US-Build requirement for ships imposes dilemma on noncontiguous jurisdictions

by Michael Hansen, Hawaii Shippers Council

A dilemma is facing the domestic noncontiguous jurisdictions of the United States – Alaska, Guam, Hawaii and Puerto Rico – in regards to interstate surface transportation. On the one hand, their geography imposes an exclusive reliance on ocean shipping and federal maritime laws require vessels engaged in the noncontiguous trades be built in the United States. While on the other hand, the prohibitively high cost of new construction at the major shipbuilding yards on the United States mainland nearly precludes all new ship orders. This situation has resulted in an ageing noncontiguous trade fleet of oceangoing deep draft ships that now averages over 28 years old; making ship replacement a critical economic issue for the noncontiguous jurisdictions.

The navigation laws of the United States, popularly known as the Jones Act, require that vessels transporting cargo and passengers between domestic points must be U.S.-Flag, U.S.-Crewed, U.S.-Owned and U.S.-Built. These requirements pertain to all the domestic noncontiguous jurisdictions with the single exception of the application of the U.S.-Build requirement to the Territory of Guam. Although exempt from the U.S.-Build requirement, Guam obtains very little advantage from this more liberal provision of the law. This is primarily because the Westbound domestic container trade to Guam depends on its linkage to Hawaii, which requires U.S.-Built ships, to be operated successfully.

The Jones Act requirements most acutely affect the domestic noncontiguous jurisdictions because they have no surface transportation alternatives to ocean shipping. In comparison, on the contiguous United States, railroad, inland barge, pipeline and road truck carriage is readily available. The high cost of domestic ship construction coupled to the availability of these alternatives has resulted in a limited number of oceangoing ships (as opposed to tugs and barges) engaged in the domestic coastal and inter-coastal trades. Virtually all the deep draft ships in the coastal trades are product tankers that carry distillate fuels such as gasoline and diesel fuel. In contrast, approximately half of the self-propelled domestic oceangoing fleet – largely containerships -- is employed in the relatively small noncontiguous trades, making those jurisdictions uniquely sensitive to the economics of deep draft commercial U.S. shipbuilding.

The ability to access new ships at a reasonable cost profoundly affects the capacity of ship operators to provide shipping services. Clearly, the acquisition cost of a ship is a key component of any shipping company’s capital structure. However, it is also essential for operators to regularly replace their fleets at realistic intervals with technically modern ships at internationally competitive prices. New ships allow operators to keep abreast of new designs and technology, avoid higher operating and maintenance costs incurred by older ships, and achieve the necessary efficiencies to charge reasonable freight rates and provide adequate service levels.

The major U.S. shipbuilding yards do not deliver new ships meeting these specifications because they have become uncompetitive under the protectionist shield of the Jones Act. The cost of building large oceangoing ships in the United States is at least three times greater than at the internationally competitive shipyards in Japan and South Korea. The process of contracting for a commercial oceangoing ship from a major U.S. shipbuilding yard is cumbersome, fraught with difficulties and subject to delays in delivery and significant cost overruns. These contracting practices reflect the U.S. shipyards heavy reliance on military construction. While, the few deep draft commercial ships constructed each year in the United States are typically built under license to a foreign shipbuilder, and not to a domestic design.

The high cost and lack of competitiveness of major U.S. shipbuilding currently burdens the businesses and residents of the noncontiguous jurisdictions with several adverse consequences:

• · Imposes large barriers to entry thus restricting competition in the noncontiguous trades.
• · Limits the construction of new ships by the existing domestic ship-operators who either don’t have the financial resources or have chosen not to build as it doesn’t make sense.
• · Results in the operation of older and inefficient ships well past what would be considered their useful life in international trades.
• · Leads inevitably to higher freight costs including excessive bunker (fuel) surcharges as operating older ships is inherently more expensive due to elevated fuel consumption, larger crews, less efficient cargo handling and significantly more maintenance.
• · Lessens the level of service as older ships are withheld from service and not replaced.

In the future, if it becomes necessary to substantially replace the oceangoing noncontiguous fleet within the current restrictions of the Jones Act, much higher freight rates would be required to justify constructing the ships in the U.S.

Virtually all the major shipowners operating in the domestic noncontiguous trades support the Jones Act in its current form, including the U.S.-Build requirement. Ostensibly, this position would not seem to be in their best interest because of their many inefficient and ageing ships that need to be replaced. The bottom line for certain of these shipowners is that they do not have the financial resources to renew their ageing fleets in U.S. shipyards. Instead, if they could acquire Foreign-Built ships for U.S.-Flag operation in the domestic noncontiguous trades, it would substantially increase their ability to replace their ships with modern tonnage significantly lowering their capital costs and improving their operating efficiencies.

However reasonable it might seem to allow Foreign-Built U.S.-Flag oceangoing ships into the noncontiguous domestic trades, the Jones Act shipowners perceive their fate is tied to maintaining the U.S.-Build requirement. They believe their support for the U.S.-Build requirement is politically necessary to hold together their pro Jones Act coalition with the maritime unions and shipyards. Equally important, they don’t want lower barriers to entry which would only serve to encourage new competition to the noncontiguous trades.

One of the primary arguments against allowing Foreign-Built U.S.-Flag ships into the domestic trades is the perceived labor cost advantage enjoyed by foreign shipyards that is said to be unfair. The three leading shipbuilding countries today are China, South Korea and Japan. Typically the more technically challenging ships are constructed in Japan and South Korea where labor compensation rates are at first world standards in Japan and approaching those levels in South Korea. Even in China, the major shipyards are on the seaboard where labor rates are the highest and the skilled shipyard workers are some the highest paid in those areas. Ergo, labor rates are not the main reason why U.S. shipyards are uncompetitive.

Inefficiency is the principal reason the major U.S. shipyards are not competitive. There are management and facilities issues. The U.S.-Build requirement is highly protectionist and prevents competitive pressures from being brought to bear on the major U.S. shipyard managements and trade unions to achieve the efficiencies of the international yards. Most yards are saddled with legacy labor contracts and managements often deal with multiple unions in the same yard organized along craft lines. The yards themselves also tend to be inefficient older facilities that haven’t been fully upgraded as their counterparts in East Asia and Europe.

The two most important production practices that allow the East Asian yards to be internationally competitive are: (i) yard specialization – concentrating on building a single type and class of ship; and, (ii) series production – building the same type and class of ship over time. These shipyards achieve their great efficiencies through specialization and long production runs.

As a rule, an international shipowner wishing to order a new ship (or series of ships) will seek out a shipbuilder who builds the desired type and class of ship. The design is usually the yard’s own proprietary design that they have perfected over time through series production. The shipowner may ask the yard to make some modifications to the yard’s standard design, but those modifications won’t substantially change the delivery specifications.

The very limited number of U.S. shipyards still building commercial deep-draft oceangoing ships could not possibly achieve the necessary efficiencies to build the several different types and classes of ships needed in the Jones Act market at internationally competitive prices. A shipyard must export most of their production as do the East Asian yards to successfully achieve series production of a particular type and class of ships. This is true for any shipyard anywhere in the world as no single domestic ship market is large enough to allow its shipbuilders to achieve these levels of specialization and production.

The U.S. shipbuilding industry is at the end of a long historic decline that has seen the number major shipyards drop by more than 70% since 1970. Today, there are eight yards normally classified as “active major shipbuilding yards” theoretically capable of building large self-propelled commercial ships. Five of the eight yards exclusively do military construction.

Three (including two of the yards performing only military construction) are widely thought to be subject to closure in the near term. The three yards accepting commercial business are:

· Aker Philadelphia Shipyard Inc., Philadelphia, Pennsylvania

· National Steel & Shipbuilding Co. (NASSCO), San Diego, California

· VT-Halter Marine Inc., Pascagoula, Mississippi

The total production of commercial deep draft ships in the U.S. is too low to permit specialization and series production. Since the termination of the Construction Differential Subsidy (CDS) program in the mid-1980, the major U.S. shipyards have delivered an average of fewer than 3 deep draft commercial ships per year. In 2011 only a single commercial deep draft oceangoing ship was delivered by a U.S. yard, the product tanker, OVERSEAS TAMPA, by Aker Philadelphia. No commercial ships are scheduled for delivery in 2012, three ships are scheduled for delivery in 2013 and two in 2014.

The primary concern for the noncontiguous jurisdictions is the common carrier / liner shipping sector that provides regularly scheduled domestic container, trailer and vehicle cargo service with the contiguous United States. These services have the largest impact on the price of goods sold in the noncontiguous jurisdictions. There are six common carriers engaged in the domestic interstate noncontiguous trades of the United States as follows:

· Horizon Lines Inc. – Alaska, Hawaii & Puerto Rico Trades – 15 Cellular Containerships – average age 35 years

· Matson Navigation Company Inc. – Hawaii & Guam Trades – 11 Cellular Containerships & 2 Ro/Ro Trailerships – average age 25 years

· American Shipping Group (Saltchuk Resources Inc.) – Alaska (TOTE) & Puerto Rico (Sea Star Shipping) Trades – 8 Trailerships – average age 28 years

· Crowley Maritime Corp. – Puerto Rico Trade – 8 Trailerbarges – average age 36 years

· Trailer Bridge Inc. – Puerto Rico Trade – 2 Trailerbarges & 5 Containerbarges – average age 18 years

· Pasha Hawaii Transport Lines – Hawaii Trade – 1 Ro/Ro vehicle carrier – age 7 years

With the exception of Pasha Hawaii, the other five operators are facing the need to replace all or nearly all of their deep draft ships and large oceangoing cargo barges that average 28 years old. Typically in the international trades, ships are scrapped at approximately 20 years of age. However, because of the extreme expense of building replacement vessels in the United States as required by the Jones Act, these domestic noncontiguous common carriers put-off buying new vessels and continue to operate ageing vessels well past 20 years of age.

The employment of large oceangoing cargo barges for regularly scheduled service in competition with deep draft ships on relatively long routes in the Puerto Rico trade is an anomaly created by the Jones Act. If the noncontiguous trades were exempted from the U.S.-Build requirement of the Jones Act, it is likely that Crowley and Trailer Bridge would not employ barges but would use cellular containerships and trailerships. For example, Crowley operates nine liner container services from the U.S. East Coast and Gulf Coasts to the Caribbean and Central America, two are U.S.-Flag trailerbarge services to Puerto Rico, and the remaining seven employ Foreign-Flag cellular containerships. Clearly when given a level playing field, the deep draft ship mode is more efficient than barge service in these trades.

It is also important to note that there are no Jones Act common carriers operating in the U.S. coastal and inter-coastal trades due to the cost of suitable U.S.-Built Jones Act ships and the ready availability of alternative transportation. While the regulations applicable to other transportation mode subject to a similar cabotage regime – Aviation, allow operators to acquire Foreign-Built aircraft for U.S.-Flag operation on all domestic routes including noncontiguous and contiguous.

Many in the Jones Act industry are hoping that the U.S. federal government will subsidize the construction of deep draft oceangoing commercial ships in the United States. However, it appears unlikely that the U.S. government will provide construction subsidies to build ships in U.S. shipyards. The U.S. federal government seems to be facing significant budget cuts for the foreseeable future. The last ship construction subsidy program known as the Construction Differential Subsidy (CDS) program was ended in the mid-1980s amid huge cost overruns and a loss of control by the administrating agency.

The Hawaii Shippers Council believes it is now the time to exempt the noncontiguous trades from the U.S.-Build requirement for large deep draft oceangoing commercial ships. Exempting the noncontiguous domestic jurisdictions from the U.S.-Build requirement of the Jones Act would permit operators to acquire technically modern ships of the right type and class for the trade they wish to participate in at internationally competitive prices and revitalize the domestic noncontiguous trades.

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