ROSY POLOZ
Beware the BoC’s optimism over oil and the economy. Chidley,
If you’ve been following the Bank of Canada’s utterances lately, you know that a consistent and pretty optimistic story is emerging about how the economy is going to unfold this year.
Governor Stephen Poloz’s view is that Canada’s growth will start to rebound this quarter, then really take off in the second half, thanks to a burgeoning U.S. economy, stronger manufacturing and export sector, and, oh yes, stable oil prices.
No doubt, a lot could go wrong and may already have.
U.S. first-quarter GDP grew by only 0.2 per cent year over year, according to data released Wednesday morning, well below the estimate of 1.1 per cent. That doesn’t bode well for Canada’s manufacturing sector, which has already been looking wan. Combine that with layoffs in the oilpatch and it could mean that jobs and real wages will remain stagnant for some time.
Yet the BoC message seems clear: It planted the seed with its January rate cut and now plans to sit back and watch the economy grow.
One of the big assumptions behind its rosy 2015 outlook is that we have entered a world of stable oil prices and the impact of the 50 per cent plummet in oil prices has worked itself through the economy — a “one-time shock,” as Poloz put it in his testimony before a House of Commons committee earlier this week.
But oil prices have not been stable. They’ve been rising — and fast. The price of West Texas Intermediate crude in April jumped 20 per cent. Heavy Western Canadian Select prices did even better, rising by nearly 50 per cent between mid-March and mid-April.
Investors have taken notice, pushing energy stocks to be among the best-performing sectors on the S&P/TSX composite in recent weeks.
On the surface, the recent oil rally suggests the optimists are right and the worst of the price story is behind us. But if investors are buying into this rosy picture — and counting on either the Canadian economy to shrug off lower prices or energy stocks to keep on pumping — they might want to try to distinguish noise from fundamentals.
Why has oil been rallying? Unrest in the Middle East is certainly one factor, sparked by conflict in Yemen, which is situated on crucial shipping lanes. But the Yemen conflict has not, so far, disrupted oil shipments.
Libya, meanwhile, is in the throes of a civil war and has suffered repeated attacks from the Islamic State of Iraq and the Levant (ISIL), but the country actually increased oil production last month, to more than 600,000 barrels per day.
Iraq has an ISIL problem of its own, but still pumped more than three million barrels a day in March, and it wants to increase production.
For both Libya and Iraq, the reason is simple: their governments need the money, and selling crude at whatever price is pretty much the only way they can do that.
Meanwhile, Saudi Arabia is showing no signs of significantly cutting production. And the possibility of a nuclear deal in Iran, brokered by the United States, could relieve the Shiite state from international sanctions and bring even more production onto global markets.
The International Energy Agency (IEA) recently estimated that Iran coming on line could lower oil prices by US$15 a barrel.
The upshot is that the Middle East situation is not clearly impacting supply. Which makes you wonder what’s justifying those higher prices.
Maybe it’s the expectation that North American production will decline thanks to lower prices. A significant number of U.S. rigs have al- ready come offline in recent months and growth in domestic production has slowed.
But as Lance Ryan, the chief executive of Conoco-Phillips Co., recently pointed out at an industry conference in Houston, much of the offline production is from marginal operators, and rising prices are likely to entice them back into the game, exacerbating the oversupply problem.
Meanwhile, stockpiles of crude keep on growing. The American Petroleum Institute on Tuesday reported that U.S. inventories reached a new record high for the 16th straight week.
In the best of worlds, global economic growth would eventually rebalance the supplydemand problem. Well, the U.S. Energy Information Administration has projected that growth in oil demand will be near zero for the next 25 years.
Meanwhile, the IEA revised upwards its projections for global consumption for 2015, to 93.6 million barrels per day, and expects fourth-quarter demand to hit 94.6 million bpd.
But even that high demand, based on optimistic projections of a U.S. and global recovery, would be only marginally higher than current supply, which came in at 94.5 million bpd last quarter, according to the IEA.
In short, the fundamentals don’t look like they have changed very much, and there is plenty of reason to expect the recent rally won’t last long. The big question may be how deep the correction will be.
Far from oil price stability, we can probably expect more volatility in the months to come. What that may mean to Canada’s monetary policy is up to Mr. Poloz, of course. But investors might want to draw their own conclusions in the meantime.
A lot could go wrong and may already have