OIL PRICE CALAMITY

When it came it was as abrupt as it was devastating, a collapse in crude oil price futures significant enough to be defined as a material adverse change. In other words a calamity, at a time Nigeria is least able to absorb it. 

Indeed the Group Managing Director (GMD) of Nigerian National Petroleum Corporation (NNPC) Mallam Mele Kyari at a meeting with the Central Bank of Nigeria (CBN) warned of the dire economic consequences of the collapse of oil price benchmarks. We learned that most of Nigeria's crude oil loading program for both March and April is distressed and has no home to go to. According to Mallam  Kyari, that amounted to around 51 cargoes, which would equate to almost 50 million barrels of crude or condensate.

The Saudi decision to respond to Russia's unwillingness to make further and deeper production cuts has resulted in them opening their spigots and flooding the market with cheap, heavily discounted crude. Their ostensible aim to block Russian crude into Europe and force Putin to accept the Saudi's plan, though there has been disquiet about Russian crude oil exports to China who are now the main buyers of Russian crude using the ESPO pipeline.  Yet the outcome has been to shock energy-exporting emerging markets economies like Nigeria.  It feels like a wanton, spiteful act of obliviousness on the Saudi’s part, a salutary lesson for members of OPEC to observe.

The Saudis as low-cost producers have a price advantage over the market as Mallam Kyari acknowledged. Whereas Nigeria typically produces its crude from anything between $15-$20 per barrel (Cost Oil), the Saudis are able to get theirs out of the ground for about $5 per barrel. To seize market share, they have aggressively discounted their barrels by between $6-$8 per barrel depending on the destination. The Saudis are also able to rapidly deploy their spare capacity which will ramp up production by about 3.5 million barrels per day in April. In any event, they have ample inventory to draw upon to achieve their objectives.

This leaves Nigeria in a critical position. Since  Mallam Kyari's denouement freight rates for  VLCCs from West Africa to East Asia have leapt to $43.22 per metric ton on Wednesday, nearly $26 up on the previous Friday's price of $17.83. The current market reality is that dated Brent oil futures at circa $30 means the Nigerian oil industry is effectively out of business. The current price for Brent is $34.60 with Bonny Light being assessed at a premium of 35 cents per barrel over Dated Brent on  Thursday, down 85 cents per barrel from the start of the week.

It is highly unlikely that the CBN will be able to keep in place the USD$ currency peg as February data showed FX reserves dropped by more than $1.6 billion to $36.38 billion. Crude oil receipts account for 90% of Nigerian foreign exchange earnings. The CBN actively intervenes in the market to maintain the official exchange rate which is currently N306.90. This will mean a devaluation of the naira and exchange rate restrictions.

The CBN have contended that a devaluation is unnecessary at the moment, but the market rate for the 1 year Non-Deliverable Forward (NDF) naira settled futures has raced to N488 to the USD$ from N388 last month. The NDF is a currency hedging tool which allows US dollar investors to lock in to a naira exchange rate. The NDF provides a much more precise indication of market fundamentals than the CBN. If the so-called Saudi-Russia price war continues unabated, then not only will Nigeria be threatened with recession, but depression and insolvency might follow in quick order.

The Saudi action to my mind is reckless and does not contemplate the damage it unleashes on other OPEC members such as Nigeria. That is not to say they would not have been appropriately aware of the consequences of their actions, but deemed Nigeria's financial distress as acceptable collateral damage in the pursuit of their  own self-interest. The Saudis, the de facto leaders of OPEC continue to treat the organisation as a tool  to achieve  Saudi foreign policy objectives. All OPEC member states agreed to cut and that’s what should have happened.

We have been made to understand that Russia’s refusal was fuelled in part by the fact that OPEC cuts only seemed to have the effect of increasing US shale market share and providing support to financially vulnerable shale producers. Whereas the focal point of Saudi motivation seems to be the Aramco IPO and MBS's 2030 Vision. However, I suspect it was the loss of Saudi market share and crude oil volumes relative to the Russians in China that created the most consternation.

In any event Nigeria has been thrown under the bus at a time the oil market is dealing with the effects of COVID-19 and it is simply not good enough. I think it is time for African producers to make their voices heard. OPEC is clearly an undemocratic organisation where smaller producers lack gravitas and are bullied.  It is time for the government to debate the benefits of belonging to an organisation where you are regarded as a vassal State.