It was in April last year when oil prices hit multi-year lows, the price of Brent crude dipping down to US$19.33/bbl late in the month and West Texas Light hitting negative US$37.63/bbl for a day as stocks rose and storage capacity became scarce. Then the United States convened a meeting of oil producers, the Organization of the Petroleum Exporting Countries and its ally Russia agreed production cuts, and prices slowly recovered, with a steady and positive trend building up from early November onwards. Although oil & gas accounts for less than 10% of the Nigerian economy, its role in providing exports, foreign exchange and contributions to the government budget are well understood. Does the current strength of oil mean that public finances are rebounding? We give our answers below..
Last week the exchange rate in the Investors and Exporters Window (I&E Window) strengthen by 0.17% to close at N409.30/US$1. In the parallel, or street market, the Naira closed flat, at N485.00/US$1. After the most recent (23 March) Monetary Policy Committee (MPC) meeting of the Central Bank of Nigeria, CBN Governor, Godwin Emefiele stated: “The CBN’s job is to moderate the market in line with where we think the exchange rate should be.” In our view he can be confident in this regard as the level of CBN gross foreign exchange reserves has been trending up recently, reaching US$34.8bn at the end of last week (the data reflects a one-month moving average). However, liquidity in the official FX markets still remains low in comparison with the period before March 2020, and therefore we think that the pressure on the exchange rate is likely to continue and the difference between the current I&E Window rate and the parallel market rate is likely to persist.
Bonds & T-bills
Last week, the secondary market yield for an FGN Naira bond with 10 years to maturity increased by 23bps to 10.95%, the 7-year bond yield increased by 11bps to 10.61%, and the 3-year bond yield went up by 2bps to 7.53%. Due to the Nigerian Treasury Bill (T-bill) primary market auction last Wednesday the week was characterised by quiet trading activity in the FGN bond secondary market. Selling interest was still keen at the long end of the curve, however.
In the secondary markets the annualised yield on a 329-day T-bill fell by 1bp to 6.64% in the secondary market while the yield on a 334-day OMO bill rose by 2bps to 8.08%. At the T-bill auction, the DMO sold N138.72bn (US$338.34m) worth of notes against N95.68bn(US$233.37m) offered. The 364-day notes were over-subscribed by +179.72% while the 91-day notes and 182-day notes were undersubscribed by -5.80% and -27.61%, respectively. Save for the long-tenor paper, rates were nearly unchanged. The 91-day, 182-day & 364-day notes were allotted at 2.00%, 3.50%, & 8.00% stop rates, respectively. The Central Bank’s OMO auction stop rates also remained unchanged as the 89-day, 180-day & 362-day notes were allotted at 7.00%, 8.50% & 10.10% respectively.
We still believe that 1-year T-bill rates are set to continue in their upward trajectory towards yields of 10.0% or more by mid-year.
The price of Brent crude rose by 0.45% last week, closing at US$64.86/bbl, a 25.21% increase year-to-date. The average price to year-to-date is US$61.37/bbl, 42.02% higher than the average of US$43.22/bbl during 2020. Last week, oil prices rose despite the decision of the Organization of the Petroleum Exporting Countries (OPEC) to increase oil production over the next few months following its meeting on 1 April. Rather than a bearish move, investors interpreted the decision as a vote of confidence in demand. Oil also found some support after US President Joe Biden outlined a US$2.3tn infrastructure spending plan. However, we believe that although oil prices are likely to remain above the US$60.00/bbl mark, there may be unsteadiness in oil prices as a result of the European lockdowns, which in turn are due to the slow vaccine rollout, and a spike of cases in India, both of which continue to weigh on the global economic outlook.
The Nigerian Stock Exchange All-Share Index (NSE-ASI) fell by 0.96% last week with a loss of 3.36% year-to-date. Guinness Nigeria (+19.67%), Fidelity Bank (+11.21%), and Sterling Bank (+9.47%) closed positive last week, while GT Bank (-5.07%), FCMB Group (-5.03%), and Honeywell Flour Mills (-4.84%) closed negative. Only 6 sub-indices closed higher in the week, with the insurance sub-index gaining 2.82%, the highest performing sub-index over the week. We do not feature our Model Equity Portfolio this week but will resume next week.
Oil prices to the rescue?
By any yardstick, oil prices and production are important to Nigeria. It is not the case that the oil & gas industry is the largest industry in the country, because it accounts for less than 10% of GDP. Rather, it is the fact that the bulk of exports are oil & gas; oil & gas provides the most reliable source of foreign exchange inflows; and the industry provides (in a good year) the Federal Government with over 60% of its budget revenues. Looking at oil prices comes second only to looking at the exchange rate in any checklist of Nigeria’s economic health.
To figure out exactly what level of foreign exchange inflows are associated with a given level of oil production and crude prices is difficult (we have tried). There are many variables, including the sell-forward factor (crude oil is sold three to six months forward), the oil-for-product swap factor, the premium of Nigerian blends over the price of Brent crude, and the fact that gas sales are made at contracted prices rather than at commodity prices.
However, over a long period of study (e.g. 10 years) it is possible to establish some rules of thumb. Oil prices below US$50.00/bbl, if sustained, are associated with weak public finances and can lead to periods during which the gross foreign exchange reserves of the Central Bank of Nigeria (CBN) trend under US$30.00bn, and this benchmark itself can be associated with Naira devaluations (as in 2016, for example). So, in our view, the CBN likely heaved a sigh of relief when it first protected its reserve position during 2020 (the low point was US$33.43bn) even though average oil prices were US$43.22/bbl during the year, and then saw oil prices rise towards the end of the year and in early 2021.
So, does the rise in crude oil prices make things better? The answer is ‘partly’. One negative factor is the fall in production levels during 2020. When OPEC and its ally Russia (hence OPEC+) agreed to cut production levels in order to support prices a year ago, Nigeria was obliged to make its own production cuts. So, production averaged 1.88 million barrels per day (mbpd) in 2019 but fell to 1.66mbpd in 2020. It has not fully recovered, as the data for March 2021 shows 1.58mbpd. If we create a very simple index of oil economic strength (output times spot crude prices) we would find ourselves in a similar position to January 2020, which is by no means bad.
However, in January 2020 (and again in February) Nigeria was able to sell over US$1.0bn worth of Naira-denominated fixed income securities to foreign portfolio investors so that foreign portfolio investment (FPI) continued (as it had done for many years) to be a support for the overall foreign exchange position of the CBN. Needless to say, these investments slowed considerably in March 2020 with the onset of the Covid-19 pandemic and the crash in oil prices. It is as moot point whether – now that crude oil prices are up again – FPI will return in significant volume to provide short-term (under one year) funding and bolster the FX reserves of the CBN. Our sense is that this trade (the so-called carry trade) may take quite a while to be restored. So Nigeria’s ability to leverage off its oil revenues has been reduced, at least for the time being.
Therefore, crude oil prices have not fully restored the oil-related financing (inflows from oil & gas sales and debt issues) that we saw during a year like 2019, for example. Nevertheless, the return to oil prices comfortably above US$50.00/bbl brings a level of security that, in our view, allows the CBN tackle the two issues that regularly fill these pages and which are the key policy areas right now: inflation and interest rates.
Nota bene: The Coronation Research Model Equity Portfolio is an expression of opinion about Nigerian equities and does not represent an actual portfolio of stocks (though market liquidity is respected and notional commissions are paid). It does not constitute advice to buy or sell securities. Its contents are confidential to Coronation Research up until publication. This note should be read as an integral part of the disclaimer that appears at the end of this publication.