Canadian Economic Weakness Is A Tailwind For Canadian Energy Producers

In the face of a weakening domestic economy and a depreciating currency, Canadian energy producers find themselves in a unique position of strength. The Canadian dollar, the loonie, has plummeted to its lowest level in seven months, following the Bank of Canada’s decision this week to hold interest rates steady. This has set the stage for a dynamic that historically hasn’t been true; a weak loonie during a period of high oil prices, providing a foreign exchange tailwind for energy producers. Several Canadian energy stocks hit 52-week highs in the last month, while many major Canadian names from utilities to banks hit 52-week lows.

Canada’s economic outlook is bleak, with forecasts predicting stagnant growth and a steady inflation rate of 3% in 2024. Real GDP per capita, the indicator most representative of what Canadian families are feeling, has been on a downward trajectory for consecutive quarters. The implication is clear—the Canadian economy is not robust.

Canadian real estate carried the economy for the past decade but the level of capital investment as a percent of total spending reached a level that had only ever previously been achieved in Greece. As a country, you do not want your economic charts to mimic Greece before the crash, but that is the place Canada got to. Having real estate reach increased levels of investment sucks up productive capital from other sectors, creates an affordability drain on household finances, and leaves the economy highly levered to rates. Real estate is now digesting the rate hikes with more pain to come. Even with inflation out of reach the real estate dynamics will likely constrain the Bank of Canada’s ability to raise rates further, and hawkish holds will be the desired approach.

A thriving oil industry would normally bolster the loonie but it remained weak amidst the recent rally. This is partially due to reduced domestic emphasis on the sector, uncertainty around regulations, and broader underinvestment in commodities globally. Energy producers are now in the unique position of benefiting from high commodity prices while also enjoying the advantages of a weak domestic currency. Unlike other sectors, they receive payments in U.S. dollars, allowing them to capitalize on the currency disparity.

Previously, a weak currency helped attract foreign investment into Canada’s rich natural resources, creating jobs and stimulating currency demand. During these times, companies and governments saw a resource they already needed and otherwise had to purchase with U.S. dollars, available for cheaper development in a stable regime. Foreign companies and governments would purchase these assets, and invest in Canada, and all of this required domestic currency. This, in turn, would mitigate the inflationary pressures as a stronger currency helped reduce inflation. The reason Canada imports a significant amount of inflation is many household goods come from other countries. Unfortunately, this equilibrium that helped relieve pressure on households has been disturbed as foreign direct investment in Canadian natural resources declined.

In this paradoxical economic landscape, Canadian energy producers emerge as unlikely beneficiaries, reaping the rewards of a weakened loonie and robust oil prices.