Does financial development intensify energy consumption in Saudi Arabia?

Abstract

Using annual data for the period 1971–2011, this study explores the relationship between financial development and energy consumption for Saudi Arabia by endogenizing economic growth, capital and urbanization as additional determinants in the energy demand function. The combined cointegration test proposed by Bayer-Hanck (2013) is used to estimate the long-run and short-run relationships among the series. The robustness of cointegration results is also tested by employing Pesaran's et al. (2001) Autoregressive Distributed Lag (ARDL) model accommodating structural break in the series. Both conventional and structural break unit root tests are applied in order to test the stationarity properties of the series. The causal relationship between the variables is further investigated by applying Innovative Accounting Approach (IAA). Both Bayer-Hanck's combined cointegration and Pesaran's ARDL bounds testing models confirm the presence of cointegration among the series. After confirming the existence of cointegration among the series, the overall results from the estimation of an ARDL energy demand function reveal that in the long-run, financial development adds in energy demand in Saudi Arabia. Furthermore, while economic growth is negatively related to energy consumption, urbanization and capital are the key factors leading to increased energy demand in the long-run. The findings also confirm the non-linear and inverted U-shaped relationship between financial development and energy demand for the Saudi Arabian economy. Finally, an evidence of unidirectional causality running from financial development to energy demand is found. These results urge for the attention of the policy makers in Saudi Arabia to design a comprehensive energy conservation policy to minimize the consequences of massive energy consumption on environmental quality and energy export-driven revenue by adding financial development, urbanization and capital as main explanatory determinants in the energy demand function.