SIM REPORT: North America, Issue 5

CANADA: Oil price plunge likely to hurt major sector, hamper investment

On 8-9 March, global Brent Crude prices dropped approximately 20 per cent amid increasing global concern over the economic impact of coronavirus (COVID-19) and an escalating dispute between Saudi Arabia and Russia over proposed oil supply constraints. Amid a backdrop of slowing global economic activity as countries across the world impose travel restrictions in an effort to halt the outbreak of COVID-19, OPEC’s Saudi Arabia and Russia failed to reach an agreement on production caps, prompting the kingdom to hike crude output and lower prices. The move triggered a similar response from Moscow. The drop, which took oil prices as low as USD34.36 per barrel, marked the largest one-day price fall since the Gulf War in 1991.

The sharp decline in crude prices has a particularly acute impact on the western Canadian province of Alberta, which is responsible for approximately three-quarters of the country’s oil output. Around one-quarter of Alberta’s economic output comes from extractive industries, with its largest city Calgary being a major hub for energy firms. The decline in prices also has a significant effect on the economies of Saskatchewan, Newfoundland and Labrador provinces, which also have sizeable oil industries.

The sudden price drop has a major effect on both commercial operations and government spending. Energy firms operating in Canada’s oil sector can expect a sharp decline in revenues, thereby reducing profitability. This, in turn, disincentivises investment and will likely lead to reviews of spending plans, halts to new projects, and worker layoffs impacting the 270,000 people employed directly in the country’s energy sector as well as the thousands more in jobs reliant on the energy industry. The price decline, however, will have variable impacts on corporates; while low-cost producers with strong financial hedges in places, which guarantee higher prices, will likely fare relatively strongly, less-efficient firms are likely to lose competitiveness and may therefore lower production in order to reduce losses, else face collapse. The impact to producers, however, will be slightly offset by the decline in the value of the Canadian dollar. The drop from a high of CAD1.30 per USD1 in January to CAD1.37 per US dollar as of 9 March makes the country’s energy exports more competitive in the albeit sluggish international markets.

The fall in prices also has important implications for government finances, particularly at the provincial level. Alberta, whose provincial public finances largely depend on oil revenues, has accumulated a large public deficit since oil prices crashed in 2014 and currently has the fastest growing debt of any province or state in North America. On 27 February, the province’s conservative government, led by the UCP’s Jason Kenney, presented its budget for 2020, which forecasts government revenue from an average West Texas Intermediate (WTI) crude oil price of USD58 per barrel. Each one dollar fall in oil prices, however, marks a USD200 million reduction in Alberta’s budget. In light of the sharp decline in prices and their effects on the provincial budget, Kenney has backtracked on his pledges to balance the province’s budget by 2022/23, and will now look to prioritise protecting jobs and Alberta’s economy. While opposition leader Rachel Notley from the centre-left NDP has called on Kenney to modify the budget, both Notley and Kenney have called for assistance from the federal government. Despite marked political differences between his administration and that in Edmonton, Prime Minister Justin Trudeau is likely to announce federal assistance to struggling industries and businesses given the severity of the price fall and its wider national impact.

The outlook for crude oil prices is likely to remain depressed in the short-to-medium terms, particularly amid the global economic slowdown caused by COVID-19 and major oil producing countries’ apparent unwillingness to agree on supply constraints. For Canada, and particularly Alberta, this will likely revert attention to the balance of power and resources between the country’s provinces and Ottawa, while further increasing calls for economic diversification away from extractive industries unpopular with multiple segments of society and vulnerable to sharp shifts in global prices and demand.

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