As Firms Contend with Headwinds

Oil prices have fallen sharply and are likely to remain low for a number of years. Obinna Chima reckons that this and other regulatory headwinds would be a heavy blow not just to the companies in the oil and gas sector, but to the economy as a whole

Crude oil prices fell to $48.90 per barrel last Friday. The prices haven’t been that low in nearly six and half years. That is why concerns have increased over the prolonged global crude price decline and its effects on the economy.

While indigenous oil firms and operators in other sectors have adopted prudent business approach as a result of the development and the tightened monetary policy environment, governments at all levels, on their part, have introduced various cost-cutting measures.

In fact, analysts at Renaissance Capital, a financial advisory firm, in a recent report noted that the clean-up of the downstream sector and issues surrounding fuel subsidies payments could negatively affect some corporates and may be potential drivers of non-performing loans (NPLs) in the banking sector.

“In gauging the asset-quality stress in the system and relative strengths of the banks through this rough patch, we establish each bank’s breakeven cost of risk and calculate what we call a ‘pain buffer,’ which estimates how much room we think the bank has to take on additional impairments before moving into a loss. Based on our 2015 estimates, GTBank, Stanbic, Zenith and UBA have the highest pain buffers in the sector,” it added.

The Central Bank of Nigeria (CBN), had stated in a December 2014, that where exposure to the oil and gas sector (as defined by the International Standard Industrial Classification of Economic Sectors as issued by the CBN), was in excess of 20 per cent of total credit facilities of a bank, the risk weight of the entire portfolio in such facilities would attract a risk weight of 125 per cent for the purpose of capital adequacy computation.

In addition, banks were then directed to prepare and forward to the central bank their computation and results of their singlefactor sensitivity stress test. The single-factor sensitivity testing is a form of stress test that usually involves an incremental change in a risk factor, holding other factors constant.

Although implementation of the policy has since been deferred to ensure that the on-going implementation of the Basel II/III capital adequacy framework is not dislocated, the policy was based on a recent risk-based supervision exercise conducted by the central bank, which highlighted the financial industry’s level of exposure to the oil and gas sector combined with existing risk management deficiencies, and the necessary steps to ensure that banks have sufficient capital buffers to mitigate escalating risk-taking activities.

In addition, as monetary policies and other regulations by the CBN become tighter in a bid to defend the naira, these have to a decline in the already fragile earnings of banks and firms in some other sectors.

Consequently, the CBN’s actions had led to precautionary measures taken by marketers on the importation of products, with a larger reliance on product allocations of the Pipeline Product Marketing Company (PPMC). As a result of this, marketers are said to be caught between a rock and a hard place as importers of petrol, under the petroleum subsidy fund scheme, as a result of the huge outstanding receivables due and payable to them by the federal government. Although the pricing template provides for a marketer to be paid the subsidy element within 45 days of submitting complete and verified documentation, the bulk of reimbursements due to importers are typically paid not less than 180 days or more.

These enormous challenges created by the liquidity squeeze, including mounting bank interest charges, and huge exposures to foreign exchange fluctuations are a major threat to the survival of many operators, especially with foreign investors wary of the country’s present economic climate.

“The nation’s marketers now face myriad issues ranging from fund sourcing, letters of credit, and more critically restrictions on the purchase of forex to enable the steady flow of product importation. They will find it very difficult to function without the appropriate fiscal backing required from the banks and the CBN in particular.

“The delays in the payment of petroleum subsidy funds by the federal government had previously led to the non-issuance of Letters of Credit for marketers, even within authorised bands of transactions, due to the CBN’s directive that banks become risk averse to oil and gas companies. The nature of it all is very cyclical,” a Lagos-based analyst who preferred to remain anonymous stated.

Continuing, RenCap noted in the report that with much talk about the federal government reforming the economy, in a weaker macro and fiscal environment, it would be unlikely that the banking sector would remain unscathed by some of the changes that could occur.

Also, the Lagos Chamber of Commerce and Industry (LCCI) has said noted that the increase in cost of production for firms in the country. Specifically, it pointed out that some of the measures adopted by the central bank would also impact on sales performance, profit margins and ultimately capacity utilisation of their firms, the Chamber added, noting that import duty and other port charges, which are computed as a percentage of import costs will also correspondingly increase.

President of the LCCI, Alhaji Remi Bello maintained that the CBN policies implied additional pressure on operating costs for manufacturers.

Already, the first quarter of 2015 earnings was the first in which the oil price drop truly reflected in the numbers of the oil and gas companies. The results provided more insights into the extent of damage done to the bottomlines of the oil industry as low crude oil prices impacted negatively on the revenues of the oil companies.

Threats of Ratings Downgrade

Similarly, the dwindling prices of crude oil and other commodities are threatening to return Nigeria and some other emerging market (EM) nations to “junk” credit ratings, laying bare many countries’ failure to reform in the good times. While the International Monetary Fund (IMF) data showed that Saudi Arabia, Russia and Nigeria need prices above $90 a barrel to balance their budgets, the first two aforementioned countries have large currency reserves. But Nigeria has not been able to accrue reserves between 2011 and 2014 the way it did in the run up to the global financial crisis in 2008 when it had accumulated reserves of $63 billion. Nigeria’s external reserves stood at $31.5 billion, according to figures from the CBN. But BNP Paribas, a leading bank in the euro zone, estimates that if oil stays around $80 a barrel for the next few years, producers in the Gulf, Russia, Latin American and Africa could see their ratings cut by between half a notch and two notches - far more if it sinks to $60.

BNP’s analysis suggests that $80 oil would see Russia, Azerbaijan and Kazakhstan lose investment grade status, while it forecast that Nigeria and other oil producers in Africa would fall deeper into junk territory.

Meanwhile, Fitch Ratings has pointed out that Africa’s biggest oil producers have debt levels low enough to withstand slumping crude prices, while Ghana faces risks without an aid package and Zambia from an unexpected election. Nigeria and Angola would be able to post budget deficits for the next year or two because of their low debt, enabling them to maintain spending with lower oil prices, Director of the Sovereign Group at Fitch, Carmen Altenkirch, had said.

“If oil prices remain lower for longer, fiscal policy may need to be tightened to avoid downward pressure on the rating,” she added. Fitch rates Nigeria and Angola BB-, three steps below investment grade.

Therefore, there is need for government to start taking serious steps towards propelling the growth of the Nigerian economy so as to safeguard the country and firms from any crisis.