Alberta emerges from the recession

After a tougher than expected 2009, Alberta’s economy is showing the first signs of a modest rebound, economists say. However, they caution, the province is not out of the woods yet — and the recovery will most likely be gradual rather than dramatic.

“The good news is that the worst is behind us in Alberta,” says Todd Hirsch, an economist with Edmonton-based ATB Financial in Calgary. “But it’s still going to feel pretty sluggish in the province for a while.”

In general, economists are calling for growth of roughly 2%-3% in real gross domestic product for Alberta in 2010, driven by higher commodities prices, slowly declining operating costs, a brighter jobs market and a rebounding residential real estate sector.

The forecast for 2010 looks much more positive than the economic scenario Alberta endured in 2009, when oil and natural gas prices tumbled and energy projects were subsequently shelved.

Unemployment across the province rose to a high of 7.5% this past October, before finishing the year at 6.7%; in addition, Alberta experienced its first net emigration since the early 1990s, losing 2,500 people in the third quarter of 2009. Although official figures aren’t in yet, the province probably saw a contraction of 2.5%-3.5% in real GDP last year, economists say.

That said, the outlook had already began to appear somewhat brighter in the second half of 2009, as oil prices stabilized above US$70 a barrel after trading below US$40 to start 2009. That has led to the announcement of several new, big oilpatch projects early in this new year, boosting business confidence in the province.

Natural gas prices, which were trading at around US$5.50 per million British thermal units in January 2010, have lifted off the lows reached in the autumn of 2009, when natural gas traded as low as US$2.50 per mmBtu, making it impossible for projects to be run profitably. (1 mmBtu is equivalent to 0.96 thousand cubic feet.)

“When natural gas prices fell below US$3 in September and October,” Hirsch says, “there were a lot of ashen faces walking around Calgary.”

Although natural gas prices have risen, they still remain well below the levels they reached in mid-2008, when gas traded north of US$11.50 per mmBtu. Low natural gas prices have acted as a serious drag on recovery, economists say.

“Many people don’t appreciate that it’s natural gas that has driven Alberta’s economy over the past 10 to 15 years,” says Mike Drotar, vice president of treasury with Edmonton-based Servus Credit Union in Red Deer. As a rough rule of thumb, he says, the natural gas price has two times the effect on the Alberta economy than does the price of oil.

Drotar believes that the global appetite for energy, particularly driven by growth in the developing world, will continue to boost energy prices over the long term. He estimates that natural gas prices will average US$5.50-US$6 per mm-Btu this year before climbing to the US$6-US$8 per mmBtu range next year. Crude oil will trade in the US$75-US$85 a barrel range in 2010; it should then climb above the US$100 a barrel level within the next five years.

Hirsch, meanwhile, is relatively more bearish on natural gas — at least, in the short term. Downward pressure in price — partly coming from the U.S., where new technologies have allowed producers to access abundant shale gas reserves profitably — should see natural gas trade between US$4 and $4.50 this year. On the other hand, he says, crude oil should rise slowly to above the US$100 level in the next several years.

One of the silver linings in the economic slowdown, however, has been the slow drop in operating costs for businesses. Between 2006 and the early part of 2008, labour and raw material costs had shot up to levels that made investment in major oilpatch projects uneconomical, economists say, but that has turned around.

“Over the past year, labour markets have slackened, wage growth has cooled, raw materials have come down in price and oil has rebounded,” says Robert Kavcic, an economist with Bank of Montreal in Toronto. “Suddenly, it’s beginning to be economical again to launch projects.”

Nevertheless, most economists are projecting a gradual improvement in Alberta’s jobs market in 2010, as new projects in the energy sector and a modest recovery in manufacturing will create new positions.

@page_break@Jobs are also being created in the construction sector, as Alberta is enjoying a rebound in its residential housing sector. Housing starts rose to more than 27,000 new homes, on an annualized basis, in December 2009, up from a low of just 12,000 during the first quarter of 2009. That rebound, however, is still well off the rate seen in the boom years of 2006 and 2007, when housing starts exceeded 40,000 annually.

Economists attribute the rebound in housing to low interest rates, the stabilization of supply and increased business confidence. But, as in other parts of the country, there is some concern that if interest rates rise, borrowers will suffer and home prices will be affected.

“While there isn’t a lot of evidence of a ‘bubble’,” Hirsch says, “residential real estate prices will be tempered by rising interest rates in 2010 and stay fairly flat.”

On the commercial real estate side, economists expect that the oversupply of units in Calgary will only get worse, as projects that were started during the boom years come to market in 2010 — while the recovery is still fresh and there isn’t a lot of demand.

“Everyone knows that once these building open, we’re going to have a vacancy overhang of about 15%-18%; everyone’s braced for it,” Hirsch says. “We’re not going to see any more commercial real estate going up in this city for the next five years.”

The province’s fiscal situation — although strong in comparison with other provinces — remains a trouble spot. Royalty revenue from the oil and gas sector is down, and this has had the most direct effect on the government’s books.

“In general, a drop of $1 [per mmBtu] in the price of natural gas,” Kavcic explains, “represents a loss of $1.2 billion for the province.”

The provincial government is projecting a $4.3-billion deficit for the fiscal year ending in March, down from an initial projection of $6.9 billion made in August. Alberta will draw down from its Sustainability Fund, a pool of money built up during years of surplus, to cover the deficit. The provincial government also says its looking to make up $4 billion in “fiscal correction” over the next two fiscal years.

“Assuming natural gas prices move higher and oil prices stay where they are, or move higher, the [Alberta] government may eventually dig its way out of deficit just from energy revenue,” Kavcic says. “If not, it’s going to have to cut spending.”

Meanwhile, raising taxes would be a “tough bargain” for any provincial government, he adds, and it is not likely to happen.

In retrospect, the Alberta government’s introduction of a higher energy royalty regime in late 2007 happened at exactly the worst time, Kavcic says. Energy companies moved many projects to neighbouring British Columbia and Saskatchewan, or to the U.S.

Since introducing the new royalty regime — and with the recession battering the energy sector — the Alberta government has largely backtracked, dropping some parts of the plan and delaying others. Nevertheless, the damage has been done, says Kavcic, at least, from the energy sector’s point of view.

“The bigger issue for businesses is the lingering uncertainty of how the new royalty regime will ultimately be implemented,” he says. “I think what the energy industry wants is more clarity in direction.”