Insights & Analysis

March 11, 2020

A perfect storm or flash flood? A commentary on Alberta’s current economic challenges

It never rains but it pours.

A confluence of events early in the year has dramatically changed the economic outlook for Alberta in 2020. Early expectations of a modest recovery have been thrown out the window as a string of bad-news announcements has Albertans worried about what else this year has in store.

The bad news began with the cancellation of the $20-billion Teck Resources’ Frontier mine project. In the background at the time was the emerging threat of COVID-19 (coronavirus) coming out of China. As that threat escalated, Canada was facing the additional impact of rail blockades disrupting the movement of goods across the country. The rail blockades and the fallout from COVID-19 resulted in many economists reducing economic performance outlooks and threw the recently-announced Alberta budget into doubt given the growing differential between market reactions and the assumptions underlying the budget.

Then, over the weekend of March 7th, the latest crisis hit: world oil prices collapsed as an agreement between OPEC and Russia to restrict production levels fell apart. In response to the impact of coronavirus on financial markets and the global economy, Saudi Arabia had proposed further production cuts. (Global oil demand falls when economic growth slows.) Russia refused to cooperate, arguing that such cuts would only hand market share to US producers. As a result, Russia left the alliance with OPEC and freed its producers to increase output. Fearing a huge loss of market share, OPEC also increased production.

The end result is the worst of all worlds for oil-producing countries around the globe, including Canada. In the face of falling demand, the world’s leading oil producers are turning on the taps. Benchmark oil prices plunged 25% and will remain low for as long as the price war continues.

At some point in the near future, cooler heads will prevail, production levels will moderate and prices will recover. The challenge, of course, is that no one knows for sure when that will happen.

It is important to emphasize that none of these events were, or are, within Alberta’s control. The Teck mine cancellation was foreseeable, largely a blend of the economics of the project and the continued challenge of getting natural resource projects approved in Canada. Similarly, the federal government has been indecisive and slow in its efforts to restore passenger and freight rail service across Canada.

This is cold comfort to Albertans who woke up on Monday suddenly very concerned about what the future holds. The provincial budget that’s only two weeks old already seems out of date. That budget forecasted a deficit of $7.5 billion in 2019-2020 and $5.9 billion in 2020-2021. Those figures were based on assumptions of 2.7% GDP growth this year and WTI oil prices averaging US$58/barrel.

Neither assumption appears likely to be met now. The government’s own sensitivity analysis suggests that for every dollar by which it misses its annual oil price assumption, it loses out on $355 million in revenues. The chances that oil stays $25-$30/barrel below provincial forecasts for the entire year are extremely low. Nevertheless, it could take months or longer for this to play out. In the meantime, the province stands to lose billions of dollars in revenues.

At some point in the near future, cooler heads will prevail, production levels will moderate and prices will recover. The challenge, of course, is that no one knows for sure when that will happen. Russia is notoriously stubborn when it comes to foreign policy, but its own producers cannot sustain losses forever. Similarly, Saudi Arabia has perhaps the lowest break-even point of any oil producer in the world, but its government relies on prices in the range of $75-80/barrel to finance services.

In the meantime, however, the economic impact will be considerable. While Albertans may feel the impact first and hardest, all Canadians will be affected. Consumers may get a break at the gas pumps, but Canada is one of the largest net energy exporters in the world. The negative effects will easily offset the positive. 

The energy sector directly accounts for over 10% of the Canadian economy and more than 30% of all private sector investment. Crude oil is not only Canada’s largest export product, but it is also the main reason our goods trade is almost balanced. Canada’s trade surplus in crude oil is valued at over $71 billion but it has a combined trade deficit of $80 billion in everything else. A sustained drop in oil prices will erode our trade balance, slow national economic growth and significantly reduce federal government revenues. Over time, this affects all Canadians either in the form of reduced federal spending capacity, increased federal deficits or higher taxes.

These events come at a time when the national economy is already struggling. National GDP growth in the final quarter of 2019 came in at an anemic 0.3% and the Bank of Canada just recently lowered interest rates by 50 basis points in the wake of concerns about a slowing economy. The Bank cited COVID-19, Canada’s declining terms of trade, flat business investment and rail blockades among the reasons for the declining growth prospects. The oil price crash only adds to these concerns.

So what can we do about this perfect storm of challenges that are entirely outside of Alberta’s control?

First of all, the provincial government should put on hold its plan to eliminate the deficit by 2022-23. Given the impact on revenues, the only way it could do so is by significantly raising taxes or making dramatic new spending cuts. Neither of these is advisable under current circumstances. Instead, it should accept larger-than-expected deficits in the near term and focus on efforts to stimulate the economy. These could include short-term investments in infrastructure, increased investment in innovation and diversification or working with the financial services community to help Alberta businesses weather the storm. 

There is a role for the federal government to play as well. For one, the oil price crash puts renewed urgency on the need to reform the fiscal stabilization fund. That fund is intended exactly for situations like this – to support provinces that experience a large decline in own-source revenues. Current ceilings on the program severely limit its impact in Alberta. Those ceilings should be lifted. Any other options for short-term stimulus should also be on the table.

Furthermore, while Canada is at the mercy of the global impacts of COVID-19 and the oil price crash, issues related to the domestic investment climate are entirely within the federal government’s control. The Teck mine project was canceled at least in part because federal policy on resource development and climate change is far from clear. More recently, Warren Buffet pulled out of a planned $4-billion liquefied natural gas (LNG) export project in Quebec amid concerns about rail blockades and investment uncertainty. These issues need to be resolved and investor confidence restored as quickly as possible.

Finally, recognizing that while this is currently a localized issue for Alberta, it will quickly become a Canadian issue. Investing in ways to further increase competitiveness and the environmental performance of the oil and gas sector would be a way to stimulate capital spending, as would investing in further diversification of the economy into areas not subject to commodity price fluctuations such as innovation and technology.

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In the spirit of truth, reconciliation, and respect, we honour and acknowledge the lands upon which we live and work as guests, including the traditional territories of the First Nations in Treaties 6, 7, and 8 and the citizens of the Metis Nation of Alberta. We thank the First Peoples of this land, which we now call Alberta, for their generations of stewardship of the land, and we seek to walk together in the spirit of truth and reconciliation to build a shared future for all in Alberta.

Ⓒ Copyright Business Council of Alberta | Whistleblower Policy

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