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Nigeria and the Voluntary Cap: Battling With Fiscal Bumps

Proshare

Wednesday, August 02, 2017, 4.25PM / Proshare Research 

Introduction                  

On Monday 24th July 2017, OPEC in a follow up to its earlier decision taken in December 2016 to protect its market share, implemented further cuts to its production, the cartel also capped Nigerian production to 1.8 million barrels per day.   

The present oil dynamics has put the oil cartel and certain non-OPEC members on the back foot as over supply have continued to weigh down price.  

The ripple effect has been a relatively slow growth in global capital expenditure in the oil and gas industry compared to 2015. More interestingly is that capital expenditure in the oil and gas industry in Africa has been sluggish. 

Fig 1: Global Capital Expenditure In Oil And Gas Industries

 

  

Source: IMF, Proshare Reseach   

Therefore, to steer the curve upwards by slimming down supply, while placing price within bands that will not encourage flooding by shale oil producers, one must admit that the cartel finds itself not just fighting to retain its market share but the desperation at which it has held it lines. Thus, reflecting an organization fighting desperately for its life. 

The only way to win this murky battle is to choke out unconventional crude by making them less profitable. At the same time, ensure the Individual budgets of OPEC countries are not heavily hit by a low oil price.  

Unlike in the past where the cartel stirs price overshoots like oil shocks in the 70s, presently they just want enough to balance their budgets and keep the shale boys off their tail.  

It is not surprisingly, the cartel has chosen to compromise price not production, to retain its chunk of the market.  

Fig 2: Cost of Producing Oil in Some Countries   

 
Source: Business Day Research (2016)   

The cost of producing shale varies from 40$ to 90$ per barrel globally (Wikipedia), over time the cost of producing shale oil in the Unites states has slipped below 40$.  

The shrinking in cost of production in the United States have been triggered by technological innovation and prudent cost cutting measures by shale producers.  

Such combination has kept them in the murky fight for this long. The fallout has been disruptive for price, forcing the cartel to further cut supply.  Certainly, the fogs hovering around oil prices haven’t left.
 

Fig 3: World Oil Production Growth

 

   

Source: IMF, Proshare research    

Capping Nigeria’s production to 1.8 million barrel per day is in tandem with OPEC strategy script. Oil receipts accounts for more than 50% of Nigerian revenue and 75% of foreign receipts. Therefore how much of a headwind does the cap pose to a fragile recovery? 

Domestic Oil Dynamic So Far  

Fig 4: Oil Produced Till May 2017 

   

Source: CBN Economic Report, Proshare Research  

Given the data above (fig4), Nigeria highest production per day stood at 1.7 million barrels per day; which was in November 2016.  According to provisional records in May, Nigeria production stood at 1.613 million barrels per day.  

The average production stood at 1.514million barrels per day; excluding both June 2016 and March 2017.  The domestic consumption have remained unchanged at 0.45 million barrels per day.  

Crude oil exports have risen from 1.05million barrels per day to 1.18 million barrels per day. Such rise was due to an increase in production. For quite some time, Nigeria has not produced up to 1.8million barrels per day. Thus, the present capacity utilized by Nigeria has been less than the required OPEC quota of 2.2 million barrels per day. 

Nigeria will not cut down on it present oil production like Saudi Arabia. Rather it would have to cut short on its recovery, to a 2.2 million barrel per day by 18%.  

Although the present production is below the budget parameter of 2.2 million barrel per day, the new dynamic makes the budget parameter of 2.2 million barrel per day unattainable.   

Fig 5: The Monthly Average Price of Bonny Oil   

 

Source: CBN monthly report, Proshare Research 

The average price of Nigerian crude oil, the bonny light stood at 47.95$ per barrel in the month of May which makes it higher than the budget benchmark of 2015.  

Certainly, the budget parameter will be undercut just on one front, which would be daily production. Compared to the previous year, where both parameters of oil price and daily production were below the budget projection for a substantial period of the year. 

Oil Revenue So Far? 

Fig 6: Gross oil revenue and total revenue from May 2016 to May 2016

 

Source: CBN, Proshare research   

Oil revenue in the month of May 2017 stood at Naira 238.1 billion, thereby plummeting by 27.4% compare to the previous month. The plummeting in oil revenue was due to the slip in prices from 51.04$ to 47.4$. 

Total oil revenue compared with the corresponding month in 2016, rose by 28.1% due to an increase in oil production. Oil revenue constituted about 49.7% of total revenue. 

The oil revenue in May fell short of the budget estimate by 46.5%, which the budget projected to be Naira 445.1 billion. Shockingly, deficit under the period highlighted stand at N3.099trillion, given a 12 month run.   

The deficit accrued in the first five months so far stand at N1.827 trillion, making it 75% and 114% of the budget deficit and debt servicing for 2017. Obviously, this underlines an acute deficit financing model and substantial bridging measures are needed.    

Evidently a limited oil recovery and tepid progression in oil production have created a faint effect on budget deficit as fiscal policy is consistently hard pressed. It is not surprising the ministry of finance has mentioned that a lot more than fiscal house cleaning is needed at this point in time.  

Current account seems to be less pressed as oil receipt constitutes between 30 to 35% of aggregate foreign exchange through the economy.         

Fig 7: Budget deficit for 13 months starting from May 2016

  

Source; CBN, Proshare research  

Certainly, OPEC’s strategy script has begun to steer the prices of crude upwards, which make it higher than the budget threshold. Even though the uplift in price will bolster oil revenue, given the fact production have been below required capacity.  

Regardless, any uptick in price below 55$ per barrel still undercut the budget projections, implying only a 23% increase in price can cover the 18% dip in production. Even though the voluntary cap will jolt revenue compare to the previous levels, regardless it still fall short of budget projections. 

Thereby, fine tuning in budget parameters to reflect the new dynamic is essential. Certainly adopting a progressive manner in   improving not only non-oil revenue but galvanizing the other revenue base more efficiently have become inevitable.   

The ability to reduce the random nature of the other revenue base will help in bridging the revenue gap.  

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