THE IMPACT OF OIL PRICE INSTABILITY ON ECONOMIC GROWTH (A CASE STUDY OF NIGERIA)


THE IMPACT OF OIL PRICE INSTABILITY ON ECONOMIC GROWTH (A CASE STUDY OF NIGERIA)  

ABSTRACT

This study assessed the impact of oil price instability on the Nigerian economic growth using the VAR model. 1981 to 2015 annual time series data was utilized in the study and it was obtained from the CBN statistical database. While cointegration test confirms the existence of a long-run relationship, test for unit root indicated that all the variables were non-stationary at level but stationary at first difference. The Granger causality result shows that oil price Granger caused economic growth and exchange rate, while exchange rate Granger caused inflation. Moreover, the variance decomposition result indicated that oil price instability is the largest source of variation in economic growth and exchange while the largest source of variation in the inflation rate is exchange rate followed by oil price. Hence, it is concluded that oil price instability significantly influences economic growth and exchange rate of Nigeria but indirectly affects inflation. This study finally recommended the diversification of Nigerian economy.

Keywords: Economic Growth, Oil Price Instability, Vector Error Correction Model, Granger Causality Test, Impulse Response, Variance Decomposition.

TABLE OF CONTENTS

ABSTRACT iv

ÖZ v

ACKNOWLEDGEMENTS vi

TABLE OF CONTENTS vi

LIST OF TABLES xi

LIST OF FIGURES xii

ABBREVIATIONS xiii

CHAPTER ONE 1

INTRODUCTION 1

Study Background1

Statement of Problem3

Research Objectives4

Research Questions4

Research Hypothesis5

Research Scope and Limitation5

Research Significance5

Research Methodology6

Research Organization6

CHAPTER TWO 7

LITERATURE REVIEW 7

Introduction7

Oil Price Evolution8

Oil Price (Before 1970)9

Oil Price (After 1970)9

Factors Influencing Oil Price9

Demand and Supply10

Speculative Buying10

Foreign Exchange Rate11

The Price of alternative commodities11

Global Financial Crises12

Political Resolutions and Restriction13

Organization of Petroleum Exporting Countries Oil (OPEC) Activities13

Political Unrest13

Economic Growth14

Economic Growth Parameters15

Relationship between Oil Price and Inflation15

Oil Price Instability and the Nigerian Economy: Import Vs Export16

Dutch Disease Syndrome17

Nigerian Experience of Dutch Disease Syndrome17

Empirical Review18

Theoretical Framework21

Linear/Symmetric Relationship Theory22

Asymmetry-In-Effect Theory22

Renaissance Theory23

CHAPTER THREE 24

OIL AND NIGERIAN ECONOMIC DEVELOPMENT 24

Introduction24

Economic and Social Development Plans of Nigeria26

Nigerian National Development Plan (1981)27

Structural Adjustment Programme (1986)28

National Rolling Plans (1990)29

National Economic Empowerment and Development Strategy (1999)30

3.2.5 Vision 2020 (1999) 31

Nigeria oil policy33

Prospects and Challenges of Oil on Nigeria Economy34

Nigerian Oil Production and Consumption36

Geographical Distribution of Nigerian Oil (Export)38

CHAPTER FOUR 39

METHODOLOGY 39

Introduction39

Model39

Definition of Variables40

Real Oil Price (ROILP)41

Real Gross National Income (RGNI)41

Real Government Expenditure (RGE)41

Real Effective Exchange Rate (REER)41

Inflation Rate (INF)42

Estimation Procedures42

Unit Root Test42

Co-integration Test42

Vector Error Correction Model (VECM)43

The Granger Causality Test43

Impulse Response44

Variance Decomposition44

Data Source44

CHAPTER FIVE 45

ANALYSIS AND DISCUSSION OF RESULTS 45

Introduction45

Unit Root Test45

Lag Selection Criteria46

Cointegration Test47

Vector Error Correction Model48

Granger Causality Test50

Impulse Response52

Variance Decomposition54

CHAPTER SIX 59

CONCLUSION AND RECOMMENDATIONS 59

Introduction59

Summary of Findings59

Conclusion62

Recommendations63

BIBLIOGRAPHY 65

APPENDIX 70

Appendix I: Lag Order Selection Criteria 70

Appendix II: Johansen Cointegration Test 71

Appendix III: Impulse Response (Table) 72

Appendix IV: Impulse Response (Graphs) 73

Appendix V: Pairwise Granger Causality Tests 74

Appendix VI: Variance Decomposition Test 75

Appendix VII: Data 76

LIST OF TABLES

Table 5.1: ADF Unit Root Test Result (1981-2015) 46

Table 5.2: Lag Order Selection Criteria 47

Table 5.3: Johansen Cointegration Test Result (Trace) 48

Table 5.4: Johansen Cointegration Test Result (Maximum Eigenvalue) 48

Table 5.5: Vector Error Correction Model Result 49

Table 5.6: Pairwise Granger Causality Tests Result 51

Table 5.7: Impulse Response of LRGNI 52

Table 5.8: Impulse Response of LRGE 53

Table 5.9: Impulse Response of LREER 53

Table 5.10 : Impulse Response of LINF 54

Table 5.11: Variance Decomposition of LRGNI 55

Table 5.12: Variance Decomposition of LRGE 56

Table 5.13: Variance Decomposition of LREER 57

Table 5.14: Variance Decomposition of LINF 58

LIST OF FIGURES

Figure1.1: Historical Price of oil 3

Figure 2.1: Price of Oil and Speculative Buying Effect. 10

Figure 2.2: U.S. Dollar Index and Oil price 11

Figure 2.3: World Energy Demand 12

Figure 2.4: Price of Oil and Financial Crisis 12

Figure 3.1: African Proved Oil Reserves 25

Figure 3.2: Oil Production and Consumption in Nigeria 36

Figure 3.3: Nigerian Oil Production and Disruptions Level 37

Figure 3.4: Nigeria Oil Export by Destination 38

ABBREVIATIONS

ADF Augmented Dickey-Fuller

CBN Central Bank of Nigeria

GDP Gross Domestic Product

GNI Gross National Income

INF Inflation Rate

LINF Log Inflation Rate

LREER Log Real Effective Exchange Rate LRGE Log Real Government Expenditure LRGNI Log Real Gross National Income LROILP Log Real Oil price

MEND Movement for the Emancipation of the Niger Delta

NEEDS National Economic Empowerment and Development Strategy OLS Ordinary Least Square

OPEC Organization of Petroleum Exporting Countries REER Real Effective Exchange Rate

RGE Real Government Expenditure

RGNI Real Gross National Income

ROILP Real Oil price

SAP Structural Adjustment Programme

VAR Vector Autoregression

VECM Vector Error Correction Model

CHAPTER ONE INTRODUCTION

Study Background

Oil has not generally been as significance as it is presently. Starting with the twentieth century, the significance of oil has expanded hugely; it overtook coal as the main source of energy. Crude oil is a dark, evil-smelling, vicious liquid consists of a blend of various chemical item largely carbon and hydrogen subsequently; it is named hydrocarbon. In the last 50 years, the total world consumption of oil has increased fourfold and presently, oil and gas account for about 70% of the global energy consumption. The energy evolution from coal to oil was mostly a reaction to technological advancement.

Oil is a natural asset that is paramount in the worldwide economy as it is the main source of energy for both industrial and domestic uses. Due to this, the pricing of the product became very responsive to the market forces of demand and supply thereby leading to an occurrence called oil price instability. Nevertheless, matters in oil price instability and its consequences on economic growth have kept on creating contentions among economist and policy makers. As some (for example, Akpan (2009) and Olomola (2006)) contend that it can advance growth, others (for example, Darby (1982)) are of the perspective that it can restrain growth. The former contend that a rise in the price of oil will increase the foreign earnings of oil exporting nations thereby affecting its national income positively. Though, the latter refer to the instance of net oil importing nations (which knowledge inflation, decreased non-oil demand, bigger input costs, lower investments) in moving forward their contention. On the opposite hand, the extreme decline in the prices of crude oil collapses the economy of net exporting nations

(diminishes national income and raises budget deficits). For example, the crude oil price drops in 2014 from $110 to less than $60 per barrel and later drops to less than $40 per barrel in 2015 (CBN, 2015). This implies more than 60% decline in the national income of the net exporting nations.

In this sense, the impact of oil price instability on a nation relies on the type of such economy and obviously, the nature of the variation in price. Nevertheless, the Nigerian economy is exclusively an oil exporting and importing nation since it both exports unrefined oil and imports refined one. Creating a final and legitimate proclamation on the influence of instability in oil price on the Nigerian economy is consequently complicated (Oriakhi & Osaze, 2013).

Presently, Nigeria depends deeply on revenues generated from crude oil export which speaks to around 90% of the aggregate export earnings, about 80% of the annual government budgets revenue and 14% of its Gross National Income (GNI). Before the advent of oil, Nigeria was not relying on the oil as the main source of revenue; agriculture has been the support of the Nigeria economy. In fact, somewhere around 1960 and 1966, Agriculture is the main source of revenue and it employed more than 90% of the country's labor force. Nevertheless, taking after the finding of oil and the ensuing oil boom in the 1970s, agribusiness lost its famous position to mining and particularly oil. Oil export earnings contributed about 59% to the Nigeria economy in 1970. Therefore, a little oil price fluctuations would have a great effect on the economy (Umar & Abdulkhakeem, 2010). Although given the instability nature of the price of crude oil, it is consequently essential to study the likely impacts of these changes on the economy of Nigeria.

Figure1.1: Historical Price of oil

Image

Source: Energy Information Administration, 2016.

Statement of Problem

Instability in oil prices have assumed a vital role in leading nations into recessions and downfall in administrations. According to Majumdar (2016), instability in oil prices is regularly disclosed by stuns to oil demand and supply emerging from financial crisis, new fields sighting, geopolitical elements, or innovations. For the past years, oil price has perceived an interplay of all these elements which brings about outrageous oil price instability and subsequently leads nations into recessions and downfall in administrations.

Both the empirical and theoretical studies have confirmed that there are instabilities in international oil prices and it has various effects on different nations but depending on how greatly the economy relies on oil. As the 7th biggest exporter of cured oil, Nigeria depends deeply on revenues generated from crude oil export which speaks to around 90% of the aggregate export earnings and about 70% of the annual government budgets revenue. Therefore, it is consequently essential to study the likely impact of this instability on the Nigerian economic growth.

However, most of the researches carried out do not focus on the effect of instability in oil price on the main macroeconomics variable. For example, Arinze (2011) study the

effect of instability in oil price on the growth of Nigerian economy. The study concentrates more on the price of petroleum products rather than showing the precise direction of the relationship between the macroeconomic variables. Therefore, this research will fill the space by investigating the effect of instability in oil price on Nigerian economic growth using the key macroeconomic variables.

Furthermore, major gaps were found in most of the previous analysis precisely in the estimation procedures. For example, Oriakhi and Osaze (2013) found their variables non-stationary at level but stationary at differences. Nevertheless, they ignored the order of integration in their estimations for variance decomposition and Granger causality by stating the variables in level forms. Therefore, this research hopes to fill this gap.

Another deficiency is the selection of estimation method. For example, Arinze (2011) study the effect of instability in oil price on the growth of Nigerian economy using Ordinary Least Square (OLS). The OLS method of estimation used in the research is not the best as it does not explain much about instability (shock). Moreover, the lag length determination in most past analyses are subjective due to the absence of a clear standard for determination of the optimal lag length (For instant, Akpan, 2009). Therefore, this research will look into it by selection of the most appropriate technique of estimation, and specify a clear standard for determination of the optimal lag length

Research Objectives

The target of this research is to assess the impact of instability in oil price on the growth of Nigerian economy between 1981 to 2015.

Research Questions

· What is the impact of instability in oil price on economic growth of Nigeria?

· To what extent does instability in oil price influence the Nigerian economic growth?

· What is the causal relationship between economic growth and oil price instability?

· What are the policy implications of oil price instability on the economic growth of Nigeria?

Research Hypothesis

To achieve the objective of this study, the following hypotheses are formulated: Ho: oil price instability has no significant impact on the Nigerian economic growth. Hi: oil price instability has a significant impact on the Nigerian economic growth.

Research Scope and Limitation

Using annual time series data, this research will assess the implications of oil price instability on the economic growth of Nigeria between 1981 and 2015. The data are obtained from the statistical database of the Central Bank of Nigeria (CBN).

This study is constrained by several factors such as the issue of inadequate data, which has become a phenomenon in most research works that used Nigeria as a case study. Nigeria’s statistical data is not only complicated to obtain but unreliable since the management and storage system is still underdeveloped. However, efforts are made to optimize the data available by prudently studying the applicable data despite the unreliability of the available data.

Furthermore, this study wishes to use monthly data because it gives more information than the annual data. However, the annual data was utilized in this study due to the absence of the monthly data.

Research Significance

Oil price has a great influence on the political and economic activities of many countries particularly oil-dependent nations such as Nigeria. Also, Empirical studies have confirmed that there are volatilities in international oil prices and these oil prices instabilities have various effects on different nations depending on how greatly the economy relies on oil.

The economy of Nigeria dependent largely on oil as the main source which contributes a large part of the countries revenue. Therefore, the study of the implications of oil price instability on the growth of the economy is significant as it helps government and

individuals in planning for the future particularly in the diversification of the economy with the hope to prevent further risk of over-dependence on oil income as the primary source of foreign earnings.

Research Methodology

This study will adopt quantitative technique of analysis to assess the correlation between economic growth and oil price instability. With the existing accomplishment and development in econometric analysis software, the Vector Autoregression (VAR) technique will be utilized to examine the correlation and significance between the variables. The following is the unrestricted VAR model for this study:

Yt = α + β1Yt-1 + + βpYt-p + ɛt

Y = (RGNI, ROILP, RGE, REER, INF)

Where:

RGNI =Real Gross National Income, ROILP = Real Oil price,

RGE = Real Government Expenditure, REER = Real Effective Exchange Rate, INF = Inflation Rate,

Yt is the vector of endogenous variables, α is the vector of constant, β is the matrix of coefficients, p is the length of the lag, ɛt is the white noise process vector.

Research Organization

This research is organized into six sections to achieve the research objective. The introduction makes up chapter one as chapter two contains the related literature reviews (theoretical and empirical). While chapter three contains the details of oil and Nigerian economy, chapter four encompasses the methodology of the study. The empirical analysis and discussion of the empirical results are enclosed in chapter five, whereas chapter six encompasses the research recommendations and conclusion.

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THE IMPACT OF OIL PRICE INSTABILITY ON ECONOMIC GROWTH (A CASE STUDY OF NIGERIA)



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