ACTA UNIVERSITATIS DANUBIUS Vol 10, no 1, 2014

Oil Price Volatility and Economic Growth in Nigeria:

a Vector Auto-Regression (VAR) Approach

Edesiri Godsday Okoro 1

Abstract: The study examined oil price volatility and economic growth in Nigeria linking oil price
volatility, crude oil prices, oil revenue and Gross Domestic Product. Using quarterly data sourced
from the Central Bank of Nigeria (CBN) Statistical Bulletin and World Bank Indicators (various
issues) spanning 1980-2010, a non‐linear model of oil price volatility and economic growth was
estimated using the VAR technique. The study revealed that oil price volatility has significantly
influenced the level of economic growth in Nigeria although; the result additionally indicated a
negative relationship between the oil price volatility and the level of economic growth. Furthermore,
the result also showed that the Nigerian economy survived on crude oil, to such extent that the
country‘s budget is tied to particular price of crude oil. This is not a good sign for a developing
economy, more so that the country relies almost entirely on revenue of the oil sector as a source of
foreign exchange earnings. This therefore portends some dangers for the economic survival of
Nigeria. It was recommended amongst others that there should be a strong need for policy makers to
focus on policy that will strengthen/stabilize the economy with specific focus on alternative sources
of government revenue. Finally, there should be reduction in monetization of crude oil receipts (fiscal
discipline), aggressive saving of proceeds from oil booms in future in order to withstand vicissitudes
of oil price volatility in future.
Keywords: crude oil prices; oil revenue; gross domestic product; white heteroskedasticity test
JEL Classification: O47; C25

1. Introduction
The Nigerian economy has been undergoing fundamental structural changes over
the years. The economy which was largely at a rudimentary stage of development
has been experiencing structural transformation after the country‘s independence
(Dappa and Daminabo, 2011). When Nigeria became politically independent in
October 1960, agriculture was the dominant sector of the economy; contributing
about 70 percent of the Gross Domestic Product (GDP), employing about the same

1
Master Student, Department of Accountancy, Nnamdi Azikiwe University, Awka,
Nigeria, Address: Anambra, Nigeria, Tel.:+2348060492273, Corresponding author:
[email protected].
AUDŒ, Vol. 10, no. 1, pp. 70-82

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percentage of the working population and accounting for about 90 percent of

foreign earnings and federal government revenue (National Centre for Economic
Management and Administration (NECEMA), 2012). During this period,
manufacturing and mining activities were at a very low level of development while
the country‘s participation in external trade was based on the level of economic
activities in agriculture where it had a comparative advantage. Thus, agriculture
dominated the country‘s export trade while manufactured items dominated imports
(Central Bank of Nigeria (CBN), 1993). Oil was discovered in commercial quantity
in Nigeria in 1956 and since then, oil has been the mainstay of the country‘s
economy up-till this present dispensation. In Nigeria, oil accounts for more than 90
percent of its exports, 25 percent of its Gross Domestic Product (GDP) and 80
percent of government total revenues (Adebiyi, et.al 2012).
The term oil price volatility refers to instability, changes, a rise or fall, in the
supply or demand side of oil prices in the international oil market. The rise or flux
in the prices of oil can be termed positive (i.e. a rise) or negative (i.e. a fall). Akpan
(2012) opined that the instability in the prices of oil have been traditionally traced
to supply side disruptions such as OPEC supply quotas, political upheavals in the
oil-rich Middle East and militancy in the Niger Delta region. Nnanna and Masha
(2003) observed that, changes in global oil market prices bring about a tremendous
effect on economic growth, especially in the real sector. The real sector is where
goods and services are produced through the combined utilization of raw materials
and other production factors such as labour, land and capital. The real sector
therefore forms the main driving force of any economy in the world and the engine
of economic growth. The real sector comprised of agriculture, industry, building
and construction, and services.
In Nigeria, much of the revenues are generated from the real sector (especially the
oil and gas industry). This forms the pivot for government budgets and
subsidization of domestic petroleum product prices (especially gasoline which is
the most demanded for transportation and other uses in the country). Volatility in
oil prices bring about a favourable investment climate, increased national income
within the period with a slight decline in the growth rate of Gross Domestic
Product (GDP); despite the perceived benefits of volatility in oil prices, the
economy of Nigeria during the boom were yet undesirable (Adeniyi, Abimbola and
Akin, 2011). Hence it appears that oil price volatility thus affect economic growth.
If this premise is true, then there is therefore the fundamental issue of ascertaining
whether oil price volatility could positively or negatively affect economic growth
in Nigeria.

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2. Prior Literature
Traditionally, oil prices have been more volatile than many other commodity or
asset prices since World War II. The trend of demand and supply in the global
economy coupled with activities of OPEC consistently affects the price of oil.
Changes in oil prices in the global economy are so rapid and unprecedented. This is
partly due to increased demand of oil by China and India (Hamilton, 1983).
However, the global economic meltdown counteracted the skyrocketing oil price in
Nigeria. During the inception of the crisis, oil price crashed below $40/b in the
world market which had serious consequences on Nigeria fiscal budget leading to
the downward review of the budget oil bench mark price. Today oil price is
oscillating between $75/b and $80/b. This rapid change has become a great concern
to everybody including researchers and policy makers.
Oil prices have been very volatile since 1999. Spikes from March 1999 are because
of the following factors: (i) OPEC restricted crude oil production and there is
greater cooperation among its members; (ii) Asian growing oil demand signifying
recovery from crisis; and (iii) Shrinking non-OPEC production. The world market
responded accordingly with sharp increase in prices, with crude oil prices
increasing and exceeding US$30/b towards the end of 2000. OPEC then tried to
maintain prices at a range between US$22/b and US$28/b by increasing or
reducing production, and with increases in output by non-OPEC producers,
particularly Russia (Adeniyi, 2012).
Gunu and Kilishi (2010) asserted that the September 11 2001 was another incident
that sent crude oil prices plummeting, despite earlier production increases by non-
OPEC producers and reduction of quotas by OPEC member countries but soon
afterwards, prices moved to the US$25/b range. In 2004, prices moved above this
range, with the crude oil hovering above US$40/b per barrel during the year. The
monthly average world gasoline prices increased from US$0.26 a litre in January
2004 to US$0.37 in January 2007 and to US$0.73 by August 2008. Diesel prices
were US$0.25 a litre in January 2004, US$0.42 in January 2007, and US$0.84 in
August 2008. Bassam (2010) observed that during this period, some developing
countries including Nigeria experienced a large currency appreciation which
partially helped offset oil price increases. Other countries experienced currency
depreciation, exacerbating the impact of steep oil price rises. Retail fuel prices of
gasoline and diesel in August 2008 were, on average, about 50 percent higher in
industrialised countries than in developing countries. Gasoline, diesel, and
household kerosene prices in oil-importing developing countries were twice as high
as those in oil-exporting countries.
By region, Sub-Saharan Africa had the highest gasoline and diesel prices in the
developing world, a consequence of the landlocked nature of some of its countries,
inadequate economies of scale in small markets, inadequate infrastructure for
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transporting fuels, rising demand for diesel to offset power shortages, and
relatively high rates of taxation. Retail prices of liquefied petroleum gas, used in
household cooking, were low in relation to world prices, reflecting the tendency of
governments to subsidize fuel. However, a number of countries - including
Bangladesh, China, Egypt, Ethiopia, India, Indonesia, the Islamic Republic of Iran,
Malaysia, Nepal, Nigeria, Sri Lanka, the Syrian Arab Republic, Venezuela, and the
Republic of Yemen - set fuel prices in an ad hoc manner, and most have seen
growing price subsidies in recent years (Akpan, 2012). In Nigeria the domestic
retail prices are regulated and subsidized by government, however, the prices are
adjusted (upward or downward) from time to time.
According to Nouriel and Brad (2004), volatility in oil prices has a stagflationary
effect on the economy of an oil importing country: they slow down the rate of
growth (and may even reduce the level of output – i.e. cause a recession) and they
lead to an increase in the price level and potentially an increase in the inflation rate.
Volatility in oil prices act like a tax on consumption. The factors contributing to
volatility in oil prices can be isolated as follows: the continued fall in Naira and
political tension in the South-South region; high demand for crude oil by other
countries and uncertainty about the future of oil producers. The depreciation of the
Naira against other major currencies contributed to increasing fuel prices. The
banking crisis that erupted in 2006, following more than a year of less acute
financial turmoil, has substantially reinforced the cyclical downturn of oil prices.
Also, the consequent global economic meltdown contributed to the volatile nature
of oil prices.

3. Empirical Evidence
Oil price volatility on economic growth has occupied the attention of researchers
for almost four decades (Adeniyi, 2012; Lutz and Cheolbeom, 2007). In a study of
the impact of oil price volatility on economic growth in Nigeria using four key
macroeconomic variables, Gunu and Kilishi (2010) found that oil prices have
significant impact on real GDP, money supply and unemployment and that the
impact on the fourth variable, consumer price index is not significant. The findings
implied that three key macroeconomic variables (real GDP, money supply and
unemployment) were significantly explained by exogenous and the highly volatile
variable, hence the economy of Nigeria is vulnerable to external shocks. Similarly,
Lutz (2006), and Olivier and Jordi (2007) empirically examined the impact of oil
price volatility on economic growth. In his study, Lutz (2006) established that
volatility in oil prices is crucial in assessing the effect it has on US real GDP and
CPI inflation, suggesting that policies aimed at dealing with volatility in oil prices
must take careful account of the origins of changes in oil prices. In the same way,
Olivier and Jordi (2007) investigated the macroeconomic effects of oil price
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volatility using a set of industrialized economies in the aftermath of oil price

changes of the 1970s and of 2000s, focusing on the differences across episodes.
They found that lack of concurrent adverse changes, smaller share of oil in
production, flexibility of labour markets and improved monetary policy played an
important role in the economy.
In a study on the effect of oil price shocks on output, inflation, real exchange rate
and money supply in Nigeria using quarterly data from 1970 to 2003, Olomola and
Adejumo (2006) established that oil price shocks do not affect output and inflation
in Nigeria. They argued that oil price shocks do significantly influence real
exchange rates.
Rebeca and Marcelo (2004) assessed the effect of oil price shocks on real
economic activity of some industrialized OECD countries using a multivariate
VAR analysis. Their study found evidence of a non-linear impact of oil prices on
real GDP. Also that among oil importing countries, oil price increases are found to
have a negative impact on economic activity in all cases but Japan with oil price
increases affecting the UK negatively and Norway positively. Empirical evidence
suggests that there are relatively few cases of research on oil price volatility in
Nigeria; thus, the present study focused on oil price volatility and economic growth
in Nigeria using the VAR model.

4. Methodology
This study was carried out in Nigeria to see the influence of oil price volatility on
the level of economic growth. The study covered the period 1980-2010.
4.1. Method of Analysis
In order to ascertain the volatility in oil prices and the influence on the level of
economic growth, an unrestricted Vector Auto-Regression (VAR) Model was
adopted. The VAR model provides a multivariate framework where changes in a
particular variable (oil price) are related to changes in its own lags and to changes
in other variables as well their lags. The VAR treats all variables as endogenous
and does not impose a-priori restriction on structural relationships (Gujarrati,
2003). The VAR estimates the relative importance of a variable in generating
variations in its own value and in the value of other variables which can be
accessed via Forecast Error Variance Decomposition (VDC). There was also a co-
integration test as well as a normality test, which helped to determine if the error
term of the variables under consideration were normally distributed.
4.2. Data Definition and Source
The data for this study were generated from the Central Bank of Nigeria (CBN)
Statistical Bulletin and World Bank Indicators for Nigeria (various issues) during
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1980-2010. The data for Crude Oil Price (COP), Oil Revenue (OREV) and Gross
Domestic Product (GDP) were sourced from the Central Bank of Nigeria Statistical
Bulletin and Oil Price Volatility (OPS) from the World Bank Indicators for
Nigeria.
4.3. Model Specification
The econometric model considered in this study takes Crude Oil Prices, Oil
Revenue and Oil Price Volatility as the independent variables and Gross Domestic
Product as dependent variable. These variables are used at constant prices. This is
used to obtain a reliable parameter estimates in the time series VAR model.
Generally, a VAR model is specified as:
Yt = m + A1Yt-1 + A2Yt-2 + … + ApY1-p+ €t (1)
Equation (1) specifies VAR (P) process, where Ai(i=1,2,…p) are K x K matrices of
coefficients, m is a K x 1 vector of constants and €t is a vector of white noise
process. Therefore, a model for the analysis can be stated explicitly as follows:
GDP = F(OPV, OREV, COP) (2)
Where:
GDP = Gross Domestic Product
OPV = Oil Price Volatility
OREV = Oil Revenue
COP = Crude Oil Price
In order to estimate equation (1 and 2), we can translate this into equation 3 as
stated below:
GDP = m0 + A1OPVt-1 + A2OREVt-2 +A3COP t-3 + €t (3)

5. Results and Discussion

The tests were conducted in order of priority. The ADF Unit Root Test came first
which was closely followed by the Co-integration Test, Over-parameterized and
Parsimonious Error Correction Test and Diagnostic Test came next which was
concluded by the Variance Decomposition Test.

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5.1. ADF Unit Root Test

Table 1. Summary of ADF Unit Root Test
st
Variables Level 1 diff 1% 5% 10% Order of
date CV CV CV Integration
OREV -2.07 -5.46* -3.69 -2.97 -2.62 I(1)
OPV -4.20* -6.38 -3.69 -2.97 -2.62 I(0)
COP 0.66 -2.86*** -3.69 -2.97 -2.62 I(1)
GDP 1.37 -5.08* -3.69 -2.97 -2.62 I(1)
* Statistically significant at 1% level
*** Statistically significant at 10% level
The Augmented Dickey Fuller (ADF) unit root test was used to test whether the
variables are stationery or not and their order of integration. The result of the ADF
unit root test is shown in table I above. The result of the ADF unit root test
followed expectations. All the variables except Oil Price Volatility (OPV) were
non-stationery. They however became stationary after taking the first order
difference. The oil price volatility was stationary at the level probably because it is
computed in ratio. This set the pace for the next stage of the analysis which is a test
of co-integration.

5.2. Co-integration Test

The Johansen co-integration test was used to test for the long run relationship
among the variables. The results of the Johansen co-integration test are shown in
tables IIa and table IIb below.
Table 2a. Summary of Johansen Co-integration Test Result
Hypothesize No. Eigenvalue Trace Statistic 5 Percent 1 Percent
of CE(s) Critical Value Critical Value
None ** 0.640692 77.78483 68.52 76.07
At most 1* 0.602173 48.10118 47.21 54.46
At most 2 0.431028 21.37075 29.68 35.65
At most 3 0.143147 5.016967 15.41 20.04
At most 4 0.018340 0.536789 3.76 6.65

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Table 2b. Summary of Johansen Co-integration Test Result

Hypothesize No. Eigenvalue Max-Eigen 5 Percent 1 Percent
of CE(s) Statistic Critical Value Critical Value
None 0.640692 29.68365 33.46 38.77
At most 1 0.602173 26.73042 27.07 32.24
At most 2 0.431028 16.35379 20.97 25.52
At most 3 0.143147 4.480178 14.07 18.63
At most 4 0.018340 0.536789 3.76 6.65
The results of the Johansen co-integration test in tables IIa and IIb above showed
that a long run relationship exists among oil price volatility, oil revenue, crude oil
prices and economic growth. The trace test indicated two co-integrating equation
while the max-eigen statistic indicated one co-integrating equation. Once there is
co-integrating vector, a long run relationship is concluded (Gujarati, 2003). The
existence of at least one co-integrating equation permits us to estimate over-
parameterized and parsimonious error correction mechanism (ECM).

5.3. Over-parameterized and Parsimonious Error Correction Mechanism

The Over-parameterized and Parsimonious Error Correction Mechanism (ECM)
test are shown in tables IIIa and IIIb below.
Table 3a. Summary of Over-parameterized ECM result Dependent Variable: DLGDP
Variable Coefficient Std. Error t-Statistic Prob.
DLCOP 0.483866 0.105695 4.577960 0.0001
DLCOP(-1) 0.300630 0.293394 1.024661 0.3184
DLCOP(-2) 0.023727 0.281602 0.084259 0.9337
DLOREV 0.291112 0.116558 2.497571 0.0219
DLOREV(-1) 0.492357 0.116026 4.243516 0.0004
DLOREV(-2) 0.029815 0.163759 0.182066 0.8575
OPV -0.889766 0.181262 -4.908717 0.0000
ECM(-1) -0.454316 0.167069 -2.719327 0.0105
C 0.068255 0.169144 0.403534 0.6911
R2 = 0.73, R2 = 0.61, AIC = 1.96, SC = 2.38, Dw = 2.07
The over-parameterized error correction mechanism (ECM) model includes various
lags of the variables. The parsimonious ECM model (or preferred model is gotten
by deleting the insignificant variables from the over-parameterize ECM model. The
Schwarz criterion and the Akaike information criteria were used to select the
appropriate lag length. The parsimonious ECM result was gotten by deleting
insignificant variables from the over-parameterize ECM model. The parsimonious
ECM result was used to test whether oil price volatility have influenced the level of
economic growth using the desirable variables based on applicable decision rule.

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Table3b. Summary of Parsimonious ECM result Dependent Variable DL GDP

Variable Coefficient Std. Error t-Statistic Prob.
DLCOP -0.685214 0.077328 -8.861098 0.0000
DLCOP 0.642603 0.149431 4.300324 0.0001
DLOREV 0.250244 0.111010 2.254250 0.0340
DLOREV(-1) 0.495617 0.108928 4.549924 0.0001
ECM(-1) -0.721014 0.304142 -2.370651 0.0242
C -0.052484 0.121754 -0.431063 0.6704
R2 = 0.78, R2 = 0.77, AIC = 1.86, SC = 2.15, Dw = 2.07
The t-value result (t-cal 8.86 > t-crit 2.052) indicates that oil price volatility have
negatively affect economic growth. The result showed an additional factor. The
negative sign attached to the coefficient of oil price volatility signifies that in
Nigeria, volatility in oil prices have negatively affected the level of economic
growth. The result showed that an increase in oil price volatility by 1 unit actually
reduced the level of economic growth by 0.69 units. Also, the t-test in this regard
has a value of 2.25 at the levels and 4.55 at the first difference which are less than
the t-critical of 2.052. This is an indication that oil revenue has significant impact
on the level of economic growth in Nigeria. This result has special significance
because both the previous level of oil revenue and the current level of oil revenue
were statistically significant. This is an indication of the Nigerian government
over-reliance on revenue from the oil sector. Furthermore, the t-test in this regards
has the value of 4.30 which is greater than the t-critical (2.052) suggesting that
crude oil price has significantly influenced the level of economic growth in
Nigeria. This is not surprising however since the Nigerian economy relies almost
entirely on crude oil revenue. The Nigerian case is so severe that the budget of the
country is tied to particular price of crude oil. This was why a sudden drop in the
oil price in 2008 as a result of the global financial crisis led to a downward
readjustment of the budget.

5.4. Vector Error Correction (VEC)

The portion of the VEC result that is of most significance is shown in table IV
below:

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Table 4. Summary of Vector Error Correction Results

Co-integrating Eq: Co-integrating Eq 2
LGDP(-1) 1.000000
LCOP(-1) 47.35423
(14.2973)
[3.31212]
LOREV(-1) 248.5813
(30.0155)
[8.28177]
OPV(-1) -848.8212
(91.2922)
[-9.29785]
OREV(-1) -0.003367
(0.00043)
[-7.91601]
C -2128.183
Error Correction: D(LGDP) D(LCOP) D(LOREV) D(OPV)
CointEq1 -0.000966 -0.407183 -0.000314 -0.173256
(0.00086) (0.05926) (0.00111) (0.05639)
[-1.12841] [-6.87080] [-0.28369] [-3.07275]
The result of the VEC showed that COP equation and the OPV equation represents
the co-integrating equation. The others are statistically flawed. They have the right
sign but were not significant.

5.5. Diagnostic Test

The diagnostic test is used to test whether the errors are normally distributed,
whether the variance is constant or not and whether the errors are serially
correlated. The test of stability also forms part of the diagnostic test. Table V
presents the first part of the diagnostic test.
Table 5. Diagnostic Test Result: Jarque-Bera
Jarque-bear 0.59 Probability 0.75
White Heteroskedasticity test
f-statistic 1.01 Probability 0.30
Breusch Godfrey Serial Correlation LM test
f-statistic 0.14 Probability 0.87
The result of the Jarque-Bera normality test shows that the errors are normally
distributed. The white heteroscedasticity test shows that the errors are
homeskedastic and the result of the Breusch Godfrey Serial Correlation LM test
indicated no evidence of serial correlation in the residuals. The result of the
stability test is shown in figures 1 and 2 below:

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Figure 1: CUSUM Stability Test Fig. 2: CUSUM Q Stability Test

The result of the Cumulative Sum of Recursive Residuals (CUSUM) test in the
figure above indicated that the model is stable since the 5 percent line falls in-
between the two 5 percent lines. Also, the Cumulative Sum of Squares of
Recursive Residuals (CUSUM Q) indicated stability in the model.

5.6. Variance Decomposition

The variance decomposition tests the proportion of changes in the dependent
variable that has been explained by the changes in the independent variables. The
result of the variance decomposition is shown in table VI below:
Table 6. Summary of Variance Decomposition Result
Period S.E. Variance COP OPV OREV
GDP
1 1780142. 100.0000 0.000000 0.000000 0.000000
2 3285982. 34.58371 40.52078 7.103264 17.79225
3 3832300. 45.29962 33.98349 5.222418 15.49447
4 4242651. 50.02630 31.11930 6.006581 12.84782
5 4504541. 46.23058 35.98962 5.371077 12.41773
6 4817001. 48.99059 34.53738 5.031366 11.44066
7 6063125. 67.07404 22.47035 3.186895 7.268716
8 6932526. 64.99905 20.03120 3.634832 11.33491
9 8244110. 59.17076 21.23684 3.578833 16.01357
10 9332918. 61.39760 20.41590 3.188355 14.99814
The result indicated that oil price volatility did not explain significant percentages
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of the changes in the level of economic growth during the first period. Oil price
volatility was explained by 7 percent of the changes in level of economic growth in
the second period and this reduced to 6 percent in the fourth period and 3 percent in
the tenth period, reflecting the problem caused by oil price volatility to economic
growth. The volatility to crude oil price however explained a significant percentage
of changes in economic growth. Volatility to crude oil price explained 41 percent
of changes in crude oil in the second period and this reduced to 35 percent in the
fifth period and declined further to 20 percent in the tenth period. This indicated
the over-reliance of the country on the price of crude oil in the world market.
Volatility to oil revenue was explained by 17 percent of changes in economic
growth and this was 16 percent in the ninth period and fell to 14 percent in the
tenth period.

6. Conclusion and Recommendations

There is a vast literature establishing robust results across many countries on the
connection between oil price volatility and economic growth. This implies that
connections should also exist between oil price volatility and economic growth in
Nigeria. This study examined oil price volatility on economic growth in Nigeria
during 1980-2010, using a VAR analysis. The study concluded from the findings
that oil price volatility have significant influence on economic growth although a
negative impact. This constitutes serious implication for the management of the
country economy because crude oil price is a major determinant of the budget
formulation in Nigeria while GDP is a key macroeconomic policy targets. If these
variables are influenced by a change, almost unpredictable exogenous variable like
crude oil prices, then the economy becomes highly vulnerable to unpredictable
external shocks.
Based on the above, it was recommended that there should be a strong need for
policy makers to focus on policy that will strengthen/stabilize the structure of the
economy with specific focus on alternative sources of government revenue. The
way to minimize this volatility in oil prices is to diversify the economy so as to
make it less oil dependent; there should be reduction in monetization of crude oil
receipts (fiscal discipline), aggressive saving of proceeds from oil booms in future
in order to withstand vicissitudes of oil price volatility in future; Policy makers
should design the optimal policy mix that would help the nation cope efficiently
with the economic and social costs of the external shocks accompanying higher oil
prices and the country need to establish and enforce prudent fiscal rules to smooth
surplus export receipts over time, invest them for future growth and minimize
wasteful spending.

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Adeniyi, O. A. (2012). Oil Price Shocks and Economic Growth in Nigeria: Are Thresholds Important
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Bassam, F. (2010). The Drivers of Oil Prices: The Usefulness and Limitations of Non-Structural
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Nouriel, R. &Brad, S. (2004). The Effects of the Recent Oil Price Shock on the U.S. and Global
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