Fiscal Reckoning Is Here, Prepare For $30 Oil -By Bámidélé Adémólá-Olátéjú

What does this mean for Nigeria? The drop in oil prices is expected by many analysts to have a prolonged permanent component. Given this scenario, Nigeria will need to make tremendous fiscal adjustments on how the country is run. In addition to declining oil receipts, we must be cognisant that we have no buffers. This means we face fiscal vulnerabilities that require a flexible exchange rate regime to facilitate adjustment. Our monetary policy response will have to be tailored to fit expected inflation rates, domestic cyclicals and external pressures.

The only thing Nigeria has to show for years of high oil prices is that it became a monument of corruption. There are no infrastructure to show, no significant build up in Foreign Reserve or the Sovereign Wealth Fund, no investment in human resources, no improvement in education and health. Nothing was done except grand stealing and conversion of public funds. Well, our day of fiscal reckoning is here. It is time to pay for our recklessness, planlessness, and lack of foresight. We are seeing a historic fall in the price of oil, more than we saw in the late 1980s. Oil prices is down more than 50 percent in less than a year. Oil prices went below $38 per barrel on Monday before it settled above $38 again. The implication is that oil prices will face turbulent headwinds for longer. It means lower prices will be more sustained during this period than we witnessed in the late 1980s. Two years ago in this column, I wrote that $70 oil is Nigeria’s destiny, it was inconceivable then because oil was at $110 per barrel. We ramped up our bad ways and stole more, instead of investing in the future. Unfortunately things will get worse, we are seeing a perfect storm of devastating proportions.

Traveling through the Canadian Ontario province by road a few months back, I could understand why there is a glut in the global supply of oil. From the early 2000s, oil prices shot up. Many industrialised nations had no choice but to invest vast amounts of money in finding alternative sources of energy. On my way, I saw vast wind and solar farms, biofuel and shale production concerns. Billions of dollars were poured into these investments and they are beginning to yield. Investment in alternative sources of energy are long term investments. They are guaranteed to keep supply flowing for years to come. Saudi Arabia, the swing supplier of oil with extra production capacity has refused to cut supplies despite pressure from OPEC member countries. They have flooded the market with oil for three reasons. One, they don’t want to lose sales to other producers. Two, Saudi’s main aim is to put American producers of shale oil out of business, and squeeze Iran and Russia until they get to breaking point. So far, the strategy has not worked. American shale oil producers continue to weather the storm and stay afloat. Iran is pumping more and may get a new lease of life after the relaxation of sanctions. Russia is feeling the heat but has not buckled yet. The last time oil fell, it caused the breakup of the Soviet Union; will this make Russia bow out of the Ukrainian border? Three, the Saudis worry that high prices will blunt the future demand for oil. Still on the supply side, America has become a net exporter of crude because of its investment in shale-oil which has boosted its oil production significantly up to about 80 percent increase since 2006. Libya and Iraq are pumping more oil into the international markets and the anticipated return of Iran is another factor driving down prices.

There is no doubt that Nigeria will come under heavy financial strains, but with President Buhari at the helm, this could well be our best chance at formulating new macroprudential policy frameworks for Nigeria and the strengthening of our institutions. The plunging oil prices underscores the need for real and financial sector reforms to foster diversification of oil Nigeria’s economy. Brace up!

On the demand side, oil demand is price inelastic according to economists. What this means is that slight changes in supply and demand can produce wide variations in price. Why are we seeing these low prices? The answer is this: People and businesses consume fuel. If oil supply is tight, we still need fuel to drive our cars and do other things that consume fuel and we will pay any amount specified at the pump to get it. If the supply of oil is surplus, we don’t need much more fuel that we are buying, therefore, we will have to be incentivised more by way of huge price discounts before we can buy more. This is what is happening in the world oil market. Supply and demand have unexpectedly expanded the global surplus, thus reducing prices. In addition, the worlds largest consumers of fossil fuel have developed betters cars that are using less gasoline per kilometre, efficient hybrids, and cars that runs on ethanol. Weaker than predicted global economic growth has also depressed demand, especially in China. 93 million barrels is produced per day throughout the world, with the capacity for two million barrels more.

What does this mean for Nigeria? The drop in oil prices is expected by many analysts to have a prolonged permanent component. Given this scenario, Nigeria will need to make tremendous fiscal adjustments on how the country is run. In addition to declining oil receipts, we must be cognisant that we have no buffers. This means we face fiscal vulnerabilities that require a flexible exchange rate regime to facilitate adjustment. Our monetary policy response will have to be tailored to fit expected inflation rates, domestic cyclicals and external pressures. There is no doubt that Nigeria will come under heavy financial strains, but with President Buhari at the helm, this could well be our best chance at formulating new macroprudential policy frameworks for Nigeria and the strengthening of our institutions. The plunging oil prices underscores the need for real and financial sector reforms to foster diversification of oil Nigeria’s economy. Brace up!

Bámidélé Adémólá-Olátéjú maintains a weekly column on Politics and Socioeconomic issues every Tuesday. She is a member of Premium Times’ Editorial Board. Twitter @olufunmilayo