Economic Confidential

“We see increase in oil reference price as a threat because the money will be shared by the three tiers of government. It will increase spending and inflationary spending. We think a reference price of $75/barrel is better than $78, and $78 is better than $80/barrel, but that is if the difference is saved.”

The above is the statement of Scot Rogers, the IMF Senior Resident Representative, at the recent International Monetary Fund (IMF) sub Saharan Regional Economic Outlook for 2013 held in Abuja.

The Finance Minister and Coordinating Minister of the Economy, Dr. Ngozi Okonjo-Iweala, is also reported by Reuters, a news agency, to “strongly believe that $75 is the right benchmark for us; it will help us to build buffers”. Indeed, both the CBN Governor, Lamido Sanusi, and the Finance Minister had a few weeks earlier also bluntly insisted that a 2013 budget crude price benchmark above $75/barrel would ‘hurt’ the economy.

In consideration of above expressed concerns, we will briefly discuss the following issues, namely; benchmark determination, alleged negative impact of higher price benchmark and the touted benefits of increasing reserves.

President Goodluck Jonathan indicated in the 2013 budget proposal that “the benchmark price is based on a well-established econometric methodology of estimating oil price moving averages”. Indeed, Dr. Okonjo-Iweala has similarly maintained that “benchmark pricing is not a thing you just sit down and concoct; they are based on some fundamental economic analysis. And we actually have a model we use to project Nigerian oil benchmark price over the past three years.”

The above suggests a scientific methodology for forecasting international crude price movements. However, in reality, even if such a pseudo-scientific model exists, it cannot be precise; it would probably be easier to have predicted the occurrence of the recent hurricane ‘Sandy’ three years earlier than to accurately predict price movements in the international oil market.

In any event, the failure of this model is probably amplified by the wide disparities between projected benchmark prices and actual prices within the three years that the Finance Minister indicated that this model had been adopted for Nigeria’s budget projections. For example, while budget benchmark remained below $72/barrel during this period, average crude prices actually hovered around $100/barrel. In other words, a methodology, which accommodates over 25 per cent margin of error cannot be relied upon for any accurate prophecy of crude price movements.

Indeed, if crude prices have remained at an average of about $100/barrel at a time when the world economy is in ‘bad shape’ as is currently the case, it should be expected that oil prices would rise as the world economy begins to ultimately turn around, rather than fall!