Ontario’s construction outlook within an uncertain economic framework

ALEX CARRICK

Chief Economist, CanaData

Ontario is presented with significant challenges heading into 2011. The economic framework may be more uncertain than ever before in the province’s history.

Emerging nations are driving the demand for commodities that is raising prospects for Canada’s western provinces above the traditional powerhouses in the centre. Some immigrants are forsaking Toronto to reside in Alberta, Saskatchewan, B.C. and Manitoba, where work is likely to be more readily available.

After raising interest rates during the summer months, the Bank of Canada (BOC) has been holding the line since early September. On Dec. 6, it chose to keep its policy-setting overnight rate at 1.00%. This decision recognized that the world economy has become shakier due to sovereign debt problems in Europe.

The BOC’s earlier rate hikes were made possible thanks to a financial sector in Canada that has been remarkably strong. Stability in the nation’s largest banks was a prime reason Canada survived the recession better than any other major industrialized nation. Toronto’s Bay Street offers a good starting point for a consideration of Ontario’s construction outlook. The financial community provided a firm base of employment during the recession, limiting the increase in office vacancy rates.

Also providing a solid core were the landlords of many of the largest office towers – giant pension funds. They have learned to eschew short term gains for longer-term goals. Office construction will experience a cyclical recovery in 2011 and 2012, unlike the fallow decade of the 1990s after an office-market-bubble burst in the late 1980s.

Hotel construction will show a similar cyclical pickup. Americans travelers have become more familiar with the requirement that they carry passports when traveling abroad. Hosting the PanAm Games in 2015 will require sports facility construction – velodrome, aquatics centre, soccer stadium – in Toronto and Hamilton. This will include work at Toronto’s waterfront, where development is showing more life than at any time in its history over recent decades.

There are usual cyclical drivers for industrial construction (i.e., stronger consumer demand and better profits), but these will be supplemented in several ways. For example, the Detroit Three carmakers are recovering nicely from their disastrous problems of mid-2009. On the downside, and serving to mute manufacturing activity, has been the climb in value of the Canadian dollar to parity with the greenback throughout this year. Some employers are making proper adjustments, through finding new markets and changing the concentration of their product offerings.

On the input side, the higher-valued Canadian dollar has been a spur to investment in high-tech productivity-enhancing machinery and equipment. Much of this M&E is only available from foreign (mainly U.S.) suppliers. It has been made cheaper by the higher-valued loonie. M&E investment in Canada has been remarkably strong in all three quarters of this year (+17.8% in Q1; +32.7% in Q2; and +28.7% in Q3 – quarter/quarter annualized). This will help to lower costs.

Institutional construction work (i.e., schools and hospitals) has been brought forward under the infrastructure stimulus program. With federal government money slowing to a trickle, there is likely to be a hiatus over the next couple of years. Also, both Queens Park and the City of Toronto are shifting toward austerity. But don’t expect institutional work to disappear forever.

The post-World War II baby boom generation will increasingly need medical attention. The first baby boomers reach age 65 in 2011. At the other end of the spectrum, boomers’ grandchildren are accounting for a mini baby boom that will need more elementary school facilities in three to four years. Furthermore, despite recent talk about government austerity measures, the public sector both federally and in most of the provinces has not “blown the budget” to anything like the same degree as in many other jurisdictions around the world. Taxpayer money will still be available.

Engineering construction tends to become lumped in with institutional on account of its reliance on the public purse. But that’s only in certain sub-categories, such as roads and highways and sewers and watermains. Engineering work also contains a fair private sector component. Elsewhere, that would include mega energy projects in Alberta. But in Ontario, one would look to lesser but still significant projects in alternative energy areas (wind, solar and geothermal).

There will also be resource projects in Ontario’s northern reaches. Huge mining investments are planned or proceeding in and around Thunder Bay and Sudbury. The former is concentrated in the “ring of fire” region with gold and chromite deposits. Mining equipment sales have received a boost from all-time high gold prices. Investment in Sudbury is assured by Vale SA’s plans for better emissions controls and new production facilities as copper prices are on an upward path.

There are also a number of major transit projects to which the province has already committed. Under new mayor Rob Ford in Toronto, the Transit City plan may be destined for the scrap heap, but there are intentions to replace it with more subway work. Longer term, there is the nuclear power program. The ruling Liberals and opposition Conservatives both want to see nuclear as a major part of Ontario’s energy mosaic. Next fall’s provincial election may still bring surprises, however, as the NDP and environmentalists are sure to initiate lively debate on the subject.

Ontario’s ties with the U.S. remain a key part of the economic outlook. South of the border, it appears President Obama and Republicans in the House of Representatives are near a compromise on the Bush-era tax cuts. The President will agree to extend the cuts for the rich (the top 2% of Americans) for another two years in exchange for Republicans agreeing to 13 more months of insurance coverage for the long-term unemployed and a 2% cut in the payroll tax.

The overall effect will be $300 billion in fiscal stimulus on top of the $600 billion addition to the money supply. This will help an economy that continues to demonstrate some fragility. Ontario is one of the provinces that most readily benefits from a pickup in U.S. consumer spending.