Ottawa is facing a $3-billion hit to its bottom line over the coming year due to the recent drop in oil prices, according to a new analysis by BMO Capital Markets.

A change of that size would have the impact of wiping out the cushion that the federal government builds into its forecasts to cover the cost of unforeseen events.

The brief research report by BMO economists Doug Porter and Robert Kavcic – titled "Petroleum Plunge: Crude Calculations for Canada" – notes that the price of oil has dropped 22 per cent in less than four months, a development that will have broad and varying consequences for the Canadian economy.

Story continues below advertisement

The bad news for the bottom line comes as federal Finance Minister Joe Oliver is preparing a fall fiscal update that is expected to shed light on how Ottawa will use projected future surpluses to cut taxes ahead of the 2015 election.

Mr. Porter, BMO's chief economist, said most of the recent drop in oil prices and the recent stock market turbulence came after economists submitted their economic projections to Mr. Oliver in early September. Finance Canada bases its forecasts on an average of private sector projections.

"My advice would be to go slow and to take into account the possibility that revenues could be significantly weaker than what the consensus forecast would have projected as recently as a month or two ago," Mr. Porter said in an interview.

He said the estimate of a $3-billion increase to the federal deficit is based on a 12-month period starting last month. However the federal government's fiscal year starts April 1. By that measure, Mr. Porter said Ottawa should expect the deficit to be $1.5-billion larger for the remainder of the current, 2014-15 fiscal year and $3-billion lower for the 2015-16 fiscal year. Ottawa includes a $3-billion "adjustment for risk" in its annual forecasts in order to cover unforeseen events. That adjustment is normally cut in half for the fall fiscal update to mark the half-way point of the fiscal year.

Should recent prices stay at current levels, BMO expects that would trim Canadian Gross Domestic Product by less than 0.2 per cent. Lower growth generally leads to lower government revenue from business and personal taxes.

Lower oil prices will cool the Alberta economy, but could prove to be a boost for central Canada when combined with a lower Canadian dollar. A majority of Canada's manufacturing jobs are in Ontario and Quebec and the sector is sensitive to the price of the loonie and to the strength of the U.S. economy.

Lower energy prices can stimulate the economy in a similar way to cutting taxes for consumers and the economists note that the current strength of the U.S. economy could combine to be a "net positive" for Central Canada.

Story continues below advertisement

The energy-producing provinces of Alberta, Saskatchewan and Newfoundland and Labrador will face the most "direct hit" to their finances, given that their budget plans are based on oil prices of about $97 a barrel for West Texas Intermediate crude rather than the current prices, which traded around $83 a barrel on Friday.

Mr. Oliver and Prime Minister Stephen Harper have both said recently that they are expecting a small deficit in the current 2014-15 fiscal year before returning to surplus the following year. Speaking with reporters earlier this week in Toronto, Mr. Oliver said the government's forecasts take into account the potential for negative economic developments.

"We always, in our projections, take into account downside risks," he said. "Taking that into account, we're very comfortable in achieving a budgetary surplus next year."

For small businesses that are not tied to the energy sector, there is good news in lower oil prices. The BMO economists say some of the benefits include lower costs for machinery and vehicles and lower heating, packaging and other energy costs.

"As well, retailers that rely on customers by care may see firmer volumes, while businesses that rely on discretionary spending, such as travel destinations, could see more visitors," the report states.