EconSouth (Fourth Quarter 2008)

The year 2008 is likely to be long remembered as one of the most volatile periods ever for global energy markets. In the first half of the year, energy prices rose to unprecedented heights as supply-side constraints, paired with surging demand, strained market fundamentals. This trend quickly reversed, however, amid a global credit contraction and fears that slowing economic growth would dampen demand for energy products. Energy markets remained relatively bullish throughout the second half of the year, brushing off two hurricanes that pummeled the U.S. Gulf Coast, the hub of the nation's energy industry, in early September.

A fueling frenzy
Three Southeastern states—Louisiana, Mississippi, and Alabama—combined with federal offshore areas in the Gulf of Mexico, are home to more than a third of the country's oil production and nearly half of total U.S. refining capacity, according to the Energy Information Administration (EIA), an agency of the U.S. Department of Energy. The Southeast is also home to the Henry Hub, in Louisiana, the largest centralized point for natural gas trading in the country, as well as the Louisiana Offshore Oil Port, the only U.S. port that can accommodate the largest oil tankers. So when significant movements occur in national or global energy markets, Southeastern businesses and consumers especially feel the effect, as they did through the end of 2007 and into mid-2008 when energy prices rose persistently to new highs.

Energy costs peaked during the summer of 2008 as the price for a barrel of light sweet oil topped $145 per barrel. The average U.S. price for regular-grade gasoline in the nation surpassed $4.11 per gallon in July, a record high, even in real (inflation-adjusted) terms, and nearly 40 percent higher than prices during the summer of 2007. Other refined products such as diesel and residual fuel oil also climbed to record levels, and Henry Hub natural gas was selling at more than $13 per mmbtu (millions of British thermal units) amid expectations for strained global supply. Energy and energy-servicing companies were raking in record profits while consumers were feeling the pinch on their wallets.

High gasoline prices sparked a national debate over offshore drilling. On July 14, President Bush lifted the presidential moratorium on offshore oil and gas drilling that had been in place since 1990 in hopes that increased leasing in the Outer Continental Shelf would ease supply pressures and allow prices to moderate. For a short while, skyrocketing energy prices sparked an almost frenzied reaction as industry members considered higher-cost drilling options and talked of hastening investment plans, and consumers were struggling to find ways to conserve fuel.

But this situation reversed itself almost as soon as it began. In mid-July indications that global economic growth was beginning to slow triggered a rapid sell-off of futures contracts for oil and other commodities in international markets. This sell-off marked the beginning of several months in which prices eased significantly, dropping to levels well below half their peak trading level.

Some uncertainty continues to cloud the forecast for the oil and gas industry as many market participants are taking a wait-and-see approach, hoping for credit markets to stabilize and economic growth to pick back up. In the final months of 2008, several companies announced plans to cancel or postpone investment and expansion plans in the region as prices continued to be weak and financing became more difficult to obtain.

The two storms
Despite all the activity in energy markets in 2008, one of the most significant events of the year for Southeastern states was two consecutive hurricanes that pounded the Louisiana and Texas coasts and left much of the region's energy infrastructure temporarily offline.

On Sept. 1, the center of Hurricane Gustav made landfall along the Louisiana coast as a strong category 2 hurricane. Gustav caused extensive flooding and power outages along the Gulf Coast and widespread shutdown of the region's energy production and refining infrastructure. Less than two weeks later, on Sept. 13, Hurricane Ike struck the coast, wreaking further havoc.

The combined impact of the two hurricanes will prove to be the second-costliest on record, behind 2005's Hurricane Katrina, according to estimates published by Action Economics. The group calculates that total damage caused by Ike could amount to $27 billion, while Gustav will cost around $15 billion. Despite reports that the hurricanes caused little major long-term damage to the Gulf Coast's energy infrastructure, their impact on oil production and refining has been, by some accounts, just as devastating, if not more so, than that of Hurricanes Rita and Katrina in 2005.

The impact of Gustav and Ike on the Southeast's refineries had substantial short-term implications for the rest of the nation. The many refineries that shut down in advance of Hurricane Gustav remained closed until Ike passed 12 days later. Even without damage, shut-down refineries can take several weeks to restart operations, and electrical outages in storm-ravaged areas further delayed return to operations. The country's refinery utilization rate dropped to 66.7 percent, the lowest rate on record, pushing the amount of crude processed by U.S. refineries to record lows as well (see chart 1). Fuel distributors were forced to draw down the country's gasoline stocks to the lowest level in 41 years to maintain supplies at the pump (see chart 2).

About 5.2 million barrels of emergency exchange oil were released from the nation's Strategic Petroleum Reserve in the weeks following the two storms because some refineries were stranded without enough oil to process while pipelines in storm-damaged areas had not yet come back online. Despite efforts to bring as much supply to the market as possible, some areas of the Southeast, including Atlanta and Nashville, faced fuel shortages through early October.

Chart 1 Total U.S. Estimated Crude Oil Production Note: Data are through Oct. 10, 2008, and represent a four-week moving average. Source: Oil and Gas Journal

Chart 2 Gulf Coast Motor Gasoline Inventories Note: Data are through Oct. 17, 2008. Source: Oil and Gas Journal

The EIA estimates that about 14.5 million barrels of crude oil production (or about three days' worth of total U.S. output) were lost as a result of hurricane-related outages in 2008. But despite the significant disruption to energy supply caused by Gustav and Ike, the resulting price effect was relatively muted largely because the worsening financial situation that was surfacing around the globe curtailed demand.

Looking ahead to 2009
For most of the past two years, the outlook for energy markets has been uncertain. Early in 2008, some analysts forecast that oil would reach $200 per barrel. With prices trending around a quarter of that level 10 months later, forecasters disagree about where the markets will go next.

Falling oil prices indicate that market supply exceeds current demand by businesses and consumers. Thus, given the recent slowdown in the global economy, unless oil output is reduced considerably in the near term, prices are likely to remain low in the coming months. In the longer term, however, as global growth recovers, demand will resume its upward pressure on prices.

One question facing the industry right now is the extent to which exploration and production projects currently under way will be canceled or postponed as a result of the recent price decline and the financial turbulence affecting investments. Cancellations and delays become increasingly likely as prices fall below levels necessary to make the more capital-intensive projects profitable. A slowdown in new oil production projects could mean that future global production capacity will be reduced, resulting in additional price pressures when demand growth resumes down the road.