Oil Prices & Financial Markets

Introduction

The importance of oil in today’s world can in no way be undermined. Was going to war in Iraq a pretext for the Unites States of America, the largest economy in the world, to acquire its oil? Keeping away from politics, I shall focus on the economical perspective only.

In the 21st century, the world must solve two great problems. These problems are rarely discussed by the public, have received little media attention and neither are they discussed by those in power, at least not publicly. They are:

• Over Population in the developing world.

• Over Consumption in the developed world.

“Oil Depletion: The primary problem of the developed world”

It is over-consumption where oil comes in. Being a business editor, I have personally always been interested in the subject of oil and its importance to the world.

Do the Arab Financial Markets impact World Oil Prices?

Surely; the vast Middle East and North African regions, depend on oil as its major source of revenue, especially Saudi Arabia.

Apart from the many other geopolitical tensions like Iraq, Iran, Nigeria, and macro-economic factors that heavily influence the oil trading mainly in the USA and the UK, the question that I want to answer though my research is, if there is an impact of the Arab markets on world oil prices.

For my project, I will concentrate only on the financial markets of the GCC and a few other Arab countries - namely: Bahrain, Saudi Arabia, United Arab Emirates, Qatar, Muscat & Kuwait along with Egypt, Lebanon & Jordan.

I don’t expect my model to be highly significant, since it excludes all of the other main factors, but want to find out, if any, the strength of their effect only.

Literature Review

I did not find any study on the exact same topic; however, for my project I referred to the following related works:

1. Economic Developments and Prospects 2006 Financial Markets in a New Age of Oil, Middle East and North Africa Region. By Office of the Chief Economist

This paper aims to shed light on recent key economic developments in the Middle East and North African region, and the forces underlying the region’s economic outcomes. It analyses the importance of Middle East’s financial markets, to understand how financial systems are poised to meet some of the region’s development objectives.

2. The Impact of Oil Price Shocks on the U.S. Stock Market Lutz Kilian and Cheolbeom Park, No 6166, CEPR Discussion Papers from C.E.P.R. Discussion Papers

This paper shows that the response of aggregate stock returns may differ greatly depending on whether the increase in the price of crude oil is driven by demand or supply shocks in the crude oil market. Further insights can be gained from the responses of industry-specific stock returns to demand and supply shocks in the crude oil market. We identify the sectors most sensitive to these shocks and study the opportunities for adjusting one’s portfolio in response to oil market disturbances.

Economic Theory

Oil prices remain an important macroeconomic variable: higher prices can inflict substantial damage on the economies of oil-importing countries and on the global economy as a whole. While there is a strong presumption in the financial press that oil prices drive the stock market, the empirical evidence on the impact of oil price shocks on stock prices has been mixed. The conventional wisdom that higher oil prices necessarily cause lower returns is shown to apply only to oil-market specific demand shocks such as increases in the precautionary demand for crude oil that reflect fears about the availability of future oil supplies. In contrast, positive shocks to the global aggregate demand for industrial commodities are shown to cause both higher real oil prices and higher stock prices. Shocks to the global production of crude oil, while not trivial, are far less important for understanding changes in stock prices than shocks to global aggregate demand and shocks to