The devastating consequences of Hurricane Katrina have obviously been a tragedy for the people of New Orleans. But the disaster is already beginning to shake the entire world economy
Hurricane Katrina could scarcely have hit at a worse time for the fragile-looking global economy, nor picked a more damaging spot to wreak her havoc. The Gulf of Mexico region accounts for 35% of US oil production and more than 20% of its natural gas. Add a "string of refineries and pipeline networks", and it constitutes the US's "single most important energy asset", said Daniel Yergin in The Wall Street Journal. In the wake of the disaster, oil prices in New York hit a record $70.80, while Brent crude surged to $66.89 a barrel. To ease supply fears, the 26-nation International Energy Agency (IEA) agreed to release 60 million barrels of crude and refined oil products from emergency stockpiles, including 30 million from the US Strategic Petroleum Reserve (SPR), which contains 700 million barrels of crude. Combined with a gradual recovery in crude output in the area, the move has seen oil prices retreat to pre-Katrina levels.
So is the worst over? Maybe, maybe not. Some cite the fact that inventories of crude in the US are relatively high as evidence that there is little to worry about and as reason for the fact that the oil price has now fallen for three days in a row but others note that, thanks to the ongoing rise in demand for energy across the world, supply was tight even before the hurricane. And those emergency reserves are exactly that emergency reserves. The world is now running on its "reserve fuel tanks", said The Wall Street Journal. If all the IEA countries now replace their emergency supplies next year, oil demand in 2006 could be about 10% higher than previously thought. And with all producers except Saudi Arabia (which says it has spare capacity, but might or might not) already pumping flat out, the market would find it difficult to cope. Either way, don't expect the oil price to fall below $60 any time soon.
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Supplies of natural gas, which heats more than half of US homes, are another worry. Industry analysts expected a rise of about 18% to 25% in the average residential bill over the winter months, said the Chicago Sun-Times and that was before the hurricane hit, driving the wholesale price of natural gas up more than 20% to record levels. Even if platforms and pipelines get back to full capacity quickly (which isn't likely some rig owners have said they'll be back in operation in two weeks, but a glance at some of the photos proves that's nonsense), most of the gas used in the US needs to be processed pre-delivery, and the condition of three processing plants in the area, accounting for about 8% of US production, is uncertain.
The biggest worry of all is petrol: it doesn't matter how much oil you have if you can't refine it. A week before Katrina hit, the US's 144 refineries were running at almost full capacity. The hurricane then shut down nearly 12% of US refinery capacity, sending unleaded gasoline futures to a record high of $2.92 on 31 August up 82% on the year before. In response, gas at the pumps in the US has gone above the psychological barrier of $3 a gallon. That makes petrol in the US about 64% more expensive than it was a year ago and the highest it has been in real terms since the Iran-Iraq war in 1981. To meet demand, European tankers have taken three times more orders than usual from the US for gasoline deliveries, which means that at least "some sections of the maritime industry look set to benefit from the hurricane", said the FT: charter rates for oil product tankers on routes to the US have shot up by up to 70% since the storm.
On the downside, those ships won't be docking in New Orleans any time soon. The hurricane wiped out the vital ports of the gulf. South Louisiana and New Orleans have the biggest port complexes in the US. New Orleans is the US's biggest port in terms of tonnage accounting for 8.9% of exports and 3.6% of imports of the whole of the US. One asset class being seriously hit by this is commodities. Some half of the goods that go through the two ports on a regular basis are commodities. Now they're going nowhere. Worse still, the storm has done around $1bn worth of damage (on conservative estimates) directly to crops and livestock. The coffee market is uncertain: 27% of America's green coffee beans or 1.6 million 60kg bags are held in New Orleans and 750,000 bags have already been declared ruined, said Chris Flood in the FT. The result? Coffee futures for December delivery have soared in price, said Peter McKay in The Wall Street Journal: they rose nearly 10% late last week. Katrina's rampage also damaged much of the region's sugar cane crops, delaying the planting season in an industry already facing tight supply. Refined sugar already costs 30% more than normal, said Jim Jubak on MSNMoney.com. Grain prices are one of the few things that have dropped so far middlemen won't buy, because without any ports they've nowhere to store or ship the grain but the long-term impact of the lack of transportation could boost the prices. And devastated sawmills and plywood plants, and the one million board feet of lumber that was destroyed in the storms let alone the forecast demand from rebuilding an entire city have meant that lumber prices have surged 7% so far.
Things are little better in the metals markets: the London Metals Exchange (LME) has been forced to suspend zinc trading, as warehouses in New Orleans held nearly half of its zinc stockpile, said Barclays Capital. Market worries about supplies caused zinc prices to rise to an eight-year high before being suspended. While commodities are stranded around the world, the insurance industry must be reeling from how much it might have to pay out in liabilities. The cost of insured damage is estimated at $20bn to $35bn, according to US insurance risk data firm Risk Management Solutions. The top end of that estimate is equal to both the world's most devastating hurricane ever, Andrew, and the September 11th attacks combined. At present, it looks as though Hannover Re, Munich Re and Swiss Re will be the worst hit. Closer to home, Amlin part of Lloyds of London has forecast that it will pay out £110m. Compare that to 2004, when it paid out $130m for all the hurricanes and typhoons over the entire year. But the losses might not be bad news, said The Telegraph. We might have just experienced the "costliest catastrophe in insurance history", but what really matters in insurance is how much you can charge people for it. Thanks to Katrina, the insurance companies think that "the slackening in premiums that has been going on for the past two years should go sharply in reverse".
That's good news for the companies and their investors. Amlin's share price rose on its announcement and "hardening rates would be good news for investors", said Martin Dixon in the FT. But it is more bad news for consumers. As if soaring oil and commodity prices weren't bad enough, we could all be facing higher insurance premiums too.
This will mean America's consumers will take yet another hit. And it is consumers we really need to worry about at the moment. The direct cost of the hurricane has been pegged at $100bn, but if rising gasoline prices (which some think will soon hit $4), natural gas prices (which were expected to be up 15%-plus this year, even before Katrina) and insurance prices hit consumer confidence, that will only be the start. Capital Economics calculates that every ten cent increase in petrol prices knocks 0.1% off GDP, as consumers forego spending on other items.
And let's not forget that US consumers were hardly in great shape before Katrina thanks to their "unprecedented debt binge", said Morgan Stanley's Stephen Roach. The household sector's outstanding debt has risen by 20% of GDP over the past five years, more than the cumulative rise over the preceding 20. Debt-servicing expenses are at a record high, despite a "rock-bottom interest rate climate", and the savings rate is minus 0.6%, which means consumers spend more than they earn. Meanwhile, real weekly wage growth has turned negative over the past few years, and poorer Americans are already spending almost 20% of their income on energy. "That's untenable for most families", as John Mauldin said on Investors Insight, the loss of around 400,000 jobs, thanks to Katrina, is hardly likely to bolster overall consumer confidence either.
Weaker consumption amid soaring energy costs casts a cloud over next year's growth, while according to Barclays Capital, GDP growth could fall as low as 2.5% in the fourth quarter, down from 3.3% in the second. The optimists think this could mean the Federal Reserve might stop raising or even cut interest rates. But we wouldn't be so sure. As Jim Jubak notes on MNSMoney.com, the devastation caused by the hurricane is "wildly inflationary". Petrol alone, at $3 a gallon, would push inflation up to 4%. With inflation rising at that speed, can rates really come down? Probably not.
There's clearly plenty to worry about. Katrina is set to get the blame for a US turndown and any global turndown that comes with the fallout from that. But anyone tempted to imagine that all was well pre-Katrina should think again. A disappointing back-to-school shopping season and slowing capital expenditure growth, along with a steep slide in the widely monitored Chicago Purchasing Managers' index, showed the "economy was losing momentum" before Katrina, said Merrill Lynch's David Rosenberg. The bulls are going to blame Katrina for their bad forecasting, but the truth is that they were wrong long before it hit. As Alan Abelson said in Barron's: "Never before will a hurricane have done so much to bail out so many people."
What we should have expected...
Cassandra was the ancient priestess who knew the future was cursed, but no one believed her warnings. There are shades of this about the flooding of New Orleans some warned of it, everyone feared it, but far too many people thought it would never happen for anything to get done about it. In 2001, The Houston Chronicle quoted the Federal Emergency Management Agency on the three most likely potential disasters that threatened America: an earthquake in San Francisco, a terrorist attack in New York (this was before 9/11) and a hurricane hitting New Orleans. This last, it said, was possible "deadliest of all", as the city's "less-than-adequate evacuation routes would strand 250,000 people or more", one in ten of whom would probably die. The results of a Category 3 storm or greater, said FEMA, would be "cataclysmic". Hurricane Katrina was a Category 4.
And FEMA wasn't alone in worrying. In December 2000, writing in Risk & Insurance, Lori Widmer pointed out that, unless preventative action was taken sharpish, there was every chance that America would soon see "New Orleans suffering the same fate as Atlantis". He noted that hurricanes of Category 4 or stronger make landfall within 100 miles of New Orleans about once every 35 years, which meant that one was due last year. Combine that with the fact that, at the time Widmer was writing, the Louisiana marshes, a natural barrier between the city and the sea, were shrinking at a rate of a football pitch every 15 minutes, and that New Orleans already eight feet below sea level was sinking a third of an inch per year, and the recent disaster starts to seem as though it were depressingly inevitable. Indeed, long before Katrina hit, many insurers in the area had already opted not to offer new flood insurance to residents.
...And what we never did expect
There's been a lot of talk about how long the housing bubble in the US could last, and here at MoneyWeek we have been of the opinion that the answer is "not much longer". But perhaps that won't be the case in Louisiana. All those displaced people from New Orleans need new houses. In Baton Rouge, for example, there are no more houses for sale: they've all been snapped up by wealthy refugees already. And America's lending industry isn't hesitating to help the suffering overstretch themselves just a little more: National Realty Investments is offering special financing deals for hurricane survivors, with no downpayments and discounted costs.
But if no one thought of Baton Rouge as a hurricane winner, it's as likely no one thought of oysters as losers. But they are. Two weeks ago, the Louisiana oyster industry was providing around 40% of oysters eaten in the US. But now that both the oyster beds and the boats have taken a battering, there's an oyster shortage. And one that may well continue for many months, given the fact that there is a nasty toxic brew of chemicals and human waste in the flood waters. That's going to hit fish too, said Tim Reid in The Times. It will take at least four months to pump New Orleans dry, but it will be years before the polluted water can support its thriving fishing industry again.
Designer labels are another unlikely loser. The US Customs service has released £75m worth of impounded clothes bearing fake designer labels for distribution to the evacuees. Refugee centres across the area are now packed with people in Gucci gear perhaps not quite the kind of PR that kind of firm likes, but on the other hand it might be what prompted Barbara Bush to make her bizarre comment that, "So many of the people were underprivileged anyway, so this is working out rather well for them."
The shares that'll love the disaster
Despite the devastation and surging petrol prices caused by Katrina, equities held firm last week, then the Dow and the S&P 500 jumped to respective two and three-week highs early this week. One reason is that investors are hoping that the hurricane will prompt the Fed to consider cutting interest rates later in the year. The theory is that a cut would prop up the economy and markets. Still, even if rates do fall (which we doubt), it may not work: in 2001, the Fed slashed rates to temper slowing growth, but it didn't prevent equities heading sharply lower.
Plenty of individual stocks are likely to benefit from the disaster. A study of sectoral performance in the three months after 13 previous hurricanes by Marko Kolanovic of Bear Stearns shows that oil and gas stocks tend to lag in the immediate aftermath; the healthcare services industry, however, fares well. Utilities are worth a look, said Jon Markman on TheStreet.com: regulators often allow price hikes after a disaster. The biggest electric utility in the area is Entergy (ETR, $76), which yields 2.8%. Brokerage Jeffries sees scope for a 15% rise from current levels over the next year. Consider also housebuilder suppliers such as Rayonier (RYN, $56), a timber provider yielding more than 4%. Another possibility is Global Industries (GLBL, $13), which is in a position to rebuild either roadways or oil-drilling platforms. Cal Dive International (CDIS, $59) is another play on the latter theme, said Jim Jubak on MSNMoney.com. Its fleet of undersea construction vehicles suits the needs of oil and gas firms based in the Gulf of Mexico. Finally, coal had a substantial cost advantage before Katrina amid high oil and gas prices, and looks even more appealing as a source of fuel now. That makes Peabody Energy (BTU, $70) worth a look.
How Bush got it wrong
Perhaps not since Richard Nixon faced Vietnam-era tumult at home and abroad has a US President had to face quite the "combination of foreign war, domestic tribulations and political division" that George Bush faces now, said Todd Purdam in The New York Times. The challenges faced by Bush from the Gulf Coast to Iraq to the "looming battles" over the double vacancy on the US Supreme Court are separate, but clearly interrelated. The people are right to ask whether the National Guard can be as prepared as necessary for a domestic emergency when it is "sapped by repeated tours of active duty on foreign soil". And the wave of cross-party anger at the fiasco of the New Orleans rescue effort "may well constrict Bush's options" as he seeks a successor to William Rehnquist, the conservative chief justice who died last week.
Slow, awkward and repeatedly misjudging the public mood as his White House slouched towards action, "it isn't easy picking George Bush's worst moment" in the aftermath of Katrina, said Matthew Cooper in Time. And this time, Americans really aren't happy: the enemy is "his own bureaucracy, the one that left American refugees to fend for themselves". Katrina's true impact might take a while to absorb, said Andrew Sullivan in The Sunday Times. But comparable disasters the Johnstown flood in 1889, the Galveston hurricane in 1900 all led to political tumult based on fury at class privilege and an apparently uncaring government. Now, as then, there is a "strong chance that this calamity could be the beginning of something profound in American politics: a sense that government is broken and that someone needs to fix it".
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