Covid-19 And a Price War Make The Perfect Storm

Upstream Oil & Gas Sector in H2-2020

Share prices across the world sank on Monday as panicked investors fled to bonds to hedge against the economic shock caused by oil prices falling 30 percent after Saudi Arabia started an oil price war against Russia. Initial losses in New York was so steep that trading was initially suspended. Brent crude futures fell by as much as $14.25, (31.5%), to $31.02 a barrel, the biggest percentage drop since 17 January 1991, at the start of the first Gulf War and the lowest price since 12 February 2016.

Nigerian equities sank 2.41% today as local and foreign investors pressed the panic button. The banking sector index bore the brunt as it closed down 8.95% as the slump in oil prices raised concerns of the quality of oil and gas loans. Investors were clearly spooked by news of oil price fall and thus fled to safety despite this being in dividend earning season. The NSE, which was the best performing market at some point this year has now lost all those gains and is in the negative year-to-date territory.

The last time oil prices collapsed this much was during the Persian Gulf War in 1991 when the United States rolled back Iraq’s invasion of Kuwait. Back then, Nigeria had been in the throes of a military dictatorship for years and had a per capita GDP of $822. Despite that, it is estimated that Nigeria made up to $12 billion from Gulf War-related oil sales, and the government was able to spin it as a win for everyone. The new reality is that given the spat between Russia and Saudi Arabia, oil prices will remain depressed in the immediate term. This brings up two critical questions.

How is the Nigerian government going to raise the $22.7 billion loan which the National Assembly approved last week? This question is important because Nigeria’s Federal Government is hedging the repayment of those loans on oil sales. Even the financing for the Ajaokuta-Kaduna-Kano gas pipeline is hedged against assets that may soon be non-performing. There is also the risk that as oil prices remain low, some of our oil wells may be shut as they become increasingly unprofitable. New investments (including the much-touted Mambila Power Project) could probably be frozen as a result.

Then there is the naira. The sensible thing to do will be to devalue in order to ease the mounting pressure on the currency and the foreign exchange reserves. However, there is the political calculus that President Muhammadu Buhari is solidly against devaluation.  Given the lack of independence of the Central Bank of Nigeria, Godwin Emefiele is sitting between the rock of currying Aso Rock’s favour and the hard place of the country’s economic realities.

We think that after a delay due to political reasons, the CBN will eventually be compelled by the price war to devalue the naira in order to maintain a semblance of stability in the country’s foreign reserves. We also think that it will be accompanied by an interest rate cut. The breaking point for the government’s naira defence policy was last year and it has been plugging the hole in official spending with an aggressive debt programme. The oil price war between Russia and Saudi Arabia will tip them over the edge. Nonetheless, Godwin Emefiele will not be looking to devalue aggressively, so a 10-12% band is our expectation for the regulator’s move. We think it will happen sometime in Q2 2020 for the simple reason that the CBN might see this price war as a window to ease pressure on the currency without causing too much disruption in the debt, currency and equities markets (we do not see it happening earlier as CBN will likely watch to see if either nation is willing to compromise). Market observers will be expecting a fall in the value of oil currencies and the naira will be given the benefit of the doubt, along with its peers.

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A recession will see a reduction in the purchasing power and living standards of Nigerians. To put it simply, the combination of increased taxes and charges and a freeze in public sector pay and private wages has left Nigerians with little financial wiggle room. In cities like Lagos, increased commuting costs as a result of a ban on commercial motorcycle taxis and rickshaws have compounded a dire financial picture for most low and middle-income Nigerians. The main risk is the Nigerian government running out of money and has been printing more naira in order to cover that fact. This could worsen the already problematic inflationary trend that the country is currently experiencing.

It might be a bit too early to talk about the re-election prospects of the APC as that is three years away, and the opposition is all over the place at this time. At the moment, the bigger risk to the ruling party is the internal fissures within it, and if there is no money to oil the political patronage networks, the All Progressives Congress runs the risk of an open schism.

As economic conditions worsen, Buhari will become less popular, and a fall in oil prices will lead to the shrinking of the administration’s many social programmes, which will guarantee the deterioration in the living conditions of the country’s poor. In this depressed economic climate, as insolvent states are unable to finance their significant recurrent expenditure commitments, another round of bailouts from the shrinking federal purse will be provided, just like in 2016. This impending fiscal crisis risks being transmuted into a monetary crisis as the government simultaneously tries to keep its constituencies happy while propping up the currency. In this regard, Abuja has been dealt a tough hand, a hand that it is difficult to see it rising to address.