May 18, 2020

New Urgency To Diversify The Economy

There is no shortage of experts to tell us that life post-pandemic will be unrecognizable. Faced with an invisible threat for which there is today no definitive cure, it is tempting to create negative scenarios. Many of our comforts have been taken away from us and everybody is talking about mental health. Globalization has taken another large hit, and will take one more when the time comes for post-match analysis and official commissions of enquiry.  The re-election of President Trump in November would reinforce this trend.

Because of Nigeria’s well-known macro frailties, analysis that writes off the oil industry has found a ready home. When WTI trades below zero (i.e. you pay to get rid of it) and UK Brent at +/- $20/b, it looks bad. The US is buying to increase its strategic reserve. The money to be made is in storage rather than production or refining. Bonds issued by several US shale producers are trading at default level. Remember also that the current reworking of the 2020 FGN budget was said to be based upon a crude price of $30/b and that Bonny Light trades at a discount to Brent.

That said, for businesses and households across the world there is generally no substitute for fossil fuels. This is particularly the case in the faster-growing large emerging markets such as India and China. (We don’t hear much talk of BRICS these days.) We expect many casualties among the small oil and gas producers. A recent study by the Federal Reserve Bank of Dallas estimates that drilling becomes profitable with a WTI price of $49/b. This floor is rather higher than we were previously told when investors were buying into acreage in the industry in the Permian Basin.

Consolidation on a large-scale beckon. Just last week the UK-based Tullow Oil sold its remaining stake in the Lake Albert project in Uganda to Total for a reported $575 million, said by an analyst to be a decent return for a seller desperate to realise cash. This is likely to be the first of many such transactions.

The oil majors have generally adopted the same strategy: cut capital spending, secure new credit lines, conserve cash and end buyback programmes, all with the aim of maintaining generous dividends. Their thinking is that institutional investors could trim their exposure to fossil fuels without these payouts. Provided that prices come off the floor at some point this year, the majors should be able to pay dividends and scoop up choice distressed assets.

The other leading players in the industry are the state-owned producers such as Rosneft, Aramco and Petronas, which will also be looking for acreage and other assets in fire sales. As we suspected, the fighting talk that followed the spat between Saudi and Russia within OPEC+ did not last long. On developmental grounds, they could not leave all the taps open and had to push for production restraint. The delivery of Russia’s budget for 2020 requires an oil price of $90/b. While elections do not present a serious challenge to those already in power, voters in Russia, as elsewhere, want regular improvements in services and the infrastructure.

We see therefore a streamlined oil industry, say, 18 months ahead. Demand will pick up as lockdowns come to an end and the price will recover once stocks held by governments and on supertankers on the oceans are exhausted. We also suspect that the momentum behind climate change will slacken as heavily indebted governments everywhere focus on revenue generation and social cohesion. One casualty of the pandemic has been the flagship international conference on climate change, previously scheduled for November in the UK.

Civilian and military administrations in Nigeria over at least the past three decades have pledged to diversify the economy away from oil. None has accomplished the mission. It has been easier to maintain the rentier economy, distributing the spoils in the good times, and duck the challenge of taking on formidable vested interests. The mission cannot be postponed indefinitely, however. There is a shift away from fossil fuels, albeit slow. Further, the population is growing by about 3 percent per year, and has needs and expectations that cannot be met by the revenue accruing from flat oil production. The unemployment rate is close to 35 per cent, and growing each year. The healthy GDP growth of the first half of the last decade was achieved with limited job creation.

The present administration also pledged to diversify the economy and has stuck to the task. We can point to some successes, mostly in agriculture and mostly driven by CBN interventions. If its reforms in the downstream petroleum industry do really amount to fuel deregulation, it will have taken a large step forward.

More substantially, the federal government of Nigeria needs private investment to create jobs, household wealth and tax revenue. Its contribution is to build an infrastructure fit for purpose, and tackle the issues that crop up every year in the doing business, competitiveness and transparency surveys, including: solidity of property rights, adequacy of power supplies, enforcement of contracts, efficiency of the judicial system and speed of the customs service. The clock is ticking, as we have noted, to diversify the economy.

Gregory Kronsten

Head, Macroeconomics & Fixed Income Research, FBNQuest