Plenty of Questions, but Few Answers for Alberta's Economy

The year got off to a very promising start for Alberta’s economy. Steadily rising oil prices were lifting drilling activity, sufficient snow pack was easing farmers’ worries, and even employment was roaring back to life with big gains in January and February. But two global events—which by their very nature were entirely unpredictable—are throwing a monkey wrench into the economic forecast for the rest of the year. Not all of the news is bad.

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The first event is the situation in Japan. The earthquake and tsunami that has killed thousands and destroyed entire villages is a human tragedy of a scope rarely matched in recent history. One short week ago, Japan was quietly hopeful for decent economic growth in 2011. Now those hopes have been dashed. Not only is it a human tragedy, it’s an economic and financial one as well. How will the industrialized world’s most deeply indebted country find the cash to rebuild?

Uncertainty is the economy’s worst enemy

  Compounding the natural disaster is the crisis unfolding around the nuclear power plants. The situation has become more serious and dangerous each day, and with it rise the fear of mass radiation poisoning.

The second global event unfolding is the ongoing situation in the Middle East, with Libya in particular marching steadily towards civil war. This week the UN impsed a “no-fly” zone over the country, which is one step away from the US and the rest of the UN Security Council declaring outright war on the regime of Muammar Gadhafi. At the same time, events in surrounding countries (particularly Bahrain) are also reaching a feverish pitch.

Two different parts of the globe, two very different tragedies, and dozens of unanswerable questions. How will Japan afford to rebuild? What will the radiation leaks mean for nuclear power on a global basis? And what will more unrest and violence in the Middle East do to oil prices?

A lot hangs in the balance for Alberta, but the direct impacts will be minimal. Alberta’s trade links with Japan are small (it receives less than 2% of our exports), and links with Libya are smaller still. However, the indirect impacts could be significant. What are the possible outcomes, and how may they affect Alberta’s economy—both positively and negatively?

One of the most significant indirect impacts on the province will be uncertainty in global financial markets. The past week has been a rollercoaster for even the Toronto Stock Exchange with wild, 300+ point swings within the same trading day. It’s not so much that stocks are down, but simply volatile.

Traders don’t fully understand yet the impact that Japan’s crisis will have on global insurance companies, commodity companies, or the bond market. They do know the Japanese government will have to borrow even more money to rebuild—but where will that capital come from? Will Japan have to sell its US bonds? That could push American interest rates higher, just at a time when the Federal Reserve is trying to keep them low. Is it possible that the US will be thrown back into recession? Not likely, but possible.

Churn in stock markets will affect Albertans, too—most of which hold at least some of their assets in stocks. Watching the value of your savings rise and fall so dramatically does nothing to instill confidence. It’s altogether too reminiscent of the crash in 2008, and no one wants to relive that.

But Alberta is also a resource producer, and many of those resources may see higher prices as Japan starts to rebuild. Lumber is a prime example. Even natural gas prices—which have been the weakest link in Alberta’s economy so far this year—may be lifted as the appetite for nuclear energy will be decidedly curbed after the Japanese experience. Something has to power North America in the future, and if not nuclear, why not natural gas?

Then there is the situation in the Middle East which had been pushing oil prices ever higher—at least until the Japanese crisis raised threats of a global recession, which sent them plunging. Oil supplies from the Middle East are critical to the global economy, and the potential for disruptions due to violence is real. The US is seeing gasoline at nearly $4/gallon in some areas, and Spain has reduced speed limits in an attempt to curb oil consumption.

Higher oil prices do help Alberta’s oil producers and provincial government royalties—at least in the short term. But if oil prices start to spike to $120, $150, or even $200 a barrel (Jeffrey Rubin will finally be right!), that could mean more long term pain for the province. Spikes in oil prices will be driven by investors’ fear, not global demand. And just as quickly as fear can drive prices up, investors can bail out. The result would be a crash in oil prices as soon as tensions in the Middle East ease.

Alberta is a small place in the global economy, but we are highly influenced by world events and commodity prices. The situations in both Japan and the Middle East are terribly tragic and their impacts will be far-reaching. The worst of it is the uncertainty that hangs over the global economy.

And when it comes to the economy, the not knowing is the worst part.