Pumping up the pain 

The price of petrol and diesel is in the headlines again as prices move close to the peaks we saw back when the Iran conflict first broke out. While the petrol price impacts most consumers directly when they fill up at the pump, the diesel price could ultimately have a longer lasting impact on household costs. Sustained high diesel prices could seep into freight costs, food and agriculture prices, and ultimately into core inflation – something that the RBNZ, and other central banks, will be monitoring closely over the coming months. 

Pain at the pump is immediate, broader impact comes with a lag 

Compared to pre-conflict levels, we estimate that the average consumer is having to pay around $60 extra per fill for petrol and around $80 extra per fill for diesel. In aggregate, this is a ~$180m impact across consumers. That is $180m every week or two that is not being spent on other parts of the economy (a rough estimate based on the number of light passenger vehicles in the fleet). 

The key issue is the price of diesel given it is used in all parts of the supply chain, making its demand highly inelastic. Diesel powers our large trucks, courier vans, farm machinery and civil construction equipment, just to name a few. This means that the rise in the diesel price impacts inflation far beyond just the energy portion of the inflation basket. While it works with a lag (and needs a sustained period of high prices), a rise in the diesel price seeps into inflation for core goods and services. 

Tradables inflation is showing the ‘first wave’ 

The direct impact of fuel came through our June quarter inflation numbers, where tradables inflation increased because of higher retail fuel prices. Annual tradables inflation increased to 4.9% in the June quarter, up from just 2.5% in the March quarter.

Indirect impacts can lag 12-18 months

What we have not fully seen yet is the indirect impact of these higher fuel prices, diesel in particular. These impacts always operate with a bit of a lag, but with the currently elevated fuel prices, are almost certain to come through in some form. 

Duration is the key for judging the eventual impact on consumer prices, but diesel costs are already spreading through freight and distribution networks as many companies have implemented price surcharges to account for higher fuel costs. While transport costs react fairly quickly through surcharges, the pass-through can be more gradual and take time to build through food, housing, and other categories. 

A longer-lasting oil price shock has the potential to raise broader inflation pressure, which would require a stronger monetary policy response. Already the market is starting to price a more aggressive hiking cycle than the RBNZ has stated in its own outlook. Remember that the RBNZ, like many central banks, have the ability to look through temporary shocks or spikes in inflation, but they cannot ignore ones that broaden out into general inflationary pressure. 

Pump prices disconnecting from oil prices

More recently, the price of refined fuels (including petrol and diesel) has moved much higher than the price of oil would imply. Figure 2 illustrates this by showing US pump prices for diesel, overlaid with the crude oil price. While the two generally move in tandem, the relationship has broken down of late with pump prices rising much higher than crude oil prices. This is due to a combination of challenges in transporting crude from conflict areas (including insurance costs, route changes, fleet supply), and reduced refining capacity (including in Russia). 

Figure 3 shows an index made up of 12 key tanker routes around the globe, tracking the cost of these tankers. The broad index is up almost 500% since the start of the year. However, some routes are facing much higher cost pressures than others. 

According to Bloomberg, it now costs around $77m to hire a very large crude oil carrier to move oil from the US to Asia. The cost of this same route through 2025 averaged around $9m. For a two-million-barrel cargo, the current freight rates imply an almost $40 per barrel additional cost – this is part of the driver of the higher pump prices we are seeing across the globe. 

It is worth noting that it is not just a New Zealand phenomenon in terms of rising fuel prices, the same impacts are being felt across Europe and the US. In the US, retail diesel prices have hit record highs, as have margins for diesel refiners. Interestingly crude oil volume is readily available, with Shell’s CEO recently noting that oil flows are near 80% of pre-war levels, however, attacks on vessels have also been rising. 

These periods test credibility

The latest surge, and persistence in fuel prices will no doubt be raising concerns amongst central banks that inflation could push higher than expected. Given the experiences of 2022, it is reasonable to expect that the RBNZ will take a conservative approach and raise rates sooner – rather than letting inflation overshoot and then having to tighten aggressively down the track. 

Along with thinking about its own credibility, our central bank also has to consider what is happening to inflation expectations. At present, inflation expectations remain slightly elevated relative to the 2% target mid-point across households, businesses, and professional forecasters. While we expect that firms, at present, broadly trust the RBNZ to manage inflationary risks, any loss in this trust (reflected through a lift in inflation expectations) would likely see firms push through price increases to help offset what they would deem to be persistently higher inflation on the horizon. 

Summary

The reality is that since the conflict broke out back in late February, the market has expected the energy spike to be short lived. While things appeared to be de-escalating in recent months, we have seen this reverse with refined fuel prices edging back up towards peak levels. 

Market pricing across most economies is that rates will need to be lifted over the coming year in order to control inflation. While a sudden reversal of fuel prices would alleviate the need for some hikes, the longer we see elevated prices, the more likely that higher interest rates will need to follow. While this has a near term impact on consumers with borrowings, it also results in a notable growth impact down the track, as we saw post the 2022/23 hiking cycle. 

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