Oil prices not likely to rebound soon: Here’s why it’s a good thing for Canadian agriculture

Oil has historically been a key driver of the Canadian dollar – upward swings in oil prices would lift the value of the loonie against the US dollar. The opposite is also true – oil price moving down would lower our currency. Interest rates have mattered more when explaining the movement in the exchange rate lately. And we expect this situation to continue for the near future – a positive trend for Canadian agriculture.

$50 oil is the new $100

Oil prices declined from their mid-2014 peak of US$110/barrel to a low of US$28/barrel at the beginning of 2015. The following rebound in oil prices stopped at around $50 a barrel, the level at which oil prices have been for almost two years.

Major oil producing countries have collectively tried to lower oil production to curb surpluses and align supply with demand. But an oil price rebound is unlikely. Here’s why:

  1. Negotiated production cutbacks between OPEC countries are notoriously difficult to implement. If cuts are successful and raise the price of oil, each country has then an incentive to deviate from their agreed production level, and sell more at a higher price. Because all countries have the same incentive, aggregate production usually returns to the initial surplus situation. 
  2. And even if OPEC oil cutbacks are successful over the long-run, an additional variable must be considered: US shale oil production. Technological advancements drive down the costs of shale production. The EIA forecasts US shale average daily production to grow by 1.7% from 2016 to 2017 and up another 5.3% in 2018.

Interest rates matter more for the value of the Canadian dollar.

The Canadian dollar moved very closely with the price of oil prior to August 2016. The last twelve months brought a different dynamic: anticipations of and/or actual interest rate increases in the US and Canada had a significant impact on the Canadian dollar.

The US rake hike of late 2016 narrowed the spread between Canadian and US rates and led to a decline in the value of the Canadian dollar. The Bank of Canada rate hike of July 2017 implied a larger spread between interest rates, which led to a spike in the Canadian dollar.

There’s more than one reason to keep an eye on the decisions of central banks

Future rate increases are obviously important to monitor because they increase borrowing costs. They will also determine the future path of the Canadian dollar. And a low loonie benefits Canadian agriculture. Financial markets currently assign a probability of less than 50% to see a rate hike in Canada and the US in September. That should keep the Canadian dollar in its current range until we get more information about where interest rates will go for the rest of 2017.

Blair Baillargeon, FCC Ag Economics student intern