The Fuse

Nigeria’s Prepayment Deals With Traders Necessary to Support Economic Goals

by Matt Piotrowski | December 06, 2017

Nigeria is reportedly looking to secure prepayment contracts with major oil traders that could be worth as much as $5 billion. The African OPEC nation would receive up-front payment for its oil and provide the traders approximately 70,000 barrels per day for five to seven years at a discount. State-owned Nigerian National Petroleum Corporation (NNPC) would likely use the proceeds to construct oil and gas infrastructure and upstream projects. Reuters said that Nigeria is seeking partnerships with the big trading merchants, either Glencore, Vitol, and Trafigura, and that Standard Chartered was hired to advise on the oil prepayment. The degree to which Nigeria would have to discount its petroleum in order to secure the loan is not yet known.

Nigeria seeking prepayment deals reflects how states that are highly dependent on oil income are taking extraordinary measures to maintain stability while oil prices are relatively low.

The fact that Nigeria—whose export revenues account for 92 percent of the country’s export earnings—is considering these deals is significant. It reflects how states that are highly dependent on oil income are taking extraordinary measures to maintain stability while oil prices are relatively low. Saudi Arabia is launching Vision 2030 to diversify its economy, while Venezuela is resorting to using a digital currency called the “petro” to avoid U.S.-led financial sanctions. The Kurdistan Regional Government (KRG), like Nigeria, has signed prepayment deals with big traders such as Rosneft, Trafigura, Vitol, and Glencore—but the agreements are precarious since Baghdad has retaken Kirkuk fields and the Kurds may not be able to ship the oil to pay for the loan.

Nigeria fell into recession last year for the first time in more than two decades, and the country is seeking ways to generate growth. President Muhammadu Buhari recently proposed a budget of 8.6 trillion naira ($28 billion) for 2018, a 16 percent increase from this year in an attempt to support the economy. The economy is starting to recover, thanks to higher oil prices and the central bank establishing currency controls. GDP growth is expected to average 0.8 percent this year, according to the International Monetary Fund (IMF), compared to a contraction of 1.6 percent in 2016. Higher oil prices and a recovery in production, along with a strong agriculture sector, are expected to accelerate growth to 1.9 percent in 2018.

Both sides benefit in prepayment deals

Securing the prepayment will likely weaken longer-term revenues since Nigeria will offer its oil at a reduced price and it will miss out on any price increases. However, a prepayment deal would provide Nigeria with up-front cash and guaranteed revenue as it expands its budget. At the same time, an agreement would assure traders a source of supply at a discount for an extended period of time that they can use for resale in the global market. Furthermore, prepayment deals allow traders to establish long-term relationships with producers.

Securing the prepayment will likely weaken longer-term revenues since Nigeria will offer its oil at a reduced price and it will miss out on any price increases.

Prepayment deals are not uncommon. Banks and bond markets remain the top source of financing for the oil and gas sector, but traders have become prominent in financing companies and petro-states. Russia’s Rosneft signed a $10 billion deal with Vitol and Glencore in 2013, and made a similar agreement with Trafigura around the same time. Other producers such as Venezuela, Ecuador, Colombia, the KRG, Libya, and Algeria have also utilized similar pre-payment structures. Producers are particularly open to these type of agreements during oil price downturns, since prepayment deals are similar to a line of credit.

Deals with Nigeria would help further consolidate the big merchants’ hold on the global oil trade.

Deals with Nigeria would help further consolidate the big merchants’ hold on the global oil trade. The five big oil merchants—Vitol, Glencore, Trafigura, Mercuria, and Gunvor—have increased their trading volumes by approximately two-thirds since 2014, when oil prices fell sharply from above $100 per barrel. Altogether, the groups trade close to 25 mbd of crude and products. Whichever traders strike prepayment deals with Nigeria, they will enjoy the advantages of a close relationship with a major oil exporter, giving them access to time-sensitive data that will boost their market intelligence and information flow.

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Production dilemma

Nigeria has not only been hurt by the oil price crash from 2014-16. It also has to contend with lower production from attacks from different militia groups such as the Niger Delta Avengers. These groups seek to undermine the country’s economy and bring attention to the government’s rampant corruption. Nigeria’s output has been volatile in the past several years, fluctuating between 1.2 million barrels per day (mbd) and 1.9 mbd. It is now producing 1.74 mbd.

Nigeriaoutages

In order to fund the 2018 budget, Nigeria will need to increase its production. However, at the OPEC meeting last week, Nigeria said it would cap production at 2017 levels in 2018—after being exempt this year—as part of its contribution to the OPEC/non-OPEC supply cut. This detail, though, was not mentioned in OPEC’s official press release, raising questions about whether the country will follow through on its pledge. If Nigeria has the capability to exceed its 2017 ceiling, it may cheat on its commitment. Prices above $60 make it tempting to bring in extra revenue through higher exports. Nigeria could sell volumes that are not locked into prepayment deals in the spot market. But any production recovery is fragile. Nigerian militants have halted their ceasefire and say they are poised to resume attacks on oil infrastructure.

Even if prepayment deals with traders help with the recovery, the country still has a large task ahead in overhauling the entire economy.

Although Nigeria’s economy is starting to rebound as a result of higher prices, it ultimately needs to diversify its economy to reduce dependence on oil revenues. Without widespread reform, the country’s economy will remain vulnerable to price fluctuations and will not be able to significantly reduce its budget deficits. “Only a durable increase in non-oil revenue will improve Nigeria’s resilience to oil price volatility and increase the realization rates of capital spending on the large infrastructure projects that are crucial for Nigeria’s economic development,” said Moody’s in a recent report. Just as crucially, economic reforms are needed to end ongoing attacks on infrastructure and generate support of people of the Niger Delta, who believe the corrupt government and oil industry have left them out of seeing any material gains from the country’s oil wealth.

Even if prepayment deals with traders help with the recovery, the country still has a large task ahead in overhauling the entire economy.

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