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December 8, 2014

 

Falling oil prices slow TSX gains

Producing companies and regions hit hard. But lower gas prices are often regarded as a tax cut

 

Oil prices have been on a steady downward trend since the start of the year. As of the last trading day in November, West Texas Intermediate closed at US $73.70 a barrel, down nearly 25% for the year to date. That momentum was confirmed when OPEC ruled out a production cut following the cartel’s latest meeting. By early December (as these word were being written), WTI prices fell to the $63 range.

 

Canadian and US consumers, who are already starting to see the results at the pump, stand to benefit big time. Gas prices are one of the most recognized economic signals. Cuts are regarded by economists much as a tax break, and thus an excellent source of stimulus.  However both Canada and the United States are energy superpowers. That means producers in both countries will feel the pinch. Whether the pluses outweigh the minuses will depend on how long the latest price cuts will last.

 

Drop driven by multiple factors

On paper, recent declines occurred for several reasons. These include a rising US dollar, which hit oil prices, as these are generally priced in greenbacks. A rise in supply stemming from a massive increase in US shale oil production in recent years, combined with increased exports from Libya, a major producer, have also been cited as causes.

 

Some attribute Saudi Arabia’s recent refusal to reduce output and support prices, to a desire to make US shale oil production uneconomical. This would run many existing shale producers out of business and stop money flows into the industry. Others attribute the Saudi move to a geopolitically-motivated desire to keep Russian and Iranian oil revenues down.  That said, falling commodity prices are often also taken as a sign of weaker demand, and could thus signal weaker-than-expected growth in some parts of the world.

 

A huge part of the Canadian economy

Here in Canada the recent declines will have mixed effects. Energy is a huge part of the Canadian economy. The falling oil prices have been reflected in the loonie’s performance, which is down more than 6% since the start of the year. Canadian stocks too felt the pain. The S&P/TSX for its part was up (+10.4% excluding dividends) since the start of the year, as at the end of November. However its gains trailed the US S&P 500 (+12.4%, in local currency terms excluding dividends), largely due to the oil sector’s weighting in the Canadian index. The S&P/TSX pulled back even further in the early days of December.

 

Continuing low oil prices could also hit public revenues hard here in Canada. Both the federal and Alberta governments will be affected. This in turn will hamper their ability to stimulate the economy.

 

South of the border, the lower energy prices could also have a surprisingly strong effect on job creation. That’s because on net basis, a huge proportion in new full time employment since that time stems from states with heavy energy sector exposure such as Texas. The good news is that consumers and almost every other economic sector will benefit.

 

peter@peterdiekmeyer.com

 

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