Sandrine Soubeyran
Energy is a significant driver of performance in Canada’s equity and bond markets, given its sizeable contribution to the overall Canadian economy. Since the Covid shock, the Canadian energy sector’s performance has undergone a roller-coaster ride, reflecting its cyclical properties as an asset class, sizeable weight and large swings in energy prices.
- Canada’s energy sector makes up an important segment of the Canadian economy, equity and bond markets
- With energy and financials dominating the equity market, the Canadian equity market is highly cyclical compared to the US
- Canadian energy equities and high yield credits have trumped investment grade corporates performance since Covid. Therefore, could the recent BOC policy easing be a turning point to finding better value elsewhere?
The energy sector in Canada makes up an important segment of the Canadian economy, equity and bond markets. Its overall economic contribution to Canada’s total GDP accounts for about C$149 billion, or 6.7% of Canada’s total GDP of C$2,202 billion at the end of 2023, and includes C$112 billion of mining, quarrying, and oil and gas extraction[1] (Chart 1). The sizeable weight of the sector in the economy explains why energy is such a significant driver of performance in Canada’s equity and bond markets.
Chart 1: Oil & gas extraction, mining and quarrying make a strong contribution to the overall Canadian GDP
Source: Statistics Canada, June 2024: Gross domestic product (GDP) at basic prices, by industry, annual average (statcan.gc.ca). Please see the end for important legal disclosures.
The oil price matters
Canada’s mining, quarrying and oil and gas extraction industry has a GDP contribution of just below C$100 billion in 2014, rising to C$112 billion in 2023, though the evolution has not been even and, in terms of GDP contribution, has fallen modestly over the 10-year period (5.3% in 2014 to 5.1% in 2023). As Chart 2 shows, the sector’s contribution to the Canadian economy has fluctuated with the global oil price’s ebb and flows: The sector fell in 2015-16 after the oil price collapsed on excess supply and strong US oil shale production; rose during the oil price recovery in 2018-19 after OPEC and non-OPEC nations agreed to cut production and Iran and Venezuela reduced exports; then fell again during the Covid shock in 2020; and finally rose in the post Covid recovery, as the oil price remained relatively more stable.
Chart 2: The Canadian energy sector has fluctuated with the oil price since 2014
Source: Statistics Canada, June 2024, Gross domestic product (GDP) at basic prices, by industry, annual average, industry detail (statcan.gc.ca). Please see the end for important legal disclosures.
Given its economic importance, it is not surprising that the energy sector is also well represented in the Canadian markets. In the equity market, energy accounts for nearly 20%, and emerges as the second largest industry after the financial sector, which dominates with a 40% weight (Chart 3). Moreover, the Canadian equity industry weights highlight the cyclical nature of the Canadian equity market relative to the US, where the combined weights for energy and financials is less than 15% compared to about 60% in Canada.
Chart 3: Energy is the second largest industry in the Canadian equity market, which is also highly cyclical compared to the US
Source: FTSE Russell, LSEG, as at June 14, 2024, FTSE Canada and USA equity indices, by ICB sectors. Please see the end for important legal disclosures.
Energy is a critical sector in Canadian credit markets
Unsurprisingly, energy is among the largest Canadian credit sectors. In the investment grade (IG) corporate bond market, energy (22%) is close to its weight in the equity market and the second largest industry after financials (39%). However, in the Canadian high yield (HY) credit universe, energy has a weight close to 40%, nearly double the weight of the Canadian IG energy sector, followed by industrials (Chart 4). After the sharp drop in the oil price between 2014-2020 (see Chart 2), Canadian oil and gas companies needed to raise capital quickly and were active HY credit issuers. But these issues were mostly BB rated, at the higher quality end of the HY spectrum, and closer to investment grade, rather than further down the credit curve (i.e., CCCs).
Chart 4: Energy dominates the Canadian corporate bond market
Source: FTSE Russell, LSEG, as at May 24, 2024. Please see the end for important legal disclosures.
Performance – a roller-coaster energy ride reflecting cyclicality, and sector-specific shocks
Since the Covid shock, the Canadian energy sector’s performance returns have undergone a roller-coaster ride, reflecting its cyclical properties as an asset class and the large swings in energy prices. As Chart 5 shows, during the initial Covid shock in March 2020, Canadian energy equities fell some 40%. However, losses in Canadian HY energy credits of 10% were smaller, while those in Canadian IG corporates were the lowest, at only 2-3%.
Higher investment grade credit correlation to government bonds protected valuations during the risk-off period
The timing of the recovery across asset class also varied. It took longer, until September 2021, for the performance of Canadian energy equities to return to positive territory, compared to just a few months for the recovery of Canadian HY credit (July 2020) and Canadian IG corporates (April 2020). But, overall, Canadian energy equities have outperformed both HY and IG corporate bonds, with gains of 66%, though with much higher volatility as Chart 5 shows. Canadian HY energy credits were also up 33%, benefiting from their higher correlation to equities, and lower correlation to government bonds. By contrast, Canadian IG energy credits showed their ‘protective’ quality, holding up much better than equities and high yield equivalents during the deeply risk-off phase of Covid.
but investment grade energy credit underperformed in 2022-23 in a rising rate environment
Since 2022, however, IG energy credits have succumbed to the rising interest rate environment, having more duration and sensitivity to changes in interest rates, and underperformed their HY credit equivalents (with lower duration). As a result, equities and HY credits have far outperformed IG credit since 2022, compared to a more modest performance of 7% for Canadian IG energy corporates. But after the Bank of Canada’s decision to be the first G7 central bank to cut rates and ease policy in June, this could well be a turning point for IG energy relative to HY, given their extra duration. However, the decline in IG spreads versus Canadian government bonds suggests government bonds may offer the best relative value.
Chart 5: Canadian energy equities and High-Yield credit trump Investment Grade corporate performance since Covid
Source: FTSE Russell, LSEG, as of May 15, 2024, total return, in Canadian dollar terms. Please see the end for important legal disclosures.
1. Statistics Canada. Canada Industry Classification System (NAICS). Table 36-10-0434-06; Gross domestic product (GDP) at basic prices, by industry, annual average, industry detail (x 1,000,000): Gross domestic product (GDP) at basic prices, by industry, annual average (statcan.gc.ca). Please note that Aggregates are not always equal to the sum of their components. At the lowest level of detail, it may not be possible to produce a homogeneous series from 1997 to the present. Only industries and certain aggregates that provide good continuity back to 1997 have data from 1997 to 2006. Effective November 30, 2023, the data is presented on a 2017 reference year basis.
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