Thursday, January 22, 2015

Oil, Interest Rates, and the NHL

Global economies are in turmoil. Central banks around the world are printing currencies to try to jump start demand from consumers and spur economic activity. Those same central banks are trying to stimulate inflation while desperately fighting deflation that has been precipitated by falling oil prices. Surprisingly, some of those central banks, most recently the Bank of Canada, have cut interest rates to try to create more economic activity.

What do sluggish economies, falling oil prices and interest rates, and deflation have to do with our beloved hockey game?

A lot more than you would imagine.

And most of it is not good.

Let's start with some basics.

Deflation is simply a persistent decline in prices. Deflation can be caused by a decline in government, personal, or investment spending. A protracted period of deflation results in falling profits for businesses, which can lead to shrinking employment and income levels and business closures. Central banks can fight deflation by printing their currency (the Quantitative Easing programs are the current example) and lowering interest rates to stimulate economic activity and demand.

Printing currency and lowering interest rates dramatically (as most Central Banks have done) can devalue the local currency relative to other currencies.

When the Bank of Canada lowered their interest rate on overnight loans to Canadian banks, the effect was immediate and dramatic. The Canadian dollar fell against the U.S. dollar immediately. The Canadian dollar was worth .84 U.S. dollars the day before the rate cut. The day of the rate cut, the exchange rate fell to .80 to the U.S. dollar.

Part of the concern about deflation has been due to the precipitous fall in oil prices. On October 1, 2014, the price per barrel of crude oil was $90.73. It closed on January 22. 2015 at $46.31.

Now we all like paying less at the pump when we fill up, but the impact of these low oil prices is far reaching and negative.

The energy sector is an important component of most global economies. In Canada, it accounts for approximately 11% of Gross Domestic Product (GDP). The decline in oil prices is deflationary and will lead to lower capital investment and employment in that sector. The Canadian Association of Petroleum Producers estimates that capital spending in the energy sector will decline 33% in 2015. The effect of lower energy prices (and consequently lower income to the energy industry) will cause GDP in Canada to decline to 1.5% in the first half of 2015, according to the Bank of Canada, and will shave .4% off annual GDP to 2.1%.

That forecast presumes that oil will rise back to $60 per barrel.

According to the Bank of Canada, the effect of lower oil prices will be "unambiguously negative" on the economy of Canada.

To be sure, a weaker currency can have some positive effects.“When our dollar falls, the cost of our inputs increases,” said Trevor Welch, president and general manager of Textile Manufacturing Co. Ltd., a Toronto-based producer of braided goods such as skate laces and cords for clothing such as hoodies.

“The upside is that when it comes time to sell our goods internationally, we are more competitive—at least in the U.S. market,” Mr. Welch said. That market accounts for 10% to 25% of the company’s sales, depending on the year, he estimates.

In general, though, a weaker currency, is negative for a local (national) economy.

So what does this mean for the game of hockey?

The sluggish Canadian economy and policy decisions have significantly weakened the Canadian dollar. At the start of the season, the Canadian dollar was trading at .90 Canadian dollars to the U.S. dollar. As mentioned, it is now at .80.

We all know that contracts for the Canadian hockey teams are paid in U. S. dollars. So a falling Canadian dollar means that more of the revenue that Canadian hockey teams generate have to be allocated to paying the players currently under contract.

This is important to the economic landscape of hockey since the Canadian teams make significant contributions to the revenue pool for revenue sharing purposes.

The most profitable hockey franchise is the Toronto Maple Leafs, showing operating income of $70.6 million according to Forbes. Their current salaries total $75,109,000.

With the decline of the Canadian dollar from the start of the season to the present, the Leafs now pay out an additional $7,510,900 from their operating revenues to effectively make up for the decline in the Canadian dollar on an annual basis (yes, I know I am using annual numbers and the decline in the Canadian dollar was not in effect for the full year, but the example illuminates the point).

Not quantifiable but equally important is the general decline in economic activity not only in Canada but the U.S. It will probably not have a significant impact in this season, but the longer this sluggishness persists, the more it  will affect sponsors (especially the small and mid size companies that support local teams) and individual ticket buyers.

A lengthy period of Canadian dollar weakness will ultimately have a negative effect on league revenues, which in term will impact the salary cap and each team as more dollars of operating revenue are used to pay salaries.

For hockey fans, our world revolves around the sheet of ice and our favorite team.

Unfortunately, the outside world and its weak economies are intruding on our world like a Zac Rinaldo hit.

And it's not pretty.

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