Oil Price Tectonics and Global Economic Recovery

The Rise before the Crisis ... Pagel

The Rise after the Crisis ... Pagel

Could the Rise in Oil Price Impede Growth?

Page 2

The Rise before the Crisis ...

How Does it Affect Oil Producers?

Page 3

Oil price reached a record peak of $147.27pb on the back of growth and strong demand in India and China. They crashed to a lowof $33pb in December 200S, but have since rebounded.

Implications for Nigeria Page 4

Oil Outlook Page 5

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After the crash experienced in 2009, oil price relentlessly recovered to about $74pb by 2009YE. It hit $S2pb on 12 April 2010. The rise in price seems to be driven largely by speculation rather than market fundamentals as investors seem to be using oil as a store of value rather than as a commodity.

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Given that the global economy is yet to fully recover from the effect of the economic crisis, there are indications, though, that global oil consumption is running behind supply. Hence, one expects oil price to be falling, given supply-demand dynamics.

So why is oil price trending upwards?

The answer, according to Peter Beutel, an oil analyst at Cameron Hanover, is that investors are driving the price of oil not the people who use it.

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Oil Now a Hot Financial Instrument.

"I nvestors seem Ito be using oil as a store of value rather than as a commodity ... u

1 H u g.e tl Dod of mo ney ceusln 9 tea r of

into the sys'tem pO.$:t.ib~e inflation

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qua ntitative easfn g

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us. I nercasi ng borrowing

Leading, to 'Norrie:;; about the lcnq-term vi;llue of the U5 Do~I",

Us.ingl oil as a hedge a.g.ainst futurl;! [lQll.al' losses ..

Could the Rise in Oil Price impede Growth?

Oil price is asymmetric in nature. This means that oil price increases have a dear negative impact on economic growth while oil price dedi nes do not affect economic activity sig n ifica ntly,

The asymmetric mechanism between the influence of oil price changes and economic activity can be captured in two models; the real balances model and the potential output model.

The Real Balances Model (RBM) postullates that oil price increases lead to inflation which lowers the quantity of real balances in the system. While the Potential Output Model (POM) suggests that oil and capital are complements, so that an increasing oil price decreases the economy's prod uctive capacity.

Generally, significant increases in oil price can induce a drag on activities of economic agents, including investments and consu mer spend ing.

ln a free market, increases in oil price may reduce purchasing power of consumers (RBM), especially for oil-importing countries. This often causes abrupt drops in consumer sentiments, leading to pos tponement of purchases and hence decline in spending.

For industries, rising oil price will increase cost of production (POM) which will be transferred to consumers throuqh increases in the prices of goods. This wil I negatively affect agg regate dema nd.

The fall in demand by consumers and the increase in the cost of production will reduce marnufacturers'/producers' profit which

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may prompt them to cut jobs (resultinq in rising unemplloyment). As the output gap widens and both consumers and producers adjust to the changes, the prospect of economic expansion is hindered.

The transmission mechanism:

ation (rise in cost of food! goods/trans port)

• Overall productivity reduced

• Unemployment rate increased

• Growth rate reduced

How Does it Affect Oil Producers?

An oil price increase leads to a transfer of income from importing to exporting countries tlhrouglh a shift in the terms of trade. The mag n itude of the direct effect of a given price increase depends on the share of the cost of oil in national Income, the degree of dependence on imported oil and the ability of end-users to reduce their consumption and switch awayfmm oil.

For oil prcducinq countries, a price increase directly increases national income throuqh hiqher export earninqs, though part of this gain would be later offset by losses from lower demand for oil exports generally due to the economic recession suffered by importing countries.

However, if the recent oil price surge is not driven by market dynamics, but is as a result of oil futures trading (speculation by investors) then it could result in oil price volatility. Given that oil revenue is a critical source of fiscal revenue for oil producing countries, oil price fluctuations would have significant negative effects on tile fiscal position of the countries. The volatility of oil

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price is transmitted into vollatility in the actual government spending stream, which can lead to difficulties in managing fiscal programmes and budgeting process (based on estimates of average oil price).

Meanwhile, the perceived adverse implications of the swift upward movement in oil price has driven oil producing countries to meet in Cancun, Mexico for the International Ener'gy Forum to map out a strategy for keeping prices from risinq higher, discuss energy supplies, and environmental as well as financial issues that affect both 0~1 consuming and producing nations.

implications for Nigeri'a

The rising oil price has mixed implications for Nigeria asan oil producer/exporter, as weH as importer of refined petroleum products. On the positive side, it would increase external reserves and funds available for government spending, if output stays high. However, the impact on aggregate commodity prices, overall cost of production for companies and industries could eventually slow down economic acl:ivities.

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Oil Price and External Reserves

The g;lobal economic crisis resulted in a precipitous decline in external reserves in 2009, attributed mainly to the fall in oil price and output leading to declining oil revenues.

60 40 20 o

During tlhe perioc, Nigeria's capital inflows and foreign direct investments dropped drastically, resultinq in the need to draw down on external reserves to maintain fiscal spending and sustain business activities in the country.

The decision of the CBN to defend the Naira around N150/US$, coupled with crude oil being produced below FG's target, caused depletion of our external reserves as shown in Chart 4.~the downward trend of tile external reserves experienced since 200.9). However, between Sept. - Dec., 2009 when prospects of global economic recovery intensified, oil price averaged US$74/barrel resulting in sharp rise In external reserves (see Chart 4). The oil price increase experienced in 01 2010 is yet to boost external reserves due to CBN's strategy to defend the Naira and support its stability.

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Implications for Nigeria continued ...

Below is a schematic of the likely impact of rising oil price on the Nigerian economy.

Via, refined product import

•

Oil price increases

Ri.sing transportation costs resulting in rising food/goods/services

Boost f'xternal reserves

...

Increase Investor confidence resulting in increase in foreign investment and capital inflows.

... business activity in the economy.

Oil Outllook

The Organisation of Petroleum Exportinq Countries (OPEC), in its latest monthly Oil Market Report projected that oil demand would grow by 900,OOOb/d in 2010. This is an upward revision of 100,OOOb/d from OPEC's previous assessment. lin 2009, oil demand contracted by1 .. 4 million bpd.

Future oil demand is hilghly dependent om the pace of the global economic recovery {forecast for global economic growth Tor 201 a is 4.2% according to the IMF).

On itne downside, the high unemployment rate, coupled with the current high public debt and risk of sovereiign debts default due to massive government-led stimulus packages have raised concerns a bout sustainabi I ity of the recovery.

Oil demand has remained robust in emerging markets. especially in China but the risk to a sustained rise in oil demand stems from China's planto avoid an overheating and curtail growth.

As the winter season comes to an end, weather-driven demand for crude oil is likely to fait however, with the rising Asian demand for oil (i ncreasing by more than 2 mi Ilion barrels per clay), prices are expected to cantin u e to rise i n 02 201 O.

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Major institutions like the International IEnergy Agency (lEA) and Barclays have projected strong demand for oil in the near future Specifically, Bardays forecasted that oil prices would likely stay in the US$SO-IUS$90 range.

From our experience, oil price is volatile and may move within a wide range in a relatively short period. Unlike conventional demand and supply fluctuations, oil demand is more price-elastic

and more responsive to certain risk factors like potential uncertainty in major oil producing countries, subdued manufacturing data and government pronouncements in oil-exporting countries.

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Given market conditions, we expect oil price to be in the range of US $82 -US$85/barrel forthe rest of 201 A..

For-@nq:u i ri~, oarrtact: Dr. f: m manuel Moo r~ Ab-o 10 (O"j,ei E cor-em ist) (01 ) :2 7 1 21 23 @mmanucLaboloc@a.r:CE,ssbilllkplceam or t.J nenrta Aja-Ol::mi ~ (01 } 1 :2 71 201 5 n nena _ af iII-o",ori~;J cccssb.a n kplc. com

Djsclaimer

This report is based 001 information obtained from various SOl1rCeS believed to be reliable a"d 110 representation is made that it is accuratecr complete. R"asDn,able car" has been taken in preparing this document, Access Bank Pic shall not take respDnsib,ility Dr liability for any errors or fart orfor any opinions ~xpr.~s<~d h~r~in This document is. for information purposes and for private circulation only, and may net be reproduced, distributed or pinblished by any recipient for any purpose without prior express consent of Access Bank Pic

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