# **4. Discussion - The Level of Sensitivity**

In the empirical analysis of Section 3, two estimates for the responsiveness of industrial production to an realized volatility shock were obtained: (i) VAR coefficients, and (ii) accumulated impulse responses. Both suggest that economic activity in all sample countries responds negatively to increased oil price volatility, while the level of sensitivity varies widely across countries.

In the literature (e.g. Cunado and Garcia, 2004) it is suggested that the **sectoral composition** of an economy is one critical factor determining how sensitive an economy is to oil prices. This is based on the reasoning that industrial production is particularly energy and commodity reliant, and will thus be more strongly affected by oil prices. Blanchard and Gali (2007) for instance show that relying less on oil in industrial production processes has reduced sensitivity in developed countries. In addition, developed economies are typically more service intensive, while their industrial sector often benefits from efficient technology making it less energy intensive. However, in the developing world the industrial share of GDP tends to be particularly large, causing these countries to be particularly exposed to commodity price effects.

||**GDP secto**<br>|**ral compos**<br>|**ition**<br>|
|---|---|---|---|
||Industry|Services|Agriculture|
|USA|21.9|76.9|1.2|
|JPN|22.8|75.7|1.5|
|GER|27.9|71.3|0.8|
|IND|28.6|55.3|16.1|
|KOR|39.4|57.6|3.0|
|MYS|42.3|47.6|1.0|

**Table 7.** 2009 sectoral GDP contribution in % (CIA, 2010).

However, it appears that factors other than the sectoral composition also influence a country’s sensitivity. For instance, Figure 8 suggests that domestic oil **consumption-production ratios** may also play a role in determining the level of sensitivity. For instance, the USA and India have had significant domestic oil production, which accounted for 46.8% and 38.6% respectively of domestic consumption throughout the sample period. This implies that these countries could cater for a significant percentage of consumption domestically, rather than relying on volatile external markets. Contrarily, in Japan, Germany and S.Korea domestic production is negligible relative to consumption. Accordingly these countries rely heavily on imports from international markets and thus expose themselves to global market volatility.

Figure 7 also shows that Malaysia’s domestic production has significantly exceeded consumption throughout the sample period. The fact that Malaysia has been estimated to be most sensitive to oil price volatility hence appears to contradict the logic that domestic oil production can reduce sensitivity to oil price uncertainty. However, the domestic consumption-production ratio may translate into the **import-export ratio** in different ways **–** domestically produced oil is not necessarily directly consumed domestically, if for instance refining capacities are insufficient. In this case even oil producing countries may need to export large quantities of domestically produced unrefined fuel, and in return import refined oil from international markets, thus exposing themselves to market volatility.

Figure 7 also shows that in the USA and India, which both have significant domestic oil production, exports were negligible relative to imports. Malaysia however, despite significant domestic production, has considerable imports, servicing close to 40% of domestic demand in 2007, and as such is the third largest oil importer among all net oil exporters<sup>10</sup> . Under these conditions a global oil price increase raises export revenues, but also raises import costs. An increase in _oil price volatility_ however is likely to have negative effects on both export revenues and consumption. Therefore, it is possible that even net exporters can suffer from positive oil price shocks, if imports are of significant size, and negative effects offset increased export revenue. In Malaysia this effect is likely to have been re-enforced by its sectoral composition, as well as a technological lack of alternative energies: The Malaysian energy portfolio consists of 96.6% fossil fuels.

In this context, it may be useful to compare Malaysia to the case of Norway, which is often regarded as a special case with respect to its energy sources. Like Malaysia, Norway is to be classified as a net oil exporter, whereas the relative dimensions of oil consumption, production, imports and exports require a clear distinction between the two. In Norway 91% of domestic production is exported and imports are less than 5% the size of exports. Furthermore, 60% of its energy demand is serviced by renewable energies, while the remainder is accounted for by domestic fossil fuel production; i.e. largely independently of global oil markets. Thus, a given global oil price increase is less likely to harm the Norwegian economy, but may increase its revenues from oil

> 10 Countries with expensive or limited refining capacities often export domestically produced non-refined oil, and import refined oil.

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