Oil & the Canadian Dollar: Understanding the Connection

The exchange rate between Canada and the U.S. is often strongly correlated to the price of oil. Over the long run, when the price of oil rises, the value of the Canadian dollar (also called the loonie) also usually rises relative to that of the U.S. dollar. That correlation can be directly attributed to the way Canada earns most of its U.S. dollars—from the sale of crude oil—and the percentage of Canada's revenue that this constitutes.

Key Takeaways

• The Canadian dollar, called the "loonie," tends to run lockstep with oil prices.
• Canada is among the top 5 oil-producing and exporting countries.
• The future of Canadian oil is shaky as export costs are high and many countries and businesses are moving toward renewable energy sources.

Crude Oil and Canada's Foreign Exchange Earnings

The strong correlation between the Canadian/U.S. dollar exchange rate and oil prices is due, in large part, to the amount of the nation’s total foreign exchange earnings that are garnered through crude oil sales. In 2019, Canada was the fifth-largest producer and exporter of crude oil in the world. Crude oil is the largest single contributor of foreign exchange to Canada, and its share has been increasing.

Crude oil is priced in U.S. dollars by most importers, so it's not surprising that U.S. dollars are the preferred currency for most energy-based transactions between Canada and the rest of the world. Furthermore, Canada is the largest foreign supplier of crude oil to the U.S. Canada regularly ships over 95% of its crude oil exports to the U.S., accounting for over 40% of total U.S. crude oil imports and nearly 20% of U.S. refinery crude oil intake.

Supply and Demand

The price of any commodity or service is determined by supply and demand, and in the case of the Canadian/U.S. dollar exchange rate, the price is determined by the demand and supply of both Canadian dollars and U.S. dollars. Because crude oil exports account for a large portion of U.S. currency that's earned by Canada, movements in the price and the volume of crude oil have a significant impact on the flow of U.S. dollars into the Canadian economy.

When oil prices are high, the amount of U.S. dollars Canada earns on each barrel of oil it exports will be high. Therefore, the supply of U.S. dollars flowing into Canada will be high relative to the supply of Canadian dollars, resulting in an increase in the value of the Canadian dollar. Conversely, when the price of oil is low, the supply of U.S. dollars will be low relative to that of the Canadian dollar, resulting in a decrease in the value of the Canadian dollar.

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How And Why Oil Impacts The Canadian Dollar

The Future of Oil in Canada

We can understand the future of oil in Canada by looking at how much crude oil is available in established reserves.

Canada's oil sands are the third-largest proven oil reserve in the world. Oil sand is a mixture of sand, clay or other minerals, and water that occurs in nature. It also contains bitumen, a thick form of crude oil. Because of its density, the bitumen needs to be extracted in order to get crude oil. The International Energy Agency (IEA) predicts that oil sands production in Canada will rise by about 2.5 million barrels per day in the next 25 years.