The Paradox of Oil and the Tragedy of a Mono-sector Economy

Its Implications for Nigeria and the 2015 Presidential Election
by G. Solomon Osho, PHD
Feb 2015

As Nigerians head to the polls to participate in the 2015 presidential election, it is widely believed that the country, the sixth largest oil producing country in the world, is at a crossroad as it currently faces myriad of problems ranging from insecurity in the Northeast-Boko Haram to economic crisis as recession looms and as the value of its currency begins to free fall due to new dynamics in the global oil market. Therefore, this presidential election would most certainly define signs of more things to come. This three part series will attempt to elicit some major frontline challenges in the nation both in the near term and in the long run.
Part I: Oil, Global Market and Nigeria
Over the past few months, the world has experienced a continuous sharp and significant drop in oil price. More importantly, gas price has asymptotically approached zero cents in the global oil market. This is due in part to several emerging factors; chief among them is hydraulic fracturing technology commonly called fracking: a well stimulation technique that uses fluid and material to create and restore small fractures in a reservoir formation to stimulate production and enable increased productivity from new and existing oil and gas wells. It also allows for the recovery of oil and gas from formations that petroleum geologists once believed were impossible to produce, such as tight shale formations. Furthermore, the United States which is both the largest importer and consumer of global crude oil has begun to reduce its over reliance on foreign crude oil, partly due to its Strategic Petroleum Reserve (SPR) Policy. In the past four years, U.S. oil and gas production has almost quadrupled especially in states like Texas and North Dakota where fracking has become an evolutionary phenomenon.
Crude oil which was once the most critical and scare commodity in the U.S. and the fuel of its economic engine is now in abundance for local consumption and now available for export. This has created a new global oil price order. This new price order is most likely here to stay. To explain this new price phenomenon, classical economic theory of the law of one price implies that the price of a commodity remains relatively the same globally and the difference is the transaction cost. Hence, as the U.S. continues to increase production, the excess crude oil is dumped into the world market which in turn increases the world supply and its final results are a continuous downward pressure on the global market oil price. Assuming the global oil and gas demand remains relatively the same, this downward pressure in global oil price posits a significant problem for oil revenue dependent countries like Nigeria.

In 2014 alone, oil price has fallen by about 50 percent and the question is: has oil price now reached the bottom?

As the global oil price plummets to its lowest in over five years, another oil revenue dependent country-Saudi Arabia has begun a dual strategy of increased production and crude oil export and drastically cutting the price of its crude oil in the U.S., a clear approach seen by many in the market aimed to choke off the U.S. shale boom, with the hope of frustrating oil producers in the U.S. and creating a condition that could lead to decline in oil production within the U.S. Also, Organization of Petroleum Exporting Countries- OPEC strongly believes that by driving down oil prices, U.S. oil production will collapse.
More so, in the past few weeks, U.S. crude or West Texas International shares have begun to fall gradually as profit from fracking slowly begins to decline and hence fear now percolates the world oil market. However, the full effect of this strategy is yet to be clearly seen and is still debatable.
In light of this dynamic changes in the global oil market, while the Saudis, the largest and most powerful producer among the OPEC members, and others within OPEC have been repositioning and restructuring their economies to absorb and withstand external shocks like the tumbling oil price, Nigerian government is presuming an increase in oil price for its 2015-2017 budget years knowing that one of the major problems in its oil revenue is the increased oil production in the U.S. By most standards, this proposed budget should have been dead on arrival!
Nigeria’s oil supply to the U.S. was the major bulk of its export revenue. In the past decade while oil price averaged about $100/b, Nigeria greatly benefited from this oil windfall and oil accounted for over 90-95 percent of its exports while at the same time contributing about 90 percent of its annual budget revenue. However, as the oil price weakens and the oil production in the U.S. increases, the U.S. oil import from Nigeria has significantly reduced from about 1.5 mb/d in 2006 to about 0.2 mb/d in 2013 and by the early 2014 the U. S. completely stopped oil import from Nigeria. The resultant effect is the sudden erosion of the nation’s trade surpluses and depletion of foreign reserves.

Simply put, has Nigeria arrived at the dead end? As Americans will say: waiting for a dead meat!

G. Solomon Osho, PhD is an applied economist and a professor of quantitative methods at Texas A&M University System. He serves as a principal consultant at Limitless Management Consulting Group (LMCG) and a director at the Nigerian Center for Alternative Thinking and Strategic Studies (NCATSS). His research-consulting has directly influenced and contributed to knowledge in strategic management and public policies especially towards the oil & gas and natural resources industries.