Businesses slash spending as oil sector downturn slows consumer demand

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Businesses are cutting their spending on equipment, buildings and even software as the bruising inflicted on the oil sector discourages companies from hauling out their wallets to upgrade operations.

Despite a solid showing in third-quarter GDP numbers released Tuesday, there is an underlying malaise in business spending that is likely to continue and could have consequences down the road. GDP data showed that spending on fixed assets such as land, buildings, machinery, equipment, vehicles, furnishings and intellectual property fell at a 3-per-cent annualized rate in the third quarter, the third straight quarterly slide.

While Statistics Canada doesn't break out quarterly business investment data by industry, there's little doubt that the deep plunge in income generated in the oil patch has been the major cause of the decline. The Bank of Canada has estimated that the energy sector has slashed its investment by 40 per cent this year, and the budget cutting isn't over: It predicts another 20 per cent decline for 2016.

Jayson Myers, president of Canadian Manufacturers & Exporters, said the main reason for the investment downturn is the weakness in the resource sector. With returns on invested capital falling as a result of low prices, companies are not going to buy more equipment, he said.

That has affected a huge number of companies in the oil and gas sector, and those that supply products to it – such as pipe, machinery and equipment makers. "Oil sands alone accounts for close to $70-billion of procurement every year, and out of that probably $45-billion is in manufactured products," Mr. Myers said. "That is a huge footprint."

A weak western economy means consumer demand has slowed, hurting companies that supply the domestic economy even beyond the oil patch, he said.

Some sectors are doing reasonably well, particularly if they are exporting to the United States and are not energy-related, Mr. Myers said. In the auto sector, for example, demand and production is fairly strong, so some companies in the supply chain are still investing actively.

Peng-Sang Cau, president of Kingston-based automation equipment manufacturer Transformix Engineering Inc., said she believes the depressed oil patch in Alberta is the main cause of the weaknesses in investment in equipment and machinery in Canada.

"As a nation, we are still too dependent on our natural resources sector," she said. When the sector is booming, many firms do well supplying it, but "now that sector is going through major downturn, it has cascading effects … it is like throwing a huge rock into our Canadian economy and you see the ripple effects."

Transformix exports its assembly machines, and they go to a diverse range of businesses. Its only client in the oil sector "has told us there is no new investment in the upcoming year but we are not seeing the same issues in other markets," Ms. Cau said.

David MacDonald, CEO of Toronto-based information technology and services company Softchoice Corp., said he too believes the spending downturn is mainly confined to the resource sector. "We're seeing good investment from everybody but the oil patch and the resource-based industries."

Softchoice's business in Calgary has been affected, "but in Ontario we feel quite good about service-based industries and some of the manufacturing companies that are starting to benefit from the reduction in the value of the Canadian dollar."

Still, there is some evidence that spending has been constrained outside of the energy sector, too – held back by a combination of a sluggish economy that has trimmed business profits and an exchange rate that has raised the costs of investing in foreign-made machinery and equipment.

Last week, Statistics Canada reported that corporate operating profits were down 5.4 per cent in the third quarter from the second quarter, and were down 10 per cent from a year earlier. Economists added that the Canadian and global economies still have excess capacity in the wake of the Great Recession – leaving reduced need for new investment.

A shift in the Canadian and global economies away from traditional manufacturing may also be contributing to the sluggish investment environment.

The slowdown not only subtracts from private-sector contribution to economic activity now, but it has a longer-term effect, because businesses aren't adding to the economy's productive capacity, said National Bank of Canada senior economist Krishen Rangasamy. "The ability of our economy to grow has been curtailed by a lack of investment."

The hope is that with the U.S. economy gaining strength, U.S. demand for Canadian goods will eat up the excess production capacity and spark a resurgence in business investment.