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CURRENT ANALYSIS
February 2015
Will lower oil prices provide a boost to Canadian
manufacturers?
The ongoing oil price shock has seen prices on a WTI basis drop from a recent
quarterly high in the second quarter of 2014 of $103/bbl to below $45/bbl at
the end of January. Prices have rebounded somewhat in recent weeks to levels
slightly above $50/bbl, and we expect there will be some further recovery over
the second half of the year; however, even in 2016 our assumption is that WTI
oil prices will average $77/bbl, which is well-below the $93/bbl and $98/bbl
averages in 2014 and 2013, respectively. The drop in prices and attendant cutbacks in production and investment in the sizeable oil and gas sector has raised
concerns about a potential negative impact on the overall Canadian economy.
Chart 1: Manufacturing Export Intensity to the United States
2014, % of Canadian manufacturing shipments exported to the United States
Transportation Equipment
Computer and Electronic Product
Chemical
Textile Mills
Machinery
Primary Metal
Paper
Plastics and Rubber Products
Electrical Equipment
Wood Product
Total
Furniture and Related Product
Leather and Allied Product
Clothing
Miscellaneous
Petroleum and Coal Products
Textile Product Mills
Food
Fabricated Metal Product
Non-Metallic Mineral Product
Printing and Related Support
Beverage and Tobacco Product
0%
10%
20%
30%
40%
50%
60%
70%
Source: Industry Canada, RBC Economics Research
Chart 2: Manufacturing GDP Share and C$
Percent of GDP (2012 and 2013 projected)
C$/US$
20
1.8
18
1.6
16
1.4
14
1.2
12
Manufacturing share of GDP (LHS)
1.0
10
C$/US$ (RHS)
0.8
8
0.6
While the impact of lower oil prices on activity in the oil & gas sector is
clearly negative, RBC Economics has made the point in previous commentaries that not all regions or sectors will be negatively impacted. Canadian consumers benefit from lower gasoline prices that free up household incomes to
purchase other goods and services and help offset a potential negative impact
on consumers’ income arising from diminished terms-of-trade and the resulting drop to economy-wide purchasing power. The resulting boost to consumer
demand helps businesses outside of the oil & gas sector which also benefit
directly from lower energy costs. Moreover, our view is that the decline in oil
prices also represents a clear net positive shock to our largest trading partner,
the U.S. This is also the view of the Bank of Canada, which noted in the January 2015 Monetary Policy Report that a 45% drop in oil prices is expected to
raise U.S. GDP by a full percentage point. Strengthening growth in Canada’s
largest trade partner, along with a weaker currency (much of which is also a
result of lower oil prices), represents a potentially substantial support to Canadian exporters.
Manufacturing industry well positioned to benefit
1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013
Source: Statistics Canada, RBC Economics Research
Paul Ferley
Assistant Chief Economist
(416) 974-7231
[email protected]
Nathan Janzen
Economist
(416) 974-0579
[email protected]
Gerard Walsh
Economist
(416) 974-6525
[email protected]
Canadian manufacturers stand out as among the best-suited to benefit from the
oil price shock. Data from Industry Canada suggest that close to 50% of Canadian manufacturing sales are exported, and about 80% of those exports are
destined for the U.S. Chart 1 shows Canadian manufacturing export intensity
(ratio of exports to sales) by manufacturing sub-industry. The largest U.S.
export intensity is in the transportation equipment component, but a diverse set
of other subsectors including textile mills, computer and electronic products,
and primary metal manufacturing also count on the U.S. market for a large
share of total sales. Although the benefit to exporters will be tempered to the
extent their inputs need to be sourced from the U.S., a strengthening in the
U.S. economy and a weaker Canadian dollar, could present a welcome reprieve for a sector that has struggled over the last decade and a half.
Despite Canadian manufacturers' exposure to the U.S. market, there has been
little transmission of U.S. growth into gains for Canada's manufacturing sector
since the turn of the century. This is likely the result of the sector’s sensitivity
to the Canadian dollar, which steadily appreciated relative to the U.S. dollar
through the 2000s and eroded the competitiveness of Canadian manufacturers.
Chart 2 illustrates the correlation of a strengthening dollar and a steadily declining manufacturing sector as a share of GDP through the 2000s. Canadian
CURRENT ANALYSIS | FEBRUARY 2015
exports have similarly lagged improving U.S. GDP growth during the recovery from the 2008/09 recession, a fact that, as we have noted in the past, has
at least in part been due to a stronger Canadian dollar relative to past recovery periods. Recent declines in oil prices coupled with policy action from
the Bank of Canada have caused substantial currency depreciation and are
turning the dollar from a headwind to a tailwind for Canadian exporters and
manufacturers.
Chart 3: Share of GDP: Manufacturing and Oil & Gas
% of GDP (based on 2011 input-output tables)
12
10
8
6
Despite a reduced share, manufacturing sector still important for Canada
4
2
O&G & related industries*
Chart 2 shows how headwinds over the last decade and a half have reduced
the manufacturing sector’s footprint on the Canadian economy, which has
raised doubts about how meaningful an offset the sector can provide to the
almost certain weakness in the oil & gas extraction sector this year. We
would note that, even with deterioration in recent decades, manufacturing
output remains an important and sizeable contributor to the Canadian economy. Although manufacturing’s share of GDP has declined to about 11%
from closer to 20% in 2000, this is still larger than the 7.8% accounted for
directly by oil & gas extraction and closely related industries (Chart 3).
Manufacturing
*includes oil & gas extraction, support activities for o&g extraction, oil & gas engineering
construction, petroleum refineries, and crude oil pipeline transportation
Source: Statistics Canada, RBC Economics Research
But can manufacturing respond?
Chart 4: Manufacturing firm counts
It has been argued that the ‘hollowing out’ of the manufacturing sector
caused by years of underinvestment means that the sector may lack the capacity to respond to the normal drivers of activity in the form of increased
U.S. demand and a weaker currency. This concern has in part resulted from
earlier indications of firms exiting the manufacturing sector with the implied
loss of production capacity inhibiting the normal boost to production that
would ordinarily accompany rising demand.
Longitudinal Employment Analysis Program, number of firms
60,000
58,000
56,000
54,000
52,000
50,000
48,000
46,000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Source: Statistics Canada, RBC Economics Research
Chart 5: Manufacturing ex. Transportation Equipment Capacity Utilization
Quarterly. Capacity utilization seasonally adjusted and approximated using GDP weights.
88
86
84
82
80
78
76
74
72
70
1994
1996
1998
2000
2002
2004
Source: Statistics Canada, RBC Economics Research
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2006
2008
2010
2012
2014
Since 2000 there has been a steady decline in manufacturing firm numbers
commensurate with declining output in the sector generally (Chart 4). However, this decline ended in 2012 with the number of manufacturing firms
ticking up for the first time in 6 years. Preliminary data on business counts
for 2013 and 2014 from Statistics Canada's Business Register are more
mixed; however, that data source is also less reliable for making comparisons across time because of difficulties classifying businesses by industry
and changes in methodology across survey periods. Data on firm entry and
exit rates paint a similar picture to the business count data. Entry rates for
manufacturing firms have been consistently below exit rates since 2000, but
the latest data available point to a sharp pickup in entry rates to 7.2% in 2012
from 4.8% in 2011. Although this data is admittedly dated, the combination
of strengthening U.S. demand and a weaker Canadian dollar which, on an
annual average basis, has weakened for 4 consecutive years relative to the
U.S. dollar provides reason to believe that the improvements observed in
2012 may have been the beginning of a more positive near-term trend.
The argument has also been made that capacity utilization in manufacturing
is already getting back close to pre-recession levels despite a tepid recovery
in output. This has led to concerns that manufacturers are permanently closing idle capacity and thereby stunting the sector’s ability to meet rising demand. Our view is that these concerns are overstated because the lion’s
share of the recent upward pressure on the capacity utilization rate is concentrated in one sector: transportation equipment. Strengthening U.S. car sales,
and to some extent reduced business investment in the Canadian motor vehicle sector in prior years, have resulted in record capacity utilization for this
sub-sector. Controlling for the impact of the transportation sector, rates of
capacity utilization in manufacturing as a whole remain below those typical
of the pre-recession period (Chart 5).
CURRENT ANALYSIS | FEBRUARY 2015
Chart 6: Manufacturing Capacity Utilization and Investment
Annual
24
90
88
22
86
20
84
18
82
80
16
78
76
14
74
12
72
10
70
1990
1992
1994
Already some signs of life
2000
2002
2004
Investment ($ bns)
2006
2008
2010
2012
2014
Capacity Utilization (RHS)
Chart 7: Manufacturing Output and Canada GDP Growth
Annual percent change
15
Manufacturing GDP growth
stronger than Canada GDP growth
10
Real mfg GDP
Real GDP
Post-recession bounce
5
-5
ytd on pace for just third
-10
Manufacturing underperformance
outperformance of mfg sector in
as CAD Strengthened
2014 since 2000
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2000
-15
1999
Alongside rising exports, manufacturing production has shown signs of improvement. The manufacturing component of monthly GDP declined 1.9%
in November; however, a rebound in manufacturing sale volumes is pointing
to at least a partial rebound in December while earlier gains leave the measure still on pace to outpace growth in the broader economy in 2014 for just
the third year since 2000, with the other two instances in 2010 and 2011 as
activity in the sector bounced following an outsized drop in 2009 that was
much larger than the decline in overall GDP recorded in that year (Chart 7).
In the late 1990s, manufacturing growth was consistently stronger than GDP
growth but consistently underperformed through the 2000s as the U.S. economy entered recession in 2001 and the Canadian dollar strengthened steadily
through the rest of the decade.
1998
Source: Statistics Canada, RBC Economics Research
1998
The above discussion suggests that there remains capacity for many manufacturing sub-sectors to respond to rising demand from the U.S. The question
remains as to whether export-oriented manufacturing firms will take advantage of the recent supportive developments. Our view is that they ultimately
will and, on that score, more recent trends have suggested some reason for
optimism. Exports, which have lagged growth in U.S. demand during the
economic recovery, have been growing more quickly with solid gains in the
second and third quarter offset by only a modest pullback in the fourth to
leave Canadian exports at the end of 2014 more than 8% above their level a
year ago.
1996
2001
While we don’t yet believe capacity constraints are binding on manufacturers, they may become so as production rises to meet demand. If history is
any guide, firms will respond to mounting capacity constraints by boosting
investment spending. Chart 6 shows the historical correspondence of investment and capacity utilization in manufacturing. Particularly noteworthy is
the 1990s during which manufacturing capacity utilization rapidly rose as
the economy recovered from recession and prompted stronger investment
growth in subsequent years. Recently, both capacity utilization and investment spending have slowly increased and are approaching pre-recession
levels. If strengthening demand causes firms to take up their slack capacity,
it may stimulate investment spending.
Source: Statistics Canada, RBC Economics Research
Chart 8: Manufacturing GDP by Industry: 2014 Year-to-date
Percent change
Transportation Equipment
Textile\Clothing & Leather Prod
Food
Non-Metallic Mineral Product
Wood Product
Primary Metal
Furniture and Related Product
Beverage and Tobacco Product
All mfg industries
Machinery
Plastics and Rubber Products
Computer & Electronic Product
Fabricated Metal Product
Although increased production in the transportation sector, largely related to
the rebound in the auto market following the recession, has led the way,
gains have been relatively broadly-based by industry with most sub-sectors
performing notably better in 2014 than their previous 10-year averages
(Chart 8). Anecdotal reports are in line with the data. The Bank of Canada’s
Q4 Business Outlook Survey pointed to notable weakness in the oil & gas
sector; however, comments on manufacturing were unambiguously positive,
particularly for those firms that reportedly export significantly to the U.S.
(see below)
Paper
2014 year-to-date average
Chemical
Printing and Related Support Activities
10-year average
Petroleum and Coal Product
Electrical Equipment, Appliance & Component Mfg
Miscellaneous
-10
-8
-6
-4
-2
2
4
6
8
Source: Statistics Canada, RBC Economics Research
Chart 9: Canada Manufacturing vs Oil & Gas Employment
Establishment survey, Thousands, Seasonally Adjusted
2200
2000
1800
Quotes from the BoC Q4 Business Outlook Survey:
1600
1400
“The winter Business Outlook Survey continues to provide signs of strengthening
demand, especially among export-oriented firms and manufacturers.”
“hiring intentions and investment plans are more robust for manufacturers than for
firms in other sectors”
“Compared with recent surveys, reports of higher investment in machinery and
equipment are more widespread in the manufacturing sector, and more projects are
aimed at expanding production capacity and reducing costs.”
1200
1000
800
600
Manufacturing
Oil & gas extraction
400
200
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: Statistics Canada, RBC Economics Research
“Capacity pressures are more prevalent among exporters and firms that reported
improved sales activity over the past 12 months. Many of these businesses are
planning to increase their investment and employment to address capacity
constraints.”
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CURRENT ANALYSIS | FEBRUARY 2015
Chart 10: Mfg Employment by Industry: 2014 Year-to-date
Percent change
Transportation Equipment
Nonmetallic M ineral Product
Textile M ills
Leather and Allied Product
Primary M etal
Wood Produc t
Fabricated M etal Product
Food
Total mfg
Plastics and Rubber Products
M iscellaneous
M achinery
Chemical
Paper
Furniture and Related Product
Beverage and Tobac co Product
Electric al Eqpt/Appliance/Comp
Printing/Related Support Activities
Petroleum and Coal Products
Computer and Electronic Produc t
Clothing
Textile Product M ills
-12
2014 year-to-date average
10-year average
-10
-8
-6
-4
-2
2
Source: Statistics Canada, RBC Economics Research
Chart 11: Canada Manufacturing Output and Employment
Year-over-year percent change
15
10
5
-5
-10
Mfg employment
-15
Manufacturing GDP
-20
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: Statistics Canada, RBC Economics Research
ECONOMICS | RESEARCH
4
To-date, growth in the sector has still been modest and largely accounted for
by productivity increases. As a result, job growth remains a sore spot with
employment headcount little changed from recession lows (Chart 9). With
that said, the number of workers directly employed in the manufacturing
sector still is significantly larger than those employed directly in oil & gas
extraction. As well, looking at the industry breakdown, there have been
some pockets of improvement in manufacturing employment recently (Chart
10). In general, the largest manufacturing subsectors have seen the best employment dynamics in 2014. For example, data through November suggest
that jobs in transportation equipment manufacturing have grown 3.2% in
2014, consistent with mounting capacity constraints in that subcomponent.
Chart 11 shows the historical correlation between manufacturing output and
employment. Although Canadian employment data is notoriously volatile,
stronger output eventually should result in stronger hiring in the manufacturing sector.
CURRENT ANALYSIS | FEBRUARY 2015
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