Katrina: A Man-Made Disaster & Its Economic Consequences

``I am absolutely disgusted. After the tsunami our people, even the ones who lost everything, wanted to help the others who were suffering...Not a single tourist caught in the tsunami was mugged. Now with all this happening in the U.S. we can easily see where the civilized part of the world's population is." Sajeewa Chinthaka, 36, as he watched a cricket match in Colombo, Sri Lanka, according to a Reuters report.

I would like to take this opportunity to extend my deepest empathies to those afflicted by the recent hurricane Katrina.

However, in the face of a calamity that was NOT entirely unexpected, New Orleans which was heavily devastated is a bowl shaped city below sea level and has long feared of the catastrophic consequences from a massive hurricane. In fact, the city had ample warnings from several entities as the prominent National Geographic, academic luminary as Ivor van Heerden of Louisiana State University and even analyst as Mark Thornton of the Ludwig von Mises.org. Yet despite the warnings, the city degenerated into a disaster and at worst fell into anarchy, where looting, murder, rape and other crimes prevailed, as law and order broke down, something unheard of especially in the ‘supposed’ aegis of the world’s greatest democracy.

``Mother Nature can be cruel, but even at her worst, she is no match for government. It was the glorified public sector, the one we are always told is protecting us, that is responsible for this. And though our public servants and a sycophantic media will do their darn best to present this calamity as an act of nature, it was not and is not. Katrina came and went with far less damage than anyone expected.” wrote Llewellyn H. Rockwell, Jr. of the lewrockwell.com.

As I have argued before, despite voter’s collective expectations that the public sector ‘knows what is best’ for its constituency, governments by nature are inherently inefficient, unaccountable, irresponsive, derelict and incompetent. Why? Mr. Rockwell gives an adequate response, he says that because ``they are not real owners. There are no profits or losses at stake. They do not have to answer to risk-obsessed insurance companies who insist on premiums matching even the most remote contingencies. So long as it seems to work, they are glad to go about their business in the soporific style famous to all public sectors everywhere.”

It happened to the United States, what more to expect from unstable developing nations as ours?

The world is already faced with abruptly expanding diversified but interlocking risks in the realms of monetary/financials, economics and geopolitics yet it appears that complacency is still the order of the day. Notwithstanding, in parallel to the New Orleans debacle, governments are once again expected to deliver us from any contingencies, most notably seen with the public sectors hands underneath the Brobdingnagian currency, interest rate and credit markets worldwide.

``If you sit there and do nothing, then you have adopted the New Orleans mindset: "Let the good times roll." (Yes, that really is the state motto of Louisiana.)” warns Professor Gary North, in his Reality Sheck column. To paraphrase the illustrious Nobel Laureate Hyman Mynski, ‘Stability breeds instability’, in short, the perception of government fostered ‘stablity’ could actually be an illusion in a world of accelerating risks.

Let us not forget that what the significance of the ports of New Orleans and the Mississippi to the US economy, according to John Maudlin, ``the centrality of the port of New Orleans and the Mississippi, if the Mississippi is not opened up for shipping, and the docks and ports are not cleared for loading and unloading, it is going to be a major hit to US exports and business, especially agriculture.”

In other words, the infrastructure displacement could serve as a supply shock that could distort global trade flows over the interim. For instance, US grain prices may fall as exports are deferred (excess local supplies which were meant for exports) whereas world grain prices may rise as a result of the distortions (temporary shortages). Chemicals, steel and other items that were normally coursed through the area could also experience price dislocations arising from the temporary disequilibrium.

More importantly, as Prof North wrote, ``Because New Orleans and the gulf area are central to the American oil industry, the marginal cost of oil has risen with the shut-down. This is well-known. Whether most Americans knew this could happen a week ago is doubtful. People assume that someone is in charge, that someone will guarantee the delivery of oil. But nature cannot be hemmed in at a low price. Market pricing will help restore the system, but a loss is a loss; it must be paid for.”

Craig Stanley of resourceinvestors.com notes that, ``The Gulf of Mexico accounts for around 25% of U.S. domestic oil production and 24% of gas production.”

According to the Washington’s post September 3 report, ``Eight refineries remain shut down, though two are in the process of restarting. Nearly 89 percent of daily oil production in the Gulf of Mexico was off line. More than 72 percent of natural gas production in the Gulf of Mexico was off line.”

Tom Doggett of Reuters reports that `` The U.S. has lost production of about 42 million gallons of gasoline a day, equal to 10 percent of its normal consumption, because Hurricane Katrina shut down oil refineries and forced others to reduce runs, according to government estimates.”

The damage arising from the Katrina has so far been incompletely assessed as several oil rigs were reportedly adrift.

Damaged Shell Mars Platform at the Gulf of Mexico

Courtesy of rigzone.com

The US government has adopted several palliatives to the oil supply uncertainties such as the release of some strategic reserves held by the US government’s Strategic Petroleum Reserve (SPR), Bloomberg’s Mark Shenk, reports, ``The agency will make 60 million barrels available, with 30 million coming from the U.S. Strategic Petroleum Reserve, over the next 30 days, Energy Secretary Samuel Bodman said. The Louisiana Offshore Oil Port, the biggest U.S. oil-import terminal, and pipelines have opened. The U.S. relaxed clean-air rules this week in an effort to increase fuel supplies.”

Further, regulatory standards for gasoline blends have also been eased, additional report from Mr. Shenk of Bloomberg, ``The EPA just relaxed gasoline standards, making a greater volume available,'' said Kyle Cooper, an analyst with Citigroup Inc. in Houston. ``Both chemically and physically it is easier to make winter-grade gasoline...The U.S. Environmental Protection Agency on Aug. 31 waived federal clean air standards for all 50 states, the District of Columbia and U.S. territories through at least Sept. 15 because of supply disruptions caused by Katrina. Refiners, importers, distributors and retailers will be able to sell gasoline that meets lower standards for emissions.”

According to Caroline Jacobs of Reuters because ``the EU nations have watched in horror as the world's richest country struggles with the aftermath of Katrina. Thousands are feared dead and troops in the flooded city of New Orleans have been told to shoot-to-kill to crack down on looting....Europe will dip into its emergency reserves of gasoline to help the United States through an energy crisis that began when Hurricane Katrina smashed into Gulf coast refiners, EU governments said on Friday.”

German Chancellor Gerhard Schroeder told a news conference in Berlin that he ``He expected a massive two million barrels per day of oil to be shipped over the next month -- more or less offsetting lost output from the Gulf coast's battered refineries.” adds Ms. Jacobs of Reuters. It would take around 10 days before EU oil reserves reach US shores taking in consideration yet the short supply of tanker space that could further delay shipment schedules.

Oil bears have been jumping in glee citing that the recent record of $70.80 per barrel of the New York’s Sweet Crude may have served as the watermark ‘peak’, reckoning that the present supply imbalances caused by Katrina failed to spark crude oil prices significantly past its previous record high of $70.5. Maybe.

However, the bears have inadequately addressed that in spite of the constricted increase in crude oil’s prices (+1.9% week-on-week at $68.16 bbl-November delivery), the refinery capacity constraints aggravated by Hurricane Katrina have resulted to staggering record-setting one week price surges in natural gas (+19.22%!!!) to $11.691 per British thermal units after reaching a record high of $12.3 Btu (!!) last August 31^st, Unleaded gasoline (+17.82%!!!) to $2.1837 per gallon after reaching $2.55 per gallon also last August 31^st and Heating oil (+11.75%!!!) to $2.0911 per gallon.

Put differently, while nation states may have excess crude oil reserves at the margins, there is no such strategic reserves for refined petroleum products, which incidentally affects consumers directly.

In sum, Hurricane Katrina simply exposed the fecklessness and ineptness of public institutions in protecting the public weal despite voter’s collective trust in them. This concern was highly aggravated by the fact that the economic significance of the affected areas, particularly of New Orleans, to the US economy was glossed over by the government’s presumption of a nonevent.

Apparently, the law of averages caught up, leaving the world’s most powerful government struggling to restore order. The damage has been done with numerous lives and properties lost and displaced. Unexpectedly, chaos reigned. More importantly, New Orlean’s contribution to the national division of labor would have to be suspended, as the city’s infrastructure had been ravaged. At present, the afflicted city would absorb capital for reconstruction rather than supply output.

The devastation has resulted to serious distortions in the economy, possibly a supply shock and heightened inflation concerns over the short term, whereby the thin margins of energy economics had been underscored at the wake of Katrina’s umbrage.

Moreover, exogenous events may further exacerbate the energy situation. This means prolonged period of high energy prices that may further squeeze consumer spending and corporate profits. Similarly, Katrina’s havoc was reflected in the financial markets, as US treasuries soared and the US dollar caved in. The prospects of a recession now loom larger today than prior to Katrina’s rendition.

Now the major risk factors stares the US economy at the face, namely, the aftermath and the unseen consequences of Katrina, soaring energy prices and the interest conundrum. The global financial markets watch in anxiety.