Tuesday, August 30, 2005

Quantifying Katrina
As the damage assessments from Hurricane Katrina start to roll in, a picture is emerging of what the next couple of weeks in the energy markets might look like. With the latest news indicating that the Louisiana Offshore Oil Port (LOOP) did not sustain serious damage and can restart as soon as power is restored, the immediate concern shifts to the shut down refineries in Louisiana and Mississippi. If the early report from Valero is indicative of the state of the other facilities, facing a delay of up to two weeks before they can restart, then the prospect of much higher gasoline prices will be a reality for some time.

Bloomberg indicates that refineries with a total throughput capacity of 1.79 million barrels per day (MBD) are shut down. Assuming a 50% gasoline yield suggests that 0.9 MBD of gasoline production are offline, out of a recent national rate of 8.7 MBD, or a bit over 10% of the total. Gasoline imports, currently running at 1.0 MBD, should be relatively unaffected, though a few tankers may have to divert to other ports to discharge their cargoes.

If the estimate of 2 weeks of downtime proves correct, and assuming all these plants start up smoothly, we are talking about lost gasoline production of up to 12.6 million barrels, in addition to corresponding shortfalls in other products, such as heating oil and jet fuel. With gasoline inventories, particularly on the East Coast and Midwest (PADD I and PADD II, respectively) starting out at the bottom of their seasonally-adjusted ranges, the spike in gasoline prices necessary to balance demand and prevent runouts is going to be stout.

For example, the NYMEX futures contract for gasoline (for delivery in New York Harbor) has popped up $0.41/gallon for the day, to $2.47. Translating that into a street price, by adding current average taxes and retail margins, would take us to something like $3.09/gallon for regular unleaded, an increase of about $0.48/gallon from the most recent reported national average price. With some suppliers already restricting dealer and distributor deliveries to historical levels, to prevent runouts, it could go higher.

Please note: I am absolutely not advising you to go out and fill up now, to avoid higher prices later. The single biggest thing you can do as an individual to influence the situation in a positive way is to stick to your normal habits and only fill up when you normally would. The distribution system is finely balanced, and a sudden decision by everyone to carry an extra 4 gallons in their cars' tanks would draw down a further 20% of the nation's gasoline inventories and give us the gas lines we've avoided so far. For that matter, dropping down a grade, to midgrade if you normally buy premium, or to regular if you normally buy midgrade, would also help, since lower octane gasoline uses less crude oil and is easier to make.

Finally, returning to the subject of imports, a refining system that has been running flat out for months will not be able to make up lost production, even if all the affected refineries restart without incident. That means that the only way to restore balance will be to reduce demand (via higher prices) and to attract enough additional imports to cover the difference. That only happens when the price here is higher than the price in Europe and Asia by enough to cover the shipping costs and provide traders with a profit. Even if we weren't dealing with a backdrop of steadily rising crude prices, it would probably take four or five weeks of sustained high gasoline prices in the US to get things back to where they were before Katrina hit.

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