Analysis: The effect of sliding oil prices on Nigeria & the world economy (Part 2)

by Mondiu Jaiyesimi and Victor Ajayi

Petrochemical Plant

A clear lesson will have been learnt here for businesses and economies heavily reliant on revenues from one of the most volatile commodity prices in the world. Most especially for countries like Nigeria and Venezuela who still treat the prospects of economic diversification with no element of urgency.

Price War

Before now, OPEC, which controls about 40% of world oil supply, has always bid to protect oil prices by controlling supply through a quota system. This tact has been employed for decades and has performed to a satisfactory point in stabilising oil prices. However, when the much anticipated OPEC meeting held in Vienna in November, it was quite surprising that Saudi Arabia (OPEC’s swing producer) rejected the request of some member countries like Nigeria and Venezuela, and other stakeholders to cut production and allow price to rise back to a desirable level. This outcome fell short of the speculation in the oil market and therefore caused oil price to plummet further. In principle, a production cut will reduce output and the market will be undersupplied which in effect will affect price.

Apparently, OPEC seems to be interested in making the current shale boom in the United States dwindle by playing its part in keeping the market over-supplied. While OPEC, especially Saudi Arabia, enjoys enormous degrees of production cost advantage, most shale-oil projects cannot survive with oil price less than $70 per barrel and will be at the danger of charging prices below their marginal cost. This will certainly discourage unconventional oil prospecting and investments as shale oil “frackers” have to seek capital for investment in these projects and generate sizeable revenue streams to pay off the debts and associated costs at a particular margin in order to breakeven. On a larger scale, this subtly appears like a battle between OPEC and non-OPEC oil producers e.g. Russia who is already feeling the pressure of the crash in oil price as we will explain next.

 

Russia’s Ruble Tumble

The economic instability in Russia is causing a stir in the global economy having been rocked by twin crises of international sanctions and plunging oil prices, being the lowest since 2009. Russia, as we know, is the second largest producer of crude oil in the world slightly edging the United States in 2013. According to BP and EIA descriptions, its economy is largely driven and highly dependent on energy exports (even though it is the largest consumer in the whole of Europe and Euro Asia). Today, the Russian ruble fell by 19% against the dollar due to these crises with the economy now tottering on the verge of recession.

 

This situation has increased the country’s overall debt burden as most companies hold a large chunk of foreign liabilities in their books and have to pay down in the face of devalued rubble. As a consequent, there has been a gradual loss of confidence by investors in the economy. The recent announcement by Apple, the US-based tech company that they will be closing down their website due to the extreme fluctuation in the currency is a case in point. Inevitably, other western companies operating in the country will be assessing their books with a very keen eye and playing their cards very close to their chest.

 

Venezuela in Bad Shape

One the few surviving socialist countries in the world, Venezuela, is currently experiencing economic hardship as a result of the tumbling oil prices. Like any other oil revenue dependent country, this phase is to a great extent inevitable.  Venezuela accounts for the world’s largest oil reserve and the 9th largest exporter of crude oil according to the OPEC and EIA 2013 data respectively. The country is heavily reliant on cash flow from crude oil sale, with 96% of its export revenues coming from oil. The actual price received by Venezuela on its oil sale is further reduced as its oil is regarded as very heavy by international standards compared to the likes of Brent crude and Nigeria’s Bonny light.

The shrinkage in revenue due to plummeting global oil prices has potential implications for the South American country as currency devaluation and general rise in cost of goods and services are already being experienced. More so, it has already defaulted on its bond However, the government has resorted to borrowing more loans from its ally, China, to finance its fiscal deficit and shore up its depleted foreign reserves.

The financial situation in the country is particularly dire and compounded by the social spending programmes that are largely financed through oil revenue which have to be sustained in the face of an imminent economic recession. Having recently witnessed series of protests, political demonstrations and civil insurrection, this recurring expenditure appears politically challenging to be cut by the populist government owing to their ideological commitment and the need to maintain their political support.  However, the government has announced its decision to cut back its budget by 20 percent by reducing the emolument of political office holders and public servants without affecting social spending programmes.

 

Nigeria’s Woes

A research carried out by the International Institute of Social Studies found that the volatility of oil price and lack of economic diversification has had a negative effect on the Nigerian economy over time. As the Nigerian government has failed to create other foreign exchange earning streams when petroleum exporting countries enjoyed high revenues from crude oil as prices stayed above $100 per barrel, the economy is now sweating heavily under the present climate of falling oil prices. The surplus petrodollar gains from the crude oil sale during this period was misappropriated and mismanaged.  As it stands, the Excess Crude Account (ECA) only has a paltry sum of $4.11 billion as stated by the Minister of Finance as opposed to over $900 billion in Saudi Arabia Sovereign Fund. The naira is now under intense pressure as oil prices continue to fall thereby depressing the country’s foreign reserve. This clearly signals a potential fiscal strain on the country’s ability to meet its financial obligations as they fall due during the year.

As part of the measures to cushion the effect of the oil price shock, the Nigerian Central Bank has already devalued the country’s currency thereby giving rise to exchange rate depreciation and higher interest rates. Nevertheless, it looks unpromising as a weaker currency which is a recipe for higher exports is not valid in Nigeria situation where imports play a critical role in practically every sector of the economy. Moreso, considering the facts that the country’s budget was prepared on a reference oil price of above $70 (approx.) per barrel in 2013, there was no significant value addition to the real sector of the economy that could possibly induce exports. A couple of week ago, the 2015 budget proposal of N4.36 trillion ($23.9 billion) was submitted by the Minister of Finance to the country’s National Assembly with a reference oil price of $65 having been revised three times due to the current instability in oil prices. The reference oil price of $65 is still too far removed from realities vis-a-vis the current oil prices in the market which will subsequently lead to significant revenue shortfalls. There is definitely no end in sight in the dismal economic outlook that lies ahead unless there is a magic wand to bolster up oil prices.

What or who blinks first?

Today, Brent crude has fallen below $51 per barrel and there seems to be no definitive pattern to what might happen next.   We are aware of OPEC’s influence on crude oil supply and a decision to cut back on production will help in raising oil prices again. Will it be back above $100 again in the next few months? Will the originally lucrative oil fracking giants run out of business?  What are the recovery prospects for the Russian economy? These are questions stakeholders will be looking to answer as too many elements are involved in the economics making it difficult to forecast.

A clear lesson will have been learnt here for businesses and economies heavily reliant on revenues from one of the most volatile commodity prices in the world. Most especially for countries like Nigeria and Venezuela who still treat the prospects of economic diversification with no element of urgency.

 

Concluded.

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Op-ed pieces and contributions are the opinions of the writers only and do not represent the opinions of Y!/YNaija.

Comments (2)

  1. A well thought out article. I totally agree with you Mondiu and Victor. OPEC initially thought that U.S. shale oil producers will cut production once the price of oil is btw $70 and $80/bbl hence there decision not to cut production at its meeting of Nov., 27, 2014. Saudi and by extension OPEC new strategy is not to stabilize price by cutting production, but to ensure survival of the fittest in the oil business. it is expected that high cost oil producing areas such as US shale, Canadian heavy oil and the North Sea can not survive under low oil price due to their higher breakeven cost ($50 to $70) and therefore expected to cut production in high cost areas. Low oil price will also discourage new investments in E&P thereby curtailing future supply. A recent analysis by Wood Mackenzie however indicates that only a price of $40/bbl and below will begin to take material volumes out of global supply. the current $94 mmbbl/day global oil supply comprises 75 mmbbl/d crude oil, 15 mmbbl/d NGLs and about 5 mmbbl/d (biofues, GTLs & refinery gains). Looking at crude oil, only 0.2% or 190,000 bbl/d is cash negative at a crude oil price of $50/bb/. At $40, 1.5 million b/d is cash negative, or 1.6% of global supply. Most shale produces will still remain in business until when price is in the region of $35 to $30/bbl. We are watching.
    Regarding vulnerability of oil producing countries to low oil prices, Business Monitor International analysed that even at $60/bbl, Nigeria and Venezuela were categorized high and severe risk due to their over reliance on oil FOREX and poor management of resources. It is pathetic that countries such as Nigeria could not take advantage of the higher oil price regime to develop infrastructure and diversify its economy. the excess crude account has dwindled from about $20b in 2009 to $4.3b in Nov. 2014 and further to $3.3 b in Dec 2014. At a FAAC Meeting of Dec 2014, there was a cry that $1b disappeared from excess crude account btw Nov and Dec 2014 without any explanation. Unlike Venezuela’s crisis which is partly due to their extensive welfare programme, Nigeria’s economic crisis is due to unabated, industry scale stealing of public funds by its leaders.
    Once again, I appreciate your well researched article. I Hope you will take it to an academic forum for discussion.

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  2. unabated, industry scale stealing of public funds by its leaders.
    Once again, I appreciate your well researched article. I Hope you will take it to an academic forum for discussion.

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