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THE EFFECT OF CRUDE OIL PRICE VOLATILITY ON ECONOMIC GROWTH IN NIGERIA.
ABSTRACT
The objective of this research is to examines the effect of crude oil price volatility on economic growth in Nigeria using annual time series data covering the period between 1981 and 2019. The techniques employed are Augmented Dickey Fuller unit root test, Johansen Cointegration Analysis, Ordinary Least Square and Granger causality test. The ADF unit root test results indicate none of the variables is stationary at level, however the variables became stationary at first difference i.e. I(1). The Cointegration test indicated the existence of long-run relationship between crude oil prices and economic growth. The ordinary least square results show that there is positive and significant relationship between crude oil prices and economic growth in Nigeria. The result of the Granger causality test result indicates the existence of bidirectional causal relationship between crude oil prices and fuel pump price, fuel pump price and exchange rate. Based on these findings, the research concludes there exists a relationship between crude oil prices and economic growth in Nigeria during the period covered by the study. This implies economic growth depends, among others, on volatility in crude oil prices. The study recommends for the diversification of Nigeria’s revenue base; the need to build a buffer in the period of increasing oil prices, for a robust import-substitution strategy, among others.
Keywords: oil price volatility, economic growth, Co-integration, Ordinary Least Square, Granger causality, Nigeria.
CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
Since its discovery in 1800, crude oil has over the years been a fundamental sources of world energy and hence, played an important role in the economic growth and development of many countries. Hathaway (2009) opined that oil has increasingly became very importance to the extent that major distribution systems that permit economic transactions would fail without oil and the world economy would collapse.
Oil market, like some other markets, is subjected to the market forces of demand and supply because of the need for this product, which do lead to the fluctuation in the pricing. Today, one common phenomenon is volatility in price of crude in the world oil market as the world economy has saw a number of changes in the price of crude oil at different times. These price variations, often referred to as oil price shocks or oil price volatility are usually labelled by the events that herald their occurrences. Hamilton (2011) observed noticeable shocks are: (1) the major post-World-War-II oil shocks; (2) the Suez Crisis of 1956-57; (3) the OPEC oil embargo of 1973-1974; (4) the Iranian revolution of 1978-1979; (5) the Iran-Iraq War initiated in 1980; (6) the first Persian Gulf War in 1990-91; and (7) the oil price spike of 2007-2008. Oil price rushed to a historic elevation in 2008 when it was sold at $140 per barrel; this was about the highest price noted in the oil market in recent times (Sanya, 2015).
The second half of 2014 marked the start of added oil price shock. By the 2015, the crude oil price has fallen by more than half of its price in the preceding year with its associated consequences on economies of the world. The immediate root of this fall was the market disparity ignited by excess supply of crude oil to the market by oil producing countries. Maugeri (2016) observed that the important output growth witnessed by major oil producers like the United States and Iraq as well as the imposition of the policy of no production falloffs by Saudi Arabia on the Organization of Petroleum Exporting Countries (OPEC) created an output level that could not be engrossed by demand.
Hamilton (1983, 2009) observed that variation in the price of oil as an imperative source of economic variations, in which the resulting effect led to global shock, capable of affecting many economic activities instantaneously. This shock is perceived generally to have a comparable effect due to events like fall in growth rate, high unemployment rate, and high inflation rate, while the scale and the causes of the effect of these shocks may vary. For import-based economy, hike in the oil price will lead to shock in the economy, vice versa for the export-based economy.
Nigeria is an economy blessed with resource endowment; specifically, the country is placed as the largest oil producer in Africa and occupies the 13th position in the world. It has a proven crude oil reserve of 37,062 million barrels, natural gas reserve of 5,284.3 billion cu m (OPEC, 2016) Thus, its reserve base is ranked the 10th in the world and 2nd largest in Africa. Following the rebasing of the country’s GDP, it became the largest economy in Africa. Subsequent to this oil endowment, the country is highly dependent on crude oil for export and as major revenue source, thus, annual budgets are usually prepared and tied to a given anticipated price and production level of crude oil. This has put the economy in a susceptible position and exposes it to the vagaries of changes in crude oil prices.
In an attempt to reduce the negative impact of such exposure (oil price shocks) on the economy, the Federal government of Nigeria introduced the Excess Crude Account in 2004 to protect planned budgets against shortages arising from changes in crude oil prices. Though this initiative helped to mitigate the effects of dropping oil prices during the global financial crisis of the 2007-2009 when the price of crude oil dropped drastically, the package could not be continued. Successive governments continued to spend even when oil prices increased leading to the exhaustion of excess crude account with no savings left for rainy days. The recent crash in oil prices undoubtedly plunged the biggest economy in Africa into an economic quagmire with incapacitating effects on some of her major macroeconomic variables. Inflation rates started a steady growth while the exchange rate continued to depreciate, causing huge economic worries among the populace. Interesting, as crude oil price is falling at the global market, domestic pump price of petrol in Nigeria suffered distortion and upward review.
Three strand of thought exists in the literature depending on the country of research, method of analysis and period of study. While many are of the view that changes in crude oil prices have positive impact on economic growth, others argued that the effect is a negative one. The third strand opined that no link between crude oil prices and economic growth. The combination of these factors provoked many questions than answers and stimulates the need for this study. Hence, this study seeks to examine the impact of changes in crude oil prices on economic growth in Nigeria within the period between 1980 to 2020. Specifically, the study seeks to investigate the effect of changes in crude oil prices on economic growth; to examine whether inflation and exchange rates in Nigeria are associated with changes in crude oil prices; and to determine if any causal relation exists between crude oil price and fuel pump price in Nigeria between 1980 to 2020.
1.2 Statement of The Research Problems
Over the years covered by this study, the spot crude prices of the Nigerian Forcados averaged at $44.50 per barrel with the lowest price of $12.62 recorded in 1998. Oil prices attained its peak in 2012 at $114.21; this rise was succeeded by a downward trend that pushed the price to drop to $54.41 per barrel in the year 2015 (BP, 2015). The recent shock in crude oil prices which started in July 2014 has adversely affected Nigeria, especially in the areas of foreign reserves, currencies crisis, declining government revenue, and ultimately, threat in terms of ability to meet financial obligations as at when due. Brent oil price declined by 24 percent to a four-year low of USD81 as at November 11, 2014. The price of Brentfell from USD114.91 on January 31 to USD102.12 on May 31, and stood at USD57.8 and 67.6 on March 31, 2015.
Trends in annual growth rate of GDP in Nigeria which measures economic growth revealed within the span of years covered in this study an average rate of 11.78%. The lowest rate was recorded in 1987 at -10.75% which is attributed to the spillover effect of the Structural Adjustment Programme (SAP). In 2004, the rate of growth in GDP rose to its highest level of 33.74% within the period and slumped to 2.65% in 2015. This drop in the annual growth rate of GDP is no doubt a consequence of the falling prices of crude at the international market (World Development Indicators, 2016.)
Studies on the relationship between changes in crude oil prices and economic growth show a mixed result. In Nigeria, oil price was found to have positive, negative or no impact on the economy. For example, while the works of Ebele (2015), Yusuf (2015), and Alley, Asekomeh, Mobolaji and Adeniran (2014) suggested that crude oil price is positively related to the level of economic activities in Nigeria, Okoro (2014) and Iyke (2016) maintained that the influence is negative. But Ani, Ugwunta and Eneje (2014) found that oil prices have no impact on real GDP and exchange rate in Nigeria. These results point to the fact that there is lack of consensus by scholars on the impact of changes in crude oil prices on economic growth in Nigeria.
The resultant effect has been a large out pour of policies among policy makers and contributions from the academia. These policy prescriptions have spurred the need to diversify the economy towards once thriving sectors in the economy, removal of subsidy, the war on corruption and reduction of government activities and government related cost.
Two basic research problems are identified in this stud: 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 three fundamental economic variables (growth domestic product, exchange rate and inflation) in Nigeria. Based on this, the researcher intends to know the relationships that exist between crude oil price and economic growth proxied by real growth domestic product.
1.3 Research Question
The followings questions will guide the study;
- Does changes in crude oil prices have any impact on economic growth in Nigeria?
- Is there any causal relationship between changes in crude oil prices and economic growth in Nigeria?
1.4 Objectives of the Study
The broad objective of the study is to examine the impact of changes in crude oil prices on economic growth in Nigeria. To achieve that, the following specific objectives will be pursued:
- Examine the impact of changes in crude oil prices and economic growth in
- Examine the causal relationship between changes in crude oil prices and economic growth in Nigeria.
1.5 Statement of Research Hypothesis
The following key research hypotheses would be addressed in the course of this study:
H0: changes in crude oil prices has no impact on economic growth in Nigeria.
H0: There is no causal relationship between changes in crude oil prices and the economic growth in Nigeria.
1.6 Significance of the Study
The recently witnessed crash in global oil prices has continue to attract heated debate among in the academia, public sector analysts and policy makers 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. Hence, study on the relationship between changes in crude oil prices and economic growth in Nigeria will be significant to all economic agents in the country being it an oil dependent economy, economic analysts and policy makers. The study will unravel some of the facts they need to know about changes in crude oil prices and the economic growth in Nigeria.
The significance of the study therefore is on 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 and will be added to the body of knowledge and serve as reference material to other researchers, scholars and writers who would want to carry out a similar study of this nature.
1.7 Scope and Limitation of the Study
The attention of this study is Nigeria, and it examines the effect of changes in crude oil prices on Economic Growth. The study covered the period spanning from 1980 to 2020. The annual figures on real growth domestic product, Crude oil prices, Real effective exchange rate and inflation will be used. The objective of the study is to specifically examine the relationship and the nature of the relationship between the selected variables. The estimation techniques to be used are the ordinary least square, cointegration and Granger causality tests.
1.8 Organization of The Study
The research work is divided into five chapters. Chapter one provides a general introduction of the study, it states the background of the study, statement of the problem, objectives of the study, research questions, statement of hypothesis, significance of the study, scope and limitations of the study, definition of terms and the organizational layout. Chapter two presents the Literature Review and theoretical framework. Chapter three examines the research methodology. Chapter four presents the data analysis while Chapter five is the concluding chapter of this study, and it sets out the summary of the findings, conclusion and recommendations.
