Tuesday, July 07, 2020
08:02 PM / by NEITI/ Header Image Credit: NEITI
Price volatility is a constant feature of the oil
market, exposing oil-dependent countries like Nigeria to regular economic
crises when oil prices tumble. Beyond surviving the latest oil price slump
largely occasioned by COVID-19, Nigeria needs a sustainable strategy for coping
with oil price shocks.
The 2019 coronavirus disease (COVID-19) has thrown
most countries into the throes of sudden and multiple crises. What started as a
health concern in a corner of China late last year has not only spread quickly
across the globe but has also triggered a global lockdown and economic crunch,
leaving even the most resilient countries gasping for breath from the combined
headwinds. While it is difficult to fully prepare for such double whammies, the
COVID-19 pandemic has also exposed the inherent economic vulnerabilities of
resource dependent countries like Nigeria.
With still relatively low infection and fatality
rates, Nigeria seems to be holding up fairly well with the health burden of
COVID-19. However, the pandemic has put Nigeria's public finances, and by
extension its economy, in dire straits, direr than could have been projected a
year or even six months ago. This is largely on account of the sudden slump in
oil prices, caused by the collapse in oil demand as countries imposed lockdowns
and scrambled to contain the crisis, and Nigeria's continued exposure to oil
revenues.
Though the dependence on oil is reducing, oil still
accounts for about 50% of government revenues and over 80% of exports and foreign
earnings. Th is still makes Nigeria highly vulnerable to oil price shocks,
which occur with much regularity and could be caused by a myriad of exogenous
factors, including, as this case shows, a tiny but deadly virus that started
from halfway across the world. When combined with the absence of a strong
fiscal cover, the precipitous fall in oil prices always guarantees revenue and
economic crisis for the country. This needs to be reversed.
To be sure, the Federal Government (FG) has moved
swiftly to address the economic impact of COVID-19. Th e 2020 Budget has been
revised, with cuts in capital and recurrent expenditures and fresh allocations
aimed at containing the pandemic and boosting economic activities. Revenue
projections and oil price and production benchmarks have been slashed. The
country has taken a $3.4 billion emergency facility from the International
Monetary Fund (IMF) and is withdrawing $150m from the stabilization fund of the
Nigerian Sovereign Investment Authority (NSIA). Subsidy or under-recovery on
petroleum products has been halted and the exchange rate has been adjusted from
N305/$1 to N360/N1. Also, the government has approved and unveiled the N2.3
trillion Economic Sustainability Plan, developed by a committee headed by the
Vice President, Professor Yemi Osinbajo, and designed to address the various
economic dimensions of the pandemic.
These are all necessary and commendable steps, which
should help in minimizing the economic impact of this immediate crisis.
However, there is need to look beyond surviving this latest episode of a
lingering malaise. It is important to use this crisis to significantly reduce
Nigeria's vulnerability to regular oil price shocks and also emplace a
framework for robust fiscal cover.
Oil prices are gradually looking north again: between
April 2020 and June 2020, oil prices increased by 114%, from $18.38/barrel to
$39.42/barrel. As more countries ease or end lockdowns and return to a
semblance of normalcy, the demand for and the price of oil are projected to
increase. Th is will give Nigeria and other oil-dependent countries more fiscal
wriggle room. But this could distract from the important work of ensuring that
resource abundance does not create a dependence and a distortion that always
make Nigeria vulnerable to fall in prices that it has little or control over.
Getting distracted or opting to just muddle through will amount to work
avoidance. Whether oil prices recover quickly or slowly, the next oil price
crash is a matter of when, not if. The time to prepare for that is now.
The Predictable and
Perennial Volatility of Oil Prices
Oil prices have been falling since January 2020, with
a particularly steep decline from March. While average oil prices were $64.35
per barrel in 2019, the average price from January 2, 2020 to June 2, 2020 was
$40.16 per barrel. These averages mask the actual fluctuation in daily
prices. The lowest oil price recorded in 2019 was $53.23 per barrel on January
3, 2019. On the other hand, prices have been as low as $9.11 per barrel in 2020
(April 21). Such drastic changes in oil prices is symptomatic of the global oil
market, characterized by the famous boom-bust cycles, with periods of
relatively stable prices followed by either rapid spikes or rapid declines in
prices.
Figure 1 presents the trend of oil prices from May
1987 to May 2020. The figure shows that oil prices were relatively stable until
the onset of the Gulf War I. Oil prices started rising in 1990 and reached a
peak of $35.92 per barrel in October 1990. Keeping with the volatile behaviour,
oil prices started falling and dropped briefly below $20 per barrel in March
1991. Following this, oil prices were in the range of $18 to $22 per barrel,
but dipped to $14.51 per barrel in December 1993. Subsequently, oil prices
remained below $20 per barrel until March 1996. From April 1996, oil prices
were between $18 and $22 per barrel. The onset of the East Asian financial
crisis brought in a crash in oil prices, with prices reaching a low of $11.28
per barrel in December 1998. After the crisis, oil prices started rising again
and by January 2003, they were above $30 per barrel . This increase in prices
continued and oil prices were above $100 per barrel in March 2008. They
remained above $100 for seven months, peaking at $147 per barrel in July 2008.
Oil prices fell sharply from October 2008 as a result of the global financial
crisis and reached $39.16 per barrel in February 2009.
Thereafter, oil prices started rising again and
crossed the $100 per barrel mark in March 2011. Another period of oil price
collapse started in late 2014. Following increased production from shale
producers, oil prices fell from $103.59 per barrel in July 2014 to $59.29 per
barrel in December 2014. This decline continued and prices reached a trough of
$30.32 per barrel in February 2016. Oil prices increased and Heralded by the price war between Saudi Arabia and
Russia, the onset of the COVID-19 pandemic has ushered in a new era in
volatility in oil prices. Oil prices declined from $67.04 per barrel on January
2, 2020 to $37.71 per barrel on June 2, 2020, a 44% fall.
Nigeria's Unhealthy Dependence on Crude Oil
Countries
that are heavily reliant on commodity exports for the bulk of their government
revenue and foreign exchange earnings are particularly susceptible to the
vagaries of international commodity markets. Thus, Nigeria, where oil earnings
have accounted for a large share of foreign exchange earnings and where oil
revenue constitutes the bulk of government revenue has been at the mercy of oil
market volatilities for over four decades. Figure 2 presents oil revenue
expressed as a percentage of total federation revenue over the period 1981 to
2018. The figure shows that oil revenue has constituted the lion's share of
federation revenue over time. In 1981, oil revenue was 64.44% of total revenue.
In 2018, oil revenue was 58.06% of total revenue. The figure shows that from
1988 to 2013, oil revenue consistently made up over 70% of total revenue. Th e
only exceptions were in 1998 (69.95%) and 2009 (65.89%). For some years such as
1992, 2004, 2005, 2006, oil revenue constituted over 85% of total revenue. It
is only in recent years (2015 - 2018) that oil revenue was below 60% of total
revenue. This can be attributed to low oil prices and increased efforts to
boost non-oil revenue.
Figure
3 presents revenue from oil exports as a percentage of total export revenue. The figure reveals that oil export revenue has consistently contributed over 90%
of total exports revenue. This shows how dominant the oil sector is for
generation of foreign exchange.
Figure
4 presents oil prices and total federally collected revenue over the period
1981 to 2018. A close relationship can be seen between oil prices and
federation revenue. Thus, generally, as oil prices rise, federation revenue
rises; and as oil prices fall, federation revenue falls. This figure shows
clearly the very strong relationship between oil prices and government revenue.
Dangers of Natural Resource Dependence
Resource-intensive
countries, like Nigeria, are prone to a number of obvious and non-obvious
risks. The first risk is from the well-known volatility of commodity prices,
which in most instances leads to regular fluctuation in the fortunes of such
countries. Ordinarily such countries should save in period of high prices in
anticipation of a price slump. But they rarely do so. In actual fact,
resource-dependent countries go on a high when prices are high, then come to an
assured grief when prices tank.
With
high prices and steady flow of cash providing an illusion of prosperity,
decision makers of resource-rich countries usually increase government
expenditures and make other choices that cannot be sustained by low commodity
prices. In addition, natural resource dependence weakens accountability
mechanisms, as extractive states (as opposed to tax states) are inclined to
white-elephant projects, leakages, state capture, and graft . High revenues
from an exported natural resource also create the risk of economic distortion.
This is
the famous Dutch Disease, where sudden influx of foreign exchange in boom
periods leads to overvaluation of the local currency and turns the economy to a
high-cost one. This leads to a situation where the natural resource eventually
becomes the sole or dominant export and main source of foreign exchange by
crowding out other sectors such as agriculture, manufacturing and services. It
also leads to a situation where those sectors cannot even compete locally and
it is cheaper to import goods and services than to produce them locally, which
then turns the country to an import-dependent one.
The
danger of this double dependence (revenue-dependence and import-dependence) is
masked in periods of high commodity prices. But when prices of commodities
plunge, resource-dependent countries (except those that save enough during high
prices) hardly have enough revenues to fund their budgets and enough foreign
exchange/reserves to feed their huge appetite for imports. Th is inexorably
leads to a cocktail of challenges such as balance of payment problems, currency
devaluation, cost-push inflation (since most things are imported, including
intermediate goods), and economic contraction. This is a recurring pattern that
has led to postulation about natural resources being more of a curse than a
blessing to countries richly endowed with them. But the experiences of
countries like Norway, UAE and Botswana have shown that resource curse is not
destiny and plenty doesn't have to be accompanied by a paradox. These positive
outliers have shown that a different path is possible. So rather than just
muddle through the crisis of another oil price crash then wait for another time
to go through the same enervating cycle, Nigeria can and should make a
conscious effort of throwing away the yoke of being eternally vulnerable to
oil price slump.
Pathways
out of the Bind This brief explores and advocates three ways of insulating
Nigeria from this predictable but perennial challenge. The recommended
pathways are: having a robust 'rainy day' fund; weaning Nigeria off its
unhealthy dependence on oil; and getting more from the oil and gas sector to
aid development of other revenue and export streams.
A
healthy minerals savings fund, the size of which should refl ect not only the
volume of revenues from mineral resources, but also the size of the national
economy, is usually recommended for resource-rich countries for three reasons:
to smoothen revenue over the life of the natural resource, a form of a hedge
against the well-known boom-bust cycle; to keep a substantial part of the
windfalls out of the budget as a form of insulation against the distortion of
the Dutch Disease; and to prepare for the eventual depletion or loss of value
of the natural resource and keep part of the accrued benefi ts for the future
generation, as a form of inter-generational equity.
The
good news is that Nigeria seems sold on these arguments already, for the
country actually has three forms of oil savings funds. The not-so-good news is
that the funds are mostly not adequately ring-fenced, and are too tiny to
adequately serve the intended purpose. Nigeria established its first
stabilisation fund, the 0.5% Stabilisation Fund, in 1989. In 2003, the country
established the Excess Crude Account (ECA). A third fund, the Nigeria Sovereign
Investment Authority (NSIA), was established in 2011. All three accounts are
currently operational. Today, these three accounts cumulatively have about
$2.25 billion, which can only fund about 7.7% of the revised 2020 federal
budget. The entire money is not available anyway and it belongs to the three
tiers of government, not just to the FG. As part of the response to the
negative impact of falling oil prices on its revenue, the government is
withdrawing $150m from the stabilisation component of NSIA to supplement
federation allocation. By contrast, Norway (a country of 5.3 million people)
has a sovereign wealth fund worth more than $1 trillion.
The
Scandinavian country is withdrawing $37b (382 Kroner) or less than 4% of its
heft y savings to fund its 2020 budget. Th at $37b is at least 25% higher than
FG's N10.5trillion 2020 budget. For a time like this, Nigeria needs the kind of
insurance cover that can come from a robust savings fund. But such a cover can
only be erected in moments of plenty. Even when backed by law, the 0.5% stabilisation
fund is too tiny to make much diff erence. Th e ECA, where earnings above oil
price benchmark are parked, could have served because it receives reasonable
infl ows but it is easily depleted because it is a political arrangement
without legal protection. It operates more like an expenditure account than a
savings account.
According
to a 2017 NEITI study, the ECA had total inflow of $201.2b and a total outflow of $204.7b between 2005 and 2015 (outflow was 102% of inflow). The NSIA
is the only proper savings fund because it is invested, generates returns on
investment and has strict conditions for drawdowns. It also takes care of
present and future needs and has inbuilt flexibility to address the country's
challenges. Its funds are current split into three: Stabilisation Fund, 20%;
Infrastructure Fund, 40%; and Future Fund, 40%. Unfortunately, the NSIA has
about $2b, and is one of the smallest sovereign wealth funds in the world.
To be
sure, there are practical challenges to achieving and maintaining a healthy oil
savings fund for Nigeria. The key impediments are fundamental: a constitutional
constraint and the difficulty in achieving centralised savings in a regime of
fiscal federalism. To sustainably address the challenges standing between Nigeria
and a healthy savings fund that can insulate the country against perennial oil
price volatility, this brief recommends the following:
2. Reduce dependence on oil for revenue and export
In
recent times, government has done a lot to reduce its overwhelming dependence
on oil for revenues. In 2019, the contribution of oil to total government
revenues was 58.1%, as against 88.6% in 2006. This is remarkable progress. But
more needs to be done and quickly too. Revenue volatility will continue as long
as government depends on a product given to price volatility for half of its
revenues. In terms of exports, oil still accounts for more than 80% of export
earnings. This level of exposure has implication not only for foreign exchange
earnings but also for the capacity to fund imports, the value of the national
currency and price stability. It is therefore imperative to further boost
non-oil revenue and increase non-oil export. The following are recommended:
Resource
dependence is known to create distortions to the economic structure of
resource-endowed countries. As stated earlier, such countries become high-cost
economies where traditional sectors such as agriculture and manufacturing are
crowded out and become so uncompetitive that they struggle to meet local needs,
making imports cheaper and preferable. Over time, the Nigerian government
(especially the current administration) has done quite a bit to correct some of
these distortions, but much more needs to be done to reduce dependence on
imports, and ensure that the agricultural, manufacturing and services sectors
can compete and meet both domestic and export needs. Recommended prescriptions
here will include ensuring macro-economic stability, further improving on the
ease of doing business, investing more in physical and human infrastructure
which should reduce the cost of doing business, and implementing a suite of
incentives and reforms to attract foreign and local investors in areas where
Nigeria should have comparative advantage such as agriculture and
agro-processing, petroleum refining, solid mineral extraction and
beneficiation, light manufacturing and services.
4. Block Leakages and Maximise Opportunities in Oil and Gas Sector
Even as
Nigeria urgently needs to diversify government revenue and exports, it is clear
that it can still make much more from the oil and gas sector both to address
the revenue needs of the country and to invest in diversification. Blocking
leakages and maximising opportunities in the sector will help in increasing
government revenues and the contribution of the sector to national
productivity. Areas needing urgent attention in this area include the
following:
Conclusion
The
economic problems brought on by the coronavirus pandemic is, without any
question, a major challenge for the global economy. But for resource-dependent
countries, it is a chilling reminder of the existential threat they all face in
earning revenues from their God-given mineral resources. Over the course of
history, and however fortunate resource-rich countries think they are, the
blessings of mineral resources can quickly transform into a curse that sets
most of these countries on a path of misery. This path follows a sequence of
delusions, dependencies and distortions. First, the onset of resource windfall
creates the delusion that the country will continue to be rich from its natural
resources. Then, overtime, the country becomes dangerously dependent on
revenues from mineral resources due to this delusion, but also because resource
rents are relatively easier to earn and spend. This dependence ultimately
creates severe distortions to the economy where productive sectors become
moribund as they are crowded out by the extractive sector.
As an
inevitable consequence, any disturbance in the flow of revenues from such
resources produces an automatic threat to the economy of such
resource-dependent country. The present slump in oil prices, largely on account
of COVID-19, has again reinforced the danger of overwhelming dependence on
natural resources by countries like Nigeria. To be sure, managing the immediate
fiscal crisis should be a priority. But it is important to come to terms with
the volatility of oil prices and immediately embark on the hard task of weaning
Nigeria off its unhealthy dependence on oil for the bulk of its government
revenues and foreign exchange. The virus will eventually be tamed. Oil prices
will go up again. So the pain of the moment shall pass. But the next slump in oil
prices is not a matter of if but when. Between 2008 and 2020, a period of 12
years, the world has witnessed three major meltdowns in oil prices: 2008/2009,
2014-2016, and 2020. The price slumps have always been accompanied by severe
pains that linger beyond the price crash. The task, therefore, is not just for
Nigeria to recover from the economic effects of the coronavirus
pandemic/current price crash, but to escape the burden of a lifetime
affliction.
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