14 Dec Oil Prices and the Canadian Dollar
The price of oil has dropped to almost half since June 2014. This is largely fuelled by an increase in manufacturing and global oil inventories, all while there is lower demand for oil due to slowing economies and countries becoming more energy efficient. Recent U.S. data showed crude stocks in storage at an 80 year high. The severe drop in oil prices has made the Canadian dollar one of the worst performing currencies in the world over the past year. Below we take a look at Canada’s dependence on oil and reasons for the correlation between the Canadian Dollar and Oil Prices.
You may be surprised to hear that Canada is one of the most oil-rich nations in the world, second to Saudi Arabia in its amount of proven oil reserves (some sources say third, after Venezuela and Saudi Arabia). Most of Canada’s oil comes from oil sands which require intense processing to extract, meaning it’s more expensive ($60 per barrel breakeven point). The oil sands are considered to be one of the dirtiest forms of raw energy available. In Canada, Alberta holds an approximate 300 billion barrels of extractable oil and with the high oil prices in the past it saw a sharp increase in production. With the liberalization of trade and the globalization of manufacturing, Alberta’s economy has become a keystone in the economic health of Canada.
Just how dependent is the Canadian economy on oil? In 2014 more than half of Canada’s merchandise exports were natural resources ($259 Billion). From this the US accounts for 78% of natural resource exports. Natural resources make a significant economic contribution to Canada. In 2014 1/3 of total GDP in Alberta, Saskatchewan, Newfoundland and Labrador, and the Northwest Territories was from Natural resources. In 2014 20% of the Canada’s nominal GDP was accounted for by Natural Resources. Unlike the past Canada has become deeply dependent on exporting natural resources as a source of revenue. However, with the falling oil prices this has caused a great loss in revenue and the prices today isn’t even close to the breakeven point to extract the oil (approximately $60 to $80 per barrel).
The fall in oil prices is forcing billions of dollars in spending reductions in Canada’s oil and gas industry. Moody’s recently predicted that very few of the 18 proposed LNG projects in Canada will be constructed. Most of them are expected to be canceled. In 2015 the oil industry is expected to lose 37% of its revenues, or a fall of $43 Billion CAD. This is bad news for our overdependence on oil and gas and results in the falling of the CAD.
Looking at Canada’s non-energy trade over the last couple decades paints an unattractive picture. Canada’s non-energy trade fell into a deficit since 2006 and has been falling ever since. In March, Canada had a trade surplus of $3.02 Billion if we include energy, but if we remove energy and look at the Non-energy trade there is a deficit of as much as $7.3 billion. This is close to the biggest gap we have on record.
The federal bank is hoping the lower loony will help increase exports and Canada’s manufacturing. However it will take some time for the weaker currency to have a sizeable impact on trade. To close the deficit we would have to have exports rise by nine per cent which is very unlikely. Part of the problem is that Canada does not have as much to sell to the world as it used to, thanks to that growing reliance on oil. Economist Tyler Cowen from George Mason University suggests that Canada is being left behind in the 21st century’s “knowledge economy”.
Diversification is the key but can only be achieved over the longer-term. In the near term Canada’s fate is tied to the price of oil. A lack of a rebound in oil prices will have a disastrous impact on the Canadian economy with decline in demand for supporting services. As there are no sign of oil prices recovering the worst may yet to come. On a positive note, the lower oil prices will in effect force Canada to diversify its economy which in the long run may be a blessing for Canada.
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