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Quantifying the Jones Act

By Simon Jacques

Feb 02, 2015
 

Analysis quantifying the costs and implications of the US Jones Act.

 
 

One Jones Act unit vs One Foreign Flag Vessel Unit

 

WHAT THE HERITAGE FOUNDATION GOT WRONG ABOUT THE JONES ACT

 

The Merchant Marine Act of 1920 (P.L. 66-261), also known as the Jones Act (JA) requires all vessels shipping cargo between two US locations to be US built, majority US-owned and at least 75% of the crew to be US citizens. There is indeed a conventional wisdom about the Jones Act (which is very located in the heart of the O&G industry saying that the Jones Act is a form of protectionism harming U.S refining margins.

 

U.S refiners have acknowledged that repealing the JA is nearly impossible, now the strategy is to push to get waivers on the Jones Act.

 

However waiving the Jones Act could add uncertainty in the U.S Shipping industry thus slowing capital investments in the U.S fleet with the unintended consequence of pushing-up rates higher.

 

One of the best-known and one most influential think tank, the Heritage Foundation, has written a piece entitled  The Jones Act’s Costly Impact. The fact is that almost nobody including the Heritage Foundation, has ever provided substantive and solid benchmarking on the Jones Act.

 

One hint is that beyond this political debate, there’s always a complex market-driven process.

 

 

What is driving up the Jones ACT numbers?

 

The Economics.

 

 

Demand

 

 

 The U.S is producing Crude Oil at level unseen since 1986

 

Supply

 

 

The U.S Flag Fleet tonnage is at an all-time Low

 

The market situation for Jones Act is (high demand/tight supply). Meanwhile the exact reverse prevails in the International Seaborne Freight Market (excess-capacity). The Jones ACT tanker market should not be regarded as different as any other markets; it’s the Supply and the demands that are moving charter rates up and down.

 

Oftentimes, a lot of folks talk about trade regulations but at the end it’s always policies within the economics context that drives up all those numbers in the real world.

 

During a recent panel discussion on oil exports, Graeme Burnett, senior VP for fuel optimization with Delta Air Lines estimated that oil shipping costs from the US Gulf Coast to Rotterdam would be $2/bbl versus $6/bbl from the Gulf Coast to Philadelphia.

 


Backtesting

 

To bring more clarity about the Jones Act Shipping Cost, we have decided to backtest the two following routes.

 

  • For Corpus-Christi/Rotterdam, cargo is 330,000 bbls on a LR1 Foreign Flag Vessel.
  • For Corpus-Christi/Marcus Hook (Delta’s Trainer, PA Refinery), the cargo is also 330,000 bbls,but the vessel is the M/V Pennsylvania U.S Flag Tanker.

 

During October, USG/Europe was traded @ $12,558/day giving an estimate for this route @ $4.15/bbl. According to Burnett, the estimate for this route is $6/bbl.

 

We have backtested Burnett’s numbers and we only get $6/bbl if the vessel was chartered at $84,000/day at the top of the range.

 

 

Size does Matter

 

While The Marcus Hook Industrial Complex, PA can technically berth Suezmax and VLCC size vessels, the maximum draught on the Delaware River is 40 FT.

 

It means that a VLCC unit laden with North-Sea can’t be laden down to its load lines (full capacity) if the final destination is Trainer refinery and we can’t get 2$/bbl on a fully laden VLCC (70 FT).

 

 

Corpus-Christi/Rotterdam

LR1 FFV Voy.

Corpus-Christi/Marcus Hook, PA

U.S Flag Voy.

  $/bbl $/bbl
Oct 2013
4.15 (SJ)
4.25 (SJ)
Oct 2014
4.15 (SJ) 6 (B) 

 

(J) Simon Jacques

(B) Burnett

 

On an Apple-to-Apple basis comparison, the conventional wisdom about the Jones Act can’t be proven. Freight costs/barrel  estimates on the two routes aren’t significantly different.

 

 

Timing element

 

Timing of investment is a key to success in both U.S Flag and International shipping. This is because freight rates are sometimes very high for long enough periods of time to make a ship look more like a money machine than a normal production unit.

 

This timing element is within both Jones Act and FFV transportations costs. The estimate for the voyage was $4.25/bbl when Jones ACT rates were assessed in the $50,000/day.

 

 

Financial and Balance Sheet Matters

 

Because Jones Act is thinly trade it is difficult to draw the frontier between operational and capital costs on a balance sheet thus getting a precise $/bbl estimate per voyage.

 

Because Jones Act charters signed between parties have very long terms, they are susceptible to be capitalized by an accountant pen at an Oil Refiner. If the charter is capitalized, the charter liability will be treated as an asset on the balance sheet.

 

3.48$ is the implied transportation cost/bbl for a Jones ACT MR-Size Tanker under these assumptions:

 

  • Jones Act Charter (the C/P is capitalized on the B/S)
  • Term= 10 years
  • 2 USGC/Marcus Hook, PA trip/ month

 

The asset value of this charter will be determined at the delivery of the vessel. PV Charter  =  Sum Monthly Rate/ (1+i)n

 

 

Example:

  • i= 4.5%
  • Charter Term = 10 years
  • PV =  $197,428,227.31 

 

Using the straight-line depreciation = $19,742,822.73  /year

 

 

 

  • Monthly depreciation    $1,645,235.23 
  • 2 trips/ month equates to 2.49  $/barrel Capitalized lease cost

 

We can add the voyages expenses per month to the capitalized lease cost per barrel to obtain a total cost per barrel.

 

  • 325,000 voyage ex. Houston/ Marcus Hook
  • 650,000 voyage expenses/ Month

 

(Capitalized lease cost ($/per bbl/Month)  +  Voyage expenses $/Month)   /  barrelsWe get $3.48/bbl                             

                 

 

The Suezmax Case

 

So far we have compared the 45,800 DWT M/T Pennsylvania with a FFV unit of a similar size.

 

Now we would like to compare a bigger size: the Suezmax (150,000 DWT).

 

Cost         JA Suezmax

$/bbl        1.28*

$/bbl        2.11**

$/bbl        4.22***

 


*2 RV/month on a JA newbuilt Suezmax 10 years charter= $1.28/bbl (assuming API 40, 991,000 bbls cargo, 15/13kts, 6d laden, 6 days ballast, 2 days loading, 1 day disch., +5% sea/weather margin)

  

**1 RV/month on a JA newbuilt Suezmax 10 years charter= $2.11/bbl (assuming API 40, 991,000 bbls cargo, 15/13kts, 6d laden, 6 days ballast, 2 days loading, 1 day disch., +5% sea/weather margin)

 

***.5 RV/monthon a JA newbuilt Suezmax 10 years charter=$4.22/bbl (1 RV/2 months , (because of unfavorable oil markets conditions or because the unit is used for storage).

 

 

FFV Suezmax TD5 Bonny - USEC

 

TD5 is the Baltic assessment for the Suezmax route TD5, 130,000 mt W Africa to US Atlantic coast, 130,000 mt.

 

As you can see the Suezmax market is red-hot right now, we are well-above the 2$/bbl assumed by Burnett. The Suezmax markets have climbed to their highest levels in over six years.

 

  • TD5 spot voyage= $4.29/bbl****
  • TD5 15’= $2.89/bbl ****

 

 

 

 

****Marex Spectron Tanker curve spreadsheet 2014-11-19 , we have used their $/MT with a API for bonny @ 35.3 degree to get $/bbl.

 

 

Jones Act Tanker, TTT (trader trading tool)

 

Shipping markets are recognized today as a key component of commodity trading.  For those actors who own vessels readily available for various destinations, “geographical arbitrage” may be achieved when the IFS is ­> than Cost shipping.

 

The Jones Act tanker unit in the spot voyage basis USGC/USEC is traded ≤ the marginal light crude oil price differential between the USEC and the Gulf Coast. This Implied Freight spread is tying up cash prices between the U.S Atlantic Coast and the U.S Gulf cost.

 

We have also demonstrated that spot rate are persistently priced above the long-term implied $/bbl. The $5 to $6 cost/bbl from Houston to USEC in the spot market reflects;

 

  • the prompt Brent CIF USEC- USGC FOB light crude oil spread
  • a certain convenience yield or benefit of owning a unit for a voyage in the spot market

 

 

A certain convenience yield or benefit of owning a unit for a voyage in the spot market?

 

No-Arbitrages Cash and Carry Formula. [1.1]

 

 

  • F0 = The forward market is not active in the U.S Flag Tanker market. However, in the long run, freight rates should gravitate towards the long-term marginal production cost per unit, this value based on 10 year c/p, new Suezmax Construction is the implied Forward in $/bbl.
  • So = spot in $/bbl
  • i= interest rates
  • y= convenience yield
  • t= time to the expiration of the charter.

 

$2.11 = $5 e (0.045–y )10

 

Solving y:

2.11=5e( 0.045-y)10

ln(2.11/5)=( 0.045-y)*10

ln(2.11/5)=( 0.45 -10y)

[ln(2.11/5)-0.45]/10 = y

y= 0.13127

 

The high convenience yield, could be explained by the relative scarcity of the Jones Act fleet ((current utilization for the coastal fleet is in the 90% to 95% range and the listing is limited.

 

Finding the theoretical forward value by interpolation.

 

F0= Soe(c-y)t      [1.1]

So= $6

$2.11 = 6e(0.045–0.13127)*10

$2.11­< 2.53213

 

It suggests selling spot voyages and buying a long forward position on Jones Act.

 

 

Brent CIF USEC – USGC FOB light crude oil spread

 

It is not certain that crude pricing will be favorable for Jones Act on average in the future because past relationships aren’t always indicative of future in the energy markets.

 

For the next decade, if on average, Brent-priced foreign oil is at +2 over the ICE Brent crude futures delivered to the USEC and U.S crude oil in the USGC is averaging between 0 and -3 under the ICE Brent;

 

Brent USEC +2

Minus

JA freight +2.11*

USGC -3

———————————–

 $2.89/bbl

 

 

PV Savings
$ 221,294,233
PV 10 yrs C/P $ 197,428,227
NPV
$ 23,866,006

 

 

*The Conservative assumption is: (1 voy/month x $2.11/bbl x 12months x 10 years)/ (1+i)10 = $221,294,233.

 

 

While the PV for the 10 years Suezmax charter was $197,428,227  NPV= $23,866,066 in Shareholders’ pockets. There is a world of possibilities to use this Jones Act Tanker.

 

By chartering a Jones Act Suezmaz, Atlantic Coast refiners, banks and traders can effectively lock the U.S crude oil economics in their favor for the next decade. It’s a gamble on the U.S energy renaissance.

 

We hope that this article has aroused the curiosity of our readers and will provoke waves because on an Apple-to-Apple basis comparison right now, we can’t prove the myth about Jones Act harming U.S East Coast refiners’ transportation costs.

 

In the paper we have underscored that timing , not just policies are determining winners and losers in this energy and shipping trade (both international and U.S Flagged).

 

Oftentimes, a lot of folks talk about trade regulations but at the end it’s always policies within the economics context that drives up all those numbers in the real world.

 

Finally, we are pointing out the capitalization of a long-term Jones Act charter can yield an even lower transportation cost/bbl that may be used to bet on the crude oil markets conjecture.

 
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  • Lars Christian Haugen :   Great article, I especially loved the charts on US oil production and the tanker fleet. Thanks for putting this out Simon. Cheers, Lars Christian

    Sep 09, 2015

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