Canadian Prosperity

Economic Underperformance, Excessive Indebtedness, and Our Constrained Future

With last week’s federal deficit announcement, it is now more important than ever that we acknowledge our current realities with detail and clarity. We otherwise will be unable to develop a believable and effective path forward in the post-COVID world. The problem is that our current realities are uncomfortably negative. Many of us just don’t want to see this or believe it. We were in a slow-moving crisis of competitiveness, investment, and productivity prior to the COVID lockdown. Now, we have both stagnant productivity and excessive levels of debt. This feels negative as most of us understandably want to feel positive and optimistic about our future.  However, for optimism to be real it must be grounded in reality. It is only then we can develop a believable and inspiring vision, and the appropriate strategies to recover and rebuild our economy.

Prior to the COVID lockdown, the economic fundamentals in Canada were already grim:

As a Canadian, if you were fortunate enough to accumulate savings, the last thing you should have done is to invest in Canadian companies on Canadian stock exchanges.

We were in a state of investment, competitive, and economic underperformance before the pandemic-related collapse. “Going back to normal” or “the way things were” is going back to a set of conditions that were compromising the future for all Canadians.

And now, we have the added reality of excessive debt. The inevitable consequence is a loss of financial flexibility, less capacity to spend, and more financial risk in the event of an extended recession, additional intermittent lockdowns, or some other new, unforeseen crisis.

Although the financial position of our federal government was reasonable going into the COVID lockdown (debt to GDP ratio was 35%), this has all changed seemingly overnight.

With a $350 billion deficit, we are now adding about 15% to the debt to GDP ratio. Maybe this still doesn’t look too alarming, however, we are missing a large part of the picture if we ignore the provinces.

We have learned in crisis that the national government will be called upon to backstop the credit demands of all provinces, and to a certain extent, even corporate and household debt.

Ontario’s debt is now about $400 billion, Quebec $200 billion, and then there are the other provinces. The Western provinces, including Manitoba, are now close to approximately $150 billion. The Atlantic provinces represent another $50 billion in debt. If you’re keeping track, that’s $800 billion of provincial debt combined with now over $1 trillion of federal debt. Total “all in” government debt is now at least $1.8 trillion and heading towards $2.0 trillion which would be 100% of GDP – that represents over $50,000 for every man woman and child in Canada, or $200,000 for a household of four.

Analysts and economists tend to look at debt solely on the basis of decision-making authority and responsibility at the entity level, as this is where insolvency would occur. This is why most don’t aggregate debt. But aside from insolvency risk, the key problem with debt that’s often overlooked is how it constrains choice and optionality. The aggregation of choice and commitment drives our overall economy. Understanding our economic outlook requires accounting for the burden of debt across all decision-making entities.

The government debt described above is layered on top of consumer and corporate debt. Total consumer debt in Canada is at a record $2.3 trillion which includes $1.6 trillion of mortgages. Household debt to disposable income is now at a record high of 181%.

Corporate debt in Canada is also at record levels of about $2.4 trillion and based on the Bank of International Settlements, our corporate debt service ratio is among the highest in the world.

Total household, corporate, and government debt is about $7.0 trillion. This is 350% on a $2 trillion economy.

The one thing we know about debt is that if you can survive through a downturn, it will constrain choice; it will constrain the scope and flexibility of decision-making commitments. This will be the new reality for many decision makers across the entire economy.

You can reasonably expect that consumers and corporations will be spending less and repairing balance sheets, and governments at all levels will be forced to be more accountable and discerning in spending and borrowing. All of this will likely be a net drag on the economy for years.

Unfortunately, this is all happening at the same time that Canada’s GDP per capita and labour productivity have been lagging.

The issue of productivity must be emphasized. To quote Nobel Laureate economist, Paul Krugman:

“Productivity isn’t everything, but in the long run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise output per worker.”

Canada is now in an era of both stagnating productivity, low competitiveness, and excessive levels of indebtedness. In the corporate investment world, we often describe this as a “strategic straightjacket” – with less choice and less freedom to move. All of this should encourage a reset in priorities towards fiscal constraint, incentivizing investment, and pursuing more business-friendly policies and strategies that will tilt towards increasing innovation, productivity, and prosperity.


Author

Mac Van Wielingen

What Drives Organizations? Applying Maslow’s Hierarchy of Needs to Corporations

In 1943, Abraham Maslow published his theory on the hierarchy of needs. You have probably come across it at some point in your life. Maslow used the terms "physiological," "safety," "belonging and love," "social needs," and "self-actualization" to describe the linear ascension of human motivation. According to Maslow, human beings are motivated to satisfy basic physiological needs such as food and water before they can progress to the next level of needs for safety, belonging, social acceptance, and self actualization. The further removed the individual is from simply obtaining the necessities of life, the less anxiety and tension is present as they seek to fulfill higher functions of personal growth. The pursuit of these functions is critical to the advancement of innovation as the individual is liberated to focus on the needs of others once their own necessities have been fulfilled.

The arc of Maslow’s theory closely aligns with the needs of corporations.  From a legal perspective, American corporations have been granted many of the same rights as individuals under the 14th amendment of the Constitution (See 1886 Santa Clara County v. Southern Pacific Rail Road). Over the past 130 years, corporations have evolved into legally distinct beings that enjoy many rights normally reserved for individuals such as the right to own property, enter into contracts, or pursue legal action. If corporations possess many of the same legal rights that individuals do, it stands to reason that corporations also share a hierarchy of motivations that begin with their basic need of survival.      

The International Monetary Fund is forecasting that the U.S. and Canadian economies will shrink by 8.0% and 8.4% this year because of COVID-19 related shutdown. As these effects hit corporate balance sheets, many executives have been forced to take extraordinary measures to keep their businesses solvent. corporate leaders are shifting their focus to satisfy the company’s basic ‘physiological’ needs for cash flow, liquidity, and debt coverage at the expense of higher corporate aspirations. The abrupt departure of these aspirations is particularly problematic when viewed in the context of environmental stewardship. As Maslow’s work highlights, the greatest advancements in corporate innovation are likely to occur beyond the base levels of sustenance. As corporations mortgage future development to sustain existing operations, critical ESG commitments, research, and technologies are less likely to come to fruition.

According to Bloomberg, climate change-related talk on S&P500 earnings calls fell from 33% in Q1 to just 17% in Q2 as Companies re-tooled their corporate strategies to focus on the fiscal necessities of survival. This is strong evidence that higher corporate functions are a luxury of choice – ones that are only possible if the basic corporate needs of survival are met. Therefore, stakeholders should celebrate Companies that remain steadfast in their commitment to environment, social, and governance standards in the face of a global pandemic. This praise is warranted because corporate ESG commitments confirms the importance of these factors to the survival of their business. These corporate leaders do not view ESG as a luxury of choice or a higher corporate function, but rather as a fundamental cornerstone to the success of their business.

As noted by Bloomberg, discussions regarding the acceleration of the climate crisis dropped by 50% on average across every industry in the S&P 500 earnings call transcripts from Q1 to Q2 2020. The largest pull back was seen by Technology Companies (53%), Financial Services (69%), and Energy Companies (58%). Energy Companies touted their energy transition goals earlier this year, but unsurprisingly this rhetoric has dwindled and has been replaced with urgent discussions regarding production cuts, liquidity, and plummeting demand. What may be surprising are the industries that have managed to keep ESG commitments front-of-mind during coronavirus-dominated earnings calls. As noted by Bloomberg, “Sustainability talk in the utility sector did decline in the first quarter, but only by 31%. The drop at industrial companies was just 10%”.

Earnings call transcripts are a way for management to communicate corporate priorities directly to shareholders.  While a pull back of long-term initiatives is inevitable as Companies focus on the short-term realities of survival, the degree of pull back could signal the level of commitment of Companies towards environmental stewardship in the long-term. The next time you are looking through the earnings call transcripts of Companies you have invested in make a point to quickly scan through previous transcripts prior to the pandemic to see which Companies are still including language outlining their ESG ambitious and what resources they will be dedicating to achieve those objectives.


Author

Michael Hebert, Viewpoint Research Team

Report: Alberta CEO Survey on Shutdown Impacts and Future Recovery

What does the road to recovery look like for Albertan businesses?

In collaboration with the Business Council of Alberta, we surveyed 61 CEOs to find out the impacts of COVID-19 on business, and what barriers and challenges lie ahead.

HERE'S A FEW HIGHLIGHTS

1 in 4 companies are unsure if they will make it through the pandemic until a vaccine is developed.

61% have engaged in layoffs, and 18% do not expect to refill these positions.

34%  anticipate needing continued or additional government support to mitigate downsides like stimulating demand, providing clarity on health and safety regulations, and maintaining liquidity.

To read the full results, download the report below.


Author

Viewpoint Research Team in collaboration with Business Council of Alberta

Share Price Performance and Value Destruction in the Canadian Oil & Gas Sector

SUMMARY POINTS

- Of the 128 Canadian independent companies listed in 2014, almost half have gone through an insolvency event, been delisted or sold.

- Of the 66 remaining companies, 49 have lost 90% or more of their total equity value. It is extremely difficult to re-capitalize these businesses.

- Approximately 13% of the original 128 companies are alive, and the other 87% have been essentially wiped out.

Some will struggle through this and survive, and new businesses will ultimately surface, but the existing reality for Canadian independent producers and service companies is unspeakably grim.


Author

Mac Van Wielingen

Canada Urgently Needs a Reset of National Priorities

Canada was in a slow-moving crisis of underperformance and dysfunction before the pandemic health crisis and consequent economic collapse. It is imperative that Canadians see this clearly. Only then will we have a better chance to reset our priorities and place our country on a different trajectory.

In recent years, we have been particularly focused on environmental priorities, most notably, our commitment to reduce emissions in accordance with the United Nations Paris Accord. It must be emphasized that this is not the problem. The problem has been the rigidity of focus on this priority at the expense of other essential priorities which has impaired the future for all Canadians.

There has been a relative neglect of critical economic, social, and governance priorities in Canada with cumulative negative impacts that are staggering We entered the pandemic and economic collapse in a position of serious vulnerability.

There is ample evidence that portrays a grim picture of Canada’s investment performance, competitiveness, and productivity in recent years.

We were in a slow-moving crisis of investment, competitiveness, and economic underperformance before the pandemic, and now we’ve gone right over the edge. There have been sharp regional disparities in economic conditions but ultimately, over time, there is no person and no sector that is unaffected by a country that underperforms.

Our national priorities also include the quality of life for all people in all regions of our country. The fact that social distress may be concentrated in one region, specifically in Alberta at this time, does not detract from the point that this is a national issue.

The distress in Alberta since 2014 is serious.

  • The number of unemployed not covered by employment insurance has risen 53 per cent, from 75,000 to 115,000;

  • Unemployment among young men is up 156%;

  • Food bank usage is up 80 per cent;

  • Suicide hotline calls have increased by 85 per cent;

  • The number of individuals seeking counselling support in Calgary has increased 46 per cent;

  • Incidents of domestic violence in Calgary have increased by 150 per cent;

  • Non-violent crime is up 34 per cent;

  • Business insolvencies have increased by 58 per cent; and

  • Consumer bankruptcies are up 101 per cent.

This data is before the horrendous impact of the pandemic and oil price collapse. It is frightening to contemplate the hardship that is now occurring.

Underlying our economic underperformance and the social distress in Western Canada is cumulative regulatory and governance dysfunction.

According to the 2020 World Bank Ease of Doing Business Index, Canada ranks 30th out of 34 OECD countries in the time to get a permit for a construction project.

There has been over $200 billion worth of major energy and resource development projects cancelled or withdrawn since 2014. Some because of market conditions, but most because of regulatory delay, changing and inconsistent rules and guidelines, decision making arbitrariness, cumulative undue expense, and intensely politicized in-fighting. The Teck Frontier mine decision and Warren Buffett’s withdrawal from the Quebec-based Saguenay LNG project are the two latest examples of this.

Governance excellence is about effectiveness. During the recent rail blockades led by a small group of eco-activists, a DART & Maru/Blue poll found that two thirds of Canadians agreed with the statement, “Canada is broken.”

Governance integrity is about fairness and creating trust. This points to what is arguably the most serious red flag of governance failure in Canada. This is the emergence of extreme alienation in Western Canada. A large proportion of the 7.5 million people in the energy producing region of the West no longer trust that their interests are fully considered as part of the national interest of Canada.

Our longer-term national priorities need a reset, which arguably in the post-pandemic recovery, will be forced by a set of new realities. The direction is a renewed focus on economic priorities and on the social conditions for all Canadian citizens, and on rebuilding trust in the full functioning of our nation.

The most important renewed priority is governance excellence and integrity and the functioning of our nation. Otherwise the polarization and infighting will continue to message to investors that Canada is a poor destination for new capital, our economic performance will continue to erode, and social distress and alienation will become even more extreme and dysfunctional.


Author

Mac Van Wielingen

What the Teck? Another Project Withdrawal for Canada’s Beleaguered Energy Industry

On February 24th, Vancouver-based Teck Resources Ltd. (“Teck”) delivered an all too familiar message to Canadians. The Company announced that it had withdrawn its application for the C$20.6 billion, 260,000 barrel-per-day Frontier mine. In a letter to the Minster, Environment and Climate Change, Teck cited a lack of investor confidence and a need for “jurisdictions to have a framework in place that reconciles resource development and climate change…This does not yet exist here (in Canada)…”

The Frontier project first applied for regulatory approval back in 2011, and now joins a long list of casualties in the Canadian energy graveyard that spans from project delays to outright cancellations, including MEG’s Christina Lake Expansion, Imperial’s Aspen Project, Petronas’ Pacific NorthWest LNG facility, TC Energy’s Energy East pipeline, and Enbridge’s Northern Gateway pipeline, among numerous others. It shouldn’t come as a surprise that ESG considerations are paramount in regulatory decisions. However, it is important to note that, while our National unity falls further into disarray over resource development, the ravenous thirst for energy globally will continue to be satisfied - with or without Canadian energy. The pendulum has swung too far in the opposing direction and created an opening where high-emission producers can capture increasing market share, while disregarding the environmental standards that Canadians are so proud of.

While Teck acknowledged a deep need to address climate change and, Canada’s role to play in their decision, skeptics of the project suggest that doubts about the Frontier project’s economic viability were the primary catalyst for the decision. In January 2020, the Institute for Energy Economics and Financial Analysis released a report questioning Teck’s financial assumptions for the project which were highly dependent on oil prices in excess of US$95/bbl Brent for prolonged periods of the project (2026-2066). While there are inherent uncertainties in forecasting oil prices, average estimates from the National Energy Board of Canada and the World Bank Commodity Outlook were more bearish on Brent prices through 2030, with an average Brent price of US$72.50/bbl. A more conservative oil price outlook was further compounded by the quality and distance differentials that heavy crude producers in Canada must endure to competitively price their barrels with counter-parties in the United States.

While Canada continues to flounder with project approvals, depressed prices, and fleeting investor confidence, capital is being mobilized. From LNG projects in Mozambique to deep sea pipelines in the North Sea capital is flowing to increase energy security and prosperity in oil producing regions around the globe. Nowhere is this more prevalent than in the prolific Permian basin in west Texas, which has spurred a flurry of new pipelines to bring crude to Houston and multiple locations along the Texas Gulf Coast (See Figure 1.1). According to Bloomberg News, more than ten pipelines are slated to start-up in 2020/21, providing additional takeaway capacity of ~5.6MM boe/d.

Figure 1.1 – Permian Basin Pipeline Projects.

figure-1.png

Midstream investment isn’t the only thing booming in the U.S. energy sector. According to the Gulf Coast Energy Outlook, new capital investment in downstream facilities in Louisiana, Texas, Alabama, and Mississippi is anticipated to reach up to US$308 billion by 2030 (See Figure 1.2). The gargantuan capital program dwarfs any such development in Canada, and will be allocated towards new LNG export terminals, petrochemical facilities, and refineries.

Figure 1.2 – Gulf Coast Energy Infrastructure Investment 2011 – 2030.

image2.png

While resource development is thriving in the U.S. Lower 48, Teck’s decision to withdraw its application for the Frontier mine continues to cast doubt and uncertainty over resource development in Canada. Not only is Teck burdened with a C$1.1 billion write-down on the project, but the opportunity for prosperity for all Canadians has been damaged. The project was expected to create approximately 7,000 construction jobs, 2,500 permanent operating jobs, and generate C$54.0 billion in royalties and taxes, C$11.8 billion in federal corporate taxes, and C$68.0 million in local property taxes over the life of the project. Additionally, the financial ramifications echo throughout the Indigenous communities in northern Alberta. Fourteen Indigenous communities bordering the project site had signed agreements with Teck to participate in the economic benefits of the project. Due to Teck’s decision to withdraw its applications, the Indigenous communities that are in favour of the project are losing out on prosperity that is desired by many, if not all, of the constituents in the community.

Ron Quintal, President of the Fort McKay Métis, accurately summarized the decision as a black eye for Canada, and rightly so, as this is yet another blow to an industry trying to shake off its multi-year hangover.


Author

Michael Hebert, Viewpoint Research Team

What Does Canada Need to Jump Start Innovation?

Despite having one of the most diverse workforces in the world, Canada was ranked 14th in the 2019 OECD Global Competitiveness Report; dropping two spots from the previous year, and scoring below the United States, Denmark, and Korea. Although we receive strong rankings in macro-economic stability (1st), sound financial system (9th), and labour market (8th), we have lagging performance in innovation (16th) and adoption of technology (35th). What is Canada missing? 

To start, we could look to the country who has lead on innovation and start-up culture, earning themselves the title of “Start-Up Nation” - Israel. Though there are many different factors that may contribute to its success in innovation, one large factor is Israel’s government initiatives focusing on developing knowledge, supporting research and development, and prioritizing the creation and long-term survivability of start-up businesses. In the past, government initiatives were created to subsidize research and development projects, and to bolster venture capital interest through tax incentives and matching investments, hoping to share and mitigate the risk to investors. This fostered collaboration between not only academic institutions and private organizations, but also across local and global organizations. However, it should be noted that these initiatives are not without flaws, as the policies have been geared to high-tech industries, and consequently “other sectors seem to have been left out.” 

These initiatives paved the way for the creation of the Israel Innovation Authority, an independent publicly funded agency, which provides support and incentives to entrepreneurs across different divisions like technological infrastructure, international collaboration, and societal challenges. The reverse innovation model is used, whereby organizations are encouraged to pitch real issues to entrepreneurs, and these entrepreneurs come to solutions by “understanding the challenge first, and then working backwards…[t]his promotes the formation of joint ventures (sometimes between competing firms) to address them.”  

Overall, the takeaway is that government-led initiatives signaled confidence to investors and laid the groundwork for a venture capital friendly environment that both corporations and research institutions were able to participate in. For Canada to break through as a powerhouse in innovation and remain competitive on a global scale, we need thoughtful government-led initiatives that promote innovation across industries.


Author

Viewpoint Research Team

What is The Role of Business in Society?

Whenever we think about the concepts of business, finance, markets, competition, and trade, they often seem disconnected from the rest of society. Successful businesses are believed to be purely driven by profit, separating them from societal views and interests. 
 
In reality, however, social institutions can exercise a profound amount of influence on businesses. Different politics and perspectives exist within every industry due to the customers, suppliers, employees, regulators, and financiers that comprise the organization. “Individuals within each stakeholder group have ideas about how they want their lives to matter in the world...[T]hose connections to the world outside of business are often strong motivators for decision-making.” 
 
Understanding the role that businesses play in society is critical. Today, the “decreasing public popularity of business leaders and the now familiar erosion of trust in business and government institutions” has led to the belief that “democratic and civil society institutions and democratic ideals are under attack.”  Societal freedoms and business are not irreconcilable; economic freedom is directly related to economic growth, and “democratic freedom provide[s] the basis for capitalism and sustained economic growth.” Historically, most businesses only engage in politics for their own gain, lobbying the government and cultivating relationships with policy-makers in order to protect their own interests. To the younger generation, “this seems inadequate at best and corrupt at worst, widening the dissonance between business and society. Businesses should preserve democratic institutions not only when it is convenient, but for their own sake as well, as “democratic institutions ensure the basis for the development of capitalism and a healthy system of business.” By preserving the societal rights inherent to democracy, including the right to privacy, labour force participation, and the pursuit of economic opportunity, communities and businesses are allowed to “freely communicate and collaborate, and thereby flourish together.” 
 
Businesses must move beyond shareholder profit and focus on the creation of value for all stakeholders. Solely maximizing profits has had a toxic impact on society, leading to “growing inequality, periodic massive financial crashes, declining corporate life expectancy, slowing productivity, declining rates of return on assets and overall, a widening distrust in business.” As we have discussed in a previous issue of Sagacious, the purpose of business should be “not only to provide needed products to a market, but to make a difference in their communities and for their employees, too.” This has already begun as 181 CEOs of different corporations across several industries signed the Statement on the Purpose of a Corporation” earlier this month in an effort to refocus on inclusive social and economic prosperity. Included in these 181 are names like Amazon, Apple, BlackRock, Chevron, EY, Pepsi, and Xerox.
 
By retiring the old model of shareholder profit and moving forward with shareholder value, businesses can begin to repair their reputation in the eyes of the younger generation. “Business is about how customers, suppliers, employees, financiers, communities, and managers interact to create value,” and is an important part of societal institutions“No business is perfect, and every business can improve, but it is time to end the myth that Wall Street is disconnected from Main Street.”


Author

Stephanie Law, Viewpoint Research Team

The Path to Economic And Social Prosperity in Canada

Last week, members of the expert panel on Sustainable Finance released their recommendations on mobilizing Canada’s financial sector, hoping to secure both economic prosperity and better environmental practices. The main takeaway from the panel is that Canada stands poised to become “a decision-maker rather than a decision-taker in a world where sound environmental stewardship is intersecting with market access and becoming critical to competitiveness.” Currently the fourth-largest exporter of oil and the fifth-largest exporter of natural gas, Canada has the potential to become the world’s safest and cleanest producer. Yet for this feat to be accomplished, the energy sector must focus on accelerating innovation, transparency, and market access. 
 
To further innovation, the panel recommends that the federal government “fund an oil and gas clean innovation cluster to pool capital and expertise,” helping to expand the next generation of innovative ventures, and consequently encourage the development and commercialization of cleaner energy-saving solutions.
 
Global perceptions of Canada’s environmental record and the carbon-intensity of oil sands extraction have caused investors in the energy sector to avoid Canada, or demand better data and evidence about the risk to their firms. “If we want to attract global capital back to Canadian resources, it will take an industry-wide commitment to report more comparable and complete data on climate-related financial risks.” Providing this type of transparency is exactly the kind of leadership that investors are seeking from Canada’s industry. 
 
In regards to market access, it is vital that Canada's market more responsibly produce oil and gas. Yet Canadian producers can only invest in cleaner technology if they are able to sell their products. “Though counter-intuitive to some, solving Canada’s market-access stalemate is fundamental to Canada’s ability to contribute to lowering emissions in the world’s global energy supply by displacing higher emissions and less transparent sources.”
 
Our founder, Mac Van Wielingen, strongly argues that this is an opportunity for Canada to be a leader in energy. Having used his decades of experience in the investment management business in capital projects all over the world, Mac’s own recommendations for the future of the energy sector align with those of the expert panel on sustainable finance. In his recent speaking event at the Calgary Petroleum Club, he states: 
 
“The industry must remain passionately committed to innovate and further improve its environmental performance, in the context of a global transition to a low carbon environment...There are two competing visions. One involves a dismantling and diminishment of our leading global industry with enormous financial and social costs. The other is to support the development of a “Clean, Canadian Energy Brand” and strategy to bring more of ourselves into the world, not less. This is Canada’s global leadership opportunity in energy and environmental stewardship.”
 
In addition, Bill Gates, chairman of the board for Breakthrough Energy Ventures (BEV), an investor-led, $1 billion fund committed to funding clean energy innovation, emphasizes the complexity of the issue of climate change. In a recent sit-down with David Rubenstein, president of The Economic Club of Washington, D.C., Gates stated that creative solutions are the key to combating climate changes; projects that utilize “the lens of innovation” are what investors should be focusing on. 


Author

Viewpoint Research Team