UNIVERSITY OF ECONOMICS

HO CHI MINH CITY

VIETNAM

ERASMUS UNVERSITY ROTTERDAM

INSTITUTE OF SOCIAL STUDIE

THE NETHERLANDS

VIETNAM – THE NETHERLANDS

PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

ESTIMATION OF CRUDE OIL IMPORT

DEMAND OF OECD COUNTRIES

BY

HOANG TUNG DIEP

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

HO CHI MINH CITY, SEPTEMBER 2016

UNIVERSITY OF ECONOMICS

HO CHIMINH CITY

VIETNAM

INSTITUTE OF SOCIAL STUDIES

THE HAGUE

THE NETHERLANDS

VIETNAM - NETHERLANDS

PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

ESTIMATION OF CRUDE OIL IMPORT DEMAND

OF OECD COUNTRIES

A thesis submitted in partial fulfilment of the requirements for the degree of

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

By

HOANG TUNG DIEP

Academic Supervisor:

DR. PHAM THI BICH NGOC

HO CHI MINH CITY, SEPTEMBER 2016

DECLARATION

I declare that: “Estimation of crude oil import demand of OECD countries” is my own

work; it has not been submitted for any degree at other universities.

I confirm that I have made all possible effort and applied all knowledge for finishing this

thesis to the best of my ability.

Ho Chi Minh City, September 2016

Hoang Tung Diep

iii

ACKNOWLEDGEMENTS

I would like to express deepest gratitude to my academic supervisor, Dr Pham ThiBich

Ngoc who gives me helpful comments, excellent guidance. Her patience and caring brings the

motivation for me.

I would like to send my special thanks to Dr. Truong Dang Thuy who always gives me

good advices whenever I got stuck. Additionally, he is the person push me to finish this thesis

and always cares of my thesis process.

I am also grateful to Prof. Dr. Nguyen Trong Hoai and Dr. Pham Khanh Nam and all of

Vietnam – Netherland staffs who always support us for the two-year of studying.

Last but not least, my sincerest thanks are for my family, my friends. Without their

frequent encouragement as well as spiritual support, I would not have been able to complete this

thesis.

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ABSTRACT

Crude oil is considerably the most important energy for world economy and most of all countries

were affected by the crude oil price no matter they are played as the producers or consumers or

both. Applying the data of 27 OECD countries from 1988 to 2013, this thesis conducts the

import demand model to estimate the income elasticity and price elasticity for OECD together

with the impact of financial crisis on 2008, the domestic crude oil production, the exchange rate,

the population growth. The estimation of price elasticity for the whole region is -0.155 suggests

that OECD is not sensitive with the increase in crude oil import price. Additionally, the income

elasticity of whole region is 0.562 implies that income raise would lead to the increase in

economic activities, so that the demand for crude oil increases. Finally, the impact of world

financial crisis is confirmed in the estimation.

Keywords: crude oil, demand, import, OECD, price elasticity, income elasticity, crisis

v

ABBREVIATIONS

OECD

Organization of Economic Cooperation and Development

IEA

International Energy Agency

EEC

European Economic Community

IMF

International Money Fund

UK

United Kingdom

USA

United State of America

GDP

Gross Domestic Product

GNP

Gross National Product

OLS

Ordinary Least Square

FE

Fixed effects

RE

Random effects

ARDL

Autoregressive Distributed Lags

FM

Fully Modified

UECM

Unrestricted Error Correction Model

RE GLS

Random effect Generalize Least Square

vi

TABLE OF CONTENTS

CHAPTER 1 INTRODUCTION .................................................................................................. 1

1.1 Problem statement ..................................................................................................................... 1

1.2 Research Objective ................................................................................................................... 2

1.3 Research questions .................................................................................................................... 2

1.4 Research scope, data and methodology .................................................................................... 3

1.5 Thesis structure ......................................................................................................................... 3

CHAPTER 2 LITERATURE REVIEW ......................................................................................... 4

2.1. Some concepts ......................................................................................................................... 4

2.1.1 Crude oil................................................................................................................................. 4

2.1.2 Import demand ....................................................................................................................... 4

2.1.3 Price elasticity and income elasticity ..................................................................................... 5

2.2 Theoretical literature ................................................................................................................. 5

2.2.1 The traditional trade theory.................................................................................................... 5

2.2.2 The new trade theory ............................................................................................................. 6

2.2.3 The standard trade model ....................................................................................................... 6

2.3 Empirical literature ................................................................................................................... 8

2.3.1 Impact of import price and income on import demand.......................................................... 8

2.3.2 Impact of financial crisis on oil import demand .................................................................. 10

2.3.3 Applied control variables ..................................................................................................... 12

2.3.4 Import demand estimation approach .................................................................................... 13

2.4 Analytical Framework ............................................................................................................ 17

CHAPTER 3 RESEARCH METHODOLOGY ......................................................................... 18

3.1. Model specification ................................................................................................................ 18

viii

3.1.1 The crude oil import demand model .................................................................................... 18

3.1.2 Price elasticity and income elasticity ................................................................................... 20

3.1.3 Variables and expected signs ............................................................................................... 21

3.2 Research methodology ............................................................................................................ 23

3.2.1 Estimation models................................................................................................................ 23

3.2.2 Hypothesis tests ................................................................................................................... 26

3.3 Data description ...................................................................................................................... 27

3.3.1 Data source........................................................................................................................... 27

3.3.2 The OECD economic development and oil demand............................................................ 27

3.3.3 Data description ................................................................................................................... 28

CHAPTER 4

EMPIRICAL RESULTS .................................................................................... 33

4.1. The OLS, FE and RE results: ................................................................................................. 33

4.2 Hypothesis tests ...................................................................................................................... 35

4.2.1 Hausman test for Fixed versus Random effects model ........................................................ 35

4.2.2 Random effects Generalized Least Square estimation......................................................... 35

4.2.3 Cointegration test for panel data .......................................................................................... 36

4.3 Estimation of the price elasticity and income elasticity.......................................................... 37

CHAPTER 5

CONCLUSION ................................................................................................... 40

5.1 Main findings .......................................................................................................................... 40

5.2 Policy implications.................................................................................................................. 41

5.3 Limitations and further research ............................................................................................. 42

REFERENCES ............................................................................................................................. 43

ix

LIST OF TABLES

Table 2.3 Summary of empirical researches ................................................................................. 16

Table 3.1 Variables expected signs ............................................................................................... 23

Table 3.3.3 Variables summary .................................................................................................... 29

Table 3.3.4 Mean of Import price (in logarithm) and Income (in logarithm) ............................... 30

Table 4.1 Summarized Estimation of specification ...................................................................... 33

Table 4.2 Hausman test ................................................................................................................. 35

Table 4.2.2 Random effects Generalized Least Square model ..................................................... 36

Table 4.2.3 Cointegration test for panel data ................................................................................ 37

Table 4.3.1 Results of individual income elasticity and price elasticity ....................................... 37

Table 4.3.2 Summarized of price elasticity and income elasticity of crude oil import demand ... 38

x

LIST OF FIGURES

Figure 2.1.2 Import demand curve .................................................................................................. 5

Figure 2.2.3a General equilibrium theory ....................................................................................... 7

Figure 2.2.3b Consumer behavior theory ....................................................................................... 8

Figured 3.3.2 OECD versus Worldcrude oil import from 1988 to 2012 ...................................... 28

Figure 3.3.3 Total Crude oil import to OECD from 1988 to 2013 ............................................... 30

Figure 3.3.4a Interrelationship between crude oil import and income ......................................... 31

Figure 3.3.4b Interrelationship between crude oil import and crude oil price .............................. 32

xi

CHAPTER 1 INTRODUCTION

1.1 Problem statement

It is no doubt about the vital role of crude oil in the world economy and most of all countries

were affected by the crude oil price no matter they are played as the producers or consumers or

both (Natural resource Canada, 2010)(1). Oil has provided about 38 % energy needs in 2014 and it

will contribute to the world economy in further (Berdzenadze, 2015). Although there is new

trend of using the renewable energy which is friendly with environment, it seems that we still not

find energy that can replace for the oil due to its unique attribution such as easy to access or low

cost of refinery.

According to the IEA statistic, Global demand for crude oil in 2014 was about 92.6 million

barrels a day and daily demand for crude oil turned to 94 million in 2015. The increase in oil

demand could be explained by the development of economic activities and human income which

push expenditure on vehicles and other energy application (Zhao and Wu, 2007).

OECD stands for Organization of Economic Cooperation and Development includes 35

members and their mission is: “promote policies that will improve the economic and social wellbeing of people around the world.” The majority of OECD is the developed countries which tend

to use large amount of oil for economic activities. In the 20th century, OECD oil demand was

accounted 70 – 80% of total world demand. The IEA reported that OECD oil demand held 53

percent of total world demand in 2010 and the majority of oil was imported.

Empirical research suggested that energy demand was affected intensely by the financial

crisis. The Global Financial crisis in 2008 was recorded the greatest financial crisis since the

Great Depression (1930s) (Zang et al, 2009) when the crude oil price dropped off more than 72%

percent within five months, from the all-time high at $145.31 per barrel on July 3rd, 2008 to the

lowest value at $41 per barrel on December 5, 2008. The economists found that the financial

crisis started from the raise of subprime mortgages in America in 2007 which leaded to the

reduction in economic activities of OECD. Yet, the economic slowdown made the OECD cut off

their expense hence the crude oil demand declined.

Natural resource Canada is an organization seeks to enhance the responsible development and use of Canada’s

natural resources and the competitiveness of Canada’s natural resources products.

(1)

1

There are many researches related to oil such as oil consumption, oil export/import in

various forms of estimation. The most popular approach is to analyze income elasticity and price

elasticity of oil import. Empirical researches proved that income is inelastic in short run and

more elastic in long run (Ghosh, 2009; Kim and Beak, 2013; Narayan and Smyth, 2007…)

whereas the price elasticity is inelastic both in short and long run (Ziramba, 2010; Yaprakli and

Kaplan, 2015; Altinary, 2007…). It is interesting that energy demand studies often estimate the

particular demand of one country whereas oil demand often analyze the demand for group of

countries or region (Altinary, 2007). Although there are numerous researches that estimate the

energy import demand for particular country, the OECD crude oil import demand is completely

rare in empirical research. Additionally, due to vital role of OECD in the world economy and the

high demand of oil consumption together with high rate of crude oil import, the model of crude

oil demand of OECD needed to be employed to help exporters make prediction of impact of

pricing on future oil consumption and help the importer regulator decide to tax or subsidy on

imported oil. That was the motivations for author to conduct a study of estimation for crude oil

import demand of OECD with the effects of financial crisis in 2008.

The results of this thesis are consisted with previous studies which stated that the price and

income has impact to the quantity of crude oil imported to OECD. Additionally, the author found

that financial crisis made the demand for crude oil import shift down.

1.2 Research Objective

The thesis aims to identify the responses of crude oil quantity imported to OECD with the

change in crude oil imported price and national income in the period 1988 – 2013.

To achieve the above objective, this thesis is conducting the import demand model to

estimate the income elasticity and price elasticity for OECD together with the impact of financial

crisis on 2008, the domestic crude oil production, the exchange rate and the population growth.

1.3 Research questions

This research is designed to answer:

(i) What is a crude oil import demand model of OECD in the period 1988-2013?

(ii) What are price elasticity and income elasticity of crude oil import demand of OECD?

(iii) Does the financial crisis have effect on the crude oil import demand in OECD?

2

1.4 Research scope, data and methodology

The reason for choosing OECD countries for conducting the thesis is the huge demand of oil

in OECD. The empirical statistic showed that OECD oil consumption was 53 percent of total

world demand in 2010, this means the OCDE plays a very important role in the oil market.

Understanding the responses of demand for crude oil to the change in import price as well as the

change in OECD income would be very helpful for the exporters. In addition, there was few

researches paid attention to estimate the OECD crude oil import demand for a long time so that

this motivate the author to investigate the thesis in this region.

The empirical analysis section of the thesis will be implemented by employing unbalanced

panel data from 27 countries in OECD region over the period from 1988 to 2013. The data was

collected from OECD library.

To achieve the research objective, this thesis applied the OLS, the Fixed effects, the Random

effects and the Random effects Generalized Least Squared methods to estimate the price

elasticity and income elasticity of crude oil demand import to OECD and the impact of financial

crisis to the import demand.

1.5 Thesis structure

The outline of paper is as follow. Chapter I introduces the research objectives, the research

questions and the research scope, data and methodology. Next, Chapter 2 provides literature of

import demand and some empirical evidences. Chapter 3 describes the model specification;

research methodology including the OLS model, the FE model, the RE model and the Random

effects Generalized Least Squared model. The empirical results will be presented in Chapter 4.

Finally, Chapter 5 summarizes the conclusions then gives some policy implications and

suggestion of further research.

3

CHAPTER 2 LITERATURE REVIEW

This chapter is a review of oil import demand with the evidences in theory and empirical

evidences. Firstly, there will be some basic concepts that bring the overall images of crude oil,

import demand, price and income elasticity. Secondly, the author will restructure the theory of

trade. In the next step, many previous researches were summarized to give a board learning of oil

and energy import demand. This chapter will end with the Analytical framework.

2.1. Some concepts

2.1.1 Crude oil

Crude oil is the component of crude oil production including crude oil, natural gas liquids

(NGLs) and additives. According to OECD, Crude oil is a mineral oil consisting of a mixture of

hydrocarbons of natural origin, yellow to black in color, and of variable density and viscosity.

Additionally, the IEA organization defines crude oil is a mineral oil of fossil origin extracted

from underground reservoirs and which comprises liquid or near‐liquid hydrocarbons and

associated impurities, such as sulphur and metals.

2.1.2 Import demand

Import demand refers to the total demand for foreign goods and services of population

within particular country. It could be considered the component of Gross National Product

(GNP). According to Krugman (1978) is “An import demand curve is the difference between the

quantity that Home consumers demand minus the quantity that Home producers supply, at each

price”

The Home import demand equation is described:

MD = D – S

The import demand curve shows the maximum quantity of imports that Home country

would like to consume at each price of import good. The import demand curve is downward

sloping indicates that the increase in oil price import lead to the decrease in quantity imported

demand.

4

Figure 2.1.2 Import demand curve

Source: Krugman (1978)

At P1, the Home country solely produces goods at S1 whereas the Home country demand for

goods is D1. The shortage of demand of Home country will be imported from foreign country

and this was estimated by: D1- S1

Similar pattern is found at P2 where the import quantity is calculated by: D2 – S2

2.1.3 Price elasticity and income elasticity

The price elasticity of demand is simply the proportion change in quantity of demand given

by 1 percent change in price.

Ep=

∆𝑄/𝑄 ∆𝑄 𝑃

= x

∆𝑃/𝑃 ∆𝑃 𝑄

The income elasticity of demand is the ratio of the percentage change in quantity demand

when the income increases 1 percent.

EI=

∆𝑄/𝑄

∆𝐼/𝐼

∆𝑄 𝐼

= x

∆𝐼 𝑄

2.2 Theoretical literature

2.2.1 The traditional trade theory

According to Ricadian theory, the country that can produce goods with lower opportunity

cost has comparative advantage. Suppose that the country can produce two kind of goods A and

B. The Ricandian theory of trade stated that: “The economy will specialize in producing A if the

5

relative price of A exceeds its opportunity cost and the economy will specialize in producing B if

the relative price of A is less than its opportunity cost”

Additionally, Hecksher-Ohlin Theory found that difference in comparative advantage is due

to the difference in factor endowment. For instant, the Home country with higher labor to land

ratio is the labor abundant, the Foreign country with higher land to labor is land abundant. The

cloth production requires more labor than the food production whereas the food production

required more land than cloth production. We call that cloth production is labor-intensive and

food production is land-intensive.

When Home country and Foreign country trade together, the relative price will converge.

The relative price of cloth will increase in Home country and decrease in Foreign country. The

raise in cloth price motivates the cloth production and the cloth consumption will decrease in

Home. As the result, the Home becomes the cloth exporter and food importer.

The Hecksher-Ohlin Theory stated that: “Countries tend to export goods whose production

is intensive in factors with which they are abundantly endowed.”

2.2.2 The new trade theory

According to traditional theory, the comparative advantage comes from difference of

technology or factor endowment between countries. Empirical analysis proves that trade between

countries with similar technology or factor endowment still occurs. Therefore, the new trade

theory was developed in 1980s (Krugman 1980). What makes new trade different from the

traditional is the source of comparative advantage. These sources consist of economic scale,

imperfect markets, and product differentiation.

The new trade theory claimed that country tend to import products from another country in

order to better specialize in other products to achieve economies of scale.

2.2.3 The standard trade model

According to the neoclassical trade theory which relies on the assumption of General

Equilibrium Theory and Consumer Behavior Theory, international trade is a function of relative

price. Therefore, the standard trade model was described by Kurgman and Obstfeld (2011) as

follow:

6

General equilibrium theory

A productive ability of a country is defined by the production possibility frontier line and

points lie on the production possibility frontier line depend on the relative price of products that

the economy produced. The market value of output is indicated by the isovalue lines which the

value of output is constant. The economy will achieve highest output level at the point where the

production possibility frontier line tangent to the isovalue line. At this point, the economy yields

the highest welfare. If relative price of one product increase (called the product F), the economy

will produce more F, indicating the decrease in producing others (called the product C).

Therefore, the equilibrium output point will shift to new equilibrium position.

Figure 2.2.3a General equilibrium theory

Consumer behavior theory

The economy choice of point on the isovalue line depends on the consumers’ tastes. The

individual tastes are designed by the indifference curves – the combination of products that

maintain the consumer well fare. The indifference curves are downward slopping indicating that

if individual consumes less C, to achieve the well fare, he must use more F.

7

As consequence, the economy produces more C and consumes more F than consumer

demand. Therefore the excess of C will used for exporting and the shortage of F must be

imported from other countries.

Figure 2.2.3b Consumer behavior theory

2.3 Empirical literature

2.3.1 Impact of import price and income on import demand

The demand of crude oil imported had been developed soon by Kouris and Robinson (1977)

using the data of EEC countries in 1956 to 1985. This research had two stages: the estimation of

EEC petroleum products consumption and the relationship between crude oil imported to EEC

and the quantity of petroleum products consumed in EEC.

At the first stage, petroleum product consumption was dominated by the income, the relative

price of crude oil, the previous petroleum product consumption and the temperature. Applying

the pooled cross-section time series approach to all observations of each country, the two authors

had found that all variables had expected sign and statistically significant even at 1%. This

suggested a positive correlation between the EEC petroleum consumption and the GDP. Also,

the research verified the increase of EEC petroleum consumption is associated with the decrease

8

of oil price. Surprisingly, a computed equation in the second stage showed approximately one-toone association of oil imported and oil consumption which indicated that all of EEC oil

consumption was imported from foreign countries.

In 1993, Hungtington introduced the response surfaces for nine different world oil models to

estimate oil demand for OECD in the period of 21 years (1989-2010) with key variables were

world oil price and GDP. The main purpose of the response surfaces model was to generate the

policy insights rather than the exactly evaluation of each model. The median results revealed that

OECD oil demand was price inelastic (-0.075) in short run and -0.4 in long run whereas the

income elasticity was closely to unity. More recently, Gately and Huntington (2002) conducted

the study to find the asymmetric effects of changes in price and income on energy and oil

demand. The estimation of 96 largest economies including the OECD in the period of 1971 to

1997 showed that long run income elasticity was 0.5 and oil demand responded more with

increase than decrease in oil price/income.

In attempt to estimate the short-run and long-rung elasticity of import demand for crude oil

for Turkey, Altinary (2007) conducted a research covered the period 1980-2005. The models

included price of energy, income and two dummy variables of economy crisis and boom period.

The estimation of short run and long run elasticity of demand applied the ARDL method which

developed by Pesaran et al (2001). The bound test exposed the lag length was 1 which suggested

the long run relationship between variables. The results indicated the long run income elasticity

was 0.61 and nominal price elasticity was -0.18. In term of short run, the result revealed the short

run income elasticity was 0.64, slightly higher than the long-run, whereas the short-run nominal

price elasticity was -0.1. The dummy variable presented for the earthquake was not significant

but the dummy variables stand for War was significant.

For a long time Middle East was recognized as one of main region of exporting crude oil in

the world but there were a truth that this region has reached to bigger oil consumers. Therefore,

the study of Narayan & Smyth (2007) focused on the demand of oil in Middle East using panel

cointegration analysis. This study was consisted with many previous researches that the oil

demand was the function of per capita real income, real price of oil. The first step of panel unit

root test presented that the panel data is stationary and all variables had unit root. As a result, the

author proceed to test the cointegration using the seven Pedroni’s heterogeneous panel

9

cointegration method which presented that that oil demand, real income and real oil price were

cointegrated at least 5 percent. This gave the implication that there was a long run relationship

between variables. For more details, the two authors tried to conduct a long run impact of income

and price on oil demand in Middle East by Dynamic ordinary least square (DOLS) estimator. It

was clear that for full panel, oil demand was income inelastic in short run but it was slightly

elastic in long run while the individual panel presented the strong positive relationship between

oil demand and real income. In term of prices, the result exposed that demand for oil in Middle

East was highly price elastic in both full panel and individual countries.

In effort to estimate the oil import demand in Africa, Ziramba (2010) processed a

multivariate regression analysis for the period of 1980 -2006. The model is simple with two

independent variables: the relative price and the income. Also, the author followed the traditional

method which included Dicky – Fuller test of unit root test of time- series data and the

cointegration test proposed by Johansen technique. The result showed one vector of

cointegration. Unfortunately, the income elasticity and price elasticity were not statistically

significant in short run. In term of long-run, the income price elasticity is 0.429 indicated that

imported crude oil is a normal good whereas the price elasticity is -0.147.

With the same purpose, the study of Ghosh (2009) estimated the oil import demand for

crude oil in India for 1970 to 2006. The Autoregressive Distributed Lags (ARDL) test approach

of cointegration is developed to test the long run relationship between the crude oil import

quantity and income, and imported price. The short run price and income elasticities were not

significant with any level of confident. The long run income elasticity estimated was 1.97 and

highly statistically significant whereas the long run price elasticity was not significant.

Additionally, the bound test indicated one cointegrated vector which motivated the author

processed to the Granger-causality tests. The Granger-causality test result suggested the long run

relationship between the India economic growth and the crude oil import.

2.3.2 Impact of financial crisis on oil import demand

Most of all the researches above were implemented in the oil import-countries where the

crude oil resource was considerably rare. Kolluri and Torrisi (1987) conducted a very interesting

research which estimated an aggregate import demand for five developing oil exporting countries

using the time series data from 1960 to 1982 (Saudi Arabia, Nigeria, Indonesia, Mexico and

10

Venezuela). In details, the oil import demand model is a function of GDP, relative prices index,

the lagged of individual total reverse and dummy variable presented for the impact of oil price

shock in 1973. The OLS estimation seemed to be face with serial correlation in residual and the

maximum likelihood method was applied. The empirical results appeared to be very statistically

significant with right expected signs. Estimated income elasticities were fluctuate from 0.57 for

Saudi Arabia to 1.25 for Indonesia, with average income elasticity for five countries was 0.82

before 1973 and 1.63 since 1973. The separate domestic and import price yield significant and

correct signs with average elasticity is -1.04. The impact of dummy variable has negative value

indicate that the oil price shock in 1973 made the import demand shift down.

Despite the growing of renewable energy, crude oil holds it vital role in production and daily

life in Korea. Therefore, Kim and Baek (2013) examined crude oil import demand in Korea for

quarterly data from 1986 to 2010 using the traditional Autoregressive distributed lag (ARDL)

bound test approach. The model showed that determinants of crude oil import to Korea were

relied on the import price and income. One thing that made this research different from others

was the dummy variable captured the market shocks. The ARDL test required to formulate the

demand equation with lag variables and the selected variables was said to be cointegrated if all

the lagged variables were statistically significant. The authors revealed the appropriate lag length

for Korea estimation was p = 2 and the cointegration test showed the long rung relationship

between crude oil import and income as well as oil price. In details, the long run income

elasticity was 1.31 and the price elasticity held the lower value at -0.43 in long run. Additionally,

the market shocks dummy variable yielded significant indicated that the Asian financial crisis

made the demand for crude oil import in Korea raised.

In 2015, Yaprakli and Kaplan built a model based on traditional import demand model

which including income and relative price variables. For deeper investigation, these authors tried

to find the impact of financial crisis on the crude oil demand in Turkey for the period 1970 –

2013. To handle time series data problems, the paper used co-integration method which

contained three steps: the unit root test, test for cointegration and the dynamic ordinary least

squared (DOLS) estimations. The cointegration test supported long run relationship between

variables and the empirical results showed the inelasticity of income and price in the long run.

Moreover, the authors concluded that external crisis had bigger impact on crude oil import

demand the internal crisis did.

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2.3.3 Applied control variables

The relationship between oil domestic energy production, population and oil import demand

were introduced in the study of Adewuji (2016). This study estimated import demand for total

and specific refined petroleum products in Nigeria from 1984 to 2013. The autoregressive

distributed lag (ARDL) bound test estimation was applied to find the long run and short run

determinants of import demand. The results showed that domestic energy production and

population growth rate were drivers of demand of import of refines kerosene and motor spirit in

long – run. In the short-run, significant effect of domestic energy production on the import

demand for refined products was not found but the population growth rate did. Additionally, the

real effective exchange rate was main determinant of total and specific petroleum products in

Nigeria due to it significant effect in almost estimation. For example, the long run elasticity of

the real effective exchange rate is -1.08 for total import of refined petroleum products and long

run elasticity of the real effective exchange rate for motor spirit product and refined distillate fuel

were -0.77 and -1.1 respectively. The effect of real effective exchange rate in short-run of motor

spirit product was 0.4 and it rose to 1.82 for refined distillate fuel.

The role of exchange rate was confirmed in the research of Schryder and Peersman (2012)

by the estimations of oil demand for 23 OECD countries, 42 non-OECD countries and total 65

oil importing countries respectively for the period of 1971 to 2008. This study was applied the

advanced recent panel technique to examine the effect of income, oil price in US dollar and the

US dollar exchange rate on oil demand. The results seemed to be very consisted with the theory

which revealed the short run income elasticity of OECD was 0.568 and it was slightly higher in

non-OECD (0.639) and the total sample of countries (0.614) whereas the long run income

elasticity was 0.674, 0.885 and 0.775 respectively. In term of price elasticity, the short run price

elasticity was -0.051, -0.026 and -0.035; the long run price elasticity was higher which yielded to

-0.150 for OECD and-0.104 for non OECD. What made this study different from the others were

the findings of impact of US exchange rate on the oil demand. In details, the 1 percent

appreciation of US dollar exchange rate leaded to 0.24 percent decrease in oil demand of OECD

countries and it was timed twice to -0.150 for 65 countries.

Another research related to energy import demand was proposed by Goldar and

Mukhopadhyay (1990). The analysis of seven petroleum products import demand for India was

12

estimated for the period of 1970 – 1986 using a very simple OLS method. In particular, the

domestic demand function for petroleum products was dominated by the price index of each

products, the price of substitution possibilities exist, the other exogenous variables included the

number of tractors, the number of vehicles, industrial production index, gross power generation,

the per capita income and the population. The results suggested that domestic demand for most

of all seven petroleum products were not influent much on price changes. The other explanation

variables were considerably statistically significant with expected signs. In the next step, the

author tried to generate the import function of petroleum and found that the gap between

domestic crude oil production and the domestic demand for petroleum was the main

determinants of quantity of petroleum imports to India. What is important conclusion of this

research was the depreciation of domestic currency (rupee) which leaded to higher price of

imports could not reduce the domestic demand.

2.3.4 Import demand estimation approach

The Monte Carlo approach

For more than quarter of century, the traditional import demand function was estimated

without econometric problems. This problem was the nonstationary of variables which could

lead to the unreliable results. Therefore, Sehadji (1997) introduced the Monte Carlo approach in

which the Ordinary Least Square (OLS) estimator was dominated by Fully –Modified (FM)

estimator. The empirical research had showed that the OLS estimator faced the problem of bias

higher than the FM estimator. The FM estimator would achieve the minimum bias when the

relative price of imports and the activity variables were not endogenous. As consequence, the

FM estimator was an optimal single-equation method based on the use of OLS with serial

correlation corrections and potential endogeneity prevention of the dependent variables. In

addition, the Monte Carlo approach was very appropriate for the estimation with small sample.

Also, the FM estimator could be recognized similar to the full systems maximum likelihood

estimators.

The Dynamic - Optimizing approach

Although the Monte Carlo approach had solved the nonstationary problem of time series

data, there were several limitations with this method. In details, the time-series approach

assumed that the output was stationary and followed AR (1) process while it was nonstationaryin

13

real. In addition, the investment and government activity was not mentioned in the model which

could lead to the unstable results. Thanks to Dynamic - Optimizing approach conducted by Xu

(2000), the import demand function had taken into account both the growing economy,

investment and government activity. The Dynamic – Optimizing approach offered a

conventional import demand equation that included the “national cash flow” variable (GDP-I-GEX), the relative prices and time trend. Additionally, the investment and government was

included as the activity variables while the activity variable in the research of Shehadji (1997)

was the GDP minus exports. The Dynamic – Optimizing approach was considered more

advantage than the previous methods because it created the more general and flexible import

demand model.

The Cointegration approach

The Cointegration approach is the test of existence of a cointegrated relationship between

the aggregate import demand function and its determinants. This process is developed by Engle

and Granger (1987) and Johasen (1988, 1991). If there is an existence of a cointegration, the

long-run relationship between the aggregate import demand function and its determinants is

determined.

The Engle – Granger’s residual –based ADF method has two steps:

1. Applying OLS on the nonstationary variables to test the parameters of cointegrating

regression.

2. Appling Aguement Dickey – Fuller (ADF) to test residuals stationary.

The Johansen –Juselius (JJ) method is considerably better than the Engle – Granger’s

residual –based ADF method due to some reasons:

- The JJ method could make the combined framework for interpreting the distinction of

cointergating vectors.

- The JJ method allows us to test the magnitude and the volume of the elasticity estimation.

The Autoregressive Distributed Lags (ARDL) bound test approach

The bound test approach is generally a test based on the estimation of Unrestricted Error

Correction Model (UECM). It has two advantages:

14

- While the Johansen (1988) and Johansen and Juselius (1991) estimation are solely

appropriate for the nonstationary time-series with the same integrated level A(1), the bound test

provides the estimation for A(0); A (1) level or fractionally integrated. It means no need of test

for non-stationay properties and order of intergration of variables.

- The bound test is very powerful in cointegration analysis for model with small data.

According to Pesaran et al (2001), the bound test is based on the value of F-statistic. The

null hypothesis here is: whether the explanatory variables are I(1) or A (0), there are no

cointegration between examined variables. If the F-statistic value is higher than critical value,

I(1) then rejects the null hypothesis. In case F-statistic value is lower than critical value, I(0), the

null hypothesis cannot be reject. Note that in case the F-statistic falls within the critical value

bounds, the bounds test is solely capable use for I(1) and I (0) regressors.

- Furthermore, the bound test help to estimate the long-run elasticity by estimated coefficient

of one lagged dependent variable divided to estimated coefficient of one lagged independent

variable. In addition, the short run elasticity is estimated coefficient of first difference of

variables in UECM model.

The Panel Cointegration approach

Pedroni’s test (2004) is broadly known as the cointegration approach for heterogeneous

panels. It provides seven statistics for the test of null hypothesis no cointegration between the

dependent variable and independent variables. Among seven statistics, four are preferred for the

“within-dimension” (panel-v, panel-ρ, semi-parametric panel-t and parametric panel-t) and three

preferred for “between-dimension” (group-ρ, semi-parametric group-t and parametric group-t).

The former are calculated by “summing up the numerator and the denominator over N crosssections separately, while the latter statistics are calculated by dividing the numerator and the

denominator before summing up over N cross-sections” (Pedroni, 2004). If the statistics exceed

the critical value which calculated by Pedroni (2004), the null hypothesis of no cointegration is

rejected. Hence, there is a long run relationship between examined variables.

15

HO CHI MINH CITY

VIETNAM

ERASMUS UNVERSITY ROTTERDAM

INSTITUTE OF SOCIAL STUDIE

THE NETHERLANDS

VIETNAM – THE NETHERLANDS

PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

ESTIMATION OF CRUDE OIL IMPORT

DEMAND OF OECD COUNTRIES

BY

HOANG TUNG DIEP

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

HO CHI MINH CITY, SEPTEMBER 2016

UNIVERSITY OF ECONOMICS

HO CHIMINH CITY

VIETNAM

INSTITUTE OF SOCIAL STUDIES

THE HAGUE

THE NETHERLANDS

VIETNAM - NETHERLANDS

PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

ESTIMATION OF CRUDE OIL IMPORT DEMAND

OF OECD COUNTRIES

A thesis submitted in partial fulfilment of the requirements for the degree of

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

By

HOANG TUNG DIEP

Academic Supervisor:

DR. PHAM THI BICH NGOC

HO CHI MINH CITY, SEPTEMBER 2016

DECLARATION

I declare that: “Estimation of crude oil import demand of OECD countries” is my own

work; it has not been submitted for any degree at other universities.

I confirm that I have made all possible effort and applied all knowledge for finishing this

thesis to the best of my ability.

Ho Chi Minh City, September 2016

Hoang Tung Diep

iii

ACKNOWLEDGEMENTS

I would like to express deepest gratitude to my academic supervisor, Dr Pham ThiBich

Ngoc who gives me helpful comments, excellent guidance. Her patience and caring brings the

motivation for me.

I would like to send my special thanks to Dr. Truong Dang Thuy who always gives me

good advices whenever I got stuck. Additionally, he is the person push me to finish this thesis

and always cares of my thesis process.

I am also grateful to Prof. Dr. Nguyen Trong Hoai and Dr. Pham Khanh Nam and all of

Vietnam – Netherland staffs who always support us for the two-year of studying.

Last but not least, my sincerest thanks are for my family, my friends. Without their

frequent encouragement as well as spiritual support, I would not have been able to complete this

thesis.

iv

ABSTRACT

Crude oil is considerably the most important energy for world economy and most of all countries

were affected by the crude oil price no matter they are played as the producers or consumers or

both. Applying the data of 27 OECD countries from 1988 to 2013, this thesis conducts the

import demand model to estimate the income elasticity and price elasticity for OECD together

with the impact of financial crisis on 2008, the domestic crude oil production, the exchange rate,

the population growth. The estimation of price elasticity for the whole region is -0.155 suggests

that OECD is not sensitive with the increase in crude oil import price. Additionally, the income

elasticity of whole region is 0.562 implies that income raise would lead to the increase in

economic activities, so that the demand for crude oil increases. Finally, the impact of world

financial crisis is confirmed in the estimation.

Keywords: crude oil, demand, import, OECD, price elasticity, income elasticity, crisis

v

ABBREVIATIONS

OECD

Organization of Economic Cooperation and Development

IEA

International Energy Agency

EEC

European Economic Community

IMF

International Money Fund

UK

United Kingdom

USA

United State of America

GDP

Gross Domestic Product

GNP

Gross National Product

OLS

Ordinary Least Square

FE

Fixed effects

RE

Random effects

ARDL

Autoregressive Distributed Lags

FM

Fully Modified

UECM

Unrestricted Error Correction Model

RE GLS

Random effect Generalize Least Square

vi

TABLE OF CONTENTS

CHAPTER 1 INTRODUCTION .................................................................................................. 1

1.1 Problem statement ..................................................................................................................... 1

1.2 Research Objective ................................................................................................................... 2

1.3 Research questions .................................................................................................................... 2

1.4 Research scope, data and methodology .................................................................................... 3

1.5 Thesis structure ......................................................................................................................... 3

CHAPTER 2 LITERATURE REVIEW ......................................................................................... 4

2.1. Some concepts ......................................................................................................................... 4

2.1.1 Crude oil................................................................................................................................. 4

2.1.2 Import demand ....................................................................................................................... 4

2.1.3 Price elasticity and income elasticity ..................................................................................... 5

2.2 Theoretical literature ................................................................................................................. 5

2.2.1 The traditional trade theory.................................................................................................... 5

2.2.2 The new trade theory ............................................................................................................. 6

2.2.3 The standard trade model ....................................................................................................... 6

2.3 Empirical literature ................................................................................................................... 8

2.3.1 Impact of import price and income on import demand.......................................................... 8

2.3.2 Impact of financial crisis on oil import demand .................................................................. 10

2.3.3 Applied control variables ..................................................................................................... 12

2.3.4 Import demand estimation approach .................................................................................... 13

2.4 Analytical Framework ............................................................................................................ 17

CHAPTER 3 RESEARCH METHODOLOGY ......................................................................... 18

3.1. Model specification ................................................................................................................ 18

viii

3.1.1 The crude oil import demand model .................................................................................... 18

3.1.2 Price elasticity and income elasticity ................................................................................... 20

3.1.3 Variables and expected signs ............................................................................................... 21

3.2 Research methodology ............................................................................................................ 23

3.2.1 Estimation models................................................................................................................ 23

3.2.2 Hypothesis tests ................................................................................................................... 26

3.3 Data description ...................................................................................................................... 27

3.3.1 Data source........................................................................................................................... 27

3.3.2 The OECD economic development and oil demand............................................................ 27

3.3.3 Data description ................................................................................................................... 28

CHAPTER 4

EMPIRICAL RESULTS .................................................................................... 33

4.1. The OLS, FE and RE results: ................................................................................................. 33

4.2 Hypothesis tests ...................................................................................................................... 35

4.2.1 Hausman test for Fixed versus Random effects model ........................................................ 35

4.2.2 Random effects Generalized Least Square estimation......................................................... 35

4.2.3 Cointegration test for panel data .......................................................................................... 36

4.3 Estimation of the price elasticity and income elasticity.......................................................... 37

CHAPTER 5

CONCLUSION ................................................................................................... 40

5.1 Main findings .......................................................................................................................... 40

5.2 Policy implications.................................................................................................................. 41

5.3 Limitations and further research ............................................................................................. 42

REFERENCES ............................................................................................................................. 43

ix

LIST OF TABLES

Table 2.3 Summary of empirical researches ................................................................................. 16

Table 3.1 Variables expected signs ............................................................................................... 23

Table 3.3.3 Variables summary .................................................................................................... 29

Table 3.3.4 Mean of Import price (in logarithm) and Income (in logarithm) ............................... 30

Table 4.1 Summarized Estimation of specification ...................................................................... 33

Table 4.2 Hausman test ................................................................................................................. 35

Table 4.2.2 Random effects Generalized Least Square model ..................................................... 36

Table 4.2.3 Cointegration test for panel data ................................................................................ 37

Table 4.3.1 Results of individual income elasticity and price elasticity ....................................... 37

Table 4.3.2 Summarized of price elasticity and income elasticity of crude oil import demand ... 38

x

LIST OF FIGURES

Figure 2.1.2 Import demand curve .................................................................................................. 5

Figure 2.2.3a General equilibrium theory ....................................................................................... 7

Figure 2.2.3b Consumer behavior theory ....................................................................................... 8

Figured 3.3.2 OECD versus Worldcrude oil import from 1988 to 2012 ...................................... 28

Figure 3.3.3 Total Crude oil import to OECD from 1988 to 2013 ............................................... 30

Figure 3.3.4a Interrelationship between crude oil import and income ......................................... 31

Figure 3.3.4b Interrelationship between crude oil import and crude oil price .............................. 32

xi

CHAPTER 1 INTRODUCTION

1.1 Problem statement

It is no doubt about the vital role of crude oil in the world economy and most of all countries

were affected by the crude oil price no matter they are played as the producers or consumers or

both (Natural resource Canada, 2010)(1). Oil has provided about 38 % energy needs in 2014 and it

will contribute to the world economy in further (Berdzenadze, 2015). Although there is new

trend of using the renewable energy which is friendly with environment, it seems that we still not

find energy that can replace for the oil due to its unique attribution such as easy to access or low

cost of refinery.

According to the IEA statistic, Global demand for crude oil in 2014 was about 92.6 million

barrels a day and daily demand for crude oil turned to 94 million in 2015. The increase in oil

demand could be explained by the development of economic activities and human income which

push expenditure on vehicles and other energy application (Zhao and Wu, 2007).

OECD stands for Organization of Economic Cooperation and Development includes 35

members and their mission is: “promote policies that will improve the economic and social wellbeing of people around the world.” The majority of OECD is the developed countries which tend

to use large amount of oil for economic activities. In the 20th century, OECD oil demand was

accounted 70 – 80% of total world demand. The IEA reported that OECD oil demand held 53

percent of total world demand in 2010 and the majority of oil was imported.

Empirical research suggested that energy demand was affected intensely by the financial

crisis. The Global Financial crisis in 2008 was recorded the greatest financial crisis since the

Great Depression (1930s) (Zang et al, 2009) when the crude oil price dropped off more than 72%

percent within five months, from the all-time high at $145.31 per barrel on July 3rd, 2008 to the

lowest value at $41 per barrel on December 5, 2008. The economists found that the financial

crisis started from the raise of subprime mortgages in America in 2007 which leaded to the

reduction in economic activities of OECD. Yet, the economic slowdown made the OECD cut off

their expense hence the crude oil demand declined.

Natural resource Canada is an organization seeks to enhance the responsible development and use of Canada’s

natural resources and the competitiveness of Canada’s natural resources products.

(1)

1

There are many researches related to oil such as oil consumption, oil export/import in

various forms of estimation. The most popular approach is to analyze income elasticity and price

elasticity of oil import. Empirical researches proved that income is inelastic in short run and

more elastic in long run (Ghosh, 2009; Kim and Beak, 2013; Narayan and Smyth, 2007…)

whereas the price elasticity is inelastic both in short and long run (Ziramba, 2010; Yaprakli and

Kaplan, 2015; Altinary, 2007…). It is interesting that energy demand studies often estimate the

particular demand of one country whereas oil demand often analyze the demand for group of

countries or region (Altinary, 2007). Although there are numerous researches that estimate the

energy import demand for particular country, the OECD crude oil import demand is completely

rare in empirical research. Additionally, due to vital role of OECD in the world economy and the

high demand of oil consumption together with high rate of crude oil import, the model of crude

oil demand of OECD needed to be employed to help exporters make prediction of impact of

pricing on future oil consumption and help the importer regulator decide to tax or subsidy on

imported oil. That was the motivations for author to conduct a study of estimation for crude oil

import demand of OECD with the effects of financial crisis in 2008.

The results of this thesis are consisted with previous studies which stated that the price and

income has impact to the quantity of crude oil imported to OECD. Additionally, the author found

that financial crisis made the demand for crude oil import shift down.

1.2 Research Objective

The thesis aims to identify the responses of crude oil quantity imported to OECD with the

change in crude oil imported price and national income in the period 1988 – 2013.

To achieve the above objective, this thesis is conducting the import demand model to

estimate the income elasticity and price elasticity for OECD together with the impact of financial

crisis on 2008, the domestic crude oil production, the exchange rate and the population growth.

1.3 Research questions

This research is designed to answer:

(i) What is a crude oil import demand model of OECD in the period 1988-2013?

(ii) What are price elasticity and income elasticity of crude oil import demand of OECD?

(iii) Does the financial crisis have effect on the crude oil import demand in OECD?

2

1.4 Research scope, data and methodology

The reason for choosing OECD countries for conducting the thesis is the huge demand of oil

in OECD. The empirical statistic showed that OECD oil consumption was 53 percent of total

world demand in 2010, this means the OCDE plays a very important role in the oil market.

Understanding the responses of demand for crude oil to the change in import price as well as the

change in OECD income would be very helpful for the exporters. In addition, there was few

researches paid attention to estimate the OECD crude oil import demand for a long time so that

this motivate the author to investigate the thesis in this region.

The empirical analysis section of the thesis will be implemented by employing unbalanced

panel data from 27 countries in OECD region over the period from 1988 to 2013. The data was

collected from OECD library.

To achieve the research objective, this thesis applied the OLS, the Fixed effects, the Random

effects and the Random effects Generalized Least Squared methods to estimate the price

elasticity and income elasticity of crude oil demand import to OECD and the impact of financial

crisis to the import demand.

1.5 Thesis structure

The outline of paper is as follow. Chapter I introduces the research objectives, the research

questions and the research scope, data and methodology. Next, Chapter 2 provides literature of

import demand and some empirical evidences. Chapter 3 describes the model specification;

research methodology including the OLS model, the FE model, the RE model and the Random

effects Generalized Least Squared model. The empirical results will be presented in Chapter 4.

Finally, Chapter 5 summarizes the conclusions then gives some policy implications and

suggestion of further research.

3

CHAPTER 2 LITERATURE REVIEW

This chapter is a review of oil import demand with the evidences in theory and empirical

evidences. Firstly, there will be some basic concepts that bring the overall images of crude oil,

import demand, price and income elasticity. Secondly, the author will restructure the theory of

trade. In the next step, many previous researches were summarized to give a board learning of oil

and energy import demand. This chapter will end with the Analytical framework.

2.1. Some concepts

2.1.1 Crude oil

Crude oil is the component of crude oil production including crude oil, natural gas liquids

(NGLs) and additives. According to OECD, Crude oil is a mineral oil consisting of a mixture of

hydrocarbons of natural origin, yellow to black in color, and of variable density and viscosity.

Additionally, the IEA organization defines crude oil is a mineral oil of fossil origin extracted

from underground reservoirs and which comprises liquid or near‐liquid hydrocarbons and

associated impurities, such as sulphur and metals.

2.1.2 Import demand

Import demand refers to the total demand for foreign goods and services of population

within particular country. It could be considered the component of Gross National Product

(GNP). According to Krugman (1978) is “An import demand curve is the difference between the

quantity that Home consumers demand minus the quantity that Home producers supply, at each

price”

The Home import demand equation is described:

MD = D – S

The import demand curve shows the maximum quantity of imports that Home country

would like to consume at each price of import good. The import demand curve is downward

sloping indicates that the increase in oil price import lead to the decrease in quantity imported

demand.

4

Figure 2.1.2 Import demand curve

Source: Krugman (1978)

At P1, the Home country solely produces goods at S1 whereas the Home country demand for

goods is D1. The shortage of demand of Home country will be imported from foreign country

and this was estimated by: D1- S1

Similar pattern is found at P2 where the import quantity is calculated by: D2 – S2

2.1.3 Price elasticity and income elasticity

The price elasticity of demand is simply the proportion change in quantity of demand given

by 1 percent change in price.

Ep=

∆𝑄/𝑄 ∆𝑄 𝑃

= x

∆𝑃/𝑃 ∆𝑃 𝑄

The income elasticity of demand is the ratio of the percentage change in quantity demand

when the income increases 1 percent.

EI=

∆𝑄/𝑄

∆𝐼/𝐼

∆𝑄 𝐼

= x

∆𝐼 𝑄

2.2 Theoretical literature

2.2.1 The traditional trade theory

According to Ricadian theory, the country that can produce goods with lower opportunity

cost has comparative advantage. Suppose that the country can produce two kind of goods A and

B. The Ricandian theory of trade stated that: “The economy will specialize in producing A if the

5

relative price of A exceeds its opportunity cost and the economy will specialize in producing B if

the relative price of A is less than its opportunity cost”

Additionally, Hecksher-Ohlin Theory found that difference in comparative advantage is due

to the difference in factor endowment. For instant, the Home country with higher labor to land

ratio is the labor abundant, the Foreign country with higher land to labor is land abundant. The

cloth production requires more labor than the food production whereas the food production

required more land than cloth production. We call that cloth production is labor-intensive and

food production is land-intensive.

When Home country and Foreign country trade together, the relative price will converge.

The relative price of cloth will increase in Home country and decrease in Foreign country. The

raise in cloth price motivates the cloth production and the cloth consumption will decrease in

Home. As the result, the Home becomes the cloth exporter and food importer.

The Hecksher-Ohlin Theory stated that: “Countries tend to export goods whose production

is intensive in factors with which they are abundantly endowed.”

2.2.2 The new trade theory

According to traditional theory, the comparative advantage comes from difference of

technology or factor endowment between countries. Empirical analysis proves that trade between

countries with similar technology or factor endowment still occurs. Therefore, the new trade

theory was developed in 1980s (Krugman 1980). What makes new trade different from the

traditional is the source of comparative advantage. These sources consist of economic scale,

imperfect markets, and product differentiation.

The new trade theory claimed that country tend to import products from another country in

order to better specialize in other products to achieve economies of scale.

2.2.3 The standard trade model

According to the neoclassical trade theory which relies on the assumption of General

Equilibrium Theory and Consumer Behavior Theory, international trade is a function of relative

price. Therefore, the standard trade model was described by Kurgman and Obstfeld (2011) as

follow:

6

General equilibrium theory

A productive ability of a country is defined by the production possibility frontier line and

points lie on the production possibility frontier line depend on the relative price of products that

the economy produced. The market value of output is indicated by the isovalue lines which the

value of output is constant. The economy will achieve highest output level at the point where the

production possibility frontier line tangent to the isovalue line. At this point, the economy yields

the highest welfare. If relative price of one product increase (called the product F), the economy

will produce more F, indicating the decrease in producing others (called the product C).

Therefore, the equilibrium output point will shift to new equilibrium position.

Figure 2.2.3a General equilibrium theory

Consumer behavior theory

The economy choice of point on the isovalue line depends on the consumers’ tastes. The

individual tastes are designed by the indifference curves – the combination of products that

maintain the consumer well fare. The indifference curves are downward slopping indicating that

if individual consumes less C, to achieve the well fare, he must use more F.

7

As consequence, the economy produces more C and consumes more F than consumer

demand. Therefore the excess of C will used for exporting and the shortage of F must be

imported from other countries.

Figure 2.2.3b Consumer behavior theory

2.3 Empirical literature

2.3.1 Impact of import price and income on import demand

The demand of crude oil imported had been developed soon by Kouris and Robinson (1977)

using the data of EEC countries in 1956 to 1985. This research had two stages: the estimation of

EEC petroleum products consumption and the relationship between crude oil imported to EEC

and the quantity of petroleum products consumed in EEC.

At the first stage, petroleum product consumption was dominated by the income, the relative

price of crude oil, the previous petroleum product consumption and the temperature. Applying

the pooled cross-section time series approach to all observations of each country, the two authors

had found that all variables had expected sign and statistically significant even at 1%. This

suggested a positive correlation between the EEC petroleum consumption and the GDP. Also,

the research verified the increase of EEC petroleum consumption is associated with the decrease

8

of oil price. Surprisingly, a computed equation in the second stage showed approximately one-toone association of oil imported and oil consumption which indicated that all of EEC oil

consumption was imported from foreign countries.

In 1993, Hungtington introduced the response surfaces for nine different world oil models to

estimate oil demand for OECD in the period of 21 years (1989-2010) with key variables were

world oil price and GDP. The main purpose of the response surfaces model was to generate the

policy insights rather than the exactly evaluation of each model. The median results revealed that

OECD oil demand was price inelastic (-0.075) in short run and -0.4 in long run whereas the

income elasticity was closely to unity. More recently, Gately and Huntington (2002) conducted

the study to find the asymmetric effects of changes in price and income on energy and oil

demand. The estimation of 96 largest economies including the OECD in the period of 1971 to

1997 showed that long run income elasticity was 0.5 and oil demand responded more with

increase than decrease in oil price/income.

In attempt to estimate the short-run and long-rung elasticity of import demand for crude oil

for Turkey, Altinary (2007) conducted a research covered the period 1980-2005. The models

included price of energy, income and two dummy variables of economy crisis and boom period.

The estimation of short run and long run elasticity of demand applied the ARDL method which

developed by Pesaran et al (2001). The bound test exposed the lag length was 1 which suggested

the long run relationship between variables. The results indicated the long run income elasticity

was 0.61 and nominal price elasticity was -0.18. In term of short run, the result revealed the short

run income elasticity was 0.64, slightly higher than the long-run, whereas the short-run nominal

price elasticity was -0.1. The dummy variable presented for the earthquake was not significant

but the dummy variables stand for War was significant.

For a long time Middle East was recognized as one of main region of exporting crude oil in

the world but there were a truth that this region has reached to bigger oil consumers. Therefore,

the study of Narayan & Smyth (2007) focused on the demand of oil in Middle East using panel

cointegration analysis. This study was consisted with many previous researches that the oil

demand was the function of per capita real income, real price of oil. The first step of panel unit

root test presented that the panel data is stationary and all variables had unit root. As a result, the

author proceed to test the cointegration using the seven Pedroni’s heterogeneous panel

9

cointegration method which presented that that oil demand, real income and real oil price were

cointegrated at least 5 percent. This gave the implication that there was a long run relationship

between variables. For more details, the two authors tried to conduct a long run impact of income

and price on oil demand in Middle East by Dynamic ordinary least square (DOLS) estimator. It

was clear that for full panel, oil demand was income inelastic in short run but it was slightly

elastic in long run while the individual panel presented the strong positive relationship between

oil demand and real income. In term of prices, the result exposed that demand for oil in Middle

East was highly price elastic in both full panel and individual countries.

In effort to estimate the oil import demand in Africa, Ziramba (2010) processed a

multivariate regression analysis for the period of 1980 -2006. The model is simple with two

independent variables: the relative price and the income. Also, the author followed the traditional

method which included Dicky – Fuller test of unit root test of time- series data and the

cointegration test proposed by Johansen technique. The result showed one vector of

cointegration. Unfortunately, the income elasticity and price elasticity were not statistically

significant in short run. In term of long-run, the income price elasticity is 0.429 indicated that

imported crude oil is a normal good whereas the price elasticity is -0.147.

With the same purpose, the study of Ghosh (2009) estimated the oil import demand for

crude oil in India for 1970 to 2006. The Autoregressive Distributed Lags (ARDL) test approach

of cointegration is developed to test the long run relationship between the crude oil import

quantity and income, and imported price. The short run price and income elasticities were not

significant with any level of confident. The long run income elasticity estimated was 1.97 and

highly statistically significant whereas the long run price elasticity was not significant.

Additionally, the bound test indicated one cointegrated vector which motivated the author

processed to the Granger-causality tests. The Granger-causality test result suggested the long run

relationship between the India economic growth and the crude oil import.

2.3.2 Impact of financial crisis on oil import demand

Most of all the researches above were implemented in the oil import-countries where the

crude oil resource was considerably rare. Kolluri and Torrisi (1987) conducted a very interesting

research which estimated an aggregate import demand for five developing oil exporting countries

using the time series data from 1960 to 1982 (Saudi Arabia, Nigeria, Indonesia, Mexico and

10

Venezuela). In details, the oil import demand model is a function of GDP, relative prices index,

the lagged of individual total reverse and dummy variable presented for the impact of oil price

shock in 1973. The OLS estimation seemed to be face with serial correlation in residual and the

maximum likelihood method was applied. The empirical results appeared to be very statistically

significant with right expected signs. Estimated income elasticities were fluctuate from 0.57 for

Saudi Arabia to 1.25 for Indonesia, with average income elasticity for five countries was 0.82

before 1973 and 1.63 since 1973. The separate domestic and import price yield significant and

correct signs with average elasticity is -1.04. The impact of dummy variable has negative value

indicate that the oil price shock in 1973 made the import demand shift down.

Despite the growing of renewable energy, crude oil holds it vital role in production and daily

life in Korea. Therefore, Kim and Baek (2013) examined crude oil import demand in Korea for

quarterly data from 1986 to 2010 using the traditional Autoregressive distributed lag (ARDL)

bound test approach. The model showed that determinants of crude oil import to Korea were

relied on the import price and income. One thing that made this research different from others

was the dummy variable captured the market shocks. The ARDL test required to formulate the

demand equation with lag variables and the selected variables was said to be cointegrated if all

the lagged variables were statistically significant. The authors revealed the appropriate lag length

for Korea estimation was p = 2 and the cointegration test showed the long rung relationship

between crude oil import and income as well as oil price. In details, the long run income

elasticity was 1.31 and the price elasticity held the lower value at -0.43 in long run. Additionally,

the market shocks dummy variable yielded significant indicated that the Asian financial crisis

made the demand for crude oil import in Korea raised.

In 2015, Yaprakli and Kaplan built a model based on traditional import demand model

which including income and relative price variables. For deeper investigation, these authors tried

to find the impact of financial crisis on the crude oil demand in Turkey for the period 1970 –

2013. To handle time series data problems, the paper used co-integration method which

contained three steps: the unit root test, test for cointegration and the dynamic ordinary least

squared (DOLS) estimations. The cointegration test supported long run relationship between

variables and the empirical results showed the inelasticity of income and price in the long run.

Moreover, the authors concluded that external crisis had bigger impact on crude oil import

demand the internal crisis did.

11

2.3.3 Applied control variables

The relationship between oil domestic energy production, population and oil import demand

were introduced in the study of Adewuji (2016). This study estimated import demand for total

and specific refined petroleum products in Nigeria from 1984 to 2013. The autoregressive

distributed lag (ARDL) bound test estimation was applied to find the long run and short run

determinants of import demand. The results showed that domestic energy production and

population growth rate were drivers of demand of import of refines kerosene and motor spirit in

long – run. In the short-run, significant effect of domestic energy production on the import

demand for refined products was not found but the population growth rate did. Additionally, the

real effective exchange rate was main determinant of total and specific petroleum products in

Nigeria due to it significant effect in almost estimation. For example, the long run elasticity of

the real effective exchange rate is -1.08 for total import of refined petroleum products and long

run elasticity of the real effective exchange rate for motor spirit product and refined distillate fuel

were -0.77 and -1.1 respectively. The effect of real effective exchange rate in short-run of motor

spirit product was 0.4 and it rose to 1.82 for refined distillate fuel.

The role of exchange rate was confirmed in the research of Schryder and Peersman (2012)

by the estimations of oil demand for 23 OECD countries, 42 non-OECD countries and total 65

oil importing countries respectively for the period of 1971 to 2008. This study was applied the

advanced recent panel technique to examine the effect of income, oil price in US dollar and the

US dollar exchange rate on oil demand. The results seemed to be very consisted with the theory

which revealed the short run income elasticity of OECD was 0.568 and it was slightly higher in

non-OECD (0.639) and the total sample of countries (0.614) whereas the long run income

elasticity was 0.674, 0.885 and 0.775 respectively. In term of price elasticity, the short run price

elasticity was -0.051, -0.026 and -0.035; the long run price elasticity was higher which yielded to

-0.150 for OECD and-0.104 for non OECD. What made this study different from the others were

the findings of impact of US exchange rate on the oil demand. In details, the 1 percent

appreciation of US dollar exchange rate leaded to 0.24 percent decrease in oil demand of OECD

countries and it was timed twice to -0.150 for 65 countries.

Another research related to energy import demand was proposed by Goldar and

Mukhopadhyay (1990). The analysis of seven petroleum products import demand for India was

12

estimated for the period of 1970 – 1986 using a very simple OLS method. In particular, the

domestic demand function for petroleum products was dominated by the price index of each

products, the price of substitution possibilities exist, the other exogenous variables included the

number of tractors, the number of vehicles, industrial production index, gross power generation,

the per capita income and the population. The results suggested that domestic demand for most

of all seven petroleum products were not influent much on price changes. The other explanation

variables were considerably statistically significant with expected signs. In the next step, the

author tried to generate the import function of petroleum and found that the gap between

domestic crude oil production and the domestic demand for petroleum was the main

determinants of quantity of petroleum imports to India. What is important conclusion of this

research was the depreciation of domestic currency (rupee) which leaded to higher price of

imports could not reduce the domestic demand.

2.3.4 Import demand estimation approach

The Monte Carlo approach

For more than quarter of century, the traditional import demand function was estimated

without econometric problems. This problem was the nonstationary of variables which could

lead to the unreliable results. Therefore, Sehadji (1997) introduced the Monte Carlo approach in

which the Ordinary Least Square (OLS) estimator was dominated by Fully –Modified (FM)

estimator. The empirical research had showed that the OLS estimator faced the problem of bias

higher than the FM estimator. The FM estimator would achieve the minimum bias when the

relative price of imports and the activity variables were not endogenous. As consequence, the

FM estimator was an optimal single-equation method based on the use of OLS with serial

correlation corrections and potential endogeneity prevention of the dependent variables. In

addition, the Monte Carlo approach was very appropriate for the estimation with small sample.

Also, the FM estimator could be recognized similar to the full systems maximum likelihood

estimators.

The Dynamic - Optimizing approach

Although the Monte Carlo approach had solved the nonstationary problem of time series

data, there were several limitations with this method. In details, the time-series approach

assumed that the output was stationary and followed AR (1) process while it was nonstationaryin

13

real. In addition, the investment and government activity was not mentioned in the model which

could lead to the unstable results. Thanks to Dynamic - Optimizing approach conducted by Xu

(2000), the import demand function had taken into account both the growing economy,

investment and government activity. The Dynamic – Optimizing approach offered a

conventional import demand equation that included the “national cash flow” variable (GDP-I-GEX), the relative prices and time trend. Additionally, the investment and government was

included as the activity variables while the activity variable in the research of Shehadji (1997)

was the GDP minus exports. The Dynamic – Optimizing approach was considered more

advantage than the previous methods because it created the more general and flexible import

demand model.

The Cointegration approach

The Cointegration approach is the test of existence of a cointegrated relationship between

the aggregate import demand function and its determinants. This process is developed by Engle

and Granger (1987) and Johasen (1988, 1991). If there is an existence of a cointegration, the

long-run relationship between the aggregate import demand function and its determinants is

determined.

The Engle – Granger’s residual –based ADF method has two steps:

1. Applying OLS on the nonstationary variables to test the parameters of cointegrating

regression.

2. Appling Aguement Dickey – Fuller (ADF) to test residuals stationary.

The Johansen –Juselius (JJ) method is considerably better than the Engle – Granger’s

residual –based ADF method due to some reasons:

- The JJ method could make the combined framework for interpreting the distinction of

cointergating vectors.

- The JJ method allows us to test the magnitude and the volume of the elasticity estimation.

The Autoregressive Distributed Lags (ARDL) bound test approach

The bound test approach is generally a test based on the estimation of Unrestricted Error

Correction Model (UECM). It has two advantages:

14

- While the Johansen (1988) and Johansen and Juselius (1991) estimation are solely

appropriate for the nonstationary time-series with the same integrated level A(1), the bound test

provides the estimation for A(0); A (1) level or fractionally integrated. It means no need of test

for non-stationay properties and order of intergration of variables.

- The bound test is very powerful in cointegration analysis for model with small data.

According to Pesaran et al (2001), the bound test is based on the value of F-statistic. The

null hypothesis here is: whether the explanatory variables are I(1) or A (0), there are no

cointegration between examined variables. If the F-statistic value is higher than critical value,

I(1) then rejects the null hypothesis. In case F-statistic value is lower than critical value, I(0), the

null hypothesis cannot be reject. Note that in case the F-statistic falls within the critical value

bounds, the bounds test is solely capable use for I(1) and I (0) regressors.

- Furthermore, the bound test help to estimate the long-run elasticity by estimated coefficient

of one lagged dependent variable divided to estimated coefficient of one lagged independent

variable. In addition, the short run elasticity is estimated coefficient of first difference of

variables in UECM model.

The Panel Cointegration approach

Pedroni’s test (2004) is broadly known as the cointegration approach for heterogeneous

panels. It provides seven statistics for the test of null hypothesis no cointegration between the

dependent variable and independent variables. Among seven statistics, four are preferred for the

“within-dimension” (panel-v, panel-ρ, semi-parametric panel-t and parametric panel-t) and three

preferred for “between-dimension” (group-ρ, semi-parametric group-t and parametric group-t).

The former are calculated by “summing up the numerator and the denominator over N crosssections separately, while the latter statistics are calculated by dividing the numerator and the

denominator before summing up over N cross-sections” (Pedroni, 2004). If the statistics exceed

the critical value which calculated by Pedroni (2004), the null hypothesis of no cointegration is

rejected. Hence, there is a long run relationship between examined variables.

15

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