Canada’s ‘loonie’, as Canadians commonly and affectionately call our currency, continues to suffer compared to the United States’s dollar. Ten years ago Canada’s dollar was equal to the U.S. dollar, and imports from the U.S. we’re almost 40% cheaper than now. Now Canadians have to pay more for billions of dollars of vital imports, from oranges to computers, while shortening their holidays down south with 72 cent dollars. Inflation and interest rates influence the exchange rate, but not exclusively.
To illustrate, one impediment to a greater adoption of pricy electric vehicles by the public, which the federal and most provincial governments would like, is the weak loonie. It makes those vehicles much more expensive than in the U.S.. Our loonie has withered against a seemingly-almighty US dollar, ‘USD’, just as have other struggling currencies such as the Japanese yen and the British pound, ‘GBP’.
However, high USD prices for our oil and gas, fertilizer, chemicals, grain, metals and other commodities benefit Canada. In loonie terms, a large part of those exports bring us 100 cents not 72 cents, generating strong export revenues. Deconstructing the balance of payments into its constituent parts reveals much of the rest of the issue, and, while illuminating, is still not the whole story.
Net investment income is a big piece of the ‘current’ ‘portion of Canada’s balance of payments. Although Canada does send a lot of dividends, interest, rents, and royalty payments to investors abroad, it also receives a large amount of such flows too. In the first quarter of 2022, perhaps surprisingly, this part of Canada’s current account, as in the trade in goods, was positive. (Yet, there were travel and services deficits in 2022’s first quarter, as foreign travel and economies rebounded from pandemic lows.)
So, if Canada has a current account surplus, to make the payments balance the capital account must be in deficit, and it is. However, it is only about minus eight billion dollars, just a small proportion of the overall near-two hundred billion in flows in the capital or financial account (as Statscan terms it). Hence, the weakness in the loonie, very apparent early in 2022, is still necessary to make the balance of payments actually ‘balance’, and not just from weak export or investment flows.
Perceptions influence financial markets and affect prices of financial instruments such as stocks and bonds. They also influence commodity prices, and, directly or indirectly, the prices of currencies in which commodities are denominated.
The strongest industry in Canada, and the country’s export leader, despite the best efforts of the Climate Crusaders and their eager acolytes in the federal and provincial governments, is oil and gas. While oil prices have slid recently this year in response to the United States depleting its Strategic Petroleum Reserve, they are still elevated, while natural gas prices in Europe, and even the United States, have soared, along with volumes traded – with the Russia-European gas trade now almost zero.
Since so much of the United States’s natural gas is being now exported to the EU and Asia, the previously gas-surplus nation, the U.S., is now drawing in gas from Canada, boosting previously depressed natural gas prices up here. For Canadian producers and transmission companies, the European-Ukraine-Russia struggle has been salutary for the industry, helping explorers, producers and transporting industries to drill, complete, and connect ever more wells in what is, broadly termed, the Montney formation in northeastern British Columbia and adjacent land in Alberta.
This is very positive financially for Canadian producers, although the Alberta price, as noted by the AECO reference for this coming November, is still around C$4.93 per gigajoule, whereas the New York commodity exchange price for the same month is USD$5.36 per million British Thermal units. Converting for the slight difference in the GJ and MBTU, and with the very dismal CAD$/USD$ exchange rate of $1.37, this means that the price is CAD$1.45 higher in the U.S.
As there is a transmission cost which cannot be eliminated, there may not be much scope to narrow the current CAD$1.45 differential. U.S. producers certainly are earning more than Canadian ones. They have been selling their gas to Europe at USD$36.77 per MBTU, or over CAD$50 per GJ in Rotterdam (source: CME Group) – making over ten times what Canadian producers earn, stuck in North America.
Canada’s surplus supply of gas is bottled up in Canada: there are no Canadian LNG terminals to send the nation’s abundant gas to the EU, Asia, or anywhere else, other than the United States.
In August of this year, Canada exported $2.31 billion of natural gas to the U.S. However, if Canada’s gas industry was able to sell their excess volumes of gas at the prices American gas traders get from European customers, it would double its take, owing to the higher prices (an extra $25 billion per year for producers). This would mean a massive increase to Canada’s already sizable trade surplus, boosting the Loonie. Yet, as noted, expectations matter as much as reality sometimes in financial markets.
Investors in the U.S., as well in Europe and Asia, may be forecasting prices of commodities such as natural gas to remain relatively high. Also, an imminent change in control in the U.S. Congress may bring about a more business and energy-friendly stance. Greater assurance of prosperity-enhancing conditions, along with strongly rising interest rates versus those in Canada and globally are undoubtedly fostering enthusiasm for U.S. financial instruments and on-the-ground direct investment opportunities, which, being denominated in U.S. dollar, forces foreign investors to sell their currencies to buy USD$.
Meanwhile, in Canada, there is little likelihood in the near future that business conditions will change. Commodity prices will likely come down as a recession sets in both in the U.S. and Canada. Reinforcing a lack of positive outlook for Canadian investments, oil and gas prices will not likely benefit much further from high U.S. prices. Limited Canadian pipeline capacity is a bottleneck federal policy has partly caused.
Canada will not have an outlet for more oil production until the TransMountain expansion is completed next year, nor for natural gas until LNG Canada in Kitimat, BC, is finished in 2025. Afterward, there will still not be any new LNG export terminals on the East Coast of Canada to take advantage of lavish EU gas prices for at least five years of planning and construction. By then, current high prices may be far lower.
Opposition to pipelines by the Quebec provincial government, despite it being unconstitutional, has been abetted by the anti-petroleum regime in Ottawa. Financial markets are forecasting mechanisms as well as vehicles for matching future and present perceptions. Right now investors do not believe that Canada’s current stymied oil and gas development and transport will be unblocked (and allowed to reach its highest value and volume of production and export).
If that perception did not prevail, it is likely that the loonie would be much higher relative to the USD. Also, our terms of trade would be much better – bringing a higher standard of living for Canadians and providing more individual purchasing power to buy those much-vaunted electric vehicles.
Unlocking Canada’s natural gas industry and allowing its expansion offers a key source of clean energy, supplanting the maligned coal. It is a mystery why Ottawa is not aiding its development, production and export. The loonie could also then approach, even surpass, USD$ parity: a huge win, for everybody.
Ian Madsen is the senior policy analyst at the Frontier Centre for Public Policy
