Oil Inflation: From Gas to Groceries

It's not just gasoline and airline tickets. An oil-price shock can raise prices for everything from vegetables to contact lenses to disposable diapers. Anything that's grown with fertilizer, made with or packaged in plastic, or transported on a diesel-powered truck tends to get more expensive when oil prices rise sharply.

Energy experts say the war in Iran has triggered one of the biggest oil-supply disruptions in history. How bad could it get if the Strait of Hormuz remains closed to oil tankers for an extended time?

The U.S. economy isn't as energy intensive as it once was, so rising oil prices don't fuel inflation as much as in the past. But they can still inflict plenty of pain. According to the U.S. Federal Reserve, a permanent 10% increase in the price of oil adds roughly a 0.4 percentage point to the headline Consumer Price Index (CPI) over the course of a year. Oil prices rose 40% in the three weeks after the United States and Israel began airstrikes on Iran on February 28.

Barring a quick resolution to the war, the Fed will closely watch not only oil prices themselves but how higher energy prices travel through supply chains and distribution networks. Below are some primary ways oil-price shocks can spread throughout the economy as well as sources that track the impacts before they show up in the headline CPI.

Crude oil counts for about half the price of gas, which tends to rise in lockstep with oil after a delay of two to four weeks. A $10-per-barrel jump in oil prices means about a $0.25-per-gallon increase at the gas pump.

Heating oil, used primarily in the northeastern United States, and jet fuel also track oil closely. All three can increase quickly and typically appear in the headline CPI within weeks.

• The Energy Information Administration's (EIA) dashboard provides daily price data for oil, gas, and heating oil.

It's not as obvious to consumers when oil prices ripple through supply chains. The effects are indirect and slower to materialize. But they're more consequential and longer lasting. Upstream industries feel about 75% of the impact within six months, while it can take roughly 20 months for the average downstream industry to feel a similar impact, according to a study by economists Robert Minton, of the Fed, and Brian Wheaton of UCLA.

In other words, downstream price increases can persist long after oil prices stop rising. Here are some channels through which higher oil prices hit businesses and consumers over the longer term.

Nearly 80% of U.S. farm products and the vast majority of non-agricultural consumer goods are carried on diesel-powered trucks at some point in the supply chain. Transportation costs are already elevated. In February, overall transportation costs hit the highest level in three years, more than 40% above the 2011–2020 average. Diesel prices, though down by more than half from their 2022 peak, are still about 30% higher than the 2011–2020 average.

• The Bureau of Labor Statistics (BLS) tracks No. 2 diesel fuel—the most commonly used diesel in heavy trucks in the United States—as part of its Producer Price Index (PPI).
• The BLS also tracks overall industry-level trucking costs in its PPI index.
• The Baltic Exchange Dry Index tracks global shipping costs.

Thousands of products, including those containing synthetic rubber, vinyl, and polyester, are at least partly made from oil or its derivatives. Oil accounts for about 20% of costs in synthetic rubber manufacturing, Minton and Wheaton noted. The BLS offers multiple metrics to track oil prices passing through petrochemicals, plastics, and rubber.

• Within petrochemicals and plastics, rising oil prices will show up first in the BLS petrochemical manufacturing series (PCU 325110) and industrial chemicals—basic organics series.
• Rubber and plastic products as well as plastic packaging products provide insight into finished goods.

Consumers have endured sharply rising food prices for the past several years. Food inflation was already picking up before the Iran war started, hitting 2.6% on an annual basis in February, the second-highest rate of increase since mid-2023. Fertilizer accounts for about one-third of the cost of corn and wheat, according to the U.S. Department of Agriculture, and the primary feedstock of fertilizer is natural gas, which tends to move closely with oil prices. About 20% of the global supply of liquefied natural gas (LNG) and about one-third of globally traded fertilizer pass through the Strait of Hormuz.

• The nitrogenous fertilizer materials component of the PPI tracks fertilizer inputs that are most sensitive to oil and natural gas prices.
• The agricultural chemicals and chemical product series includes pesticides and herbicides, which are made from petrochemicals.
• Processed food and feeds and farm products are also useful PPI metrics.

The war in Iran and closure of the Strait of Hormuz pose an inflationary threat in other ways. Energy infrastructure has been damaged in multiple countries, raising questions about how quickly supply could be restored when full traffic through the strait resumes. And strikes on Qatar's energy infrastructure have removed about a third of the world's commercial supply of helium—a key element in semiconductor manufacturing—from the market.

The Fed will face a significant challenge if oil prices remain near current levels. Headline inflation never fell to the Fed's target of 2% after the 2021–2022 COVID-19-driven spike, and inflation appeared to be warming up even before the war in Iran began. Meanwhile, the jobs market has deteriorated enough that the Fed had been expecting additional rate cuts later this year.

If the oil sticker shock continues, the Fed is likely to face a dilemma when it comes to managing its dual mandate to maintain price stability (inflation) and maximize sustainable employment. Coming so closely after the COVID spike, a prolonged shock risks not only soaring inflation but also dislodging inflation expectations, which is dangerous for any central bank.