The Loonie and Oil Exports
Like other disciplines, economicsÂ tends to organize material into narratives. It is worth scrutinizing the “stylized facts” that underlie these narratives, as page B15 of Saturdayâ€™s Globe endeavoured to do.
One piece of conventional wisdom is that the Canadian dollarâ€™s value is driven by the skyrocketing price of oil. David Wolf argued, and Heather Scoffield reported, that the loonie is probably overvalued because crude oil accounts for a relatively modest share of Canadaâ€™s global trade surplus (much less than natural gas, forest products or metals). Currency traders are using the “petrocurrency” theory to rationalize their speculative purchases of Canadian dollars.
This analysis reflects three important points. First, “oil and gas” are typically bracketed together into a single economic sector. However, while world oil prices have taken off, North American gas prices remain grounded partly due to the prospect of large-scale imports of liquified natural gas from overseas.
Modest natural gas prices explain why return on equity in “oil and gas” does not dramatically exceed the economy-wide average and buttressed the industryâ€™s opposition to higher royalties in Alberta. These prices do not support the loonieâ€™s petrocurrency status.
Second, while western Canada is a huge oil exporter, central and eastern Canada remain significant oil importers. This dynamic limits the countryâ€™s trade surplus in oil.
Third, since almost all of Canadaâ€™s oil and gas exports go to the US and most of Canadaâ€™s oil imports come from overseas, fossil fuels contribute far more to our trade surplus with the US than to our total international trade surplus. However, the Canadian dollar has mainly been appreciating against the American dollar. To contend that the role of oil in our global trade surplus does not support this appreciation may be an apples-and-oranges comparison.
The piece of the puzzle that Wolf and Scoffield leave out is refined petroleum products. Canada ran a $6-billion trade surplus in this area from January through August 2007, according to Industry Canadaâ€™s Strategis database. Adding refined oil to crude oil makes it as significant as forest products or metals inÂ our worldwide trade surplus. In this case, the conventional wisdom may not be as far off as Wolf and Scoffield suggest.
Also, whatever oilâ€™s current role in our trade surplus, it is likely to increase as the oil sands and offshore oil are developed. Higher provincial royalties could slow this development, but last weekâ€™s federal corporate-tax cuts fully offset Albertaâ€™s modest royalty hike. Foreigners may be buying Canadian dollars expectingÂ that they will soon need them to pay for future Canadian oil exports. This approach may be “speculative,” but it is not entirely unfounded.