The Katrina crisis

Editor’s note: The following opinion piece is reprinted from the Wall Street Journal with permission.

By Daniel Yergin

Man’s technical ingenuity has collided with nature’s rage in the Gulf of Mexico, and the outcome has been an integrated energy disaster. The full scope will not be understood until the waters recede, the damage to platforms and refineries is assessed, and the extent of damage to underwater pipelines from undersea mudslides is determined. Yet what has happened is on a scale not seen before, and the impact of the price spikes and dislocations will roll across the entire economy. Even as we confront the human tragedy, the consequences will also force us to think more expansively about energy security, and to focus harder on a matter which other events have already emphasized: The need for new infrastructure and investment in our energy sector.

What makes it an integrated crisis is that the entire energy supply system in the region has been disabled, and that the parts all depend upon each other for recovery. If the next weeks reveal that the losses are as large as some fear, this would constitute one of the biggest energy shocks since the 1970s, perhaps even the biggest. Unlike the crises of the ’70s or the Gulf Crisis of 1990-91, this does not involve just crude oil: It includes natural gas, refineries and electricity. The 1.5 million barrels of oil production capacity that has been “shut-in” — closed down — is much less than was lost to the market when Saddam invaded Kuwait. But although it has received less attention, 16 percent of U.S. natural gas is also shut-in; and 10 percent of our refining capacity is under water at a time when there is no slack at all in the world’s refining system. The electric and natural gas distribution system in the region has also been knocked out. All of this has a knock-on effect: Boats can’t get out to the platforms without diesel fuel; and refineries can’t operate without electricity or people. Those last two are the preamble to recovery. With communications broken down, companies are still trying to make contact with the missing employees who run the different parts of the energy infrastructure. As for electricity, a frontline manager summed up the problem: “You can’t overemphasize the absolute enormity of the undertaking to put this place back together again.”

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This shock has revealed how crucial is the vast Gulf of Mexico energy complex. In the 1930s, drillers had put down wells in the waters off the beaches of Louisiana and Texas, to little effect. The first company to really go off shore — that is, out of sight of land — was the Oklahoma independent, Kerr-McGee, just after World War II. The company figured the risk was worth it: There was not much competition and so the acreage was cheap. The risk lay in the fact that the technology did not yet really exist for building a platform, getting it into position, drilling into the ocean floor — or even servicing a platform. All that needed to be invented.

In October 1947, Kerr-McGee hit oil in Block 32, 10 miles off Louisiana. That marked the beginning of what has turned into an extraordinary accomplishment of science and engineering. All the elements that were needed did get invented, reinvented, and reinvented yet again. The pace has only increased. Even as recently as the late ’70s, the “frontier” for drilling was in 600 feet of water. Today, the new frontier is up to 10,000 feet. This means a super-platform, part of a billion-dollar-plus mega-project, from which workers guide a steerable drilling apparatus down through 10,000 feet of water and then another 20,000 feet of rock under the seabed.

The full extent of the Gulf of Mexico energy infrastructure is hard to grasp. Altogether, about 800 manned platforms, plus several thousand smaller unmanned platforms, feed their oil and gas into 33,000 miles of underwater pipelines, a good part of which eventually reaches shore at Port Fourchon at the mouth of the Mississippi. That adds up to 35 percent of domestic oil production (including oil from state as well as federal waters) and over 20 percent of our natural gas coming from off-shore. Add to that the 10 percent of U.S. oil imports that flow in through the same corridor, plus the string of refineries and pipeline networks that sprawl along the Gulf Coast, and you have a complex that constitutes our single most important energy asset.

How badly damaged is the Gulf complex, and how quickly can it come back? As an executive of a major oil company put it, “Our platforms and facilities are designed for a 100-year storm. But this storm was something else.” Some of the platforms directly hit by Katrina are vividly damaged, and repair could take months, even longer — depending on the availability of people and materials. Platforms more to the west will turn out not to have been damaged, and, after inspection, will be ready to go. Companies are already starting up some of the shut-in production. The LOOP — the off-shore unloading port — is back in partial operation, much more quickly than would have been expected. The big question surrounds underwater pipelines. Their vulnerability to mudslides was a prime lesson of last year’s Hurricane Ivan, and remotely operated underwater vehicles will have to methodically assess the damage. Initially, 1.5 million barrels per day of oil were shut down with both Ivan and Katrina. Within six weeks of Ivan, the shut-in capacity was reduced to just 200,000, which persisted for several months. But Katrina was worse than Ivan and hit more of the bull’s-eye. Unlike Ivan, it also devastated a significant part of the onshore logistical infrastructure that supplies the offshore. That suggests a slower rebound.

But, fortunately, the Strategic Petroleum Reserve, with 700 million barrels, can compensate for an extended period for the missing oil. The SPR is certainly demonstrating its value here. Without it, people would be apprehensively asking how deeply into recession the resulting $80 or $90 a barrel oil would push the U.S. While the trigger for its use is not what was anticipated, the SPR is proving its role — not as a tool of market management, but to offset a major disruption, protect GDP, and maintain the viability of our economy.

In terms of price, natural gas has actually been hit more. Until this week, commercial gas storage, banked for the winter, looked comfortable. But now those inventories may not be built up sufficiently for a cold winter, a prospect that is already stressing the natural gas market. Over the last four days, natural gas prices are up 20 percent, while crude prices are, by comparison, up 6 percent.

The immediate big hit is from the loss of that 10 percent of U.S. refining capacity. The world’s refining system is stretched taut, and gasoline, diesel and jet fuel now teeter on the brink of short supply. The shortfall has been accentuated by the shutdown for part of the week — due to electricity loss — of the two major pipelines that carry refined products from the Gulf Coast to the Southeast and the Mid-Atlantic states. That is why wholesale gasoline prices have shot up 60 cents in four days. The shortfall will be made worse if panicked motorists rush to fill up. In that case, stations would be drained, only further fueling the scramble.

No consuming industry is hit harder than airlines: 13 percent of our jet fuel production capacity has been lost, but the proportion is much higher for the part of the country that stretches from Miami International to Reagan National. Jet fuel inventories are adequate for two weeks, but shortages can develop if new supplies do not arrive. The financial pressure on airlines is huge; just the increase in the fuel bill this year will likely exceed by several billion dollars the industry’s anticipated overall $7 billion loss.

Some of the refining capacity may come back quickly, while flooding may have put others out of commission for some time. Increased product imports from Europe, the Caribbean and Latin America can help offset the losses, but that will take weeks. In the meantime, calls for price-controls and allocations will likely grow. As painful as the price hikes may be, those calls should be resisted: The gas lines of the ’70s were largely self-inflicted, the perverse result of controls. More constructive, and hugely less cumbersome and costly, would be clear communication to consumers. A package of responses, such as properly inflated tires, adherence to speed limits, consolidation of trips, and tune-ups, could cut gasoline consumption by 10 percent to 20 percent. This needs to be reiterated again and again, for modest restraint on demand is the quickest way to take the pressure off the market. The flexibility of markets and the resilience of the energy sector are the most effective antidotes to high prices and disruption. We can see markets working, also, in the substantial build-up of supply from around the world that will occur over the next few years.

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Post-Katrina, companies will have to continue to weigh relative risks when deciding whether to invest in the ultra-deep Gulf, West Africa, or the Caspian. The rocks under the Gulf are highly prospective, and companies will carry on applying capital and ingenuity to developing the resources — now planning not for the 100-year Storm, but for a 200-year one. Oil production from the Gulf could rise from two million barrels today to 2.4 million by 2010. That would mean the Gulf’s share of total U.S. oil production rising from today’s 35 percent to 45 percent, although the recovery from Hurricane Katrina could end up pushing that level back a year or two.

Katrina’s shock underscores a transition in the idea of energy security. For three decades, the operating concept was “1973 Vintage”: In response to the 1973 embargo and then the Iranian upheaval, it focused on securing the flow of crude, primarily from the Middle East, and coping with any disruption. The SPR was created in the mid-’70s for 1973 Vintage reasons (although the idea of such a reserve had first been bruited by Eisenhower after the Suez Crisis). Its proponents, focused on another Middle Eastern crisis, never thought that its second major use (the first being in the 1990-91 Gulf Crisis) would be for domestic disruption.

But a host of developments — from terrorism to the California power crisis to the East Coast blackout to Katrina — have emphasized a return to what might be called the World War II model of energy security, assuring the security and integrity of the whole supply chain and infrastructure, from production to the consumer. (The gravest energy threats during World War II were when Nazi U-boats came close to cutting the tanker pipeline across the Atlantic that supplied U.S. military forces). This more expansive concept of energy security requires broader coordination between government and the private sector; more emphasis on redundancy, alternatives, distributed energy and back-up systems; planning and pre-positioning of vital supplies (“strategic transformer reserves” for electric substations); and methods that can quickly be applied to promote swift market adjustment. As with the August 2003 blackout, this crisis underlines the need for modernization and new investment in the energy infrastructure that supports our $12.4 trillion economy. A strong push in this direction may come from the new energy legislation, rather than from the idea of “energy independence.”

A great precept of energy security was laid out by Churchill when, on the eve of World War I, he converted the Royal Navy from (Welsh) coal to (Persian) oil. “Safety and certainty in oil lie in variety and variety alone,” he said. In other words, diversification of supply sources expands the margin of security. Margaret Thatcher gave us an equally sturdy dictum: “The unexpected happens. You had better prepare for it.” Disruption on the scale of Katrina was never anticipated, neither for the Gulf’s energy complex, nor for the larger tragedy that unfolds. And hurricane season is not over. From now on, a hit of this scale will not be unexpected. But what else is out there? That is a question for the world’s entire energy supply system. For surely, somewhere, the unexpected is brooding, and waiting to happen.

Mr. Yergin, chairman of Cambridge Energy Research Associates, is author of “The Prize: The Epic Quest for Oil, Money, and Power” (Free Press, 1993).

This article originally appeared in the September 2, 2005 edition of the Wall Street Journal.

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