Canadian Prime Minister, Stephen Harper recently made the statement, ‘The oil industry isn’t remotely the entire Canadian economy.’ While this is not a startling statement in itself, since production of crude oil represents just 3% of Canada’s GDP, the surprise is that Mr. Harper felt he has to state the obvious.
He pulled Canada out of the Kyoto protocol on climate change and promoted the Keystone XL pipeline that would carry Alberta bitumen to refineries in the southern United States. He has likened the development of Alberta’s tar sands to building the Great Wall of China. Canada, the fifth-largest producer of crude oil (which makes up 14% of exports), is an “emerging energy superpower”, Mr. Harper has proclaimed.
However, since June 2014 oil prices have dropped by over fifty percent leading to a shift in the engines of economic growth from western Canada to the central provinces of Ontario and Quebec, which concentrate on services and manufacturing. The weakness in the energy sector prompted a surprise cut in interest rates by the Bank of Canada on January 21st. The federal government, which usually delivers its budget by the end of March, has put that off until April at the earliest. Volatile energy markets make it impossible to predict revenue accurately, says Joe Oliver, the finance minister.
While the energy slump will boost some parts of the country, it will depress others. According to the Conference Board of Canada, oil-rich Alberta, which has grown faster than the rest of Canada for the past 20 years, will enter recession this year, predicts one.
This is the reason behind the central bank’s decision to reduce the target for its key interest rate by a quarter of a percentage point from 1%, its level since September 2010. This has puzzled the financial markets since core inflation stands at 2.2%, well within the bank’s target range. Lower rates could encourage consumers, who are already carrying record levels of debt, to take on even more. Stephen Poloz, the central bank’s governor, acknowledged the risk but argued that the recession in the oil industry made it worth taking. He fears that the loss of jobs, investment and export income from the energy sector will eventually spread to other parts of the economy. He said the rate cut was similar to taking out an insurance policy.
Ontario and Quebec, which account for over half of Canada’s GDP, are home to large manufacturing industries, such as cars and aerospace, which have long complained that the oil-fuelled rise in the Canadian dollar was damaging their competitiveness. The currency has fallen by 15% against the American dollar since June, giving exports a boost, and may weaken further because of lower interest rates. This combined with strong growth in the United States, Canada’s biggest trading partner, bodes well for manufacturers.
There are two threats to Mr. Harper’s campaign plan. The first is that, as the central bank fears, the petro-plunge will pull down growth overall. The second is that the economy will continue to do relatively well but that the Conservatives will not get credit for it.
Mr. Harper is a skilled political scrapper; he may well find a way to turn the shift away from oil-led growth to his advantage.