Volume 93 No. 5 - May 2022
Why the Rising Price of Oil Means You’ll Pay More for Pizza
The painful effects of high inflation can be felt everywhere. If you have recently filled up your tank at the gas station, purchased a meal at a restaurant, or searched for a new apartment or house, you have seen the effects of high levels of inflation. Inflation has become one of the most discussed topics in the U.S. On a fundamental level, the costs to produce any good or service: labor, capital, and raw materials, have risen. The cost of one of the key components to any good or service, oil, has also risen, which impacts many parts of the economy.
In the U.S., pizza has emerged as a go-to food, ubiquitous in our culture and ever-present on many of our dinner tables—often at least one night per week. The process involved in making a pizza, from the farm to the dinner table, is comprised of several steps, commonly referred to as the supply chain. Two of the issues the economy is currently facing are supply chain disruptions and inflation. Pizza can be used as an example to illustrate how rising input costs of the supply chain, namely oil, can cause the cost of the finished product to increase.
This Pizza Tastes Oily
The prices of the ingredients used to make a pizza are on the rise. The crust requires inputs like flour, dough, cornmeal, sugar, salt, and yeast. The toppings almost always require tomatoes and cheese, and often toppings like pepperoni, sausage, or green peppers. Delivery drivers use the fuel in their cars to bring the pizza to a restaurant’s patrons.
The common denominator of all of these inputs is oil. Oil is a key input to almost every step of the process. Oil is used to power the machines that grow crops to produce flour, tomatoes, or green peppers and in the gasoline used to transport ingredients to the store. By some measures, the cost of a pizza that can be attributed to oil is as high as 70%. When we strip pizza down to its core ingredients, the rising price of oil explains the higher costs we see in the finished product.
We’ve seen inflation before – most notably during the extended run in the 1970s and in the postwar years of the 1940s and 1950s as the U.S. digested the spending that had fueled World War II and the New Deal programs before it. Increased energy costs were a large contributor to inflation during each of these periods. Oil and gasoline often move in tandem with inflation. In recent decades, the correlation between the two is evident. The following graphic displays the gasoline component of the U.S. Consumer Price Index alongside the U.S. Inflation Rate.
Oil is deeply rooted into the country’s supply chain. The creation of a pizza is one example of the effect of oil and oil prices on production, distribution, and ultimately consumption of products. This, combined with higher costs of capital and labor can cause a pizza that formerly cost $5.99 to increase to $8.99 or more. Inflation is everywhere, and not just in pizza prices. Since March 2021, inflation has risen 8.5%. That’s the highest inflation in more than forty years, dating back to December 1981.
What Can Be Done?
Early in the pandemic, amidst government stimulus programs and large amounts of spending, we wrote that a few things would occur; one of these was higher inflation. Now, years later, the economy, the Fed, and consumers are coping with record levels of inflation. As we learned from the supply chain of pizza, higher prices at the gas pump are just one of many impacts the price of oil has on the economy.
High levels of inflation affect individual companies in different ways. Companies that can capitalize on the current strong demand, expand market share, grow revenue, and expand margins, can prosper. Conversely, companies that incur higher costs, are unsuccessful at passing along these higher costs to their customers, and experience margin contraction, can be negatively affected by high levels of inflation. Volatility and market declines can create opportunities for investors with a long-term strategy. We are evaluating new companies and emphasizing existing companies on our approved list that can navigate and benefit from this challenging environment.
The companies on our approved list have strong brand power, customer loyalty, and competitive advantage that give them pricing power, enabling them to pass along higher costs to their customers and drive margin expansion. This positions our portfolios well and can provide an inflation hedge in times of high inflation. Another way the companies on our approved list provide an inflation hedge is through dividends. Companies that prosper in challenging times and maintain or increase their dividend provide cash to your portfolio. Dividends provide a return on your investment and can be used as a source of funds for withdrawals.
Inflation is painful and unfortunate. We hope that through monetary policy from the Federal Reserve, supply chains improving, and normalization of supply and demand, inflation will subside in the second half of the year. We have weathered periods of record-high inflation before. We have helped clients chart their investment strategies through every business cycle by constructing investment portfolios that stand the test of time and endure through periods of uncertainty.
If you have any specific questions about your portfolio or our investment strategy as it relates to inflation, please contact us. We are glad to answer your call or email.
Inside the Office
We are delighted to welcome Aaron Ritsema to Investment Counsel. Aaron joins our team as Senior Portfolio Manager, adding depth and experience to our firm. Aaron has nearly 20 years of investment and financial planning experience and previously served as a financial advisor at Charles Schwab & Co., Inc. He obtained his Certified Financial Planner™ certification in 2014. Aaron is excited to work with Chris and Todd to provide excellent service and portfolio management to our clients. When not in the office, Aaron enjoys spending time with his wife and two young boys, traveling, playing golf, fitness, and seeking new food experiences.
Investment Counsel Inc., a Division of LaFleur & Godfrey, is a registered investment adviser. Information presented is for educational purposes only. It should not be considered specific investment advice, does not take into consideration your specific situation, and does not intend to make an offer or solicitation for the sale or purchase of any securities or investment strategies. Investments involve risk and are not guaranteed. Be sure to consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein.