Crude Oil Price Volatility Economics Essay

Energy plays the cardinal function in the universe economic system. In malice of considerable disposition to alternative renewable beginnings of energy like air current, H2O, atomic and solar power, the function of rough oil in macroeconomic motions has non waned yet ( Mehrara & A ; Mohaghegh, 2011 ) . Since the find and production of oil Nigeria in 1958, the subsector has continued to play a major and dominant function in the Nigerian economic system. The extractive sector in the Nigerian economic system is big and extended, with oil playing a critical function. With about 37.2 billion barrels in militias and 2.13 % of planetary production, Nigeria has the universe ‘s 10th largest proven militias ( 3.1 % of planetary militias ) , and is among the top 10 oil manufacturers ( Akinlo, 2012 ) . Nigeria has been a member of the Organization of the Petroleum Exporting Countries ( OPEC ) since July 1971. Presently, there are 12 member states including Nigeria in this international organisation whose purpose of the organisation, harmonizing to its Statute, is the finding of the best agencies for safeguarding their involvements, separately and jointly ; inventing ways and agencies of guaranting the stabilisation of monetary values in international oil markets with a position to extinguishing harmful and unneeded fluctuations ; giving due respect at all times to the involvements of the bring forthing states and to the necessity of procuring a steady income to the bring forthing states ; an efficient, economic and regular supply of crude oil to devouring states, and a just return on their capital to those puting in the crude oil industry ( OPEC, 2012 ) . Crude Oil is an of import trade good non merely because it is of course happening in the Earth but because of the many fractions that are derived from it after the refinement procedure. Those changing fractions such as fuel oil, jet fuel, kerosine etc. are extracted at different temperatures during the refinement procedure. The demand for rough oil is derived from the demand for its fractions and it depends on a big figure of factors such as its class, sulfur content and its locations. Crude Oil is classified in the international market harmonizing to changing molecular features by giving pricing mentions to the countries where such barrels are produced. Such pricing mentions include the North American West Texas Intermediate, Nigerian Bonny Light, Brent etc. In most oil exporting states, authorities which is well big in comparing with little private sector, straight receives the oil gross. Spending this gross, authorities ‘s behaviour becomes the most of import feature of the economic system. In other words, the financess needed for authorities ‘s outgo come from oil gross. So, financial and pecuniary policies depend upon oil monetary value ( Rosser & A ; Sheehan, 1995 ) . Oil monetary value is extremely variable ; even more than any other trade good ( Dehn, 2001 ) . Crude oil monetary values have increased on norm from US $ 25 per barrel in 2002 to US $ 55 per barrel in 2005. There has been a steep upward tendency in the monetary value of rough oil in recent old ages, making a record nominal high of US $ 147 in mid-2008 and a crisp bead to US $ 46 a barrel ( Akpan, 2009 ) . The transmittal mechanisms through which oil monetary values have impact on existent economic activity include both supply and demand channels. The supply side effects are related to the fact that rough oil is a basic input to production, and accordingly an addition in oil monetary value leads to a rise in production costs that induces houses to take down end product. Oil monetary value alterations besides entail demand-side effects on ingestion and investing. Consumption is affected indirectly through its positive relation with disposable income. Oil monetary value rises cut down the consumers passing power. Investing may besides be affected if the oil monetary value daze encourages manufacturers to replace less energy intensive capital for more energy-intensive capital. The magnitude of this consequence is in bend stronger the more the daze is perceived to be durable. For this ground, the theoretical literature has been of a general equilibrium nature, with different writers delega ting different weights to the supply and demand channels ( Olomola & A ; Adejumo, 2006 ) . When oil monetary value depreciates, big public sector expectedly can non cut down its disbursement instantly and proportionally ; so faces immense shortages. The financial instabilities followed by an oil monetary value lessening can be lay waste toing if the state is extremely dependent on oil grosss ; which is the instance in most oil exporting states. More disappointingly such falls are normally unpredictable. Several uncomplete undertakings and immense debts are the chief heritages of this period for the undermentioned fruitful epoch. After some rough experiences, presents, insulating the existent sectors of economic system from oil monetary value volatility is accepted as one of the most of import functions of authorities ( Mehrara & A ; Mohaghegh, 2011 ) . Presently, one-year budgets are formulated in Nigeria based on oil monetary values. The 2009 budget was revised in line with the predominating market monetary value of oil declarative mood of immense dependance of Nigeria on oil returns. In 2012, there was an intense argument refering the benchmark monetary value of Crude Oil that would be the footing of gross and outgo computations in the passing of the 2013 Appropriation Act ( budget ) through the Nigerian National Assembly. Huge influx of oil grosss in Nigeria are more frequently associated with enlargement in the degree of Government passing while periods of dwindling oil grosss are normally accompanied by budget shortages. There is no addition stating that Nigeria relies so much on gross from oil exports, but, it every bit massively imports refined crude oil and other related merchandises. Evidence, for case, shows that Government disbursement, which hitherto, before 1999 remained good below N0.5 trillion, hit N1.02 trillion grade in 2001 and N1.5 trillion in 2004. The figures for 2006 and 2007 stood at N2.04 and N2.45 trillion severally ( Aliyu, 2009 ) . Oil monetary value dazes are preponderantly defined with regard to monetary value fluctuations ensuing from alterations in either the demand or supply side of the international oil market ( Hamilton, 1983 ) . These alterations have been traditionally traced to provide side breaks such as OPEC supply quotas, political turbulences in the oil-rich Middle East and activities of hawkish groups in the Niger Delta part of Nigeria. The dazes could be positive ( a rise ) or negative ( a autumn ) . Two issues are identified sing the dazes ; foremost is the magnitude of the monetary value addition which can be quantified in absolute footings or as per centum alterations, second is the timing of the daze, that is, the velocity and continuity of the monetary value addition ( Akpan, 2009 ) . Traveling by the foregoing, four oil dazes can be observed in Nigeria. Each of the dazes had connexions with some motions in cardinal macroeconomic variables in Nigeria. For case, the 1973-74, 1979-80, and 2003-2006 periods were associated with monetary value additions while the oil market prostration of 1986 is an episode of monetary value lessening. During the first oil daze in Nigeria ( 1973-74 ) , the value of Nigeria ‘s export measured in US dollars rose by about 600 per cent with the footings of trade lifting from 18.9 in 1974 to 65.3 by 1982. Government gross which stood at 8 per cent of GDP in 1972 rose to about 20 per cent in 1975. This resulted in increased authorities outgo owing mostly from the demand to monetise the rough oil grosss. Investing was mostly in favor of instruction, public wellness, conveyance, and import replacing industries ( Nnnanna & A ; Masha, 2003 ) . During the oil monetary value daze of 2003-2006, Nigeria recorded addition in the portion of oil in GDP from approximately 80 per cent in 2003 to 82.6 per cent in 2005. The daze was gradual and persisted for a piece. This could be regarded as a lasting daze. The consequence of the daze was a favorable investing clime, increased national income within the period although a little diminution was observed in the growing rate of the GDP. Despite this sensed benefit of oil monetary value alteration, the macroeconomic environment in Nigeria during the roars was unwanted. For case, rising prices was largely dual figure in the 1970s ; money supply grew steeply, while immense financial shortages were besides recorded ( Akpan, 2009 ) . The growing way of the state has been really unsmooth over the old ages. During the oil roar epoch, approximately 1970-78, GDP grew positively by 6.2 per centum yearly – a singular growing. However, in the 1980s, GDP had negative growing rates. In the period 1988-1997 which constitutes the period of Structural Adjustment Programme ( SAP ) , which entails economic liberalisation, the GDP responded to economic accommodation policies and grew at a positive rate of 4.0 per centum. Agriculture, industry and fabrication, oil and gas sectors had greater laterality in the composing of the Nigeria ‘s GDP. The twelvemonth 1989 – 1998 was the most disruptive period in the history of the state ‘s growing form. Real GDP grew merely by an norm of 3.6 per centum, against the population growing rate of 2.8 % during the same period. Inflation, poorness, exchange rate were all at dismaying rates. Foreign direct investing, which is a necessary engine of growing, was stifled be cause of unsupportive enabling environment. Between 1999 and 2008, the state ‘s growing public presentation improved significantly. GDP growing rate averaged 7.8 % during the decennary entirely due to the growing of non-oil sector which grew by 9.5 per centum. In this respect, nevertheless, oil sector constitutes both a retarding force on growing and a beginning of instability in GDP growing form ( Aliyu, 2009 ) . Ongoing financial and pecuniary reforms aim to cut down the degree of rough oil dependence but at the minute, uncertainnesss about the degree of rough oil monetary values has cost the economic system a batch of investing chances over the old ages. In order for Nigeria to achieve balanced, uninterrupted and sustainable economic growing, the consequence of volatility in oil monetary values must be given equal attending.STATEMENT OF THE PROBLEMIn Nigeria, the rate of petroleum oil dependence is high. It accounted for about 82.1 % of entire authorities gross during the oil roar in 1974 before cut downing to a portion of 64.3 % by which was a effect of the rapid diminution in universe market monetary value of rough oil. The portion of oil gross in entire authorities gross still remains significant as evidenced by the attainment of 85.6 % and 86.1 % in 2004 and 2005 severally ( Akpan,2009 ) . This has generated a batch of involvement particularly amongst stakeholders in the Nigerian econom ic system. Of recent, is the argument in the Nigerian National Assembly about the appropriate petroleum oil monetary value benchmark to be included in the 2013 Appropriation Act which has generated a batch of contention. From a planning position, fluctuations in the petroleum oil monetary value have been the beginning of a batch of incomplete authorities undertakings due to the alterations in the gross watercourse and the dependability of cost estimations. The transmittal mechanisms through which rough oil monetary values impact on existent economic activity and analysing the dynamic interrelatedness among the selected macroeconomic variables is of great importance. Variations in rough oil monetary values hinders effectual economic planning and development most particularly for rough oil dependent economic systems like Nigeria. The impact of these fluctuations in footings of magnitude, continuance and way is of great importance if the Nigerian economic system must come on. The following are inquiries refering to the impact of rough oil monetary value volatility in Nigeria: – How significantly can Crude Oil Price fluctuations hinder sustainable economic growing in Nigeria? What magnitude of the alterations in macroeconomic variables is associated with fluctuations in rough oil monetary value?1.3 OBJECTIVES OF THE STUDYThe wide aim of this survey is to analyse the consequence of petroleum oil monetary value volatility on economic activity in Nigeria. The specific aims include: a. To analyse the consequence of oil monetary value volatility on the growing rate of existent GDP, Inflation rate, Money supply and other financial and pecuniary variables. B. To find whether there is a long tally relationship between oil monetary value volatility and existent GDP growing in Nigeria. 1.4 RESEARCH QUESTIONS The inquiries that guide the research are as follows: a. Is there a important relationship between Oil monetary value dazes and economic system activity in Nigeria? B. What is the magnitude of the relationship ( if any ) between Oil monetary value dazes and macroeconomic variables in Nigeria?1.5 HYPOTHESES OF STUDYThe followers are the research hypotheses to be tested during the survey: Holmium: Crude Oil Price has no important consequence on economic activity in Nigeria. H1: Crude Oil Price has a important consequence on economic activity in Nigeria.1.6 SCOPE AND LIMITATIONS OF THE STUDYThis survey on the consequence of volatile economic activity may be relevant to all states in the universe but the overall considerations, analysis and deductions are within the model of the Nigerian economic system. This survey covers the periods from 1975 to 2011. However, restrictions due to unavailability and undependability of informations could originate in the class of the survey and this should non be overlooked.1.7 DEFINITION OF UNFAMILIAR TERMSThe undermentioned footings used during the survey are explained below: a. Volatile: Care to change frequently or widely B. Organization of Petroleum-Exporting Countries ( OPEC ) : An organisation of states formed in 1961 to hold on a common policy for the production and sale of crude oil. Its members include Iraq, Indonesia, Iran, Kuwait, Libya, Angola, Algeria, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela.1.8 SIGNIFICANCE OF STUDYThis survey is of import to demo the extent to which the Nigerian economic system is affected by rough oil by analyzing macroeconomic variables. It is necessary to understand the way, continuance and magnitude of the relationship.1.9 METHODOLOGYThe variables to be considered include: a. Oil Price Variance B. Real Gross Domestic Product Growth Rate c. Inflation Rate d. Index of Industrial Production e. Money Supply f. Government Outgo The clip period under consideration is 1975-2011. The Ordinary Least Square Method is used because it is the best linear indifferent calculator. Garch ( 1,1 ) theoretical account is used to mensurate rough oil monetary value volatility and the conditional discrepancy series generates the volatility informations. Johansen Co-Integration technique based on vector autoregressive theoretical account determines the long tally relationship between oil monetary value fluctuations and GDP growing. Vector Error Correction Model ( VECM ) specifies convergence or divergency among the variables in the theoretical account. Trials for Stationarity ( being of unit roots ) such as the augmented dickey-fuller and Phillip Perron Tests will be employed. Variance decomposition, impulse response map, farmer causality trial examines consequence of Oil Price volatility on other variables.1.10 DATA BeginningsSecondary informations beginnings from Central Bank Statistical Database, Central Bank Statistical B ulletin, OPEC Statistical Bulletin British Petroleum Statistical Review of World Energy.1.11 OUTLINE OF CHAPTERS