Hurricane Harvey: Another Blow For Oil Prices?

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The oil and gas industry that was once the “apple of the eye” of all investors has turned sour over the last three years. The slump in commodity prices has swayed the fundamentals of the industry, leaving it susceptible to every unforeseen event that can impact the demand and supply factors of oil. Hurricane Harvey which hit the US Gulf Coast last week is one such unfortunate event that could change the dynamics of the commodity markets.

Harvey made landfall in Texas on Friday, 25th August, as a Category 4 hurricane, making it the strongest storm to hit the state since 1961. However, it was downgraded to a tropical storm on Saturday by the National Hurricane Center. Despite the downgrade in terminology, the destruction by the storm has been humongous. For instance, Houston, the fourth-largest city in the US, has received around 34 inches of rain in the last few days and is suspected to be one of the worst hits by a natural disaster. The experts forecast another 10-20 inches of rainfall in the next couple of days.

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Not only have the torrential rains left hundreds of thousands of people homeless and in pain, they have further ruined the bleak chances of a recovery in the commodity markets. To begin with, Exxon Mobil (NYSE:XOM) was forced to shutdown operations at its Baytown refinery, which is the second-largest refinery in the US with a production capacity of 560,000 barrels of oil per day (bpd), due to severe flooding of the plant. Further, the integrated company may soon have to abandon operations at its Beaumont refinery in Texas as well for the same reason. This refinery has a total production capacity of 362,300 bpd, of which the company is likely to shut the 240,000 bpd Crude B distillation unit and the 45,000-bpd coking unit first.

Following Exxon’s footsteps, Saudi Aramco’s Motiva Enterprises, which operates the country’s largest refinery with a capacity of 603,000 bpd, is expected to make a final decision on whether to shut its Port Arthur refinery today. Similarly, Royal Dutch Shell (NYSE:RDS.A) announced earlier this week that its Deer Park refinery and chemical plant complex is likely to remain closed for about a week due to the severe rains caused by Tropical Storm Harvey. Other integrated energy companies such as Petrobras and Chevron also shut down their refineries at Pasadena and Baytown respectively. On an aggregate basis, Harvey has so far resulted in the shutting down of more than 1 million bpd of refining capacity in Houston and Galveston, Texas. This number could increase in the coming days as torrential rains are likely to continue in the region for the rest of the week.

Apart from acutely disrupting the refining capacity of the Gulf Coast, the catastrophic rains have uprooted onshore production in the Eagle Ford Shale region. According to analysts, this is the first storm in the Gulf of Mexico that has had such a severe impact on onshore oil and gas production in the area. The heavy downpours in the region have pressured exploration and production (E&P) companies to withdraw their workers from the province and curtail operations. Consequently, oil and gas producers, such as Anadarko Petroleum (NYSE:APC), Chesapeake Energy (NYSE:CHK), EOG Resources (NYSE:EOG), and ConocoPhillips (NYSE:COP), that have a sizeable presence in the Eagle Ford shale region, have witnessed a sharp drop in their stock price over the last couple of days. In fact, according to the U.S. Department of the Interior’s Bureau of Safety and Environmental Enforcement, the Tropical Storm Harvey has already closed down roughly 380,000 bpd, or 22% of the oil production in the Gulf of Mexico, and 828 Mcf per day of natural gas output. If the rains persist over the next few days as predicted, there are strong chances that these players will have to cut down further production in the region.

Our Take

As mentioned earlier, Tropical Storm Harvey has led to the closure of almost 1 million bpd of refining capacity in the US.  Depending on the damage to the plants, it could take days, weeks, or even months for these refineries to come back online. Consequently, the prices of gasoline have surged to $1.78 per gallon, the highest in the last two years. On the flip side, crude oil prices have dropped to $46.57 per barrel, as the market fears that the lack of transportation demand in the country will lead to a decline in demand for American oil. Since crude oil has become sensitive to any change in global demand and supply, the disruption caused by Harvey in the Gulf Coast could instill anxiety among investors in the short term, resulting in a further plunge in oil prices.

That said, the disaster has also restricted oil supply from the Eagle Ford region, which could partially offset the impact of lower demand for oil. Thus, we believe that the decline in oil prices as a result of Harvey is not expected to be significant enough to send the benchmark below the $40-per-barrel mark anytime soon.

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