Canadian Economy ‘Held Hostage’ by Oil, U.S.

Hanging by a thread.

U.S. President-elect Donald Trump’s threat to cripple the Canadian economy with tariffs is exposing Canada’s heavy reliance on oil exports to America. The U.S.’ largest trading partner is set to suffer lower living standards and higher inflation should Trump make good on his promises. 

The U.S. is the largest buyer of Canadian crude, purchasing 97% of all exports, according to the Canada Energy Regulator. Oil represents 16% of Canada’s total export value. Trump has threatened to slap 25% tariffs on all Canadian imports to reduce America’s trade deficit with its northern neighbor. This comes as Canada’s economy is facing headwinds fanned by lagging productivity and growth, according to a TD report.

“The reality is, Canadian oil producers don’t have any choice but to take whatever price the U.S. is willing to pay. They have no one else to sell it to,” said Joseph Steinberg, an Associate Professor of International Macroeconomics at the University of Toronto, in an interview. “Canada is held hostage to the U.S. in that sense.”

Canadian crude oil trades at a discount of $15.72 to the U.S. benchmark West Texas Intermediate as of today. That discount was $12.58 on the day of Trump’s re-election.

Political Scramble

Trump’s threats have already claimed its first Canadian victim: Prime Minister Justin Trudeau, abandoned by his own Liberal Party members, announced his resignation as Canadians blame his administration for inflation and slowing growth.

Trudeau’s resignation two weeks before Trump’s inauguration sent Canadian premiers scrambling to present a unified response.

Premier Doug Ford of Ontario, Canada’s most populous province, threatened to cut off energy to Michigan, New York, and Wisconsin. “He’s not putting a tariff on that oil no matter what,” Ford said in an interview with Bloomberg News referring to Trump. 

Premier Danielle Smith of Alberta, Canada’s largest oil-producing province, did not share Ford’s certainty.“I think we need to be prepared that tariffs are coming,” Smith said to reporters after meeting Trump at his Mar-a-Lago resort in Florida last Saturday. Smith also warned the Canadian federal government against “making idle threats” using oil as a leverage in trade negotiations with the U.S. “Don’t do it,” Smith said.

There may not be much leverage in the first place.

“I don’t see oil as a meaningful source of leverage for Canadians. I see it as a source of potential leverage for the Trump administration,” said Steinberg, who has also researched NAFTA trade dynamics under Trump’s first term. “What does Canada have to gain by not selling oil to the U.S.? It would just be shooting ourselves in the foot. There is plenty of oil to go around in the world the U.S. can buy from and produce on its own.”

Under Trump’s first administration, America became a shale fracking powerhouse and net-exporter of fossil fuels for the first time in more than 75 years. As he accepted the RNC nomination days after surviving an assassination attempt, Trump promised to “drill, baby, drill” the U.S. into a new era of energy independence.

Canada faces limited options to retaliate against Trump’s tariffs—at least not without increasing the cost of living on already inflation-weary Canadians. “Canada was always in a bad negotiating position with the U.S. It is just driven by the fact that the Canadian economy is a hell of a lot more reliant on the US economy than vice versa,” said Steinberg. “It's actually unilaterally suboptimal for us to retaliate. It makes us worse off, but it barely hurts the U.S. Conditional on the really bad outcome, the loonie has to depreciate further. And with that comes higher costs, worse living standards.”

The Canadian dollar has dropped about 3.7% to 1.434 today since the re-election of Donald Trump, dragged down by rapid Bank of Canada interest rate cuts and Trump’s tariff threats.

Difficult Choices

There may be a silver lining: the Trump threat can provide Canadian leaders the political capital they need to loosen Canada’s regulatory environment and boost competition. “Opening up to free trade with dairy and poultry to placate Trump is an example. If a Canadian politician was forced to open up the telecoms industry to American players, that would be a win-win,” Steinberg said. “Sometimes it just takes somebody who acts like a maniac to shake things up to a degree that you get forced to make politically hard decisions that are actually great.”

When asked whether Canada’s leaders had the will to make those sacrifices, Steinberg said, “I don’t have high hopes.”