Crude Oil Price Risk Management: Should Nigeria Hedge Its Crude Oil Production?

Abstract

The volatility of the crude oil market and the uncertainties imposed on oil companies and oil producing nations is well documented. For National Oil Companies (NOCs) vested with the responsibility of managing their country's oil and gas resources and providing revenue needed for much investments, the unpredictability of the crude oil market poses more challenges. In Nigeria, oil price fluctuations constraint national and sub-national budgets as oil benchmarks are typically optimistic. From 2015 – 2019, actual revenue accretion from crude oil sales compared to benchmark price and production have been as low as fifty percent (50%) of target. To address the uncertainties and guarantee stable revenue, it's imperative for Nigeria to implement best practice in crude oil price risk management by considering the merits and demerits of available tools such as hedging. A pertinent question is if hedging (similar to Mexico) a credible, beneficial option for Nigeria? Would hedging have improved Nigeria's revenue if adopted in the last five (5) years? This paper attempts to provide answers by analysing various hedging options and studying the success and downsides of major sovereign hedging programs. We further explored the empirical and normative dynamics that will accelerate or impede the adoption of hedging and suggested mitigating options. We find that considering the empirical factors alone, crude oil price risk management is a potentially viable option for Nigeria as benefits extend beyond direct revenue increase. Hedging will instil discipline, confidence and ultimately attract investments into the Nigerian oil sector. Our conclusions nonetheless recognise that the soft, qualitative factors around hedging if not well managed could be a drawback, impacting revenues.