Driver of Canadian dollars is broken

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Remember the days when the price of oil would go up and the loonie would follow suit?

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The long-established link between the Canadian dollar and the price of oil — “an important driver” of the currency — is ruptured, a new analysis suggests and it could have to do with the way oil majors at home are spending their cash.

“The good old way of seeing the Canadian dollar is over. We need to put that to rest,” said Charles St-Arnaud, chief economist at credit union Alberta Central.

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Over the last year, higher oil prices have failed to translate into an appreciating Canadian dollar, St-Arnaud said in a recent note, putting an exclamation point on the notion that the loonie appears to be a “petro-currency” no more.

The Calgary-based economist said there was a clear break in the relationship between currency and commodity starting in 2016 that has “become acute over the past year.”

Recall that in 2007, just prior to the Great Recession, US benchmark West Texas Intermediate (WTI) rose to about US$140 per barrel, pulling the Canadian dollar above parity with the greenback. Leap ahead to 2022, and a WTI rise above US$100 failed to have a similar effect — in fact, the loonie moved in the opposite direction.

St-Arnaud identified what he believes are two important reasons for this rupture, which are having a compound effect on other forces driving down the loonie.

The Calgary-based economist estimated that over the past year 10 per cent of revenue ($20 billion) has gone to investors in the form of buybacks and dividends, compared with three per cent ($3.7 billion) in 2014. Alberta Central based its estimates on data from major Alberta oil producers including Suncor Energy Inc., Cenovus Energy Inc., Canadian Natural Resources Ltd., Imperial Oil Ltd., and Meg Energy Corp.

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But perhaps more critically, 78 per cent of the investors receiving share buybacks are non-Canadian compared to 62 per cent in 2014.

“We estimate that the payment to foreign shareholders is currently equivalent to about $11 billion, or 1.5 per cent of GDP, compared to about $3 billion or 0.4 per cent of GDP in 2014; almost four times bigger,” St-Arnaud said. “This means that most of the flows back to shareholders are not an inflow into Canada.”

“The question is: what does the buyer do with it? Most likely they convert it back to their local currency,” St-Arnaud said, adding to downward pressure on the loonie.

The other factor the economist cited is the slowdown in reinvestment by Canadian energy majors.

He estimated that oil producers reinvested about nine per cent of revenue ($17 billion) into operations over the past year, down from 25 per cent ($28 billion) in 2014.

It’s not so much the drop in reinvestment that is detrimental to the loonie as the fact that most oil majors in Canada hold debt and savings in US dollars since oil is priced in that currency. Declining reinvestment in operations means companies are converting less of the US holdings into Canadian money.

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“This means the purchase of CAD for reinvestment is about half of what it used to be,” he said. “When there is less buying the currency does not appreciate.”

A weaker link between the price of oil and the Canadian dollar doesn’t just stop with the currency but will feed into higher inflation as the loonie receives less of a boost from rising oil prices.

It could also have implications for the Bank of Canada and interest rate policy.

“Higher oil prices will be, in general, more inflationary and could lead to the BoC being more sensitive to energy prices when setting monetary policy,” he said.

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The government’s budget, released last month, included plans to tax Canadian companies on two-thirds of their capital gains, up from half currently. The change will also apply to individual taxpayers when they have gains over $250,000 in a year, although people will still be able to sell the homes they live in tax-free.

The money raised by the tax hike is to be spent on a number of programmes, including initiatives to help younger people afford a home. But the poll suggests many are not swayed by the plan.

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Read the full story here.

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Today’s Posthaste was written by Gigi Suhanic, with additional reporting from Financial Post staff, The Canadian Press and Bloomberg.

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