Oil price fluctuations and its effect on GDP growthA case study of China and Germany

Bachelor Thesisto graduate from the School of Business and Social Sciences of the

Århus University, Denmark

Author: Academic supervisor:Christopher Dirzka Dr. Habil Peter Kesting

Matriculation number: Word count: 201208062 99.780

Århus, 04th May 2015

Abstract

Since the 1980s when economists and government leaders understood the potential and threat of oil dependence, the research field dramatically expanded. The fact that rising oil prices have adverse effects on macroeconomic activity, has become widely accepted due to James D. Hamilton’s article ”Oil and the Macroeconomy since World War II” in 1983.

Many others confirmed his results, however changes to the oil market also affected the focus of research, in the sense that not only the price levels had an effect on the GDP growth, but price volatility as well.

To give a perception; an increase 10% in oil prices, which is according to the WTI spot price per barrel from the 30th March 2015 - 4.86$, might decrease the GDP growth by 0.6% (Hooker, 1996), in relation to the U.S. GDP a potential loss would be between tens and even hundreds of billion dollar.

Moreover, several researchers found evidence that oil prices also affect a wide range of economic factors, such as employment, interest rate, stock markets, inflation- and exchange rates.

Yet the exact correlation between oil price fluctuations and GDP growth for a particular country remains controversial.

The author chooses to analyse the relationship between GDP growth and oil price fluctuations, via a bivariate analysis for the time 2000, 1st quarter to 2015, 1st quarter.

Germany and China, where chosen to exemplify this relationship. The backbone of both economies is the export of production goods; this implies a sizeable transportation sector, especially road transportation, which is fuelled by petroleum.

In the observation period, both GDPs grew, yet the oil consumption declined in Germany, while China’s GDP increased proportional with the consumption.

The analysis indicates that Germany’s and China’s GDP are correlated to each other and that the relationship in the third quarter after the change is negative and statically significant for Germany, however China’s GDP and the oil price fluctuations are positive directly linked without any lag.

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Table of Content.......................................................................................................................3

1 Introduction...........................................................................................................................5

1.1 Introduction to the subject .......................................................................................51.2 Problem statement and research questions ..........................................................71.3

Purpose........................................................................................................................81.4

Delimitations ...............................................................................................................81.5

Method........................................................................................................................91.6 Structure of the thesis ................................................................................................9

2 Background.........................................................................................................................10

2.1 Oil Price History..........................................................................................................112.1.1 History Overview........................................................................................................112.1.2 Pre-Embargo Period.................................................................................................122.1.3 Middle East Crisis.......................................................................................................132.1.4 Role of the OPEC 1980 - 2000..................................................................................142.1.5 After 11th September 2011.......................................................................................152.1.6 Oversupply in 2014-2015..........................................................................................172.1.7 Sub – Conclusion......................................................................................................18

3 Oil price and economical activity....................................................................................19

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3.1 Literature Review......................................................................................................203.1.1 Models in relation to the GDP and employment..................................................203.1.2 Models in relation to the stock market...................................................................223.1.3 Literature Summary...................................................................................................233.2 Correlation economy and oil prices.......................................................................233.3 Oil Price Increase......................................................................................................243.3.1 Impact of an oil price increase on exporting countries.......................................243.3.2 Impact of an oil price increase on importing countries.......................................253.3.3 Stock market and exchange rate..........................................................................26

4 Cases study Germany and China....................................................................................28

4.1

Germany....................................................................................................................284.2

China..........................................................................................................................30

5. Analysis...............................................................................................................................33

5.1 Data background.....................................................................................................345.2 Descriptive Analysis...................................................................................................345.3 Spearman's rank-order correlation.........................................................................35

6 Conclusion...........................................................................................................................35

7 References...........................................................................................................................36

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7.1 Summary Figures Reference....................................................................................437.2 Summary Appendix Reference...............................................................................46

8 Appendix.............................................................................................................................47

Figures

Figure°1 BP Review: World consumption...............................................................................6Figrue°2 Purpose: Link between oil price and GDP.............................................................8Figure°3 Structure of the Thesis...............................................................................................9Figure°4 Structure of the Chapter 2.....................................................................................10Figure°5 Average Historic Oil prices per barrel from 1861 to 2013...................................11Figure°6 Average Oil prices per barrel from 1946 to 1972................................................12Figure°7 Average Oil prices per barrel from 1972 to 1983................................................13Figure°8 Average Oil prices per barrel from 1980 to 2000................................................14Figure°9 Total Oil Supply (Thousand Barrels Per Day) from 1980 to 2004.........................15Figure°10 Average Oil prices per barrel from 1999 to 2013..............................................16Figure°11 Total Oil Supply (Thousand Barrels Per Day) from 1999 to 2013.......................16Figure°12 Oil prices per barrel – Benchmark WTI & Brent from 2011 to 2015...................17Figure°13 Recessions in the U.S. from 1970 to 2012............................................................18Figure°14 Structure of the Chapter 3...................................................................................19Figure°15 Worldwide GDP vs. Oil price per barrel in international real 2010$................23Figure°16 Oil price increase in relation to oil exporting nations.......................................25Figure°17 Oil price increase in relation to oil importing nations.......................................25Figure°18 Total Primary Energy Supply of Germany in 2010 (Mtoe).................................28Figure°19 German Production vs. Consumption from 1991 to 2013................................28

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Figure°20 German GDP vs. Total Oil Consumption from 1991 to 2013............................29Figure°21 Total Primary Energy Supply of China in 2011....................................................30Figure°22 Chinese Production vs. Consumption and Ratio from 1987 to 2013...............31Figure°23 Chinese GDP vs. Oil Consumption from 1991 to 2013......................................32

SPSS

Figure°24 Frequency Test Germany and China.................................................................34Figure°25 Spearman's rank-order correlation.....................................................................35

Appendix

Appendix I: Production & Consumption by region............................................................47Appendix II: World consumption by energy source..........................................................47Appendix III: Histogram German_GDP_Growth.................................................................48Appendix IV: Histogram China_GDP_Growth....................................................................48Appendix V: Descriptive Statistics Germany......................................................................49Appendix VI: Descriptive Statistics China............................................................................49Appendix VII: Descriptive Statistics WTI Spot Price.............................................................49

1 Introduction

This chapter provides for the reader a basic overview of existing studies in relation to macroeconomic consequences of oil price fluctuations and GDP growth.

It also contains the problem statement with the research questions, which this paper aims to answer in the consecutive sections. Some boundaries are acknowledged in delimitations section and lastly the structure of the thesis is presented.

1.1 Introduction to the subject

“By the fall of 1918, it was clear that a nation's prosperity, even its very survival, depended on securing a safe, abundant supply of cheap oil.” - Albert Marrin, Chairman of the History Department at New York's Yeshiva University (2012)

In his book - Black Gold: The Story of Oil in Our Lives, published in 2013 he outlines the significance of oil for the being of our humanity in the 20th and 21st

century.

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The usage of crude oil is not delimited to fuel vehicles / airplanes; it also can be transformed into heat and components of it are used in almost all chemical products. Until the availability of a more efficient resource, crude oil will shape humanities further development. (http://www.wintershall.com/en/company/oil-and-gas/oil-can-do-more.html)

For instance, the thirteen of the thirty biggest companies in relation to their revenue, are oil & gas producers. (http://fortune.com/global500/.)

The history of dependence could be determined by the invention of the four-stroke combustion cycle by the German engineer Nikolaus Otto in 1867. He created the first internal combustion engine that compressed the fuel mixture prior to combustion for higher efficiency. At the time of creation, it was superior to any other engine. Currently almost all vehicles, which run on any form of crude oil, use this particular combustion engine, called Otto cycle. (Grenning, 1991)

Due to the appearance of renewable energy sources, such as wind, water, and solar power and higher efficiency of combustion engines, the importance of crude oil as the main source of energy has been diminished. Nonetheless, the significance of oil exceeds economic aspects and affects social life in general.

Oil represents one of the most important macroeconomic factors for the world economy; thusly the crude oil market is the largest commodity market in the world. According to the Energy Information Administration (EIA) Global economic performance remains to this the day highly correlated to oil prices. (http://www.eia.gov/finance/markets/demand-nonoecd.cfm)

According to the IEA Research Paper, by R. Sauter and S. Awerbuch (2003), crude oil differentiate itself from any other commodities, due to its nature to affect the GDP of a country asymmetrically. Oil price increase and decrease do not have the same overall impacts. (Mork, 1989) Moreover, when the price of oil per barrel increases, oil-exporting countries can accumulate higher revenues, on the other hand importing countries generally suffer due to higher prices. Thusly this effect is also visible in reverse, when prices decrease.

The Journal of Political Economy published the article, “Oil and the Macroeconomy since World War II” by J. D. Hamilton (1983), which is seen by many scholars as the keystone of Oil & GDP research.

Hamilton demonstrated that the historical correlation between oil price increase and economic downturns were no coincidence. In the time period from 1948 – 1980, his results showed that after an increase in oil price, 3 to 4 quarters later the economic growth decreased, which was followed by a recovery beginning after 6 to 7 quarters.

Thusly most post WW2 recessions were preceded by a sharp increase in oil price (Guo & Kliesen, 2005), due to simultaneous rising production costs. Moreover the price fluctuation in itself creates uncertainty of risk, which will delay investments and trigger higher unemployment. (Sauter & Awerbuch, 2003)

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To understand the vital importance of oil for the world economy and our everyday life, the following figure°1 from the BP Statistical Review of World Energy 2014, shows that nearly 30% of the worldwide energy consumption relies on crude oil.

Figure°1 BP Review: World consumption

The transportation sector, especially road transport, which accounted in 2012 for more than 50% of the worldwide oil demand, would suffer under higher prices. (Baroni, 2013)

In January 2000 the oil price per barrel rose from 25.56$ to 145$ in July 2008. Referring to this issue the professor of the University of California J. D. Hamilton (2014) expected that “hundred dollar oil is here to stay”; meaning that the price per barrel will remain in the future above the 100$ mark. In contrast to Hamilton’s assumption, John Kemp, Senior Market Analyst for Commodities and Energy at Reuters (http://www.rigzone.com/news/oil_gas/a/134256/Kemp_Forecasts_for_Higher_Oil_Prices_Misjudge_the_Shale_Boom/?all=HG2), forecasted a decline in oil prices due to the additional supply of oil by the shale industry.

The sky rocking prices in 2008 made the previously uneconomical hydraulic fracturing commonly referred to as fracking, for private and governmental energy agencies attractive. The U.S.A as the former main importer of oil ranks on the second place after Russia in shale oil resources and is ranked fourth globally after China, Argentina and Algeria in shale natural gas resources. (Kuuskraa. & Stevens, 2013) Subsequently, this contributed to the current oil price of 47$ in March 2015, which is the lowest level since 2009.

To sum up, inexpensive oil is a vital commodity for the major economies of the world. Moreover, it can be stated that countries with high economic activity (export / industry) and marginal access to own recourses, are significantly more affected by oil prices fluctuations than others.

For the aforementioned reasons, the case study chose to exemplify this struggle using the two major export nations: Germany and China

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1.2 Problem statement and research questions

Previous studies were concerned whether the relationship between oil prices and output, might be just be a coincidence or actual statistically significant. Following researchers rejected the hypothesis that this might be only a coincidence; Hamilton (1983, 2000, 2005), Loungani (1986), Gisser & Goodwin (1986), Mork (1989), Lee et al. (1995), Ferderer (1996), Rotemberg and Woodford (1996), Hooker (1996), Sadorsky (1999) and Ciner (2001). These studies were mostly done in relation to the economy of the United States of America, which might be explainable by the countries high oil intensity.

However in the last decade the BRIC nations (Brazil, Russia, India and China) affected the entire commodity market and shifted the primary oil demand away from the U.S. Therefrom this thesis includes China in the case study, along with Germany as the powerhouse of Europe.

Both were chosen due to their high - and industrial sector, which consumes most of the total primer energy supply. While Germany’s GDP experienced a stable growth, the oil consumption declined. On the other hand, Chinas GDP grew rapidly since the early 2000s in correlation with the oil consumption.

Questions:

What is the general relationship between oil prices and economic activity? Which factors contribute to oil price fluctuations? What is the correlation between GDP and oil price fluctuations for the

countries Germany and China in a given time period?

1.3 Purpose

The purpose of this academic work is to display in a primarily theoretical manner how the oil price fluctuations affect the economy of a country. Furthermore, the case study aims to present similarities and differences in relation to this matter.

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Oil Price (Demand and

Supply)

Previous research

(Hamilton, Awerbuch, Mork, etc)

Case-Study (Germany and

China)

Figrue°2 Purpose: Link between oil price and GDP

The outcome of this paper will help companies and the governments, to predict future risks and to construct mechanisms to prevent economic downturns due to increasing oil prices. On the practical side, this paper aims to provide information for the average customer to decide whether it is sustainable that the future transportation vehicle should run on fossil fuel.

At last, it is important to mention that the purpose of this paper is to point out the mechanisms, which influence oil prices and GDP growth, rather than offer new solutions on how to overcome the issue of dependency.

1.4 Delimitations

Nearly all researches in the field of macroeconomic activity and oil focus on the U.S. economy. However the results of these might be not universally applicable, due to the issue that every country has a specific relationship between Oil & GDP and a different geopolitical history. Factors such as oil intensity and own reserves can alter the link.

Secondly, the sources used, are in some cases out-dated, or only usable for a specific time period, the outcome is in some cases not transferable, e.g. hydraulic franking shifted the role of the U.S.A from 2008 onwards from the main oil importer to the second biggest oil producer. This reduces the overall effect from external oil price shocks, triggered in the Middle East and also changes the relationship between importing- and exporting countries.

1.5 Method

The bivariate correlation, the Spearman rank correlation method was selected to test the relationship between oil price fluctuations and GDP growth, due to the issue that all three variable sets failed the assumption to be normally distributed. The Spearman's rank-order correlation is the nonparametric version of the Pearson correlation and measures the strength of association between two ranked variables.

Furthermore based on the findings by Hamilton (1983) and Lee et. al. (1995), the analysis will include lags, its can be generally assumed that oil price fluctuations will have no immediate effect on GDP growth.

For the entire analysis the IBM SPSS statics program is used; Chapter 5 will contain the main findings of the tests and the appendix the overall output.

The model uses quarterly GDP- and the benchmark crude, West Texas Intermediate (WTI) data of the time period from 2000, 1st quarter to 2015, 1st

quarter.

1.6 Structure of the thesis

Figure°3 illustrates the structure of the thesis, which starts with the current chapter 1 – the introduction, followed by chapter 2 – background information,

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which discusses the concept of demand & supply for the crude oil market and the oil price history. The third chapter summaries the findings of previous studies in this research field; the general relationship between the economic output, the oil price fluctuations on economic growths and the asymmetry of the effects. Furthermore the fourth and fifth chapter, analyses the relationship between oil prices and the GDP from the countries; Germany and China.

Figure°3 Structure of the Thesis

2 Background

The theory of demand and supply can be considered as the keystone of a free market economy, the roots date back into the fourteenth-century century (http://www.islamic-banking.com/early-muslim-thinkers.aspx.) and was shaped by the most influential economics, such as John Locke (1691) or David Ricardo (1817).

According to the theory the market is divided into demand, for a desired product, for which the buyer is willing to pay a certain price and on the other hand the supply, which refers to the quantity the producer of the specific product can offer at a certain price. Therefore, the final market price for this product is the reflection of the demand for the goods and the supply. It can be summarized that in a free market the price of the good will vary until the equilibrium for price and quantity is met.

In the case of the commodity - crude oil, prices have the nature to reflect the demand and supply by OPEC and non-OPEC and are correlated to shortage or oversupply of the market. On the other hand, the price of crude oil is not only determined by a simple demand and supply approach, the reality is far more complex, in the sense that geostrategic-, speculative- and even cultural factors play a role.

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Oil price fluctuations and

GDP growth

Abstract Chapter 1 - Introduction

1.1 Introduction

1.2 Problem statement and

research questions

....

1.6 Structure of the thesis

Chapter 2 - Background

Chapter 3 - Oil price and Econmy

Chapter 4 - Casestudy

Case study Gemrnay and

China

Chapter 5 - Analysis

Chapter 6 - Conclusion

To finalize the introduction of the second part it is crucial to point out the difference between crude oil and petroleum; Crude oil is a “mixture of hydrocarbons that exists as a liquid in natural underground reservoirs” and Petroleum is “produced from the processing of crude oil and other liquids at petroleum refineries” (http://www.eia.gov/dnav/ng/TblDefs/ng_enr_deep_tbldef2.asp.)

The following chapter 2 displays the history of demand and supply for oil, to enable the reader to understand how the price is determined. This section is separated chronologically into the periods: before the embargo in the 1973, the crisis in the Middle East in the 1980th and finalized by the abstract of current events. In addition, this part also covers the role of the OPEC during the 80s & 90s and the current decrease of the oil price in relation to the hydraulic fracking.

Figure°4 Structure of the Chapter 2

2.1 Oil Price History

The price of oil refers to the spot price of one of the four main benchmarks: West Texas Intermediate (WTI), Brent Blend, OPEC Reference Basket and Dubai Crude. (George & Breul, 2014) These benchmarks differentiate by content and primary trading location; The West Texas Intermediate (WTI), a light crude oil, is used for New York Mercantile Exchange's oil futures contracts in North America. In contrast to the WTI, the Brent Blend is traded on the Intercontinental Exchange and is produced by oil suppliers located in the North Sea. The third major benchmark for crude oil is the Dubai crude, which is produced in the Emirate of Dubai and the Middle East. The fourth is the OPEC Reference Basket, which uses a weighted average of prices for all eleven blends produced by the OPEC countries. (Miller et. al., 2010)

The price of a barrel on the free market is correlated to its specific gravity, the sulfur concentration and the production costs, including location and production method. For example, a barrel produced in Saudi Arabia costs between 10$ - 25$ while a barrel from the North Dakota Bakken, hauled by hydraulic fracking 54$ – 79$. (Mohr, 2014)

2.1.1 History Overview

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2 Background 2.1 Oil Price history

2.1.1 History Overview

2.1.2 Pre-Embargo Period

2.1.3 Middle East Crisis

2.1.4 Role of the OPEC 1980 - 2000

2.1.5 After 11th September 2011

2.1.6 Oversupply in 2014-2015

2.1.7 Sub – Conclusion

From 1861 to 2013, the average inflation adjusted oil price, from the U.S. dollar rate of 2013 is 33.03$, only 45 of 153 (29%) recordings were higher than the average price. (http://www.bp.com/en/global/corporate/about-bp/energy-economics/statistical-review-of-world-energy/2013-in-review.html)

The lowest recorded price was 9.94$ in the year 1931, during the “Great Depression”, which lasted from 1929 to 1932, the worldwide GDP, and the oil consumption fall during this period. On the other hand, the highest price was reached in 1864 and the second highest in 2011, at around 115.22$ per barrel.

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$ money of the day $ 2013Figure°5 Average Historic Oil prices per barrel from 1861 to 2013

By separating the historical oil price data, into four time periods, 1861-1946, 1946-72, 1972-2000 and 2000-13, intense price fluctuations are visible. These fluctuations can be illustrated using the ratio of values, which are higher than the average of the given sample period and the absolute number of the samples.

The periods 1861-1946 and 1972-2000 indicate that 26% and 41% of the values are higher than the average of the particular time period, respectively. Given this fact, severe price changes were common in these times.

The following section will analyse the period after 1946 and links oil price fluctuations to historic events.

2.1.2 Pre-Embargo Period

After the Second World War the nominal crude oil price per barrel rose, from 1.12$ in 1946 to 2.48$ in 1973, translated into real 2013 dollar; 13.35$ to 13.81$.

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$ money of the day $ 2013Figure°6 Average Oil prices per barrel from 1946 to 1972

From 1961 till 1970 the nominal oil price stayed constant at 1.8$, however the inflation adjusted price decreased from 14.93$ to 10.79$.

The rescission 1960-61 in the United States of America was the only one, which was not caused by a significant increase in oil price. (Hamilton, 2011)

The decrease in oil price in 1969 to 1970 is related to the discovery of the Ekofisk oil field in December 1969 and the giant Forties Oil Field in October 1970, which are located in Norwegian and British waters, respectively. (Robelius, 2007)

Another event happened in this time period; the establishment of the OPEC, Organization of the Petroleum Exporting Countries in 1960, which included Iran, Iraq, Kuwait, Venezuela, Iraq, Kuwait and Saudi Arabia. (Trott et al., 2009) Later in 1971 Qatar, United Arab Emirates, Indonesia, Algeria, Nigeria and Libya joined the Organization of the Petroleum Exporting Countries.

2.1.3 Middle East Crisis

The nominal price per barrel in US$ was in the year 1972 at around 2.48$, this changed during the last quarter of the year 1973, initiated by the 19 days war of Yom Kippur between Israel and a coalition of mainly Islamic- and communist nations, in particular Syria and Egypt (Williams, 2011). On the 25th of October 1973, the war ended in a ceasefire and an Israeli victory. As retaliation, several Arab countries stopped their oil export towards Israel and its Western allies, including the United States of America.

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$ money of the day $ 2013Figure°7 Average Oil prices per barrel from 1972 to 1983

All together the Arab nations in the coalition produced before October 1973 approximately five million barrels per day, which vanished from the free market during the embargo, resulting in a nominal price increase from 3.29$ in 1973 to 11.58$ in 1974. (17.25$ to 54.74$ in real 2013 US$) Converted into percentage, the oil price rose from 1973 to 1974 by 252%.

The researcher J. D. Colgan from Brown University (2014), concluded that the embargo demonstrated the threat of oil dependence. In the following decades, the industrial nations diversified their supply, to overcome future shortages.

In the next four years till 1978, the oil price remained fairly stable (54.74$ to 50.09$ in real 2013 US$), due to a worldwide production increase of nearly 25%.

The years from 1978 onwards were marked by the Iranian revolution and the Iran – Iraq War, which occurred straight afterward. According to P.Ditte and Dr. P. Roell (2006) Iran lost due the collapse of the Shah regime nearly 2.0 - 2.5 million barrels per day of oil production, which doubled the oil price. Shortly after the Islamic revolution and the installation of the Ayatollah Khomeini as the country leader in February 1979, the pre-revolution oil production got restored.

Due to the invasion of Iran in 1980 and the following nearly seven years lasting war, the production capacities of the former major oil exporters decrease from 6.5 million barrels per day to only one million. In a broad context, the daily net oil production decreased by 5.5 million barrels, which represented nearly 10% of the worldwide output.

Thusly the oil price more than doubled from 14.02$ per barrel in the year 1978 to 36.83$ in 1980. (50.09$ to 104.12$ in real 2013 US$)Due to the aforementioned events, between 1973 to 1981, it can be concluded that oil price fluctuations would have been less significant if the U.S.A., as the biggest oil importer at that time, would have been less dependent on crude oil. (Barsky & Kilian, 2004)

2.1.4 Role of the OPEC 1980 - 2000

The previous part dealt with worldwide events to the beginning of the 1980; this section presents the role of the OPEC in the 80s and 90s.

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The OPEC, Organization of the Petroleum Exporting Countries, was founded in 1960 and coordinates the petroleum policies of its Member Countries in order to influence the oil price. (http://www.opec.org/opec_web/en/about_us/25.htm.)

During the embargo in 1973, the OPEC became aware of its the market power and displaced Railroad Commission of Texas, as the most influential oil regulation agency. (Williams, 2011)

However in contrast to the Railroad Commission of Texas, the OPEC can not enforce policies for their oil-producing members. According to the Journal of Energy Security (Brune, 2010), the only enforce “mechanism that ever existed in OPEC is Saudi spare capacity”. Given this fact the OPEC as an organization of several oil exporters, relies on the power of one country. Saudi Arabia could increase with these spare capacities the production, which would lead to a decline in oil price.

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$ money of the day $ 2013Figure°8 Average Oil prices per barrel from 1980 to 2000

Due to the missing enforce mechanism, the Saudi government failed in 1980, after peaking oil prices, due to the Iranian revolution and the Iran-Iraq war, to urge the other OPEC members to increase oil production, in order to decrease prices. (Williams, 2011)

The lack of responsible price control mechanisms resulted from 1982 onwards in a production increase by Non OPEC countries, with the aim to overcome the price monopoly of the OPEC.

Thusly from 1981 to 1988 the oil production of Non OPEC countries increased by 15%, in contrast the production by the OPEC, which decreased by 7%.

In 1988, the oligopolistic position of the OPEC in the oil market diminished, due to lower demand and higher supply by Non OPEC nations. (Alkhathlan et. al., 2013)

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OPEC Non OPECFigure°9 Total Oil Supply (Thousand Barrels Per Day) from 1980 to 2004

In reaction to the price plunge of 1981 - 86 the OPEC tried to reduce the production quotas, in order to hold the price per barrel on a higher level.

In August 1990, the oil price stopped to decline and rose again due to the Iraq -Kuwait invasion, which resulted into the first Gulf War. (Looney, 2003) The following years the price stayed stable around 20$ until the year 1998, when the economic boom in Asia stopped and “Indonesia, Japan, Malaysia, South Korea, and Thailand experienced a recession, which lasted from 1998 to 1999” (Manning, 1998)

Due to the increase of oil production, by the OPEC and Non OPEC, in correlation with the decrease in economic activity in Asia the oil prices reached the pre-Iran revolution level from 1976.

2.1.5 After 11th September 2011

The burst of the “Dot-com bubble” in the first quarter of the year 2000 weakened the U.S economy (Kraay & Ventura, 2007). Additionally the non-OPEC countries expanded further their production, which resulted in a drop in oil prices in 2001- 02.

To counter the decrease, the OPEC countries lowered their quota at around 3 million barrel per day in the time period between 2000 and 2002.

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Figure°10 Average Oil prices per barrel from 1999 to 2013

Under normal circumstance the decrease of production by the OPEC would have increased the price per barrel again, yet the attack on the Twin Towers on the 11 th

September 2011, weakened the U.S. economy further and the aggregate demand decreased. (Jackson, 2008)

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OPEC vs. Non-OPEC production

Non OPEC OPECFigure°11 Total Oil Supply (Thousand Barrels Per Day) from 1999 to 2013

In the year 2002 the OPEC and Russia reduced their production, to raise the oil price again over 25$. (Schlink, 2012)

However, the Iraq War in 2003 and the general strike of the state-owned oil company PDVSA in Venezuela, between 2002-2003, diminished in both OPEC countries nearly the entire production capacities. To compensate, the other OPEC countries needed to raise their production again.

During the year 2003, the Asian demand for crude oil was rising and the U.S. economy recovered from the recession; due to the aforementioned struggles in Iraq and Venezuela, the other OPEC members had to increase their production so far that their spare capacities reached the limit.

In relation to the demand and supply theory, the price of oil increased between 2003 and 2008, from 36.5$ to 97.26$. An article of the magazine The Economist in 2005, named the Hurricane Katrina, as another factor for rising oil prices, due to supply interruptions in the Golf Coast area.

December 2007 marked the start of the Great Depression, which refers to financial crisis and subprime mortgage crisis. Throughout the years 2008 and 2009 the oil price dropped, due to lower demand, from 97.26$ to 61.67$. Followed by a cutback in oil production by the OPEC, to stabilize the prices. (Hamilton, 2009)

The increase in 2010, is related to the Arab Spring (Darbouche & Fattouh, 2011), which interrupted the oil production in most of the Middle Eastern and North African countries, especially Libya, where the civil unrest continuous still in the year 2015.

2.1.6 Oversupply in 2014-2015

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In June 2014 the market price for the crude oil benchmarks, Brent & WTI started to fall steadily and reached in January 2015 the lowest price since the 2009, converted into percentage the price per barrel lost 252% of its value.

Figure°12 Oil prices per barrel – Benchmark WTI & Brent from 2011 to 2015

The U.S. shale oil production is another factor that contributed to the decline; from mid 2008 till 2015 the oil production in the Bakken Region, increased from 200thousand to 1300thousand barrels per day, which is approximately the output of the OPEC member Qatar, in the year 2007. (EIA Bakken Report, 2015)

In November 2014, Reuters published (http://www.reuters.com/article/2014/11/27/us-opec-meeting-idUSKCN0JA0O320141127.) an article, which stated that “Saudi Arabia blocked calls on Thursday from poorer members of the OPEC oil exporter group for production cuts to arrest a slide in global prices, sending benchmark crude plunging to a fresh four-year low”

According to the Saudi government, the low oil price is necessary to make the U.S. shale oil production uneconomical, which needs an oil price above 60$, to pay for the running costs. (http://www.format.at/wirtschaft/preisverfall-oel-saudis-5191403.) Further increase in shale oil production would weaken the market position of the OPEC, especially Saudi Arabia’s.

The current market prices for the crude oil benchmark WTI and Brent, are around 51.95$ and 57.14$, respectively. However, according to International Business Times a slow recovery is predicated, which would increase the price up to 70$ by the end of 2017. (http://www.ibtimes.co.in/strong-recovery-crude-oil-prices-unlikely-says-analysts-629858.) Already in April 2014, (Hou et. al., 2014) the working paper “The development implications of the fracking revolution” presented the “winner” (United States and China) and “looser” (Russia & the OPEC). In general it can be stated that former oil intense nations will reach a relative independence from the OPEC and Russia, due to the shale oil production.

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2.1.7 Sub – Conclusion

The Chapter 2 analysed the main historical events and price fluctuations; to introduce the next section, which displays the theoretical framework, the following Figure°13, illustrates the connection between oil price peaks and rescissions in the U.S.

To sum up the foregoing sections, between 1970 and 2012 the U.S. economy experienced five major recessions, all of them were related partially to peaking oil prices.

These oil price shocks were caused by the following events: The embargo 1973 due to the Yom Kippur war, the Iranian revolution in 1978, the Iran – Iraq War 1980, the Iraqi invasion of Kuwait 1990 and the supply shortage in 2008.

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$ money of the day $ 2013Figure°13 Recessions in the U.S. from 1970 to 2012

Mid 1970s recession (1973–75): Triggered by the embargo of 1973, which led to quadrupling oil prices and high government spending because of the Vietnam War. (Roubini & Setser, 2004)

Early 1980s recession (1981–82): Revolution in Iran, 1979, which abolished the pro-American Shah regime, causing insecurity on the energy market. Restrictive monetary policies of the U.S., to control the inflation resulted in the recession. (Mussa, 1994)

Early 1990s recession (1990-91): Mix out of oil price shock in 1990 and debt accumulation weakened the economy, which resulted in the recession. (Hall, 1993)

Early 2000s recession (2001): Due to the sharp oil price increase in 2000, violent struggles in the Middle East, especially the Israel-Palestine conflict (second intifada), burst of the speculative dot-com bubble and at

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last the attack on the Twin Towers in New York, U.S. – decreased the GDP. (Roubini & Setser, 2004)

End 2000s recession (2007-09): Housing bubble & subprime mortgage crisis of the U.S., were preceded by the global financial crisis, including peaking oil prices – Leading to the “Great Recession”. (Hamilton, 2009)

In conclusion, not all recessions were caused primarily by higher oil prices, but according to the discussion paper “The Role of Oil Price Shocks in Causing U.S. Recessions” by L. Kilian & R. J. Vigfusson (2014), the effect of this commodity, contributing to a rescission is undeniable.

3 Oil price and economical activity

The following Chapter illustrates the relationship between oil price fluctuations and the economic activity, in terms of the GDP. To provide an overview of these contributions in this field is the primary aim of this thesis.

Researchers are confident about the existence of this correlation. However the exact approach to model and the effects of it remain controversial.

Chapter 3 is structured in the following order; 3.1 presents the literature background and is divided into, research overview and literature summary, 3.2 reviews the correlation of the economy and oil prices and 3.3 analyses the effect of increasing oil prices in relation to importing-, exporting oil countries and the stock market.

Figure°14 Structure of the Chapter 3

3.1 Literature Review

Due to the multi-dimensional impact of oil prices, many economists have dedicated their research to investigate the relationship between economic growth and oil prices. The literature to this date provides several different theories, which aim to build the link between this commodity and economic factors.

The following section displays the findings in the chronological order.

3.1.1 Models in relation to the GDP and employment

The oil crisis in 1973 and 1979 triggered the interest to investigate and quantify this relationship. The article, “Oil and the Macroeconomy since World War II” in the Journal of Political Economy by J. D. Hamilton (1983), stated that three to four

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3 Oil price and

economical activity

3.1 Literature Review

3.1.1 Models in relation to the GDP and employment

3.1.2 Models in relation to the stock market

3.1.3 Literature Summary

3.2 Correlation

economy and oil prices

3.3 Oil Price Increase

3.3.1 Exporting Countries

3.3.2 Importing Countries

3.3.3 Stock market and exchange rate

quarters after an oil price increase the economic activity will slow down and recover after six to seven quarters. The linear correlation was proven valid in the period from 1948 to 1980.

M. Gisser’s and T. H. Goodwin’s (1986) study confirmed the results of Hamilton (1983), additionally they could prove that the model by Hamilton was applicable before and after the oil embargo in 1973.

The book chapter, “Oil Price Shocks and the Dispersion Hypothesis” by P. Loungani (1986) investigated the link between oil price increase and labour market, and concluded that between 1947 - 1982 oil price shocks caused disturbances in the labour reallocation process.

Another major contribution was made by Mork (1989), which focused on the collapse of the oil market in the 1980s, using the negative correlation model previously invented by J. D. Hamilton (1983). The results showed that the negative relationship was even stronger than Hamilton (1983) had predicted. In contrast, he found out that a decrease in oil price had not the same effects on the market as an increase, which led to the assumption that oil as a commodity has asymmetric effects. The contribution by Mork (1989) about asymmetric effects was thereafter considered as valid for most of the further researches in this field.

Given this finding Mork, Olsen and Mysen (1994), tested the asymmetric effects on other OECD countries than the U.S. economy and confirmed that an increase in oil price will lead to a downturn in the economic activity, even if the particular nation is less dependent on crude oil, on the other hand, a decrease will not stimulate the economy.

The third major result in the field of oil price research was obtained by Lee et al. (1995), which focused on oil prices shocks (volatility), which are defined as significant changes in price in a given time period. They confirmed in the period from 1950 to 1992 that price shocks had higher implications on the economy of a country if they occur in a less volatile period. Moreover Lee et al. (1995) estimated that four quarters after an oil price shock the lowest output growth and rising unemployment rates can be expected, which will recover in six to eight quarters after the shock, respectively.Building on the volatility research of Lee et al. (1995), Ferderer (1996) examined the asymmetry in effects in the time period from 1970 to 1990. Given this time frame Ferderer (1996), found evidence that volatility and oil price changes had a stronger impact on the economy of a country than monetary policy variables.

Furthermore volatility in oil price, negatively impacted output growth, immediately and again eleven months after the shock, while oil price changes influenced the output growth after one year.

Rotemberg & Woodford (1996) developed a model, which determined that an increase of 1% in oil price will reduce the production output by -0.25% and a 10% rise will decrease real wages by 1% after five to six quarters, in relation to the time period from 1948 to 1980. The consequences of this increase in oil price will have even stronger implications in the second year.

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Based on the model by Rotemberg & Woodford (1996), Hooker (1996) argued that the patter of influence changed between the 1948 – 1972 and 1973 – 1994; he could not find any evidence that in the second time period oil price levels had any influence on unemployment rates nor the GDP growth. Although according to his research the volatility in oil prices had a statistically significant impact on economic activity. In comparison to other studies Hooker (1996) rejected the linear relationship by Hamilton (1983) and the asymmetric relationship by Mork (1989).

Due to aforementioned research by Hooker (1996), Hamilton (1996) illustrated in the Journal of Monetary Economics, that the linear - (1983), as well as the asymmetric model by Mork (1989), need to be changed in order to display the link between oil prices and economic activities.

Hooker (1996) suggested an alternative model, which combines the asymmetric - with the nonlinearity model, using the net oil price increase specification, which considers the amount by which oil prices have gone up over the previous year. During the period from 1948 to 1994 the link between U.S. GDP growth and the net oil price increase specification remained significant.

The working paper “What is an oil shock?” published by Hamilton (2000) contrasted the use of a linear- versus a nonlinear model. He found out that a nonlinear model would be superior if the research aims to forecast GDP growth, using data of oil price changes. Moreover, Hamilton stated that an increase is much more important than a decrease in oil price, to predict the GDP growth. Furthermore, the working paper supported the finding from Lee et al. (1995) that “price shocks have higher implications on the economy of a country if they occur in a less volatile period”. Lastly, Hamilton concluded that the historic data until 2000 was insufficient, to develop a “particular form with is unambiguously over anther one”. Moreover he suggested filtering out historical events, which contribute to a peak in oil prices, in order to increase the reliability of the nonlinear model.

In the period 1973 to 1996, Chaudhuri (2000) was able to prove that real oil prices affected the production of other commodities, even if it was not directly used in the process. Davis & Haltiwanger (2001), discussed the effects of oil shock in relation to U.S. manufacturing jobs in the time from 1972 to 1988 and found evidence that “employment growth responds asymmetrically to oil price” (Davis & Haltiwanger, p. 465, 2001) These shocks have a great impact on the unemployment rate, especially in capital- and energy intensive industries.

The European central bank paper by Jimenez-Rodriguez and Sánchez (2004) used different specifications, including a “linear model and three leading non-linear specifications” and found evidence of “non-linear effects of oil price on real economic activity, having different impacts on real output when they increase than when they fall.” (Jimenez-Rodriguez & Sánchez, p. 27, 2004) This relationship was statistically significant in some of the OECD countries, however the exact effects of it were different in each of the analysed countries.

It can be concluded that the literature has not yet found prove whether oil prices influence the GDP growth or vice versa. (Adelman, 2004)

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The relationship between oil prices and economic activity needs further research to determine the exact link between those two variables.

L. Ghalayini (p. 129, 2011) from the Lebanese University stated; “A possible reason why there are so many different results regarding the subject is the usage of several different models. By using one model a certain solution is found and in another one might find the opposite results.”

3.1.2 Models in relation to the stock market

Since the end 1990s, economists analysed the link between oil prices and the effects on the stock market. One of the first authors, who dedicated themselves to this thematic were Jones and Kaul (1996). Their article “Oil and the Stock Markets” showed that oil price shocks had a significant impact on the worldwide stock market.

Therefrom Sadorsky (1999) used monthly data in contrast to quarterly data in the study of Jones and Kaul (1996) and proved that increasing oil prices trigger a downturn in real stock returns, which would happen instantly in an efficient stock market. This is based on the assumption that higher oil prices will increase production costs for the industry. Sadorsky (1999) separated the analysis into two time periods 1947 to 1986 and 1986 to 1996 and displayed that after 1986 oil price shocks had higher consequences for the stock market.

Papapetrou (2001) confirmed Sadorsky’s (1999) study; additionally he investigated the process after an oil price shock in relation to industrial production and employment. As a result of an oil price shock the interest rate rose, and the industrial production and employment decreased and resulted in a decrease in real stock return.

3.1.3 Literature Summary

The aforementioned researches can be summarized by the following four main findings:

Economic activity & oil prices are linked and can be quantitatively measured.

An oil price increase has a significantly higher impact on the economy than a decrease - depending on the scale of previous oil price volatility.

Price volatility creates uncertainty in investments and causes disruptions on the labour market. Furthermore, the pattern of oil price volatility changed after 1986; before this time oil price steadily increased, after 1986 large price fluctuations reflected a rise in volatility of real oil price.

Oil price shocks, have a statistical significant impact on stock returns. Adverse effects, for industrial production and employment, are immediately visible after an oil price hike. The effects of asymmetry also apply to stock markets.

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3.2 Correlation economy and oil prices

As described in the previous chapters oil prices have a significant influence on the economic activity.

To measure economic activity, the gross domestic product is used as an “indicator of the economic health of a country ... and the standard of living” according to the International Monterey Fund. (http://www.imf.org/external/pubs/ft/fandd/basics/gdp.htm.)

The formula for GDP includes; consumer spending (C), government spending (G), investments by businesses (I) and the net export (NX) (Exports – Imports).

GDP = C + G + I + NX

Usually the GDP, Gross Domestic Product, is calculated on an annual basis and within a country's borders in a specific time period.

The figure°15 displays the oil price behaviour and world economic growth for the period 1969 to 2010. The world gross domestic product and the real oil price per barrel show an upward trend. Visible on this chart the decline in GDP due to the financial crisis in 2007-2009 and the decline in oil prices.

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GDP World (2010$) Oil price in (2010$)Figure°15 Worldwide GDP vs. Oil price per barrel in international real 2010$

The aggregate production function can be used to describe the how real gross domestic product is linked to available inputs. (http://catalog.flatworldknowledge.com/bookhub/reader/2498?e=coopermacro-ch16_s15.)

These inputs are physical capital, labour, human capital, social infrastructure and the availability of natural resources in an economy.

An economic growth would increase the demand for these factors and therefore increase according to the demand and supply theory the price of these factors. Therefore fluctuations in oil price can be explained by economic growth.

Assuming increasing oil prices, a transfer of wealth would occur, from consuming- to producing countries, vice versa if the prices decrease.

The global gross domestic product would depend in the case of an increase on the

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amount of extra revenue, which would be reinvested in the global economy. According to L. Ghalayini (2011) the “boost to economic growth in oil-exporting countries provided by higher oil prices in the past has always been less than the loss of economic growth in importing countries, such that the net effect has always been negative.“

This means that a boost in GDP of the oil-producing nations, due to higher oil prices, is lower than the decrease in GDP of the importing countries. For the aforementioned reasons, higher oil prices result in a decrease in net global demand and GDP.

3.3 Oil Price Increase

Previous sections illustrated that an increase in oil price, results in asymmetric effects for the economy, depending on the status of an oil exporting- or importing nation. The following part presents the mechanisms, which will be triggered in such countries, due to a rise in oil price.

3.3.1 Impact of an oil price increase on exporting countries

A net oil-exporting nation can expect a higher national income, due to an increase in oil price, which would raise the GDP growth. On the other hand, the demand in importing countries would be interrupted due to the price shock and might create a global recession.

Too high prices, give importing nations incentives to search for new solutions. For example price shocks led to the discovery of new oil fields in the North Sea in the 1970s or hydraulic fracking in the U.S. in 2008 (Hou et. al., 2014). The consequence would be higher oil supply, which reduces the price of oil on the international market and finally decrease the real national income of the exporting nations.

Figure°16 Oil price increase in relation to oil exporting nations

3.3.2 Impact of an oil price increase on importing countries

According to the literature an oil price increase would create a net income loss for importing country. The degree of loss is correlated with the dependency on crude oil and the impact on other commodities, such as gas or electricity.

The average private consumer, will reduce in the short run other expenditures on

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International oil price increase Higher export earnings

Short-Run: increases real national income

Higher GDP for exporting Nations

Long-Run: GDP growth of importing nations

decline

Reducing the demand and the price of oil.

Higher development of fuel efficient solutions and alternative fuels

Increases exploration and finally supply

Higher supply decreases GDP of exporting nations

goods, due to the issue that transportations is in general not substitutable and that the oil price is inelastic in the short run. Reviewing the GDP function, the consumer spending would decrease, and so the total GDP. Generally, higher price levels for a long period of time have a bigger negative impact on the economy. (Qianqian, 2011)

Figure°17 Oil price increase in relation to oil importing nations

An oil price increase, will affect the general price level of a country, which leads to a rise in inflation, depending on whether the workers and employers can increase wages, and the will to face income losses. Furthermore inflation encourages the monetary authorities to apply restrictive monetary and fiscal policies, for instance by raising the interest rate, which would make it for companies difficult to borrow money from the banks.

On the other hand expansionary monetary and fiscal policies, particularly injecting capital directly into the economy, would lag the reduction of real income, resulted from the increase in oil prices and impact the economic activity, in the long run, due to higher price levels / inflation. (Ghalayini, 2011)

Depending on the monetary policy, the adjustment of real wages to shocks, the decline of output can disturb the labour reallocation process, which would trigger a downturn in GDP growth.

The adjustment of real wages would increase production costs, which can either passed on to consumers or the producers. In a competitive market, the literature suggests that an oil price increase result in an upward pressure on nominal wage levels. In the short run producers would be affected by falling profit margins and lower return on capital. (Ghalayini, 2011) However if companies are able to push the increase of input costs to the consumers, oil price shocks have smaller affects.

In the long run consumers and producers change their consumption behaviour, to withstand future oil price shocks. Therefrom the income loss from the price shock can be reversed by a lower dependence on oil.

Another impact of oil price fluctuations is the change in patterns of investment,

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International oil price increase

Income losses Consumers reduce expenditures Decrease of GDP

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Recession Decrease of GDP growth

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production industryHigher product

costsConsumers reduce

their spendings

savings, and spending, due to higher perceived risks. Furthermore, the research by Bernanke et. al. (1997) showed that companies postpone their investment expenditures and plan no longer far ahead, resulting in a further reduction of GDP growth.

To conclude, the literature agrees that the oil price has a significant impact on the GDP growth; in the case of sharp increasing oil prices, it may cause even a recession.

The costs of input for the production will rise simultaneously with the inflation rate. This will be followed by a decline in the net exports by oil importing countries, which disrupts the international trade balance. Moreover consumer/government spending and investments by businesses decrease, resulting finally in an overall decline in gross domestic product growth.

3.3.3 Stock market and exchange rate

According to the Federal Reserve Bank of New York Staff Report (2006) by Goldberg and Tille, a change in trade balance caused by an oil price shock, which increases the general price level, would alter the exchange rate between the Dollar and other currencies.

Due to the fact that most oil contracts settle in US dollar, oil exporters invest their earnings in US dollar-dominated assets, higher oil prices would lead to an increase in value of US dollar by increasing the transactions demand for it. The increase in value of US dollar would also increase the costs of servicing the external debt of oil-importing countries, which is usually in US dollar, exacerbating the economic damage caused by higher oil prices. (Moshiri & Banihashem, 2012)

To sum up, oil price fluctuations affect the economic activity, corporate earnings, inflation, stock markets, equity values and exchange rates, based on the assuming that there is no change in monetary policies.

From a global perspective, the change in oil price has a different impact on every country. In this context, the following section, will analyse as a case study the countries Germany and China, both have different economic backgrounds and dependencies on oil.

4 Cases study Germany and China

The previous chapter illustrated the research and the mechanisms, which explain the link between oil price fluctuations and GDP growth.

Therefrom this section displays the economic activity of Germany and China, in relation to their dependence on oil.

Furthermore, it introduces the data used in the fifth chapter, which will statistically test whether oil price fluctuations and GDP is correlated via the Spearman rank correlation method.

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The data for the following section is mainly obtained from the U.S. Energy Information Administration, the United States Department of Agriculture and the International Energy Agency, an autonomous intergovernmental organization from the OECD, Organization for Economic Co-operation and Development.

4.1 Germany

In the year 2012 Germany was the largest energy consumer in Europe, the eighth-largest energy consumer- and the fourth-largest economy in the world, in terms of nominal gross domestic product (GDP). Moreover, Germany is the highest populated country in Europe and is due to its central location Europe, the main transit country. Additionally Germany was in 2013 the worldwide third biggest exporting country, before China, Untied States of America. (http://www.eia.gov/countries/index.cfm?topL=con.)

The Total Primary Energy Supply in 2010 was 328.71 Mtoe, which is defined as “Megatonne Öleinheiten” – one “Megatonne” is equivalent to one million tones of oil. (International Energy Agency, 2012)

Since the energy peak in 1979 with 367.9 Mtoe, the Total Primary Energy Supply is decreasing, despite a GDP growth.

The International Energy Agency points out that the recent decline is caused by the economic crisis in 2007-2008 and general efficiency gains.

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Figure°18 Total Primary Energy Supply of Germany in 2010 (Mtoe)

According to the EIA Germany, was ranked in 2013 the ninth biggest oil consumer and sixth biggest oil importer in the world.

However, Germany has barely any domestic oil and natural gas production and relies heavily on imports.

In 2013 Germany imported the oil mainly from Russia (33,8%), followed by Norway (11.9%), Great Britain (10%), Nigeria (7.9%), Kazakhstan (7.6%), Libya (7.2%), Azerbaijan (3.9%) and Algeria (2.8%), while the domestic production is 2.8%. (Rost, Norbert, BAFA, 2014)

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As previously indicated, the Total Primary Energy Supply declined in recent decades, including the oil consumption. It is expected that in the time period from 2010 till 2025 the oil consumption will further decrease by 14%, naming the promotion of biofuels / alternative fuels, energy taxation levels, efficiency standards for buildings and cars as critical factors which influence this process.

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Total Oil Production Total Oil ConsumptionFigure°19 German Production vs. Consumption from 1991 to 2013

Due to Germany’s export capacitates the transportation sector accounts for the majority of the petroleum product demand, which consumed in 2010 49% of total oil supply. However, the government strives to decrease (International Energy Agency, 2012) the enormous dependence of the transportation sector on oil, by promoting the use of electric vehicles. The industry sector and private consumption had in 2010 an oil product demand of 20% and 31%, respectively.

Moreover, with around 2.2 million barrels per day of crude refining capacity, Germany is the second largest refiner in Europe and Eurasia after Russia. Most oil is imported through four crude oil pipelines as well as the deep-water port at Wilhelmshaven, Germany. Since Germany has neither a substantial domestic gas production, most of the natural gas is imported from Russia, Norway, and the Netherlands. The consumption peaked in 2003, which can be also explained by efficiency improvements.

Nuclear plants account for 11% of the Total Primary Energy Supply, yet the government decided in 2011, due to public pressure after the Japanese Fukushima accident to shut down by 2022 all of their 17 nuclear reactors.

Germany’s only indigenous energy resource is coal, which accounted in 2010 for 24% of the Total Primary Energy Supply, due to the closure of the nuclear facilities, the consumption of coal, is predicted to increase. In the global scale, the country was ranked the world's eighth-largest producer of coal in 2012. The Ruhr Coal Basin and Saar Basin produces more than 75% of the country's hard coal. ( http://www.mining-technology.com/features/featurecoal-giants-the-worlds-biggest-coal-producing-countries-4186363/.)

Renewable energy contributed with 11% to the Total Primary Energy Supply in 2010, which ranks Germany as the largest European producer of non-hydro renewable electricity. According to the Federal Government's energy concept of 2011, renewable energy should substitute the nuclear power in the future.

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To summarize, Germanys energy demand, especially crude oil decreased while the GDP continues to increase. However irrespective of efficiency gains, Germanys economy still relies heavily on inexpensive crude oil to fuel the transportation sector, which is the backbone of the export.

The following chart illustrates the correlation between the GDP growth in real 2010 ($billions) and the oil consumption in thousand barrels per day.

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Total Oil Consumption GDP GermanyFigure°20 German GDP vs. Total Oil Consumption from 1991 to 2013

Germany currently struggles due to the weakness of the Eurozone, the skyrocketing national debt at around 78% of the GDP in 2013, the slowly recovering banking system and 30% higher energy costs than the EU average. (http://www.marketwatch.com/story/germanys-economy-isnt-as-strong-as-europe-believes-2013-12-04.)

All in all these factors reduce competitiveness and increase vulnerability to oil price shocks.

4.2 China

In 2015 nearly 19% of the world population lived in China, therefrom it is the world's most populous country and the GDP quintupled from 2005 to 2014. (Heerman, 2014), After the European Union and the Untied States, China is the third largest economy in the world. Additionally China was in 2014, according to the Global Energy Statistical Yearbook 2014, by far the biggest energy consumer in the world. (https://yearbook.enerdata.net.).

The fast-growing economy led to a higher energy demand, especially for liquid fuels, which “has made China extremely influential in world energy markets”. (U.S. Energy Information Administration, 2014)

According to the analyse by U.S. Energy Information Administration, China’s economy in 2011 was powered to a vast majority by coal (69%), oil 18%, hydroelectric and other renewables (8%), natural gas (4%) and nuclear power (nearly 1%). (U.S. Energy Information Administration, 2014)

The use of coal created in recent years massive air pollution; to tackle this problem the Chinese government plans to decrease its use below 65% by 2017 and by 2040 below 55%, of the total energy mix. Moreover by 2020 15% of the

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Total Primary Energy Supply should come from non-fossil fuels, such as hydroelectric and other renewables.

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Figure°21 Total Primary Energy Supply of China in 2011

In the Total Primary Energy Supply from 2011, oil consumption only accounted for 18%, yet China became in 2010 the second largest consumer behind the United States. In March 2014, the U.S. Energy Information Administration, stated that China has surpassed the United States as the largest net oil importer, moreover forecasting that the net import will further increase while the U.S import decrease. (http://www.eia.gov/todayinenergy/detail.cfm?id=15531.)

The China’s booming economy accounted for one-third of the world's oil consumption growth in 2013. The domestic production only contributed for 39% and is controlled mainly by government-owned oil companies, although in recent years international oil companies received access to technically challenging onshore and deep-water offshore fields.

The domestic oil production has already peaked; only complex techniques on- and offshore, such has hydraulic fracking still increases the production output. Rising oil prices and economic activity, made it necessary to import greater amounts of oil from a wide range of sources. Since 2008 Chinese national oil companies acquired worldwide sources of oil supply. Furthermore the government expended the domestic oil pipeline network, refinery plants and crude oil storages, in order to withstand future oil price shocks.

To fill the gap between production and consumption, China imports 62% of its oil demand from OPEC members, mainly Saudi Arabia (19%), Angola (14%), Iraq (8%), Iran (8%), Venezuela (6%), United Arab Emirates (4%) and Kuwait (3%). The remaining 38% comes from Russia, Brazil, Congo and others. (U.S. Energy Information Administration, 2014)

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Figure°22 Chinese Production vs. Consumption and Ratio from 1987 to 2013 (*Excluding Hong Kong and Macau)

Natural gas only accounted for 4% of the energy mix in 2011. Due to explorations of new domestic gas sources, such as shale gas, gas derived from coal seams and deep-water fields, the production is predicted to increase. Investments in the gas pipeline network to link production areas in the western and northern regions with the consuming regions on the coastline will further increase demand.

According to the report from the Lawrence Berkeley National Laboratory in 2012 (Fridley et. al., 2012) China is the largest producer and consumer of coal worldwide. In 2010 China consumed 46% of the entire worlds coal production, followed by Germany with 15% on the second place.

Due to the excessive coal consumption, China became in 2010 the country with the highest carbon dioxide emissions. The EIA named coal as the backbone of the GDP growth (U.S. Energy Information Administration, 2014)

The hydroelectric and other renewables energy, contributed with more than 27% to the total electricity supply in 2012, yet it is forecasted that this share will increase by 5% till 2040.

To conclude, China is the most populous country in the world and had a GDP growth from 2000 - 2011 at around 10% every year, yet the economical activity slowed down in 2012 and 2013, and the industrial production and exports decreased. Nevertheless the country is the by far the biggest exporter in the world, even after the entire European Union.

However the country struggles with an increase in inflation and local government debt, both would be negatively affected by an oil price increase. It can be expected that the seriousness of these issues increase, with the rising demand for crude oil.

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The following chart illustrates the correlation between the GDP growth in real 2010 ($billions) and the oil consumption in thousand barrels per day.

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Chinese GDP vs. Oil Consumption

Total Oil Consumption GDP ChinaFigure°23 Chinese GDP vs. Oil Consumption from 1991 to 2013 The government strives to stabilize the economic activity, in order to create a more balanced economic growth and increase the domestic consumption.

Moreover private investments in the energy sector, lower price controls, higher competition among energy firms, improvements in the energy transmission network and the shift from coal to renewable energy sources should help China to expand the GDP growth.

5 Analysis

To test the relationship between the two variable sets, oil price change and GDP growth, the Spearman correlation was chosen over the Pearson correlation, due to its ability to compare two variables even if their relationship is not linear. Moreover the Spearman rank correlation method, does not make any assumptions about the distribution of the data, which makes it appropriate to use for samples with large outliers or for series, which are not normally distributed. (http://www.statstutor.ac.uk/resources/uploaded/spearmans.pdf.)

The section 5.2 tests for skewness and kurtosis, in order to support or reject the choice of the correlation model. If the outcome of the descriptive statistic for the variables sets - Change_Germany_GDP and Change_China_GDP, supports the choice of the model, the Spearman's rank-order correlation test will be conducted.

Furthermore the analysis will take into account five time lags – each equivalent to one quarters / three month, based on the assumption by Hamilton (1983) and Lee et. al. (1995), that oil price fluctuations will have in general no immediate effect on GDP growth. Contractual obligations may shift the effect of the oil price change. (Gujarati, 2005).

The Spearman rank correlation method (rs), statistical measures of the strength of a monotonic relationship between paired ranked data. A monotonic function can either entirely non-increasing or non-decreasing. (https://statistics.laerd.com/spss-

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tutorials/spearmans-rank-order-correlation-using-spss-statistics.php.) This correlation method calculates the Pearson’s correlation between the ranked values; these values are assigned to a rank, ranging from the lowest to the highest. Due to the rank order the actual size of the value has no effect. However, due to the conversion to ranks the data loses some precision.

The Spearman rank coefficient has a single value between -1 and +1 and determines the strength of the correlation. An absolute value close to one indicates a strong correlation while a coefficient of zero indicates that there is no relationship between the variables. Additionally the mathematic symbol of the correlation coefficient determines if the relationship is positive (both variables sets increase) or negative (one variable set increases, while the other decreases)

Moreover if the value of the significance level for the two-tailed test is higher than 0.05 it can be stated that there is no statistically significant correlation between the two variables, an increase (decrease) in one variable is not significant related to the increase (decrease) in the second variable.

If the value is less than or equal than 0.05 it can be concluded that there is a statistically significant correlation between the two variables, an increase (decrease) in one variable is significant related to the increase (decrease) in the second variable.

5.1 Data background

The data for the Gross Domestic Product is provided by the Levy Economics Institute of Bard College (2013); cited from the OECD Quarterly National accounts database and the International Monetary Fund.

To illustrate oil price fluctuations, the oil pricing benchmark West Texas Intermediate (WTI – Cushing) was chosen, which also serves as marker for other crude streams. The data was obtained from the Federal Reserve Bank of St. Louis (2015) and displays the change in spot price in nominal dollar per barrel, aggregated by the moving average method into quarterly prices.

5.2 Descriptive Analysis

The figure°24 displays the frequency test of the variable sets; change GDP growth in Germany and China from 2000, 1st quarter to 2015, 1st quarter.

Figure°24 Frequency Test Germany and China

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The value for skewness indicates asymmetry and deviation from a normal distribution while the kurtosis is used as a sign for a sharp or flat distribution. (DeCarlo, 1997)

A skewness value bigger than zero means that the distribution is right-skewed, most values are concentrated on left of the mean, with extreme values to the right.

Values smaller than zero indicate left-skewness, most values are concentrated on the right of the mean, with extreme values to the left, which is the case for Germany (-1.949<0) and China (-0.466<0).

If the skewness is equal to zero then the distribution is symmetrical around the mean.

The value of the kurtosis, for Germany, is 7.895 (>3), which means that the distribution is sharper than a normal distribution, with values concentrated around the mean and with thicker tails. This means high probability for extreme values. However, the kurtosis for China is 0.669 (<3), indicates that the distribution is flatter than a normal one and has a wider peak. The probability for extreme values is less than for a normal distribution, and the values are wider spread around the mean. (DeCarlo, 1997)

The kurtosis equal to 3 is a normal distribution.

The outcome of this frequency test is also visualized in the appendix III / IV.

5.3 Spearman's rank-order correlation

Figure°25 Spearman's rank-order correlation

The figure illustrates that the increase in German’s GDP corresponds positively to the increase of China’s GDP, which is indicated by the positive correlation coefficient (rs=0.396 / Sig (2-tailed) = 0.002).

Furthermore the German GDP growth and change in WTI oil price, are significant negative correlated at a 0.05 significance level toward each in the third lag (r =-0.270 / Sig (2-tailed) = 0.041. Meaning that the relationship is visible three quarters, after the oil price change.

The Chinese GDP growth and change in the WTI oil prices are significant positive correlated at a 0.05 significance level toward each other with any lag. (rs=0.353 / Sig (2-tailed) = 0.005)

6 Conclusion

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It can be concluded that oil prices significantly influence the GDP growth or vice verse, the impact depends on the magnitude of fluctuation, the share of crude oil in the Total Primary Energy Supply and external factors, such as historic events.

As indicated in the section Oil price and economical activity, oil prices influence a variety of economic factors, such as corporate earnings, stock markets, equity values, inflation, unemployment and exchange rates. On the other hand, negative (positive) GDP growth affects the input factors for the production, which decrease (increases) the demand and price for crude oil.

The Spearman's rank-order correlation method could not conclude that there is not a clear relationship between oil price and world economic growth for both countries. The analysis indicates that GDP growth and oil price fluctuations are significant negative correlated for Germany while the relationship for China is vice versa.

This result might be explainable in the case for Germany due to the decline in oil consumption and efficiency gains, which decreases the impact of oil price fluctuations on the GDP. In the case of China the positive relationship might indicate that the WTI spot price rise simultaneously with the GDP growth of China.

It can be presumed that Germany GDP is far less affected by oil price fluctuations than other countries, due to efficiency gains and alternative fuels. However due to the high dependence on Russia (Westphal, 2014) and Libya, in terms of oil supply and the further destabilization of these countries, can cause shortages. In the long run Germany will still rely on inexpensive fossil fuel, due the petroleum product demand of the transportation sector.

Chinas’ GDP growth is positively correlated to the oil price increase, which is explainable by the issue that China accounted for one-third of the world's oil consumption growth in 2013. Furthermore, due to the marginal domestic production the country is highly dependent on imports mainly for OPEC members, crisis in the Middle East might cause supply shortages. Moreover, the country already struggles under a high inflation rate; further oil price increase would have negative impact on GDP growth. In the long run it is expected that the fuel consumption will increase, due to a growing middle class, which have the finical recourses to purchase a vehicle. (Barton, 2013) Without efficiency gains and rising oil intensity, oil price fluctuations will have a highly negative impact on China’s GDP growth.

In both countries higher domestic production, in form of shale oil, would decrease the dependence on imports and would lower the vulnerability by oil price fluctuations.

To sum up, research needs to take into account efficiency gains, in order to model the relationship between growing GDP and declining oil consumption.

Furthermore, as illustrated in the second chapter, historical events might cause oil supply disruption and price shocks. However, most of the studies in this field are conducted in relation to the U.S. economy. Researchers could analyse the impact

37

of the Crimea Crisis in 2014 and the following sanctions, on the oil price and GDP growth for Germany.

Another interesting case study would be to investigate, which impact the shale oil and gas production has in China, in relation to oil prices and GDP growth.

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7.1 Summary Figures Reference

(*References used for the following figures and relating calculations, are already inside the main list)

Figure°1 BP Review: World consumption (http://www.bp.com/en/global/corporate/about-bp/energy-economics/statistical-review-of-world-energy.html.)

Figure°5 Average Historic Oil prices per barrel from 1861 to 2013 (British Petroleum. (2014). Statistical Review of World Energy 2014. Available: http://www.bp.com/en/global/corporate/about-bp/energy-economics/statistical-review-of-world-energy.html. Last accessed 1st April 2015.)

Figure°6 Average Oil prices per barrel from 1946 to 1972 (British Petroleum. (2014). Statistical Review of World Energy 2014. Available: http://www.bp.com/en/global/corporate/about-bp/energy-

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economics/statistical-review-of-world-energy.html. Last accessed 1st April 2015.)

Figure°7 Average Oil prices per barrel from 1972 to 1983 (British Petroleum. (2014). Statistical Review of World Energy 2014. Available: http://www.bp.com/en/global/corporate/about-bp/energy-economics/statistical-review-of-world-energy.html. Last accessed 1st April 2015.)

Figure°8 Average Oil prices per barrel from 1980 to 2000 (British Petroleum. (2014). Statistical Review of World Energy 2014. Available: http://www.bp.com/en/global/corporate/about-bp/energy-economics/statistical-review-of-world-energy.html. Last accessed 1st April 2015.)

Figure°9 Total Oil Supply (Thousand Barrels Per Day) from 1980 to 2004 (British Petroleum. (2014). Statistical Review of World Energy 2014. Available: http://www.bp.com/en/global/corporate/about-bp/energy-economics/statistical-review-of-world-energy.html. Last accessed 1st April 2015.)

Figure°10 Average Oil prices per barrel from 1999 to 2013 (British Petroleum. (2014). Statistical Review of World Energy 2014. Available: http://www.bp.com/en/global/corporate/about-bp/energy-economics/statistical-review-of-world-energy.html. Last accessed 1st April 2015.)

Figure°11 Total Oil Supply (Thousand Barrels Per Day) from 1999 to 2013 (British Petroleum. (2014). Statistical Review of World Energy 2014. Available: http://www.bp.com/en/global/corporate/about-bp/energy-economics/statistical-review-of-world-energy.html. Last accessed 1st April 2015.)

Figure°12 Oil prices per barrel – Benchmark WTI & Brent from 2011 to 2015 (U.S. Energy Information Administration. (2015). Spot Prices. Available: http://www.eia.gov/dnav/pet/pet_pri_spt_s1_m.htm. Last accessed 18th April.)

Figure°13 Recessions in the U.S. from 1970 to 2012 (British Petroleum. (2014). Statistical Review of World Energy 2014. Available: http://www.bp.com/en/global/corporate/about-bp/energy-economics/statistical-review-of-world-energy.html. Last accessed 1st April 2015.)

Figure°15 Worldwide GDP vs. Oil price per barrel in international real 2010$ (British Petroleum. (2014). Statistical Review of World Energy 2014. Available: http://www.bp.com/en/global/corporate/about-bp/energy-economics/statistical-review-of-world-energy.html. Last accessed 1st April 2015.

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Heerman, Dr. Kari . (2014). Real Historical Gross Domestic Product (GDP). Available:https://www.google.de/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&cad=rja&uact=8&ved=0CDAQFjAB&url=http%3A%2F%2Fwww.ers.usda.gov%2Fdatafiles%2FInternational_Macroeconomic_Data%2FHistorical_Data_Files%2FH. Last accessed 12th April 2015.)

Figure°18 Total Primary Energy Supply of Germany in 2010 (Mtoe) (International Energy Agency. (2012). Germany. Oil & Gas Security, Emergency Response of IEA countries. pp. 1-13.)

Figure°19 German Production vs. Consumption from 1991 to 2013 (U.S. Energy Information Administration. (2013). International Energy Statistics. Available: http://www.eia.gov/cfapps/ipdbproject/IEDIndex3.cfm?tid=5&pid=53&aid=1. Last accessed 6th April 2015.)

Figure°20 German GDP vs. Total Oil Consumption from 1991 to 2013 (U.S. Energy Information Administration. (2013). International Energy Statistics. Available: http://www.eia.gov/cfapps/ipdbproject/IEDIndex3.cfm?tid=5&pid=53&aid=1. Last accessed 6th April 2015.

Heerman, Dr. Kari . (2014). Real Historical Gross Domestic Product (GDP). Available: https://www.google.de/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&cad=rja&uact=8&ved=0CDAQFjAB&url=http%3A%2F%2Fwww.ers.usda.gov%2Fdatafiles%2FInternational_Macroeconomic_Data%2FHistorical_Data_Files%2FH. Last accessed 12th April 2015.)

Figure°21 Total Primary Energy Supply of China in 2011 (U.S. Energy Information Administration. (2014). China. Country Overview. pp. 1-35)

Figure°22 Chinese Production vs. Consumption and Ratio from 1987 to 2013 (*Excluding Hong Kong and Macau) (British Petroleum. (2014 ). Statistical Review of World Energy 2014. Available: http://www.bp.com/en/global/corporate/about-bp/energy-economics/statistical-review-of-world-energy.html. Last accessed 1st April 2015.

Heerman, Dr. Kari . (2014). Real Historical Gross Domestic Product (GDP). Available: https://www.google.de/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&cad=rja&uact=8&ved=0CDAQFjAB&url=http%3A%2F%2Fwww.ers.usda.gov%2Fdatafiles%2FInternational_Macroeconomic_Data%2FHistorical_Data_Files%2FH. Last accessed 12th April 2015.)

Figure°23 Chinese GDP vs. Oil Consumption from 1991 to 2013 (British Petroleum. (2014 ). Statistical Review of World Energy 2014. Available: http://www.bp.com/en/global/corporate/about-bp/energy-

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economics/statistical-review-of-world-energy.html. Last accessed 1st April 2015.

Heerman, Dr. Kari . (2014). Real Historical Gross Domestic Product (GDP). Available: https://www.google.de/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&cad=rja&uact=8&ved=0CDAQFjAB&url=http%3A%2F%2Fwww.ers.usda.gov%2Fdatafiles%2FInternational_Macroeconomic_Data%2FHistorical_Data_Files%2FH. Last accessed 12th April 2015.)

Figure°24 Frequency Test Germany and China (Levy Economics Institute. (2013). GDP database. Available: www.levyinstitute.org/pubs/gdp_ustp.xls. Last accessed 18th April 2015.)

Figure°25 Spearman's rank-order correlation(Levy Economics Institute. (2013). GDP database. Available: www.levyinstitute.org/pubs/gdp_ustp.xls. Last accessed 18th April 2015.

U.S. Energy Information Administration. (2015). Crude Oil Prices: West Texas Intermediate (WTI) - Cushing, Oklahoma (DCOILWTICO). Available: https://research.stlouisfed.org/fred2/series/DCOILWTICO/downloaddata. Last accessed 18th April 2015.)

7.2 Summary Appendix Reference

(*References used for the appendix, are already inside the main list)

Appendix I: Production & Consumption by region (British Petroleum. (2014). BP Statistical Review of World Energy June 2014. BP Statistical Review. 63.)

Appendix II: World consumption by energy source (British Petroleum. (2014). BP Statistical Review of World Energy June 2014. BP Statistical Review. 63.)

Appendix III: Histogram German_GDP_Growth (Levy Economics Institute. (2013). GDP database. Available: www.levyinstitute.org/pubs/gdp_ustp.xls. Last accessed 18th April 2015.)

Appendix IV: Histogram China_GDP_Growth (Levy Economics Institute. (2013). GDP database. Available: www.levyinstitute.org/pubs/gdp_ustp.xls. Last accessed 18th April 2015.)

Appendix V: Descriptive Statistics Germany(Levy Economics Institute. (2013). GDP database. Available: www.levyinstitute.org/pubs/gdp_ustp.xls. Last accessed 18th April 2015.)

Appendix VI: Descriptive Statistics China(Levy Economics Institute. (2013). GDP database. Available: www.levyinstitute.org/pubs/gdp_ustp.xls. Last accessed 18th April 2015.)

Appendix VII: Descriptive Statistics WTI Spot Price

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(U.S. Energy Information Administration. (2015). Crude Oil Prices: West Texas Intermediate (WTI) - Cushing, Oklahoma (DCOILWTICO). Available: https://research.stlouisfed.org/fred2/series/DCOILWTICO/downloaddata. Last accessed 18th April 2015.)

8 Appendix

Appendix I: Production & Consumption by region

Appendix II: World consumption by energy source

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Appendix III: Histogram German_GDP_Growth

Appendix IV: Histogram China_GDP_Growth

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Appendix V: Descriptive Statistics Germany

Appendix VI: Descriptive Statistics China

Appendix VII: Descriptive Statistics WTI Spot Price

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