The possibility of a trade war loomed last week after a preliminary World Trade Organization ruling found the US complied with international law by imposing billions of dollars in duties against Canadian lumber companies.

The confidential ruling, released to both countries on Aug. 29, has fueled further talk of an outright trade war between the world’s largest trading partners and concerns that the rules of free trade under the North American Free Trade Agreement between the US, Canada and Mexico were now unraveling.

A Nafta panel on Aug. 10 dismissed Washington’s claims that Canadian softwood exports are subsidized by Ottawa and therefore damage the US lumber industry. But Washington said that ruling didn’t address a 2004 decision by the US International Trade Commission which found in favor of Washington. US Trade Representative Rob Portman pledged to maintain punitive tariffs.

Further supporting the US position is the WTO, which found US lumber mills were in fact threatened by government-subsidized lumber imports from Canada.

The Bush administration imposed the tariffs in 2002 after accusing Canada of subsidizing its lumber industry. Most US timber is harvested from private land at market prices, while in Canada, the government owns 90% of timberlands and charges fees for logging.

Neena Moorjani, a spokeswoman for the US Trade Representative’s office, said that the WTO decision confirms that Canada’s subsidies threatened to harm the US industry.

“Despite this win, the United States believes that back-and-forth litigation won’t solve this 20-year-old issue. The best course of action is to come to a negotiated solution,” Moorjani said in a statement.

Canadian officials, however, insist the Aug. 10 Nafta ruling means Washington must reimburse more than $4.1 billion in punitive tariffs.

“If Nafta is going to have meaning, then we all have to live within its rules,” Canada’s Trade Minister Jim Peterson said.

He said the WTO ruling - which won’t be final or made public until October - would likely be appealed and wouldn’t sway Ottawa from considering retaliatory tariffs against US imports.

David Wilkins, the new US ambassador to Canada, said free trade had served both countries well. Wilkins, whose comments about the “emotional” tone of the Canadian officials have irritated them even more, urged both sides to tone down the rhetoric and resume negotiations.

(Dow Jones Commodities Service)