October 19, 2005
Federal Reserve Districts
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Eleventh District economic activity continued to expand in September and early October. Two major hurricanes caused loss of life and significant economic disruptions in some areas, destroying property and dislocating families and businesses. Many areas of the District received an influx of evacuees that accelerated activity and made assessment of the underlying business cycle more difficult. Some firms anticipate increases in demand, at least temporarily, to supply goods and services to evacuees and to support rebuilding efforts. Still, in the near term, many contacts say the higher cost of fuel, energy and other inputs has dampened the economic outlook.
Demand for energy and manufactured products remained strong, but hurricane damage slowed the rate of growth of activity. Retail sales and service sector activity increased and, for some firms, was boosted by the storms. Construction and real estate activity continued to strengthen, and some markets were strongly stimulated by demand from hurricane evacuees. There was little change in activity in the financial services sector, where contacts say the supply of credit continues to outstrip demand. Agricultural producers reported that dry conditions are hurting some production, but hot weather is encouraging a large cotton crop.
Heavy demand and hurricane disruptions pushed crude oil prices to near $70 per barrel, but prices fell to $62 per barrel in early October, the lowest price of the last two months. Crude inventories remain near 5-year high levels. Distillate inventories (diesel and heating oil) are near a 5-year high, but contacts say inventories should be building more rapidly. A series of mechanical problems, fires in the refinery system and a strategy of building distillate inventories had reduced gasoline inventories prior to the storms. Gasoline inventories have bounced back strongly as increased imports bolstered supply and consumers reduced gasoline consumption in response to high retail prices. Natural gas prices increased from $9 per million Btu to $14. With the approaching heating season, contacts are concerned about the loss of natural gas production in the Gulf of Mexico. Natural gas inventories were heavy last spring but were reduced close to normal levels by a very hot summer. Injections into inventory have been near normal in recent weeks despite the loss of Gulf production, partly because so many large gas-using petrochemical plants are down.
The strength and uncertain path of Hurricane Rita led to an unprecedented shutdown of 90 percent of petrochemical capacity on the Gulf Coast. Coming on the heels of Katrina, the result has been widespread shortages of many chemicals and plastics. A number of large producers declared force majeure, allowing them to break contracts. Basic chemicals and plastics are now on allocation, with sizable price increases for ethylene, propylene, polyethylene, PET bottle plastic, polystyrene, polyvinyl chloride and polypropylene. Chemical prices have not risen in the rest of the world, but contacts say it takes roughly six weeks for imports to reach U.S. markets.
Contacts expressed optimism that evacuees would bring much needed skills to the labor pool, and some businesses report hiring skilled workers who intend to stay in the District. Hiring has picked up to provide goods and services to evacuees.
Demand for metals was mixed. Some producers experienced a strong surge in orders to supply product to the Gulf Coast, but others reported a dip in orders, largely because of a loss of the New Orleans market. Prices are up for some metals, such as for copper and scrap steel. Demand for lumber was stronger than usual because competitors in the Gulf Coast and New Orleans were unable to fill their orders. Demand for paper products was unchanged over the past month.
Respondents in high-tech manufacturing said sales and orders continued to grow at a solid pace. The semiconductor industry reported no noticeable impact from the hurricanes, although some electronics producers had increases in orders for emergency related items, such as two-way radios. Demand from Asia continued to pickup.
Refinery utilization rates have fallen sharply, with about 15 percent of U.S. capacity still out of service. The decline in utilization has been similar to the drop that occurs with the usual fall maintenance schedule, but maintenance has not been done. Contacts expect more mechanical problems because some plants are being run hard. Respondents say refinery margins have increased from an "excellent" $10 per barrel to $22 in September. Refined product imports have soared.
A lack of basic inputs is keeping a number of chemical plants on partial or complete shutdown. Contacts say the actual damage to these plants is not serious. The system is unbalanced for a number of products, pushing up costs and prices. For example, chlorine and caustic soda are joint products. Much of the demand for chlorine was put out of service by Katrina, but the demand for caustic soda remains strong. Chlorine is hard and expensive to store, so caustic soda users (particularly pulp manufacturers in the southeast) are facing allocations and large price increases.
Demand is up for railroad, trucking and cargo firms. The rail and trucking industries say they are operating at or near full capacity. Trucking firms say Katrina and Rita have recently stimulated demand for shipping, but their ability to increase fees is not keeping pace with rising fuel prices and, in some instances, customers are choosing to forgo shipments because prices are too high. The rail industry has been unable to meet demand because of a lack of capacity. Grain volumes have almost tripled because grain that used to be shipped down the Mississippi by barge to the New Orleans port and is now being shipped by rail to other international ports. Shipments decreased significantly for chemicals, petroleum products, coke, pulp, paper, lumber, wood and raw logs. Contacts were surprised by a significant and unexpected slowing in rail shipments of metals, metallic ores (used in cars, appliances and construction), cars and other construction-related materials. This was unrelated to the hurricanes, they say, and suggest that this may indicate an upcoming slowdown in consumption of intermediate goods and home building.
A sharp increase in jet fuel costs has added to the airline industry's difficulties. Contacts say demand remains strong despite fare increases. But higher ticket prices have not been sufficient to cover fuel costs for most airlines, leading some carriers to reduce flights. This, along with the bankruptcy of two more major carriers, has reduced capacity in the domestic market--but not enough for most carriers to be profitable. The labor market for airline employees has become even looser as some workers attempt to flee newly bankrupt carriers. High fuel costs along with proposed pension reform are expected to force further structural change in the industry.
Construction and Real Estate
Demand for new and existing homes remained strong. While demand was slightly boosted by sales to hurricane evacuees, the larger influence continued to be from relocations and investment purchases. In Austin, sales strengthened for higher-priced homes. Builders in Dallas say competition is stiff, holding down price increases despite strong demand. Rising construction costs have led builders to be more uncertain about the outlook.
Office markets continued to improve at a steady pace. Leasing continued to increase in Dallas, and landlords are reducing incentives while rents are holding firm. Houston's office sector also continued to improve, with rising occupancies and rents, but contacts say Katrina's impact has not been huge. Some temporary space has been absorbed by legal and energy firms with operations in both Houston and New Orleans, and some of the energy firms may choose to remain in Houston, which reflects an on-going trend.
The hurricanes caused some significant loss of rigs in the Gulf of Mexico, and repairs have been hampered by a lack of infrastructure. Katrina's damage to Louisiana's staging areas for the Gulf forced the industry to move its logistical base to Cameron, Texas, which was wiped out by Rita. Loss of docks, boats, warehouses and equipment has hampered repairs in the Gulf. The repair effort will create jobs for diving companies, supply boats and helicopter transportation for months or years to come.