The Impact of Low Oil Prices on the Canadian Dollar
While the largely diminishing valuation of the Canadian dollar can be attributed to a number of different variables and factors such as the decline of overall commodity prices, the decline of the Canadian manufacturing sector and Canadian household debt: none is as significant as the rapidly falling price of oil. The impact of low oil prices on the Canadian dollar cannot be understated, as of January 22, 2016, the price of oil had dropped to $31/barrel having dropped to as low as $29 a few days earlier. For comparison, the average price of oil was at $100/barrel in the summer of 2014. Since the Canadian dollar is a petrocurrency, its valuation is largely tied to the price of oil as well as the currency which is used to purchase oil which in this case is the USD. So unless oil prices make a strong recovery, the fate of the Canadian dollar is pessimistically tied to it.
Oil Price and the Relationship with the Canadian Dollar
The relationship between the price of oil and the Canadian dollar can generally be observed as follows:
If the price of oil goes up, the Canadian dollar becomes stronger, if the price of oil goes down, then the Canadian dollar also goes down. This is based on the relationship between commodity prices and currency movements. To better understand the mechanism of how this works:
If oil is priced in US dollars, Canadian companies that sell oil to the United States will be paid in US dollars. Therefore, if the price of oil is high, they will receive more USD. These Canadian companies will then need to exchange their US dollars into Canadian dollars, which creates more demand for Canadian dollars thus ultimately driving up the value of the Canadian dollar itself. On the other side, the increase in the supply of the US dollars in order to accommodate the purchase of higher oil prices will inversely drive down the value of the American dollar.
Why is Oil Price Falling on a Global Level?
As with any wide scale commodity, the price of oil is simply based on the laws of supply and demand. At this point in time, there is simply an overproduction and supply on a global level thereby driving down its price. Members of the Organization of Petroleum Exporting Countries and other nations such as the United States and Canada continue to increase production despite the oversupply and decreasing demand in some regions such as Europe. OPEC and their unwillingness to stabilize and reduce production levels amongst their members continue to be one of the primary factors, citing that they would rather see low prices than lose market share to their competitors especially in competition for emerging energy markets in Asia.
It’s also hard to ignore the political element as well, since low oil prices have crippled the Russian economy and the Ruble. There seems to be a systematic intent on the part of a Saudi Arabian led OPEC to engage in an economic war with Russia; of course OPEC denies any intent on its part but history would suggest otherwise.
Future Oil Price and Canadian Dollar Outlook
In the long term, there are already indications that oil production will be decreased amongst non-OPEC countries as investments in exploration have sharply decreased, this can be seen in the massive amount of job layoffs. In Alberta alone, 40,000 jobs in the oil sector were loss with more to be expected in 2016.
In the short term, the outlook will be largely contingent on what OPEC will choose to do. In spite of members announcing that they were accepting of the low price; the reported loss of hundreds of billions of dollars in potentially loss revenue cannot be sustained in the long term. Members such as Venezuela who is experiencing its worst economic recession in 70 years, along with Algeria and Libya will look to seek reformation.
It’s quite inevitable that in the long term we will see the price of oil bounce back. Historically, the oil sector has always been a boom-bust cycle and right now is no different. However, it might get worse before it gets better with a possible projection of $20/barrel being touted. For Canada, it’s clear that we’ll see a rise in the valuation of the Canadian dollar when we see oil prices rise again. For now, we’ll just have to weather the economic storm. For more information on the Canadian dollar, please consult our article on the 2016 Canadian dollar forecast.