Nigeria's 2021 Oil Market Playbook: Eyeballing Opportunities and Mitigating Threats

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Saturday, March 13, 2021,   /09:50 AM / By Adesola Borokinni and Tosin Ige, Proshare Research/Header Image Credit: Oilprice


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Global oil market playbooks are changing as countries look out for their interests in the glacial movement of oil prices and the market's recent choppiness. India, for example, recently announced its decision to diversify its oil import markets as it angles towards lower average energy prices. The gambit sees the country looking to extend imports beyond its traditional trade partners of the United States of America (USA) and Guyana.  

 

The India market shift, analysts note, could set the tone for more aggressive supply chain competition amongst non-traditional suppliers of oil to India who would find the country a fine game for offering 'sweeteners' to take a piece of the Asian oil and gas market. How would the tactic pan out for prospective suppliers? the possible outcomes are mixed depending on the existing relationships between India and the new supplier and the type of oil produced in the prospective country of supply. For example, Indian industries prefer heavier oil to the lighter oil brands that come from countries such as Nigeria and Angola. This would mean that African countries would not be the first choices in India's oil supply diversification plans.

 

Preferred countries for the Indian foray into new supply markets for heavy crude would be Iran and Venezuela, but the ongoing political tiffs between both countries and the USA would make these options very difficult choices.

 

Many non-oil-producing countries depend on OPEC and its allies, a group called OPECplus, to supply oil for their domestic consumptions. To strengthen oil price, OPECplus extended its production cuts to April 2021 with little exception to Russia and Kazakhstan. But as OPECplus uses the production cut to tighten the oil market, oil importers are seeing domestic growth chopped at the knees by the rising cost of oil imports.

 

The Local Cost of An Oil Squeeze

Analysts note that domestic inflation in oil-importing countries has started to rise above policymaker's expectations and could lead to unexpected monetary tightening which in turn would raise domestic interest rates and clobber gross domestic product (GDP) growth.

 

Against this development, oil importers have started to look for strategies that would improve possible economic outcomes such as diversify their import sources to generate more supplier competition to contain a supplier price squeeze.

 

The Indian economy was adversely affected by the coronavirus pandemic as it recorded the highest number of coronavirus cases in the Asian continent. To curtail the spread of the virus the Indian economy enforced strict lockdown which adversely affected the economy. Although the Indian economy is out of recession as its GDP grew by +0.4% in Q4 2020, it recorded a pandemic induced recession in Q3 2020 as its GDP contracted by -7.3% (see Chart 1 below).

 

Chart 1: India's GDP Growth Rate (%)

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Source: Trading Economics, Proshare Research

 

Fuel consumption has become an integral part of the Indian economy, therefore, activities in the international oil market affect the Indian economy. Also, recent reforms of the fuel taxation and subsidy system in India have meant that consumers would increasingly be susceptible to changes in the international oil market. Although India's inflation rate eased to a 16-month low of 4.06% in January 2021 mainly on account of the softening of food and vegetable prices, the rise in crude oil prices and their transmission into retail fuel prices have posed a concern for the government's economic recovery effort and the mandate by the Indian government to the Reserve Bank of India (RBI) to keep inflation within an average rate of 4% and a margin rate of 2% on either side of the average (see Chart 2below).

 

 

Chart 2: India's Inflation Rate (%)

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Source: Trading Economics, Proshare Research

 

The fear of the effect of the rise of international oil price and its impact on growth has fueled the country's decision to diversify its import source away from OPEC. India's share of oil imports as a percentage of the world's total stood at 9.7% in 2019, underlining its status as the world's third-largest crude oil importer. According to a Reuters report in 2020, India, imported over 80% of its crude oil from OPEC in the last two decades, but between 2019 and 2020, OPEC's share of India's total oil imports dipped to 78.3%.

 

Following the maintenance of oil production cut by OPECplus till April 2021, India has sought to further diversify its import away from its two main OPEC suppliers in the Middle East, Iraq, and Saudi Arabia in a bid to keep its import bills down and domestic price level stable at lower single-digits. The economist's game theory framework comes in handy in interpreting the global state of play in the international oil market in months, the strategic possibilities between India and OPECplus can be understood using the matrix below (see Illustration 1 below).

 

 

Illustration 1: The Oil Market PlayBook: India Vs OPEC Plus

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The contextual positions and likely outcomes to the growing international oil price hike for the Indian economy appear in Illustration 1. The horizontal axis describes the strategies OPECplus could adopt, given the alternative policy actions of India's OPECplus could either cut back supply or keep a supply at current levels. The vertical axis describes strategies available to India's government, which involves either buying from OPECplus regardless of cutbacks or buy from competing suppliers outside OPECplus such as America and Guyana, given the cutback strategy of OPEC and its non-OPEC allies. The likely actions and the possible outcomes of the competing interests are described below:

 

  • Quadrant A - This game strategy paints a scenario around what happens if OPECplus maintains its crude oil production cut, as it has done presently, rolling over the cut to April 2021, and India continues buying crude oil from OPECplus. The outcome of this strategy makes OPECplus winners, as the rise in price will shore up revenue generation from oil supply. On the flip side, if India continues buying from OPECplus despite rising prices, India would record a higher import bill and a rise in domestic inflation. Thus India would likely alter the balance of power going to tilt towards this strategy if the cuts in oil supply by OPECplus lingers.
  • Quadrant B - If OPECplus maintains its crude oil production cut and India reacts by seeking alternative sources for its crude oil imports, both players would experience neutral outcomes. India could seek supply alternatives while OPECplus could protect prices while it sends supplies to other global markets.  This rationale stems from the fact that OPECplus members would still benefit from rising oil prices while India's import bill would fall (if it could negotiate new supplies at comparatively lower prices).
  • Quadrant C - If OPECplus does not cut oil supply and India chooses to continue buying from OPECplus, the possible outcome would be that in the short run, OPECplus would suffer lower oil prices but India gains from the lower price which would reduce its import bill.
  • Quadrant D - Conversely, if OPECplus opts for the no-cut oil supply option and India chooses to seek other alternative sources for its oil imports, OPECplus would likely record a decline in the OPEC oil basket but India would gain from the lower price from an alternative source in the short run. This outcome might not be feasible as India would not contemplate seeking an alternative source of supply if OPECplus does not cut production/supply.

 

Intuitively, the best outcome for both players would be Quadrant B, where OPECplus gains from the production cut, and India would also gain by seeking alternative energy sources. Although, some analysts have speculated that countries like the US, Guyana, Iran, and Venezuela could be an alternative source for India's oil import diversification plans insufficient volumes and political considerations are making these options dim.

 

Indeed, oil experts have expressed strong doubts that Guyana would be able to ramp up sufficient volumes to meet India's import needs. Furthermore, the sanctions on  Venezuela and Iran by the US have eliminated both countries as options in its oil import diversification programme. Therefore, India's limited options as regards its alternative sourcing of crude oil might hurt its plan for diversification.

 

The Oil Market Playbook: India vs Nigeria

Nigeria is the fourth-largest supplier of crude oil to India, coming behind Iraq, Saudi Arabia, and the United Arab Emirates (UAE). Nigeria's active membership of OPECplus aligns her with the position of the middle east oil suppliers, as it must abide by the OPECplus cut. However, the game of competing strategies still comes into play between Nigeria and India (see Illustration 2).

 

Illustration 2: The Oil Market Playbook: India

 

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The strategies available for Nigeria given India's reactions are:

  • Quadrant A - If Nigeria cuts oil supply and India retains buying from Nigeria, the possible outcome would be that Nigeria gains from the increasing oil prices while India suffers high import bills in the short run. It favours Nigeria to stick with this action in the hope that India will continue to trade with her (however, countervailing trade actions by India seem compelling here).
  • Quadrant B - If Nigeria cuts oil supply in line with OPECplus's decision and India responds by seeking an alternative source for its oil, the outcome is that Nigeria suffers a drop in its oil revenue in the short-term since India is a key importer of Nigerian oil. On the other hand, India would benefit by seeking alternative lower-priced oil. Its import bills and the domestic price level would both fall drop. It favours India to seek alternatives when Nigeria maintains an oil production cut.
  • Quadrant C- If Nigeria decides against an oil production cut and India maintained buying from Nigeria, the outcome is that Nigeria loses with the attendant low oil price minimizing its revenue opportunities, but India gains from lower import bills and a reduction in the domestic inflation rate.
  • Quadrant D-If Nigeria agrees not to cut oil production and India seeks alternative oil sources, the outcome is that Nigeria suffers lower oil price, but India gains from the lower oil price in terms of lower import bills in the short run. This outcome might not be feasible as India would not contemplate seeking an alternative if Nigeria does not cut oil supply.

Nigeria holds dim prospects in the international oil game. The only favourable outcome for Nigeria is to stick with the production cut hoping that India will continue to buy its oil. Currently, Nigeria exports a significant amount of its crude oil to India which makes it susceptible to India's threat. India's threat to OPECplus means a major threat to Nigeria's export earnings. The only alternative solution would be for Nigeria to seek an alternative destination for her crude oil, considering Reuter's report published on January 2oth 2021 that India's import from the middle east and Africa recorded a decline in December 2020 from its value in the previous month. A trend that may continue going by OPECplus's current decision. Some analysts argue that even if Nigeria opted out of OPECplus cut in crude supply to the international market, it was unlikely for Nigeria to receive India's attention because it produces mainly lighter low-sulfur grade fuel which yields more gasoline than heavier fuels preferred by Indian refineries.

 

Cleaner Energy: Shifting the Pendulum

 

Global economies have suffered a major decline in economic activities and low oil demand for about a year due to the adverse impact of COVID-19 on international manufacturing. The rebound in oil demand and economic activities is presently stirring a resurgence in global business activity. The distribution of the COVID-19 vaccine is beating up the demand for oil and the recovery of economic activities. However, recoveries to pre-pandemic levels will be slow but varied across industry categories.

 

There is a new normal for all sectors. Governments across the globe are seizing the moment to push the world into a decarbonized (global) economy. According to the Intergovernmental Panel on Climate Change (IPCC), the global economy has just one decade left to change or bear the worsening effects of climate change. Climate analysts insist that the world cannot afford to see the worst of climate change. Hence, the oil and gas industry needs to create opportunities for a shift in production technology, products, and technical efficiency. Furthermore, countries like Nigeria, Angola, Venezuela, and so on, largely dependent on oil must readjust economic structures to cope with the global pivot towards cleaner energy and a climate-friendly environment.

 

In line with the global drive for a cleaner energy transition Nigeria's President, Mr. Muhammadu Buhari, has led the charge towards a gas-powered economy by 2030, the administration has initiated several gas developments programs such as; a decade of gas agenda, industry-university gas collaboration, as well as the inclusion of gas terms in production sharing contracts which covers the fiscal and legal framework for gas development. Sector analysts have noted that while pursuing a gas agenda for a green energy transition, many oil-dependent sectors will be adversely affected, therefore, a need has been identified for all stakeholders in the oil & gas industry to collaborate, re-imagine, re-evaluate and restrategize their business processes.

 

 

 

Rethinking Oil's Reality

The FY 2020 performance of Nigeria's oil and gas industry is on amber alert due to the large presence of crude oil in their traded product baskets of major market players. Notably,  crude oil as a preferred energy source is fading and the timeline for its continued use is shortening as a result of the aggressive global drive towards cleaner energy.

 

With global economies pirouetting from oil to greener alternatives, countries like Nigeria need to move swiftly and deliberately towards a new export portfolio of tradeable goods and services.  

 

Postscript-Nigeria's Domestic Fuel Pricing; from Confusion to Confession

First Side Bar

On March 11, 2021, the Petroleum Product Pricing and Regulatory Agency (PPPRA) kicked dirt into the eyes of retail market pricing of domestic premium motor spirit (PMS). The agency jacked up the price of petrol to between N209.61 and N212.61 per litre up from between N168 and N170 per litre at most filling stations at the beginning of the month (see table 1 below). The sudden sharp rise in the price of PMS led to a lightening dash for filling stations as motorists dazed by the announcement made a beeline to petrol stations to buy either at lower prices than was announced by the PPPRA or before fellow motorists got wind of the price hike and swarmed the stations themselves.

 

The upward price bump in the PPPRA-advised fuel rates was quickly met with a response from the Nigerian National Petroleum Corporation (NNPC), the state-owned oil behemoth and parent of the PPPRA, which insisted that it had not changed the ex-depot price of PMS to major marketers (the ex-depot price is the price at which the product is sold by the NNPC to marketers at the depots) and therefore would not support any upward retail price adjustment. The confusion left many motorists in a haze of indecision. Who do you believe? So far, nobody. The Minister of State for Petroleum Resources has also distanced himself from the knowledge of the price increase and insisted that the PPPRA's announcement was, according to the junior minister, "completely untrue".

 

Nevertheless, by the evening of Friday, March 12 2021 petrol stations across the federation had been jammed with motorists queuing for fuel to fill their cars and generators. Analysts noted that the queues were symptomatic of the problems that arise from discretionary public sector price determination of products or services and suggested that the national assembly (NASS) pass the petroleum industry bill (PIB) 2020 into law without further delay. They argued that for the economy to rethink and reposition the oil and gas sector the parliamentarians need to pass the PIB and free the market from the overbearing and market-distorting actions of government agencies.

 

Table 1: PPPRA Product Pricing Template (PMS)

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Oil and Gas (O&G) sector analysts believe that the PPPRA and NNPC communication gaffe was indicative of a lack of coordination amongst government agencies and corporations and a strong reason for the domestic oil market to be unbundled and allowed to operate within the best global market governance practices. Inherent in the price announcement confusion by the PPPRA is a confession that the sector would do much better without state price-determination.

 

Second Side Bar

If India goes ahead with its decision to pivot away from OPEC and OPECplus suppliers of oil, the Nigerian economy would hit a double whammy. The first being a reduction in revenue, as the Indian economy is a major export destination of Nigeria's crude. Therefore, a reduction in India's demand for Nigeria's crude would hurt Nigeria's oil revenue. The second being that Nigerian citizens would have to pay more for local oil products such as PMS as the rise in the cost of refined fuel would be passed on to domestic consumers, this, in turn, would raise transport costs and increase the cost of food distribution. The combined effect of a transport cost hike and food price increases would be a rise in the domestic inflation rate.

 


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