Have you noticed that the Canadian dollar and oil prices move together? In other words, if the price of crude oil goes down, the Canadian dollar also decreases (relative to the U.S. dollar). And if the price of crude oil goes up, the Canadian dollar is worth more. There's an economic mechanism at play here. Read on to learn why the Canadian dollar and oil prices move in tandem.
Supply and Demand
Because oil is an internationally traded commodity and Canada is so small relative to the United States and the European Union, price changes in oil are caused by international factors outside of Canada. The demand for both oil and gas is not elastic in the short run, so a rise in oil prices causes the dollar value of the oil sold to rise. (That is, while the quantity sold will decrease, the higher price will cause the total revenue to rise, not fall).
As of January 2016, Canada exports around 3.4 million barrels of oil a day to the United States. As of January 2018, the price of a barrel of oil is about $60. Canada's daily oil sales, then, are about $204 million. Because of the magnitude of sales involved, any changes in the price of oil have an impact on the currency market.
Higher oil prices drive up the Canadian dollar through one of two mechanisms, which have the same result. The difference is based on whether the oil is priced in Canadian or American dollars-as it generally is-but the final impact is identical. For different reasons, when Canada sells a lot of oil to the U.S., which it does on a daily basis, the loonie (the Canadian dollar) rises. Ironically, the reason in both cases has to do with currency exchanges, and in particular, the value of the Canadian dollar relative to the U.S. dollar.
The Oil is Priced in U.S. Dollars
This is the most likely of the two scenarios. If this is the case, then when the price of oil rises, Canadian oil companies receive more U.S. dollars. Since they pay their employees (and taxes and many other expenses) in Canadian dollars, they need to exchange U.S. dollars for Canadian ones on foreign exchange markets. So when they have more U.S. dollars, they supply more U.S. dollars and create demand for more Canadian dollars.
Thus, as discussed in "Forex: The Ultimate Beginner's Guide to Foreign Exchange Trading, and Making Money with Forex," the increase in the supply of the U.S. dollar drives the price of the U.S. dollar down. Similarly, the increase in demand for the Canadian dollar drives the price of the Canadian dollar up.
The Oil Is Priced in Canadian Dollars
This is a less likely scenario but easier to explain. If oil is priced in Canadian dollars, and the Canadian dollar rises in value, then American companies need to buy more Canadian dollars on foreign exchange markets. So the demand for Canadian dollars rises along with the supply of U.S. dollars. This causes the price of Canadian dollars to rise and the supply of U.S. dollars to fall.
Kaplan, James P. "Forex: The Ultimate Beginner's Guide to Foreign Exchange Trading, and Making Money with Forex." Paperback, CreateSpace Independent Publishing Platform, April 9, 2016.