indicatorThe Owl

The Weekly Wrap, May 3, 2024

Now flowing

By Mark Parsons, ATB Economics 3 May 2024 9 min read

In this week’s ATB Economics Weekly Wrap…

  • Western egress  - Trans Mountain expansion up and running
  • East and West - The outlooks for Saskatchewan and B.C. 
  • Speed bump - GDP growth slows in 2023
  • U.S. hawks, Canadian doves - Interest rate differential widens
  • Interesting Fact: Free trade renewal
  • Charts of the Week: Naturally speaking - Population growth from natural increase

This week the Trans Mountain pipeline expansion (TMX) entered into service and the Edmonton Oilers (named after the product shipped via the pipeline) advanced to round 2 of the Stanley Cup playoffs.

We discuss why the pipeline expansion matters for Canada.

We also look at how the economies of Alberta’s provincial neighbours are faring, the GDP by industry results for 2023, and the widening U.S.-Canada interest rate differential.

Finally, how much of each province’s population growth is coming from natural increase (births minus deaths)?

Much-needed pipeline capacity added

A major milestone for Canada and Alberta was reached on May 1. After years of delays and cost overruns, the TMX connecting Alberta to the B.C. coast has commenced commercial operations.

Why does this matter for Canada’s economy? There are a few reasons.

First, the expanded pipeline will provide a boost to Canada’s single largest export. Crude oil and bitumen represented 18% of Canada’s exports last year, or $137 billion. The Bank of Canada estimates that the TMX will add a quarter of a percentage point to Canada’s GDP growth in the second quarter. This largely feeds through the productivity channel, with past investments in the oil sands now translating into major output gains. Right about now, Canada could use some productivity improvements.

Crude oil and bitumen accounted for 18% of Canada’s total merchandise exports in 2023

Crude oil and bitumen accounted for 18% of Canada’s total merchandise exports in 2023

Second, the price Canada receives on its energy exports will improve, lifting netbacks to producers and government revenues (taxes and royalties). Research shows a significant net positive on Canada’s GDP from higher oil prices. The price uplift benefits all heavy barrels, not just the one shipped through the new pipeline. Moreover, an improvement in oil prices from a narrower differential boosts Canada’s terms of trade (export less import prices).

In contrast, when Canada’s energy products can’t reach international markets due to transportation bottlenecks, they trade at a discount to similar products produced elsewhere. One study by IHS Markit estimates that insufficient export capacity resulted in $US14 billion in lost value to the country between 2015 to 2019 (the study notes it’s a conservative estimate).

Consider the situation in 2018. Rising oil sands production bumped up against limited pipeline space, increasing reliance on more costly rail. At one point in October 2018, Canada’s heavy oil benchmark price (Western Canada Select) sold at nearly $50/bbl below WTI! Mandated production cuts ensued to correct the problem, and Alberta’s economy stagnated in 2019. Similar issues occurred in 2012-13 (the so-called ‘Bitumen Bubble’) but with a double discount - pipeline constraints throughout North America amid surging supply led to large discounts between both U.S. benchmark (WTI) and Western Canada Select as well as WTI and Brent oil price (an international benchmark).

Third, easing pipeline constraints reduces volatility. Without sufficient pipeline capacity, even minor disruptions can lead to major price swings. More pipeline capacity provides some breathing room, and better ‘optionality’ with access to coastal markets (most Alberta crude flows to the US Midwest).

The WTI-WCS oil price differential is sensitive to transportation capacity out of Alberta

The WTI-WCS oil price differential is sensitive to transportation capacity out of Alberta

Peering West and East: B.C. and Saskatchewan economic outlook

At ATB Economics, our main focus is Alberta. But Alberta doesn’t operate in a vacuum (at last count, there are about 8 billion people outside Alberta).

Trade with the rest of the world is key, but so is trade with other provinces.

Our next door neighbours are important trading partners. Alberta’s exports to B.C. and Saskatchewan averaged more than $28 billion a year between 2015 and 2020 (latest year available). That’s about 16% of Alberta’s total exports!

ATB Wealth has expanded into  Saskatoon and Kelowna, giving us yet another reason to dig into developments next door.

Let’s start with B.C., where higher interest rates have left their mark. Household debt to income ratios are higher in B.C. and housing affordability ratios are stretched, weighing on residential activity and consumer spending. Affordability issues have also contributed to recent outflows of interprovincial migrants (many to Alberta). The province has benefited from some major projects - Trans Mountain Expansion, Coastal GasLink, LNG Canada, and Site C Dam to name a few. However, many of these projects are wrapping up, slowing capital investment in the next couple years. All told, B.C.’s economy is expected to grow less than 1% this year according to provincial budget forecasts, improving to just over 2% next year as lower interest rates support a rebound in housing.

Traveling east, Saskatchewans economic activity in 2023 was weighed down by droughts and a sharp slowdown in consumer spending. A stabilization in fertilizer markets should support potash exports, while constructive oil prices and improved market access helps conventional oil and gas activity. BHP’s massive Jansen potash project will lift construction in the next few years, and then production when it comes online 2026. Saskatchewan budget forecasts from early 2024 pegged GDP growth at 1% in 2024 and 1.8% for 2025.

Alberta's population growth was the strongest among the western provinces in 2023

Alberta's population growth was the strongest among the western provinces in 2023

Economic growth slowed last year, weighed down by construction and agriculture

Recently released GDP by industry data from Statistics Canada told us something we already knew - the Alberta economy slowed in 2023 after a big jump (5.3%) in 2022.

However, the 1.5% increase was lower than our tracking estimate of 2.5%. This is where it gets confusing. GDP by industry is measured on a different basis (at factor prices) than expenditure based GDP (market prices), which is what we forecast. It is also subject to significant revisions. So while the two series move together, they are not the same. And unfortunately we won’t know for sure until November when the expenditure data are released (that’s not a typo - November).

As we prepare our next quarterly forecast, we will revise down the estimate for GDP growth in 2023 to 1.5% for now. At the same time, our tracking of indicators is pointing to some upside to our March forecast for 2024 (currently 2.3%). Stay tuned for the June edition of our quarterly outlook for Alberta.

Breaking it down by industry, Alberta GDP growth was held back by a decline in construction (a weak first half in residential activity) and agriculture production (droughts). Oil and gas added to growth, but with production disruptions (maintenance, wildfires) and limited pipeline capacity, the sector contributed far less to growth than in the previous two years.

Service industries fared better, boosted by record population growth and post-pandemic pent up demand. However, growth was held back by rising interest rates - particularly in real estate related industries.

Some good news. At long last, the food and accommodation sector fully recovered its output from COVID, returning above 2019 levels.

Nationally, real GDP by industry grew by 1.2% following a 3.9% gain in 2022.

Different economies, different (rate) expectations

Last week, we talked about diverging economic growth between Canada (weak) and the U.S. (resilient) since interest rate hikes kicked in. This is especially true in per capita terms.

Not surprising, given differing economic temperatures, inflation rates have been stickier in the U.S.

Bank of Canada Canada Governor Tiff Macklem faces pressure to act sooner. But moving solo makes things a bit more complicated. A lower interest rate in Canada puts downward pressure on the loonie, which feeds through to import prices, and potentially frustrates efforts to tame inflation.

Markets are shifting their expectations, with the U.S. Fed widely seen holding longer. There were even talks of a rate hike, though Fed Chairman Jerome Powell seemed to allay those fears in comments made earlier this week. And there are finally some cracks in the U.S. labour market - today’s April employment report (+175K jobs) fell short of expectations (+240K), and the jobless rate nudged higher to 3.9%. A June Fed cut has been mostly ruled out, with greatest odds priced for September.

In Canada, a June cut is still a possibility depending on how the data lands, though there’s also a good chance the Bank waits for July (giving it even more data and the chance to release an updated forecast).

Shifting rate expectations can be seen in near-term yields. The spread between U.S. and Canada 2-year bond yields has widened significantly since the start of the year.

Canada is far from being alone. A widening gap between U.S. and Japanese interest rates has recently put extreme downward pressure on the Yen (relative to the greenback). It fell to the lowest level since 1990 early this week before recovering some of its losses later in the week.

The spread between U.S. and Canada 2-year bond yields has widened significantly since the start of 2023

The spread between U.S. and Canada 2-year bond yields has widened significantly since the start of 2023

Interesting Fact: The Canada-U.S.-Mexico Agreement (CUSMA) entered into force on July 1, 2020 when former president Donald Trump was in office. The free trade agreement, however, has a review clause that requires all three parties to confirm in writing that they will continue with the agreement by July 1, 2026. No matter who wins the 2024 U.S. Presidential election, the renewal of CUSMA will be critical. A recent piece by the Business Council of Canada argues for the need for business certainty with an overarching principle of “first do no harm.”

Chart of the Week: Population growth, naturally speaking

With Canada’s population surging, most of the attention has been on immigration. There’s a good reason for that. International migration (including temporary residents) accounted for nearly 98% of Canada’s population growth in 2023.

Put another way, 3.1 percentage points of the 3.2 percent gain in Canada’s population came from newcomers in 2023. Or in people terms, 1.24 million of the 1.27 million people added to the country.

The remainder is what demographers call ‘natural increase’, simply measured as births minus deaths. The numbers are small and shrinking, thanks to an aging population and declining total fertility rates, which hit an all-time low in 2022. Natural increase peaked in 1959, with the downward trend accelerating after 2009.

The national numbers mask a greater deal of regional variation, mainly reflecting different age structures. Of the 31,100 national population gain through natural increase, 16,350 came from Alberta and 16,770 from Ontario. Natural decline was experienced in B.C. and each of the Atlantic provinces, while Quebec was effectively flat (+300).

A better way to compare the role of natural increase is in percentage terms. That is, what percentage of each region’s population growth came from natural increase? In that case, the territories are the highest (Nunavut ranks first at 1.2%). Among provinces, Manitoba and Alberta are the highest at just under 0.4%, while Newfoundland is lowest at -0.5%.

Natural increase added 31,103 people to Canada's population in 2023

Natural increase added 31,103 people to Canada's population in 2023

B.C. and the Atlantic provinces experienced natural decline (births less deaths) in 2023

B.C. and the Atlantic provinces experienced natural decline (births less deaths) in 2023

Answer to the previous trivia question: The North American Free Trade Agreement (NAFTA) came into force on January 1, 1994, superseding the 1988 Canada–United States Free Trade Agreement.

Today’s trivia question: Approximately how many times larger is the population of Mexico compared to the population of Canada?

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