BUSINESS

As European fears diminish, high oil prices emerge to trouble economy

03/06/2012 05:00 EST | Updated 05/06/2012 05:12 EDT
OTTAWA - With the near-term chances of a full-blown European debt crisis diminishing, and the U.S. recovery firming, the high price of oil is becoming a key new risk factor for Canada's economy.

That's one of the under-the-radar messages delivered to Finance Minister Jim Flaherty this week by a group of 13 economists participating in the traditional sharing of views that precedes federal budgets.

The take-away from Monday's meeting was mostly cheery — conditions are better than a few months back, they told Flaherty — but TD Bank economist Derek Burleton was one of several who voiced concerns about new risks emerging to replace old ones.

After the meeting, Burleton said he believes Flaherty would do well to keep his rainy day fund — a set-aside of $4.5 billion expected in the March 29 budget — and possibly even increase it for future years.

"As a general rule of thumb, every $10 rise in crude oil prices shaves 0.2 percentage points off U.S. gross domestic product," he explained in an interview Wednesday.

"I think the risk factor is still very significant. There are still a lot of question marks hovering over the Canadian landscape."

Burleton believes oil would be at about US$90 a barrel instead of hovering near US$105 — but for the tensions in the Middle East, particularly Iran's threat to block critical shipping routes through the Strait of Hormuz.

That means the U.S. is already experiencing a drag, he said.

But if Iran should carry through its threat, or other disruptive events occur, oil prices will continue to climb and start undermining the U.S., Europe and the world economy in general, he added.

National Bank of Canada chief economist Stefane Marion, who also briefed Flaherty, has estimated pump price hikes have taken the equivalent of $40 billion annualized from consumers since the beginning of the year.

Oil prices affect the economy in several ways, few of them good. At the most basic, they represent a tax on consumers in the form of higher pump prices and home energy costs, things most people can't do without, depriving them of disposable income they would otherwise spend on consumer goods that boost economic activity.

Higher energy prices also increase input costs on producers and air travel, further depressing activity.

While the 2008 global market downturn was mostly attributed to subprime mortgages and risky lending practices in the U.S. and Europe, analysts point out that the U.S. economy had already slipped into a mild recession as oil climbed close to US$150 a barrel just prior to Lehman Brothers delivering the coup de grace.

"If you look back in history, it's hard to see a period where oil prices weren't a contributing factor to a recession in the U.S.," said Pedro Antunes of the Conference Board of Canada.

"They are a concern for us," he added.

As a net exporter of oil, Canada is in an enviable position, analysts note. But it's also true that Canada was unable to avoid a recession, although a milder one, once the U.S. economy crumbled.

Canadian exports auto parts and other manufactured goods, lumber and commodities. Overall exports representing one-third of the economy fell by more than 25 per cent and still have to further recover.

In the end, oil prices also collapsed, completing the vicious cycle of destruction. While all parts of the country felt the pain, it was most acute in goods-producing regions, particularly Ontario and Quebec.

In about a year, Canada's economy shrank by close to four per cent and over 400,000 Canadians were out of work.

Royal Bank chief economist Craig Wright said it makes a difference to Canada's economy whether the build-up in oil prices is due to increased demand from booming global growth, or to an artificial shock. In the former case, Canada's economy will likely experience a net benefit since outside demand will sustain exporters.

"If oil prices move up because of demand, it's a good news story. If they spike because of political uncertainty, that's not a good news story because you get the higher price but not the demand accompanying it," he explained.

Antunes noted that the other variable is how long oil prices remain elevated. If it's a one-week spike, the impact on economic growth is barely noticeable, he said, but if they persist, consumers start feeling the pinch and moderate their behaviour.

"We are seeing a U.S. economy finally being spurred back to life, consumer spending growing strongly, employment doing better, and all of a sudden here comes another potential hiccup," he said.

"If you affect the U.S. consumer, it will have an impact on our trade."