CANADA ECONOMICS FEATURE: Canada's Heavy Oil Dependency - BMO's Douglas Porter and Benjamin Reitzes


"Canada's energy industry is increasingly in the spotlight, between the high-profile debate over pipeline construction, decade-low natural gas prices, the double-discount on crude exports, and rapidly rising oil sands production. While the latter has raised loose talk of Canada becoming an energy superpower, the evidence is a bit more nuanced, and the economic and financial impact of the energy sector is far from clear-cut. Indeed, Bank of Canada Governor Carney just last week suggested that "it is far too simplistic to talk about the Canadian dollar as a commodity currency, let alone a currency that moves consistent with one commodity." While it may be simplistic to consider the loonie a petro currency, there is little doubt that oil is now the single most important commodity for the Canadian economy, and commodity wealth is what differentiates Canada from most other industrialized countries.

"The net merchandise trade surplus on all forms of energy totaled $61.4 billion over the past year, or roughly 3.5% of GDP over that period. While certainly significant, the energy trade surplus in fact averaged 3.4% of GDP from 2000-

2011, so recent trends are consistent with the past decade. The big break occurred around 2000, when the energy trade surplus took a step up from a 20-year trend of just over 1% of GDP to around its current level, as both oil

and gas prices ramped up. Taken as a whole, the energy sector's importance for the broader economy has increased markedly from the 1980s and 1990s, but hasn't really changed much from the 2000s. For comparison, Russia's net energy trade surplus is about 17% of GDP, while the U.S. energy deficit was just over 2% of GDP in the past year.

"Yet, there is little doubt that the Canadian dollar is heavily influenced by the direction of oil prices. We have long contended that the currency tends to move by 3-5 cents (US) for every US$10 move in oil prices. The wide divergence

between Brent, WTI, and Western Canadian Select (WCS) prices in the past 18 months has seen the relationship temporarily weaken, compounded by heavy capital inflows. Still, in the long term, we find that WTI provides the best fit

with the currency, with a correlation coefficient of more than 0.90 on week-to-week moves in the loonie.

"No doubt, WTI is currently not an accurate gauge of oil's impact on Canada, with most of our consumers effectively paying Brent prices, and many of our producers receiving the low-end WCS price. The Bank of Canada estimates that

this spread is costing the Canadian economy 0.1% of GDP (roughly $2 billion) this year. The spread between Brent and WCS has exploded to about $43 barrel on average so far in 2012, up from $33 last year and just under $15 in 2010. While rising export and falling import volumes have expanded the oil trade surplus, a narrower price gap would clearly be extremely beneficial to Canada. Indeed, if

all exports were sold at Brent prices, Canada would reap an additional $19 bln annually (roughly a 4% increase in total exports). However, the gap is expected to be transitory, as new pipelines improve product flow in North America and

Mid-East tensions ease. In the event, the high correlation between WTI and the loonie will likely re-emerge.

"The other dampening issue on Canada's energy sector is the deep dive in natural gas prices. One key shift in the past decade has been the reversal of fortune between oil and gas. Net crude oil exports are now running at $42.9

billion per year (or 2.5% of GDP), while natural gas sales have dropped to just $12.5 billion (0.7% of GDP, the lowest since the early 1990s). Indeed, due to the incredibly mild winter and the upswing in U.S. production, Canadian

gas exports dropped below $700 million in February, onethird of the 10-year trend and just 1.7% of all merchandise exports, the lowest since the mid-1970s. Until 2006, oil and gas exports were running almost hand-in-hand, but

now they are on different planes altogether. Also note that trade in coal, electricity and refined petroleum products have all been in small surplus

positions over the past year but, combined, account for little more than 0.3% of GDP.

"Weak gas prices and the discount on Canadian crude have undercut our overall commodity price basket and have trimmed the terms of trade. While well above the

2009 lows, neither measure has progressed since 2005 2006."

Bottom Line: "There is much more to Canada's economy than commodities, and there's much more to commodities than oil. However, crude oil has become the single most important commodity for Canada and, arguably, our single

most important product. Crude oil exports alone are now larger than all exports of autos, trucks and parts, whereas they were one-seventh of auto sector exports in the 1990s. Crude oil exports are also now larger than agriculture and

forest product exports combined. It may seem simple that Canada's currency and economic outlook will be heavily influenced by the fate of oil output and prices, but the simple explanation is often also the best."

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

Copyright (C) 2014 All rights reserved. Unauthorized reproduction is strictly prohibited.

This article appears in: Investing , Commodities

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