Last Friday traders left for the weekend confident in dumping their oil positions ahead of a hurricane that was going to miss the Gulf oil fields. That was the last moment of calm they have seen in a week. Record oil prices, record gasoline prices, massive damages not only to the New Orleans area but to the oil production facilities in the Gulf. An entire city nearly wiped out and rebuilding efforts still weeks to months away. The potential for that rebuilding effort to eventually provide an economic lift managed to give the markets lift as well. At least that is the conventional wisdom. In reality the only thing giving lift to the markets were very large gains in the energy sector.
Dow Chart - Daily
Nasdaq Chart - Daily
The hurricane damage and the 24/7 coverage of this damage pushed major economic reports to the back burner with some of them completely ignored. For instance we got the ISM on Thursday and it showed a very sharp drop to 53.6 from 56.5 and well below consensus estimates of a rise to 58. New Orders and Production fell sharply while the prices paid component spiked sharply by +14 points. This spike shows the impact of higher energy prices filtering through the system. Inventories fell to the lowest reading since April 2004. Any headline number of more than 50 still represents economic expansion but very weak expansion at 53. The August drop wiped out two months of gains and puts us back very close to a recessionary level.
The Jobs Report for August also came in at +169,000 jobs but much lower than July's +242,000 and estimates of +195,000. This is likely to be a sharp contrast to the September report where the impact of Katrina should produce a sharp drop in gains and probably a net loss for the next few months. There will be some jobs gained by the rebuilding effort but there are far more who will lose their jobs until companies reopen for business months from now.
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The various talking heads on TV continue to talk about the boost to GDP from disaster recovery. I have no problem with that concept, especially given the magnitude of the destruction. However, I do not believe that positive GDP bounce will be seen until Q1-2006. In fact despite the initial boost from initial rebuilding efforts there will be a massive sucking sound from the region for the rest of 2005. Tourism is a $5 billion business and it has come to a dead stop. Hotels are expecting to be closed or full of relief workers until spring of 2005. Those relief workers are not going to be spending like tourists. All the major waterfront casinos were wiped out. High-rise hotels suffered substantial damage. Airlines are no longer offering routes to New Orleans. Refunds for previously purchased travel and lodging bookings are going to be huge. New Orleans is the 7th largest convention city and all conventions for the rest of 2005 have been cancelled. 100 major events with tens of thousands of attendees have been cancelled. Football games both college and professional will be rescheduled to other areas. Each game is a major contributor to the local economy, especially the Sugar Bowl. Mardi Gras is Feb-28th in 2006 and many attendees book a year in advance. It is a major cash cow for the city and they will be racing to have a semblance of normal in advance of that event. This means the uptick to GDP will surge in the Dec/Jan time frame. Experts think it will take 60-90 days just to get the power, water and sewage systems running again and very little actual rebuilding will be done in that period. The Corp of Engineers estimated late Friday that just draining New Orleans will take over 80 days due to the volume of water that must be pumped. Only demolition and cleanup is likely to occur for the next 60 days. Will GDP see a boost from the rebuilding? Sure but probably not until Q1 or Q2 of 2006. The rebuilding efforts will be offset by the thousands of businesses shutdown for months to come.
While the damage to the New Orleans/Biloxi area is enormous and producing pain for local residents the damage to the energy sector is producing pain at the pump for everyone else. The energy sector saw 14 refineries either shutdown or production sharply curtailed. Latest count shows more than 58 drilling rigs and production platforms were not just damaged but completely destroyed. More than 70% of natural gas production is still shut in and around 80% of oil production. The Minerals Management Service (MMS) said 2% of the annual supply of gas for the next 12 months has been lost either from damaged or destroyed rigs or pipeline breakages. Most of the pipelines in the Gulf have yet to be tested but in New Orleans and Biloxi there are pipelines venting massive amounts of gas. MMS said probably 10% of the gas supplies needed for the Q4 demand have been lost.
Good news was breaking out all over on Friday with the Colonial pipeline, which serves the North East from the New Orleans area, back in operation but only at 66% of normal volume. They hope to achieve 80% sometime next week. The Plantation pipeline, which supplies products to the Southeast, is back at 95%. The Louisiana Offshore Oil Port was restarted on Friday on a limited basis. Now all they need is product to ship. Of the 14 refineries damaged by the storm all but five have either been restarted or are close to being restarted. All they need then is crude and that is going to be coming from various sources. Refineries still down include Valero's St Charles at 260,000 bbls per day is scheduled to restart on Sept 12th. Murphy Oil's Meraux refinery at 120,000 bbls per day could still be down another two weeks due to flood damage and power issues. Exxon's Chalmette plant at 183,000 bbl remains shut and no estimate of a restart date. Conoco's Alliance plant at 255,000 bbls remains shut with no estimate of a restart date. Chevron's Pascagoula plant at 325,000 bbls remains shut and under water with no damage estimate or restart date. Six refineries not in the area with a capacity of 1.5 mbpd are running at 60% to 85% of capacity due to a shortage of crude. Just getting refineries restarted does not solve the problem because of the lack of crude to feed them. There is also a problem with employees. There are over 10,000 employees needed to power all these refineries and many of those employees are no longer in the area. Their houses were destroyed and transportation crippled. Families are moving to live with relatives well out of the New Orleans area and in many cases out of the state. There will be an extreme shortage of experienced workers over the next 30-60 days and the refineries may not return to 100% capacity even if crude supplies return to normal.
However, experts expect unemployment in the area to soar to 25% or higher as the working poor are left out of the recovery process. Workers in retail, food service and those businesses severely damaged by the storm will be out of work until the infrastructure is restored and rebuilding is completed. 28% of workers in New Orleans earn below poverty level wages. These will be the hardest hit and the last back to work. Not only will they be unemployed but homeless. There are talks of major tent cities being erected but concerns of violence and riots are casting a pall over the idea. Most of the flood damage is not covered by insurance and this compounds the potential rebuilding problems. It could literally be years before this problem is erased. Many buildings will be condemned and destroyed to prevent illness from multiple factors present in flooded structures.
Over 58 rigs/platforms were completely destroyed. The loss of production has not yet been tallied but it will be significant. Some rigs not destroyed still sustained severe damage and it will be months before that production is recovered, possibly up to a year in several cases. Apache lost eight platforms accounting for more than 7,000 bbls and 12.1 mcf of gas. Diamond Offshore found their Ocean Warwick rig 60 miles from its site. The Ocean Voyager rig also broke loose and has to be returned to the shipyard for damage assessment once the shipyards reopen. Newfield lost a production platform making 1500 bpd. Shell said there was significant damage to their giant Mars platform and to a key pipeline hub. Marathon said there was significant damage to three platforms at South Pass. El Paso lost one rig out of 61 inspected but the fate of 16 more is still unknown. HP said they sustained serious damage to one of its 8 active rigs. Enbridge said there was serious damage to the 800 million cubic foot Mississippi Canyon Corridor pipeline. These are just a few of the types of problems being reported. The eastern platforms are the ones most likely to have sustained serious damage and a shortage of fuel, boats and aircraft has prevented them from being surveyed as of Friday afternoon.
There are reports of several oil spills, one major, and this points out the potential for damage to the undersea pipeline network. Once rigs break lose they tend to tow their undersea anchors behind them and can wreak havoc with the underwater infrastructure between rigs and the shore. There is over 10,000 miles of pipelines connecting rigs, platforms and the shore. Once a rig breaks loose it becomes a sailboat pushed by 150 mph winds and 50 ft waves dragging thousand pound anchors behind it. The Ocean Warwick rig was found 60 miles from where it broke free to illustrate this point. With 58 rigs/platforms lost there is no telling how many blew for miles before finally sinking. Bottom line there are known pipeline problems already as evidenced by various oil spills making their way to the surface. There are doubtlessly others that have not yet been found. Until the pipelines are pressure tested and the breaks fixed there will be a production shortfall that could last for months. Ivan caused a loss of 44 million bbls and months of repairs and it was much farther away and much weaker. The Gulf energy story is far from over.
With gasoline prices over $3 and shortages in 12 states the relief efforts were being announced almost hourly on Friday. The administration said they would release 30 million bbls from the Strategic Petroleum Reserve. This would relieve some of the shortages of crude at the refiner level. Secondly, the International Energy Association, announced that its 26 member nations would release 2 mbpd for the next 30 days to offset the current shortages. This was the first release since 1991 when Saddam's foray into Kuwait cut global supply. A large portion of the IEA release will be in refined products that circumvent the need to go through our crippled refining system. European crude take 10-15 days to reach the U.S. but tankers are in short supply given the disruption in global traffic. The IEA was created after the 1973-74 oil crisis to protect consumers and member countries. The IEA requires that each member store at least 90 days of crude supply net of imports.
While it seemed on Friday that the crisis was over given the supplies of crude headed in our direction and facilities beginning to come back online this is a false assumption. Concentrating on the energy sector only there are numerous problems as I have alluded to above. These problems will continue to cause a reduction in output of both oil and gas well into 2006. The SPR supplies will taper off once a large portion of production has returned. It is not a long-term solution. The IEA supplies are crisis only and will probably not be continued past the announced 30-day period. They are intended to be a parachute only not long-term support. Before the hurricane everyone was worried about how we would make it through the Q4 demand season and prices were pressing $70 without a disaster. Now that nearly 30% of the U.S. domestic crude supply and 26% of natural gas is questionable the risk for Q4 is even greater. There is no way there will be enough production from the Gulf to offset a shortage in Q4. Oil prices may have receded from their record highs but the closing price of $67.57 is still above last Friday's close and still in a long-term uptrend. After a week of soaring prices this was simply profit taking ahead of an early close on the Nymex and a long holiday weekend.
Crude Oil Chart - Daily
Chart of Lumber Futures -
The markets finished up for the week but I would not get too excited about the gains. Were it not for energy stocks there would have been no gain at all. Energy stocks now account for 9.5% of the S&P and that energy component of the S&P rose +5.5% for the week even after Friday's profit taking. The gains by the major indexes pale in comparison to the S&P energy. Dow +.4%, Nasdaq +.9%, SPX +1.0%. Aside from speculation in companies that may benefit from the rebuilding boom and energy stocks there was no rally. A few drug companies rallied on the potential need for drugs. Home supply stores like HD and LOW rallied on the coming building supply boom. CAT rallied on the potential need for tractors and earth moving equipment. WY rallied on increased demand for lumber. Lumber futures rose +21%. Outside of these types of exceptions the market strength came from energy. On Friday with good news breaking out all over the markets fell because profits were being taken in energy stocks. Last fall I profiled 350 energy stocks in my Oil Crisis report but there are well over 500 publicly traded. With over 6500 publicly traded stocks nearly 10% are energy related. Just like chip stocks tend to lead the Nasdaq the energy stocks have taken the lead in the S&P. I heard several analysts saying "the energy problem was over now that the SPR and IEA supplies had been promised. If oil prices didn't hit $80 on this disaster then the energy bull had made its last run." I have four words for them, "don't hold your breath." Friday's profit taking may extend for several days but I would again consider it a buying opportunity. Once the oil and gas inventories are reported next Wednesday the move higher should begin again. With stockpiles severely depleted and already overburdened refinery capacity down a minimum of -5% it will be a race to rebuild that supply before Q4. A race that we are likely to lose. The wild card here is gas at $3.00 and the end of the driving season on Tuesday. $3 gas has been slowing demand but I do not expect it to continue. Gasoline to Americans is about as critical as air. You can hold your breath for a long time in certain situations but eventually you will breath again. Demand may be slow for a few days but we still have to go to work and take our kids to school, football and soccer.
We are also moving into the peak shipping season from September to December and diesel fuel demand will grow substantially to take up the refining slack after the summer driving season ends. Heating oil demand will increase as those hoping for cheaper prices ahead finally bite the bullet and pay the price to make sure they have it when needed. The Friday selling was just a pause and another dip to buy.
Stock news other than energy was very quiet with all eyes on the hurricane news and in expectations of the three-day weekend marking the end of summer. Bush met with Greenspan and got a financial update. At least that is the official news. Odds are good Bush pressed him to pass on raising rates over the next few meetings. The Fed funds futures still suggest a 100% chance of a 25-point hike at the September 20th meeting but after that the odds of another hike drop sharply. At this point one more hike is meaningless and with economic signals slowing before the disaster there is more than one reason to end the measured pace of hikes.
The markets rebounded early in the week on disaster stimulation hopes but stopped at resistance of 10500/2150/1225. The fade began on Thursday and continued into Friday's close. The bounce took us right back to ideal short entry territory at SPX 1225 and my outlook is still the same. Continue to remain short under SPX 1225 and buy energy on the dip.
SOX Chart - Daily
S&P Energy SPDR Chart - Daily
Oil Service Index Chart - Daily
Oil Service Holders (OIH) Chart- Daily
Next week has a lengthy list of economic reports but none are highly anticipated and the markets will probably continue to focus on Katrina rather than economic news and earnings. We are in that period on the calendar where big declines typically appear and once the Katrina news fades we could see the decline, which began in early August continue. As buyers we should continue to expect a bottom sometime in late September, early October and not get over anxious ahead of time. If you have been trying to trade the broader markets over the last several weeks you know how difficult it has been. The next four weeks is earnings warning season for Q3 and the number of warnings should far outweigh any positive surprises. This could color sentiment significantly and I urge everyone to be careful buying the dips.
Be patient, our buying opportunity is coming but still too far away to be worried about it. Short/put any material bounce for the next couple weeks and then we will start making plans for the rebound. Just remember to enter passively and exit aggressively and definitely don't get married to your positions.
The real hurricane season begins this weekend and runs through October. The weather service is still predicting another 8-10 hurricanes over the remainder of the season and Sept/Oct is the prime time for hurricanes. If you start to see another storm heading in our direction your can expect a lot more interest next time around. If the predictions work out as expected we could be setting up for something on the frequency of one every two weeks.
I ran across an interesting tidbit of information in the hurricane news. In New
Orleans on any given
night an average of 700,000 people logged into the Internet
on dial-up lines. After the hurricane that number dropped to less than 70,000.
In Biloxi the nightly average was 160,000. Since Katrina the number has fallen
below "reportable levels." How quickly lives can be changed.