The Canadian economy grew at an annual rate of 6.7 per cent in the fourth quarter, much faster than the Bank of Canada was expecting, guaranteeing an interest-rate increase when policy-makers announce the results of their latest policy deliberations on March 2.
A war in Europe has upended the near-term outlook, which was dominated entirely by inflation until the middle of last week, when Russian President Vladimir Putin stunned the world by sending a wave of troops into Ukraine. Inflation remains too high for the Bank of Canada to ignore, especially with evidence of strong demand.
“Canada’s economic engine was going almost full throttle,” Arlene Kish, director of Canadian economics at S&P Global Inc., said in a note to clients.
Kish predicted a quarter-point increase, a “first step in slowing demand as supply catches up,” she said. “Geopolitical events are impacting energy prices, adding to already strong inflationary pressures, and may require the Bank of Canada to act more swiftly during the initial monetary policy tightening cycle.”
Business investment, fees related to home sales and company stockpiling led the surge in economic growth in the fourth quarter,Statistics Canada said. The latter could help offset inflation pressures, since it suggests companies were either learning how to deal with all the supply disruptions that came with the pandemic, or had decided to build their inventories in anticipation of new ones.
“The inventory component of GDP was generally a much larger boost to (fourth-quarter) growth than we had penciled in, similar to end-of-2021 GDP data in the U.S.,” Veronica Clark, an economist at Citigroup Global Markets Inc., said in a note. “This could partly be due to continued global supply issues, as inventories of intermediate goods are accumulated while final production is stalled due to shortages of some final inputs.”
A separate Statistics Canada reportshowed that GDP, based on output by industries, was little changed in December, suggesting the economy held up in the face of the Omicron wave of COVID-19 infections. The agency said preliminary information suggests GDP increased 0.2 per cent in January, a positive surprise, because there had been speculation that strict health restrictions in Ontario and Quebec might have caused economic growth to stall at the beginning of the year.
“These reports clear the way for the Bank of Canada to begin its hiking process,” Phil Suttle, a former Bank of England and New York Fed economist who now runs his own research firm, Suttle Economics, said in a note to his clients.
The Bank of Canada in January predicted Canada’s gross domestic product would grow at an annual rate of 5.8 per cent in the fourth quarter, a strong enough estimate for the central bank to conclude the time had come to end its promise to keep the benchmark interest rate near zero until at least the spring of 2022.
Canada’s economy ended 2021 with considerable momentum, as the fourth-quarter acceleration followed growth at an annual rate of 5.5 per cent in the third quarter, which was also much faster than the country’s economy typically expands.
Overall, GDP grew 4.3 per cent in 2021, enough to get back to $2.13 trillion, slightly more than at the end of 2019. The eight-quarter recovery was a bit faster than the average 8.75 quarters it took GDP to recover during Canada’s five recessions since 1974, according to Jocelyn Paquet, an economist at National Bank Financial.
Household spending led the most recent recovery, as Canadians took advantage of elevated savings and low interest rates to buy houses. New construction, resales and renovations were at record levels. Mortgage debt climbed 10.3 per cent in 2021, an unprecedented increase of $182.4 billion, Statistics Canada said.
That consumption impulse could begin to fade, as household disposable income dropped 1.3 per cent in the fourth quarter from the previous quarter, even as employee compensation increased 1.9 per cent.
The main reason was the federal government’s tapering of emergency benefits, as government transfers to people dropped almost 12 per cent in the final three months of 2021. Transfers were about 19 per cent of all disposable income, marking a return to pre-pandemic levels of less than 20 per cent, Statistics Canada said.
The savings rate dropped to 6.4 per cent from nine per cent, still high by recent historical standards, but down from the previous five quarters, when the savings rate was above 10 per cent.
Prices for financial assets tied to short-term interest rates suggest traders’ confidence that the Bank of Canada will raise interest rates is fading, as worries that the financial and economic sanctions the West is using to hobble Putin’s ability to fight a war could lead to a global recession or financial instability.
Inflation is probably the greater threat to Canada, at least for now. The consumer price index surged to 5.1 per cent in January from a year earlier, the biggest increase since the central bank started targeting inflation in 1991.
Even if much of that inflation is related to supply issues, and, therefore, beyond the Bank of Canada’s control, the latest GDP numbers show there is also a demand element. Commodity prices are surging anew because of the war, and that will strengthen demand in Canada because the country exports much of what Russia and Ukraine export.
The Bank of Canada’s target for year-over-year increases in the CPI is two per cent. Some economists observed inflation might also now be hurting growth, as weaker consumption could be the result of higher prices.
“This morning’s GDP reports underline the risks from waiting,” economists at RBC Capital Markets said in a report. “From a fundamental perspective, there is no real justification for the BoC to avoid raising rates due to developments in Russia.”
But what exactly is causing the increase and what are Canadians really paying for at the pump?
CTVNews.ca spoke to experts about what goes into the price of gas, the effect of refinement on high prices, concerning trends around diesel, and how costs could dissuade consumers from driving altogether.
A number of factors play into the price tag drivers see when they fill up their vehicles.
One, which may not come as a surprise, is the price of oil. Due to the war in Ukraine, the price for a barrel shot up in recent months, with global benchmarks Brent Crude and West Texas Intermediate selling in excess of US$100 a barrel.
“So we’re at the mercy of international markets for better or worse,” Werner Antweiler, director of the Sauder School of Business Prediction Markets at the University of British Columbia, told CTVNews.ca in a phone interview on May 17.
Beyond the price of oil, different margins also factor into the price of gas.
They include the refining margin, which comprise the cost to refine, store and deliver. More specifically, it is the difference between the cost of crude and the wholesale price of gas.
After that, there is the retail margin, which goes to gas stations, and then the various federal, provincial and sometimes regional taxes that are added on.
The Canadian Fuels Association says, in 2021, crude oil made up 39 per cent of the price for regular gasoline, followed by 35 per cent for taxes, 20 per cent for refining and six per cent for distribution and marketing.
Generally, the price of gas reacts fairly quickly to changing oil prices, Antweiler said, a point other experts say is true. Competition between gas stations does vary depending on where in the country you live, which can play a role in what regional gas prices will be.
But price fixing or “collusion” is rare, Antweiler said.
Drivers in Quebec may remember one example from 2008, when several companies and an individual pleaded guilty and were fined in connection with a gas price-fixing scheme.
In practice, Antweiler said the retail margin for gas stations is relatively flat at around 10 cents per litre in most places where there is competition.
What is “peculiar” now is the volatility in the refining margin, which in the Vancouver area has shot up to about 70 cents per litre from 45 cents previously, Antweiler said.
This stems from issues around transportation and capacity constraints.
“It’s not the gas stations or the retailers, it’s the wholesalers,” he said.
Roger McKnight, chief petroleum analyst for En-Pro, stressed that the country is not unified on how gas prices are set.
Anywhere east of Thunder Bay, Ont., will tend to follow traders on Wall Street, specifically the futures price for oil, he said.
If the futures price rises one day, the price at the pump will generally follow 48 hours later.
West of Thunder Bay, the price of gas tends to follow more closely with the global price of crude oil, with the exception of lower mainland B.C. which is more aligned with wholesale movements in Seattle, Wash.
“So when you get right down to it, the day-to-day prices across Canada follow different markets,” McKnight said in a phone interview on May 17.
SUPPLY AND DEMAND
At the end of the day, the issue is a classic case of supply and demand.
“The supply is very, very tightly in sync with demand,” Ian Lee, an associate professor at the Sprott School of Business at Carleton University in Ottawa, told CTVNews.ca in a phone interview on May 17. “There’s no slack in the system to use slang English.”
The COVID-19 pandemic greatly reduced the demand for gas, as lockdown measures meant people largely worked from home.
As more sectors of the economy reopened, demand for gas increased sharply.
But Lee said oil producers have taken a longer time to increase production, with previous pandemic-related shutdowns making the demand for gas uncertain.
“We’re paying, all of us, higher prices than we ought to be because of the shortages at the refinery level, so that’s what’s exacerbating the problem,” Lee said.
Similar to Canada’s housing crisis, he believes the solution is to bring supply back into the marketplace. But in the short run, it “hurts like hell.”
The U.S. Energy Information Administration, which is part of the U.S. Department of Energy, releases weekly reports on the status of petroleum.
Motor gasoline inventories are about eight per cent below their five-year average, while distillate fuel, which includes diesel, jet fuel and heating oil, is down approximately 22 per cent from its five-year average.
“So when your supply side is all in negative and your demand side is all in positive … the consumer’s going to end up paying for that,” McKnight said.
OPEC, or the Organization of the Petroleum Exporting Countries, has said it will not increase production to compensate for lost Russian oil, of which a number of European countries, as well as Canada and the U.S., are boycotting. OPEC and its allied countries, which together are known as OPEC+, also includes non-member Russia.
Earlier this week, oil giant Saudi Aramco, which is 98 per cent owned by the Saudi government, said its profits had soared more than 80 per cent in the first three months of the year, causing it to overtake Apple as the world’s most valuable company.
The Utah State Capitol, rear, is shown behind an oil refinery on May 12, 2022, in Salt Lake City. (AP Photo/Rick Bowmer)While the price of retail gas may be top of mind for most consumers, what may be overlooked is the unusual surge in the cost of diesel.
Since diesel is used across the commercial sector, from heavy equipment to transportation, this issue is probably the most worrisome, Antweiler said.
“Diesel is the fuel of commerce and so this cost will get passed on to consumers,” he said.
This is in part being driven by missing feedstock, or the raw materials that refineries need of which Russia is a source, making it much harder to refine diesel.
Refineries need natural gas in order to make hydrogen, which is used in the refining process and also has become more expensive, Antweiler said.
Refineries tend to switch their output to gasoline during the summer to accommodate the increased demand and stocks of diesel fuel were already low coming into 2022.
Refining capacity is also limited and falling in North America and Europe, Antweiler said.
“The bottom line is that the market for diesel fuel is complex, and follows its own market logic that is not the same as for gasoline,” Antweiler said in a follow-up email to CTVNews.ca.
“Mostly, the extra demand from Europe is spilling over to North American markets. If refineries rush to make more diesel, this will lower output of gasoline. So if prices for diesel start coming down, they will go up further for gasoline.”
High gas prices are seen in front of a medical billboard, May 11, 2022, in Milwaukee, Wis. (AP Photo/Morry Gash)
How drivers respond to persistently high gas prices is something experts will watch for.
Lee predicts that if there is any reduction in demand for gas, it will be the result of “demand destruction,” caused by prices rising so much that it “literally kills some demand.”
With gas, people may end up driving less often, switching to smaller cars, taking mass transit, carpooling, working from home or potentially moving closer to work.
But whether that falloff in demand occurs, which will be known by measuring the average kilometres driven by Canadians, won’t be known for another year, Lee said.
“That’s why I don’t think there’s any rioting on the streets yet at $2 a litre,” Lee said.
“As painful as it is, the reaction from consumers is grumbling, a lot of grumbling for sure, but it’s been muted and I think it’s because consumers, individuals, face options to mitigate the effect of the price.
“I think if natural gas to heat homes or home heating had risen by the same magnitude, I think you would have seen riots on the streets.”
WHERE DO WE GO FROM HERE?
Concerning the price of crude oil, Antweiler doesn’t see it going much beyond US$120 a barrel unless something occurs to make the situation worse.
A lot of operations shut down during the early part of the COVID-19 pandemic as demand plummeted, and Antweiler said producers will be incentivized to increase production although this will take time, meaning prices will remain high throughout the summer.
For McKnight, the answer to when this will stop is less clear.
“I’d be a multi-billionaire if I could answer that question,” he said.
Nevertheless, he said governments could look at the HST and consider capping the amount that is charged on a litre of gasoline.
It’s a point Lee also raised, saying governments could temporarily suspend certain taxes on gasoline.
Lee said he would not expect gas to be more than $2 per litre a year from now.
But the distress caused by the price of oil could lead to some policy changes in the United States, he said, with Americans potentially shifting their views on pipelines as more view energy as a national security issue.
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