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Analysts say revenue target still realistic despite decline in oil output

By BusinessNews Staff on October 20, 2014

The nation’s oil output may be on the decline, economic analysts, who weighed various scenarios likely to play out in the last quarter of the year, insisted that it is possible for the federal government to achieve the target set for the 2014 economy, reports Festus Akanbi
As expected, the Budget Office should, by now, be busy collating reports from the various federal ministries and parastatals in preparation for the 2015 federal budget.

As the nation’s policy makers settle down to fashion out appropriate economic policies for next year, analysts say a number of factors, will determine the direction of the Nigerian economy in the year to come. Some of these include the twin factors of the dwindling oil prices at the international market, and the drop in output in recent times, the attendant pressure on the naira, the next year election and the United States of America’s oil policy, among others.

Interestingly, the International Monetary Fund, (IMF) said last week that the decision of the US to close its door against Nigeria’s oil export will not hurt the Nigerian economy because of the nation’s aversion to debt.

However, analysts drawn from Financial Derivatives Company and the international financial advisory firm, Renaissance Capital, in the various scenarios painted for the Nigerian economy last week said there is fire on the mountain although they believe this will not deter the government from meeting its target at the end of the year.

In its Monthly Economic News and Views, a documentation of the Executive Breakfast Session at the Lagos Business School, titled Cheaper Oil, Lower Revenues & Higher Inflation – What Next?? Rencap pointed out some gaps in the nation’s oil production.
Quoting data from the Organisation of Petroleum Exporting Countries, Rencap noted that Nigerian oil production is now 1.9mbpd whereas budget is for 2.36mbpd.

This is happening at a period when the non-oil sector growth has stalled due to insurgency. Farming communities have been displaced, Brent crude price tested $95pb in September; lowest point since 2012. It has remained below $100 per barrel for over a month.

Further Monetary Policy Tightening Likely
It warned that Nigeria’s 2015 C/A balance will turn negative if the average oil price falls below $85 per barrel. This is assuming oil output of 2.25Mb/d vs 2.27 in 5M14.” However, we will begin to worry about the naira if the price falls below $90/per barrel, as this means a C/A surplus below 1.0 per cent of GDP that fails to cover the financial account deficit of 0.5 per cent of GDP. Our core scenario is an oil price of $105/bbl., which implies a C/A surplus of 2.9 per cent of GDP and an exchange rate of N168/$1.”

The report said the most plausible alternative scenario is an oil price of $95/bl. This means a leaner C/A surplus of 1.6 per cent of GDP and a weaker naira at N170/$1. “Our severe-risk scenario is an oil price of $85/bbl., when the C/A barely balances and the naira depreciates to N172/$1. We think the increased risks to the naira, among other issues, may compel the monetary policy committee (MPC) to tighten policy at the November meeting, in particular through a hike in the private sector cash reserve requirement.
The caveat of our analysis is the large negative ‘net errors and omissions’ in Nigeria’s balance of payments, which implies our naira forecasts may be a little optimistic,” the report said.

Realistic target
Analysts from Renaissance Capital said in a scenario like this, “When the oil price falls in Nigeria, the breakeven oil price (the oil price at which the budget balances), which is $111/bbl. for the 2014 budget, on our estimate, comes under scrutiny. One potential concern is that the oil price will drop below this breakeven price and result in the federal government failing to meet its fiscal obligations. We do not share this concern simply because the federal government has chosen to run a budget deficit (c.1 per cent of GDP in 2014), instead of balancing the budget, and has a conservative budget oil price of $77.5/bl.

“Given our expectation of an oil price of $100-105/bbl. for 2014E, we are comfortable that this year’s revenue target will be met. We think the effective budget oil price is of greater importance than the breakeven price, because if the actual price falls below it, the fiscal outlook is at risk. We think the bigger risk to the fiscal outlook is below-target oil production.

Budget Assumptions
“Our estimate of the effective budget oil price accounts for the difference between projected and actual oil production. Since 2012, the effective budget oil price has become more significant because oil production has fallen short of that projected in the budget. That implies the effective budget oil price (the price that will generate the revenue targeted, at the lower oil production level) is rising and its spread with the actual oil price is narrowing. The effective price increased to a recent peak of $91/bbl. in 2013 (vs. the budget price of $79/bbl.), on the back of a 300,000 b/d shortfall in production. We believe a recovery in production in 2014 (2.27Mb/d in 5M14) will allow for the effective price to fall to $84/bl.”

Also speaking on the 2015 budget, the report said, “The federal government has yet to announce its 2015 budget assumptions. However, we expect the government to lower its oil production projection, as it did in 2014, to c. 2.3Mb/d, and reduce its oil price projection to c. $75/bbl., on the back of the softening in the oil price, but not too sharply, as that would squeeze the federal government’s revenue. If actual production turns out to meet our projection of 2.25Mb/d in 2015, then the effective budget oil price will fall to $77/bl.
That is below our severe case scenario price of $85/bl. If, however, oil production comes in below 2.25Mb/d, then the spread between the effective and actual oil price narrows, and the risk to the fiscal outlook increases.

“We think the risk of oil production falling below our projection (40 per cent) is greater than our severe case scenario (10 per cent).”
“Raising the fear of erosion of the nation’s current account surplus, Rencap said, “Our naira analysis is premised on Nigeria’s C/A balance. However, the large negative net errors and omissions in Nigeria’s balance of payments, which in 2010 were equivalent to the C/A surplus, have the potential to undermine the C/A surplus.

“We believe the devaluation in 2011 was in part due to a negligible positive overall balance, which was preceded by a negative overall balance of 2.8 per cent of GDP in 2010. The biggest item in the 2010 balance of payments was the (negative) net errors and omissions, of 4.3 per cent of GDP which we believe was largely made up of unrecorded imports.

“It believed a surge in pre-election spending in 2010 explained the big increase in unrecorded imports. “We think this time around, fiscal policy is relatively more conservative, and partly for that reason, pre-February 2015 elections, we do not expect an increase in import demand equivalent to that of 2010.

“That said, we think the 2014 balance of payments may be undermined by financial outflows given the increase in risk aversion to EMs, and the uncertainty that typically precedes an election, thus we expect a further decline in the overall balance in 2014 vs. 1.6 per cent of GDP in 2013. Our core scenario (oil price of $105/bbl.) implies that the overall balance could potentially improve in 2015.”

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