Ahmed Adamu, PhD
It costs Nigeria $15 and $30 to produce one barrel of oil in
onshore and offshore (deep water) production sites respectively. If the oil is
sold below any of these levels, does that mean the respective production site
will go out of business? The answer is no. Even if the oil price is below the
production cost, you will still produce, despite the loss.
For example, as I write this article Nigerian Bonny Light
oil is selling at $18.70 per barrel, which means the offshore production will
be making a loss of $11 per barrel, and the onshore sites will be making a $3.70
margin per barrel. Though 55% of the Nigerian oil production fields are
onshore, the expensive offshore fields produce more quantity per well. However,
for offshore production to be profitable, oil prices must be high above $30.
This means that for more than a month now, the Nigerian offshore production has
not been profitable, but we still have to keep producing anyway.
Except for a few days last month, the oil price has not been
below the onshore production cost. The lowest Nigerian oil was sold during this
coronavirus crisis was approximately $15 per barrel. The question is why
Nigeria would produce oil despite the loss.
In oil production, the exploration and development costs are
the fixed costs, while the cost of production or oil lifting is the variable
cost. The cost of a barrel is the average of the fixed and variable costs. So,
even if the price is less than the total cost of the barrel, production can go
ahead, because the oil industry is capital intensive and has a low variable
cost. So, the bygone rules suggest that production can continue as long as the
price is paying back the variable cost i.e. the lifting cost. The expensive
fixed costs are assumed to be recovered later when prices become higher.
The variable or lifting cost of the Nigerian barrel of oil
is $3.5 and $5 for onshore and offshore respectively as reported by NAPIMS. So,
the rule is that, as long as the oil price is above $5 per barrel, Nigeria can
produce irrespective of the loss relative to the total costs. Nigeria will go
out of business if the barrel of oil sells below $3. It is best to shut down
production at this low oil price ($3) if it can be reopened. The onshore oil
wells are more flexible, they can be shut down and reopened quickly depending
on the market, unlike the offshore wells that are not so flexible.
Nigeria having one of the best oils in the world and having
quick access to seaports may not face that appalling low oil price. The good
news is that, as the world is gradually reopening from this week, the oil price
is likely to go high, and I will predict, the oil price will surpass the $30
Nigerian benchmark. So, the oil will still be the savior of the Nigerian
economy because no other sector of the Nigerian economy is contributing even
just 5% of the export revenue. With the acute recession underway, the fiscal
receipts will be low too.
Even after the coronavirus, the oil will continue to
dominate the global energy mix for some years due to its suitability and
versatility. The biggest threat to oil is the evolution of the electric
transportation system. More than 60% of the oil demand is for transportation
purposes, and if you replace that with more environmentally friendly
transportation options, the oil prices will likely peak at $15 per barrel. This
will then make countries like Nigeria to suffer huge economic costs, like
weaker Naira, inflation, low GDP, a possible recession, etc. and leading to
shut down of many oi production sites.
It is very easy to sit back and produce oil as far low as $5
per barrel in the short run, but in the long run, it is a trap and disaster.
So, there should be a strategy for the next energy shift. We can either produce
electric transport systems or produce batteries or at least produce more
electricity for sufficient domestic demand and export purposes. Electricity
will then be the next oil, and we should plan to export it too. The question
is, with which fuel are we going to generate the electricity? The wind? Solar?
Hydro? Gas? Or Coal?
Among fossil fuels, only Natural gas seems to be favorable
due to its thermal efficiency and relative cleanness. The good news is that
Nigeria has the largest gas reserves in Africa. Very soon, gas prices will get
uncoupled from the oil price, and it will become the next major fuel, I
reckon.
Dr. Ahmed Adamu
Petroleum Economist, Nile University, Abuja.
