*High production cost, OPEC cuts erode Nigeria’s advantage
*Oil price now 32% above benchmark; senators say no further adjustments
By Emeka Anaeto, Business Editor, Emma Ujah, Mike Eboh and Henry Umoru
Despite price recovery recorded last week in the international oil market, the Federal Government’s revised 2020 budget revenue stream would suffer significant pressures. This is because Nigeria will have to bear OPEC cut penalty of over 500,000 barrels per day (bpd), while production cost cutbacks has failed to materialize.
Consequently, the Finance Ministry and the National Assembly are not prepared for any further adjustment to the oil price benchmark as well as the revenue and expenditure estimates even with the rise in oil prices far above the current budget benchmark.
Last week the National Assembly approved the revised 2020 budget with oil price benchmark of USD28 per barrel, down from initial USD33 at the onset of the impact of the Coronavirus (COVID-19) pandemic on the domestic economy in March 2020.
The average price of USD37 per barrel recorded last week by Nigeria’s top grade, Bonny Light, in the international oil market has put 32 per cent headroom above the 2020 revised budget oil price benchmark with estimated oil revenue at N300 billion above current budget target of N924 billion. The executive arm of government had presented a revised budget with about 20 per cent headroom against the prevailing oil price. But sources close to both the Finance and Petroleum Resources ministries indicated that there are more problems associated with the country’s current oil production positions which will not allow it take advantage of the positive development in the global oil market and bring the advantage to impact the nation’s economy.
They pointed at an OPEC+ (Organisation of Petroleum Exporting Countries plus the allies) penalty over non-compliance with initial production quota cut as well as high cost of production in Nigeria.
On OPEC+ output cut, Financial Vanguard learnt that Nigeria’s output has now been restricted to about 1.4 million barrels per day, mbpd, as against 1.9 million mbpd initially budgeted.
On cost of production, Financial Vanguard learnt that at over USD23 per barrel, Nigeria has one of the most uncompetitive crude oil in the international market, making marketing and profitability difficult.
International average production cost is about USD6 per barrel with Saudi Arabia at the low of about USD4.
Financial Vanguard also learnt that the nation’s oil conglomerate, the Nigerian National Petroleum Corporation, NNPC, is struggling to push the cost down to at least USD18 by end of this year, but it is already facing resistance from local vested interests as well as some International Oil Companies, IOCs.
The National Assembly is said to be planning a probe into the high cost of oil production in Nigeria with a view to unmasking the vested interests when it resumes recess.
However, to achieve a significant reprieve on revenue pressures, the Finance and Petroleum Resources ministry are said to be banking on further rise in oil prices on the backdrop of recoveries in economic activities across the world.
‘No excess revenue above benchmark’
A Finance Ministry source told Financial Vanguard that at current crude oil price of between $35-$40 per barrel, there is no excess revenue yet even though the prices are far above the budget benchmark. With OPEC Basket price of USD37.09 pbl on Friday, government officials and analysts warned that prices are still too low to consider any savings into the Nigerian Excess Crude Account (ECA).
They explained that with current crude oil production costs of about $20-$22 pbl netted out, what remains of current crude price to be shared by the three tiers of government is still less than the newly reduced oil price benchmark.
The Finance Ministry source said: “The ordinary man might think that oil prices at the international market literally translates to absolute earnings into the Federation Account; but it is not so.
“Let me quickly say that the budget was predicated on $57 originally, now reduced by the executive to $25 but moved to $28 by the National Assembly. Now the price of crude is between $35-$40 per barrel.
“In the first place, there can’t be any money going into Excess Crude Account because the way you calculate this oil price is not the way it is calculated technically. It is calculated over a margin.
“Therefore, a price above the benchmark is not an automatic excess revenue in the real sense of the word. We are having ups and downs. So don’t calculate it as if we have already had a steady revenue above the benchmark.
“What is the cost of producing a barrel of oil? In Nigeria, a barrel of crude oil is produced at the cost of between $20 to $22.
“If you net out the cost of production, you will see that even at the current $35-$40 pbl of crude, we have not even met the benchmark oil revenue.
“Don’t look at it in that generic form as if there is excess revenue because the price is around $35-40 pbl. So where is the excess coming from? By the time you remove the cost of production, you will see that we have not even met the benchmark yet, talk less of having excess revenue, to share or with which to build a buffer.
‘No more benchmark adjustments’
Despite the upward movements in oil prices, Senate Minority Leader, Senator Enyinnaya Abaribe(PDP, Abia South) said: “It is better not to adjust the benchmark upwards again but watch trends. Any surplus will go to Excess Crude Account, ECA, but not for sharing by states.
“Rather, we advocate it should be deployed to reduce the deficit. At more than 30 per cent the deficit is scary and whatever should be done to reduce it will be in the best interest of the country.”
On his part, Chairman, Senate Committee on Petroleum Resources (Upstream), Senator Bassey Akpan (PDP, Akwa Ibom North-East) said: “It is about taking a safe and realistic benchmark in line with current reality; moreso any increase in price of crude oil will compensate for the cuts in production in line with OPEC quota of 1.4mbd.
“My only worry is that we are borrowing to pay for consumption and not necessarily capital projects. So we had to take this position today to keep our economy afloat without slipping into recession but we must be cautious going forward.”
Osten Olorunsola, former Director of the Department of Petroleum Resources (DPR) and Expert Advisory Panel of the Nigeria Natural Resource Charter (NNRC), hinted on how the just-concluded 11th OPEC and non-OPEC Ministerial Meeting underscored production adjustments in May, alongside emergence of many economies from the lockdowns have helped garner tentative signs of recovery in the global economy and oil market.
The meeting, however, emphasized that it was vital that members and all major producers, remain fully committed to efforts aimed at balancing and stabilizing the market, in particular as global oil demand is still expected to contract by around 9.0 mb/d for the whole of 2020.
Olorunsola stated: “Although the benchmark Brent crude actually leaped to a three-month high of above $42 a barrel, the price is only expected to remain at about the same level for a while until global economy truly bounces back.
“That also assumes there is no major resurgence of COVID-19 pandemic across the globe again, and that the existing surplus inventories are rapidly used up to allow the much needed balance between global demand and supply.
“The current deal amongst OPEC+ members as well as the promised adjustments by other producers is a positive development. Unless a second COVID-19 wave hits the world, it will be the backbone of a structured recovery for the market as well as the industry.”
On Nigeria’s position in the OPEC+ scheme he stated: “At about the time the Nigeria budget was being reviewed, there was specific agreement during the OPEC+ meeting on April 10 2020, to cut production by 9.7 million barrels per day. Nigeria’s share of this was 417,000 barrels per day. It is very unfortunate that Nigeria was unable to fully respond to its share of that production adjustment, the failure of which has now been demanded as additions to future cuts during the months of July to September when prices have significantly recovered.
“Going forward, there will be need to ensure strict discipline in responding to agreed production cuts while monitoring the markets closely. In particular, Nigeria needs to be clever in determining how and where the cuts should come from, taking full consideration of revenues to government, technical issues, unit cost issues, as well as production associated with strategic supplies.
“Finally, to better manage this, it is advisable to always take a long term view of oil and gas matters. The sector has long been overdue for reforms, to remove investor uncertainties as well as upgrade terms to competitive and contemporary standards.
“Because of the struggle for market shares seen clearly in fossil fuels today and going forward, such reforms will ensure that all molecules produced will make it safely to market ensuring sustained revenues for development of other sectors of the Nigeria economy.
“A petroleum revenue distribution legislation to guide management of resources from Nigeria’s oil and gas will be the best way going forward, similar to best practices across so many countries today.”
Also commenting on the situation, Professor Uche Uwaleke, Professor of Finance and Capital Market, Nasarawa State University, Lafia, laments instability in the international market and Nigeria’s inability to cope with it.
He stated: “Perhaps more than ever before in the last few decades, the international oil market environment has been made highly uncertain and unstable by the Coronavirus pandemic following widespread lockdowns and economic downturns globally.
“Against this backdrop, the oil price shock is likely to persist for a long time, possibly till the pandemic is effectively contained worldwide. In light of this, I would rather go for a lower crude oil benchmark, say $25 per barrel than the $28 per barrel used for the 2020 budget.
“My take is that a budget is only a short term plan containing estimates of government revenue and expenditure and as such should be guided by the principle of conservatism. In other words, in budget presentation, it is better to err on the side of caution, such that, if crude oil price performs better than the benchmark, then it provides an opportunity to build fiscal buffers. The country can transfer the positive difference to the Excess Crude Account that is now depleted to cushion against unexpected shocks to revenue and part to the Sovereign Wealth Fund especially the infrastructure component.
“As a matter of fact, the Federal Government can agree with state governments to ring-fence part of any excess inflows for critical infrastructure projects such as power.”
‘Oil price rise is muted’
Nevertheless, in an email to Financial Vanguard, an energy analyst, Dr. Bala Limamn, who pointed out that oil prices should not be expected to rise much at this time, said: “Many analysts are basing their prediction of the direction of oil prices on how well the COVID-19 pandemic eases up. As countries start to open up their economies we should see a gradual increase in demand for oil and this pushes prices higher.
“However, recent events seem to indicate that early opening up of the lockdown in many countries is seeing a jump in new COVID-19 cases and this might result in what experts have warned as a second (and likely deadlier) wave of the spread. This might lead to a more pronounced and longer period of global slowdown and a drop in demand for oil that will keep prices low.
Limamn also stated: “The factors that will drive the market will include increased industrial production in the developed countries as they try to kick start their economies. These countries are providing huge injections of funds into their economies to stave off the contraction that occurred because of the COVID 19 pandemic. However, with unemployment levels rising, there will likely be a fall in consumer demand and this will negatively affect production numbers, keeping demand for oil and prices low.
“Another factor that might push up demand for oil is if the tourist industry picks up and spurs increased air travel in the developed countries.
“However, it is important to note that there are other geopolitical factors that could affect the market. These include events in Iran and Venezuela that could push prices up on the one hand and the Saudi Arabia/Russia face-off that could lead to increased production and a glut in the market that could negatively impact on prices. It will thus be important to keep an eye on these factors as they unravel.”
Budget and planning
On planning, Limamn stated: “The Federal Government has recently kicked off the process for a Medium Term Development Plan to replace the Economic Recovery Growth Plan (ERGP) that ends in December 2020 and the 2021 budget will be based on that. Given the country’s huge reliance on oil revenues, it will be important for the plan to recognize the politics of oil so that they do not develop plans that will ultimately fail due to poor revenue projections.”
Managing excess oil revenue
On providing buffers from crude oil revenue in the event of excess, Limamn, said: “The Excess Crude Account, ECA, was put in place to ensure that any revenue above the approved budget figures are saved for the rainy day, but it is now being used to solve short term funding shortfalls especially around FAAC disbursements.
“It will be important if a threshold is set which the funds cannot be drawn below.
This should help push all arms of government to look for alternative sources of revenue rather than keep relying on the Excess Crude Account. “The government to support government projects has used the Nigerian Sovereign Investment Authority (NSIA), manager of the Sovereign Wealth Fund and gets some funding from the government through the Excess crude Account.
“Just like the Excess Crude Account, it will be important for thresholds to be put in place so that the funds in the Sovereign Wealth Fund are not depleted.”