It is preferable to use olive oil for the Misva of the Hanukah candle lighting, as this is what was used for the Menorah lighting in the Bet Ha’mikdash.
The Ben Ish Hai (Rav Yosef Haim of Baghdad, 1833-1909) writes that may use even olive oil that is bitter to the point where it is inedible. As long as the oil had not been defiled, such as by being left under a bed, it may be used regardless of its taste.
On this basis, several Halachic authorities, including Rav Haim Kanievsky and Rav Nissim Karelitz, permit using olive oil even if it says on the bottle’s label, "Not fit for consumption." Once the Ben Ish Hai permits the use of bitter oil, we may also use modern-day oil which is not suitable for consumption. Others, however, disagree, and distinguish between oil which is inherently suitable for consumption but has a bitter taste, and oil which cannot be ingested at all and would even be dangerous to consume. This was the view of Rav Yosef Shalom Elyashiv (Jerusalem, 1910-2012), who maintained that one should not light Hanukah candles with oil that is not fit for consumption. (This ruling appears in Ashreh Ha’ish, p. 239.)
In light of this debate, one should preferably use olive oil that is fit for consumption, though one fulfills the Misva even with inedible olive oil. This is the ruling of Yalkut Yosef – Hanukah (p. 117, note 54).
(It should be noted that some manufacturers print "Not fit for consumption" on the bottles even though the oil is edible in order to avoid the higher tariffs which are levied upon food products. Thus, even when this appears on the label, the oil might nevertheless be suitable for consumption.)
Summary: One should preferably use for the Hanukah lighting olive oil that is fit for consumption, though one fulfills the Misva even with inedible olive oil.
