I don’t like assumptions, but when you don’t have enough data, and when you also have no idea what will happen to y when x happens, then you have to fall back on assumptions. So I decided to pull out my Excel Spreadsheet, after an interesting conversation with a good friend this morning about whether improved oil production can lift Nigeria out of recession.
I am not an oil and gas specialist, and I am not even an economist. I am just an investment manager, but I watch all my investments, both personal and for others, like a hawk. So I tend to do a lot of exercises because I combine both top-down and bottom-up investment models when I make investment decisions.
We are going to keep it as simple as possible. Nothing complicated. No Monte Carlo simulations, just add, multiply and divide.
The first assumption we are going to make is that oil price will remain stable at $45 per barrel. While in reality, it is possible that if Nigeria suddenly ramps up oil production, oil price may take a hit. We will ignore that, because there is no way to know how much the price will be impacted.
The next data point is the level of oil production. The 2017 budget assumption placed oil production levels at about 2.2 million barrels a day. Now, let’s take a look at oil production in the first half of 2016. The average oil production was about 1.9 million barrels per day according to the Nigerian Bureau of Statistics (which stated that oil production dropped by 0.42 million in 2016 Q2 to 1.69 million barrels per day from 2.11 million barrels per day in 2016 Q1). The second assumption we are going to make is the maximum output that can be generated in reality. According to NNPC, Nigeria can produce up to 2.7 million barrels per day. The maximum output Nigeria has experienced over the past 10 years was sometime in mid-2011, and it was just a little above 2.25 million barrels per day. That was the time during which vandalism was at its lowest ebb, and well, crude oil theft also held sway. No one has been able to estimate exactly how much was stolen but there is a ballpark value of around 250,000 barrels per day. Adding the maximum output in 10 years with the estimated amount stolen, we can arrive at a maximum output of 2.5 million barrels per day.
We now have all the data we need. Let’s get to work.
If vandalism and crude oil thefts are handled, Nigeria will improve its output by 600,000 barrels per day. At $45 per barrel, this will amount to about $9.855 billion in one year. But not so fast. We are not done. Nigeria operates Joint Ventures with major oil producers and gets about 60% share. So, that 60% share will lead to about $5.913 billion additional income in one year.
Let me rephrase this. Nigeria will only enjoy additional income of $5.913 billion in one year, if oil vandalism and crude oil thefts drop to zero. This is based on two assumptions — one, oil price will remain stable at $45 (we will leave the exact oil price for the gods), and two, Nigeria will be able to produce 2.5 million barrels per day — and one fact, which is, Nigeria average production was 1.9 million barrels per day in the first half of 2016.
Now, let’s attempt to answer the question: can improved oil production lift us out of recession?
Summary up to this point. We know that we are in a recession and contracting at 2% per annum. We also know that we can generate an additional $5.913 billion per annum from crude oil sales.
It is time to make the third assumption. The income generated by the improved crude oil production is expected to have a multiplier effect in the economy. But by how much? This is a critical point because it will be foolhardy to assume that a $1.00 growth in oil production will lead to a $1.00 growth in the GDP. The effect could be $5.00 or $10.00 or even $20.00. I have scoured the Internet and no such data exists. But we are not going to just pull figures from the air, we need something to work with. Let me apologize at this point, because things are going to get just a teeny weeny complicated now. You don’t need to understand the mathematics behind it, so feel free to skip the next two paragraphs. And I will not be taking questions on how I did the mathematics, unless you are willing to pay for it. In US$.
At the end of June 2015, crude petroleum and natural gas (oil and gas for short) sector accounted for N1.614 trillion, while the GDP stood at N16.623 trillion. At the end of June 2016, oil and gas dropped to 0.896 trillion — this is a 17.5% drop. The GDP also dropped by 2.2% within the same period to N16.254 trillion. All prices used are at 2010 Constant Basic Prices (this has to do with the GDP rebase all those economists have been talking about). Going by the values provided, oil and gas dropped by N282 billion within a period of one year, while the total economy dropped by N369 billion within the same period. We can stop here and say okay, the first amount led to the second amount, but it is not that simple.
We will have to take it just one notch up again. We don’t want to be making too many assumptions. We need to be as close to reality as possible. So, we should have used some kind of time series to define the correlation between oil and gas output and GDP growth over the past 30 years or so. But that will need a lot of data and the results are going to be very close to what we have now because we need to weight the time series to actually reflect current realities. The relationship between oil and gas and telecommunications, for example, will not be significant prior to 2002, just before the telecommunication companies entered Nigeria. But that relationship may be quite significant now, and using an equal weighting may not show the true picture of things. Yeah, I know I am getting really academical, and that was not my intention. So, I will stop here.
Okay, so we know that oil and gas sector production dropped by N282 billion, while the GDP dropped by N369 billion between June 2015 and June 2016. Based on that we can assume (yikes, that word again) that the multiplier effect that oil and gas has on the economy is about 1.3x. This means that for every N1.00 drop in oil and gas production, the economy will suffer by N1.30 and for every N1.00 rise in oil and gas production, the economy will grow by N1.30.
Now, let’s go back to that $5.913 billion. This is the value we calculated to be the increase in output that Nigeria will enjoy if oil vandalism and thefts are curtailed. Also remember that the Nigerian economy lost N369 billion over the past one year. We also said the multiplier effect is 1.3x. So for the $5.913 billion extra income, GDP is expected to add $7.687 billion. Using the official exchange rate of N315/$, this is equivalent to N2.4 trillion. This is a far cry from the N369 billion lost in 12 months.
So, to get us out of this recession, we don’t seem to need oil price to rally. All we need is for oil production to improve a little from where it is, and we can get our economy ticking over again.
This is wishing Operation Crocodile Smile all the best with getting us back to where we belong.