On Tuesday, oil prices continued dropping as investors and traders weighed oversupply prospects, dollar strengthening, and refining margins. Brent crude traded down to $39.92 a barrel, while West Texas Intermediate (WTI) fell to $37.06 during the trading sessions.
What are the issues?
Earlier this week, Saudi Arabia decided to end additional output cuts this month, which consequently means that in the coming months, an increase in supply in the market would be inevitable. The end of additional output cuts seems to be subscribed by other Gulf producers as they were also keen on ending further cuts.
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If the OPEC+ party was successful, the afterparty was not. The press conference was not bullish, as the outcome of the meeting, the measures to ensure compliance for members cheating on their quotas sounded weak. The impression that suppliers would self-inspect themselves is the monitoring equivalent of students invigilating themselves during examinations, without any external supervision. Given the mechanical strains in shutting off production and revenue targets by member countries, there would surely be some malpractice. However, Iraq has shown signs of ethical conduct by asking Asian refiners to forgo shipments of its Basrah crude.
Also, the market assessed the tone of the Saudi and Russian Ministers when asked about production policies for August, earlier in the week. Novak, the Russian Energy Minister, claimed that it was too early to say what would happen in August, while Saudi’s Energy Minister also said that it was premature to discuss August’s policies. Bear traders considered that and believed there were no assurances for reducing the supply, which would affect the rallying of prices in the short term.
READ MORE: Who will ruin the OPEC+ party?
UBS Commodity analyst, Giovanni Staunovo stated that, “A slightly stronger U.S. dollar is weighed on crude prices with the prospect of higher production from Saudi Arabia, Kuwait, UAE and Oman in July which would not help prices.”
These events colliding with the impending return of Libyan oil and unrestricted oil production from U.S. and Canada raise an oversupply concern.
Historically, there is an inverse relationship between the price of the U.S. dollar and the price of oil. The reason for this is that when the dollar is strong, fewer dollars are available to purchase oil (remember oil is priced in dollars). With this explanation, a comeback for the greenback after weekly declines has resulted to the increase in its purchasing power. However, traders are expecting the dollar to take a hit, with the “potential FED stimulus” approaching.
Two months ago, there were problems with storage capacity in the oil market. Now, another two-word phrase has been injected to give the bears momentum—refining margins. Defined by Mckinsey, ‘It is an industrial measure of the value contribution of the refinery per unit of input.’ This problem formed a part of Goldman Sachs’s outlook for Brent crude in the short term. The investment bank believes that prices would pull back to $35 because of the collapse in refinery margins and the incoming oil production from the U.S. and Libya.
The bank also said, “the collapse in refining margins to unprecedented lows is reflective of both over-valued crude prices as well as a more moderate demand recovery, two pillars of our short-term bearish view.”
Warren Patterson, head of commodities strategy at ING, signalled caution saying, “if we look at the rally we’ve seen in crude oil prices, it’s been amazing, but the big uncertainty is if you look at refinery margins, they are very weak across the board across all regions.”
Could this be a market correction, or is the market taking a breather after strong rallies in the previous weeks, or are oil prices over-valued? The following weeks would be crucial to know the answer to this question.
World Bank: Lower oil demand may persist till 2021
Energy price remain well below pre-pandemic levels and is expected to stabilise below pre-pandemic levels in 2021.
According to the World Bank’s semi-annual commodity outlook, the organisation anticipates demand for oil will remain below pre-pandemic levels beyond 2021. In the statement credited to the multi-lateral body, it tried to juxtapose the performance of energy commodities with agriculture and metal commodities. According to the World Bank, metal and agricultural commodities have recouped losses posted due to the impact of the pandemic and are even expected to post some modest gains in 2021. However, energy price, despite some decent recovery, remain well below pre-pandemic levels and is expected to stabilise below pre-pandemic levels in 2021.
We recall in February/March 2020, oil price began to dip on the back of fears of price war between Saudi Arabia and Russia as well as demand concerns stemming from lockdown measures (which restricted movements) implemented to control the spread of covid-19. As a result, oil prices dipped close to the US$22/bbl support level. However, an OPEC+ meeting in April which led to historical cuts in crude oil supply lent some support to oil price as Brent rallied to a c.US$40/bbl. resistance.
While compliance to cuts have been impressive (underproduction in some countries compensated for overproduction in non-complying countries), production is gradually climbing as the cuts are being relaxed in phases in line with the April agreement. Despite this, the same cannot be said of demand which has recovered decently but remains well below pre-pandemic levels. According to the World Bank, tourism and travel continues to be held back by health challenges, thus, demand for jet fuel and other energy products
We agree with the World Bank’s prognosis on outlook for energy commodities. We recall highlighting new cases of new covid-19 cases in many European countries that had previously brought the pandemic under control which implies a second wave may be in swing as we enter the winter months. This may to lead to renewed lockdown measures in different regions as countries try to limit the spread. In addition, we expect it to weigh on the minds
of travellers & tourists who may be reluctant to travel as health concerns remain elevated.
Examining the impact on the Nigerian economy, we think an above US$40/bbl Brent price remains healthy for the 2021 budget revenue projections which is critical to achieving the historic revenue numbers projected in an ambitious budget. However, we retain grave concerns on the countries external conditions and consequently exchange rate. We think the prolonged weakness in oil prices would drag on export receipts and thus FX earnings.
That said, we reiterate our agelong clamour for economic managers to adequately diversify the country’s export earnings particularly exploring opportunities in mining and agriculture. Furthermore, investments and business regulations to accelerate local industrialisation which would foster local production of many imported products would significantly help to reduce dependence on imported products and thus conserve scarce FX.
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How Cash flow, Liquidity, and Leverage impacts your financial plans
Aja discusses how Cash flow, Liquidity, and Leverage impacts your financial plans.
It is key to discuss cash under the three themes of Liquidity, Leverage, and Cashflow. These concepts are interrelated, but each has different impacts on your financial plan.
It captures only cash transactions and is simply the amount of cash flowing in and out of your business or person. Hence, if you buy an asset and issue a Purchase Order to pay a supplier in 90 days, that transaction will not show up on your cash flow.
As an illustration, if Emeka buys a TV with N200,000 but issued a cheque for N100,000 cashable in 90 days; only N100,000 will be captured leaving his cash position. Thus, Emeka has positive cash flow and negative leverage, because his debt has gone up.
For Okafor, the seller who received half of the proceeds in cash, he may be liquid but cannot replace his stock due to lack of enough cash flow. He may have to leverage to generate cash. Should he need cash, he can create liquidity from his paper check of N100,000 by discounting to cash before 90 days, but at a cost.
You must be aware of negative and positive cash flow and avoid as much as possible, generating cash from financing activities i.e. borrowing to fund non-income generating assets or activities.
It is determined by how fast an asset can be converted into cash. If Okafor gets a cheque offer from Dangote Cement and another from Emeka to pay for a TV, which do you think he will accept all things being equal? Most likely the Corporate cheque, because he perceives that it is easier to discount to cash; thus, more liquid than the individual cheque.
Federally issued bonds are said to be less risky than State or Corporate bonds of similar tenor because the issuer (the FGN) is more liquid than the States or even Corporates.
The same can be said of Equities. Stocks that are traded more often and held by more investors are more liquid and commands a better premium to the bonds of a similar company. This is one reason large blue-chip stocks command higher market prices, the investors are also paying for the ease of liquidity.
A good metric for measuring liquidity has to be the Acid Test liquidity ratio that determines how easy it is for you to generate cash in an emergency. It is calculated by dividing your assets by your liabilities, but the key is that the assets are stripped off all hard assets and will include only cash and easily marketable securities and commodities like gold that can be sold. The higher the ratio the better.
Simply put, leverage is borrowing. You can borrow to increase potential profits or to meet an obligation that is due. When cash is borrowed, it must be paid back with a cost called interest. Leverage can produce cash flow and liquidity, but no firm or household can remain a going concern solely on cashflow financed by leverage.
Eventually, the interest cost will swell and more of future operating cash generated by the firm or household will be earmarked to pay off interest, leaving the principal to remain and generate more interest cost.
In the earlier example, Emeka used leverage to buy the TV and gave Okafor a cheque, who will in turn generate cash flow by liquidating the instrument from Emeka.
A good leverage analysis is to calculate your Leverage Ratio. To determine your leverage ratio, list out all your liabilities, divide by your total assets, and multiply by 100. The answer tells you how much of your assets are financed by debt i.e. leverage ratio.
Hence, you can have positive cash flow, be liquid but be highly leveraged, which is not ideal. The rule of thumb says the lower the leverage ratio, the better.
Summarily, with cash, you must be aware of the implication in terms of cash flow, liquidity, and leverage.
#EndSARS: Analyzing the economic prospects of another lockdown
Decisions taken in the next few days will determine how soon the issues surrounding the #EndSARS protests will be resolved.
The past five to seven days in Nigeria have been nothing short of fictional for the Nigerian people.
One would be hard-pressed to describe the events without seeming to take sides with either part of the standoff as emotions, euphoria and sometimes, unfounded principles have seemed to become the order of the day. Logic, accountability and common sense being on vacation as they often are in such matters.
If there were negotiations (of which there are none presently), parties involved may likely disagree on a couple of things ranging from the sincerity of the other party, approach to a peaceful resolution, what amounts to a peaceful resolution and how to forge ahead.
There would be accusations and counter-accusations, more so, as the chasm of discord between stakeholders continues to widen with each passing day of the #ENDSARS protest across major cities and towns of the Country. Nonetheless, one thing both parties would agree on is that their continued standoff and reluctance to resolve the complex issues around the protest is ruinous to the economy.
Nigeria’s real GDP growth for 2019 was estimated at 2.3% by the AfDB. It was an improvement on the 1.9% estimate for 2018 and an achievement of the 2019 expert projections despite the uncertainty about the 2019 election outcomes, policy implementation slowdown and sell-offs by foreign investors in 2018.
Household consumption was the key growth driver in 2019, followed closely by growth in transport, the oil sector and information and communications technology. Agriculture, for all its Government patronage could not withstand the floods that heralded a climate change while suffering from the conflicts between herdsmen and farmers- it flopped, and so did manufacturing which could not be reckoned with due to a lack of financing. Estimated inflation for 2019 was 11.3%.
After a turnaround from –1.6% in 2016 to 0.8% in 2017, 2020 was supposed to be the year where Nigeria consolidated on the steady GDP growth of previous years by implementing its Economic Recovery and Growth Plan with an emphasis on economic diversification.
The CBN’s proactive decree that banks hold loan–deposit ratios of 60% was geared to increasing lending to the real sector, even as they eased the risks of lending to small businesses.
An increase in the value-added tax from 5% to 7.5% was implemented to shore up domestic non-oil revenues, and agro-industrial support from the Government was supposed to make 2020 a year to surpass growth forecasts even as oil revenues began to improve and drive foreign exchange reserves. Then came COVID-19.
Lacking a clear nationwide pandemic framework, coupled with a nonexistent welfare system and weak healthcare infrastructure, the Nation did a relatively impressive job in managing the pandemic but did lose the economic advantage it started the year with. Negative GDP growths were projected for Q2 and Q3 even as oil prices slumped to an all-time low.
Diaspora remittances (which accounted for 83% of the FG budget in 2018) had reduced to a trickle because of the pandemic, and unemployment surges. The World Bank predicted a recession by Q4, it would be Nigeria’s worst in four decades.
Once again, Nigeria beat the odds. A series of monetary and fiscal policies saw to it that more funds were made available to the real sector; delinquent loans were restructured to keep from becoming bad; the free fall of the Naira was staved off and key industries were supported through Government’s special intervention programs. A few optimists were beginning to think we had rounded the corner, then came #EndSARS protests.
In the few days since the protests have begun, the Nation is estimated to have lost billions of Naira with Lagos state, understandably, being the biggest loser so far hosting the largest protests. Manpower hours have been lost, properties have been destroyed and worst of all lives have been lost.
Household spending, transportation and manufacturing cannot continue to thrive in these unrests. September inflation was pegged at 13.7%, its highest since February 2018 there is already considerable strain on healthcare due to the pandemic and the exposure of the populace during the #endsars protests and counter-protests could spike up the COVID-19 numbers once again.
The peculiarity of the nature of the protest has seen Nigerians in the Diaspora channel their funds to supporting the protests in Nigeria while organizing theirs in their host country. Another significant loss of diaspora remittances which represent a substantial percentage of the GDP. Also, the protests are beginning to weigh in on stock market activities and could affect other economic indices if tensions escalate further.
The unfortunate resolve of both sides to fight to the finish without giving room for dialogue could lead to another lockdown of economic activities as witnessed in Edo, where a 24hr curfew has been declared; Lagos where schools and businesses have shut down; Osun, Ekiti, Plateau, Imo and the FCT where business activities have come to a grinding halt.
The cyber warfare being threatened by both sides could also have far-reaching effects on the liquidity of our financial institutions as their customers opt for crypto wallets as safe haven for their funds and as punitive measure for brands they perceive as not being supportive towards their cause.
Of course, decisions taken in the next few days will determine how soon the issues surrounding the protests will be resolved, but for a country on the precipice of serious economic repercussions, both parties seem a little too comfortable in staring down the opposition when serious gains could be made by coming to a round table.