Market Sentiments, the Oil Price and the Naira’s Exchange Rate, By Ifeanyi Uddin
Two developments (the first, over the last three weeks, and the other, work in progress of sorts) underscore the role that sentiments could play in driving divergence between the actual direction of a measure and the trajectory suggested by its underlying processes.
Global oil markets have recently presented us (denizens of oil-exporting economies, whose public finances are burdened by and currently labour under much lower oil prices) with the possibility of a price recovery. From around US$42 per barrel (pb) early January, oil now sells for about US$60pb.
What has changed, and by how much, since the heady days when predictions were of the bottom falling out of the oil market, and a bloody cull of marginal producers?
The rig count, for starters. Last week’s drop (Bloomberg reports US drillers idled 48 rigs — 37 of them oil rigs) was the 11th consecutive weekly drop this year, bringing the number of mothballed rigs to 1,310 since the oil price tanked. The rig count matters in the context of rigs being the major production piece in oil exploitation. As rigs fall, drilling should fall off, and with drilling activity slowing, much less oil should be produced.
Add to this, the fact that across the sector, oil exploration companies are reportedly cutting down on their capital expenditure budgets, and the Organisation for Petroleum Exporting Countries’ (OPEC) bid for market share, which lies at the heart of the current crisis in the oil market looks like being fulfilled. Recall that OPEC had argued for lower prices as part of a process of throttling marginal producers whose expensive operations was made profitable by high oil prices, but who were likelier on account of lower prices to leave the markets first?
Peek a little under the headlines, though, and the picture barely concealed beneath all the new guff is far more nuanced. Only last week, the (US) Energy Information Administration forecast that United States’ production of the black gunky stuff would top 9.3 million barrels every day this year. This is much more than the US did last year, and the highest it has produced in four decades. It helps to add that product at this level puts the US at the head of the global log of oil producing nations.
A rise in the number of decommissioned oilrigs. Rising US oil production. Recovery in crude oil prices. Arguably, the arithmetic does not add up. Especially when demand is far from back up. The US remains the only healthy economy today. Emerging markets labour under the prospects of continued recovery in the US feeding off capital that ordinarily would have headed their way. Output in the euro area is not likely to be headed anywhere soon, distracted, as policy makers there are by the game of chicken they are playing with Greece (on the economic front), and with Russia (on the political one).
Growth in China slowed last year, and is projected to soften further this year. Most China-watchers do not expect growth to resume there until the authorities successfully manage their efforts to redirect the growth engine from exports to domestic consumption. And may be, not even after that. Even with services driving new output in China, it is doubtful that we will see a return to the heady output numbers that described much of the last three decades there.
India? Strong new growth numbers — the Narendra Modi effect? But India is largely a service economy, and its manufacturing base is too small for higher growth to drive the kind of global demand that the Chinese economy was recently accused of being responsible for.
Flat-lining demand. Bolshie supply. Oil prices should be anywhere but up. In the end, this tension is easily explained. Those pesky fund managers, that is why. Their models make the obvious link between falling rig counts, lower oil production levels, and an eventual rise in oil prices, and their traders hit the “buy” button. The buildup of oil inventory associated with the “financialisation” of the oil market explains how much of the 2 million barrels a day excess of supply over demand was accounted for at the height of the oil bull market. Two weeks ago, the EIA reported that crude oil in storage in the US had risen by 7.7 million barrels to 425.6 million barrels, 20% up on the five-year average.
Still, the supply of storage space is finite, as is fund managers’ appetite for the oil punt. The Economist reports this week that “Storage facilities in Europe and Asia are already 80-85% full. Much more and they will overflow. As it is, companies are renting tankers to keep oil in”. On this evidence, oil prices still have further to go, but in a different direction from where they now point.
This leads to the second of my developments. The link between oil prices and the naira’s exchange rate is basic economics in the country today. The central bank only reinforced that link when, last week, it closed down its official foreign exchange sales window. We are not selling enough oil, and thus not earning sufficient dollars to support the central bank’s traditional play in the foreign exchange markets.
However, it would seem to me that the naira is depreciating far more than the fundamentals suggest. Indeed, it has completely ignored the bulls’ recent appearance in the oil markets. How much, therefore, of the demand pressure on the naira is the result of the markets’ worry over the sophistication of our domestic policy responses?
Put differently, have we responded to concerns over the ability of the economy to sustain the naira exchange rate, in our preferred band, in a way that reassures the market that we understand the issues involved, and we have the tools — both fiscal and monetary — to do so?
I do not think we have, or that we currently can. This is why the naira may have further to fall.