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Rising “Loonie” is More Complicated Than One Might Suspect

Sunday, 27 May 2012

Written by: Sanjay Patel

After weeks of intense debates, the Calgary Herald conducted an online poll to check what people think about the rising Canadian dollar (commonly called “loonie”). The poll result suggests Canadians are roughly split over NDP Leader Tom Mulcair’s contention that Alberta’s oil sands are responsible for raising “loonie” and its negative impact on country’s manufacturing sector. The Canadian Press Harris-Decima survey, released Friday, suggests slightly more Canadians disagree than agree with Mulcair — 45 per cent compared to 41 per cent — although opinions varied across the country. You may not be a fan of public opinion polls anymore (If you live in Alberta !) but here are the survey results anyways. Read Here.

The issue is, the issue of rising “loonie” is not that simple for everyone to understand. I’m sure majority of the people who took the survey are not well informed about the issue and have sided with one of the groups (i.e. Alberta or Ontario) – like we always do – and either voted in favour or against the rising loonie.

There is a common perception that “Alberta’s Oil industry (and Oil sands in particular) is solely responsible for rising “loonie”. There is also the perception that “Ontario’s manufacturing industry is suffering, but only Alberta is benefiting”.
Before we delve into the details of rising loonie, let us look at some background information first. In last decade or so, the Canadian Dollar has done really well in financial markets, soaring from an average of 0.64 US dollar in 2002 to 1.01 US dollar in 2011. Currently, the “loonie” is at par with the U.S. dollar and it is explained by the soaring price of oil. Canada’s oil reserves are now officially ranked as third largest oil reserves in the world (It used to be second). When higher oil prices lead to an increased oil production which, in turn, increases the value of the loonie (due to the increased oil production and its export) in comparison with the US dollar. While a strong loonie is good news for Alberta’s oil industry, it hurts local manufactures, however. As loonie goes up in price, Canadian products become more expensive for U.S. buyers and as a result the export of manufacturing products (Automobile, wood, paper, etc.) declines.

 

Perception#1: Alberta’s Oil industry (and Oil sands in particular) is solely responsible for raising “loonie”.
It is true that Canada is a net exporter of oil, so the Canadian dollar moves in tandem with the world oil price, but there are many other reasons that are responsible for rising Canadian dollar:
·     Canada is a resource based economy: Although the price of oil has gone up in last 5 years, Canada’s metals and minerals sector have actually performed better over the last five years. According to Patricia Mohr (Scotiabank’s commodities specialist) metals and minerals account for 30 per cent of the value of commodity exports. Over the last five years, prices for metals and minerals are up 12.2 per cent, which exceeds oil and gas at 9.7 per cent, she said.
·     US Dollar has lost value: We all know that Canadian economy has performed much better than the US economy including many other economies around the world following the 2008 recession. The US economy has suffered a lot after 2008 economic and it still continues to post low growth figures. Two rounds of quantitative easing in the US have devalued its currency and we all remember that there was no quantitative easing in Canada. At the end of 2010, Canada was the only country in the G7 nations to have fully recovered all of its output and employment losses during the recession.
The correlation between the loonie and crude oil is breaking down, says Marc Chandler, who is a Global head of currency strategy at New York-based Brown Brothers Harriman. He provides some interesting perspective on this topic. According to Marc, Canada is a net exporter of oil, but not nearly as it may appear as the eastern part of the country that is home to most of the population and industry are substantial importers of oil. The dollar value of oil exports is a minuscule fraction of the overall turnover of the Canadian dollar in the foreign exchange market. Capital flows are more important than trade flows. Read Here.
 
Perception#2: Ontario’s manufacturing industry is suffering, but only Alberta is benefiting.
While it is true that the strong loonie hurts Ontario’s manufacturing sector, don’t you think the leaders of the major political parties have to show some maturity and stop thinking in terms of Alberta’s interest Vs. Ontario’s interest? After all, we are one country and all the provinces & territories of Canada are not fiscally independent of each other. It is simply a mistake to think that only Albertans stand to lose in any meaningful way from stopping or slowing Alberta’s oil sands. Halting oil sands production would take a heavy toll on Canada’s economy.
·      Alberta’s energy industry employees one in every 14 Albertans.
·      The current value of the oil sands plants is over $100 billion. The industry generates billions of dollars of tax revenue for the government and 60% go into federal coffers.
·      The provincial government collects almost $2 billion annually from royalties and this will increase to $350 billion (cumulative) by 2035, according to CERI. If future oil sands development continues as planned, significant benefits will be realized in terms of job creation including royalty and provincial & federal tax collection and its positive impact will be felt across the Canada. Read Here.
·      New and existing oil sands projects will require an estimated $55 billion worth of goods, materials, and services from suppliers in Ontario – Canada’s largest province – by 2035, according to CAPP. Read here.
Let us be honest. Alberta’s oil or oil sands companies don’t set the price of oil. The price of oil is mainly determined in the world oil market based on oil supply & demand dynamics. People who work in Alberta’s oil industry are simply doing their job by supplying energy demanded by our society. Halting oil production from Alberta’s oil industry is simply not an option when we look at the consequences & rewards.
True, there is a positive relationship between the two (i.e. oil price and loonie) and it does have some losses in manufacturing sector but blaming oil sands or to keep the Canadian dollar weak is not the answer. Productivity gains through efficiency improvement in manufacturing sector is one of the options to mitigate the loss of competitiveness caused by a strong loonie. Many countries blessed with the natural resources have experienced the similar situation and Canada can learn from them. Norway is often discussed as a role model in mitigating the economic difficulties caused due to the abundant natural resources. Norway’s experience demonstrates that fiscal & monetary policies such as the establishment of a petroleum fund can help alleviate the effects of strong currency. 
(Note: The opinions expressed here are my own and not of Suncor’s)
 

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Comments ( 12 )

  • Kristina says:

    >Thanks, informative & insightful blog!

  • Nrupal says:

    >The rise in currency valuation dampen's exports, but it also signals increase in demand of the country's export goods/services. In addition it is a reflection of fiscal policy of the country. Above highlights these concerns only.

  • Mayra (NJ) says:

    >Hi Sanjay. I’m a Harvard Business School student and I read your blog with great interest. I find your blog very useful especially oil sands info ! Thanks.

  • Sanjay says:

    >Very interesting and useful. Thanks, Mr. Patel.

  • Anonymous says:

    >You neglected to mention that a high loonie hurts the oil industry in Canada, as input costs are $CAN and revenue is $US.

    I don't have the numbers handy, but the high loonie has hurt Alberta (because of above) and helped Ontario by significantly reducing import costs.

  • Anonymous says:

    >Thanks Sanjay ji for insight info. Thanks again

  • Anonymous says:

    >Very thoughtful Sanjay. Carefully executed future development of the oil sands is very beneficial for all of North America, not just Canada. The US, too, will stand to benefit through the construction, supply and contracts markets.

  • Ashish Madan says:

    >Excellent thoughts Sanjay. I enjoy reading your blogs…Thanks

  • Mercury says:

    >Insightful…. thanks for sharing!

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