Oil and Gas Disruption From Hurricanes Katrina and Rita
Released: 2006-04-06T00:00:00

Overview

Hurricanes Katrina and Rita shut down oil and gas production from the Outer ContinentalShelf in the Gulf of Mexico, the source for 25% of U.S. crude oil production and 20% of natural gasoutput. Katrina, which made landfall on August 29, resulted in the shutdown of most crude oil andnatural gas production in the Gulf of Mexico, as well as a great deal of refining capacity in Louisianaand Alabama. Offshore oil and gas production was resuming when Hurricane Rita made landfall onSeptember 24, and an additional 4.8 million barrels per day (mbd) of refining capacity in Texas andnearby Louisiana was closed.

The most profound impacts of the hurricanes were on refined product supply, althoughnatural gas supply to the U.S. pipeline grid is also a concern. At one point, about one-third of thenation's refining capacity was closed. Virtually all have been restored, although output at a coupleof units is still in the process of ramping up. Heroic recovery efforts at refineries and increasedimports of refined products met a warm heating season's needs and kept gasoline supplies flowingwithout isolated run-outs.

About 400,000 bd of crude oil from the outer continental shelf (OCS) and Louisiana statelands is currently shut in. This is the equivalent of about 5% of total U.S. petroleum demand. Imported crude has kept stocks at more than adequate levels.

Refined product supplies were initially made up from the release of 30 million barrels ofgasoline, middle distillate and other products from the strategic reserves of member nations of theOrganization for Economic Cooperation and Development (OECD) who are International EnergyAgency (IEA) members. Since those barrels arrived in early fall 2005, the world market privatesector has provided the United States with an increased level of imports. Supply appears to havematched demand, as prices fell through late 2005 and early 2006.

A number of crosscurrents bear on this situation, including how fuel demand is affected byprices, and when winter weather arrives and how cold it might be. On the supply side of therelationship are factors which include the rate at which U.S. refining recovers, and the availabilityon world markets of commercial refined products. In addition, some waivers of gasolinespecifications have been granted by the Environmental Protection Agency (EPA), aimed at makinggasoline easier to supply.

With natural gas, about 85% of the nation's supply comes from domestic production; thereis very little opportunity to import replacement supply. As of October, nearly 10% of totalnationwide consumption was shut-in because of production problems in the Federal Offshore Gulfof Mexico, or because of damage to critical infrastructure. Another 3% of nationwide supply fromLouisiana state lands is shut-in. Despite reduced output, gas was still being placed in storage; theadditions during the week ending October 14 were 75 billion cubic feet (bcf). The amount of gasalready in storage was equivalent to the five-year average, although it was slightly below year-earlierlevels.

Gas sold from storage is used to balance seasonal demand swings, and not to replace acatastrophic loss of production. Given that the current amount of shut-in OCS and Louisiana statelands gas is the equivalent of half the most recent week's storage addition, the perception of a robustinjection to storage should be adjusted accordingly.

Despite the fact that supplies continue to flow, wellhead prices have doubled since lastsummer. Issues for the onset of cold weather include timing and severity, as with oil, as well as"demand destruction" resulting from higher prices. But if Gulf of Mexico production does notrecover, there is no import safety-valve, and supplies could become tight and prices could spike.

In the immediate wake of Katrina and Rita, much of the impacted area was without electricpower. But nearly all customers who had been without power in Texas have had service restored.In Louisiana, power outages are more widespread, although many customers listed as being withoutpower are unable to receive it because of damage to the premises.

Hurricane Effects on Crude Oil Production, Imports, and Transportation

Nearly 1.6 mbd of crude oil -- the equivalent of 7.6% of U.S. oil consumption -- wasproduced on the Gulf of Mexico Federal Offshore before the hurricanes struck. Production wasvirtually halted in the wake of both storms, as production facilities were evacuated and wells wereshut down. The storms destroyed 111 production platforms, and 52 were seriously damaged. Anumber of drilling rigs were destroyed, which will limit future production from new wells yet to becompleted.

Oil production has begun to resume. Output has begun to ramp-up, reaching 600,000 bd onOctober 11. But 60% of Gulf of Mexico oil remains shut in, and over 50 million barrels of oil outputhave been lost since Katrina-related shutdowns began on August 26. The amount of lost outputcontinues to mount, as about 1 mbd of capacity remains shut-in.

Between October 1 and October 7, oil output rose by 300,000 bd, an encouraging sign ofrestarting operations. But a full assessment of damage to facilities, including underwater productionplatform-wellhead connections and pipeline gathering systems, has not been completed. It may betoo early to assess whether production is steadily coming back, or if all the production that has comeback was the easiest to restore while currently shut-in output presents significant challenges atproduction platforms, within transport infrastructure, and at coastal processing facilities. Productioncan come back only as fast as pipelines and processing facilities return to service.

That said, Energy Information Administration (EIA) Administrator Guy Caruso has estimatedthat shut-in production will continue being restored; the amounts shut-in will likely average 930,000bd in October, 724,000 bd in November and 517,000 bd in December. (1)

In addition to disrupted production, the operation of two important long-distance crude oilpipelines were impeded. CAPLINE, which transports crude from Louisiana to Illinois, was shut forseveral weeks; it is now operating at 80% capacity. This limited crude supply to a number of refinersin the central part of the nation. And the Sun Pipeline and terminal started limited operations in earlyOctober, supplying a number of Texas and Louisiana refineries.

Some pipelines transporting refined products had service outages or throughput reductionsas a result of the hurricanes. Most notable was the Colonial Pipeline, which transports fuels from theGulf northeastward, ending in New York. This is an important source of supply for consumers allalong its route, and its outage resulted in very high prices in places like Maryland and Washington,D.C., which at one point had the highest gasoline prices in the nation. Colonial received fullcommercial electric power on October 13; full capacity is now available, subject to availability ofpipeline input. Gasoline prices in its service area are returning to parity with prices elsewhere.

About 2.5 mbd of crude oil imports -- including 0.9 mbd by way of the Louisiana OffshorePort (LOOP) -- flow through storm-damaged ports in Louisiana, Mississippi, and Alabama. Thisconstitutes more than 12% of petroleum consumption. (2) LOOP was operating at full capacity when it was shut down againas a precautionary measure in anticipation of Hurricane Rita. It is reportedly operating at 100%capacity, having escaped more damage from Rita. Other Gulf Coast ports through which oil importsflow have resumed operation, except for Port Arthur, which can accept barge traffic only duringdaylight hours. The Mississippi River is open with some restrictions.

Refineries and Product Pipelines

In the days after Rita, 5.6 mbd of refining capacity was shut -- nearly one-third of the nation'stotal. By mid-October, most of this capacity was operating or in the start-up process. Four facilitieswere closed in the wake of Hurricane Katrina; one has restarted, and full production is expected atthe end of October. Electric power has recently been restored to three other Louisiana plants whichsustained substantial damage, and they are expected to be down for an extended period. They havea combined capacity of 554,000 bd (3) .

An additional 722,000 bd of capacity shuttered in the wake of Rita remains off-line, leavinga total of 1.3 mbd down as a result of both hurricanes. This represents nearly 8% of nationalcapacity, and presents potentially serious supply problems, given the lack of any spare U.S. refiningcapacity. Additionally, the shutdown of over 5 mbd of capacity for virtually all of September hasaffected refined product stocks as seasonal demand starts to grow.

Strategic Petroleum Reserves -- Coordinated Release by the U.S. and IEA

On August 31, Secretary of Energy Bodman announced that the Bush Administration wasauthorizing releases of Strategic Petroleum Reserve (SPR) crude oil. Seven refiners requested loansof crude oil totaling more than 13 million barrels. The release of SPR oil and the announcement onSeptember 2 from the IEA of a coordinated drawdown of 30 million barrels of crude and 30 millionbarrels of refined products calmed markets by early in the week of September 5.

The U.S. SPR holds crude oil only. The net-importing IEA member countries are requiredto hold at least 90 days of net imports, and this obligation is met with a combination of crude andrefined products. At the end of June 2005, these stocks amounted to 222 million barrels of productsand 545 million barrels of crude.

Two million barrels were to be released daily by the IEA. (4) Nearly all 30 million barrelsof products have been released, gasoline and heating oil imports are still in transit and continue toreach United States. (5) Theyare reflected in the gasoline import statistics reported each Wednesday by EIA. Citing falling U.S.product demand, IEA Executive Director Claude Mandil told Platts :

There is no immediate issue right now, but there is stilla lot of oil and products that will be missing in the balance. We still need to carefully monitor thesituation together with our American friends to see whether demand destruction is long-lasting ornot because there may be risks to supply in November andDecember.

The most recent import statistics for the four weeks ending October14 (6) show that refined productimports were about 1.4 mbd higher than year-to-date 2005, suggesting a continued flow of this fuel.As the IEA's Mandil points out, it remains to be seen how U.S. gasoline and distillate stocks holdup as the oil industry recovers from the hurricane damage.

Loans of crude oil from the Strategic Petroleum Reserve were granted to seven companiestotaling roughly 13.2 million barrels. (7) On September 2, as part of the 60 million barrel crude and productstock drawdown coordinated by the International Energy Agency (IEA), the United States offered30 million barrels of SPR crude for sale. On September 14, DOE announced the sale of 10.8 millionbarrels of sweet crude and 200,000 barrels of sour at prices ranging from $59.76 to $66.46. Bids foran additional 8.2 million barrels were rejected. Additionally, some of the companies awarded loansmay not borrow the full volume of crude for which they asked.

The results of crude oil and refined product offerings from government strategic reservesshow demand for products to be stronger than crude, perhaps as a result of so much refining capacityshut by the hurricanes, and U.S. product demand exceeding the nation's refinery capacity duringperiods of normal supply and demand.

Petroleum Inventories and Prices

Despite a list of impediments to adding to crude and refined petroleum inventories, stocksof crude oil and refined products have not dropped to levels which could cause alarm. Table 1 showsthe changes in stocks for total petroleum, crude oil, gasoline, and distillate fuel oil between the weekbefore Katrina struck (August 26) and the most recent week of October 14.

Table 1. U.S. Commercial Petroleum Stocks AfterKatrina

(million barrels)

Source: EIA Weekly Petroleum Status Report , Table 3.

Table 1 shows that the major categories of petroleum inventories have experienced declinessince Katrina, with the exception of gasoline. Total stocks have declined at a rate of about 750,000bd. How these figures might be interpreted is a matter of some debate -- the obvious facts are thatthey have declined, and that there is some level below which spot shortages and distributionalproblems begin to appear. Prior to March 2003, DOE's Weekly Petroleum Status Report referred tothis as the "minimum operational inventory" (MOI). Subsequent issues have dropped any referenceto MOI because of differing views within the industry regarding what the minimum level might be.Because of improvements and inventory management and logistics, industry had recommended usinglower figures than DOE had previously been using.

A DOE-industry dialogue held by the National Petroleum Council in August 2004 failed toreach an agreement on MOI, and it has not been referenced since it was dropped. When last shownon DOE's charts of inventory levels, (8) these statistics were 185 million barrels for gasoline and 85 millionbarrels for distillates (which includes both heating oil and diesel fuel). If these levels are a guide,there is about one day's worth of gasoline stocks available (10.7 million barrels of "extra" stockscompared to about 8.8 mbd of demand) before run-outs would start to occur.

A tight inventory situation might be expected to be cause for concern; however, prices -- forthe moment at least -- are falling. At the pump, regular gasoline prices peaked at $3.06 (an all-timehigh) on September 5; they have steadily declined, falling to $2.70 in mid-October. Wholesaleprices and gasoline traded on the New York Mercantile Exchange (NYMEX) fell similarly.

The market does not appear to be responding to any shortage-related fears, but it may beresponding to concerns about "demand destruction" resulting from high prices. Indeed, the data forthe four weeks ending October 14 show demand for gasoline and middle distillates each about200,000 bd below the year-ago period (9)

Distillate stocks are 37.7 million barrels above the old MOI level; demand is about 4.0 mbd,implying less than 10 days worth of supply cover. Wholesale trading on the NYMEX has seendistillates decline from $2.13 per gallon at the end of September, to $1.85 in mid-October,suggesting few current concerns -- other than the level fo retail prices -- for the approaching heatingseason. EIA's Heating Oil and Propane Update for October 10 shows a residential heating oil priceof $2.65 per gallon, down 4.4 cents from the prior week.

DOE has forecast that home heating costs will be much higher this winter than last. EIAAdministrator Caruso indicated heating oil was forecast to cost $2.54 per gallon, an increase fromthe 2004-05 heating season average price of $1.92. He added that it could range as low as $2.34 pergallon if the weather is warmer than normal, or as high as $2.80 in a colder winter.

On October 12, the EIA lowered its estimates of fourth-quarter 2005 demand for the UnitedStates by 900,000 bd -- from 21.3 mbd to 20.4 mbd. Reductions included 160,000 bd in gasoline,170,000 bd in distillates, and 430,000 bd of intermediate products, petrochemical feed stocks, andlubricants. (10) It remainsto be seen how this demand scenario plays out against fuel supply as refineries recover from thehurricanes, and if there are additional sales from IEA strategic stocks.

Relaxation of Motor Fuel Standards(11)

On August 31, 2005, Environmental Protection Agency (EPA) Administrator StephenJohnson announced that EPA would temporarily waive certain gasoline and diesel fuel standardsnationwide through September 15, 2005, in order to help increase available fuel supplies. Forgasoline, EPA waived volatility standards that would have otherwise prohibited the sale of gasolineproduced for northern states in the South, or the sale of "winter" gasoline in the summer months. This waiver was intended to make it possible for gasoline normally prohibited in certain areas to betransported to those areas in response to supply limitations.

After September 15, many of the waived standards no longer applied, as the countrytransitioned from "summer" to "winter" gasoline. (12) EPA also waived national sulfur standards for diesel fuel, so thatthrough September 15, fuel produced for non-road uses could be legally used in highway vehicles. This waiver was intended to help mitigate some of the disruption in diesel fuel supplies. (13)

In several cases, EPA has also issued waivers of specific standards for certain states orregions. These waivers have been issued on a case-by-case basis, as some standards and specific fuelsupply issues vary from state to state, and within states. In most cases, these waivers will expire bythe end of October. (14)

Natural Gas Disruption

In addition to crude oil, about 10 billion cubic feet per day (bcfpd) of natural gas -- theequivalent of roughly 17% of total U.S. consumption -- is produced from the federal offshore Gulfof Mexico. Cumulatively, since Katrina, a total of 278 bcf of production has been shut in. As ofOctober 12, 5.2 bcfpd (or 52%) of output was shut in. In effect, this amount reduced the nation's totalcurrent gas supply by about 10%.

Natural gas production from Louisiana state lands was also interrupted by the hurricanes. TheLouisiana Department of Natural Resources estimated that 0.7 bcfpd of gas production has beenrestored, which is the equivalent of 31% of the 2.2 bcfpd state total. (15) About 1.5 bcfpd remainsoffline in the 38 parish coastal region surveyed.

Combining lost gas output from state and federal lands, the total amount of 6.7 bcfpd is theequivalent of 11% of an average day's total consumption for the whole country.

Natural Gas Pipelines and Processing Facilities

Gas production can recover only as fast as transport facilities return to service. There is nocomprehensive overview of the condition of pipeline and processing infrastructure in thestorm-damaged region; repairs could prove a lengthy bottleneck in re-attaining pre-Katrina levelsof gas flow.

One industry analyst noted:

While most pipeline companies have been eerily quietabout the status of pipelines, major facilities are still offline with little guidance as to when they willreturn to full strength. (16)

On October 13, DOE's Office of Electricity Delivery and Energy Reliability noted that 15 gasprocessing plants with aggregate capacity of 9.5 billion cubic feet or greater were offline inLouisiana. These plants had a pre-Katrina throughput of 5.3 bcfpd. Gas processing plants treat gas,upgrading it to "pipeline quality" and making it physically suitable for transport.

Both DOE and the Louisiana Department of Natural Resources publish updates of pipelineand infrastructure service status, but they do not paint a comprehensive picture of how gas is flowingover the long-distance grid and how much capacity remains sidelined. The case of Henry Hub is agood example. Henry Hub is a nodal point on the Sabine Pipeline, which connects with nineinterstate and four intrastate pipelines. When fully operational, it has the capacity to move 1.8 bcfpd.Because of these attributes, it is the point at which NYMEX contracts for physical delivery aresettled. Trading in Henry Hub futures is an extremely important benchmark for establishing naturalgas prices nationwide.

The Sabine Pipeline went out of service after Rita, and force majeure was ultimately declaredon the NYMEX contracts, resulting in postponement of trades and physical deliveries. Trading wassuspended on September 22; it resumed on October 7, when Sabine partially reopened. How muchgas can be transported given limited availability of pipeline compression is unclear, as is how thislimited pumping ability might affect trading in futures and physical deliveries for traditionalcustomers of deferred gas. The absence of definitive reports on the condition of the gas deliveryinfrastructure has caused uncertainty that has become reflected in spot gas prices.

Natural Gas Prices and Inventories

For the first months of 2005, wellhead prices for natural gas (17) averaged just over $6.00per million Btu's. In July, they began to rise, averaging $6.69 for that month and to $7.48 in August.With the impact of both storms felt in natural gas markets during September, prices rose to anaverage of $9.50. Trading on the NYMEX for Henry Hub has averaged between $13 and $14 permillion Btu's.

While it may be early to make estimates of what natural gas prices could be this winter,producer gas prices have more than doubled since the first half of 2005. EIA recently forecast thatwellhead prices will average $11.40 this heating season if the weather is normal; they will run $13.20if the winter is 10% colder than normal and $10.00 if the weather is 10% warmer than normal. (18)

In addition to the producer price of natural gas, residential consumers' rates also includelong-distance pipeline tariffs and charges of a local distribution utility, which actually owns theconnection to the home. Delivered residential natural gas cost $11.13 per million Btu's during thewinter of 2004-2005; this winter, EIA projects a range of $15.32 to $16.68, and $15.58 with normalcold weather. A normal winter would see prices about 48% above last winter.

Natural gas demand tends to be highest during the winter months, and gas produced innon-peak demand months is stored to meet peak demand. Storage peaks at about 3.25 trillion cubicfeet (tcf) in late fall, and declines to about 0.75 tcf at the end of the heating season, typically duringApril. (19) Currentinventory is about 3.0 tcf -- about the average stock level during the past five years.

During the most recent week, 75 bcf were added to storage (slightly under the five-yearaverage figure for this week), suggesting that gas is available and flowing in the nation's pipelinesystem. To what extent this will be the case after the onset of cold weather remains to be seen, butit is likely that prices will keep demand in check, and allocate supply where needed.

Electric Power (20)

At the end of September, more than 340,000 customers remained without power in Louisiana-- more than 190,000 from Hurricane Katrina, and an additional 149,000 from Hurricane Rita. InTexas, 316,000 remained without electricity.

October saw great progress in restoring electricity to customers whose premises were ableto accept power. At the middle of the month, only 12,500 customers were without power in Texas;129,300 did not have electric service in Louisiana.