A Second Look at Katrina's Cost

It's becoming clear that the price is greater than first thought. However, disruptions to the oil supply remain the biggest economic risk

By David Wyss

The damage done by Katrina to the U.S. economy is still unknown, but it's clearly more than first expected, with estimated costs now as high as $200 billion. The physical damage to the city of New Orleans and the surrounding Gulf Coast communities makes this the worst natural disaster in U.S. history.

Any such calamity has two effects on the economy: the destruction of physical capacity and the disruption of normal activities. The latter causes the major damage to gross domestic product and is magnified in Katrina's case by the fact that the storm hit the country's main energy production and refining center. Indeed, the biggest economic problem isn't the damage to urban areas but the loss of oil supplies and refining capacity.

Our best guess is that the hurricane will cut a 0.7 percentage point out of gross domestic product growth in the second half of 2005, but the economy will recover fully next year because of rebuilding and despite higher energy prices. Economic momentum is strong, so the slowdown won't cause a recession.


  Normally, a hurricane's disruptive impact is limited, but in the case of New Orleans the reliance on energy and tourism may make recovery more difficult. It's still too early to assess the damage to oil fields and refineries. Our best guess is that they'll be back in weeks, not months. Their recovery is the most critical issue for the U.S. economy.

The U.S. Energy Information Administration has been providing regular updates on the progress in restoring energy supply, but it's offering only estimates, not firm dates. Offshore production is the most difficult area to assess. The U.S. hasn't built a new refinery in nearly 30 years, and at Standard & Poor's we were beginning to worry about refining capacity even before Katrina. Although the peak driving season has come to an end, any outages at the refineries or to the pipelines connecting those refineries to the rest of the U.S. will create severe shortages of gasoline and heating oil if the outages extend into the winter heating season.

The interruption to crude-oil and natural gas production has the potential to be almost as damaging. Until the oil companies get out to the platforms, the extent of the undersea damage will remain unknown. The visual inspections of the rigs suggest that they look as good as can be expected, with most having survived with minor damage. But the underwater pipelines may be the bottleneck.


  The Gulf accounts for only 2% of world oil production (about 25% of U.S. output), but there's little margin for even a 2% shortfall. Although oil prices have come down from their $70 peak as strategic reserves have been opened, these reserves can't be tapped for very long. The danger to the U.S. is magnified because much of the crude imported into the U.S. comes through the Port of New Orleans.

From the standpoint of the local economy, tourism is the largest industry. Tourist facilities, including the waterfront hotels and casinos, have been wiped out. But that will have limited impact on the national economy. People who can't visit Biloxi or New Orleans will go somewhere else to relax and gamble, such as Las Vegas. Big conventions may have a harder time finding new venues, however, and some could be canceled.

The Port of New Orleans remains the other major issue for both the national and local economies. It's the largest shipping point for agricultural exports from the Midwest and South, and a prolonged closure will hurt trade. Imports, other than oil, are less important, and can probably be shipped through other ports, although some supply disruptions will occur. The deepwater port, through which crude oil is imported, seems to be relatively undamaged.


  While the destruction was much greater than in any previous hurricane -- with damages likely to be more than double those of Andrew -- it will eventually be a positive for employment and GDP. Repair and rebuilding work generate jobs. But rebuilding New Orleans can't begin until the water has been drained out of it and the damages assessed. Surrounding areas will begin to rebuild earlier, with some having begun already.

Many of the displaced may well never return to New Orleans, which needs a major reconstruction. The levee system was far too vulnerable and should be rebuilt to modern specifications. The cost of a new system will be substantial, but if it isn't done in concert with the overall rebuilding effort, the city will be just as vulnerable next time a major storm hits. Global warming may not give us the 36 years between major storms we had between Katrina and Camille.

Wyss is chief economist for Standard & Poor's

Edited by Patricia O'Connell

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