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Will Katrina tip the U.S. into recession?
Economists are wondering whether soaring prices for gas and heating oil will send consumer spending into a tailspin. Will the storm's ripples send the economy reeling?
By Jim Jubak
I've been worried that this winter, thanks to Hurricane Katrina, could put an end to the strong consumer spending that has driven the economy since this economic recovery began in the fourth quarter of 2001.
Analysts like our Jon Markman are right when they note that a disaster like Katrina, or Hurricane Andrew in south Florida, can produce a boom in the local economy as cleanup gives way to rebuilding.
But I think the effects on the local economy are only part of the Katrina story -- and a very small part, at that. Since it hit the U.S. energy infrastructure where it is most vulnerable -- in the oil-producing, oil-importing and oil-refining complexes of the Gulf of Mexico and the Gulf Coast -- Katrina's effects will ripple out across the nation. The economic effects may be negative enough to tip the economy into a recession next year.
The attention right now is on the soaring price of gasoline, widely predicted to hit $3 a gallon in time for the peak driving days of Labor Day weekend. In the next few weeks, refineries were supposed to shift over to produce home heating oil to build up supply for winter. Forget about that now. With individual Gulf Coast refineries shut for next two weeks to three months, the buildup will inevitably lag. Natural gas and heating-oil prices were headed higher before Katrina, and now they're headed for the moon. I think heating bills -- piled on top of higher gas prices -- could take a big enough bite out of consumers' wallets to put a real damper on consumer spending this winter.
How Katrina trumped Alan
Katrina has changed everything for economists. Just a few days before the storm hit the Gulf Coast, Federal Reserve Chairman Alan Greenspan told the Fed's annual Jackson Hole retreat that higher energy prices hadn't yet put a damper on the U.S. economy. That was certainly reassuring to financial markets that had become worried by anecdotal evidence from Wal-Mart Stores (WMT, news, msgs), Dollar General (DG, news, msgs) and other retailers with a big hunk of lower income consumers that higher prices of gasoline were cutting into spending by these customers.
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Well, Katrina certainly revived those fears.
Gasoline inventories were tight even before the hurricane, with the U.S. Energy Information Administration reporting that inventories were 7% below last year's level and well below the historical average. About 1.4 million barrels of production in the Gulf Coast -- equal to about 7% of U.S. daily crude-oil demand -- was shut down by Katrina. More critically, refinery companies shut down eight refineries in Louisiana and Mississippi that refined about 10% of total U.S. refinery capacity.
Right now, no one knows how quickly any of these refineries will get back into action, since refinery companies are still trying to assess the damage to plants. But it's clear that the industry is not looking at restoring production in the next few days.
For example, Valero Energy (VLO, news, msgs), one of the few refiners to give a definite startup date, has said that its 260,000-barrel-a-day St. Charles refinery suffered only minor damage and would restart in two weeks.
This uncertainty has seriously spooked energy traders, since they don't know whether we're facing a quick restart of this capacity -- like Valero's -- or an extended outage. It doesn't help that the U.S. Strategic Petroleum Reserve, which the federal government says it will tap, holds millions of gallons of crude oil but no gasoline.
So no wonder that on Tuesday, Aug. 30, gasoline futures for September delivery climbed 20% to hit a record $2.4745 a gallon, and then climbed to $2.68 on Aug. 31. Crude-oil futures closed at $69.81, a 61% increase for 2005 to date. Analysts are speculating that we could soon see an average price of $3 a gallon gasoline at the pump, a level that has already appeared at some gas stations, up from the national average of $2.604 reported by the AAA on Aug. 30. A short-term peak near $3.50 or even $4 is certainly possible.
Will the Fed do an about-face?
With floodwaters still rising, the Federal Reserve on Aug. 30 released the minutes from the Aug. 9 meeting of the committee that sets interest rates. Energy prices, the members of the committee said at the meeting, were a significant drag on consumption, although household spending could be expected to advance at a moderate pace. The committee added, "High and rising energy prices were adding to pressures on overall inflation, and energy price increases probably would feed through, at least temporarily, to core measures of inflation.''
That set economists to rethinking their assumption that the Federal Reserve would continue to raise short-term interest rates well into 2006. That's what the Fed's Open Market Committee had clearly signaled at the time of its Aug. 9 rate increase. Mind you, the Fed met before Katrina pushed gasoline above $3 a gallon. Investors and the financial markets are now wondering if maybe this latest blow would be the straw that broke the consumers' back and caused the Federal Reserve to take a breather.
You'll notice, though, that most of this thinking is about the relatively short-term impact of higher gasoline prices on the consumer. I'm much more worried about what will happen this winter. I don't think $3 a gallon gasoline has the power to send the economy into a slump by itself. But add in heating oil priced at $2.50-to-$2.75 a gallon (and $14 per million BTU natural gas), and this winter could well do the job.
Even before Katrina hit, the U.S. Department of Energy was projecting home-heating oil would hit $2.20 a gallon this winter and natural gas would climb to $13 per million BTUs. That was already a 17% increase in heating oil and a 16% increase in natural gas from the previous winter.
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