Monday, February 18, 2013 / FDC
A report released by PricewaterhouseCoopers (PwC) this month revealed that oil prices are likely to decline by 25-40% over the next four years as a result of increased shale oil and gas production in the US. This comes soon after other reports show that the US is reducing its imports of African crude oil including that from Nigeria and will fully halt importation from Africa next year.
The threat of lower oil revenues at a time of increasing government expenditure will be a true test for the National Assembly (NASS) and Executive as they negotiate a Budget 2013 deal. The review below explains in some detail the fallout of oil prices on the Nigerian economy and also deals with the industry struggle between cement importers and manufacturers.
Haunted by the Spectre of Declining Oil Prices
“By the second quarter of this year, we will stop importing West African light, sweet crude into the Gulf,” says Morse, the Head of Commodities research at city group global markets. Sometime before mid-2014, he predicts that the U.S. and Canada will stop importing crude from West Africa . A quote culled from a Bloomberg Business week article, has triggered numerous reactions, most especially- what does this mean for Nigeria ?
It is no longer news that the US will be self sufficient in its oil consumption in the not too distant future. However the latest report that predicts the most powerful country will completely halt oil importation of West African sweet crude by 2014 has sent the alarm bells ringing. Nigeria , a highly dependent hydrocarbon economy is one of the 2 highest producers of sweet crude in West Africa, alongside Angola with each producing 2.02mbpd and 1.74mbpd respectively according to OPEC’s January 2013 report.
A review of the US imports of crude oil and petroleum products from Nigeria according to the Energy Information Administration (EIA) shows that the US imports from Nigeria has been on the downward trend from January 2011. US oil imports from Nigeria declined by 46.8% to 543,000bpd in October 2012 from 1.02mbpd in January 2011. In addition, a further study of US import of Nigeria ’s crude reveals that the decline in the US ’ import of Nigeria ’s crude is insignificant to Nigeria oil revenue. To see this clearly, we consider two periods where US ’ consumption of Nigeria ’s oil declined. In February 2012, US ’ consumption of Nigeria ’s sweet crude hit its record low of 353,000bpd, representing a decline of 30% from the previous months’ 504,000bpd. This decline was attributed to the drop in crude lifting as a result of production shutdown in some terminals but not as a result of US’ decision to reduce its demand. The decline in US’ consumption impacted negatively on Nigeria ’s oil revenue for February. Also in July, the US ’s consumption of Nigeria crude declined but this time, as a result of reduced oil demand by 28% to 372,000bpb from 515,000bpb in June. However, Nigeria ’s oil revenues rose by 9.14% despite the huge reduction in US import. This shows that the increasing demand for Nigeria ’s crude from Asia, notably China and an oil price (bonny light crude) above $115pb was able to quell the negative impact from the decline in US’ demand.
Hence, the major challenge given the above would not be the reduction or halt in US’ import of Nigeria ’s crude but rather how to deal with factors such as theft, production slowdown, and difficulties in shipping to Asian countries compared with shipping to the US among other challenges. The Nigerian oil industry has been subject to leakages in the form of oil theft ($7m annually) and pipeline disruptions. The direct relationship between production and revenue calls for an effective production process to boost growth in oil output. Also, Nigeria has 4 refineries with a combined in-stalled capacity of 445,000bpd which are in a dilapidating state. The petroleum industry bill (PIB), a reform that is expected to alter the fiscal and regulatory framework of the industry and usher in the much needed investment is stuck in limbo at the National Assembly. Meanwhile, an early passage of the bill will improve the oil industry activities and growth.
Price, another important variable, has been robust in the last 12 months, with Bonny Light trading at an average of $117pb, Brent crude at $115.22pb and West Texas Intermediate at $97.62pb. The high oil prices pose serious threats to crude shipment from Nigeria due to Asian buyers’ demand for discounts as a result of the long distance of shipping. Given the changing global energy dynamics, the current trend of high oil prices may not be sustainable in the long run. The major challenge to oil price sustainability is the growing production of shale oil and gas through fracking. According to a report by PricewaterhouseCoopers (PwC), fracking if deployed to other parts of the world could depress global oil prices. PwC further predicted that an increase in shale oil/gas production to about 12% of total oil production could reduce oil prices by 25-40%. This is in line with our projection that global oil prices could drop sharply to-wards $90pb in early 2014, a price level that will now be the ceiling rather than the floor it’s been for years.
Impact of decline in Oil Price (Bonny) on Macro-economic Indicators
Oil exports remain the major source of fiscal and export revenues in Ni-geria. Oil is responsible for 75% of fiscal and 95% of export revenues. This structure leaves the country highly vulnerable to either price or production shocks. We have attempted to calibrate the impact of price changes on leading economic indicators. The regression and outcomes confirm the fears of a profound impact of price changes on the Nigerian economy.
There is a positive correlation between oil price and GDP growth. Our model shows that any $1 decline in oil price would result in a 0.1% slow-down in real GDP growth i.e. Real GDP growth = 0.0612*Oil price (Bonny)
If oil prices decline from the current price of $117pb to $90pb, GDP growth will decline from 7.09% to 5.5%p.a. This is because of the revenue effect on government expenditure and negative multiplier on GDP.
Foreign Exchange (FOREX) inflows
Forex inflow = 0.034*Oil price (Bonny) i.e. Foreign exchange (FOREX) inflows to the Central Bank of Nigeria (CBN) is positively correlated to the movement in oil price. Hence, a decline in oil price ($1) would lead to a decline of 0.03% in forex inflows given that other sources of forex inflows and oil production remain constant. A decline in Nigeria ’s oil price to $90pb would result in a decline of the monthly oil revenue to $3.36bn, a 38.91% drop from $5.5bn recorded in November 2012.
Exchange Rate = 1.33*Oil price i.e There is a positive correlation between oil price volatility and the exchange rate in Nigeria due to the dependence on foreign currencies by oil companies. For every $1pb fall in the price of Nigeria ’s Crude, the naira depreciates by 0.8% given that the external reserves are not used to support the naira. Hence, if Nigeria ’s oil price falls to $90pb, the naira could depreciate to N177.26/$. However, we expect that the reserves will be used to support the naira and this could imply a slower depreciation against the dollar.
Oil price movement have a significant and positive correlation with external reserves accretion. Our investigation shows that a drop in oil price will lead to a 0.85% decline in the reserves levels, holding other sources of reserves accretion constant. External Reserve= 0.3099*Oil price (Bonny)
Therefore, if oil price falls to $90pb from current price of $117, the external reserves should decline to $35.05bn from the present level of $46.63bn. This would put the country in a chaotic situation that includes a threat to government expenditure which may lead to increase in debt, a depreciation of the naira which will increase the cost of imported materials/ cost of inputs of manufacturers and a drop in general economic out-put.
If all these happen, who will be the first to succumb?
What does this Future hold for Nigeria ?
The shale oil revolution taking place in the US poses grave implications for Nigeria ’s trade pattern. The excess crude that will result from the halt in consumption by the US will have to find their way to other markets probably the China and India . The intense competition that will take place is going to have a downside effect on global oil prices which will be dis-ruptive for the heavily oil dependent Nigerian economy. The ripple effect will trickle down from a decline in oil receipts to a decline in government revenue, depletion of external reserves, pressure on the naira and overall macro economy. Nigeria has a subsidy plan that lowers the price of fuel for its citizens. The pressure will be intense to maintain this and also keep the government afloat.
FDC Bi-Monthly Economic and Business Update – February 2013
FDC Bi-Monthly Economic and Business Update - December 2012
Disclaimer/Advice to Readers:
While the website is checked for accuracy, we are not liable for any incorrect information included. The details of this publication should not be construed as an investment advice by the author/analyst or the publishers/Proshare. Proshare Limited, its employees and analysts accept no liability for any loss arising from the use of this information. All opinions on this page/site constitute the authors best estimate judgement as of this date and are subject to change without notice. Investors should see the content of this page as one of the factors to consider in making their investment decision. We recommend that you make enquiries based on your own circumstances and, if necessary, take professional advice before entering into transactions. This article is published with the consent of the author(s) for circulation to the online investment community in accordance with the terms of usage. Further enquiries should be directed to the author, Financial Derivatives Company Limited whose e-mail firstname.lastname@example.org.