With Hurricane Rita about to hit the Texas coast, oil refineries are already starting to close. Four refineries in Louisiana remain shut down in the wake of Hurricane Katrina. This double whammy has already taken about 14 percent of U.S. refining capacity offline.
Texas has 26 refineries, 18 near the Gulf. The combined crude oil distillation capacity of these 26 refineries adds up to 4 million barrels a day, roughly 23 percent of the U.S. total. We don’t know yet exactly where Hurricane Rita will hit, or how hard. But sometime this weekend, we could find ourselves with 20 percent or more of total U.S. oil refining capacity knocked offline. This would mean some 2 million fewer barrels of gasoline a day, 1 million fewer barrels of heating oil a day, and half-a-million fewer barrels of airline fuel a day coming out of the Gulf.
Oil prices have already spiked at over $68 a barrel. Depending on the damage done by Rita, we could see prices hit over $70 a barrel. It’s hard to remember that only a year ago crude oil was $45 a barrel. But Gasoline has to be refined before it reaches the gas pump. Gasoline prices topping $4 could easily result from this storm. Many consumers haven’t thought about it, but winter heating season is just around the corner. How long will the refineries stay off line?
We’re going to lose more than refineries, we’re also going to lose oil production in the Gulf. RigZone.com estimates that some 44 mobile offshore drilling rigs are in Rita’s current path. The construction cost of these rigs exceeded $1.1 billion. Also in the path of Rita are 534 unmanned platforms and 215 manned platforms, with crews of 3,876 workers. Crews are being evacuated and we’re sure to lose substantial oil production capacity.
The impact on the economy is equally dark. The Fed is obviously in no mood to repeat the mistakes of the 1970s, when not tightening rates allowed an oil crisis to expand into an inflationary spiral that took us another decade to control. With interest rates rising, we are already seeing increases in adjustable-rate mortgages, a trend which generally predicts increasing mortgage defaults and home foreclosures. There is hardly an industry in the economy that is not affected by increased energy and transportation costs. So, the Fed’s concerns are probably well placed – most likely we are in for a round of price increases across the board as industry after industry passes increased energy and transportation costs off to consumers.
We already have four major airlines in bankruptcy, how many more airlines are going to go into crisis if oil goes to $70 a barrel, or higher, and holds there?
In retrospect, the managers of Southwest Airlines look like geniuses. A year ago, Southwest used available cash to buy oil futures, effectively locking in their future costs of fuel. Right now, Southwest is flying on fuel purchased on futures contracts when oil was $26 a barrel. Even more prescient, Southwest is locked in at $32 a barrel for some 65 percent of the fuel needed to fly throughout 2006. As far out as 2009, Southwest has its fuel needs locked in at $35 a barrel. Those deals aren’t available anymore.
Maybe we should listen very carefully when billionaire entrepreneur Richard Branson tells us he has decided to build an oil refinery, adding Virgin Oil to his flagship Virgin Air. Branson’s thought was fairly direct: Why not hedge by entering the industry that is damaging airlines so much?
For normal mortals, taking advantage of increasing energy prices is hard to imagine. A coming recession, however, is starting to be uncomfortably easy to see coming.