Category: Economics

Canada’s political environment is really easy to model – whatever is in the best interests of Ontario and Quebec tends to become national policy, irrespective to the impact it has on jurisdictions west of Ontario.

Let’s look at the proposed national carbon tax, which will take the carbon tax from $30/tonne CO2-equivalent in 2020 to $170 in 2030:

2019 – $20/tonne
2020 – $30/tonne (+10)
2021 – $40/tonne (+10)
2022 – $50/tonne (+10)
2023 – $65/tonne (+15)
2024 – $80/tonne (+15)
….
2030 – $170/ton

To put this into context, at CAD$40/ton, a gigajoule of natural gas has a carbon tax of CAD$1.99/GJ applied to it. At CAD$170/ton, that is CAD$8.44/GJ. The AECO market price for natural gas at the moment (note, it is December when there is peak demand) is CAD$2.53/GJ. The projected carbon tax at the end of the decade will be over three times the commodity cost. Needless to say, this puts Canadian companies that rely on natural gas consumption at significant cost disadvantages over jurisdictions that do not impose such taxes (the United States, for one).

Let’s take a look at electricity generation, for example.

On the electricity generation side, we see that 99% of Quebec’s electric generation comes from non-carbon taxed sources – Hydro (94%) and Wind (5%). Ontario’s non-carbon taxed electricity (91%) is Nuclear (57%), Hydro (24%), Wind (8%) and Solar (2%).

Electricity generation is about a third of energy consumption. A really good illustration is provided by the Lawrence Livermore Labs (this was linked to from one of Peyto’s president’s reports):

You can find detailed Canadian data here, albeit not in such a convenient manner.

One issue is that it takes a lot of energy to extract energy (and resources such as iron ore, copper and pretty much anything else in the ground), and of course this puts Alberta, Saskatchewan and British Columbia at a significant disadvantage with this cost regime.

The political aim with this carbon tax continues to be levying a tax that purports to be country-wide, but the impact is concentrated on a regional basis which conveniently happens to be in areas where there is the least support for the ruling party in government.

For those of you that claim there is a corresponding payment to individuals, while this might be true at first, it is performed to get initial acceptance while the proverbial frog boils in the pot. The rebate will be whittled away and eliminated over the coming years in the name of equality. This will come in the form of income testing these “climate action incentive” payments. Eventually the threshold will be lowered to the maximal vote-buying point and any pretense of the tax being “revenue-neutral” will be eliminated, similar to what happened in British Columbia when they dispensed of the notion in 2017. I wrote about the myth of carbon tax revenue neutrality for another publication back in December 2018.

As an example, in British Columbia, it is estimated in the 2020/2021 fiscal year that the carbon tax will raise about $2 billion in revenues, or about $400 per British Columbian. About $300 million in total is estimated to be directly paid back to people (initially called the “Climate Action Dividend” but renamed “Climate Action Tax Credit” as the word “dividend” appears to be dirty with the current BC NDP government) – normally this Climate Action Tax Credit is $174.50/person that earns less than $35,748 (or family income of $41,708), but this was topped up to $218 due to COVID-19. For relation, the median family income in BC is around $90,000.

In terms of the net carbon tax revenue, the $1.7 billion the BC government collects is free for them to do whatever they want. Nationally, it will work the same way, at least for the provinces that do not levy their own carbon taxes.

The decision to raise carbon taxes across Canada does not cost the ruling Liberal party much politically, but will allow them to raise disproportionately high revenues from those areas and enable the redistribution to their vote-friendly base, namely Ontario and Quebec. Such is the nature of politics and power.

There are two standardized mathematical methods of measuring raw performance (non-risk adjusted) and that is time-weighted and dollar-weighted returns. I won’t get into the definitions (go to investopedia for a good primer), but either method is legitimate. Typically funds that have lots of inflows and outflows use dollar-weighted returns, while time-weighted returns allows for an “apples to apples” performance comparison between funds.

Something we almost never question is the unit of measure that we use to evaluate such performance. This is most typically in the currency of the portfolio construction. For Canadians, this is usually in Canadian dollars, although it can be acceptable to use US Dollars as well.

However, is this yardstick, the currency, a correct one? It is very easy to overlook as this core assumption is baked into everybody’s consciousness that the currency is stable. Times are changing, however, where we now have to question the currency we use.

I looked at a couple alternative measures of past performance.

One alternative measure is the portfolio value in relation to the price of gold – i.e. performance in how many ounces of gold you could purchase at quarter-end. Using this metric, despite the fact that I have fared reasonably well in the COVID crisis, I have not done that much better today in relation to gold since the September 2018 quarter. In fact, going back as far as I could with some moderately reliable records, my performance, as strictly measured in gold, for the past 15 years has been about 7% compounded annually (compared to roughly 19% if you use a standard time-weighted return). This is a huge difference in performance – it shows that I am barely treading water.

If I use crude oil as a benchmark, I’m making out like gangbusters.

Another common measure is benchmarking to an index – relating your portfolio performance above or below the overall TSX Composite or S&P 500 is popular. Indeed, when I do my regular performance reports, I include those indices as a benchmark, simply because if I could do just as well (or better) sticking my money in an index fund, there’s no point in me bothering to do any investment research at all (indeed, I’d be adding negative value with every minute spent on investment research!).

I’m always cognizant that my past performance could purely be a function of luck. While depressing to think about, it is a possibility.

Another measure is benchmarking your portfolio to real dollars (instead of nominal dollars). This doesn’t change too much since reported CPI figures are under-reported (typically around 1.5% per year), so I do not consider this a useful measure. However, for marketing purposes, fund managers can claim victory in that most of them will show “your purchasing power will increase” – a 1.5% friction to nominal performance is not too difficult to overcome when central banks are applying a category 4 hurricane tailwind to your portfolio, especially if you invested in Tesla and Nio.

Is using real dollars to benchmark absolute performance correct?

I’d view M2 as a better barometer, as it reflects the fraction of currency that you control of the entire float of currency (that gets created through loans and central bank actions). This represents cash and cash-like instruments at banks. Over the past five years, it (USA) looked like this:

Very roughly, M2 has increased about 6% a year from 2016 to 2020. Going back earlier, we have the following:

We see during the economic crisis that the overall trend did not really change (there was a mild inflection) but during the COVID crisis, it really ramped up. Assuming the year ended today, M2 in the USA has increased by a factor of 24%. Needless to say, this is unprecedented in the past 40 years of financial history.

When applying M2 from 2005 to present, the growth has been about 7% compounded annually. Hence, my “real” performance as measured by USA M2 is about 12%.

Canada (Bank of Canada Statistics) has a similar M2 curve, please forgive my thirty second excel job on this dataset:

While their M2 is only refreshed up to September 1, 2020 (the USA data is updated weekly and is current), Canada’s M2 growth over the past 15 years is roughly 5% compounded. From January 1 to September 1, M2 growth in this year alone has been about 15%.

I generally believe that measuring absolute performance in relation to monetary aggregate growth is a more realistic measure than using CPI. There are still deficiencies using this as a yardstick, but the overall point of this exercise is to use different ways of measuring absolute performance.

Interestingly, if you relate USA M2 to the S&P 500 index, the price index return of the S&P 500 is roughly equal to the growth of the M2 over the past 15 years. The 15 year price return of the TSX Composite has lagged the growth in Canada’s M2 – using this metric, an index investor has barely kept afloat when you factor in dividends.

I deeply suspect we are all doing a lot worse in absolute terms than our nominal and real returns indicate – something to keep in mind when measuring our financial objectives.