What Will Katrina Cost the Nation?

---Reprint from Global Insight, August 31, 2005---

Impact On US Economy of Hurricane Katrina
by Nariman Behravesh, Global Insight

Unlike prior hurricanes such as Ivan, Katrina could inflict a lot of pain on the US economy, as a whole, because of the potential for extensive damage to oil and natural gas supplies in the Gulf of Mexico, as well as to the many refineries in Louisiana.

It is still too early to determine exactly how much harm was done by Katrina. Because of this uncertainty, Global Insight has made a preliminary assessment of a couple of scenarios based on the level of damage to the energy infrastructure and how much supply is lost leading up to the winter months. Even in the best-case scenario, US efforts to build inventories of crude oil, natural gas, and refined products will be set back.

Best-Case Scenarios: Oil at $70 to $75 a barrel for a couple of weeks; gasoline prices over $3.00 for a couple of months; and the economy takes a small hit (between 0.5% and 1.0% on growth in the third and fourth quarters).

This scenario assumes that the damage from Katrina is very limited: oil, natural gas, and gasoline supplies are cut by 5% or less for a couple of weeks.

In this scenario, oil prices could rise to $75 a barrel for a couple of weeks and fall to low $60s per barrel by the end of the year.

Gasoline prices could rise to $3.00 or a little higher for a couple of months, but would likely fall back to around $2.50 by year end.

Real GDP growth would be reduced 0.5% to 1.0% in the third and fourth quarters.
Worst-Case Scenario: Oil at $100 a barrel for a month; gasoline prices at $3.50 a gallon for a few months; and the economy closer to a recession by the fourth quarter.

This scenario assumes that because of the damage from Katrina to oil rigs and natural gas production infrastructure and oil import facilities, US oil and natural gas supplies could be cut 10% for a couple of weeks. Likewise, because of damage to refineries, gasoline, jet fuel, diesel, and home-heating-oil supplies could also be cut 10% for up to a month.

In such a scenario, oil prices would spike to $100 a barrel for a month before falling gradually to around $70 per barrel by the end of the year. Prices would fall back due to slower growth in the economy, release of the SPR, and an increase in US-imported refined products making up for the domestic shortfall.

In this worst-case scenario, gasoline prices would average around $3.50 per gallon (for unleaded regular) for the next four to six months. This could be mitigated, if the US EPA temporarily relaxes some of its gasoline standards.

The impact on consumer spending in such a scenario would be very dramatic, cutting the growth rate by as much as 3% and pushing real GDP growth in the fourth quarter closer to zero.
Bottom Line: Early estimates suggest that the worst-case scenario is unlikely to happen. However, much in the same way that after Hurricane Ivan successive damage estimates kept being revised upward, the impact of Katrina could well be considerably larger than the best-case scenario estimates (and what the markets seem to be expecting).