ANALYSIS OF THE PRICE AND INCOME ELASTICITIES OF ENERGY DEMAND IN NIGERIA. (1980-2019)

ABSTRACT

 

This study estimated price and income elasticities of energy demand in Nigeria. The objective of the study was to examine the responsiveness of demand for energy to changes in price of energy and per capita income in Nigeria. The demand for petroleum product (gasoline and diesel), proxy for energy demand is the dependent variable, while weighed average price for energy demand and per capita income are the independent variable. The study adopted regression analysis and vector error correction model to dichotomize the short run and long run in price and income of energy demand in Nigeria, using annual time series data over a period of 1980-2019. The cointegration test revealed that there is significant long run relationship between energy demand, price and per capita income. the result of regression analysis showed that the price and income elasticity of energy demand are moderately inelastic in the short run while the long run elasticities indicate that price and income responsiveness to demand are relatively elastic. The policy implication is that demand side management, through price change will be ineffective in influencing the demand for energy in short run. Therefore, any policy effort on the part of government to manage energy demand should focus on supply side and long term policy impact on the aggregate economy that has the potential of affecting the overall economic activity and aggregate income.

CHAPTER 1: INTRODUCTION

1.1 BACKGROUND OF THE STUDY

The Nigeria’s economic policies and growth have been influenced by energy sector for more than four decades, particularly, the oil and gas sector. Since the global energy crisis of 1972/73, the energy sector, particularly the petroleum subsector of the Nigerian economy has become the most important source of revenue and foreign exchange earnings. Although, crude oil production and export commenced in Nigeria in 1958, the oil sector of the economy did not achieve its present pre-eminent position until the mid-1970s, a rise aided by rising national production level and the hike in international price resulting from 1973 Arab-Israel war. The period of 1970 to 1980 represent Nigeria’s oil boom era in term of production, export and earnings. Peak production in the boom era was achieved in 1979 with a yearly production of 845.463 billion barrel representing an average daily production of 2.3bpd (CBN, 2008). In view of the strategic nature of the petroleum industry as the predominant source of global energy, it has become a prime source of revenue generation to many countries, particularly in Nigeria. The oil sector contribution to Gross Domestic Product (GDP) at current basic prices was as low as 0.9 percent of GDP in 1961. With increase in exploration and production related activities consequent on the boom of the 1970s, the sector contribution to GDP has risen to 28.48 percent by 1980. The slump in world price of crudeoil and the bust created dampened growth in the Nigerian oil sector throughout the 1980s. The industry contribution to Nigeria GDP commenced its impressive recovery from 1989 fiscal year. Its contribution to GDP increased to 37.46 percent in 1990. The sector continued its impressive performance throughout the 1990s such that by the year 2000, its percentage contribution stood at

47.72percent.

Similarly, oil export to total export was 2.3 percent as at 1960, this rose to 92.6 percent in 2010. Nigeria recorded total export revenue of $10.4 billion in 2019, the highest since 2008 which is farthest we can trace the country’s export data. According to the data from the CBN, total exports

(Free on Board “FOB”) in 2019 was $64.9 billion. Thus for the first time ever, oil revenue as a percentage of total exports fell to 83.9% as against over 90% in previous years.

Latest data from the National Bureau of Statistics (NBS) has showed Nigeria’s crude oil exports which still cover a huge chunk of Nigeria’s total export of 85.6 per cent recorded an increase in the second quarter of 2019 of 16.5 percent compared to the corresponding period last year. This implies that Nigerian economy is still reliant on crude oil for foreign exchange earnings and by extension government revenue. According to the latest data from the state’s statistical agency, Nigeria recorded a total crude oil export of N3.9 trillion in Q2 2019 which was 16.5 percent higher than Q2 2018 and 4.40 percent higher than in Q2 2018.Further, breakdown revealed in April 2019

Nigeria’s total crude oil export was valued at N1.3 trillion, while in May and June the country recorded N1.2 trillion and N1.2 trillion respectively.

As impressive as the growth in Nigeria’s production and export of crude oil might be, Nigeria’s foreign trade record shows that petroleum products import out of national import has continued to rise over the years due to poor state of her refineries. Nigerian petroleum sector is the engine room of growth that drives the entire Nigerian economy and society (Iwayemi, 2001); however, the legacy of oil has also imposed economic costs on the economy such as price distortions, volatilities, Dutch disease, corruption and inefficiencies.

The demand for petroleum products in Nigeria (especially the PMS and Diesel) has been on the rise since the early 70’s when the golden water was first discovered in commercial quantities

(Iwayemi, Adenikinju, and Babatunde, 2010). This continuous rise has been due largely to (not until recently), the price of petroleum products which have been heavily subsidies in order to achieve some national objectives, as well as to protect the domestic consumers  from the stochastic nature of the international crude oil market. The growth of GDP per capita as a result of the oil boom is another major factor that has contributed to the rise in the domestic demand of petroleum products. Industrial expansion through the influx of foreign direct investment has resulted in demand for energy, increase in demand for vehicles has also resulted in increase in demand for fuel, the epileptic nature of electric power has also increases the demand for private household generator, as well as for firm which has also heighten the demand for petroleum products. Lastly, the ever growing population and extension the adult population has also contributed to the increase in demand for petroleum products in Nigeria.  In spite of the huge market presence of the country in the world oil market, the country still sometimes struggle to meet domestic demand for petroleum.

Nigeria’s economic policies and growth have been influenced by energy sector for more than four decades now, particularly the oil sector. Hence, the government usually determines the price point of all petroleum products which over the past years since the 1970’s caused an inconsistent upward adjustment by different political administration. With such substantial dependence on gasoline as a contribution in the production process, a significant proportion of firms earning which in any case would have been diverted into investment is utilized to meet energy shortage in the form of the demand for gasoline. In this manner, the extensive use of gasoline makes the various sectors of the economy inclined to unexpected price increase in gasoline. The demand for petroleum products in Nigeria (especially the PMS and Diesel) has been on the rise for nearly over a quarter of a century ago. It is against this bourgeoning demand that this study investigates the demand for petroleum products in Nigeria. The study employed the Error Correction Model to examine both the short and long dynamics of petroleum in Nigeria. The study therefore found that price and income elasticity of demand for petroleum product have long run impact on the energy demand in Nigeria. Although, there are short run fluctuations, the impact of the elasticities on energy demand does not exist in the short run Therefore, this study seek to critically examine of impact of the short run and long run elasticities of petroleum demand in Nigeria.

1.2 STATEMENT OF RESEARCH PROBLEM

The attention on oil demand studies has increased since the first oil price shocks of early 1970s, with a focus to generating accurate demand parameters for planning, projections and policy formulation. According to the study by Aigbedion and Iyayi (2007), Nigeria’s extreme reliance on the crude oil market has triggered structural difficulties for the economy, as earnings from crude oil fluctuate along with market trends which are exacerbated by the country’s neglect of other productive sectors of the economy. The dynamics of the petroleum sector in the Nigerian economy has made the study of the demand for petroleum products in the country highly imperative (Sulaimon Said, 2009; Iwayemi et al, 2010). This makes the knowledge highly fundamental for a more informed and effective understanding in energy policies in production and distribution of petroleum products.

Nigerian petroleum sector has been established as the major driver of growth in the entire Nigerian economy and society (Iwayemi, 2001). However, the heirloom of oil has also inflicted several economic costs such as price distortions, volatilities, Dutch disease, corruption and inefficiencies. Price fixing of energy products has been one of the major impairment to the development of energy sector, as there is a lack of incentive to encourage private individuals to participate and invest in this sector. Iwayemi, et al. (2007) has also identified the importance of understanding the energy industry dynamics in the design of policies for dealing with the negative environment side-effects of the energy sector. Also, better understanding of the energy demand dynamic will is essential for more informed and successful energy policy decision making and implementation (Iwayemi, et 2007). Evaluating the short- and long-run amendments to energy price changes requires careful consideration of the energy consumption decisions, and past research has emphasized that the nature of the oil price change may be as important as its magnitude hence the need to have a full understanding of the elasticity dynamics. Also, some studies assumed that demand change is in a long run equilibrium based their use of static models for their analysis. However, the model does not factor the impacts of price and income shock lingering for more than a period, and causing adjustment lags in demands. This results in a discord on the short run and long run elasticites in the estimation of price and income that will be addressed in this study. Various studies on the demand for petroleum product, specifically gasoline consumption have mostly focused on developed countries like the United States and other advanced economics. This study therefore is an attempt to fill this vacuum in the literature. The study attempts to model short-run and long run price and income elasticities of demand of energy in Nigeria.

1.3 OBJECTIVES OF THE STUDY

The aim of this study is to analyze the short-run and long-run elasticity of energy demand in Nigeria. The specific objectives are to determine:

1. To investigate whether there is a long-run relationship between energy demand and prices and income.
2. To examine the short run and long effect of energy price on energy demand.
3. To examine short run and long run effect of income on energy demand.

 

1.4 RESEARCH QUESTIONS

The following research questions are raised to guide the study:

1. Is there a long run relationship between energy demand, price and income?
2. What is the short and long run effect of energy price on demand for energy?
3. What is the short and long run effect of per capita income on demand for energy?

1.5 HYPOTHESES OF THE STUDY

Based on the above objectives, the following hypotheses (Ho) are formulated in null form to guide the study.

H₁ There is no significant long run relationship between energy demand, price and income.

H₂ There is no significant short run or long run effect of energy price on energy demand

H₃ There is no significant short run or long run effect of per capita income on demand for energy.

1.6 SCOPE AND LIMITATION OF THE STUDY

This research covers the analysis of the short run and long run elasticity of petroleum/gasoline demand in Nigeria. The study covers the period of forty (40) years from 1980 – 2019. The dependent variable is gross domestic product (GDP) used as a proxy for Nigeria economic growth while the independent variables are: oil revenue used as a proxy for petroleum/gasoline demand.

As it is expected with written work of this kind, the completion of this project would not be possible without limitation or problems encounter in the course of writing this project which includes difficulties in obtaining relevant and up-to-date, data due to poor nature of Nigeria’s data collection and storage facilities, The first of such constraints or difficulties concerns data collection from different sources. Also was the reluctance of some library or Liberians to make data available.

The above-mentioned constraints are capable of adversely affecting the accuracy of the results of this research work. 

1.7 SIGNIFICANCE OF THE STUDY

The significant of this study is very important in much respect. Moreover, the oil sector is a key player in the Nigeria economy. In that regard anything that affects it in variable touches every sector.  Therefore, to the manufactures, it’s of great interest to know possible solution to the persistent and intermittent supply of the petroleum products as a means of enhancing their capacity utilization profit level output.

Thus, the significance of this study cannot be overestimated, first and foremost, the research work will be useful to Nigerian policy makers by assisting them in understanding clearly the impact of policies made on crude oil revenue on standard of living of the common man. Secondly, this research work on completion could assist students of related discipline in their course of study. Also, this study did not only add to the available literature on the research topic but also contributed to an area of study that has been scantily visited by scholars. This research work also has constituted a reference material to policy makers and prospective researchers who will be interested in topics related to this research work and hence would stimulate deep and fresh ideas, practically relevant to help key stakeholders enhance the management of oil revenue for the achievement of real economic growth and development in Nigeria. Nevertheless, this study will throw more light on the role which the crude oil plays in the reformation of the Nigerian economy.

1.8 DEFINITION OF KEY CONCEPTS

Economic growth: Thisis the increase in the inflation-adjusted market value of the goods and services produced by an economy over time. It is conventionally measured as the percent rate of increase in real gross domestic product, or real GDP.

Oil sector: This is also known as the oil industry or the oil patch, includes the global processes of exploration, extraction, refining, transporting, and marketing of petroleum products. The largest volume products of the industry are fuel oil and gasoline.

Oil Price Volatility:  This is the measure of the tendency of oil price to rise or fall sharply within a period of time, such as a day, a month or a year. Lee (1998) as cited in Mgbame, Donwa and Onyeokweni (2015) defines volatility as the standard deviation in a given period and noted that volatility has a negative and significant impact on economic growth instantly, while the impact of oil price changes delays until a year.

Non-oil revenue: This is the income or proceeds generated from the commodities that are sold in the international market excluding crude oil (petroleum product). Non-oil exports on the other hand are those commodities (excluding crude oil) that are sold abroad in order to generate revenue. These non-oil exports include agricultural products or crops, manufactured goods, tourist services/receipts, solid minerals, telecommunication services and other exports.

Gross Domestic Product: This implies the market value of all officially recognized final goods and services produced within a country in a given period. GDP per capita is often considered as an indicator of a country’s standard of living. GDP is related to national account, a subject in macroeconomics. It is customarily reported on an annual basis. It is defined to include all final goods and services, that is, those that are produced by economics resources located in that nation regardless of their ownership and are not resold in form.

Inflation is defined as a generalized increase in the level of price sustained over a long period in an economy. It is a rise in the general level of prices of goods and services in an economy over a period of time.

Exchange rate: An exchange rate (also known as foreign exchange rate) between two currencies is the rate at which one currency will be exchanged for another. It is regarded as the value of one country’s currency in terms of another currency. Exchange rates are determined in the foreign exchange market, which is open to a wide range of different types of buyers and sellers where currency trading is continuous.

Non-oil export: These include the exportation of the non-oil produces among which are agricultural, industrial and manufacturing outputs.

Non-oil export index: This is the fraction of the total export of goods and services that are produced within the economy that are not directly related to the oil sector of the economy. The non-oil products exports are unlimited as they include cash crops, food crops, manufacturing, entertainment, tourism etc. the value of the non-oil export index shall be used for measuring the non-oil export.

1 .9 RESEARCH OUTLINE

This research is presented in five chapters.  Chapter one consists of the background of the study, statement of the problem, research questions, research objectives, hypotheses of the study, scope of the study, significance of the study, theoretical framework and organization of the study.  Chapter two holds the review of related literature which includes conceptual issues, and empirical literature. Chapter three is the methodology of the study. Chapter four will focus on data presentation, data analysis and interpretation of results. Chapter five will summarize the major findings and presents the conclusion and recommendations.

ANALYSIS OF THE PRICE AND INCOME ELASTICITIES OF ENERGY DEMAND IN NIGERIA. (1980-2019)

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