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Economists warn the worst isn’t over for Canada after oil’s drop

If 2015 goes down in history as a bad year for the Canadian economy, next year could be far worse.

The oil shock will not subside in 2016. Even if crude prices do stage a dramatic comeback next year – as most experts expect - it will still take considerable time for private investment to return. Without a rebound, any hope for meaningful economic improvement will be even further out of reach.

“Businesses are already getting their brains beat in,” Philip Cross, former chief economic analyst for Statistics Canada, told BNN in a telephone interview. “It has been extremely negative up until now and likely those negative effects will intensify if oil stays low.”

The Conference Board of Canada now expects virtually no increase in crude oil prices next year. Matthew Stewart, who runs the Conference Board's national forecasts, told BNN he expects “some” increase in oil prices by the end of 2016, but no higher than the low US$40s for the majority of the year.

“Originally we thought the worst was behind us,” Stewart said, “We do not think that is the case anymore. The economy is really being held back by a complete lack of investment.”

Stewart expects oil and gas investment to decline by another 15 percent next year, after falling more than 40 percent (or roughly $30-billion) in 2015. If prices fail to meet even the Conference Board's meagre expectations of breaking back above the US$40 per barrel mark, Stewart said the decline in spending will be even more substantial.

The real risk to the bottom lines of Canadian energy companies next year is the end of hedging. When oil prices first began to plummet in late 2014 (and even through most of 2015), producers were to a large degree protected by having already established prices for much of their output in advance. Those pre-established prices, referred to as hedges, were mostly agreed to before the reality of this “lower for longer” environment took hold and therefore tended to be much higher than so-called spot or current prices.

“Those will mostly unwind in 2016,” said Cross. “We will be fully exposed.”

 

That is where the contagion effect will begin to spread its tentacles across the Canadian economy: Faced with yet another year of sinking revenue, energy executives could have no choice but to cut even more jobs in 2016.

Most of Canada's oil and gas production – the oil sands in particular – require oil prices well in excess of US$40 per barrel just to break even; not to mention making even the narrowest profit. And Cross argues the longer profits remain out of reach, the longer the economy will take to recover.

“The longer prices are low, the weaker and more constrained the recovery is going to be,” Cross said, “Whenever [oil prices] do recover I suspect firms will say they are still fixing their balance sheets and you won't see that quick bounce back in investment that we have seen in past cycles.”

Governments in Edmonton and Ottawa will need to “revise” their expectations for deficits in such a scenario, Cross said, since corporate tax revenue will not be filling their coffers anywhere near to the extent it once did. That will make it harder for the public sector to help soften the economic blow.

With only a few trading days left in 2015, the Canadian dollar could be on the verge of its worst year in this country’s history. The loonie lost 18 percent of its value compared to the U.S. dollar in 2008 during the Great Recession. This year it has dropped 17 percent against the greenback, falling to the US$0.72 range.

“The resource shock has pulled down the dollar and it actually hurts households in particular,” Cross said. “And it is also not clear how big the benefit to the business sector really is. Manufacturing was supposed to help lead us out of it but we are not getting that; so we are kind of getting all of the pain and none of the gain.”

“If the Canadian economy is so weak and we have no response from manufacturing, one would expect the downward pressure on the Canadian dollar to continue,” Cross said, adding “it is not inconceivable that we could test the lows of the 1990s,” when the loonie fell as far as US$0.6311.

If the economic fortunes of Alberta become so bleak that Canadians in even less prosperous parts of the country stop moving there, Cross believes “that is going to be problematic for Canada as a whole because [residents] will be sitting in their relatively high unemployment areas.” In other words, unemployment across the country will rise as Canadians unable to find work in their home provinces stay where they are rather than seek opportunities elsewhere.

“The longer oil stays lower in 2016, at some point the moving vans will slow down,” Cross said.

That has already begun to happen. Todd Hirsch, chief economist for Alberta's ATB Financial, noted in his most recent report on interprovincial migration the flow of new arrivals into Alberta “barely” exceeded those leaving the province during the third quarter.

“Net interprovincial migration could still turn negative,” Hirsch said in his December 17th report. “And while it's difficult to watch friends and family leave the province, it will help stabilize the unemployment rate.”

That may be true of Alberta’s unemployment rate, but Cross notes “lower for longer would lead to a backup of employment in other areas of the country.” And that could have the ultimate effect of pulling out what has up until now been the lynchpin of Canada's non-oil and gas-related economic growth: housing.

The national housing market watchdog – Canada Housing and Mortgage Corporation – recently determined oil staying in the mid-US$30s for a five-year period would not only end the country's housing boom, it would actually cause a 26 percent price correction nationwide; with the particularly hot markets of Toronto and Vancouver taking an even more significant hit. Cross considers that estimate to be “conservative.”

“Last year we were looking at a sharp drop from which the industry could recover quickly enough,” he said. “But now, we are looking at a sustained decline. …This could be painful.”

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