The role of natural resources in Canada’s economy
by P. Cross *
One of the dominant themes in Canada’s economy so far this decade has been the resurgence of its natural resource sector. Now in its seventh year, the resource boom has re-shaped large sectors of the economy. Led by energy, which became our leading export in 2008, resources have sustained export growth, despite the slumping auto sector. With prices and profits at record levels due to strong global demand, resources pushed the stock market to record highs in the first half of the year and stimulated business investment.
This paper looks at the impact the commodity boom has had on various sectors of the economy, which at the same time highlights those sectors that are most vulnerable to the recent bust in commodity prices. Natural resources have always been a key sector in Canada’s exports and business investment, where their share has hit new highs in the current cycle. The surge in commodity prices also boosted profits and made the resource sector the leading factor in our stock market and direct investment flows into Canada, although these increases were partly reversed as commodity prices fell in response to the recent turmoil in global financial markets.
Despite the dominant role resources play in exports and investment, they have had a surprisingly small impact on the recent growth of output and employment. In fact, resource output has subtracted from the volume of output in the last two years, although their higher prices and incomes indirectly supported domestic spending. And because of their capital-intensive production processes, resources have not been an important source of recent job growth.
Not all resources have participated equally in the commodity-price boom, which is hardly surprising for such a broad and diverse sector. Energy has seen the largest and most sustained increases, led by crude oil. Metals prices took the lead in 2006 and 2007, but more recently have pulled back. Grain prices jumped in 2007 and early 2008, but have eased on the prospect of a good harvest. The boom bypassed the forestry sector in recent years, due to falling demand for lumber and newsprint.
The commodity-price boom has had a large impact on both the structure and the growth of exports. Exports of natural resources have jumped from 45% of all exports of goods in 2002 to nearly 65% so far in 2008. Resource exports are defined as energy, forestry, agricultural products and industrial materials (which include metals and chemicals such as potash and petroleum-based chemicals).1 The increase was especially pronounced in 2008, reflecting record energy prices. The surplus in trade in energy products alone has been equal to all of Canada’s merchandise trade surplus since the second quarter of 2006. Canada also runs surpluses in trade for all other resource products.
Since 2004, natural resources have accounted for all of the growth in Canada’s export earnings. Resource exports jumped by one-third from about $20 billion in 2003 to $31 billion (at annual rates) so far this year through August. Over the same period, non-resource exports fell 17%, notably for automotive products.
The role of resources in value-added exports (that is, gross exports net of imported inputs) is even larger. This reflects the large import content (nearly 50%) of exports of autos and machinery and equipment and the low import-content of most resource exports. Using the import-content ratios from the Input/Output tables2, the share of resources in value-added exports has risen to over 70%.
Surprisingly, earnings from commodity exports have not been the dominant force in boosting corporate profits. Profits in natural resource industries have risen at about the same pace as the rest of the economy since 2003, leaving their share at about one-quarter of all operating profits generated in Canada. Mostly, this is due to large gains in profits in several non-resource industries, notably finance, transportation, and information and culture, where profits at least doubled from 2002 to 2007. As well, steep losses in the forestry industry partly offset the doubling of profits in the energy and mining sectors. The rapid rise of the Canadian dollar also slowed the increase in profits from natural resource exports, most of which are priced in US dollars and therefore converted into fewer Canadian dollars as the loonie appreciated. The sharp slide of the loonie in October will help cushion the impact of falling commodity prices.3
Still, the doubling of profits in the resource sector has had a number of consequences. It has driven increased investment in the stock market from both foreign and domestic investors. It also has helped finance higher business investment in structures and equipment, which has been an important source of the growth of incomes and employment in Canada.
Both foreign and domestic investors have increased their buying of resource companies in the stock market as profitability has risen. As a result, the proportion of natural resources in the value of all shares traded in the Toronto stock market has risen from about 20% in 2003 to just over half in the first three quarters of 2008 (the definition of resources in the source data from the TSX is limited to energy and metals; adding in other sectors like forestry would raise their share). Most of the increase in the value of resources stocks reflects higher prices. The share of resources in the volume of trading on the TSX has risen by a similar amount, from 30% to 60%.
The boom in Canada’s energy and mining industries has attracted increased foreign investment. Foreign direct investment in our resource sector has always been important, averaging about one-third of all direct investment inflows from 1983 to early this decade. However, foreign direct investment in resources rose sharply in 2006 and 2007, mostly due to the takeover of several large mining companies (which helped boost the stock market). As a result, the resource sector accounted for over half of all gross long-term direct investment inflows into Canada in the last two years.
Higher resource prices have been the driving force in recent export growth and foreign investment inflows into Canada. This was a major factor in the rise in the Canadian dollar exchange rate since 2003. Crude oil prices alone had a close correlation with the loonie until 2008. The rising dollar reinforced the increase in Canada’s terms of trade by lowering import prices even as resources boosted export prices.
National balance sheet data provide a measure of Canada’s wealth from timber and subsoil resources. Their share of total wealth dipped below 10% in the early 1990s when prices were low, but since then rose to nearly 19%. These increases were driven by higher prices and the exploitation of new sources, such as offshore oil and the oilsands. These measures of natural resource wealth do not include other forms of wealth directly attributable to resources, such as the value of resource issues in the stock market or investment goods held by resource companies.
Since 2002, business investment in structures and equipment by the resource sector has increased faster than in the rest of the economy. This raised the share of natural resource industries from 36% to nearly 44%, the highest on record. Energy consistently led this increase, driven by the oilsands, although more recently metal mines saw rapid gains. While farm incomes soared in the last two years, investment in this sector is relatively small.4 Investment in the forestry sector has fallen as markets for these products have shrunk.
The resource sector by itself contributed over half of the growth in business investment from 2003 to 2006. This followed a long period of slow capital spending on resources during the 1990s when prices were low. The boom in resource investment was briefly interrupted in 2007, reflecting large cuts in natural gas in response to rising costs and lower prices, but growth in investment intentions by the resource sector resumed in 2008.
The recent surge in business investment in natural resources has been reflected in a recovery in their share of the capital stock, which had fallen below 50% during the prolonged slump in investment in resources in the 1990s.
Output and employment
The resource boom since 2003 reflected primarily higher prices. The share of natural resources in nominal GDP rose from 13.3% in 2002 to 16.1% in 2005 (the latest year available for nominal GDP by industry), and undoubtedly continued to climb in 2006 and 2007. But real GDP in the resource sector (defined as the primary industries, utilities and downstream manufacturers in wood, paper, petroleum and primary metals) has fallen slightly since the fourth quarter of 2002. Output in resources initially rose in response to higher prices, gaining 6% by the end of 2005. Since then it has fallen steadily, with mining output particularly weak over the past year (down 5%).
The drop in resource output after 2005, despite record prices and profitability, reflects a number of factors. Some sectors cut output sharply due to weak prices, notably forestry where output fell by over a third. However, not even the energy and metal mining industries have been able to boost output. Partly, this is due to the depletion of the most productive sources, forcing industries to move into more marginal or expensive sources (notably the shift of oil production from the Western Canadian Sedimentary Basin to the oilsands or offshore). These structural problems in energy output were compounded over the summer of 2008 by supply disruptions arising from accidents and maintenance, to which the oilsands are particularly prone. These disruptions began to diminish in July 2008, when energy output rose sharply.
Every dollar of output in the resource sector generates another 69 cents of GDP. The largest of these spin-off effects is within oil and gas, as most resource industries are energy-intensive. Other industries that see high spin-off effects are finance, trade, business services and transportation. All told, the direct and indirect impact of resource output was equivalent to 22% of all GDP in 2005.
Natural resources have not been a large source of jobs for Canadians this decade. Partly this reflects their capital-intensive production process (a large offshore oil platform, for example, can be run by just a handful of workers). As a result, the share of employment in natural resources industries has hovered around 7% since 2000. Still, this represents a levelling off after a rapid decline during the 1990s from near 10% in 1990. Of course, the importance of resources is much higher in some provinces.5 This is magnified in small towns and rural areas, where resources may be the dominant employer.6
The high capital-to-labour ratio in most resource industries is reflected in their above-average level of productivity. Output per employee in the primary and utility industries is the highest of any sector of the economy. However, this level has been falling in recent years as more marginal assets were exploited. This has been one factor in Canada’s slow productivity growth in recent years.
While the resource boom has not directly boosted real GDP in the past year, it certainly has had an indirect impact on real incomes and spending in Canada. Record energy prices have pushed Canada’s terms of trade to new highs. This was reflected in a higher trade surplus and strong growth in disposable incomes and corporate profits. These gains in income are captured in a measure called real Gross Domestic Income (GDI). Real GDI is nominal GDP deflated by the price index for domestic spending.
As a result of the increase in the terms of trade, real GDI growth continued despite the slowdown in real GDP. The growth of real incomes explains why final domestic demand grew steadily even as output and employment slowed.
The terms of trade also help account for the divergence between GDI in Canada and the US since the credit crisis hit global markets just over a year ago. In the four quarters ending in June 2008, real GDP in the US has grown 2.2%, the most in the G7, while in Canada it has edged up 0.7%. But using real GDI shows incomes in Canada rising almost 4%, versus a 0.7% gain in the US. This is more consistent with other indicators that point to stronger demand growth in the Canadian economy than the US, such as employment, auto sales and the housing and stock markets.
For many Canadians, the most visible impact of the commodity boom has been on consumer prices. By themselves, rising prices for food and energy lifted the annual rate of increase of consumer prices to 3.5%, the highest since 2003. Food prices were pushed up mostly by the rising cost of bread and cereals, while energy was inflated mostly by the price of filling up at the gas pump. Lower commodity prices for grains and oil over the summer point to some relief for consumers soon.
Excluding food and energy, consumer prices edged up 1.2%—half their rate of increase in the summer of 2007.
The seven-year old commodity-price boom has had a large impact on key sectors of the economy. It has buttressed export earnings and profits. In turn, resources lifted the stock market to record heights while attracting foreign direct investment to Canada. In response, firms substantially increased fixed investment in the resource sector. Higher commodity prices have been a key factor in boosting the exchange rate, before a sharp reversal in October 2008.
The commodity boom has been largely confined to prices, as the importance of natural resources in the real economy of output and jobs has been little affected. As well, the fortunes of various industries within the resource sector have varied widely, ranging from steady gains in crude oil over the last seven years to steady losses for forestry. On balance, however, this has been the longest and strongest cycle for resources in postwar history. This helped sustain domestic income and spending growth even as real output slowed in 2008. The resource sector remains highly cyclical, a reminder driven home by their recent slump in response to the growing turbulence in global financial markets.
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Of necessity, the definition of natural resources varies slightly depending on the classification and level of detail in the source data. International trade data is based on a sectoral and not an industrial classification. Stock market data only has three subcomponents: energy, mining, and other. The data on investment, profits, output and employment are all based on the same industrial classification (NAICS), which includes the primary sector, utilities and downstream manufacturers in wood, paper, petroleum refining and primary metals.
The latest data from the Input/Output tables are for 2005; we apply these import content ratios to the trade data after 2005, because these import ratios change very little from year-to-year.
For example, a barrel of crude oil sold at $70 (US) at an exchange rate of 78 cents (US) is equivalent to $90 a barrel (US) when the dollar is at parity.
Investment in farming was $3.6 billion in 2007, compared with $54.1 billion in mining.
The primary sector alone accounted for 13% of all jobs in Saskatchewan and 10% in Alberta in 2007.
See “Minetown, Milltown, Railtown” by R. Lucas for a study of life in single-industry towns (Oxford University Press, 1971).