The world has experienced some major economic shifts due to the Covid-19 pandemic, one of which is the unprecedented fallen oil price and how this affects the world, and more specifically, Nigeria.
Brent crude oil prices fell to approximately $33 per barrel (bbl) as at 9th March, the worst of its kind fall in a day since 1991. Earlier in 2020, oil prices had fallen to almost $45 per barrel, the lowest for years. Back then, the combination of shale oil production from the US and predictions about sluggish global demand growth was to blame. Now the Coronavirus, which has slashed Chinese oil demand by more than 20%, has added fuel to the fire. For Nigeria, an OPEC member, its path to quickly ramp up production is limited by operational, regulatory and infrastructure challenges.
Some OPEC members could decide to go renegade and pump out more barrels in the hope of compensating for the rapid decline in prices. Already the uncertainty has been devastating to oil markets, with the lack of coordination and trust amongst key members of the Organisation of Petroleum Exporting Countries (OPEC) and non-OPEC actors, fueling a new era of volatility., drastic action is required.
While non-oil GDP growth has shown welcome signs of improvement in recent years, close to 90% of Nigeria’s FX revenues still come from oil exports (another point of discussion here but let’s move on). Many countries that use commodity price benchmarks have not figured out how to weight Black Swan events – i.e. low probability, high impact – of which the Coronavirus is arguably one, in their budget assumptions.
Nigeria’s oil price budget benchmark has already been blown out of the water several times this year. This latest rumble is the surest sign yet that the 2020 oil price average may continue to sit well below $30 per barrel for the foreseeable future. In this case, it is the manner in which the Coronavirus has spread in a deeply-interconnected world that is alarming.
The World Health Organisation’s Director-General, Tedros Adhanom Ghebreyesus and his organization declared the Covid-19 a global pandemic, with more than 2 million cases now reported worldwide. A drop in reserves in Nigeria, from $38bn to $30bn, can happen just as dramatically.
Nigeria’s FX reserves are there to help the Central Bank preserve the naira’s value; Central banks can sell FX reserves to buy their local currencies in an attempt to uphold the currency’s value. Nigeria’s economy never fully recovered from the oil price crash in 2014 – 2015.
The naira is still a classic Petro currency whose fate remains intrinsically tied to global oil prices, at least without a seismic shift in economic structure. That shift is not a short-term task. Not even for our very SPONTANEOUS president.
The stance by Nigeria’s key economic actors to defend the naira will likely be tested by the expected further decline in Nigeria’s foreign reserves – the Central Bank set a $30bn foreign reserves threshold for devaluation. Nigeria is treacherously close. About $9trillion was wiped off global equities in 9 days into early March as a result of coronavirus.
Devaluation would lead to increased importation costs for raw materials and other soft and hard commodities that have to be paid for using FX. Raw inputs for manufacturers will become more expensive and ultimate losers will be everyday consumers who will see further erosion in their purchasing power. (now you see why goods will be slightly more expensive after the lockdown). If the CBN strategy fails and Nigeria runs extremely low on reserves, the naira could depreciate, allowing speculators to arbitrage.
Nigeria’s gross foreign reserves are at a similar level – around $38bn – as they were in 2014/15 when oil prices also fell steeply – compare both periods with the $53bn in foreign reserves. Nigeria had in 2008, at the height of the global financial crisis, and which still incurred a heavy economic toll on Nigeria. This action depends on the supply of FX, and any action taken by Nigeria’s central bank could actually provide an indicator to foreign speculators of impending devaluation. The cycle would be aggravated if foreign investors begin to exit Nigerian equities and bonds en masse.
Global investment bank Goldman Sachs has lowered its Brent oil forecasts to $30/bbl for Q2 and Q3, and by most estimates, the rest of the year will be gloomy. Demand is weak and dwindling, with cargos of West African crude blends from Nigeria other African countries now heavily discounted to buyers mostly in Europe or remaining unsold. A Central Bank intervention to adjust the value of the naira, is almost certain if FX reserves run below the threshold set.
What is a bigger unknown is whether such an intervention will be heavily pre-emptive as the current official exchange rate is the longest-run of stability that Nigeria’s FX regime has had in decades.
Recently, low-interest rates in advanced economies have allowed Nigeria’s central bank to ease rates locally, but if oil prices continue to come under pressure, putting further pressure on the naira, there will be a continuous hike on rates. The combination of rising inflation which is currently at about 12% and naira devaluation risks may force the Central Bank’s hand on rates.
All of Nigeria’s 2020 budget indicators; an oil production volume of 2.18 million barrel per day, oil benchmark of $57, N305 exchange rate to the US dollar, GDP growth rate of 2.93%, and inflation rate of 10.81% now appear out of reach, and will most likely result in a downsizing of expenditure plans in 2020. Nigeria has no such luxury – the country’s excess crude account (ECA) which had a balance of $20bn in January 2009, stands at a balance of approximately $70m today).
There is a need to reform the ECA’s governance structure and prioritize the types of drawdowns that have long term economic and infrastructure benefits such as investments made into the Nigeria Sovereign Investment Authority (NSIA).
Nigeria spent approximately $28bn on subsidies between 2006 and 2018 alone, a financial burden that hampers development in other crucial sectors. Nigeria is still 3 years away from the next election cycle in 2023, under an administration that is in its second and final term. Thus, with little political capital to exploit here, there is probably no better time than this low oil price environment to revisit this issue.
There are no quick fixes for Nigeria, but this may be a good time to plug some of the wastage. Nigeria needs to deregulate the downstream energy with a focus on gasoline subsidies, which promotes rent-seeking and has fueled several inefficiencies within the downstream oil network. Deregulation before the end of 2020, would at least give the current administration the opportunity to demonstrate the longer-term benefits of a liberalized oil market, without the political pressure of high petrol prices.
This Article Was Written By Marvin Palmer