Impacts Of Oil Price Volatility On Economy

The Impacts Of Oil Price Volatility On Economy (PDF/DOC)

Chapter One

INTRODUCTION
1.1 Background to the Study
Economic growth plays a key role in industrial innovation (Malatyali, 2016). The first fluctuations in crude oil prices that occurred in 1973s have made economists to view sudden movements in the oil price as a fundamental source of economic fluctuations, for example, Hamilton (2005) suggests that in the last few decades, nine of the ten recessions in the USA were preceded by large positive increases in crude oil price. Moreover, the very recent highs registered in the crude oil market are causing concern about slowing in the economies of many developed countries including Nigeria. The price of a barrel of Brent crude oil in European countries fell from than $100 p/b in Sept 2014 to less than $46 p/b in January 2015. Besides, the decline was the third largest over the past 30 years, has particularly interesting parallels with the episode in 1985-86, therefore, renewed interest in the impacts of fluctuating oil prices on the economy. Therefore, this relation has captured increasing attention of academic researchers such as: (Hamilton, 2009; Kilian and Vigfusson, 2011; Edirneligil and Mucuk, 2014; Ftiti et al., 2016) the most influential articles in the field, and others. The impacts of fluctuations in oil prices on economic growth and their mechanism in oil-exporting countries differ from those in the oil-importing countries (Moshiri and Banihashem, 2012).
Over the years, concerned economists have examined the possible factors that lead to oil price fluctuations. For instance, shocks to the supply arising from political events such as wars and revolutions in OPEC member countries, improvements in the technology of extracting crude oil price, and the discovery of new fields. Also important steps in this regard, for example, in Taiwan “renewable energy development plan” of the installed capacity of solar power generation capacity planned between the years 2002-2020 in accordance with the aimed to reach 10 percent (Kizgin and Benli, 2013). In addition, a shock to the oil demand for crude oil price associated with unexpected movements in the global business cycle. As well, demand shock for above ground oil inventories, reflects shifts in expectations about future shortfalls of supply relative to demand in the oil markets (Hamilton (2008)). The period includes a lot of fluctuation and two severe accidents. One crash, in recent months of 2008, the so-called worst financial crisis since the great depression. Due to the expansion of financial derivative instruments, which have often been held accountable for giving rise to the financial crisis in 2008 (Ulusoy, 2011).
The second crash experienced in the oil price has declined sharply over $100 per barrel since June 2014 to around $30 pb recently. The decline in oil price poses considerable challenges for fiscal, monetary and structural policy. However, the shocks in oil price create uncertainty and undermine effective fiscal management of oil revenues. According to costs (Erdoğan, 2011) businesses seeking capital, uncertainty affecting the cost of capital is beneficial because it eliminates and reduces compliance costs. Changing oil prices have an effect on the global economic performance and the economy level of any country. The effects of this is positively or negatively dependent on the nature of the relation between oil-exporting economy and oil-importing economy (Le and Chang, 2015) that higher oil revenues play an oil price increase contributes to a transfer of wealth from oil importing to oil-exporting countries (Balcilar and Ozdemir, 2013). Studying the relationship of between crude oil price shocks and economic performance is significant for investors to take necessary investment decisions and for policy makers to regulate financial markets more effectively. Marketable securities, which can be considered as an indicator of accounting standards increase refers to temporary investments that are bought or sold for companies, the evaluation of the fair value method of marketable securities is another important issue (Erdoğan et al., 2016). Hierarchical structure may be useful in the detection of the theoretical description of financial markets and in the search of economic factors affecting special groups of stocks (Ulusoy et al., 2012). This study will examine the impacts of oil price volatility on Nigeria economy 2000-2016.

1.2 Statement of the Problem
It is no more news that the recent fall in crude oil prices that began in July 2014 is seriously affecting the economic activities of Nigeria and also in the areas like foreign reserves, currencies crisis, declining government revenue, and majorly possesses a threat to meet financial obligations as at the right. The implication of this is that it brings a large out pour of policies among policy makers and contributions from the academia. These policies have brought about the need to diversify our economy towards once thriving sectors in the economy, removal of subsidy, the war on corruption and reduction of government activities and government related cost. This study identified two basic research problems. First is the need to determine when agents believe that the effects of shocks will be permanent, shocks feed into their expectations, and the persistence of shock is thus large. In the same vein, when agents believe that the effects of shocks are only temporary, prices quickly return to their initial position. Secondly, the research problem is the need to understand the effect of oil price volatility on four fundamental economic variables (total government revenue, capital importation, exchange rate and foreign exchange reserves) in Nigeria. It is against this background that the researcher seeks to examine the impacts of oil price volatility on Nigeria economy from the year 2000-2016.

1.3 Research Objectives
In order to achieve the broad objective of the study, the following specific objectives were investigated. The broad objective of the study is the impacts of oil price volatility on Nigeria. To achieve this objective, the study strived to;
1. Determine whether there are attendant positive significant relationship exist between crude oil price and economic growth.
2. Examine the effects of crude oil price volatility on government revenue, foreign exchange rate, capital importation and foreign external reserves.

1.4 Research Hypotheses
Hypothesis Two
There is no positive and significant relationship between oil price and economic Growth.
Hypothesis Two
There is no positive effect of crude oil volatility on government revenue, foreign exchange rate, capital importation and foreign external reserves Economic (foreign exchange rate, foreign external reserves, government revenue and capital importation) impact of Crude oil price volatility is positively significant.

1.5 Significance of the Study
The recent crashing of global oil prices is attracting heated debate among policy makers and academics because of the effect on global output, inflation and economic stability. Nigeria represents a good case study for exploring the effect of exogenous oil price shock on oil exporting countries because of her dependence on crude oil earnings, and the challenges currently confronting the government. The significance of the study therefore is its contribution to literature as well as methodology and the economic importance of oil price uncertainty to growth for oil exporting countries like Nigeria. Thus, the findings of this study are beneficial to the government, policy makers, the private sector and academia.

1.7 Scope of the Study
The focus of the study is Nigeria, and it estimates the impact of crude oil prices on Nigeria’s Economic Growth. The study covered the period of 2000 to 2016. The yearly figures on GDP, Per-capita Income and Crude oil prices and the monthly average prices of Brent, West Texas Intermediate (WTI) and OPEC basket were used as proxies for crude oil prices, while foreign exchange rate, foreign external reserves, government revenue and capital importation were used to proxy economic indicators.

1.9 DEFINITION OF TERMS
OIL PRICE VOLATILITY: It is a rate at which the price of oil increases or decreases for a given set of returns. Volatility is measured by calculating the standard deviation of the annualized returns over a given period of time. Volatility is a statistical measure of the dispersion of returns for oil.

1.8 ORGANIZATION OF THE STUDY
This research work is organized in five chapters, for easy understanding, as follows
Chapter one is concern with the introduction, which consist of the (overview, of the study), historical background, statement of problem, objectives of the study, research hypotheses, significance of the study, scope and limitation of the study, definition of terms and historical background of the study. Chapter two highlights the theoretical framework on which the study is based, thus the review of related literature. Chapter three deals on the research design and methodology adopted in the study. Chapter four concentrate on the data collection and analysis and presentation of finding. Chapter five gives summary, conclusion, and recommendations made of the study.

Chapter Five

Summary of Findings

The findings from this study revealed that the current negative global oil shock has significant negative impact on the Nigeria economic growth. Specifically, the results revealed that the current shocks result in USD/Naira exchange rate depreciation, serious depletion of Nigeria’s external foreign reserves, steep downward trend in government revenue, and reduction in capital inflows. These findings clearly show that Nigerian economy is extremely vulnerable to global commodity price shocks as a result of over-dependent on oil.

Growth theorists have steadily identified a causal relationship between crude oil shocks and economic growth addressed under two streams;

oil price shocks hinder economic growth; and
a circular relationship such that oil price shocks could hinder or stimulate economic growth.

The first line argued that oil shocks increase uncertainties, which could adversely affect economic planning and projections, thus hindering economic growth (Narayan and Liu, 2014[29]; Shahbaz, Tiwari, Ozturk and Farooq, 2013[30]). That is, since the events are unpredictable, they could cause large-scale private sector defaults, trigger distressed assets sales, high bank insolvency, depletion of external reserve, currency crisis and loss of market confidence. In contrast, the second line argued that oil price shocks could hinder or promote growth depending on whether the country is an oil importer or oil exporter. In their view, increasing oil price stimulates oil exporting economies and hurts oil importing economies, while decreasing oil price could stimulate the economies of oil importing countries and hurt oil exporting economies.

Conclusion

The nation is yet to succeed at breaking the chain of poverty despite her abundant endowment of oil resource. The problem is caused by many factors. However, the focus of this research is identification of the impact of oil price volatility on the growth of the Nigerian economy. This study finds that oil price volatility does not have a positive impact on the economy (contrary to the findings of some earlier studies) but oil price itself does. While increase in price positively affect the economy through its contribution to export revenues (and government revenues), surges in oil price induce or worsen uncertainty in the economy through its effect on fiscal instability and vulnerability of budget implementation. This negatively affects the economy, The reason for this is that, in spite of numerous problems facing the nation (locally and globally – among theglobal factors is the fluctuations in oil prices arising from global events), the country‟s GDP has been, virtually always, on the rise; and the Nigeria‟s economic growth has suffered severely leading to poor standard of living.

Recommendations

Notwithstanding, the country should diversify its export revenue base as a means of minimizing reliance on crude oil and petroleum product. Some of these include; fiscal prudence, reform in budgetary operations, export diversification, revival of the non-oil sector of the economy, accountability and corporate governance. This will further shield the economy from the impact of oil price shocks on the economy, and thus prevent the negative effect of the shocks from attaining a statistical significant level. Some other recommendations are as follows:-

Need for Structural Reforms: The reform should be targeted at eliminating structural rigidities, enhance production, and promote global competiveness. Such reforms should aim at fashioning institutions to prevent politicians from violating inter-temporal budget constraints, and more generally, from engaging in short-sighted, time inconsistent policies that in the end stymie economic growth.
Tax Authorities Must Retrieve Their Legitimacy from Economic Agents in Order To Augment Government Revenue Sources: Increasing income tax (as currently practiced in some states of the federation) and the clamor to increase value-added-tax (VAT) is a wrong approach. It is counterfactual to increase the burden during an economic recession.

Need for A National Technology Development Plan: The need for a national technology development plan. Apart from the undiversified structure of the Nigerian economy and declining oil prices, a critical technology gap predisposes the country to external shocks. Concerted effort towards mass skills acquisition in the form of technology transfer is imperative for global competitiveness.

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Economics (1237), Petroleum, Oil, and Gas (31)