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Canada’s commodity buffer

Solid energy prices have helped protect Canada from the worst of the global economic slump, but recent weeks have seen a sharp drop in commodity prices.

Oil prices, in particular, are flirting with presumed “break-even” levels for oil sands investment, says Mark Chandler of RBC Dominion Securities Inc.

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If oil prices continue to fall and stay at relatively low levels for an extended period of time, there could be a negative impact on Canada’s oil patch, he writes in a recent report.

Looking out to 2015 and beyond, production growth will depend critically on new investment projects coming on stream, particularly in growing oil sands sector, he says.

The investment flow will, in turn, depend on anticipated product prices. Break-even rates on new projects are estimated to be in the $60 (U.S.) to $70 per barrel range.

Current capital expenditure plans in the oil patch are running at $35.8-billion (Canadian), close to 14 per cent of total private investment in Canada.

“It is unlikely that these would be curtailed significantly on a modest price decline ... but it is worth noting that the decline in oil prices of some 40 per cent in 2009 to an average of $62 (U.S) per barrel saw a drop of some $20-billion (Canadian) in capital expenditures in the industry,” he writes.

Rising investment from China

Canada’s resource sector got a boost recently from Chinese energy giant Sinopec’s $2.2-billion bid for Alberta oil-and-gas company Daylight Energy.

The proposed takeover marks the acceleration of a growing Chinese trend toward exchanging its massive $3-trillion (U.S.) in foreign reserves for hard, tangible assets, says Stéfane Marion of National Bank Financial Group.

“We think that China is about to go on a global shopping spree by unleashing a wave of foreign direct investments (FDI) that will most certainly include Canada,” he writes in a report.

China ranked fourth in the world in terms of FDI outflows in 2010, with a total of $68-billion. The rising global power surpassed Japan for the first time on record.

Still, Mr. Marion notes that the stock of FDI held by China accounted for a tiny 5.1 per cent of its gross domestic product.

The stock of FDI held by China remains well below that of much smaller countries, such as Italy, Spain and the Netherlands, he points out.

“Given the considerable upside for Chinese FDI and that country’s appetite for natural resources, we expect Canada to remain a magnet for such funds,” he writes.

Sinking loonie

The gloomy global economic outlook and decline in commodity prices over the past two months are reflected in the downward move of the Canadian dollar against the U.S. greenback.

The loonie’s sharp decline and lower long-term interest rates have helped offset the need for immediate easing of monetary policy to cope with the effects of the commodity price slump, says Capital Economics’ David Madani.

Expect the Canadian dollar to continue its downward trend, ending the year at 95 cents and falling to 90 cents by the end of 2012 as commodity prices continue to trend lower , he says in a recent analysis.

The loonie seems to have taken its knocks along with just about every other currency, except the Japanese yen, as investors rushed to the safety of the U.S. treasury market, he writes.

Yet, with the possibility of a full-blown crisis in Europe, Canadian interest-rate cuts over the next 12 months can’t completely be ruled out, he says.

An eventual housing-market correction, coupled with the negative effects on trade from weak economic growth in the rest of the world, will further undermine Canada’s economic recovery next year, he adds.

“As such, the Canadian dollar is expected to be under downward pressure again next year, as interest-rate expectations are cut even further and commodity prices drift somewhat lower.”

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