National Post (National Edition)
Ottawa’s pipeline move little help to lagging loonie
News that the Canadian government will step in to purchase the Trans Mountain pipeline project from Kinder Morgan will do little in the short term to help the canadian dollar, according to senior bank economists.
Even as the price of West Texas Intermediate has swung wildly on geopolitical news coming out of Iran and Saudi Arabia this year — jumping over 20 per cent before losing half those gains in a week — the loonie has barely budged. It’s down 3.5 per cent year to date.
Benjamin Tal, deputy chief economist at CIBC World Markets, says the divergence is unprecedented.
“We’ve never seen the Canadian dollar so weak during such a period of elevated oil prices, which means there’s something else going on in the background — and that something else is interest rates,” he said.
The U.S. Federal Reserve Board is expected to raise rates two or possibly three more times this year, as companies south of the border continue to reap the benefits of tax cuts and subsequent price revisions.
Canada’s central bank, meanwhile, seems caught in the headlights, paralyzed by fears of a real estate crash. The resulting yield spread has kept the loonie down, Tal says, despite the rise of WTI.
CIBC predicts the Canadian dollar will fall another penny this year, to US$0.76, as investors fixate on interest rates.
Asked whether petroleum and the Canadian dollar have “decoupled,” Tal stops short, suggesting rather that the correlation has weakened, mainly due to what he calls “the pipeline saga” and the Canadian oil industry’s inability to access a diverse market of foreign offshore buyers.
“What we need is access to China, and Trans Mountain is the only line that does that,” said Tal, “so it’s not just about delivering oil. It’s about making sure that we have a diversified oil market 10 years from now.”
Robert Kavcic, senior economist at BMO Capital Markets, concurs with that assessment, pointing to the differential between WTI and the Canadian benchmark, Western Canadian Select.
Until recently, WCS had been trading at a steep discount to WTI, and Kavcic says it’s easy to see why: as oil prices rise, lower-cost U.S. shale producers quickly absorb pipeline and refining capacity south of the border.
That leaves higher-cost oilsands producers in Canada at a distinct disadvantage, requiring them to sell their crude at a discount and pay for transport by rail.
More investment in pipelines and refining capacity could solve the problem, but Kavcic says Canadian producers can’t justify the investment required to access foreign markets at current prices, particularly given the geopolitical uncertainties.
“There has to be an expectation that it’s going to be sustainable,” he said. “So you have talk of OPEC and Russia easing their supply curbs, so expectations for oil prices may not be at that level.”
And while Ottawa seems to recognize the importance of reaching foreign markets, Kavcic says it will be a long time before the infrastructure is in place to eliminate the oil-price differential.
Nevertheless, BMO is forecasting a slight rise in the loonie this year, to US$0.79, as the Bank of Canada starts to raise rates during the second half of the year.
Senior economist Michael Dolega at TD Bank says that, until Canada can address the differential, the interest rate spread will drive the loonie.
“Here in Canada we’re so much further ahead in the credit cycle,” he said. “The Bank of Canada just will not be able to raise rates very quickly, because that’s just going to snuff out any sort of economic growth.”
TD is forecasting that the Canadian dollar will remain at current levels by year-end, although Dolega thinks it could rise as high as US$0.79 if the differential manages to tighten in a more sustainable way.