Nigeria’s obsession with oil is well documented. Oil and gas exports still account for 90% of the country’s foreign exchange earnings, so the economy has generally enjoyed stronger growth when oil prices are high and struggled when they fall. Yet falling oil output and demographic growth mean that production is spread increasingly thinly across the population.
At the same time, the country spends a worrying proportion of its hard currency on fuel imports, although a huge new industrial project could stem the outflows, benefitting the entire financial system.
Nigerian Banks have minimal exposure to Russia and Ukraine
Abuja blames current economic problems on the war in Ukraine and the pandemic, and these undoubtedly play a role. Yet ratings agency S&P argues that Nigerian banks have minimal exposure to Russia and Ukraine, so the war should have no significant impact on their asset quality or profitability. Nigerian banks’ main exposure is to other African markets, the UK and Asia.
They are of course indirectly affected by the impact of the war on the wider Nigerian economy, such as through the rising cost of key commodities. For instance, Nigeria imports about 50% of all its wheat from Russia and Ukraine but Black Sea ports are currently struggling to ship agricultural commodities, so the price of imports from other suppliers is rising.
In addition, it could be more difficult for Abuja, state governments and corporates to issue debt as a combination of the pandemic and the war in Ukraine has seen appetite for bond issues in emerging markets decline.
The economy has benefitted from higher oil prices since the lifting of most Covid-related restrictions elsewhere in the world, which have also been fuelled further by the war in Ukraine.
Oil prices stood at $104 a barrel in the third week of July, slightly down from a peak of $116 in March but still very high by recent standards. As a result, higher oil revenues helped narrow the current account deficit last year. However, domestic oil production fell in the first months of 2022, with crude output falling to 1.49m b/d in the first quarter, depressing economic growth.
At the same time, an upsurge in petro-crime, including illegal refining and pipeline attacks, have depressed oil production in the Niger Delta. Such criminal and militant activity both affects current production and deters investment in oil exploration and production, depressing longer-term production capacity.
As a result, Nigeria has not been able to make maximum use of high oil prices. Some reports suggest that crude production has been as low as 1.2m b/d, meaning that Nigeria has been unable to make full use of its OPEC quota of 1.8m b/d, and even that is a far cry from government ambitions of 4m b/d.
Estimates vary wildly, but according to the Nigerian Upstream Petroleum Regulatory Commission, only 132m barrels out of the 141m barrels of oil produced in the first quarter of 2022 were actually received by export terminals because of theft, costing the government about $1bn in lost revenue.
Various initiatives have been launched by successive governments, including military crackdowns, militant amnesties and widespread court action, but all with limited success.
Force majeure even had to be declared at Bonny Oil & Gas Terminal. The CEO of the Commission, Gbenga Komolafe, said: “This trend poses an existential threat to the oil and gas sector and by extension, the Nigerian economy if not curbed.”
As a result of low output, higher oil prices have proved insufficient to stem the loss of foreign exchange reserves. The government’s foreign exchange reserves stood at $38.6bn at the end of May 2022, slightly down on the $41.5bn recorded in September 2021. This may not seem like a significant change but the fact that the fall was registered at a time of bumper oil prices suggests something is seriously amiss with the country’s finances.
Impact of high oil prices on banks
Fitch reported in May that “the most pronounced benefit of higher oil prices is decreased pressure on asset quality. Oil prices and Nigerian banks’ non-performing loan ratios have been closely inversely correlated in the past, reflecting the outsized exposure to the oil and gas sector in loan books, the Nigerian economy’s high dependence on oil revenues, and the spill-over effects from oil to non-oil sectors.”
Higher oil prices have also had a negative effect on the economy because of much higher prices for diesel, which is used as feedstock in the country’s many small-scale electricity generators, which are used as back-up by millions of people across the country. Intermittent local but all too regular power cuts gave way to total blackouts across much of the country, including Lagos and Abuja, in March and April.
Fuel subsidies cost the government up to $7bn a year but President Muhammadu Buhari failed to tackle the problem, despite promising to do so at the start of his presidency, probably fearing civil discontent if fuel prices jumped.
In the current high oil price environment, the government is paying roughly half the cost of every litre of petrol and diesel.
In addition, a significant proportion of the fuel subsidised is then smuggled into neighbouring states where fuel prices are higher. Part of the resistance to higher fuel prices in Nigeria is a cultural feeling that it should be relatively cheap given that the country is a substantial oil producer.
Lack of hard currency
This would be easier to understand if it were not for the fact that Nigeria imports most of the refined petroleum products that it consumes because of inactive domestic refining capacity.
The country’s fuel import bill varies in line with oil prices but can be as high as $9bn a year, which has to be paid for in hard currency. Abuja’s total budget for the current financial year is $39.4bn.
The lack of forex in recent years has had huge implications for the economy, with the CBN forced to intervene to protect precious reserves and resulting in a 255% depreciation of the naira against the US dollar over the past decade, including three devaluations since the outbreak of the Covid pandemic.
The naira fell to a record low of about 600 against the US dollar on the black market in May, while the exchange rate premium in the parallel market stands at 35-40%.
Insufficient foreign currency is affecting companies in all sectors, while foreign currency deposits account for about 20% of total bank deposits, providing hedging against a weaker naira, so it is vital that this buffer is protected. The CBN regulates the use of forex by the country’s banks and as well as successfully cracking down on fraud, in the past it has closed down banks that it has found to be pursuing illegal forex practices.
Yet help could be at hand with the expected completion of the massive Dangote oil refinery at the port of Lekki this year.
It has a production capacity of 650,000 b/d, compared to the total 428,750 b/d nameplate capacity of the country’s existing four refineries, that are generally either out of operation or functioning at reduced capacity.
The Dangote plant will be the biggest single train refinery in the world. As well as providing much-needed employment, being an anchor tenant for the country’s first deepwater port and hopefully, a reliable supply source for refined petroleum products, it will save the economy a huge amount of foreign currency, with big benefits for the wider financial system.
The CBN has required banks to achieve a loan to deposit ratio of 65% since March 2020 to boost lending levels. There is some evidence to suggest that the sector is indeed becoming more effective in lending to companies, with the level of outstanding credit to the private sector reaching N38trn this May, its highest-ever figure, N6trn up on the figure for the same month last year.
The credit ratings agency, Fitch, warned in late May that the operating environment of Nigerian banks could deteriorate in 2022-23 as adverse global economic conditions feed through to the local economy, and it expects the CBN to further increase interest rates, given accelerating inflation.
However, it does not expect Nigeria’s banking sector to experience a material shock and it calculated in July that Nigerian banks can absorb up to $6bn of credit losses without breaching the minimum Capital Adequacy Ratio requirements of 15% for banks with international authorisation, and 10% for all other banks.
Until the economy can be rebalanced to achieve much higher sustained levels of growth, the country will remain vulnerable to both domestic and external shocks, and the retail and corporate customer bases available for the country’s banks will remain limited.