Tuesday, April 14,
2021 /10:18 AM / by Coronation Research / Header Image
It was in April last year when oil prices hit multi-year lows, the price of Brent crude dipping down to US$19.33/bbl late in the month and West Texas Light hitting negative US$37.63/bbl for a day as stocks rose and storage capacity became scarce. Then the United States convened a meeting of oil producers, and the Organization of the Petroleum Exporting Countries and its ally Russia (OPEC+) agreed production cuts. Prices slowly recovered, with a steady and positive trend building up from early November onwards. Although oil & gas accounts for less than 10% of the Nigerian economy, its role in providing exports, foreign exchange and contributions to the government budget are critical. Does the current strength of oil mean that public finances are rebounding?
Last week the exchange rate in the Investors and Exporters Window (I&E Window) strengthened by 0.07% to close at N409.00/US$. In the parallel, or street market, the Naira closed flat, at N485.00/US$1. Last week Nigeria's external reserves gained US$29.0 million to close at US$35.0 billion, being the highest external reserve position recorded in over a month. This recent increase can be attributed to the increase in crude oil prices recorded in the run-up to early March (before the recent downtrend) and the increase in diaspora remittances as the Central Bank of Nigeria (CBN) offers incentives for every US dollar received. Our view is that the official foreign exchange markets continue to suffer from a shortage of foreign currency inflows. As such, we believe that the gap between the I&E and NAFEX rates on the one hand and the parallel market rate on the other is likely to remain for some time.
Last week, the secondary market yield for a Federal Government of Nigeria (FGN) Naira-denominated bond with 10 years to maturity rose by 56bps to 11.51% and at 7 years rose by 34bps to 10.95% while at 3 years the yield fell by 31bps to 7.22%. The annualized yield on a 356-day T-bill rose by 134bps to 7.98%, while the yield on a 340-day OMO bill rose by 159bps to 9.67%. In the FGN bond market the upward trends in yields over the prior week were countered with some buying of short duration paper, leading to significant decline in yields in the short-end of the curve and steepening of the yield curve overall. The average market yield declined 3bps to close at 10.66%. Our sense is that there is still upward pressure on yields.
The week closed on a bearish note in the T-bill market where activity was low after the concentration on the Primary Market Auction (PMA) the week before. Despite improved offers seen across board, not many trades were closed, especially at the long end of the curve. Hence rates increased by circa 20bps across all durations. The Debt Management Office (DMO) has published its Q2 2021 FGN bond issuance calendar for the reopening of the March 2027, March 2035, July 2045 and April 2049 bonds. The auctions are scheduled for 21 April, 19 May and 20 June. In our view, 1- year T-bill rates are still set to continue on their upward trajectory towards yields of 10.0%, or even more, by mid-year.
The price of Brent crude dropped by 2.94% last week, closing at US$62.95/bbl, a 21.53% increase year-to-date. The average price to year-to-date is US$61.47/bbl, 42.24% higher than the average of US$43.22/bbl in 2020. There has been a push-pull in the market based on global vaccination acceleration, increased production, and new lockdowns, making prices struggle for direction. The US dollar fell to a two-week low against a basket of currencies, tracking Treasury yields lower, after data showed a surprise rise in U.S. weekly jobless claims. (A weak dollar makes oil cheap for holders of other hard currencies, which can support crude prices.) On the other hand, OPEC+ agreed to increase oil production. Our view is that oil prices are likely to remain above the US$60.00/bbl mark for several weeks, if not months.
The Nigerian Stock Exchange All-Share Index (NSE-ASI) fell by 0.46% last week with a loss of 3.49% year-to-date. Flour Mills of Nigeria (+6.90%), Honeywell Flour Mills (+4.24%), and Okomu Oil Palm (+3.33%) closed positive last week, while Guinness Nigeria (-17.27%), Sterling Bank (-15.68%), and MRS (-9.92%) closed negative. Performance across sectors was broadly negative this week. The NSE Consumer Goods Index was the highest-performing sub-index over the week with a (+1.12%) gain while the NSE-30 Sub-Index recorded its highest loss for the week with (- 10.83%). Our view is that overall investor sentiment continues to be weak amid the improvements in bond yields. We will continue with the Model Equity Portfolio next week
Oil Prices to the Rescue?
By any yardstick, oil prices and production are important to Nigeria. It is not the case that the oil & gas industry is the largest industry in the country, because it accounts for less than 10% of GDP. Rather, it is the fact that the bulk of Nigeria's exports are oil & gas; oil & gas provides the most reliable source of foreign exchange inflows; and the industry provides (in a good year) the Federal Government with over 60% of its budget revenues. Looking at oil prices comes second only to looking at the exchange rate in any checklist of Nigeria's economic health.
To figure out exactly what level of foreign exchange inflows are associated with a given level of oil production and crude prices is difficult (we have tried). There are many variables, including the sell-forward factor (crude oil is sold three to six months forward), the oil-for-product swap factor, the premium of Nigerian blends over the price of Brent crude, and the fact that gas sales are made at contracted prices rather than at commodity prices.
However, over a long period of study (e.g. 10 years) it is possible to establish some rules of thumb. Oil prices below US$50.00/bbl, if sustained, are associated with weak public finances and can lead to periods during which the gross foreign exchange reserves of the Central Bank of Nigeria (CBN) trend under US$30.00bn, and this benchmark itself can be associated with Naira devaluations (as in 2016, for example). So, in our view, the CBN likely heaved a collective sigh of relief when it first protected its reserve position during 2020 (the low point was US$33.43bn) even though average oil prices were US$43.22/bbl during the year, and then saw oil prices rise towards the end of the year and in early 2021.
So, does the rise in crude oil prices make things better? The answer is 'partly'. One negative factor is the fall in production levels during 2020. When OPEC and its ally Russia (hence OPEC+) agreed to cut production levels in order to support prices a year ago, Nigeria was obliged to make its own production cuts. So, production averaged 1.88 million barrels per day (mbpd) in 2019 but fell to 1.66mbpd in 2020. It has not fully recovered, as the data for March 2021 shows 1.58mbpd. If we create a very simple index of oil economic strength (output times spot crude prices) we would find ourselves in a similar position to January 2020, which is by no means bad, though not optimal.
However, in January 2020 (and again in February 2020) Nigeria was able to sell over US$1.0bn worth of Naira-denominated fixed income securities to foreign portfolio investors so that foreign portfolio investment (FPI) continued (as it had done for many years) to be a support for the overall foreign exchange position of the CBN. Needless to say, these investments slowed considerably in March 2020 with the onset of the Covid19 pandemic and the crash in oil prices. It is a moot point whether - now that crude oil prices are up again - FPI will return in significant volume to provide short-term (under one year) funding and bolster the FX reserves of the CBN. Our sense is that this trade (the so-called carry trade) may take a while to be restored. So Nigeria's ability to leverage off its oil revenues has been reduced, at least for the time being. On the other hand, the way is open for Nigeria to make a significant US dollar-denominated Eurobond issue this year, so some of its ability to borrow against the surety of oil income has been restored.
Crude oil prices have not fully restored the oil-related financing (inflows from oil & gas sales and debt issues) that we saw during a year like 2019, for example. Nevertheless, the return to oil prices comfortably above US$50.00/bbl brings a level of security that, in our view, allows the CBN to tackle the two issues that regularly fill these pages, and that are the key policy areas right now: Naira inflation and Naira interest rates.
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