Oil price fluctuations and its effect on GDP growth
A case study of China and Germany
Bachelor Thesis
to graduate from the School of Business and Social Sciences of the Århus University, Denmark
Author: Academic supervisor:
Christopher Dirzka Dr. Habil Peter Kesting
Matriculation number: Word count: 201208062 99.780
Århus, 04th May 2015
Abstract
Since the 1980s when economists and government leaders understood the potential and threat of oil dependence, the research field dramatically expanded. The fact that rising oil prices have adverse effects on macroeconomic activity, has become widely accepted due to James D. Hamilton’s article ”Oil and the Macroeconomy since World War II” in 1983.
Many others confirmed his results, however changes to the oil market also affected the focus of research, in the sense that not only the price levels had an effect on the GDP growth, but price volatility as well.
To give a perception; an increase 10% in oil prices, which is according to the WTI spot price per barrel from the 30th March 2015 - 4.86$, might decrease the GDP growth by 0.6% (Hooker, 1996), in relation to the U.S. GDP a potential loss would be between tens and even hundreds of billion dollar.
Moreover, several researchers found evidence that oil prices also affect a wide range of economic factors, such as employment, interest rate, stock markets, inflation- and exchange rates.
Yet the exact correlation between oil price fluctuations and GDP growth for a particular country remains controversial.
The author chooses to analyse the relationship between GDP growth and oil price fluctuations, via a bivariate analysis for the time 2000, 1st quarter to 2015, 1st quarter.
Germany and China, where chosen to exemplify this relationship. The backbone of both economies is the export of production goods; this implies a sizeable transportation sector, especially road transportation, which is fuelled by petroleum.
In the observation period, both GDPs grew, yet the oil consumption declined in Germany, while China’s GDP increased proportional with the consumption.
The analysis indicates that Germany’s and China’s GDP are correlated to each other and that the relationship in the third quarter after the change is negative and statically significant for Germany, however China’s GDP and the oil price fluctuations are positive directly linked without any lag.
Table of Content.......................................................................................................................3
1 Introduction...........................................................................................................................5
1.1 Introduction to the subject .......................................................................................5
1.2 Problem statement and research questions ..........................................................7
1.3 Purpose........................................................................................................................8
1.4 Delimitations ...............................................................................................................8
1.5 Method........................................................................................................................9
1.6 Structure of the thesis ................................................................................................9
2 Background.........................................................................................................................10
2.1 Oil Price History..........................................................................................................11
2.1.1 History Overview........................................................................................................11
2.1.2 Pre-Embargo Period.................................................................................................12
2.1.3 Middle East Crisis.......................................................................................................13
2.1.4 Role of the OPEC 1980 - 2000..................................................................................14
2.1.5 After 11th September 2011.......................................................................................15
2.1.6 Oversupply in 2014-2015..........................................................................................17
2.1.7 Sub – Conclusion......................................................................................................18
3 Oil price and economical activity....................................................................................19
3.1 Literature Review......................................................................................................20
3.1.1 Models in relation to the GDP and employment..................................................20
3.1.2 Models in relation to the stock market...................................................................22
3.1.3 Literature Summary...................................................................................................23
3.2 Correlation economy and oil prices.......................................................................23
3.3 Oil Price Increase......................................................................................................24
3.3.1 Impact of an oil price increase on exporting countries.......................................24
3.3.2 Impact of an oil price increase on importing countries.......................................25
3.3.3 Stock market and exchange rate..........................................................................26
4 Cases study Germany and China....................................................................................28
4.1 Germany....................................................................................................................28
4.2 China..........................................................................................................................30
5. Analysis...............................................................................................................................33
5.1 Data background.....................................................................................................34
5.2 Descriptive Analysis...................................................................................................34
5.3 Spearman's rank-order correlation.........................................................................35
6 Conclusion...........................................................................................................................35
7 References...........................................................................................................................36
7.1 Summary Figures Reference....................................................................................43
7.2 Summary Appendix Reference...............................................................................46
8 Appendix.............................................................................................................................47
Figures
Figure°1 BP Review: World consumption...............................................................................6
Figrue°2 Purpose: Link between oil price and GDP.............................................................8
Figure°3 Structure of the Thesis...............................................................................................9
Figure°4 Structure of the Chapter 2.....................................................................................10
Figure°5 Average Historic Oil prices per barrel from 1861 to 2013...................................11
Figure°6 Average Oil prices per barrel from 1946 to 1972................................................12
Figure°7 Average Oil prices per barrel from 1972 to 1983................................................13
Figure°8 Average Oil prices per barrel from 1980 to 2000................................................14
Figure°9 Total Oil Supply (Thousand Barrels Per Day) from 1980 to 2004.........................15
Figure°10 Average Oil prices per barrel from 1999 to 2013..............................................16
Figure°11 Total Oil Supply (Thousand Barrels Per Day) from 1999 to 2013.......................16
Figure°12 Oil prices per barrel – Benchmark WTI & Brent from 2011 to 2015...................17
Figure°13 Recessions in the U.S. from 1970 to 2012............................................................18
Figure°14 Structure of the Chapter 3...................................................................................19
Figure°15 Worldwide GDP vs. Oil price per barrel in international real 2010$................23
Figure°16 Oil price increase in relation to oil exporting nations.......................................25
Figure°17 Oil price increase in relation to oil importing nations.......................................25
Figure°18 Total Primary Energy Supply of Germany in 2010 (Mtoe).................................28
Figure°19 German Production vs. Consumption from 1991 to 2013................................28
Figure°20 German GDP vs. Total Oil Consumption from 1991 to 2013............................29
Figure°21 Total Primary Energy Supply of China in 2011....................................................30
Figure°22 Chinese Production vs. Consumption and Ratio from 1987 to 2013...............31
Figure°23 Chinese GDP vs. Oil Consumption from 1991 to 2013......................................32
SPSS
Figure°24 Frequency Test Germany and China.................................................................34
Figure°25 Spearman's rank-order correlation.....................................................................35
Appendix
Appendix I: Production & Consumption by region............................................................47
Appendix II: World consumption by energy source..........................................................47
Appendix III: Histogram German_GDP_Growth.................................................................48
Appendix IV: Histogram China_GDP_Growth....................................................................48
Appendix V: Descriptive Statistics Germany......................................................................49
Appendix VI: Descriptive Statistics China............................................................................49
Appendix VII: Descriptive Statistics WTI Spot Price.............................................................49
1 Introduction
This chapter provides for the reader a basic overview of existing studies in relation to macroeconomic consequences of oil price fluctuations and GDP growth.
It also contains the problem statement with the research questions, which this paper aims to answer in the consecutive sections. Some boundaries are acknowledged in delimitations section and lastly the structure of the thesis is presented.
1.1 Introduction to the subject
“By the fall of 1918, it was clear that a nation's prosperity, even its very survival, depended on securing a safe, abundant supply of cheap oil.” - Albert Marrin, Chairman of the History Department at New York's Yeshiva University (2012)
In his book - Black Gold: The Story of Oil in Our Lives, published in 2013 he outlines the significance of oil for the being of our humanity in the 20th and 21st century.
The usage of crude oil is not delimited to fuel vehicles / airplanes; it also can be transformed into heat and components of it are used in almost all chemical products. Until the availability of a more efficient resource, crude oil will shape humanities further development. (http://www.wintershall.com/en/company/oil-and-gas/oil-can-do-more.html)
For instance, the thirteen of the thirty biggest companies in relation to their revenue, are oil & gas producers. (http://fortune.com/global500/.)
The history of dependence could be determined by the invention of the four-stroke combustion cycle by the German engineer Nikolaus Otto in 1867. He created the first internal combustion engine that compressed the fuel mixture prior to combustion for higher efficiency. At the time of creation, it was superior to any other engine. Currently almost all vehicles, which run on any form of crude oil, use this particular combustion engine, called Otto cycle. (Grenning, 1991)
Due to the appearance of renewable energy sources, such as wind, water, and solar power and higher efficiency of combustion engines, the importance of crude oil as the main source of energy has been diminished. Nonetheless, the significance of oil exceeds economic aspects and affects social life in general.
Oil represents one of the most important macroeconomic factors for the world economy; thusly the crude oil market is the largest commodity market in the world.
According to the Energy Information Administration (EIA) Global economic performance remains to this the day highly correlated to oil prices. (http://www.eia.gov/finance/markets/demand-nonoecd.cfm)
According to the IEA Research Paper, by R. Sauter and S. Awerbuch (2003), crude oil differentiate itself from any other commodities, due to its nature to affect the GDP of a country asymmetrically. Oil price increase and decrease do not have the same overall impacts. (Mork, 1989) Moreover, when the price of oil per barrel increases, oil-exporting countries can accumulate higher revenues, on the other hand importing countries generally suffer due to higher prices. Thusly this effect is also visible in reverse, when prices decrease.
The Journal of Political Economy published the article, “Oil and the Macroeconomy since World War II” by J. D. Hamilton (1983), which is seen by many scholars as the keystone of Oil & GDP research.
Hamilton demonstrated that the historical correlation between oil price increase and economic downturns were no coincidence. In the time period from 1948 – 1980, his results showed that after an increase in oil price, 3 to 4 quarters later the economic growth decreased, which was followed by a recovery beginning after 6 to 7 quarters.
Thusly most post WW2 recessions were preceded by a sharp increase in oil price (Guo & Kliesen, 2005), due to simultaneous rising production costs. Moreover the price fluctuation in itself creates uncertainty of risk, which will delay investments and trigger higher unemployment. (Sauter & Awerbuch, 2003)
To understand the vital importance of oil for the world economy and our everyday life, the following figure°1 from the BP Statistical Review of World Energy 2014, shows that nearly 30% of the worldwide energy consumption relies on crude oil.
Figure°1 BP Review: World consumption
The transportation sector, especially road transport, which accounted in 2012 for more than 50% of the worldwide oil demand, would suffer under higher prices. (Baroni, 2013)
In January 2000 the oil price per barrel rose from 25.56$ to 145$ in July 2008. Referring to this issue the professor of the University of California J. D. Hamilton (2014) expected that “hundred dollar oil is here to stay”; meaning that the price per barrel will remain in the future above the 100$ mark. In contrast to Hamilton’s assumption, John Kemp, Senior Market Analyst for Commodities and Energy at Reuters (http://www.rigzone.com/news/oil_gas/a/134256/Kemp_Forecasts_for_Higher_Oil_Prices_Misjudge_the_Shale_Boom/?all=HG2), forecasted a decline in oil prices due to the additional supply of oil by the shale industry.
The sky rocking prices in 2008 made the previously uneconomical hydraulic fracturing commonly referred to as fracking, for private and governmental energy agencies attractive. The U.S.A as the former main importer of oil ranks on the second place after Russia in shale oil resources and is ranked fourth globally after China, Argentina and Algeria in shale natural gas resources. (Kuuskraa. & Stevens, 2013) Subsequently, this contributed to the current oil price of 47$ in March 2015, which is the lowest level since 2009.
To sum up, inexpensive oil is a vital commodity for the major economies of the world. Moreover, it can be stated that countries with high economic activity (export / industry) and marginal access to own recourses, are significantly more affected by oil prices fluctuations than others.
For the aforementioned reasons, the case study chose to exemplify this struggle using the two major export nations: Germany and China
1.2 Problem statement and research questions
Previous studies were concerned whether the relationship between oil prices and output, might be just be a coincidence or actual statistically significant. Following researchers rejected the hypothesis that this might be only a coincidence; Hamilton (1983, 2000, 2005), Loungani (1986), Gisser & Goodwin (1986), Mork (1989), Lee et al. (1995), Ferderer (1996), Rotemberg and Woodford (1996), Hooker (1996), Sadorsky (1999) and Ciner (2001). These studies were mostly done in relation to the economy of the United States of America, which might be explainable by the countries high oil intensity.
However in the last decade the BRIC nations (Brazil, Russia, India and China) affected the entire commodity market and shifted the primary oil demand away from the U.S. Therefrom this thesis includes China in the case study, along with Germany as the powerhouse of Europe.
Both were chosen due to their high - and industrial sector, which consumes most of the total primer energy supply. While Germany’s GDP experienced a stable growth, the oil consumption declined. On the other hand, Chinas GDP grew rapidly since the early 2000s in correlation with the oil consumption.
Questions:
· What is the general relationship between oil prices and economic activity?
· Which factors contribute to oil price fluctuations?
· What is the correlation between GDP and oil price fluctuations for the countries Germany and China in a given time period?
1.3 Purpose
The purpose of this academic work is to display in a primarily theoretical manner how the oil price fluctuations affect the economy of a country. Furthermore, the case study aims to present similarities and differences in relation to this matter.
Figrue°2 Purpose: Link between oil price and GDP
The outcome of this paper will help companies and the governments, to predict future risks and to construct mechanisms to prevent economic downturns due to increasing oil prices. On the practical side, this paper aims to provide information for the average customer to decide whether it is sustainable that the future transportation vehicle should run on fossil fuel.
At last, it is important to mention that the purpose of this paper is to point out the mechanisms, which influence oil prices and GDP growth, rather than offer new solutions on how to overcome the issue of dependency.
1.4 Delimitations
Nearly all researches in the field of macroeconomic activity and oil focus on the U.S. economy. However the results of these might be not universally applicable, due to the issue that every country has a specific relationship between Oil & GDP and a different geopolitical history. Factors such as oil intensity and own reserves can alter the link.
Secondly, the sources used, are in some cases out-dated, or only usable for a specific time period, the outcome is in some cases not transferable, e.g. hydraulic franking shifted the role of the U.S.A from 2008 onwards from the main oil importer to the second biggest oil producer. This reduces the overall effect from external oil price shocks, triggered in the Middle East and also changes the relationship between importing- and exporting countries.
1.5 Method
The bivariate correlation, the Spearman rank correlation method was selected to test the relationship between oil price fluctuations and GDP growth, due to the issue that all three variable sets failed the assumption to be normally distributed. The Spearman's rank-order correlation is the nonparametric version of the Pearson correlation and measures the strength of association between two ranked variables.
Furthermore based on the findings by Hamilton (1983) and Lee et. al. (1995), the analysis will include lags, its can be generally assumed that oil price fluctuations will have no immediate effect on GDP growth.
For the entire analysis the IBM SPSS statics program is used; Chapter 5 will contain the main findings of the tests and the appendix the overall output.