Oil prices: Hard times are here

23 November 2014, Lagos – Nigerians are in for a hard time. This seems to be the damning verdict of a few discerning Nigerians as they express anguish and fear that the nation’s somewhat weak economy may be doomed, no thanks to the fall in oil prices at the global market.

Crux of the matter

Nigeria, widely acclaimed as one of the new global economy frontiers following the rebase of its GDP and whose economy is fuelled largely by oil earnings for its foreign exchange and national income, may be in dire straits, as there are fears that the effect of the slide on the global oil price might plummet the economy if steps are not taken to cushion the effect through sound economy measures.

Oil-worldThough, last week, the federal government proposed an oil benchmark of $78 per barrel for the 2015 budget, 0.50 cents higher than the $77.50 per barrel approved by the National Assembly in the 2014 budget, economy experts are afraid that these economy measures might deepen hardship for average Nigerians as the effect on exchange rate, capital market, fiscal operations of governments, among others, will affect industries and commercial activities generally.

Currently, the federal government through the Minister of Finance and Coordinating Minister for the Economy, Dr. Ngozi Okonjo Iweala, announced an austerity measure to cushion the effect of the slide.

Apart from the crude oil price benchmark for 2015 budget to $73 per barrel from $78, the government also stiffens its spending by increasing taxes on luxury goods, restriction on foreign travels and withdrawing sponsorship for training of civil servants.

These measures, according to market observers, will bounce back on key sector of the economy. Market sources are already blaming the depreciation of the naira and increase in interbank lending rates on austerity measures.

According to an analyst in the research unit of one of the banks, the measures are being interpreted to mean there are bad times ahead and people should make necessary preparations.

He said the sentiments in the market are that the CBN does not have the resources to defend the naira and hence the naira will continue to depreciate.

Industry stakeholders react

Expectedly, the Lagos Chamber of Commerce and Industry (LCCI)’s Director General, Muda Yusuf, while reacting to the inherent dangers that may befall the nation’s economy following the introduction of austerity measures, stated that the salaries and wages would be adversely affected.

He said: “The introduction of austerity measure by the federal government is inevitable in the light of the current situation of a decline in the price of crude oil, but the dangers in the policy would be a sudden reduction in spending and adjustments on capital projects as part of the sacrifice to the paid by government.”

Echoing similar sentiments, the organised labour, under the aegis of the Nigeria Labour Congress (NLC) and Trade Union Congress (TUC), has warned the federal government to ensure the new policy does not inflict more hardship on Nigerians.

NLC General Secretary, Comrade Peter Ozo-Eson, while reacting to the new policy, stated that the federal government must be transparent enough to ensure that more hardships are not inflicted on the Nigerian masses.

In his reaction, President of TUC, Comrade Boboi Bala Kaigama, stated that there is the need for the federal government to tell Nigerians the relevance of the policy that never favoured the nation’s economy during the administration of former President Shehu Shagari.

According to Oscar Odiboh, publisher, Newsletter, and a consultant in the auto industry, people knew that the economy was unstable, saying that Okonjo-Iweala has been at the vanguard of defence and denial of the fact that the economy was not working well.

The fact that this is just manifesting, Odiboh maintained, shows that things are really bad.

He said Okonjo-Iweala, by her pedigree, should not have put her hands in it.

On his part, Kehinde Olawumi, a chartered accountant, said the situation was as a result of insensitivity of the government to the people. He said the country has relied too heavily on oil, which they don’t have control over the price.

For Wale Omole, President of Peoples Problems and Solutions, a non-governmental organisation, which assists Nigerians in poverty eradication and other economic problems, the move has shown that the current government has failed in its responsibilities to Nigerians and Nigeria as a country.

His words: “Austerity measure is not a bad thing on its own. It has been used by governments in the developed world of recent to redress their spending and return their economies back on its feet, but the problem with Nigeria is that we are not supposed to be experiencing this. The way we waste money on frivolities in government has led to this state.

Jude Udeozor of Financial Initiatives Limited said that “Even Dr Okonjo-Iweala knows it that she can only bark but she cannot bite; all what they are doing is playing to the gallery and they would always protect themselves.

Some others said, “If the government was truthful and ready to protect the masses, all those driving expensive cars would be made to pay heavy duties and taxes on those facilities as this is the only way that the poor would be protected.”

Though an Ernst & Young Africa Advisory Oil and Gas Lead, Mrs. Claire E. Lawrie appeared more optimistic that such measures could lift the nation’s economy out of the impending doom that the oil price fall might bring when she said recently that “crude oil exports generate over 90 per cent of Nigeria’s foreign exchange earnings and as such the country is prone to serious economic pressure if there are no plans to deal with the situation.”

According to the oil and gas expert, the price of oil is important to the world economy, given that oil is the largest internationally traded good, both in value and volume terms. “Since the era of the oil boom in the 70s, Nigeria has been dependent on ‘oil-cash’ with a need to continue diversification of the economy,” she said.

She said that continuous decrease on the prices of crude oil could result in long-term reductions in OPEC oil export revenues, and would force OPEC countries to make difficult economic, social, and political tradeoffs.

She stated: “The price of oil is linked to some extent to the price of other fuels. Therefore, abrupt changes in the price of oil have wide-ranging ramifications for both oil-producing and oil-consuming countries (that is, the multiplier effect of oil prices on other products).

“Nigeria’s sweet crude is in demand. China alone can take all that we produce. The recent decline in crude oil price has impacted negatively on the capital market activities and has become a source of worry to stakeholders. The stock market is reacting negatively to the decline in crude prices. This is normal – anytime the crude oil price falls, it usually has negative impact on the stock market.”

Lawrie said that there is need for the federal government to adjust the macro economic variables. “This can be achieved by stabilising inflation rate and exchange rate. For oil prices to go up, there has to first be a production shut-in by all OPEC members. Secondly, to try and solve the problem locally, the federal government should look towards refining locally and becoming the central supplier of refined product to West.

A recent monthly oil market report of OPEC stated that in October, OPEC crude oil production averaged 30.25 million barrels per day (mb/d) and that, according to secondary sources, a drop of 0.23 mb/d over the previous month was recorded.

The reports explained in context that crude oil production from Saudi Arabia, Angola and Nigeria decreased, while crude oil output in Libya increased. It noted that production not including Iraq stood at 27.02 mb/d in October and down by 0.21 mb/d from the previous month.

It is thus needless to say that Nigeria’s preferred high grade Bonny Light oil, will by this month begin to feel the pinch from the crude oil price slides as recently disclosed by Okonjo-Iweala.

Fiscal operations of governments

Declining oil price means reduction in revenue inflows. This has implications for the capacity of government at all levels to meet their statutory obligations. Most states are over 70% dependent on statutory allocations, which makes the impact of declining oil price very profound. This is even more so when the culture of big and profligate spending has been entrenched.

Already, some states are having issues with the payment of salaries of their workers just as many have issues with payment to contractors even as it is expected that major adjustments in government spending at all levels is clearly inevitable.

Naira exchange rate

Exchange rate is a price determined by forces of supply and demand. The strongest factor on the supply side is the forex inflow from crude oil. Therefore, a downward trend in oil price would naturally result in exchange rate depreciation. Although the CBN has been struggling to defend the naira, this may not be sustainable if the slide in oil prices persists.

The Nigerian economy is estimated to be over 80% dependent on imports. Exchange rate depreciation would mean new pressures on production and operating costs in the economy which would generate new inflationary pressures. High importation costs will also come with high import duty payment, port charges and VAT, as all of these are computed as percentages of import value.

Capital flow reversals

Trend of oil prices is a major driver of foreign capital flows, especially portfolio flows. This is because the prosperity of the Nigerian economy is perceived to be inextricably tied to the developments in the oil market, and rightly so. For portfolio investors, oil price and exchange rate conditions are major indicators that drive their investment decisions. The impact of such capital flow reversals is often profound in the stock market and the foreign exchange market.

Stock market

There is a correlation between stock market performance and the fortunes of the oil market. Nigerian stock market is well known to be more vibrant when oil prices are high.

A major factor in this is the profundity of foreign portfolio investors who currently account for about 60% of the market. Their sensitivity to oil price and exchange rate movements is very high.

Furthermore, declining oil price scenario would result in further tightening of monetary policy to preserve macroeconomic stability. The result is high interest rates and superior returns on investments in the money market which could have negative impact on the stock market.

External reserves

Declining oil price scenario would reduce the accretion to reserves. Therefore, there is a good chance that the reserves will come under pressure.

Besides, the customary disposition of the CBN to defend the naira through increased supply of foreign exchange will take its toll on the robustness of the external reserves. This is even more so when the excess crude account has dried up.

Interest rate

The likely CBN response to the current scenario is to intensify the tightening of monetary policy. This will further push up interest rates, increase cost of funds to investors in the economy and constrain the access of the banks to investible funds. All these would impact negatively on the bottom line of enterprises in the economy.

Energy cost

The good news in all of these is the likely moderation of cost of fuel importation. This is well known to be a major burden on the finances of the country. The share of the nation’s resources committed to fuel importation and fuel subsidy is horrendous and perhaps scandalous. It is hoped that declining oil price would moderate this cost.

Also, Managing Director and Chief Executive Officer, Financial Derivatives Company Limited, Mr. Bismarck Rewane, said the CBN’s recent move to restrict dollar sales to some importers at the RDAS forex market was a form of devaluation.

This, he said, was because the affected importers were now buying dollars at the interbank market at higher rates.

Asked if such an action would not lead to inflation, Rewane said, “The action is currently inflation negative but in the long run, it will be inflation positive.

“Already, at the interbank market last week, the naira was selling at N169 before the CBN intervened and sold some dollars. At the official rate, it is already N156.3. So what is devaluation? Devaluation is allowing the currency to flow, which is what they have done by directing some of the activities at the CBN RDAS forex market to the interbank market.”

He also said the country’s external reserves could fall to $34bn by December.

The stock of external reserves has depleted to $37.5bn and can finance 7.6 months of import of goods, according to the CBN.

Noting the increasing pressure on the naira at the foreign exchange market, Rewane said so far external reserves had moved from accretion to neutral and now depletion.

He said Nigeria was slowly moving towards exchange control, noting that the CBN had given a two-day window for the utilisation of intervention funds.

“The potential revenue loss on unsold dollars purchased is expected to reduce the speculative activities of the banks on Forex. It may also increase the frequency of the CBN’s intervention as banks may reduce the quantum of forex purchased during each intervention.

“Dollar sales to the Bureaux de Change have been restricted, effectively reducing dollar cash at the parallel market. On the flip side, the restriction may lead to excess demand at the interbank market and widen the divergence. The premium between the two market rates is expected to increase and expand the arbitrage opportunity.”

He said external reserves level declined as the CBN intervention at the RDAS increased and naira depreciation intensified at the interbank market due to demand pressure from international investors.

“Can the CBN defend the naira at current levels? The willingness to defend is strong but the ability to defend is falling apart,” Rewane said.

Oil marketers fume

Reacting to some of the concerns raised, the Independent Petroleum Marketers (IPMAN) said the Nigerian oil industry has not fully developed in such a way that white products like diesel, petrol and kerosene could be sourced within.

The IPMAN stated that the likely failure of the National Assembly to live up to its promise to pass the Petroleum Industry Bill (PIB) before the end of the 7th session of the Assembly is a source of worry.

Gani Dibu Aderibigbe, national treasurer of IPMAN, who reacted to some of the issues while speaking with The Nation, believes that the passage of the PIB will bring to an end the era of fuel subsidy, importation of fuel and kerosene, which will further aggravate the situation that will arise by the oil price drop as government will not have much funds to sustain the subsidy regime.


– Bukola Afolabi, The Nation

About the Author