Kayode Oluwadare, CEO, Green Fort Ltd

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Covid-19 and the Nigerian oil economy 15 Jul 2020

The resurgence of Covid-19 in some countries that had contained the spread of the coronavirus disease and prolonged lockdowns elsewhere have become threats to the recovery of crude oil demand and stabilisation of prices of the commodity. For this reason, the Organisation of Petroleum Exporting Countries (OPEC) and other non-OPEC producers, including Russia and Mexico, a group collectively known as OPEC+, agreed last month to extend its record oil production cuts until the end of July 2020.
The output cut of 9.7 million barrels per day (bpd), which the cartel agreed in April this year to help rebalance the market, was supposed to terminate at the end of June. However, the producers were concerned about the lingering pandemic and how it might continue to affect demand. The demand and supply fundamentals became so precarious in April that the oil market was in freefall and got to a point where the West Texas Intermediate (WTI), the United States oil price benchmark, went into negative territory largely due to a huge glut in the market and lack of storage capacity.       

Apart from the Covid-19 health crisis that has hit all the countries of the world – although to varying degrees across the countries – large oil producers like OPEC+ are faced with an economic crisis of huge proportions. To be clear, the global oil market has been experiencing a supply overhang since the 2014 slump in oil prices – at some point the excess of supply over demand rose to as much as two million bpd.

While the world’s largest producers were ramping up output, the Asian heavyweights such as China and India had been reducing their demand for crude oil as they deepened investments in renewable energy technologies. The current and previous output cuts by the oil producers have made some differences in terms of stabilising the market. But this ad hoc approach is not a sustainable means of achieving a semblance of equilibrium amid disproportionate supplies from the top producers like the US, Saudi Arabia and Russia and declining demand in the global market.

Most oil-producing nations are heavily reliant on crude oil revenue to balance their budgets. Although Brent crude, the global benchmark, traded slightly above $40 per barrel (pbl) at the end of last month, that price is still below the fiscal breakeven of oil producing countries. According to data by the International Monetary Fund (IMF), projected fiscal breakeven (the minimum price per barrel that a country needs during the year to meet its spending needs while balancing its books) for Saudi Arabia in 2020 is $76.1 pbl. The price for United Arab Emirates is $69.1 pbl, Kuwait $61.1 pbl, Iraq $60.4 pbl, Iran $389 pbl and Nigeria is $144 pbl.

The breakeven for Nigeria’s African counterparts like Algeria is $109 pbl, Libya is $100 pbl, while Angola is $55 pbl, according to IMF. This data shows Nigeria is one of the high cost producers in the world, therefore, low oil prices will make it difficult for the government to ease the burden of poverty and boost the economy for its over 200 million citizens.

According to the World Bank, oil represents more than 80 per cent of Nigeria’s exports, 30 per cent of its banking-sector credit, and 50 per cent of the overall government revenue. The fall in oil revenue is already affecting critical development expenditures in 2020 as the government struggles to stimulate economic activities. A main objective of OPEC’s price-propping interventions such as the production cuts is to help its member countries like Nigeria to meet their fiscal objectives. Such interventions are also a critical part of OPEC's mandate to protect the common economic interests of its members.

But despite the well-understood mandate, compliance with the production cuts by member countries is often not uniform. For instance, Nigeria was among countries that were identified for non-compliance with the output cut for May and June. According to OPEC+ data, countries that produced above their stipulated quotas include Iraq, Angola, Kazakhstan, Russia and Nigeria, which exceeded its quota by 120,000 bpd.

However, Group Managing Director of the Nigerian National Petroleum Corporation (NNPC), Mele Kyari, stated last month that Nigeria's daily oil production would abide by OPEC+’s quota of 1.41 million bpd in July, which is lower than the revised production output of 1.7 million bpd in the country’s 2020 budget. According to the cartel's initial stipulation, Nigeria was supposed to produce 1.50 million bpd in the second half of the year. Kyari said apart from meeting the required cuts this month, Nigeria will also compensate for its excess output in May and June.

This implies there would be a further decrease in the revenue needed for critical development projects and palliatives that should help to cushion the effects of Covid-19. But given the fact that oil represents less than 10 per cent of the national gross domestic product (GDP), strategically stimulating economic activities in the non-oil sectors like agriculture, manufacturing, solid minerals, construction, etc, would help lift growth, perhaps as from Q4 2020.

The dependence of the Nigerian economy on the oil sector has made the Nigerian currency susceptible to the vagaries of price fluctuations. This situation has continued to mount pressure on the naira, causing the Central Bank of Nigeria (CBN) to devalue the naira in March from N305 per $1 to N360 per $1. Currency devaluation in a country that is heavily import-dependent has the effect of increasing the cost of imported goods, including raw materials used in production. The cost will eventually be passed on to the consumers, many of whom have already seen a decline in their purchasing power.

Millions of Nigerians were already facing hardship before the pandemic. The impact of Covid-19 is further exacerbating the tough economic conditions for them and many more citizens. The government is confronted with a one-two punch of the health crisis of the pandemic and the socio-economic impact. Given the outlook of reduced oil revenue this year, the government’s ability to deliver a strong response is also constrained.

Added to the mix of a grim economic outlook, the government stands a high chance of defaulting on some of its foreign and domestic loans. Key ongoing federal projects such as the Second Niger Bridge and the Mambilla Hydropower Project in Taraba State would fall behind schedule and miss the government’s development targets.

If the much-dreaded second wave of the pandemic occurs and countries retreat into lockdowns for the second time in one year, the economic impact would be much more devasting than it currently is. Among the first economic casualties would be current oil prices. But apart from the impact of the quarantine and physical distancing restrictions on the oil market that has led to production cuts, the Nigerian crude oil output is also susceptible to further cuts due to the coronavirus transmission among exploration and production workers in the country.

Recently, the Department of Petroleum Resources (DPR) said there were rising Covid-19 cases among workers at offshore and remote oil locations. As a result, Shell has begun the evacuation of its workers from the Bonga FPSO unit in a move that will shut down operations at a field that contributes 225,000 bpd in the country. The potential spread of the virus in offshore locations such as the Bonga field threatens Nigeria's ability to sustain production as offshore production accounts for more than 60 per cent of the country's crude oil output.

Furthermore, the shutdown of oil fields due to rising level of infection would lead to temporary and permanent layoffs of oil workers. This would have attendant negative effects on services that are allied with the oil industry.

To reduce the vulnerability of the Nigerian economy to volatility in the oil market, and thereby mitigate the suffering on the people, it is high time the country started to explore techniques, technologies and procedures that will reduce the production costs in the oil and gas sector. This will lessen its fiscal breakeven price of oil. A reduction of this indicator has become more imperative at a time when the long-term outlook of oil prices is nowhere close to the current minimum oil price for Nigeria to balance its budgets.

The country also needs to pay greater attention to opportunities in other areas in the value chain, including petrochemicals and shipping. For instance, the country can use more of its oil resources to develop other products apart from fossil fuels. Petrochemical products are used across sectors such medicine, agriculture, food packaging, household products, among others. This could be one of the diversification strategies that would help to reduce dependency on export of crude oil. The government must use this current adversity to think long term and begin the process of investing in a more sustainable and inclusive economy.