The Nigerian oil and gas sector heavily relies on international transactions, making it highly susceptible to foreign exchange fluctuations. Fluctuations in exchange rates can significantly impact the sector’s revenue and costs, leading to currency depreciation, inflated import prices, and fluctuations in export revenue.
Since Nigeria’s economy depends heavily on oil exports, this volatility directly affects Nigeria’s foreign exchange earnings and overall economic stability. Additionally, oil exports, often transacted in US dollars, contribute significantly to the country’s foreign exchange reserves. Thus, sharp declines in oil prices can trigger currency depreciation, further pressurizing the Nigerian Naira.
Of a necessity, Nigeria’s oil and gas firms must put hedging strategies in place to deal with this currency fluctuation.
Hedging Strategies for Nigeria’s Oil & Gas Firms
Oil and gas companies in Nigeria can hedge against the risks posed by currency fluctuations in several ways. These hedging measures are broadly categorized into:
- Forward Contracts
Oil and gas firms can utilize forward sale contracts, also known as forward purchase agreements or advance payment facilities. These agreements involve a lender agreeing to buy a predetermined quantity of crude oil from the producer at a fixed price. This price is paid in advance by the lender while the crude ould is delivered at a later date. This provides predictable revenue and financial certainty.
An example is the proposed $33 billion crude oil repayment loan from Afreximbank Limited to the Nigerian National Petroleum Company Limited, which aims to improve dollar liquidity, stabilize the Naira, and reduce fuel prices.
- Swap Contracts
These bilateral contracts involve exchanging cash flows at predetermined intervals. They lack upfront costs (like premiums) and offer an active trading market due to high counterparty participation. Consequently, the market enhances liquidity.
Again, price swaps exchange a floating price for a fixed price based on a notional quantity of oil or gas. Throughout the length of the swap, the fixed price specified in the swap contract remains constant. These price swaps are permanently settled financially by comparing the floating price of the oil or gas (as published by an index chosen by the parties) to the fixed price stipulated in the swap contract on predetermined periods. This helps ensure predictable revenue and financial stability.
- Options Contracts
These instruments grant the holder the right, but not the obligation, to buy or sell a specified quantity of oil or gas at a fixed price (strike price) within a specific timeframe (expiration date). This allows risk management and price speculation.
Options contracts can further be broken down into two main types of options: call options and put options. Whereas call options are often used by buyers who anticipate that the price of oil or gas will rise, sellers who want to protect themselves from potential price declines use the put option. In both cases, the options seller does it to either profit or cut losses.
- Sourcing Locally
Oil and gas companies can reduce import costs by adopting locally produced equipment and tools. This promotes local industry development and reduces reliance on foreign exchange.
- Infrastructure Investment
Investing in domestic refining and downstream infrastructure can help decrease reliance on large-scale fuel imports, mitigating the impact of currency depreciation on import costs. This promotes self-sufficiency and economic diversification.
Beyond Hedging Strategies
While financial and non-financial instruments are vital to mitigating risk, legal expertise provides the foundation for successful hedging strategies for oil and gas firms. By partnering with a qualified law firm, oil and gas companies can navigate the complexities of the law while confidently protecting their financial interests in the face of volatile currency fluctuations.