The post-Katrina rise in energy prices is expected to affect US consumer spending nationwide in the fourth quarter. Consumers may absorb part of the higher costs by further reductions in savings but GDP growth is likely to fall to 2.5%, well below the 3.5% recorded in the first half. Nevertheless the strong performance of the earlier part of the year means that US growth for 2005 as a whole will be about 3.5%. The impact of the higher energy prices on other G7 economies will be much less marked as household savings are higher than in the USA. G7 growth is expected to be below 2% in the final quarter. This would be the lowest growth rate since the recovery started in early 2003. However, the US economy should accelerate in the first quarter of next year as a result of reconstruction efforts, and forecasts for Europe and Japan indicate moderate growth for the first quarter — indeed for the G7 as a whole this period is expected to see growth very close to the long-term
average of 2.5%. GDP growth in the Developing Countries should remain stable at about 5%, which should keep world growth close to 4% for the first quarter of 2006 compared to 4.1% in the same quarter this year.
Recent US data indicates that gasoline demand declined by 2.6% in the last four-week period ending 30 September, compared to the same period last year. This has raised the perception in the market that higher product prices may lead to ‘demand destruction’ and will significantly cut into consumption over the next few months. However, so far, there is insufficient evidence to support the perception that this rate of decline will continue. Indeed, a number of factors appear to indicate that the recent downturn is not likely to persist at such a strong pace. First, as has been shown, the outlook for the world economy has not changed noticeably. In fact, if there has been any adjustment, it has been upward, as Japan is expected to show an improved performance at the end of 2005. Second, demand is inelastic to price hikes in the short term. Finally, oil consumption for
industrial uses and heating purposes is not usually strongly affected by high prices, particularly if the market faces a colder than normal winter.
Despite the recent slowdown in demand, the product markets continue to provide the greatest challenge for the industry. The US energy complex is facing an unprecedented situation as a result of the Hurricanes Katrina and Rita. The combined effects of these two destructive hurricanes caused over 1.6 mb/d of the US refining capacity to remain offline, a major part of which may remain out of operation for an extended period as reflected in the very low refinery utilization rates, currently standing at 75%. This situation is likely to result in a shortfall of domestic product output of about 150 mb in the USA by the end of the year.
Following Hurricane Katrina, the bullish sentiment of the market calmed somewhat. This was a result of the immediate reaction of the oil industry to boost output at non-affected refineries, raise imports as well as the release of emergency crude and product reserves by the IEA and the offer of an additional 2 mb/d of crude production by OPEC. These moves, along with the decline in demand, helped to effectively cap the upward price trend, allowing crude and product prices to lose part of their post-Katrina gain over the last weeks. The results of these measures have also been reflected in gasoline stocks, which still stand slightly higher than early September levels, currently at 192.8 mb. These developments have led some to predict a sharp and persistent drop in demand.
As the combined effects of Hurricanes Katrina and Rita begin to show over the next few weeks, the current surplus in distillate stocks may disappear while gasoline inventories are likely to tighten even further. In the week ending 7 October, US refinery runs dropped to 75% while gasoline and distillate output plunged by 890,000 b/d and 700,000 b/d, respectively compared to the middle of September. At the same time, imports rose 493,000 b/d for gasoline and 84,000 b/d for distillates. It is very difficult to say whether the shortfall in petroleum products of about 150 mb could be compensated by additional imports, as there is lack of effective refining.
Apart from the refinery shut-downs and a shortfall in petroleum products, the US market is also suffering from lower natural gas production, as around 55% of gas production remains shut in the Gulf of Mexico. Natural gas stocks are set to fall further in the coming weeks, as there is little possibility of arbitrage cargoes from other markets. This may trigger fuel switching, which would further increase demand for heating oil. The current situation of the oil and gas industry in the US Gulf Coast could potentially face further risks in the next few weeks, given that the hurricane season typically lasts until early November.
In contrast, the crude market appears relatively bearish as there is ample supply of crude, inventories are at comfortable levels and the outage of 14% of US refining capacity should reduce demand requirements. However, with the tight supply and demand balance on the product side, the market is likely to continue to be led by products. As the market remains sensitive to refinery outages, any further unplanned shutdown or unexpected improvement in demand throughout the winter could allow speculative activity to push prices above the level justified by crude market fundamentals. In light of the current circumstances, OPEC has offered as much as 2 mb/d of spare capacity to the market, if needed, to moderate prices. This, along with continuing evidence of adequate supply, the expected 0.9 mb/d growth in OPEC capacity (end 2005 to end 2006) as well as a 1.6 mb/d rise in non-OPEC supply (including OPEC NGLs), should help to ease the current volatility and bring
prices closer to levels supportive of healthy growth in the world economy.
