THE EFFECT OF CRUDE OIL INCOME ON PRICE STABILITY IN NIGERIA
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This study examine the effect of crude oil income on price stability in Nigeria. Nigeria is a mono-product economy, where the main export commodity is crude oil, changes in oil prices has implications for the Nigerian economy and, in particular, exchange rate movements. The latter is mostly important due to the double dilemma of being an oil exporting and oil-importing country, a situation that emerged in the last decade. The study utilizes secondary data from various sources and covers a period of 1980 to 2015. Findings revealed that there is a positive and significant relationship between oil price and economic growth. Based on the findings the researchers hereby conclude that oil price does not have a positive impact on the economy (contrary to the findings of some earlier studies) but oil price itself does. In the light of the above findings, the researchers hereby recommend that, the country should diversify its export revenue base as a means of minimizing reliance on crude oil and petroleum products, Such as fiscal prudence, reform in budgetary operations, export diversification, revival of the non-oil sector of the economy, accountability and corporate governance.
1.1 BACKGROUND OF THE STUDY
Crude oil was discovered in Nigeria in the year 1956 and it became an export commodity in 1958. Before the discovery of crude oil, the export commodities were agricultural products. The production level of crude oil in the country has fluctuated over the years due to OPEC’s quota and socio-political instability. Following its discovery, crude oil has become major source income and foreign exchange for the country, thereby contributing to over 80% of the federal government’s revenue. Recently, the global price of crude oil dwindled in the international market; this led to a shock on the foreign exchange rate of the country and thereby affected consumer prices. Invariably, Exchange rate is the price for which the currency of a country can be exchange for another country’s currency. Exchange rate is said to depreciate if the amount of domestic currency required to buy foreign currency increases, while the exchange rate appreciates if the amount of domestic currency required to buy a foreign currency reduces. An appreciation in the real exchange rate may create current account problems because it leads to overvaluation. Overvaluation in the turn makes imports artificially cheaper while export relatively expensive, thus reducing the international competitiveness of a country
Oil products are basically used in industries for production of goods and services and they are also used domestically for personal consumption in which the greater percentage of it comes from developing countries. The oil industry is very important to the Nigerian economy. It provides among other things the greatest part of the foreign exchange earnings and total revenue needed for socio-economic and political development of Nigeria. The bulk of Nigerian crude oil is sold unrefined and when refined, the products range from petrol to heavy liquids for road tarring. Government has been the custodian of petroleum and its products in Nigeria. Though, this brought a temporary growth in the economy, the price instability of the crude oil in the world market has led to the downfall of Nigerians economy in various sectors, such as the production, manufacturing and services sectors. Oil products are derived from crude oil and they include petrol, diesel, kerosene, natural gas, bitumen. Oil was discovered in Nigeria in 1956 at Oloibiri in the present Bayelsa State, after a century of searching (Dharam,1991).
Oil price instability may have real effects, as a higher oil price may affect output through the aggregate production function by reducing the net amount of energy used in the production. In addition, aggregate demand, of which investment is a major part, may also change in response to energy price changes. An oil price increase will typically lead to a transfer of income from the oil importing countries to the oil exporting countries. This reduction in income would cause rational consumers in oil importing countries to cut back on their consumption spending and investment, hence, reducing aggregate demand and output. However, to the extent that the increase in income in the oil exporting country will increase demand from the additional income transferred to them from the oil importing country, the global effect would be minimized (Bohi, 1989 and Mork, 1994). The level of demand may also change due to actions taken by government in response to change in oil prices. To illustrate this point, to offset the increase in the general price level that might have been observed after the second oil price shock, several countries pursued tight monetary policy, which may itself have lowered real activity (Bjornland, 2000). The current declining oil price and the daunting challenges it poses to the Nigerian economy, has brought to the fore, the need to reconcile theory with practical realities. Given the empirical literature on the recent shocks, this study fills an important research gap by clarifying our understanding of the effect of crude oil income on price stability in Nigeria.
1.2 STATEMENT OF THE PROBLEM
The country produced 2 million barrel of oil pending and high oil price has seen to it that its current account changed from a deficit of 9% GDP in 1998 to a surplus currently. Crude Oil is a key source of energy in Nigeria and the in the world. Oil being an important part of the economy of Nigeria plays a strong role in influencing the economic and political fate of the country. Crude oil has generated great wealth for Nigeria, but its effect on the growth of the Nigerian economy as regards returns and productivity is still questionable (Odularu 2007). From the period of the oil boom of the 1970s till now, Nigeria has neglected her strong agriculture and light manufacturing bases in favor of unhealthy dependence on crude oil. New oil wealth has led to a concurrent decline of other sectors in the economy and has fueled massive migration to cities and led to increasingly wide spread poverty especially in rural areas. Nigeria’s job market has witnessed very high degree of unemployment, small wage and pitiable working environments (Adedipe, 2004 and Odularu 2007). Between 1970 to 2000, Nigeria’s poverty rate increased from 36 percent to just fewer than 70 percent and it is believed that oil revenue did not seem to add to the standard of living at this time but actually caused it to decline (Martin and Subramanian, 2003). Oil price fluctuations have received important considerations for their presumed role on macroeconomic variables. Higher oil prices may reduce economic growth, generate stock exchange panics and produce inflation which eventually leads to monetary and financial instability. It will also lead to high interest rates and even a plunge into recession (Mckillop, 2004). Sharp increases in the international oil prices and the violet fluctuations of the exchange rate are generally regarded as the factors of discouraging economic growth (Jin, 2008). A very good example is the period of the global financial crisis, the price of oil fell by about two thirds from its crest of $147.0 per barrel in July 2008 to $41.4 at end of December 2008. Before the crises, oil price was high, exchange rate was stable but with the dawn of the global financial crisis (GFC) oil price crashed and the exchange rate caved-in, depreciating by more than 20 per cent. Since oil price volatility directly affects the inflow of foreign exchange into the country, there is a need to investigate if it has direct impact on the Naira exchange rate volatility (Englama et al, 2010). The oil market has been and will continue to be an ever changing arena. This is because oil is so vital to the world economy, it is present in everyone’s daily lives and its market is truly global (El – badri, 2011). Thus, it is on this note that this research seeks to find out the effect of oil price on exchange rate volatility and its effects on the Nigerian economy, as well as suggest methods of minimizing the adverse effects it can produce on the economy as a whole.
1.3 OBJECTIVES OF THE STUDY
The major objective of this research is to determine if a long run relationship exists between crude oil income and price stability in Nigeria. The specific objectives include:
- To examine if there exists a significant relationship between crude oil income and price stability in Nigeria.
- To assess the long run impact of crude oil income and price stability in Nigeria.
- Determine whether there are attendant positive significant relationship exist between crude oil price and economic growth.
- Examine the effects of crude oil price volatility on government revenue, foreign exchange rate, capital importation and foreign external reserves.
1.4 RESEARCH QUESTIONS
- Is the discovery of crude oil the cause of neglect of other sectors of the economy?
- To what extent has oil price instabilities constrained the industrial sector performance in Nigeria
- Is there any positive and significant relationship between oil price and economic growth?
- Is there any positive effect of crude oil volatility on government revenue, foreign exchange rate, capital importation and foreign external reserves?
- How adverse is the price instability of oil products on Nigeria economy?
1.5 HYPOTHESIS OF THE STUDY
To realize the objective of this study, the following hypothesis was formulated by the researcher.
H0: There is no positive and significant relationship between oil price and economic growth
H1: There is a positive and significant relationship between oil price and economic growth.
H0: There is no positive effect of crude oil income and price stability in Nigeria.
H2: There is a positive effect of crude oil income and price stability in Nigeria.
1.6 SIGNIFICANCE OF THE STUDY
Research conducted on crude oil income have found out that oil price influence exchange rate to a great extent, especially oil producing countries like Nigeria. Nikbakbt (2009) showed that real oil prices have been a dominant source of real exchange rate movement and there exist a long run and positive linkage between real oil price and real exchange rates for OPEC countries. Oil exportation has contributed positively to Nigeria GDP, local expenditure, government revenue and foreign exchange reserves (Odularu 2007). Also in the words of Adedipe (2004) the oil price influences government policy and exchange rate in Nigeria. Although a wealth of literature exist relating oil price and exchange rate to economic growth in Nigeria, little focus on the effect of the oil price on exchange rate in Nigeria. This project seeks to fill this gap in literature as it focuses on the effect of oil price on exchange rate volatility in Nigeria and whether or not it has a significant influence on exchange rate volatility in Nigeria. Thus, this study is of great benefit to the government and policy makers. It reemphasizes the need to diversify and promote the growth of other sectors of the economy, in other to increase economic growth and improve the standard of living for Nigerians.
1.7 THE SCOPE AND LIMITATION OF THE STUDY
The study will basically cover the period of “1980 to 2015” the choice of the long span is deliberate as it cover the “oil boom” era the early 80’s and “oil gulf” era of the early 1980’s and the post structural adjustment programme era of the 1990’s. In the cause of the study, the researcher encounters some limitations which limited the scope of the study;
Time constraint: The researcher will simultaneously engage in this study with other academic work. This consequently will cut down on the time devoted for the research work.
Inadequate Materials: Scarcity of material is also another hindrance. The researcher finds it difficult to long hands in several required material which could contribute immensely to the success of this research work.
Financial constraint: Insufficient fund tends to impede the efficiency of the researcher in sourcing for the relevant materials, literature or information and in the process of data collection (internet, questionnaire and interview).
1.8 DEFINITION OF TERMS
Crude oil: Petroleum (from Greek: petra: “rock” + oleum: “oil”) is a naturally occurring, yellow-to-black liquid found in geological formations beneath the Earth’s surface. It is commonly refined into various types of fuels. Components of petroleum are separated using a technique called fractional distillation i.e separation of a liquid mixture into fractions differing in boiling point by means of distillation, typically using a fractionating column.
Price stability: Price stability implies avoiding both prolonged inflation and deflation. Inflation is a rise in the in the general price level of goods and services in an economy over a longer period of time resulting in a decline in the value of money and purchasing power.