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Michael McDonald

Michael McDonald

Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…

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What Are The Long Term Effects Of The Oil Crash For Canada?

What Are The Long Term Effects Of The Oil Crash For Canada?

It should come as no surprise that the oil price crash has hit Canada particularly hard. Much of the Canadian economy’s strength in the last few years was built around the export of commodities and production of oil. The fall of China hobbled the first leg of the Canadian economy, while the oil price crash has hammered the second. The Bank of Canada recently offered new evidence supporting that view.

According to Deputy Governor of the Bank of Canada Lynn Patterson, Canadians should not expect oil prices to exceed $100 a barrel again any time soon, and the pain from the oil price crash will radiate across Canada. In particular, Patterson noted that while income and wealth losses are going to be greatest in oil producing regions like Alberta, those effects are going to spread as the knock-on impacts of lost income hurt businesses in all sectors of the economy. Related: U.S. Oil Supply To Fall Faster Than Expected

Patterson estimates that it could take an additional two years for the effects of the oil price crash to work their way through the economy, and that once they do, energy exports will represent roughly 40 percent of Canada’s total exports versus around 50 percent in 2014. Those expectations likely figured strongly in the Bank of Canada’s growth estimates of 1.5 percent GDP growth in 2016 and 2.5 percent in 2017.

On the whole, the oil price crash has reduced Canadian income by about $1,800 per capita. That is, economic damage has been so significant that the country has already seen almost $2,000 of wealth evaporate for every man, woman, and child across the country. Oil investments accounted for 56 percent of total investments in Canada in 2014, and the damage to the Great White North has already knocked roughly 1 percent off of GDP. Roughly 70,000 jobs have been lost in the three main energy producing provinces of Alberta, Saskatchewan, and Newfoundland and Labrador which in turn pushed the jobless rate up by 2-3 percent. Related: Saudi Arabia Steps Up Drilling Despite Downturn

These negative effects already appear to be largely baked into the price of Canadian stocks. The iShares MSCI Canada index ETF has fallen by more than 20 percent from its highs in late 2014 even after a modest rebound in the last month. Canada’s economy is in far better shape to weather the storm than some other major oil producing nations, but the pain is still palpable.

Fortunately for Canada, the country has a diversified economy, which is helping to stabilize the overall economy to some extent. The loonie has already weakened considerably as FX markets anticipated the impact of weaker commodities prices on the Canadian economy, and that in turn is providing a boost to other sectors like tourism, movie production, and non-commodity exports. Related: Why India Matters More For Oil Than China

The rebalancing economy also reveals an important dark side to the oil boom: crowding out of non-oil investments. When oil extraction works, it is often so profitable that it leads to enormous inflows of investing dollars to the energy sector. While that is good for the sector and jobs in the energy space in general, it does draw investing dollars away from other potential uses. This crowding out effect raises interest rates thus hurting other sectors of the economy that are seeking capital. With oil prices down and the energy sector no longer an attractive investment, interest rates will fall and new areas of the economy should benefit.*

*Note: This is a point of confusion often encountered by non-economists related to interest rates. Many casual observers believe that Central Banks control interest rates. That’s only partially true. Put simply Central Banks exert control over short term interest rates, but long term interest rates and corporate debt rates are driven by economic conditions and supply and demand for funds, rather than by the Central Bank directly.

By Michael McDonald of Oilprice.com

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