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Katrina Rips Into the Economy

By Michael Englund The physical impact of Hurricane Katrina, which slammed into the U.S. Gulf Coast on Aug. 29, was immediately visible: high flood waters, caved-in roofs, smashed windows, downed power lines and trees. But in economic terms, the full brunt of the Category 4 storm will take some time to assess.

We at Action Economics will comb out the broader impact of Katrina on U.S. economic data in an upcoming report, but for now we'll focus on the storm's impact on one key segment: energy. Due largely to Katrina's blow to the energy sector nationally, as well as to the New Orleans regional economy, our U.S. gross domestic product forecast for the third quarter has been preliminarily bumped down to 4.4% from 4.6%.

It's hard to gauge the storm's impact at this early stage, but shipping disruptions through the region even for just a few days could easily cause a 0.2% subtraction from third-quarter GDP, vs. the 0.5% third-quarter subtraction we assumed from last year's "triple hurricane punch" (See BW Online, 9/15/04, "Summer's Tempests Twist the Numbers").

MINI-SHOCKS. The Katrina effect might best be seen in the context of our oil-import estimates, which have been revised to incorporate the effect of disrupted oil shipping at the end of August. Though the distortion is large, it will be temporary and should be offset by stronger import figures through September and October to make up for the supply gap.

However, these assumptions are obviously sensitive to incoming reports on the extent of the damage. The disruptions alone for the past two days already, through Aug. 29, could easily prompt a petroleum-import shortfall of $1 billion, and a domestic-production drop-off that's close to that as well.

Katrina will boost oil prices via the effects of Gulf oil-well shutdowns (9 rigs and 12 platforms had been evacuated as of Aug. 29), and gasoline prices will rise due to refinery shutdowns in Louisiana, Alabama, and Mississippi, all of which are aggravating the energy-price surge. These supply shocks will add to the much larger and prolonged upside-demand shocks for oil that have dominated the market for the last three years, and that have taken prices to the record levels evident prior to the Katrina-related price spike on Aug. 29.

LINGERING EFFECTS. About a third of the petroleum produced in the U.S. (which meets 45% of U.S. demand), is from the Gulf of Mexico, and 90% of that moves through Louisiana, according to Biz New Orleans, which reports on business and financial information. Also, New Orleans is a major port for importing oil, via offshore facilities for unloading supertankers that send oil to the mainland. The oil travels through underwater pipes via New Orleans.

Supply disruptions will have a price impact that could linger through the winter, given tight inventories of many refined products. But these distortions reflect a small part of the hefty demand-led energy-price gains of the current business cycle.

The oil-market disruptions from Hurricane Katrina will have a net negative impact on GDP growth over the quarters ahead. But aside from this adverse supply shock, most of the uptrend in oil prices through this expansion has been due to unexpected and prolonged strength in global demand for petroleum products, and aggregate demand overall.

PRODUCTION PROBLEMS. As such, markets may have focused too much on the negative ramifications for future quarterly GDP growth rates from oil-price gains with each new set of record high prices, and not enough on what rising oil prices imply for upside risk in current GDP estimates.

The economy now faces production bottlenecks for exploration, drilling, and refining that are prompting spikes in oil and gasoline prices each time already-high world growth rates threaten to accelerate.

The upshot: Oil prices now act like a throttle on global economic growth, keeping it in line with petroleum supplies via price spikes that serve as the market's "rationing" mechanism. And with the likely disruption of supply caused by the devastating tempest known as Katrina, those elevated crude prices may cause the global economic engine to rev a little slower in the near term.

Englund is chief economist for Action Economics

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