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In a time with shocking and unprecedented economic events, today’s plunge in oil prices is another one for the history books. The price on the futures contract for West Texas Intermediate crude oil for delivery in May fell into negative territory and dropped to -$37.63 US dollars.
The explanation is that although essential economic activity is still happening, non-essential demand has collapsed, leading to lower oil prices. As we noted last week, the 9.7 million barrels per day production cut by OPEC and other countries coordinating with the cartel would not be sufficient to stop the rise in North American inventories. Crude oil stockpile at Cushing, where much of WTI priced crude oil is stored has surged by 48 percent since February.
Oil prices for delivery in May turned negative because there is simply no demand for it. But, prices on the contract for delivery in June remain in positive territory and ending trading today at US$20.43 per barrel. What this shows is that markets don’t want more oil in May, but believe that the lockdown should ease in June.
The Canadian energy sector is in dire straits. The volatility in crude oil prices and the low prevailing price of crude oil is creating unprecedented challenges. It is causing significantly lower capital investment, material job losses and lower production—as reported by a litany of recent company announcements.
Canada’s fiscal policy response to COVID-19 has elements that will aid the energy sector, such as wage subsidies, access to additional funding, low interest rates and a new $2.4 billion federal program for cleaning up orphan wells and stop the leakage of methane gas (a program that was just announced last week).
However, the aid at this point pales in comparison to the financial strains on oil and gas producers. Notably, the energy sector is an important part of the Canadian economy and is regionally concentrated—leading to pressures that will be felt in energy-rich provinces. During this pandemic and oil shock, we expect that the provinces of Alberta, Newfoundland and Labrador, and Saskatchewan will fare worse than the national economy (which we forecast to contract by close to 10 percent in 2020). Moreover, even when containment is relaxed and economic activity improves, the energy sector will still be dealing with excessive inventories that will constrain its recovery.
On the real estate front, Canadian home prices were rising at a solid pace before non-essential economic activity was shut down in March. The Teranet-National Bank Composite House Price Index rose 0.6 percent last month and was up 3.8 percent year-over-year, but this strength is bound to evaporate as the effects of the economic lockdown unfold.
A key question is how home prices will fare in the coming months? During containment, listings and sales will decline, and few transactions will occur. Then, when containment is relaxed, housing activity will accelerate, but we will be dealing with the economic fallout from lower household income and higher unemployment. However, with the virus still in circulation until there is a vaccine, new listings may remain low. As a result, weak demand combined with soft supply could limit the effects of the current recession on home prices. A key question is whether additional supply could come on to the market as investors sell properties that were owned to generate rental income flows (such as Airbnb rentals). On balance, the odds favour a drop in home prices of at least 5-to-10 percent. They key factor that will slow the decline is the exceedingly low interest rate environment.
Tomorrow, we launch our weekly Economic Update webinar with special guests to discuss whether China’s economic recovery is for real. Please register. The webinar is open to all.