How conflict-driven energy prices could benefit Canada’s economy

Conflict-driven energy price spikes are very hard to plan for. They come with hits to consumers, especially those on the lower end of the income spectrum. They upset global markets and put the word ‘stagflation’ back out into the zeitgeist. Even the energy sector can struggle with them, as the uncertainty around when, or if, a conflict will end can make the huge undertaking of new capital expenditure to increase production impossible to plan for. Despite all those negative pressures, Vanguard believes that if the Strait of Hormuz stays closed for a certain length of time, it could benefit Canada’s economy on aggregate.

Ashish Dewan, Senior Investment Strategist at Vanguard Investments Canada, recently co-authored an outlook from Vanguard which mapped out three timelines for the US-Israeli conflict with Iran. The three scenarios outlined were de-escalation, which ends the war within a month, moderate, where the war lasts 1-2 quarters, or protracted, which sees the war lasting for more than two quarters. He explained how each of these scenarios could end up impacting the Canadian economy and Canadian asset prices.

In the deescalation scenario Vanguard expects oil prices to hit $80-90 (USD) per barrel, with Canada picking up 15 basis points of GDP growth on an annualize basis and facing a core inflation increase of seven basis points. In the moderate scenario, oil prices would rest between $90 and $100, Canada would see a GDP growth of 23 basis points and core inflation of 16 basis points. In the protracted scenario, oil prices would rest over $100 per barrel, Canadian growth would only hit 9 basis points with core inflation at 30 basis points. Across all three scenarios, the US, the Euro Area, and Japan all see negative hits to their GDP growth and core inflation rates higher than GDP growth.

“The moderate scenario, if we're just looking at it from a GDP lens, this is probably the optimal scenario for Canada,” Dewan says. “Now the protracted scenario where you see two or more quarters of conflict… we'd see GDP actually go down to nine basis points just because oil prices would hurt aggregate demand in other sectors of the economy.”

Dewan notes that Vanguard doesn’t have a ‘house view’ of how this conflict will play out. He adds, as well, that the Bank of Canada may see things differently, weighing inflationary pressures more heavily in its decision making than the growth benefits that might come. Dewan also notes that higher sustained oil prices may be good for Canadian GDP on aggregate, but there will be winners and losers based on region and income.

While Alberta oil producers are the primary winners in this scenario, Dewan notes that corporate taxes on those oil companies could see the Canadian government pick up some additional revenues, supporting its long-term stimulatory nation building projects. Corporate intermediaries and transit-related companies should also see a benefit from higher oil prices. He notes, however, that the uncertain nature of conflict-driven energy prices makes significant capital expenditures from Canadian energy companies unlikely, simply due to how long-term those projects are and the potential that oil prices normalize sharply with the sudden end of this conflict.

Regionally, Dewan sees the biggest hits coming to the Maritime provinces, which has very little energy industry of its own. Certain manufacturing and export sectors could be at risk as the price of inputs rise, as well. From a Canadian consumer standpoint, Dewan notes that high oil prices aren’t great for everyone, but that lower income Canadians and those in rural and remote locations may face deeper hardships, given that gasoline already comprises a higher proportion of their incomes. Inequality remains a factor that the Bank of Canada has said they want to address, though Dewan also notes that the slowdown in Canadian inflation seen recently could help this country endure energy price shocks overall.

For Canadian financial advisors and investors, Dewan’s message is ‘don’t panic.’ He emphasizes the significant different between Canada’s stock market and its economy, and highlights his view that Canadian stocks still offer a good value play, with the potential for further appreciation as the promises of AI efficiencies are extended beyond the technology sector. Advisors, he says, should be keeping their clients invested as best they can through all this volatility.

“Focus on things you can control your [clients’] goals. They should be clear, they should be appropriate,” Dewan says. “I would say focus on balance. Keep a strong balance of diversified investments, whether it's stocks or bonds or within equities, really being diversified. Look at returns as just a weighted average standard deviation, really benefits from non perfect correlation. Diversification is only the only free lunch.”