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Playing catch up after a lost decade for Canadian exports

The energy revolution south of border means the pressure on Canada to look towards other markets, most notably those in the Asia Pacific region, is building quickly. Philip Moore reports.

Glance at a map of Canada and the province of Manitoba seems an unlikely candidate to spearhead the diversification of the country’s trade. It is, after all, only 30km from the provincial capital, Winnipeg, to the hamlet of Landmark, which claims to be at the longitudinal centre of Canada. From here, you can take your pick which coast to travel to: each is 4,000km away.

Unsurprisingly, the US remains Manitoba’s major trading partner, but its share of the province’s exports has declined precipitously over the last decade. Narendra Budhia, director in the research department at Manitoba Finance in Winnipeg, says that while the US accounted for 81% of Manitoba’s exports in 2002, by 2012 this share had fallen to 67%. Over the same period, exports to non-US markets increased by 7.5% annually. Particularly striking, says Budhia, has been the rise of exports over the last decade to the Brics (Brazil, Russia, India and China), which have expanded by an average of 26.1% annually.

For a province which tends to act as a reliable barometer to what’s going on elsewhere in Canada, Manitoba appears to have had a rather different experience from other provinces in recent years. “The volume of Canadian exports today is at the same level it was a decade ago,” notes a recent report published by CIBC. “And after rising for most of the previous decade, the share of non-US exports in total exports has hardly changed in the past four years. In fact, recently it has been moving in the wrong direction.”

According to the CIBC report, while global trade in goods has surged by 70% since 2002, in Canada the volume of imports has risen over the same period by 45%, while exports have remained essentially unchanged. “Regardless of how you look at it, this was a lost decade for Canadian exports. And for a small, open economy, this is not a positive trajectory,” says the report.

A nation of SMEs

In part, that reflects the structure of the Canadian corporate sector, which is heavily populated by relatively small companies. Craig Wright, chief economist at RBC in Toronto, says that 99% of Canadian companies employ fewer than 500 people, compared with closer to 85% in the US. “We’re a nation of SMEs, and SMEs tend to be less export-oriented than large companies,” he says. 

That may also explain why those companies that are successful exporters have tended to focus on their closest neighbour. That works fine in the good times, but leaves the corporate sector vulnerable to downturns south of the border. As the IMF observes in its most recent assessment of the Canadian economy, the country’s exporters have suffered “disproportionally from the Great Recession, given their heavy exposure to some of the US sectors hardest hit by the crisis (e.g. housing and automotive). While the recovery of the US economy will help strengthen Canada’s trade balance over time… full absorption of the US output gap would still leave Canada’s current account balance about 2-3 percentage points below its norm.”

All the more reason, says the IMF report, to recognise that it is “essential to increase the competitiveness of Canadian firms and reduce their dependence on US markets.”

US self-sufficiency poses problem

By far the most important reason why Canada urgently needs to explore opportunities beyond in markets other than those across the 49th Parallel, however, is the rapid expansion of US domestic oil and gas production and the subsequent effect on Canadian exports. 

This is a drum that Jim Prentice was banging as early as 2008. At the time, he was minister of industry, which was one of a number of portfolios that he held in the Canadian government between 2006 and 2010. Since January 2011, Prentice has been senior executive vice president and vice chairman at CIBC, where he is responsible for expanding CIBC’s relationships with corporate clients across Canada and internationally.

Prentice’s thesis on the challenges and opportunities created for Canada by the production boom in oil and natural gas south of the border is straightforward enough. “It surprises many people to hear that the largest supplier of oil to the US is not Saudi Arabia, Venezuela or Mexico, but Canada,” he says. 

Canada’s oil and gas exports in 2012 were worth $93bn, almost all of which went to the US, according to Prentice. “Canada has enjoyed a privileged trading and economic relationship with the US, and particularly in the energy sector since the implementation of the North American Free Trade Agreement (Nafta) 20 years ago,” he says. “So it is difficult to envision any scenario in which Canada ceases to be the largest single foreign supplier of oil and natural gas to the US,” he says. 

That’s the good news. The bad news is that the volume of those supplies are in steep and probably irreversible decline — partly because of improvements in energy efficiencies in the US, but largely as a by-product of growing self-sufficiency south of the border. 

“In 2005,” says Prentice, “about 60% of the oil the US needed to meet its domestic requirements was sourced from overseas. Today, that share has fallen to below 45%, and is headed towards about 35% in the next five years.”

To Asia, quick!

This leaves Canada with no choice but to look towards other markets, most notably those in the Asia Pacific region. “Canada has to diversify, because if it wants to be an energy superpower it can’t have all its eggs in one basket,” says Prentice. “I would go so far as to say that in light of the importance of oil and gas to the Canadian economy, this is the single most pressing issue facing policymakers today.”

Those policymakers, Prentice adds, are well aware of the need to cultivate closer trading relations with Asia. But if Canada is to unlock the potential of the Asian markets for its exports of oil and natural gas (and other products), it will need to address existing shortcomings in terms of trade agreements and infrastructure.

Progress is being made on both fronts. In late 2012, Canada (along with Mexico) became members of the Trans-Pacific Partnership (TPP). Although China is not a member of TPP, the scope of this free trade agreement was considerably enlarged in April, when Japan signed up. This has created freer access for Canadian exporters to an Asian market of 277m people and combined GDP of $8.4tr, according to a briefing note published by CIBC in May.

The more formidable challenge that Canada needs to overcome if it is to achieve a more balanced distribution of its energy exports is creating the necessary infrastructure to transport its natural gas and oil across the Pacific. “We won’t be able to export LNG without very significant investment in infrastructure,” says Prentice. “The need to build two or three world-class LNG facilities off the west coast is immediate because at the moment Canadian natural gas is trading at a discount in the North American market.”

RBC’s Calgary-based head of energy, Derek Neldner, agrees that Canada is inevitably feeling the backlash of the US shale oil and gas revolution. “With over 60% of our energy production being natural gas, and the US becoming increasingly self-sufficient, Canadian producers are under pressure to become more competitive, and to develop access to new markets such as through LNG exports,” he says.

Nafta splits opinion

Economists say that beyond initiatives such as the TPP, there are other opportunities Canadian exporters could harness more effectively in order to bolster exports. “I think Canada could do a better job of leveraging its membership of Nafta,” says Stefane Marion, chief economist at National Bank in Montreal. 

Canada signed up to join Nafta in January 1994, but its membership has been controversial, and the subject of considerable opposition from commentators such as Jim Stanford, economist for the Canadian Auto Workers Union and founder of the Progressive Economics Forum. 

Stanford recently blogged that the bilateral trade deficit between Mexico and Canada rose by more than 70% between 2009 and 2012. This lopsided trading relationship, he added, has been the cause of about a quarter of the half-million jobs that Canada has lost in the manufacturing sector since 2000. Half of those job losses have been in the Canadian auto sector, which explains why Stanford has been such a vocal critic of Nafta.

Marion says that Canada should embrace rather than oppose the opportunities created by Nafta, especially now that the shale gas boom south of the border is pushing down energy costs so sharply in the US. “The US energy revolution is a very significant structural change that Canada needs to adapt to,” says Marion. “Rather than focusing just on trying to increase our energy exports to other parts of the world by building more pipelines, we should be integrating our manufacturing base more efficiently within North America to take advantage of lower production costs there,” he says. “We should also be integrating more closely with Mexico, where production costs are still lower than they are in several Asian economies.”

There have been a handful of Mexican success stories among Canadian manufacturing companies. None has been more striking than the Montreal-based Bombardier, which since 2005 has invested some $500m on its aerospace plant in Queretaro, where its 1,800-strong workforce manufactures parts for the Learjet 50. But economists say that Bombardier has been the exception rather the rule in terms of Canadian companies capitalising on the potential of Mexico.

They add that there are other trading agreements beyond TPP and Nafta that Canadian exporters need to harness in order to diversify further. One of these is the Comprehensive Economic and Trade Agreement (CETA) with the European Union. Negotiations aimed at promoting closer ties with the EU, which accounts for about 9.5% of Canada’s external trade, were launched in May 2009 and are due to be finalised this year.  

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