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In light of what probably is the
largest natural disaster of US history we have put
aside comments on longer term resource trends to focus
on Katrina and its wake. Recrimination seems to have
found a place that should be filled with resolve.
That we find as troubling as the storm was tragic.
To the million displaced souls we can only add our
hope that with some focus having appeared, each can
now grieve and seek out a semblance of normal life
quickly.
Efforts continue to rescue the last
of tens of thousands stranded by breached seawalls
in New Orleans. The direct impact of Katrina's passing
was most heavily felt along the Gulf Coast east of
New Orleans, literally flattening the waterfront in
much of Mississippi and flooding part of Alabama.
The human cost of this disaster is obviously enormous,
and the more so with a weak initial response.
In an age when 24-hour news tends to
exaggerate, Katrina's build up seemed mild. Even after
gathering strength and sweeping over the Gulf coast
it seemed manageable. First appearances misled. We
are no ones' apologist, but do feel this needs recognition.
Yes, rescue was too slow to get started,
but not we think from indifference. What the world
has witnessed has in fact largely been the inertia
of an elephantine bureaucracy attempting to turn and
focus. Katrina's progress may have been acting out
its own place as metaphor - a glancing blow to a centre
that seemed ready for its full brunt lulling an overly
prepared bureaucracy into misreading damage by its
wake. A storybook giant killer.
At an individual level, many witnesses
to a tragedy are less likely to bring aid then is
a single witness who realises he or she has to act
if anyone is going to. From a Canadian perch, where
Mounties still police for all levels of government
in many areas (including parts of suburban Vancouver),
the countless number and variety of uniformed and
armed services in the US has always been mind boggling.
A multiplicity of US services meant
to control government may well have overbalanced in
this situation. Add to this the re-direction of many
of them to terrorist watch, and makings of tragedy
on top of disaster were laid. And the world has had
no sense of how to respond to this, the floundering
of an elephant in mud it had no way to avoid.
But Katrina was also a giant itself,
drowning a major city and knocking flat major regional
infrastructure. It will take months to properly repair
New Orleans' levees and seawalls and pump out the
water and sludge, and to sweep away debris in the
neighbouring states. That will be followed by years
of rebuilding.
We hardly assume that Mounties or others
will be better able to act when Vancouver has its
"big" earthquake at some point in the next
several centuries. We know its coming, being overdue
in a statistical sense, but who is every really prepared
for an inevitable disaster they will likely not witness.
Disasters are inherently not normal. They define what
we take for granted, and what we shouldn't. The next
weeks and months will be doing that for Americans
and by extension for all of us.
Energy Storm
In our mid August Dispatch we
had made the point that jumping crude prices then
were counter intuitive against refinery shutdowns.
Fewer refiners, regardless of the reason, should mean
a lower crude oil price. Though many see refineries
as simply and extension of the oil delivery process
they are, in fact, the crude producer's largest customer
base. They are the manufacturer/wholesaler in the
supply chain. It appears Katrina has underscored this
seemingly basic point for traders.
Somewhat less than 1.5 million barrels
of crude production and a similar level of natural
gas output were knocked out by the storm. Oil rigs
lost and damaged by the storm were secondary to refining
and transport systems damaged to a similar degree.
Gasoline and other derivative products
are in short supply. The hasty retreat of crude's
price after an initial surge indicated a concerned
market, though one that was finally accepting that
shut down refineries should ease, not worsen, the
crude supply problem.
Severe damage includes 10% of a US refining
capacity that is barely adequate to supply the domestic
market even while operating full bore. There was also
a larger temporary loss of pipeline capacity that
caused gasoline prices to spike as filling stations
ran out product.
The crude production lost to Katrina
has now been supplanted by two million barrels a day
from emergency inventories, for the next month or
so. A month may be needed just to determine time lines
to bring the Gulf of Mexico output back on-line.
We expect sufficient crude oil, and
refined product from Europe's strategic gasoline reserves,
to keep the global system fuelled for the immediate
future. What happens in October is really up in the
air. Oil producers are assessing their potential to
increase supply near term, but most are after all
pushing hard already.
The time frame for bringing refinery
capacity back in the Gulf Coast is still uncertain.
Keep in mind that these are old systems. No new refineries
have been built in the US for a quarter century. Refiners
will now be faced with bringing back to life equipment
that should probably be put to rest after Katrina's
damage. Though many refineries went off line for safety
reasons and due to power outages several of the larger
ones are damaged. It's likely that refined product
capacity will be constrained into next year.
Likewise at least one report described
lost oil rigs as "older", which could make
the cost of re-drilling some lost wells questionable
if they are already well into their decline curve.
A theme we have touched on before, the lack of upkeep
for the resource sector, is being forced to surface
by Katrina's shove. Some larger production platforms
have been damaged, particularly the Shell Mars operation
that pumps 250,000 barrels of oil and 365 mmcf of
natural gas a day. It's likely that the longest shut-ins
will occur in the offshore natural gas fields since
the myriad lines running together under the Gulf of
Mexico have to be checked for damage.
US gasoline prices were reaching the
inflation adjusted pricing of the '70s oil
shock, due mainly to lack of refinery capacity. There
have been significant price declines over the past
week as markets rationalised the situation and strategic
reserves came into the picture. However, it is unlikely
crude will now drop below the $60 level. If, and it's
a big if, pre-Katrina demand is sustained it is likely
crude prices would rise again next month.
Gasoline prices that are felt immediately
by consumers filling the SUV's tank may be slower
to come off. Europe and Canada are moving what they
can into the US market and the end of the summer driving
season will help but until refineries are back on
line pump prices will remain high, in US terms. As
we've noted in the past, even current US prices would
be considered a bargain in most of the world.
The biggest problem is certain to be
natural gas. As noted above, a major platform was
lost and it will take weeks to check all the undersea
pipelines before they can be brought back to full
capacity. Gas prices were moving to multi-year highs
even before Katrina struck and are now sitting at
close to $12 per mcf, roughly twice last year's level.
September-November is the shoulder season
for natural gas, when the air conditioners are being
turned down but its not cold enough to turn on the
furnace. In-ground gas inventories have been high
the last couple of years and this will give the market
some wiggle room but a sustained shut in of any size
will keep natural gas prices at their lofty heights.
This is where we think the real potential
drag on the economy lies. Because it was plentiful
and cheap for 20 years natural gas became the fuel
of choice for both homeowners and factories. There
is no simple way to switch fuels even if that was
cost effective which is by no means certain. Natural
gas consumption in 2001 in the US was 81mcf per capita.
That means that an average family of four could be
paying about $1000 more for natural gas through the
winter months. In northern areas where winter usage
is concentrated the increased expense to natural gas
users could be considerable. At current prices winter
heating bills could add several hundred dollars a
month to household expenses. In an economy that reported
a savings rate of zero in July only the truly naive
believe this won't result in some reallocation of
income away from consumer spending in other areas.
Our assumption for the better part of
a year has been that oil price gains would impact
demand. In fact Detroit automakers are indicating
demand for gas guzzlers is starting to wane. That
seems likely to become a trend. And concern about
a broader decline of US consumer demand has been around
for a while. Katrina only heightens that concern.
Disaster
Markets
It has become a basic axiom that highly destructive
events like Katrina initially knock an economy down
as it deals with life's necessities, but that is followed
by a rebound based on rebuilding. Recent hurricanes
in Florida have followed this pattern. So too did
most of the globe after World War II, and many natural
disasters in between.
This has been an evolution from the
European winners extracting wergild from Germany after
World War I, only to spawn fascism from the rot they
caused. North America's infrastructure survived World
War II and the west wanted to strengthen former enemies
against communist encroachment.
The psychological benefit of helping
others has been as important as the economic benefit
in the creation of post war disaster markets. Without
that psychic benefit driving rich donors, poor areas
would find it difficult to fund rebuilding. The case
in point, and perhaps the lesson, is the Indian Ocean
tsunami of last Boxing Day. It generated a huge and
immediate response, both of field units for triage
and immediate care and funding.
It should be pointed out that in contrast
to Katrina, the Boxing Day tsunami was a complete
surprise that happened during the planet's least active
week and when many are in a giving mood. But then
it was obviously an event without precedent for scale
or scope. And some regions were as obviously poor.
In short, it was about the best day of the year to
seek aid for a major disaster.
By all accounts Thailand's resort beachfront
is well on the mend. Private capital to repair it
already existed in insurance policies, or could be
borrowed against a history of earnings potential.
In northern Sumatra, most heavily decimated by the
wave, a civil war has ended but rebuilding barley
begun. Elsewhere bureaucratic inertia slows rebuilding
efforts.
The Thai rebuilding is the sort of disaster
market that analysts expect for the Gulf Coast. If
it goes as expected, the next several months will
be bad stats months, followed by an up-tick as rebuilding
gets underway. That has been the pattern in Florida
for several recent hurricane years. But then, Florida
is one of the fastest growing areas in the US at any
rate.
The difference along the Gulf Coast
is Katrina's much larger scale than past hurricanes,
and that it hit areas that have been, at best, slow
growth regions. People being moved to temporary shelter
in Houston are finding the city welcoming. If they
have little or nothing materially to go back to at
least some will stay put. It will be weeks if not
months before we know how many tens of thousands of
dwellings will have to be destroyed in New Orleans.
One thing we already know however is that the worst
damage has occurred in areas where most if not all
the residents are uninsured and unable to fund rebuilding
themselves.
It will tough getting people to move
back to below sea level housing, once it is rebuilt
unless someone else is paying for the rebuilding.
In this case, that "someone else" will be
state and federal relief organizations.
Estimates of damage vary wildly but $100 billion seems
like a realistic number. Those expecting a big boost
later in a disaster market are thinking in terms of
these expenditures. But, if much of this comes out
of government coffers the spending period will be
much more attenuated than it would be if it was private
insurance payouts.
This means that the "short term"
effects (large scale employment losses, higher energy
costs) could all but wipe out the rebuilding premium
that comes later.
The one silver lining in this horrible
situation is that it suddenly has many thinking we've
seen the end of interest rate increases for a while.
We talked before about all the reasons the Fed wants
to keep raising rates. Those haven't changed but the
danger of overshooting with rate increases has vastly
increased in the wake of this tragedy. We're not going
to second guess the Fed (this time) but the market
clearly already has, to the benefit of resource investors.
The Dollar was losing steam before the
hurricane hit and it's seen some of its biggest losses
in the storm's wake. This is unsurprising since a
lot of the Dollar's recent strength was about rate
differentials, not optimism about the US economy.
With estimates of 0.5-1% reductions in GDP for the
next 2-3 quarters the reasons to be bullish on the
greenback became a much tougher sell. These losses
have fed directly into $US price gains for virtually
all commodities, helping to make a fall market we
thought would be strong even stronger. The one fly
in the ointments is that a weakened economy could
stall demand for some items, like base metals, though
they too will be in demand for rebuilding once it
starts to occur.
We are not jumping to any conclusions about whether
New Orleans will come back. Rather, we are pointing
out that there is no certainty that it will come back
as it was. And, if there is evidence of permanent
migration to parts of the US, then some lost asset
values in New Orleans will stay lost. In an economy
being driven by consumer debt against property values,
that is a concern. A pause in rate increases will
help mitigate the effects but there is already anecdotal
evidence that the housing market is starting to top.
These effects all point to the likelihood
of continued strength in the gold market. Other metals
need to be watched to see if a slowing US economy
cuts demand enough to weaken prices. A secondary "benefit"
of spiking gas and natural gas prices is that they
will feed directly into inflation numbers on the next
few months. Although Wall St likes to ignore energy
and food costs when looking at inflation numbers the
price increase are large enough to start pushing even
the "core" rates. Here too, these increases
will be pushing against demand reductions from a Katrina
slowdown but it's very possible that the "inflation
card" will again be played in the gold market.
This will simply add to demand generated by those
buying it as the "anti-Dollar". The effects
on both government finances and private spending will
be large enough that you should be very cautious about
the major markets for a couple of months at least.
Wall St. is factoring in disaster gains already, before
it even starts accounting for disaster costs.
Eric & David Coffin
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