What’s going on?

Oil majors are haggling with national governments over how to share out deep oil production cuts following a collapse in oil prices driven by a dip in demand because of the coronavirus pandemic and Saudi Arabia-Russia price war.

What does this mean?

Oil majors are a group of multinational oil companies given the moniker due to their size, age or market position. They have traditionally escaped big cuts in OPEC nations, such as Nigeria, and have never experienced such in countries outside the OPEC alliance, such as Kazakhstan, where they are protected by special clauses agreed with governments.

But those production sharing agreements (PSA) are being set aside following a deal between OPEC (the Organisation of Petroleum Exporting Countries) and its allies (OPEC+) to cut production by 23% to bolster prices as coronavirus lockdowns reduce global oil demand by a third. Such unprecedented output reductions, effective from May 1, are impossible in most nations without the help of majors.

During the last oil price crash between 2014 and 2016, integrated majors (oil companies involved in the entire value chain of the oil business) such as BP, suffered a decline in earnings from their upstream (oil extraction) units but were rescued by robust downstream (refining and distribution) results as consumers profited from cheap fuel. But this time is different. BP’s chief executive Bernard Looney has said that the major is expecting significantly lower refining profit margins in the second quarter when global restrictions on movement to halt the spread of the virus reach their apex, stifling consumption of gasoline, diesel and jet fuel. Throw in compulsory production cuts across the world, and majors face a perfect storm.

What’s the big picture effect?

The prolonged negotiations highlight the power that oil majors wield vis-a-vis governments. In Kazakhstan, for example, Exxon and Chevron are taking a hard stance over the size of production cuts demanded. Oil majors are already facing an uphill battle to remain solvent due to the slump in oil demand – and, by extension, their profits. BP announced an almost 70% drop in first-quarter profit and has taken on a fresh $10bn overdraft and sold $7bn of new bonds to investors. Shell cut its dividend last week for the first time since World War II. Eni revealed a 94% drop in first-quarter profit and has lowered forecasts for the remainder of the year. Production cuts, therefore, bring into question the short-term future of the sector because of the impact it will have on their already weakened profits. As lockdown measures continue, we will likely see mergers & acquisitions, particularly in the renewables sector, and large-scale corporate restructuring. Depending on how long the pandemic lasts, we may see a fundamental shake-up of the oil & gas sector.

How does this affect Nigeria?

Oil is the largest source of income for OPEC countries: in Nigeria, the oil and gas industry provides roughly 90% of the country’s foreign exchange. So the story highlights the vulnerability of the naira to oil price fluctuations. A decline in oil demand leads to fewer Nigerian oil exports, which makes the naira less attractive to foreign investors and reduces its value. The Nigerian Finance Minister, Zainab Ahmed, has stated that the government is amending its 2020 budget to assume an oil price of $25 per barrel from its previous estimate of $57. This means the government will have less money available for public spending in vital areas such as healthcare and education, which could end up prolonging the virus outbreak in Nigeria. Nigeria, like the UK and US, is in imminent danger of a recession.

The Central Bank of Nigeria (CBN) has kept the naira on a quasi-peg to the US dollar since the last devaluation in 2017. However, the naira has been hitting new lows on the black market (unofficial currency exchange) since March after the Central Bank was forced to adjust its official rate, implying a 15% devaluation. The black market currently remains 16% weaker than the official market rate of N360 to $1 or N444 to £1. This is putting severe pressure on the country’s already dwindling foreign exchange (FX) reserves: $33.44bn as of last month. FX reserves are used to stabilise a currency; by selling foreign reserves on the open market, the Central Bank tries to equalise the supply and demand for the naira. However, these reverses are finite. If reserves get too low, the Central Bank will be helpless against currency depreciation (loss of value).

A weaker naira means imports become more expensive. So those fancy cereals, Dairy-milk chocolate, apple cider vinegar or Spanish beers that we all enjoy will cost you more in Lagos. More expensive imports can also lead to inflation (an increase in the general price of goods and services), which means that even domestic goods could cost more. The inflation rate in Nigeria is currently 12.26% and a further increase may raise concerns about how the indigent will be able to afford essential resources during this period of quasi-lockdown. For those living outside of Nigeria, a weaker naira could be either good or bad. If your girlfriend’s parents earn their income in Nigeria, their spending power will decrease and, unfortunately, that may mean no PS5 for you. Conversely, for those whose parents earn in the UK or US, you should be able to enjoy a couple of extra bottles of Hennessy or Moet during Christmas (provided the travel bans are lifted).

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