Nigeria Strategy Report H1 2017 (11) – Balance of Trade Deficit: Moderation In Sight?

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ARM Research

We continue with our series of excerpts from our core strategy document – The Nigeria Strategy Report. In today’s piece, we review Nigeria’s trade balance over H2 16 and delineate our outlook for same over 2017.

In line with patterns observed since the collapse of oil prices in 2014, Nigeria’s external trade balance continued to be adversely impacted by depressed oil receipts as available data over H2 2016  showed that exports ($10.5 billion) continued to trail imports ($11.3 billion) leaving the deficit picture intact. On the export front, though crude oil prices have rallied over 2016—posting a 55% gain which ought to have been favourable, average Bonny Light remained 37% lower YoY at $30.7/bbl due to the depressed price levels in January. Added to this, renewed unrest in the Niger Delta drove production to multi-decade lows (9M 16: -13% YoY to 1.84 mbpd) to leave exports softer in the review period (-17% YoY to 1.39mbpd).

On the import side, Nigeria’s economic managers resorted to demand management measures ranging from outright ban of some items to proscribing of FX access for certain imports. In addition, various single digit financing arrangements were deployed to bolster local production of some imported items. Although, the cutback in non-oil imports in 2016 suggests  that the policy is working as intended,  scanning across the various sectors reveals that weakness across non-oil largely stemmed from industrial supplies, capital goods as well as transport, equipment and parts. The trio accounted for over 60% of import contraction using an attribution analysis. Given that these goods are not currently in the crosshairs of the earlier cited protectionist measures and are vital for manufacturing, which slipped into recession in 2016, we view dollar shortages as the underlying driver of cutbacks in the importation of these items.

Going into 2017, FG’s adoption of a conciliatory stance on the Niger Delta unrest, amidst increased amnesty allocation in the 2017 budget, suggest an end to the turmoil which hurt crude production in 2016. On the import side, continued focus on demand curtailment measures for agricultural raw material imports and increased import substitution should work to temper import demand growth.  For oil imports, implicit in the crude price recovery is potential for higher refined oil imports relative to 2016 at least. On balance, we see flat to modest uptick in imports, which we forecast at $45 billion in 2017. Consequently, we expect trade deficit to halve to $5.2 billion in 2017, largely reflecting price-driven improvements on the oil side of exports.

Import contraction drives softer trade deficit
In line with patterns observed since the collapse of oil prices in 2014, Nigeria’s external trade balance continued to be adversely impacted by depressed oil receipts as available data over H2 20161 showed that exports ($10.5 billion) continued to trail imports ($11.3 billion) leaving the deficit picture intact. That said, the underlying picture shows signs of a thaw in run of external sector imbalance as trade deficit shrank 76% YoY to $855 million. Sequentially, persisting shutdowns along crude export platforms, which resulted in lesser oil production (YoY: -25%, QoQ: -12% to 1.6mbpd) and weaker prices (avg: -26% YoY) resulted in lower crude oil exports in Q3 16 (-26% YoY to $7.8 billion). On the import side, as in recent quarters, a combination of shrinking dollar liquidity and growing import substitution resulted in 42% YoY contraction to $8.5 billion.

Breakdowns reveal cutback in oil imports, which declined 10% YoY (-14% QoQ) to 48.6million liters in Q3 16 while non-oil imports slid 24% YoY (-38% QoQ). Though only October data is available for Q4 16, the pattern remained the same as the trade balance printed red with a deficit of $235 million (vs a surplus of $408 million in 2015).

Figure 1: External trade data

Dollar shortages underpin import suppression
In response to the plunge in crude oil receipts, Nigeria’s economic managers resorted to demand management measures ranging from outright ban of some items to proscribing of FX access for certain importations. In addition, various single digit financing arrangements were deployed to bolster local production of some imported items. Indeed, following the cutback in non-oil imports in 2016, on the heels of similar contraction in 2015, it would appear that the policy is working as intended. However, scanning across the various sectors reveals that weakness across non-oil largely stemmed from industrial supplies (-34% YoY), capital goods (-17% YoY) as well as transport, equipment and parts (-8% YoY) with the trio accounting for over 60% of import contraction using an attribution analysis. Given that these goods are not currently in the crosshairs of the earlier cited protectionist measures and that these goods are vital for manufacturing, which slipped into recession in 2016, we view dollar shortages as the underlying driver of cutbacks in the importation of these items.

However, declines in other components of non-oil imports: food and beverages (-44% YoY) and consumer durables (-42% YoY), largely reflect increasing import substitution as NGN depreciation increases price competiveness of locally produced raw material inputs. Complementing the increased switch to local products is the provision of low cost financing by the CBN to Agriculture. By our estimates, the cutback across these two sectors, accounted for 12.2% of non-oil import moderation. On oil import, NBS data indicate a 10% YoY drop in fuel imports to 4.37million litres in Q3 2016.

Figure 2: Attribution analysis of non-oil import growth

To provide further evidence of import suppression, we undertook a regression analysis of imports (as a share of GDP) using CBN interbank dollar sales, real effective exchange rate (REER) and growth rate of real GDP as independent variables with quarterly data ranging from Q1 2008 to Q3 2016. Though our results affirmed theoretical relationships, with real GDP growth and CBN dollar sales having positive coefficients while REER was negative, CBN dollar sales and REER were statistically significant at 5%. Among these two variables, we find CBN dollar supply as having more significance which lends credence to our view that shortages in dollar supply had more impact in fueling the weakness in import demand than the impact of import substitution caused by depreciation in the naira.

Production shocks and rebounding Iranian sales weigh on crude exports
On the export front, though crude oil prices have rallied over 2016—posting a 55% gain which ought to have been favourable, average Bonny Light remained 37% lower YoY at $30.7/bbl due to the depressed price levels in January. Added to this, renewed unrest in the Niger Delta drove production to multi-decade lows (9M 16: -13% YoY to 1.84 mbpd) to leave exports softer in the review period (-17% YoY to 1.39mbpd).

Accordingly, NNPC data as at 9M 2016 show that crude exports declined 23% YoY (-8% QoQ) to 146 million barrels. In terms of market share, NNPC numbers reveal cutbacks across all regional markets except the US.

Figure 3: Nigerian Crude Oil Production and Exports

Starting off with Europe, which is Nigeria’s largest crude export market, Bonny Light purchases shrank 38% YoY to 52 million barrels in Q3 16—extending the pattern over 2016 (9M: -36% YoY). In addition to impact of outages along the Shell operated Forcados and Bonny export terminals, higher Iranian exports to Europe, as aptly noted in our H1 16 review, continues to pose a direct threat to Nigerian crude exports.

To be clear, these attacks on Nigeria’s share of the European market continued in H2 16 as Iran signed deals to sell crude to refineries belonging to France’s Total, Spain’s Cepsa, Greece’s Hellenic Petroleum. These were added to by a further deal to sell condensate to BP in October as well as the return of Libyan exports and first oil from Kazakhstan’s Kashagan field which were targeted at European refiners located along the Mediterranean Sea. Evidently, Iranian crude shipments to Europe have doubled to 700kbpd.

Interestingly, returning Iranian supply also posed a problem in Asia, where Nigerian exports slumped 22% YoY to 40 million barrels (9M 16: -7% YoY to 135million barrels). Specifically, despite robust crude oil consumption growth in India, which rose 8.9% YoY to 4.1mbpd, Bonny light sales slumped 30% YoY to 30million barrels (9M 16: -9% YoY to 103million barrels). In South America, Nigeria’s crude oil sales shrunk 70% YoY to 6.9 million barrels following a fire at Brazil’s 242,000kbpd refinery which resulted in a pick-up in refined imports. On the other hand, fluid movement in the differentials between Bonny light and WTI (-75% YoY to $5.25/bbl) continued to influence crude shipments to the US which surged three-fold YoY to 23 million barrels in Q3 16. QoQ, US imports of Nigeria’s oil fell 34%, tracking more than two-fold expansion in differentials.

Figure 4: Regional breakdown of Nigeria’s crude exports

Recovery in crude exports to underpin moderation in trade deficit
Going into 2017, FG’s adoption of a conciliatory stance on the Niger Delta unrest, amidst increased amnesty allocation in the 2017 budget, suggest an end to the turmoil which hurt crude production in 2016. That said, as noted in our GDP review, possibility of copycat attacks underpins the still fragile security situation in the region and leaves our pessimism towards crude production target of above 2mbpd intact.

Thus, we forecast output to be little unchanged from 1.8-1.9mbpd. Production worries aside, the recovery in crude oil prices, which strengthened following OPEC’s output cut agreement in Q4 16, however provides some cheer for oil export outlook.

Accordingly, incorporating the view from our oil price review, where we forecast $55/bbl, (+25% YoY) and flat YoY production, we estimate a 17% YoY rebound in oil exports to $37billion. Though our forecast for oil exports remains well below pre-2014 levels, together with slight improvement in non-oil exports, as naira weakness increases incentive to export, we estimate that overall exports should rise 17% YoY to $40.5billion in 2017.

Overall, the key driver of import cutback is the impact of dollar shortage on imports of capital goods and equipment. Given the critical nature of these imports for manufacturing, we see any improvement in dollar supply from higher exports as capable of inducing recovery in these imports. That said, continued focus on demand curtailment measures for agricultural raw material imports and increased import substitution should work to temper import demand growth. For oil imports, implicit in the crude price recovery is potential for higher oil imports relative to 2016 at least.

On balance, we see flat to modest uptick in imports over 2016, which we forecast at $45 billion in 2017. Consequently, we expect trade deficit to halve to $5.2 billion in 2017, largely reflecting price-driven improvements on the oil side of exports.

ARM Securities | 1, Mekunwen Road, Off Oyinkan Abayomi Drive, Ikoyi, Lagos, W:www.armsecurities.com.ng | M: 234 (1) 2701653

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