On Monday, April 20th, the world watched history unfold with dropped jaws: crude oil sold for below $0.
If this doesn’t make sense to you, you’re not alone. Not many people understand how a thing could sell for minus $40, as a barrel of crude did at some point during the day.
In practical terms, it meant that producers were paying buyers to take crude oil from them.
So what exactly happened? And what could this strange event portend for Nigeria, an oil producer that’s heavily dependent on revenues from its ‘black gold’?
What Made Oil Prices Go Negative?
It turns out that Nigeria wasn’t selling at a negative price after all. Neither were most of the world’s oil-producing countries. But the United States did.
The price of US oil, measured by the West Texas Intermediate (WTI), fell below $0. It was the first time that a barrel of oil had ever been priced in the negative. The event sent shockwaves through the global oil industry. Production facilities were forced to shut down, in fear of the massive losses that could befall them.
All of this happened because there’s more oil on sale than buyers are willing to take. Global demand for crude has dried up; due to the coronavirus pandemic, most industries that use fuels derived from crude oil (aviation, land transportation, manufacturing, etc) are barely functioning. So they don’t need new supplies.
In summary, there’s an excess of crude oil, and producers in the US were running out of storage space for it. The only way out for them is to pay buyers to take the oil off them. That’s essentially what ‘selling’ at a negative price means.
But this happened with crude oil produced in the US. Why should Nigerians be concerned?
How Ultra-Low American Crude Oil Prices Affects Nigeria
Nigeria is struggling with a fall in oil prices too. It sells the Bonny Light Crude variety of oil. That’s recently plunged to $12 per barrel, far below the $57 that the government had projected for the year 2020.
Like the US (and other oil suppliers), Nigeria has had to cut its prices to make its product more attractive to buyers. This hasn’t been enough; it still can’t find enough customers.
Then there’s the competition from super-cheap US crude, available for a fraction of the price that Nigeria is offering. Other players in the market, like Saudi Arabia and Russia, can also afford to sell their crude well below the price of Bonny Light crude.
This all leads to one thing: Nigeria won’t be earning much from crude oil for a long while. And that’s putting it mildly.
Throw in the fact that Nigeria’s Bonny Light Crude is selling at lower than its production cost, and the picture looks even direr.
The Impact of the Oil Price Crash on Nigeria’s Economy
Nigeria earns almost 90% of its foreign exchange (denominated in dollars) from crude oil sales. If it’s getting far less revenue than it used to, the naira will come under pressure against the dollar. We could see further naira devaluations in the coming months.
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A lot of manufacturers in the country depend on imported inputs. A devaluation of the naira means they have to exchange more of the local currency to get the dollars to import those inputs. They may have to pass on the increased cost of forex to the final consumers in the form of higher prices for those products.
Consumers could consider those products overpriced, and refuse to buy. This will shrink the income of the producers and retailers on the product’s chain. Industries could be shedding thousands of jobs just to cope. Several companies may even shut down altogether.
The government also earns 65% of its revenues from crude oil sales. It needs this money to pay civil servants, maintain security, and provide public infrastructure. It has had to cut down its oil benchmark price for its budget in 2020 from $57 to $30. Current numbers suggest that this isn’t low enough.
In simple terms, the government isn’t earning enough to meet its basic obligations. If the low crude oil prices are sustained, it may have to make painful cuts to spending. This could include scaling back on infrastructure projects. Jobs in the civil service will be threatened.
The ripple effect of these outcomes will be felt across all sectors. Banks could see rises in loan defaults that are big enough to threaten their stability. Telecoms revenues may decline as customers become more frugal. Entertainment will reel from poorly attended concerts and a lack of finance. This picture will be replicated across all sectors except, perhaps, agriculture.
A recession seems inevitable. Experts are now wondering how severe it will be.
Is There a Silver Lining?
Economic downturns present countries with an opportunity to reevaluate their position and priorities. Nigeria had that chance in 2015-16. It will be getting it again, starting this year.
Some reforms are already in the offing. There’s talk of the petroleum subsidy being abolished, as a way of reducing inefficient public spending. Tax reforms are due to come into force as well. A greater reliance on the revenues generated from within the country could lessen the impact of the oil price crash.
But the COVID-19 crisis persists, and it will probably limit the government’s willingness to implement fiscal reforms. Local businesses may not be in the position to pay more tax in the immediate aftermath of the pandemic.
In the end, painful sacrifices will have to be made. But the pain of those sacrifices could become the pangs of a birthing process, the delivery of a Nigeria that stands on a sound economic footing.
Featured image source: Nigerian News Direct
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