If you were concerned about which way the oil price is heading, you can stop worrying because Finance Minister Joe Oliver has the answer. According to the government's 2015 budget, the price of a barrel of West Texas Intermediate crude oil will average just $54 this year but it will rise to $67 next year and reach $75 in 2017. No reason to pop the champagne's corks but it looks like things are looking up, if you believe a word of it.
The forecasts for WTI, the benchmark against which Canadian oil is priced, as well as forecasts for economic growth, inflation and interest rates are sourced from a panel of venerable academic institutions and big banks. If you set out to write a budget, you need to make assumptions about what income you will earn and, for an energy exporter such as Canada, the price of oil is critical to what the nation earns and therefore what the government can expect in tax revenues.
So, it's reasonable for Mr. Oliver to pick an oil price to put in his budget, but the problem is that the price of oil is extremely volatile. In the fall, the government's panel of wise guys said the oil price in 2015 would be $81; now they reckon it's going to be $54. Once upon a time, major oil companies would issue crude price forecasts. Each year, at the annual press conference, Shell and BP would give their prognosis of the average price for Brent over the coming 12 months, but they gave up the practice many years ago. The number was always wrong and sometimes embarrassingly so. It seemed pointless to offer up such an obvious hostage to fortune and, instead the companies now say they flex their budgets on a range of oil price forecasts. In recent years, the range has been very wide indeed and commentators looking for clues have had to rely on cryptic remarks from chief executives about oil being "very high" or demand looking "very strong."
The Conservative government has hung its hat on the promise of returning the national accounts to surplus and a steadily rising oil price is very helpful to that end. If we look at the underlying picture, there are some indications that oil may be on a rising trend but no great certainty. The good news is that onshore drilling activity in the United States has been falling fast. According to Baker Hughes, the oil services company, the rig count has almost halved over the past year. The falling oil price has spurred a frantic drive for efficiency among the shale exploration companies which means focusing investment on only the most productive opportunities. According to estimates from the U.S. Energy Information Administration, May oil output from the Bakken and Eagle Ford shales will be very slightly down on April. The expected drop in output prompted Adam Sieminski, the head of the EIA, to suggest at a conference in Houston this week that the plateauing of shale oil could bring the oil markets back into balance – a welcome development.
Other voices are more sceptical, notably ExxonMobil's chief Rex Tillerson, who suggested at the same conference that the recent price rally may be a false signal and he predicted that the low oil price would be "with us for a while." The army of explorers that have reined in their drilling activity will probably surge back to Eagle Ford and the Bakken at the first sign of a strong price recovery. Bob Dudley, the chief executive of BP, reckons that the shale industry has proved to be very resilient and we should expect a "lower for longer" oil market. Meanwhile, Chinese demand for oil remains lacklustre; Europe is weak and Saudi Arabia is continuing its strategy of exporting as much oil as it can in pursuit of market share.
While the outlook for the oil price is uncertain, we can be sure of one thing: Canada's continuing enslavement to cheap oil markets in continental United States. No U.S. government will contemplate opening the door to exports of crude, a step too far that would anger domestic consumers as well as industry, including the U.S. Gulf coast refiners which are earning huge windfall profits from exporting gasoline and jet fuel to more pricey overseas markets.
With so much uncertainty, the writer of a prudent Canadian budget might choose not to make a forecast. Rather, he should budget on the basis of a constant oil price, adjusted to the annual inflation forecast. That is the norm and if we look back into the history of oil price downturns, there is no reassurance that collapses necessarily lead to quick recoveries. Consider the oil glut in the late 1980s. After a period of cutbacks, Saudi Arabia lost patience with its OPEC partners and launched a price war. Oil collapsed from more than $30 per barrel to less than $10. There followed a decade of weakness with a very brief surge when Iraq invaded Kuwait in 1990 followed by another slump.
Historical analogies can be misleading, but the history of oil is mostly about long periods of glut interspersed by shorter periods of famine. When we forecast oil prices, we do so at our peril and perhaps the best solution is adopt the practice followed in most oil companies of working with a range of prices. Indeed, would it not be useful for the government to provide us with ready reckoner, a spreadsheet that would allow us to update the government's budget as the economic landscape unfolds by changing the GDP, inflation or employment numbers every three months? Better still, and for the amusement and education of the general public, the spreadsheet could be turned into a computer game, which you could purchase online, allowing players to guess the right oil price number. A cartoon figure of the prime minister could wave a stetson as the oil price rose.
That might be a step too far for the people engaged in the serious business of managing public finances. Yet, if it is such a difficult task, it deserves a bit more caution than a stab in the dark.
Carl Mortished is a Canadian freelance writer based in London.