Economic effects of Rita

A lot of people are bracing for huge effects of the latest Gulf storm on energy markets. I see reasons for hoping things won’t be that bad.

Houston Ship Channel (source:

Still trying to recover from the wounds of Katrina, here comes another big one. Minerals Management Service is currently reporting 92% of crude oil production and 66% of natural gas production from the Gulf of Mexico shut in, though the lasting effects on oil production predicted for Rita by Kinetic Analysis Corporation/University of Central Florida are less severe than those they had fairly accurately predicted for Katrina. A significant number of critical refineries could also be affected by the storm.

A rough prediction of the effects of such disruptions on energy prices can be obtained by dividing the percentage drop (after inventory adjustments) in the quantity produced by the elasticity of demand. The market for crude oil is a global market, and the entire production from the Gulf of Mexico represents far less than 2% of the world total. On the other hand, it is much harder to make rapid changes in imports of gasoline or natural gas, and 20% of U.S. refinery capacity is currently shut down as a result of the effects of the last storm and fear of the next one. Details on affected refineries have been reported by the Oil Drum and Outside the Beltway. Since Rita’s threat to the oil patch became clear, the near futures price for crude oil has risen 5%, natural gas 15%, and gasoline 20%.

This threat has James Joyner of Outside the Beltway, among others, talking about the possibility of $5 a gallon gas. Personally, I share the skepticism of Steve Verdon (another writer for Outside the Beltway) about such claims. For one thing, the Texas refineries, unlike many in Louisiana, are above sea level, one of those little details that become important at a time like this. And it was the break in the levee, rather than the wind and the rain, that caused the real damage in New Orleans. Admittedly, it’s no trivial thing to stop and restart a refinery. But if things do return to normal quickly enough, a week of shut down is something that we could forget soon enough.


The graph above relates the U.S. average retail gasoline price to the NYMEX gasoline futures price for the nearest month; (data from EIA). The retail price had averaged about 60 cents a gallon above the futures price for most of the summer, reflecting state and local taxes plus the wholesale and retail markups. With Katrina, the retail price went well above the value predicted by this usual relation. This was a feature of the very short-run nature of much of the supply disruption from Katrina. The spot bulk price in New York actually reached $3.00 a gallon at the end of August, which from the 60 cent rule would have meant $3.60 a gallon retail. The futures price curve was very sharply sloped downward as one went from the September futures contract to the October futures contract, with the retail spot price moving to a point in between the very high bulk spot price and the more modest October futures spot price. As this graph shows, and as I pointed out here and here, in the absence of the most recent resurgence of gasoline futures prices from Rita, we could have expected to see another 20 cents per gallon drop in the retail price below its current value. With the futures price coming back up before the retail price had the chance to complete that downward move, at the moment there’s not much pressure from fundamentals for retail prices to make any further move, up or down, from where they are right now. What that means is that one possibility is that motorists may not see any effect of Rita at all.

To be sure, the NYMEX traders may have this all wrong, and the multitude of worried pundits quoted by the media could have it right. But let me just point out that the futures traders could be wrong in either direction. Another possibility is that the damage will be even lighter than the market is expecting, and you’ll soon be getting that price break after all.

Rita undeniably has the potential to be the energy Armageddon that many people are talking about. But my guess is that it probably won’t be.


25 thoughts on “Economic effects of Rita

  1. kuros

    anything less than an “armageddon” is a full blown disaster for those near to or at the bottom of the economic system

  2. Houston's Clear Thinkers

    Economic waves of Rita

    With the eastern shift of the projected path of Hurricane Rita directly into the part of the Houston metro area that contains a huge number of some of the nation’s largest oil refineries and petrochemical facilities, Rita’s economic ripples have…

  3. Joseph Somsel

    Gasoline is important, certainly, but the effects on natural gas markets can be even worst. We can bring in tankers of gasoline. We’re now in the “filling season” where the underground resevoirs are being filled with gas in anticipation of the winter heating demand. A shortfall in deliveries and a cold winter could mean actual failure to deliver gas this winter. Our current LNG terminals have very limited additional capacity. And that will mean someone’s grandma will be found froze to death in her unheated home (actually, a bunch of people). Let’s hope they have enough for the electric plants that can only burn gas.
    Already, prices have been OVER $12/mmBTU for several days. Those are historic numbers and indiciative of post-peak production in North America.
    The longer effect will be a Federal MANDATE for LNG terminals and acceleration of our nuclear construction program. Heck, at these prices, a MERCHANT nuclear power plant can make loads of money, even with 15% mortgages.

  4. spencer

    Because of Katrina the supply of gasoline fell
    x%. To bring demand down to meet that supply prices had to rise over $3.
    At some $3 gas prices demand was in balance with the supply after Katrina. If Rita causes another drop in supply to less then it was after Katrina then prices would have to rise above the some $3 equilibrium price that had been established.
    But if Rita does not cause another drop in supply prices should remain near their previous market clearing price.
    We do not know the impact of Rita, but it is unlikely to generate the longer term supply disruptions Katrina did. If the supplies disrupted by Rita prove to be short run the impact on prices should also be short run.

  5. Tom Leeman

    This is a cat 4 hurricane the damage will be catrastrophic. 11 Texas refineries are shut down thats 16% of production
    ExxonMobile Baytown & Beaumont 905,000 barrels
    BP’s Texas City 437,000 barrels
    Valero’s Port Arthur 414,000 barrels
    ConocoPhillps 216,000 barrels
    Deer Park 340,000 barrels
    Marathon Oils Texas City 72,000 barrels
    Motiva Port Arthur 235,000 barrels
    Lyonell Citgo 270,000 barrels
    Flint Hills Corpus Cristy 288,000 barrels
    and the list goes on there are still 4 refineries still shut down from Katrina
    Chevron Pascagoula 325,000 barrels
    ConocoPhillips Bell Chasse 247,000 barrels
    Exxon Chalmette 183,000 barrels
    Murphy Oil 120,000 barrels
    With just in time inventory this is a disaster beyond anyones imagination this hurricane is hitting smack dab in the middle of energy ally.
    If we are lucky gas will only hit $5 a gallon. This will derail the economy. Get ready for run away inflation unlike anything we have seen before the only thing that could drive down energy prices now is bird flu pandemic either way we are screwed

  6. Full Disclosure

    An upbeat outlook for Rita

    With Rita bearing down on us, James Hamilton offers a different view of the storm’s economic impact. It’s a little more upbeat than some of the other predictions and assessments. For more predictions and analysis on Rita’s possible effects on…

  7. bubba

    I so think TL is a little pessimistic on this. However, what do the economic models suggest is the impact to the overall US economy when two major US cities are shut down. New Orleans is of course shut down for a long time. However, Houston has been at a dead stop for two days. Over 2.5 million people evacuated (that is the number I heard the governor quote). Without even thinking of the damage, it will take a week just to get the economy of the city even approximating normal. And this will be made much worse if there is considerable infrastructure damage. Your thoughts JDH?

  8. brad setser

    My sense is that there may be a fair amount of damage to the offshore production infrastructure given Rita’s current course, but the impact on the market of any temporary disruption in offshore crude production is assumed to be limited because any short-term disruption can be offset by drawing on the SPR — the true bottleneck is refining capacity. Wanted to see if the energy gurus here think that a fair description …

  9. Hal

    I have been wondering, why did retail prices get so far out of line with respect to the prices quoted on the futures market? Two things happened there. First, the retail price spike was far higher and more dramatic than the futures market spike. And second, retail prices have been much slower to come down than the futures prices.
    Is it reasonable to think of the futures price as a sort of “wholesale” gasoline price, so that the difference between the two represents a markup in the distribution chain? If so, does this point to “profiteering” by distributors and retailers?
    If gasoline could be purchased in bulk at $2.00 why is it selling for $3.00 on the street? I understand that the retail price will balance supply and demand, but the same thing should happen to the “wholesale” price as well. Why has the price differential become so much larger at this time?
    (I do have a theory to explain this, which is that futures prices are not true “wholesale” prices, but rather there is a spot market for bulk gasoline distribution, and that prices in this spot market are staying high, $2.20 – $2.50/gal or so for the past few weeks. But I’ve never seen discussion of such a market, nor any such price quotes, so I don’t know if this market really exists and is responsible for keeping wholesale prices high.)

  10. Duncan Brown

    Brad, “damage to the offshore production infrastructure” (i.e. pipelines and rigs) is suprisingly light even in majore hurricanes (since the pipes have breakaway joints and other devices to limit spillage). Production comes back fast.
    As for the supposedly limited refining capacity, Prof. Hamilton showed last week that output can rise substantially even if capacity doesn’t.
    – Duncan

  11. Joseph Somsel

    “If gasoline could be purchased in bulk at $2.00 why is it selling for $3.00 on the street?”
    Taxes – state fuel, federal fuel, and local – THEN state sales on top of price+tax – at least in California.
    Price lags also occur because of inventories and distribution lags. Retail prices will head up with wholesale if every other station is doing it – the dealers want to have the cash to pay for the next, more expensive shipment. On the downswing, they have no incentive to rush to the bottom profit-wise and would want some hedge against a price inflection point and prices heading back up.
    It must be pure heck being an independent gas station owner.

  12. JDH

    Macroblog has shown that historically, hurricanes don’t have big macroeconomic effects. I think if Houston comes back in a few days, there won’t be any big consequences there. New Orleans, as I’ve argued earlier, is another story, and that may be where we again see Rita pack the ugliest punch.

  13. JDH

    Hal, one of the issues about comparing the retail with the futures price is the date. Retail is a spot market. One aspect of the effects of Katrina was that the very near-term price skyrocketed, because in part the most serious problems were very near-term issues. In my opinion, that’s why you saw this discrepancy between retail and the futures price. In addition, retail prices can take some time to adjust, because they’re not the same competitive auction type markets as NYMEX. Put the two together, and my pre-Rita prediction had been for further declines in the retail price.

  14. Scott

    At various times, weve discussed the capacity limitations were up against in the refining industry. Im not sure everyone understands how that plays out. The US does not have enough refining capacity to meet the demand for gasoline in the summer. Because of that, refineries run flat out in the summer and draw down stocks that were built up in the spring. In addition, there are many more special blends required in the summer meaning any one market will have fewer refineries supplying it than in the winter.
    During the winter, demand is less and refineries can run at 85% of capacity to meet it. In addition, a number of the special blends go away for the winter and more refineries make gasoline that can be sold into more markets than in the summer. Combine those two things and it gets tough to get a price spike from refining in the winter.
    That also means that youll only get a big return on a refinery in the summer. In the winter, its a very competitive market.
    If youre looking for evidence of limited refining capacity, look for an increase in the spread between crude and gasoline in the summertime. It wont show up in the winter. Further, look at gasoline price spikes. The refinery related ones ought to occur in the summer, not in the winter when there is lots of extra capacity.
    I suggest that two factors account for the absence of $5 gasoline.
    First, were past Labor day and the amount of gasoline people want to use typically falls after Labor day. That decrease in demand moves us down the US gasoline supply curve and relieves the summer capacity constraint. In addition, the President removed the summer blend requirement after Katrina which increased the supply options for various parts of the country.
    Second, the market learned something from Katrina. It wasnt as disruptive as anticipated. Since the market reacts to uncertainty by pushing prices up and there was less uncertainty with Rita we didnt get as much of a price spike.

  15. The Oil Drum (heading out)

    The overall supply disruption from Katrina could not be fully discerned before Rita arrived, because of the “loan” of refined product from the IEA partnerships. That was a one-shot deal and helped conceal some of the impact on the refineries. It remains to be seen how soon the refineries can be brought on line, and while a month may not seem to be all that much, the 30 mb of oil that it reflects might well be. Further the delays in bringing the production from Thunder Horse and Mars into the market may well increase the impact next year.

  16. Barkley Rosser

    I agree that usually hurricanes do not have major macro effects and noted one reason why in an earlier thread on this blog, that the reconstruction effort (however financed) provides
    a positive stimulus after a while.
    It may be that we have seen the top of oil and gasoline prices (although perhaps not natural gas prices) for now, given that refinery damage seems not to be so bad after Rita. The more likely down kick would seem to be coming from your earlier thread, the hit on consumer confidence that all this has engendered and does seem to be pretty severe.
    The housing bubble also looks to be about near its end, perhaps at it now with the decline in consumer confidence. JDH’s earlier work involved arguing that one could never prove the existence of a bubble because of the “misspecified fundamentals” problem. However, the issue of premia that appear and crash on closed-end funds would appear to be a case where one can pretty clearly identify the fundamental and we have seen bubbles appear and crash.

  17. Tom

    > If gasoline could be purchased in bulk at $2.00
    > why is it selling for $3.00 on the street? I
    > understand that the retail price will balance
    > supply and demand, but the same thing should
    > happen to the “wholesale” price as well. Why has
    > the price differential become so much larger at
    > this time?
    It’s called “paying for the presidential election.”
    or … “public financing” of elections. We already have it! :)

  18. Houston's Clear Thinkers

    Economic waves of Rita

    With the eastern shift of the projected path of Hurricane Rita directly into the part of the Houston metro area that contains a huge number of some of the nation’s largest oil refineries and petrochemical facilities, Rita’s economic ripples have…

  19. fringy

    Question: I’m not an economist but it looks like $20 Natural Gas this Winter after both of these storms – or more than twice the price of last Winter. – Also I think it will be at least $15 the winter after and never be less than that in the US again.
    What is the impact of that price on the US?
    We’ve seen a lot of ammonia and fertilizer production go down in the US (although I can’t find any actual data on this).
    A lot of electricity is needed in the US and the price is going up because of natural gas prices, this will affect a lot of compoanies and individuals.
    Can we predict how many jobs this will cost in the US?

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