April 23, 2020 / 08:48 AM / By FDC Ltd / Header Image Credit: Financial Times
Since the historic output cut by OPEC and its allies, oil prices have continued to trade below $30pb, contrary to market expectations. West Texas Intermediate (WTI) traded in negative territory (-$37pb) for the first time ever due to the slump in oil demand and storage constraints. This is an indication of the softness of the global oil market and the fact that the global oil market is more demand sensitive than supply. With the largest oil consumer (China) likely to post a meager growth rate of 1% in 2020, oil prices at current levels of $27pb and possibly lower may be the order of the day. Other demand factors that have suppressed the price of oil include the suspension of all flights except for essential services and the postponement of summer trips and tourist events.
What Does This Mean For Nigeria?
Part of the Federal Government's policy responses to the contraction in economic activities and drop in fiscal revenue was the adjustment of the 2020 budget oil price benchmark to $30pb from $57pb initially approved. The oil production benchmark was adjusted from 2.18mbpd to 1.7mbpd, with a further decline to 1.4mbpd being considered. All revenue projections initially made have become null and void and the fiscal deficit of N1.85trn earlier projected is looking more like N4.9trn. The bad news is that the Nigerian economy was already in a dire state prior to the slump in oil prices and the COVID -19 pandemic. The country was already facing challenges such as sub-optimal growth, fiscal and external imbalances and negative total factor productivity.
Impact of oil price plunge in Nigeria
The average price of oil YTD is $47.43pb. This is 58.18% above the FGN's budget benchmark of $30pb. This coupled with a 35.78% reduction in oil production (from 2.18mbpd to 1.4mbpd) will impact significantly on Nigeria's fiscal position. The government has requested for $6.9bn from multilateral organizations to boost its funding needs, which are now focused on addressing the impact of the COVID-19 pandemic on the economy. State governments depend partly on oil receipts to meet their debt obligations. We are anticipating a further decline in FAAC disbursement in subsequent months. However the new exchange rate of N360/$ used to convert oil revenues may cap the losses as evident in April's disbursement, which increased by 9.1% to N634.72bn. This means that states will struggle to pay salaries and meet other obligations.
Nigeria's external reserves level has depleted 12.33% ($4.76bn) so far this year to its current level of $33.84bn (April 16, 2020). Over 70% of Nigeria's forex receipts are from oil proceeds. While on the demand side, forex demand pressures have been muted due to suspension of flights and shutdown of schools, the supply of dollars has dropped sharply and may continue to fall as oil revenue slides. The IMF is projecting an average oil price of $35pb in 2020.
The CBN in March adjusted the official exchange rate and IEFX rate to N360/$ and N380/$ to reflect current market realities. At the parallel market, the naira is trading within a range of N415/$ and N430/$ (that is even if it is available to buy). Due to the high dependence on oil proceeds, the softness of the oil market may lead to a deterioration of the terms of trade, thereby heightening the pressure on the currency. This may call for further adjustments to the currency if need be.