Jubak's Journal Recent articles: • Play the lottery with airline, tech stocks, 8/30/2005 • 3 picks for the dog days of summer, 8/26/2005 • A hero for speculators: Davy Crockett, 8/16/2005 More... | Jubak's Journal 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 Related news and commentary on MSN Money
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 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. Chilling winter forecasts Now, though, with refineries unable to predict when they'll make the shift to heating oil and almost 90% of the Gulf 's natural gas production offline, those projections look quaintly optimistic. On Aug. 30 alone, September heating oil futures climbed by almost 10%. Home-heating oil dealers reported receiving notice from their wholesalers to raise prices by 10 cents to 15 cents a gallon. Last year, home-heating oil and natural gas prices climbed by about a third from the previous winter. I think we're looking at bigger increases than that this year. Increases in heating bills this winter are likely to have an even bigger impact on consumers than increases in the price of gas at the pump for three reasons:
Beyond energy, beyond borders Whether or not higher gasoline and heating costs will be enough to send consumer spending into a tailspin depends on how long the Gulf Coast energy infrastructure is crippled. A substantial recovery would have most refineries restarted within a month or two, natural gas production back to 75% of normal by November, and most of the 2,800 oil drilling and production platforms in the Gulf of Mexico back in operation by December. That would most likely add up to slower but still positive economic growth for the rest of 2005. Stretch out the recovery -- and keep energy prices at elevated levels for more than six months -- and the odds of a major slump in growth go way up.
Katrina's impact isn't limited to energy prices. For example, grain-shipping season in the Midwest starts in about a month. New Orleans normally exports two million bushels of corn, wheat, and soybeans each year. No one knows when the port will be able to handle anything near those volumes again. If it can't, farmers will have to ship their grain through other ports and find terminals and mills in other areas for domestic markets. All that will drive up transportation costs, especially since alternative shippers, such as railroads, don't have much volume to spare. Don't forget Katrina's global impact, either. For example, China took steps on Aug. 30 to prevent domestic Chinese refineries from exporting oil products out of fear that Katrina would limit global oil supplies and raise global prices. Investment bank UBS estimates that with $50-a-barrel-oil, China's economy will grow at 8.2% in 2006. With $70 a barrel oil growth I would slip to 7.6%. New developments on past columns 6 stocks for a second-half growth rally I'm going to ignore my own stop loss at $33.60 on shares of Komag Hutchinson Technology cut its sales estimates for the quarter to 170 million-180 million suspension assemblies from an earlier estimate of 190 million-200 million units. That weakness in demand, plus a shift in revenue mix toward products that carry a lower profit margin, will reduce gross margins to from 19% to 23%, from an earlier estimate of 28% to 30%. I don't see any signs that the weakness in demand for Hutchinson Technologies suspension assemblies carries over to the hard disk-drive media produced by Komag. Channel checks by Wall Street analysts show five to six week inventory, improving sell through, and slightly higher selling prices. Remember that just this happened in the June quarter when Hutchinson Technology missed estimates and Komag positively pre-announced. As of Sept. 2, I keeping my $48 price target by December 2005 on these shares and removing my stop loss. (Full disclosure: I own shares of Komag.) Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday. E-mail Jim Jubak at jjmail@microsoft.com. At the time of publication, Jim Jubak owned or controlled shares of the following equities mentioned in this column: Komag. He does not own short positions in any stock mentioned in this column. | ||||||||||||||||||||||||||||||
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