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An Application of Stata

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Visayas State University

ViSCA, Baybay City, Leyte

Estimating Supply Elasticity of Crude Oil in United

Arab Emirates (UAE)

CHRISTOPHER A. LLONES

Presented to:

Dr. Moises Neil V. Serio

As Partial Requirements in

Econometrics

st

1 Semester S.Y. 2015-2016

SEPTEMBER 2015

Table of Contents

Table of Contents

Introduction

Data Collection

Data Analysis

Choice of Model and Variables

Scope and Limitation

Regression Analysis

Summary and Descriptive Statistics 0f the Model

Modifying and Organizing the Variables

Correlation

Regression

Regression Diagnostic Tests

Test for the Normality of Residuals

Test for Heteroscedasticity

Test for Multicollinearity

Test for Specification Error

Test for Autocorrelation

Prais-Winsten Regression

Findings

References

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Introduction

United Arab Emirates (UAE) is a member of the Organization of Petroleum Exporting

Country (OPEC) and the country is located at the Middle East. The country has a huge

production of crude oil which made UAE the fourth largest supplier of crude oil amounting to

12% of the total world supply of crude oil based from Energy Supply Security 2014 of

International Energy Authority (IEA). Crude oil is a non-renewable resource found in natural

underground reservoir and it has no close substitute yet found making its demand inelastic in the

side of consumer and supply elasticity also is quite inelastic since market of oil is monopolistic

in nature.

This paper aimed to apply analysis in regression to estimate supply elasticity of crude oil

of United Arab Emirates (UAE) as a function of real oil price of crude oil, production of crude

oil advanced by 1 year and export of crude oil lagged 1 year.

Data Collection

The data used in this paper were collected from the website of OPEC and World Bank.

Data Analysis

The study used descriptive statistics to describe data used and Stata to conduct regression

analysis and diagnostic tests in estimating the coefficient of supply elasticity in crude oil.

Choice of Model and Variables

The study used a basic double-log model with lag and lead variable to estimate the

coefficient of elasticity of crude oil. The dependent variable is the annual export of crude oil of

UAE to represent supply outside the country. Explanatory variables were real crude oil price,

production of crude oil advanced by 1 year and export of crude oil lagged by 1 year. A variable

has been lagged by a year to account the effect of previous supply of the country at present

exportation while a variable has been advanced by a year to account future anticipation in the

market of oil by the exporter which can affect present willingness to supply.

Scope and Limitation

The data used a time series data from 1960-2014 collected from OPEC and World Bank.

This paper focused primarily in conducting and applying regression analysis and gave less

elaboration in discussing the implication of the estimates generated from the model. The author

discourages that the model would be used in any policy recommendations. This papers primary

objective was only to apply methods in regression using Stata as the statistical software.

Regression Analysis

The model was based from export of crude oil=f (real oil price, production of crude oil

advanced by a year, export of crude oil lagged by 1year). This can be expressed as;

CrudeXport= 0 + 1 RealOilPrice + 3 LeadProd + 3 LagXport +

. summarize

Variable

Obs

Mean

year

CrudeXport

RealOilPrice

CrudeProd

55

35

43

53

1987

7.634224

3.024035

7.165557

Std. Dev.

16.02082

.3228516

.5816263

.9962443

Min

Max

1960

6.975414

2.257588

2.639057

2014

8.161945

4.23931

7.936303

Variable

year

CrudeXport

RealOilPrice

CrudeProd

Obs=.

20

12

2

Obs<.

Obs>.

Obs<.

Unique

values

Min

Max

55

35

43

53

55

34

42

51

1960

6.975414

2.257588

2.639057

2014

8.161945

4.23931

7.936303

Using the command summarize the stata has provided a summary of the variable where

it shows number of observation, mean, the standard deviation and the minimum and maximum

value of the variables. The starting year is 1960 until 2014 based from min. and max. of the

variable year in the summary table which has 55 observations. Then, if number of observation is

below 55 the variables has missing observations. Using the command misstable summarize, all

stata will generate table summarizing number of missing observation (obs=.), number of

observation (obs<.) where observation is less than missing values since stata treats missing

observations as large positive values. Therefore, the model has 20, 12 and 2 missing values in

export of crude oil, real oil price and crude production, respectively.

Since the model will be in a double-log form, both the explained and the explanatory

variables will be transformed into logarithmic form. Using the expression replace variable,

ln(variable) the variables will be in log form without changing the variables name.

7

. d CrudeXport RealOilPrice CrudeProd

variable name

CrudeXport

RealOilPrice

CrudeProd

storage

type

int

float

int

display

format

value

label

%8.0g

%9.0g

%8.0g

variable label

Xport Crude

Real Oil Price

Crude Production

. replace

CrudeXport=ln( CrudeXport)

CrudeXport was int now float

(35 real changes made)

. replace RealOilPrice=ln( RealOilPrice)

(43 real changes made)

. replace CrudeProd=ln( CrudeProd)

CrudeProd was int now float

(55 real changes made, 2 to missing)

After transforming variables into a log form the storage type will change into float as

shown by the command d (short for describe) which shows storage type before the variable

was transformed into log form. Since the data will be in a time series, the command tsset was

used to tell stata that the data will be in time-series data and also we could use lag and lead

options to generate a lag and lead variables which can only be used if the data would be in timeseries.

. tsset year, yearly

time variable:

delta:

1 year

. gen lagCrudeXport=L1.CrudeXport

(21 missing values generated)

. gen leadCrudeProd=F1.CrudeProd

(2 missing values generated)

The option yearly would tell stata that the time variable is annually. Then the time-series

operator L. (for lag) and F. (for lead) can be used. The number 1 means that export in crude

will be lagged by 1 year and crude production will be advance by a year. This is to capture the

researchers hypothesis that expected production and past exportation will affect the amount to

be supplied at present aside from price.

Correlation

Before regression, it would be useful to determine the possible associations among the

variables in the model. The command pwcorr would perform a pairwise correlation.

. pwcorr CrudeXport RealOilPrice CrudeProd lagCrudeXport leadCrudeProd

CrudeX~t RealOi~e CrudeP~d lagCru~t leadCr~d

CrudeXport

RealOilPrice

CrudeProd

lagCrudeXp~t

leadCrudeP~d

1.0000

0.7437

0.9844

0.9551

0.9681

1.0000

0.6701

0.7250

0.6385

1.0000

0.9681

0.9855

1.0000

0.9168

1.0000

The result of the pairwise correlation means that all the independent variable has a

positive association with the independent variable. The magnitude of associations among

variables are quite strong since the coefficient is close to 1.

Regression

Using the basic double-log form of the model;

CrudeXport= 0 + 1 RealOilPrice + 3 LeadProd + 3 LagXport +

The independent variable would be regressed by its explanatory variables using the regress

command in stata.

. regress CrudeXport RealOilPrice leadCrudeProd lagCrudeXport

Source

SS

df

MS

Model

Residual

3.20418579

.096579859

3

29

1.06806193

.00333034

Total

3.30076565

32

.103148927

CrudeXport

Coef.

RealOilPrice

leadCrudeP~d

lagCrudeXp~t

_cons

.0580351

.6313507

.357686

-.0604724

Std. Err.

.0258407

.0851185

.0882998

.309896

t

2.25

7.42

4.05

-0.20

Number of obs

F(

3,

29)

Prob > F

R-squared

Adj R-squared

Root MSE

P>|t|

0.032

0.000

0.000

0.847

=

=

=

=

=

=

33

320.71

0.0000

0.9707

0.9677

.05771

.005185

.4572639

.1770926

-.6942809

.1108853

.8054375

.5382794

.573336

Based from the F-test which measures the overall significance of the model, the model is

significant at 1% significance level since the p-value is less than 0.01 margin error. This implies

that at least one of the explanatory variables has able to explain the variability in crude export.

The explanatory variables have able to explain the variability in the exportation of crude oil by

97% based from the R-square. Based also from a t-test that tests if the individual independent

variables have linear relationship with the dependent variable, the independent variables:

RealOilPrice, leadCrudeProd and lagCrudeXport are significant at 5% and 1%. However, before

making an inference out of the results in this regression, the model must undergo a diagnostic

test to determine if the coefficients are unbiased and p-values are valid.

Test for the Normality of Residuals

Although normality is not required in order to obtain unbiased estimate of the regression

coefficients however, normality is required for valid hypothesis testing, that is the normality

assumptions assures that the p-value for t-test and f-test will be valid. A graphical approach can

be used to test the normality of residuals using the command kdensity and pnorm where

kdensity stands for kernel density estimate. After regression the command predict will create a

variable for residuals.

. predict r, residual

(22 missing values generated)

. pnorm r

. kdensity r, normal

Using

result

the

in

kernel density estimate and normal probability (pnorm), it shows a slight deviation from normal.

Nonetheless, the residuals were quite close to a normal distribution. In order to have a clear

result if the residuals are normally distributed, a Shapiro-Wilk test for normality will be used

using the command swilk.

. swilk r

Shapiro-Wilk W test for normal data

Variable

Obs

33

0.97667

0.796

z

-0.473

Prob>z

0.68200

The null hypothesis of Shapiro-Wilk test is that the distributions are normal. Based from

the result, it fails to reject the null hypothesis and accept that residuals are normally distributed.

According to Wooldridge (2009), one of the main assumptions of Ordinary Least Square

(OLS) regression is the homogeneity of the variance of the residuals. If the variance of the

residuals were not homogeneous then the residual variance is heteroscedastic. Presence of

heteroscedasticity does not affect the unbiasedness of the estimates but can cause invalidity of

inference. The command rvfplot, yline(0) will generate a graphical estimate to detect

heteroscedasticity.

. rvfplot, yline(0)

It is quite difficult to trace a pattern if heteroscedasticity is present using the plot above

since the number of points in not enough to established a good pattern. However, it can be

10

roughly estimated that heteroscedasticity is not present since the data points is not quite

narrowing to the right. Using White test and Breusch-Pagan test it can be concluded if

heteroscedasticity is present using the p-value. The command estat imtest and estat hettest is

for White test and Breusch-Pagan test, respectively.

. estat imtest

Cameron & Trivedi's decomposition of IM-test

Source

chi2

df

Heteroskedasticity

Skewness

Kurtosis

7.90

2.00

0.85

9

3

1

0.5440

0.5723

0.3552

Total

10.76

13

0.6311

. estat hettest

Breusch-Pagan / Cook-Weisberg test for heteroskedasticity

Ho: Constant variance

Variables: fitted values of CrudeXport

chi2(1)

Prob > chi2

=

=

1.19

0.2756

The p-values of the tests are against the null hypothesis that the variance of the residuals

are homogeneous or homoscedastic. Since the p-value for both test is large and not significant

then, the test fails to reject the null hypothesis and accept that the variance of the residuals is

homogeneous or homoscedastic. If the results reject the null hypothesis, the option vce(robust)

in the regression will be used to come up with an estimate of the coefficients adjusted for the

presence of heteroscedasticity.

When variables are linear combinations of other independent variables then the problem

of multicollinearity exists. As the degree of multicollinearity increases, the regression model

estimate of the coefficient become unstable and the standard error for the coefficients can get

wildly inflated (Chen et.al., 2003). Using the command vif after regression, stata can detect if

multicollinearity among variables exists.

. vif

Variable

VIF

1/VIF

lagCrudeXp~t

leadCrudeP~d

RealOilPrice

7.09

6.27

1.96

0.140980

0.159400

0.510924

Mean VIF

5.11

The rule of thumb states that vif with greater than 10 and tolerance (1/vif) less than 0.1

shows presence of multicollinearity. Then the result for variance inflation factor (vif) and

tolerance here is fine then, the variables is not a near perfect linear combination of the other or

the variables is not capturing the same thing.

11

A model specification error occurs when one or more relevant varables ae omitted from

the model or one or more irrelevant variable are included in the model (Chen et.al., 2003). The

linktest command detect that the test should not find any additional significant independent

variable in the model.

. linktest

Source

SS

df

MS

Model

Residual

3.20427346

.09649219

2

30

1.60213673

.003216406

Total

3.30076565

32

.103148927

CrudeXport

Coef.

_hat

_hatsq

_cons

.7272369

.0181491

1.022852

Std. Err.

1.651505

.1098676

6.196664

Number of obs

F( 2,

30)

Prob > F

R-squared

Adj R-squared

Root MSE

P>|t|

0.44

0.17

0.17

0.663

0.870

0.870

=

=

=

=

=

=

33

498.11

0.0000

0.9708

0.9688

.05671

-2.645586

-.2062304

-11.63242

4.10006

.2425286

13.67813

The test creates two variables the _hat and _hatsq, the _hatsq should not be significant so

that the predictor of our model is specified correctly. The _hat is the variable of prediction and

_hatsq is the variable of the squared prediction. The primary concern in this test is the test for

_hatsq. Based from the link test _hatsq is not significant and it fails to reject the assumptions that

the model is specified correctly.

The ovtest command shows if the model has omitted a variable that is essential in the

model and supposedly be included in the model.

. ovtest

Ramsey RESET test using powers of the fitted values of CrudeXport

Ho: model has no omitted variables

F(3, 26) =

0.82

Prob > F =

0.4969

The test fails to reject the null hypothesis that the model has no omitted variables, then

there are no omitted variables in the model.

Lastly, using a lag and lead in time series data is prone to autocorrelation. The command

estat bgodfrey for Breusch-Godfey and estat dwatson for Durbin-Watson test for serial

correlation of the error term or disturbance.

. estat bgodfrey

Breusch-Godfrey LM test for autocorrelation

lags(p)

1

chi2

df

4.867

0.0274

. estat dwatson

Durbin-Watson d-statistic(

4,

33) =

2.55771

The two tests rejected the null hypothesis of no serial correlation, then the eror term is

serially correlated. Using the Prais-Winsten and Cochrane-orcutt regression, according to the

12

stata manual prais uses the generalized least-squares method to estimate the parameters in a

linear regression model in which the errors are serially correlated. Specifically, the errors are

assumed to follow a first-order autoregressive process. Using the Prais-Winsten regression, a

new estimates of the coefficient can be obtain adjusted for autocorrelation.

. prais CrudeXport RealOilPrice lagCrudeXport leadCrudeProd, rhotype(theil)

Iteration

Iteration

Iteration

Iteration

Iteration

Iteration

0:

1:

2:

3:

4:

5:

rho

rho

rho

rho

rho

rho

=

=

=

=

=

=

0.0000

-0.2901

-0.3060

-0.3064

-0.3064

-0.3064

Source

SS

df

MS

Model

Residual

14.0513271

.084277236

3

29

4.6837757

.002906112

Total

14.1356043

32

.441737635

CrudeXport

Coef.

RealOilPrice

lagCrudeXp~t

leadCrudeP~d

_cons

.0497158

.3543518

.6477729

-.1344191

rho

-.3063733

Std. Err.

.0190028

.0688691

.0662351

.2252445

t

2.62

5.15

9.78

-0.60

Number of obs

F( 3,

29)

Prob > F

R-squared

Adj R-squared

Root MSE

P>|t|

0.014

0.000

0.000

0.555

=

33

= 1611.70

= 0.0000

= 0.9940

= 0.9934

= .05391

.0108507

.2134987

.5123069

-.5950959

.0885809

.4952049

.7832388

.3262576

2.557710

Durbin-Watson statistic (transformed) 2.127848

multicollinearity, linktest and omitted variable test. The model has failed to pass the test in

autocorrelation then, using the Prais-Winsten regression adjusted for the presence of

autocorrelation a new estimate of the coefficient was obtained.

Findings

The p-value of the F-test is less than the marginal error of 0.01, the model is significant at

1%. We have evidence to say that at least one of the explanatory variables has able to explain the

variability of crude oil export of UAE. Based from the R-square the independent variables has

able to explain the variability of crude oil export by 99%. Furthermore, all the explanatory

variables are significant by 5% and 1% based from the p-value of the t-test. Since the model had

undergone diagnostic tests and estimates of the coefficients are adjusted in the presence of

autocorrelation, we can now make inferences based from the estimates of the coefficients.

Based from the classical law of supply it is expected that real oil price should have a

positive sign, as well as for future production of crude oil and past exportation of the country.

The coefficient of RealOilprice is the supply elasticity of crude oil for United Arab Emirates. The

elasticity of supply at 0.0497 is inelastic which means that exportation of crude oil is not

responsive to changes in price of crude oil. Crude oil has no close substitute then the demand for

this good is inelastic. United Arab Emirate is a member of the Organization of Petroleum

Exporting Country (OPEC) which has the power of a monopoly to set prices then it coincides

13

with the estimates that the elasticity of supply of crude oil would be inelastic. A 1% decrease in

price would only decrease exportation by 0.049% since prices is dictated by the OPEC itself. A

percent increase in the previous exportation of crude oil of UAE will increase its present

exportation by 0.354 percent, the percentage of increase in present is lower than the previous

because sellers kept supply at low level to maintain higher price level and also crude oil are nonrenewable resources. Lastly, if anticipated production would increase by 1% exportation of crude

oil will increase by 0.67%. The explanation is quite straightforward, when production of the

good increases sellers has more to supply.

14

References

Chen, X., Ender, P., Mitchell, M. and Wells, C. (2003). Regression with Stata, from

http://www.ats.ucla.edu/stat/stata/webbooks/reg/default.htm

INTERNATIONAL ENERGY AGENCY (IEA), 2014. Energy Supply Security 2104: Emergency

Response of IEA Countries, pp. 502-510

ORGANIZATION of the PETROLEUM EXPORTING COUTTRIES (OPEC) 2015. OPEC

Annual Statistical Bulletin- 50th Edition.

WOOLDRIDGE, JEFFREY, 2009. Introductory Econometrics, Fourth Edition, p. 339-435

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