Spike in oil prices could darken a brightening growth outlook

Even as encouraging signs of economic growth seem to be multiplying, increasing pain at the pump points to a danger for both Canada and the U.S.: a spike in prices driven by oil-export sanctions on Iran could undermine this improvement.

The price of unleaded regular, now averaging 132.7 cents across Canada, has jumped by 10 per cent since the beginning of this year, according to the M.J. Ervin Associates survey of pump prices. Americans have endured a jump that’s nearly twice as big, calculates economist Sal Guatieri at BMO Capital Markets.

The added pain in the U.S. reflects a greenback that has slipped a little against the loonie, as well as the fact that lower gas taxes south of the border mean that more of any rise in oil gets passed on at the pump.

Still, both countries are significantly vulnerable if there should be a big further spike in oil, Guatieri says. So far, the odds still look to be against this, but some analysts are starting to worry.

Guatieri calculates that a jump in price to $1.60 a litre, or its rough U.S. equivalent, $5 a gallon, would be enough to slash economic growth in both countries by nearly half, assuming the higher price lasted for a full year.

The likely result of this admittedly dire scenario: unemployment heading back up toward eight per cent in this country and nine per cent in the U.S., predicts Guatieri.

While that’s not recession territory, it’s bad enough to cut off the recent gains in stock markets, strain the budgets of heavily indebted Canadian households and squelch signs of improvement in the devastated U.S. housing market.

A further danger is that Europe, already teetering on the edge of recession, could be pushed over the edge, lifting the danger of a new credit crisis if governments were forced to impose even more austerity.

Is there any good news here? Some.

For one thing, it’s entirely possible that any further rise in oil would be smaller than in Guatieri’s scenario. As well, North America is far more resilient in the face of high oil prices than it was in past years.

One piece of evidence: in spite of costly gas, car sales are booming, with consumers apparently choosing to respond to pricier fuel by buying more economical cars, and quite a lot of them.

This strategy actually makes a lot of sense. Data gleaned by Guatieri from the U.S. shows that the average quantity of fuel consumed per vehicle has plunged to about half the amount they used just over a decade ago, and the pace of decline has been speeding up.

This helps explain how total personal spending on vehicle fuel by Americans has gone into a steep decline since it peaked in 2005. It’s now about half that peak level.

Canadians seem to have been following a similar trajectory. Despite a bigger, more thinly populated country, we devote just over four per cent of consumer spending to gas, only slightly more than the U.S. share, which is just shy of four per cent.

As well, overall conditions in both the U.S. and Canada have brightened recently, with employment growth accelerating south of the border and Canada’s outlook improving on slightly betterthan-expected economic growth, along with less austerity than foreseen from the new Ontario and federal budgets.

If economic growth is speeding up, any drag from a jump in gas prices can be expected to have somewhat less impact.

Just as a bicycle becomes less stable when it’s moving slowly, an economy is most vulnerable to shocks when growth is feeble. Finally, any oil shock would have less impact on Canada than on other industrial nations.

Economist Emanuella Enenajor at CIBC World Markets has simulated the impact of a 25-per-cent spike in oil prices (a somewhat smaller increase than Guatieri modelled) and found that while Canada would suffer, the impact would be smaller and take longer to be felt than in the U.S., Japan or Europe.

The obvious reason is that Canada, unlike any of the others, is a major oil exporter, so any jump in price boosts investment in the oil industry and improves export earnings. As well, Canada has so much hydroelectric power that the share of petroleum in total energy consumption is lower.

Still, Enenajor warns, a sharp jump in oil prices would do nobody any favours. Even in Canada, the harm to consumers and industry would outweigh gains in the oilpatch.

jbryan@montrealgazette.com

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Category: Crude Oil, Energy, and Gold Futures