Published Friday, Oct. 24 2014
There’s a vague déjà vu taking place in Alberta right now, and it’s not about the Oilers struggling to win hockey games. The petroleum price plunge is threatening to ruin the party that just got started. With so much dependency on the energy industry, a lot of Alberta’s economic growth is at risk if oil prices slip much lower.
Even more troubling could be the consequences for Alberta’s provincial government. It derives about a quarter of total revenue from petroleum royalties. Coffers had been filling up and the government was well on its way to being back in surplus, but now question marks looms. What if oil prices continue to slide? What then for the planned schools, roads and long-term-care beds that Alberta so desperately needs?
But as vital as the energy sector is for Alberta’s economy, there are a few upsides to the recent oil price plunge.
The first has nothing to do with Alberta but everything thing to do with our neighbours to the south. Since the U.S. (okay, and Britain) is about the only developed economy in which growth is picking up, it’s critical for the global economy that it doesn’t suddenly lose momentum.
The drop in oil has led to an unexpected windfall for American motorists as gasoline prices have trended steadily lower. The average gallon in the U.S. is currently going for about $3.05 (U.S.), compared to $3.70 back in June. These tumbling prices are like unexpected tax cuts, freeing up extra cash for discretionary spending on other items. That will help lift consumer confidence and propel American gross domestic product growth through to the end of the year.
The second upside to lower oil prices is that it will help rein in soaring costs. A significant challenge facing Alberta’s petroleum producers are spiralling costs, and when oil prices are strong, the suppliers to the energy companies hold all the cards. While oil was above $100 a barrel, producers were keen to get production going quickly – and if that meant paying more for labour, materials and engineering services, they’d pay it. That is precisely what drove wages and production costs through the roof over the past few years.
Softer oil prices give the suppliers a bit less clout in negotiating contracts. They know that if they keep pressing the producers for higher prices, projects become uneconomic. And if projects start getting delayed or cancelled, no one wins. With lower oil prices, the negotiating tug of war between suppliers and producers becomes more balanced.
Finally, the slump in oil prices will bring capital spending back into sharper focus. This isn’t to imply that there was no focus before. But with money gushing through the door, it’s easy for spending to ratchet up quickly. Expect to see much greater caution around capital expenditures, including acquisitions. At current prices, producers are still in decent shape, but cash flow has been reduced. There will be much greater scrutiny on every nickel spent.
And in Calgary, that will even mean scrutiny over the lavishness of the next corporate Stampede party. There’s nothing wrong with a good vodka-fuelled party with jeans and Stetsons, and these events can be very useful in building client relationships. The problem is that every year has to outdo the year before.
When corporate profits are at record highs and there’s no end in sight, scaling back the party seems unthinkable. How many A-List rock bands do you need to play the private concerts to “build relationships” with clients? When does a pancake breakfast start requiring a dedicated full-time staff to plan it? Even the wildest Stampede spendthrift would have to agree that the cost of these events can be difficult to justify. Eighty-dollar oil has a sobering effect this way.
Looked at another way, there are good reasons to feel okay about lower oil prices, even in Alberta. Faster is not always better and Alberta’s economy is strong enough to easily sustain a bit of a slowdown. And even with the discomfort, there will be benefits too. Ensuring U.S. economic momentum, controlling costs, refocusing capital spending decisions – what’s not to like about plummeting oil prices?
Todd Hirsch is the Calgary-based chief economist of ATB Financial, and author of The Boiling Frog Dilemma: Saving Canada from Economic Decline.