Provincial performance gap narrows as volatile resource markets dampen
outlook for some regions, while budding U.S. recovery lifts others
TORONTO, Jan. 29, 2013 /CNW/ - Canada's resource-rich provinces whose
fortunes have been dampened by commodity price swings should consider
hedging against those risks, even if it means giving up part of the
revenue windfall when prices are high, notes a new report from CIBC
World Markets Inc.
Canada's "resource bounty has in the past decade been a big winner for
government coffers. But resources are called cyclicals for a reason,
and provincial finance ministers are now acutely aware that a bountiful
surplus can turn into a gaping deficit in a hurry when commodity prices
slip," says Chief Economist Avery Shenfeld at CIBC in the latest
Economic Insights report. "The result is that fiscal outcomes in any
one year are highly uncertain, leaving finance ministers struggling to
explain why they held spending lean when revenues were gushing in, or
why a deficit suddenly emerged and forced borrowing up in the process."
In the corporate world, strategies for protecting revenues against
adverse swings in commodity prices are routinely used and could be
similarly applied by governments, says Mr. Shenfeld. "To smooth out
the bumps and allow time to adjust" to new commodity prices, resource
producers and buyers "typically use derivative markets to hedge against
some of the price risks in the near term, giving up some of the upside
in exchange for protection against large adverse swings.
"There's no reason why provinces couldn't do the same, locking in a
range for current year fiscal results, and giving time to make
adjustments in revenue or expenditure policies in the following year's
fiscal plan should the resource price trend persist. That would clearly
be preferable to surprising the bond market with in-year borrowing
changes, or rushing to make mid-year spending swings that might not be
optimal on other public policy grounds."
Provincial sensitivities to commodity price swings can be dramatic, the
report notes. For example, a $10 per barrel drop in oil costs Alberta
$2.2 billion in its fiscal bottom line, and hits Saskatchewan and
Newfoundland by nearly $200 million each. "Provinces also have
exposures to other commodities including potash and natural gas. The
revenues at risk not only include direct royalties but also land sales
and corporate income taxes that are correlated with underlying
Mr. Shenfeld notes that provinces are already using hedging strategies
to manage interest rates and currency risk by swapping
foreign-denominated debt into Canadian dollar obligations, as well as
to use other "instruments to lock in favourable rates when the market
Mr. Shenfeld adds that hedging strategies "aren't cut and dried
decisions, nor is there a one-size-fits-all approach given the
variation in exposures and the commodities involved. But it's at least
worth a serious look by finance ministers, and Canadian taxpayers,
finding themselves increasingly at the whim of volatile resource
Elsewhere in the report, Senior Economist Warren Lovely and Economist
Emanuella Enenajor note that a "sideways profile" for some key
commodity prices could dampen fortunes in the year ahead for Canada's
"Critically, North America's limited pipeline capacity means Alberta
crude oil is trading at a growing discount to international benchmarks.
That has triggered a substantial falloff in provincial royalties and,
as some recent announcements highlight, jeopardizes investment and
prospects in the oil patch."
Alongside pipeline constraints, Europe's recession and softness in
emerging markets "have dimmed the lights in heretofore fast-growing
resource rich provinces, creating intense fiscal pressure in uncommon
Meanwhile, as commodity related pressures face some regions, a budding
U.S. recovery is lifting others, resulting in the performance gap
narrowing between provinces.
"American domestic demand is in its ascendance, and as we settle into
2013, it's the provinces more levered to U.S. consumer and housing
market demand that are better positioned to ride out less supportive
domestic fundamentals and uncertainty overseas," note Mr. Lovely and
Ms. Enenajor, adding that Ontario in particular stands to benefit.
"Once-slower growing regions like Ontario are seeing economic and fiscal
fortunes hold up better, with a big assist from a reviving U.S.
economy. While not exactly redefining Canada's "haves" and "have
nots", the provincial economic and fiscal playing field is now more
evenly balanced than at any time in the past decade."
The complete CIBC World Markets report is available at: http://research.cibcwm.com/economic_public/download/eijan13.pdf
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SOURCE: CIBC World Markets
For further information:
Avery Shenfeld, Chief Economist, at 416-594-7356, email@example.com; Emanuella Enenajor, Economist at 416-956-6527, firstname.lastname@example.org; Warren Lovely, Senior Economist at 416-594-8041, email@example.com; or Tom Wallis, Communications and Public Affairs at 416-980-4048, firstname.lastname@example.org.