How Does The Price Of Oil Affect The Canadian Economy?

Since the late 18th century, crude oil has been a sought-after commodity in Canada. The earliest oil exploration in the country came from the frontiersmen and aboriginal peoples who lived in the remote areas and territories of its wilderness. They observed and took note of the visibly abundant deposits of bituminous sands, also known as oil sands, along waterways in what is present-day Alberta. Numerous discoveries of substantial petroleum deposits ultimately led to the development of the oil cultivation and extraction industry in Canada.

The era of large-scale crude oil cultivation in Canada began in 1901 with the drilling of the first Canadian commercial oil well in Cameron, Alberta. Over the course of the 20th century, private oil production companies such as Texaco, Standard Oil, Shell Oil and Chevron became major participants in assorted Canadian oil development projects. Drilling for liquid crude oil commenced on sites ranging from the east coast of Canada's Labrador Shelf, to the far northwest regions of the Canadian Arctic. More than 500,000 oil and natural gas wells have been drilled in the country dating back to the industry's beginnings during the mid-1800s.

Crude Oil Exports

The vast geographical area in which Canada encompasses is abundant with many natural resources. Among the most valuable of these resources is energy, and more specifically, crude oil. The country's economy is export based, and its exports account for 45% of its total gross domestic product (GDP). The exportation of crude oil itself represents 10% of total Canadian exports. The country produces more crude oil than it imports or consumes, thus Canada is said to be a "net exporter" of crude oil.

Oil Rent

A key statistic that measures the percentage of a country's GDP that is occupied by the value of a nation's oil is its "oil rent." Basically, the oil rent is the total market value of the crude oil being produced by a country minus its production costs. It's an important indicator to consider when attempting to measure how dependent a country's overall economy is on crude oil pricing; the larger the oil rent, the greater the country's dependence on the current price of crude oil.

Canada's oil rent represents 4% of Canada's total GDP. When taking into account that Canada is the world's seventh-largest oil producing country, having an oil rent of 4% is a healthy figure. For instance, Saudi Arabia, the leading producer of crude oil in the world, has an oil rent of 43.1%. Nearly half of the total economic output of Saudi Arabia is crude oil, making any downturn in crude oil pricing detrimental to the overall economic health of the country. On the other end of the spectrum is the United States, the third-largest oil producer in the world, which has an oil rent of just .9%.[4]

The oil rent statistic gives us some scale by which to judge the potential impact of a prolonged downturn in crude oil pricing on a given country's economy. Although a sharp decline in oil pricing would certainly negatively impact the oil-producing regions of Canada, the impact would not be seriously detrimental to Canada's overall GDP growth.

An example of such a downturn was the dramatic decrease in crude oil price from the period of August 2014 to January 2015. Crude oil suffered a 55% decline in per barrel price over this period. In response, the projections for Canadian GDP were revised downward by a figure of .5% for quarter one (Q1) 2015. The figure of .5% represented a substantial decline in expectations, but it was far from a catastrophic revision.[5]

Production Costs: Alternative Methods Of Crude Oil Extraction

Crude oil production in Canada is largely derived from unconventional, or alternative, crude oil sources. The two most prominent alternative methods of extracting crude oil are hydraulic fracturing and through the refinement of "oil sands." Canada ranks seventh in the world in oil production, producing 3.8 million barrels of crude oil per day.[6] Nearly 70% of the total crude oil production is derived from alternative extraction methods.

Oil sands are deposits of crude oil that are dense and heavy in particulate. Their consistency is much thicker than conventional crude oil, and it largely resembles heavy syrup or molasses. It has been estimated that 95% of all crude oil reserves in Canada are in the form of oil sands. Nearly 70% of the world's oil sands deposits are located in parts of northern Alberta, Canada. Potential oil reserves, in the form of oil sands, contained in these areas have been estimated at the enormous figure of nearly 300 billion barrels. If these estimates are accurate, the potential oil reserves in Canada are the largest in the world. Currently, oil sand refinements account for nearly 60% of all crude oil production in Canada.

Hydraulic fracturing of shale oil deposits is the other major unconventional method of extracting crude oil in Canada. As of 2014, hydraulic fracturing operations, or "fracking," accounted for 10% of the country's total crude oil production.

The costs associated with hydraulic fracturing, as well as the costs related to the cultivation of oil sand deposits, are substantially greater than those related to conventional crude oil wells. It is important to recognise this cost difference. To cultivate a barrel of crude oil using oil sands as the raw input has a cost between US$60 and US$100 per barrel. To produce one barrel of crude oil through the hydraulic fracturing of shale deposits, the cost is between US$40 and US$80. A majority of the per barrel cost associated with these methods of crude oil production is from up-front infrastructure investment and exploration expenses.

In periods of depressed oil pricing, the cultivation of crude oil from these alternative methods of production gives way to less expensive, more traditional means of production. This change in methodology can cause economic consequences ranging from negatively impacting regional labour markets, to affecting the total volume of national crude oil exports.

Regional Unemployment

The provinces of Alberta, Newfoundland and Labrador are exceptionally vulnerable to a downturn in crude oil pricing. For instance, Alberta saw its unemployment rate rise from 4.3% in January 2015, to 6.8% in February 2015 as a result of the dramatic decrease in crude oil pricing from the period of August 2014 to January 2015. Fracking and oil sands operations, as modes of crude oil production, were scaled back and caused the rise in the regional unemployment rate.

Currency Valuations

During the oil price devaluation of August 2014 to January 2015, the relationship between commodity pricing and the purchasing power of the Canadian dollar came to the forefront. The Canadian dollar saw a 15% depreciation of its value against the United States dollar during the selloff. In an attempt to combat the deflating currency, the Central Bank of Canada cut interest rates and took an active role in managing the currency.[13] The crude oil price devaluation, and the subsequent depreciation of the country's currency, was a good illustration of how crude oil pricing can influence Canada's economy on a national level.

Any opinions, news, research, analyses, prices, other information, or links to third-party sites are provided as general market commentary and do not constitute investment advice. FXCM will not accept liability for any loss or damage including, without limitation, to any loss of profit which may arise directly or indirectly from use of or reliance on such information.

FXCM Research Team

FXCM Research Team consists of a number of FXCM's Market and Product Specialists.

Articles published by FXCM Research Team generally have numerous contributors and aim to provide general Educational and Informative content on Market News and Products.



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