Oil rout impacts the Canadian economy

Canada , Energy , Oil Jan 22, 2015 No Comments

Oil rout impacts CanadaA new Conference Board of Canada report released today at the Oil and Gas Summit 2015 in Calgary estimates Canada’s economy will suffer a 0.4 per cent hit to growth this year. Lower oil prices will have sharply differing effects across Canada’s regions and industries.

The Canadian dollar fell to its weakest in five years Tuesday on speculation the more than 50% drop in oil prices since June would lead to sharp economic revisions by the central bank.

In a shock move, the Bank of Canada cut its benchmark interest rate on Wednesday to counter the effects of cheaper oil on economic growth and inflation and help guard against the risks of a housing market downturn.

The bank cut its rate on overnight loans between commercial banks by a quarter point to 0.75%, a decision none of the 22 economists in a Bloomberg News survey predicted. The rate, which influences car loans and other lending rates across the economy, had been at 1% since September 2010, and was last cut in April 2009. The decision marked the first time the rate budged at all since September 2010 when the central bank raised it by a quarter point to one per cent.

Oil prices have plunged to five-and-a-half-year lows amid soaring production from U.S. shale and sluggish demand, a situation compounded by OPEC’s refusal to cut output. Instead, members of the producing club are boosting production, adding to supply pressures: Iraq pumped a record four million barrels a day in December, the country’s Oil Minister said over the weekend, and U.S. production has so far not ebbed.

In recent months, forecasts for the Canadian economy have gone out the window in the wake of the huge shift in the energy picture. Until the effects of oil‘s late-2014 tailspin started to trickle through, Canada appeared to be on the cusp of a promising post-recession rebound — and inching closer to a rate hike. “The drop in oil prices is unambiguously negative for the Canadian economy,” governor Stephen Poloz said.

Oil extraction accounts for about 3 per cent of Canada’s total economic output (GDP) while crude represents about 14 per cent of exports. But the sector is intertwined with several areas of the economy, helping to support regional housing markets and services that feed into oil development.

The oil rout has thrown long-term growth prospects across much of Canada’s energy industry into neutral, forcing producers to cut deeply into 2015 spending plans and others to delay investments in new projects. Oil companies will slash $23 billion from their capital spending in Western Canada this year as a result of lower oil prices, a move that will shave about 65,000 barrels a day in 2015 and 120,000 barrels a day from expected production in 2016, the Canadian Association of Petroleum Producers said.

Oil sands production this year will reflect investment decisions five or ten years ago, the CAPP said. Some companies have announced delays to oil sands projects, including Suncor Energy of Canada and Total of France, but the developments that are being postponed would have come on stream in late 2016 at the earliest. CAPP President Tim McMillan said the effect of delayed oil sands investment will likely become apparent in two or three years. CAPP will release another forecast in June with more detail on the long-term impact of falling oil prices.

“Business investment in the energy-producing sector will decline. Canada’s weaker terms of trade will have an adverse impact on incomes and wealth, reducing domestic demand growth,” the central bank said in a statement accompanying the rate reduction. “Although there is considerable uncertainty around the outlook, the Bank is projecting” the economy “will slow to about 1.5 per cent” in the first half of 2015, Poloz said in the statement. For 2015 as a whole, however, the bank predicts growth of 2.1 per cent. Previously, the bank had expected growth of 2.4 per cent this year. He added, “The negative impact of lower oil prices will gradually be mitigated by a stronger U.S. economy, a weaker Canadian dollar, and the bank’s monetary policy response.”

One of the complications of using interest rates to stimulate an economy is that it encourages people to borrow, leaving an overhang of high-cost debt when interest rates inevitably rise again. Low rates also drive up asset prices, including the price of houses and stocks, disproportionately benefiting the owners of capital and increasing the rich-poor divide. “The maximum effect of a change in interest rates on output is estimated to take up to about one year, and the maximum impact on consumer price inflation takes up to about two years,” says the Bank of England report How Monetary Policy Works.

The International Monetary Fund lowered its forecast for global economic growth, helping trigger a 4.7 per cent drop Tuesday in the price of North American crude, which closed at $46.49 a barrel Tuesday. The IMF also cut its forecast for Canada.

Veteran oil forecaster Martin King expects crude prices to fall further before a gradual increase later this year. The FirstEnergy Capital commodity analyst provided an update on his forecast for oil this year during a presentation in downtown Calgary on Tuesday morning. He said he expects the price of crude to average $54.50 US a barrel in 2015 and $67.20 in 2016.

Pascal Blanc

Pascal has implemented numerous software solutions in the areas of procurement, sourcing, spend management, supplier evaluation and performance. His clients include Fortune 500 companies in Europe, Asia and North America. He is a co-founder of Source & Procure.

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