Monday, August 29, 2005

Assessing Katrina's Impact (updated 2:09 PM EDT)
It was eerie watching the storm track of Katrina and recalling the remarkably similar starting point of the oil crisis scenario presented in June's somewhat schlocky TV movie, "Oil Storm". All my reservations about that scenario remain, but there's no disputing the importance of this stretch of Louisiana coastline and its oil and gas infrastructure to the nation's energy wellbeing.

One estimate of potential lost production made in advance of the storm suggested a loss of up to 13 million barrels of total production, but I suspect it will be days before we know the true extent of the damage. As a number of commentators have pointed out, it has taken a year to recover from the impact of last year's Hurricane Ivan on the industry, and Katrina had at least the potential to do worse.

As many of the analysts I've seen on CNBC and elsewhere have commented, the impact on gasoline will be more immediate and probably larger than on crude oil, given that roughly 10% of the nation's refining capacity is shut down at the moment, due to the storm. A quick glance at gasoline inventories shows that they have dropped considerably in the last six weeks, both in absolute terms and by comparison to their historical seasonal range. Even though overall US gasoline inventories are just barely within that range, much of the remaining flexibility in the system seems to be on the West Coast, where it is both unaffected by the storm and of no possible help to other parts of the country. That leaves inventories in the rest of the country very tight, with little buffer for a disruption like Katrina. Crude oil, by contrast, remains above its seasonal range.

Although much of the coverage has been thorough and professional, I wanted to strangle the reporter on CNBC who, standing in front of a gas pump in New Jersey, urged viewers to run out and fill up, before gas prices spike higher. This is completely irresponsible and a great way to turn higher prices into widespread outages and gas lines.

Thinking about this storm prompts two concerns, one short-term and one long-term:
  • Given the extremely tight global oil market, in which the loss of any production is immediately translated into extra dollars at the pump, I would urge the Administration to be very aggressive and proactive with the use of Strategic Petroleum Reserve barrels to cover any shortfall. My long-time readers know my aversion to using the SPR to moderate prices, but a hurricane counts as a genuine emergency; this is precisely why we have an SPR.
  • It's still controversial whether climate change will increase the severity and frequency of storms like this. If it is proved out, then we need to factor this in when assessing the real productive potential of the deepwater Gulf of Mexico, one of the last high-potential oil basins in the US. Not only would more frequent major hurricanes in the Gulf reduce production by means of periodic outages, as we are seeing today, but higher insurance premiums on offshore facilities could actually change the economics of this kind of production, making it less attractive. That would mean less domestic production and higher oil imports, as well as higher prices.

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