The impact of Oil price changes on the Gulf Council Countries (GCC) stock markets - Dissertation Example

?The impact of Oil price changes on the Gulf Council Countries (GCC) stock markets Contents Contents 2 Introduction 3 Objective of the Project 4 Justification 4 Literature Review 5 Cause and Effect of Oil Price Fluctuations 5 Effect on Financial condition 5 Importance of the Gulf Council Countries in Determining Oil Price 6 Historical Review of Impact of Oil Price Volatility on Financial Markets 7 Methodology 8 Data Collection 9 Linear Model 9 Conclusion 9 Reference 10 Bibliography 13 Introduction Energy is one of the most important factors of global economy. A country, which has enough sources of energy, can be one of the richest countries of the world. At present oil is the primary and most used sources of energy in world. Gulf countries are the major sources of oil, so their economy is one of the strongest in the world. The changes of the world economy majorly depend on the changes of oil prices. When the oil price increases, then the manufacturers around the world has to incur more cost in the manufacturing process. The cost of transportation also increases. Because of the increment in the operating cost, the profit of the company decreases. A country’s economy mostly depends on the performance of the companies. When the performance of the company decreases that is the profit of the company decreases, then the economy of the country also get affected. The foreign investors also feel less attracted for the economy of the oil importing country. The investors feel that if they invest that amount of money elsewhere then they can generate more return as the efficiency of the oil importing countries have been decreased due to the oil price hike. However, it is also a fact that the present era is the era of globalization. In this era of globalization, the economy of one country has certain effect to the economy of other country. As the oil price hikes so, the country, which imports oil from some other country, found problem in manufacturing. They have the problem in the manufacturing of the products, which are the need of the oil exporting countries (Aliyu, pp. 8-9). The product price will also be high. The inflation increases and the price of the goods and services increases. The value of the currency comes down for the oil importing countries. For the oil exporting countries the price of goods, which they have to import from any other country increases. Though they make huge profit by exporting oil to other countries, they also have to pay more than the normal for the goods they import from the other countries. The oil price hike does not only increase inflation, but also it affects other macro economical factors like gross domestic product, unemployment rate of the country. As the productivity of the companies decrease due to the hike of oil prices, the gross domestic product of the country also decreases (OECD, pp.5-6). As the productivity of the companies decreases, the unemployment rate also increases. If the productivity of the company decreases and the unemployment rate increases, the economy would suffer huge blow. The capital inflow in the market would decrease. The stock market of the countries would have less capital flow and the market indices will be down, as it was in the case of the global recession of 2007-2010. In the era of globalization, when the stock market of one country depends on the performance of the performance of the stock market of some other country, then the stock market of the richest countries even get affected. This happens in case of the gulf Council Countries also. The gulf council countries are consisting of Qatar, Baharin, United Arab Emirates, Saudi Arabia, Oman and Kuwait. All are the countries from Middle East. The countries of the Middle East are one of the largest oil producing countries (International Monetary Fund, “The Impact of Higher Oil Prices on the Global Economy”). Though they get benefit from the price hike of oil, their stock market also get affect from the events. Objective of the Project The objective of the study is to examine the effect on the stock market of Gulf Council Countries due to the fluctuations of the oil prices. There are many macro economic factors, which affects the stock market like the capital existing in the market, the gross domestic product, the unemployment rate etc. Considering all the factors the researcher will try to find out the effect of the oil prices on the stock markets of GCC countries. The stock market condition for a period will analyze by the statistical tools and the conclusion would be whether the oil prices affect the stock markets of the gulf council countries or not. If the oil price fluctuations affect the market then how does it affect. Is there a positive correlation between the two or there is a negative correlation between the two variables that would also be analyzed. Justification The Gulf Council countries are one of the biggest oil producers in the world. They have enough reserves also. Oil prices are one of the major factors of global economy and from the point of view, the Gulf Council countries are very important for the world. Therefore, the researcher has chosen to analyze the effects on the stock market of those countries for the change of oil prices. The investors have the view that if the oil price rises then the stock market trend is bearish and if the oil price decreases then the stock market trend is bullish. However, from some previous events it has seen by the researcher that the trend has not followed always. For these reasons, the researcher has chosen the topic to do the research. Literature Review Cause and Effect of Oil Price Fluctuations There are several geopolitical factors, which affects the prices of oil, which is one of the biggest factors of the world economy. The oil prices changes over the demand and supply of oil throughout the world. Historically, it has founded that the demand of oil is higher than the supply, so there is the chances of increasing the oil prices. The changes of oil prices also depend on the natural disaster like Hurricane Katrina, also depends on the war between the countries (like the war between the United States and Iraq). For the events like war and natural disaster, the oil prices are subject to change as the supply become lower than the normal condition. The price of oil also depends on the labour productivity of the manufacturing company as well as the government spending of the country as well as the countries where the oil exported (Unalmis, Unalmis and Unsal, pp.14-17). If the oil price rises in the world economy, as an effect the level of output can decrease in the oil importing country. The recession may hit the country as a result. If the oil price hikes then the countries, which imports oil from other country (most of the countries in the world) loss the benefit of collecting tax from the country people (Ramos and Veiga, pp.8-10). The benefits of tax go to the country, which exports oil. It has found from the research that the demand for the oil is increasing persistently, when the supply is decreasing; as a result, the price is increasing continuously (Research Department, pp.23-24). In addition, there are other factors those affects the oil prices. It has found that countries like China, the most populated country in the world, the demand for oil will increase 40%, which is the factor for increasing the oil price. In addition, the fear premium of the Middle East, which is the main supplier of oil, add $4 to $8 with the current prices (Roubini and Setser, pp.4-7). Effect on Financial condition Fluctuations of the oil price affect the world economy and the financial market is a major component of the world economy. The inflation of the oil importing country affected, the corporate earnings decrease as well as the monetary policy of the country tightened. Because of all these, the fluctuation in the stock market happens. The asset prices of the companies as well as the households become decreases because of increased oil prices (African Development Bank, p. 126). Debt of the country (Developing economy) increases (Denominated in local currency) when the oil price increases. The confidence of the foreign investor also decreases on the economy; as a result, the capital inflow decreases. The currency of the country declined than the other currencies of world. As the economy of the country is down, because of this the index of the stock market of the country also decreased. As the oil price increased, the cost of manufacturing, the transportation cost of the company increases. Therefore, the operating cost increases. As the operating cost increases, the profit of the company comes down (Moselle, Padilla and Schmalensee, p. 146). The capital inflow from the foreign investors also decreases. The domestic investors are also no longer attracted to invest in the company. As a result, the stock price of the company gets affected. The stock price comes down for the companies of the oil importing countries. In oil importing country, if the oil price of the increases then the stock market is likely to take a bearish trend and when the oil price is likely to decrease then the stock indices is likely to take a bullish trend (Walayat, Stock-Markets / Stock Markets 2011). The stock market is the index of the economy of a country. If the stock market is down, the implication is that the economy of the country is in the bad phase, and the opposite is true. If the stock market trend of the country is bullish, then it the interpretation is that the economy of the country is in a good phase. Importance of the Gulf Council Countries in Determining Oil Price The countries, which belong to the Gulf Council Countries (GCC), have significant effect in the world economy. The economies of the countries have developed very fast, which made the area one of the prosperous of in the world. The gross domestic product of the country has increased at a fast pace from the year 2003 to the year 2007. The estimated Gross Domestic Product in the year 2007 was US $791 billion for all the GCC countries as a whole (International Monetary Fund, “IMF Executive Board Concludes 2011 Article IV Consultation with Saudi Arabia”). The main reason of increasing the gross domestic product of the country is the increment of the oil prices, which has increased 300% in the four years. The main export good of the GCC countries is oil which accounts for 70% of the total export (Sturm et al., pp. 57-68). The countries have produced more than one fifth of the oil in the world. From the published data of the year 2007 by British Petroleum, it has revealed that the oil reserves accounted for 40% of the total oil reserve of the world and the gas reserve accounted for 23% of the world (BP, pp. 8-12). It is also fact oil and gas is the two major primary energy sources of the world. United Arab Emirates, Kuwait and Saudi Arabia are among the top ten countries of the world based on oil reserves. The dependency on import of oil is high in case of the European Union, China and the United States, which will rise further as per the projection (Helbing et al., pp. 1-2). It has also projected that the Middle East countries will be the main supplier for the remaining world in the future. As per the publication of British Petroleum the GCC countries are at the unique place when the oil reserves are considered. When the reserve oil is considered, it has found by the British Petroleum, that the 61% of total reserves are hold by the Middle East countries and the GCC comprised of two third of the Middle East countries (International Monetary Fund Fiscal Affairs Department, pp. 6-7). The oil reserve in the GCC countries are of lower quality and therefore the processing charges are high. However, the oil finding costs are lower in the countries than the other countries having the oil reserve. Considering all the factors it can conclude that the Gulf Council Countries are competitive in the industry of oil production and it will remain the competitive one in future. Historical Review of Impact of Oil Price Volatility on Financial Markets Several researches have conducted to find the relation of the oil price fluctuation and their effect on the stock market. A research by taking two different periods the relation between the oil price changes and the GCC stock market has analyzed by the researcher. The time taken by the researcher was from 2005 to 2008 and the other period taken by the researcher was 1996 to 2007. It has found by the researcher that the relationship of the stock market of Saudi Arabia and the oil price is bi-directional. The oil price depends on the changes of the stock market of Saudi Arabia. It has concluded by the researcher that the price changes of the stock market of other GCC countries doesn’t affect the changes in oil prices, but the changes in oil prices affect the stock market prices of all the GCC countries (Arouri and Rault, pp. 13-16). From another research work for identifying the relation of the stock market returns of the GCC countries and the oil prices, it has found by the researcher that the changes in oil prices does not affect the stock markets of Baharin and Kuwait. It has found that in the remaining four countries of GCC the relation of the stock markets and the oil price movement is nonlinear (Arouri, Lahini and Bellalah, pp. 135-136). A research has been conducted on the Chinese stocks. The data collected for the period of 1994 to 2009. It has found from the research that the return from the Chinese stock markets is positively sensitive to the oil prices. As the Chinese stock markets are positively correlated with the oil price movements, so, it has concluded by the researcher that the stock market of China is an attractive area for hedging against the oil price hike. The theoretical assumption by the researcher was that the oil price hike is negatively correlated with the stock market returns. When the oil price hikes then the return from the stock market decreases as inflation, unemployment affected the country. On the other side, when the oil price decreases then the return from the stock market increases. However, the data analysis of the Chinese stock market contradicts the theory (Nandha and Singh, pp. 12-15). One of the research conducted by the researchers before the year 2003, implied that investors generally under react to the fluctuations of the oil prices in the short run. As per the efficient market hypothesis of Eugene Fama the information is available to all the investors readily, which is related to the stock market (Fama, pp.412-414). But it has been found that the effect of prediction is less strong for the oil related industries. Which also arise a question against the efficient market hypothesis of Fama. The researchers have used Thirty years data for analyzing the relation between the oil prices fluctuation and the return from the stock markets. They have found that the oil prices have substantial effect to the return of the stock markets (Driesprong, Jacobsen and Matt, pp.13-16). Reviewing all the literatures and researches about the topic, the researcher has found the justification for analyzing the relation between the oil prices and the return of the stock market. It has been found from the researches that the results are contradictory. Therefore, in this scenario the researcher will try to find out the relation between the changes of oil price and their effects on the stock markets of the Gulf Council Countries. Methodology The researcher will conduct the research for analyzing the relation between the fluctuations of the oil prices and the subsequent changes of return from the stock markets of the Gulf Council countries. For analyzing these researchers have to analyze the stock market data for the past few years. In the past few years the world has seen many ups and downs in the financial as well as political world. So this is an ideal time frame for conducting the research about the relation between the stock price changes in the stock markets of the gulf council countries and the changes of the oil prices. Data Collection The researcher has to find the data of the stock market from the website where the historical data about the stock markets of the six countries Qatar, Baharin, United Arab Emirates, Saudi Arabia, Oman and Kuwait are available (GulfBase, “GCC Stock Market Indices”). The data about the oil prices will be collected from the secondary sources also. The sample period will be of five years. The data of the stock market of the six countries will be collected for these last five years, as well as the data about the price of oil will also be collected for the last five years. It is also a fact that the return from the stock market is not only dependent on the prices of oil for the stock markets. So the researcher has also find out the factors of the return from the stock markets. The data related to the factors are also collected from the authenticated secondary sources. Linear Model The researcher has to find the relation of two variables which is dependent on the time period. Therefore, the researcher has to do the time series analysis. For analyzing the time series the linear model will be used by the researcher. The linear regression model will be used for which there would be one independent variable (Hocking, pp 7-8). The independent variable in this case will be the price of the oil during the five year time period selected by the researcher. The dependent variable of the analysis would be the return from the stock market. Conclusion Oil is one of the most important sources of energy of the present world. The gulf council countries are one of the major sources of oil to the remaining world; also there are sufficient future sources. Oil prices are one of the major determinants of today’s’ economy. The macroeconomic factors of the world like the inflation, the gross domestic products of the country, the unemployment rate depends majorly on the oil prices. The oil importing countries suffered financially if the price of oil hikes, and if the price decreases then financial condition gets a boost. In the era of globalization the oil exporting countries are also likely to suffer. Previous researches conducted on this topic showed contradictory results. Some of these say that the oil prices don’t affect the return from the stock markets of the GCC countries, some contradicts that. The research is to analyze the effect of the changes in oil prices to the return of the stock market of the GCC countries. The effect will be analyzed and it will also be analyzed by the researcher that the effect is to which extent. Reference Unalmis, D. Unalmis, I. and Unsal, D. 2009. IMF Working Paper on the Sources of Oil Price Fluctuations. 9 March, 2012 from . Roubini, N. and Setser, B. 2004. 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