Dec 2017

Trade Winds Can’t Cool Canada

The Canadian manufacturing economy has enjoyed 'extraordinary growth' in 2017, and most signs point to continued strength in the year to come.

By Dan Markham, Editor-in-Chief

The ongoing renegotiation of the North American Free Trade Agreement hasn’t been enough to scuttle the legitimate optimism permeating the Canadian manufacturing sector. Canada’s industrial economy enjoyed a robust 2017, and most are expecting the good times to continue into the coming year.

“Our economy continues to be on a roll,” says Bill Chisholm, president of Samuel, Son & Co., Mississauga, Ontario. “There’s been a synchronization of the global economy. North America is on an uptick. Europe is on an uptick and even Asia.”

The Canadian manufacturing economy grew at a healthy 3.2 percent clip in 2017, with most major sectors sharing in the gains. Perhaps most notably, the oil and gas market has finally demonstrated signs of life after three difficult years.

Rig counts were up in Western Canada as oil prices came off the bottom. Mississauga, Ontario-based Russel Metals, which has a significant presence in Alberta and the other western provinces, reported a 56 percent increase in its energy products unit in the third quarter compared with 2016. “Our margins are improving as the volumes are coming back up,” retiring CEO Brian Hedges told investors at the company’s most recent conference call.

IHS Markit, which conducts a Canada Manufacturing PMI, backs that sentiment. Western Canadian provinces have been the strongest performing regions for manufacturing growth throughout 2017. “The improvement in sales to energy-related clients meant that Western Canada continued to outperform,” says Tim Moore, associate director of survey compilers for IHS Markit. “Manufacturers based in Alberta and British Columbia saw another robust improvement in business conditions during October, which was underpinned by the steepest rate of job creation since the third quarter of 2011.”

Not everyone is convinced the gains will continue. Michael Burt, director for industrial economic trends for the Conference Board of Canada, expects some flattening in the production growth in Western Canada. “Prices are at a level that stabilized the industry, but they’re not high enough to drive big investments in oil and gas in Western Canada. Our view is we won’t see oil prices above $60 per barrel much over the next few years.”

That conclusion is driven by the shale revolution, primarily a few hundred miles southeast of the oil sands. When oil prices show some bounce, shale producers quickly come on line, putting a de facto cap on pricing, he says.

Nonetheless, the overall business conditions remain good. Most end markets enjoyed growth this year, including industrial production, construction and agriculture.

Additionally, the Canadian government has successfully enacted a major infrastructure endeavor, a 10-year $180 billion program. “When those programs are announced, it involves provincial and municipal funding as well. It’s a significant investment in our infrastructure,” says Joseph Galimberti, president of the Canadian Steel Producers Association in Ottawa.

Unlike the proposed infrastructure project in the United States that has failed to gain traction, the Canadian effort is going ahead as planned. Moreover, “Generally with these programs in Canada, if there is an adjustment to the amount being spent, it’s only to increase the amount,” he says.

Overall, the PMI was 54.3 percent in October. That was the slowest growth since January, a sign of the strength in the manufacturing sector throughout the year.

The surge in the industrial economy was not entirely unexpected. When the Conference Board of Canada conducted its business confidence surveys of local firms in 2016, economists discovered the sector was consistently running at or above capacity. Yet, they weren’t seeing the level of business investment such a condition would be expected to produce.

“We were quite surprised by that,” says Burt. “Businesses were being cautious about expanding. But as business conditions persisted in a positive way long enough, they were finally willing to make those investments. And we’re seeing evidence of that. We’ve gone from overcapacity to being in line with where they’d like to be.”

While most observers expect continued strength in 2018, the Conference Board is anticipating a significant slowdown, from 3.2 percent growth to 1.8 percent next year. But, Burt says, that’s “tied to the fact that the Canadian economy has been really hot this year. The first six months of the year were extraordinary in terms of economic growth, and we don’t feel as if that pace of growth was sustainable.”

Still, there are no obvious red flags on the macroeconomic front. There are, however, concerns outside the normal supply-demand conditions.

“The underlying concern is geopolitical,” says Chisholm. “What’s going on with North Korea. What’s going to go on with Iran and Saudi Arabia, and what will the implications be to the economy?”

And as is typical with the Canadian manufacturing sector, one eye remains focused on what’s happening south of the border. The health of the Canadian economy correlates strongly with how well things are doing in the United States.

At the moment, the country has even more reason to be following the happenings in New York, Chicago and, in particular, Washington. The ongoing NAFTA renegotiation talks are a major source of concern for the Canadian manufacturing community, as is the Section 232 debate.

“We’re keeping a close eye on the NAFTA negotiations,” says Burt. “We are concerned it may lead to businesses being a little more cautious. In a world of uncertainty, you don’t necessarily take those big risks.”

The Canadian steel production industry is likewise following the negotiations closely. The CSPA has shared what it believes are “appropriate outcomes” with the Canadian government, and has co-signed a letter with steel trade groups from the U.S. and Mexico about the value of the deal from the steelmakers’ point of view.

“There are ways it could be modernized to make it more successful, more vital from a steel perspective,” says Galimberti. “We believe the NAFTA renegotiation represents an opportunity for all three jurisdictions to improve their global competitiveness, and we hope that’s the outcome.”

Of course, that isn’t the only possible result. The Conference Board has been running the economic outcomes of various scenarios, including the worst-case one, NAFTA’s demise.

“On the face of it, that’s not good news. But it may not be terrible news for Canada. If Canada falls back to most favored nation status with trade, it would mean tariffs for a lot of goods, but low tariffs, under 5 percent. It wouldn’t be the end for Canadian businesses, just a reduction in competitiveness in the U.S. market,” Burt says.

Section 232 discussions have created a second set of issues. Russel executives say the threat of action created some supply chain inventory spikes at the end of the second quarter, as service centers were buying ahead of any ruling. Now the talk is about what happens if the U.S. cracks down on imports through administrative action.

“They’ll wait and see what happens with 232, but they’ll move quickly to not become the dumping ground for the rest of the world,” Russel President and COO John Reid said of the Canadian response.

The CSPA agrees. “In instances where there is dumping or subsidy behavior of any kind of quantity into the Canadian market, we have been extraordinarily successful in bringing trade cases and getting appropriate margins on those products,” says Galimberti.

While imports are a steady concern for steelmakers, exports are of growing importance to the Canadian manufacturing sector. Notably, it isn’t just the U.S. that is the recipient of Canadian products. “We have seen some broadening of our export base, some growth to countries other than the U.S.,” says Burt. However, after experiencing growth in exports for almost a full year, the trend has slowed since May, when the Canadian dollar began to strengthen.

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