H2’23 Nigeria Oil & Gas Outlook – Policy reforms to drive strong performance

What shaped the past week?

Global: Asian markets faced a challenging week as stock exchanges traded lower, primarily influenced by global factors. Investor sentiment was impacted by the Bank of Japan’s unchanged monetary policy stance and the People’s Bank of China’s announcement on lending rates. Political tensions escalated on the Korean Peninsula, and US Secretary of State Antony Blinken’s visit to China drew attention. The overall negative market sentiment was driven by losses in Europe and the US, coupled with the Federal Reserve’s projection of additional rate hikes. Economic data from Japan, including a decline in business activity and slowing inflation, further weighed on investor confidence.

European stock markets endured a bearish week as major indexes closed lower on the week. The focus was on economic data releases and central bank decisions. Disappointing reports on Germany’s producer prices and Eurozone construction output dampened investor sentiment. Concerns about easing underlying inflation were expressed by European Central Bank members. The Bank of England’s unexpected decision to raise interest rates by 50 basis points shook investor confidence. The United States Federal Reserve also hinted at upcoming rate increases. Central banks in Turkey and Switzerland tightened their monetary policy. .

US markets also had a bearish week of trading as major indexes closed in the red w/w. Investors eagerly awaited Federal Reserve Chair Jerome Powell’s testimony before Congress, where he discussed monetary policy and the economy. Powell’s comments on potential future rate hikes influenced market sentiment, while some Fed officials advocated for a cautious approach. Thursday’s session closed mostly with gains, primarily driven by the tech sector. Throughout the week, investors carefully considered the Fed’s statements alongside economic data. Powell reaffirmed the expectation of two more rate hikes by the end of 2023.

Domestic Economy: This week, we observed a convergence in the foreign exchange market, with the I&E window rate trading closer to parallel market levels at ₦756/$. The Central Bank of Nigeria (CBN) has confirmed that the current FX regime is a managed float regime. However, we believe that market-reflective interest rates are necessary to incentivize portfolio inflows and increase FX supply to the foreign exchange market. Therefore, it is crucial for the apex bank to ensure that investors can earn positive real returns on their investments. Although this may conflict with the objective of reducing the debt service burden, we acknowledge that further expenditure cuts and revenue mobilization measures can be explored to manage the fiscal balance. In terms of revenue mobilization, the Federal Government has introduced a Value Added Tax (7.5%) on Automotive Gas Oil, commonly known as diesel. We also consider cost-cutting measures such as liberalizing power tariffs and eliminating fuel subsidies as necessary to alleviate the fiscal burden, despite the potential short-term inflationary effects.

Equities: The local equities market displayed positive performance driven by investor optimism in the Industrial Goods and Oil and Gas sectors. The Oil and Gas sector continued its impressive performance following the removal of the fuel subsidy, returning 2.97% w/w. Investors showed interest in oil marketing companies, contributing to their patronage. The Industrial Goods sector saw capital appreciation in companies like WAPCO (+2.30% w/w) and DANGCEM (+1.23% w/w). The Banking sector also closed higher w/w, with buying interest observed in ZENITHBANK (+3.23% w/w) and other stocks. The Consumer Goods sector experienced modest gains, particularly in mid-small cap counters.

Fixed Income:   Local bonds experienced a bullish week of trading, driven by ample liquidity levels that bolstered positive sentiments. Investors showed a preference for longer-dated tenors, while avoiding shorter-dated ones. The market focus centered around mid-long tenors, as investors reacted to the latest economic updates from the current administration. Yields on benchmark bonds saw an average easing of 5bps w/w, with the 12.50% FGN-JAN-2026 and 12.50% FGN-MAR-2035 tenors experiencing 98bps and 25bps easing, respectively, settling at 11.37% and 14.40%. Moving to the NTB space, while activity was sparse throughout the week, the space so a reversal on Friday, translating to a 24bps moderation in average yield, albeit driven by interest in the 214DTM paper. 

What will shape markets in the coming week?

Equity market: We anticipate a cautious stance to the market in the coming week, as investors maintain a risk-averse approach to the market, while favoring counters in the Oil and Gas space.

Fixed Income:  We anticipate cautious positioning from investors to start next week, following the aggressive buy-side action observed this week; that said, we expect liquidity levels to dictate activity in the secondary market next week..

H2’23 Nigeria Oil & Gas Outlook –     Policy reforms to drive strong performance      

Demand stays resilient, despite economic uncertainty

The first half of the year saw weaker oil prices, driven by the prevailing risks of an economic downturn, which consequently dampened the outlook on demand. At a glance, the world economy appears to be slowing and it can be said that the global economy is now feeling the effect of the persistent rate hikes. In Q1, the global manufacturing index recorded contractions y/y, while the US has seen some bank failures. Amidst this heightened economic uncertainty, oil demand has remained resilient, inching up by 1.4mb/d y/y and 0.2mb/d q/q for the Q1 period.

We assert that risks for a dent to demand appear to be more heightened vis-à-vis our last report, as the global economy has remained tumultuous. However, fundamentals remain strong as overall demand and inventory data continue to show an improvement in consumption rather than a decline. Inventory data continue to show heavy inventory draws especially in the US, that had been net positive for most of 2022. Also, despite these rate hikes, major economies continue to record growth, and most corporations have reported healthy earnings. That said, we maintain our outlook for a steady growth in demand. Even if a recession was to happen, we do not expect a material dent to oil consumption.

Supply challenges persist

We had seen releases from the Strategic Petroleum Reserve (SPR) support oil supply throughout H2’22. Now, risks for a supply tightness have re-emerged stronger as the era of SPR releases have come to an end. Oil output improved y/y largely supported by the spill-over of these SPR releases into Q1’23 but on a q/q basis, production declined by 0.1%. This decline can be attributed to the persisting supply challenges faced by major producers.

OPEC continues to underperform, and its production output has seen consistent decreases in the last 3 quarters.  Although the sharpest decline was observed in Q1’23 due to the implementation of production cuts, years of under-investments has impacted the ability of its members to raise output, especially its African members. Its Middle-Eastern members are already producing near optimal capacity, whilst Russia’s output has been constrained by the embargos placed on its exports. Meanwhile, US output has remained flattish due to ongoing capital discipline.

We reiterate that much of the challenges OPEC members are facing do not have a quick fix, even as international sanctions are expected to limit Russia’s exports. Also, we expect some output growth from the US albeit minimal. Thus, for the rest of the year, we expect supply growth to come majorly from the US and non-OPEC producers. However, we anticipate that this supply increases will come at a much slower pace relative to demand growth given the ongoing capital discipline being implemented by oil majors. Thus, in the midst of all these supply challenges being faced by OPEC who still controls a significant market share, an anticipated slow growth in supply from non-OPEC members, and with demand projected to come in higher y/y, we expect to see upward pressure on oil prices in the second half of the year. In light of this, our base case forecast for Brent prices comes in at $80/bbl, bear case sits at $70/bbl, whilst our bull case prints at $90/bbl.

Upstream sector has relatively performed better

2023 has been a relatively positive year for Nigeria’s oil industry. Oil production has remained stable, averaging 1.2mb/d in Q1’23. We, however, highlight that weak infrastructure and aging fields have deterred Nigeria from drastically improving output and meeting its OPEC quotas. Given this, we maintain our outlook for oil output at 1.4mb/d. We expect recoveries but reiterate that weak infrastructure will remain a bottleneck for oil producers.

Downstream margins to get respite on subsidy removal

For the first half of the year, margins remained on a downward trend for downstream players due to persistent increases in the ex-depot price, as the government sought to reduce its subsidy expense. Thus, whilst topline expanded for most downstream companies, the presence of price caps constrained profitability and earnings came under pressure. However, fuel subsidies have now been terminated, ushering in deregulation of the sector. In light of this, we expect downstream players to report better margins in H2, as the absence of controls will allow for price discovery.