Nigeria, oil firms risk another oil price crisis for not hedging

Nigeria, and oil firms operating in the country risk exposing themselves to another round of oil price crisis, as many of them are not taking advantage of the current higher crude oil price environment to hedge their crude oil sales against lower oil prices in future. The need for hedging has risen, based on rising uncertainties over the direction of oil prices, as oil producers in OPEC battle for market share with Shale producers in the US.

Global oil companies ramped up hedging activity to about 648,000 barrels per day (bpd) in the fourth quarter of 2016 according to figures from Wood Mackenzie, yet very few Nigerian companies participated.
Hedging allows the buyer to place a contract to buy a commodity at a fixed price from the seller at a future date. This supports cash flow and investment plans, even when prices are depressed.

A group of 33 largest global upstream companies with active hedging programmes accounted for a surge by 33 per cent in the last quarter of 2016 compared to the third quarter, helping them to stave off the effect of low oil prices.

“Recent disclosures reveal that producers rushed to lock in oil prices above US$50 a barrel after OPEC’s November announcement about production cuts,” says Andy McConn, research analyst at Wood Mackenzie, on why recent hedging activity will keep drilling levels buoyant during periods of low oil prices.

McConn further said, “Those producers – most of which are highly exposed to US tight oil – will use hedging gains to help plug any budget deficits caused by sub-US$50 spot prices.”

Apart from the international Oil Companies, only a few Nigerian companies like Seplat and Oando hedge their oil output. Experts say that apart from indigenous companies, Nigeria should also consider this option, which will reduce their high exposure to the volatility of oil prices.

“The size of production in Nigeria may be too large to be accommodated by one hedging company but you can hedge a portion of your production, less the IOC’s equity oil, then we have 60 percent of production so if you want to protect 80 percent of what is ours, what that means is that we will be looking at hedging 1 million barrels per day,” says Tunde Afolabi, CEO AMNI International Petroleum Development Company Limited, in an interview.

Afolabi further said, “But now that oil price is bouncing back a little bit, if you are using $53 a barrel as your benchmark, go and insure it, it is cheaper now.”

Other African countries are seriously considering the option. Ghana’s Public Interest and Accountability Committee (PIAC), the body charged with monitoring the proper utilisation of oil revenue has urged the government to hedge the country’s crude oil to maximise profit.

“In order to mitigate the impacts of the volatility of crude oil prices on the world market and following the successful hedging programs being implemented by other Jubilee partners, the government should consider resuming its hedging program on crude oil exports,” the group said in a report to the Ghana government.

However, analysts caution that hedging by a developing country, where crude oil is sold and little value is obtained in the form of derivatives, is fraught with risks when oil prices shoot above projections.

Professional service company, Deloitte, in its article on the impact of plummeting crude oil prices on company finances, said that lower prices may mean more producing companies, including smaller ones, resorting to ‘locking down’ their output with hedging instruments.

“Hedging instruments may become effective for accounting purposes, and companies that have maintained price hedges (for instance, for a price floor of $80/bbl) will find that they are now ‘in the money,’ says Deloitte.

McConn said that oil futures prices must recover before producers can lock in prices over US$55 a barrel for next year, “which is what we think is needed to organically fund significant tight-oil production growth.”

This has become critical for Nigeria, as the use of advanced technology by shale producers means that they can get to market faster and produce at lower cost, as their break-even cost has been reduced to less than $35 per barrel. Furthermore, many US producers are hedging their own exports.

This is why Wood Mackenzie warns that those hoping that recent oil price weakness will prompt US producers to pull back drilling activity and ease the glut of oil supply may need to wait longer.

 

ISAAC ANYAOGU