Poor oil outlook may slow economy

Oil prices will continue to be volatile and may cause further economic sluggishness.

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So says Colum McKinley, vice-president of Canadian equities at CIBC Asset Management. He manages the Renaissance Canadian Core Value Fund. “If you look at our economy today, it really does feel like it’s on a knife’s edge. Further weakness in oil prices is going to contribute [to] or exaggerate fears around an economic slowdown, especially in Western Canada.”

That poor performance will affect more than the economy; it will be detrimental to the stock market, and has potential to negatively impact Canadian housing and banks, says McKinley.

But there is hope.

“On the positive side, a sustained rally or change in the outlook for the price of oil will mitigate or dissipate many of the challenges that we’re seeing in the Canadian marketplace.”

Read: Don’t let a good oil crisis go to waste

One short-term factor that could boost the price of oil and energy companies’ stock prices is slower oil production in the U.S., McKinley says.

“If you look at the Baker Hughes rig count, we’ve seen the number of rigs operating in the U.S. drop quite significantly. We’re now at levels below where we were during the U.S. financial crisis.”

That’s positive, because “ultimately we’re going to see that translate into a slowing of production growth, and ultimately a decline in production growth in the U.S., and that will be supportive for oil prices.”

Until then, McKinley expects the price of oil to hover between US$40 and US$60 per barrel. “The outcome on the oil pricing dynamic is going to have a significant effect on the economy,” he says.

Read: Why bond yields will be low for the next decade

And, the continued low prices will “have a significant effect on the earnings and cash flows of many of the businesses. For some of the more challenged companies, it’ll be an environment where they will be hard-pressed to generate enough cash flow to continue to invest in capital expenditures and finance their dividends.”

If the challenged oil companies can’t withstand the market volatility, “We could see further consolidation in the oil patch. [But] we don’t want to buy companies just for the probability that they’re going to be bought out.”

Instead, McKinley looks for “good strong businesses that have the ability to weather what will continue to be a challenging environment. So we continue to look for situations where higher-quality, lower-leveraged businesses are mispriced.”