| Global Insight Perspective | | | | Significance | It has become clear that the US has suffered its worst natural disaster since at least the 1906 San Francisco earthquake and fire. | | Implications | New Orleans and other towns along the US Gulf Coast are likely to remain uninhabitable for months, and full recovery will take several years. There is great disruption to oil production, which is adding additional pressure on global oil prices. | | Outlook | Global Insight has produced some initial scenarios for the likely economic impact. Even the best scenario sees at least 0.5% taken off growth in the third and fourth quarters. | New Orleans 'Almost Wiped Out' After some initial relief that Hurricane Katrina had lost some of its intensity and veered away from central New Orleans, the mood changed abruptly as key levees were breached. Water from Lake Pontchartrain flooded into the city, sparing only the few areas built above sea level. There are now thought to be several thousand dead, but the authorities have yet to even start collecting the bodies while rescue efforts for the living continue. Many of the victims were caught out by the sheer depth of water that submerged their houses. Sheltering in attics or on rooftops was no longer an option when floodwaters rose to the height of two- or three-storey buildings. Hundreds of buildings were completely obliterated, either destroyed by the initial winds, or washed away by the flood waters. Many of those who are still marooned on buildings have been without food or water for two days. Some 20,000 people who sheltered in the city's stricken Superdome stadium are now being taken to the Astrodome in Houston, Texas. The flooding has stopped a city of 500,000 functioning - there is no electricity, gas, fresh water or even road access in many parts. The mass evacuation of survivors continues with the help of many helicopters and boats brought in from across the country. Disorder and looting is a major problem and the police have been out in force. Many stores have been ransacked and there has been a string of carjackings and shootings. New Orleans is by no means the only victim of Katrina. Many other towns along the Gulf Coast have been all but wiped out, with the loss of hundreds of lives. In all, some five million people in four states are still without electricity. A major concern now in flooded areas is the spread of disease and pollutants. 'Recovery Will Take Years' President George W. Bush yesterday flew over New Orleans and saw the scale of the disaster for himself. He pledged all the assistance the country can muster, but conceded that even with this the recovery would take years. The immediate relief effort is being joined by 30,000 troops and hundreds of military aircraft and boats. The situation is potentially complicated by the scale of the existing deployment to Iraq, but the administration believes there are sufficient resources to hand. New Orleans is to be fully evacuated 'for two or three months', according to the city authorities, while the waters are pumped out. Engineers are currently trying to plug the three major breaches in the levees with sandbags and concrete barriers. There has been talk of using shipping containers or barges full of concrete. The authorities now believe the waters cannot get any higher as equilibrium has been reached, but that is scant comfort for the city's displaced population. There are even question marks over the future of the city itself. Rebuilding is the natural reaction, but so long as New Orleans remains below sea level it will be at threat from a repeat disaster. The system of levees did not cope with Katrina, and while taller defences may now be constructed, they can never offer complete peace of mind. The authorities have been understandably reluctant to speculate on what happens next, but very tough, and costly, decisions lie ahead. The city is so vulnerable because it is sandwiched between the Mississippi River to the south and Lake Pontchartrain to the north, both of which are at higher levels. Once levees with either break, water floods in until they reach the same level. There is, moreover, nowhere for the water to run off afterwards, as would normally happen on a floodplain. Man-made changes to the coastline and course of the Mississippi arguably meant a disaster waiting to happen. Gulf of Mexico Oil Production Largely Shut Down, Administration Releases Reserves The government's Minerals Management Service (MMS) has confirmed that approximately 1.4 million barrels per day of crude production and 8.3 billion cubic feet per day of natural gas production from the Gulf of Mexico remain shut in. There are also at least nine refineries that remain completely closed, with three others suffering reduced production due to supply difficulties. According to the United States Coast Guard, meanwhile, 'five rigs from the West Delta Platform are missing, one submersible rig is grounded, two mobile offshore drilling units are adrift and two semi-submersibles are listing.' The government has moved quickly to try and stem rising energy costs by releasing crude oil from the strategic petroleum reserve (SPR) and has temporarily waived fuel standards. While crude prices continue to hover just below the record highs reached earlier this week, petrol (gasoline) prices surged to new records once again - retail prices, in real terms, now rival those set in the 1979 oil crisis. However, there is still a lack of hard information on how much damage has been caused, but as refineries and platforms remain idle and inoperable, so the risks of a real fuel crisis grow. In such a tight market the loss of any capacity is problematic - the capacity losses in the US market could be much greater than the system can comfortably sustain or offset. In these circumstances prices will work to restore the balance by squeezing off demand, but not before too much demand fights for too little supply. While it is still too early to make too many predictions, it does seem clear that the effects of Katrina will be felt well into 2006. Rising product prices in the US will put added pressure on global prices and support higher crude prices as well. Supply Chains Badly Hit for Many Sectors The intricate supply chains that underpin the US economy can be easily disrupted and immediate effects are felt across the country. The port of New Orleans is a major gateway for a wide range of commodities and will remain closed for some time. Navigation system failures and debris have made the Mississippi impassable for larger vessels. Agricultural producers will be among the hardest hit as they seek to ship the main harvest's produce. Other ports can be used instead, but congestion will become a major problem. Chemicals production and pipelines are another major worry, while a number of major retailers have seen key warehouses inundated. For retailers and the construction industry, a silver lining is the custom they will eventually receive once Gulf Coast residents start to rebuild and refurbish their homes and businesses. Preliminary Economic Scenarios Paint Grim Picture Unlike prior hurricanes such as Ivan, Katrina could inflict a lot of pain on the US economy as a whole. The local economies of the Gulf Coast have been shattered, but it is the disruption to energy production that will make the biggest nationwide difference. Given ongoing uncertainty over the precise extent of disruption, Global Insight has made a tentative assessment of two scenarios based on the level of damage to the energy infrastructure and how much supply is lost leading up to the winter months. Even in the best-case scenario, US efforts to build inventories of crude oil, natural gas, and refined products will be set back. Best-Case Scenario: Oil at US$70-75 a barrel for a couple of weeks; petrol (gasoline) prices over US$3.00 a gallon for a couple of months; and the economy taking a small hit (between 0.5% and 1.0% on growth in the third and fourth quarters). - This scenario assumes that the damage from Katrina is very limited: oil, natural gas, and petrol supplies are cut by 5% or less for a couple of weeks.
- In this scenario, oil prices could rise to US$75 a barrel for a couple of weeks and fall to low US$60s a barrel by the end of the year.
- Petrol prices could rise to US$3.00 a gallon or a little higher for a couple of months, but would likely fall back to around US$2.50 by year-end.
- Real GDP growth would be reduced 0.5% to 1.0% in the third and fourth quarters.
Worst-Case Scenario: Oil at US$100 a barrel for a month; petrol prices at US$3.50 a gallon for a few months; and the economy closer to a recession by the fourth quarter. - This scenario assumes that, because of the damage done by Katrina to oil rigs and natural gas production infrastructure and oil import facilities, US oil and natural gas supplies could be cut by 10% for a couple of weeks. Likewise, because of damage to refineries, petrol, jet fuel, diesel, and home-heating-oil supplies could also be cut 10% for up to a month.
- In such a scenario, oil prices would spike to US$100 a barrel for a month before falling gradually to around US$70 a barrel by the end of the year. Prices would fall back due to slower growth in the economy, release of stocks from the SPR, and an increase in US-imported refined products making up for the domestic shortfall.
- In this worst-case scenario, petrol prices would average around US$3.50 per gallon (for unleaded regular) for the next four to six months. This could be mitigated if the current temporary relaxation of the US Environmental Protection Agency (EPA)'s petrol standards is extended.
- The impact on consumer spending in such a scenario would be very dramatic, cutting the growth rate by as much as 3% and pushing real GDP growth in the fourth quarter closer to zero.
Bottom Line: Early estimates suggest that the worst-case scenario is unlikely to happen, but this still means GDP growth forecasts being trimmed by up to 1.0% for the third and fourth quarters. The worry is that, much in the same way as after Hurricane Ivan, successive damage estimates will keep being revised upward, and the impact of Katrina could well be considerably larger than the best-case scenario estimates. Tough Political Challenge for Bush The disaster will naturally focus the eyes of the public on President Bush, and he needs to show once more the kind of leadership that was seen after the 11 September 2001 terrorist attacks. This time round, however, things are tougher. His approval ratings have sunk to their lowest point yet as problems in Iraq continue and high oil prices hit people's wallets. The disaster could of course distract attention from Iraq, but there are concerns that the commitment of troops there has weakened the authorities' ability to respond to domestic emergencies. If this becomes a big political and media issue, the pressure for troops to be brought home from Iraq will increase. On the petrol prices front, Katrina is also clearly a major problem and consumers nationwide will feel the pinch. In Bush's favour, he tends to rise to such emergencies well and inspires public confidence. Outlook and Implications Hurricane Katrina has brought home how vulnerable even the world's most advanced economy is to natural disasters. It was known for decades that New Orleans could one day suffer this sort of calamity, but all the planning had little effect in the face of a Category Four hurricane. Major lessons will have to be learnt for the future, particularly as scientists predict hurricanes will become more frequent and intense over coming years. As described above, Global Insight believes that up to 1.0% will be knocked off growth rates in the third and fourth quarters, although the economy is better able to bear it thanks to its robust performance this year. These are still early days, nonetheless, and there could be worse news still to come. | |
