Canada is on the verge of a recession
By Nick Cunningham of Oilprice.com @CNNMoney
The latest economic data from Canada shows that it is inching toward recession, after its economy posted its fifth straight month of contraction.
Statistics Canada revealed on July 31 that the Canadian economy shrank by 0.2% on an annualized basis in May, perhaps pushing the country over the edge into recessionary territory for the first half of 2015.
“There is no sugar-coating this one,” Douglas Porter, BMO chief economist, wrote in a client note. “It’s a sour result.”
The poor showing surprised economists, who predicted GDP to remain flat, but it the result followed a contraction in the first quarter at an annual rate of 0.6%. Canada’s economy may or may not have technically dipped into recession this year — defined as two consecutive quarters of negative GDP growth — but it is surely facing some serious headwinds.
Attempts to rebound: Canada’s central bank slashed interest rates in July to 0.50%, the second cut this year, but that may not be enough to goose the economy. With rates already so low, there comes a point when interest rate cuts have diminishing returns. Consumer confidence in Canada is at a two-year low.
There are other fault lines in the Canadian economy. Fears over a housing bubble in key metro areas such as Toronto and Vancouver are rising.
“In light of its hotter price performance over the past three to five years and greater supply risk, this vulnerability appears to be comparatively high in the Toronto market,” the deputy chief economist of TD Bank wrote in a new report.
A run up in housing prices, along with overbuilding units that haven’t been sold, and a high home price-to-income ratio has TD Bank predicting a “medium-to-moderate” chance of a “painful price adjustment.” In other words, the bubble could deflate.
Housing markets in the oil patch have already started losing value. The Calgary Real Estate Board predicts that the resale value of homes will fall by 0.2% by the end of the year. And total home sales could fall by 22% in 2015. That is a dramatic downward revision from the group’s prediction in January that home sales would rise by 1.6%.
It’s all about oil: But that’s because the economic situation is much worse in the oil patch than many had predicted six months ago. And oil prices have crashed again, a detail not yet captured by the disappointing GDP figures. Crude oil (WTI) is now below $50 per barrel, and Canada’s heavy oil trades at a discount to even that low figure due to pipeline constraints and lower quality.
That’s bad news for companies like Canadian Oil Sands (COSWF), which owns a 36.74% stake in the Syncrude project, Canada’s largest producer of synthetic oil made from Canadian oil sands. The company lost $128 million in the second quarter due to lower oil prices and higher corporate taxes in Alberta.
Recessionary conditions along with low oil prices could lead to “deteriorating” asset quality for some of Canada’s largest banks, according to Moody’s.
What’s next? The grim oil price picture is forcing companies to slash spending and delay projects. Canada’s oil sands tend to come from large-scale, multibillion dollar projects. The high cost puts them on the frontlines for cancellations when oil prices sink.
According to the Financial Post there have been 33 major oil and gas projects that have been delayed or cancelled so far this year, and 16 of them are located in Canada’s oil sands. Many, if not most, of these cancelled projects will need much higher oil prices in order to breakeven.
For now, it is unclear when that might happen. Oil price predictions should be taken with a large grain of salt, but Again Capital’s John Kilduff, appearing on CNBC, said that oil could dip into $30 territory later this year.
“Christmas time we’ll probably be rebounding off new lows off of the mid to low 30s,” he said on Squawk Box. “We have a lot to go. We’re going to take out the March lows of $43 and trade down to the 30s in my view.”
And of course long-term projections are not worth much, but Goldman Sachs now says that oil could remain around $50 through 2020.
That is not something Canada’s oil producers want to hear.
Nick Cunningham covers energy and environmental issues for Oilprice.com.
