A prominent economist recommended on Monday that Canada's provinces consider hedging their exposure to volatile energy prices, less than a week after Alberta's premier warned of a C$6 billion ($5.98 billion) budget shortfall because of deeply discounted Canadian oil prices.
Avery Shenfeld, chief economist at CIBC World Markets, said Canada's provinces should consider locking in oil prices to provide some certainty to budgets that can be thrown out of whack by commodity swings.
"Provincial finance ministers are now acutely aware that a bountiful surplus can turn into a gaping deficit in a hurry when commodity prices slip," Shenfeld wrote in a research report.
Alberta, Canada's largest oil producer and the biggest exporter to the United States, is dealing with plunging resource revenue as a lack of pipeline capacity backs up oil in the province, pushing crude prices to as much as $40 per barrel below the U.S. West Texas Intermediate benchmark.
The province's premier, Alison Redford, took to television last week to warn voters of a C$6 billion shortfall caused by the unexpectedly low prices. Alberta relies on the oil industry for nearly a third of its revenue but does not lock in a price by hedging.
Hedging can be used to guarantee prices but it can backfire if the price of oil rises above the hedged price. Missing out on a potential windfall may be the reason that politicians have steered clear of the practice.
"In a rising commodity price environment, hedging could be seen as either money spent to protect against something that didn't happen or giving up some of the upside," Shenfeld said. "So it's probably something that politicians and their advisers have looked at but (they) haven't been willing to take the risk of making the wrong call."
Shenfeld points out that the provinces routinely hedge to manage interest rate risk on debt but avoid energy hedges even though the financial risks can be greater.
In Alberta, a $10 per barrel drop in oil prices costs the province C$2.2 billion, while revenue in Saskatchewan and Newfoundland and Labrador, the two other major oil-producing provinces, declines by C$200 million.