Renewed optimism for oil prices over Nigeria’s subsidy issue
Oil prices maintained their momentum as OPEC + abandoned its meeting scheduled for Wednesday April 28 and decided to go ahead with previously agreed plans to increase production. Brent is up 0.73% to $ 67.17bp since the decision. The coalition is now expected to bring in 350,000bpd in May, with Saudi Arabia adding an additional 250,000bpd. This could mean adding an additional 2.1 mbpd in July despite the resurgence of the covid crisis in India. The alliance likely based its decision on the expected recovery of the global aviation industry by this summer, as vaccine deployment increasingly gains coverage around the world. The markets are already forecasting a recovery in demand for jet fuel by the summer as more and more airlines around the world announce the resumption of international flights.
Optimism justified: vaccines to the rescue
US bank Goldman Sachs, in a note to clients, said the current global momentum – which has triggered pent-up travel demand due to the rollout of vaccinations in Europe and parts of the world in 5.2 million barrels per day (b / d) increase over the next six months. “The volume of new demand cannot be matched by immediate increases in supply. The bank, at the beginning of March, had forecast a rise in prices Brent 10 to hit $ 80bp in the third quarter of this year. However, interest rates will be lower around the world as central banks in many advanced economies try to support the economic recovery. In addition, a weaker US dollar will also support global commodity prices in the coming months.
The global covid-19 pandemic is, by far, the main factor affecting the outlook for long-term oil prices. OPEC + is now planning to meet in early June as concerns about increasing cases of covid-19 – particularly in India, the world’s third largest importer – rise. The cartel and its allies are also keeping their eyes on events in Brazil and Japan, where cases of covid-19 are also on the rise. The resurgence in all three countries could wipe out up to 350,000 bpd of global oil demand.
Damned if you do, damned if you don’t
While the rise in oil prices has put OPEC + members in a better financial position, it has become a double-edged sword for one of its poorest members. Nigeria depends on oil revenues for more than 60% of government revenues and 90% of foreign exchange earnings. Yet Nigeria is unable to refine enough crude oil domestically to meet demand and relies on imports to fill the gap. Nigeria also has a high marginal propensity to import and relies on imports for most of its consumables. Therefore, on the one hand, the government derives more revenue from rising oil prices, but then spends a significant portion of that revenue to subsidize the country’s fuel needs. It is also imperative to note that an OPEC-sanctioned reduction in Nigeria’s oil production quota from 21% to 1.41 mbpd from 1.8 mbpd also significantly reduced oil revenues. This was recently increased to 1.54 mbpd, effective May 2021.
The government’s attempt to embark on the complete deregulation of prices in the downstream sector of the petroleum industry has been met with refusal by unions, who are calling for government-owned refineries to be rehabilitated first. According to the Nigerian National Petroleum Corporation (NNPC), the average landed cost of premium motor alcohol (PMS) for the month of March 2021 was 184 N per liter, against the existing price on the coast (cost of landing at port) of 128 N per liter. and a retail price of N 162-165 per liter. A cost-reflective price would be at least N212 per liter, taking into account current world oil prices and the prevailing exchange rate (N / $ 379), among other factors.
Hard choices and few options
The company now spends more than 120 billion naira per month on subsidizing fuel, an act that is no longer sustainable. Government revenues now face major uncertainty under the weight of fuel subsidy payments, as the NNPC has indicated it will not make any payments to the Federal Accounts Allocation Committee (FAAC) for April and May after recorded fuel subsidy payments from its income. At this point, the government has a clear choice: remove fuel subsidies and face industrial action and possible civil unrest, or continue with subsidies and collapse under the weight of the financial burden.
Subsidies have become a major drain on Nigeria’s financial resources and the difficulty of phasing them out raises questions about fiscal sustainability and resilience, especially in the face of significantly lower incomes. Over the past decade, more than 75% on average of Nigeria’s budget has been allocated to recurrent expenditure on an annual basis. That left only 25% for capital spending and was very pale in comparison to the estimated spending of $ 3 billion to fill the infrastructure gap over the next 30 years.
If oil prices tend to rise, continued subsidies will also mean that many states will face the prospect of not being able to meet salary obligations to civil servants in the months to come. These states will be forced to enter the debt market, adding to their already rapidly increasing debt levels.
OPEC + needs to remain vigilant and beware of US shale producers who are stealing market share as they try to gradually reduce the brakes on production. U.S. shale producers have higher costs than traditional oil producers and are incentivized by rising oil prices to increase oil production. The positive outlook for oil has sparked renewed optimism about the fortunes of the U.S. shale after it was decimated by COVID-19. It may not seem like a good thing, but an increase in the supply of shale to the United States would reduce the rise in oil prices and help ease the Nigerian conundrum – albeit temporarily.
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