Oil Shocks, Inflation & Recessions

Canadian inflation dipped in February. Expect the respite to be short-lived.

Expect Canadian Inflation to Rise

Canadian consumers can take comfort in the fact that Core Inflation fell to 2.3% in February, down from 2.6% in January. This reprieve will be short-lived. According to the IceCap Inflation model, Core Inflation was expected to rise towards the back half of the year. The escalation in hostilities in the Middle East and the subsequent spike in energy prices all but guarantee this. Higher crude oil prices will increase energy and transportation costs, and a prolonged rise in natural gas prices will drive up fertilizer and food costs.

Pipelines to Tidewater Work, Obviously

Over the last 12 months, there has been rhetoric and handwringing over how to diversify Canadian trade away from the U.S. The most obvious and efficient way to achieve this has, of course, been expressly ignored: build more pipelines from east to west and to British Columbia tidewater. But the proof is in the pudding. Since the TMX (Trans Mountain Expansion) pipeline began operations on May 1, 2024, increasing capacity from 300,000 to 890,000 barrels per day, the share of crude oil exports to the U.S. has fallen to a record low. The pipeline has the added benefit of narrowing the discount between Western Canadian Select (WCS) crude and West Texas Intermediate (WTI), which has narrowed from an average of roughly $18/bbl before TMX to approximately $12–$14/bbl since. This means more money for Canadian producers and higher tax revenues for the provincial and federal governments.

Oil Shocks & Recessions

The relationship between oil price shocks and recessions is one of the most reliable in macroeconomic history. As the chart illustrates, outside of COVID, every major spike in real crude oil prices past the +50% deviation threshold relative to trend has been followed by a recession. This is because Crude Oil and its derivatives are the lifeblood of the global economy. When their prices surge, it acts like a tax on businesses and consumers alike. Higher energy prices raise transportation, manufacturing, and energy costs while squeezing disposable incomes and eroding corporate margins. Today, in the wake of the bombing of Iran, Brent Crude Oil has surged to $120.1 USD per barrel, with real prices once again breaching that same +50% threshold. For an already fragile global economy navigating the aftershocks of protectionism and slowing growth, an oil shock of this magnitude may well tip the scales back into recession.

Natural Gas & Food Price Spikes

The attacks on oil and gas infrastructure in the Persian Gulf and the blockade of the Strait of Hormuz have sent natural gas prices sharply higher. This will eventually reverberate through the entire food supply chain. Natural gas is the primary input in the production of nitrogen-based fertilizers, and as the chart illustrates, when natural gas prices rise, Urea Ammonium Nitrate (UAN) and agricultural commodity prices follow. When European natural gas prices (TTF) spiked in 2021 and 2022, fertilizer costs skyrocketed, dragging food prices sharply higher. Today, TTF natural gas sits at 52.1 euros per MWh, and UAN fertilizer has surged to $694.5 USD per metric ton — levels not seen since the post-COVID commodity shock. The S&P GSCI Agriculture Index and the World Food Price Index have yet to fully reflect this move, but if history is any guide, they will.

P.S.

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