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Low oil prices a double-edged sword for Canadian economy: KPMG seminar speaker

October 24, 2016   by Jason Contant, Online Editor

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Low oil prices continue to present a major challenge for the Canadian economy, but they could be viewed as a “positive shock” for some jurisdictions and the economy of the United States, a speaker suggested on Monday at KPMG’s annual Financial Reporting Update in Toronto.

3d arrow with oil on finance reportIn his Ontario regional outlook, guest speaker Paul Ferley, assistant chief economist at the Royal Bank of Canada, said that oil-producing jurisdictions – such as Newfoundland and Labrador, Alberta and Saskatchewan – will be hurt from low oil prices, but oil-consuming jurisdictions – such as Ontario – will benefit.

“We view it as a positive shock for the Ontario economy,” he said, adding that it is the current weak energy investment environment that is weighing on the Canadian economy. “That’s the channel through which the negative aspects of the oil price shock will play out. Anecdotally, all these reports about energy companies cutting back on investment is having a material impact – a double digit decline in investment in 2015.”

This year, Ferley expects energy investment to decline about 7.5%, before picking up about 2% next year.

According to Ferley, those provinces that benefit from low oil prices, that can take advantage of a low Canadian dollar and a strengthening in U.S. economy – British Columbia, Ontario and Manitoba – all come out on top. For Ontario specifically, there are “clear signs” of strengthening exports and economic growth in that province should continue to outpace growth in Canada, Ferley said. He is projecting growth in Ontario at 2.7% in 2016 compared to a national gain of 1.3% and 2.4% in Ontario in 2017 compared to the national rate of 1.8%.

Although negative for some Canadian provinces, low oil prices are positive for the U.S. economy, which is expected to strengthen next year, Ferley told seminar attendees. “Low energy prices, in our view, will return the U.S. economy, on a sustained basis, to above average,” he said. “That will result in growth next year of 2.3%, up from 1.6% that we are expecting for 2016.” Overall global growth is expected to strengthen next year to 3.4% from 3%, with the U.S. economy being the key driver.

The strengthening U.S. economy also “puts downward pressure on the Canadian dollar, therefore enhancing our export advantage in terms of exporting to the U.S. economy. As well, low oil prices, low gasoline prices, are like a tax cut for Canadian households.”

The issue for the Canadian economy, Ferley said, is will these positive aspects overcome the drag on the energy side? “At the moment, the picture is a bit mixed,” he said, adding that the Bank of Canada’s policy going forward will be dependent on whether they see more signs of these positive offsets dominating the overall picture. “If they don’t, they made clear from their comments, they are prepared to act and at the moment, that does imply potentially another cut in interest rates. We are not assuming that, we think that the positive aspects of low oil will start to dominate the picture.”

Related: Bank of Canada maintains interest rate at 0.5%

But Ferley did forecast that oil prices will “strengthen gradually.” The expectation is that next year, prices will average about $56 per barrel from the current $50 per barrel, $63 in 2018 and up to $75 in the long-term. “We are taking the view that oil prices will start easing; these prices will start trending higher,” he said. “If that doesn’t happen – if prices stay around 50 or start dropping towards 40, it would be a more negative outlook for the Canadian economy. If we get up by 60, it will be an important threshold, tone will start to improve.”

From an export perspective, there has been a bit of an upward trend, but it’s been “pretty choppy,” Ferley said. While exports are picking up to about 2.5% next year from the “disappointing” 0.7% increase this year, where the economy is responding is on the interest rate side. “Auto sales as well – these levels are very high,” Ferley added. “We are getting indications that households are responding to those low interest rates. The [issue] is it’s keeping debt level high and that’s a worrying factor. If a major downturn were to hit, it’s going to leave a lot of households in a tough financial position.”

For example, while the Fort McMurray wildfire did send the GDP down “dramatically” in May, Ferley continued, it bounced back in June and July and grew in the third quarter, offsetting the second quarter decline. Beyond the third quarter, “our assumption is it will be slightly above average,” he suggested.

The KPMG annual Financial Reporting Update was held at the Metro Toronto Convention Centre and featured numerous presenters from KPMG in Canada’s Accounting Advisory Services and Professional Practice.