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Nigeria dangerously exposed to oil crash

The recent drop in oil prices will hit Nigeria hard, making a big dent in government revenues and threatening the viability of upstream projects

Nigeria is bracing to take a big hit from the collapse in oil prices resulting from the end of the Opec+ agreement and the Covid-19 pandemic. The country is particularly vulnerable as it has not fully recovered from the previous crash in 2014.

Nigeria’s 2020 budget is based on an anticipated oil price of $57/bl, but the decline in the price of the Brent benchmark crude has forced the government to revise this to $30/bl while maintaining proposed production volumes at 2.18mn bl/d.

The crash in prices means volume is especially important for oil-dependent Nigeria, and as there will be no Opec output limits to adhere to after March, the country can pump at will. However, in the medium-to-long term it may be difficult to increase output “as investment in oil fields is even less attractive now”, says Lagos-based Michael Famoroti, chief economist at Stears. Moreover, “companies will face liquidity problems and pumping oil will become difficult”, he adds.

The current low oil prices are a serious problem for oil investors in Nigeria, as “prices are perilously close to per-barrel costs of production for many operators”, says Ekpen Omonbude, a petroleum and mining economist based in the UK and a former economic advisor to The Commonwealth. “A sustained period of these prices or, even worse, a further decline, would make things such as shut-ins and slashed budgets [likely].”

Subsidy regime

A positive aspect of the collapse in oil prices is that it offers Nigeria the opportunity to wind down its subsidy regime. The government cut the price cap for petrol by NGN20/litre ($0.054/litre) last week, triggering a surge in demand that resulted in a scarcity of fuel in the nation of nearly 200mn people.

The oil price crash “presents an opportunity to exit the subsidy arrangements for motor gasoline”, says Omonbude. He adds the reduction in petrol prices “reduces pressure on the already limited resources which have to be dedicated to funding the subsidy”.

$57/bl - oil price Nigeria expected in 2020 budget

A halfway house could be to calculate the savings made by the government from having to pay a reduced subsidy. “This would then support a price modulation system that actually works. But such ‘savings’ at a time like this would be urgently needed elsewhere,” says Omonbude.

The oil price crash could lead to a permanent change in Nigeria’s subsidy arrangement, according to Famoroti, although nothing has been confirmed. “Until the government gives clear direction on how prices will be set when oil prices are higher, we can assume that subsidy will be back at some point, until the market is liberalised,” he says.

Government finances

Less positively, Nigeria could lose more than $9bn as a result of the fall in oil prices, according to Goldman Sachs. The bank predicts oil will stay at around $30/bl over the next six months as the price war between Saudi Arabia and Russia continues. This could plunge Nigeria into its second recession in six years and its third under president Muhammadu Buhari.

Finance minister Zainab Ahmed says the collapse in oil prices will slash Nigeria’s revenue by as much as 50pc, causing a 20pc cut to the nation’s capital budget and an additional 25pc cut in annual expenditure.

Ahmed adds that Nigeria would have to reduce the amount of federal funding for upstream projects. “The reduction of the crude oil price from the $57/bl we budgeted for to $30/bl means that we are going to get so much less revenue, almost 45pc less than we planned, and because of that we have to amend a lot of projections in the budget to reflect our current realities,” she says.

“Companies will face liquidity problems and pumping oil will become difficult” Famoroti, Stears

In the long term, present government expenditure is unsustainable with current oil prices. “The government cannot carry on with these prices for a sustained period,” says Omonbude. "Something has to give. It has had to review its benchmark price downwards, and one can fairly confidently expect capital expenditures to nearly cease.”

Omonbude says the finance ministry faces limited options. “There is not much capacity for raising debt, and there is not much [potential] for raising [more] non-oil tax revenue. Some respite could come from a currency devaluation, but the central bank's position on this matter is still one of defiance. The disappointing results of the recent [treasury bill open market operations] OMO auction add to the pressure.”

Given that the price war will probably mean ongoing discounts for Bonny light crude and other Nigerian grades will be larger than for benchmark grades, despite being comparable to Brent, Famoroti expects oil revenues to significantly underperform, saying that “the government essentially needs to provide an entirely new fiscal plan or budget”.

“Nigeria will withstand low oil prices, but the government will just not be able to spend much at all, and things like salaries and pensions will take a hit,” Famoroti adds.

Financial retrenchment

Omonbude says the drop in oil prices should not affect major projects, particularly gas developments, although many IOCs have announced broad budget cuts.

50pc - cut to Nigeria’s revenues from lower oil prices

“The concern is more on the crude oil side, particularly with regard to work programmes envisaged for this year. Sustained periods of these prices or lower will likely force further budget cuts. This will hit the services and engineering, procurement and construction [EPC] companies hard,” he says.

Nigeria’s oil and gas sector has already become less attractive following the government’s revision of production-sharing contracts (PSCs) to seek more revenue from oil majors. Famoroti says appetite and capacity for Nigerian projects will become even more limited as major investors and stakeholders are likely to be adversely affected by the oil price slump.

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