Closer ties to oil prices could mean more volatility for Canadian dollar

When it comes to figuring out what happens next with the Canadian dollar, checking the price of oil might be a good guide.

Werner Antweiler, a trade economist and an associate professor at the University of British Columbia, said in a recent interview that the loonie has become a petrocurrency, which hasn’t always been the case in Canada. Antweiler analyzed the tie between oil prices and the Canadian dollar and found that every one dollar increase in the West Texas Intermediate benchmark price for crude oil translates to a nearly half-cent increase in the loonie compared to the U.S. dollar.

If the oil price index hits $100 a barrel, the Canadian dollar should buy about 99.8 U.S. cents, he said. If crude oil prices are at $60 a barrel, the Canadian dollar should be around 83.12 cents.

That matches what’s been happening recently: This week the West Texas benchmark has risen from around $50 to around $57. The Canadian dollar also has rallied this week, rising 3 cents to reach 82 cents compared to the U.S. dollar.

Antweiler said he was quite surprised how much closer oil prices and Canada’s currency are linked than 15 years ago.

“Canada has always had a diversified export economy, but that changed dramatically around 2000,” said Antweiler, who teaches at the Sauder School of Business at UBC.

In some ways, it means that Whatcom County’s economy is influenced by what happens to oil prices, and it’s become apparent in recent years. When gas prices were hovering near $4.50 a gallon a few years ago, the Canadian dollar was around par with the U.S. dollar. Whatcom County residents were paying high prices for gas, but local retailers also were seeing plenty of Canadian shoppers. Now that oil prices are low and prices at the pump are averaging around $2.70 a gallon, the Canadian dollar has weakened, leading to fewer cross-border shoppers in Whatcom County.

Paying attention to the price of oil is a way to predict what will happen to the Canadian dollar, but local residents also should pay attention to other factors, said Paul Storer, an economics professor at Western Washington University. He notes that sometimes in the short term the loonie goes a different direction than oil prices. One example was earlier this year when the Bank of Canada announced a surprise interest rate cut that lowered the value of the loonie.

The loonie wasn’t always this closely tied to the price of oil. According to Antweiler, energy’s share in Canadian trade was around 5 percent in the 1980s and 1990s. That changed at the turn of the century, as Canadian oil production increased, surpassing its peak production in the mid-1970s. By 2014, energy’s share in Canadian trade had tripled to about 15 percent. When looking at just exports, the energy share in Canadian trade was at 25 percent last year.

Before the recent boom in oil production, other Canadian manufacturing was much more influential on the currency. Making car parts, particularly near Detroit, was very strong in the 1980s and 1990s, but Canadian manufacturing exports suffered when the loonie was strong between 2007 and 2014. With the current weaker Canadian dollar, the manufacturing sector is starting to recover, but the volatility of oil prices could make it difficult because the industry can’t adapt quickly.

“What’s concerning to me is the (Canadian) manufacturing industry is at the mercy of oil prices,” Antweiler said.

The currency’s close ties to oil prices also has created some economic conflicts. A weaker Canadian dollar is generally good news for manufacturers, while it hurts the oil sector. So while some Canadian provinces are seeing economic growth, others are seeing a slowdown.

While being dependent on Canadian cross-border traffic can be risky given the ups and downs of oil prices, Storer said it does help diversify sales for a Whatcom County business. During the years following the global financial meltdown in 2008, Canada’s economy did somewhat better than the U.S., which helped cushion retail sales in Whatcom County.

“I think that Canadian shoppers provide clear benefits to local retailers, but managing the effect of exchange rate volatility is also a challenge,” Storer said.