Effects of Booms and Oil Crisis on Colombian Economy: A Time-Varying Vector Autoregressive Approach/Efectos de los auges y las crisis del petroleo en la economia colombiana: un enfoque con vectores autorregresivos cambiantes en el tiempo/Efeitos dos auges e as crises do petroleo na economia colombiana: um enfoque com Vetores Autorregressivos variaveis no tempo.

• Author: Melo-Becerra, Ligia Alba
• Pages: 31(33)

Introduction

Since the mid-1980s, oil has played an essential role in the Colombian economy due to the improvement of the productive capability and the resumption of oil exports. The importance of oil became evident in the 1990s and from 2004 to 2014 because of the boom in oil prices and quantities. Due to the relevance of oil in the Colombian economy, the fall of the international oil price since mid-2014 caused macroeconomic imbalances, which are still in the process of adjustment. In general, oil shocks have affected Colombia's finances, destabilizing the balance of payments and influencing levels of private consumption and investment. The relationship between oil indicators and the macroeconomic context has remained unstable over the last 30 years.

The Colombian oil industry developed during a period of institutional and legal development characterized by significant fluctuations of both international oil prices and worldwide production. These factors have determined the impact of oil shocks on the Colombian economy, which can be characterized based on the evolution of some key economic variables and the behavior of the principal industry figures. In the 1990s, the production boom resulting from new oil discoveries had less impact on public finances and the external sector than the price-production boom observed since 2004. In the latter context, the oil industry acquired a leading role in the economy. Because of its importance, the recent changes in international oil prices has caused considerable imbalances, especially in the fiscal posture.

The aim of this paper is to estimate the impact of oil price or production shocks on macroeconomic variables such as the real exchange rate, private investment and consumption, and public debt over the last 30 years. To measure this impact, we use an econometric methodology based on autoregressive vector models that consider the dynamic relationship between oil price/ production and macroeconomic variables. This model is known in recent literature as TVP-VAR. The relevance of this methodology is that it accounts for changes in the volatility of oil price/production shocks and assumes that the relationship between prices and oil production with macroeconomic variables changes dynamically.

This paper contains seven sections apart from this introduction. In section 1, we describe the historical importance of oil to the Colombian economy and its evolution through time. In section 2, we explain the transmission channels of oil shocks in the macroeconomic setting. In section 3, we describe the econometric methodology, which bases on mixed time-varying autoregressive vectors. The data and the procedure used for the statistical inference are explained in section 4. In section 5, we summarize the main results, including impulse response functions. Finally, we present our conclusions.

1. Oil in the Colombian Economy

   Oil became significant to the Colombian economy at the beginning of the twentieth century with the Barco and de Mares concessions granted by the Colombian state. The scarcity of capital and technology led to the transfer of these concessions to multinational companies that exploited this natural resource. During the first half of the twentieth century, most of the oil production went to domestic consumption (Perry & Olivera, 2012). At the end of the 1960s, the depletion of oil reserves was evident. Thus, it was necessary to introduce adjustments to the national legislation in order to encourage exploratory activity (Perry & Olivera, 2012). Nevertheless, in the early 1970s, Colombian oil production declined drastically, and in 1974, the country became a net importer. During the same period, international oil prices increased rapidly, from close to 3 USD per barrel in 1973 to close to 37 USD per barrel in 1980. As a result of the crisis, the Colombian government issued a regulatory framework to stimulate oil exploration in order to recover the country's production capacity. These adjustments caused an increase in exploratory activity and foreign investment in the sector. In 1983, the Cano Limon field was discovered, which allowed for the recovery of Colombia's productive capability, the growth of the oil reserves, the fulfillment of domestic oil demand, and the resumption of exports (Perry & Olivera, 2012).

   Later, the Cusiana (1988) and Cupiagua (1992) fields were discovered. These findings raised oil production from 450 KBPD in 1993 to close to 850 KBPD in 1999. In 1995, the government created an Oil Savings and Stabilization Fund as a mechanism to smooth the impact of increasing oil revenues. Over the last 30 years, oil variables have registered important changes in Colombia's economic performance. Indeed, since the late 1980s, new discoveries have increased oil reserves, and its production has consistently increased, reaching as much as 800 KBPD in 1999, the period in which the international crude oil price WTI fluctuated at around 20 USD per barrel.

   Simultaneously, exploratory activity consistently decreased due to the reduction of foreign direct investment in this sector. In this period, the real exchange rate appreciated until 1997, and the share of oil and its derivatives in the country's exports increased from 15 % in 1994 to 32 % in 1999. Moreover, fiscal revenues from oil accounted for about half a percentage point of GDP in national fiscal accounts and in oil royalties transferred to regions. (1) At the beginning of the first decade of the 2000s, there was a reduction in the exploratory activity, as oil production gradually declined to levels lower than 600 KBPD in 2003. At the same time, the oil price has experienced an upward trend since 2000, fluctuating at around 30 USD per barrel. Government revenues attributable to oil activity accounted for about 1 % of GDP in 2001 and declined to 0.7 % of GDP in 2003.

   Since 2003, international oil prices have increased gradually to reach a peak of 100 USD per barrel in 2008. However, in 2009, the economic stress caused by the international financial crisis temporarily decreased the price to 60 USD per barrel, cutting off the upward trend. In the following years, oil prices recovered levels above 90 USD per barrel, until 2014, when the global increase of crude supply and the decline in the demand for commodities pushed the oil price downward. At the end of 2015, crude oil price WTI reached a value of 49 USD per barrel. The spike in the oil price since 2003 encouraged oil production that, with booms and busts, gradually increased until settling around one million daily barrels per day between 2013 and 2015. The recent drop in prices has reduced oil exploration activities.

   The increase in price and production resulted in higher shares of the oil and its derivatives in Colombia's total exports, accounting for about 50 % in 2011 and 55 % in 2013. With the decline in crude price, this share decreased to 40 % in 2015. In turn, the oil boom improved the country's trade terms and increased the flow of foreign direct investment, which, in turn, pushed the real exchange rate up, which caused an appreciation from 2004 to 2012. The recent drop in prices generated a depreciation of the real exchange rate during 2014 and 2015 (Appendix A).

   The oil boom during the last few years has produced a critical flow of resources to the public sector that has significantly exceeded those of the 1990s. Government revenues from oil, mainly compounded by dividends distributed by the Colombian oil company (Ecopetrol) and taxes from the sector, increased from 0.8 % of GDP in 2002 to 1.8 % GDP in 2009. After a transitory reduction in 2010, these revenues continued to grow to account for about 3.3 % of GDP in 2013 and fell to 1.2 % of GDP in 2015. Likewise, oil royalties, which constitute a source of income to regional governments, rose from 0.6 % of GDP in 2005 to 1 % of GDP in 2008. After a decline in oil royalties due to the international financial crisis, they increased to 1.5 % of GDP in 2012. According to the economic activity, the share of the oil sector in the value of production fell from 5.3 % to 3.4 % of GDP between 2001 and 2007. Later, in the...