Why the budget set an ‘excessively low bar’ with US$25 oil price — and what it means for Ottawa’s spending

The Liberal government could still meet its budget targets if oil prices fall to US$25 a barrel this season and Canada’s economy only grows by one percent.

That’s thanks to a $6 billion contingency fund Finance Minister Bill Morneau has generated into this year’s $29.4 billion budget deficit, though he has not explained how he intends to use that contingency plan if that bearish scenario fails to materialize.

The government’s base case scenario requires oil prices to stay at US$40 a barrel (based on the Western Texas Intermediate benchmark) but for the Canadian economy to develop at 1.4 percent this season.

If that plays out – and it is the consensus forecast among economists – then your Liberals may have an additional six billion to either help pay off debt or put into additional spending.

“By setting the bar excessively low to begin, the Finance Minister now has lots of space to manoeuvre on the spending front, while still hitting the (inflated) deficit targets published now,” said Robert Kavcic, senior economist at BMO Capital Markets. “In other words, when the economy performs as expected, Ottawa can spend yet another $4 billion, but still claim that they ‘beat their deficit projection’ by $2 billion.”

Caution may be warranted, of course, because crude prices have consistently defied any predictions made by economists. However the US$25 scenario would envision prices – which on Wednesday pushed back above US$40 a barrel – falling to a new post-crisis low and at their weakest level since 2002.

There are also signs that Canada’s economy could surprise towards the upside this season, as recent data shows that exports are gaining strength on the back of the lower Canadian dollar and weak oil prices. All of that raises questions regarding if the contingency – the largest since former Liberal Pm Paul Martin’s $7 billion contingency in 2005 – is essential.

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Most budget contingency funds have been in existence $3 billion previously 2 decades, though they are often a source of criticism. Within the 2015 budget, the Conservatives were blasted for lowering the contingency from $3 billion to $1 billion, with critics accusing them of creating the modification so they could post a pre-election surplus of $1.4 billion.

Kavcic also points out that contingencies have commonly been used for end-of-year bonanzas. He notes the Ontario government has employed this plan because the 2012 budget.

“In a nutshell, area of the contingency reserve and lower-than-expected debt service costs happen to be recycled into the spending plan, with a few left over for the main point here,” said Kavcic. “Don’t be amazed if Ottawa takes a similar tack.”

But being too rosy on oil prices and never planning adequately might have also come back to haunt the federal government.

Alberta’s provincial governments have consistently overestimated the price of oil recently. The province’s finance minister, Joe Ceci, said last month that because of lower-than expected prices, Alberta’s deficit will balloon this season from the $5.4 billion projected in October’s budget to $10.4 billion.