Oil Price Shock: Bracing for cost-cutting measures

02 November 2014, Lagos – It is natural for the sustained slump in prices of crude oil at the international market to make Nigerian government uneasy. However, the price shock on the eve of an election year has left the policy makers with the difficult task of adopting belt-tightening measures, reports Festus Akanbi

Ngozi Okonjo-IwealaFor obvious reasons, the dramatic slump in global oil prices has spooked investors and exposed tensions between Organisation of the Petroleum Exporting Countries (OPEC) members. It has also exposed the vulnerabilities of countries like Nigeria with heavy dependence on oil proceeds for survival.
Benchmark Brent crude has been at the forefront, tumbling 25 per cent since June. It was trading around the $85 (£53, €67) per barrel mark last week, after news that Saudi Arabia had cut its oil exports in September.
Nigerian crude oil export, Bonny Light has also suffered the same fate trading at $87.4 per barrel as at last week, with a corresponding uneasiness in the corridor of power.
Analysts are divided over the medium-term future for oil prices. Many believe the price will remain around its current low in the short run, while others have predicted further drops in the price. Those predicting resurgence have certainly been a minority.

Time for Belt-tightening
It is in the midst of the global apprehension that the Nigerian Coordinating Minister for the Economy and Minister of Finance, Dr. Ngozi Okonjo-Iweala, warned that a sustained drop in the price of crude oil will force the federal government to adopt painful cost-cutting measures.
She told the London-based Financial Times (FT) newspaper a fortnight ago that, “We will have to look very hard at recurrent expenditure, and identify overlapping agencies. When the price is heading down, everyone sees the necessity but that doesn’t stop them from hating you.”
Okonjo-Iweala agreed, however, that lower oil prices would provide a stronger incentive to government to rein in oil theft, which has cost billions of dollars a year, and help to drive through stalled oil sector legislation to stimulate production.
“That would enable us to pick up quantity to help us cushion on the price side,” she said.
Going by the mood of the nation and the direction of economic discussions in recent time, to say the Federal Government is in dilemma of how to dance out of the current logjam caused by the sustained oil price shock is to say the least.

Changing Dynamics in Oil Market
Capturing the emerging scenario, Asst Vice President and Head, Research & Intelligence at BGL Plc , Mr. Olufemi Ademola, noted that the oil price has fallen from about $114/barrel in June 2014 to $81/barrel currently, adding that this is only slightly above the budget benchmark price of $79/barrel.
He argued that while it appears that the price trend was reversing in the last few days, the fall to $81/barrel from such a high price in four months despite the turmoil in the Middle East is a sign that the dynamics of the international oil market may be changing.
According to him, “The self sufficiency of the US and other developed economies and the potential for the commencement of oil exports by the economies is a signal that the market may be heading for a glut.”
He regretted that while some other oil-dependent economies such as the UAE have diversified away from oil dependence, Nigeria’s most important revenue earner remains oil. Noting that analyses show that most of the major OPEC countries in the Middle East have breakeven point of less $30/barrel hence, they are not currently worried about the falling oil price, saying however, that Nigeria’s expected $79/barrel (subject to daily domestic production of 2.5 million) may have been breached at the current price and production. “Therefore, the problem is quite significant as the country would be unable to meet its revenue expectation and may have to depend on its savings (if any) to meet its budget. “Capital expenditure may suffer further with implication on infrastructure development while continuous fall may also affect recurrent expenditure including personnel emoluments and overheads. It is not looking very pleasant at the moment,” he said on a sad note.

Budget Sensitivity
Ademola’s apprehension was shared by Managing Director, Head – Africa Macro, Global Research department of the Standard Chartered Bank, Razia Khan, when asked to comment on the reality of the grim situation for the Nigeria’s economy should the slump in oil price persist.
She said the situation is already very ‘real’ for Nigeria. She said although the price of oil assumed in this year’s budget is $77.50/ barrel, the actual budget sensitivity will depend on the extent to which oil output differs from the 2.39million barrel per day assumed in the budget. “Given output levels of circa 2.0mn bpd, we may already be at the oil price where Nigeria’s oil sensitivity kicks in.
Underutilisation of some elements of the budget will provide some buffer – but it is difficult to quantify how much of a buffer this is,” she stated.
The next issue that naturally dominated discussions last week was the issue of fuel subsidy in the face of threat to income streams. The question put forward by THISDAY was whether it still makes sense to continue with controversial fuel subsidy arrangement in the face of the instability in oil price.

Time to Rethink Fuel Subsidy
According to Khan, time to review the subsidy arrangement is now. She said, “Given the way Nigeria’s fuel subsidy is designed, a lower oil price should mean less spending on the subsidy. However, falling oil prices provide an opportunity to think through the longer-term reforms that the economy needs.
“Oil subsidies are regressive – they benefit the wealthy (who consume more products) much more than the poor. Longer-term, with its poor rate of non-oil revenue mobilisation, Nigeria will have to think about whether it can afford the fuel subsidy.
On his part, Ademola said it may appear that the falling oil price support the subsidy regime because landing cost of refined petroleum products should also fall in response to the declining price of crude oil.
He added that if the current pump price is more than cover the landing cost, then there won’t be any need for subsidy as long as there is transparency and honesty in the management of the oil subsidy programme.
“One of the arguments for oil subsidy is that if the government would completely remove the subsidy, it should be timed at a period when oil price is low such that the increase in pump price will be insignificant (if any). This development may provide the opportunity for that to happen. As long as fuel price remains around the current price for some time after the removal of subsidy, the public would adjust to it over time as price moves up and down.

Election Fever
But in a country preparing for a general election, taking drastic decisions to tighten the belt may be as delicate and controversial. Ademola said the current situation if not reversed quickly may lead the government to take drastic measures that would make it unpopular and greatly affect their chances at the polls. He said although Nigerian electorate are believed to be dogged supporters across party lines and especially in their support for the incumbent government, recent voting patterns in national elections and the unseating of incumbent administrations in sub-national elections across parties suggest that Nigerian voters are getting more involved and discerning. The government must manage the situation in such manners as not to hurt their outing at the next general election,” he suggested.
As far as the Standard Chartered chief is concerned, it seems unlikely that there will be any move to reduce the subsidy meaningfully just ahead of the election, saying however that this means that Nigeria’s fiscal flexibility is more limited in the short-term, and that is a concern.
On the ability of the Central Bank of Nigeria (CBN) to defend the naira in the face of the cascading price of oil, Khan said in the event of a sustained oil price shock, it would do better to allow the RDAS rate to adjust gradually to the interbank rate.

Exchange Rate
“There is little economic benefit to using existing reserves to support an increasingly unrealistic exchange rate. But any exchange rate adjustment would need to be accompanied by further tightening to limit the inflationary impact.
The CBN will face tough choices if low oil prices are sustained,” she maintained. But Ademola was categorical, saying the CBN will defend the naira for as long as they have the capacity to do it. The most important action to take is to ensure the supply of foreign exchange to meet the demand at every point in time. Although oil export is the largest foreign exchange earners to the country, other sectors also earn some sizeable foreign exchange including remittances. The CBN could also use other monetary policy instruments to manage the supply and demand for foreign exchange. This may include interest rate adjustments and other macro-prudential tools.
Having witnessed a near 30 per cent decline in revenues over the past three months, Nigeria is already facing a painful readjustment. The political timing is awkward, with opposition preparing to mount a strong challenge to President Goodluck Jonathan at elections scheduled for next February, and rival politicians bidding to outspend each other ahead of the vote.
Should the oil price dip below $78, the federal government could have to draw down on the Excess Crude Account (ECA). This is a fund which Okonjo-Iweala set up during a previous stint as finance minister to gather savings above the budgeted oil price.
“Our intention is not to run in there and raid it,” she told FT. “But even if prices continue to go down we can survive sufficiently for two to three months. That is the time needed to get other measures in place,” she said.
“What you don’t want is a hard landing.”
Nigeria was in a much stronger position last time the world price of oil tumbled, with about $22 billion squirrelled away in the ECA. Those funds helped the country weather the 2008 global financial crisis with economic output relatively unscathed.
But during the recent boom years, the government has persistently used the ECA, dividing out the proceeds among the 36 states in the federation, which are constitutionally entitled to their share.
“Our buffers are slimmer this time,” Okonjo-Iweala acknowledged, adding that there is about $4 billion in the ECA at present, $2 billion short of what the International Monetary Fund (IMF) had recommended. A sustained slump in world oil prices would therefore necessitate either greater borrowing to finance the deficit, or budget cuts.
Nigeria also holds foreign reserves equivalent to $39 billion. These have come under recent pressure as the Central Bank of Nigeria (CBN) has stepped in to prop up the naira, but still cover nine months worth of imports.
“On the fiscal side we need to ramp up our non-oil revenues,” Okonjo-Iweala, said. To this end, she said, the consulting firm McKinsey, had been carrying out an extensive review of revenue services in order to identify potential gains.
Nigeria’s ratio of non-oil tax revenues to GDP, at 4.5 per cent, is among the lowest on the continent. McKinsey helped South Africa broaden its tax base to the tune of about $3 billion and Okonjo-Iweala believed similar gains were possible over the longer term in Nigeria.
After the decision of the United States of America to shut its door against Nigerian oil, attention was shifted to the Asian countries, especially China for the nation’s oil export. However, there are reports that China has expanded its search for cheap crude oil as falling prices have presented opportunities to purchase oil from new sources.
Petro China Co. said it had purchased Colombian crude for the first time because it proved good value. The purchase amounted to 7.8 million metric tonnes from January to September, more than double the volume purchased in the same period in 2013.
The shift reflects the tumble in oil prices, which reached their lowest level since 2010 this year. Benchmark Brent crude prices have fallen 25 per cent since June, amid relatively high supply in the United States. OPEC, the organisation for oil petroleum exporters, responded to the glut by reducing its prices in an attempt to protect its own market share, meaning global prices came down.
“China will just look to get the cheapest crude possible from whatever source it can,” Virendra Chauhan, analyst at Energy Aspects, told Bloomberg. “I expect a lot more volumes flowing to China in particular.”
The number of supertankers heading for China reached a nine-month high last week, Bloomberg reported, suggesting that China has already moved to take advantage of the fall in oil prices.



– This Day

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