Canadians have a history of overcoming disastrous events such as floods, blizzards, earthquakes and wildfires. Partly due to having the second largest surface area of any country in the world, these events have caused significant economic damage over Canada’s 149-year history, with the most recent major wildfire occurring in Slave Lake in 2011—a disaster that displaced 7,000 people, caused USD1.5bn in damage and reduced annual GDP output by 0.13 percentage points (pp.).
The May 2016 Alberta wildfires will be remembered as one of the most devastating ever. At the time of publication the wildfires have encompassed an area nearly twice the size of New York City, ravaging homes, displacing thousands and putting Alberta’s already battered hydrocarbon sector under further pressure. While initial damages are hard to quantify, the fires have forced an estimated 70-100,000 people to be immediately relocated from fire damaged areas in and around Fort McMurray, Alberta. Estimates put the number of homes damaged at over 1,600. Furthermore, according to Dun & Bradstreet’s commercial database, the fire has the potential to impact 3,650 active businesses or 0.2% of Dun & Bradstreet’s total active Canadian universe.
In terms of importance to the overall Canadian economy, Alberta accounts for nearly 19% of total GDP, 12.6% of Canada’s total employment and about 14% of Canadian goods exports. Alberta is home to the world’s third largest crude reserves and contains large quantities of non-traditional, petroleum known as crude bitumen or oil sands. Exports of these resources remain a crucial component of Canada’s long-term economic growth and export strategy. Currently crude oil and crude bitumen make up about 11% of annual exports, slightly lower than in prior years, but a sizable contributor to export revenues. Therefore, one of the biggest risks comes not just from the immediate displacement of people and the damage to infrastructure but also from the long-term disruption of oil production within this region.
While the implications of this disaster will be far reaching we have outlined three potential scenarios exploring the associated impacts based upon the severity of the wildfire.
- The hydrocarbon industry, including firms in crude oil extraction, refinement, oilfield services and ancillary services, will be negatively affected by the fires. The lost output from the shutdown will result in foregone revenues, impacting businesses’ top-line and at a higher level, expected provincial tax revenue.
- In addition, employees within these verticals will lose out on lost earnings, negatively impacting consumption rates in the local economy, and to a lesser degree in the entire country.
- Non-renewable resource revenue is forecast to be 6% of Alberta’s 2016-17 provincial budget revenue. Given the disaster, that number will likely be lower, increasing the budget deficit. Positively, the Alberta government does have one of the lowest debt-to-nominal GDP ratios among Canadian provinces which will allow the government additional flexibility should it need to borrow to rebuild essential infrastructure.
- Initial total insured loss estimates range between CAD4-9bn or roughly 0.5% of annual GDP, making this one of costliest natural catastrophes on record. While estimates remain preliminary, the insurance sector will face financial pressure lowering operating margins and likely raising premiums for all sectors within Canada.
- While Canada has extensive national road and rail network and supply chains are well-integrated across the nation, transportation in and around the region will be limited while the fire continues.
- The rebuild effort will require a large number of homes to be rebuilt, the construction sector, building material, household goods and related services stand to benefit.
- Make immediate contingency plans if your supply chain is reliant on companies active in areas in the vicinity of the fires.
- Certain oil extraction firms have exercised force majeure on contracts. Review clauses within your contracts should force majeure be exercised, create contingency plans should you be reliant upon companies that have these clauses and which have reduced or suspended output.
- Expect a short to medium term disruption in local supply chains within the Alberta and surrounding Saskatchewan province. Look for alternative supplies if current supplies come from the Fort McMurray area, especially for firms that rely upon Highway 66 and Highway 881 as road blocks remain in place.
- Continue to purchase disaster-related insurance if you’re active within the region. Wildfires are common in Alberta (between 1000-7000 wildfires in a year), and more broadly across Canada (over 8,000 annually).
- For the time being, assume fires in the Fort McMurray area will continue.
Background and Context
Even before this unfortunate disaster, Canada’s oil and gas sector, related industries and hydrocarbon-reliant provinces had been feeling the financial strain from low global oil prices. Indeed, credit rating agency Moody’s downgraded Alberta’s long-term debt prior to the fire. Depressed oil prices have triggered job losses, reduced output and scaled back investment spending, and the disaster will aggravate these aspects. Dun & Bradstreet downgraded the Canadian country risk rating by one quartile in February (Chart 1) to DB2C (still within the low risk category) primarily due to the deteriorating short-term economic outlook; the current wildfire will only worsen the situation, heightening risks and negatively impacting cross-border trade.
While the wild-fire has been contained to a specific area within Alberta and has caused limited damage to hydrocarbon production facilities so far, the temporary closing of facilities due to safety precautions will limit Alberta and Canada’s oil production in the coming weeks and possibly months. Alberta’s total oil production was already on a steady decline given low prices: according to Statistics Canada data, provincial production has fallen an estimated 17.5% since January 2015. Since the fire, as much as one million barrels of oil production per day is being lost, with the total growing daily. On the one hand, lost production could put upwards pressure on global oil prices but on the other hand it is still lost output for Canada, hurting Canadian businesses by way of lost revenue and hurting the Canadian economy through lost potential tax revenue.
While any direct damage to oil facilities will take production offline for a longer time, factors such as the lack of surrounding vegetation will help to limit fire damage. Areas surrounding the facilities are cleared of vegetation limiting the possible spread of the fires.
However, the threats to Canada’s transport infrastructure remain. While Canada has an extensive national road and rail network, and supply chains are well-integrated across the nation, transportation in and around the region will be limited while the fire continues. Roadblocks are still in effect at the intersection of Highway 63 and Highway 881 south of Fort McMurray. Highway 63 is a core route of Canada’s national highway system, and the only road leading out of Fort McMurray. Authorities planned to complete the twining of the current route 63 by the end of 2016 due to its importance to the region; the government has already spent CAD1.2bn in upgrades. Transportation damage assessment is limited at this point, but should remain a risk to Canada’s market environment.
While the severity of the wildfire can change quickly, we currently believe that Scenario A, one in which the wildfire is contained to the surrounding area, causing limited damage and having a transitory effect upon Q2 GDP will be the likely outcome. However, fires can change direction and intensity quickly, meaning that scenarios B and C are non-negligible.
The impact on Canada’s short to medium-term economic performance depends on how far the fire spreads, and how long oil production is brought off-line. While the chances of recession have increased as a result of the fires, given the likelihood of Scenario A we believe that fire will trim about 0.1 pp. from real GDP, similar to the 2011 Slave Lake fire. On the one hand Stephen Poloz, the Bank of Canada’s Governor, identified a number of positive developments in Canada’s economy during the April 2016 monetary policy briefing. Such as: rebounding global oil prices, an improving U.S. housing market, new fiscal stimulus spending and a rising labour market participation rate. On the other hand, alternative indicators continue to point towards sagging economic fundamentals and a deteriorating short-term economic outlook. The Canadian economy is experiencing rising unemployment (currently 7.1%), as well as slowing annual (and below trend) quarterly real GDP growth. The country entered a technical recession (two consecutive declines in quarterly GDP) in 2015. In addition, declining terms of trade, since 2014, point to underlying fundamental issues with the Canadian economy. While Canadians are traditionally resilient, households do remain highly leveraged. Household debt as a percentage of gross disposable income has grown to historical highs, rising to 159% as of Q4 2015, compared to 101% in the U.S. and 136% in the U.K. While this fire might not officially knock Canada into a recession the longer the duration and more severe the intensity, the higher the chances of that happening. We project real GDP to grow at a subdued annualised 0.1% in Q2 and at an annual rate of 1.4% in 2016.