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 costsfrom 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) / barrels. We 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.

All conversions and rates ($/bbl, $/day, other estimates) and opinions provided are made in

good faith. A courtesy of