Katrina’s effect on fuel prices still unfolding

 - October 23, 2006, 7:52 AM

In the wake of Hurricane Katrina the surge in auto-fuel prices–with the per-gallon increases lagging just hours behind the rising flood waters–was at the forefront of everybody’s mind. A flurry of activity on the political front–including the release of six million barrels of crude oil from the Strategic Petroleum Reserve–further focused the nation’s attention on the cost of keeping America’s engines running.

Right behind concerns for automotive fuel prices, worries lurked over the hit airlines would take at the pumps. With so many carriers operating so close to the edge of bankruptcy already, it was widely feared that rising fuel bills or limited availability of jet-A because of Katrina would sink airlines even deeper into fiscal malaise. Indeed, Delta and Northwest chose the immediate post-Katrina time frame to declare bankruptcy, though they had been talking about taking that plunge for months–and there was speculation that in at least one case pension obligations also played a role in the timing.

The fuel that powers business aircraft takes a significantly different route compared with automotive gasoline and airline supplies, but anyone who filled up a Gulfstream over the Labor Day weekend felt the strong blast of Hurricane Katrina on the retail price of jet fuel.

The spike in prices had many operators crying foul, wondering aloud why they were paying around $3.50 per gallon at one fuel stop, while the tab was approaching $6 per gallon down the road. Some pilots were dusting off their fuel-tankering formulas in an effort to stave off high costs of filling up on the road.

Now, weeks after the fact, prices have receded along with the flood waters. But the memory of those stinging fuel bills is still fresh. In some cases, it has strained the relationships between FBOs and their customers. The operators might harbor suspicions of price gouging, but they are not likely to confront the FBO for an explanation. In fact, even the general managers of FBOs might be hard pressed to explain why the prices rose so steeply, then fell away just as quickly after the holiday weekend, if not all the way back to pre-Katrina levels.

Supply Interruptions

Craig Sincock is CEO of Avfuel, the world’s largest independent fuel supplier, based in Ann Arbor, Mich. Sincock explained his take on whether the initial spike was for real or simply evidence of retailers padding prices in anticipation of higher wholesale prices in the months ahead. In his view, the temporary price hike was legitimate, though he did not dismiss the theory that some might have taken advantage of the situation to supplement sagging profit margins.

Sincock said, “The Gulf Coast accounts for 48 percent of the oil refining capacity in the U.S., and it was operating at 98 percent of that capacity. They weren’t even taking time out for maintenance. The region also represents about 25 percent of our crude oil production.”

Katrina temporarily knocked out the refineries, largely because of lack of electrical power rather than damage, though Sincock said that as of late last month, production in the Gulf region was still off by between 5 and 15 percent, “depending on whose figures you believe.” A spokes-man for ChevronTexaco said its refinery in Pascagoula, Miss. sustained damage, which was still being evaluated at press time. President Bush visited the ChevronTexaco facility and praised the workers for their courage.

In addition to the refineries’ hiccup in production, closed ports created shipping bottlenecks, not only lessening the amount of imported crude oil that could be unloaded at the docks, but also delaying domestic shipping. Sincock cited his own company’s experience, saying Avfuel was waiting for a fuel barge on the Mississippi River to get to Tampa, Fla., to supply an airline fuel depot. He said “The airlines were questioning why they were sweating fuel in Florida from a storm that hit Louisiana, Mississippi and Alabama.”

A spokesman for BP told AIN that all its deep-water rigs in the Gulf escaped serious damage and the company was not on a “critical path” in terms of production. He said all the product that could be in process was moving through the system at normal rates.

Two major pipelines that supply jet fuel to the rest of the nation were off line for several days, again primarily due to lack of electrical power rather than storm damage. Once the Colonial and Plantation pipelines were back in action, the fuel spigot was turned back on, but not before some customers were faced with some difficult decisions.

Bob Wilson, president of Wilson Air Centers in Memphis, Tenn., and Charlotte, N.C., told AIN he had concerns about fuel in both locations–at Charlotte because the FBO’s existing storage capacity is small and the area depends on the 5,500-mile Colonial pipeline for regular delivery of jet-A; and at Memphis because he experienced an influx of aircraft that were diverted from other airports where there was no fuel.

Wilson said, “We filled our fuel farm just before the storm and we’ve got good capacity in Memphis, but we were beginning to sweat the supply when so many started dropping in asking to fill up because they couldn’t get fuel elsewhere.” Wilson said he was concerned he’d have to limit fuel sales to some regular customers if the situation continued.

Fuel Pricing Structure

At the heart of the process is the question of how frequently a fuel supplier or FBO must refill its existing supply. The larger the storage capacity, the longer an FBO can subsist without raising prices when wholesale prices go up. The downside of oversupply is that the price could go down, and the lower-capacity competition is selling fuel that it bought at lower prices. Setting retail fuel prices for FBOs is a balancing act between sustaining workable profit margins and pricing themselves out of the market among their competitors.

The time lag between when an FBO–or anyone else dealing in quantities of fuel, for that matter–buys and then resells its fuel supply is the key element in determining whether a price increase constituted a gouge or a prudent business move. Some can go weeks without buying a load of fuel; others get several deliveries a month.

If one of the low-frequency FBOs had its tanks full of jet-A at yesterday’s prices and knew that wholesale prices were likely to return to normal within days, raising prices could be considered a questionable move. But if the same operation was anticipating the need to refill (and pay the bill up front) early next week when prices could jump another double-digit figure, then increasing prices to meet an anticipated price increase is not out of line. That could account for some of the price discrepancies in the days immediately following Katrina. Still, one long-time observer of the aviation fuel industry pointed out an old adage: it takes only one second to raise fuel prices but it can take months to bring them back down.

At the time he spoke to AIN, Sincock had recently prepared a presentation on the global oil market and added a new element to his talk to address the Katrina phenomenon. He told AIN that the U.S. consumes much more oil than it produces.

Add to that some dramatic numbers on global economic growth. According to the U.S. Energy Information Administration, the economies of China and India are expected to grow by 6.2 percent and 5.2 percent per year, respectively, between 2001 and 2025 as the leaders of an overall global economic growth rate of 3.1 percent per year. Since economic growth is intertwined with energy consumption, Sincock concluded, “We were already short before Katrina.”

The result is the kickoff of a seven-phase process, he said, starting with the pre-existing market imbalance for oil; followed by the hurricane; the shutting down of infrastructure such as refineries, pipelines and shipping ports; price increases that attract imports; the arrival of the new supply; the infrastructure coming back on line; and finally, the return of the supply balance to “normal.” Sincock said, “It may sound contradictory, but the best cure for high prices…is high prices. Not only do they attract imports, but they bring in money to provide extraordinary solutions. For example, in the case of the Gulf Coast, it becomes worthwhile to fly in equipment, people, whatever it takes to get the system back in operation.”

A spokesman for ConocoPhillips said that, although one of its refineries was still out of commission at press time, two others had been able to increase production to close the gap. He added, “Now we’re just waiting for the next [hurricane] to hit and crossing our fingers.”

In its report last month addressing Katrina, the U.S. Department of Energy’s Energy Information Administration (EIA) admitted considerable uncertainty, making it difficult to forecast supply and demand trends into the winter months. As of September 21, fears of Hurricane Rita were hampering the recovery. Several companies, including BP, ExxonMobil, ConocoPhillips, Chevron, Marathon and Valero, had evacuated facilities in the Gulf. The U.S. Minerals Management Service reported that 53 platforms were evacuated on September 20, for a total of 136 that remained unstaffed, mostly in the New Orleans area. And this all occurred as the industry was gearing up for the peak season for distillate fuels, which include heating oil, kerosene and jet fuel.