potential crude oil reserves. Ultimate reserves may be as high as 315 billion barrels.The Canadian-US market is unique in its integration, particularly for natural gas markets. Hydrocarbons from both countries pass freely over the Canadian-US frontier in a seamless web of pipelines, by vehicle and tanker transport. New England's natural gas demand is critical to offshore Nova Scotia. Futures contracts for gas sold at Henry Hub in Louisiana affect the overall North American price structure, playing a role similar to that for NYMEX futures contracts for West Texas Intermediate (WTI) crude sold at Cushing, Oklahoma. Thus a Wyoming refiner can purchase Saskatchewan Lloydminster grade crude at a discount from the prices quoted for WTI at Cushing, or it can purchase Mexican Mayan or Alaskan North Slope crude, both of which are priced with reference to WTI quotes. The Sable Island Consortium sells Atlantic Canada natural gas at spot prices in the northeast corridor, prices which in turn reflect the going prices at Henry Hub.Pipelines are being redirected to take account of freer North American trade. For example, the flow in the Sarnia-Montreal pipeline, designed to carry oil from the WCSB to Montreal, has been reversed from west-to-east to east-to-west, reflecting market fundamentals. In May 2004, the main federal Canadian regulatory authority, the National Energy Board (NEB), and its US counterpart, the Federal Energy Regulatory Commission (FERC) signed a memorandum of understanding committing themselves to further harmonization of their regulatory approaches to cross-border projects.After many years of teething problems, there is now progress in developing the Albertan tar sands. As can be seen from table i, current production of the various grades of tar sands-based bitumen (and synthetic crude) is one million barrels per day, and is predicted to increase to two millions per day by 2015. There are over 40 tar sands projects, projected with a cumulative investment value of Cdn. $60 billions. Virtually every major oil company or large independent from the US, Canada, or Europe is involved in some fashion with the tar sands industry. Two million barrels is roughly equivalent to 60 percent of total current Canadian production level, and 133 percent of the level of current crude exports to the United States.The integration of Canadian-US continental hydrocarbons trade would appear to be a success. How did it get that way? What are its prospects for the future?MARKET INTEGRATION: TWO VIEWSEconomists look at market integration in terms of an efficient allocation of resources and a consequent increase of the absolute gains made from trade. When these gains are viewed politically, however, there is a tension between the absolute gains from trade, and how these gains are distributed among various parties, i. …