The Pains And Gains Of The Falling Crude Oil Prices

Supply glut at the international crude oil market has seen the oil prices nosedived by 21.8 percent from $100.06 a barrel on August 27 to $78.27 a barrel on November 6, 2014. Analysts across the globe have linked the current slide at the international crude oil market to many issues.

One of the factors is that the falling crude oil prices could be an economic war which is meant to ward off further investments in shale gas production. This is because by allowing crude oil prices to fall below a certain point, oil extracted through shale technology will be more expensive compared with fossil fuel.

And in turn, customers will opt for fossil fuels and this will allow OPEC member countries to hold on to their traditional customers. Unarguably, there is a price to pay; nevertheless, they justified their assertion with a reference to a similar case that happened not too long ago.

“In 2012, a slump in the price of US natural gas led to major changes. Exploration and production companies had rushed into shale gas drilling, only to be forced into a huge retreat when the ensuing fossil-fuel glut saw prices fall from $11 per million British thermal units in 2008 to below $3. Even the largest oil companies, such as Exxon Mobil and Shell, were badly burned by their shale gas assets plunging in value,” an analyst with The Guardian/Observer submitted.

Another reason is the recovery in crude oil production in Libya and Iraq. The two countries have started to pump more oil into the international market, having secured their oil fields from crisis, and their quotas have raised average daily crude oil supply by OPEC members to about 31 million barrels per day.

On the demand side, there is a low demand for fossil fuel in Germany and China, which are among the biggest economies in the world. China’s GDP growth marginally fell to 7.3 percent in Q3 2014 down from 7.5 percent in Q1 2014, and it is even expected to moderate to 7.1 percent in Q1 2015.

Reuters’ poll attributed the slowdown in China to factory overcapacity and the property sector which has started to cool down. In a similar manner, Germany’s GDP contracted by 0.2 percent in Q2 2014.

Faced with these facts, the International Energy Administration lowered its crude oil demand projections for 2014 to around 200,000 barrels a day on “reduced expectations of economic growth and the weak recent trend.”

Furthermore, many countries have started to diversify their energy mix as they move towards green energy and to hedge against crude oil supply disruptions. One of these countries is Japan, the third biggest economy in the world.

In 2013, Japan’s daily oil consumption declined at an average of 0.16 million barrels a day. It further fell by 0.13 million barrels a day in 2014 and will further decrease by 0.14 million barrels a day in 2015.

According to IEA, “Japan’s oil consumption is expected to fall as the country continues to reduce its share of oil used in the electricity sector, replacing it with natural gas, coal, and nuclear power as the country returns some nuclear power plants to service in 2015.”

How does it affect Nigeria?

The downturn in oil prices is not a good news for Nigeria because it derives most of its revenues from the sale of crude. Available data show that on those occasions that the crude oil prices fell below $100 a barrel, inflows into the economy were affected.

In 2009/2010, monthly available data from the Federal Ministry of Finance (FMF) show that the monthly federal allocations increased as the crude oil prices rose at the international market and vice versa. Also, in June 2013 when the oil prices dipped below $100 a barrel for about two weeks, total federally collected revenue at the end of that month fell by 10.4 percent to N766.3bn from N855.1bn the preceding month.

To show the extent of Nigeria’s vulnerability to external shocks, in that period, it was only the oil revenue component of the total federally collected revenues that fell to N579.6bn from N671.1bn the preceding month. For an economy that is built around the monthly federal allocations, economic activities contract when allocations to the three arms of government reduce.

The Nigerian banking system will also be negatively affected if the present price regime stays for too long. Nigerian deposits money banks are exposed to the oil and gas sector as evident in their loans and advances to that sector which grew from N1.76trn (21.1 percent) in 2012 to N2.42trn (24.1 percent) in 2013. 

Affected oil companies may find it difficult to service their loans obligations which in turn will raise the spectre of non-performing loans in the country and may eventually affect banks’ earnings as we witnessed in the financial crisis of 2008-2010, when AMCON acquired non-performing loans estimated at about N3.3trn.

Additional effects will be that commercial banks will become reluctant to grant credit facilities to economic agents just as it happened in 2008/2010 period. Then, the share of their short term loans and advances relative to their total loans and advances shrank from 75.4 percent in 2008 to 70.3 percent in 2009 and further to 65.3 percent in 2010.

Meanwhile, during the same period, short term deposits relative to total deposits grew from 94.8 percent to 96.87 percent suggesting that it was other factors that caused the shrinkage in the amount of short term loans and advances granted to the economy.

The naira-dollar exchange rates are not spared whenever the crude oil prices slump. The gap between the Weekly Dutch Auction System (WDAS)-the official exchange rate and Bureau De Change (BDC) widens when expectations are high that the crude oil earnings will fall as this will limit the ability of the Central Bank of Nigeria (CBN) and the multinational oil companies to intervene in the market.

For instance, the difference between WDAS and BDC rates hovered from N1.82 in January 2013 to N9.87 in November of the same year. The margin became wider and jumped to N14.13 in December 2013 from the point the crude oil prices began to slide, and has since remained around that range. 

External reserves have not shown any immunity to the downturn in crude oil prices. From the peak of $39.62bn on August 12, 2014 and a low of $38.07bn on November 6, 2014, the external reserves have experienced a marginal decline of 3 percent or have lost $1.55bn within the period.

Another point is that a sustained downward movement in crude oil prices will make investment in biofuels not profitable. In recent times, investors have shown interest in biofuel production. Atlantic Distilleries Limited recently commissioned a 10 million litres capacity ethanol plant in Igbesa, an industrial hub of Ogun State.

Who gains?

Globally, it is the consumers. Economies with active manufacturing sectors have started to benefit from the falling crude oil prices in the forms of reduced prices of consumer goods.  In the UK for instance, Asda, Tesco and Morrison have announced a price cut in the pump prices of fuel by 2 pence. They attributed their decisions to the decline in crude oil prices.

For Malaysia and Indonesia, Morgan Stanley has projected that the downturn will reduce the amount these countries allocate to subsidy.  It will also help reduce consumer inflation in India, Singapore, Thailand and Philippines. However, we haven’t seen this happen in Nigeria.

SOURCE: BUSINESS DAY

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