Why rising diesel costs will increase food and commodity prices

Consumers are feeling threatened by rising gasoline prices. But another type of fuel, diesel, could also drive up store prices in less obvious ways, economists say.

According to AAA data, diesel prices have soared 68% since the start of the Iran war, a steeper increase than gasoline prices.

Economists say this dynamic could raise costs for consumers on everything from food to physical goods at a time when inflation is already high.

“It’s going to put additional pressure on consumers,” said Michael Reid, head of U.S. economics at Royal Canada Bank. “And it’s the low-income and middle-income consumers who are really feeling the brunt of it.”

Average diesel prices rose from $3.76 per gallon on February 27, the day before the U.S. and Israeli bombing of Iran, to $6.32 per gallon on Tuesday, according to AAA.

In September, the national average diesel price exceeded $6 per gallon for the first time.

The group of seven countries – France, Canada, Germany, Italy, Japan, the UK and the US – agreed on Friday to “significantly release” diesel stocks to counter soaring fuel prices. The Trump administration had been pressuring Europe to release its diesel stocks in exchange for the U.S. imposing an export ban to lower prices.

President Donald Trump signed an executive order Monday that temporarily allows broader use of cheaper red-dyed diesel, normally reserved for farm work, in an effort to cut record fuel costs.

Economists say the Iran war is the main reason for the rise in prices. The conflict has reduced the supply of oil flowing through the Middle East, raising prices and damaging the region’s refining infrastructure that turns oil into products such as diesel, gasoline and jet fuel.

Russia’s war in Ukraine is also contributing to the rise in diesel prices, economists said. Kiev’s bombing of a Russian refinery led Moscow to ban diesel exports.

Meanwhile, average gasoline prices were $4.37 per gallon as of Tuesday, up about 47% from $2.98 per gallon on Feb. 27, according to AAA.

Economists say gas price changes are more noticeable to consumers than diesel price changes because drivers feel them immediately when refueling. However, the impact of diesel is not well known.

“Gas is direct. It’s coming out of your pocket, straight into your gas tank,” said Mark Zandi, chief economist at Moody’s. “Diesel is indirect.”

Diesel is the fuel used in trucks, trains, and ships to transport goods to stores. Beyond transportation fuel, it has many other uses, including agriculture, manufacturing, and residential and industrial heating, according to a Sept. 21 Goldman Sachs Research memo.

Economists say companies are passing on these higher diesel prices to consumers through higher prices in stores.

“Everything that’s on a truck, from groceries to things delivered to your door via UPS or Amazon, will be affected by rising diesel costs,” Zandi said.

There’s a common saying that sums it up well, he said: “Cars run on gas, the economy runs on diesel.”

Reed said freight costs are rising as quickly as the economy reopened after COVID-19, and much of this transportation relies on diesel.

Since trade routes are largely fixed, meaning companies cannot shorten distances to save fuel, higher diesel input costs are likely to be passed through the supply chain and ultimately to consumers, he said.

It will take time for these price impacts to trickle down to consumers, and it will likely take six months to a year for the impact to be fully felt, Zandi said.

As a general rule of thumb, he said, assuming prices remain high, consumers can expect overall inflation to rise by 0.1 percentage points for every $1 increase in the price of a gallon of diesel.

Zandi said diesel prices have increased by about $2.50 a gallon since the start of the Iran war, which typically translates into about a 0.25 percentage point increase in inflation, as measured by the Consumer Expenditure Price Index.

The PCE index is the Federal Reserve’s recommended inflation measure. The central bank aims to keep annual inflation at around 2% over the long term. As of August, it was running at an annualized rate of 3.4%.

“We may see a temporary period of rising prices over the next few months,” said Royal Canada Bank’s Reid. “And consumers won’t see it as a one-time increase. It’s going to keep going up and up.”

Goldman Sachs said in a Sept. 21 note that it expects higher diesel prices to cumulatively push food prices up by 0.2 to 0.4 points in the coming months. On average, diesel prices account for about 5% to 10% of input costs across crops, the report said.

According to Goldman Sachs, “Prolonged rises in diesel prices risk further increases in food prices, as farmers disproportionately purchase fuel during the fall harvest season and often purchase fuel for storage in the winter.”

Goldman expects diesel prices to remain high through 2027.

Mr Reid said the G7 announcement on strategic diesel releases would do little to dilute high prices.

“The longer oil (and) energy prices continue to rise due to the Iran conflict, the greater the risk that it will have a significant impact on the consumer goods sector,” Reid said.