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In Depth: Natural Disasters
Energy: A system at risk?

Effects of hurricanes seen as short term but market sensitivity is exposed

Photo: Gasoline prices in the United States rose above $3.00 per gallon after hurricanes Katrina and Rita dealt a severe blow to the Gulf Coast energy infrastructure. AP Photo.

When hurricanes Katrina and Rita tore through the Gulf Coast oil fields, consumers worried about the impact to already rising oil prices. While experts say the storms will not prove as cataclysmic to the energy infrastructure as initially feared, the storms underscored the sensitivity of an increasingly global energy market.

MIT Sloan Senior Lecturer A. Denny Ellerman predicts the storms' effects will play out within three to six months and will recede as damaged facilities are repaired.

“There is some talk of longer-term impact, particularly from the standpoint of oil platforms and the undersea infrastructure. ...” he says. “But even this impact is only that the Gulf of Mexico will be seen as a riskier area in which to drill and to produce than it has been. In theory, that might mean slightly higher oil prices, but whatever that effect, it will be minor compared to everything else that is going on.”

Delicately balanced system
Still, MIT Sloan Fellow Liam Reid, an energy analyst for Alinta in Australia, says the energy industry in the United States and in much of the world is near peak capacity. Natural disasters, he says, wreak havoc on the delicately balanced energy system.

“Even a few hours of shutdown can take days for full recovery,” he says. “Just-in-time production schedules are economically efficient and shareholder friendly, but have small tolerance for mishap. When these systems go out of kilter, supply falls and prices tend to go up.”

MIT Sloan Fellow Ziyad Al Shiha, director for New Business Development at Saudi Aramco, agrees.

“The U.S. market and consumer behavior largely affect the price on a global market,” he says. “If gasoline prices go up in the United States, you will find that generally gasoline prices go up worldwide. The world energy market is so connected and interdependent that no country can isolate itself from any event that affects oil or refined products somewhere else in the world.”

The energy industry is aware of its vulnerability to disruptions and is prepared to respond to late-breaking events, says Al Shiha. But market conditions leave little room for play. Energy is a real-time product. The need for it cannot wait.

“Energy is not a luxury issue,” he notes. “Cars need to run now and so do airplanes. The livelihood of industries relies on their ability to move their products on land, by sea, and by air all over the world.”

Lessons, looking ahead
Reid says it's impossible for engineers to build structures that can withstand any storm, but he expressed surprise at the industry's inadequate recovery plans.

“It is possible to make plans to quickly repair failed oil rigs, pipelines, and transmission lines when the unexpected happens,” he says. “The only way that the energy industry can deal with natural disasters is to have adequate recovery plans in place.”

With projections of increased climatic instability in the Gulf, some have suggested production in the region should be scaled back. That's unlikely, according to MIT Sloan Dean Richard Schmalensee.

The United States, he says, does not have a lot of choice as far as the location of refineries. “Louisiana seems to be one of the few places in the country where one can build a refinery, and this nation of gas guzzlers needs refineries.”

Ellerman agrees: “Offshore facilities and refining facilities are located where they are because the oil is there, and there is good economic sense for locating a significant refining capacity in the Gulf Coast. Arguing that we should not do so would be akin to arguing that we should not look to Florida to supply grapefruit because the crop gets wiped out periodically by an early frost. It's better to enjoy the economic benefit of the resource even at the price of an occasional disruption than to forego the benefits altogether.”

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