When oil prices go up, investors are generally warned that inflation will soon follow. To what extent, however, does the cost of oil contribute to rising prices generally?
Currency depreciation caused by inflation drives up the cost of everyday purchases. Consumers’ discretionary expenditure and GDP growth may suffer as a result of the higher cost of living.
Inflation has been shown to correspond with rising oil prices historically. When the price of oil increases, so does the cost of other commodities that rely on it. Commodities like fruits and vegetables that have historically been delivered to market through gasoline- or diesel-powered vehicles and trains may see price increases as a result.
Investors are paying close attention to crude oil prices and energy companies as the national average price of a gallon of gas has risen to its highest level since 2008 and the first land conflict in Europe since World War II is being conducted by one of the world’s top crude oil producers. In this article, we’ll give you more information on how oil prices and inflation are related and whether or not it’s a good idea to invest in oil.
Oil prices and inflation – what should you know?
Since crude oil is a vital component of many industries, its price increases will have a multiplier effect on inflation.
U.S. inflation, which is calculated year-over-year increase. As a result of COVID-19 supply interruptions, the Consumer Price Index (CPI) reached a 40-year high in March 2022. As a result of sanctions the United States and its allies put on Russia for its invasion of Ukraine, crude oil prices reached their highest point in a decade. In addition to that, as this website shows, the recent report on CPI might cause fluctuations and volatility in financial markets. Economists have argued the United States is in better shape to withstand the storm than many of the other countries whose central banks are planning to keep raising rates to battle inflation. In response, the value of the dollar rose to its highest level against the yen in 24 years and its highest level against the pound in 37 years. Since most international sales of oil are settled in dollars, a stronger currency puts downward pressure on oil prices.
A change in the price of oil may have far-reaching repercussions for the economy as a whole, as well as for individual households.
As we’ve seen, on a broader economic scale, increasing oil prices may make it more costly for businesses to manufacture and ship their products and provide their services. Indirectly, rising oil prices increase the cost of doing business by increasing the price of materials, fuel, and energy used in manufacturing. As a result, manufacturers may decide to raise prices.
Should you consider oil as an investment?
Although it may not be the best moment to invest in oil and gas firms, recent falling prices for these commodities have not made them terrible buys. Companies seem to be in good financial shape as they continue to profit from high oil and gas prices. The pandemic bankruptcies also helped to eliminate inefficient businesses. Electrical grids and the transportation sector will still depend on petroleum for some time, even if broad renewable energy is on the horizon. In particular, natural gas, which is cleaner than coal and is considered a transition fuel to renewable energy, fits this description.
Early in March of 2022, the price of oil soared beyond $100 per barrel, and everything changed. The Fed had not yet begun its quantitative tightening program at the time, thus it was still purchasing long-term bonds.
The federal funds rate dropped by around 2.25 percentage points, drastically lowering the cost of credit. The current 30-year fixed mortgage rate is above 5%, although it was under 3% not so long ago.
The Federal Reserve has been steadily increasing interest rates since then in an effort to bring down historically high inflation. At the recent Jackson Hole economic conference, Fed Chair Jerome Powell reiterated the central bank’s commitment to restoring inflation to its 2% objective, despite the potential costs to the wider economy.
Investors should start making plans immediately in case these circumstances cause crude oil prices to rise substantially higher. If you have a large portfolio of expensive growth companies, you may want to consider diversifying by purchasing oil firms, which should gain from increasing crude prices.
So, is it a good time to invest in oil? Until you invest your money in the commodity, it’s important to take into account several things where one of the main ones being increasing inflation and its impact on the price of oil. In addition to that, you should take into account the ongoing war in Ukraine, which, firstly, resulted in the price increase in oil. However, the price of the commodity also depends on U.S. monetary policy. If the Fed will increase interest rates, oil and gas prices are most likely to stay volatile. So, before you invest money in oil, you should take into account that energy markets might continue to fluctuate. Hence, investing in oil or other energy-related commodities might not be a smart move, right now.