Billion Dollar Blowout

By Daren Fonda

Several days before Katrina struck, John Walker shut down production and evacuated crews from the oil and gas fields that his company operates in the Mississippi Delta. The CEO of EnerVest, a Houston energy-asset-management firm, was luckier than most. Katrina spared four of his fields, though the damage to a fifth was ugly. The storm blew a barge five miles down the bayou from its moorings in marshy Garden Island Bay. Nearly every piece of oil equipment was destroyed, and Walker estimates it will take several months to get that field running at full capacity. "When there's this much damage, there are only so many spare barges, compressors and generators out there," he says. "We're losing 1,000 barrels a day."

Katrina didn't just fling barges across bayous--it ripped a hole in the nation's economy. The storm crippled oil and gas production in the Gulf, idled refineries and chemical-processing plants and devastated New Orleans' $7 billion tourism industry. The city stands to lose more than $500 million a month in visitor dollars. J. Stephen Perry, head of the Convention and Visitors Board, says the empty and damaged hotels "are like Baghdad on a bad day." But for the national economy, what's more critical is that Katrina disrupted a vital node in the country's transport network. You name the commodity--coffee, fertilizer, lumber, steel, wheat--it ships through the Gulf's ports, rails and riverways. All told, Katrina knocked out a region that contributes $130 billion to GDP, roughly 1% of the national total, according to Economy.com Risk Management Solutions, a leading risk-assessment firm based in Newark, Calif., estimates that damages will run up to $100 billion. Insurance companies are on the hook for some $25 billion. Our guide to the fallout:

How high will energy prices go?

America's energy infrastructure was running at full capacity before Katrina hit, and the fact that so much of that capacity is concentrated in Hurricane Alley means more pain at the pump--especially if another big storm hits or events in the Middle East disrupt supply. Katrina sidelined nine refineries that account for about 12% of U.S. capacity. By the end of last week, the storm had prevented production of 547 million bbl. of crude, a 25-day supply. Offshore oil production in the Gulf accounts for nearly 10% of U.S. daily consumption. Worse yet, natural-gas production also shut down, costing us about 8.3 billion cu. ft. a day, which is 13% of what we consume, according to the U.S. Minerals Management Service.

Although the U.S. Energy Department says Katrina didn't damage production as badly as Ivan did a year ago, one energy executive, trading private e-mail, fretted that "the oil industry might be impacted for a year by Katrina." Several days after the storm, the price of gasoline moved above $3 per gal. in cities from New York to Los Angeles, and the government reported receiving more than 5,000 calls to its price-gouging hotline.

But that doesn't mean we're running out of gas and oil. The U.S. consumes about 21.5 million bbl. of crude a day, and with inventories of 321.4 million bbl., stockpiles are above average for this time of year, according to the Energy Department. The major Gulf Coast pipelines were up and running by the end of last week, albeit at reduced capacity. The Louisiana Offshore Oil Port, the nation's only deep-water tanker port, unloaded its first cargo since Aug. 27. Still, some analysts predict that disruptions in the supply chain mean motorists will be in for several more months of $3 gas or worse. "The only thing we can hope for is an amazing amount of conservation," says Houston oil analyst Matt Simmons.

Optimists say the situation could stabilize relatively quickly. There have been no reports of major damage to Gulf refineries. The problem is there isn't enough electricity to power them. Demand for gasoline typically tapers off after Labor Day. And thanks to a presidential directive, the crude is flowing; 30 million bbl. from the Strategic Petroleum Reserve is being loaned to companies like Exxon. In addition, foreign producers in 25 countries have pledged another 30 million bbl. of crude and refined product. The EPA is allowing sales of less stringently refined fuel, and President Bush is permitting foreign vessels to ferry oil and gas between U.S. ports (suspending a law prohibiting such transport).

Cars, coffee, cement--what's happening to industry?

Katrina dealt another knockdown punch to Detroit. Ford and General Motors rely heavily on full-size SUVs for profits, and sales of those vehicles were softening even before the latest surge in gas prices. "We have some dealers we haven't been able to contact," says Ford spokesman George Pipas, who estimates that 40 Ford and Lincoln-Mercury dealerships in southern Alabama, Mississippi and Louisiana were affected by the storm. Katrina forced Nissan to close its assembly plant in Canton, Miss., 211 miles north of New Orleans. When the plant reopened, employees reported they were having a hard time finding enough gas to make the commute, says Nissan spokesman Fred Standish. The only nugget of good news: Katrina doesn't appear to have disrupted supplies of critical material like steel.

The airlines are in a precarious spot. They may have to pass on the cost of jet fuel--up more than 20%--to ticket holders, which could depress air travel. Northwest, for one, warned that higher fuel prices could tip it into bankruptcy.

Homebuilders are eager to start reconstruction--some 200,000 homes in New Orleans alone need to be rebuilt--but supplies may be tight as the city is an import hub for cement and other building materials. Plywood will probably cost more for a while; after Hurricane Andrew, the price shot from $222 per 1,000 sq. ft. to $321.

Consumers can expect to pay more for basics such as coffee, bananas and paint (made at idled chemical-processing plants in the Gulf). New Orleans is the second largest coffee port in the country, after New York, and stores 27% of the nation's beans. "Right now those supplies are off the table," says Joe De Rupo of the National Coffee Association. Imports are being rerouted to Houston, Miami and Jacksonville, but no one knows whether the 211 million lbs. sitting in bags in New Orleans is salvageable or whether the roasting equipment, possibly submerged in contaminated water, can be saved. That's troublesome for small roasters and for giants like Procter & Gamble, which closed its Folgers plant in New Orleans just before the hurricane. Bananas destined for Gulfport, Miss., are being diverted to other ports, with Chiquita sending boats to Freeport, Texas, and Port Everglades, Fla. "If volume is affected, our customers will have to raise prices," says Chiquita spokesman Michael Mitchell. At least hot-sauce fans can rest assured: Avery Island, La.--based McIlhenny, maker of Tabasco sauce, claims production is running smoothly and all its employees are safe.

How will this affect the price of cornflakes?

Katrina hit just as the farm belt was gearing up for the fall harvest, and exporters may be forced to find ways around the blocked shipping channels in the lower Mississippi--a critical conduit for agricultural products. The U.S. exports about $600 billion in cargo through ports that were hit by the hurricane, and some 2,000-ton barges are literally stuck in the mud, says Larry Daily, president of Alter Barge Lines. "It's like you've clogged the pipeline for a week." Archer Daniels Midland, a major grain exporter, operates four grain terminals in Louisiana. Several hundred of its barges are stranded in the lower Mississippi, some grounded and waiting to off-load. The firm is studying rail alternatives and considering diverting some shipments to Galveston, Texas.

But shipping grain by rail or truck isn't feasible on a large scale; it's too costly, and freight lines are already booked solid. It would take as many as 60 trucks to transport the 55,000 bu. of corn that would fit on a barge, says David Feider, a spokesman for the grain exporter Cargill. "We're not diverting cargo," he says. The prospect of corn being dumped on the domestic market has already depressed spot prices. But don't expect a break in the price of cornflakes. The corn in a 1-lb. box costs cereal makers just 3-c-, a tiny part of the total cost, according to Robert Wiser, an agricultural economist at Iowa State University. Higher energy costs more than offset any cuts in the price of corn.

Will insurance rates go up?

Not necessarily. Last year the global insurance industry paid out a record $49 billion in claims, including $23 billion for U.S. hurricane damage, according to the reinsurance firm Swiss Re. There is plenty of money sloshing around the global- insurance pool to handle Katrina claims, and the Federal Government will pick up the tab for flood damage. One concern for consumers is that many insurers, facing hurricane-related claims, may pull out of the state, setting off a homeowner scramble for new policies. Only a month after state regulators approved a 21% rate hike, Nationwide Insurance announced that it wouldn't renew policies for more than 35,000 homeowners in Florida.

Whether rates will ultimately rise is a matter of debate. Premiums are set according to a state's loss-data history, not a single event. Insurance firms developed more sophisticated modeling techniques after Hurricane Andrew. Now they are able to predict with greater accuracy the frequency and potential damage of storms like Katrina and spread their risk across the country accordingly. While residents in hurricane-prone areas can expect rate hikes, "people in Alaska won't be paying for this," says Robert Hartwig, chief economist with the Insurance Information Institute.

Kevin McCarty, Florida's insurance commissioner, disagrees. He believes that homeowners across the board will pay more because of the storm. "The insurance companies are out there saying Katrina won't affect rates in their states, but that doesn't make sense," he says. "Demand for reinsurance is going to rise, supply is down, and that cost will be passed on to consumers." All this is academic, though, for the thousands of poor homeowners who did not have federal flood insurance and may have to rely on low-interest loans in order to rebuild.

Can the economy take the hit?

For the most part, yes. In the near term, economists say, Katrina may shave half a point off GDP growth over the next couple of quarters, largely because everyone from homeowners to truckers to airlines will be paying more for energy. But the U.S. economy can withstand some big blows. The nation was emerging from recession on 9/11, and that event did not ruin the recovery (thanks to billions in tax breaks). A slowdown may give the Fed reason to suspend its interest-rate hikes, a prospect that has already sparked a bond-market rally. While Katrina's impact on the Gulf economy is devastating in the near term, an infusion of federal disaster-relief dollars should stimulate industries from homebuilding to appliances and help lift the economy in 2006.

And never underestimate the indefatigable American profit motive. One Houston contractor, Bert Screen, hopes to make his fortune rebuilding New Orleans. He was packing up his Ford pickup last week, rounding up a crew and planning to head east. "In a twisted way, I'm looking forward to it," he says. "I've always felt New Orleans was my second home, so I will help rebuild it, and make a pile of money." The recovery has already begun. --With reporting by Lisa Takeuchi Cullen, Jyoti Thottam, Dody Tsiantar and Deirdre van Dyk/New York, Wendy Grossman/ Houston and Douglas Waller/Washington

With reporting by Lisa Takeuchi Cullen, Jyoti Thottam, Dody Tsiantar, Deirdre van Dyk/New York, Wendy Grossman/ Houston, DOUGLAS WALLER/WASHINGTON