Nairaland economists, please enlighten us on the global oil crises and its economic implications by answering the following questions in simple english.

1. What controls the oil price, why does it fall and rise.
2. how does crude oil prices affect exchange rate, foreign reserve and the economy in general
3. If naira is already declining, why are some economist suggesting devaluation
4. Some people have argued that nigerians should be buying fuel at a very low price due to the oil crises, how true is this.

Thanks for responding.

Million barrel questions!

ask your question one by one

1. Demand and supply is what drive oil prices and all other commodities.
OPEC has the largest share of the market, so the cartel simply reduce and increase production to control price. but today we have to many big players in the market. they are US shale oil companies, Russia, Mexico, Canada etc all these countries supply the markets at will, OPEC still has some control because together if they can agree and at least get Russia and mexico on their side they can still put a stop on the current price slide. but right now there is know will among members.
the problem is the fear of the Saudis not wanting to loose market share hence the current price war.

2. because oil is our largest foreign exchange earner, hence as oil goes the naira goes.

3. in this case I think what they are simply saying, is that the central bank should simply let the naira float, let the market decide. the naira held at 196 by the central bank is not a reflection of reality.

4. is not possible in my opinion, because whatever we gained from the fall in crude oil price, we lost in exchange rate difference, this is basically because we still import PMS

1. What controls the oil price, why does it fall and rise.
In simple terms, Demand & Supply. Demand is affected by personal income & substitutes to oil. If the global economy slows down, demand from major economies (US, UK, China, Europe, etc) who are the largest consumers of oil will slow down. Also, as developed countries move towards alternative energy (solar, electric, etc), demand for traditional fossil fuels will drop.

Supply, on the other hand, is influenced by production cost and discovery of more oil reserves. As it it becomes relatively cheaper for countries (like US) to exploit Shale Oil, then they are going to pump out more crude into the market.

There is also another determinant of price - Geopolitical events. As sanctions have been lifted from Iran, they are going to pump more oil into the market - increasing supply. When Supply becomes more than Demand, then Price will adjust to a new (lower) equilibrium.
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2. how does crude oil prices affect exchange rate, foreign reserve and the economy in general
As per Exchange Rate: As oil price declines, major oil exporting countries will see their government revenues and corporate profits decline. The Central Bank tries to compensate for this reduced govt revenue by depreciating the local currency - such that govt revenue in the local currency will be boosted. So, let's say govt has a budget that is predicated on $38pb oil price & N197/$ exchange rate. That translates to a revenue of N7,486/bbl of crude oil. If oil price crashes to $30 and is expected to stay there for long, that will reduce govt revenue to N5,910/bbl of oil. The CBN can then adjust the exchange rate to around N250/$ to enable the govt have N7,500/bbl of oil (i.e. N250 X $30) to fund the budget.

As per Foreign Reserves: A country's FX earnings is usually received into the Central Bank's Foreign Reserves. As the price of oil declines, the FX receipts into the reserves also declines. If the FX demand for imports becomes higher than the FX inflow, then the Reserves will continue to decline. The Central Bank can prevent this by depreciating the exchange rate to curb demand. But in our case, the CBN has chosen to eliminate demand by excluding certain import items on its list.

As per the Economy: For an oil exporting country, most of its economic activities will be tied to oil revenue, from government revenue to corporate earnings. In Nigeria, most banks that have loan exposure to Oil & gas will see their non-performing loans (NPLs) increase resulting in lower corporate profits. Companies directly involved in Oil & gas activities will also experience lower corporate profits. These banks and oil companies usually engage a lot of Service companies. They will cut down on these services to manage cost, resulting in lower corporate profits for these service coys. Most banks and oil related companies may also engage in employee retrenchments to save cost. All these will lead to lower tax revenue (Company Income Tax, Petroleum Profit Tax, PAYE, etc) to government. The combined effect of these activities is a slowdown in the economy and a decline in GDP growth. In extreme cases, it could lead to a Recession. Note that as portfolio investors anticipate these events to unfold, they will flee the country with their capital resulting in a stock market collapse.
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3. If naira is already declining, why are some economist suggesting devaluation
The Naira is only declining at the parallel market. The CBN is still holding it steady at N197 as the official rate. What people are calling for is for the CBN to devalue the official rate to a more realistic and appropriate price (say N240) to help converge the prices at the two markets.
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4. Some people have argued that nigerians should be buying fuel at a very low price due to the oil crises, how true is this.
That argument usually comes from a limited understanding of how the economic dynamics are interwoven in an oil dependent country.

So, let's just use hypothetical figures for purposes of analysis. Let's say oil was selling for $80pb and petrol is imported into the country at $0.5/ltr (i.e. N97/ltr assuming N197/$ exchange rate). If oil price collapses to $40/bbl, then the import price of petrol might reduce to around $0.35. Note that apart from oil price, most other refining cost (like staff, haulage, insurance, shipping, etc) will remain constant so one would not expect an exact movement with oil price and petrol price.

Typically, if the exchange rate adjust to around N250 because of the reasons we explained earlier, then the landing cost of petrol will be like N250 X $0.35 = N88. Clearly, N97 - N88 is not the kind of reduction most people would expect from a reduction in oil price from $80 - $40.

But you might argue that the official rate of the Naira has not changed, so the price should be lower. This would have been so, if the government wanted to maintain the same level of subsidy that existed. Usually, with subsidy, the landing (+ ex Depot) cost is much higher than the recommended pump price. So, while we were buying petrol at N97, the real ex-depot price was around N140. Currently, the ex-depot price is under N85 meaning the government is not subsidizing a dime. N140 to N85 is a fair reduction in price. The government cannot afford to go lower than this, else, if the CBN happens to adjust the exchange rate later, then the ex-depot price might rise up to over N100, either forcing the government to increase pump price or re-introduce subsidy (to maintain price at current level). This is what the former Finance Minister used to refer to as Interest Rate Differential when talking about subsidy payments.

sir, I learnt a lot from this writeup, just that I am a novice ....kudos to u Prof of economics

onojiwizardgmailcom:
1. Demand and supply is what drive oil prices and all other commodities.
OPEC has the largest share of the market, so the cartel simply reduce and increase production to control price. but today we have to many big players in the market. they are US shale oil companies, Russia, Mexico, Canada etc all these countries supply the markets at will, OPEC still has some control because together if they can agree and at least get Russia and mexico on their side they can still put a stop on the current price slide. but right now there is know will among members.
the problem is the fear of the Saudis not wanting to loose market share hence the current price war.

OPEC used to have the largest share of the market. At this point, they probably have 40%.

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OPEC used to have the largest share of the market. At this point, they probably have 40%.

With US Shale on stream, they now control ~30%. If they cut production in a bid to shore up prices, they will loose market share much further.