Tuesday, January 05, 2016 5.37 AM / By Temitope Oshikoya**
“Beware of the wisdom of the crowds”-- James Surowiecki
On Tuesday, 22nd December, 2015, President Buhari finally unveiled the 2016 Budget of Change. In several respects, the budget is bodacious: a blend of the bold and the audacious. The presentation of Buhari’s Bodacious Budget (The Triple B) has focused more on the attempt to walk the talk on the electoral poll change trinity of security, economy, and corruption.
For a sluggish economy, the budget is boldly expansionary proposing to spend N6.08 trillion, the highest in our history and a quarter higher than the 2015 budget. Recurrent expenditure consumes N4.8 trillion (70%) and capital expenditure represents N 1.8 trillion (30%). The budget is audacious in its attempt to finance spending with non-oil revenue of N1.45 trillion (50%), independent revenue of N1.3 trillion (30%) and projected oil revenue accounting for only N840 billion (20%).
The budget is even more bodacious, with a deficit of N2.2 trillion to be financed by misappropriated funds recovery (N380 billion), domestic borrowing (N900 billion) and external borrowing (N984 billion) when debt servicing is already at a record high of N1.36 trillion.
In analyzing the budget, attempts should be made to address four questions – what, where, why, and how? Popular commentary on the budget proposals has generally focused on the what (assumptions, revenue, spending, and deficits figures) and the where (the sector allocation of spending) of the budget. Some have also raised concerns about the assumptions on oil prices, the lack of detail on the cost of the social welfare programs, and rising deficits.
This three-part article focuses specifically on real oil prices, exchange rates regime, and the real cost of financing the deficits and other real parameters. The assertion here is that the commentaries have largely focused on the nominal figures, neglecting the real fiscal and economic analysis, the why and how the budget would affect the economy. Economists would also be interested in the why and how of the budget, especially its real impact on the economy both in the short-term and in the long-term.
Real and Nominal Oil Prices
Let us consider a few real economic parameters underlying the budget.
But before proceeding further, it is important to shed light on the sensational reporting in some newspapers about oil prices going to $20 based on the Report of IMF Article IV Consultation on Iran which indicates that “The expected increase in oil supply from Iran would put downward pressure on global prices, by an estimated $5–$15 per barrel… While part of this impact may be already discounted in futures markets, a further decline could materialise when Iran’s exports rise, depending on how other OPEC producers react.”
The conclusion drawn by newspapers is that the IMF suggested that oil prices fall to $20. That is not correct. Indeed, the IMF never implied that as it actually projected an oil price of approximately $50 for 2016, rising to $63 in 2020, according to Table 1 of the same IMF Article 4 Consultation Report on Iran. Now, an average fall of the oil price in 2016 by $15 from $50 would yield $35, roughly $3 below the $38 benchmark set for Nigeria’s 2016 budget.
The Report also clearly states that “The RAM (Risks Assessment Matrix) reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities.” The consultations with the Iranian Authorities actually ended on September 30, 2015, while the IMF Board discussed the Report on December 7, 2015. Those who are familiar with the workings of international financial institutions (IFI) know that there is a time lag between the conclusions of consultations with national authorities and discussions by the Executive Board of the IFI.
Even more interesting is the real price of oil over time. Meticulous readers will find the messages from the following articles rather interesting. First, remember the famous Jim O’Neil of Goldman Sachs? He wrote an article on 7th January, 2015, titled The Price of Oil in 2015 with the following concluding remarks: “Oil prices may not start rising in the coming months, but, as 2014 comes to a close, forces that would eventually halt their decline are beginning to appear. The drop in oil prices has taken it significantly below the five-year forward price, which remains close to $80 per barrel. My hunch for 2015 is that oil prices may continue to drop in the short-term; unlike in the past four years, however, they are likely to finish the year higher than they were when it began.” .
On the other hand, Anatole Kalestky on 14th January 2015 penned an article suggesting $50 as A New Ceiling for Oil Prices. According to Kalestky “Most analysts still see $50 as a floor – or even a springboard, because positioning in the futures market suggests expectations of a fairly quick rebound to $70 or $80. But economics and history suggest that today’s price should be viewed as a probable ceiling for a much lower trading range, which may stretch all the way down toward $20.
Readers will find even more interesting the key message of this article by Floris Laly :. According to the author: “In 2008, many commentators predicted that the sky was the limit for crude oil prices due to the so-called peak oil theory. Seven years later, crude oil is still in bear market territory and WTI crude oil prices are down 77% from their 2008 top. As often, mean reversion, i.e. the process by which prices tend to revert and move towards their long-term average over time, made a comeback with a vengeance (excesses on the upside being compensated by excesses on the downside).”
Laly continues: “Over the 393 months (observations) of the time series, WTI crude oil prices fell below $20/bbl only 5 times (August 1998, November 1998, December 1998, January 1999, February 1999), i.e. 1, 3% of the time (also note that these extreme prices were reached at the end of the previous bear market). The big picture is now quite different. Indeed, when adjusted for inflation, we notice that WTI crude oil prices have, for the last 33 years, been above $20/bbl almost 99% of the time (in 2015 US dollars). We also know that WTI crude oil prices in 1973, before the oil crisis, were floating around $3/bbl, which in 2015 US dollars would represent $16/bbl, i.e. not that far from $20/bbl in today's US dollars. Last but not least, the sample mean is increased when taking inflation into account ($54/bbl in real terms vs. $42/bbl in nominal terms), which means average prices are expected to be higher over the long-term that what could be induced from historical nominal prices.”
Beware of the wisdom of the crowd. Those who relied on the predictions of oil price hovering higher around $70-$80 by the likes of Jim O’Neill, including possibly our previous economic management team, will have eaten humble pie by now. At the time, this writer had penned an article titled “How not to manage the economy” in The Guardian suggesting Nigerians should be provided with a budgetary scenario for an oil price as low as $40 to $30, while a >$70 price benchmark was initially being used for the 2015 budget and for 2016 in the 2014-2016 MTEF.
Far from following the wisdom of the crowd which believed that oil price was going to the moon on the way up (some projected up to $200pb), and now going to the dog house on the way down (some are projecting below $20pb), this writer believes that for 2016, the price of oil may be far from its top, but may be closer to the bottom.
**Dr. Temitope Oshikoya, an economist and a chartered banker, is CEO of Nextnomics Advisory. He can be reached at firstname.lastname@example.org