Energy Crash Detours Half of Canada

Historically, the economies in the U.S. and Canada travel basically the same route. In the past year, however, their paths have diverged—and Canada’s has gone downhill. More dependent on the troubled energy market, Canada and its metals suppliers face a slippery slope in the coming year.

Canada’s economy finished the first half in negative territory, but posted strong growth numbers in June and July. The Bank of Canada projects real GDP growth of about 1.1 per cent for the year, improving to 2 percent in 2016 and 2.5 percent in 2017. “We are not looking at a deep recession. It’s more of a slight dip. The question is how long lasting that dip will be,” says economist Mike Holden, director of policy and economics with Canadian Manufacturers and Exporters, Calgary, Alberta.

Canada fared better in 2008 when the housing bubble burst in the U.S., inciting the Great Recession. In Canada, housing and consumer spending were relatively unaffected, and oil and gas exploration triggered a lot of investment in the western provinces. Fueled by the energy boom in the Canadian oil sands, crude oil surpassed automotive as the No. 1 export for Canada. Then last fall, the price of oil began a sharp descent that took it from over $100 per barrel to less than $50. Capital spending in the oil sands declined by 40-50 percent. “Energy sector capital spending accounts for 30 percent of all cap spending in Canada, versus 10 percent in the U.S. We are much more closely tied to oil production in Canada, and that is really hitting a lot of metal producers,” Holden says. Also a blow to metal producers in Canada, and those around the world, are steel prices that have declined by 40 percent this year.

Holden sees some positive signs ahead for the Canadian economy. Outside the energy sector, employment is stable, manufacturing is strong and exports are growing. The sharp decline in energy prices has weakened the Canadian dollar, giving it a larger currency advantage over the U.S. dollar. “For the last 10 months, there has been hope the Canadian economy would pick up as the U.S. economy picks up, aided by the fact our exchange rate is more competitive than a year ago. Some of those benefits are starting to come, but they have taken a lot longer to filter through than people expected. That’s where growth is expected to come from next year,” he says.

Both residential and nonresidential construction are finally improving in the U.S. In Canada, the housing market is fairly strong in major markets such as Toronto and Vancouver, but many nonresidential projects are on hold due to the falloff in the oil sands. “One of the challenges is to trigger companies not in the energy sector to start investing,” Holden says. “Companies have been sitting on pretty substantial amounts of cash for the last four or five years and not investing much in new plants and equipment. There is hope that business investment will start to pick up, but we have not seen much yet.”

In light of low inflation and the need for economic stimulus, the Bank of Canada opted last month to maintain interest rates at the current low level, following the lead of regulators in the U.S. The eventual rate hike in the U.S. will drive the exchange rate down further and give Canadian exporters an even greater currency advantage, Holden notes.
 
Automotive production has been rising in Canada, as well as in the U.S. Canadian plants currently in operation are producing at capacity, but not a lot of new capacity is coming on line. “The issue with the auto sector is how Canadian producers can compete with Mexico. Some production has migrated to Mexico, and some greenfield decisions have passed over Canada, as well,” Holden says.

Government fiscal policy in Canada tends to be more conservative than in the U.S. Politicians are not as quick to approve deficit spending. Much of that cost falls to the provincial governments, Holden says. Last month’s election of Prime Minister Justin Trudeau and his Liberal party opens the door to possible increased government spending on infrastructure, which would be positive for the steel industry. But it’s too soon to tell whether that will be a significant factor next year, he adds.
 
Essentially, recovery of the Canadian steel industry is in the hands of energy, which makes the future uncertain. “The energy sector will be an anchor on growth for the next year,” Holden says. “Low steel prices hurt producers and distributors on both sides of the border.”

Service center perspective
Canada has a “bifurcated” economy, says Brian Hedges, president and CEO of Russel Metals, Mississauga, Ontario, one of the largest steel distributors in North America. The western half of the country, largely dependent on the energy market, is struggling. The eastern half, with relatively strong manufacturing and exports, is doing pretty well. How individual companies are faring depends on how much of their business is concentrated on sectors in the East or West. For Russel, a major supplier to energy, it’s not an even split. “We see the West having a bigger drag on the numbers than the East is generating positive numbers right now,” Hedges says. But he expects better results in 2016. “I think we are pretty close to the bottom now. Next year conditions should improve, depending on what happens with steel and energy prices.”

Samuel, Son & Co., Ltd., Mississauga, Ontario, is also one of North America’s largest service center organizations and, in addition to Russel, dominates metals distribution in Canada. Samuel is somewhat less reliant on sales to the energy sector, but is certainly feeling the hit. “Apparent steel consumption in the first half of the year in Canada was down 10 percent. It’s really tough. We have to focus on inventories and operational excellence,” says Bill Chisholm, Samuel president and CEO.

Oil rig counts are 54 percent lower than this time last year, and the agricultural equipment sector is suffering from low farm commodity prices. Automotive, on the other hand, is forecasting robust sales of 17.5 million vehicles this year. “Automotive continues to be the bright light as we go forward,” Chisholm says.
 
Samuel’s shipments are fairly stable, but its margins have suffered. “We are still seeing volumes, albeit at lower pricing,” he says. Because Samuel does business on both sides of the border and has holdings in manufacturing as well as metals distribution and processing, it is partially insulated from the energy downturn. “One of the strengths of Samuel is our balanced portfolio,” he notes.
 
Looking ahead, Chisholm is hopeful the second half of 2015 will top the first half. Next year, he expects Canadian manufacturing and exports to benefit further from the low Canadian dollar. Automotive and aerospace will remain strong, while nonresidential construction is due to improve. Service centers will continue to work through their inventory overhang. “I am certainly more optimistic for 2016 than I am for 2015,” he adds. “Growth won’t be great, and it will be very competitive, but it will shake out some of the problems caused by the sudden collapse in oil and gas prices.”
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Wednesday, July 26, 2017