Impact Of Oil Price Changes On Nigerias Economy Economics Essay

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INTRODUCTION.

Oil, as a globally traded commodity, is one of the most important and controversial, sources of energy. Given that it is a natural resource that is finite and is highly concentrated only in certain parts of the globe has created so many uncertainties about the future of oil [1] . This uncertainty is predominantly reflected in its prices.

Before that first oil shock between 1973 and 1974, oil prices were on the low side but the first shock saw prices rise from $3.29 per barrel to $11.58 per barrel, a huge 252% rise in price in money of the day terms.

Sine after the first oil shock, prices of oil have been erratic and volatile consequently resulting in another oil shock between 1978 and 1980.

The world thrives on the demand for and supply of oil. For the oil importing countries, they need oil to meet their domestic needs and are willing to pay for it even at high prices.

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For the oil exporting countries, their economy is predominantly dependent on the revenue generated from oil exports to consumers across the world. This dependence on oil should make their economy susceptible to the volatility of oil prices, with increased revenues as the price of oil rises and shortfall as the price falls.

Nigeria is a typical example of an oil exporting country whose economy is sustained by the revenue generated from oil exports to consuming countries.

This dependence on oil will have both a positive and a negative impact on it economy and the people at large.

It is the aim of this paper to ascertain the impacts that oil prices will have on the economy of Nigeria. This will involve looking at the impact of oil prices on exports and imports, national income, revenue generation, inflation, industry and agriculture, and then, the cumulative effects on the GDP of the country.

GLOBAL TRENDS IN OIL PRICES

Oil is a global commodity [2] . It is a commodity that is of utmost importance to the world. Its unique characteristics ranging from its fluidity and high energy content has earned it a global market. So it is one of the most traded commodities in the world.

As a globally traded commodity, oil accounts for 35% of the total world Primary Energy Consumption (PEC) as shown below;

Figure One. Primary Energy Consumption as at 2008

Source: Author of paper.

But the uncertainty as regards its abundance, its uneven distribution across the globe and geopolitical tension has grossly affected the price of oil over the years, making it erratic and creating a very volatile environment. This was the case in 2006 when oil prices hit $68.93 per barrel amidst fears of a United States led military attack on Iran [3] .

Over time oil prices have shown an unpredictable trend rising and falling at different points in time as shown in the figure below;

Figure Two. Trend in oil prices 1971 to 2008

Source: Author of the paper.

Over the period 1971 to 2008 the percentage change in prices exceeded 100% twice (between 1973 1974, as well as 1977 between 1978 and 1979) and fell steeply, by as much as 74percent, between 1981 and 1998. Prices have risen since after 1998 to date.

2.1 IMPACT OF OIL PRICES ON NATURAL GAS PRICES

Prior to the gas shock of 2000 and 2001, gas prices were thought to be independent of oil prices; but after the gas shortage in North America and Canada, where gas prices were lifted up to the prices of oil, gas prices have predominantly followed oil prices [4] . This shown in the trend below;

Figure three. Trend in Oil and Gas Prices

Source: Author of the paper.

Most oil importing countries like the US, Germany, China, are also high importers of gas. As such, an increase in the prices of oil will also raise prices of gas which will increase the impact of oil prices on the economy. In general, the extent of the impact will be dependent on the energy intensity of the country [5] .

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Similarly, the cost of oil on the national expenditure as well as the manner in which the end users consume energy will also contribute to the extent of the impact of oil prices on the economy of the oil importing country.

For the oil exporting country, high oil prices are expected to boost the economy and increase revenue from increased exports of oil to consumer countries.

2.2 TREND IN OIL PRICES AND THE DOLLAR

The US dollar is an internationally accepted currency which is used in trading between countries. Oil trade is in dollar per barrel, and as the changes in oil prices will affect the dollar. The literature says that rises in the price of oil depreciates the dollar and depreciation of the dollar also raises oil prices. Whichever case, an increase in prices of oil makes exporting countries spend in dollar based assets rather than investment in trade and consumption. The propensity to build reserves and accounts has negative effects on the GDP of the importing countries which ripples into the world.

2.3 NET EFFECTS OF OIL PRICES

When a country is highly industrialized, the quest for economic growth will be predominantly driven by the demand for oil. As oil prices vary the level of demand would change. With low oil prices, the demand for oil increases and this will tend to yield positive economic benefits for the oil importing country in terms of growth in GDP. The economic gains that will be experienced by oil exporting countries will not be as pronounced as for the importing countries.

In the case of high oil prices, due to the nature of the demand in oil consuming countries, the demand for non-oil products fall, costs of inputs increase and the investment costs of the country increases [6] . Increasing investment costs reduce investments in the country.

Ultimately, the GDP of the importing country falls, there is increased unemployment, inflation, exchange rates fall, imports become more expensive, export earnings fall and the real national income of the country falls [7] . As a result, the economic growth of the country slows down.

For oil exporting countries, the gains of high oil prices yield benefits to the economy in the short term. This may span the first two years, as stated by the IEA in an analysis of the impact of high oil price on the global economy, but in the long run the effect of the depression experienced by most oil importing countries will outweigh the economic benefits of the high oil prices to the exporting countries and the resultant effect is a fall in the global GDP manifesting itself in an economic recession.

As such, fluctuations in oil prices will affect both the oil importing and the oil exporting countries. Thus the impacts of the fluctuations in oil prices on an oil exporting country, such as Nigeria, will be investigated in the next section.

BACK GROUND INFORMATION OF NIGERIA

Nigeria is the 8th largest oil exporter in the world with the second largest oil reserves in Africa, and is similarly the continents highest oil producer.

According to the Oil and Gas Journal the estimates of proven reserves in Nigeria as at January 2009 was 36.2 billion barrels [8] . The country produced 1.94 million bbl/d in 2008 and exported all of this to consumer countries [9] .

As such, the country's economy and national earnings is highly dependent on the oil sector.

According to the World Bank, oil accounts for over 97.5 percent of the country's export earnings and 81 percent of the government revenue generated each year [10] . This corresponds to an average 37.7percent contribution of the oil sector to the country's GDP.

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This signifies a lack of diversification in the country's economy. Being that dependent on oil revenues, means that the economy will be exposed to changing oil prices and puts a strain on it economic development.

IMPACT OF HIGH OIL PRICES

With a 97.5 percent share in Nigeria's export earnings and 81 percent contribution to the governments' revenue base, an increase in the price per barrel of oil would translate to even greater revenues for the government and the country at large.

3.1.1 IMPACT ON EXPENDITURE

In the short run, high oil prices are a will be synonymous with prosperity and increased wealth for the oil exporters (developing exporting countries in particular) but leaning towards this abundance of wealth without caution, as regards expenditure, most often leads to a draw back in the economic growth in the countries.

A classical example was the windfall in 1973 and 1980. Following the first oil shock of 1973, as Tom Forrest author of Politics and Economic Development in Nigeria notes, the oil shock and subsequent windfall increased the oil revenue at the time by 3.5 times with oil taking a share of approximately 80 percent of the total government revenue [11] .

Within the same period, the expenditure of the government increased astronomically. Coming from an agriculturally supported economy to appoint where the suddenly existed a surplus of finances in revenue, government would usually have the tendency to push its ability as a government in terms of expenditure.

This expenditure would most definitely be in the best interest of the country and its citizens creating jobs, increasing the purchasing power of its citizens, and generally increase the supply and flow of money in the country. This would usually be a period of economic growth.

The graph below shows that the trend in government expenditure appears to have a positive correlation with oil prices.

Figure four. Government Expenditure and Oil Prices in Nigeria.

Source: Author of the paper.

The graph shows that for the period of falling oil prices, between 1980 and 1988, government expenditure was low. As prices increased significantly from 1998 to 2004, so did the government expenditures.

One area of huge government expenditure in the country is in fuel subsidies as the country imports most of its fuel. These subsides tend to keep the prices of fuel in the domestic arena low and at the same time shield it from oil price fluctuations [12] . This imposes a great burden on the Federal account in times of high prices. In 2003, the government spent $2bn on subsidies. With increases in oil prices the amount spent on subsidies will also be expected to increase [13] .

3.1.2 IMPACT ON INCOME

With government expenditure increasing, supply of money to the market also increases. This period will normally see an increase in the disposable income of the working population as well as employment.

3.1.3 IMPACT ON PRICES AND INFLATION

Within a period like this, as the supply of money to the market increases, people have more access to money; the economy improves with rising of standard of living. More and more consumers are now able to afford goods and services. This increase will translate into a rise in the demand for non traded goods and services [14] . In the long run, increased demand and the ability to pay, will lead to competition for available goods and the prices for those goods will rise.

This means the purchasing power of the money fall's in the long run and inflation sets in.

As such inflation is a common feature of high oil prices and a corresponding increase in government expenditure.

3.1.4 IMPACT ON AGRICULTURE

Before the discovery of oil in Nigeria in 1958, and its subsequent contribution to total government revenue, Nigeria was predominantly sustained by agriculture. With the dominance of oil as the number one source of revenue for the government, there was no obligation to finance other sectors and cases where a few sectors were financed, it similarly made them susceptible to oil price fluctuations.

Similarly, the oil booms meant that food was easily accessible and soon in the supply could not meet the demand.

Below is a trend for crude oil prices, as well as agricultural imports and exports;

Figure five. Imports and Exports of Agricultural Products and crude oil Prices.

Source: Author of the Paper.

The trend visibly shows that the export of crops from the country fell at about the time of the second oil shock, and the importation of agricultural products had now become cheaper and was seen as a substitute to the falling capacity of local supply.

Despite efforts by the world-bank through its African Development Project (ADP) to help boost food production in the country, little was achieved then and up till now the agricultural industry is still lagging in crop production.

WHEN THE PRICE FALLS

Rising oil prices make large revenue sources for the government of Nigeria. When oil prices go up, a look at the trend suggests that a high price for oil is not usually sustainable and will subsequently fall in the long run.

When oil prices do fall, governments usually find that the level of expenditure they have attained is not sustainable. At such times, the will be a cutback in expenditure, as the government tries to reduce its spending so that it does not go beyond its revenue. At such times there will be an upward resistance to wage reductions, primarily because the population feels the entitlement to the oil revenue; this will mean a reduction in manpower and production as well.

Consequently, the fall in oil prices will lead to increasing unemployment in society and the once rising economic growth will eventually decline; sometimes beyond its' original value.

As such, though the oil price increase brought with it high export earnings and revenue for the FGN, the depressive effects of the high oil prices to the economy of the importing countries ultimately outweighs its economic benefits to oil exporting countries like Nigeria [15] .

4.0 CONCLUSION

When a country like Nigeria is so dependent on oil exports that it constitutes a major portion of its export earnings and revenue, there are bound to be consequences on the economy.

More importantly, the impact of the oil price changes on the economy will to a large extent depend on the expenditure of the government. Most governments of developing countries like Nigeria have the propensity to engage in huge expenditures that can yield a level of economic growth that cannot be sustained when oil prices fall, leading to a cutback in the expenditure.

Also, anticipation of large revenues from high oil prices can also lead governments to engage in excessive expenditure. There are suggestions that the Nigerian government at one time boycotted tax revenues and engaged itself in spending, hoping to make up with revenue from oil sales.

The basic point is that oil revenues create a false sense of financial security. Because oil prices are unpredictable, the level of financial sustainability of an economy will similarly be uncertain.

As such, according to Siamac Shojai, author of new oil markets, the impact of windfalls on the economy will be dampened if rather than just spending the governments can invest and save more, building assets that they can fall back upon as the future of their one most important economic commodity is uncertain.