Oil Prices and the Canadian Economy

Commentary, Energy, Elmira Aliakbari

Back in 2010, soaring oil prices and the accompanying appreciation of the Canadian dollar was perceived by some to be a major problem for the Canadian manufacturing sector. People argued that our economy suffered from a “resource curse”- a phenomenon where a resource boom and its resulting currency appreciation damage the manufacturing sectors and economic growth, as the currency appreciation would make exports more expensive and less competitive. Based on this view, surging oil prices were interpreted as a serious threat that would put the economy in jeopardy.

In June 2014, as oil prices started plummeting due to an oversupply of oil in the market, many claimed that sliding prices and the associated depreciation of the dollar were threatening to the Canadian economy. They argued that plunging oil prices reduce investment in the energy industry and consequently reduce oil production and exports. This hampers the Canadian economy because oil and gas are two key contributors to Canadian economic growth. In addition, the rapid depreciation of the loonie increases the cost of imported goods, leading to a loss of purchasing power for Canadian consumers.

So which is it? How can rising oil prices be bad for the economy, then a few years later, falling oil prices also be bad for the economy?

The truth is that oil price fluctuations have both positive and negative effects that vary across different sectors and different provinces. While oil producing companies in Alberta are grappling with slashed budgets and declining profits due to the recent oil slump, some manufacturing companies in Ontario are poised to benefit due to cheaper fuel and more competitive export terms. Tumbling oil prices should be advantageous for energy consuming sectors such as airlines, the auto industry, and transportation providers. Air Canada and WestJet both obtained higher profits in 2015 due to the reduced cost of jet fuel, though WestJet has suffered due to declining consumer demand in its western base.

Lower gasoline prices have also induced more demands for cars, especially for SUVs, minivans, and trucks, which benefits the North American auto industry. Also, in contrast to those oil and gas companies that only engage in exploration and extraction, refineries may benefit from dipping prices, as crude oil constitutes their major input costs. In addition, the lower loonie would be beneficial for Canadian exporters since it makes Canadian products cheaper than US ones, leading to a transfer of production activity north of the border.

The fall in the oil prices also affects the US economy, which is the largest market for Canada. Despite the United States’ boom in the shale industry and its massive expansion of oil production, it is still the world’s biggest consumer of oil and a net importer. Hence, sliding oil and gasoline prices should have a positive net effect on US economic growth. As with many Canadian businesses, US businesses also now enjoy lower costs of production due to reduced energy prices. Compounded with the lower loonie, which enhances competitiveness of Canadian exporters, a stronger US economy and higher US demands would boost Canadian economic growth. In 2015, a report released by RBC economists argued that the positive impacts on the Canadian economy due to lower oil prices could outweigh the negative effects. Therefore, we can expect that the Canadian economy, overall, could benefit from the slumping oil prices.

While plunging oil prices can eventually generate positive net effects for the Canadian economy, the negative consequences currently appear to be a larger factor, especially out west. But this should not lead us to assume that a new round of oil price increases would be a good thing overall. In fact, if the price of oil were once again to begin soaring, it would surely not be long before some observers begin warning that rising oil prices are bad for the economy. As is the case in a period of declining prices, oil price fluctuations create both winners and losers; but for now we should expect that lower oil prices will eventually yield positive net effects for the Canadian economy as a whole, though economic solutions for oil-producing provinces must be pursued in order for Canada to benefit as a whole.