Revitalizing Canada is a multi-year IISD research project that looks at Canada’s future beyond the oil and gas sector. This policy brief is part of “The Bottom Line,” a series of articles that examines the complex issues that will shape Canada’s place in future energy markets. (Download PDF)
Fossil fuel prices are highly volatile, affecting not only the prices of energy services but also the prices of many non-energy goods. Energy prices are a key driver of inflation, but are also the most volatile component of overall inflation in Canada. From February 2021 to June 2022, energy prices accounted for one-third (33%) of overall inflation in Canada.
Oil and gas price shocks are nothing new, and if Canada continues to rely on fossil fuels, energy-driven inflation will continue. Geopolitical conflicts, climate disruptions that affect supply and demand, and the growing integration of regional gas markets with the global liquefied natural gas (LNG) market will lead to ongoing volatility in fossil fuel prices.
At the same time, the levelized cost of electricity generated from renewable energy is now lower than that of electricity generated from fossil fuels, reflecting significant cost savings from efficiency gains. Recent estimates suggest that Canada could save up to $15 billion a year on overall energy costs by converting its grid to net-zero emissions by 2050, with most Canadian households saving an average of $1,500 a year on their energy costs.
Policies that encourage the use of oil and gas (such as carbon pricing) and encourage fuel switching and efficiency (such as subsidies for electric vehicles and heat pumps) will help Canadians save money and protect the economy from fossil fuel inflation. Creating an enabling environment for investment in renewable energy and increasing the capacity and flexibility of the electricity grid should be a priority for federal and provincial governments, as these investments are critical to supporting electrification and reducing dependence on fossil fuels.
Despite claims that climate policy reduces the cost of living, fossil fuels expose consumers to wild swings in energy prices. In the transition from fossil fuels to clean energy, costs to consumers will vary by region. Governments must recognize this and take steps to mitigate the impact of price changes on regional energy access and affordability. The federal government must play a role in minimizing potential increases in costs to consumers in regions that currently rely heavily on fossil fuels for electricity generation.
Purchasing power is currently at the forefront of public debate in Canada. Canadians are facing unprecedented inflation, which has driven up the prices of basic necessities like food, housing, and energy. However, one key driver of rising prices is often overlooked: the significant impact of oil and gas prices. Canada relies heavily on fossil fuels for its energy consumption, meaning that the prices of energy services like transportation, home heating, and electricity are dependent on international fossil fuel markets. Changes in oil and gas prices impact non-energy goods like food and various durable goods and services.
Rising oil and gas prices are nothing new, but as climate change intensifies, so too do the risks to fossil fuel assets and supply chains. As global demand for fossil fuels declines, market reactions, geopolitics, and potential supply and demand imbalances could increase oil and gas price volatility. Transitioning the energy system away from fossil fuels would not only protect against fossil fuel price volatility and energy inflation, but would also reduce energy consumption and overall emissions. Sound climate policies can be a win-win for Canadians by promoting affordability while creating a net-zero emissions economy. Given the importance of energy to price stability, governments should develop policies and create an investment environment that encourages a shift away from fossil fuel energy dependence.
Fossil fuel prices are notoriously volatile (see Figure 1). This volatility is largely inevitable, as oil and gas are subject to boom-bust cycles in commodity markets. This volatility is further exacerbated by international conflicts, as evidenced by the ongoing conflict in the Middle East and Russia’s invasion of Ukraine.
Historically, natural gas markets have been regional, making them more resilient to global price shocks. However, this is changing, in part due to the growth of transcontinental and international pipelines for natural gas exports. The growing integration of regional gas markets and the global liquefied natural gas (LNG) market also means that fluctuations in the latter will impact regional prices. For example, a sharp increase in demand for LNG exports in other parts of the world (e.g., extreme weather events, geopolitical conflicts) could cause prices for North American natural gas to rise sharply as domestic supplies are reduced to meet export demand. This is similar to the experience in the United States and Australia, where domestic energy bills have risen due to increased gas exports.
In Canada, consumers’ reliance on fossil fuels exacerbates the economic impact of price shocks and supply disruptions. In 2022, the top sources of primary energy consumed in Canada were natural gas (38.1%), refined petroleum products (35.0%), followed by electricity (23.5%). Many provinces continue to rely heavily on fossil fuels to generate electricity. While provincial policies and market structure determine electricity prices, fossil fuel prices also directly impact the cost of electricity generation.
Like global markets, fossil fuel prices in Canada are subject to significant volatility (Figure 2). Canada’s energy dependence on fossil fuels means that energy prices are the most volatile component of overall inflation in the country, and energy prices have a much larger impact on inflation, both positive and negative, than goods, food, services, and housing (Figure 3). The impact of energy price fluctuations is also evident in inflation data for the United States and the European Union, where natural gas, oil, and petroleum products account for about 70% of total energy consumption.
Fossil fuel price volatility is expected to continue and intensify as climate-related changes impact infrastructure, supply, and demand. For example, the 2021 polar vortex reached South Texas and the Gulf of Mexico, bringing winter storms to areas ill-prepared for prolonged subzero temperatures. Texas’s energy grid relies heavily on natural gas, but gas supplies have been limited by icing on equipment, and the extreme cold has shut down 25 Gulf of Mexico refineries. Rising demand and shrinking supply have sent natural gas prices soaring in Texas and across North America, including Canada.
The 2016 and 2023 Canadian wildfires also had unexpected effects on North American oil prices. In both years, West Texas Intermediate crude oil prices rose sharply as production fell, although prices fell again when production recovered. Wildfires that damage oil sands can also cause price volatility. Alberta oil sands production accounts for more than 25% of Canada’s natural gas demand, and when that demand is disrupted, Alberta natural gas prices fall. For example, in the month before the 2016 wildfires, Alberta natural gas was trading at $1.08 per gigajoule (G); in May, prices fell to an all-time low of $0.58/G, then rose to $2.77/G after production recovered.
As climate risk increases, market responses and potential supply-demand imbalances could increase price volatility as global demand for fossil fuels declines. Likewise, ongoing geopolitical tensions and declining global cooperation increase the risk of market disruptions and price shocks. Increasing investment in reliable, efficient, and affordable energy is critical to mitigating the inevitable swings in global fossil fuel prices.
Lower fossil fuel prices are beneficial to consumers during a recession, but sudden price drops can also disrupt the economy, creating uncertainty and impacting businesses, jobs, and productivity. Consumers are often exposed to rising prices, adding to the hardships of businesses and households that cannot hedge against energy price fluctuations. Another concern with volatility is that ongoing shocks to fossil fuel prices can trigger sustained price increases. Higher energy prices can lead to inflation in other energy-sensitive sectors of the Canadian economy, such as food and housing costs, where prices tend to fall more slowly once they rise.
The side effects of high energy prices should not be underestimated. As energy prices continue to fluctuate and the prices of other basic goods and services continue to rise, central banks around the world are looking for strategies to combat inflation, typically by raising interest rates. In turn, higher interest rates will further reduce housing affordability for consumers as mortgage and rental costs rise. This highlights the disproportionate and growing impact that rising energy prices can have on consumers.
The impact of Canada’s dependence on fossil fuels on the economy will be particularly noticeable during the post-pandemic recovery phase. Energy demand has grown rapidly since COVID-19 restrictions were lifted in 2021 and the economy began to recover. However, supply issues have also emerged due to low oil production in major OPEC+ countries, unexpected disruptions in liquefied natural gas supplies, and Russia’s invasion of Ukraine, which have exacerbated already strained oil and gas markets. This combination of supply and demand pressures has led to a sharp increase in global oil and gas prices. Global energy consumption costs in 2022 will be 20% higher than the average over the previous five years. By June 2022, Canadians were paying an average of $2.07 per litre of gasoline, up 55 per cent from a year ago, while diesel prices in some regions have risen more than 80 per cent over the same period. It is worth noting that while the price of carbon in Canada also increased over this period, and gasoline prices increased by $0.73 year-on-year, only $0.03 per litre of the increase was due to rising carbon taxes, with the remaining $0.70 per litre due to international price movements (Figure 4).
An analysis of inflation in Canada shows that Canada’s high inflation during the post-pandemic recovery is primarily driven by three specific items: energy, food, and housing (Figure 5). These items accounted for more than 60% of overall inflation in Canada in June 2022, playing a larger role in the acceleration seen in the previous year. From February 2021 to June 2022, energy prices alone accounted for a third (33%) of overall inflation in Canada. When energy prices rise, many other programs suffer.
Energy-intensive goods contributed nearly three percentage points to overall inflation in Canada in the third quarter of 2022. The cost of these goods fluctuates as oil and gas prices rise and fall. Up to 25% of non-energy items in the Consumer Price Index are sensitive to oil prices (including most food groups and various durable goods), accounting for nearly 60% of non-energy inflation in Canada in July 2022 and more than 85% of the increase since February 2020. These spillovers accelerate overall inflation and are difficult to reverse once they have set in.
Recognizing the systemic importance of energy for maintaining price stability, price fluctuations need to be taken into account, monitored, and incorporated into monetary policy. To combat inflation, raising interest rates has historically been the policy of choice for central banks around the world. This approach aims to limit consumer cash flows in the face of demand-pull inflation (i.e., excessive consumer spending). However, when supply-pull inflation is rising (i.e., energy prices are rising rapidly), interest rate changes have no direct impact on inflation and can lead to higher loan and mortgage payments for consumers who are already facing rising prices for energy, goods, and services. As a result, the combined effects of rising energy prices and higher interest rates are very costly for consumers. Higher interest rates will also increase the upfront costs of clean energy projects, creating a feedback loop that will slow the energy transition.
To provide consumers with immediate energy price relief, Ontario, Alberta, and Manitoba have provided gasoline tax “holidays” as part of their provincial fuel tax programs, temporarily reducing the cost of gasoline by $0.057/L, $0.13/L, and $0.14/L, respectively (Government of Alberta, 2024; Government of Manitoba, 2024; Government of Ontario, 2024). Attempts have also been made to introduce carbon price “incentives” for individual consumers, but the results have been mixed, including increased emissions and reduced rebates. These temporary price reductions are temporary, do nothing to reduce energy costs in the long term, and deprive the federal and provincial governments of important tax revenue. These one-size-fits-all responses are simple to implement, but are ultimately costly and ineffective ways to protect the consumers who need the help most. Subsidizing fuel costs artificially lowers prices, reduces incentives to improve energy efficiency and switch to other fuels, and traps consumers in a fuel price roller coaster.
By supporting the transition away from fossil fuels, Canada can help cushion future inflation and make life more affordable for Canadians. In fact, moving the global energy system to a net-zero emissions path by 2050 could cut energy operating costs by more than half by 2035. By adopting more energy-efficient technologies or changing behaviour (such as driving less), the overall amount of energy consumed can be reduced, which has the potential to lower energy costs. Electrifying transportation, heating, and cooling can also save money. This is partly because electric vehicles and heat pumps are more efficient than their fossil-fuel counterparts, using less energy to provide the same service. Thus, public policies that support and incentivize fuel switching, energy efficiency, and behaviour change will help smooth and accelerate the transition away from fossil fuels.
Cheaper, cleaner energy options depend on the availability of infrastructure and services, such as efficient public transportation, electric vehicle charging infrastructure, and clean, reliable electricity. While building the supporting infrastructure and services requires significant investment, it is a long-term investment that will both grow Canada’s economy and reduce the cost to Canadians of the services they need. It is also a smart investment, as the cost of clean energy is falling below the cost of fossil fuels and is expected to continue to fall.
While only 18% of Canada’s electricity is generated by fossil fuels, there are significant differences across the country. The provinces with the highest fossil fuel electricity generation are Nunavut (99%), Alberta (81%), Saskatchewan (79%), Nova Scotia (59%), Yukon (32%), and New Brunswick (30%). While coal use has declined, natural gas use for electricity generation has increased significantly, from 3% of total electricity generation in 1996 to 16% in 2022.
Expanding natural gas production will increase the system’s reliance on intermittent energy sources and could result in higher costs for producers and higher prices for consumers. For example, Canada used 5% more natural gas to generate electricity between 2020 and 2022, increasing its output by 16% (thanks to more efficient technology), but costs rose 151%, from $1.9 billion in 2020 to $4.7 billion in 2022. These higher operating costs are ultimately paid back through electricity bills. The situation is even more dire when you consider the long-term operating costs of natural gas-fired power generation. A 2021 study of power generation facilities in the European Union, the United Kingdom, and the United States found that the economics of gas-fired power generation are becoming increasingly volatile due to fluctuating fuel prices and other factors. An estimated 31% of US gas-fired power plants and 22% of European gas-fired power plants are already unprofitable, while other gas-fired power plants face a growing risk of becoming stranded assets.
In contrast, the cost of renewable energy has fallen significantly over the past decade (as shown in Figure 6), making it the cheapest form of electricity generation in most jurisdictions. The levelized cost of electricity (LCOE) for solar has fallen by 89% and for onshore wind by 69%, falling below the fossil fuel floor. The cost of these renewables is expected to continue to fall, reaching nearly 60% of the cost of natural gas production by 2030. By 2023, more than 95% of new utility-scale solar installations and new onshore wind capacity will be cheaper to generate than new coal and gas-fired power plants.
Renewable energy generation, especially wind and solar, can lower and stabilize electricity prices. This is partly because wind and solar power do not rely on imported fuel. Once built and connected to the grid, the cost of renewable energy is not affected by fluctuations in fuel prices. Long-term price stability can be achieved through power purchase agreements, which guarantee the price of renewable energy for decades to come. Thus, integrating renewable energy can lower electricity prices for consumers. Modeling in Alberta, New Brunswick, and Nova Scotia shows that a portfolio of clean energy sources can provide the same electricity supply as natural gas-fired power generation, but at a lower cost.
The variability of renewable energy can be addressed through storage, as well as demand-side and grid measures to ensure that sufficient power is available when needed. Modelling shows that Canada’s electricity capacity could grow to the required level by adding wind and solar power, energy storage and interprovincial transmission without compromising reliability.
However, by 2050, Canada will need 2.6 to 2.9 times more electricity than it does today to meet growing demand. Building on this scale will require significant upfront investment. It will require capital expenditures of about twice today’s levels, but moving to a zero-emission grid could save Canadian households $15 billion per year by 2050, or about $1,500 per household per year. Investments in transmission infrastructure and interconnectors, flexible generation and dedicated forecasting and planning tools, and access to regional electricity markets are critical (Eriksen, 2018). Fortunately, Canada performs well in all four categories, including through significant amounts of conventional hydropower, which can provide stable, dispatchable power to complement intermittent wind and solar generation.
Canada’s energy system is diverse, with jurisdiction over electricity supply and pricing largely determined by province. Provinces and regions with large shares of fossil fuel-based electricity generation will face the highest costs of the energy transition. These costs will likely be passed on to consumers to some extent, and in some cases prices will increase in some provinces despite long-term trends favouring affordability and price stability. Policies and incentives can and should be developed to address these regional challenges, including direct support to consumers through energy efficiency measures and initiatives such as interagency collaboration on transmission lines. Detailed analysis of who will be positively and negatively impacted by the clean energy transition should also be a priority to understand the problem and develop regionally-focused responses. At the same time, delaying the transition to clean energy will only lead to higher production costs and price volatility, as fossil fuel-based energy systems will become less attractive compared to renewable energy technologies.
The federal government’s announcement of financial support for provinces to develop a clean grid is, in part, an acknowledgement of the regional challenge. The support measures are designed to provide provinces with emissions-intensive grids the most support relative to the size of their existing grids — about 33% more than provinces with abundant hydroelectric power. Through these financial incentives, as well as the Clean Power Rule, the federal government aims to achieve a zero-emission grid by 2035. In addition, policies that level the playing field for renewable energy technology and investment will ensure that the clean energy industry remains competitive with fossil fuels.
Canadian household energy use relies heavily on fossil fuels (Figure 7), primarily for heating, and consumers are vulnerable to fluctuations in fossil fuel prices. Moving away from fossil fuels will increase Canadian household electricity consumption, but the average energy cost is expected to fall by 12 percent between now and 2050. Further analysis showed that households could save up to $1,500 per year. One of the most direct ways to improve energy affordability for Canadians is to reduce household energy costs through fuel switching, efficiency improvements, and electrification.
Electric air source heat pumps are more efficient and offer significant cost savings compared to gas furnaces. Research conducted by the Canadian Climate Institute found that, on average, a standard heat pump with electric backup costs 13 percent less over its life than a gas heater and air conditioner, and can save a single-family home in Ontario about $55 per month. The Canadian Clean Energy Association found that air source heat pumps “are the least expensive option for many Canadian households, even when installation is included.” Additionally, by not connecting your home to natural gas, you can save an average of $328 per year.
Federal and provincial initiatives are designed to help consumers offset the upfront costs of home energy upgrades through rebates and low- or no-interest loans. The Government of Canada’s Green Homes Grant program, launched in 2021, provides homeowners with up to $5,000 in funding to upgrade energy-efficient systems (such as insulation, windows, doors, heat pumps, and solar panels), as well as up to $600 toward a home energy assessment. The $2.6 billion program was originally scheduled to run until 2027 or until funding runs out, but was suspended in the spring of 2024 due to high demand (especially for heat pumps) and indications that the program needed to be reviewed. Natural Resources Canada reports more than half a million applications over three years, so it’s clear that the program is in high demand and there is an expectation that it will continue.
Reducing reliance on fossil fuels through targeted home energy retrofit programs can improve energy efficiency and protect consumers from price fluctuations. Consumer demand for these programs is high, and the home improvement industry is creating jobs across the country. Modeling by the Pembina Institute shows that if Canada chose to reduce carbon emissions from homes and buildings through investments in deep energy retrofits, up to 200,000 long-term, high-paying jobs could be created over 20 years. Saving energy, creating jobs, and reducing emissions is a win-win for the climate and affordability.
Personal transportation is another area where non-fossil fuel alternatives offer consumers greater affordability. In 2021, transportation costs accounted for 15% of Canadian household spending, second only to food (15.4%) and housing (31.4%). According to a recent report, the average Canadian car owner spends $200 per month on gasoline, while a comparable electric vehicle (EV) costs $23 to $54 per month on electricity. Clean Energy Canada compared the lifetime costs (10 years of ownership, 20,000 km per year) of different categories of EVs to similar internal combustion engine vehicles and found that even before provincial rebates, EVs are cheaper in all scenarios in Canada. For example, the lifetime cost of a Honda Civic is $36,000 more than a comparable EV (Nissan Leaf S Plus) (Figure 8). Similar savings were found for hatchbacks, SUVs, and crossovers (based on the 2022 average retail price of gasoline – $1.73/L).
A 2022 study calculated how much it would cost to charge an electric vehicle from empty to full in each Canadian province. The cost to charge a Chevrolet Bolt ranges from $5.46 in Quebec to $12.61 in Prince Edward Island, but in all cases the cost per kilometer is significantly lower than the cost of gasoline. This means significant savings over the life of the vehicle. As the cost of producing electric vehicles gradually decreases, retail prices will also decrease, making the switch to EVs more attractive.
Electric vehicles are only available to those who can afford the initial purchase price, so many people still cannot afford them. Innovation and scale-up will eventually reduce retail costs. At the same time, tax credits and incentives can make EVs more affordable, and governments can further support EV adoption by developing charging infrastructure. The federal $5,000 EV rebate, as well as rebates offered by the provincial governments of Yukon, British Columbia, Manitoba, Quebec, and all Atlantic provinces, help consumers make the transition. Making used EV rebates available can help reach more consumers, as many provinces offer rebates.
While infrastructure investment is necessary, there must be sufficient demand for that investment to pay off. Growing the EV market can be achieved by better supporting low- and middle-income households through a graduated, income-tested rebate program to ensure that high-income households are not the primary beneficiaries. Ensuring access to clean transportation is critical to keeping costs down for everyone, not just those who can afford EVs. Supporting clean, reliable, and accessible public transportation can also expand affordable options for Canadians while reducing transportation-related emissions.
Over-reliance on fossil fuels (which are volatile and expensive) is a problem for Canadian consumers, inflation, and affordability. Record inflation has been largely driven by rising oil and gas prices, which have spilled over into other energy-sensitive areas of the economy. By reducing reliance on fossil fuels, Canada can address climate change and inflation in a way that ensures affordability, protecting consumers from energy price volatility by switching to cleaner, more efficient energy sources that are less expensive and more stable.
Governments should strategically discourage fossil fuel use through policies such as carbon pricing, fuel taxes, and fossil fuel subsidy reform. By doing so, they can raise revenue, further support efforts to improve affordability, and incentivize savings by moving away from fossil fuels and the associated energy price volatility. Contrary to the narrative that climate policy is making life unaffordable, fossil fuels are trapping consumers in an energy price roller coaster. Renewable and electrified energy is not only good for the climate, it also saves people money by reducing costs and increasing efficiency. Governments have a responsibility to advocate for policies that will accelerate the transition to more affordable, efficient, and clean energy, with a focus on energy affordability for Canadians now and in the future.
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