Let’s Talk About Oil-conomics…

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2020 hasn’t been very kind to us, has it? And we’re not just talking about public health, but also from an economic perspective. That is because recently, we’ve had another major problem; global oil prices. They fell around 30% on Monday amid production disagreements between Saudi Arabia and Russia.

It’s a new, unwelcome problem for the global economy. But for Canada, this is especially serious.

Oil markets recently crashed in their biggest one-day drop since 1991, as Saudi Arabia and Russia are determined to increase production after failing to reach an agreement to curtail supply in order to prop up prices.

“We’ve seen a number of oil shocks,” BMO chief economist Douglas Porter said. But, he added, “I must say this one is quite abrupt.” The last time oil prices dived that low was the crash of 2014-2015. Back then, he remembers, “we certainly saw the Alberta economy suffering a huge way.”

“It’s bad news for the Alberta economy on the whole,” said Nick Falvo, a research associate at Carleton University. “With this recent drop, I think people will be starting to say the R-word and they would not be foolish in suggesting that.”

Canada’s energy sector felt the immediate effects of the drop in the price of crude oil. The stock prices of producers Suncor Energy Inc. and Canadian Natural Resources Ltd. were both down 20 to 25%.

“For now, the impact on oil production in Alberta’s oil patch looks likely to be more contained than in the U.S. shale-oil fields, which account for 80% of U.S. output growth,” said Rene Santos, manager of North America supply analytics at S&P Global Platts.

While the lower oil prices could make a number of new U.S. shale-oil developments uneconomical, the impact on Alberta’s producers will be more limited, Santos predicted. That’s because the province doesn’t have many new projects slated to come online in the near term.

“What is good for Canada is that the oil sands have a very steady production,” Santos said.

Oil-price drops are more likely to affect new energy projects that are nearing completion. For existing projects in the oil sands, current production levels should continue for the most part, barring a further, steep drop in prices, Santos said.

“With supply ramping up at the same time as coronavirus-related demand losses reach their maximum, the short-term floor to oil prices is extremely weak,” Standard Chartered said.

Alberta’s recent spring budget had forecast West Texas Intermediate will average $58 a barrel in the coming year. Falvo said this should be a wake-up call for Alberta to move away from being reliant on oil revenues.

“The Kenney government should be thinking carefully about the advantages of investing in the public sector and the drawbacks of cutting in that sector,” he said. “Given that you can’t change the price of oil, you might want to think about what you can control.”

While the last oil shock was painful for oil-producing provinces, “the rest of country pretty much drove on as if nothing really happened,” Porter said.

In general, low oil prices drag down both interest rates and the Canadian dollar, which stimulates economic activity, Porter noted. Lower interest rates mean cheaper borrowing, while a weak loonie helps boost exports.

This time, however, Canada is also coping with the economic implication of COVID-19, which had already put pressure on global oil prices amid factory shutdowns and reduced travel worldwide.

On March 4, the Bank of Canada cut its trend-setting interest rate by half a percentage point to 1.25% in an effort to soften the economic impact of the outbreak.

Now economists expect Ottawa to step in with fiscal measures. Policymakers should be focused on ensuring the current turmoil “doesn’t morph into a broader downturn for the economy,” Porter said.

Porter added that federal coffers are in fairly good shape compared to other governments.“I’m not particularly worried about a couple of years of big deficits, not when Ottawa can borrow for less than 1% [interest rate].

What the economy needs is a focused, “surgical” intervention, he said.

Finance Minister Bill Morneau sought to reassure Canadians, saying Canada has a “very strong fiscal position” with “a level of debt as a function of our economy that is very low. First and foremost, we are focused on dealing with assuring people that we have our health system strong,” he said.

“We’re also making sure that we tell people we have their backs.”

In his own press conference, Kenney told reporters the challenge to Alberta and Canada “could not be more serious.”

“We are in uncharted territory,” he said, noting that Alberta is “resilient. We’ve gotten through bigger challenges in the past and we’ll get through this one together.”