Under the Weather: the Impact of Hurricane Harvey

September 15, 2017
Editor(s): Wen Lin Ong
Writer(s): Tharaka Segar, Acqeel Ziyad, Oliver Thorne

Hurricane Harvey, alongside Irma, are amongst the largest hurricanes to have made landfall in the United States. According to Accuweather (2017), Hurricane Harvey was considered  a highly severe “Cat 5” storm, with sustained winds of up to 185mph (300km/h). The storm wreaked havoc on Texas, and subsequently spilled over into Louisiana, causing widespread devastation (mainly flooding) in much of southwestern United States. According to Goldman Sachs (2017), Hurricane Harvey alone will be responsible for a 1% reduction in GDP growth during the third quarter of 2017.

 Economic Repercussions

A natural disaster of such severe and widespread extent undoubtedly wreaks damage on capital stock, including production equipment, real estate, and factories, affecting key industries of that geographical region, such as oil refineries. Based on economic theory, destruction in the capital base results in a lower rate of productivity. This is especially true in the U.S’s case, where the highly developed economy requires intensive use of  advanced technology with relatively little need for labour. As such, many companies will likely face difficulties restarting operations in the aftermath of the hurricane given the combination of reduced capital and labour as well as incidental costs associated with restarting operations.

However, despite the negative short term impacts, not all will be bad news. According to the Solow Swan model, output reaches a steady state at a certain level of capital and labour in the long run (Domar, 1957). While capital and labour have diminished significantly in the wake of Hurricane Harvey, this is likely to persist only in the short term. Most companies are likely to be sufficiently insured and capital stock levels will be replenished by technologies that are in fact more efficient than those previously used. To elaborate on the latter point, companies are often reluctant to outlay expenditure on marginally better technologies, preferring instead to amortise existing capital stock until they find that their competitors’ marginal costs are significantly lower than their own to the extent that they are now uncompetitive. Thus, in the long run, with better technology, there should be a cumulative effect of higher productivity, which in turn, increases output per capita. Increased production output will also benefit the workforce via increased wages, and the economy as a whole benefits.

The Markets

As for financial markets, Hurricane Harvey’s impact was profound, notably in the natural resources sector. The Gulf Coast between Texas and Alabama, which experienced heavy flooding, is home to refineries that account for 46% of refining capacity in the U.S. (Business Insider, 2017). In the wake of Hurricane Harvey, major refinery shutdowns occurred in Houston, Galveston and Corpus Christi, and 30% of products were taken out of the equation. As a result, refinery product prices are set to increase, while crude oil prices fall, hitting producers hard.

After Hurricane Katrina, the stocks of large insurance companies like Allstate, Progressive and Chubb increased, but the reaction has been distinctively different this time around. Shares of insurance companies most exposed to damage from Hurricane Harvey slipped last Thursday (7th August) as the Texas clean-up efforts continued and an even more powerful Hurricane Irma barrelled toward Florida. It’s safe to expect that insurers will raise rates after a storm of this magnitude. Harvey is likely to cost the insurance industry as much as $10 billion-$15 billion, according to one analyst, with most of the hit to commercial carriers. In numbers: Aspen shares were down 7%, Validus shares lost 4.8%, and Axis slipped 4.2%, as of Thursday the 7th (CNBC, 2017). Reinsurers like AIG and Berkshire Hathaway, who help smaller insurance companies manage risk will see a more complex outcome.

It is also worth noting that after Katrina, most re-insurers stock took an initial hit but recovered over the medium term as they were able to raise interest rates. Insurance brokers’ stocks like Marsh & McLennan have also had the tendency to rise. Jim Cramer believes “insurers are all buys after another day or two of selling…although the federal flood program will bear the brunt of the losses here, it’s safe to expect that insurers will be able to raise rates after a storm of this magnitude.” (CNBC, 2017)

Social Impact

Numerous local and national organisations, including The American Red Cross, Texas SPCA and Houston Humane Society, have come forward in raising funds to aid Texas residents following the financial and economic devastation sparked by Hurricane Harvey. As outlined by the founder of the Global Resilience Institute Professor Stephen Flynn, such aid systems are an important determinant of social allegiance.

Presently, 30 000 people have been forced out of their homes while 45 000 are seeking federal aid (St. Martin, 2017). Numerous different sources predict different recovery costs, however the predicted estimate is between $40 and $50 billion, making it “one of the most expensive hurricanes in American History” (Struyk, 2017). Economists predict it will cost $40 billion to restore houses alone (Meyersohn, 2017), where only 15% of Houston homeowners have flood insurance. Federal aid allocated is approximately $25 to $32 billion, which is at the 62% threshold allotted. An outlier of these standardised predictions is AccuWeather, estimating an approximate $190 billion in infrastructure restoration, which is more costly than Hurricanes Katrina and Sandy combined.

Environmental clean-up efforts constitutes another pressing, and equally costly issue. Holding more than 450 plants and refineries which house billions of gallons of hazardous chemicals, Houston is considered to be the petrochemical capital of the U.S.. Over 750 000 pounds of chemicals have been dumped in the Texas Coast Gulf, also known as the “Chemical Coast”. In the wake of the storm, the Houston Health Department are more than certain that water sources are now filled with “millions of contaminants” (Tabuchi & Kaplan, 2017).

Climate change has been cited as one of the largest environmental factors to the harsher weather patterns, where atmospheric scientists have noted heavier precipitation, higher temperatures and rising sea levels, which collectively equate to growing storm intensity and harsher winds. As such, Hurricane Harvey illuminates the imminent threat we all face when we overlook the greater risks that climate change pose. In order to alleviate the plethora of debilitating economic and social impacts of climate change, greater effort could be placed on harnessing renewable energies, via establishing wind farms and harnessing solar energy. In addition, innovative energy companies could consider further efforts to decrease coal mining and other fossil fuels. Currently, gas and oil prices are expected major price shocks, increasing to a five year high.

Indeed, it will take several months to determine the full impact of Hurricane Harvey on the US economy. The consensus, so far, is that it won’t cause a drastic impact on economic growth in the long-run although early forecasts suggest that Harvey would be the most expensive natural disaster in US history.

The CAINZ Digest is published by CAINZ, a student society affiliated with the Faculty of Business at the University of Melbourne. Opinions published are not necessarily those of the publishers, printers or editors. CAINZ and the University of Melbourne do not accept any responsibility for the accuracy of information contained in the publication.