The price of oil has risen sharply in recent weeks in response to concerns that the war in Ukraine will significantly reduce supply. But what happens in oil markets never stays in oil markets.
The price of US crude oil jumped to a 13-year high of US $ 130 from March 6, 2022. It has fallen but has been trading above $ 110 since March 17. This is more than 60% higher than it was in mid-December, before fears of a Russian invasion began to increase.
Of course, this pushed up the cost of gasoline, which averaged $ 4.32 per gallon in the U.S. on March 14th. But it is less well understood how rising energy prices are leaking into the prices consumers pay for toys, electronics, food and almost every other product you can think of.
Energy is becoming one of the main causes of inflation, by which I mean a sustained, general rise in the prices of goods and services in an economy. The latest data shows that prices are rising at an annualized rate of 7.9%, the highest in 40 years.
In my economics classes, I like to make jokes to my students that we eat petroleum. Students can hardly imagine them drinking crude oil or gasoline, but in reality this is both figuratively and almost literally true – and I’m not even referring to how people consume about a credit card’s oil-based plastic every week.
Let me explain.
Aircraft, packages and polyester
Oil prices affect the prices of other goods and services in some significant ways.
The most obvious is that petroleum drives the vast majority of cars, planes and other vehicles that move around well. About 71% of the 6.6 billion barrels of petroleum consumed by the U.S. in 2020 were used for various types of fuel, such as gas, diesel, and jet fuel.
This increases transportation costs and makes the shipping of everything from refrigerator components to everyday items like toothpaste more expensive. Businesses can choose to absorb the cost – for example if their market is highly competitive – but usually pass it on to customers.
But oil is also a key ingredient in many of the things people buy, both in the packaging and in the products themselves, especially food. This is where most of the other 29% of oil used by Americans comes in.
Petrochemicals obtained from petroleum are used to make clothing, computers and more. For example, the amount of oil-based polyester in clothing has doubled since 2000. More than half of all fibers produced around the world are now made from petroleum, which requires more than 1% of all oil.
In addition, the cosmetic industry is very dependent on petroleum as items like hand cream, shampoo and most makeup are made from petrochemicals. And as with many products, all those creams and cosmetics are made from disposable plastic containers made from oil.
Similarly, the vast majority of toys made today are made of plastic.
Crude in our cookies
The food industry is particularly sensitive to the price of energy, more than any other sector because petroleum is such a key component of its supply chain at every step of the way, from planting and harvesting to processing and packaging.
Interestingly, the largest use of petroleum in industrial farming is not transportation or fuel machinery, but rather the use of fertilizers. Large amounts of oil and natural gas go into fertilizers and pesticides used to produce and protect grains, vegetables and fruits.
This is one of the reasons why it takes 283 liters of oil to raise one 1,250-pound steering wheel. And that’s why even a loaf of bread requires an extraordinarily high amount of energy.
Oil is also an ingredient in the food we consume. The most important food product that comes from petroleum is known as mineral oil. It is commonly used to make food last longer because petroleum does not become rancid. Packaged pastries such as cookies and pizza often contain mineral oil as a way to preserve their shelf life.
Petrochemicals are also used to make food dyes, which can be found in grains and sweets.
Paraffin wax, a colorless or white wax made from petroleum, is used in the manufacture of some chocolates and sprayed on fruit to delay spoilage and give it a shiny finish. It also helps keep chocolate solid at room temperature.
And plastic is an important part of food packaging because it is relatively inexpensive, durable and lightweight, it offers protection and is sanitary.
Oil inflation and the Fed
The importance of oil to the US economy has been a major concern since the 1973 oil crisis, when prices rose, prompting calls to save energy.
Since then, the amount of oil consumed for every dollar of economic output has decreased by about 40%. In 1973, for example, it took just under one barrel of oil to produce $ 1,000 in economic output. Today it takes less than half a barrel. That’s the good news.
The bad thing is that because the US economy is now 18 times larger than it was in 1973, it needs a lot more oil to function.
That’s why the rising price of oil is now the main driver of inflation – and why the Federal Reserve is preparing for some big interest rate hikes to fight it.
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