How Much of an Impact Does the Canadian Oil Industry Have on the Loonie?
If you’ve been keeping up with news media relating to the financial markets for any length of time, you’ve probably come across analysis that links the performance of the oil industry to various major currencies.
As a valuable commodity — both for traders and global business as a whole — crude oil prices regularly have a ripple effect across the wider financial sphere; however, due to the unique make-up of certain countries’ economies, it impacts some more directly than others, with the Canadian dollar (CAD, colloquially known as the ‘loonie’) being one of the most prominently affected.
But why is it that we so often hear of oil prices ‘underpinning’ (i.e. bringing up) or ‘undermining’ (i.e. pushing down) the value of the Canadian currency and its corresponding major pair, USD/CAD?
How Important is Crude Oil to the Canadian Economy?
Generally speaking, the crude oil and USD/CAD markets move together — meaning that when the price of oil increases, so does the value of the Canadian dollar in a roughly proportional manner.
This correlation is largely due to the huge impact the oil industry has on the Canadian economy; last year, Canada was the fifth largest producer and exporter of petroleum products in the entire world, and crude oil comprised the largest component of its foreign exchange activities.
In fact, Canada is the largest foreign exporter of oil to the US — the country with the highest petroleum consumption globally — and is estimated to export over three million barrels of oil to the US alone each and every day, being responsible for around 40% of all crude imports to the US and almost 20% of petroleum intake to American refineries.
Further reading: https://www.fxcm.com/ca/insights/canadian-oil-economy/
How Does Oil Supply and Demand Influence the Loonie?
Like any product that is bought and sold, the law of supply and demand is primarily responsible for the changing exchange rate between the USD/CAD pair as the rate at which the two currencies are bought and sold is adjusted. Think of it like a children’s see-saw; when supply of one currency goes up, the demand goes down, which bolsters the price of the other currency in the pair (and vice versa)!
However, oil prices are an additional factor with this particular pair, owing to the fact that crude exports account for such a high proportion of all the US dollars earned by Canadian entities. Simply put, the volume and buying price of the petroleum being sold to American consumers at any one time has a significant impact on the movement of USD into the Canadian market.
When oil prices are at a higher-than-average level, then it necessarily follows that the amount of USD flowing into Canada for each and every barrel sold will also be higher — this has the knock-on effect of the circulation of USD being proportionally higher than CAD, which makes the Canadian dollar’s value increase.
The opposite principle also holds true — when oil prices are low, Canadian exporters gain less USD on every barrel they sell; as such, the supply of USD goes down in proportion to the CAD, lowering the value of the Canadian dollar as its rival currency becomes more scarce.
Further reading: https://www.thoughtco.com/oil-prices-and-the-canadian-dollar-1147845
What Does the Future Look Like for the Canadian Oil Industry?
As a major producer of oil, Canada has third largest oil reserves in the world, and the International Energy Agency (IEA) estimates that ‘oil sands’ production — the mixture of sand, clay, water and bitumen from which crude oil is extracted — will rise by roughly 2.5 million barrels per day in the country over the next 25 years. Faced with this data, one could be forgiven for assuming Canada’s position as a primary player in the industry looks iron clad.
However, recent trends and geopolitical events have led some analysts to cast doubt on the viability of Canada’s oil trade over the long term — citing competitors such as Russia and Saudi Arabia, who are both able to produce much lighter oil at a cheaper price, for example.
Indeed, despite OPEC’s efforts to regulate supply and demand (and thus keep prices artificially high), some commentators predict these cheaper producers could effectively ‘kill off’ their competition by flooding the market with their own product in the short term in order to pre-emptively establish market dominance for future peak demand periods.
Further reading: https://boereport.com/2020/04/08/column-saudi-russia-price-war-effects-canada-too/
What are the Main Concerns Regarding Oil Production and the Canadian Economy?
Another long-term concern is that Canadian oil presents more numerous logistical challenges than other sources; for instance, Alberta crude oil often retails at a lower price than it costs to ship to customers, with Western Canada Select — the primary domestic benchmark — commanding less than $5 USD per barrel as of March 2020.
And the headaches don’t stop there — as Michael Barnard, Market Commentator and Chief Strategist of future-proofing organisation TFIE Strategy Inc, noted in a recent piece for Clean Technica:
“Canada’s crude oil is expensive to extract, higher in CO2 emissions from extraction, far from water, and more expensive to refine. That’s why it’s at the bottom of the market today, and that’s why it will be at the bottom of the market when climate change action reduces demand.”
Barnard’s final point is perhaps the most prescient of all — the COVID-19 pandemic has transformed the global economy beyond recognition in a matter of months, and many advocacy groups and prominent politicians alike are pushing to make the forced lockdowns and re-openings an opportunity for a reboot of the world’s industries in a greener, more environmental image.
Alberta’s oil production activities have long attracted disdain from environmental agencies — just last year, National Geographic magazine called it ‘the world’s most destructive oil operation’ — and as the coronavirus makes us re-think our fossil fuel-centric way of living, Canadian crude is only likely to become less fashionable with time.
Taking all of the above onboard, it seems the Canadian economy (and by extension the Canadian dollar) will not be able to sustain itself on oil production alone forever — though it remains to be seen if the COVID-19 fallout will serve as an adequate enough wake-up call to accelerate the country’s transition to, and investment in, renewable energies and environmentally friendly technologies.
Further reading: https://www.theglobeandmail.com/opinion/article-the-oil-boom-is-over-will-albertas-energy-policy-catch-up/
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