The Economic Consequences of Dependence on a Commodity: The Nigerian Oil Crisis

by Brandon Foreman


This essay seeks to present the results of an inquiry into Nigeria, where militant uprisings and a history of corruption have dominated the national landscape since its inception. A country completely dependent on oil has made headlines lately, precisely because the oil and the precious dollars that come from it have stopped flowing. Hence, business has evaporated in Nigeria, thousands have lost their lives, and major reconciliations must be made. After providing basic context for the crisis, this essay’s main purpose is to analyze the economic effects of the situation and the consequences of dependence on such a vital commodity.


Section 1: Background on the Crisis

Nowadays, just about every time Nigeria comes up in the news, “oil” appears in the same sentence. How did this come to be? After all, isn’t the world’s oil supposed to come from the Middle East? Well, in 1956 after receiving permits from the Nigerian government, a cohort of Royal Dutch Shell, Chevron, and other oil producers stumbled across a wealth of the commodity in a region known as the Niger Delta, the southernmost part of the country. At the time, Nigeria’s economy was barely industrialized and highly dependent on fishing and agriculture. [6] The arrival of oil changed everything.

Fig. 1. Oil is clustered in southern Nigeria, an area known as the Niger Delta. [10]

A former British colony, Nigeria’s government has been swamped with corruption dating back to its independence. When the government saw how much money could be made from oil, it wasted no time in licensing drilling zones to international oil companies, sharing in the profits. [6] With the peak oil crisis in the 1970s, the price of crude was driven up, and the government got even more greedy: in 1977, the Nigerian National Petroleum Corporation (NNPC) was created, which became an official body used to govern and establish a joint venture with Shell and Chevron. The NNPC has been the main mechanism to channel Nigeria’s oil profits into the hands of the rich and powerful. Two years later, when Nigeria was rewriting its constitution, it created a statute of eminent domain that allowed the federal government to takeover any land for developmental purposes and repay its owner the value of the crops that could have been grown there. [22] This enabled the government to strip landowners of precious oil reserves and deny them any material share of the proceeds.

Naturally, the Nigerian citizens were devastated by this action. Not only were they robbed of their land and forced to uproot themselves and find a new profession, but the livelihoods they could turn to were all based off the land, which was rapidly becoming tainted. In the early 1990s, the people started to take up arms against the government. These people, native to the Niger Delta, were easily repressed by the government with significant help from the oil companies. The situation quieted towards the end of the decade, when Nigeria elected a new leader and the country finally became democratized. However, in the mid-2000s, the people grew restless and rebelled once again. They blamed Shell and the government for reaping all the benefits of the oil without returning anything to the people. These militant groups began kidnapping foreign oil workers and breaking open pipelines to siphon off oil to sell on the black market, a process known as bunkering. The government easily overpowered the militants, and along with the creation of an amnesty policy in 2009, rebellious activity in the Niger Delta came to a halt. [6]

Meanwhile, the Nigerian government faced a new problem at the start of the current decade: a radical Islamist group known as Boko Haram. As the predominantly Christian South had become economically developed, the mostly Muslim North had been left impoverished. This economic unrest fueled tensions that created a recruiting ground for al Qaeda, ultimately becoming the group known as Boko Haram. This organization has been responsible for hundreds of murders, targeting Christians localized in the north of the country. [3] Thus, the government has had to commit resources to extinguish the group, and they have been mostly successful in doing so.

Fig. 2. Nigeria is heavily segregated by religion, with Muslims occupying the North and Christians occupying the South. [13]

In turn, this created a vacuum taken advantage by militants in the south, again focusing on oil. The most notable of these groups was the Niger Delta Avengers. Rather than profit from oil, however, the Avengers’ goal was to create an independent state in the south known as Biafra. In order to draw attention to their cause, the Avengers have been destroying oil infrastructure, often announcing their intentions and claiming responsibility through their Twitter account. [11] Between January and July of 2016, the Avengers claimed responsibility for thirty-five different incidents of destruction, causing overall oil production in the country to decline to the point where Nigeria was passed by Angola as Africa’s largest oil producer. [17] Both the Avengers and other militant groups feared the prospect of Boko Haram taking over the oil infrastructure, a common goal shared with the government, and a ceasefire was ordered in late August of 2016. The government then launched Operation Crocodile Smile, an Army venture to counteract all militant activity, which has been highly successful. The attacks on oil pipelines have continued but remain sparse. [31] As a result, the Nigerian government and international oil companies have lost billions of dollars of potential revenue and must spend millions more repairing all the damage caused by the militants.


Section 2: Economic Analysis

Like any market, the oil market is determined by supply and demand. The simple rule is: when demand goes up, price rises; when supply goes up, price falls, and vice versa. For most of the last decade, a price of $100/barrel was common for oil, yet one big thing happened that sent the market spiraling down.

Whereas oil-rich countries such as Nigeria and those in the Middle East have the ability to stick a pipe in the ground and suck up oil almost instantaneously, the U.S. energy industry faces much greater complications. The United States had been an importer of oil for more than fifty years until the arrival of new technology gave way to the process known as fracking. Fracking is a method by which rock is fractured due to pressurized injections of liquid, causing the rock to release oil. When fracking was proven to be a success, lots of companies rushed in to buy up land and mimic the new technology. This reached a climax in mid-2014 when the market began to realize a supply glut as a result of all this new production. This forced the price of oil to nosedive. It also did not help that China, with a population of greater than one billion and double digit GDP growth since the start of the millennium, had begun showing signs of a slowdown. While global supply had increased to record levels, global demand was subsiding.

Over the next year and a half, oil was in free fall, touching below $30/barrel at some points. As a result, U.S. companies that had taken out massive loans and still had enormous capital expenditures could not profit at the lower prices, and hundreds went bankrupt. In addition to supply removed from the market in the United States, Canada’s oil sands faced uncontrollable wildfires and Nigeria’s supply outages caused by the militants pushed the price into the mid $40’s. In late 2016, the Organization of Petroleum Exporting Companies (OPEC) reached an agreement to coordinate supply cuts, hoping to address budgetary concerns and push revenue up across the board. This strategy has been moderately effective, keeping oil at around $50/barrel; still, the International Energy Administration (IEA) and OPEC forecast that supply will outpace demand for at least the next three years. [26] Meanwhile, U.S. oil producers are back in business and increasing their supply on a weekly basis. As they have become an undeniable source, it is hard to imagine the price of oil reaching above $60/barrel in the next five years.

Fig. 3. The price of a barrel of oil fell off precipitously in mid-2014. [4]

Just as cars and air conditioning run on oil, so does the Nigerian economy. In fact, oil usually accounts for 40% of the federal government’s revenue in a given year. In 2016, oil revenue comprised 19% of total revenue, meaning that oil revenue was only about 37% of what was expected. [16] This is a logical contraction, because in 2016, Nigeria averaged 2.0 bbl/day, whereas back in 2014, about 500 million barrels of oil were produced per day at prices double those in 2016. [19] Furthermore, the overall value of all exports, including petroleum, peaked in 2011 at $99.9B and decreased for each of the next five years, reaching $28.4B in 2016, as shown in the graph below. [1]

Fig. 4. Nigeria’s oil production peaked at 2.5 bbl/day in 2014. [19]


 Fig. 5. The value of Nigeria’s exports in 2016 were a fraction of that from 2011-2013. [1]

It is easily imaginable how oil singlehandedly could rupture Nigeria’s entire economy. Like many emerging markets, Nigeria tied their currency, the Naira, to the U.S. dollar, meaning that as the dollar fluctuates with value relative to other currencies, the Naira does the same; however, the value of the dollar relative to the Naira is held constant. This is not an easy measure to execute and requires the Nigerian central bank to purchase massive quantities of dollars in order to maintain a constant exchange rate. In June 2016, after holding the value of $1 at 190 ₦ for over a year, the central bank decided that it would no longer be able to continue these purchases and unpegged the Naira. [8] Market forces began to take effect, and as of April 21, 2017, $1 was equivalent to 316.5 ₦.

Fig. 6. Nigeria’s central bank unpegged the Naira from the dollar in 2016, deflating the value of the local currency. [18]

Why is this a problem? On a basic level, when a local currency depreciates in value, all foreign goods become expensive to import. Over the previous ten months, 126.5 ₦, or 67%, more have been necessary to obtain a single dollar. At first, the people start to realize that they can no longer afford U.S.-made and other international goods they have come to rely on. [12] Next, prices for all goods and services in the local currency rise, as suppliers try to recoup their losses. Inflation takes hold across the entire economy, and those at the bottom are left helpless. For example, food prices have increased 18.44% over the past year alone. [18] To compound the problem, Nigerian exports fetch far less when converted back to Naira, which includes some high revenue petroleum products.

Fig. 7. Food prices have severely crippled Nigerian’s poorest citizens. [18]

The depreciation of the Naira has also curtailed foreign investment. From 2014 to 2016, foreign direct investment, a measurement of how much foreign capital is invested in local enterprises, more than halved from $2.28B to $1.04B. Over the same time period, foreign portfolio investment, the amount of money invested in Nigeria’s stock and bond markets, plummeted from $14.92B to $1.81B. [16] This is logical on behalf of the investors, because if the expectation is that the Naira will continue to weaken, then converting dollars to Naira and leaving them in cash will return a smaller value of dollars at a later date. Investors also hate uncertainty, and when the GDP growth has the shape of a curly fry, as shown below, the only predictability is more uncertainty. [18] However, for Nigerians, the flow of money contracts throughout the economy, and due to the multiplier effect, each unit of currency that is removed from the economy takes away around five units in actuality. Furthermore, the central bank’s foreign exchange reserves decrease, which, as demonstrated above, poses severe issues in maintaining the value of the local currency. The purchasing power of the Naira plummets, inflation occurs, and everyone suffers.

Fig. 8. Foreign investment has flocked out of Nigeria since 2014. [16]

Fig. 9. Nigeria’s GDP has been anything but steady since 2013. [18]

After taking such a damaging hit, one would expect the Nigerian federal government to remain fairly cautious when construction the next budget. Sadly, this has not been the case: at 7.3 trillion Naira, projected expenditures for 2017 are larger than they have ever been. The government hopes to commit hundreds of billions of capital to repair oil infrastructure, bolster the military, and stimulate other areas of the economy. In order to provide the revenue to execute its goals, the government expects about 2 trillion Naira solely from oil. It even gives the assumptions necessary for this to hold true: 2.2 bbl/day, an exchange rate of 305 ₦/$, and a GDP growth rate of 2.5%. [16] Meanwhile, the current exchange rate of 316.5 ₦/$ is already above expectations, and only last month, oil production sank to 1.2 bbl/day, as Shell and Chevron were forced to close pipelines for repairs. [24] All this being said, Nigeria expects a fiscal deficit of 2.4 trillion Naira, or an additional 1.19x the amount of current oil revenue. [16]

Fig. 10. Even with optimistic assumptions, Nigeria expects a deficit of more than two trillion Naira. [16]

Many governments with developed economies can cheaply raise money from the bond market; however, Nigeria does not have that luxury. All three credit rating agencies (Moody’s, S&P, and Fitch) have downgraded Nigeria’s debt to non-investment grade and have given it ratings that indicate to lenders that Nigeria is likely to be unable or unwilling to repay the debt in full. [27] In many emerging markets, such a credit rating does not imply the same difficulty in obtaining funds because of aid from the International Monetary Fund (IMF), World Bank, or other such institutions. Yet, in Nigeria’s case, both the IMF and World Bank, along with the African Development Bank, have refused to loan the country additional funds because they are not satisfied with Nigeria’s economic plan for recovery. [15] A rise in the yield of the government’s 10-year bond also indicates that the country is a less trustworthy debtor. [20]

Consequently, Nigeria was forced to turn to the bond market and pay a hefty price. In February 2017, Nigeria sold a bond worth $1.5B, an amount three times greater than its current bonds maturing in 2018, 2021, or 2023, and agreed to pay a coupon of 7.875%, also higher than any of its other bonds. [23] This means that the country will have semi-annual payments of $59.1M for the next fifteen years before paying the $1.5B off in full. Considering that it has coupon payments for its other three bonds in addition to the $500M in maturities from each of those three bonds expiring in the next six years, it is fair to wonder if Nigeria will default and hinder its ability to obtain additional financing at a reasonable rate in the future.

Fig. 11. Nigeria has had to pay a higher price to raise debt than at any point in the past. [23]

 The debt that Nigeria has taken on has significant risk. Owing to the volatility of the Naira, the government was unable to secure debt denominated in the local currency. Thus, foreign investors have purchased debt denominated in dollars and euros. [23] When the transactions that contribute to revenue occur in a different currency than the debt of a country, the debt becomes highly sensitive to global interest rates and currency fluctuations, since the government must exchange currency to repay the debt. Many financial analysts expect the dollar to appreciate, a move that would make it all the more difficult for Nigeria to repay its debt. This is due to a combination of scenarios on the horizon in the United States, such as the Federal Reserve raising interest rates, which it is almost certain to do (they have provided guidance for two more rate increases this year alone), especially considering that rates were at an all-time low for the half-decade after the financial crisis. [30] Moreover, the new White House administration and Congress project an increase in fiscal spending, spurring demand for loanable funds and sending those yields higher. Lastly, the creation of a border-adjusted-tax will boost the entire U.S. economy, sending exports higher and triggering capital expenditures. Foreign countries will likely buy more U.S. goods, increasing demand for the dollar, causing it to appreciate. As mentioned earlier, the dollar has already appreciated a vast amount (67%) against the Naira; any additional one-sided fluctuation would worsen the debt situation in Nigeria a great deal.

Nigeria’s recent bond offering was denominated in euros. It just so happens that analysts also expect the euro to appreciate. The future of both the Eurozone and its currency were in jeopardy entering 2017, but recent geopolitical events have been able to ease the tension. In Netherlands, the far-right party led by Geert Wilders threatening to exit the Eurozone was defeated in elections held in mid-March. On April 23rd, the first round of France’s presidential election provoked a run off to be held in early May between the top two candidates, where most pollsters expect the nationalist, anti-Euro party of Marine Le Pen to be defeated. Both results caused some of the dark clouds surrounding the future of Europe’s unity to recede after Britain’s exit of the Eurozone in June of 2016 unleashed fears throughout the continent. With investors more certain of Europe’s, and thus, the euro’s, future, the value of the euro has been on the rise. In addition, interest rates across Europe have also been suppressed, and the European Central Bank has kept key rates below zero for several years as a form of monetary stimulus. Most expect this stimulus to end in the near future, pushing up rates across the globe.

Futhermore, central banks are expected to end their policy of quantitative easing. Quantitative easing was created after the financial crisis to stimulate the economies of developed nations, whereby the central bank of each country or zone purchases enormous quantities of sovereign bonds. This tremendous increase in demand for these bonds pushes up prices, putting downward pressure on yields, since bond prices are inversely related to yields. In recent statements published by the Federal Reserve and European Central Bank, they have indicated a willingness to unwind these massive purchases. [30] Doing so would decrease demand for the bonds, causing yields to rise. When the value of U.S. Treasury and European sovereign bonds waver, there is a chain reaction across the globe. The rationale is this: if investors are charging a higher yield (such as 2-3%) to purchase debt of developed nations, they must charge an even higher yield (like 6-10%) for more emerging economies with less creditworthiness. Therefore, however unjust it may seem, countries like Nigeria will have to pay even more to raise money when the U.S. and strong European countries see a rise in the yields of their bonds.

Fig. 12. Quantitative easing measures have put a ceiling on sovereign bond yields that is sure to lift in the near future. [2] [7] [9]

Fig. 13. Nigeria’s sovereign bond has already felt the rise of global interest rates. [18]

The NNPC has also seen difficulties staying in the green. On April 20th of this year, the NNPC announced that they had reached a settlement of $5.1B that they are required to pay to international oil corporations Shell, Chevron, Exxon, Total SA, and Eni SpA. The NNPC creates joint ventures with these companies, employing them and using their infrastructure to pump the country’s oil, and the NNPC had not fulfilled the capital contribution obligations set forth in the contracts. Luckily, the settlement is structured so that the debt will be interest-free and will be paid from a percentage of future crude sales; however, the debt installments begin in April 2017 and represent another hurdle arising from the oil crisis. [25]

One potential solution for Nigeria is to mimic the direction of Saudi Arabia. Just like Nigeria, Saudi Arabia’s economy is incredibly dependent on oil, and its revenue has been used to provide extensive subsidies to the people, provide steady, high-paying government jobs, and keep the Kingdom’s reserves flush with cash. Similarly, the collapse of oil prices delivered a wake-up call to the government, who has realized the need for economic development outside of the oil industry and also faces an extreme budgetary deficit and restructuring issues. In addition to turning to the bond market, Saudi Arabia is planning an initial public offering (IPO) of a five percent stake of the Saudi Arabian Oil Company, or Aramco. Initial valuations of the company are approximately $1.5 trillion, meaning that issuing five percent would raise $75B before brokerage fees. [28] This would triple the previous largest IPO (Alibaba) and could set a precedent for other sovereign wealth funds dependent on oil. Not only could Nigeria generate a huge source of funding by offering a piece of NNPC to the public, but allowing outside investment into the state-controlled business could spur additional foreign investment into the struggling economy.

Aside from its budget, Nigeria has other issues requiring immediate attention. Thousands of oil spills have gone unaddressed, causing almost irreparable damage to the environment. [14] According to a report released by the United Nations in 2011, before the plethora of explosions set off by the militants, a full environmental restoration could take thirty years, requiring $1B in the first five years alone. None of that has commenced, and the air, water, and soil have only gotten more contaminated. [5] The economy is pitiful with regards to its dependence on oil, and President Buhari and his ministers have developed what they call a Zero-Oil Plan, whereby Nigeria will target growth in other sectors to achieve $100B in non-oil exports per year (the country currently has $5B annually in non-oil exports, but the optimism is appreciated). [21] Unfortunately, the plan calls for increases in palm oil, soybeans, and cocoa exports, and while palm oil is harmful to the environment, the soybean and cocoa markets are flooded with supply, and their prices are depressed worldwide.

For all the clouds surrounding Nigeria’s future outlook, it appears as though they have the right leader to carry them forward. President Buhari wrote an article for the Wall Street Journal where he accepted that the days of high energy prices are in the past, called for an end to corruption and the restoration of trust in the government, and expressed the need to regenerate growth in the private sector and rebalance the economy. [29] After uniting the country and eliminating the violence and factions between Boko Haram as well as the Avengers and other militants, it is hopeful that Nigerians can come together to repair their national identity. As for the economy, Nigeria can reasonably expect a bounce back in oil revenue; yet, $50/barrel is the new norm, and the government is irrational to believe it can maintain the same expenditures or economic plan as it has had in the past. Where they will start and where they can turn to plug the holes in their budget are uncertain; what is certain, though, is that unless Nigerians can work together to address the present, future, and, most importantly, past, the country will be in turmoil for the foreseeable future.


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