OIL PRICE SHOCKS AND THEIR EFFECTS ON OIL AND GAS STOCK RETURNS IN NIGERIA

TABLE OF CONTENTS

Title Page       –                   –           –           –           –           –           –           –           2

Certification  –              –           –           –           –           –           –           –           3

Approval Page          –            –           –           –           –           –           –           4

Dedication     –           –                    –           –           –           –           –           –           5

Acknowledgement   –         –           –           –           –           –           –           6

Table of Contents     –                 –           –           –           –           –           –           7

List of Acronyms            –           –           –           –           –           –           9

List of Figures           –     –           –           –           –           –           –           –           10

List of Tables               –           –           –           –           –           –           11

Abstract               –           –           –           –           –           –           –           –           12

CHAPTER ONE:    INTRODUCTION

1.1       Background to the Study    –         –         –           –           –           13       

1.1.1    Oil Price Volatility –                –           –           –           –           –           14

1.2       Statement of the Problem    –     –           –           –           15       

1.3       Research Questions –           –                  –           –           –           17       

1.4       Objective of the Study        –                    –           –           –           –           17

1.5       Research Hypotheses          –              –           –           –           17

1.6       Significance of the Study    –             –           –           –           –           18

1.7       Scope of the Study   –               –           –           –           –           –           18

CHAPTER TWO:   LITERATURE REVIEW

2.1       Conceptual Framework       –          –           –           –           –           19       

2.2       Theoretical Literature         –             –           –           –           –           20

2.3       Empirical   Literature          –                –           –           –           23

2.3.1   Foreign Studies         –           –         –           –           –           –           23

2.3.2.   Nigerian Studies      –           –            –           –           –           –           29

2.4.      Limitations of Previous Studies              –           –           –           30

CHAPTER THREE:           METHODOLOGY

3.1       Theoretical Framework       –          –           –           –           –           31

3.1.1   The Model     –           –            –           –           –           –           –           32

3.2       Estimation Procedure and Model Justification   –         –           33

3.3       Sources of Data        –           – –           –           –           –           34

CHAPTER FOUR:  RESULTS ANALYSES AND INTERPRETATION

4.1Presentation of Results  –           –            –           –           –           –           35

4.1.3Response of Oil Stock Returns to Oil Price Shocks      –           –           39

4.1.4Diagnostic Tests Results        – –           –           –           –           –           40

CHAPTER FIVE:   CONCLUSION AND POLICY IMPLICATIONS

5.1     Conclusion     –                   –           –           –           –           –           –           43

5.2       Policy Implications  –            –           –           –           –           –           43

References    –           –           –               –           –           –           –           –           45

LIST OF ACRONYMS

OPEC = Organisation of Petrol Exporting Countries.  

VAR=Vector Autoregressive.

OECD=Organisation for Economic Cooperation and Development.

GARCH=Generalised Autoregressive Conditional Heteroscedasticity.

ARCH=Autoregressive Conditional Heteroscedasticity.

CBN=Central Bank of Nigeria.

LIST OF FIGURES

Figure 1: OPEC Crude Oil Price in US Dollar from January 1986 to February 2016.           15

Figure 2: Oil Export and Import-   –            –           –           –           –           16

Figure 3: Transmission of Shocks –           –           –           –           –           19

 Figure 4: Plot of the Residual of Oil and Gas Stock Returns-  –           –           35

Figure 5: Response of Oil Returns to Negative and Positive Oil Price Shocks-         –           39

LIST OF TABLES

Table 4.1.1 ADF and KPSS Unit Tests      –           –           –           –           36

Table 4.1.2aResults of the Mean Equation         –           –           –           38

 Table 4.1.2bGeneralized Autoregressive Conditional Heteroscedasticity (GARCH 1, 1). 39      

 Table 4.1.4aCorrelogram of Standardized Residuals Squared –    41       

Table 4.1.4b Heteroscedasticity Test         –                  –           –           42

Abstract

This study examines the effect of oil price shocks on oil stock returns in Nigeria for the period from January, 2000 to December, 2015. The study employs the Augmented Dickey-Fuller (ADF) and Kwiatkowski-Phillips-Schmidt-Shin (KPSS) tests for Unit root, Schwartz-Bayesian criterion for lag length, and a General Autoregressive Conditional Heteroscedasticity (GARCH 1, 1) modeling approach. First, the mean equation was estimated and residual derived from it was used to estimate the variance equation. Finally, volatility impulse response function was estimated. The mean equation reveals that if oil price increases by one percent, oil sector stock returns will decrease by 74%. If exchange rate increases by $1, oil sector stock returns increases by about 0.78%. Furthermore,an increase in interest rate differential will cause a decrease in oil sector stock returns by about 25%. On the other hand, results of the variance equation, which captures volatility, suggest that oil price shocks and oil stock returns are negatively related. It shows that the expected negative relationship between these two variables in an oil importing economy outweighs the positive relationship expected in an oil exporting country. The impact of oil price shocks due to importation crowdsout the supposedly positive impact due to oil exportation.On the other hand, results of the impulse response suggest that the effect of the negative and positive shocks are equal in absolute terms. Thus, the study recommends that the government should make concerted effort toward ensuring a conducive investment environment that would cushion the effect of oil price shocks on oil stock returns to attract both local and foreign investors.

CHAPTER ONE

INTRODUCTION

1. Background to the Study

Over the years, oil price has experienced incessant volatility and this has attracted the attention of researchers. The spillover effect of oil price shocks on the economy in general and specifically on the stock market returns has necessitated lots of studies in oil exporting and importing countries respectively. This is informed by the fact that the dynamic and pass-through effects of oil price shocks on the capital market are of utmost importance to the financial sector and investors. Thus, Ready (2013) is of the view that given the apparent importance of oil prices, it is natural to examine the relationship between oil prices and other traded assets, such as equities, to help better understand the link between oil prices and the economy. However in doing this oil price changes and stock market returns seem to be unrelated.

Furthermore, it is necessary to note that the effectof oil price shocks is different in oil exporting and importing countries.For instance, according to Abdelaziz, Chortareas and Cipollini (2008),in an oil-exporting country, a rise in world oil prices improves the trade balance, leading to a higher current account surplus and an improving net foreign asset position. At the same time, increase in oil prices tends to increase private disposable income in oil-exporting countries. This increases corporate profitability, at the same time raises domestic demand and stock prices. In oil-importing countries, the process works broadly in the reverse: trade deficit are cancelled out by weaker growth and, over time, stock prices decrease.

Volatility of stock markets returns has been related to key macroeconomic indicators. Oil price and its volatility has a major impact on economic activity and hence on futures and spot stock market returns. If oil price affects real GNP, it will affect the earnings of companies for which oil is a direct or indirect operational cost. Thus, an increase in oil prices will possibly cause expected earnings to decline, and this will bring about an immediate decrease in stock prices if the stock market efficiently capitalizes the cash flow implications of the oil price increase. If the stock market is not efficient, there may be a lag in the adjustment to oil price changes (Valdés, Vázquez and Fraire, 2012).

As such, policy makers, international institutions, politicians and investors have expressed concern about the volatile nature of oil price and its possible detrimental consequences on the aggregate economy. Consequently, researchers have become increasingly interested in understanding the nature of the linkage between oil price volatility and macroeconomic performance (Aye, 2015).Again, much of the extantliterature has focused on the effects of oil price changes on stock market returns. Current evidence suggests that oil price changes are associated with fluctuations in stock prices, although the results are mixed (Degiannakis, Filis and Floros, 2013).And as shown by Arouri and Nguyen (2010) and Arouri, Bellala and Nguyen (2011), various transmission channels exist through which oil price fluctuations may affect stock returns. The value of stock in theory equals discounted sum of expected future cash-flows. These discounted cash-flows reflect economic conditions and macroeconomic events that are likely to be influenced by oil shocks. Accordingly, oil price changes may affect stock returns.

Meanwhile, Broadstock, Cao and Zhang (2012) provided an insight into how this channel may likely take place in an oil importing country. The mechanism by which the effect of oil price shocks is transmitted can be summarized asfollows: higher oil prices increase the cost of production for companies that directly or indirectly require oil as an input; assuming that firms will not fully transfer rising costs onto their customers/investors, profits will inevitably shrink hence reducing expected returns. Therefore, the consequence of an oil shock upon the stock market will in general be negative. Another indirect mechanism by which oil prices affect stock values comes from the stylized fact that an increase in oil prices pushes up overall inflation. This can cause central banks to respond by raising the interest rate, which will in turn affect stock prices.

Oil Price Volatility