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Overhang and Aftermath - Canada's Construction Outlook, 2010 to 2012

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Alex Carrick

Positions:
Alex Carrick is Chief Economist for CanaData, Reed Construction Data’s Canadian economic forecasting and statistical service.

Economists

The United States has been in recession since the final quarter of 2007. Canada has been experiencing economic weakness since the fall of last year. Both economies are expected to turn in positive growth in third-quarter 2009. Canada, in June, had its first month-to-month gain in gross domestic product (GDP) in a year. The economy is on the mend. But there are two words that set the tone for the economic future – overhang and aftermath.

The United States has been in recession since the final quarter of 2007. Canada has been experiencing economic weakness since the fall of last year. Both economies are expected to turn in positive growth in third-quarter 2009. Canada, in June, had its first month-to-month gain in gross domestic product (GDP) in a year. The economy is on the mend.

The big debate, however, is over what form recovery will take. Will it be V-shaped (a solid and rapid recovery), U-shaped (only a gradual and slow pickup) or W-shaped (recovery, followed by another bout of weakness)? The “W” scenario takes into account the limited time horizons for some incentive spending programs and tax rebates – such as “cash for clunkers” in the U.S. and home renovation projects in Canada. The “U” scenario worries about consumers who have changed their first priority from spending to saving. More conservative consumers will thwart a “V” recovery. “U” is the best bet.

There are two words that set the tone for the economic future – overhang and aftermath. There are consequences from the deepest recession since the Great Depression that will have ongoing implications for the recovery going forward. First among these is credit availability. The high profile failures of some major financial institutions and the rescue packages needed for many others have left credit markets skittish. De-leveraging of loan portfolios has been undertaken on either a voluntary basis or it has been forced upon lending institutions by regulatory agencies as a means to shore up capital. The net effect is to reduce the total amount of money available to businesses and consumers around the world. This is one primary source of scepticism that economic recovery can be rapid.

Another problem is the harm done to labor markets. Companies have achieved more success in maintaining profit levels in this recession than might have been thought possible. This has been accomplished by laying off workers. The jobless rate in the United States is set to breach 10%. What may work for an individual company may also harm total demand and output. The high levels of unemployment in the U.S. and Canada can only mean a delayed recovery in consumer spending, tying an anchor to GDP.

The Bank of Canada is currently forecasting Canadian GDP growth to be –2.3% in 2009, but +3.0% in 2010 and +3.5% in 2011. This may require a too optimistic coming-together of good news. The future for Canada depends on: 1) U.S. auto demand; 2) U.S. housing markets; and 3) most of all, higher world commodity prices. U.S. auto demand sets parts and assembly-operation levels in Ontario. A recovery in U.S. housing markets will remove a drag on U.S. GDP and will boost regional forestry sectors across Canada, especially in B.C. Stronger commodity prices will impact in metals and minerals, uranium and potash, aluminum and iron ore and, most significantly, in oil and gas.

China has been leading the world out of recession. Massive government spending in that nation, mandated loan expansions, car-buying incentives and infrastructure construction have been the means to re-achieve a growth rate of nearly double digits. However, even the Chinese government recognizes that it may have gone too far. Lending is being reined in, leaving the short-term outlook for many world commodity prices in more doubt.

The world price of oil dropped from $145 USD per barrel in July of last year to only $35 in February 2009. Since then, it has recovered to around $70. Chinese stockpiling and increased auto-driving demand have been the primary causes. There is no doubt that the impetus to higher prices exists longer-term, but from now to the end of this year, price increases may be a little more restrained. This will apply across all commodity sectors.

Residential Construction Outlook in Canada

Canadian housing starts in 2009 are likely to be about 135,000 units versus an average of more than 220,000 in the seven years from 2002 to 2008. Canada Mortgage and Housing Corporation (CMHC) estimates that the current need for housing is 175,000 units per year based on demographic trends. Thus, the decline in starts is easy to understand. Sky-high prices and overbuilding were the result of speculative binges in some parts of the country, mainly in the west, during the exceptional good times of mid-2008 and earlier.

The 135,000 units may be a floor for housing starts. A solid foundation for new home demand is being provided by historically low mortgage rates, improving affordability as home prices moderate and the recent pick-up in existing home sales traffic. CanaData is forecasting that starts will recover modestly in 2010 to 150,000 units, then move up to 180,000 units in 2011. It will take until 2012 before another 200,000-unit year is seen.

Commercial Construction

Starts in the commercial construction category have dropped by about half so far in 2009 versus the first half of last year, according to CanaData. This is where the bulk of privately-funded projects appears. Credit has been harder to come by and demand for space has fallen off. For example, office vacancy rates have been on the rise. Retail sales are -5.0% year over year whereas their norm is +5.0%. The list of negatives goes on.

Accommodation construction has been hurt by passport requirements for U.S. citizens leaving and returning to the U.S. Also, many hotel projects are now built half condo and that segment of residential construction is suffering badly. Warehouse work has been hurt by poor retail and manufacturing sales. Most of these are cyclical factors that will turn around as the economy picks up, but that will take time. Only modest improvement in commercial work is to be expected in 2010, with much better prospects coming in 2011.

Industrial Construction

A huge uncertainty for the industrial sector concerns the value of the Canadian dollar. At first, the U.S. dollar will receive support from an improving economy. Longer-term, it will come under pressure on two accounts – the huge size of Washington’s deficit financing and dependence on foreign oil, which will tip foreign trade back into deep trouble. While the U.S. dollar is coming under pressure, the Canadian dollar is tied ever tighter to world oil and other commodity prices. The bottom line is that there is a good chance the loonie will shoot past parity with the greenback again some time in 2010.

Elsewhere in industrial, the auto sector is enjoying some stability, with Chrysler and General Motors emerging from bankruptcy protection so quickly and coming under new ownership. Weakness in Canadian housing starts will put a crimp on manufactured products sold to homeowners. Otherwise, inventories have been run down and now need replenishing and that will provide short-term relief for many manufacturing concerns.

Institutional Construction

It is in the institutional category of non-residential buildings and in civil/engineering work that government stimulus money is such a big factor. In CanaData’s Top 10 lists of construction starts each month, these two categories have accounted for 36 of the largest 40 projects over the last four months. That is way higher than their usual proportion.

It is hospital projects and additions to institutions of higher learning that are getting the additional federal and provincial funds. The first is justified on the basis of an aging population. The latter is necessary to educate the children of the baby boomers, plus the need to provide service to an influx of both employed and laid-off workers looking to upgrade their skills and knowledge in today’s highly competitive workplace environment.

Engineering Construction

The private spending side of engineering construction is concentrated in oil and natural gas. Atlantic offshore oil fields and Oil Sands projects in Alberta will get a boost from higher prices as recovery slowly accelerates. In Newfoundland and Labrador, the province has come to ownership and revenue-sharing agreements with major energy players to bring investment forward. But natural gas prices are historically low on an energy-equivalency basis due to the opening up of new fields. For this, thanks go to technology advances that allow horizontal drilling. Large shale deposits are now being tapped in many regions, including northeast British Columbia and northern Texas.

In other areas of civil work, it is government spending that is providing the spur. Transit projects, road, bridge and highway work and sewer and watermain construction is on tap in large and small municipalities across the land. Finally, another era of mega electricity projects appears to be in the offing, although some doubts have been cast in this area. For one thing, power usage has dropped dramatically, but this is mainly due to recession-induced declines in residential and industrial usage, as well as conservation efforts.

The primary focus of cleaner environment initiatives will be to reduce emissions from vehicles. This push means more hybrid and all-electric cars. How can this lead anywhere but to greater demand for power generation? New electricity has to come from cleaner sources. Hydro and nuclear are the lowest emitters of all. The outlook for nuclear power is harmed by doubt as to the future of Atomic Energy of Canada. This has already caused Ontario to postpone a huge expansion of its nuclear generating facilities in the province.

Alex Carrick

Find Canadian construction-related economic articles in Canadian Construction Market News and in the Economic Outlook section of Daily Commercial News. Mr. Carrick also has a lifestyle blog that can be reached by clicking here.

by Alex Carrick

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