Jones Act Product Tanker Outlook

Bind the hands of time back about three years and the Jones Act recipe sounded tasty; add one part Oil Pollution Act of 1990 (OPA) with its mandated phase-out of existing single-hulled vessels between 1995 and 2015, sprinkle in an aggressive marketing effort by the shipyards who were interested in developing commercial contracts, add a dash of US Maritime Administration's Title XI financing program and sit back and wait for rates to go sky high. And wait. And wait. And wait.

What was missing from the Jones Act recipe was one important ingredient - demand.

While the strategy of capitalizing on the short supply of qualified vessels may have inspired a number of newbuilding orders, shipowners anticipated neither the impact of diminished demand for this new tonnage nor the precise dates when vessel supply would be reduced. Since 1994, rates have held at about $20,000-$22,000 for term charters of steam tankers while the spot market has recently dipped down as low as $15,000 a day.

The $65 million question (you could pay that to build a Jones Act product tanker today): will the decrease in demand amount to more or less than the ultimate decrease in supply?

Supply
The supply of Jones Act product tankers has been bolstered by two factors that operate outside the realm of conventional economic forecasting; Marad's Title XI financing program and the de-rating of vessels thereby allowing them to trade longer than originally anticipated.

Briefly, Title XI financing, a provision of the Merchant Marine Act of 1936, allows for the US government to lend its AAA credit rating to borrowers for up to 87.5% of the actual cost of a newbuilding project. While Title XI has been the source of some differences of opinion among owners, it is interesting to note that not all Jones Act owners actually use Title XI financing. For example, companies such as Mobil and Arco have financed their Jones Act newbuildings internally.

The second factor that has prevented Jones Act product rates from rising has been a less than anticipated level of scrapping. Going forward, it is difficult to predict at what rate ships will go to the proverbial boneyard. While OPA mandates will balloon shortly after the turn of the century, and with heavy retirement around 2005 and 2006, Jones Act optimists speculate that special surveys will turn up problems that may not be worth fixing for the remaining years of service restricted by law. Sweeten that up with a front haul of grain on the way to breakers and some think you might see some of the old iron ladies go to bed early. We'll have to wait and see.

Further, many argue that supply levels have also been affected by oil major fleet sell-offs to private owners. While the total available tonnage may not change by virtue of this trend, it does affect dwt availability in that, historically, oil companies were more inclined to run their own ships with holds in ballast. Independent owners understandably take a different view.

Demand
Analysis of the demand side of the Jones Act equation is the most puzzling element in trying to predict the future of rates. While the US coastwise trade may be known for having high barriers to entry, end users are far from a captive market even for those who have scaled the regulatory walls to get inside. To the contrary, rates in the trade are effectively capped, at least on the upside, by the number of alternatives to domestic seaborne product carriage including pipelines, barges, foreign flag imports and cargo swapping arrangements.

By way of example, Jones Act long-haul cargoes which originate in the US Gulf Coast destined for California or ports in the northeast, have been cut into by foreign ships which call directly at Boston, Jacksonville, or Portland, Maine. In the past, ton miles were generated by carrying cargo to such regional ports from transshipment hubs like New York or Houston where foreign flag ships would call. In addition to the reduction of ton miles, many hoped that reformulated gasoline transport (a substance referred to by one shipowner as "really scary stuff") would exceed pipeline capacity due to the federal RFG program in 1995 and strengthen rates. But, alas, such was not the case. In the east increased capacity from the mid-Atlantic refineries and imports from Europe and Caribbean, combined with the infamous "opt-outs" of 1995, reduced the need for coastwise shipments. Meanwhile, on the west coast local refiners and long haul imports from the middle east cut cargoes in half last year.

While the upside for Jones Act owners is limited, the downside is not. As a result, in a gloomy rate environment like the present one, it is actually the oil majors ("the sharks" as one owner casually refers to them) that have the upper hand by tempting owners with longer term charters, effectively compelling them to leave the market upside (for which the owners entered this sleepy market in the first place) on the table.

Future Prospects
So what does all this mean for the future of the Jones Act product fleet? We believe that much of the "doom and gloom" that hangs over the future of the Jones Act product fleet is brought about by those who are trying to guess the bottom. However, as we all know, newbuilding orders chase strong markets, they don't create them. Therefore, conviction, faith and patience will be the trick to catching this market.

Going forward, the fine line a successful owner will have to walk will be one of having ships ordered early enough to keep newbuilding prices within the realm of rate ceilings while at the same time having the vessels delivered late enough to have such newbuildings enter a market with some strength.

The Hvide/Van Ommeren (HVO) joint venture which has on order five 45,300 dwt double-hull petroleum products carriers from Newport News might be such an endeavor. We believe that it is possible that these ships may be the last viable new tonnage to enter the market based on the newbuilding cost and the timing of delivery. Let's run the numbers:

The aggregate cost of the five HVO vessels is estimated to be $255.0 million, of which approximately $40.0 million will constitute equity investment and $215.0 million will be financed with the proceeds of government guaranteed Title XI ship financing bonds issued in March 1996.

Based on a 25 year mortgage-style amortization, from a cash on cash standpoint, the vessels will need to earn about $10,500 per day (7.54% of the $215 million in Title XI bonds), add to that initial operating costs of about $13,000 per day (by initially we mean until maintenance costs arise) and the new ships will require about $23,500 per day to get into the black, a return on the equity portion not withstanding. Brokers report that such ships have fetched $25,000 per day in a market that will get stronger by virtue of vessel attrition.

While the margins may appear tight at first blush, we have heard estimates that Newport News is losing about $19 million per vessel and now that the yard has about a $3.5 billion backlog, it will be interesting to watch if the yard will engage in such projects in the future.

Some of the Players
The Jones Act product tanker owning community is a small one. In fact, one person we spoke to estimated the market to have about 65 vessels servicing a market with a 50 vessel baseload demand (he defined this fleet as consisting of vessels of 70,000 dwt and below). As such, an action taken by one player in the market might well have an equal and opposite effect on another. Below we have provided a profile of the owners who have either been active recently or whose presence in the trade we find interesting. While major players such as Keystone are not profiled below, that is because we have found the availability of reliable information limited.

American Heavy Lift
Jones Act Fleet: (4 vessels) 38,000 dwt vessels delivered in 1996-1997

Marine Money Comment
The American Heavy Lift vessels were among the first round to be retired under the initial five year OPA retirement mandates. With that in mind, the ships went into Avondale with Title XI financing and emerged about $160 million later (expensive when you consider that the brand new HVO ships built at Newport News were only a few million more each) with new forebodies.

As we mentioned above, one essential ingredient for success for Jones Act newbuilding owners is the timing of when the ships enter service. The American Heavy ships entered the market before retirement mandates caused a strengthening of rates. It will be interesting to watch what happens in November when the company must make a repayment to Marad in a freight market where owners have not been able to build cash reserves.

Hess
Jones Act Fleet Profile: (6) 47,000 dwt vessels delivered in the the mid-80s

Marine Money Comment
Hess is one of the only part-time operators in the Jones Act and is considered one of the greatest threats to rates. Some brokers and owners seem to feel that the industry is "in denial" of the impact that these vessels will have when rates pick up.

The strategy works like this; when a good spot market develops from MTBE trading to the West and #2 oil trading to the Northeast, the Hess ships, which normally trade in the Caribbean, can pop up and grab the cargoes and push rates back down. Each ship carries about 40% more cargo than a typical Jones Act ship and therefore the six vessels can have a profound impact on rates.

Crowley
Jones Act Tanker Fleet Profile:
Coast Range 42,000 dwt, built early 80s
Blueridge 42,000 dwt, built early 80s

Marine Money Comment
In 1997 Crowley and Keystone made a joint bid for the 3 vessel Unocal fleet from Tosco. In the end, Crowley walked away with two 42,000 dwt double-bottom, early 1980s-built product tankers and Keystone took the third.

Crowley's entry into the Jones Act trade is significant. The vessel Coast Range is presently on charter to Tosco while the Blue Ridge is trading in the spot market. There is a sentiment that the company may take a more significant position in the Jones Act product tanker trade in the near future.

Kirby
Jones Act Fleet Profile: (7) vessels ranging with in size from 210,000-270,000 barrels, average age 30.6 years

Marine Money Comment
Two recent events mark Kirby's possible exit from the bluewater Jones Act trade.

First, while the company indicated in early 1997 that it intended to purchase the remaining marine assets of Sun Transport, when the decision came before the Kirby board it was rejected at the 11th hour. Next, Kirby put the Sabine fleet up for sale.

Kirby's decision to sell Sabine may be based on factors independent of Jones Act pessimism. Some think that the challenges which the company experienced in the South American liner trade and through the purchase of Afram carriers, a breakbulk operation that was wounded when the preference market collapsed, may simply have encouraged them to focus on the highly profitable brown water business.

Mobil
Jones Act Fleet Profile: American Progress, 42,500 dwt double-hulled product tanker.

Marine Money Comment
Mobil is the last of the oil majors to remain on the owning side of the market, with Sun finally selling its fleet to Maritrans during the summer. The Progress replaced the Seminole, which formerly ran the Beaumont route, and was due to be scrapped in October of 1997.

Maritrans
Jones Act Tanker Fleet Profile:
31,382 dwt New York Sun
(on charter to Military Sealift Command)
34,000 dwt Philadelphia Sun
40,000 dwt Chevron Oregon
40,000 dwt Chevron Louisiana

Marine Money Comment
The summer of 1997 was a particularly active one for Maritrans. The company became the newest addition to the Jones Act product tanker owning community when it purchased 2 product tankers from Sun and about a month later acquired the Chevron ships. Acquisitions notwithstanding, the company has options to build up to six product tankers for the US domestic trade at Avondale and presently has a bid out to have one of its 190,000 barrel barges fit with a double hull.

While Maritrans has been carefully calculating its entry into the self-propelled Jones Act trade, the company's entry into the market was an ideal opportunity to extend existing relationships.

Hvide/Van Ommeren (HVO)
Jones Act Vessel Profile: The HVO joint venture has orders to build five 45,300 dwt "Double Eagle" doubled-hulled tankers at Newport News. Briefly, Hvide owns a 2.4% equity stake in the vessels which can grow to as much as 75% through the exercise of a series of options extending through 2002. Van Ommeren owns 25% of the deal while an investor group and Newport News each own 23.4% and 49.3%, respectively.

Marine Money Comment
The rationale behind the HVO project was to get quality ships built on the cheap with Marad money in time for the rising market. As discussed above, the HVO vessels have the potential to be the last economically viable newbuildings that will come out of US yards.

HVO's entry into the market has not been without incident. While the company sued Marad to disallow the American Progress from trading in the Jones Act, it is understandable.

While the group clearly did not take issue with Mobil's motivation, it was the potential impact of the other three Eletson Double Eagles falling into the hands of independent Jones Act owners that posed the biggest threat. While such fears have dissipated and the market is more comfortable that Eletson will take delivery, Jones Act owners must be holding their breath until the ships sail into the sunset.

Newport News
Jones Act Fleet Profile: Newport News owns a 49.3% interest in five doubled hulled Double Eagle product tankers on order for the HVO joint venture.

Marine Money Comment
More than 100 years ago, the founder of Newport News, Collis Potter Huntington, is noted for having summed up the company's philosophy; he said "We shall build good ships here - at a profit if we can, at a loss if we must- but always good ships."

In trying to assess Newport News' role in the Jones Act, Mr. Huntington's 100 year old statement begs a significant question; if the yard has a $3.5 billion backlog (85% of which involves aircraft carrier work) and a private vessel construction business that is hemorrhaging money to the tune of $19 million per vessel, according to Mr. Huntington's logic, doesn't the yard have no choice but to get out of the commercial tanker construction market?

Curiously, the day that Newport News CEO Fricks announced that the yard had lost money on the ships, the company's stock went up. We will leave it to the reader to decide what the market was trying to tell him.

United States Government
Jones Act Fleet Profile: (5) vessels 30,000 dwt; 5 vessels are presently part of the US Military Sealift Command. MSC options indicate that these vessels could be returned to private ownership as early as 2,000 and as late as 2,004.