Oil Makes the World Go Round

Oil makes the world go round.

The prices of crude oil in the USA topped $130 a barrel in March this year and, when compared with December 2021, were trading at levels as much as 60% higher. Prices were rising even before the Ukraine conflict began in February, with global demand outpacing supply. The outbreak of the conflict, however, with its ensuing Russian embargoes, sent oil prices shooting higher. The first thought many people have when it comes to rising oil prices is of the cost of filling up their car, but, when oil prices go up, it can affect many more household costs in almost every area.

For example, the food industry uses oil for its machinery, as a preservative and food dye, to produce fertilizers and pesticides, and for plastic packaging. If it costs more to produce the foods you buy, those costs will likely be passed on to you. Labor shortages and supply chain obstacles had already pushed up food prices by an average of 28% last year. The fact that Russia, the target of Western sanctions in 2022, is a major source of fertilizer for the world, made things worse. For readers who engage in CFD commodity trading with oil, let’s explain more specifically how oil prices influence the economy and what those effects may be.

Why Oil Prices Affect the Economy

Gasoline prices in the USA were, on average, over $4 in March, and, in California, they were about $6. For most people, if travel costs go up significantly, there is less money available for other purchases. Therefore, we would usually see less money spent on entertainment when oil prices are up. Also, any business that relies on oil to make its shipments will find its productions costs go up, which will be felt by the consumer. Again, if the householder’s discretionary income is cut down, it will impact parts of the economy that deal with recreation.

Looking at the economy on a broader level, when companies find the costs of production surge, they might decide to produce fewer goods, which would squeeze supply and raise prices. From the perspective of the consumer, demand may also drop, as we mentioned, and general confidence in the economy could go a notch down. The whole economy could, as a result, slow down. The oil price spikes of the 1970s led to an economic slowdown but also to higher unemployment and inflation. The oil price hikes in the late 1990s, however, did not spark off consequences of the same magnitude. One reason for this is that the improvement in energy efficiency means the economy became less dependent on energy prices. After 2000, the US Federal Reserve devoted itself more to curbing inflation than in the 1970s, which is another reason for the difference.

Effects on the Economy

Beyond specific results like spikes in food prices, a general, long-lasting rise in costs can settle in, which is called inflation. In March, commodity trading prices were going up at a rate of 7.9% for the year, which was the highest rate in 40 years. 71% of American petroleum was used for fuel in 2020, which helps explain why shipping costs spike when oil prices go up. Petrochemicals, which are used in clothes, computers, cosmetics, and containers, are made from oil, so the prices of these items have a direct connection with oil prices. Resins are a common petrochemical and saw a huge price hike of 28% in the year ending January 31st, 2022. What it will cost you to heat your home may change when oil prices rise, but so may the price you’ll pay to buy a home, because building costs go up as well.

Even people who use public transport are likely to be affected by hiked gasoline prices. “I do think buses and trains will see a pickup, especially with people going back to work”, suggests analyst Joe Perry. In the third week of March, users of publictransport in Washington increased by 4%, and in San Francisco by 7%. Transport companies Uber and Lyft increased their fees in March due to higher fuel costs. If we look at the airline industry, we see the effects of oil price hikes even more clearly. Airfares were going up even last year due to shortages of labor and efforts to reduce greenhouse gas emissions. But add to this the fact that up to a quarter of an airline’s operating costs can be made up by jet fuel, and you get the reason why the price of taking a domestic flight in the US has increased by 36% between January and March. With travel costs like these, it might make financial sense for many people to cut out their planned vacations altogether.

Wrapping Up

Looking ahead to the impact of hiked oil prices for the rest of the year, some analysts—like Dave Harden of Summit Global Investments, believe consumers will face the brunt: “Clearly, we’re going to see it at the gas pump, but, for consumers, it means higher prices across the board for anything”, he said. If you’re interested in CFD commodity trading, you’ll have an extra reason to monitor oil prices in weeks to come.