Oil and Economy

Abstract

This project aims to establish a relationship between oil price shocks and the changes in value and quality of macroeconomic factors. With the intent of not getting over-comprehensive and overcomplicated, the macroeconomic factors we’ve considered are: GDP and Inflation Rate. We’ve chosen these two factors because GDP and Inflation Rate indirectly influence other macroeconomic factors such as unemployment, consumer spending and consumption, price indices, international trade etc. Inclusion of other factors would have entailed the analysis of several indirect and sparsely related channels of influence (when it comes to oil price and change in these factors) and as such, GDP and Inflation Rate are the key factors we believe to be influenced by oil price shocks. The aim of this project is to show to what degree these factors are affected by oil price shocks in different types of economies; namely, oil dependent and oil independent countries. We have chosen India and Japan as the study subjects for oil independent countries. Japan is a highly industrialized and developed country, with a majority of its GDP being comprised by the automobile, services, electronic components and research and development sectors; not directly dependent on oil & gas. India is a rapidly developing country with its GDP being driven by services, IT, manufacturing, mining and agriculture. Both these countries rely on foreign oil imports to meet their oil demands for the most part. Japan is a volcanic and mountainous country and hence lacks the natural resources (oil, gas, minerals) it needs and hence meets its consumption demands mostly through imports. India is rich in minerals and ores but still lacks the ability to meet its significant oil and gas demands solely through its own reserves, so it relies on imports from the Middle East.

The other two countries we’ve considered for this study are the UAE and Kuwait. Kuwait is a rich Middle Eastern country with abundant oil reserves and a majority of its economic activities are driven by exports of crude oil and refined oil products. In some part, the Kuwaiti economy is also driven by the services sector (food processing, ship building, desalination) but oil still plays a major role in the performance of the economy. The UAE on the other hand is one of the most diversified economies in the region. The government has taken many steps to try and steer the economy away from oil dependence. Despite this, even today, majority of the Emirati wealth is derived from Oil. The Emirate of Dubai lacks natural resources and thus relies on tourism, financial services, aviation and real estate for revenue. Abu Dhabi on the other hand derives its wealth from crude oil and refined oil products exports. A small part of the Abu Dhabi economy is also driven by aviation and tourism but nowhere near the scale of Dubai. Abu Dhabi has had to bail out Dubai during the 2007-2008 financial crisis and may need to do the same during the aftermath of the COVID-19 Pandemic as well. All in all, the UAE is highly dependent on Abu Dhabi’s petrodollars.

We have collected GDP and Inflation Rate data on these four countries from 1990 to 2018. This timeline was chosen because it includes the Gulf War, the recession of 2008, the Arab Spring and the oil crisis of 2014. These events give us adequate data points and evidence to establish a relationship between oil price shocks and economic performance.

Members

• Aditya Shrikhande
• Mansi Saxena

Methodology of Analysis

We have compiled the data for Kuwait, UAE, India and Japan. This data includes the absolute GDP values, Gross Annual Crude Oil Exports/Imports, Average Annual OPEC Crude Oil Prices and Inflation Rate for these countries, over a span of 28 years (from 1990 to 2018). Sources for Data: OPEC Annual Bulletin, Statista.

The data is first taken through the Logarithmic Smoothening (or Differencing, if negative values are present) process, to make the data static, instead of time varying. We then use Microsoft Excel’s Data Analysis package to perform Linear Regression and convert the resultant values to exponential form. We then use the Data Forecasting function to forecast future values of the given macroeconomic factors. A correlation matrix is then constructed using the same Data Analysis package, by going through the data and measuring the amount of inter-dependence between the various factors. The correlation value between two factors always lies between 0 and 1; the value of 1 indicating direct dependence and 0 indicating complete independence.

Below is some of the data we’ve compiled, which we’ve used for performing our analysis.

Conclusion

Through performing the analysis of the given data, we can conclude from the so derived ‘correlation matrices’ that exports/imports and price have varying influences on GDP and Inflation. From the matrices, we can draw the following conclusions:

Oil Exporting Nations

The Oil Price and Oil Export volumes are strongly related to each other, which make their way into influencing the nation’s GDP quite strongly as well. Inflation on the other hand seems to be more or less unaffected by export volumes and vice versa. Oil Price and Inflation are moderately co-dependent, since the nation’s economic performance depends heavily on Oil prices. GDP and Inflation are also moderately co-dependent.

Oil Importing Nations

Crude oil imports seem to have a stronger impact on GDP than avg. global crude oil prices. Oil Price has an affect on the quantity of oil imported/exported and vice versa. Oil Price and imports are observed to have a negligible influence on Inflation, while having quite a strong effect on GDP.