Renewed Optimism for Oil Prices Amid Nigeria's Subsidy Question


Wednesday, May 26, 2021 / 03:30 PM /  by FDC Ltd / Header Image Credit: Dispatch

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Oil prices maintained their momentum as OPEC+ ditched their meeting scheduled for Wednesday the 28th of April and decided to go ahead with previously agreed plans to ramp up output. Brent crude is up 0.73% to $67.17pb since the decision. The coalition is now set to bring back 350,000bpd in May with Saudi Arabia adding another 250,000bpd. This could mean the addition of an extra 2.1mbpd in July despite the re-emerging covid crisis in India. The alliance is likely to have based its decision on the expected recovery of the global aviation industry by this summer as the rollout of vaccines gains increasingly more coverage across the globe. Markets are already pricing in a recovery in the demand for jet fuel by summer as more and more airlines globally are announcing the resumption of international flights.


Justified Optimism: Vaccines to the Rescue

US bank Goldman Sachs, in a note to clients, stated that current global dynamics - unleashed pent-up travel demand due to the rollout of vaccinations in Europe and parts of the developing world - will spark "the biggest jump in oil demand ever, a 5.2 million barrels per day (bpd) rise over the next six months". The volume of new demand will be unable to be matched by immediate increases in supply. The bank, at the start of March, had forecast a rise in Brent 10 Crude prices to hit $80pb by the third quarter of this year. However, there will be lower interest rates globally as central banks in many advanced economies try to support economic recovery. Moreover, a weaker US dollar will also prop up global commodity prices in the coming months.


The global covid-19 pandemic is, by some distance, the biggest factor affecting the oil price outlook in the long-term. OPEC+ now plans to assemble in early June as concerns about surging covid-19 cases - especially in India, the world's third-largest importer - grow. The cartel and its allies also have their eyes on events in Brazil and Japan where covid-19 cases are also on the rise. The resurgence in all three countries could wipe out as much as 350,000bpd in global oil demand.


Damned If You Do, Damned If You Don't

While higher oil prices put OPEC+ members in better financial positions, it has become a double-edged sword for one of its poorer members. Nigeria is dependent on oil receipts for over 60% of government revenue and 90% of foreign exchange earnings. Yet Nigeria is unable to refine enough crude oil domestically to meet demand and relies on imports to address the shortfall. Nigeria also has a high marginal propensity to import and is dependent on imports for most of its consumables. Therefore, on one hand, the government earns more revenue from higher oil prices but then spends a significant amount of that revenue to subsidize the country's fuel needs. It is also imperative to note that an OPEC sanctioned reduction in Nigeria's oil production quota by 21% to 1.41mbpd from 1.8mbpd has also significantly lowered oil revenues. This was recently increased to 1.54mbpd, effective May 2021.


The government's attempt to embark on the complete price deregulation of the downstream sector of the oil industry has been met with pushback from labor unions who are demanding that government owned refineries be rehabilitated first. According to the Nigerian National Petroleum Corporation (NNPC) the average landing cost of premium motor spirit (PMS) for the month of March 2021 was N184 per liter as against the subsisting ex-coastal price (landing cost at the port) of N128 per liter and a retail price of N162-165 per liter. A cost-reflective price would be at least N212 per liter given current global oil prices and the prevailing exchange rate (N379/$) among other factors

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Tough Choices & Few Options

The corporation reportedly now spends over N120bn monthly subsidizing fuel, an act that is no longer sustainable. Government revenue is now facing major uncertainty under the weight of the fuel subsidy payments as the NNPC has indicated that it would be making no remittances to the Federal Accounts Allocation Committee (FAAC) for April and May after accounting for fuel subsidy payments from its revenue. At this point, the government is left with a clear choice: remove fuel subsidies and face industrial action and possible civil unrest or continue with subsidies and crumble under the weight of the financial burden.


Subsidies have become a major drain on Nigeria's financial resources and the difficulty in phasing them out is raising questions about fiscal sustainability and resilience especially in the face of significantly lower revenues. Over the last decade, more than an average of 75% of Nigeria's budget was allocated to recurrent expenditure on an annual basis. This left just 25% for capital spending and pales significantly in comparison when compared with the estimated $3trn spending to bridge the infrastructure gap in the next 30 years.


If oil prices trend higher, continuing with the subsidies will also mean that many states will be confronted with the prospect of being unable to meet salary obligations to civil servants in the coming months. These states will be forced into the debt market - adding to their already rapidly increasing debt levels.


Silver Lining?

There is need for OPEC+ to remain vigilant and stay wary of US shale producers stealing market share as they attempt to gradually ease production curbs. US shale producers have higher costs than traditional oil producers and are incentivized by higher oil prices to ramp up oil output. The positive outlook for oil has sparked renewed optimism about the fortunes of US shale after it was decimated by COVID-19. It may not sound like much of a silver lining, but increased US shale supply would taper the oil price rise and help ease Nigeria's conundrum - albeit temporarily

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