A change in energy prices will affect the aggregate economic activity through five channels (CITATION REQUIRED). The channels are the following:
• Foreign Demand
• Energy Supply
The terms-of-trade is defined as the ratio of export prices to import prices (CITATION REQUIRED). According to the Bank of Canada’s report: “Following an energy price change, there is a redistribution of real income between energy-exporting and energy importing countries.” (CITATION REQUIRED) .Hence, lower oil prices reduce the ratio of export prices to import prices (the terms-of-trade) thereby reducing the volume of imports that can be purchased with a given volume of …show more content…
On the other hand, this puts net importers, such as the United States, in a better position. As prices of oil decreases, the terms-of-trade of net importer will improve. The United States is a net importer of oil products (See Figure II-B), and is also the main trading partner for Canada. Roughly 62% of the Canada’s exports are sent to the U.S (CITATION ). In fact, 40% of America’s oil imports come from Canada, and it seems to be consistently increasing (CITATION). Furthermore, this trend should continue as Canada keeps expanding is capacity to export oil (See Figure II-C). Projects for this are already on their way such as the KeyStone XL, a pipeline that ' 'will have the capacity to transport 830,000 barrels per day of crude oil from Canada ' ' to the United …show more content…
As the economy of U.S. grows, so do Canada’s exports, especially in the non-energy sectors. Thus, this increase should in other sector should offset the decline in the energy sector. In fact, Baumeister et al. found an essentially neutral impact on Canadian GDP growth from a supply-driven 10% oil price shock, once accounting for the impact of the shock on foreign demand (Baumeister et al. 2010). In more recent research, it was found that external demand will offset the weakness of the oil sector resulting in positive impact on Canadian GDP less than .1% working with the assumption that for 10% decline in oil prices raises U.S. GDP growth by 0.1% to 0.2% (CITATION). Thus, it seems that an change in oil-price has somewhat neutral impact on aggregate output for Canada, as a whole, when accounting for changes in foreign demand.
On the other hand, a drop in the oil price will have both short- and long-term effects on oil supplies (CITATION). A drop in oil prices puts Canada’s industry in a tough position because the prices are now too low to justify new profitable projects. In fact, Canada’s main source of new oil projects comes from oilsands (CITATION). Since the extracting oil from the oilsands is rather expensive, it needs the prices to be high enough for future profitability (Citation). This leads to the conclusion that investment in this industry should decrease, and