As a net commodities exporter, Canada has benefited from strong energy prices over the past decade. Indeed, the surging terms of trade (export prices relative to import prices) have stimulated corporate investment and job creation across the country, particularly in the Western provinces. Reflecting the importance of natural resources in the Canadian stock market benchmark, the S&P/TSX has outperformed its U.S. counterpart seven times in the past 10 years.
But with the U.S. shale oil boom underway, are we headed toward a game changer for Canadian terms of trade and economic prosperity?
Shale oil: A "shock wave" on global oil trade, according to the IEA
Remember peak oil theory? The members of this club argued that global crude oil supplies have peaked and entered an irreversible long-term decline, setting the table for permanently elevated oil prices. The concept didn't account for, or at least underestimated, the impact of technological innovation fostered by rising energy prices. That's what recently happened to natural gas prices in North America, which have plummeted from above $10 (U.S.) per million British thermal units to under $4, as hydraulic fracturing ("fracking") and horizontal drilling have unlocked huge reserves of natural gas believed unreachable as recently as five years ago.
Similarly, according to a recent report from the International Energy Agency, booming U.S. shale oil production will send "shock waves" through the global oil trade over the next five years, in a development that could be as dramatic as the rise of Chinese demand over the past 15 years. The IEA predicted in its latest report that the U.S. will overtake Saudi Arabia as the world's top oil producer by 2017, thanks to horizontal drilling and fracking. At 7 million barrels a day, the U.S. is currently producing more oil than it has in 20 years.
Putting aside some issues related to water management and social acceptance in populated areas, booming shale oil activity is more than welcome to stimulate the economy in many states such as North Dakota, Louisiana, Wyoming, Montana and West Virginia (to name a few), which are involved in this energy revolution. In addition, prospects on external trade are improving, with U.S. oil imports having already dropped to their lowest level in 16 years.
As far as Canada is concerned, the improved U.S. economic outlook represents good news in the short term and won't immediately threaten our oil exports south of the border, as Canada has outpaced OPEC as the U.S.'s number-one oil supplier. Over the medium and long term, however, we are much more concerned, since this new unconventional oil supply could have significant ramifications on global oil trade and the price outlook.
Heading towards a higher WCS oil price or a much lower WTI price?
So far, the negative impact of the combined surging oil production from U.S. shale oil and the Canadian oil sands has been limited to an unusual price gap between Western Canadian Select (WCS) and West Texas Intermediate (WTI) crude, stemming mostly from transportation bottlenecks and high level of maintenance from some U.S. refineries. The prevailing wisdom among Canadian experts is that this phenomenon is temporary, since the situation will correct itself when regulatory approval is received from Washington on the Keystone XL pipeline project or from the National Energy Board on several Canadian pipeline projects. We are not convinced.
If the traditional optimism from the IEA regarding oil demand increase (an additional 6 million barrels a day from 2012 to 2017) fails to materialize due to prolonged stagnation in Europe or a deceleration in the Chinese economy, we must be ready for much weaker oil prices – unless OPEC members agree to cut production. With its already shrinking global market share (now about 33 per cent), this potential call for OPEC to reduce production and maintain current elevated oil prices in order to accommodate surging North American production will become an intriguing open debate.
Bottom line: Canadian investors and policy makers should remain vigilant
Since Canada's crude oil exports are a critical driver of high-paying jobs, royalties, taxes and, ultimately, federal equalization transfers, all Canadians should closely monitor the impact of this energy revolution south of the border. In the short term, like many pundits, we believe that the current U.S. shale oil boom will help the U.S.'s still frail economic recovery, and not greatly threaten Canadian oil exports and oil sands projects. However, Canadian political leaders should remain vigilant about the willingness of Capitol Hill to authorize the Keystone project, given the strong opposition from environmental groups regarding the oil sands carbon footprint and the U.S.'s possible energy independence in sight by 2030.
Down the road, investors should also monitor OPEC's reaction (particularly that of Saudi Arabia, with its huge proven reserves), since artificially elevated oil prices will not necessarily be in their long-term strategic interests. Any intention from OPEC to protect market share, or a decision from Washington to reject the Keystone project ,will send a disconcerting message regarding oil sands expansion and be a potential game changer for Canada.
Clément Gignac is senior vice-president and chief economist at Industrial Alliance Inc., vice-chairman of the World Economic Forum Council on Competitiveness and a former cabinet minister in the Quebec government.