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Nigeria is a mono-product economy in term of  generating revenue from Crude oil price, which constituted its major export commodity, changes in oil prices have continued to have  implications for the Nigerian economy and, in particular on the exchange rate movements. This study examined the effects of crude oil price and exchange rate on the Nigeria economy using quarterly data from the year 1985 to 2015.

Relevant descriptive and econometric analyses were employed. The econometric tests used which include the unit root tests, Johansen co-integration technique and the Vector Error Correction Model (VECM), the unit root tests was carried out using the ADF, Phillip perron and ADF-GLS; all the variables were stationary at first difference. The long run relationship among the variables was determined using the Johansen Co-integration technique and there were 3 co-integrating vectors in total, the vector error correction model was used to examine the speed of adjustment of the variables from the short run dynamics to the long run and the impulse response function was used to determine the causal impact of shocks of the independent variables to response of the dependent variables.

The result findings revealed that there is no significant relationship among Crude oil price, exchange rate and RGDP, no significant relationship among Crude oil price, exchange rate and external reserve and no significant relationship among Crude oil price, exchange rate and CPI.

The study concluded that there exist a strong empirical evidence of timing importance in the crude oil price and exchange rate relationship. And recommendations were that the country should diversify from crude oil dependency because as crude oil price increases, the CPI also increases largely. Second, government pursuit of managed float exchange rate is desirable to ensure a substantial increase in the external reserve without significant damage of the exchange rate of the country. Third, an effective management and stabilization of crude oil price by Organization of Petroleum Exporting Countries (OPEC) could reduce the effect of its shocks on economic performance of Nigeria.

Keywords: Crude Oil price, Exchange rate, Economic Growth (RGDP), CPI, External reserve.

Word Count: 340


Content                                                                                                                       page

Title page                                                                                                                                 i

Certification                                                                                                                            ii

Dedication                                                                                                                               iii

Acknowledgments                                                                                                                  iv

Abstract                                                                                                                                  v

Table of Contents                                                                                                                   vi

List of Tables                                                                                                                          x

List of Figures                                                                                                                         xi


1.1 Background to the Study                                                                                                 1

1.2 Statement of the Problem                                                                                                 4

1.3 Objective of the Study                                                                                                     5

1.4 Research Questions                                                                                                           5

1.5 Hypotheses                                                                                                                       5

1.6 Scope of the Study                                                                                                           6

1.7 Justification for the study                                                                                                 6

1.8 Significance of the Study                                                                                                 7

Content                                                                                                                                   Page

1.9 Operational Definition of terms                                                                                        7


2.1 Conceptual Model                                                                                                                        8

2.1.1 Concept of Crude oil Price                                                                                            8

2.1.2 Concept of Exchange Rate                                                                                            9

2.1.3 Oil price and Exchange Rate                                                                                         10 Post independence Era                                                                                               10 Oil Boom Era                                                                                                              10 Post Sap Era                                                                                                                11

2.1.4 Concept of Fixed Exchange Rate                                                                                  12

2.1.5 Concept of Floating Exchange Rate                                                                              11

2.1.6 Concept of Exchange rate Volatility                                                                             12 Measuring Exchange Rate Volatility                                                                          13

2.1.7 Foreign Exchange Market in Nigeria                                                                             15

2.1.8 Structure of Nigeria’s Foreign Exchange Market                                                          16 Second tier Foreign Exchange Market                                                                       16 Autonomous and interbank foreign exchange market                                                17 Dutch Auction System                                                                                               17

2.1.9 Exchange Rate Stability                                                                                                            18

Content                                                                                                                                   Page

2.1.10 Concept of Foreign Reserve                                                                                        20

2.1.11 Concept of Inflation                                                                                                    20

2.1.12 Conceptual Model                                                                                                       21

2.2. Theoretical Framework                                                                                                    22

2.2.1 Theories on Exchange rate                                                                                             22 Asset approach theory                                                                                                22 Purchasing power parity theory                                                                                  23 Traditional theory                                                                                                       24 Monetarist theory                                                                                                        24 International Effect Theory                                                                                        25 Balance of Payment Theory                                                                                        26 Sterilization Theory                                                                                                     27

2.2.2 Theories on Oil Prices                                                                                                    29 Hotelling Theory on Price                                                                                           29 Oligopoly Pricing Theory                                                                                            29 Commodity Price Speculative Theory                                                                        30 Economic growth theory                                                                                            31 Inclusive Growth Theory                                                                                            32

2.3 Empirical Review                                                                                                              32

Content                                                                                                                                   Page

2.4 Gaps in Literature                                                                                                             41


3.0 Introduction                                                                                                                      43

3.1 Research Design                                                                                                               43

3.2 Population                                                                                                                         44

3.3 Types and sources of data                                                                                                            44

3.4 Model specification                                                                                                          44

3.5 Method of Data Analysis                                                                                                 46

3.6 Model estimation procedure                                                                                             46

3.6.1 Unit root test                                                                                                                  47

3.6.2 Dickey Fuller                                                                                                                 47

3.6.4 Johansen co-integration                                                                                                 47

3.6.5 Impulse response function                                                                                             49

3.6.6 Variance decomposition                                                                                                            49

3.7 A priori Expectation                                                                                                         49

3.8 Ethical Consideration                                                                                                       50



4.0 Introduction                                                                                                                      51

4.1 Descriptive Analysis and Trend                                                                                        51

4.2 Econometrics Analysis                                                                                                      64

4.7 Theoretical findings                                                                                                          72

4.8 Empirical Findings


5.1 Summary                                                                                                                           74

5.2 Conclusion                                                                                                                        74

5.3 Recommendation                                                                                                              75

5.5 Contribution to knowledge                                                                                               75

5.6 Limitation of the study                                                                                                     76

5.7 Suggestion for further research                                                                                         76

References                                                                                                                              77

Appendices                                                                                                                             83




Table                                                                                                                                       Page

4.1 Descriptive statistics                                                                                                         51

4.2 Correlation Analysis                                                                                                         57

4.3 Unit root and Stationary tests                                                                                           58

4.3.1 Using Statistical value and Critical value                                                                      60

4.4 Summary result on Co-integration test                                                                             62

4.5 Relationship between Exchange rate, Crude oil price and RGDP                                               64

4.6 Relationship between Exchange rate, Crude oil price and external reserve                     65

4.7 Relationship between Exchange rate, Crude oil price and CPI                                       66

4.8 Summary of Variance decomposition results                                                                   71



Figure                                                                                                                                      Page

4.1 Trend of RGDP, Exchange rate and Crude oil price in Nigeria                                      54

4.2 Trend of External reserve, Exchange rate and Crude oil price in Nigeria                        55

4.3 Trend of CPI, exchange rate   and crude oil price in Nigeria                                           56

4.4 Impulse response of RGDP to Exchange rate and Crude oil price                                              68

4.5 Impulse response of External reserve to Exchange Rate and Crude oil price                  69

4.6 Impulse response of CPI to exchange rate and crude oil price                                         70




1.1       Background to the Study

The search for oil which began in 1907 when Nigeria Bitumen Corporation conducted exploratory work in the country; however the firm left the country at the onset of world war. Thereafter licenses were given to D’Arcy Exploration Company and Whitehall petroleum. However, neither company found oil of commercial value and they returned their licenses in 1923 (Frynas, 1999). A new license covering 357,000sq.miles was given to a new firm called shell D’Arcy petroleum Development Company of Nigeria. The new firm was a consortium of Shell and British petroleum (then known as Anglo-Iranian). The company began exploratory work in 1937. Oil was discovered in non-commercial quantity at Akata near Eket in 1953 (Frynas, 1999).Shell BP in the pursuit of commercially available petroleum found oil in Oloibiri, Niger Delta which is in present Bayelsa state in 1956.  Since the discovery of oil in commercial quantity, Nigeria has been largely a mono-product economy. The value of Nigeria’s total export revenue in 2010 stood at US$70,579 million, while income from petroleum exports of the total export revenue was US$61,804 million representing about 87.6 percent (Ogundipe&ojeaga, 2014).The discovery of oil brought in the eastern and mid-eastern regions of Nigeria, this brought hope of a brighter future for Nigeria in terms of economic development as Nigeria became independent. In 1969 the Nigerian government enacted decree 51 to strengthen its hold on the oil industry. With this decree the country (Nigeria) took greater control over the granting of concession and more involvement in the refining, distributing, and price of crude oil (Genova and Falola, 2003). It is clear that Nigeria realized the importance of its oil industry as well as the need to control it.

Prior to the discovery of Oil, Nigeria (like many other African countries) strongly relied on agricultural exports to other countries to supply to their economies (Andrew, 2009). Agriculture was the dominant source of Nigeria’s revenue earning and hence the sustenance of the economy accounting for 64.1% of the GDP before the discovery of petroleum of commercial quantity in 1956 (Oluwasanmi, 1960).Palm oil became an export commodity in Nigeria as far back as 1558; and by 1830, the Niger Delta, which now produces crude oil, had become the major source of palm oil which dominated Nigeria’s export list for more than 50 years (Olukoju, 2009). Cotton joined the export list in 1856, while cocoa was introduced and became an export cropin 1895 (Olukoju, 2009). Together with rubber, groundnut, palm kernel and Bennie-seed in later years formed the major valuable crops. These cash crops formed the main source of revenue, export and foreign exchange for the government (Udo, 1967). The savannah grassland to the north supports the planting of cereal and leguminous crops such as sorghum, millet, ground nuts as well as animal rearing mostly for hide and skin (Ekundare, 1973). Agriculture was the mainstay of Nigeria’s economy from the earliest time up to 1950s. Nigerians had an enviable record of food sufficiency but the era did not last beyond the 1960s when its economy began a descent into an abysmal dependence on imports (Ake, 1985).Agriculture provided 95% of the food needed to feed Nigerians, contributed 64.1% Gross Domestic Product (GDP) and employed over 70% of Nigerian population before oil began to be exported (Oluwasanmi, 1960).

The oil dependence and volatility of oil prices in international markets often lead to significant problems in areas of fiscal planning, quality of public spending, and other financial institutions when oil prices collapse. When oil prices fall, fiscal budgets sometimes go into deficit; countries badly affected start taking loans tied to their reserves, and incur more debt. The activities of cartel pricing policy and oil speculators have also affected the price of crude oil, growth of speculative activities which often influence exchange rate. Speculation causes short run fluctuation in exchange rate, and when there is speculation or expectation of a change in the rate of exchange or oil price, a state disequilibrium arises.  The forex reserve is at the lowest level since October 2005 when Nigeria recorded $23.92 billion in external reserve. With this, the central bank has ignored calls to devalue the naira, maintaining an official exchange rate of N197 per dollar while the currency trades at N350 per dollar at the parallel market (Financial Nigeria, 2016).

According to Adedipe (2004), the rise in oil revenue was caused by the Middle East war of 1973. It created extraordinary wealth for Nigeria and the naira appreciated as foreign exchange influxes offset outflows and Nigeria foreign reserves assets increased. Between 1973 and March 1974, when OPEC announced an Oil embargo against a number of western countries for their support for Israel during the six days war, Oil prices reach $12 per barrel from $3 per barrel( premium times, 2014). By 1979 to 1980, the new Nigeria narrative was ‘austerity’ as oil prices fell for two decades thereafter. Until 2003, the Nigeria economy’s boom and burst cycle was predicted using the oil price outlook( Premium times, 2014) Oil prices fell sharply in the second half of 2014, bringing to an end a four-year period of stability of $105 per barrel. The decline, which is much larger than that of the non-oil commodity price indices compared to early-2011 peaks, may signal an end to a price “super cycle” (Pricewaterhousecoopers, 2015).The economy of Nigeria gradually became dependent on crude oil as productivity declined in other sectors (Englama, Duke, Ogunleye&Isma., 2010). Between June 30 2014 and Dec. 31 2014 oil prices declined from $112.78/barrel to 55.57/barrel, they recorded a decline of 15%, the naira depreciated by 8% and 13% at the official and interbank market in 2014 and by 5.6% at the interbank market as at Jan 23 2015(Godwin, 2015).The sources and implications of the sharp decline in oil prices led to intensive debate,the oil price falls to $50/bbl. in the second quarter of 2015, before recovering to an equilibrium level of $70/bbl. in 2016. At $55/bbl. in 2015, the average oil price falls short of Nigeria’s proposed federal budget benchmark, of $65bbl (PWC, 2015).Oil prices remained low in 2015 and rose only marginally in 2016.

Exchange rate is the price for which a country’s currency is exchanged for another’s country’s currency and is influenced by several factors among which are interest rates, inflation, or political condition of the country (Oliver &Okpe, 2015). The exchange rate is perhaps one of the most widely discussed topics in Nigeria today because of its macro-economic importance especially in a highly import dependent economy as Nigeria (Olisadebe, 1995). Although the Naira exchange rate witnessed some period of relative calm between July to November 1986 since the implementation of the structural adjustment programme (SAP) in July, 1986, its continued depreciation form December 1986, however, may have implications on the level of real sector activities in the country. The Naira which traded at N0.960 = US$1.00 in December 1985 depreciated to N3.18 to $1.00 by December 1986 and further to N8.71 against the US dollar in  December 1990. To stem the trend, the policy of guided deregulation pegged the naira at N21.89 against the dollar in 1994.

Further deregulation of the foreign exchange market in 1999, however, pushed the exchange rate to N97.60 to US$1.00 by December (CBN statistical bulletin, 2015). With huge inflow of oil revenue due to hike in the oil price, the end-period rate stood at N118.21 in December, 2007. This remained stable until towards the end of 2008 when the global financial crisis took its toll on the oil sector thereby causing naira exchange rate to depreciatefrom 117.74, 2008 to N126.48 in December, 2008 and further to N149.68 in December 2009, (Aliyu, 2009).In  December 2010, the exchange rate further depreciated to N150.48 and 157.32 by December 2013. In December, 2014 the exchange rate stood at N169.68 which later depreciated to N196.99 as at December, 2015 (CBN statistical bulletin, 2015).

1.2       Statement of the Problem

Nigeria as Africa’s largest oil exporter and the world’s tenth largest oil producing country has realized over US$ 600 billion in oil revenues since 1960, currently the 5th highest net oil exporter in the World (CIA World Fact Book, 2015). Nigeria’s economy is heavily dependent on natural resources where oil and gas constitutes 90% of total exports, 80% of government revenues and about 35% of GDP (Opec Annual Bulletin, 2015).Oil price fluctuation has taken the center stage in national economic consideration in over two decades due to its role in all facets of life, and thereafter on all macroeconomic variables. Monetary and financial instability is often caused by unstable oil prices in a nation such as Nigeria which also result in setbacks in fluctuating oil price has made planning of the economy difficult due to the multiple crises arising from it. Oil price fluctuations create shocks in the economy leading to spiral effects on prices of all other goods and services, and on planning by all segments in the system, government, firms, consumers and externals. Nigeria’s daily output level has been recently affected by the militants’ attack on oil wells in Niger Delta area of the South-South region; OPEC and international market control of oil prices make the effects of fluctuations harder on citizens.

The Nigeria economy has been adversely affected by external shocks, particularly a fall in the global price of crude oil. Growth slowed sharply from 6.2% in 2014 to an estimated 3.0% in 2015. Inflation increased from 7.8% to an estimated 9.0% in 2015. The slow growth is mainly attributed to a slowdown in economic activity which has been adversely impacted by the inadequate supply of foreign exchange and aggravated by the foreign exchange restriction targeted at a list of 41 imports, some of which are inputs for manufacturing and agro industry (Africa development bank, 2015).

Since 1986, when the market determined exchange rate was introduced, the naira exchange rate has exhibited the features of continuous depreciation and instability resulting in decline in the standard of living of the populace, increased cost of production leading to cost push inflation.  Additionally, speculators have made the exchange rate to continue to suffer, thus making international competitiveness for our products to be endangered. A good number of small and medium scale enterprises have been forced out due to high exchange rate and increase in prices of petroleum components thereby causing untold hardship on the citizens of the economy (Oliver, 2015). This movement of the exchange rate along the path of depreciation since 1986 has raised a lot of questions on the effect of exchange rate on the Nigerian economy.

1.3       Objective of the study

The main objective of this study is to determine the degree to which fluctuation in exchange rate and oil prices affect the Nigerian economy.The specific objectives of this study are to:

  • analyze the relationship between GDP; exchange rate and crude oil prices in Nigeria;
  • analyze the relationship between external reserve; exchange rate and Crude oil price in Nigeria and
  • analyze the relationship between Inflation; exchange rate and crude oil price in Nigeria.

1.4       Research Questions

  • What is the relationship between exchange rate, Crude oil price and GDP?
  • What is the relationship between exchange rate, Crude oil price and External reserve?
  • What is the relationship between exchange rate, Crude oil price and Inflation?

1.5       Hypotheses

The following are the research hypothesis for the study at 0.05 level of significance

H01There is no relationship between exchange rate, crude oil price and GDP.

H02: There is no relationship between exchange rate, crude oil price and external reserve.

H03: There is no relationship between exchange rate, crude oil price and Inflation.

1.6       Scope of the Study

The study covered the period of 1985 to 2015; to account for the various fluctuations in the trend of the oil prices. Data used were quarterly because CBN publishes quarterly which served the purpose of this study rather than annual publications and the main variable of concern were the Real Gross Domestic product,External  Reserve , Consumer Price Index, Crude Oil  Price and Exchange rate.

1.7       Justification for the Study

The justification of the study is to examine the extent to which crude oil price and exchange rate affect the Nigeria’s economy. Oil price changes directly affects the inflow of foreign exchange into the country, therefore there is a need to investigate its effect on the naira exchange rates; as crude oil is a key source of energy in Nigeria and in the world. Oil being an important part of the economy of Nigeria plays a strong role in influencing the economic and political fate of the country, crude oil has generated great wealth for Nigeria, but its effect on the growth of the Nigerian economy as regards returns and productivity is still questionable (Odularu, 2007).

Oil prices have received important considerations for their presumed role on macroeconomic variables. Higher oil prices may reduce economic growth, generate stock exchange panics and produce inflation which eventually leads to monetary and financial instability. It will also lead to high interest rates and even a plunge into recession (Mckillop, 2004). Since oil price volatility directly affects the inflow of foreign exchange into the country, there is a need to investigate if it has direct impact on the Naira exchange rate volatility (Englamaet al., 2010). The oil market has been and will continue to be an ever changing arena. This is because oil is so vital to the world economy, it is present in everyone’s daily lives and its market is truly global (El-badri, 2011).

Thus, it is on this note that this study seeks to examine the relationship between crude oil price and exchange rates and its effects on the Nigeria economy, as well as suggest methods of minimizing the adverse effects it can produce on the economy as a whole.

1.8       Significance of the Study

The study is important for Nigeria’s economy; it gives a better insight into how crude oil prices and exchange rates affect the economy which could either be positive or negative effect. The study would help policy makers develop economic policies that would capture the specific macroeconomic needs of Nigeria. The mechanism through which shocks are transmitted would become channels through which the economy would be rescued. The recent global financial crisis has caused policy makers around the world to be very cautious with macroeconomic instability. This study would add to knowledge of the sources of shocks by looking country specific characteristics and appropriate policy interventions for specific cases.

The study is useful in policy recommendation, as it helps to improve the policy making of the government of Nigeria that is characterized by weak rule of law, malfunctioning bureaucracy and Corruption. The country often relies on a system of patronage and do not develop a democratic system based on electoral competition, scrutiny and civil rights. Thus, oil exporting country like Nigeria should ensure enforcement of rule of law and reduce corruption and rent-seeking activities so that oil rents can filter to economic growth. Moreover, developing countries also need to diversify the production base so that manufacturing activities can be developed.

1.9       Operational Definition of Terms

Oil – prices: The price in dollars at which a barrel of crude oil is sold for in the international market.

Exchange rate: The price of one currency in terms of another. It can be expressed in one of two ways, as units of domestic currency per unit of foreign currency or units of foreign currency per unit of domestic currency.

Economic growth: This is the growth of the real output of an economy overtime.

Volatility: Fluctuations in the value of a variable, especially price.



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