Eye of the Storm

Analysts are searching for any clue that could help predict the way the global economy is going to turn in the wake of Hurricane Katrina. Rhys Jones, Richard Agnew and Stuart Qualtrough examine the indicators.

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By  Rhys Jones, Richard Agnew and Stuart Qualtrough Published  September 11, 2005

|~|200-main.jpg|~|ON PATROL: Troops mobilised on New Orleans’ streets.|~|Analysts are searching for any clue that could help predict the way the global economy is going to turn in the wake of Hurricane Katrina. Rhys Jones, Richard Agnew and Stuart Qualtrough examine the indicators. THE CATASTROPHIC BREACH OF THE New Orleans levee system didn’t just send millions of gallons of floodwater pouring into the heart of the historic city, it sent shock waves reverberating across the globe. The destructive winds of the 12-hour hurricane onslaught may have died down but its fall-out is likely to be suffered for months and years to come. From a series of interviews with industry commentators and analysts, Arabian Business has built a picture of the likely outcome of the turbulent short-term future — as trade and commerce come to terms with the destruction of one of the country’s most strategically important areas. In the immediate aftermath of the tragedy, investor gloom was lifted as crude oil and gas prices edged downwards following the decision by industrialised nations around the world to release more than 60 million barrels of crude from strategic stockpiles after the hurricane. But the cheer was short-lived as top insurer Lloyd’s of London announced the repair bill was likely to top US$50 billion with other experts sharing the pessimistic outlook. Ironically, the estimated cost of rebuilding New Orleans and its environs is now said to be at least US$26 billion, to finish the levee projects would have cost US$208 million, of which the Bush Administration sent US$10 million. But political costs look likely to pale into insignificance when the full economic toll is taken into account. Economists at Goldman Sachs think Katrina might knock around one whole percentage point off US growth in the third and fourth quarters, especially if insured losses and rebuilding costs head towards the anticipated US$50 billion mark. “The hit to growth, expected to last through the year-end, will be larger than from other disasters for two reasons,” they said. “First the scope of the storm and the area affected is much bigger, forcing larger and longer cutbacks in output. Second, the nation’s energy output has been hurt and this is likely to force cutbacks in spending by the public.” Research suggests that every 10-cent rise in the price of petrol takes US$11.4 billion out of consumers’ pockets a year. Given that prices had already risen sharply before Katrina, and have jumped since, the hit to consumption could be large. The cost of a litre of unleaded petrol in the UK rocketed past GBP£1 last week, leading many forecourt operators struggling to fit the extra digit on their petrol station signs. Global Insight, a UK-based consultancy, has also become more concerned about the economic impact of the hurricane. It, too, expects third and fourth-quarter US growth to be down by some 0.5-1.0 points. Furthermore, it forecasts petrol pump prices to remain between US$3 and US$3.50 for weeks, if not months. Its chief economist, Nariman Behravesh, thinks the Fed will halt rises in US interest rates, which have taken them to 3.5% and were expected to take them to 4% or higher by the end of 2005. “[We] believe that, at most, the Fed will hike the federal funds rate another 25 basis points [0.25 percentage points] before the end of the year,” he says. The insurance sector is likely to be hit hardest with Lloyd’s of London insurer last week warning that the final cost to the industry was likely to top US$50 billion — making it by far the most expensive natural disaster it has ever faced. Brit said the situation in the southern US meant it was simply too dangerous for its loss adjusters to begin estimating the cost of the disaster but said the impact of the New Orleans flood would leave many buildings “virtual write-offs” for insurance purposes. So far, estimates of the cost of the tragedy to insurers have ranged from as low as US$15billion to US$40billion but Brit chief executive Dane Douetil said: “I think the cost to the industry will be substantially bigger. It would not surprise me if it got to US$50billion.” That would comfortably surpass the cost of Hurricane Andrew in 1992, which cost the industry US$21billion. Douetil said that in most flood situations buildings could be dried out relatively quickly and then repaired. “This time, though, it will be weeks or even months before the water is out and, remember, it is highly polluted. Then you have the cost of business interruption insurance and everything else,” he said. “It is too early to give an estimate of our losses because the public order situation there means it is too dangerous on the ground to get our loss adjusters in but we are confident we have enough capital even if the cost is at the absolute maximum.” Douetil said it was still unclear whether some buildings would be covered. Most policies in New Orleans exclude flood damage but include damage wrought by winds and it could be argued that the floods were caused by winds. The stories of human misery provided the TV broadcasters with stacks of drama and sights that defied belief. But for economists it has been extremely difficult to find the intelligence that might clarify how Katrina could impact across the country. Although oil prices have stabilised, it is the depressing effect of long-term higher gasoline prices that is causing most concern. Despite the agreement to release some of the international strategic reserves and Saudi Arabia’s promise to work towards stepping up production, America’s petrol hungry motors seem sure to dent household income for many months to come. Last week a few of New Orleans’ refineries were back in service, but the extent of the damage done to the majority remains unclear. Neither is it yet possible to say when production will be restored from the huge offshore oil and gasfields. It may be months, if not years, before the US will be able to resume collecting the pre-Katrina levels of 35% of its domestic oil production from the region. Meanwhile, there will be booming rates for the tanker trade and Americans will be footing the bill. Even the price of coffee is likely to soar as 250,000 tonnes of beans are imported into the US each year through the port of New Orleans. Last year it also handled the bulk of US corn and soybean exports. The hope is that some of the berths might be fit for limited use again this week although the possibilities bringing the port back into full commercial use must depend on the restoration of the entire region. Ports need workers and transport infrastructure if they are to be of any use. The coffee beans that were destined for New Orleans will get to the US via other ports. More road transport, however, will mean higher costs because of inflated fuel charges. Other businesses that fuelled the local economy will be gradually accommodated elsewhere in the country. Conventions, for instance, bring millions of visitors to the area every year. Now that the New Orleans convention centre has notoriously played host to displaced local people, conference organisers will be scrambling to relocate to places such as Las Vegas. The challenge of rebuilding the area so devastated by Katrina is daunting but now the authorities do seem to be grappling with it. Optimists have looked at the massive rebuilding efforts that will be required and conclude that it could provide a boost to the economy in a similar way the 9/11 attacks held off a likely recession. In economic terms, when we go beyond the lives lost, the damage in such disasters takes the form of the destruction of tens of billions of dollars worth of consumer goods, housing, commercial property or facilities and even personal property such as clothing and appliances. These represent huge losses in wealth for the property owners, whether individuals, companies or government. For many poor families, in which a residence and its contents constitute their only significant assets, the reduction in net worth may be total. This is more common in floods than tornadoes or earthquakes. Most home insurance does not cover flood damage but does compensate for wind and earthquake damage. Federal flood insurance protects some property, but such coverage is haphazard and limited at best. Households whose financial well-being is mostly tied up in a house often are the least likely to be covered. A large fraction of the affected region’s wealth was wiped out in a few minutes or days following the hurricane. Even with insurance payouts and government disaster assistance, years will pass before many affected families and businesses recover the financial position they had two weeks ago. The disaster will, however, spur demand for many goods and services. Households need to repair or replace damaged residences. They also must replace everything from clothing and housewares to furniture and appliances. Businesses must replace destroyed plants, equipment and inventories. State and local governments will need to repair damaged roads, bridges, pumping stations, buildings, parks and other facilities. All this spending is largely involuntary. Available cash constraints may force households to spread their spending over time. But it will spur local economic activity for an extended period. For consumers, the fallout means higher prices not only for gasoline, which has soared over the US$3 mark, but potentially for a variety of other goods as well, analysts said. “Consumers are likely to pay more for lumber, coffee, chocolate, perhaps sugar — anything that we import through the ports in the affected region will face higher prices,” said Mark Zandi, chief economist at Economy.com. More expensive fuel costs to transport all kinds of goods also are likely to show up in higher prices charged to consumers. “Almost every good that sits on store shelves might see an increase in price related to Katrina,” Zandi predicted. Most natural disasters, including other destructive storms such as hurricanes Andrew and Camille, do little to lower production of goods and services nationwide. Katrina may be an exception for at least two reasons. Firstly, a significant chunk of the nation’s petroleum and chemicals flow from or through the affected area. If storm damage reduces such flows to the point where businesses cannot get the supplies they need to operate, national output may drop. New Orleans is also an important transportation hub. It handles a significant portion of the nation’s international trade and is the interchange point for large volumes of commodities transported on inland waterways. Again, if storm damage is great enough to disrupt flows of goods to the point where factories must curtail production, gross domestic product may drop for some time. “The economic loss from the hurricane will total around US$175 billion,” said Paul Getman, chief executive officer of Economy.com. “Of that — US$100 billion — is damage to homes, businesses, roads, bridges, levees, telecommunications, water and sewer systems and other public infrastructure, he said. Another US$25 billion is the cost of disrupted economic activity. Larger energy bills faced by consumers and businesses make up the other US$50 billion,” he added. Risk Management Solutions of Newark, California, which specialises in estimating potential losses from natural disasters and terrorist attacks, estimates the economic loss from Katrina could exceed US$100 billion in terms of property and infrastructure damage and business interruptions, marketing director Shannon McKay said. ||**||

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