Wednesday, August 31, 2005

Economics of Katrina (pt. 1) 

Very busy day with college and department meetings and signing up a couple of majors. I noticed $2.80 gas yesterday afternoon after it had hung in at $2.55 throughout most of Monday. I needed a quick lunch and ran down to the store for an energy bar and afternoon carrots (I'm trying that for the busy lunches) and saw my first $3 gas ($2.989 for regular, $3.089 for premium.) A blogger in Pelican Rapids took a picture of $3.10 gas, and someone reported on the St. Cloud Times gaswatch page that a station down near the highway is asking $3.199. Current price at the local bulk distributor is $3.28, says another Times article. Late afternoon the newspaper called and asked for "expert reaction". "Are we going to $4?" "Effect on retail sales?" "Recession?"

Oddly enough, I'd done a post-deadline edit on the upcoming QBR that I might want to edit again, because I thought we'd get to $3 but maybe over the weekend, not today. So I hedged myself somewhat talking with the paper, guessing we have perhaps another 10% up from here. And given the reaction of the financial markets (Asia's up this evening as I write, and for once I'm running past the 11pm hour with Bloomberg on my TV rather than Fox).

Speaking of Bloomberg, they have someone already speculating on $4 gas. But I do note that crude oil supplies are up over year-ago levels. Where we're tight is on refined gas (down 13 million barrels versus same level last year). And while that probably gets worse short term, one person in the Bloomberg article says the problem doesn't appear long-run.

"Once the refineries start making the product you have to transport it,'' said Mark Routt, a senior consultant at Energy Security Analysis, Inc. in Wakefield, Massachusetts. "The Northeast is less of an issue because we can get cargoes from Europe. Florida has a big problem because 60 to 70 percent of their gasoline is barged across the Gulf.''

Restoring power to the Gulf state refineries and pipelines is the biggest issue, said Chris Ovrebo, a broker with FC Stone LLC in Eden Prairie, Minnesota.

"Most of these refineries didn't sustain heavy damage,'' he said. "It's not going to take them six months to get back on line.''

One problem is that we're seeing some rationing of supplies from the refineries to independent distributors. Jim Feneis, who runs the local First Fuel Bank here in St. Cloud, points out that the large price swings this summer have made distributors gun-shy about holding inventories. This of course is going to exacerbate price swings in the short run.

James Hamilton points out that the EPA has removed the clean-air mandates for gas through September 15.

Those who have followed my discussion of these fuel standards will know that I see this as one bit of welcome news. In addition to allowing a greater quantity of usable gasoline to be produced, the EPA measure will create a more integrated national market in which it will be easier to get the fuel to those communities where it is most needed. I was worried that the interaction between the refinery outages and the patchwork of isolated retail markets would produce a logistical nightmare.
In addition, the government is using the Strategic Petroleum Reserve as we'd hope: to keep refiners with enough crude to stay operating. This should also ameliorate the price swings.

I'm still thinking $3.30 is the central tendency based on what I'm reading right now. $3.50 is possible but I just don't see $4 in the cards.

William Polley has a rundown of the recession talk. (He's also the source of the Park Rapids picture I linked at the top.) He says the talk is speculative and not well-formed opinion yet. I tend to think it's something you can model. I have one I use for training some of our masters students that I will have to play with. It has a linkage between interest rates and commodity prices. What caught my eye from Polley's post was this post from David Altig on softening of market sentiment for higher interest rates. I need to look more carefully at the oil price impact in the model, but I suspect markets (and Polley) are correct here. But with the 10-year bond hitting 4% today (4.03% right this second) you have to start thinking flattening yield curves. That used to be a predictor of recessions, but the relationship hasn't held as well over the last fifteen years or so.

The reason you'd cut interest rates (or more precisely, not raise them as fast) is because you expect retail sales to soften up. Retail stocks are getting beaten up this week, and that's because the pump prices are getting people to spend less in the stores. (And please, dear readers, beware the broken window.) So far, the news on consumer confidence has been good pre-Katrina. That might keep the hit to retail sales short-lived.

Note to my majors: Mark Thoma is trying to explain this in AD-AS analysis. Go read.