The aim of this research is to identify how OPEC oil prices are affecting the economy of the US. First of all we will do a time series regression analysis to see the impact of OPEC oil prices on the economic growth as well as energy prices of the US over time. As an indicator of the economic growth we will take the GDP percent growth annually. After understanding the relationships, we will conduct analysis to see the relationship of the economic indexes in the US, how they behave, and whether there is a change of the behavior related to OPEC oil price changes. We will do Granger causality test between the internal economic indexes and GDP growth. (needs more work, will write according to findings in lit review)
Background and literature
The recent sharp changes in oil prices put under doubt the common accepted belief that low oil prices are good for US and global economies. In their paper, Mohaddes et al.\cite{Mohaddes_2016} used a quarterly multi-country econometric model, and showed that a fall in oil prices lowers interest rates and inflation in most countries, and increases global real equity prices. Moreover, they found positive relationship between equity and oil prices . In contrast, there was a stable negative relationship between oil prices, dividends and monthly real activity measures such as industrial production. For their analysis they used Global VAR model.
Ratti and Vespignani \cite{Ratti_2015} in their paper analysed the behavior of OPEC and non-OPEC oil production over 1974 to 2012. As an analysis model is taken SVAR constructed with quarterly data with the following variables: OPEC oil production (OOPt), non-OPEC oil production (NOOPt), purchase power parity measure of global GDP in U.S. dollars (GGDPt) and oil prices (OPt). Both, oil prices and global GDP (PPP) in U.S. dollars are deflated by the U.S. GDP deflator. As a classification for years, Hamilton's definition has been used: from 1973 to 1996 as “the age of OPEC” and 1997 to the present as “a new industrial age.” They reveal that the logs of OPEC oil production, non-OPEC oil production, real global GDP and real oil price are first difference stationary. They found, that during “the age of OPEC”, growth in non-OPEC oil production Granger causes growth in OPEC oil production while growth in OPEC oil production does not Granger cause growth in non-OPEC oil production. During the new industrial age, growth in OPEC oil production does not Granger cause growth in non-OPEC oil production and growth in non-OPEC oil production does not Granger cause growth in OPEC oil production. Also, structural shocks to growth in non-OPEC oil production make a large cumulative contribution to growth in OPEC oil production. However, the reverse does not hold. Consistent with the results from the SVAR analysis, authors used a new econometric prediction technique, which suggests that during the “the age of OPEC”, growth in OPEC oil production can be predicted by growth in non-OPEC oil production and growth in global economic growth, and that during the “new industrial age” period, growth in OPEC oil production can be predicted by change in real oil prices and growth in global GDP.
In his work, K. Gupta \cite{Gupta_2016} analysed the effect of country-level determinants, competition, and asymmetrical relationship in affecting the oil & gas stock return at the firm-level. A comprehensive firm-level monthly data was used in the analysis from 70 countries spanning 1983 to 2014. The findings showed, that first of all, macroeconomic stress negatively impacts firm-level returns, but on the other hand, oil price shocks positively impact firm-level returns . Moreover, firms located in high oil producing countries are more sensitive to global uncertainty and oil price shocks in contrast the firms which are located in non-competitive industries are less sensitive to oil price shocks. And last but not least, firms located in non-competitive industries are less affected by the drop in oil price, as compared to firms that are located in highly competitive industries.
Adjaye\cite{Asafu_Adjaye_2000} estimated the causal relationships between energy consumption and income for India, Indonesia, the Philippines and Thailand, using co-integration and error-correction modelling techniques. The modelling strategy adopted in the paper, is based on Engle-Granger methodology. Maximum likelihood procedures had been used to analyse the time series properties of the variables and error-correction models were estimated and used to test for the direction of Granger causality. The findings showed that there is an unidirectional Granger causality from energy to income for India and Indonesia, while bidirectional Granger causality exists from energy to income for Thailand and the Philippines. In the long time periods, there is unidirectional Granger causality running from energy and prices to income for India and Indonesia. However, in the case of Thailand and the Philippines, energy, income and prices are mutually causal. Price effects are relatively less significant in the causal chain. The results of this study do not support the view that energy and income are neutral with respect to each other, with the exception of Indonesia and India where neutrality is observed in the short run. As a conclusion, author suggests several policy implications. As high level economic growth leads to high level of energy demand and vice versa, it is suggested to implement policies controlling energy demand. It can be achieved through an appropriate mix of energy taxes and subsidies. Meanwhile, industry should be encouraged to adopt technologies, which minimizes pollution.
An interesting research has been conducted by Cologni and Manera \cite{Cologni_2008} in order to analyze the direct effects of oil price shocks on output and prices, and the reaction of monetary variables to external shocks in the G-7 countries. They used co-integrated VAR model for their studies. The indicators considered in the analysis are interest rates, price index, gross domestic product, money aggregate and exchange rates for each country on one hand, and crude oil prices over time on the other hand. The results sowed, that a stationary money demand can be identified for most countries. Moreover, according to the estimated coefficients of the structural part of the model, for all countries except Japan and U.K. the null hypothesis of an influence of oil prices on the inflation rate cannot be rejected. The real economy is affected by inflation rate shocks by increasing interest rates. Based on the impulse response analysis, they found out that for most countries exists a rapid, temporary effect of oil price innovations on prices. The impulse response functions indicated different monetary policy reactions to inflationary and growth shocks and the simulation exercises directed to estimate the total impact of the 1990 oil price shock, that indicates that for some countries such as US, a significant part of the effects of the oil price shock is due to the monetary policy reaction function. On the other hand, for other countries such as Canada, France and Italy, the total impact is offset, at least partly, by an easing of monetary conditions.
Since the oil crisis in 1970s, a remarkable question had been raised: how oil production shortfalls caused by wars and other exogenous political events in OPEC countries affect oil prices, U.S. real GDP growth, and U.S. CPI inflation. The paper of Kilian\cite{Kilian_2008} focused on the modern OPEC period of the oil market starting from 1973 (to be continued).
Another research of Kilian and Barsky \cite{Barsky_2004}, has been reviewed the arguments that oil prices spikes are responsible for recession, inflations and other economic fluctuations in US. According to the paper, there is a believe, that exogenous political events in the Middle East cause recessions in industrialized countries and affect on the prices of oil, hence there is close statistical relationship between political event in Middle east and recession in the US. Oil price shocks is believed to cause inflation and increase unemployment rate. Authors try to trace weather these beliefs are strong enough. They challenge the notation, that at least the major oil price movements can be viewed as exogenous with respect to US macroeconomy. Moreover, they explore and explain, that despite the common believe, that only oil price shocks can explain US stagflation in 1970s, is not the case. Their analysis is based on other researches and historical event graphical analysis, and as a conclusion they argue, that the effect of the political events in Middle east effect on US economy is indirect, and the response of the economy is not always immediate. Moreover, they confirm, that sharp increases of oil price may come even if there is no major event happening in the Middle East.
(Esra, you can add the paper you are going to present here)
There are many interpretations about the nature of of the Organization of Petroleum Exporting Countries (OPEC) and its influence on world oil markets which go from claiming that OPEC plays no role or a very limited role to playing the price-setter role (Fattouh, 2007). Some important observations are essential to understanding OPEC behavior: OPEC’s pricing power is not constant, but varies over time; this change in pricing power is induced by market conditions and can occur both in weak and tight market conditions; pursuing output polices has become more complicated with the growing importance of the futures market in the process of oil price discovery; long-term investment plans can have important implications for OPEC’s continuing pricing power. Although there is plenty of room for OPEC to influence the oil price in the current oil pricing system, this influence is not unconstrained. Fattouh argues that the recent changes in the international oil pricing system have diminished OPEC pricing power, especially when compared to the previous administered oil pricing system. The economic factors are the strongest, but the political ones should not be ignored. In general every pricing systems reflect the balance of political power of the time and this balance can have an impact on OPEC behavior. It has been argued that Saudi Arabia (considered to have gained the predominant role in OPEC) and the USA might have influenced the decline in oil prices in 1986 in order to undermine the financial position of the USSR.
Fattouh B., “OPEC Pricing Power: the Need for a New Perspective”, Oxford Institute for Energy Studies. WPM 31. March 2007.