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The significance and indispensable nature of oil, coupled with some other factors, had over the years exposed many developing countries to oil price volatility, declining exchange rate and revenues arising from falling prices. This has a multiplier effect on other sectors of the economy because of linkages. The reason for this is not unconnected with the monoculture nature of these economies, and this has some implications on economic growth and development. The transmission mechanisms through which oil prices have impacted on real economic activity include both supply and demand channels. The supply side effects are related to the fact that crude oil is a basic input to production, and an increase in oil price leads to a rise in production costs that induces firms’ lower output. Oil price changes also entail demand-side effects on consumption and investment. Consumption is affected indirectly through its positive relation with disposable income (Olomola, 2006).
A large number of studies suggest that oil price fluctuations have considerable impacts on economic activity. These impacts are expected to be different in oil importing and in oil exporting countries. Whereas an oil price increase should be considered good news in oil exporting countries and bad news in oil importing countries, the reverse should be expected when the oil price decreases (Amano and Nor den, 1998). However, in reality, poverty persists in the face of upsurge in international oil prices in most of the oil exporting countries including Nigeria- Dutch disease (Ayadi, 2005).
Nigeria is regarded as the largest oil producing nation in Africa and the tenth largest in the World in terms of oil reserves. It has a production level of close to 2 million barrels per day, though this level has been seriously affected due to crisis in the oil producing region. Nigeria benefited, handsomely from hikes in the oil since the beginning of second Gulf war. The balance of payments position of the country remains highly favourable with over 20 months of imports, which translates to over $55 billion of reserves. Exchange rate was moderately stable between 2000 and 2008, while real GDP growth averaged 5.01 percent within the same period. However, oil consumption in the country heavily relies on the import of refined petroleum products since the collapse of local refineries in the late 1980s. Thus, over 80% of the country’s domestic requirements of oil are sourced from imports. The near collapse of the power generation and distribution industry in the country further accentuates the acute shortage of energy. The burden on the government to provide energy resources at subsidized rate became very unwieldy and between 1999 and 2008, the federal government of Nigeria has reduced its subsidy approximately nine times, this seriously affects production, consumption and investment decisions.
Though, the reduction in agricultural export earnings were noticeable as early as 1965-1969, especially during the civil war, while oil export started in 1958, the agricultural decline became a steady depression in the mid seventies Nigeria. As an oil-exporting Third World nation, Nigeria’s economic development has witnessed trials and tribulations, as the nation's fortunes have risen and fallen in the stormy seas of the international oil market. Nigeria's vulnerability to oil price shocks stems from the nations over dependence on crude oil export. This is amply evident from the drastic decline in non-oil exports over the past three decades of petroleum production in Nigeria. The challenge, however, of the combined effect of hikes in oil prices and exchange rate instabilities on macroeconomic stability and economic growth for oil producing nations like Nigeria is really enormous. (CBN Bulletin, 2000).
Onimode (1983) posits that “the juxtaposition of the oil booms especially the oil crisis of 1973 and agricultural stagnation is perhaps the sharpest expression of the structural distortion of the Nigerian economy initiated under colonialism and intensified by neo-colonialism. Just as OPEC oil price hikes gushed in billion of fortuitous ‘petrodollars’ from booming export sales of petroleum, so did agricultural export earnings fall systematically into relative insignificances”.