Would oil price spoil Nigeria’s naira party?

It has been a great unbelievable three weeks for the naira recovering from a low of N520 to the US$ at the end of February to now trade at about N375 to the US$ as at Friday evening closer, to its estimated “fair value” of N350 to the US$. The naira’s rise has been mainly on the strength of the decision by the Central Bank of Nigeria (CBN) to use the power of its more than US$30 billion external reserves war chest to punish speculators in the black market who have been betting on a continuous drop in the value of the naira.

 

At the time the CBN decided to move against speculators, the naira was already receiving a significant beating in the black market and some analysts were already forecasting a N1000 to the US$ exchange rate by the end of the year after it touched a low of N520 to the US$ on 28 February. It is to the credit of the CBN that it had always insisted that the black market rate was not a true reflection of the value of the naira and was a product of wild speculation.

 

But then the CBN was helped by a surge in oil prices from January after the Organisation of Petroleum Exploration Countries (OPEC) agreed in December to cut crude oil supply. This immediately resulted in a spike in crude oil prices, with Brent crude, touching a new high of US$58 per barrel, almost 100 percent higher than the price in January 2016. The rise in crude oil prices was good news for Nigeria, which had been exempted from complying with the OPEC restrictions, and which also depends on crude oil sales for more than 90 percent of export earnings.

 

The surge in crude oil prices helped the CBN to rebuilding its external reserves. This also has coincided with a period in which peace moves in the Niger Delta has helped reduce vandalisation of pipelines in the region in a way that crude production started picking up again. Data from the Nigeria National Petroleum Corporation actually show that crude oil production picked up from a low of 1.5 million barrels per day in August 2016 to an average of 1.92 million barrels per day by November, representing an additional production of 420,000 barrels per day, at a time crude oil prices were also rising which helped to significantly boost the country’s export receipts and consequently reserves.

 

But the tables may be turning currently on rising crude oil prices. First doubts are being created around whether OPEC members are strictly adhering to the agreements to cut crude oil production. There is strong suspicion that Russia and other non-OPEC members have not strictly adhered to the promise to cut production. Meanwhile, Shale producers in the United States, taking advantage of the initial rise in price, have been boosting their production taking the US oil production to about 9.1 million barrels per day currently.

 

All these are beginning to impact on Brent prices which has slipped from an average of US$55 this year to close at four month low of US$49.71 before staying marginally above US$50 well below its January high of US$58. Already analysts are revising downwards their outlook for crude oil prices for the second half of 2017.

 

The declining crude oil price has the capacity to spoil Nigeria’s “naira party” as it can erode the CBN’s capacity to build its external reserves, which also determines its capacity to continue to intervene in the foreign exchange market to keep the naira in its preferred range. There are already signs that the significant interventions of the last few weeks is beginning to have an impact in the buildup in reserves. The external reserves, which have shown a steady increase since the beginning of February, broke that trend on 22 March when it slipped marginally by about US$5 million to close at US$30.35 billion. The CBN has spent about US$1.8 billion intervening in the foreign exchange market in the last three weeks, so the slight drop in the reserves is expected.

 

Sceptics that strongly believe the recent intervention by the apex bank is not sustainable will now closely watch the direction of the reserves going forward. If the slip in reserves continues, expect the speculators to start betting on a weaker naira again.

 

Surprisingly, the increased interventions by the CBN have not triggered autonomous inflows into the foreign exchange market, which could have reduced the pressure on the CBN. But that could be because; many foreign investors are still not very clear on the long-term strategy of the CBN.

 

Even though the CBN has also been weakening the official exchange rate of the naira, which has moved from N305 to the N308, there is no indication of how low this will go even though there is speculation that the CBN is targeting N350, which is considered officially as a fair exchange rate for the naira based on current economic fundamentals.  However, there are many in the business community who believe that the fair exchange rate of the naira should be between N380 to N400 to the US$, which means that the naira in the black rate has already reached its fair value as at Friday.

 

But the falling crude oil price means that the CBN has to move quickly to resolve the exchange rate situation. Having succeeded in moving the black rate from the low of N520 to its current N370 to N400 range, it must not allow it to slip out of its control again. At this point, the CBN should immediately remove some of the restrictions around pricing and allow for a more flexibly determined interbank rate that could incentivise autonomous inflows and reduce the pressure on its reserves. It must do this now before the full impact of lower crude oil prices starts eating away at its reserves and the capacity to sustain its intervention.

 

Anthony Osae Brown