The Worst Storm in U.S. History Will Have a Large Impact on the National Economy

by Nariman Behravesh

Hurricane Katrina was the costliest storm ever to hit the United States, although thankfully it appears the death toll will not reach the many thousands once feared. The deadliest storm was the hurricane in 1900, which destroyed the city of Galveston, Texas, and killed between 6,000 and 8,000 people.

The wealth destroyed in the wake of this hurricane is many times greater than following any other U.S. storm. Before Katrina, Hurricane Andrew (in 1992) inflicted the most damage—estimated at around $26.5 billion. Estimates of the damage from Katrina range from $100 billion to $200 billion.

Not only was Katrina the worst storm ever, but its national impact will be much larger because of ripple effects on trade volumes and energy prices.

A Huge Hit to a Poor Region. The regional impacts Katrina are bigger than anything we have seen before. The states (Alabama, Mississippi, and Louisiana) and metropolitan areas devastated by the hurricane have smaller, less diverse, and therefore less resilient economies than those of Florida and Texas, which have also been hit hard by hurricanes in the past. For example, the gross state product of the three affected states combined is just 61% of Florida's. All three of these states have also significantly underperformed the nation with respect to both output and job growth.

New Orleans, which has suffered the greatest number of deaths and the most damage from the floods accompanying Katrina, is about 0.4% on the national economy. It is also one of the poorest metropolitan areas of the United States, with a poverty rate of 18.4%, compared with an average of 10.9% for large U.S. cities. While there has been a lot of talk about the boost to the local and national economies when the reconstruction boom gets under way, it will take many months before rebuilding can actually start. Many parts of New Orleans are still under water, and it will take months to dry out the city and clean up the mess before any new construction can begin.

The national impact of Katrina is also far larger than any other storm because of the damage to the region's trade and energy infrastructure. Despite its relative poverty, this region plays a vital role in international commerce, as well as in both the upstream (extraction of oil and natural gas) and downstream (refining and petrochemicals) energy sectors.

Fortunately, Damage to Largest U.S. Port May Be Limited. The port of New Orleans and the adjacent port of South Louisiana, together, are the largest port in the United States, in terms of tonnage. If you include the other ports on the Mississippi River up to Baton Rouge, then this is the largest port area in the world.

Imports to these Gulf Coast ports include coffee, sugar, fruit, steel, rubber, and oil (for the petrochemicals plants in the area). Exports primarily consist of agricultural commodities (including wheat, corn, and soybeans) that come down the Mississippi and are then shipped all over the world.

Fortunately, the track of Hurricane Katrina spared much of this trade infrastructure. Moreover, the river channels have been re-opened, so that upriver ports are no longer cut off. Finally, the impact on grain exports is likely to be limited, because the peak harvest and barge traffic on the Mississippi River are still a few weeks away. However, with the mass evacuations of New Orleans and surrounding areas, there could be a serious shortage of skilled labor at these ports.

The Biggest National Impact Has Been Through Energy Prices. Southern Louisiana plays a crucial role in U.S. energy markets. Not only are large amounts of oil and natural gas extracted offshore, but the Louisiana Offshore Oil Port (the LOOP) is a major entry point for oil imports. Even more important are the many refineries in this region. In the immediate aftermath of Hurricane Katrina, roughly 10% of U.S. refining capacity, 18% of crude oil production, and 17% of natural gas production were out of commission. Two weeks later, about 5% of refining capacity, 9% of crude production, and 6% of natural gas production were still off line.

The impact on energy prices was immediate and dramatic. Oil prices were briefly pushed above $70 per barrel and gasoline prices passed $3 per gallon. Subsequent announcements about the release of crude and refined products from the Strategic Petroleum Reserve and by foreign governments, along with an easing of gasoline standards, helped to calm markets down and lower prices.

Global Insight believes that energy market conditions will return to the pre-hurricane levels over the next few months and that prices will continue to ease. By year-end, though, consumers will still be paying 35-40% more for gasoline than in December 2004, and home heating bills will likely be 30-40% higher. Energy costs are now biting into consumer budgets more severely than at any time since the early 1980s. Total consumer spending on energy should absorb about 6.0% of disposable income in the fourth quarter, up from 5.1% a year ago and 4.5% two years ago. The saving rate (even though it is less than zero) can absorb some of the shock, especially if the spike proves temporary. But it is unrealistic to suppose that consumers—especially lower-income consumers for whom gasoline forms a relatively high share of their budget—will simply carry on spending as if nothing had happened.

The risks to energy prices remain predominantly on the upside. The full extent of the damage to the energy infrastructure is still unknown. Moreover, market conditions remain very tight. Hurricane Katrina was a supply shock on top of a "demand shock" that has being going on for a couple of years. Prices are close to record levels in both nominal and real terms. Another supply disruption (e.g., rebel activity in Nigeria, sabotage in Iraq, unrest in Venezuela, or terror attacks in Saudi Arabia) could easily send prices to levels never seen before.