Breakin’ Through the (GDP) BS

Canada’s first quarter GDP number was the worst among the Group of Seven (G-7), trailing the US, the UK, Europe and Japan. Real GDP growth slid into negative territory during the first quarter after expanding at an annualized 0.8 percent during the fourth quarter and 2.3 percent during the third quarter of 2007.

Part of the story is a long-term theme of diversification away from manufacturing, one that trails by several years a similar global-market-forces-driven shift in the US economy. The relative importance of manufacturing in most G-7 countries has already declined in favor of higher-growth service sectors.

A critical distinction to bear in mind is the size of Canada’s resource economy relative to its overall economy, a clear advantage our neighbors to the north hold vis a vis other developed economies. For example, as auto manufacturing in Ontario declined, there was enough activity in Alberta to buoy the national employment rate.

The headline-generating GDP number may lead you down a path of worry, but the quick-and-dirty mainstream media definition of a recession is two consecutive quarters of declining GDP. How useful is that standard?

The National Bureau of Economic Research defines a US recession–a step it typically takes months after the fact–as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.” A recession may involve simultaneous declines in coincident measures of overall economic activity such as employment, investment and corporate profits.

Canada’s official arbiter of recessions adopts a less nuanced approach: “The term recession refers to a significant drop in economic activity, lasting more than a few months, as measured by employment rate and real gross domestic product.”

Recessions occur for many reasons. Most often, businesses build up inventories and, consequently, cut back their production and lay off workers, thus depressing earnings. The effect of lower income and low spending also dampens confidence in the economy.

So what’s happening on the employment front?

The most recent data from Statistics Canada indicate that, over the prior 12 months, employment increased by an estimated 348,000, or 2.1 percent, with full time growing twice as fast as part time. The employment rate, the share of the working-age population employed, continued to hover around a record high in April.

In April, the share of the population with a job was 63.8 percent, 0.1 percent below the record high set in the first quarter. Since 2005, Ontario has lost 14 percent of its manufacturing employment, while Quebec has lost 15 percent. However, despite the loss of more than 300,000 manufacturing jobs, total employment increased 2.1 percent during the past year, slightly topping the pace of the prior five years.

And wage growth continues. Year-over-year growth in average hourly wages was 4.3 percent in April, slightly lower than earlier in the year but well above the most-recent increase in the Consumer Price Index, which was 1.4 percent.

The strength of Canada’s resource economy has led to significant improvement in its terms of trade, which has boosted income growth. Since the loonie began its rise six years ago, export prices have risen 14 percent; import prices have dropped 11 percent, generating a sustained run-up in Canada’s terms of trade and boosting Canadian real income, which is now rising at a 3.7 percent year-over-year pace, compared with 1.5 percent for the US.

Canada’s economy could prove surprisingly resilient in the face of the US slump, as long as global commodity prices remain robust. Surging wages in a low-inflation environment are likely to bolster domestic consumption–despite slumping non-energy US exports–and allow economic expansion to resume. Output shrank in the first quarter, but the value of Canada’s economic production is rising. And that, ultimately, determines living standards.

As weak as the real GDP figure was, it’s a reflection of output, not a reflection of the prices Canada gets for that output. In terms of nominal growth, Canada is still way ahead of many other countries, thanks to soaring commodity prices. Employment is still rising, consumer spending is fairly healthy, business investment is still growing, and real incomes are growing as a result of the commodities boom and retail discounting. Canada could see two consecutive quarters of negative GDP growth with no recession; this isn’t a perfect picture, and the Bank of Canada is likely to lower its prime interest rate by 25 basis points when it meets June 10.

Efficient Technology, Now

Diane Francis is on the trail of a low-cost, high-yield oil sands development process, calling Ivanhoe Energy’s (NSDQ: IVAN, TSX: IE) proprietary HTL heavy-oil upgrading technology a “game changer.”

Ivanhoe Energy recently signed a preliminary agreement with Talisman Energy (NYSE: TLM, TSX: TLM) subsidiary Talisman Energy Canada to acquire all of Talisman’s interests in three leases located in the heart of the Athabasca oil sands region in Alberta. The transaction will enable the first commercial application of Ivanhoe’s patented process in a major, integrated heavy-oil project.

HTL is a field-located upgrading process that converts heavy oil to a transportable, partially upgraded synthetic crude oil and converts the upgrading by-products to on-site energy. The process frees the heavy oil producer from the need to purchase diluent for transport, significantly eliminates the need to purchase natural gas to steam the reservoir and allows the producer to capture the majority of the heavy oil-light oil value differential.

And a 2002 study conducted by Enbridge (NYSE: ENB, TSX: ENB) concluded that partial field upgrading of bitumen could reduce total greenhouse gas emissions by more than 20 percent from a generic steam assisted gravity drainage (SAGD) operation.

Recent estimates of the Talisman leases suggest they contain approximately 294 million barrels of contingent bitumen resources. The first HTL heavy-oil project will be Lease 10, near Fort McMurray. Based on estimates of contingent bitumen resources, Lease 10 would be capable of producing between 30,000 and 50,000 barrels of oil per day (bpd). The Lease 10 reservoir characteristics are believed by Ivanhoe to be similar to those at Petro-Canada’s (NYSE: PCZ, TSX: PCA) 30,000 bpd MacKay River project, one of the most successful, longest-running SAGD projects in the Athabasca oil sands.
 
Ivanhoe intends to integrate established SAGD thermal recovery techniques with its patented HTL upgrading process, producing and marketing a light, synthetic, sour crude.

Stand Down, Stephane

If Arizona (and perhaps Virginia) rejects John McCain, he’s toast. Barack Obama must have Illinois. Had New York (or Arkansas or Pennsylvania) turned its back on Hillary Clinton, this thing would have been over long ago.

According to the best gauge of public opinion in Quebec, Stephane Dion’s home province ain’t buying what he’s got to sell. L. Ian MacDonald of the Montreal Gazette writes:


Additional recent polling suggests that, were Canadians to go to the polls for a federal election immediately, the Tories would win another minority government.

Given Dion’s failure thus far to lead, our working assumption is that we won’t see a federal election until the required date of October 2009. There will still be time for the Liberals, should they win, to follow through on their commitment to revisit the tax on income trusts.

Speaking Engagements

Be sure to wear a flower in your hair when you venture west to San Francisco. I’ll be heading to “The City” with Neil George and Elliott Gue Aug. 7-10, 2008, for the San Francisco Money Show.

Neil, Elliott and I will discuss infrastructure, partnerships, utilities, resources and energy, and tell you what to buy and what to sell in 2008.

Click here or call 800-970-4355 and refer to priority code 011362 to attend as our guest.

The Roundup

Oil & Gas

Daylight Resources Trust (TSX: DAY.UN, OTC: DAYYF) is buying Cadence Energy (TSX: CDS, OTC: CDSFF) for about CAD301 million to expand its ownership of an oil field in northwestern Alberta. Cadence shareholders will receive 0.47 of a Daylight trust unit for each common Cadence share or may elect to get CAD5.32 in cash for each common share of Cadence. The cash payment is capped at CAD30 million.

Daylight closed May 23 at CAD11.33, valuing Cadence at CAD5.33 per share, a 12 percent premium to its CAD4.75 May 23 close. According to Daylight’s statement announcing the deal, consolidating ownership in the Sturgeon Lake South Leduc oil pool will lead to lower costs and more orderly development of the field.

The acquisition will add daily production equivalent to 3,600 barrels of oil. Daylight Resources Trust is a buy up to USD12.

Penn West Energy Trust (NYSE: PWE, TSX: PWT.UN) is acquiring Endev Energy (TSX: ENE, OTC: ENEEF) in an all-stock deal that will add about 3,500 barrels of oil equivalent per day (boe/d) to its production base. Penn West will exchange 0.041 of a trust unit for each Endev share.

Based on May 20 closing prices, that equates to an offer of CAD1.41 per Endev share and values the deal at about CAD125.5 million. Penn West will issue 3.9 million units under the transaction.

Endev’s current production is weighted approximately 78 percent to natural gas and 22 percent to light oil and natural gas liquids. Its primary property is near Majorville in southeast Alberta, near existing Penn West operations.

Penn West has also filed a Preliminary Short Form Base Shelf Prospectus with the securities regulatory authorities in each of Canada’s provinces and a Registration Statement with the US Securities and Exchange Commission that will allow the trust to offer and issue units and subscription receipts, warrants, rights and options convertible into trust units during the next two years. The securities may be issued from time to time, with an aggregate offering amount not to exceed USD1.5 billion. Penn West Energy Trust is a buy up to USD38.

Progress Energy Trust (TSX: PGX.UN, OTC: PGXFF) sold light oil and natural gas assets located in southeastern Saskatchewan to Seaview Energy (TSX-V: CVU/A) for CAD24 million. Current production from the assets is estimated at about 270 boe/d.

Progress will get 8.3 million class A shares valued at CAD2.25 per Seaview share. The share price reflects the 10-day volume weighted average trading price of the Seaview shares. Progress will also get CAD5.4 million in cash, and Progress CEO Michael Culbert will join Seaview’s board of directors.

Current production comprises primarily long-life, light crude oil pools, with current net-backs from the assets exceeding USD70 per barrel. Buy Progress Energy Trust up to USD15.

Gas/Propane

AltaGas Income Trust (TSX: ALA.UN, OTC: ATGFF) has executed a bought-deal financing arrangement with a syndicate of underwriters, co-led by Clarus Securities and Scotia Capital, for the purchase and sale to the public of 3.8 million units. The syndicate paid CAD26.20 per unit for gross proceeds to AltaGas of CAD100 million.

The net proceeds will be used to pay down debt, fund capital programs and for general purposes. AltaGas Income Trust is a buy up to USD28.

Business Trusts

Bird Construction Income Fund (TSX: BDT.UN, OTC: BIRDF) announced five new projects worth an aggregate CAD116 million. An operating subsidiary of the fund won a contract to build an outpatient hospital in Surrey, British Columbia; the Surrey hospital project was procured through a public private partnership (P3). The emergence of the P3 trend in Canada is certain to benefit Bird down the road.

The trust also announced four additional deals: the construction of a new city hall building and conference facility in Snoqualmie, Wash.; two Lowe’s retail outlets in Whitby and Barrie, Ontario; and construction of the Coady International Centre for St. Francis Xavier University in Nova Scotia. Bird Construction Income Fund is a buy up to USD40.

Menu Foods Income Fund (TSX: MEW.UN, OTC: MNUFF) announced that a US court gave preliminary approval to a settlement agreement covering class-action lawsuits filed in US and Canadian courts last year after pet foods Menu Foods distributed were found to contain toxic ingredients imported from China.

The settlement agreement calls for Menu Foods and its insurer to create a fund of USD24 million to pay for up to 100 percent of damages incurred by pet owners, subject to certain limitations. Hold Menu Foods Income Fund.

Real Estate Trusts

RioCan REIT (TSX: REI.UN, OTC: RIOCF) began work on a greenfield development in Vaughan, Ontario. The retail development, a joint-venture project with Trinity Development Group and Strathallen Capital Corp, will total approximately 504,000 square feet of leasable area.

Phase I will be anchored by a Wal-Mart Supercenter, which will take up 213,000 of the initial 262,000 square feet; the remainder of the Phase I retail space has been pre-leased to a number of national tenants. The Wal-Mart Supercenter is scheduled to open in January 2009. Buy RioCan REIT up to USD25.