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Write a critical analysis of the impact of economic recovery on the oil sector in Nigeria.

Research Question

Oil is one of the mainstays of the Nigerian Economy as revenues from oil dominate the exports as well as the fiscal revenues of the country.(International Monetary Fund, 2017).

The economic growth of Nigeria and the oil exports of the country are closely linked. Nigeria is one of the fastest growing economies in the African country and has showed tremendous growth performance in the last decade.(International Monetary Fund, 2017) It would be interesting to know the effect of the recent uncertainty in the global oil market and its impact on the economy of Nigeria and vice versa.

  • Justification of the research: The Nigerian economy has a very tricky relationship with the crude oil sector of the economy. If the oil prices in the global market are lower, it would imply that there will be availability of cheaper oil in the economy, which would lead to greater energy sufficiency. As the GDP grows, the energy requirement of the country will grow. The demand for domestic consumption of oil has increased drastically.(Oyedepo, 2012)Energy sufficiency is one of the key targets of the economic growth plan of the country in the near future. (Federal Republic of Nigeria, 2017). Energy efficiency can help increase the overall productivity of the Nigerian economy, especially the manufacturing sector, other exports like agricultural exports etc. This, in turn, will reduce the dependency of the economy on oil exports. If Nigeria seeks to achieve balanced economic growth, actions concerning the domestic market are important (The World Bank, 2007) However, in spite of such importance of oil in the domestic sector, the IMF has expressed concerns over the low oil revenues as one of the reason for the fall in economy. The shrinking of GDP in the last two years has been linked to the decline in the global crude oil prices. However, The Annual Statistical Bulletin of Organization of the Petroleum Exporting Countries, (2016) revealed that the total value of petroleum exports for Nigeria has been  falling since 2014. The same trend was observed for other OPEC countries too. However, the difference between other countries and Nigeria is that there is no limit  to the production of oil for Nigeria imposed by OPEC, which allows it to grow exports at will. (Organization of the Petroleum Exporting Countries, 2016)This indicates that the price of crude oil is an important factor other than just the total quantity of supply of oil. The price of a product may be affected by various factors, other than just the total aggregate market supply of a product.(Etele, 2015) This leads to the question whether there are factors in the economy of Nigeria that led to this decrease in the value of exports.  There are many factors such as exchange rate, supply of oil, domestic consumption of oil, prices of substitutes like shale oil etc. could affect the falling export values.(Ekmekcioglu, 2012) One such factor is the exchange rate.
  • Aim: This paper seeks to analyse if there is a signficant relationship between the Real Exchange Rate of a country and oil exports. As imports become cheaper, and domestic consumption rises, policies may raise the export prices. The research aims at assessing this tricky relationship between the Gross Domestic Product of Nigeria and the oil sector and whether there are endogenous factors in the Nigerian economy that may be affecting the export value of oil exports of Nigeria. (International Monetary Fund, 2017)

As the economy becomes less competitive, Real Exchange Rate rises. If the REER affects the GDP greatly, then there are factors within the economy that prices of exports which in turn affects the demand for exports and in turn, the total value of exports of oil.

Graph 1 Real Effective Rate of Exchange of Nigeria since 2000

Source: ( The World Bank, 2017) . Chart prepared by author.

If the REER affects the GDP greatly, then there are factors within the economy that prices of exports which in turn affects the demand for exports and in turn, the total value of exports of oil.  “Does the REER affect the Demand for Nigerian Crude Oil Exports significantly?” In order to answer this question better the link between the GDP and REER has been shown by testing the corelation and covariance of the two variables. Thus , the cause effect realtionship is meant to be established is GDP- REER - Demand for Nigerian Crude Oil Exports.

The research is limited to secondary data i.e data is collected from news articles, articles from journals, data banks and all other published sources of data. No primary data was collected. Data was collected from international databanks such as OPEC data, World Bank data and IMF Data Mapper. 

Nigeria is a member of the Oil Producing and Exporting Countries (OPEC) Group. However, despite being one of the oldest members of the group, the country is yet to place an upper limit or ‘cap’ to its oil production. The reason cited for this decision is that the production of the country is unreliable. (Natural Resource Governance Institute, 2016) . This allows the country to increase or decrease production at will.

The Effect of the economy on the sector: Oil is not just a majorly exported item but also one of the key sources of fiscal revenue in Nigeria. In order to keep revenues high, the country must keep production high. Thus, the oil sector must keep production high, even if the prices of exports keep going down.(Vaughan, 2017) In the recent times, the country has hit record production of oil.(Natural Resource Governance Institute, 2016)

Scope of the Research

If the glut of oil in the economy remains low, then the country will be forced to keep its costs of production and exchange rate down so that the final cost of oil will be lower.

Nigeria has been exempt from capping its oil production in spite of being a member of the OPEC. The excess supply of oil from Nigeria has been cited as a cause for the oil glut in the market and consequently, the historically low prices of oil. Hence, the country is increasingly coming under pressure to place a cap on its oil production.(Natural Resource Governance Institute, 2016)  If both the prices of oil remain low and the production is capped, then the country faces the possibility that the revenues from oil will slow down.In such as situation, the competitiveness of the country’s exports affect the prices of the crude oil produce which in turn , affects the demand of the crude oil produced in the country.

Table 1Key Economic Indicators for 2016

Source: (Organization of the Petroleum Exporting Countries, 2017)

Total GDP of Nigeria

400,571

Total Exports

34,704

Value of petroleum exports

27,788

Current account balance

2,722


As seen above, Oil exports form over 90% of exports of the economy and generate positive current account balance for the country. It is important to maintain the positive current account balance because as the current account balance stays positive, the more would be the import capacity of the country. High import capacity and foreign reserves are important to fuel the growth of the country.(Akinlo, 2012) The table below depicts the low current account balances that could have been affected by the low export value of the Nigerian crude oil. Similarly, the falling value of total petroleum is also highlighted in the table.

Table 2 Current Account Balance of Nigeria since 2012

Source: (Organization of the Petroleum Exporting Countries, 2017)

Year

Total Current Account Balance

2012

17,516

2014

907

2015

–15,439

2016

2,722

 Table 3 Total Value of Petroleum Exports of Nigeria since 2012  (in Million USD)

Year

Total Value of Exports  (in Million UDS)

2012

95,620

2013

90,546

2014

78,053

2015

41,818

2016

27,788

 
The falling prices lead to the belief that the current situation in the world oil market may be responsible for the lower exports. However, there is no analysis of whether any endogenous factors in the Nigerian economy are responsible for this slump in export revenues.

Nigeria is the largest oil exporting country in Africa and the eleventh largest producer of oil in the world. (Natural Resource Governance Institute, 2016) Nigeria has over 35 Billion Barrels in proven reserves. Some of the top importing partners of Nigerian Crude oil are India, North America etc.

Background to Research

Table 4 Production Capacity of Nigeria

Source: (Organization of the Petroleum Exporting Countries, 2016)

Proven Reserves of Crude Oil (in million barrels)

37,453

Daily Production of Crude Oil (in Thousand Barrels)

1,427.3

Total Daily Capacity of Refineries

446.0

Daily output of refined petroleum products

53.5

Exports of Crude Oil (in  Thousand Barrels Per Day)

1,738.0

Exports of Petroleum (in 1000 barrels per day)

17.9

The purpose of this paper is to understand if there is are endogenous factors in the economy that affect the oil sector. Hence, the relationship between the Real Effective Exchange Rate and the oil sector of the economy was studied. In order to understand whether the REER is a factor that is correlated to the GDP, covariance of the two variables was studied.

Further, to understand the effect of REER on the export demand, the total production of oil in Nigeria is used. The data for the exports of crude oil from Nigeria were difficult to obtain. Most of the data for exports from Nigeria includes composite data for several products such as natural gas, other fuels etc. Hence, the daily production data was substituted here instead. It is assumed that production follows demand and that producers will change production based on demand. The data given in the tables 5 and 6 reflects the fluctuations in production in past few years, attesting to the fact that production follows demand.

For the purpose of this paper, in order to establish the relationship between the GDP and REER, covariance (COVAR formula in MSExcel is applied) and Correlation (CORREL function in Excel is used) of the two variables is analysed.

REER was taken as a variable because Real Effective Exchange Rate is very effective in capturing the competitiveness of the economy and in turn, its effect on the oil sector. Given that the oil sector of Nigeria is very export oriented, the exchange rate of the country is critical factor in the demand for the oil of the country. However, instead of using the nominal exchange rate, the Real Effective Rate is used here “REER is the nominal effective exchange rate (a measure of the value of a currency against a weighted average of several foreign currencies) divided by a price deflator or index of costs.” (International Monetary Fund, 2017)  Real Exchange captures the competitiveness of the economy. Data was obtained from the World Bank website. ( The World Bank, 2017)

Similarly, the Real GDP has been used since real GDP is a better indicator of the output in the economy that the nominal GDP. Data was obtained from the website of International Monetary Fund.(International Monetary Fund, 2017)

Data for oil production was taken from U.S. Energy Information Administration’s Monthly Energy Review, September 2017

The Linkages between the Economy of Nigeria and The Oil Sector

In order to verify this, an OPEC study was used. The OPEC study gives data on the active oil wells and rigs. The table below is representative of the fluctuations in production due to fluctuation in demand.

Table 5 Total Number of Rigs and Oil Wells in Nigeria Since 2012. These reflect the fluctations of demand for crude oil in the international market

Source(Organization of the Petroleum Exporting Countries, 2017)

Year

Total Number of Active Rigs

Total Number of Well

2012

38

2,168

2013

44

1,951

 2014

59

2,010

2015

46

1947

2016

29

1668

 
According to OPEC, 20 rigs and 279 shut down production in Nigeria. The fluctuation in the number of active rigs is an indicator of the instability that the country experiences due to the volatility of demand in the market.

Additionally, no new investment in crude oil extraction in Nigeria is being made currently, which could be related to the current glut in the international market(Organization of the Petroleum Exporting Countries, 2017)

In order to understand if there is really some correlation before proceeding to the analysis, the following comparison was made.

 

Graph 2 Crude Oil Production of Nigeria Since 2007 (Measured in Barrels Per Day)

Source: Made by Author. Source (U.S. Energy Information Administration, 2017)

 

Graph 3  Annual Real GDP Growth Rate of Nigeria since 2012

Source (International Monetary Fund, 2017). Made by Author

As it is visible from the chart above, the production of Nigeria Crude Oil hit a peak between July 2009 and 2010 while the economy, also grew sharply during the same period. Similarly, a decline in the output of crude oil per day since 2014 is also accompanied by a corresponding decline in GDP growth rate. However, the resemblance is not as strong between the periods of 2011 and 2013.

Hausmann, Pritchett, & Rodrik, (2005) demonstrated that high growth rates were in fact , co-related to lower REER.  Hua explained the close relationship between the GDP and REER as “If  a  real  appreciation  exerts positive   effects   on   economic   growth   by   exerting   pressure   on   efficiency   improvement   and technological  progress  via  workers’  motivation,  education  and  capital  intensity,  it  exercises  negative effects  by  deteriorating  the  international  competitiveness  in  tradable  sector  and  thus  by  destructing employment.”(Hua, 2011)

Moya & Watundu, (2009 ) studied the relationship and found that there was a negative correlation between the GDP of a country and its REER.

According to International Monetary Fund, (2017) The REER is a reflection of the competitiveness of the economy and gives an idea of where the exports stand versus the imports. If the REER is higher, them either the export value of the country has decreased or the imports have increased. Lower REER, in turn, further boosts the demand for exports such as  crude oil. (Habib, Mileva, & Stracca, 2016)

Importance of Oil Exports to the Nigerian Economy

Table 6 Data for Research

Source Daily Production Data: (U.S. Energy Information Administration, 2017)

Real Effective Rate: ( The World Bank, 2017)

Real GDP Growth Rate (Annual) : (International Monetary Fund, 2017) 

Real Effective Rate of exchange

Real GDP Growth Rate (Annual)

Daily Production of Oil in Nigeria in Barrels

2000

69.91509

5.5

2165

2001

77.88371

6.7

2256.156

2002

78.12852

14.6

2117.863

2003

73.24737

9.5

2275

2004

74.95608

10.4

2328.962

2005

85.5458

7

2627.438

2006

91.50238

6.7

2439.863

2007

89.64686

7.3

2349.644

2008

99.12497

7.2

2165.44

2009

92.13575

8.4

2208.311

2010

100

11.3

2408.027

2011

100.3082

4.9

2473.751

2012

111.3891

4.3

2457.109

2013

118.813

5.4

2307.318

2014

127.0951

6.3

2347.178

2015

126.0684

2.7

2171.162

2016

115.6631

-1.5

1871.205

Co-relation and Co- Variance between GDP and REER

The tests found that there was definitely a correlation between the Gross Domestic Product and Real Effective range. The co-relation value is close to 0.5 and cannot be considered either strong or weak. The covariance test found that there is a negative relationship

Table 7 : Test Results

Test

Result

Covariance

-36.071

Co-Relation

0.536447

Daily Production of Oil was taken as Dependent variable and REER was taken as independent variable. The Regression test yielded the numerical value of -0.00831 .

  • The number is negative and that signifies a negative relationship between REER and demand for exports. i.e lower the competitiveness of the economy, greater the exports.
  • The number is very close to 0. Hence, the number is not statistically significant enough to convey that there is a relationship between REER and demand for oil exports from Nigerian economy.

Conclusion

There is a weak relation between the Real Effective Exchange Rate and the demand for oil exports from Nigeria as observed from the regression value. This could imply that the result of the growing macro economic incompetitiveness of the Nigerian economy is not being transferred to the prices of the crude oil exports of the country. (Okafor, 2016) Thus this implies that the global demand and supply mechanism Iincludeing demand and supply of substitutes) is a greater factor for falling value of exports from Nigeria. However, in the course of this research the following challenges relating to the oil sector were observed:

Over Dependence to Oil leading to neglect of other sectors in the economy: The focus on the oil sector in policies, budgeting etc. has led to over dependence of economy on oil.  Other sectors, particularly agriculture and forestry have been neglected. (Odularu, 2008) As a result, the growth of the country has been lopsided.(Natural Resource Governance Institute, 2016) Focus on traditional exports like cocoa and other agricultural exports must be increased. Currency Finance to these sectors from the revenues accrued from the oil sector must be used as investments in these sectors. (The World Bank, 2007)

Instability in Domestic Market: The over dependence of the oil sector can transfer the instability of the international markets into the domestic sector as it affects investment cycles, jobs and inflation. (Akinlo, 2012) (Etele, 2015) Given below is a table of the inactive rigs and wells in Nigeria due to the slowdown of demand of oil exports. The fluctuations of demand in the international markets leads to fluctuations in investment and jobs in the domestic market.(Organization of the Petroleum Exporting Countries, 2016)

In order for the country to gain from the exports of the industry, it is important to ensure that the gains are equally distributed among all the sections of the economy. The country would be hoping for a recovery in the crude oil market so that the economy can continue on its path of high growth as seen a few years ago. However, the amount of oil production itself is an issue with the international audience. (Natural Resource Governance Institute, 2016)

The growth of the country is certainly linked very strongly to the oil sector but the country has recognized that and now seeks a balanced growth based on providing other sectors of the economy.(Federal Republic of Nigeria, 2017)

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  2. Akinlo, A. E. (2012). How Important is Oil in Nigeria’s Economic Growth? Journal of Sustainable Development, 179.
  3. Ekmekcioglu, D. E. (2012). HE MACROECONOMIC EFFECTS OF WORLD CRUDE OIL PRICE CHANGES. International Journal of Business and Social Science , 268-272.
  4. Etele, P. (2015, July 27). Slumping Oil, Ailing Economy. Retrieved October 1, 2017, from National Review: https://www.nationalreview.ng/category-economy/item/776-slumping-oil-ailing-economy.html
  5. Federal Republic of Nigeria. (2017). Ministry of Budget & NAtional Planning.Abuja: February.
  6. Habib, M. M., Mileva, E., & Stracca, L. (2016). The real exchange rate and economic growth: revisiting the case using external.Frankfurt am Main: European Central Bank.
  7. Hausmann, R., Pritchett, L., & Rodrik, D. (2005). Growth Accelerations. Journal of Economic Growth,, 303-329.
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  9. International Monetary Fund. (2017). 2017 ARTICLE IV CONSULTATION—PRESS RELEASE;STAFF REPORT; AND STATEMENT BY THE EXECUTIVE.Washington, D.C.: International Monetary Fund.
  10. International Monetary Fund. (2017). REER is the nominal effective exchange rate (a measure of the value of a currency against a weighted average of several foreign currencies) divided by a price deflator or index of costs.Retrieved September 6, 2017, from International Monetary Fund: https://datahelp.imf.org/knowledgebase/articles/537472-what-is-real-effective-exchange-rate-reer
  11. International Monetary Fund. (2017). World Economic Outlook 2017.Washington DC: International Monetary Fund.
  12. Moya, M. B., & Watundu, S. (2009 ). ECONOMETRIC ANALYSIS OF REAL EFFECTIVE EXCHANGE RATE ON GROSS DOMESTIC PRODUCT OF UGANDA.
  13. Natural Resource Governance Institute. (2016). Country Strategy Note 2016.Natural Resource Governance Institute.
  14. Odularu, G. O. (2008). Crude Oil and the Nigerian Economic Performance. Oil and Gas Business.
  15. Okafor, P. (2016, July 13). Nigeria ranks 124 on Global Competitiveness Index—World Bank. Retrieved September 30, 2017, from VanGuard: https://www.vanguardngr.com/2016/07/nigeria-ranks-124-global-competitiveness-index-world-bank/
  16. Organization of the Petroleum Exporting Countries. (2016). OPEC Annual Statistical Bulletin.Vienna: Organization of the Petroleum Exporting Countries.
  17. Oyedepo, S. O. (2012). Energy and sustainable development in Nigeria: the way forward. Energy, Sustainability and Society, 2:15.
  18. The World Bank. (2007). Nigeria: Competitiveness and Growth, Main Reotrt.Washington DC: Poverty Reduction and Economic Management Department, The World Bank.
  19. S. Energy Information Administration. (2017). September 2017 Monthly Energy Review.Washington DC: Government of USA.
  20. Vaughan, A. (2017, March 21). Oil theft 'provides billions for terrorists and drug cartels' . Retrieved September 30, 2017, from Guardian weekly: https://www.theguardian.com/business/2017/mar/21/oil-theft-terrorism-drug-cartels-mexico-eu-atlantic-council
  21. Watts, M. (2010). Resource curse? governmentality, oil and power in the Niger Delta, Nigeria. Geopolitics , 50-80.
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