Mathematics Analysis and Approach Standard Level Internal Assessment:
Multiple Regression Analysis between Crude Oil Price and Geopolitics Introduction 7 years ago, my native country Ukraine engaged in war. Before we used to keep away from politics, however when geopolitical events affect you personally, it is hard to be apolitical.Since then, I have developed a big interest in international relations, especially conflicts and economics, and hope to pursue it in my future. Throughout IB I explored this area, and once stumbled upon an article about how Geopolitical Tensions influence Oil Prices. While reading the article, it was hard for me to comprehend that such things as terrorism can influence Oil Prices. Therefore, I started to wonder What is the level of relationship between Geopolitical Tension and Crude Oil Price, and how can we estimate future oil prices’ shifts depending on geopolitical factors? Since Oil is the most important source of energy, it is crucial to know what factors affect its price change. I want to know how the sphere of my interest – geopolitics – can influence the economy of Oil. The use of mathematics through Multiple Linear Regression plays a pivotal role in understanding the relationship and project possible oil changes .Background information Crude Oil Prices and influential factors Crude Oil has been the most essential commodity in the world during the last half-century, as the majority of our energy comes from the oil supply. Its production, storage, import, and export create a multi-trillion-dollar industry. However, the prices of Crude Oil are a
complicated puzzle that is influenced by multiple factors. In this exploration, I am focusing on geopolitical factors - Number of Terrorist Attacks Worldwide and OPEC’s Oil Production 1 / 4
in Barrels. OPEC is a major oil-related intergovernmental organization, as its members own the biggest amount of oil (in barrels) in the world.1
Historically, the relationship between geopolitics and fuel prices is a sensitive one and, it is based on principles of supply and demand. As some of the biggest oil-producing countries suffer from high political instability, the oil market is threatened by the rising number of terrorist attacks that change physical supply or the sheer threat of production instability which decreases demand. These geopolitical metrics thus allow capturing hidden structure in the dynamics of the Crude Oil market.2 Econometrics
To understand the relationship between the oil market and geopolitical changes and to explain consistently occurring correlation, econometrics is used. In general, the application of econometrics serves to develop theories or test existing hypotheses and forecast future trends from historical data in economics. It is useful for the investigation as it subjects real-world data, as well as provides models to analyze the complex relationship between many variables.This exploration will rely on multiple regression analysis techniques and null-hypothesis testing.
3 Multiple Linear Regression In statistics, linear regression is a model of a relationship between one independent variable and a dependent variable. However, in reality, multiple factors predict the outcome of an 1
Mostert, Wolfgang. “Factors Influencing the International Price of Oil in the Medium to Long-Term.” Mostert.dk.Accessed January 15, 2021. https://mostert.dk/pdf/Factors%20influencing%20price%20of %20oil.pdf.
Niemi, Jaradd. “T-Distribution Critical Value.” Accessed March 19, 2021.
https://www.jarad.me/courses/stat226/tables/t-table.pdf.
2
Bariviera, Aurelio. “Crude Oil Market and Geopolitical Events: an Analysis Based on Information-Theory- Based Quantifiers.”
Https://Arxiv.org/.
Accessed January 5, 2021. https://arxiv.org/pdf/1704.04442.pdf.
3
Hayes, Adam. “Econometrics: What It Means, and How It's Used.” Investopedia. Investopedia, December 14, 2020. https://www.investopedia.com/terms/e/econometrics.asp. 2 / 4
event.A dependent variable is rarely explained by only one independent variable. The crude oil price depends on more than just the amount of oil produced or just the demand for it. To assess the strength of a relationship, in which more than two independent variables are present, which is often the case in social science, multiple linear regression is used. In causal analysis, it also separates the effects of independent variables on the dependent variable so that you can examine the unique contribution of each variable. The model assumes that there are no major correlations between the independent variables, and often the effect of other predictors statistically eliminated.The formula for predicting the value of a dependent variable by multiple independent
variables:
4 y=β
+β 1 ∗x 1 +β 2 ∗x 2
+…β
p ∗x p +ϵwhere, y=dependentvariable x=independentvariables β 0=y−intercept(constantterm) β p=slopecoefficientsforeach∈dependentvariable ϵ=themodel’serrorterm(residuals) Aim of Exploration The study aims to “Detect whether two independent variables (Number of Terrorist Attacks Worldwide and OPEC’ Oil Production in barrels) affect the dependent variable (Price of Crude Oil), to estimate the magnitude of this effect, if any, and to create forecast formula through Multiple Regression Analysis”. Results Expected 4
Bevans, Rebecca. “Multiple Linear Regression: A Quick and Simple Guide.” Scribbr, October 26, 2020.
https://www.scribbr.com/statistics/multiple-linear-regression/.
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Moderate correlation between the independent variables and the dependent variable is expected, as the variables are produced by human-behavior. In the exploration, independent variables are Number of Terrorist Attacks ( x 1 ¿ and OPEC’s Oil Production in barrels ( x 2 ¿,
the dependent variable is Price of Crude oil (y).Alternative hypothesis (H A) anticipated to be accepted.H 0:thereisnorelationshipbetweentheindependentvariables∧thedependentvariable(y), ¿theindependentvariablesshouldnotremain∈themodel.H A
:thereisasignificantrelationshipbetweentheindependentvariables(x
1 ,x 2)∧the dependentvariable(y),∧theindependentvariablesshouldremain∈themodel.Raw Data To conduct the multiple regression analysis, quantitative data for the two independent variables
¿¿) number of terrorist attacks worldwide 5
and number of barrels of crude oil produced by OPEC between 1989-2019 6 , and data for dependent variable ( y¿Price of Crude between
1989-2019
7
was found. In total, every variable includes 30 independently selected observations that can be observed in Table 1. First 10 observations are presented below.
Table 1. Data on number of terrorist attacks worldwide ( x 1 ¿; OPEC’s production of oil barrels (x¿¿ 2 and Price of Crude Oil (y) between 1989-2019 Raw Data (sample) YearNumber of TerroristOPEC’s Crude Oil Price of Crude Oil addjusted 5
Hayes, Adam. “How Multiple Linear Regression Works.” Investopedia. Investopedia, March 17, 2021.
https://www.investopedia.com/terms/m/mlr.asp.
6
Global Terrorism Database. “Terrorism. Number of Terrorist Attacks, 1970-2019.” Accessed March 13, 2021.
https://ourworldindata.org/terrorism.
7
Sönichsen, N. “OPEC's Crude Oil Production in Barrels from 1989 to 2019.” Accessed March 10, 2020.https://www.statista.com/statistics/292590/global-crude-oil-production-opec-share/.
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