The new oil normal

In the past few months, the plunge of oil prices has escalated. The trend is secular by nature. The good old complacent days are over in the energy-producer economies.

In mid-summer 2008, only weeks before the onset of the global crisis, the oil price hovered close to $150 per barrel and Goldman Sachs predicted it would exceed $200 by the year-end. In reality, it plunged to around $45.

With stimulus packages and recovery policies, the crude Brent price returned to almost $130 by early 2011. In the subsequent two years, it gradually fell to $110 in 2013. And in the past year, it has plunged again, to $57 recently.

These are drastic shifts. What is driving them? And what does the outcome mean to Nigeria?

The rise and decline of oil prices

In October, Nigeria assumed an oil price of $78 per barrel for its 2015 budget, up from $77.5 in 2014. In reality, the prices were in for a drastic year-end plunge.

Until recently, more than 40 percent of Nigeria’s crude oil and condensate exports went to Europe, 18 percent to the US and 25 percent to India, Brazil and China. In turn, almost 40 percent of liquefied natural gas (LNG) exports went to Europe, 24 percent to Japan, 9 percent to South Korea, and 7 percent to India.

Since the 1970s, the United States has been Nigeria’s greatest importer of oil. Even in 2010, a million barrels were delivered on a daily basis to North American refineries. However, as the gradual decrease of the oil price suggests, US energy boom began to drive prices down in the early 2010s and by mid-2014 oil imports from Nigeria plunged to zero.

As energy continues to account for most Nigerian exports and the industrial structure remains characterized by low diversification, rapid demand shifts can have a significant impact – as evidenced by the economic and political repercussions of the 2012 fuel subsidy debacle.

Since the drastic expansion of US oil production has made Nigerian crude imports obsolete in America, it was only natural that Lagos would seek new alternatives in Asia, especially in India, Indonesia and China. The problem is that Nigeria is no longer alone in courting the large emerging powers.

Strategic readjustment in OPEC

Recently, China has overtaken the United States as the world’s biggest importer of oil. By the early 2010s, half of China’s imported oil came from the Persian Gulf, whereas America’s reliance on Middle Eastern crude was shrinking.

As Nigeria hopes to secure a larger presence in Asia, the energy producers’ rivalry for market share came fully out in the open in the recent Organization of the Petroleum Exporting Countries (OPEC) summit.

In early November, Venezuela’s foreign minister asked to meet Saudi oil minister Ali al-Naimi. Since Riyadh produces almost as much oil as Iraq, Iran, Kuwait, United Arab Emirates and Venezuela together, Caracas pleaded the Saudis to cut oil production and strengthen markets. Nevertheless, Naimi made it clear that Saudi Arabia would not cut production on its own.

When OPEC failed to reach an agreement in Vienna later in November, oil prices took still another tumble. As crude prices fell to their lowest level in five years in early December, investors concluded that the world economy was about to face another challenging year and the Dow Jones Industrial (DJIA) suffered a 316 point loss to 17,281.

Meanwhile, Nigeria has lost its oil markets not just in the US but in Europe. As Lagos began to push oil shipments toward China, Saudi Arabia cut its official crude price in Asia by $1 per barrel, while Iran and Kuwait followed in the footprints.

Naturally, industry observers urged Nigeria to find new customers for its light, sweet crude streams in Asia. But that was easier said than done. MENA energy producers have made it challenging to Nigeria – and other non-North American energy exporters, such as Colombia – to build long-term relationships with Asian refinery buyers.

The trend is secular

Some observers argue that the energy slowdown is really a showdown between Washington and Riyadh. Nevertheless, the underlying drivers of price declines are more complicated. They involve much more than the energy revolution in the US.

The descending prices are driven by the gradual decline of demand in China, which is now rebalancing from its most energy-intensive stage toward greater productivity and efficiency. Meanwhile, several Asian currencies have been softening against the rising US dollar. The plunge of the prices has also been fuelled by rising costs of gas in several Asian economies that have been phasing out fuel subsidies.

In contrast to the expected decline of oil production in Iraq, both Baghdad and the Islamic State (IS) have sought to sustain oil output to cover their respective military expenditures, while Libya has re-opened its oil export terminals. Moreover, Washington has given permission for oil exports, which has promoted US production as well.

The ongoing strategic readjustment will have a substantial impact on both energy producers and importers. While the latter will benefit from the decline of oil price, which will support higher growth and lower inflation, producers must cope with the new normal.

If the new consensus is that oil prices will test the floor in the first half of 2015, the anticipation is that the prices will stabilize in the second half at about $80-$85. However, if Saudi Arabia will continue to avoid production reductions, prices could well stay in the sub-$70 per barrel territory for longer than anticipated.

Coping with the new normal

Those producer countries that allow foreign exchange adjustment (e.g., Russia, Mexico and Colombia) cannot avoid worsening trade and fiscal balances, even if the adverse impact is lower relative to many of their peers.

In turn, producer countries that have substantial external debt, such as Russia and Nigeria, cannot avoid penalization either. Similarly, devaluation pressures are likely to be elevated in the coming months in those producer economies, including Nigeria and Venezuela, which have quasi-pegs.

Finally, all energy producers that remain reliant on singular resources and have failed to use their energy revenues to diversify the industrial structure over time must now seek to do so in far more challenging conditions – as evidenced by the economic agony of Russia, which is struggling amidst sanctions.

Unfortunately, Nigeria will not be an exception to the rule. Nevertheless, this crisis should not be seen simply as a challenge. It is also a potential asset.

All economies must cope with crises occasionally. But it is the winners that can turn their adverse challenges into an opportunity for greater diversification.

Dan Steinbock