Macroeconomic

13 Pages   |   2,175 Words
Table of Contents
Introduction: 4
Long term Impact on Financial Institutions: 4
Demand and Supply Gap: 4
Diversity of Effect: 6
Terms of Trade: 6
Canadian Consumer and Institutions: 8
Employment: 9
Money Market Scenario: 10
Overall Effect: 11
Conclusion: 11
References. 12

List of Figures

Figure 1: Demand-Supply Gap: 4
Figure 2: Oil Costs (US and Canada): 5
Figure 3: Terms of trade: 7
Figure 4: Crude Oil Production: 8
Figure 5: Regional Unemployment: 9
Figure 6: CPI in Canada: 10
Figure 7: Money Market: 10
 

Introduction:

Under the circumstances of rising production from its competitor US and Russia, Saudi Arab is unwilling to cut its production (Carlson, 2014). Oil minister of Kuwait stated that as US and Russia are giving high oil supply, reducing oil supply would results just a little rise in oil prices. That is the reason Saudi Arab is trying to keep its share in the global market and maintain its customers (Bousso & Schneyer, 2014). This oil price reduction is causing multiple changes in Canadian economy. This report explores different dimensions of oil price reduction effects on Canada.
 

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Long term Impact on Financial Institutions:

Saudi Arab, has third share in OPEC oil production or 9.7 million barrels per day, stresses on keeping the oil supply sustained even if the price goes down to 90$ or 80$. OPEC might be producing more than the demand of oil due to this sustained oil production decision. Some member of OPEC, e.g. Venezuela wants OPEC to reduce oil supply and push the oil prices above 100$ (Bousso & Schneyer, 2014). This unexpected price war left some losers and some winners (Mufson, 2014).

Demand and Supply Gap:

The figure shows the supply-demand situation over the last few years. It is evident that the gap between supply and demand has widened in the last year. It is expected to become even wider in the future that would reduce the prices in the global market (Plumer, 2014).
Figure 1: Demand-Supply Gap:

Source: Economics - Macroeconomics Task
Saudi Arab’s reluctance to keep the oil supply sustained is causing some issues in Canada. Some of the drilling projects have already shut down because they are unable to maintain the breakeven prices to cover the project cost. Some are still able to stay in the market and manage the costs. The figure below shows cost curves in US and Canada (Plumer, 2014).
Figure 2: Oil Costs (US and Canada):

Source: Plumer (2014)
Nobody would like to invest in an economy where prices are low. In this way, potentials for investment in energy and other sectors would reduce. Consumer might be better off due to lower prices and even start saving more money. But this situation might not last much longer. As savings and investments run in the same circular flow and without potential investments, savings also begin to dwindle (Faucon, Summer, & Kent, 2014).
As Canada is an oil-producing economy, the effects of oil prices reduction for a longer period might generate negative effects in the economy. Revenues and profits would go down and eventually, investors would be reluctant to invest in the economy (Isfeld, 2014).

Diversity of Effect:

The oil price fall may affect different locations of the country differently. It would affect oil-rich provinces negatively. For instance, oil prices need to be higher to run oil sands in Alberta. If the oil prices remain low, oil extraction projects might get to a halt that would generate inflation and business cycles. A fall in revenue and profits of the oil industry might result in unemployment and lower GDP as well. In a result of unemployment, oil-rich provinces would also experience lower consumption. The reduced demand in other sectors would reduce money demand and slow down the economic activity. The demand for loan able funds by investor would reduce as well. If this situation persists, consumers will start experiencing serious economic and liquidity issues; including loan and mortgage payments (Sakir, 2014).
Conversely, as oil price reduction would depreciate Canadian dollar in the global market that would benefit Canadian exporters. By exporting more, their share in the global would rise, and more employment opportunities would be generated in the local market. More employment means more consumption and better GDP. In this way, oil price reduction would affect one part of Canada positively and another part of the country negatively. It might compensate for the loss in oil-rich industries (Sakir, 2014).

Terms of Trade:

Instead of no significant effect on real production, real national income is expected to fall slightly due to deteriorated terms of trade. Reduced oil price level and cuts in revenues would reduce purchasing power in the economy and would also slightly decrease GDP. The figure below shows Canada’s terms of trade over the last few years and two years ahead.
Figure 3: Terms of trade:

Source: Royal Bank of Canada (2014)
At the end of 2014, there is a fall in term of trade. This fall persists for about a year, and a slight recovery is observed in 2016 (Royal Bank of Canada, 2014).
About 1.98 million barrels are produced by Alberta’s oil sands. The revenue collected from the output is spent in other sectors e.g. health, education, and infrastructure. Newfoundland is also expected to get affected by the scenario. Oil prices reduction for a longer term would results in a serious output crisis in oil sands (Talaga, 2014).
Money and goods market activities might dwindle. But it would not be so much intense to shake the entire economy. There are bright chances of recovery (Royal Bank of Canada, 2014).

Canadian Consumer and Institutions:

Figure 4: Crude Oil Production:

Source: Hirst (2014)
After May 2011, the recent drop in is the biggest drop in crude oil prices. This constant oil price reduction might be good for the Canadian economy, at least temporarily. Gasoline would be sold at low price. But government revenue might reduce, and Canadian government should not hope for a surplus budget until the prices go up again (Hirst, 2014).
Deputy Chief Economist, Pedro Antunes stated that the gasoline is not a product with elastic demand. We are not able to adjust our demand in accordance to immediate changes in prices. Due to this inelasticity, people would keep on buying gasoline. As the gasoline is cheaper now, people would have more money that can be spent on other goods (Al Jazeera, 2014).
Parts of the economy might get negatively due to the volatile oil market conditions. This negative effect would probably make their way to real estate and other financial sectors (Kennedy, 2014). Consumers would benefit from the reduced oil prices due to reduced transportation costs. Firms depending on oil would experience reduction in costs, which would induce them to raise their profits and get more revenues. As people’s real income would increase, they would go to the markets to buy more and spend on things they never did before. More production, revenues, higher profits and more economic activity would benefit the Canadian economy, at least for a short period (Sakir, 2014).
 

Employment:

The effect of oil prices scenario on the employment sector would be different for various regions of Canada. This heterogeneity might act as an offsetting tool. The figure below shows the regional unemployment rates.
Figure 5: Regional Unemployment:

Source: Royal Bank of Canada (2014)
Atlantic Canada, Quebec and Ontario experience unemployment levels, higher than the national average. Prairies and B.C are below the national average unemployment rate.
The figure below shows the CPI growth in Canada from 2005 to 2016. After a decline in CPI in mid-2015, CPI again starts to rise and maintains a stable position for the year after. It means that because of oil prices fall; cost of production in other non-energy sectors would fall. Consumers would be attracted to these products and buy more.
Figure 6: CPI in Canada:

Source: Royal Bank of Canada (2014)
Canadian citizens are enjoying low gas prices due to oil price cuts. But it did not make them completely better off in all terms. Toronto stock exchange lost a few percentages after the OPEC’s decision to sustain the oil production (Financial Post, 2014). Energy sector consists only 7% of Canadian GDP. This sector accounts for about 5th of provincial output and 7% of the employment share. It helps to predict that even oil-rich provinces of Canada would survive the oil price reduction. The benefits to exporters of Canada, in the form of depreciation in Canadian dollar, are rather bigger. And exporters from other sectors of the economy are also expected to get a benefit from a reduction (Coyne, 2014).

Money Market Scenario:

Figure 7: Money Market:

Source: Glahe (2004)
Quantity of money is on x-axis and interest rate is on y-axis. If there is an increase in money demand, the MD curve shifts upward, causing a rise in interest rate. It happened because people want to hold money in cash not bonds. So banks would increase the interest on bonds to encourage people to buy bonds. Similarly, if money demand falls, more people would go to buy bonds, interest rate on bonds would fall. If the money supply shifts rightwards, interest rate will fall and vice versa (Glahe, 2004).

Overall Effect:

Except for affecting the oil-rich provinces in Canada, oil price reduction is expected to generate limited overall impacts on Canadian economy. Overall inflation is also expected to reduce. Bank of Canada predicted that the oil supply glut and oil price reduction situation would drop Canada’s GDP for 2015 by only 1/4 of a percentage point and the real national production growth is also less prone to sensitivities. The financial institutions might experience a jerk (Royal Bank of Canada, 2014).

Conclusion:

Instead of 50% price cut since last few months, OPEC decides to keep its production at 30 million barrels a day until other non-OPEC countries take the first leap. This sustained oil production by OPEC would glut the oil supply in the world market. Canada, being one of the largest oil suppliers in the world along with US, is expected to get affected by OPEC’s decision. In short run, low prices would benefit consumers as they will have more money in their pockets, and their real income would increase. It would result in an increase in real GDP. But due to this situation, some oil-rich industries might need to put a halt to their production due to higher costs and lower profitability that might cause unemployment. It can be said that this oil price reduction would have multiple effects on Canadian economy. Some critics say the overall effect of the situation is minor on Canadian economy.
After a long-term, the oil demand would increase in the global market. Only then, this gap between supply and demand of oil would be balanced. If the demand of oil goes even higher due to rising globalization, there might be shortage of oil that would push prices upward. It seems like the only option to get out of this price war between OPEC and non-OPEC countries. It is difficult to predict when this war comes to an end and prices would oil increase.

References

Al Jazeera. (2014, December 22). Gulf OPEC Members Refuse to Cut Oil Output. Retrieved December 27, 2014, from Aljazeera.com: http://www.aljazeera.com/news/middleeast/2014/12/gulf-opec-members-refuse-cut-oil-output-2014122204456675415.html
Bousso, R., & Schneyer, J. (2014, October 13). Exclusive: Privately, Saudis Tell Oil Market-Get Used to Lower Prices. Retrieved Decemcer 27, 2014, from Reuters.com: http://www.reuters.com/article/2014/10/13/us-oil-saudi-policy-idUSKCN0I201Y20141013
Carlson, D. (2014, December 3). Collapse of Oil Prices Leads World Economy into Trouble. Retrieved December 27, 2014, from The guardian: http://www.theguardian.com/business/2014/dec/03/oil-collapse-leads-world-economy-trouble
Coyne, A. (2014, December 1). Canada's Economy-Even Alberta's Will Survive Oil Price Volatility. Retrieved December 27, 2014, from Fullcomment.natioanlpost.com: http://fullcomment.nationalpost.com/2014/12/01/andrew-coyne-canadas-economy-even-albertas-can-survive-oil-price-volatility/
Faucon, B., Summer, S., & Kent, S. (2014, November 27). OPEC leaves Production Target Unchanged. Retrieved December 27, 2014, from Wallstreetjournal.com: http://www.wsj.com/articles/opec-leaves-production-target-unchanged-oil-price-falls-1417086606
Financial Post. (2014, November 28). Gas Prices Falling Fast Across Canada along with Crude Oil. Retrieved December 27, 2014, from Business Financial Post: http://business.financialpost.com/2014/11/28/canada-gas-prices-oil/?__lsa=0f93-9f54
Glahe, F. R. (2004). Macroeconomics:Theory and Policy. University of Colorado.
Hirst, T. (2014, November 27). OPEC Votes Not to Cut Production, Oil Prices Plummet. Retrieved December 27, 2014, from Businessinsider.com: opec-votes-not-to-cut-production-oil-prices-plummet-2014-11
Isfeld, G. (2014, November 27). Oil Price Loss Seen as Gain for Consumers:What is Saved at the Pumps Will be Spent at Malls. Retrieved December 27, 2014, from Business.financialpost.com: http://business.financialpost.com/2014/11/27/oil-price-loss-seen-as-gain-for-consumers-what-is-saved-at-the-pumps-will-be-spent-at-malls/
Kennedy, B. (2014, December 12). Tumbling Oil Prices Ripples Across the Globe. Retrieved December 27, 2014, from Cbsnews: http://www.cbsnews.com/news/tumbling-oil-prices-create-a-worldwide-ripple-effect/
Mufson, S. (2014, December 1). As Oil Prices Plunge, Wide-ranging Effects for Consumers and the Global Economy. Retrieved December 27, 2014, from Washingtonpost.com: http://www.washingtonpost.com/business/economy/as-oil-prices-plunge-wide-ranging-effects-for-consumers-and-the-global-economy/2014/12/01/904984b2-7971-11e4-9a27-6fdbc612bff8_story.html
Plumer, B. (2014, December 18). Why Oil Prices Keep Falling and Throwing the World into Turmoil. Retrieved December 27, 2014, from Vox.xom: http://www.vox.com/2014/12/16/7401705/oil-prices-falling
Royal Bank of Canada. (2014). Impact of Lower Oil Prices on the Canadian Economic Outlook: An Update. RBC Economics Research .
Sakir, S. (2014, December 9). The Consequences of Falling Oil Prices. Retrieved December 27, 2014, from Huffingtonpost: http://www.huffingtonpost.ca/salman-sakir/falling-oil-prices_b_6292224.html
Talaga, T. (2014, December 10). Oil Price Plunge Would be Felt Throughout Canadian Economy. Retrieved December 27, 2014, from Thestar.com: http://www.thestar.com/news/world/2014/12/10/oil_price_plunge_would_be_felt_throughout_canadian_economy.html

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