Oil and Canada (part 2)

When the Bank of Canada speaks, we should pay attention!

Further to my comments yesterday:

Bank of Canada deputy governor Timothy Lane (who happened to be at the University of Western Ontario when I was studying Economics) spoke to the Madison International Trade Association in Wisconsin yesterday.

Drilling Down - Understanding Oil Prices and Their Economic Impact

(full speech available here): http://www.bankofcanada.ca/2015/01/drilling-down-understanding-oil-prices/

Here are some salient points:

• In Canada, oil extraction now accounts for about 3 per cent of our GDP and crude oil about 14 per cent of our exports.
• The urbanization and industrialization of emerging economies and the growth of their middle classes is far from complete. China’s urban population has grown by about 300 million people since 2000 but, even now, only 55 per cent of its people live in urban areas, compared with more than 80 per cent for North America and advanced Asian economies such as Japan and Korea. According to some estimates, another half-billion people in China and India alone will move to cities and likely join a growing middle class over the next two decades. As long as these trends continue, they will add to world demand for oil.
• Oil sands production rose fivefold between 1993 and 2014, to 2.3 million barrels per day, and now accounts for more than 60 per cent of Canada’s crude production. Between 2006 and 2013, investment in the oil sands more than doubled to over $30 billion.
• Over time, these activities have delivered an outsized supply response, which has been driving prices down.
• In all, it may take quite some time before supply and demand are brought back into balance.
• prices can be subject to large overshoots in the short run, in either direction. The only true floor to prices in the short term is the short-run marginal cost, at which point producers would lose more money by continuing to pump oil from existing installations than by shutting it in.
• For the world as a whole, the decline in oil prices is beneficial. If it is caused by new sources of supply, the price drop spreads the benefits of a favourable shock; if it is partly the result of slower demand growth, it mitigates the effects of an unfavourable shock.
• The United States, as a net importer, will benefit from the drop in oil prices.
• Other economies that are large net importers of oil, such as China, Japan and Europe, will also get a boost to their economic growth.
• Canada, like other countries, has been trying to regain its economic footing since the global financial crisis. From the outset of the Great Recession, the Bank of Canada has been providing significant monetary stimulus. But we have yet to reach the point where growth is self-sustaining. For that to happen, the sources of growth will have to rotate away from consumption and toward increased exports, which are our traditional economic engine.
• Signs of a broadening recovery have been emerging during the past year. Stronger U.S. growth and a weaker Canadian dollar have boosted non-energy exports. Investment spending and job creation have also begun to pick up, although significant slack remains in the labour market.
• The most immediate impact will be positive: a boost to consumers’ disposable incomes and spending. Lower oil prices will also benefit many sectors, such as manufacturing, by reducing production costs. Our latest Business Outlook Survey, which was published yesterday, showed that more firms than in previous surveys are anticipating declines in their input costs, thanks in good part to cheaper oil and cheaper commodities in general.
• Despite the mitigating factors I enumerated, lower oil prices are likely, on the whole, to be bad for Canada.
•  The recent movements in oil prices have been dramatic, but they are not random. Once we sort through the different economic forces at play, we see that underlying the recent drop in oil prices is a surge in unconventional oil supply against the backdrop of slower growth of global demand. Over time, higher-cost oil is still likely to be needed to satisfy growing global demand, but prices could go lower, or remain low, for a significant period before those medium-term forces do their work.
• These developments are among the most important that the Bank of Canada takes into account in making monetary policy. We will continue to work to bring the Canadian economy back to its potential and return inflation sustainably to our 2 per cent target. However things play out, we have the tools to respond.

Scott's Comments:

This  is not far-off from my commentary from yesterday:

The key takeaway here is that, if necessary, The BOC will use monetary policy to help alleviate the negative impact on the Canadian economic situation.

In other words: if lower oil prices hurt the Canadian economy, lower interest rates are to be part of the conversation.