The major geographical area of Canada is rich in natural resources like energy, minerals and timber. Amongst all, energy, especially crude oil, contributes most to the prosperity of the Canadian economy. As the 6th largest producer of oil, Canada produces 4.6 million barrels of oil per day (MMb/d), of which exports constituted 3.7 MMb/d and imports being 0.6 MMb/d.[1] [2] The country produces more oil than it imports or consumes; thus, Canada is considered to be a net exporter of crude oil. Provided that the oil and gas industry contribute to around 8% of Canada’s GDP in 2019, oil business, therefore, plays an important role as one indicator of the Canadian economy.[3] In 2014, due to factors like the unprecedented oil production growth in the US and weakened global demand, especially from China’s slower economic growth, the world’s oil price collapsed by over 70 percent to $40 a barrel in January 2016. Despite the gradual recovery to about $60 a barrel, the current price level is 50% under the pre-shock level. As a result, the lower oil price can have material impacts on the Canadian economy through different channels. This paper aims to provide the economic consequences of falling oil prices with empirical evidence supporting the net negative impact on the Canadian economy. The adverse effect of a negative oil shock is transmitted through both the supply and demand channel and demonstrated by major economic factors of employment, exchange rate, trade balance, and government revenue. Corresponding to the worsen Canadian economy, this paper will conclude with the recommended policies to remove the negative externalities or commodity cycle.
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Producer output/capital investment
The fall in oil price negatively affects both the supply and demand sides of the Canadian economy through its effect on producer output and capital investment. Given that 96% of Canada’s oil is produced in the provinces of Alberta, Saskatchewan, and Newfoundland and Labrador, there would be an initial disproportional negative effect in these regions.[4] For example, oil producers, especially the upstream providers, would experience a sharp decline in revenue from the reduced price. In short-run, due to fixed production technologies and capital inputs, oil projects begun before the downturn would be completed. However, oil firms would reduce future investments in new oil projects as lower price decreases the economic feasibility of capital-intensive oil projects. Figures from 2015 showed that the oil industry was expected to lose 37% revenue totalling to CAD$43 billion from reduced production and investments.[5] According to CERI, “every Canadian million dollars invested and generated in the Canadian oil and gas sector, the Canadian GDP impact is CAD$ 1.2 million.”[6] The cutback in oil projects would further tamper Canada’s already weak business investment relative to other economies.[7] Additionally, the lessened profitability discourages not only domestic but also a foreign investment in Canada. Indeed, after the price shock in 2014, many large foreign-controlled international businesses operating in the oil sands have withdrawn their investment and sold their equity shares (reference) as uncertainty increased.The adverse effects spill over to the demand for oil-field related sectors through significant capital expenditure on non-residential tangible assets, particularly in the industrial sectors such as construction and manufacturing.[8] Oil producers would also exert pressure suppliers to reduce price, hence may further reduce their profitability. On the other hand, the lower oil price, as an input cost, would benefit the non-energy sector, especially for those where petroleum constitutes a significant part of operating costs such as the manufacturing, transportation and airline industry. However, the lower energy cost on non-energy producers and consumers only partially mitigates loss in revenue and investment triggered by the oil price decline. As a whole, Canada’s productive capacity and economic growth is weakened through reduced oil-related output, orders and investments.
Employment
The curtailment of oil production and investment in countering the price shock would generate a small net negative impact on the country’s employment growth. The immediate direct impact is in the local oil sector, which contributes to around 205,000 (direct and indirect) jobs across Canada [Fact 5]. According to CERI report, “every direct job created in the Canadian oil and gas sector, two indirect and three induced jobs in other sectors are created in Canada on average” [Fact 6]. Hence the scale back in operational spending and cost-cutting would result in the layoff of workers in both the oil and oil-related sector. This would increase the unemployment rate mostly in the oil-related region, however, given that the oil sector is one of the least labour-intensive industries in Canada, the job loss’s effect on the Canadian economy is less severe than other economic factors. Meanwhile, additional jobs would be created in the non-energy sector, especially for an industry that is more energy-intensive like airlines and transportations, as they benefit from lower input costs. Industries that depend on consumer spending, such as retails and wholesale, would also enjoy higher profitability aside from lower oil cost, as consumers have additional discretionary income from lower fuel costs. Overall, despite job creations in other regions and sectors, the weakened growth from falling oil prices in the energy sector leads to a negative impact on employment in Canada in the subsequent years of the oil shock.
Exchange rates
Due to the importance of oil as a commodity in the Canadian economy, the decline in oil prices would result in depreciation of the USD/CAD exchange rate. Given that the majority share of crude oil are exported to the US, with a share of 96% in 2018, the reduction in price greatly reduces the inflow of foreign currency into Canada.[9] The depreciation in the exchange rate would, in turn, benefit Canadian exports as it increases its international competitiveness in terms of a lower relative price converted from the Canadian dollar. Due to the high dependency of the Canadian economy on the US, most of the increased demand from currency depreciation would come from the US. This would most benefit the Canadian manufacturing sector due to its export-oriented nature. The boost in US consumer’s disposable income form lower oil prices would then have a positive impact on the demand side for Canada. However, for Canadian consumers and businesses, this would increase their cost for foreign imported goods and services, which would reduce their income. Overall, the depreciation of the exchange rate would positively contribute to the exportable sector of the Canadian economy from the increase in foreign demand.
Academic references:
Carbone, J.C., & Mckenzie, K.J. (2016). Going Dutch?: The Impact of Falling Oil Prices on the Canadian Economy. Canadian Public Policy 42(2), 168-180. https://www.muse.jhu.edu/article/626785
ELDER, J., & SERLETIS, A. (2010). Oil Price Uncertainty. Journal of Money, Credit and Banking, 42(6), 1137-1159. Retrieved March 4, 2020, from www.jstor.org/stable/40784879Al-zyoud, Hussein & Wang, Eric Zengxiang & basso, Michael. (2018). Dynamics of Canadian Oil Price and its Impact on Exchange Rate and Stock Market. International Journal of Energy Economics and Policy. 8
Sek, S.K., Teo, X.Q., & Wong, Y.N. (2015). A Comparative Study on the Effects of Oil Price Changes on Inflation.
Plourde, A. (1987). The Impact of $(US)15 Oil on the Canadian Economy: Evidence from the MACE Model. Canadian Public Policy / Analyse De Politiques, 13(1), 19-25. doi:10.2307/3550539
[1] https://www.capp.ca/economy/canadian-economic-contribution/
[2] https://www.nrcan.gc.ca/science-data/data-analysis/energy-data-analysis/energy-facts/crude-oil-facts/20064
[3] https://www.fraserinstitute.org/sites/default/files/assessing-canadas-energy-sector-competitiveness.pdf
[4] https://www.nrcan.gc.ca/our-natural-resources/energy-sources-distribution/clean-fossil-fuels/crude-oil/oil-supply-demand/18086
[5] https://money.cnn.com/2015/04/13/investing/canada-economy-trouble-low-oil-price/
[6] https://www.nrcan.gc.ca/sites/www.nrcan.gc.ca/files/energy/energy-resources/CERI_Study_166_Full_Report.pdf
[7] https://www.fraserinstitute.org/studies/business-investment-in-canada-falls-far-behind-other-industrialized-countries
[8] https://www150.statcan.gc.ca/n1/daily-quotidien/170228/t001c-eng.htm
[9] https://www.nrcan.gc.ca/science-data/data-analysis/energy-data-analysis/energy-facts/crude-oil-facts/20064
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