How Nigerian manufacturers can survive falling oil prices
It could be 2016 again for many Nigerian manufacturers who fail to embark on strategies that would reduce their business exposure to the shocks that come with falling oil prices.
This could come with a lot of devastating consequences as seen four years ago when tumbling oil prices and low production caused a naira devaluation that jacked up commodity prices to an all-time high, eroded investments, increased stock of inventory and nearly brought economic activities to a halt.
And now the Nigerian economy has been caught unawares in a similar scenario it faced in 2016, after the outbreak of Coronavirus spreads into over 67 countries causing a slowdown in demand for global oil prices.
Brent crude price slumped by over 40 percent to $30 early hours on Monday, its biggest daily fall since the Golf War in 1991.
The abrupt drop in the prices of oil happened after Saudi Arabia, world’s biggest exporter of oil, decided to use its weapon to force Russia back to the negotiating table, after Moscow said it was not sticking to a 1.5 million barrel per day production cut with members of the Organisation Petroleum Exporting Countries (OPEC).
The disagreement between OPEC and allies forced Saudi Arabia to enact an oil price war by pumping in more crude in the market while still slashing the price at which it sold its oil in order to attract more buyers.
The supply glut, alongside the slow demand in the commodity, pushed the price to its lowest level since 2017. This has led to global sell-offs in stocks on Wall Street and caused yields on the U.S treasury bills to rally as investors demanded higher yields to keep their investments
S&P 500, known as the stock market index that tracks the stocks of 500 large-cap U.S companies, has shed 13 percent since the start of the year, with Goldman Sachs on Tuesday slashing its midyear forecast for S&P 500 on the back of a further fall in the market index.
The Dow Jones Industrial Average, an index that tracks 30 large, publicly-owned companies trading on the New York Stock Exchange (NYSE) and the NASDA, is also not left out as the index has shed over 15.76 percent year –to-date,
The impact of the deadly Coronavirus, which has killed over 3,800 people and infected 120,000 people across the world, has caused global economies to shiver with many of them cutting their growth forecasts for the year.
Oil price gained momentum to $36 per barrel around 16:26 Nigerian time, after the U.S president Donald Trump, Tuesday, proposed a payroll-tax cut to boost the U.S economy.
Back home, Africa’s largest economy is already having a hard time being that it gets over 85 percent of its dollar liquidity and over 70 percent of revenue from crude oil sales. The commodity is already trading below the $57 mark which is the benchmark for its budget.
Falling oil prices do not align well for Nigeria as it would make the government handicapped in carrying out its planned expenditure and also put pressure on the naira.
Already, the country has blown over $8 billion of its reserve as it continues to defend the naira from falling against the dollar.
Sustained price at a low level could further lead to depleting reserves as the country would have less dollar to cover up for its import bills.
At the start of the year, Godwin Emefiele, governor of the Central bank, had assured investors that devaluation would only be considered if oil prices traded below $45 per barrel while external reserves fell below a $30 billion mark.
Already, with oil price trading as low as $36 per barrel, he first condition for a devaluation has been met. External reserve stood at $36 billion, based on CBN data, and has come under pressure as investors sell off Nigeria’s assets.
This has made analysts say devaluation might be in the cards for the West African nation, which has fought through its reserve to see its currency stabilise for close to four years.
Zainab Ahmed, Nigeria’s finance minister, has called for the review of the budget to reflect the current fall in oil price. The CBN, on the other hand, has convened a confab of over 75 business leaders from both the private and public sector to discuss the growth of the economy in the wake of the current macroeconomic realities
Aside from the fall in oil prices, Nigeria is having a tough time selling its already exported crude, with over 50 of its oil export cargoes currently unsold, according to statement by Mele Kyari, group managing director(GMD) of state-owned oil company, the Nigerian National Petroleum Corporation (NNPC).
Manufacturers need dollars to import inputs or buy equipment for their day-to-day running of their operations. They also require foreign exchange to buy certain types of packaging materials and ramp up production.
An acute dollar shortage owing to falling oil prices could make manufactures get dollars at higher rates, which would lead to an increase in the cost of production.
With the weak consumer income, manufactures, especially those producing substitute goods, might find it difficult transferring the high cost of production onto the consumers. This might push some out of business as it did in 2016 when 54 manufacturing firms shut down. It could also hit their revenues and profits hard.
Although the effect of the Coronavirus, which has resulted in the collapse of oil prices, is a macro and not a micro issue, as it is not within the powers of businesses to solve, it requires a fiscal stimulus response. Analysts have, however, proffered various steps to manufactures to take in order not to get too exposed to the shocks emanating from the pandemic.
One of these viable actions that could be taken by manufacturers to cushion the impact of the shock is local sourcing of inputs. Analysts advise that manufacturing companies that are heavily reliant on the importation of raw materials should consider local alternatives. This would make them less reliant on the dollar, which would be scarce due to the high demand.
Next that is related to the former is backward Integration. Manufacturers can engage in backward integration by expanding their role to fulfil tasks formerly completed by similar companies up the value chain. It could be an outright purchase of another company that supplies the product and services needed for its production. And they can set up backward integration projects themselves in naturally gifted and less volatile states.