The Global Oil Shock: The Short-Term Impacts in Canada

Transcription

1 The Global Oil Shock: The Short-Term Impacts in Life is full of surprises. Canadians, along with financial markets, got a big one at the beginning of 2015, when the Bank of (BoC) cut its policy rate by a quarter of a point on January 21st. The target for the overnight rate now stands at 0.75%, which is still higher than in most other industrialized countries. Australia Norway UK Japan US Euro Zone Sweden Denmark Switzerland Policy Rates in Selected Central Banks Source: Bloomberg, LBS Economic Research and Strategy No one expected the rate cut. However, a closer look at the situation leads us to believe that this decision will be good for the Canadian economy. Investors, analysts, economists and entrepreneurs do not yet seem completely familiar with the particular approach that Governor Poloz is currently introducing into the decision-making process since he joined the central bank in mid No one can accuse Governor Poloz of not being transparent on this matter. For example, in a speech delivered in Montreal at the end of 2013, he stated that monetary policy formulation these days is more a process of risk management. He expounded further on this approach in June 2014, in a report titled Integrating Uncertainty and Monetary Policy-Making. In Governor Poloz s latest speech, last November, one sentence caught our attention, but not enough it seems because we were also surprised last Wednesday, along with everyone else when he said: as policy-makers, we acknowledge that, in the current situation, the consequences of an upside risk [to inflation] would be more manageable than those associated with a downside risk. January 29, 2015 The oil shock is now THE main downside risk tied to the inflation outlook and financial stability. The 25 basis point rate expresses concerns among the Governing Council that activity in the energy sector will drag down the Canadian economy more severely than expected just a few weeks ago. Moreover, the oil price war that started after the November OPEC meeting when members chose not to cut production is still ongoing. Saudi oil minister Ali Al-Naimi reiterated at the end of December that OPEC would not be reducing its output. And last week, Iranian oil minister Bijan Zangeneh stated that he was not contemplating any action aimed at stopping the decline in prices. As a result, the shortterm dynamic suggests an accumulation of inventories, until the oversupply situation is resolved. In short, oil prices have not found the bottom of the barrel yet, the main opinion we voiced in the December 5 issue of the Monitor. Beyond uncertain developments that will influence global oil prices, it goes without saying that the short-term negative impacts on the Canadian economy related to the drop in crude oil prices played in favour of the 25 basis point cut in the overnight rate target. Here are some examples: Alberta s retail sales fell by a cumulative 0.8% in October and November, the first sign that consumers are hesitating to spend. December s transactions in the Calgary and Edmonton resale housing markets fell by 25% m/m. Calgary s resale market was very tight for over two years; now, the sales-to-new-listings ratio show that the market s pendulum is swinging toward buyers. Yet, buyers are postponing their plans to buy a new home or condo as the employment outlook has deteriorated for a few weeks. According to the Canadian Federation of Independent Business s barometer, SME confidence started to fall in Alberta and Saskatchewan at the end of In December, Alberta SME confidence was only slightly higher than Ontario s, while Saskatchewan business confidence suddenly dropped below that of Quebec SMEs. 1

2 Companies that operate in the oil sector have begun to cut staff, along with capital spending. We estimate that the five biggest Canadian corporations with operations in s oil sector, which account for more than half of Canadian oil output, will cut capital spending by 25% in 2015 compared to For its part, the Canadian Association of Petroleum Producers (CAPP) is forecasting a 33% decline in capital spending this year (from $69B to $46B). Their estimate is similar to the BoC s projection (-30%). It will shave s real GDP growth by approximately 1 1/4% this year. According to the CAPP, the magnitude of the decline in investment promises to be twice as large for conventional oil projects (-42%) than for oil sand projects (-21%). Given that the latter have production horizons of several decades and that heavy fixed costs have already been incurred, temporary declines in oil prices are not stopping producers. In fact, producers usually choose to keep producing or wrap up projects that are closest to completion so as to move on to the extraction phase and start generating revenue as quickly as possible. SMEs Confidence Index Saskatchewan Alberta 30 1-Dec-08 1-Dec-10 1-Dec-12 1-Dec-14 Source: CFIB, LBS Economic Research and Strategy Sales / New Listings Ratio on the resale housing market Edmonton Calgary In light of these observations, it seems reasonable to think that the current economic conditions could erode rapidly, particularly as the confidence of economic agents has been shaken. This is no time to pat ourselves on the back about the fact that Alberta s real GDP growth could still be positive in Moreover, we think there is already a risk that our 2.3% real GDP forecast set out when we published the Provincial Monitor in December will be trimmed. How is positive real GDP growth possible in Alberta despite the oil shock? The reason is fairly simple. Experts expect the production and export volumes for Canadian oil to increase by approximately 4.5% in For the reasons given above, it is better for most producers to keep producing, as the marginal cost of extraction is still lower than the current crude oil price. However, aside from exports, we can essentially expect all other parts of the Alberta economy to be walking a tightrope: non-residential investment (especially in energy), the housing market and consumption could all decline, with obvious repercussions for employment. As for the Alberta s fiscal expenditures, we should not expect drastic cuts to program spending according to the latest remarks from Premier Jim Prentice. The provincial government has a solid surplus in terms of financial assets, so it can afford to take a few years to mop up a deficit that was not on the radar just a few months ago. The short-term economic repercussions from the oil shock, listed above, augur a tough year for Alberta. The real danger is that this would be just the first chapter in an even more painful period for the province, and for as a whole. In our view, due to this uncertainty, the BoC was justified to move away from the sidelines immediately. Let s assume that the situation worsens and oil prices stay at US$45 for an extended period of time (the BoC s assumption is that WTI will average US$60 in 2015 and 2016). In such a scenario, further postponements of investment are very likely to be announced. Also, oil sands projects are likely to be cancelled entirely, rather than just postponed. Canadian oil production which CAPP last year projected would double over the next 20 years will rise at a much slower pace. Last week, the CAPP downgraded its forecast for 2015 s production volume by 1.5%, and trimmed its 2016 projection by %. Such a debacle would have a negative impact on Alberta s economy that would last for a long period of time, after so many years of very robust growth. The implosion of oil sector projects could then prompt a sharp downturn in Alberta s housing market. Risk of contagion to the entire Canadian housing market could then materialize, to the point of changing foreigners view of the Canadian economy s long-term potential Source: CREA, LBS Economic Research and Strategy January 29, 20152

3 Total Oil Production in (millions of barrels per day) Oil Sands Source: Canadian Association of Petroleum Producers (CAPP) This is not our core scenario, nor is it the Bank of s; however, the repercussions of a very pessimistic scenario could cause long-term damage. This gives the insurance that Governor Poloz spoke of this week real meaning. The insurance notably took the form of a pronounced depreciation of the Canadian dollar last week; it is now close to 80 cents US (US$1.25/C$). Since other rate cuts are possible at upcoming BoC meetings (early March, mid-april, end of May, mid- July), it would be premature to assert that the loonie will not continue to depreciate. From a peak of US$1.02 in September 2012, the cumulative 22-cent drop recorded in the last 121 weeks is a post-war record. Of course, we must keep in mind that a sharp turnaround in the oil market situation (such as an announcement of cuts to output from OPEC and other countries) could cause the loonie to appreciate swiftly. The currency s depreciation is giving a real boost to Canadian producers selling crude oil in USD. A weaker loonie also benefits businesses exporting non-energy products abroad. The transmission of monetary policy through currency depreciation is perfectly in line with the BoC s base-case scenario, which holds that exports, rather than household spending, will become the country s main driver of growth in 2015 and The industrial diversification that is heavily benefiting is increasingly apparent, especially in Ontario, which will lead the pack this year in terms of economic performance. This economic diversification is certainly the envy of other oil-producing countries (Russia, Norway, Brazil), where the outlook is somewhat grimmer than s. Accordingly, although the oil sector development has been at the core of s economic performance for several years, and that the export capacity of Central is no longer what it used to be, the speed at which the poles of provincial growth will shift this year and next could take some by surprise, especially if BoC officials remain proactive. Failing a potential agreement among OPEC members to cut production or any other development that would prompt a sustainable increase in oil prices, we believe probable that the overnight rate target could end the year at 0.50%. Sébastien Lavoie Assistant Chief Eonomist January 29, 20153

4 Market Review: Bonds and Currencies INTERNATIONAL BONDS Benchmark 2-Year Yield Yield (%) Jan week -4 weeks -1 quarter - 1 year Jan U.S Spread US Germany France Portugal Spain Belgium Netherlands Italy Switzerland UK Australia #N/A Japan INTERNATIONAL BONDS Benchmark 10-Year Yield Yield (%) Jan week -4 weeks -1 quarter - 1 year Jan U.S Spread US Germany France Portugal #N/A Spain #N/A Belgium #N/A #N/A Netherlands #N/A Italy Switzerland UK Australia #N/A Japan PROVINCIAL BONDS Benchmark 10-Year Yield Current Spreads (b.p.) against Jan Jan week -4 weeks -1 quarter - 1 year Jan Alberta British Columbia Prince Edward Island Manitoba New Brunswick Nova Scotia Ontario Quebec Saskatchewan Newfoundland & Labrador Currencies CURRENCIES Jan week -4 weeks -1 quarter - 1 year Jan (%) (/US$) (US$/) Australia (Australia/US$) U.K. (US$/ ) Japan (US$/Yen) Euro (US$/Euro) Mexican Peso (Peso/US$) Brazilian Real (Real/US$) Chinese Yuan (Yuan/US$) Data updated as at: 28/01/2015 January 29, 20154

5 Market Review: Fixed Income Charts % 6.0 Yield on 3-Month T-Bills % 6.0 Yield on 10-Year Federal Bonds 5.0 U.S. 5.0 U.S Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 % - Yield Curve % U.S. - Yield Curve Jan-15-1 month -1 year Jan-15-1 month -1 year m 6m 2y 5y 10y 30y 0.0 3m 6m 2y 5y 10y 30y Yield Spreads in basis points ( minus U.S.) 23-Jan-15-1 month -1 year 3m 6m 2y 5y 10y Oct-12 Jan-13 Apr-13 Spreads on 2-Year Federal Bonds (Can-U.S., basis pts) Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 January 29, 20155

6 Market Review: Stocks Exchange and Commodities Stock Market Summary Level Change (%) Jan w HI 52w LOW (-1W) (-4W) (-13W) (-52W) Jan S&P/TSX 14,834 15,658 13, S&P/TSX S&P/TSX Small Cap Index United States S&P 500 2,030 2,091 1, Dow Jones 17,387 18,054 15, Nasdaq 4,682 4,807 3, International U.K. - FTSE 100 6,812 6,878 6, Germany - DAX 10,629 10,798 8, France - CAC 40 4,624 4,675 3, Japan - Nikkei ,768 17,936 13, Hong Kong - Hang Seng 24,807 25,318 21, Russia - RST 821 1, Australia - ASX All Ordinaries 5,511 5,657 5, Brazil - Bovespa 48,591 61,896 44, S&P/TSX Sector Summary Level Change (%) Jan w HI 52w LOW (-1W) (-4W) (-13W) (-52W) Jan S&P/TSX 14,834 15,658 13, Energy Materials Industrials Consumers Discretionary Consumers Staples Health Care Financials Information Technology Telecommunication Services Utilities Commodities Level Jan w HI 52w LOW (-1W) (-4W) (-13W) (-52W) Jan London -- Gold (US$/once) London -- Silver (US$/once) Copper (US$/LB) WTI Crude Oil (US$/barrel) Natural Gas (Henry Hub) (US$/MMBTU) Data updated as at: 28/01/2015 January 29, 20156

7 Calendar of Major Economic Indicators Date Time Release Unit Data for: LBS * Consensus Previous Jan 30 8:30 Gross Domestic Product M/M November - 0.0% 0.3% * Laurentian Bank Securities Forecast Consensus from Bloomberg L.P 26/01/2015 KEY ECONOMIC INDICATORS WEEK OF JANUARY 26, 2015 United States Date Time Release Unit Data for: LBS* Consensus Previous Jan 27 8:30 Durable Good Orders M/M December - 0.3% -0.9% Jan 27 8:30 Durable Good Orders Ex. Transportation M/M December - 0.6% -0.7% Jan 27 10:00 New Home Sales Thousands December Jan 27 10:00 New Home Sales M/M December - 2.7% -1.6% Jan 27 10:00 Consumer Confidence - January Jan 28 14:00 FOMC Rate Decision - Jan % 0.25% 0.25% Jan 29 8:30 Initial Jobless Claims Thousands Jan Jan 30 8:30 GDP (Annualized) Q/Q 4Q A - 3.1% 5.0% Jan 30 8:30 GDP Price Index Q/Q 4Q A - 0.9% 1.4% Jan 30 8:30 Core PCE Q/Q 4Q A - 1.1% 1.4% Jan 30 9:55 U. of Michigan Confidence - Jan F Consensus from Bloomberg L.P 26/01/2015 January 29, 20157

8 North American Economic Indicators CANADA Period Monthly Chg. (% or Level) Cumulative change Current Previous - 3 Month - 1 Year Gross Domestic Product (GDP) October 0.3% 0.4% 0.7% 2.3% Manufacturing Shipments October -1.1% % -2.6% 4.8% Housing Starts ( ' 000) * November Retail Sales October 0.0% 0.9% 0.6% 4.8% Trade Balance (M$) * October -39 2,336 2, Employment ( ' 000) * * December Unemployment Rate * December Wages (avg. hourly earnings) December 1.9% 1.5% 2.5% 2.6% Total CPI inflation December 1.6% 1.9% 2.1% 1.5% Inflation ex-food & energy December 2.3% 2.3% % 1.5% Industrial Product Price Index (IPPI) November -0.4% -0.6% -1.3% 1.9% IPPI ex. energy November 0.0% 0.1% 0.2% 3.5% UNITED STATES Period Monthly Chg. (% or Level) Cumulative change Current Previous - 3 Month - 1 Year ISM - manufacturing * November ISM - Non-manufacturing * November Industrial Production * November Capacity Utilization Rate * November Consumer Confidence Index * December Retail Sales November 0.4% 0.3% 0.7% 4.7% Trade Balance (M$) * October -42,249-43,603-40,695-35,972 Housing Starts ( ' 000) * November 1,043 1, ,105 Existing home sales November -6.3% 1.4% -2.6% 1.9% Median price of ex. home sales November -0.1% -0.8% -5.1% 6.0% Non-Farm Payrolls ( ' 000) * * November Unemployment Rate * November Wages (avg. hourly earnings) November 2.2% 2.2% 2.5% 2.3% Total CPI inflation November 1.3% 1.7% % 1.2% Inflation ex-food & energy November 1.7% 1.8% 1.7% 1.7% Producer Price Index November -0.6% -0.3% -1.2% 1.0% - Ex-Food & Energy November 0.1% 0.1% 0.3% % * Lev el, * * Change in lev el for the last month, 3 months and 1 y ear, * * * Annual % change Data updated as at: 28/01/2015 This document is intended only to convey information. It is not to be construed as an investment guide or as an offer or solicitation of an offer to buy or sell any of the securities mentioned in it. The author is an employee of Laurentian Bank Securities (LBS), a wholly owned subsidiary of the Laurentian Bank of. The author has taken all usual and reasonable precautions to determine that the information contained in this document has been obtained from sources believed to be reliable and that the procedures used to summarize and analyze it are based on accepted practices and principles. However, the market forces underlying investment value are subject to evolve suddenly and dramatically. Consequently, neither the author nor LBS can make any warranty as to the accuracy or completeness of information, analysis or views contained in this document or their usefulness or suitability in any particular circumstance. You should not make any investment or undertake any portfolio assessment or other transaction on the basis of this document, but should first consult your Investment Advisor, who can assess the relevant factors of any proposed investment or transaction. LBS and the author accept no liability of whatsoever kind for any damages incurred as a result of the use of this document or of its contents in contravention of this notice. This report, the information, opinions or conclusions, in whole or in part, may not be reproduced, distributed, published or referred to in any manner whatsoever without in each case the prior express written consent of Laurentian Bank Securities. January 29, 20158