The Impact of Hurricane Katrina on Distribution

by Jim Haughey, director of economics for Reed Business Information -- Industrial Distribution, 9/13/2005

The closure of highways, railways, shipping channels and ports, airports, warehouses, manufacturing plants, refineries and pipelines has created havoc for distributors who operate, source or sell in the New Orleans area. Now the havoc, on a smaller scale, is spreading across the country. 

Two weeks after the storm and flood, the disruption has eased substantially in the outlying Mobile, Baton Rouge and Jackson areas but not yet in New Orleans.  The few facilities now even partially usable have been commandeered for use in the federal relief effort and will not be available for commercial use for several months. While New Orleans is primarily a bulk commodities port, most distributors have already or soon will experience the loss of manufactured parts imported through New Orleans.

Beyond the Gulf Coast, the initial supply and distribution chain disruption will be largely handled by changes in supply sources, freight lanes and freight modes in an intense period of expediting similar to what distributors have experienced many times for different reasons. Then, an even bigger hurricane impact will begin to creep into your daily operations.  This is the impact of Katrina on the overall economy, which will be transmitted from New Orleans to you via higher energy prices, possible spot fuel availability problems, and a more cautious attitude about spending by both consumers and business managers.

The higher cost of energy is now draining as much as $100 billion (annual rate) out of purchasing power, just like a tax increase would do. A brief price spike would be absorbed by reducing savings. But it is not clear to most consumers how long gasoline prices will stay over $3.00.  This uncertainty makes people more cautious, which in turn cuts consumer spending. Business inventory and capital goods reductions follow with a short delay. 

Only a little added caution can turn the economic trend abruptly. If 20 percent of households cut spending 10 percent, aggregate spending falls 2 percent, excess inventories pile up, and layoffs and investment cancellations begin. Recall that we experienced exactly this scenario in the early 1970’s and early 1980’s with oil supply interruptions, and then again in the early 1990’s and in 2002 in the prelude to the Persian Gulf wars when oil supply disruptions were feared. 

On August 29th, the source of oil price increases shifted from demand to supply. It took two years for gasoline prices to rise from $1.50 to $2.50 in a period of unusually strong worldwide demand for oil. Consumers grumbled, shifted spending from goods to energy, but did not turn cautious. Instead, economic growth jumped to a well-above-average pace, and more than three million jobs were added. Consumers expected to be able to buy all of the fuel they needed and expected prices to ease with slower economic growth.

Now, the dominant cause of rising fuel prices is a supply shortage. Gasoline prices jumped nearly $0.70 in a week. Consumers are very rational about the impact of supply interruptions on prices.

The key to the overall impact on the economy is the price sign at your corner gas station.  If it is near $4.00 by the end of September ($4.50 in California), then expect the drop in economic growth to be as large as what we experienced in the early 1970’s and 1980’s.  And it will happen very fast. Given the current strong economy, it may not cause a recession.

If gasoline prices are still at the Labor Day weekend level by the end of the month—of about $3.15-$3.20—expect an economic slowdown approaching the “fear of supply interruption” slowdowns in the 1990’s and 2002 (approximately half as much slowdown as $4.00 gasoline would cause).

If gasoline prices drop to $3.00 or less and appear to be stable or headed down at the end of the month, expect only a major bump in the road to continued economic expansion.  This is the most likely outcome. GDP growth will slip 0.5 percent lower for the rest of 2005 and then bounce back to 0.5 percent higher in the first half of 2006. This is the only outcome consistent with the worldwide release of emergency oil and gasoline supplies— and much better than feared reports from New Orleans on the share of oilfields, pipelines and refineries that have resumed operations or expect to reopen shortly.

This means that distributors will see sales slightly below their plans for the rest of the year and will have to be cautious about accumulating excess inventory. Overall, lost fall sales will be regained in the winter and spring. The forecast assumes that there is at least a mini inventory cycle ahead in the next 10 months. Indeed, most of the drop and recovery in GDP growth will be due to errors in inventory management.

Katrina will also impact prices. There will be a general rise of about 0.2 percent to 0.3 percent in inflation, but this is not enough to seriously erode spending growth. However, there will be far large price changes for selected items. Other than fuel, plastics, cement and lumber will experience the largest price rises. Plastics prices will rise, although less so, with oil and natural gas feedstock prices. Cement and lumber, especially plywood and panels, will experience rising prices because there is not enough reserve capacity to absorb rebuilding demand. Metal prices should not be bumped up by Katrina; New Orleans is not a major port for the metals industry.