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A Tale of Two Canadas By Dan Markham, Senior Editor Energy exploration and manufacturing make up equal parts of Canada's steel market, but the two segments, and the provinces where they take place, are heading in very different directions. The U.S. steel industry has muddled through a dispiriting 2013, with tepid pricing and demand delivering a dual dose of disappointment. But U.S. supply chain members will get no sympathy from their neighbors to the north, whose fortunes have been a bit worse in 2013. Service center shipments of steel products are almost on par with 2012, according to Metals Service Center Institute data, thanks to a late-year rebound in activity. Canadian service centers also have bounced back from the weak first half, but their falloff was greater and shipments remain 7.3 percent below last year. Industry watchers agree the supply side of the business is generally OK, with any issues with the summer labor issues that shuttered U.S. Steel’s Lake Erie Works facility for 18 weeks having already been worked through the system. Of course, Canadian distributors have been extraordinarily cautious about adding product, particularly in recent months. Inventories at Canadian service centers have been moving down all year, with the biggest drop coming in the last two months. Canadian distributors are now at 1.2 million tons in stock, more than 30 percent below the January figure and a number that represented a year-low 2.3 months on hand. With price increases showing surprising strength at year’s end, service centers may begin restocking earlier than usual. "We're having a surprising end to 2013 in terms of steel pricing. I think everyone expected the steel prices to go down in the fourth quarter, as they have the last 2-3 years. So everyone got caught off guard and is scrambling to get some steel. That's creating some tightness in the market," says Scott Jones, president of Nova Steel, Mississauga, Ontario. Even with a healthy end to the year, the Canadian distribution market has continued to lag its U.S. counterparts. Theories why include a step back in the energy market, a dramatic fall in the mining sector, a greater penetration from U.S. service centers into the Canadian market and shrinking market share of the robust automotive market. There are two areas where Canadian steel market participants are in agreement about the industry's outlook: Manufacturing in the traditional powerhouses of Ontario and Quebec will continue to be threatened; and the tar sands of Alberta will drive demand for steel products for the next decade. The M&A activity of the country’s two dominant service center companies demonstrates where Canada's future’s growth is expected to come. Russel Metals’ three most recent acquisitions, all in 2012, were of assets in the western provinces, including its purchase of Apex Distribution, an oilfield supply company with more than $500 million in revenues. Earlier this year, Mississauga, Ont.-based Samuel, Son & Co. Ltd. acquired Wilkinson Steel and Metals, a company with facilities in British Columbia, Alberta and Saskatchewan. Additionally, "we are working on a small niche thing in western Canada that will help solidify and cement our position we developed with the Wilkinson acquisition," says CEO Bill Chisholm, who replaced former Samuel head Wayne Bassett this summer. While activity in the tar sands paused in 2013 due to lower prices and market uncertainty, the long-term trend is unmistakable. Canada has the largest supply of petroleum open to private investment in the world, according to the A.T. Kearney, a worldwide analysis firm. That distinction has made Canada the fourth-largest destination for foreign direct investment, trailing only the United States, China and Brazil. Investment in the oil sands is estimated to exceed $100 billion over the next 10 years, reports Industrial Info Resources. That figure doesn’t even include the supporting infrastructure that would accompany the drilling activity. Those investments, however, remain mostly on standby, primarily due to haggling on the other side of the border. The Obama administration's unwillingness to approve the Keystone XL Pipeline project has left significant oil and gas investments in a holding pattern. "At this point in time, it's a bit of a wait and see in both countries," says Marion Britton, executive vice president and chief financial officer at Russel Metals, Mississauga, Ontario. "And Canadian companies are trying to think of other solutions." Two other pipeline projects have been proposed as a means of getting the resource out of the landlocked middle part of the country to the coasts. The Northern Gateway project would take the product west, over the Rockies and to the ports of British Columbia, where it could be exported to the energy-hungry Asian markets. The most recent proposal is Energy East, which would supply the heavily populated provinces of Ontario and Quebec, and also continue east to the Atlantic for shipment to Europe and Asia. "The potential exists for all of the above," says Ron Watkins, president of the Ottawa-based Canadian Steel Producers Association, the trade group representing Canadian steelmakers. "Whether things would change the thinking on some of the other projects, I don’t know. But I don't think it would bring into question whether they go through. The proponents want to do it anyway." Of course, these projects have their own hurdles. The Northern Gateway project faces both environmental and Native land claim issues that must be overcome. Chisholm thinks they ultimately will. "I'm a proud Canadian, and I don’t want to see our lovely country hampered in any way by these pipeline projects. But at the same time it’s important for the economic vitality of the country," he says. The growth of the oil and gas industry in Alberta and Saskatchewan will also benefit the manufacturing sectors to the east, Chisholm says. And not just with a source of affordable energy, a condition that's currently lacking despite Canada's rich energy resources. Development out west will require production of tanker cars for the rail industry, fracking tanks, pipelines and long products for infrastructure. “All of these are opportunities for eastern Canada to support the growth in Western Canada,” Chisholm says. Those manufacturing opportunities are instrumental, because otherwise Canada's production base is shrinking. Ontario and Quebec have already seen their manufacturing base shaved in recent years, with companies leaving for other parts of the world or simply elsewhere in North America. "We think most of the manufacturing jobs that have been lost in Canada are not coming back here. The thing the industry has to do is right-size itself," says Britton. This trend is evident in the automotive industry. While the Canadian distribution sector has enjoyed the benefits of the resurgence of the light vehicle market over the past few years, it has not been able to take as much advantage of it as it would have in previous upturns due to the changing nature of the North American supply chain. "A lot of that new automotive capacity is located in Mexico or Alabama or Tennessee. It's not in Michigan or Ontario. It's in those other states, and we're not getting the spin-off effect," says Paul LeGendre, vice president of sales and marketing for Brampton, Ontario-based Del Metals. He notes the last automotive investment in Canada was the Toyota facility in Woodstock, Ontario, which opened in 2008. The trend is similar with other manufacturing facilities, which ship about two-thirds of their production into the United States for consumption. But one of the appeals of Canadian products was based on its historical currency advantage, an edge that has been all but eliminated in recent years. In 2002, the Canadian dollar fell to a little more than 60 percent the value of the U.S. dollar. Five years later, the two currencies were at parity, and it has bounced around level for most of the time since then. The Canadian dollar had been trending downward in November, gaining a little edge for manufacturers. But the long-term expectation was for the two currencies to move in a narrow band close to par. The currency situation is one big reason that Canadian companies do not expect to see the same boost from any reshoring activities as American firms. Companies looking to return to North America are bypassing Canada for the southeastern United States and Mexico, locations that provide the advantages reshoring businesses are looking for but with more attractive labor costs than found in Ontario or Quebec. "We have an operation in Mexico, and if you want to compare the environment there to the environment here, it’s night and day," says Jones. "The opportunity there is phenomenal. There's a lot of growth in Mexico. We’re just managing a shrinking pie here." Energy and automotive each make up about 30 percent of the steel consumption in Canada. Another 30 percent is bound for the nonresidential market. Like that market in the United States, nonresidential construction has been flat at low levels. "The main fly in the ointment is nonresidential construction," says LeGendre. "It ties up so much steel capacity. We need it to come back in a meaningful way, not the 0.2 percent year over year. We need to get back to the 07-08 type levels to really pull us out of where we're at." The public side of nonresidential construction got a boost with the passage of a 10-year, $50 billion infrastructure bill. "We're pleased to see that long-term commitment to infrastructure. It's still short of what would be optimal, but it’s a sizable commitment," says Watkins. At the provincial level, there's more concern, particularly in Quebec. The ruling party there, Parti Quebecois, "is more focused on religion and language rights than on the economy," says Chisholm. "In Montreal there are construction projects everywhere, but there's no work going on. They’re not focusing on financial stability and what’s necessary to get the economy going." The just-passed infrastructure bill excludes the New International Trade Crossing that will connect Windsor to Detroit, a project that will be paid on the front end by the federal government but costs recouped through tolls. That project is important to the Canadian economy for more than just the steel that will be consumed. "What's really important is we're very much interested in seeing the federal government here and in the U.S., and also the appropriate provinces and states, keep working at means to streamline the border processes. Impediments at the border make it less efficient for moving goods intra-NAFTA," Watkins says. "The efficient functioning of the border is always important for all manufacturing due to the integrated nature of the two economies." That will remain the case, even with Canada signing an expansive free trade agreement with the EU in November. "The economies are kind of moving in tandem. The U.S. doesn't really look at what’s going on in Canada, but we’re always watching what is going on in the U.S." Britton says. And even with some of the structural realities facing its manufacturing base, not all hope is lost. "We wouldn't have invested the money we have in inventory and equipment if we didn’t think there was a market out there we could service. North America is stable, it's a good place to do business," says Jones. "We're still kind of a bit on tilt, but we're much better than Europe is."