It’s not quite the best of times and the worst of times, but the economic outlook for the United States’ neighbor to the north is undeniably a tale of two Canadas.

The split in Canada is geographic, with the western provinces enjoying prosperity while eastern Canada, specifically southern Ontario, is facing challenges.

“Canada is split in two—boom and bust,” says Randy Cousins, a steel analyst for BMO Nesbitt Burns in Toronto. “If you have any business in oil and gas, you’re doing well. Ontario is the bust,” he says.

President and CEO Wayne Bassett of Mississauga, Ontario-based Samuel, Son and Co. Ltd., one of Canada’s two largest service center companies, echoes that thought. “Right now, the Canadian economy is significantly different depending on what part of the country you’re talking about and some specific industries within those geographical areas. Western Canada, that’s the good side.”

While the oil sands of Alberta are driving the prosperity in the plains, Bassett says, British Columbia is also thriving, in part because of infrastructure building for the 2010 Olympics.

The same cannot be said for the eastern half of the country. Unlike the United States, where the manufacturing base is fairly well spread out and expanding, Canada’s production capacity is concentrated in southern Ontario. More than 60 percent of the country’s manufacturing production comes from that single province.

All talk about manufacturing woes begins with the strong Canadian dollar, which leaves the country’s producers in a position of weakness vs. competitors in the United States. “It increases the relative cost of labor,” Cousins says of the Canadian dollar, which rose from around 64 cents against the U.S. dollar to more than 90 cents by the end of 2005.

Moreover, the quick escalation of the Canadian dollar’s value hurts more than a slow ramp-up. “That’s like taking you from Saudi Arabia to the North Pole without giving you the chance to change clothes,” Cousins says.

Bassett notes it’s not the cost of steel that’s doing the damage, as the price Canadian companies pay is roughly the same as their U.S. counterparts.

“It’s really the fact that if you’re manufacturing a part where 50 percent of the cost is conversion cost, and you’ve just had the dollar change by 34 percent vs. the U.S. dollar, that’s effectively 17 percent of the selling price you’re no longer getting. That’s more than most manufacturers would ever make on the product, and it’s really putting the Canadian manufacturing economy in a very difficult spot relative to their U.S. competitors,” he says.

Hardships caused by the strong dollar are not widely evident in the overall marketplace. One reason is that this is the second time Canadian manufacturers have gone through such a change in the exchange rate, Cousins says. A similar run from 1987 to 1991 took out many of the country’s weaker manufacturers, sparing only the low-cost producers. Still, the impact is coming, he predicts.

“The costs will catch up with them,” Cousins says. “If a company was thinking of taking their business offshore, they’re now doing it.”

Bud Siegel, CEO of Russel Metals, Mississauga, Ontario, says the Canadian economy’s ability to withstand the strong dollar may be misleading. “The States up until recently had been a growth market, and Canadian shipments have been relatively flat. What we may have done is missed the growth because of the currency. It doesn’t show up in the numbers because the numbers are OK, they didn’t go backward. But we didn’t grow.”

Bassett believes the prospect for a more favorable exchange rate in the near future isn’t encouraging. The strength of the energy and mining sectors, coupled with the Canadian central government running consistent surpluses, is likely to keep the Canadian dollar strong in relation to the U.S. dollar.

The other reason for the shaky conditions in southern Ontario is the fact that much of the province’s manufacturing capacity is tied to the troubled automotive industry.

“The Big Three are becoming the lesser three,” Cousins says, as once-foreign carmakers such as Toyota, Honda and Nissan continue to win market share by building production capacity in North America. “The transplants are helping, but not enough to offset what’s going on with the Big Three.”

Moreover, as Bassett points out, shifting preferences in automotive demand are having a bigger impact on metals suppliers in Canada than the United States. “Automotive is really down, and Canada tends to be heavier on SUVs and minivans, so it’s a disproportionate hit.”

Bassett’s company is feeling the pinch, as 50 percent of its business in Ontario is automotive-related. In contrast, Russel Metals has little to no involvement in automotive, leaving Siegel slightly more optimistic about the province’s short-term outlook.

Also more optimistic about Ontario’s future is Peter Warrian, a University of Toronto professor who specializes in steel issues. Warrian offers an upbeat outlook for the province’s health, even for the automotive industry.

“Ontario is assembling more cars than the state of Michigan now. The pressure has been on Ontario for that next wave of auto investment, and it has competed fairly well. Three new transplants are going into Ontario, and the Japanese auto parts manufacturers are coming in,” Warrian says. “Ontario’s auto employment will see a net gain when the restructuring’s done.”

While the exchange rate and auto outlook dominate discussion on the future of Canadian steel, the metals market faces other strains. For Bassett, it begins in Ottawa, the capital city, where support for manufacturing is almost nonexistent, he says.

Unlike his facilities in the United States, which are welcomed by local, state and even federal governments, the central and provincial governments of Canada are far more hands-off in their approach to new or existing industry. Tax abatements, land procurement assistance and employee-training programs that are common in the United States are tough to find in Canada, says Bassett, whose company has about 30 percent of its operations in the U.S.

Moreover, the Canadian government is unlikely to back industry in trade disputes. “If you take a trade case to Ottawa for dumping, your chances are smaller than a similar case in the United States. We have a government that believes in an open-door policy,” he says. “Of course, it isn’t a level playing field.”

Another example of government laxity that is threatening Canadian industry is its stewardship of the power supply, Bassett says. Once the home to enough surplus energy that it sold some to the United States, Ontario and Quebec are now staring at a dramatic power shortage. Between $40 billion and $60 billion in investments in energy infrastructure are needed to keep pace with demand, according to Karen Taylor, energy analyst for BMO Nesbitt Burns.

The scarcity of power has led to a near doubling in the price of energy. Transitional pricing arrangements put in place to assist industry when the energy market was opened in 2002 have expired, with no great hope for further assistance. This as another example of how the country’s governing bodies are not looking out for its manufacturing base, Basset maintains.

Looking at Canada’s economy overall, concerns about Ontario’s future are largely offset by optimism in Alberta. Energy exploration in the West figures to keep Canada’s overall GDP above 3 percent, a healthy figure and ahead of the United States. According to Warrian, the energy boom should last a while.

“You’re talking about more oil than there is in Saudi Arabia,” he says. “Ontario has been the engine of the Canadian economy, and Alberta is emerging as its equal.”

Tubular goods manufacturers are among the biggest beneficiaries of the boom there, though steel demand is up in various sectors including manufacturing, construction and mining.

“Western Canada is going crazy,” reported Robert “Butch” Mandel, Welded Tube of Canada executive vice president, who spoke at the Metals Service Center Institute’s recent Forecast Conference. “It started with oil, and we’re starting to see manufacturing follow.”

Warrian says leaders in the province are trying to use the energy boom to develop the entire economy. “Alberta doesn’t want to be just a processor of raw materials. It wants to have the other parts of the economy as well. It’s more than just an oil patch.”

Some of the activity there has resulted in gains for the eastern half of the country, Siegel and Bassett agree. “We are getting a little bit of a bump because the oil patch is so busy in Alberta. Some of the business has come back to Ontario because they simply can’t get enough workers to produce the product out there. And a lot of the metal is coming from the east, so there’s not a great disadvantage in processing it here and shipping it out west,” Bassett explains.

Cousins, too, acknowledges that despite rough conditions for the historical epicenter of the Canadian economy, there are positive signs as well. “The labor force remains highly productive and educated. It’s easy to dwell on the negatives, but there are some base strengths, too.”

Canadian Steel Ripe for More Consolidation

The future of Canadian steel mills has been the subject of intense speculation for the past year as Stelco emerged from bankruptcy and control of Dofasco remained up in the air. Experts expect similar uncertainty in the year to come.

“We still don’t know who’s going to own Dofasco,” says Randy Cousins, steel analyst for Canadian management firm BMO Nesbitt Burns. “If it’s Arcelor-Mittal, how will they behave? How will they be managed?”

Dofasco was initially purchased by Arcelor in the early months of 2006, though Arcelor’s merger with Mittal Steel has thrown that deal into flux. To meet the requirements of antitrust regulators, Mittal had agreed to divest Dofasco to rival suitor ThyssenKrupp Materials. But that sale is complicated by Arcelor’s earlier decision, a defensive measure against a hostile takeover, to turn control over to an independent Dutch foundation, Strategic Steel Stichting, which now holds the authority to sell Dofasco.

As the Dofasco situation sorts out, analysts predict the reorganized Stelco and other Canadian steel companies may be targets of further mill mergers.

The Canadian service center sector is also ripe for consolidation, according to Samuel, Son and Co. President and CEO Wayne Bassett and University of Toronto Professor Peter Warrian.

“We believe that the service center capacity is about one-third more than it needs to be to service the current manufacturing market here,” Bassett says. “There needs to be significant consolidation in the service center industry in southern Ontario. The rest of Canada is probably OK, but if it doesn’t happen here, there are going to be some pretty rough times for earning a reasonable rate of return.”

Warrian notes that the nature of the consolidators could change the market. If additional European mills make inroads into Canada, they may bring with them the European model of mill-owned service centers, and acquire captive distribution in the region. If major U.S. service center companies make a bigger push into Canada, independent distribution will remain the dominant model.

“Either way, because the Canadian service center industry is more fragmented than in the U.S., I expect to see on the distribution end more of the sort of consolidation we’ve seen on the producer end,” Warrian says.