PREAMBLE
Refineries process petroleum liquids, and their value is influenced by crude oil costs. Factors such as access to crude oil and proximity to markets can affect the refining net value of refineries based on their location. The medium of exchange in crude oil transactions, like Nigeria’s Naira, affects both the refining business and the local economy. Recently, discussions have appeared on the use of domestic currency for local refinery transactions in Nigeria. This op-ed aims to encourage discussions on the effects of using domestic currency for crude trade in Nigerian refineries, focusing on the consequential outcomes. The op-ed explores the stochastic consequences of employing domestic currency in crude oil transactions in Nigeria for refineries.
POTENTIAL BENEFITS OF PAYING NAIRA FOR DOMESTIC CRUDE OIL TRANSACTIONS
In October 2024, Nigeria’s Federal Government negotiated a deal to use Naira for crude oil transactions with upstream firms for local refineries in Nigeria. The success of this deal presumptuously depends on a stable exchange rate and low inflation. This aligns with practices in China and India, and may potentially boost economic activity, government revenue, local refinery competitiveness, and monetary policy effectiveness in Nigeria. Under the stated conditions and circumstances, this section presents an overview of the potential benefits of paying Naira for crude oil sales to local refineries in Nigeria.
Increased Economic Activity
Economic activity includes producing, distributing, and consuming goods and services. It involves creating, moving, and buying goods and services. Factors influencing economic activity are household spending (C), business investment (I), government fiscal policies (G), and trade balance (NX).
Gross Domestic Product (GDP=C+I+G+NX) measures a nation’s economic output. Economic activity creates jobs, generates income, and fosters innovation. Spending on local currency can boost demand for local goods and services, creating jobs and enhancing investment conditions for business growth. Historically, local currency has eased domestic transactions, and increased spending can help the economy according to the law of demand.
Improved Government Revenue
Petroleum revenue in Nigeria consists of four main components: equity crude oil sales, petroleum taxes (including VAT and taxes on local crude sales), corporate income tax, and fees and charges (permit, license, and service fees). Despite challenges such as corruption and management inefficiencies, increased Naira revenue presents opportunities for economic diversification, investment in human capital, and the establishment of a sovereign wealth fund.
Increased Naira-denominated revenue may enhance economic stability and reduce leakages, as it is less affected by foreign exchange rates compared to foreign currency. Utilizing Naira for domestic crude oil payments can bolster the local economy, create employment opportunities, and increase government revenue through taxation. It may also reduce foreign exchange leakages since local refineries would not need to convert Naira to other currencies, minimizing potential revenue loss.
Furthermore, making domestic crude transactions in Naira could lead to improved fiscal discipline, with increased transparency to mitigate the risks of corruption and better budgeting practices that enable more efficient allocation of government resources.
Enhancement of the Competitiveness of the Local Refineries
Paying for crude oil in Naira within Nigeria can lower costs for local refineries, making them more competitive globally. This reduction in production costs encourages greater efficiency without the need to convert Naira to Dollars, ending foreign exchange and transaction costs. It also diminishes the demand for foreign exchange, conserving it and reducing risks of production disruptions by enhancing the crude supply chain. Overall, these benefits could boost refinery profitability, attract investments, increase refining capacity utilization, and improve energy security through sustainable energy availability, accessibility, and affordability. Additionally, reduced pressure on foreign reserves makes imported equipment cost-effective.
Improve Monetary Policy Effectiveness
Monetary policy aims to control the money supply and interest rates through actions of the Central Bank to promote economic growth and stability with low inflation. The specific goals of Central Bank, therefore, are to support low inflation, promote economic growth and development, support stability in the financial system, and to achieve full employment. The type of monetary policy that supports paying for a domestic factor of production in a domestic economy to increase money supply and low interest rate is called expansionary monetary policy to stimulate economic growth keeping in perspectivity the possibility of demand-pull inflation and cost-push inflation.
Paying for crude oil in Naira could allow the CBN to manage money supply more efficiently and effectively. Such mandate could reduce the influence of external factors including fluctuation in the global oil prices and foreign exchange on the money supply and improve the transmission of monetary policy. Furthermore, payment in Naira for crude oil transactions in domestic market could reduce the dollarization of the economy in terms of vulnerability of the economy to external factors. The increased use of Naira would give the Central Bank more control over monetary policy.
Additionally, paying Naira for domestic factor of production could reduce the influence of global interest rates on domestic interest rates. It could also increase lending in Naira, improve financial intermediation between savers and borrowers to enable CBN to implement monetary policy more effectively. Finally, there is the potential for payment in Naira for domestic crude to reduce inflationary pressures, which could improve price stability eventually.
THE DILEMMA ASSOCIATED WITH PAYING IN NAIRA FOR CRUDE OIL TRANSACTIONS IN NIGERIA
For this op-ed, the crude for naira dilemma refers to the situation where Nigeria, a major oil producing country, still imports the bulk of its refined petroleum products to improve energy access and reduce energy poverty. The following are the key aspects of this dilemma.
First, Nigeria exports a great proportion of it oil production to improve its foreign reserves and inadvertently dollarizing its economy and weakening its currency. Second, because of low and inadequate refining capability, Nigeria imports refined petroleum products, and, in the process, there is increased demand for forex often, which creates a market disequilibrium. Third, paying for imported petroleum products in Naira puts tremendous pressure on exchange rates and Nigeria’s forex reserves. The fourth aspect of the “Naira-for-Crude” dilemma is its economic implications including the possibility of high inflation, the weakening of the value of Naira, and the likelihood of persistent trade deficits.
It would be foolhardy to not recognize the stochastic nature of the possible impacts of trading crude with local refineries using Naira in the domestic economy. The dilemma suggests counter arguments or strawmen on the null hypothesis premised on a set of deterministic baseline assumptions. For example, the first phase of Naira crude sale, which started in October 2024, assumed a stable exchange rate, low inflationary pressures, sustainable crude capacity and crude availability to local refineries. The ensuing null hypothesis suggests that payment in Naira for crude oil transactions with local refineries would increase government revenue, improve monetary policy, expand economic growth, and promote local refining capacities subject to the constraints that other factors are constant.
However, these other factors (inflationary pressure, exchange rate volatility, dependence on government subsidies or incentives and low economic distortions), which, though presumed to be precisely known and constant, are complex, multidimensional, and stochastic. On the other hand, if they are known precisely and are not constant, then the following major concerns on paying with Naira for crude used in the domestic economy offers alternative null hypothesis.
The alternative null hypothesis states that if local refineries pay for crude they use with Naira, then they may be exposed to exchange rate risks, if exchange rate fluctuates; there could be inflationary pressures because high demand for Naira may push up prices of goods and services; and the lack of refinery capacity and crude availability may delimit the implementation of this Naira for domestic crude policy. The synopsis of the potential strawman concerns on paying Naira for crude oil sales to local refineries in Nigeria is as follows.
Inflationary Pressures Concerns
Inflationary pressures refer to the factors which contribute to an increase in the general price level of goods and services in an economy, leading to inflation. The common causes of inflationary pressure in an economy include aggregate demand outpacing aggregate supply resulting in inflation. An increase in money supply and/or decrease in the interest rate can cause more money to chase fewer goods and services causing a rise in the general price level. Thus, in the context of paying Naira for crude, it may lead to increase in money supply and lead to inflation. Such policy action has the possibility to weaken the purchasing power of Naira by making imported goods to be more expensive.
However, reduction in the dependence of Nigeria on imported petroleum products because of improved local refinery abilities may reduce the vulnerability to exchange rate risks to global price shocks in Nigeria counteracting expanded money supply in the economy. Of course, consequentially improved monetary policy decisions of the Central Bank can influence inflation. Additionally, a weak Naira can make local goods and services cheaper for export to increase the foreign reserves in the process. Thus, with effective monetary policy, inflationary pressure can be curtailed to not delimit the use of Naira to pay for crude.
Exchange Rate Dilemma
The exchange rate concerns due to paying in Naira for crude oil trade transactions involve devaluation of Naira, foreign exchange scarcity and volatility. Paying for domestic crude in Naira could lead to a depreciation of Naira. The increased demand for Naira could put downward pressure on the exchange rate. However, the discontinuation of demand for dollars to pay for imported refined products could have a counteractive effect on the value of Naira to dollars in the Forex market. In this regards an appreciative Naira can lead to lower import cost thereby lessening inflationary pressures.
Foreign exchange scarcity due to high imports is derisked if local refinery capacity and use increase due to Naira for crude policy. Additionally, uncertainty and volatility in the FOREX market due to Naira for Crude policy are possibilities making it quite challenging for businesses to make strategic business plans and investment. Predicting future costs can also be challenged under a failed Naira for Crude policy. Building and upgrading domestic refineries could address these concerns. CBN is implementing foreign exchange reforms to stabilize FOREX by adopting a flexible and progressive exchange rate regime. Of course, diversifying the economy can reduce the vulnerability of Nigeria economy to exchange rate volatility and uncertainty.
Corruption and Management Concerns
The strawman on Naira for Crude Policy raises laudable corruption and management concerns. The first is corruption risk, claiming that an increased flow of Naira for crude would increase corrupt practices such as kickbacks and bribery and fund embezzlement more than they were the increased flow of dollars at a high FOREX rate would. Empirical evidence suggests otherwise looking at the precedency in terms of the fuel subsidy swindles, illegal bunkering, and oil theft. There is also the insinuation that more Naira would be more difficult to manage than dollarizing the economy to buy a factor of production in a domestic economy.
There are subjective management concerns, that a Naira for Crude Policy in the downstream petroleum value chain could lead to inefficient resource allocation that prioritize imported petroleum products over enhancement of local refining capacity. The strawman suggests that the Naira for crude policy could increase the opaqueness of the oil and gas sector and may promote lack of transparency and accountability leading to poor governance. The concern that the Naira to Crude Policy can fail due to inadequate planning and policy implementation sounds legitimate. Truthfully, there might be no policy institution in place with a transformational mindset to develop and implement effective and sustainable Crude for Naira Policy with consequences.
Corruption and poor governance in the oil and gas sector under Naira for Crude could lead to economic instability, loss of government development, underdevelopment, and environmental degradation. To address these concerns, Nigeria needs to invest in local refineries, increase transparency and accountability in the oil and gas sector and this is common mantra in PIA 2021. PIA 2021 also tries to strengthen institutions and governance structures to address these concerns, emphasizing the necessity to clearly separate the roles of the PIA anchor institutions into policy, regulatory, and commercial. The policy institutions remain the weakest link, yet to address the challenges and concerns the development and implementation of effective petroleum policies is the first order condition.
Economic Distortions Dilemma
That paying Naira for domestic crude sales to local refineries could lead to economic distortions is not conjectural. The extent of the distortion is, however, highly uncertain. Fundamentally, economic distortions denote the misallocation of resources in an economy as a result of government intervention such as Naira for Crude Policy, market failures such monopolies or externalities, and external factors such as natural disaster or trade barriers. Below are probable mechanisms through which paying Naira for domestic crude use in local refineries could lead to economic distortions in Nigeria.
First, is price distortion through artificially low prices because government may subsidize the cost of crude to the refineries. This could lead to an inefficient allocation of resources with refineries producing more products than the market demands. The next is over-dependence of local refineries on government subsidies, which could create an unsustainable business model. The unsustainable business model could make business investment for efficiency delimited leading to misallocation of capital to unproductive sectors. Subsequently, it leads to inefficient production and low economic efficiency. Economic distortion is a legitimate concern regarding Naira for domestic crude unless the policy is apolitically developed and implemented equitably.
CONCLUDING REMARKS
In October 2024, Nigeria’s Federal Government negotiated a deal to use Naira for crude oil transactions with upstream firms for local refineries in Nigeria. The success of this deal presumptuously depends on a stable exchange rate and low inflation. This aligns with practices in China and India. Using the Naira, a currency susceptible to economic shocks, for crude oil transactions in Nigeria has significant implications. Economic impacts include inflation, risks associated with oil dependency, Naira instability, economic growth, job creation, investment inflows, government revenue management, local refinery competitiveness, foreign reserves, forex stability, and the effectiveness of monetary policy.
There are, however, legitimate concerns with Naira for Crude Policy. It could be foolhardy to not recognize the stochastic nature of the possible impacts of trading crude with local refineries using Naira in the domestic economy. There could be an alternative null hypothesis that states that if local refineries pay for crude they use with Naira, then they may be exposed to exchange rate risks, if exchange rate fluctuates; there could be inflationary pressures because high demand for Naira may push up prices of goods and serves; and the lack of refinery capacity and crude availability may delimit the implementation of this Naira for domestic crude policy.
The way forward is to address these concerns by investing in local refineries and increasing transparency and accountability in the oil and gas sector. This is a common mantra in PIA 2021. PIA 2021 also tries to strengthen institutions and governance structures to address these concerns, emphasizing the necessity to clearly separate the roles of the PIA anchor institutions into policy, regulatory, and commercial. Unfortunately, the PIA policy institution remains the weakest link, yet to address effectively, the challenges and concerns the development and implementation of effective petroleum policies stand as the first order condition to realism.