Finance Committee on March 12th, 2015

[The Chair, Conservative, James Rajotte]

I call this meeting to order. This is meeting No. 72 of the Standing Committee on Finance. Orders of the day pursuant to Standing Order 108(2), we are continuing our study of the impact of low oil prices on the Canadian economy.

Colleagues, we have two panels here this morning.

In the first panel we have five presenters. From the Bank of Canada, we have the deputy chief, Mr. Rhys Mendes. Welcome to the committee. From the Canadian Automobile Association we have the vice-president, Mr. Jeff Walker. Welcome. From the Canadian Manufacturers and Exporters, we have the president and CEO, Mr. Jayson Myers. Welcome back. From the Canadian Vehicle Manufacturers Association, we have the president, Mr. Mark Nantais. Welcome to you as well, Mark.

We're expecting to have economist Jim Stanford from Unifor, but we're having a little trouble with our video conference. We're hoping to get that up in the next minute or so.

You will each have five minutes maximum for an opening statement.

We'll begin with Mr. Mendes.

[Rhys Mendes, Deputy Chief, Canadian Economic Analysis, Bank of Canada]

Thank you, and good morning, Mr. Chair, and honourable members. On behalf of the Bank of Canada I'd like to thank you for this opportunity to share our analysis on the impact of global oil prices both on the Canadian economy in general and on the manufacturing sector in particular.

I should mention that our analysis is at the level of the economy as a whole. The rapid fall in oil prices is going to have both positive and negative effects on different sectors of the Canadian economy. To assess the overall impact, we used a modelling tool that we built to take account of the various channels and spillovers across sectors. We also drew on numerous surveys and meetings with firms and business associations. The bottom line is that a sizeable decline in oil prices since June 2014 is unambiguously negative for the Canadian economy as outlined in our January monetary policy report. Most of the negative effects will appear in the first half of this year.

The energy price decline will reduce aggregate income. Even though real GDP grew in the fourth quarter of 2014 by 2.4%, the real incomes of Canadians contracted. This occurred because the world price of an important Canadian export declined, and that means the loss of purchasing power for Canadians. In addition to this negative terms of trade effect, business investment is expected to be weaker. Business investment in the oil and gas sector, which is roughly a third of total business investment, is anticipated to fall by about 30% in 2015, but the effects of the oil price shock will be felt across the country.

The main transmission channels are the aggregate income effect that works through lost purchasing power and supply chain effects that work through interprovincial trade. For example, nearly one-third of the goods and services purchased by Alberta's oil sands industry are drawn from other provinces.

There are some positive but partial offsets. While Canadians are worse off than the aggregate, cheaper oil means more money in the pockets of individual consumers. They can either spend the additional disposable income or save it, and these decisions will matter for economic growth. Lower costs for firms that use oil as an input may lead to a rise in profits, output, and investment in non-oil related sectors of the economy.

It's also important to keep in mind that today's lower oil prices are mainly the result of abundant global supply as my colleague deputy governor Tim Lane pointed out in a recent speech. This supply-driven decline in oil prices is stimulating economic activity in the United States, our main trading partner. This will support Canadian exports if the export sector responds in line with historical experience.

Lower oil prices will have an impact on Canada through another channel. We are not net oil exporters and the value of the Canadian dollar tends to move with the price of oil. From 2002 to 2008, oil prices and the dollar were both on a general upward trend. You may recall that in 2008, when oil was trading at well over $100 per barrel, the Canadian dollar was almost at parity with the U.S. dollar. Today we're much lower and our dollar is at about 80¢ against the U.S. dollar. The lower dollar is improving the competitiveness of production in Canada, which should further boost exports and eventually investment. As we noted in our January monetary policy report, the manufacturing sector is expected to benefit from stronger U.S. demand, lower shipping costs, and the weaker Canadian dollar.

As we assess the ability of Canada's manufacturing sector to benefit from cheaper oil and the lower dollar, we have to recall where we're coming from. In Canada, competitiveness challenges and a prolonged period of weak U.S. demand forced many of our non-energy exporters to discard unneeded capital and eliminate jobs, or to close their doors for good. Rebuilding the lost productive capacity won't happen overnight. The bank has long been saying that in order for us to return to sustainable growth, we need a rotation of demand toward exports and business investment. Growth in our non-energy exports is showing more momentum in recent quarters, suggesting that rotation is indeed happening.

Finally let me note that our most recent business outlook survey indicated that hiring intentions and investment plans were robust for manufacturers. A majority of firms reported that they were planning investment projects aimed at increasing production. Overall, these are positive signs that the rebuilding process is under way.

This concludes my opening remarks, and I look forward to the discussion.

[The Chair, Conservative, James Rajotte]

Thank you for your presentation.

We'll go to Mr. Walker, please.

[Jeff Walker, Vice-President, Public Affairs, Canadian Automobile Association]

Thanks for having me. It's very much appreciated.

The Canadian Automobile Association is a representative organization of 6.1 million Canadians. We're very active in the consumer space. We're keen to stay apprised of key issues affecting Canadian consumers that cover the waterfront of the areas we're in, specifically around vehicles and things like gas prices. We've been commissioning consumer research on the changes in gas prices over the last few months. Our most recent research came out in January, and it's quite fascinating what we're observing.

The first thing to say is people are paying attention. People are paying attention both to the drop in gas prices and to the larger changes that are happening in terms of oil prices overall. The world they see is that they have cheaper gas. The world they're thinking about is not so much about oil prices. From a consumer point of view, for the most part, Canadians are seeing it through that lens at least today. They're watching it and they're doing some things that are counterintuitive economically. What we found is people are paying more attention. They're driving further to get cheap gas, as gas is cheaper than it was before. Some of the stuff that's going on doesn't always make economic sense behaviourally, but people are happy at that level. That's what we've observed.

In terms of how people see the larger impact, what we observe is that there's Alberta and there's everybody else. Albertans in the data say they're worried about the macro-economic part of this equation and the numbers. Is this going to have a significant long-term economic impact? Two-thirds of Albertans say it will have a significant effect. Everybody else, the minority in the one-third to 40%, say it will have a significant negative macro-economic effect over the longer term.

The reason, from what we see in the data, is that most Canadians still believe this is a short-term thing. They don't think that this is going to go on for a long time. We asked them how long it would be until gas prices go forward. Will they go up again over time, or will they stay down? People are still saying that this is a three- to six-month thing. They're expecting it to turn around, maybe not quite go where they were before, but not to stay down in the ballpark where it has been. Since they don't see it as a long-term thing—and I think people on this panel would say it could be—there's a gap in terms of their perception of where it's going to be macro-economically over time. We would perceive that as this goes on, there will be more Canadians who will be thinking more like Albertans already are thinking about where this is.

Let me make a couple of final points about this. What we observe now is that they are feeling pretty good economically overall, as Jason alluded to. They're not seeing, other than Alberta, prices changing in housing or job losses. Reference was made to job intentions in Ontario and other manufacturing parts of the country. People aren't seeing that. When they're not seeing that, they're not going to start saying that they're concerned. What we see is that it's a micro-economic problem today for everybody outside of Alberta. In Alberta it's a macro-economic problem. We'll see where that goes over time as people understand and recognize this could be a longer-term versus a shorter-term problem.

[The Chair, Conservative, James Rajotte]

Thank you for your presentation.

We'll go to Mr. Myers, please.

[Jayson Myers, President and Chief Executive Officer, Canadian Manufacturers and Exporters]

Thank you, Mr. Chair.

I have prepared and distributed a document analyzing the impact of lower oil prices on the manufacturing sector from our perspective. I'm not going to go into detail on that subject; you can take a look at that yourself. The only thing I could probably accurately forecast is that if you have a group of economists, you'll at least get as many, if not more, opinions about the impact of lower oil prices on the economy.

Let me focus on a couple of key issues. One is the relationship between the American dollar and the price of oil. It's important to realize that oil prices are denominated in U.S. dollars, and if the currency exchange rate of the U.S. dollar is rising against other currencies, the price of oil will naturally fall, and you don't need any change in supply and demand to effect that decline in the price of oil. There's a very strong correlation. In fact, if you take the U.S. dollar against a basket of currencies and weight it in terms of overall transactions for oil, what you find is that the U.S. dollar has fallen by 25%. That accounts for just over half of the decline in the price of oil that we've seen since last September.

This is a story about the strength of the U.S. dollar right now, which is an indication that other economies appear weak or are weakening, which also feeds into the other 50% of the equation about supply and demand in oil. Lower global demand for oil and continued overcapacity are on the supply and demand side and that's also bringing oil prices down.

That's important because the impact on Canadian manufacturing of the lower price of oil, I agree with Rhys, is net negative. However, that is being offset and will be offset over a period of time by a stronger U.S. economy, and also by the fact that the Canadian dollar is relatively low against the U.S. dollar. Rhys mentioned the impact that lower oil prices are having on economic activity in western Canada. That of course affects manufacturing across the country. We estimate that the hit on the manufacturing sector will be about $12 billion a year. It's not only because of lower demand for manufactured products and equipment particularly in the new projects in the oil sector in western Canada, but it's also because right now there's tremendous downward pricing pressure being exerted by the procurement companies, by the major oil operators, throughout the supply chain. It's not only a matter of lost production, but also of very dramatically lower pricing leverage.

The part that is offsetting the impact of oil prices, of course, is the fact that to some extent, some sectors will benefit primarily from lower feedstock costs. In the petroleum products sector, for instance, the price of petrochemicals and plastics is coming down along with the price of oil, not as rapidly, but it is having some positive cost implications for manufacturers who use those feedstocks.

On the whole though, let's not exaggerate the impact of lower oil prices on energy costs. Energy costs from oil are 0.3% of total operating costs for manufacturing. The impact is marginal. The biggest benefit will be on the purchasing power, not of Canadian consumers—because if you go down south you're going to be spending a lot of that money there, or on imported products—but the biggest benefit is to strengthen consumer recovery in the United States. The combination of a lower dollar and a stronger U.S. recovery is where the major benefit is.

One final point is that we can't take the lower oil price, the stronger U.S. economy, or the lower dollar for granted. Nobody is going to be competitive unless they continue to invest in new technology, new products, better skills. Competition is intense, and the currency rates around the world are also falling, so this is no silver bullet for Canadian manufacturers.

[The Chair, Conservative, James Rajotte]

Thank you very much for your presentation.

We'll go to Mr. Nantais, please.

[Mark Nantais, President, Canadian Vehicle Manufacturers' Association]

Thank you very much, Mr. Chairman, and good morning.

From the CVMA's perspective, we expect lower oil prices will have a mixed effect on the auto sector for consumer purchases and manufacturing operations. If there are four points I'd like to leave you with today, they would be as follows:

First, automobile manufacturing looks at the long term for investment decision-making and for establishing business contracts with suppliers and transportation services.

Second, the price of oil potentially impacts auto companies in two ways, both in terms of vehicle sales and in terms of production.

Third, the impacts of lower-priced oil are varied and they are not immediate, and the vehicle market response and demand for certain vehicles can adversely impact production, depending on the types of vehicles being produced at our plants.

Fourth, the suggestion that competitiveness is enhanced by a lower Canadian dollar can be misleading and may not be a factor in changing a company's outlook on competitiveness.

Prior to the decline in oil prices, Canada experienced two back-to-back record years for new vehicle sales, and forecasts for 2015 suggest another record year, with new vehicle sales growing at between 2% to 4%. Since the decline in oil prices, new vehicle sales in Canada continue to increase on an overall basis at a rate of about 2% to 3% over last year.

We are starting to see signs of regional differences in the rate of sales, however. For example, new vehicle sales in Alberta declined in January 2015 vis-à-vis last year, with overall sales in Canada continuing to increase. Thus far, the impact of lower oil prices has strengthened truck and crossover sales on a North American basis, but there is a related softening in car demand in certain segments. As such, we submit that lower oil prices and a lower Canadian dollar will still result in softening of some car-related production in Canada.

As mentioned, investment decisions are made on a long-term basis, and while the lower Canadian dollar and lower energy prices should help some input costs, the relative cost of manufacturing in Canada will have to continue to be measured against the relative cost of manufacturing in other countries that will also benefit from lower energy prices and lower currency values.

In theory, auto manufacturing plants should benefit from the recent drop in oil prices in the short term in respect of both operations and transportation costs. This is subject to any drop in oil prices being passed on to the manufacturer or customer in the form of lower energy prices. This cost reduction is not immediate, nor is it absolute.

When considering the longer-term competitiveness and factors that weigh into investment decisions, the changes in oil prices and resulting fluctuations in currency represent short-term impacts and are likely not the most critical factors in manufacturing investment decisions, nor do they guarantee improved competitiveness.

In terms of auto manufacturing, the lower cost of oil highlights the increased importance of non-energy related exports and investment to support the Canadian economy, and hence, and of even greater importance, of having the right mix of policies in place to support a competitive auto manufacturing industry and manufacturing more generally.

Annual Canadian automotive exports are at about $64 billion. About 85% of the vehicles we build in Canada are exported to the United States. It is anticipated that the added savings due to low oil prices will add to the available personal disposable incomes in the United States and that this will be positive for the U.S. economy and for the demand for products that we export there.

We cannot look at these issues in isolation, and while we have seen recent investment announcements, it is imperative that we continue to assess all the factors that affect investment decisions in the longer term. It remains critical for Canada to have globally competitive investment support strategies in place to secure reinvestment of the existing automotive footprint.

To keep pace with changes in competitive jurisdictions for auto investment, the government is encouraged to review, for example, the automotive innovation fund in the context of incentives being promoted in competing jurisdictions that are actually successfully winning some of these new investments. It should also look at the ability for large companies to exchange unused SR and ED tax credits in exchange for direct funding when used for new R and D projects. These would both be improvements.

In closing, Mr. Chairman, let me say that the committee's study of the impact of the price of oil on the economy is really a worthwhile exercise. The message I would like to impart to you today is that in a highly competitive environment for global automotive investment decisions, there are factors more in the control of government than the price of oil that would have a greater positive impact.

Mr. Chairman, thank you very much. I would be pleased to answer any questions the committee may have.

[The Chair, Conservative, James Rajotte]

Thank you very much for your presentation.

Colleagues, we are still trying to get the video conference set up with Toronto. We haven't been successful yet. We'll keep trying to do it.

Let's do six-minute rounds, starting with Mr. Cullen, please.

[Nathan Cullen, NDP, Skeena—Bulkley Valley, BC]

Mr. Nantais, would you repeat the last sentence you made in your testimony, if you have it handy?

[Mark Nantais]

It was: The message I would like to impart to you today is that in a highly competitive environment for global automotive investment decisions, there are factors more in the control of government than the price of oil that would have a greater positive impact.

[Nathan Cullen, NDP, Skeena—Bulkley Valley, BC]

There are factors more in the control of government...?

[Mark Nantais]

That's correct.

[Nathan Cullen, NDP, Skeena—Bulkley Valley, BC]

Can you illuminate one or two specific ones?

Thank you, first of all, for your presentation.

I find this very engaging. What we're looking at here is what the impacts are, as many of you have outlined, and also what, if anything, government should be doing about it. We have a budget coming sometime this spring. We're looking at policy options, and we of course are in an election year as well, and people are considering what to do about the current situation, given what it is.

Can you give us one or two things, Mr. Nantais, that you would point to?

[Mark Nantais]

Sure.

First off, I mentioned the automotive innovation fund. Clearly, making that fund competitive with other competing jurisdictions and benchmarking with other jurisdictions—

[Nathan Cullen, NDP, Skeena—Bulkley Valley, BC]

Are we competitive with Mexico right now in terms of support for the industry?

[Mark Nantais]

Well, you would have to look at this in the context of what is appropriate for Canada vis-à-vis Mexico: what we can afford, what we can build upon in terms of our competitiveness here, and the combination of other policies that will contribute to our—

[Nathan Cullen, NDP, Skeena—Bulkley Valley, BC]

The straight-up subsidies that Mexico.... Mexico is doing quite well. We're experiencing our lowest market share since 1987 in the North American market as automakers, and it has been in a pretty steady decline over the last number of years, since the recession in particular. We have seen large investments heading south of the other border and less investment here. But we can't subsidize the way the Mexicans do.

[Mark Nantais]

No, but we have other things we can build upon, and there are other things we can do. We've had three major investments recently; that's in the context of the current competitive environment, so we can do more. Standards harmonization is another area that provides real benefits to our industry on a North American basis. These are things we're already doing.

[Nathan Cullen, NDP, Skeena—Bulkley Valley, BC]

These are concerning trends, just the few that I mentioned and the $19 billion trade deficit we're running right now, just on auto and auto parts.

Mr. Mendes, is the bank concerned with the personal debt load that consumers are currently bearing in Canada right now?

[Rhys Mendes]

Yes. We have outlined on a number of occasions that the high levels of household debt create a vulnerability in the Canadian economy.

One important thing to note is, with respect to the decline in oil prices, our analysis suggested that the decline in oil prices from $110 in the middle of last year to $60 at the time we did our January monetary policy report would have reduced incomes in such a way, in the absence of any policy response, that it would have actually raised the debt-to-income ratio, which is what we would think is the key for assessing that vulnerability. The policy action that the bank took in January was aimed in part at mitigating—

[Nathan Cullen, NDP, Skeena—Bulkley Valley, BC]

—that debt-to-income ratio.

[Rhys Mendes]

—that adverse impact on that debt.

[Nathan Cullen, NDP, Skeena—Bulkley Valley, BC]

The bank took action out of concern for not just the personal debt that Canadians are holding. I don't want to put words in your mouth, but was it a stimulus initiative? Was it an effort to, in a sense, kick-start the economy?

[Rhys Mendes]

As I said, the oil shock was unambiguously negative for Canada overall, so we assessed that in the absence of any policy response, Canadian output would have been about 1.4% lower by the end of 2016. The output gap, that is, the difference between actual economic activity and the potential full capacity level of economic activity, wouldn't have closed until sometime in 2017. We were basically taking out insurance to give us greater confidence that we would return to a full capacity economy by the end of 2016.