There is an ever evident relationship between oil and food prices phenomena mostly experienced after the recent crisis in the Middle East. One of key issues with respect to the recent Middle East crisis is that the crisis led to increased fuel prices. This in turn led to an increase in food prices and an overall rise in living standards. “A continuation of political unrest in oil producing countries in the Middle East that are not food producers has further caused food prices to go even higher”(2006 pp.356). It is very important to understand the role of crude oil in agricultural processes. One practical example is that tractors that pull plows run on diesel or gasoline. The main reason for the increment of food prices as result of an increase in oil prices is due to the increased cost of production that is eventually passed on to the overall consumers.
Rising food prices
According to the UN food agency, food prices have recorded a record high as a result of the rising cost of fuel. Most economists also predict that food prices could go even further if fuel prices continue to rise. The Food Price Index which is one of the key tools that economist measure inflation and economic situation has risen to up to 236 in a short period of 2 months. This has been attributed to the Middle East crisis and the slow economic growth in the global economic recovery process. According to UN’s Food and Agriculture Organization, this is one of the highest recorded figures in history. It is expected that future food spikes could further slow down the global economic recovery efforts. The rising food prices are also said to be responsible of the political unrest that has taken place in various parts of the worlds especially in Arab countries.
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According to recent surveys, the recent increase in food prices will be of great inconvenience to the western world where the cost of food is relatively a small part of the family budget. However, the situation is different in Third World countries where the cost of food accounts for almost a half of the family’s budget. This further implies that a small increase in food prices can be devastating for poor nations. Such minimal increase in food prices may lead to civil unrest which may in turn affect the economic situation not only in the individual country but globally specifically in oil producing countries. A perfect scenario is that of Egypt where it can be said that Egypt itself is not a major oil producer hence any increase in crude oil prices won’t benefit the country that much. However, an increase in crude oil prices implies that the price of food imports in Egypt will increase. This is with respect to the fact that Egypt itself is not a self sufficient country in food production.
The same people who overthrew Hosni Mubarak form leadership will once again face the problem of starvation due to the increased cost of living. One thing that is evident in the case of Egypt is that the country sits on the Suez Canal which is one of the major channels used in the transportation process of crude oil from the Middle East to the Western countries. Any further increase in food prices implies that the Egyptians will become so frustrated that they will try and restrict traffic on the Suez Canal. This will further create a situation where the food and oil prices will continue rising higher and higher frustrating the world prices of the same. The reason why the Middle East crisis is the beat practical example in examining the relationship between oil and food prices is because most of the Arab region countries are not self sustaining when it comes to food but most of them are oil producing countries.
According to the IMF, the soaring oil prices and the inflation levels in emerging economies are a great risk towards the global economic recovery. Some of the economies which have exhibited rapid economic growth are economies such as China, Brazil and India. According to the IMF, emerging economies should be very careful so as to ensure that market conditions like he recent housing boom in the US do not lead t a near collapse of the economy. Despite showing some signs of recovery from the recent economic recession, most economies have not realized full recovery hence demand a lot of attention in the financial context.
The prospect of oil at $120 is perceived not enough to indicate a steady global expansion. Most commodity prices have increased a situation which has seen the rising food prices in the relatively developing countries. This increase in commodity prices is seen as the key factor that led to the recent Arab world revolts in Yemen, Saudi Arabia, Egypt and Tunisia. The IMF predicts that the inflations levels in developing countries were much likely to increase accompanied by a push for higher wages. The recent Arab crisis which was recently experienced in oil producing countries had led to a sharp incline in oil prices in recent days but these prices retreated signaling a progress in the Libyan peace talks.
Connection between oil prices and inflation
Inflation has been found to move in a similar direction with oil prices implying that an increase in oil prices lead to increased global inflation and vice versa. The major reason for this is as a result of oil being a major input in the world economy. Oil is one of the commodities used in almost each and every activity in the modern world. This implies that an increase inputs will undoubtedly lead to increased cost of end products. A practical example of this is that if an increase in oil prices is passed on to the plastic industry which is then passed on to the final consumer.
The direct relationship between oil and inflation became evident in the early 70s when the price of oil historically rose from the nominal price of $3 before the oil crisis of 1973 to $40 in the 1979 oil crisis. This is attributed with the Consumer Price Index which is a key measure of inflation which doubled from 41.20 in 1972 to 86.30 in 19.80. Economists found out that it had previously took almost twenty four years for the CPI to double, it took only eight years for the same to double depicting the effects of oil on global prices.
However, the relationship between oil and inflation deteriorated after the period of the oil crisis. During the Gulf War oil crisis, the prices of crude oil doubled from $20 to $40 in a short period of six months. Despite this increment, the Consumer Price Index experienced some stability growing form 134.6 in January to 137.9 in December. The relationship between oil and inflation became even more apparent between the years 1999 and 2005 when the annual average nominal price of oil increased from $16.56 to $50.04. During the same period, the Consumer Price Index grew from 164.30 to 196.80 by the end of the same period. However, the strong correlation that existed between oil and inflation in the past is seen to be significantly weakened.
Global Inflation and surging oil prices
In recent times, the global oil prices have led to the global inflation amid fears of interest rates increment as well as steep rises in consumer prices. According to the US labor department, the inflation rate in the US posted a record rise of 2.7% while the Euro zone 17 member states posted increased consumer prices to up to 2.7% increase. At the same time, China Bureau of Statistics stated that the Chinese inflation soared to a record three year high by growing to 5.4% in the month of March. India is also experiencing the same situation where consumer prices unexpectedly rose to 8.9% during the same month
Oil prices and inflation effects on the global recovery.According to the International Energy Agency, high oil prices are impacting negatively on the oil demand growth which has seen slowed. The same sentiments were made by the IMF stating that the soaring oil prices and inflation were a risk to the global economic recovery. Oil prices are seen to cause an effect on key inflation indicators such as the consumer price index and consumer sentiments on the economic outlook.
The correlation between oil and food prices was particularly evident during the period between 2007 and 2008 when both the oil and food prices recorded a historic high figure. This rise of the fuel and food prices is specifically responsible for the acceleration of the Great recession. Between the month of July 2007 and June 2008, the prices of crude oil rose from $75 to $140 per barrel which is an increase of almost 85%. During the same period, food prices recorded a record high figure of $225 all the way from $160 according to the Food Price Index. According to the World Bank, agricultural production is relatively energy intensive implying that any changes in fuel prices impact heavily in the agricultural sector. This is a larger context implies that the increase in fuel prices led to an increase in power machinery, irrigation systems as well as an increase in fertilizers and other chemicals that are energy intensive.
The situation is further worsened by the fact that most government have embarked on a campaign to grow plants for bio-fuel instead of food crops. This is what is responsible for the increase in food prices whenever oil prices go up. The World Bank has also come up with a rather interesting data signifying that there is a 0.9% in maize prices whenever there is a 1% increase in oil prices. This is because; any increases in fuel prices increase the profitability of price increase in the agricultural sector due to inflation that greatly affects prices of basic commodities.. This can be further be demonstrated in the graph below.