OPECplus Extends Output Cuts Amid Fears of an Overheating

Oil & Gas
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Sunday, March 14, 2021 / 04:20 AM / by FDC / Header Image Credit: oedigital.com

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The Organization of Petroleum Exporting Country and its allies known as OPEC (+) surprisingly extended their ongoing output cuts (7.2mbpd) to April, allowing for an increase in production for just Russia (130,000bpd) and Kazakhstan (20,000bpd). This was contrary to market expectations, which expected a further relaxation or a stalemate as the two power-houses - Saudi Arabia and Russia - were on opposing sides. This decision was based on the need to see concrete signs that global oil demand was rising. Prior to this, OPEC (+) had relaxed its production cuts by a total of 150,000bpd for two months (February and March), while Saudi Arabia reduced its production by 1mbpd for two months (starting February). Saudi's 1mbpd voluntary cut is expected to continue for an undisclosed period of time.


Impact Analysis

Oil prices rallied higher immediately after the release of the outcome of the meeting, trading to a new one-year high. Brent crude rose to almost $68pb, while the US West Texas Intermediate neared $65pb. So far in March, oil prices (Brent) have increased by 92.47% to an average of $64.92pb compared to the corresponding period in 2020. Oil prices have been on the increase, supported by improving Asian fuel demand and the distribution of covid vaccines, which have boosted market sentiment of a quick recovery in global oil demand.


This is occurring at a time when the prices of global commodities are on the increase and inflationary pressures are rising especially in emerging markets. There are fears that the tightening stance of the oil cartel could lead to an overheating of the global economy. The rollout of more covid vaccines, strengthening economies and government stimulus have contributed to higher commodity prices.


Rising inflation means that returns on investments would fall barring upward adjustments of interest rates by the monetary authorities to support yields. Adopting a tightened stance now may be premature for many economies that are still battling with negative growth rates and in need of significant stimulus to boost their economies. In Africa for instance, Nigeria despite posting a sur-prise positive growth of 0.11% in Q4'20, is not yet out of the woods and has an inflation rate that could cross 17% in February.

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Oil prices at $68 still below Nigeria's breakeven point of $138pb

For Nigeria, oil prices at approximately $68pb is good news. This is 70% above the 2021 budget of $40pb. However, this is still significantly lower (50.72%) than the country's breakeven point of $138pb, according to an S&P Global Platts data. Russia has the lowest breakeven price point of $57pb, followed by Saudi Arabia with $89pb. This means that only Russia is technically in the money at the current oil price.


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Higher oil prices will also offset the decline in Nigeria's oil output. Nigeria has an OPEC quota of 1.5mbpd as against its production budget benchmark of 1.86mbpd. The country produced 1.34mbpd in January, 10.67% below its quota and 27.96% below the budget benchmark, to make up for past cheating of its OPEC quota.


Nigeria's monolithic economy is dependent on the oil sector, which contracted further by 19.76% in Q4'20 and contributes a mere 5.87% to GDP. However, in revenue and external reserves terms, oil accounts for over 70% and 90% respectively. Higher oil prices will slow the pace of depletion in Nigeria's external reserves, which has declined so far this year by 1.27% ($450mn) to $34.92bn as at March 3.


The federal government's deficit financing needs (projected at N5.6trn), which is exclusive of the funding for the covid vaccines, could reduce on higher oil revenues. Monthly statutory allocation to state governments will likely increase beyond N700bn, which will help the states meet their financial obligations. The downside is the resultant increase in petrol prices that would most likely occur if global oil prices continue to rise and the naira continues to fall at the IEFX window. Currently, the government and organized labour are yet to finalize on next steps. One thing is clear, the era of subsidies is gone; it is just a matter of time and how much more Nigerians are going to be paying to buy a litre of fuel.


Risk of ideological backsliding

A major risk to higher oil prices is the reversal of key economic reforms put in place by the Nigerian government to bridge the deficit gap, boost the growth and development of the economy. With the gradual shift to electric vehicles, oil is gradually becoming obsolescent and this will lead to a drop in investment by the oil majors. Lack of investment will disincentivize production and could lead to a further increase in oil prices to triple digits.

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The demand for crude oil will continue to increase as more countries inoculate their residents. This will fast track the recovery process, the lifting of lockdowns, the reopening of economies and resumption of key business activities. OPEC (+) will meet again on April 1 to decide production levels for May. The World Bank projects that the global economy will grow by 4% from an estimated contraction of 4.3% in 2020. Oil prices are also projected to cross the $70pb threshold in the next month or two.


A global recovery will benefit Nigeria, which is highly import dependent, as this means more trade flows. An increase in production will suppress the price increase of global commodities. In addition, we expect to see new projects being embarked upon and a resumption of halted projects. In-vestment flows will also increase, while remittances will pick up as businesses employ more. In-creased investment flows and diaspora remittances will support the Nigerian growth process.

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 Proshare Nigeria Pvt. Ltd.


 Proshare Nigeria Pvt. Ltd.

Proshare Nigeria Pvt. Ltd.


 Proshare Nigeria Pvt. Ltd.

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