Rudy Freno
Is The Price Of Oil Going Up Or Down – Historically high oil prices preceded high inflation. Is there a significant relationship between oil prices and inflation?
A rise in oil prices is often associated with news that warns investors of the impending threat of inflation. But is there a causal relationship between oil prices and inflation?
Is The Price Of Oil Going Up Or Down
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Inflation reduces the value of the currency and leads to higher prices for consumer goods and services. On the other hand, the cost of living of consumers can have a negative impact on discretionary spending. mind and economic growth.
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Historically, higher oil prices have been statistically correlated with financial crises. Fur. As oil prices rise, so do the prices of oil-based products. For example, costs may increase for products made from petroleum such as plastics, or for products such as fruits and vegetables that are usually transported to market via gasoline or diesel trucks and trains.
That said, there is evidence that the relationship between oil prices and inflation began to decline decades ago. According to Bob Iaccino, co-founder of Path Trading Partners, “History shows that the two are related, but the relationship has declined since the rise in oil prices in the seventies.”
At the macroeconomic level, higher oil prices can make companies produce and transport goods or services more expensive, as mentioned above. An increase in oil prices can also increase the cost of production, transportation and heating for businesses, making production more expensive. On the other hand, producers can choose to pass those costs on to consumers.
However, at the microeconomic level, as many consumers know well, the increase in prices at the pump and in the store can reduce the spending that is decided to spend on new electronic equipment, clothing or leisure. High prices for consumer goods and services in the long run can reduce demand for those goods, causing economic growth to slow or even lead to recession.
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Three recessions preceded the rise in oil prices. “One of the things that can disrupt a bull market is a rise in oil prices that could lead to a recession,” said Paul Hickey, co-founder of Bespoke Investment Group. “When you have high oil prices, it has a significant cost impact for many different businesses.”
Nicholas Colas, co-founder of DataTrek Research, agrees. “A rule of thumb I learned from the economics of the auto industry in the 1990s is that if oil prices go up 100 (percent) in a year, expect a recession.”
However, many economists argue that the rise in oil prices does not cause a recession – the US Federal Reserve does when it raises interest rates in an attempt to reduce demand.
Higher oil prices can be more profitable for oil producers, but as Dmitry Marinchenko, managing director of Fitch Ratings, explained, inflation also brings higher costs.
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“The increase in activity in the sector and inflation in general may cause pain for many producers,” he said, talking about the latest inflation environment in 2022. “Many companies have reduced costs significantly in recent years, and now this situation can be reversed.”
Traditionally, the most watched inflation indicator is the Consumer Price Index (CPI), which is known to move in line with oil prices. The US Bureau of Labor Statistics defines the CPI as “a measure of the average change over time in the prices paid by urban consumers for a market basket of goods and services.”
The CPI basket includes products and services in the food and beverage, clothing, accommodation, transportation, medical, entertainment, education and communication sectors.
High oil prices can increase the cost of consumer goods because the producers of these goods contribute to the increase in production and transportation costs. Those costs are often passed on to consumers. A rise in oil prices could be a buy signal for gold investors as the precious metal is seen as a hedge against inflation and economic turmoil.
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The cause and effect relationship between oil prices and inflation is shown In 1973, the Organization of the Petroleum Exporting Countries led by Saudi Arabia Water embargo against the United States due to America’s support for the Israeli army. The Iranian revolution in 1979 also increased the price of oil.
The increase in oil prices caused the CPI to more than double in the late 1980s. Conversely, Investopedia notes, “Previously it took 24 years (1947-1971) for the CPI to double. The result was a period of stagnation – low economic growth, high unemployment and inflation.”
The relationship between oil prices and the CPI has declined in the years since then. When oil prices rose from $14 to $30 per barrel in six months in 1991 during the first Gulf War, the CPI failed. Additionally, the increase in crude oil prices that increased from $16 to $50 between 1999 and 2005 had little effect on the CPI. Importantly, this recent increase in oil prices has had little effect on economic growth, unemployment or inflation.
What is behind this division? Some have suggested that improvements in energy efficiency have reduced energy use per dollar in many industries. Some have argued that since the 90s, monetary policymakers have changed the way they control inflation, thereby reducing the impact of high oil prices.
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Economists, including those at the Federal Reserve in St.
However, the relationship between oil prices and inflation is not completely dead. Instead of CPI, St. The Louis Fed said today that oil prices are correlated with the Producer Price Index (PPI). The PPI is a measure of the average change over time in the selling price that producers receive for their output.
According to Investopedia, between 1970 and 2017, PPI and oil prices had a positive correlation of 0.71 (compared to a correlation of 0.27 between CPI and oil prices). “This seems to indicate that crude oil, as a hedge against inflation, is not important,” concluded Iaccino of Path Trading Partners in his discussion of oil prices and inflation. “But as a contribution to the idea of ​​possible future inflation, crude oil prices have some value.”
Over the past 40 years, the Fed’s response to rising inflation has been to raise interest rates. But will higher interest rates lower oil prices? Iaccino said that in the last six rounds of rate hikes, the price of the WTI crude oil contract rose an average of 16.06 percent six months after the rate hike.
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“So, is crude oil rising due to price increases, or is this just a fluke from an unrelated situation?” He asked that. “The simple answer is…both.”
Although oil can be a driver of inflation, changes in inflation-adjusted rates do not seem to affect oil prices in the short or medium term. “There are other factors that affect the price of crude oil, including geopolitics and a sudden increase in supply or demand. It can only be an important part of inflation is the price of energy, of course, including crude oil,” explained. Product market specialist.
“Normally, the increase in crude oil prices is the main factor that causes high inflation, or the increase in oil prices is a function of a strong economy and strong demand.”
Following the Fed’s May 2023 interest rate hike, oil prices fell 4 percent on concerns that higher costs could translate into reduced economic activity and oil demand. However, oil prices continued to rise from US$65.48 per barrel on May 3 to US$83.60 per barrel on July 31, despite interest rate increases at the end of the month. Supply pressures from low US inventories and production cuts by OPEC appear to have had a bigger impact on oil prices than the Fed’s interest rates.
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The drop in oil prices remains the biggest energy story in the world. This will bring cheap gasoline back to the United States while undermining oil producing countries like Russia and Venezuela.
But why oil prices continue to fall? In June 2014, the price of Brent oil was around 115 dollars per barrel. By January 23, 2015, it had more than halved, to $49 per barrel:
The short version of the story is like this: for most of the past decade, the price of oil has been high – almost $100 per barrel since 2010 – due to increased oil consumption in countries such as China and conflicts in major oil countries such as Iraq. . The production of oil in the normal area cannot meet the demand, so the price increases. up
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But beneath the surface, many of those trends are changing rapidly. High prices have prompted companies in the United States and Canada to start drilling new wells,
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