Katrina's Wake

In addition to the hurricane's human toll, damage to the nation's energy infrastructure could reverberate well into the future

Days after its howling winds died away, Hurricane Katrina continued to punish the people unlucky enough to have been in its path. Initially underestimated, the storm that slammed into the Gulf Coast on Aug. 29 left hundreds of thousands of families homeless and hundreds -- and possibly thousands -- more dead in and around New Orleans. Parts of the Mississippi coastline were nearly swept clean.

In New Orleans flooding worsened as breached levees gushed water into the city. The Big Easy has become a toxic soup bowl, with looters roaming the flooded streets and residents airlifted from rooftops. "We are dealing with one of the worst natural disasters in our nation's history," said President George W. Bush, who flew over the stricken region on Aug. 31.

Now it's becoming clear that Katrina's economic impact, too, will be more severe and far-reaching than first thought. Certainly, the estimates of insured losses are enormous -- indeed, they could easily top the record of $21 billion set by Hurricane Andrew in 1992, according to Robert Hartwig, chief economist at the Insurance Information Institute.


  But the estimate actually understates Katrina's impact. That's because the property damage in Katrina's direct path, however painful for the region's residents, represents only a small part of the harm inflicted by the hurricane. More significant -- and harder to measure -- is the damage to the national economy caused by soaring energy prices and shipping disruptions.

What makes Katrina different is that it wasn't a strictly local disaster. It pummeled the nation's all-important energy infrastructure as well as the main shipping channel of heartland America. The Gulf accounts for 17% of the country's refining capacity and one-quarter of its daily crude output. Much of U.S. imports of Saudi Arabian oil pass through Louisiana.

"You have a major energy network that is down, and it is not clear when it can come back up," says one pessimist, Roger Diwan, a senior analyst at PFC Energy in Washington. "We could run out of gasoline or diesel or jet fuel in the next two weeks here."


  The damage to the energy and transportation infrastructure comes at a time when the country can ill afford any disruption. Prices of oil, natural gas, and gasoline were already at record highs, and producers were running flat-out to satisfy demand.

"This is going to keep energy markets on a razor's edge for the rest of the year," predicts Mark Zandi, chief economist at Economy.com, a West Chester (Pa.) forecasting firm. The hurricane "is taking what was shaping up to be a good second half and turning it into a big question mark." Nariman Behravesh, chief economist at Global Insight in Waltham, Mass., is predicting growth of around 2.7% in the fourth quarter, roughly half a point lower than he expected before the storm. In the worst case, he fears growth could slow to below 1%.

How bad will Katrina be for the U.S.? Much depends on the severity of the damage to the oil, electrical, and transportation infrastructure -- something that was impossible to assess as BusinessWeek went to press, with much of the region still out of communication with the outside world.

Says John C. Felmy, chief economist at the American Petroleum Institute: "Offshore, we're just barely out to fly over and find out which platforms are safe to board. Then we have to inspect, which means sending down divers. Helicopters are in short supply. It's impossible to estimate when production will be back."


  The U.S. Minerals Management Service said that as of Aug. 31, 92% of oil production in the Gulf of Mexico was still shut down. Nine refineries accounting for about 9% of U.S. output were not operating, and most were likely to remain out of service for weeks. All of the major railroads closed down traffic in and out of the region. Interstate 10, a vital highway that runs clear across the South, was severed.

Even if the refineries are relatively undamaged by the winds and flooding, a trashed electricity grid could prevent them from coming back online anytime soon. A lack of power also shut down pipelines that ship gasoline and other products from the Gulf to the Northeast.

There was some good news on Aug. 31: Colonial Pipeline Co. restored enough power to start pushing gasoline through part of its 5,500 miles of pipeline, which stretch from Houston to New York. Colonial expected capacity to reach 50% to 60% by the weekend.


  But Entergy (ETR ), which serves Louisiana, said it will take "weeks" to fully restore electricity, noting that 150 substations were destroyed or damaged. And the utility said it can't afford to give top priority to getting power back to the refineries. Tops on the list are hospitals and emergency services, a spokesman says.

Already, spot shortages of gasoline and diesel supplies have emerged at wholesale terminals, according to Dan Gilligan, president of the Petroleum Marketers Assn. Says Gilligan: "It's worse than tight. It's a total domino effect all throughout the infrastructure."

Some parts of the country are already starting to hunker down. Florida gets most of its natural gas for generating electricity from Gulf of Mexico production wells that were shut by the hurricane. On Aug. 31 the state's power-grid monitor ordered utilities to line up emergency backup power and curtail power to customers who have interruptible-supply contracts.


  Meanwhile, as far away as Connecticut, lines at the pump grew as people filled their tanks in fear of shortages and rising prices. That, of course, only makes matters worse, says Amy Myers Jaffe, a fellow at the James A. Baker III Institute for Public Policy at Rice University: "If everybody in America fills their tank, [the added consumption] could be in the millions of barrels a day. You want to do the opposite. If everybody in the country filled their tank only halfway, it puts less strain on the supply system."

The question, of course, is whether these will prove to be short-term blips or whether they herald the start of more serious problems. In the best-case scenario, damage to the energy, power, and communications infrastructures will turn out to be fairly light and the spike in energy prices temporary. In that case, GDP growth in the fourth quarter could actually come in higher than previously expected thanks to the stimulative effects of reconstruction spending.

Indeed, some industries will benefit once the rebuilding process begins. "From a bank's perspective...it's good economically in the same paradoxical way that a war is good economically for a lot of people," says bank research analyst Eric Reinford of snl Financial in Charlottesville, Va. "Natural disasters historically have been a boon for banks because they'll be lending and speeding up the processing of loans." Other big winners are construction companies and building-materials makers. Stocks of those companies have soared.


  In the worst-case scenario, though, it will take months to get Gulf production and refining back into full swing. That could lead to regional shortages of gas and other fuels and could send oil prices soaring to $90 a barrel or more for an extended period. The result would be a huge drag on the economy, clobbering corporate profits well beyond the energy-intensive sectors such as airlines.

Consumer spending, too, could take a dive. While consumers have shrugged off retail prices averaging around $2.60 a gallon nationwide before the storm, if prices stay above $3 a gallon for a long time -- or move even higher -- that could change. "I think $3 a gallon is a psychologically important threshold for consumers and could finally impact spending," says Mark Vitner, senior economist at Wachovia in Charlotte, N.C.

But if the situation really gets bad, price won't be the problem. The biggest danger is outright shortages that mean products aren't available at any price. That could keep people from getting the gasoline they need to get to work and could even result in temporary factory shutdowns.


  Even if those worst-case scenarios don't come to pass, many sectors of the economy could still take a hit. Energy-futures markets are betting that high prices are here to stay. And with many companies already finding it tough to pass price increases through to consumers, economists believe business may simply have to absorb any spike in oil prices. Vitner predicts that corporate profit growth could slow to 8% next year -- and to only 4% for those companies not in the energy sector.

Air carriers will be especially hard hit. "The hurricane aftereffect is just one more thing that will make it harder for Delta to avoid a bankruptcy filing," says Ray Neidl, an analyst at Calyon Securities (USA). Delta Air Lines has refused to comment. "Today's jet-fuel prices are crushing and could prove to be a knockout blow for some," says John Heimlich, vice-president and chief economist at the Air Transport Assn., which represents major carriers.

Companies that ship goods through New Orleans and nearby ports also face problems if power and communications are not restored to the area soon. In other times, producers could simply shift traffic through Houston or any other port. But with virtually every other U.S. port running near capacity, there are few easy alternatives.

John A. McFarland, CEO of Baldor Electric in Fort Smith, Ark., says his company imports components and exports finished products through New Orleans. "We ship [the components] on a just-in-time basis, but they may be under 20 feet of water," says McFarland. "There's no way to tell when we'll know their condition, or if we can ship from there again."


  Still, many believe shipping problems will be relatively short-lived. Says Jeffrey H. Schwartz, CEO of ProLogis, an Aurora (Colo.) provider of distribution facilities and services to the likes of Wal-Mart Stores, Unilever, and DHL Worldwide: "I don't think you're going to see a major disruption in the overall system."

Katrina could also have a damaging impact on the Corn Belt, which stretches from Ohio to Nebraska. Virtually all the export corn and soybeans, and much of the export wheat, is shipped down the Mississippi by barge to terminals in Louisiana. So any backup of barges or damage to terminals could hurt both farmers and grain processors, says Mark Drabenstott, chief regional economist at Kansas City Federal Reserve Bank.

The pressure is on to reopen the ports with the harvest about to start. "The big question is, are we going to be able to move the fall harvest?" Drabenstott says. "To the extent that this backs up the transportation system, that is a question on the mind of the grain trade throughout the region."


  Another question is how aggressively the federal government will act to cushion the economic blow. President Bush, already suffering in the polls, partly as a result of high energy costs, has raced to mitigate the economic damage. The White House confirmed on Aug. 31 that it will release oil from the Strategic Petroleum Reserve -- a boon to the few refineries that are in operating order but haven't been able to get crude because of the shutdown of Gulf output.

Financial markets are keeping a close watch on the reactions of the Federal Reserve. The Fed has been steadily raising interest rates to quell inflation. Higher energy prices would ordinarily give the Fed even more reason to jack up rates. But they also weaken growth -- which would argue against more rate hikes.

As recently as July, most Fed watchers were betting that Greenspan & Co. would raise short-term rates at least a percentage point more, taking the federal funds rate to 4.5% or higher, yet Morgan Stanley Chief U.S. Economist Richard B. Berner predicts that they might pause at 4% in their raising of the federal funds rate. In a speech on Aug. 31, Federal Reserve Bank of Philadelphia President Anthony M. Santomero gave few signs that the Fed would pause in its campaign to push rates higher.

Echoing Santomero, most economists believe the U.S. economy is resilient enough to avoid the worst and keep growing at a reasonable clip in spite of Hurricane Katrina's havoc. But for drivers, truckers, airlines -- and the hapless Gulf Coast residents caught in its path -- this killer storm will cause misery for months to come.


By Peter Coy in New York and Dean Foust in Atlanta, with Lorraine Woellert in Washington, Christopher Palmeri in Los Angeles, Stanley Reed in London, and bureau reports

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