U.S. Economy
Two Hurricanes Too Many

Stephen P. A. Brown, Mine Yücel and Robert W. Gilmer look at how Hurricanes Katrina and Rita have affected energy markets and what these effects may mean for U.S. economic activity.

Two hurricanes—first Katrina, then Rita—had a devastating effect on the Gulf Coast. The human tragedy is incalculable; the property losses are still being assessed; and those of us who live farther away are seeing higher and turbulent energy prices. Perhaps surprisingly, most economists are expecting that temporarily higher energy prices will have a modest effect on overall economic activity.

We first examine how the hurricanes affected energy markets and then consider how these effects will translate into overall U.S. economic activity.

Oil and Gasoline Prices
The hurricanes have increased energy price volatility. Over the past two months, crude oil prices rose from near $60 per barrel to near $70 per barrel, partly as a result of Hurricane Katrina. Oil production in the Gulf is still not back up to full capacity. By mid-October, three weeks after Rita came ashore, 1.03 million barrels of daily crude oil production (about 5.2 percent of U.S. oil consumption and 69 percent of Gulf production) remains shut in. The release of oil from U.S. and European oil reserves eased concern about the supply of crude, as did reduced demand from damaged refineries. The result was crude prices falling back to $62 per barrel by mid-October, the lowest price of the last two months (Chart 1).

Compared with Hurricane Ivan, the amount of shut-in oil and natural gas production from Hurricanes Katrina and Rita is much higher (Chart 2).

Refining
Before Hurricane Rita, four refineries in Louisiana and Mississippi remained shut down, putting upward pressure on refined product prices such as gasoline and jet fuel. Three of these refineries, with a total capacity of 554,000 barrels per day, are still down. Hurricane Rita further aggravated an already tight market for refined products. Refineries from Corpus Christi (Texas) to Lake Charles (Louisiana), with a combined capacity of 4 million barrels per day (nearly 20 percent of U.S. oil consumption), closed down in anticipation of Rita. Currently, there are 633,000 barrels of refinery capacity shut down in the Port Arthur/Lake Charles area and about 437,000 barrels per day in the Houston/Texas City area. The combined capacity of the shut-down refineries is 1.6 million barrels per day (7.8 percent of U.S. oil consumption and 9.3 percent of U.S. refinery capacity).

With so many refineries shut down, prices for refined products—such as gasoline—have been high and volatile. After Hurricane Katrina closed refineries along the central Gulf Coast, gasoline prices rose about 50 cents per gallon to over $3 per gallon as a nationwide average. As refineries, crude oil pipelines and product pipelines restored operations, prices moderated. But gasoline prices had not yet fallen to pre-Katrina levels before Rita made her presence known and pushed them up again. Gasoline prices are inching down as more refinery capacity comes back on line. Moreover, lower demand and higher imports are helping keep higher prices at bay. In the first week of October, gasoline demand was down 1.5 percent, with gasoline imports up 38 percent from a year ago.

Because of the turmoil due to the hurricanes, refineries have not yet done their usual fall maintenance. The government has also asked refiners to forgo maintenance for some time to keep product prices from moving up further. This is causing some concern in the industry about the ability to keep the system running. Moreover, this also sets up the possibility of tight markets and volatile prices for distillate (heating oil and diesel) over the winter months. The Energy Information Administration forecasts heating oil bills to be 32 percent higher than a year ago, increasing to nearly 70 percent higher if we have a cold winter.

Natural Gas
The two hurricanes’ strongest effects have been felt in the natural gas market, where the EIA is forecasting a nearly 50 percent gain in heating bills over the coming winter. After surging to more than $15 per million Btu, natural gas prices moderated down to $12.71 by mid-October. A little more than three years ago (in early 2002), the Henry Hub price of natural gas was $2–$3 per million Btu.

Katrina- and Rita-related outages are contributing to an outlook for a tighter natural gas market and increased price volatility this winter. Natural gas in storage is about 1.2 percent above the five-year average inventory level, which is regarded as only adequate for the buildup to winter. Prices could dip relatively quickly, however, if natural gas production in the Gulf is quickly restored close to pre-Rita levels. They could also rise further if it becomes apparent that the damage to the offshore infrastructure is substantial. Contributing to the tightness in the natural gas market is that 15 natural gas processing plants, with a total of 9.5 billion cubic feet per day are not active, according to the U.S. Department of Energy.

Petrochemicals
Hurricane Rita caused the shutdown of almost 90 percent of the Gulf Coast's petrochemical capacity. Although some of this capacity has come back on line, a lack of feedstock is causing problems for some petrochemical producers.These plants account for 10–12 percent of U.S. production of building block chemicals such as ethylene, polypropylene, methanol and benzene. The shutdowns have led to widespread shortages of many chemicals and plastics and price increases for a long list of products. These come on the heels of strong demand, low inventories and rising feedstock prices even before the storms.

Damage to Energy Infrastructure
Repairs in the Gulf continue to be hampered by the lack of basic infrastructure like docks, supply boats, warehouses and skilled labor. Undersea pipelines need repair, plus platforms and rigs were damaged extensively. A total of 113 platforms were destroyed by the hurricanes; 52 platforms had extensive damage, 19 are still adrift, 8 are destroyed and 19 have extensive damage. When Katrina damaged the traditional staging areas at Venice and Port Fourchon, near New Orleans, the industry moved its operational base to Cameron—just in time to be ravaged by Hurricane Rita.

Effects on Economic Activity
What about the overall effects of higher energy prices on the economy? Rising oil prices have preceded nine of the 10 post–World War II recessions, but the recent gains in energy prices are unlikely to lead to another U.S. recession.

At their pre-hurricane values, energy prices were exerting a mild drag on economic activity. At pre-hurricane values, energy prices probably reduced U.S. GDP growth by an average of 0.3–0.5 percentage points over each of the past two years and will take about 0.7–0.9 percentage points off growth over the next two years.

The hurricanes should have only transitory effects on energy prices. The transitory gains in natural gas and refined product prices will increase the drag on economic activity over the winter months, but the effects should be relatively mild because consumers and investors are likely to look past temporarily elevated energy prices in making decisions.

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