It’s pretty clear now why the Bank of Canada (BoC), in its December 8 interest-rate policy statement, suggested that a rising loonie “could act as a significant further drag on growth,” a softening of the warning that a stronger currency would “more than offset” progress toward economic recovery: Statistics Canada reported two days later that the country generated a trade surplus in October.

To the surprise of most analysts, and after four consecutive months of net deficits, Canada posted positive net exports of CAD428 million. Rising exports to the US accounted for three-quarters of the increase despite the relative strength of the loonie versus the greenback. StatsCan reported increases in both shipments of and prices for gold and energy.

Exports of precious metals, primarily gold, surged 34 percent to a record CAD1.3 billion in October. Canada also benefited from higher shipments of copper ores and other non-metallic minerals. Energy sales rose 6.5 percent to CAD6.8 billion because of higher prices.

As was the case during the 2002-08 expansion, people are buying Canada’s stuff; not the high-value-added stuff, but the stuff that comes out of the ground, oil and gold, and, critically, at higher prices. And this is the stuff of Canada’s future economic growth. Commodities prices are established according to international–not just North American–markets. Although there’s still a lot of work to do to expand direct trade with Asia, particularly China, that doesn’t mean Canada can’t benefit from the impact on global demand emerging economies continue to exert.

Contrary to conventional wisdom, export growth, strictly speaking is not the key to Canada’s recovery. Rather, as Stephen Gordon, a professor of economics at Laval University in Quebec City and proprietor of Worthwhile Canadian Initiative, has argued, self-sustaining growth, at least according to recent experience, is more a question of the price commodities fetch in the global market than it is about the volume and value of manufactured goods.

The gist of the argument is this. An increase in net exports is sufficient–if all other variables that comprise aggregate demand stay the same–to support growth, but it isn’t necessary. And, as the data covering the 2002-08 period suggest, it’s more efficient for Canada to sell its oil and gold on the international market than it is to prop up a high-value-added and therefore labor-cost-intensive manufacturing industry. Professor Gordon explains:

In the early 1990s, commodity prices fell, and the only way for us to obtain the imports we wanted was to shift workers to the manufacturing sector, and to increase the value-added of exports. But devoting more of our productive capacity to making things that are to be consumed by foreigners isn’t a path to prosperity, and workers’ real buying power stagnated.

 In 2002, commodity prices rose, and we were able to get the imports we wanted with fewer productive resources allocated to the export sector. The expansion of 2002-2008 was characterised by a shift out of export-oriented manufacturing, and these workers were able to produce more for domestic consumption. Exports stagnated, but real incomes increased.

In this context, the idea that “Canada will need a thriving export industry to maintain stronger growth rates” seems rather odd. I don’t see how paying more for imports is going to make us better off.

In the context of the rhetorical battle between those who observe a change in the composition of the Canadian economy, toward energy-and-resource-led exports and a service-intensive domestic economy, against those who hold fast to the notion that high-value-added “manufacturing” is the key to economic revival, the BoC’s new phrasing is no small shift.

Naturally Speaking

ExxonMobil’s (NYSE: XOM) USD31 billion acquisition of natural gas producer XTO Energy (NYSE: XTO) has sparked a speculative frenzy in the energy space as traders try to zero in on potential targets. Various specific names have been tossed about, including EnCana Corp (TSX: ECA, NYSE: ECA), a competitor of XTO’s and Canada’s largest player in a reviving North American gas market.

Enthusiasm for natural gas is also reflected in the fact that ARC Energy Trust (TSX: AET-U, OTC: AETUF) was able to raise CAD252 million in a bought-deal issuance of 13 million new trust units. ARC had announced plans to raise CAD200 million on 10.3 million units, but “strong investor demand” led to an increase in the size of the offering.

ARC is using the proceeds to fund the acquisition of a general partnership that holds tight oil and gas properties in the Ante Creek area of northern Alberta’s Montney formation. ARC has a significant presence in the area; it’s drilled more than 125 wells and generates more than 5,000 barrels of oil equivalent per day (boe/d) there. According to ARC, the acquisition will boost production by approximately 2,000 boe/d and its undeveloped land holdings by approximately 20 percent. The new assets comprise an estimated 12.6 million boe of proved plus probable reserves.

Meanwhile, Andrew Willis of the Toronto Globe and Mail reports that Canadian Oil Sands Trust (TSX: COS-U, OTC: COSWF) may have a little competition for ConocoPhillips’ (NYSE: COP) 9 percent stake in the Syncrude venture. Willis writes that “one or more one or more public sector pension funds” is negotiating with ConocoPhillips for a stake in the oil sands that could be worth up to CAD4 billion.

The Exxon/XTO and ARC deals highlight the vast potential unleashed by new discoveries in North America. The idea that natural gas could be the environmentally and economically friendly alternative that spurs reindustrialization in the world’s largest energy market isn’t so far-fetched. At the same time, the rumored battle for 9 percent of Syncrude suggests appetite for long-life assets that produce steady cash flow is still strong–and that there has to be a fossil-fuel bridge to that cleaner-burning future.

Names How They Rate’s Oil and Gas section rallied across the board on the news of Exxon’s offer, which represents a 25 percent premium to XTO’s December 11 closing price.

Exxon, because it’s so big, has to make big acquisitions to generate growth. This naturally limits its potential field of targets. This doesn’t mean, however, that other players won’t look to consolidate.

As our colleague Elliott Gue noted in a Flash Alert to Energy Strategist subscribers yesterday, the Super Oil has enough cash to pay straight-up for XTO, but it offered 0.7098 of its common shares for each share of the target. Though credit is rather cheap these days, and would be particularly so for a company of its ilk, Exxon chose not to finance the USD41 billion purchase. It did assume USD10 billion of XTO debt as part of the USD41 billion transaction cost, which it’ll probably carry for some time.

What this deal is likely about, as Elliott posits, is the direction of natural gas prices, and that bodes well for all North American producers.

Battle of the Bully Pulpits

Barry’s the hammer…and Barry’s the nail:

Of all the critics out there on this issue, none is more important, accurate and credible (present company included) than Volcker. He is The Man on these issues: Make banks smaller, make them accountable, don’t engage in moral hazard, do not reward reckless speculation. If they are too big to fail, then they are too big.

If the President were nearly as smart as advertised. he would jettison the dynamic duo in favor of Volcker’s prescriptions. He is the only politician/banker who is not afraid to prescribe foul tatsing but effective medicine . . .[sic]

Unless and until President Obama ditches Geithner and Summers and replaces them with Volcker, all the name-calling only makes him a hypocrite.

The Roundup

Activity in the energy space, specifically the natural gas market, is clearly heating up. A bullish inventory report from the Energy Information Administration last week and ExxonMobil’s (NYSE: XOM) USD41 billion move on XTO Energy (NYSE: XTO) has clearly attracted a lot of investors.

A lot of attention will fall on US-based unconventional natural gas plays, those with exposure to the various shale plays, the Barnett in Texas, the Marcellus in Pennsylvania, the Haynesville in Louisiana.

But there are other unconventional plays in North America, specifically the Montney resource straddling the Alberta/Saskatchewan border. ARC Energy Trust (TSX: AET-U, OTC: AETUF) has clearly made its presence known in the region, and Advantage Oil & Gas (TSX: AAV, NYSE: AAV) took radical steps to make sure it had the resources to properly exploit its opportunity there.

We’ll be taking a deeper look at the Oil and Gas names in the CE coverage universe, specifically with regard to a reviving North American natural gas market, in a coming feature article.

Conservative Holdings

Innergex Power Income Fund’s (TSX: IEF-U, OTC: INRGF) 49.9 megawatt (MW) Ashlu Creek run-of-river hydroelectric power generating is now in commercial operation after successful completion of its performance tests. Innergex now boasts 145 MW of installed run-of-river capacity, an increase of 53 percent. CEO Michel Letellier forecast that Ashlu Creek would add CAD18 million to annual revenue and CAD15.1 million to operating profits.

According to a company press release, the new facility will supply enough electricity for 24,000 homes each year. By comparison, an equivalent-sized coal-fired power plant releases approximately 219,000 tons of carbon dioxide, while Ashlu Creek is emission-free.

The power plant was built at a cost of CAD138 million. Its production is covered by a 30-year power purchase agreement with BC Hydro. The project will also benefit from the Canadian federal government’s ecoENERGY initiative, which offers a CAD10 per megawatt-hour incentive for the first 10 years of operations. Innergex Power Income Fund is a buy up to USD12.

Aggressive Holdings

Enerplus Resources Fund (TSX: ERF-U, NYSE: ERF) forecast fiscal 2010 average production of 37,000 barrels per day (bbl/d) of crude oil and natural gas liquids (NGL) and 294 million cubic feet per day (MMcf/d) of natural gas. The total production of 86,000 barrels of oil equivalent per day (boe/d) is about 2 percent below the 2009 rate of 88,000 boe/d. Management expects crude and NGL production to rise throughout 2010 and represent approximately 45 percent of exit rate volumes. Enerplus Resources Fund is a buy up to USD25.

Oil and Gas

Advantage Oil & Gas (TSX: AAV, NYSE: AAV) is issuing CAD75 million of 5 percent convertible unsecured debentures on a bought-deal basis through an underwriting syndicate led by RBC Capital Markets. If the syndicate exercises its over-allotment option Advantage will see net proceeds of approximately CAD86 million, cash it will use to pay down existing debt and for general purposes.

The CAD1,000 face value debentures mature Jan. 31, 2015; they’re convertible into common shares at the option of the holder at a conversion price of CAD8.60 per common share. Advantage can’t redeem before Jan. 31, 2013.

The new capital raise comes on the heels of management’s update on progress at Advantage’s Montney shale operation; a new horizontal well is producing at rates well ahead of what test runs suggested was possible. As work progresses at Montney Advantage is seeing greater and greater efficiency–i.e. higher production and lower cost.

The next step is expanding the infrastructure supporting the drilling activity; existing facilities and gathering systems are currently at capacity. Advantage Oil & Gas is a buy up to USD7.

Electric Power

Boralex Power Income Fund (TSX: BPT-U, OTC: BLXJF)–validating its place on CE’s Dividend Watch List–will pay one final installment on its CAD0.70 annualized distribution rate before cutting the payout to CAD0.40 on a yearly basis. Boralex will pay CAD0.05833 per unit on Jan. 21, 2010, to unitholders of record as of Dec. 31, 2009.

The new, lower rate will kick in with the distribution to be declared in January and payable in February 2010. Boralex will save about CAD18 million a year because of the reduction, which will allow it to maintain a steady distribution “for several years.”

Management cited “the uncertainty of the forest industry’s future” as the underlying cause of the reduction as well as the appreciation of the Canadian dollar against the US dollar. This decision, it said, “is the most conservative in the circumstances.” Boralex Power Income Fund remains a buy up to USD5.

Gas/Propane

Consumers’ Waterheater Income Fund’s (TSX: CWI-U, OTC: CSUWF) prospects look much brighter after a bill that would address the many concerns associated with the provincial government’s smart metering program and the federal Green Energy Act received first reading in the Ontario legislature. The law would permit individual suite sub-metering in prescribed apartment buildings and condominium complexes in Ontario, good news for Stratacon, the sub-metering business Consumers’ acquired in August 2008.

The strong rally in the unit price on this news is a good opportunity to get out of Consumers’ Waterheater Income Fund if you haven’t already.

Real Estate Trusts

Dundee REIT (TSX: D-UN, OTC: ) is buying Adelaide Place, a 655,000 square foot office complex in the financial district of Toronto for CAD211.5 million. Dundee is issuing 4.8 million units on a bought-deal basis at CAD18.75 per for gross proceeds of CAD90 million; if the over-allotment option is exercised by the underwriting syndicate proceeds will be CAD103.5 million. Dundee REIT is a hold.

InnVest REIT (TSX: INN-U, OTC: IVRVF) is issuing, on a bought-deal basis, CAD50 million of 6.75 percent convertible unsecured subordinated debentures due March 31, 2016. The debentures are convertible at the holder’s option into InnVest units at CAD5.70 per.

The REIT will use the proceeds “to repay indebtedness and for general trust purposes.” InnVest REIT is a sell.

Financial Services