Katrina and Oil Prices

Katrina and Oil Prices

September 7, 2005 11:54 am (EST)

To help readers better understand the nuances of foreign policy, CFR staff writers and Consulting Editor Bernard Gwertzman conduct in-depth interviews with a wide range of international experts, as well as newsmakers.

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Hurricane Katrina caused severe damage to U.S.refinery and production capacity in the Gulf of Mexico. Oil prices briefly spiked to above $70 per barrel before dropping after President Bush decided to release 30 million gallons from the country’s Strategic Petroleum Reserve (SPR). With demand already high and supplies stretched—the world currently consumes 85 million barrels of oil a day, only 1 million short of total global pumping capacity—the crisis caused by Katrina couldn’t have come at a worse time. Richard Karp, spokesman for the American Petroleum Institute (API), talks about Katrina’s impact. He was interviewed by Esther Pan, cfr.org staff writer, on September 6, 2005.

What will be Katrina’s impact on worldwide oil output and prices?

First, obviously, Katrina had a major impact on the U.S. industry infrastructure. Both offshore Gulf of Mexico crude and natural-gas production have been hit very hard. The refining sector in the Gulf Coast, particularly in Louisiana, has had a major impact, and pipelines in the Louisiana offshore oil-port loop have all been impacted. We have seen pretty significant improvements over the last week, but there’s obviously a lot more to be done. People need to keep in mind that this is an unprecedented impact on our industry. Also, more importantly, it hits us very personally. There are tens of thousands of our employees who live in the area. In many cases, our companies are still trying to track down their own employees, which, of course, affects our ability to recover. Many people have lost properties or loved ones, and have other and bigger issues to deal with.

Between the refinery capacity and production capacity lost, what’s more significant?

Both are equally significant in different ways. A lot of analysts have argued that the impact right now is more on product supply. The two major product-distribution pipelines that run from the Gulf Coast out to the Southeastern states, the mid-Atlantic and the East Coast—the Colonial and Plantation pipelines—were both hit. Because of the loss of power, they couldn’t operate and were down for several days. This is where you got a lot of the stories of rumored shortages and dislocations in certain parts of the country. That’s probably been the most immediate impact consumers have noticed. Both of those pipelines are now back operating at 100 percent capacity, which will alleviate some of the impacts in those regions.

Why was there such an immediate price shock from Katrina? Was it speculation, or was the impact so direct that with those two pipelines down the prices really did go up to $6 or $5.50 per gallon?

Well, the price of gasoline futures on the NYNEX, [the New York Mercantile exchange, where oil, gas, and other commodities futures are traded] which is where retail prices flow from, shot up immediately in the wake of Katrina as expectations about how this would impact the market were felt. We’ve heard stories that prices are coming down a bit now.

Are the prices coming down because of the decision to tap the SPR, or does that action not affect prices so directly?

It’s hard to say until we see more concrete data about what gasoline prices are doing around the country. Crude prices are roughly back now to where they were before Katrina, around $66 per barrel. We’ll have to see how that filters through to gasoline prices. The SPR release did help some refiners start operating again who were having problems getting crude feed stocks.

How long does it take to restart a refinery? Months? A couple of weeks?

It depends on the particular circumstances. It’s important to remember it’s not like turning on a light switch. Even under the best of circumstances, there’s a very structured, direct way that you restart certain parts before others, kind of a chain reaction. It’s very hard to speculate. Some of the refiners affected still don’t even have power. In the best of cases, it would take a day or two to get a refinery restarted—assuming it had been shut down in a precise, operational manner.

What about damage to oil rigs in the Gulf of Mexico?

The most recent statistics we’ve seen from the Minerals Management Service, the federal agency that oversees oil and gas production in the offshore continental shelf, say the damage so far has not been nearly as extensive as some people feared. Of the roughly 4,000 production facilities in federal waters, thirty-seven platforms were destroyed. Those produce about one percent of total Gulf production. Four large platforms, accounting for about ten percent of offshore production, suffered extensive damage and could take three to six months to get back on line. So roughly forty-one platforms out of 4,000 is what we’re seeing so far.

So not terrible.

Not terrible, but do keep in mind that four of them were pretty large producers. But it’s perhaps not as bad as some people feared.

How serious was Katrina compared to other natural disasters that have affected the oil industry?

This was the most dramatic impact of any hurricane that I can remember.

Do you feel the government is doing as much as it can to bring things back online?

Federal, state, and local governments have played valuable roles. Federal government has played its part so far through a number of steps, including the release of oil through the SPR, waiving the Jones Act—the law that prevents non-U.S.-flagged tankers from delivering products between U.S. ports—and the EPA [Environmental Protection Agency] has waived certain environmental fuel standards. These are all the right steps. Clearly there are obstacles because of the devastation in the area, but our industry is doing everything it can. Everyone’s doing their part.

What about the impact of the SPR release? Could they do it again, or is it a short-term fix only?

The SPR has about 700 million barrels of inventory. They’re going to put 30 million barrels up for sale, and they’ve already agreed to certain swap arrangements with refiners for about 12.6 million barrels. Essentially, what they do is loan a certain amount of crude oil to a refiner who can’t get it anywhere else. At a later date, the refiner pays back that crude oil, plus a bit of interest in additional crude oil.

But that’s a small enough hit that it won’t affect the security of the SPR?

Yeah, the SPR still has well over 650 million barrels, and the swaps will be paid back with interest.

Has the SPR been tapped before? I remember it being a loaded political issue.

Swaps were made during Hurricane Ivan last year, when a smaller volume was swapped out. Also during Hurricane Lily, back in 2002. There are a number of previous cases where it was used to respond to immediate supply disruptions, including the first Gulf War in 1991.

With the oil market already quite stretched, global reserves already low, and demand already high, what will the impact be of this storm on top of all those other factors?

I think that’s exactly the right way to look at it. It’s important to remember this happened on top of a market that was stretched very thin already. Demand was very strong, and there was very limited surplus capacity in the world, meaning nobody could really produce much more oil during an emergency, if necessary. Those basic supply-and-demand conditions put us where we are now in terms of the prices we have. With Katrina layered on top of it, it’s going to stretch the market pretty thin.

Where does it go? If demand continues to rise and there’s no excess capacity, will prices just continue to go up?

Whenever you have a situation with a very tight supply-and-demand balance, you’re going to get a lot of supply volatility and upward pressure on prices.

Is there any precedent for what to expect from the oil markets?

This is kind of a unique situation because of the extent of Hurricane Katrina’s damage. But it’s important to remember that market forces work, and high prices tend to bring on more supply and dampen demand. It’s impossible to predict over what time period that cycle will occur, but there’s no reason to think the basic laws of supply and demand will be suspended.

But if there’s very little surplus, where would it come from? Are you talking about supply from new sources?

Both new sources and capacity increases from countries that tend to keep surplus capacity. A lot of the Persian Gulf producers have already indicated plans to increase their capacity. It just takes time.

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