A new report from RBC Economics puts a relatively positive spin on the potential impact of falling oil prices on Canada’s economy. Headlines have recently warned that as much as $60 billion in oil sands investment in Canada could be cancelled because of plummeting oil prices, which have fallen from $107 US per barrel last June to under $50 today. One project reportedly at risk is a Suncor Energy development priced at $13.5 billion, which could be in jeopardy if its profitability is no longer assured.
Also, government revenues will be impacted by oil’s price slide. A government economic update warned that its revenues could fall by $2.5 billion per year from 2015 to 2019, and that the country’s GDP could fall by $16 billion annually. It is the oil-producing provinces that will be hit hardest, but RBC says that they are in an “enviable” position at present, as a result of earlier boosts to revenue when oil prices were rising.
The RBC report does not dispute that investment in the oil and gas extraction sector will shrink if prices don’t recover. Its estimate of how much business investment will be reduced in 2015 is a relatively modest 3 per cent, however, far less than other oil analysts are predicting, and far less than occurred in 2009 when investment shrank by 40 per cent.
The authors of the RBC analysis take the position that there are “offsetting positive outcomes” to lower oil prices. One of these offsets will be in the form of a “clear positive shock” to the US economy. This is the argument that lower oil prices mean lower gasoline prices, which in turn boost consumer spending and lead to greater investment spending outside the oil and gas sector. Specifically, RBC says, for every 10 per cent decline in oil prices there is a corresponding boost in US consumer spending of about $29 billion. Assuming a 30 per cent drop in oil prices in 2015, the consumer spending boost will be $86 billion. This is good for Canada because “a stronger US economy implies a growing market for Canadian exports.”
As in the United States, Canadian consumers clearly benefit from lower oil prices via lower fuel costs. Over the first half of 2014, Canadian consumers purchased roughly $48.5 billion of motor fuel, at an annualized rate. Based on our own estimates of the rate of pass-through of lower oil prices into gasoline prices, a 30% drop in oil prices typically would be reflected in about an 18% drop in gasoline prices. That represents a savings of $8.9 billion on the consumer’s motor vehicle fuel bill, all else held equal.
The other two offsets are familiar: a weaker Canadian dollar, in part due to the oil price crisis, makes those Canadian exports more competitive in the US market; and lower gas prices will boost consumer spending in Canada, which will offset a drop in investment in the oil sector. Based on “very conservative” assumptions, Canadian consumers can be expected to spend about $4.4 billion more in 2015 due to the drop in energy costs. That translates into a net add to GDP of about 0.1 per cent.
How important is the oil and gas sector to Canada’s economy? According to RBC’s numbers, the sector directly accounts for about 5.3 per cent of GDP. Including support activities, engineering and construction, refining, and pipeline construction, the total contribution reaches 11 per cent. However, current oil extraction is not likely to suffer, RBC says, pointing to what happened in 2009. That year, with the world in recession and oil prices falling, crude oil production fell just 0.3 per cent. Support activities are likely to decline more drastically, but they account for less than 1 per cent of GDP.
Furthermore, Canada’s labour markets will not be significantly impacted by the drop in oil prices. This is due to the offsetting effect of increased consumer spending and greater business investment in non-oil sector industries.