Managing Risks to Nigeria’s Economy from Russia-Ukraine War

Postscript by Waziri Adio

Nigeria’s economy, ordinarily, should secure more benefits than losses from the ongoing war in Ukraine. Based on current realities, the chances of this happening are slim. If the war and the attendant sanctions on Russia linger, Nigeria’s economy may actually slip into a more desperate state. The country may earn little or no windfall from the ongoing spike in the prices of oil and gas; and the expected boosts to budgets, savings, foreign reserves, and the national currency may not materialise. Meanwhile, the expected losses from the war/sanctions are already manifesting. People are taking the hit in their pockets. Prices of food and other basic items are soaring and are likely to fly higher with the dramatic increase in commodity prices. All of these are likely to have negative implications for unemployment and poverty, which are already sky high, and economic growth, which though now positive is still fragile. Government needs to anticipate and manage the looming risks, especially to the most vulnerable.

Nigeria has walked with two eyes open into another avoidable bind. An oil-producing country shouldn’t be in such an obvious risk at a time of record-high oil prices. Apart from those under sanctions, hardly is any other leading oil producer in such a terrible spot. Brent crude briefly touched $139 per barrel on Monday, the highest price since 2008. That same day, the price dropped to $130 per barrel and kept falling. As at Friday, Brent crude was trading at $110 per barrel, which is still $48 or 77% higher than Nigeria’s budget benchmark price of $62 per barrel. With this, Nigeria should be facing a bright, not a grim, prospect. And the conversation should be on how not to waste the windfall this time or at least about how to use part of the boon to cushion the likely negative economic effects of the war and the sanctions on the poor. Alas, that is not where we are.

So how did we get to this confounding pass?

For many reasons, most of which are self-inflicted, we are not in a good position to benefit optimally from the current hike in petroleum prices. The first reason is that our oil production has declined precipitously over time. We have moved from producing an average of 2.51 million barrels per day in 2005 to an average of 1.31 million barrels per day in December 2021. In 16 years, we experienced an almost 50% reduction in production, and the culprit is not OPEC+’s decision to curtail global oil supply. It is largely due to aging infrastructure, underinvestment, incessant vandalism, fiscal uncertainties, policy flip-flops, and industrial-scale theft of crude oil. Nigeria cannot even meet its current OPEC quota of 1.72 million barrels per day. Anyone talking of Nigeria having spare capacity now is just sounding off.

The second issue is that based on the changing structure of oil production in Nigeria, the Federation gets lower proportion of the oil produced. From getting 56% of the 828 million barrels produced in 2000, the Federation now gets less than 30% of an average of about 1.4 million barrels per day. According NNPC’s most current monthly report, the one for August 2021, the Federation lifted 192m barrels out of the total 682 million barrels for the period between July 2020 and July 2021. That’s 28.2% as Federation’share. It is important to note that while total production between the two years reduced by about a fifth, the proportion of the total production lifted by the Federation shrank by half.

The major reason for this dramatic reduction of Federation’s share of oil is that production shifted away from Joint Ventures (which give government more oil) to Production Sharing Contracts (PSCs) and other production arrangements which are more favourable to the companies. According to a 2019 analysis by the Nigeria Extractive Industries Transparency Initiative (NEITI), production from JVs tumbled from 97% to 32% of total oil production between 1998 and 2018. Overtime, the oil companies moved upstream to take advantage of more generous terms and to avoid the challenges from vandalism, community issues, crude theft and unpaid JV cash calls.

The third major development is the gradual but now consequential change in how we allocate the portion of oil that goes to the country. Federation’s entitlement is usually broken into two: federation oil export and domestic allocation. In 2000, the oil due to the Federation was 465 million barrels, out of which 36 million barrels and 429 million barrels were allocated as domestic supply and federation export respectively. But the allocation formula changed dramatically in 2005 when out of a total of 456.4 million barrels of Federation’s entitlement, 160.9 million barrels were allocated for domestic supply and 295.5 million barrels for federation export. This means that allocation for domestic consumption moved from a mere 7% of Federation’s entitlement in 2000 to 35% in 2005.

The proportion of Federation’s oil that goes to domestic consumption—officially called Domestic Crude Allocation (DCA)—kept leaping. This is because of the decision to keep allocating 445, 000 barrels per day to NNPC for domestic use despite the well-known state of its four refineries and despite that both total production and Federation’s share keep shrinking as stated earlier. Now with daily production averaging about 1.4 million barrels and government’s take falling below 30%, the picture is more dire. Currently, NNPC doesn’t receive 445, 000 barrels per day because total Federation entitlement sometimes doesn’t even amount to that. But because the national oil company has become the sole supplier of petrol, almost all of Federation’s oil now goes the Direct Sale Direct Purchase (DSDP) arrangement.

And this is where it gets really interesting. The national oil company is required to pay for the full value of the oil allocated to it but it is allowed to deduct costs upfront. It pays in Naira, not dollars, and mostly at a different exchange rate. By the time NNPC deducts costs of subsidy (sometimes called under-recovery or value shortfall recovery) and subtracts amounts for crude losses, pipeline repairs and maintenance, and sometimes fund for strategic projects, there is hardly any money left. In its February 2022 report to FAAC, the national oil company said the total value of domestic crude and gas revenue for January 2022 was N253.4 billion while the PMS (petrol) value shortfall recovery was N210.3 billion. So, subsidy alone wiped out 83% of value for domestic crude and gas revenue. The N3 trillion estimated for subsidy for 2022 was not based on the current price of crude oil. If crude stays above $100 per barrel, and it is likely to, subsidy will go north too, and may either equal or even surpass government’s total revenue from the oil and gas sector.

As stated earlier, NNPC pays for the value of the crude that it receives for domestic consumption in Naira. This can be justified since NNPC sells the petrol in Naira. But a major problem here is that Nigeria doesn’t earn corresponding foreign exchange from the bulk of the oil that still accounts for more than 80% of its exports. Note that through the DSDP, the national oil company basically tells the oil traders to give it petrol for the value of the crude they receive from it. While this arrangement ensures that petrol is available most times and at a subsidised price, it affects dollar inflows to Nigeria.

In January 2008, 69.4% of the dollar inflows that came through the CBN came from the oil sector. In September 2021, only 7% of the dollar inflow through CBN came from the same sector. While it is true that oil production in January 2008 was 2.1 million barrels per day against about 1.4 million per day in September 2021 and that oil price was $92 and $74 per barrels respectively, the difference in volume and price does not fully explain why oil inflow through CBN fell from $3.45 billion in January 2008 to $569.75 million in September 2021. You can plot a line from the commencement of DSDP to the dramatically reduced dollar inflow from oil, irrespective of oil price. So, if you are looking for why the central bank is rationing dollars and your bank is limiting your monthly limit on your Naira card to $20 at a time of rising oil prices, now you have an answer.

In sum, potential increase in the ever-expanding subsidy, low or no spare production capacity, shrinking share of dwindling oil production, and decreasing dollar inflows are likely to stand between us and reaping corresponding benefits from the current oil shock which actually predated the war in Ukraine. Even if we are able to capture some benefits from the war and the sanctions, especially from the gas subsector, there is no guarantee that the benefits will immediately impact the mass of our people. However, most people, especially the vulnerable, are already feeling the pinch. To start with, we import a lot of things, including food items and intermediate goods. Higher energy costs and higher inflation in Western countries will pass through and affect prices here.

Second, we get substantial supply of some items from Russia and Ukraine, and both the war and the sanctions will constrain supply of these items and push up prices. For example, we rely on Russia for 26% and on Ukraine for 4% of our wheat imports. In 2019, we expended $1.48 billion on importing wheat, our third highest import. Price of wheat has increased by more than 60% in the last few months, and this has impacted the price of flour, and ultimately will touch the price or size of bread, a staple in many homes. The supply and price of fertiliser and cooking oil are likely to be impacted too because both Russia and Belarus are leading exporters of ammonia and Ukraine is the leading exporter of sunflower oil. The price of diesel has hit the roof, with grim implication for household and industries, especially at a time of erratic power supply. Both the IMF and The Economist have projected increased hunger and even possible unrests in Africa and the Middle East because of the war and the sanctions.

Third, there is likelihood of increased pressure on the Naira, as we need to find 50% to 100% more dollars to import wheat and other critical items. The CBN has rolled out an intervention to increase local production of wheat. Even if this works out, it won’t mature in time to take care of this immediate shock. The forex rationing is on already. It is reasonable to expect more.

Our economy is already in a hard place. Current hike in oil price may further constrain, rather than expand, the room for manoeuvre. But we have to manoeuvre, and quickly too. Government needs to swing into action, anticipating and responding to how our already pressed people are likely to take the hit. It is important to consider measures that can bring down food prices such as releasing grains from our reserves and removing tariffs and restrictions. That will be lost revenue for government but it will bring some ease to the populace. Having robust savings could have strengthened the hands of government to undertake other measures. Unfortunately, that window is not open. When the global meltdown hit in 2009, Nigeria had $20 billion in Excess Crude Account. As at January 17, 2022, the balance in ECA was $35.8 million.

Given that options are limited and the impacts will be immediate, Nigeria should rally other African countries to seek support or concessions from Western countries and multi-lateral institutions. We should also lead advocacy for the war to end because though it is not our war, we are on the economic frontlines, and we don’t have the flexibility that others have. But once the dust settles, we need to restart frank discussions not just about savings, perverse incentives, food and energy security, deregulation and subsidy removal but also about how we have done an awful job in managing our petroleum sector and what we can still salvage as we prepare for energy transition. Time is of essence on all fronts.