MARKET NEWS

This is no ordinary energy shock.

Predictably, the Iran war has driven up the price of oil, but what is not typical, economists say, are soaring diesel prices which have climbed far beyond what a move in crude would normally imply.

"This is no longer just an oil shock," said Olivier Gervais, director of modelling and forecasting at Scotiabank Economics, in a report this week.

Historically refined products like diesel move with crude oil, but usually by less, he said. This episode, however, looks quite different, and adds a "distinct and broader layer" of inflation pressure.

The price of refined products has been pushed higher than oil this year because of challenges in transporting the products through the Middle East and because the Ukraine conflict has shut down some of Russia's refining capacity.

"These two events combined led to a crunch in the supply of diesel in the global market and sent prices higher," said Gervais.

To determine the impact of this additional shock, Scotiabank isolated the diesel price movements that could not be explained by crude oil and tracked their impact through consumer and producer prices.

"We find clear evidence that the inflationary effects extend beyond energy in both Canada and the United States," said Gervais.

The economists calculate that a temporary increase of about 15 per cent in the diesel spread close to what we are seeing now would raise consumer price index inflation in Canada by 0.6 percentage points and by 0.8 points in the U.S. This pass-through is not limited to headline inflation, but shows up in underlying measures as well.

"When diesel prices rise  independently of crude oil, the impact does not stop at the pump; it leads to broader price pressures later on," said Gervais.

The pass-through is gradual and persistent, said the report. Because diesel is critical to trucking, agriculture, construction and manufacturing, higher fuel costs spread through freight, production and distribution networks before reaching consumer prices.

Transportation prices are the first to rise, followed by food, shelter and other categories a year to 18 months later as higher costs work their way through the supply chain.

A separate study by Oxford Economics found evidence that U.S. trucking companies are already passing part of the fuel shock onto customers.

Neither are major crude producers with domestic refineries protected as oil and refined products trade in global markets that set the prices.

"Even large producers such as the U.S. and Canada remain exposed to higher global crude and diesel prices despite having greater domestic supply security than major importers," said Oxford.