How FG arrived at $73 per barrel benchmark price for crude oil
The Federal Government through the minister of Finance and the Co-ordinating Minister for the Economy, Ngozi Okonjo-Iweala, announced last Sunday, some measures to insulate the economy from the oil price slump.
A key measure announced was a cut of the 2015 oil benchmark price from $78 to $73 per barrel. BusinessDay investigations reveal that this measure was not reached in a haphazard or rushed manner, but based on statistical analysis – an Autoregressive Integrated Moving Average (ARIMA) model, and carried out over several months.
The new benchmark price is based on the findings of the 2015-2017 Medium Term Expenditure Framework (MTEF) and Fiscal Strategy Paper , which was published in September this year.
It was stated in the paper, “We estimate the benchmark oil price to be $73.28pb based on the 15-year moving average, while the 10-year moving average gives a price of $92.34pb.”
The 15-year moving average captures the beginning of the commodity super cycle, and covers the boom and bust cycle of the period. It also smoothes out short-term fluctuations and highlights longer term trends.
On the future trend of oil prices, the paper alludes to a paradigm shift, stating, “there are indications that the spikes in oil prices witnessed in recent years are likely to ease following [the] increase in global oil supply.”
It is estimated that crude oil production in the US would average 9.3 million barrels per day (mbpd) in 2015 — its highest level since 1972.
The paper however points out that a sharp drop is unlikely but moderation from current level is a high possibility; implying a further decrease in oil prices.
The price of oil has dropped by 28 per cent from June, spurred by stagnant global economic growth, slow growth in oil demand, and increasing oil supplies from shale oil in the US, record oil production in Russia, and the resumption of production in oil producing countries plagued by unrest.
According to the paper, the price forecast is “premised on the increase in the exploitation of shale oil, as well as improved Iranian oil supply and the potential resolution of political crisis in some major oil producing countries like Libya.”
Adding to this, is the spill over effect of the Russia-Ukraine geopolitical risks, lowering trade activities – the EU accounts for over 40 percent of Nigeria’s export. Additionally, the slowdown in growth in countries like Brazil and China is expected to have an impact on demand.
This paradigm shift would pose dual risks to the economy – risk to oil price as well as the demand for our crude oil, says the paper.
WTI Crude dipped below $75/b earlier last week – the lowest in four years; and Brent Crude is trading $79, rising from $77/b on Monday.
The Bonny Light Crude is currently at $79.
Nigeria is expected to produce 2.27 million bpd next year, generating revenue of N6.8 trillion, Okonjo-Iweala said at the press conference.
This year’s budget was based on output of 2.39 million bpd at a benchmark price of $78. Actual production is at 2.27 million bpd.
Despite the 28 percent oil price decline from June 2014, energy analysts across the globe see the price of oil declining further to $65-$75 per barrel in the near term, before rebounding moderately.
“The sentiment is really bearish; $75 is the technical target,” Kyle Cooper, director of commodities research at IAF Advisors in Houston, said by phone to Bloomberg.
JPMorgan, on the other hand, in a report released last week, expects oil price to trend further down before hitting its bottom. “In the short term, we now expect OPEC to be unable to reach an agreement in its end-November meeting. Consequently, the prospect of oil inventories increasing substantially in excess of seasonal norms will likely pressure prices,” JPMorgan analysts David Martin and Upadhi Kabra said.
Without an agreement by the OPEC members on production cuts, Brent prices are expected to fall toward $70 per barrel in December, and could sink to $65 per barrel by early January, the analysts said.
Speaking on whether the $73 benchmark price is pragmatic, an energy analyst said, “There are two moves the Government can make. Tighten unproductive spending on estacodes and other wasteful recurrent spending, while at the same time there is an option for higher deficit financing (Through bond issuances) up to 3 percent of GDP, if oil prices fall below the benchmark for a significant period of time next year .”
Gregory Kronsten, Chief Economist at FBN Capital, explained the difficulty in the setting a lower benchmark price. “The FGN cannot cut the benchmark price too far because of the mountain of recurrent expenditure. Governments everywhere will trim this spending as a last resort because it often brings conflict with its employees who resist cuts in their wages and allowances”, he said in an emailed response to BusinessDay questions.
In 1986, oil price fell to about $8pb from over $30pb, from $20pb to $11pb in 1998 and from $147pb to $38pb in 2008. “These are some of the reasons why commodity-dependent countries are generally advised to be cautious in fixing the benchmark price for their products. It is instructive to learn from the experiences of Ghana and Zambia who experienced adverse commodity price shocks and have now turned to the IMF for bailout”, says the Paper.
The Medium-Term Expenditure Framework (MTEF) sets out government strategic policies, fiscal outlook and financial programme in the medium term, with a focus on improving revenue from non-oil sources; working down the recurrent-capital expenditure ratio so as to free up resources for infrastructure development; managing the debt profile; strengthening the investment climate; and promoting job creation as well as inclusive growth.
Yinka Abraham