Petroleum Pulls the Purse Strings: Implications of Low Oil Prices for the Nigerian Economy

The price of oil, the commodity that more than any other determines the fortunes of Nigeria, has fallen over 50 percent since June 2014. The country’s 37 billion barrels of oil reserves are now significantly less valuable than before. Previous slumps in prices have spelt disaster for Nigeria and other oil-dependent countries, leading to depleted government coffers, painful fiscal cuts and reduced economic growth. What will be the impact for Nigerians this time around?

To answer this question, a group of Nigeria’s foremost economists and experts on oil governance recently met in Lagos to discuss the impact of low prices for the economy, and the consequences for the new government. The group included members of the expert panel of the Nigeria Natural Resource Charter (NNRC), an independent, multidisciplinary advisory group, as well as representatives from the government and private sector. In their discussions, the panel members drew on the findings of the 2014 NNRC Benchmarking Report, which scored the government’s performance in managing the oil sector between 2012 and 2014.

Nigeria has experienced at least five serious oil price shocks in its history, including a drop in 2008 that looked not too different from what occurred in mid-2014. After the last drop in 2008, prices soon rebounded and then rose to historically high levels. This time around, experts from the World Bank and elsewhere believe the current price drop may last much longer, and suggest that a more appropriate analogy is the decline in the late 1980s, after which prices stalled below 1985 levels for another 20 years. If these pundits are correct, the consequences for Nigeria could be drastic.

The biggest and most immediate impact of low prices is lower export earnings. Assuming similar production levels, oil exporters are only receiving just over half (54 percent) of what they were in 2013. Nigeria’s foreign exchange reserves, derived almost entirely from the export of crude oil, have plummeted by 13 percent in only three months. In a bid to defend the Nigerian naira, the Central Bank devalued the currency twice within two months, and has replaced the Dutch auction system with a pegged official exchange rate of NGN198 to the US dollar. This has been bad news for consumers, who of course must pay for imported food and other goods in naira.

While Nigeria’s economy has somewhat diversified, with the oil sector’s contribution to GDP declining at the same time as other sectors’ have grown, the government’s income is not diversified, with proceeds from oil still accounting for two-thirds of total government revenue. This means that the drop in prices is hitting government accounts hard; oil revenues allocated by Federal Accounts Allocation Committee (FAAC) to the federal government between July 2014 and January this year fell by 28 percent from the year before.

So, given these challenges, how is the government responding?

The Excess Crude Account (ECA), the country’s stabilization fund, was meant to help in exactly this kind of price-drop scenario. However the fund was largely depleted during the last oil price drop in 2008 and 2009. Since then, the little revenue the government did manage to save was quickly spent, despite the record high oil prices. In 2012, the balance of the ECA stood at $11.5 billion (NGN1.7 trillion); by January 2015, it was a mere $2.4 billion (NGN372 billion). This makes for a significant constraint on government response to the latest price fall and points to the poor management of the ECA. More prudent countries are not in the same situation. Having saved during years of plenty, countries such as United Arab Emirates, Norway, Saudi Arabia and Algeria have been able to draw from their oil savings to avoid harmful spending cuts.

With a near-empty ECA making it tough to maintain spending, the government will face increasing pressure to borrow. However, this policy lever may not be available to the government. Federal government debt already rose by NGN10.4 trillion to NGN11.24 trillion in the first two months of this year. While public debt is still relatively low at 12 percent of GDP, but lower oil revenues mean the government has less fiscal ability to pay back these loans. Debt servicing is already expected to rise to 26 percent of the government’s 2015 budget. Further, at the subnational level, states have been borrowing heavily, recently prompting the minister of state for finance to call the domestic debt profile of some states “scary.” The combined domestic debts of subnational governments, estimated at NGN1.471 trillion in 2013, will likely rise during this ongoing crisis.

Are there opportunities for reform? Without the ECA or borrowing to fall back on, the new government of President-elect Muhammadu Buhari may be forced to reduce spending and embrace prudence. Recent spending behavior does not suggest that the outgoing government spent wisely. Recurrent expenditure of the federal government has been rising in recent years and remains far above capital spending. As the NNRC 2014 Benchmarking Report notes, this “indicates that the government prioritizes short-term agendas over long-term development aims.” The new government should, therefore, begin by reducing spending on payrolls and overheads, including the costly allowances provided to members of the National Assembly. Another immediate opportunity presented by the low oil price is to re-evaluate fuel subsidies, which accounted for 1.5 percent of GDP last year.

The new government will also have to better manage the oil sector. The NNRC benchmarking report found that there was only a marginal improvement in the management of the oil sector between 2012 and 2014, and governance actually worsened in some areas. The corruption and mismanagement of the past years are too costly to continue during these tighter fiscal times.

The oil sector can be a source of wealth or sieve through which Nigeria’s bounty can drain away. The Nigerian National Petroleum Corporation (NNPC) is one high-risk hole in that sieve. Enhancing the governance of NNPC and the management of cash flows to the government treasury can help reduce the significant budget pressures facing the government. One component of ensuring efficient management of the sector is introducing greater accountability in the actions of the government. Initiatives such as the Nigerian Extractive Industries Transparency Initiative (NEITI) are introducing greater transparency in the sector and allowing citizens to hold the government to account.

If the new government is to stand a chance at putting public finances back in order, it must start by reforming the oil sector.

Akpan Ekpo is a professor of economics and a member of the NNRC expert panel. Dauda Garuba is the Natural Resource Governance Institute (NRGI)’s Nigeria officer and co-ordinator of the NNRC. Max George-Wagner is a governance associate at NRGI.

This article is adapted from one originally printed in Nigeria’s Tell magazine on 11 May 2015 under the headline “Nigeria’s Low Oil Prices.”