Era of High Oil Prices Slowly Ebbing as OPECplus Eases Supply Cuts


Friday, April 16, 2021 / 11:51 AM / by FDC Ltd / Header Image Credit:  OPEC Secretariat

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OPEC and its allies have finally taken the step to reduce ongoing output cuts and increase production. This is occurring after several months of tightening in addition to voluntary cuts by Saudi Arabia. At its April meeting, OPEC+ agreed to increase production by 1.14mbpd for three months starting in May and ending in July. Oil prices fell to $62pb as a knee-jerk reaction to the outcome. The cartel had hesitated until now to relax its grip on oil output levels due to uncertainty about the strength of the recovery in global oil demand. Eu-rope, a major oil-consuming region is experiencing its third wave of the coronavirus and has imposed new lockdowns. There have also been controversies surrounding the AstraZeneca vaccine in the continent, which led to the halt of its use and this could slow down the recovery of the region.


OPEC's share being eroded, new kids are on the block

OPEC for decades maintained its position as the leading and dominant player in the global oil market, with Saudi Arabia at the helm. However, this is changing with the cartel slowly losing its grip on the reins of bargaining power. The commencement of output cuts have also steadily chipped off some of the cartel's hold. New kids on the block such as the US and the mix with its allies (called OPEC+ mainly Russia) are altering the dynamics and widening the divide between price leaders and followers.


OPEC's share of global oil supply has dropped to approximately 26.9% (24.8mbpd) from 34% 10years ago.4 In recent times, the cartel's decision on the global oil market is jointly made with its allies such as Russia. In March, there were speculations that Saudi Arabia and Russia (the two major forces in OPEC+) were on opposite sides of the output cuts, with the former favoring a more cautious approach and the latter pushing for a relaxation. It seems Russia won this round.


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Price followers struggling, price leaders going on strong

In any oligopoly, there are the price leaders, who set the tone for price movements and the price followers who are vulnerable and stand to lose the most. In the global oil market, the likes of Nigeria, Angola and Gabon are the price followers. These countries are the worst hit when oil prices are down, due to low fiscal and external buffers. Their production levels account for a marginal amount of total global oil supply.


For instance, the three aforementioned countries account for less than 4% of total global output. These countries also usually have a high fuel import bill due to defunct or nonexistent domestic refineries, forcing them to import refined petroleum products.


The price leaders in the global oil market are the US, Russia and Saudi Arabia. These three powerhouses combined account for 32% of total global output. They have significant oil reserves and external buffers to support their currencies should oil prices fall sharply like in April 2020. However, the price leaders do not necessarily have the lowest cost of production as shown in the table below.


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Nigeria's diversification story from oil, when will it yield the desired outcome?

For as long as I can remember, I have heard policy authorities in Nigeria talk about the diversification story and the need to reduce the economy's reliance on oil. Over the years, it seems ef-forts implemented are yet to produce the desired result. Oil and gas exports' share of total export earnings have increased in the last decade, from approximately 70% in 2010 to almost 90% in 2020. On the other hand, the sector's contribution to economic activities has been hovering around 8-9% of GDP while the non-oil sector accounts for the bulk. Why has the government been unable to convert the over 90% contribution of the non-oil sector to GDP output, to generating significantly more in exports and revenue? There have been import substitution strategies put in place to support local industries, forex restrictions to reduce competition from imported goods and several intervention funds disbursed by the government and the CBN. However, all these efforts appear to be rhetoric with no results, as the non-oil sector only accounts for a paltry 10% of export earnings.


There is a direct correlation between oil earnings and the external position of the country and the exchange rate. The higher the oil proceeds, the higher the increase in the external reserves accretion and the CBN's ability to support the currency and ensure exchange rate stability. With oil prices projected to slide due to OPEC+ relaxation of output cuts amid still low production levels, Nigeria's oil proceeds may dwindle and this will affect the CBN's ability to support the currency.


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