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February 3, 2015

How Will Canada Survive A Housing and Oil Crash?

By Wolf Richter at Wolf Street

Ratings agency Fitch had already warned about Canada’s magnificent housing bubble that is even more magnificent than the housing bubble in the US that blew up so spectacularly. “High household debt relative to disposable income” – at the time hovering near a record 164% – “has made the market more susceptible to market stresses like unemployment or interest rate increases,” it wrote back in July.

On September 30, the Bank of Canada warned about the housing bubble and what an implosion would do to the banks: It’s so enormous and encumbered with so much debt that a “sharp correction in house prices” would pose a risk to the “stability of the financial system”

Then in early January, oil-and-gas data provider CanOils found that “less than 20%” of the leading 50 Canadian oil and gas companies would be able to sustain their operations long-term with oil at US$50 per barrel (WTI last traded at $47.85). “A significant number of companies with high-debt ratios were particularly vulnerable right now,” it said. “The inevitable write-downs of assets that will accompany the falling oil price could harm companies’ ability to borrow,” and “low share prices” may prevent them from raising more money by issuing equity.

In other words, these companies, if the price of oil stays low for a while, are going to lose a lot of money, and the capital markets are going to turn off the spigot just when these companies need that new money the most. Fewer than 20% of them would make it through the bust.

To hang on a little longer without running out of money, these companies are going on an all-out campaign to slash operating costs and capital expenditures.The Canadian Association of Petroleum Producers estimated that oil companies in Western Canada would cut capital expenditures by C$23 billion in 2015, with C$8 billion getting cut from oil-sands projects and C$15 billion from conventional oil and gas projects.

However, despite these cuts, CAPP expected oil production to rise, thus prolonging the very glut that has weighed so heavily on prices. 

Then on January 21 – plot twist. The Bank of Canada surprised the dickens out of everyone by cutting the overnight interest rate by 25 basis points. So what did it see that freaked it out? A crashing oil-and-gas sector, deteriorating employment, and weakness in housing. A triple shock rippling through the economy – and creating the very risks that it had fretted about in September.
“After four years of scolding Canadians about taking on too much debt, the Bank has pretty much said, ‘Oh, never mind, we’ve got your back’, despite the fact that the debt/income ratio is at an all-time high of 163 per cent,” wrote Bank of Montreal Chief Economist Doug Porter in a research note after the rate-cut announcement. Clearly the Bank of Canada, which is helplessly observing the oil bust and the job losses, wants to re-fuel the housing bubble and encourage consumers to drive their debt-to-income ratio to new heights by spending money they don’t have.

And what Fitch worried about concerning the housing market in July – that “high household debt relative to disposable income has made the market more susceptible to market stresses like unemployment…” – is now coming to pass.

On Wednesday, Statistics Canada rejiggered its job creation and unemployment numbers by slashing the number of jobs created in 2014 to a mere 121,000. December proved to be even drearier than previously reported: a total of 11,300 jobs were lost.

Now layoffs have begun to cascade through the Canadian oil patch, with 20,000 to 25,000 job cuts already announced so far. They will trigger additional job cuts in other industries. Plus Target’s 17,500 cuts to hit when it leaves Canada. Alberta’s Labor Minister, Ric McIver, told AM 770 on Saturday that the number of unemployed workers would jump by 22%. And he exhorted the government and employers to think long-term about retaining skilled workers for whenever the good times might return.

John Garth Turner, former Member of the House of Commons and now best-selling author in Canada, explained it this way on his always pungent site, The Greater Fool:
The fewest number of people are currently working in Canada since back in 2000, which is a big black eye for a government that slashed interest rates, crushed the dollar, and added $170 billion in national debt over the last six years. Now it doesn’t even have the stones to bring forth a budget, or warn people from scarfing down more debt when the party’s clearly over. Sad.
The oil industry in the US too is dead-serious when it talks about slashing operating costs and capital expenditures. Preserving cash is suddenly a priority, after years when money was growing on trees. And cost cutting has reached frenetic levels.

Courtesy Wolf Richter at WolfStreet.com (EconMatters archive HERE)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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