Thursday, 11 April 2013

Which Way for the Loonie?

Ralph Shell, Excel Analyst
Excel Marekets ECN Forex Broker Demo Account Trading Contest April 2013
Whether the Canadians like it or not, their economy and that of the US are bound together, though not with a single currency.  The under-performing countries in Europe are locked into a single currency, unable to recovery from a competitive disvantage with a weaker exchange rate.  Considering the recent economic numbers from Stats Canada, this could be the time when Canada will be better served if her currency were to trade at a discount to the US dollar.

Last Friday, the US unemployment percentage - the number of Americans who have dropped from the work force - and the Non-Farm Payroll report dominated that day's news and analysis.  Canadian numbers released that day, though important, received far less attention.

To review, the employment numbers came in far less than expected.  Falling of out of employment during the period were 54.5K people, and the unemployment rate went up from 7% to 7.2%.  Released at the same time was the Canadian Trade Balance.  In the previous month there was a trade deficit of C$ .24B.  Though the forecast was a positive C$ 0.1B, the trade balance fell to a negative C$ 1.02B.  Exports to the US fell 1.1% to $28.4B for the month.

Part of Canada's reduction in exports to the US is due to increased production of US oil and natural gas.  The December 2012 oil production in the Bakken field was up to 770 b/d about twice the 2010 production.  Oil from the Bakken formation competes with Alberta oil for pipeline capacity to the Gulf Coast refineries.  The shale gas revolution, which has resulted in a glut of supplies, has also displaced importation of Canadian natural gas production. 

Price for Western Canada Select currently runs at about a 15/barrel discount to the WTI, and it has traded as wide as $30/barrel.  Most of the discount for the Canadian oil is because of location, not because of the quality of the heavy bitumen oil. 

Shipping by rail is possible but expensive, and the US Gulf refiners can be fickle buyers.  For example, there has recently been a flurry of tanker bookings  for March April loading to haul Persian Gulf oil to the US Gulf.  It is estimated these vessels are to carry about 26 million barrels to the US Gulf.  Ocean freight rates have gone up recently but, according to Bloomberg it cost only about $1.31 a barrel to ship the crude; this compares to about $15.62 to ship the oil by rail from Alberta.

Transporting Canada's daily oil production of nearly 4 million barrels per day is no small feat, so the oil producers have been campaigning for the Keystone pipeline.  This pipeline was originally proposed in 2005 at a cost of $5.2B but with the extension to Gulf running the price up to $7.0B  When completed it would transport about 820,000 barrels of oil per day. 

Shipping by pipeline is cheaper, once you build it.  Construction of the Keystone pipeline was a good idea when initially proposed and a win-win for the oil producer and the US consumer; but, alas, that is way too simple.  Despite the presence of over 25,000 miles of pipelines in the US, the environmental left has made opposition to construction of the Keystone a cause celeb.  Pleading the case to an administration who has rarely seen an alternative energy project they did not like, or an oil investment they did, the Keystone pipeline is now held up by politics.

As an alternative to the expensive pipeline, the Canadian National Railway (CA:CNR) has proposed a "Pipeline on Wheels."

"Within months, CN will be shipping 10,000 barrels daily from producers whose reserves are now stranded. The railway will deliver the oil sands production through the use of insulated and heatable railcars or by reducing its viscosity by mixing it with condensates or dilutents.
But the "scalability" of the concept - up to four million barrels per day - means that the railway can ramp up production vastly by just adding rail cars. Shipping four million barrels a day is possible with current rail capacity, said Foote."

It remains to be seen if the Canadian National can perform as well as advertized. Contending with American obstruction of a viable plan must be frustrating.  When complete, the Keystone would ship only 820,000 b/d.  Finally, the shippers price for the crude would be at the mercy of refiners who have increasing production in Texas and North Dakota, as well as access to Venezuelan or Persian origin oil.

Canada is much better off not being the captive supplier for the US market.  They should be making alternative plans for the transportation of the crude, rather than spending time and enriching the pockets of the Washington lobbyists.

 Click to Enlarge USDCAD Daily Forex Chart

Should permission be granted for the Keystone it will only be after further negotiations.  It is rumored the Washington administration will require some environmental requirements to appease the green lobby.  One of the rumors has been a carbon tax on all oil sands production.  Details are lacking on this proposal, but it seems to me any further drawn out negotiations are bearish on the CAD.

Click to Enlarge USDCAD Weekly Forex Chart

Looking at the weekly chart of the USDCAD (FXC), the loonie has been gaining on the USD since its high of 1.0340 in late February.  Now trading at only 1.0160, the CAD has not been running away.  Looking at the latest COT report, the large spec remains short the C$ by a healthy 3.6-to-1 ratio.  Often big numbers move through the CME Canadian futures market without making a big price splash.  Our preference is to buy the USD versus the C$ at around the 1.01 handle.  As always, mind your money.
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