18 February 2013

Nigeria: Between Oil Prices, Exchange Rate, Forex Inflow and Economic Growth

The progress of your neighbour can undermine your own growth rate.

That is one possible scenario for Nigeria in the second quarter of this year, if the oil prosperity in the United States of America comes of age. This is because oil export remains the major source of fiscal and export revenues in Nigeria. Oil is responsible for 75 per cent of fiscal and 95 per cent of export revenues.

Bismarck Rewane, chief executive officer of Financial Derivatives Company (FDC) said this structure leaves the country highly vulnerable to either price or production shocks.

"We have attempted to calibrate the impact of price changes on leading economic indicators. The regression and outcomes confirm the fears of a profound impact of price changes on the Nigerian economy", he said.

The implication of price volatility is that Foreign Exchange (FOREX) inflows could shrink if prices of crude oil declined.

"FOREX inflows to the Central Bank of Nigeria (CBN) is positively correlated to the movement in oil price. Hence, a decline in oil price($1) would lead to a decline of 0.03 per cent in forex inflows given that other sources of forex inflows and oil production remain constant", said Rewane.

It is expected that a decline in Nigeria's oil price to $90pb would result in a decline of the monthly oil revenue to $3.36 billion, a 38.91 per cent drop from $5.5 billion recorded in November 2012.

Also, a fall in crude oil price could weaken the naira. Thus, there is a positive correlation between oil price volatility and the ex-change rate in Nigeria due to the dependence on foreign currencies by oil companies.

It is estimated that for every $1pb fall in the price of Nigeria's Crude, the naira depreciates by 0.8 per cent given that the external reserves are not used to support the naira.

"Hence, if Nigeria's oil price falls to $90pb, the naira could depreciate to N177.26/$. However, we expect that the reserves will be used to support the naira and this could imply a slower depreciation against the dollar", said Rewane.

Also, oil price movement has a significant and positive correlation with external reserves accretion. Our investigation shows that a drop in oil price will lead to a 0.85 per cent decline in the reserves levels, holding other sources of reserves accretion constant.

Therefore, if oil price falls to $90pb from current price of $117, the external reserves should decline to $35.05 billion from the present level of $46.63 billion. This would put the country in a chaotic situation that includes a threat to government expenditure which may lead to increase in debt, a depreciation of the naira which will increase the cost of imported materials/ cost of inputs for manufacturers and a drop in general economic out- put.

Thus, the shale oil revolution taking place in the US poses grave implications for Nigeria's trade pattern. The excess crude that will result from the halt in consumption by the US will have to find its way to other markets probably China and India. The intense competition that will take place is going to have a downside effect on global oil prices which will be dis- ruptive for the heavily oil dependent Nigerian economy. The ripple effect will trickle down from a decline in oil receipts to a decline in government revenue, depletion of external reserves, pressure on the naira and overall macro-economy.

Oloye Gideon, an analyst in Lagos compared what will happen to the danger the vandalisation of oil installation in the Niger-Delta by militants poses to the country's economy before the amnesty programme initiated by the late president Musa Yar'dua.

According to Oloye, the easiest way to bring any government in Nigeria to its knee is by dealing a blow on the oil and gas industry. He thus advised the government, particularly the National Assembly bent on higher bench-mark price, and the governors who want everything in sight to be shared to be wary of a rainy day.

Analysts said Nigeria has a subsidy plan that lowers the price of fuel for its citizens. The pressure will be intense to maintain this and also keep the government afloat.

"By the second quarter of this year, we will stop importing West African light, sweet crude into the Gulf," says Morse, the Head of Commodities research at City Group Global Markets. Sometime before mid-2014, he predicts that the US and Canada will stop importing crude from West Africa.

It is no longer news that the US will be self sufficient in its oil consumption in the not too distant future. However, the latest report that predicts the most powerful country will completely halt oil importation of West African sweet crude by 2014 has sent the alarm bells ringing.

Nigeria, a highly dependent hydrocarbon economy is one of the highest producers of sweet crude in West Africa, alongside Angola with each producing 2.02mbpd and 1.74mbpd respectively according to OPEC's January 2013 report.

A review of the US imports of crude oil and petroleum products from Nigeria according to the Energy Information Administration (EIA) shows that the US imports from Nigeria has been on the downward trend from January 2011. US oil imports from Nigeria declined by 46.8 per cent to 543,000bpd in October 2012 from 1.02mbpd in January 2011. In addition, a further study of US import of Nigeria's crude reveals that the decline in the US' import of Nigeria's crude is insignificant to Nigeria oil revenue.

Rewane said to see this clearly, we consider two periods where US' con- sumption of Nigeria's oil declined. In February 2012, US' consumption of Nigeria's sweet crude hit its record low of 353,000bpd, representing a decline of 30 per cent from the previous months' 504,000bpd. This decline was attributed to the drop in crude lifting as a result of production shutdown in some terminals but not as a result of US' decision to reduce its demand.

The decline in US' consumption impacted negatively on Nigeria's oil revenue for February. Also in July, the US's consumption of Nigeria's crude declined but this time, as a result of reduced oil demand by 28 per cent to 372,000bpb from 515,000bpb in June.

However, Nigeria's oil revenues rose by 9.14 per cent despite the huge reduction in US import. This shows that the increasing demand for Nigeria's crude from Asia, notably China and an oil price (bonny light crude) above $115pb was able to quell the nega- tive impact from the decline in US demand.

Hence, the major challenge given the above would not be the reduction or halt in US' import of Nigeria's crude, but how to deal with factors such as theft, production slowdown, and difficulties in shipping to Asian countries compared with shipping to the US among other challenges. The Nigerian oil industry has been subject to leakages in the form of oil theft ($7 million annually) and pipeline disruptions. The direct relationship between production and revenue calls for an effective production process to boost growth in oil output.

Also, Nigeria has four refineries with a combined installed capacity of 445,000bpd which are in a dilapidating state. The pe- troleum industry bill (PIB), a reform that is expected to alter the fiscal and regulatory framework of the industry and usher in the much needed investment is stuck in limbo at the National Assembly. Meanwhile, an early passage of the bill will improve the oil industry activities and growth.

Price, another important variable, has been robust in the last 12 months, with Bonny Light trading at an average of $117pb, Brent crude at $115.22pb and West Texas Intermediate at $97.62pb.

The high oil prices pose serious threats to crude shipment from Nigeria due to Asian buyers' demand for discounts as a result of the long distance of shipping. Given the changing global energy dynamics, the current trend of high oil prices may not be sustainable in the long run.

The major challenge to oil price sustainability is the growing production of shale oil and gas through fracking. According to a report by PricewaterhouseCoopers (PwC), frack ing if deployed to other parts of the world could depress global oil prices. PwC further predicted that an increase in shale oil/gas production to about 12 percent of total oil production could reduce oil prices by 25-40 percent.

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