US embassy cable - 03ABUJA653

UNCLAS SECTION 01 OF 02 ABUJA 000653 
 
SIPDIS 
 
 
STATE FOR AF/W, AF/EPS AND EB/TPP 
SATE PASS COMMERCE FOR ITA/MAC 
STATE PASS USTR 
CAIRO FOR MAXSTADT 
PARIS FOR OECD/IEA 
TASHKENT FOR BURKHALTER 
 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, EPET, ENRG, EINV, PGOV, PREL, NI 
SUBJECT: NIGERIA: DELTA OIL CRISIS MAY PINCH THE ECONOMY 
 
 
REF: LAGOS 731 
 
 
Summary 
------- 
1. News that Chevron returned to Escravos to gradually resume 
oil production is encouraging. Shell also may soon return. 
However, armed local groups remain a wild card. Their ability 
to foil resumption of oil production is all too real as 
evidenced by the April 6 pipeline disruption only a few days 
after Chevron announced the resumption plan. Even under the 
most roseate projections for resumption of oil production at 
the sites, financial damage has been done to the GON and, by 
extension, the national economy. Deputy Director of the 
Central Bank Research Department Olekah told Econoff on April 
5 that the ongoing crisis in Warri (reftel.) would affect GON 
finances and macroeconomic policy. The hit taken by the oil 
sector, combined with the related domestic gasoline shortage, 
will stifle economic output and activity during the first 
half of 2003 and maybe the third quarter as well. This is bad 
news for President Obasanjo's reelection prospects. End 
Summary. 
 
 
Government Spending Likely to Fall 
---------------------------------- 
2. About 90 percent of government revenues are derived from 
profits on oil sales. Deputy Director of the Central Bank 
Research Department Olekah told Econoff on April 5 that with 
fixed costs for oil production unchanged, the 40 percent cut 
in oil output could translate into an even larger cut in 
Nigerian National Petroleum Corporation (NNPC) profits 
remitted to GON accounts. (Comment: The story is the same 
even for a 25 percent cut in output, as would be the case if 
Chevron's Escravos facility does come back online soon. 
Meanwhile, falling world oil prices could compound the 
problem. End Comment.) 
 
 
3. GON spending is difficult to track, but Olekah says 
spending increased somewhat over the first quarter of 2003, 
the run-up to elections in April. That spending was financed 
by larger than expected profits on oil, as prices reached a 
high of $35/barrel for Bonny Light and Nigeria pumped about 
2.08 million bpd., well above GON budget estimates of 
$18/barrel for 1.8 million bpd. (Comment: Given the 
significant drop in revenue, the GON's spend-as-you-earn 
budget rule could put a break on spending during or shortly 
after this crucial election period, unless the GON decides to 
abandon its 12.5 percent cap on deficit financing. State and 
local government spending, with more limited access to 
deficit financing, may be forced to cut spending even more 
than the federal government. In particular, southern states 
that benefit from the GON oil derivation rule may be hard 
hit. End Comment.) 
 
 
Downward Pressure on the Naira 
------------------------------ 
4. Nearly all foreign exchange earnings are derived from NNPC 
oil sales. Consequently, Olekah admitted, foreign exchange 
reserves are taking a hit because of the crisis. He could not 
provide current figures, but said depletion of the reserves 
could be significant if the crisis continues, unless the GON 
decides to devalue the naira. (Comment: The GON will be 
reluctant to devalue the naira--devaluation is a policy tool 
of last resort here. It is more likely that the GON will tap 
into its foreign currency holdings over the next couple 
months to maintain current import levels while also propping 
up the inflated naira. Should the crisis linger, however, 
that option would prove unsustainable, and a substantial 
devaluation--popular or not--would be the only option left. 
Over the last three weeks, the exchange rate has held steady 
at 127 naira/dollar. End Comment.) 
 
 
Comment: Macroeconomic Impact Could be Far-Reaching 
--------------------------------------------- ------ 
5. The oil sector accounts for about 12.5 percent of Nigerian 
GDP, so we can expect to see economic growth take a 
noticeable hit as a result of this crisis. Oil service 
companies and other companies dependent on oil production 
will suffer most. The government also will be hamstrung in 
meeting cash calls for joint-venture production agreements, 
which, in turn, will slow further investment in the oil 
sector. 
 
 
6. However, direct losses sustained by the oil sector are 
only part of the equation--the other is the economic impact 
of gasoline shortages (reftel.). The transportation system is 
grinding to a halt, delaying and increasing the costs of the 
movement of goods (food, for example) and services (labor) 
and causing employers to scramble for inputs--especially 
diesel needed to run generators that augment unreliable power 
provided by NEPA. In addition, with the oil crisis 
constraining government spending at all levels, fiscal policy 
will be unavailable as a tool to cushion the blow. It is too 
early to tell what impact this economic slowdown will have on 
President Obasanjo's reelection prospects for April 19. End 
Comment. 
 
 
Comment: Gasoline Price Controls 
-------------------------------- 
7. If there is any silver lining to this clouded scenario, it 
is that the GON can mitigate some of the oil crisis' impact 
on the average Nigerian by removing price controls on 
gasoline. After suffering through hours-long gas lines for 
several weeks now, many consumers would be willing to spend 
more than the 26 naira/liter service stations now charge. 
Black market fuel sells for between 120 and 150/liter, and 
people are paying the higher price. However, there are 
political concerns about increasing gasoline prices during 
the election period; also, influential vested interests whose 
profiteering in the black market would be diminished should 
market forces be allowed to determine domestic gas prices 
would oppose lifting controls. End Comment. 
JETER