THE ANALYSIS OF OIL PRICE SHOCK IN NIGERIA (1970-2014)
CHAPTER TWO
LITERATURE REVIEW
2.0.Introduction
This chapter discussed various previous relevant literatures and studies. This section is divided into three parts, which are the conceptual frame work, the theoretical review and the review of other empirical literatures. The conceptual framework discuss various concept and definition relating to oil price shock and economic growth. In the theoretical review, different existing theories linking oil price shock and economic growth are discussed while the empirical review discusses various empirical investigations carried out by other researchers in the past.
2.1. Conceptual Review
This section is devoted to an extensive review of various concept relating to crude oil price shock and economic growth in Nigeria. An overview of the world oil sector and the Nigeria Oil Industry was discussed, followed by concept of volatility, the relationship among oil price shock, and the linkage between oil price shock and Nigeria economic growth.
2.1.1. An Overview of the World Oil Market
The global oil market includes thousands of actors who facilitate the flow of oil from where it is produced, to where it is refined into products, and also from there to where those products are ultimately sold to consumers. (Levine et. al, 2014) reported that the market value of crude oil is driven by demand for refined petroleum products, particularly in the transportation sector, virtually all motor vehicles, aircraft, marine vessels, and trains around the globe are driven by petroleum product. Products derived from oil, such as motor gasoline, jet fuel, diesel fuel, and heating oil, supply all the energy consumed by households, businesses, and manufacturers worldwide. Fig 2.1 below shows that consumption of oil exceeds $500 billion which is about 33% of the world energy consumption is derived from crude oil. Crude oil is also the world’s most actively traded commodity, accounting for about 10% of total world trade. (Namit, 1998)
Indeed the demand of crude oil has consistently increased in the last two decades as seen in fig 2.1 below
Source: Adapted from Dirzka 2015
Figure 2.1: World Crude Oil Consumption
The economic significance of oil is not only derived from the sheer size of the market, but also from the crucial, almost strategic, role it plays in the economies of oil-exporting and oilconsuming countries. Oil prices drive revenues to oil-exporting countries in a large number of which, oil exports comprise over 20% of the GDP. On the other hand, costs of oil imports (typically over 20% of the total import bill) have a substantial impact on growth trends in developing countries.
The organization of petroleum exporting countries (OPEC) which holds majority (77%) of global proved reserves, has not gained market share in recent times, OPEC’s market share of about 51% in 1973 has dropped significantly to 41% in 2010. The decline in OPECs market share is attributed to continuous production increase in Non-OPEC nations such as U.S, Russia, brazil etc., onshore production in the U.S. has been on the increase due to innovations in the development of shale resources (both oil and natural gas-related liquids); biofuels have been another key source of liquids supply growth (primarily the U.S. and Brazil—both enabled by rising oil prices in recent years with the U.S. also receiving a boost from tax credits and mandates). Fig 2.2 below shows crude oil supply output for both OPEC and Non OPEC producing nation, as depicted, oil production in Non-OPEC has increased more consistently than OPEC.
2.1.2. The Nigerian Oil Sector
Since the discovery of crude oil in 1956, the Nigerian oil industry has been active and vibrant, the sector was largely dominated by multinational corporations until the early 1990s when Indigenous companies started springing up. The creation of the Nigerian National
Petroleum Corporation (NNPC) and the implementation of the Nigerian Oil and Gas Industry Content Development (NOGIC) Act have indeed boosted Local participation of indigenous company. (KPMG, 2014). Structurally the Nigerian Oil industry is divided into upstream sector and downstream sector.
•Upstream Sector
The Nigeria’s upstream sector is characterized by exploration, production and joint venture activities of crude oil and gas. This sector is the single most important sector in the country’s economy, generating over 90% revenue from total exports. As at 2007 Nigeria’s proven oil reserves were estimated at 36.22 billion barrels which is 2.92 % of the world's Reserves. Oil
Is Produced from Five of Nigeria’s Seven Sedimentary Basins which are located in Niger Delta, Anambra, Benue, Chad, And Benin. The Niger Delta Basins Contain About 80% of producing wells Drilled In Nigeria. (SSA Nigeria report, 2009). Currently, Crude oil production in the country stands at between 2.2million barrels and 2.5 million barrels per day. This output is strictly based on OPEC regulation on production. The United States used to be Nigeria’s largest importer of crude oil, accounting about 10% of overall U.S. oil imports. But from july2014 Nigeria ceased exports to the US due to the impact of shale production in America; currently, India is the largest importer of Nigeria’s crude oil.
Oil exploration from 1937 to 1993 was restricted to land and swamps, but from 1993, exploration turned to high risk ventures in the frontier basin of deep water off-shores which yielded massive result. The offshore exploration became increasingly attractive as a result of significant discovery of oil in the deep water aided by novel exploration and production technology. This development has boosted the nation's crude oil reserve by more than 25% in the last decade. (Igbatayo, 2016)
Figure 2.4: Crude Oil Production and Consumption in Nigeria
The major challenge faced by the upstream sector is pipeline vandalism in the Niger delta region. The energy information report in fig 2.4 shows that the main cause of the fall in oil production in 2009 and partially in 2013 was pipeline vandalism and oil theft.(Okoli, 2013) reported that a total of 16,083 pipeline breaks were recorded within the last 10 years.
According to the 2013 annual report of the Nigerian Extractive Industry Transparency Initiative (NEITI), Nigeria lost a total of 10.9 billion US Dollars to oil theft between 2009 and 2011 (NEITI, 2013; Okoli, 2013).
•Downstream Sector
Activities that are characterized with the Nigerian downstream petroleum sector are transmission and conveyance crude oil, refining, distribution and marketing. Transmission and Conveyance activities involves the transportation of oil and gas to refinery and gas stations, in other words it involves the transportation by pipelines, rail, barge, oil tankers or truck from crude oil production terminals to refineries or export terminals crude . There are pipeline networks, tankers and purpose built vessels for this purpose. (KPMG, 2014)
Nigeria through the management of the NNPC has four refineries, two are situated in Port Harcourt and the other two in Warri and Kaduna respectively. The four oil refineries have a combined capacity of 445,000 barrels per day (bpd). (Odularu, 2008) However, these refineries only produce about 30% of their installed capacity; necessitating the importation of refined products to meet growing local demand. The combined capacities of these refineries exceed the domestic consumption of refined products, in which premium motor spirit (gasoline) is the most consumed. (Adedipe 2004). Recent development indicates that refinery activities will be boosted soon, owing to the fact that the Federal government of Nigeria has awarded contracts for
Turnaround Maintenance to be performed on the refineries so as to increase the level of their production. The number of refineries in the country is expected to increase in future as new license have been granted. In addition, the Government’s strategy of tying award of new oil licenses to securing commitment on the part of license holders to build new refineries, railway lines, gas pipelines or power plants should help in this regard. (KPMG 2014).
Distribution and Marketing of refined petroleum products are complementary activities. Distribution involves the transportation of refined petroleum products from the refineries through pipelines, coastal vessels, road trucks, rail wagon etc. to the storage/sale depots. Petroleum products are supplied in Nigeria principally through the Petroleum Product Marketing Company’s (PPMC) pipeline system, which links the refineries to the about 21 regional storage/sale depots.
Marketers lift products from PPMC depots and deliver to their various retail outlets. They also import refined products from outside of Nigeria to meet the demands of their customers. There are however guidelines issued by the DPR to prevent importation of substandard products.
The FGN currently regulates the prices of refined petroleum products. The Petroleum Product
Pricing Regulatory Commission (PPPRC) is responsible for fixing the prices of the products. However, as part of the energy sector reform of the FGN, there is a plan to deregulate fuel pricing and privatize the refineries. The proposed energy reforms currently faces stiff opposition from the organized labour and civil society groups in the country.
2.1.3. Volatility
The concept of volatility is sometimes confused with consistent rise in price of commodities, though volatility can result in rising prices, it could also equally result in significant drop or decrease in prices. Volatility measures the extent of the variability of price or quantity that occurs on a daily, weekly, monthly or yearly basis, it measures how much a price changes with regards to either its trend or constant long-term level. (Bernardino Algieri (2012).
It is important to note that volatility does not measure the direction of price changes; rather it quantifies variation of prices around the mean. (Kotze, 2005) further explained volatility as the variation or dispersion or deviation of an asset’s returns from their mean.
When price movements are extremely wide over a short period of time we have “high volatility”.
On the other hand when price movements are low over a short period, there is low volatility.
This is seen in the graph below.
Source:
Figure 2.5: Volatility
A typical example of a low volatile price is seen above in the period 1950-1971, while on the other hand the period 1986-2010 shows a relatively high volatile period.
2.1.4 Volatility in Crude Oil Prices
In an efficient market, prices reflect known existing and anticipated future circumstances of supply and demand and factors that could affect them. Changes in market prices tend to reflect changes in what markets collectively know or anticipate. When market prices tend to change a lot over a relatively short time, the market is said to have high volatility (Institute of 21th energy, 2012). This indeed is the main attribute of crude oil prices characterized by this highly volatile nature of market makes it one of the major macro-economic factors that create an unstable economic condition for countries around the world. Oil price shock has an impact on both oilexporting and oil-importing countries. According to Federer, (1996) as cited in whidi and prajitno, (2011), an increase in the oil prices influences the economy of oil-importing countries negatively. This further causes increase in inflation and economic recession. On the other hand, oil-exporting nations are positively correlated to the increase in oil prices.
•Historical Path
Source:
Figure 2.6: Historical Path of Volatility in Crude Oil Prices
Fig2.7 explains in details trends of high volatility and shocks in crude oil prices over the last 85 years. Massive industrialization took place after the Second World War and crude oil become the main source of energy in the world. The pricing power of crude oil was in the hands of the multinational oil corporations before the establishment OPEC in 1960s. At this period oil price were seen to be relatively stable. OPEC gained dominance gradually and the first major oil shock was witnessed in 1973, this was attributed to the Arab embargo against countries supporting Israel In the Yom Kippur war, as a result, the crude oil price increased dramatically by approximately 260% resulting in the U.S. imposing a ban on its oil exports and the world economy entering a recession. Further surge in the prices of crude oil was witnessed between 1978 and 1980 largely due to the Iranian Revolution in November 1978 and crude oil price spiked from US$13.00 to US$35.00 per barrel. This gave rise to further increase in oil prices in the early 1980s before it dropped dramatically between 1986-19 due to Saudi Arabia increase in crude oil production and the end of the war between Iran and Iraq. The decreased demand caused the price of world crude oil fall in 1996, The Asian financial crisis triggered further decline in oil prices at US$24.00/barrel which further declined to US$12.00/barrel in 1998. Nevertheless, the world economy recovered once again and crude oil was trading at approximately US$24.00 per barrel in the end of 1999. After 1999, Oil prices also fell by over 50 percent during the Great Recession of 2007-09. However, the price declined during the Great
Recession was due primarily to a pronounced slowdown in global economic activity (Davig, ÇakırNie, Smith, and Tüzemen 2015) thoughthe economy flourished till around mid-2008, when the oil price was historic high at US$ 115 per barrel (IFS, 2015). but the financial crisis hit the world economy later that same year and the price dropped to US$44 per barrel in the beginning of 2009, according to (Kutulu, 2015) this was indeed the fastest crash in oil price history. It took four years for the economies around the world to recover from this economic recession, and crude oil price again surge to US$112 per barrel by 2012 (IFS, 2015).
From June 2014 the market price for the crude oil fell steadily and reached in January 2015 the lowest price since the 2009 as shown in fig fig2.5 within this period the decline in oil prices was about 252%
Source: Adapted from Dirzka 2015
Figure 2.7: Trends of Oil Price from 2011-2015
The U.S. shale oil production was one major factor that contributed to the decline. According to an article by Reuters in November 2014, it stated that “Saudi Arabia blocked calls on Thursday from poorer members of the OPEC oil exporter group for production cuts to arrest a slide in global prices, sending benchmark crude plunging to a fresh four-year low” (Dirzka, 2015). The reason stated by the Saudi government was that, the low oil price was necessary to make the U.S. shale oil production uneconomical, which an oil needs price above US$60.00 to pay for the running costs. (http://www.format.at/wirtschaft/preisverfall-oel-saudis-5191403.) (Dirzka 2015). This downward trend continued as OPEC announced that it would not cut its production, in order not to decrease their market share. Currently the world market price for crude oil is still oscillating around 40 to 50 dollars per barrel, and its future remains uncertain.
2.1.5. Oil Price Determinants and Causes of Price Fluctuation
From the historic events presented, the volatile trend of oil price can be seen clearly. When imbalances in global oil supply and demand occur, the price fluctuates. (Baffes, Kose,Ohnsorge, Stocker 2015) The traditional factors driving oil prices have always been the fundamental factors or events which affect oil supply and demand (PRB, 2012). Direct factors includes; Changes in OPEC objectives, developments in supply and economic growth affect prices of crude oil, while the indirect determinant includes, appreciation of the U.S. dollar, geopolitical developments and speculations (PRB, 2012).
Source: Author’s expression
Figure2.8: Determinants of Oil Price
1. Changes in OPEC Objectives
OPEC accounts for 40% global oil supply with about 36 million barrels daily production in which 30 mb/d are subject to quotas and have the potential to be the swing producer in global oil market if it chooses. But as a result to rising unconventional oil production and incontinence decision making, OPEC’s share of global oil supply has been steadily eroded in the last few years. (Baffes et al, 2015)
2. Developments in Supply
Rising unconventional sources of oil production such as the shale oil production in the United States and the Canadian oil sands have increased significantly the supply of crude oil production, this factor was one of the major causes of the oil price glut between 2014 and 2015 as aforementioned. (Benes et al. 2012) noted that the cost of unconventional oil production is likely to decline as new technologies will reduce the cost of exploration and extraction.
3. Appreciation of the U.S. Dollar
Another possible rationale for oil price shock is the rising foreign exchange value of the U.S. Typically, an appreciation of the U.S. dollar raises the local currency cost of oil in countries using currencies not linked to the U.S. dollar. (Akram, 2009) as cited in (Davig et al, 2015) present’s evidence that a stronger dollar has historically been associated with declining oil prices. The rise in the dollar’s value against other major currencies was substantial in the second half of 2014 and was a possible factor contributing to the declining price of oil. (Davig et al, 2015). Between June 2014 and January 2015, the U.S. dollar appreciated by more than 10 percent against major currencies in trade-weighted nominal terms. This resulted into a weaker oil demand in those countries and stronger supply from non-U.S. dollar producers, therefore contributing to the glut in crude oil price in that period.
4. Geopolitical Developments
Over the past 3 decade geopolitical tensions have indeed cast a long shadow over oil prices. Some of the major oil shocks that occurred most especially in the 80s and 90s have been linked heavily to conflicts in Asia, Middle East, and US, as shown in fig 2.7. Though in more recent times this factor has not pulled much weight on oil price, for instance in the second half of 2014, it was obvious that conflict in the Middle East and Eastern Europe weighed less heavily than expected on oil supply. In Libya, despite internal conflict, they added about 0.5 mb/d of production in the third quarter of 2014. Likewise in Europe, the sanctions imposed after June 2014 conflict between Russia-Ukraine have had little impact on European oil and natural gas markets.
5. Speculations
Prices are affected not only by changes in the level of production, but by changes in production relative to what the market expected (Davig et al, 2015).When the speculators take part in the market, they can control the prices due to their individual views. This is due to the fact that they can buy and sell oil stocks based on the opportunities opinion. (Abdulla Alikhanov Trang Nguyen, 2011).
EIA,(2012),summarized the drivers of crude oil price in four broad categories; OPEC investment and production decisions; the economics of non-OPEC supply; the economics of other liquids supply; and world demand for petroleum and other liquids. OPEC.s role is a critical factor in determining long-term supply because oil resource is only available in limited amount within a particular geographical distribution, and more than 70% of proved oil reserves are concentrated in the OPEC countries. In the short run oil prices are mainly influenced by speculators in the financial market (Suleiman 2013). When the speculators take part in the market, they can control the prices due to their individual views. This is due to the fact that they can buy and sell oil stocks based on the opportunities opinion. (Abdulla, et al, 2011)
2.1.6. Oil price shock and Economic Growth in Nigeria
There is considerable controversy among economic researchers on how oil price shock affects economic growth, some researchers such as Gunu and Kilishi (2010) and Akpan (2009), are of the view that a positive volatile crude oil price encourages economic growth but some other researchers such Darby (1982), Cerralo (2005) are of the view that it can inhibit growth. The former argues that for net-oil exporting countries, a price increase in crude oil impacts positively real national income through higher export earnings whereas, the latter cite the case of net-oil importing countries which experience inflation, lower investment, fall in tax revenues, increased input costs, reduced non-oil demand, and ultimately a reduction in economic growth(Oriakhand Iyoha, 2012).Boheman and Maxén 2015 explain this argument further by stating that a positive oilprice brings about increase in national income for oil importing countries, while a negative volatility brings about decrease in national income for oil importing nations. The reverse is the case in the case of a negative price volatility.
Nigeria's national income has been heavily linked with crude prices over the years, and it has indeed been more complicating due to the fact that the country qualifies simultaneously has an oil importing and exporting nation.(Oriakhi and Iyoha, 2012). According to the world bank(2013), the Nigerian economy exhibited strong GDP growth over the last decade with a growth rate of about 8% in which the oil sector comprises 40% of Nigerian GDP at current prices.
The genesis of the huge impact oil price shock and volatility on economic growth in Nigeria can be traced to the 1973 oil shock, which brought about massive wealth to the nation economic purse (Oyeyemi 2013). At that time, the value of Nigeria’s export rose by about 600 per cent and by 1975 GDP had risen by 20%. Indeed this resulted in increased government expenditure owing largely from the need to monetize the crude oil receipts. Investment was largely in favour of education, public health, transport, and import substituting industries (Nnanna and Masha, 2003). During the oil price shock of 2003-2006, Nigeria recorded increases in the share of oil in GDP from about 80 per cent in 2003 to 82.6 per cent in 2005.
Source: Author’s computation of data from British Petroleum Statistical Review and World Bank data Figure 2.9: OIL PRICE AND GDP IN NIGERIA
Fig 2.9 above stressed the fact that there is indeed a correlation between oil price and Nigeria economic growth, as the chat depicts. It is evident that both variables exhibited the same trend pattern in most of the periods between 1970 and 2014.Positive volatility and shocks in oil prices that occur between 1970 and 1984 indeed boosted the country GDP significantly, while the huge drop in oil prices in the periods 1985-1986, 2008-2010 really witnessed a huge drop on the country’s GDP.
The result of positive shocks in prices of crude oil has been seen to be favourable to investment climate, increased national income within the period although a slight decline was observed in the growth rate of the GDP. Despite this perceived benefit of oil price change, the macroeconomic environment in Nigeria during the booms periods was undesirable. For instance inflation was mostly double digit in the 1970s; money supply grew steeply, while huge fiscal deficits were also recorded. (Akpan 2009).
Hanna Boheman and Josephine Maxén (2015) noted that many of the world’s crude oil netexporters suffer from what is referred to as the “Dutch disease” or “resource curse”. These terms depict the negative relationship found between a heavy reliance on natural resources and economic growth. Nigeria which is heavily endowed with crude oil, tend to develop its markets through revenues gained from producing this resource but inevitably experience huge income losses in the event of a decreased oil price, thereby leading to a resource curse.
2.2. Theoretical Review
In the last few decades a quite number of theory’s relating to the issue of oil price shock and economic growth has emanated.
Traditional growth theories concentrate on primary inputs of factors of production such as Capital, labour & land, while failing to recognize the role of primary energy inputs such as; oil deposits. Ndungu(2013).However, economists and social scientists in the last few decades have made efforts at evolving some theories which capture impact and rolesof oil price on economic performance, thereby integrating the linkage between energy resources and economic growth. Dominantly, the Linear/Symmetric relationship oil price transformation and asymmetry/nonlinear transformation are popular theories that links oil price fluctuations and economic growth.
2.2.1. Linear/Symmetric Theory
Linear/Symmetric relationship theory of growth whose expounders include; Gisser(1985), Goodwin (1985), Hooker (1986) and Laser (1987). They theorize that a linear negative relationship between oil prices and real activity exists especially for oil importing countries. This implies that an unexpected increase in the real price of oil will cause aggregate income to fall by the same magnitude, also, if an unexpected decline in the real price occurs aggregate output will increase by the same magnitude. They pivot their theory based on the experiences in the oil market between 1948 and 1972 and its impact on the economies of oilexporting and importing countries respectively. Hooker (2002) confirmed that between 1948 and 1972 oil price level and its changes exerted influence on GDP growth significantly. Laser (1987), likewise validate the symmetric relationship between oil price shock and economic growth. After an empirical study of her own, she submitted that an increase in oil prices necessitates a decrease in GDP, while the effect of an oil price decrease on GDP is unclear, because its effects varied in different countries.Mgbame et al, (2013). However, By the mid-1980s . the projected linear relationship between oil prices and real activity began to lose significance, for instance, the declines in oil prices occurred over the second half of the 1920s were found to have smaller positive effects on economic activity than predicted by linear models. The mis-representation of the linear specification has led to different attempts to re-define the measure, Lee et al. (1995) and Hamilton (1996) and some other researchers to introduced non-linear transformations of oil prices, thereby establishing an asymmetric relationship between oil prices and economic growth. (Killen and Vigfusson, 2011)
2.3.4. Asymetric Theory
The rationale for asymmetric responses of real output to oil price innovations hinges on the existence of additional indirect effects of unexpected changes in the real price of oil on micro economic performance. Lee et al. (1995), reported that the response of the GDP to an oilprice shock depends greatly on the environment of oil-price stability. An oil shock in a price stable environment is more likely to have greater effects on GDP than one in a price volatile environment. They therefore, propose a measure that takes the volatility of oil prices into account, specifically, they capture these features through a GARCH(1,1) model based on an oil-price transformation that scales estimated oil-price shocks by their conditional variance, Their result shows an asymmetric effects of positive and negative oil-price shocks, They further attempt to distinguish between oil price changes and oil price shock and they positedthat volatility has a negative and significant impact on economic growth immediately, while the impact of oil price changes delays until after a year. This implies that oil volatility rather than the level oil price has a significant influence on economic growth. Another popular upholder of the school, Hamilton (1996) claims that it seems more appropriate to compare the prevailing price of oil with what it was during the previous year, rather than during the previous quarter. He therefore proposes defining a new measure known as the net oil price increase (NOPI), which also restores the negative correlation between GDP and oil-price increases.
2.3. EMPERICAL REVIEW
Empirical investigations on oil price shock and its impact on economy has been emerging and expanding over the years. The empirical studies reviewed in this literature cuts across cross country studies, Nigeria Studies and other country case studies.
2.3.1. Cross Country Studies
Hanna and Josephine (2015) studied the effect of oil price shocks on economic growth in OPEC and non-OPEC economies from 1980 to 2008 based on the vector auto regression modelling; they revealed that OPEC and non-OPEC oil exporting countries’ economic growth shows nearly identical responses to oil price shocks. They concluded that OPEC countries appear to be just as sensitive to oil price shocks as non-OPEC countries. They suggested that Countries can enhance the positive effects of oil prices on lower inflation by putting in place financial/budgetary instruments to smooth the effects of the price fall, reduce oil price subsidies or increase taxes, reduce energy intensity or diversify trade and production to reduce the economy’s dependence on changing oil prices so as to foster cooperation amongst major gainers and losers from oil price changes so they are able to jointly manage upturns and downturns.
Jimenez and Marcelo (2003) studied the effects of oil price shocks on the real economic activity of the main industrialised OECD countries; distinguishing between net oil importing and exporting OECD countries. Their findings suggest that the effects of an increase and a decrease in oil prices on real economy show substantial evidence against the linear approach that assumes that oil price declines are as beneficial/detrimental as oil price increases of the same magnitude are detrimental/beneficial to real economic activity. The results obtained in the paper are broadly consistent with the expectation that the real GDP growth of oil importing economies suffers from positive oil shocks. With regard to net oil exporters, Norway benefitted from oil price hikes while in the UK a rise in oil prices is found to have a significant negative impact on GDP growth. This result relates to the evidence of a Dutch disease effect.
Bouakez, Kamara and Vencatachellum (2008) uses a dynamic stochastic general equilibrium model to quantify the effect of the increase in the price of oil on the main macroeconomic aggregates in some African economies. Their result indicates that a doubling of the price of oil on world markets with complete pass through to oil consumers would lead to a 6 per cent contraction of the median net-oil importing African country in the first year. If that country were to adopt a no-pass through strategy, output would not be significantly affected but its budget deficit would increase by 6 per cent. As for the net oil exporting country, a doubling in the price of oil would mean that its gross domestic product would increase by 4 percent under managed-float and by 9 percent under a fixed exchange rate regime. However, inflation would increase by a much greater magnitude under managed than a fixed exchange rate regime in a net oil exporting country.
Baghirov, (2014) examined the direct and indirect effects of an oil price shock on economic growth of Lithuania from 1995 to 2012, taking into consideration her trade linkages with main trade partners. Using the structural VAR model. His findings indicated that the indirect effects of a 50% increase in oil price growth rates on real GDP growth of Lithuania are positive, while the direct effects are negative. He posits that the positive indirect effects through the trade linkages mitigate the negative direct effects of oil price shock both in short and long run.
Mohmmadreza, Ali and Zahra (2013) examined the impact of oil price shocks on economic growth in various oil-exporting countries across the globe, using a panel data regression model with fixed and random method, from the period 1990 to 2009. Their results show that the positive shocks of oil price has a positive effect and the negative shocks of oil price has a negative effect on the GDP growth of oil exporting countries.
Farhad and Naoyuki (2015) studied the impact of crude oil price movements in three countries, which are China, Japan, and the United States. Through the structural VAR methodology, they examined the reaction to oil price movements and also compare their reactions. Their results suggest that the impact of oil price fluctuations on developed oil importers’ GDP growth is much milder than on the GDP growth of an emerging economy.
On the other hand, however, the impact of oil price fluctuations on the People’s Republic of China’s inflation rate was found to be milder than in the two developed countries that were examined.
Zhenbo, Jodie, Jane and Dirk (2014) investigated into the drivers, impacts and policy implications of the 2014 oil price shock on African economies. They found out that oil price drop has both direct effects through trade and indirect effects through growth and investment and changes in inflation. They stated that a 30% drop in oil prices is expected to directly reduce the value of oil exports in sub-Saharan Africa by $63 billion (major losers include Nigeria, Angola, Equatorial Guinea, Congo, Gabon, Sudan), and reduce imports by an estimated $15 billion (major gainers include in South Africa, Tanzania, Kenya, Ethiopia). The trade effects feed through to economies including through current accounts, fiscal positons, stock markets, investment and inflation
Youngho,, Kamika, Katrina and Noor Fatein (2011)investigated into how oil price shock have influenced the macroeconomic performances of economies in the AsianOceanic region and South Asia (ASEAN), through the VAR methodology. Their result reveals that oil price-GDP relationship is distinct among countries by their economic characteristics. They discovereda short run negative impact of an oil price shock to the GDP of small and open economies and an ambiguous effect of oil on the GDP of fast growing, large economies. Their result also indicated no clear pattern exist in the relationship between oil price fluctuations and inflation and unemployment. They also found a unidirectional causality relationship running from oil price to GDP.
Lim, Ngow and Phang (2011) studied the relationship between oil price and economic growth in 10 sub-saharan African Countries, from 1980 – 2008. They found a strong positive relationship between positive oil Price changes on economic growth in the selected oil exporting countries. Thier empirical results also show that there is at least one long run relationship exits.
Berument, Ceylan and Dogan (2010) examined how oil price shocks affect the output growth of Some selected middle east and north Africacountries through the Vector Autoregressive Methodology Their result suggest that oil price increases have a statistically significant and positive effect on the outputs of Algeria, Iran, Iraq, Kuwait, Libya, Oman, Qatar, Syria, and the United Arab Emirates. However, oil price shocks do not appear to have a statistically significant effect on the outputs of Bahrain, Djibouti, Egypt, Israel, Jordan, Morocco, and Tunisia. They further discovered that oil supply shocks are associated with lower output growth but the effect of oil demand shocks on output are positive.
Rebeca Jiménez-Rodríguez (2007) examined empirically the dynamic effects of oil price shocks on the output of the main manufacturing industries in six OECD countries via an identified vector auto regression for each economy. She discovered that the pattern of responses to an oil price shock by industrial output is diverse across the four European Union countries under consideration which are France, Germany, Italy, and Spain, but broadly similar in the UK and the US. Evidence on cross-industry heterogeneity of oil shock effects within the EU countries is also reported.
3.3.2. Case Studies of Other Countries
Balke, Brown and Yücel (2010) studied the interaction between Oil price Shock and Economic activities in the United State via the Bayesian methods and dynamic stochastic general equilibrium model of world economic activity, they found that changes in oil prices are best understood as endogenous. They further discovered that U.S. output fluctuations owe mostly to domestic shocks, with productivity shocks contributing to weakness in the 1970s and 1980s and strength in the 2000s.
Al-Ezzee(2011) identified the relationship between the growth of real GDP, real exchange rate, and oil prices in Bahrain from year 1980 to 2005. Via the Error Vector correction
Mechanism. He found out that a long run relationship exists between the growth of Real GDP, International Oil Prices, and Real Exchange Rate (REXR). He also discovered that the real exchange rate is an important variable to the growth of RGDP, and devaluation will improve the income growth rate of Bahrain in the long run. He further found a bilateral and unilateral causality among the variables of the model.
Usama and Normee (2009) studied the impact of oil shocks on the real exchange rate of the United Arab Emirates (UAE). Through the Vector Error Correction Model (VECM). Their results shows that there is a long run relationship between the real exchange rate of the dirham against the dollar and the oil price, GDP per capita, they also found out that oil price has a positive long run relationship with the real exchange rate and that an increase in the price of oil will lead to a real depreciation of the UAE dirham. Their Granger causality test found that the oil price, GDP per capita, trade balance, and FDI inflows Granger cause the real exchange rate in the short run and that 28.2% of the disequilibrium in the real exchange rate is corrected within a year. Their empirical results also indicated two-way causality between the oil price and real exchange, thus indicating that both the real exchange rate and the oil price are endogenously determined.
Hidhayathulla and Mahammad (2015) examined the effects of oil price on exchange rate of Indian rupee against US dollar from 1972 to 2012, using the multiple regression analysis of the OLS estimator, their findings suggests that the import of crude oil continues to rise when the crude oil future price increases. The oil imports thus is a substantial source of demand for dollar in India’s foreign exchange market. This strong demand contributes to strengthen the dollar against Indian rupee, among the other factors.
Sibanda and Mlambo (2014) through the Generalized Autoregressive Conditional Heteroscedasticity (GARCH) methodology determined the impact of oil prices on nominal exchange rate in South Africa, from 1994-2012. Their results showed that oil prices have a significant impact on nominal exchange rates. They further found out that an increase in oil prices leads to a depreciation of the rand exchange rate.
Shafi, Liu, Hua, Idrees, Satti and Nazeer (2015) in their research identified the impact of exchange rate volatility and oil prices fluctuations on economic growth in France using the Error correction Model from year 1971 to 2012. Their result showed that rise in oil prices affects positively gross domestic product and a significant long run relationship, Also the error correction adjustment mechanism (ECM) depicts a short runs significant relationship. They also discovered that effect of imports, exports, interest rate, inflation, government consumption expenditure and foreign direct investment affects exchange rate. Foreign direct investment and import of the country has significant positively related to the exchange rate while the exports and other factors has negatively related to the real effective exchange rate.
Dogah(2015) Uses arestricted VAR model and Johansen Cointegration test to investigate the impact of oil price shocks on the macro economy of Ghana a developing oil importing economy from 1972-2012. His findings reveal that oil price shocks have significant negative impact on output and economic activities in Ghana. His results indicate a nonlinear oil-price macro economy relationship but with no evidence of asymmetric effects exist between oil price shocks and macroeconomic variables in Ghana.
2.3.3. Case Studies of Nigeria
Aliyu (2009) in his research assessed the impact of oil price shock and real exchange rate volatility on real economic growth in Nigeria, using the Johansen VAR-based cointegration technique, from 1986 to 2007. His Granger causality test revealed unidirectional causality from oil prices to real GDP and bidirectional causality from real exchange rate to real GDP and vice versa. His Findings further showed that oil price shock and appreciation in the level of exchange rate exert positive impact on real economic growth in Nigeria. His research revealed also that oil price shock has both income and output effect on the Nigerian economy, while exchange rate instability, beside its direct effect on foreign trade.
Akinlo (2012) in his study examined the importance of oil in the development of the Nigerian economy using a VAR technique. His findings showed that the five subsectors are cointegrated and that the oil can cause other non-oil sectors to grow. However, oil had adverse effect on the manufacturing sector. His Granger causality test depicts a bidirectional causality between oil and manufacturing, oil and building & construction, manufacturing and building & construction, manufacturing and trade & services, and agriculture and building & construction. His findings also reveals a unidirectional causality from manufacturing to agriculture and trade & services to oil. But no causality was found between agriculture and oil, likewise between trade & services and building & construction, he however, found a unidirectional causality from manufacturing to agriculture and trade & services to oil. No causality was found between agriculture and oil, likewise between trade & services and building & construction.
Akpan (2014) in his work on oil price shocks and Nigeria’s macro economy points out the asymmetric effects of oil price shocks he stated that positive and negative oil price shocks significantly increase inflation and also directly increases real national income through higher export earnings, though part of this gain is seen to be offset by losses from lower demand for exports generally due to the economic recession suffered by trading partners. His findings of the study show a strong positive relationship between positive oil price changes and real government expenditures. His result further identifies a marginal impact of oil price fluctuations on industrial output growth. He concluded that "Dutch Disease" syndrome is observed through significant real effective exchange rate appreciation.
Adeniyi (2014) explores alternative measures of oil price shocks with an attempt at introducing threshold effects into the linkage between oil price shocks and output growth in Nigeria from 1985 to 2008. He adopted the dependent multivariate threshold autoregressive model with the forecast error variance decomposition to estimate a non-linear model of oil price shocks and economic growth. His result shows that oil price shocks do not account for a significant proportion of observed movements in macroeconomic aggregates. Even despite his introduction of threshold effects he ascribes the enclave nature of Nigeria’s oil sector with weak linkages. He conclusively stated that ‘’though a policy of diversification is usually recommended for economies which depend solely on oil revenue, the applicability of such an option appears unclear in the case of Nigeria’’
Igberaese(2015) examined the effect of oil dependency on Nigeria’s Economic growth. Using the explanatory data analysis (EDA) she asserted that Oil dependency in the short runs resulted in volatile and rapid economic growth in Nigeria but in the long-run oil dependency has caused Nigerian economy to become stagnant. She ascribes this to Nigeria’s inability to diversify its economy. She found that in years of high oil production, GDP growth appeared to decrease while in years of low oil production, GDP growth increased. a negative correlation exists between GDP growth and oil production and there is a positive correlation between GDP and value of exports which suggests that oil prices indeed affect economic growth. She suggested that appropriate policies to address the issue of oil dependence in Nigeria should focus on both diversification and industrialization so as to promote economic growth. She opined that Nigeria’s transformation from being oil exporter to manufacturing exporter will take time, therefore in the short-run, focus should be on the fiscal policy can lead to improved development.
Oyetunj (2013) examined the effects of oil price, external reserves and interest rate on exchange rate volatility in Nigeria from 1970 to 2011. He observed that a proportionate change in oil price leads to a more than proportionate change in exchange rate volatility in Nigeria by 2.8%.He Further recommended the diversification from the Oil sector to other sectors of the economy so that frequent changes in crude oil price will not influence exchange rate volatility significantly in Nigeria.
Charles and Adebayo used the structural VAR Methodology to show that the impact of oil price shocks on output and prices in Nigeria between (1999-2008) is asymmetric in nature. They asserted that the impact of oil price decrease significantly greater than oil price increase. Their empirical results reveal that. Firstly, positive oil price shocks are associated with an increase in real GDP after two months, whereas oil price decrease significantly reduces real output immediately. Secondly, oil price decrease leads to a depreciation of naira, thirdly that the impact of oil price shock on money supply and all-share index is asymmetric that is it raises the all-share index and money supply immediately. Fourth, shocks to oil price (increase in oil price) contribute between 22.2- 32.2% to money supply variance decomposition whereas oil price decrease contributes 18.1-86.5 percent of the variance decomposition of money supply in the same period; and fifth, oil price increase accounts for an average of 15.5 percent variation in real output between 6 and 24 months horizon, whereas oil price decrease contributes, on average 93.2 percent to the variation in real output in the same period. In conclusion, the asymmetric effect of oil price shocks on output and price indicates that economic policy should respond cautiously to it. Theyimplied that any policy that is aimed at moving the economy forward must focus on price stability in which changes in oil price play a significant role.
Oyeyemi(2013) in his investigation into the growth implications of crude oil price shock in Nigeria (1979-2010).Using the ordinary least square technique he revealed that a little shock in the price of crude oil in the global oil market in the current period will produce a long– term effect on economic growth in Nigeria. He then suggested that there is need for diversification in the productive sector of the economy so as to break from overdependence on the oil sector.
ThankGod and Maxwel (2013)(2013) studied the impact of oil price shock on macroeconomic activity in Nigeria using exponential generalized autoregressive conditional heteroskedasticity (EGARCH), impulse response function and lag-augmented VAR (LAVAR) models. He found out that unidirectional relationship exists between the interest rate, exchange rate and oil prices, with the direction from oil prices to both exchange rate and the interest rate. However, a significant relationship between oil prices and real GDP was not found. His findings presented in this study demonstrate that oil price shock does not have substantial effects on government spending, output and inflation rate in Nigeria over the period covered by the study. However, the findings demonstrated that fluctuations in oil prices do substantially affect the real exchange rates and interest rate in Nigeria. Also, it was found out that it is not the oil price itself but rather its manifestation in real exchange rates and interest that affects the fluctuations of aggregate economic activity proxy, the GDP. That is to say that oil price shock is an important determinant of real exchange rates and in the long run interest rate, while exchange rate rather than oil price shocks that affects output growth in Nigeria. His results conclusively suggest a potentially important role for energy prices in future research on exchange rate modelling.
Oriakhi and Iyoha (2013) examined the consequences of oil price shock on economic growth in Nigerian within the period 1970 to 2010. Using VAR methodology, their findings reveals that that there is a direct impact of oil price shock on real government expenditure, real exchange rate and real import, while other variables such as real GDP, real money supply and inflation are impacted through other variables, notably real government expenditure. This implies that oil price changes determine government expenditure level, which in turn determines the growth of the Nigerian economy. This result seems to reflect the dominant role of government in Nigeria. Considering the destabilizing effects of oil price fluctuations on economic activity and government spending in Nigeria, the study makes some recommendations. 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.
Alley Asekomeh, Mobolaji and Adeniran (2014) examined the impact of oil price shocks on the Nigerian economy, from 1981 to 2012 employs the general methods of moment (GMM) methodology they found out that oil price shocks insignificantly retards economic growth while oil price itself significantly improves it. Oil price increase is beneficial to Nigeria economy Shocks however create uncertainty and undermine effective fiscal management of crude oil revenue; hence the negative effect of oil price shocks. Their study finds that oil price shocks do not have a positive impact on the economy but oil price itself does. While increase in oil price positively affects 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, though not to a statistically significant extent, as this study finds out. The reason for this is that, in spite of numerous problems facing the nation (locally and globally - among the global factors is the fluctuations in oil prices arising from global events), the country’s GDP has been, virtually always, on the rise; and the Nigerian economic growth has not suffered any set back. They clamoured that the country should diversify its export revenue base as a means of minimising reliance on crude oil and petroleum product. 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 significance level.
Okoro (2013), examined oil price shock and economic growth in Nigeria linking oil price shock, crude oil prices, oil revenue and Gross Domestic Product in the period 1980-2010, via the VAR methodology. His study revealed that oil price shock significantly influenced the level of Nigeria’s economic growth. Also his result indicates negative relationship between the oil price shock and the level of economic growth. Furthermore, His result further reveals that the country‘s budget is tied to particular price of crude oil showing that Nigerian economy survives on crude oil. He recommended amongst others that there should be a strong need for policy makers to focus on policy that will strengthen/stabilize the economy with more emphasis on alternative sources of government revenue. He concluded by clamouring for reduction in monetization of crude oil receipts, aggressive saving of proceeds from oil booms in future in order to withstand vicissitudes of oil price shock in future.
From the reviewed literatures, the major gap identified is that of the time lag, most of the data sourced didn’t exceed 2012. Due to the dynamic attributes of oil price shock, there is need to extend the period of analysis so as to analyse the impact of recent oil shocks that occurred between 2013 and 2015. Also, there has been a lot of conflicting findings among the studies and many of the studies in Nigeria lacked insufficient theoretical and econometric evidence to back up their findings. Therefore, this studies attempts to improve on the previous empirical literatures.