On the economic impact of the Keystone pipeline...

Date: 03.19.2013

There is a lot of debate these days on whether the US government (Obama, EPA and others) should allow or not the construction of the Keystone pipeline to connect the oil production regions in Alberta to the refineries of the US gulf coast. In Canada there has not been much of a debate, the federal government is well aligned with the interest of the oil industry. Taking Canada's stand point this seems quite logical, building the pipeline will allow the oil producers from Alberta to receive a higher price for the oil they produce and allow the industry to increase their production volumes, in return this will increase the royalties the governments receive from the industry. But are these pipeline projects (Keystone XL, Northern Gateaway, Enbridge Line 9 reversal) really good for the Canadian economy?

Over the last decade, oil sands have unquestionably made Canada a more prosperous country (see this graph showing how Canada has outperformed the US in GDP growth since year 2000). But the benefits from of oil sands exploitation seem to be disproportionately skewed towards a small part of the Canadian population (mostly in Alberta) and have a negative impact on the other parts (mostly in Ontario) - let me explain why that is.

Comparison of Canadian and US GDP growth

Consider that more revenues from oil sands result in a stronger Canadian dollar

The first key relation to underrstand is the one between the Canadian dollar and the revenues from oil sands production, as described in my previous post the higher the revenues from oil sands, the stronger becomes the Canadian dollar. We have calculated that a 10% increase in oil revenues strengthen the Canadian dollar by 3%, this is quite significant.

And that a higher Canadian dollar equals less manufacturing jobs in Canada

The second relation to understand is the link between the value of the Canadian dollar (compare to the US dollar) and the manufacturing employment in Canada. A large portion of the Canadian manufacturing sector produces product for export to the US. Because it increases the price US companies have to pay for Canadian goods, a stronger Canadian dollar has a negative impact on the competitiveness of Canada’s manufacturing sector. As a matter of fact, since year 2000 a period during which the Canadian dollar strengthen by 40%, Canada has seen a 20% reduction in manufacturing employment (500,000 jobs lost since the peak) - This graph should quickly convince you of the relation between the strength of the Canadian dollar exchange rate (vs the US dollar) and the manufacturing employment in Canada. Notice how the manufacturing employment increase when the Canadian dollar goes down from the period going from 1992 to 2002 and then how employment goes down with the strengthening of the currency past 2002.

Relation between the Canadian dollar exchange rate and the manufacturing employment in Canada

Hence, more revenues from oil sands equal less manufacturing job in Canada

From there it is easy to put the pieces together: more revenues from oil sands equals a stronger Canadian dollar, a stronger Canadian dollar equals a reduction in the manufacturing employment in Canada. An industry mostly concentrated in southern Ontario. Keystone and the other pipeline projects are likely to make this relationship stronger further impairing the competitiveness of the Canadian manufacturing industry. In fact it’s not far-fetched that Keystones and the other pipelines projects could results in 75,000 manufacturing jobs (see note) lost in Canada…

By the way, the big beneficiaries of these job losses in Canada are the American manufacturing workers. For instance, many of the auto manufacturing jobs lost in Canada at Ford, Toyota or GM plants found their way to brand new plants in southern USA. See how, over the last 10 years, the manufacturing employment in the US has declines more slowly than the one in Canada.

 

Note: Assumes that Keystone and the other projects will close the Edmonton Par to Brent oil price spread (return to pre 2008 level). This would results in an increase of ~30$/bbl received by the oil sands producers, a 30% increase from the current level. We have calculated in the past that a 10% increase in the oil revenues increased the value of Canadian dollar by 3%. Based on the 2000 to 2013 period, we can also safely assume and a 1% increase in the value of the Canadian dollar results in a 0.5% reduction of manufacturing employment. So based on historical trends and everything else being equal we can assume that Keystone XL (and the other projects) could results in a 4.5% reduction of the manufacturing employment. Based on current level of 1.7 million jobs this corresponds to 75,000 manufacturing jobs lost in Canada.