Moderation is the word after 2017’s big economic leap
March 19, 2018
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Ernest Granson takes a look back at the year that was 2017 in the latest issue of PROCESSWest magazine, and generally speaking, 2017 will wind up being much merrier than the past few years, not just for Western Canadian provinces, but for the country as a whole, and there’s good reason to believe that 2018 is also shaping up as a year of optimism.
The Conference Board of Canada says that for 2018, the Canadian economy is on track to record its fastest pace of growth since 2011, thanks to strong consumer spending and a hot housing market. According to the board’s Canadian Outlook Bulletin, the labour market has also been remarkably strong with 329,000 new jobs created over the last year – the fastest gain in a decade. In all, the Canadian economy will have expanded by 3 per cent in 2017, resulting in the fastest increase among G7 countries.
Both the Washington-based International Monetary Fund and Paris-based Organization for Economic Co-operation and Development agree with this assessment, saying that Canada’s 2017 growth rate places the country at the top of the list of the G7 countries with the U.S. coming second at 2.2 per cent.
“Canada was able to post such remarkable growth over the past year because the economy had adjusted to the prior commodity shock and it had significant spare capacity to accommodate the rapid growth,” said Matthew Stewart, Director, National Forecasting, The Conference Board of Canada. “However, that excess capacity has diminished greatly over the past few quarters and economic growth will slow to a more sustainable pace going forward.”
Western Canadian economic outlook
After bringing up the rear during that nasty stretch of 2014-2017, Alberta bounced back strongly in 2017. The province is expected to post a GDP rate of 4.1 per cent for 2017 once all the numbers are in, but that rate, just like the national rate, will moderate to about 2.3 per cent for 2018. RBC believes the real positive aspect of this situation for the province is, while the energy sector’s growth rate will level off, the rest of the economic sectors will catch up, resulting in a more balanced economy.
British Columbia’s economy is also pushing ahead strongly, with growth expected to reach 3.2 per cent for a fourth-straight year in 2017. RBC suggests, like Alberta, growth will cool down slightly in 2018 to 2.7 per cent. B.C. will be watching its forestry sector closely this coming year to see if its economy will be negatively impacted by U.S. softwood lumber tariffs or if U.S. demand for B.C. lumber products will remain firm and neutralize those tariffs.
In the land of Rider Nation, optimism will remain high for both the gridiron and the economy. Perhaps, the province did not soar quite as high as its neighbor provinces in 2017, with a projected growth rate of 2.1 per cent, but RBC believes that number will improve substantially next year to 2.7 per cent, leading the country. A more robust oil and gas sector, along with higher than expected potash production, will certainly propel that growth but so will a rebound in agriculture, provided the weather co-operates.
Manitoba’s growth rate, also, has held quite steady through 2017, forecasted at 2.6 per cent, although, RBC says dwindling recoverable mineral deposits in the province’s prominent mining sector could have a domino effect on the construction side.
Oil and gas slowly creeps upward
You would think that the extension by members of OPEC and non-members of OPEC, including Russia, to extend oil production cuts through 2018 would be good news all around, but there has been no confetti tossed about.
While the original agreement had its intended effects in the reduction of global oil stocks during 2017, it also created other less desirable circumstances, some analysts believe.
“The problem with the production cuts and resulting higher oil prices, is that the free market economies and aggressive oil developments in North America opened up the opportunity for oil companies to get back out and drill,” says Andrew Botterill, Partner, with Deloitte Touche Tohmatsu Ltd.’s (DTT) Resource Evaluation and Advisory group. “Those production cuts did take volumes out of the system, by about 1.8 million barrels per day, but it also created space for North American companies, mainly in the U.S., to generate growth by increasing their drilling rate. The rig counts and oil production there have risen significantly in 2017.”
According to DTT’s 2018 Forecast, this increased production widened the price differential between Brent crude oil (BCO) and West Texas Intermediate (WTI) by more than US $6/bbl. last year, but also resulting in transportation issues and oversupply.
That same kind of price separation has taken place over the last quarter between Canadian heavy crude oil (Western Canadian Select –WCS) and WTI as increasing supplies from oil sands projects are held back by insufficient pipeline capacity. It’s frustrating because of decreasing heavy oil imports from Venezuela and Mexico to the U.S. which could be serviced by more Canadian oil. If that oil could reach U.S. heavy oil refineries, the price gap between WCS and WTI could narrow. Deloitte’s forecast is for WTI oil to attain US$55/bbl. and for WCS to attain C$46.40/bbl. in 2018.
Botterill says with those kinds forecast prices, companies in the oil sands sector are weighing their long term plans very seriously and it’s unlikely there will be any huge investments anytime soon.
“They’re not focused on the next big project, but rather looking at strategic add-ons to grow their existing infrastructures,” says Botterill. “However, the economic difficulties they experienced during the last couple of years, has made them significantly stronger because they’ve made amazing strides in optimizing their efficiencies and managing costs. So it’s a far more resilient oil sands sector and these companies are more likely to weather volatility in prices. And now, with more certainty of prices and the lower costs, some projects might be more economically viable. But, are they going to build the next big mine? That will be a big question.”
It’s been a tough go for the natural gas sector over the past several years, but especially 2017 in terms of price volatility. According to Alberta Energy, the price of natural gas in October 2017 was C$1.11 per gigajoule, down 53.9 per cent from October 2016. This is the second-lowest monthly price for natural gas in Alberta since 1995. But talk about volatility! On a year-to-date basis, the average natural gas price in Alberta was up 22.8 per cent through the first 10 months of 2017 compared to the same period in 2016.
Some of the volatility occurred because of infrastructure and pipeline maintenance causing supplies to back up, but Canadian gas prices were also affected by increased U.S. natural gas production through both shale gas plays and solution gas from tight oil fields, according to Deloitte’s 2017 oil & gas overview. Currently, 22 per cent of U.S. shale gas production (11 per cent of total gas production) is attributed to solution gas from the Permian, Eagle Ford, and Bakken tight oil drilling. This equates to over 10 Bcf/d of gas from oil plays that affect the supply-and-demand balance.
Considering natural gas pricing seasonality and increased production in the U.S., Deloitte has forecast AECO to be C$2/Mcf and Henry Hub to be US$2.80/Mcf in 2018.
For those who may not be aware, AECO stands for Alberta Energy Company, and is the Canadian benchmark price for natural gas. The AECO Hub™ is comprised of the Suffield Gas Storage Facility near Medicine Hat and the Countess Gas Storage Facility, south of Drumheller.
Also, the Henry Hub is a distribution hub on the natural gas pipeline system in Erath, Louisiana, and lends its name to the pricing point for natural gas futures contracts traded on the New York Mercantile Exchange (NYMEX).
As a consequence of the price spikes and plunges caused by infrastructure issues which are preventing gas supplies to be shipped out of Canada, some Canadian producers are trying to directly market their gas to the U.S. instead of relying on the AECO or Henry Hub, says Botterill.
“They’re spending a lot of their time on direct marketing,” he says. “They are also trying to find other ways of avoiding price volatility such selling fixed or guaranteed volumes to utilities or consumers in the U.S. to get past that open market volatility. There is also that issue of large gas volumes from the U.S. because of all the oil plays, so it’s not just volume from gas wells but also from shale. It’s created an oversupply in the U.S. allowing those producers to export LNG into Mexico. That has also backed up Canadian gas, so it’s a tough sector. I am optimistic about the technology to bring on more gas, but certainly the oversupply is a concern.”
There’s definitely more cautious optimism for drilling activity in this new year. The Petroleum Services Association of Canada’s (PSAC) 2018 Canadian Drilling Activity Forecast expects a total of 7,900 wells (rig releases) to be drilled in Canada in 2018. For 2017, the Association’s final revised forecast predicts a yearly total of 7,550 wells.
“The small uptick in activity we realized in Q1 of 2017 has carried on through the year,” says Mark Salkeld, PSAC President. “Budgets set with initial optimism for a gradual climb in prices by year-end continue with their plans as drilling and completion efficiencies improve. Due to pressure to stay low, costs for services continue to be suppressed affording better margins for producers. For 2018, confidence that oil will stay in the low-to-mid US$50 range as markets tighten and inventories reduce, along with growing interest in Canada’s vast liquids rich natural gas, should support a 4-5 per cent increase in activity levels.”
On a provincial basis for 2018, PSAC estimates 3,998 wells to be drilled in Alberta, and 2,931 wells for Saskatchewan, year-over-year increases of 152 and 84 wells, respectively. At 230 wells, drilling activity in Manitoba is expected to remain constant year-over-year whilst activity in British Columbia is projected to increase from 612 wells in 2017 to 730 wells in 2018.
Although PSAC expected 2018’s activity to be better than 2015, 2016 or 2017, the projected total of 7,900 wells is still 30 per cent lower than the number of wells drilled in 2014.
While there are higher expectations for drilling and production levels, there’s much concern about transporting oil and gas supplies out of Canada, as Salkeld points out.
“The cancellation of TransCanada’s Energy East pipeline is another blow to investor confidence in Canada and so PSAC will continue to advocate hard for market access and a competitive environment,” he says. “The world’s energy needs are growing and polls show that countries would prefer Canadian oil and gas that is responsibly-developed and working to reduce carbon emissions through innovation. Market access and development of our natural resources would not only help reduce global emissions and help lift third-world countries out of energy poverty, but would continue to benefit Canadians too by providing energy security, LNG for remote and northern communities, great high-tech jobs and world prices for our resources so that they can continue to provide economic benefits to all Canadians.”
PSAC bases its 2018 forecast on average natural gas prices of C$2.50/mcf (AECO), crude oil prices of US$53/barrel (WTI), and the Canadian dollar averaging $0.82USD.
A slight rebound for mining
The mining industry has had a nice run of about six to eight quarters, and profitability is back. That is the general consensus for the global view, although from the Canadian perspective, 2017 has not measured up to previous years. Natural Resources Canada (NRCan) is projecting a significant reduction in national expenditures for mineral exploration, plus deposit appraisals, fall the way from $4.23 billion in 2011 to approximately $1.85 billion in 2017.
But a price recovery over the past two years, after hitting a low point in 2015, has put the industry in a nice financial position, says John Mothersole, Director, Pricing and Purchasing, IHS Markit, a global information and analysis corporation.
“Our focus is on prices which dictate the general environment of the mining industry,” says Mothersole. “The industry has shifted from hunkering down in the form of cost cutting to now searching out exploration opportunities. Although, the sector hasn’t quite shaken off the uncertainty of the years of 2014 – 2015, the overall tone is much more optimistic than the past three, four or five years. The atmosphere, while not necessarily buoyant, is definitely hopeful.”
A number of factors have converged this past year to contribute to this upswing. First, while in 2016, Russia was considered to have been the only soft spot in the global economy, global growth balanced out in 2017. Now, with GDP growth rates being forecast to continue accelerating in all regions, it’s been very positive for the natural resources sector.
Secondly, the continued economic upward performance of China, has been a bit of a surprise, Mothersole points out.
“In December of 2016, we forecast that Chinese growth would slow down in 2017. That has not happened,” he says. “It has remained remarkably stable and definitely has created a certain optimism. Nevertheless, most analysts are still forecasting growth to slow for the 2018-2019 term. And, because of China’s enormous footprint in this market, prices will also decelerate. It means that the intensive resource pressures which helped lift prices in 2017 will be absent. However, I wouldn’t label this a correction in prices. Even with this slow down, I would never relegate China to the sidelines in any industry. They are the 800 pound gorilla in every market. That, I believe, will be the story for this upcoming year. What is going to happen in China?”
Another major factor affecting the sector will be recent U.S. economic moves and those yet to take place in this coming year.
“We think global financial markets will begin to tighten in the short term,” says Mothersole. “Specifically, credit conditions will tighten in Canada because of its position to the U.S. whose monetary policy has been quite loose since 2009. While the banks have recently been injecting significant amounts to generate activity, the U.S. will be the first to shift to a tightening of the money supply. We have seen signs of this with interest rates being raised in 2017, and with more expected raises coming in 2018. European banks aren’t projected to raise the rates until 2019. With higher interest rates, those are especially negative implications for the gold situation.
“In addition, the recent U.S. tax cuts have great potential to stimulate the economy, thereby strengthening the U.S. dollar. A stronger U.S. dollar is also a negative for gold prices as are higher interest rates because, naturally, investors are looking to maximize their return and could be considering other investment options such as the yields from safe assets like U.S. treasury bonds. This may not be a significant impact but these factors will make it difficult for gold to rise in price. It may even retreat a bit.”
Read the entire Market Forecast article in the Jan/Feb issue of ProcessWest magazine