Effect of Oil Price Volatility on Economic Performance

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CHAPTER 2: FOUNDATION OF THE STUDY

History of the Oil Market

Between the late 1930 and the late 1960s the Texas Railroad commission (TRC) acted as the dominant producer by prorationing Texas production to match demand.This reduced volatility of the real oil price (Dees et al., 2007). Starting from the early 1970s Organisation for Petroleum exporting countries (OPEC) became the dominant oil producer. OPEC had a different model hinged on the fundamentals of Cartel in which it is a price maker and a competitive model in which it is a price taker. These behaviours brought about oil price volatility in the market. This coupled with geopolitical and economic situations contributed immensely to the oil price volatility. Since the 1980s, there has been a marked shift in power from OPEC to the oil market. The oil markets became the new determinants of oil price. The historical circumstances that led to the shift in pricing power are the US decision in 1981 to deregulate state control over the oil industry. Soon other industrialised countries followed suit. Once oil consuming states had deregulated control over oil supply and oil imports, oil exporting states were forced to cede oil pricing to the oil market (Momani, 2008). This was coupled with the fact that the OPEC‟s share of world oil production was nearly halfed as smaller and new competitors entered the production market. In response to the new regulatory environment and exploration developments of the late 1980s, two oil markets were created (ibid): the British North Sea Brent Crude (Brent) – traded on London International Petroleum exchange (IPE) until 2005 and thereafter on London‟s Intercontinental Exchange and
 the US gulf crude – traded on the West Texas Intermediate (WTI) operating out of the New York Stock Exchange (NYSE).
Oil companies now had three means of purchasing oil:
 a bilateral contract with oil exporting country
 on the spot or a cash market
 a futures contract at oil markets.
Oil market soon became the primary means of oil trade and hence these oil markets became the new “oil markers”. Since the bilateral contract with oil exporting country is less affected by market dynamics such as oil price volatility, it is not discussed
further.

Oil Price Volatility

Oil price volatility is the amount of uncertainty or risk about the size of changes in oil price. A higher volatility means that oil price can potentially be spread out over a large range of values. A lower volatility means that the oil price does not fluctuate dramatically but changes in value at a steady pace over a period of time. Volatility can be measured using the standard deviation or the variance of the oil price. Therefore, volatility can be considered as a measure of risk. As in a portfolio of stocks, the relative volatility of the stock is measured by the beta of that stock. That is the risk contribution of an individual stock to the overall risk of the portfolio.The volatility of oil prices creates uncertainty which is disruptive to the economies of both oil exporting and importing countries. Higher prices result in an increase in inflation and subsequent recession in oil consuming nations as high oil prices are negatively correlated to economic activities (Yang et al., 2002; Guo and Kliesen, 2005 and Mork et al., 1994). Oil price increases lower the economic growth in oil importing countries because it increases the production costs. In addition to this, aggregate output is adversely affected as businesses delay their investment or reallocate their resources to sectors which have a certain degree of certainty. This is termed sectoral resources reallocation. The same negative effect can be observed in oil exporting countries since the high oil price raise the cost of imported capital goods therefore, adversely affecting the prospects of higher profits for firms in oil exporting countries.

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ACKNOWLEDGEMENTS
ABSTRACT
Chapter 1: Research Orientation
1.1 Introduction
1.2 Problem Statement
1.2.1 Subproblems
1.3 The delimitations
1.4 Limitations
1.5 Definitions of terms
1.6 The assumptions
1.7 The importance of the study
1.8 Background
1.8.1 Oil Price Volatility
1.8.2 Currency Volatility
1.8.3 Oil and gas stocks
1.9 Data and its treatment
1.9.1 Research Methodology
1.10 Ethics
1.11 Summary
Chapter 2: Foundation of the Study
2.1 History of the Oil Market
2.2 Oil Price Volatility
2.3 Models for Forecasting Oil Price Volatility
2.3.1 Constant Volatility Models
2.3.2 Historical/Rolling Window Moving Average Models
2.3.3 Implied Volatility Models
2.3.4 Exponentially Weighted Moving Average
2.3.5 Autoregressive Volatility Models
2.4 Effect of Oil Price Volatility on Economic Performance
2.5 Currency Exchange Volatility (R/$)
2.5.1 Determinants of South African Exchange rate
2.6 Oil and Gas Companies Stocks
2.7 Summary.
Chapter 3: Literature Review
3.1 Oil Price Volatility
3.2 Oil Price vs. Currency
3.3 Oil Price Volatility and the Macroeconomy
3.4 Oil Price Volatility and Oil and Gas companies stocks
3.5 Summary
Chapter 4: Research Methodology
4.1 Problem Statement
4.1.1 Sub-Problems
4.2 Methodology.
4.3 Data
4.4 Summary
Chapter 5: Research Results and discussion
5.1 Oil Price
5.1.1 Oil Price Return
5.2 OIL Price Volatility
5.3 Rand Dollar Exchange
5.4 Rand Dollar Exchange and Oil Price
5.5 Oil and Gas Companies
5.6 Summary
Chapter 6: Conclusions and recommendations
6.1 Summary
List of Reference