Commodity hedging could help provinces manage sudden swings from surplus to
Provincial performance gap narrows as volatile resource markets dampen outlook
for some regions, while budding U.S. recovery lifts others
TORONTO, Jan. 29, 2013 /CNW/ - Canada's resource-rich provinces whose fortunes
have been dampened by commodity price swings should consider hedging against
those risks, even if it means giving up part of the revenue windfall when
prices are high, notes a new report from CIBC World Markets Inc.
Canada's "resource bounty has in the past decade been a big winner for
government coffers. But resources are called cyclicals for a reason, and
provincial finance ministers are now acutely aware that a bountiful surplus
can turn into a gaping deficit in a hurry when commodity prices slip," says
Chief Economist Avery Shenfeld at CIBC in the latest Economic Insights report.
"The result is that fiscal outcomes in any one year are highly uncertain,
leaving finance ministers struggling to explain why they held spending lean
when revenues were gushing in, or why a deficit suddenly emerged and forced
borrowing up in the process."
In the corporate world, strategies for protecting revenues against adverse
swings in commodity prices are routinely used and could be similarly applied
by governments, says Mr. Shenfeld. "To smooth out the bumps and allow time
to adjust" to new commodity prices, resource producers and buyers "typically
use derivative markets to hedge against some of the price risks in the near
term, giving up some of the upside in exchange for protection against large
"There's no reason why provinces couldn't do the same, locking in a range for
current year fiscal results, and giving time to make adjustments in revenue or
expenditure policies in the following year's fiscal plan should the resource
price trend persist. That would clearly be preferable to surprising the bond
market with in-year borrowing changes, or rushing to make mid-year spending
swings that might not be optimal on other public policy grounds."
Provincial sensitivities to commodity price swings can be dramatic, the report
notes. For example, a $10 per barrel drop in oil costs Alberta $2.2 billion in
its fiscal bottom line, and hits Saskatchewan and Newfoundland by nearly $200
million each. "Provinces also have exposures to other commodities including
potash and natural gas. The revenues at risk not only include direct royalties
but also land sales and corporate income taxes that are correlated with
Mr. Shenfeld notes that provinces are already using hedging strategies to
manage interest rates and currency risk by swapping foreign-denominated debt
into Canadian dollar obligations, as well as to use other "instruments to lock
in favourable rates when the market is ripe."
Mr. Shenfeld adds that hedging strategies "aren't cut and dried decisions, nor
is there a one-size-fits-all approach given the variation in exposures and the
commodities involved. But it's at least worth a serious look by finance
ministers, and Canadian taxpayers, finding themselves increasingly at the whim
of volatile resource markets."
Elsewhere in the report, Senior Economist Warren Lovely and Economist
Emanuella Enenajor note that a "sideways profile" for some key commodity
prices could dampen fortunes in the year ahead for Canada's West.
"Critically, North America's limited pipeline capacity means Alberta crude oil
is trading at a growing discount to international benchmarks. That has
triggered a substantial falloff in provincial royalties and, as some recent
announcements highlight, jeopardizes investment and prospects in the oil
Alongside pipeline constraints, Europe's recession and softness in emerging
markets "have dimmed the lights in heretofore fast-growing resource rich
provinces, creating intense fiscal pressure in uncommon places."
Meanwhile, as commodity related pressures face some regions, a budding U.S.
recovery is lifting others, resulting in the performance gap narrowing between
"American domestic demand is in its ascendance, and as we settle into 2013,
it's the provinces more levered to U.S. consumer and housing market demand
that are better positioned to ride out less supportive domestic fundamentals
and uncertainty overseas," note Mr. Lovely and Ms. Enenajor, adding that
Ontario in particular stands to benefit.
"Once-slower growing regions like Ontario are seeing economic and fiscal
fortunes hold up better, with a big assist from a reviving U.S. economy.
While not exactly redefining Canada's "haves" and "have nots", the provincial
economic and fiscal playing field is now more evenly balanced than at any time
in the past decade."
The complete CIBC World Markets report is available at:
CIBC's wholesale banking business provides a range of integrated credit and
capital markets products, and investment banking to clients in key financial
markets in North America and around the world. We provide innovative capital
solutions and advisory expertise across a wide range of industries as well as
top-ranked research for our corporate, government and institutional clients.
Avery Shenfeld, Chief Economist, at 416-594-7356,firstname.lastname@example.org;
Emanuella Enenajor, Economist at 416-956-6527,email@example.com;
Warren Lovely, Senior Economist at 416-594-8041,firstname.lastname@example.org; or
Tom Wallis, Communications and Public Affairs at
SOURCE: CIBC World Markets
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-0- Jan/29/2013 12:30 GMT
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