Lau Lau Fiscal Policy

The boom, not the slump, is the right time for austerity at the Treasury – John Maynard Keynes, 1937

Money is sweet to spend, especially when it’s other people’s money or it has ‘no owner’. A couple of months ago, I wrote about how Nigeria has been in Boom Time for the last 4 years with oil prices consistently above $100 per barrel since the current government came into office.

Given that Nigeria really has no say in the global oil markets – we cant really deliberately affect prices to our own benefit – the time was bound to come when the party music would stop. It appears that time has now come.

Here’s what the story of oil prices in the last 1 year looks like:

Crude Oil

It’s not yet a disaster of course; in theory it’s still above the price we based our budgets on this year ($79), assuming you believe the difference is being saved somewhere. The reasons for this fall in oil prices are numerous and beyond the pay grade of this blog but we can take one useful one:

(Reuters) – Saudi Arabia is quietly telling oil market participants that Riyadh is comfortable with markedly lower oil prices for an extended period, a sharp shift in policy that may be aimed at slowing the expansion of rival producers including those in the U.S. shale patch.

Some OPEC members including Venezuela are clamoring for urgent production cuts to push global oil prices back up above $100 a barrel. But Saudi officials have telegraphed a different message in private meetings with oil market investors and analysts recently: the kingdom, OPEC’s largest producer, is ready to accept oil prices below $90 per barrel, and perhaps down to $80, for as long as a year or two, according to people who have been briefed on the recent conversations.

The discussions, some of which took place in New York over the past week, offer the clearest sign yet that the kingdom is setting aside its longstanding de facto strategy of holding prices at around $100 a barrel for Brent crude in favor of retaining market share in years to come.

The Saudis now appear to be betting that a period of lower prices – which could strain the finances of some members of the Organization of the Petroleum Exporting Countries – will be necessary to pave the way for higher revenue in the medium term, by curbing new investment and further increases in supply from places like the U.S. shale patch or ultra-deepwater, according to the sources, who declined to be identified due to the private nature of the discussions.

All the Saudis need to do to make that happen is to ignore OPEC and pump more oil until prices drop to the level they want. This is a high stakes game and the Saudis are battling for their own future. Aside from Shale Oil in America which threatens them, there are other long term problems they are trying to avoid as well:

After plunging below $35 during the 2008-09 recession, the price of Brent had recovered to $128 a barrel by spring 2012. The oil firms responded by pouring cash into all sorts of projects, from American shale to deepwater fields in the tropics. Analysts at EY, a consulting firm, estimate that the world’s energy companies are currently bankrolling 163 upstream “megaprojects”—those costing more than $1 billion apiece—worth a combined $1.1 trillion dollars. The majority, EY found, are over budget and behind schedule. Most big projects have been planned around the assumption that oil would stay above $100—a notion that in recent years has become an article of faith in the industry

My favourite economist, Thomas Sowell (as you may have guessed), likes to say that the amount of oil available in the world is determined by the ‘cost of knowing’. If the price of oil is high enough, people will go to the strangest places to look for it – the oil in Kurdistan is obviously a lot easier to pump from the ground than the one in Canada’s Tar Sands. Because prices have been so high for so long, people have been emboldened to go out and spend insane amounts of money looking for oil – the Kashagan oil field in Kazakhstan has so far cost $43bn (original budget was $13bn) and the oil hasn’t started flowing yet. If and when all these investments start to pump oil, then the Saudis would be in big trouble. This is what they are guarding against – they are trying to raise the ‘cost of knowing’ as high as possible so no one is crazy enough to go and start looking for oil in strange places.

This game is not for little children as you’d imagine. But what has Nigeria been doing all this while? Well, we know there’s hardly been any new investment in Nigerian oil for a while now due to uncertainty over non passage of the PIB and general persistent anyhowness.

We have also been spending the money in a Lau Lau manner. None of this is new of course, which is what makes it even more depressing.

Screen Shot 2014-10-14 at 11.06.50

I took the chart above from the excellent book – The Oil Curse by Professor Michael Ross. From 1969 to 1977, the price of oil increased by just under 400% while the amount of crude oil Nigeria produced in that same period increased by 380%. In dollar terms, Nigeria’s revenues went from $4.9bn to $21.5bn, adjusted for inflation. And yet, you can see how the government was growing faster than the economy in that same period from the above chart – government share of the economy more than doubled in the period.

One of the lovely things we did with the money in that period was the Udoji Awards. All that money was coming in and no one knew what to do with it, so we did the tried and tested thing – salary increases for everyone!:

Screen Shot 2014-10-14 at 11.27.47

We have a long history of Lau Lau fiscal policy in Nigeria, so one might expect that any government today would try to avoid toeing the same path. Listen to what Ngozi Okonjo-Iweala said last year in November:

The finance minister noted the factors that contribute to the rise in recurring expenses to include the very high salary increase that was agreed for public servants in 2010.

“A very high salary increase was agreed at 53 percent for public office holders. This singular act raised salary figures from about N800 billion to about N1.7 trillion,” she said

Right at the start of the oil boom, we were already spending the money. Part of the reason for that astronomical increase in recurrent expenditure was the minimum wage increase from N5,500 to N18,000 in early 2011. It’s easy to think that this was just about minimum wage but the clever thing that the NLC did was to get Goodluck Jonathan (who wanted to get elected) to agree to maintain the gap between the bands after the minimum wage increase. Say you were earning N16,500 when the minimum wage was N5,500. After the increase, your salary went up to N54,000. Everybody got a pay rise not just the lowest paid.

And the spending on salaries has not stopped. Everyone demands and gets something. Take this gem from earlier this year as another example:

Pension stipends received by professors and permanent secretaries will be augmented by the Federal Government when the new Pension Reform Act is eventually passed into law, investigation has revealed.

This development will enable them to continue to earn their full salaries in retirement even when they don’t have enough funds in their Retirement Savings Accounts, unlike other retirees under the Contributory Pension Scheme.

To be fair, GEJ will be enjoying his retirement in Otuoke by the time the full bill for this one comes in but it’s the little things that add up.

All of this brings us to where we are today. Heavy domestic borrowing with so much of government spending being financed ‘off balance sheet’ through grants and cheap Chinese loans. Major infrastructure projects are also being financed with private sector borrowing. The government does not seem able to ‘shake body’ and drop $1bn on a project. Jonathanism – the ideology which posits that it is possible to describe a bungalow as a skyscraper – is now going to be seriously tested.

Over the weekend the Finance Minister made the following statement in Washington DC (emphasis mine):

She however said government will definitely not borrow to finance its expenditure. “There are three ways we can manage this; you can either go outside and look for resource, but we are not planning to do that. So I just want to make that clear. That is the pride we have. Ever since we have been managing the economy, we have not done that.
“What else we have to look at is our revenue and expenditure side to see how we are prepared. There are already some good news, because we are already ahead in trying to bring out some extra help from FIRS, we gave a target of half a billion dollars (N750bn).  I’m happy to announce to you that they have already hit N800 billion as at the end of the July.
“So we have to go back and encourage them even more, that is one of the measures to take. The other ways are on the expenditure side and this is where we have to plead; this is not a situation created by any one of us but all Nigerians should see openly, something that the DG Budget and I have been saying for quite some time is we have to be very careful to build up what we call a buffer. All of you know the buffer we have as excess crude account. We have to build it up so that if we experience any shock we can now use it.

I always remember being in church and Dr. Okey Onuzo preaching that anytime you open your mouth to make a strong vow, all the demons that were previously bored and fast asleep suddenly wake up excited at finding someone to test. Saying you ‘definitely’ wont borrow is a strong vow to make indeed. I also like her use of the word ‘encourage’ when what she really means is that we are going to send FIRS after Nigerians and businesses to collect as much tax as possible so we can continue to pay it to civil servants. And is it now that oil prices are crashing that you want to ‘build up’ the reserves?

This is the story of how so many countries become ‘customers’ of the IMF – they ignore Keynes and spend like there’s no tomorrow. Well, tomorrow is almost here.

And I did not mention corruption at all.

FF

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11 thoughts on “Lau Lau Fiscal Policy

  1. In view of the crashing oil prices and the impending impact, 2 battles NOI has recently fought (or still fights) come to mind: 1. Creation of the SWF: let’s hope the governors and the APC who are still opposed to the SWF will see reason now. Ideally, the ECA should have been scrapped with proceeds transferred to the SWF. But our SWF still remains a $1b fund (save for the additional $500m being managed on behalf of NBET or so)

    2. Budget Benchmark: over the last 2 budgeting cycles, the Finance Ministry has consistently pushed fro lower benchmarks but our legislators would rather have it higher. I recall how they were all applauding Tambuwal at the joint sitting of both houses to pass the last budget when he was insisting on higher benchmarks to finance infrastructure. I guess they also know better now.

    In any case, this might ultimately be a blessing in disguise. GEJ/ NOI or whoever comes in to manage the economy has no choice but to tighten things up. And one more thought – should the APC come in, how do they plan to fund the social welfare scheme they’ve promised in the party’s manifesto in the face of declining revenues?

    1. Let’s not waste time on hypotheticals…the only APC going near the presidency will be an Armoured Personnel Carrier 🙂
      GEJ will be reelected and will have 2 very different terms.

      And yes I agree – the NASS have been the biggest instigators of higher benchmarks. They, along with the governors, simply want to spend everything

  2. My observation (more like confusion):
    1. Comparing the first part of the 6th paragraph, where you quoted Sowell:
    “If the price of oil is high enough, people will go to the strangest places to look for it – the oil in Kurdistan is…” and the part you stated what the Saudis are doing:
    “This is what they are guarding against – they are trying to raise the ‘cost of knowing’ as high as possible so no one is crazy enough to go and start looking for oil in strange places.”
    Do you mean “they are trying to LOWER the cost of knowing”?

    2. The numbers quoted from NOI (which are not yours) seem confusing too:
    “…half a billion dollars (N750bn)” Is this supposed to be “Half a Trillion (N500bn)”?.

    Good work…

    1. They are trying to raise the cost, definitely not trying to lower it. You see, cost of exploration and production especially for crude reserves such as shale oil, ultra deep water, tar sands etc are very high and can only be economically sensible if crude oil prices are high. However when prices are low, then it doesn’t make much sense to spend so much on looking for unconventional oil.

    2. The cost of knowing is another way of saying the cost of exploring and pumping out the oil.
      Obviously this cost varies from place to place but as long as the price of oil is high enough, why not?

      Think of it this way – cost of knowing, $50. Price of oil, $100. In that case, cost of knowing is 50% of revenues.
      If oil prices drop to $80, cost of knowing becomes 63%…until it gets to 100% and you realise it’s not worth knowing if there is oil in the arctic or not.

  3. These things are not this simplistic or straightforward. The refusal of the Saudis to cut supply for instance is not one of the reasons for the fall in oil prices , it’s more of a strategy to keep oil prices from rebounding. The falling oil prices are majorly down to a supply glut, weakened demand in the EU & Asia and some of it to market sentiments.

    Of course Saudi has historically been a swing producer, but there has been some recent fundamental changes in oil dynamics. The current global crude oil supply glut is in part largely from light & sweet oil from US shale & increased output from Libya whereas Saudi and other gulf countries produce heavier & sour oil. These oil types end up in different markets & refineries, so one cannot easily replace another. In 2011, after supply disruptions from Libya, Saudi increased production but that was not enough to lower oil prices. This is because the disrupted Libyan supply was light sweet crude, and refiners who needed it could not replace it with heavier & sour oil. It is also not absolutely certain that if Saudi & OPEC cut supply, there will be a serious effect in halting the falling oil price; in the short term most likely, when market sentiments set in, in the long term, maybe, maybe not.

    Moreover, the Saudis do not have really an incentive to cut supply. They’re keen to maintain market share in the face of growing supply from the US & other producers. Also US oil imports from Saudi increased in recent months, even though total imports to US is declining and is now zero from Nigeria. Again, US shale supply glut is light oil, majority of US refineries especially in the gulf coast process heavy oil.

    Also, it is not necessarily true that the Saudis are trying to raise the ‘cost of knowing’ as high as possible so no one is crazy enough to go and start looking for oil in strange places. To some extent, it may be true that Saudi will for instance want oil prices to decline further to slow down the supply growth from US shale oil, but even that is debatable. How far can they go? There are arguments that many of the current US shale growth can still be sustained at a breakeven oil price at $60+. Plus all oil companies & oil producers like high oil prices.

    In essence, changing times demand different strategies. That perhaps was why Saudi unusually cut their oil price in Asia even in the face of falling oil prices. If the supply glut was heavy oil, the Saudis probably would have reacted differently.

    Meanwhile, hope those blockheads in the NASS will now realise that laulau doesn’t last forever!

    1. Not sure I get your point?
      You wont find any serious oil analyst saying the fall in oil prices is down to one reason…there are a variety of reasons and I did say above I only chose one of them.

      I’m not sure you can say the Saudis don’t want to do what they are doing and when they have admitted that they can tolerate $80. Some shale wells cost $53, some cost $100.

      Nothing simplistic here…just pointing out that oil prices can drop lower and those who have the power to change that have different incentives this time around

  4. Sure falling oil prices is not down to one reason, but the Saudis refusing to cut supply is not one of them. It is more of a reaction to (not a reason for) already falling prices. However, Saudis cutting their price in Asia is one of the things that further contributed to falling oil prices.

    I agree Saudis want to do what they’re doing but for different reasons, not necessarily because they want to “discourage” high risk oil prospecting. Plus it’s not certain that an $80 oil price will significantly impact shale oil supply in the US, different analysts say different things. A lot of analysts have said that the established companies driving the US shale oil boom have breakeven price around $60. The IEA in a recent analysis say that just over 4% of US shale oil production this year have breakeven price above $80.

    In fact, the shale oil boom in the US has not had direct adverse effect on Saudi oil so far, as it has adversely affected supply from North & West Africa. That doesn’t mean the Saudis will sit easy because other things might change the dynamics in the future e.g. significant light oil export from the US or retrofitting of US refineries to handle light oil.

    Yes oil prices will likely drop lower than they already have but it’s emerging that those who used to wield significant leverage in the past no longer wield that much power because of changing oil market dynamics.

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