It is impossible to comment on the state of the U.S. shipping market without mentioning the Jones Act. Amid surging U.S. oil production, this once-obscure 95-year-old piece of federal legislation has re-entered the public focus, bringing back memories of Political Economy 101 – evoking concepts of free trade, protectionism, competitive advantage and laissez-faire economics. Originally designed as a protectionist measure to ensure defense and promote the domestic water-based transportation industry, the Jones Act is under fire from many who consider it the culprit for transportation bottlenecks and market distortions.

While it may seem that the current debate is new, conflicting viewpoints are reflected as early as Adam Smith’s 1776 publication of The Wealth of Nations. Smith insisted that a government’s “core functions are maintaining defense, keeping order, building infrastructure and promoting education,” yet he also argued that the government “should keep the market economy open and free, not acting in ways to distort it.”

In this article, the CMU does not seek to comment on the political aspects of the current debate. Instead, we trace the history of the Jones Act, analyze its current impact on the U.S. shipping industry and offer some practical insights into the future.

Winter 2013 to 2014 brought freezing temperatures and heavy snowfall to the Northeast, as well as thrusting a relatively obscure piece of transportation legislation into the spotlight. Road salt, a key and oft-taken-for-granted material in the emergency response chain, was in short supply – and the Jones Act was standing in the way.

From February 6 through February 12, 2014, Newark, New Jersey, did not log a single temperature over freezing; the city recorded a 260% increase in snowfall in 2014 compared with its average winter. As Newark’s supply buffers of road salt dwindled against skyrocketing demand, and yet another snowstorm moved their way, officials at the New Jersey Department of Transportation clamored for a solution. They found one: a 40,000-ton pile of road salt sat just 400 miles away on the coast of Maine near a vessel willing to bring it south. Yet upon discovery that the ship did not hail from the United States, the U.S. Department of Transportation banned it from completing the delivery.

In the face of icy roads, disrupted commutes and a potential slowdown in interstate commerce, why did the federal government prohibit the vessel from making this crucial delivery? The answer lies in the Merchant Marine Act of 1920, colloquially referred to as the “Jones Act.” The 95-year-old law states that all goods transported by water between U.S. ports must be carried by U.S.-flagged ships that are constructed in the U.S. and are owned and crewed at least 75% by U.S. citizens. This once-sleepy piece of federal legislation – originally created to support a strong U.S. merchant marine and domestic shipbuilding industry following World War I – has re-entered the public debate.

A Historical Perspective: Protecting a Strategic Industry

The author of the Jones Act, Sen. Wesley Jones of Washington state, was determined to help maintain the U.S. maritime industry after military demand from WWI dissipated. Recognizing that skilled shipbuilders were an invaluable resource during times of war, the senator vowed that the U.S. would remain committed to protecting and growing this strategic segment of the domestic labor force in times of peace. The act was meant to support the U.S. military, permitting the Navy to use commercial ships to transport men and arms when necessary. It also allowed the U.S. government to sell the superfluous cargo ships constructed for WWI to the private sector. Perhaps not coincidentally, the act served to safeguard the shipping industry in Washington, Jones’ home state, by ensuring that Alaskan businesses remained dependent on Seattle’s ships.

Such legislation is not outside of historical norms; the United States had passed protectionist shipping laws as early as the colonial era to protect the shipbuilding industry in New England. In order to support this burgeoning industry after the Revolutionary War, the United States passed a series of cabotage laws, specifically tariffs on foreign vessels, throughout the 18th and 19th centuries.

At its core, the Jones Act was originally an act designed to protect American national defense. The economic result has been the protection of the domestic shipping industry against foreign competition. Skyrocketing U.S. oil and gas production in the past six years, however, has raised a question over whether the Jones Act’s value to national defense justifies rising shipping costs and capacity challenges in today’s global marketplace.

The Jones Act Today: The Scramble for Transportation Solutions

The explosion of domestic shale oil production has dramatically changed the U.S. energy landscape over the past six years. In 2009, the U.S. imported 9.4 million barrels (bbl.) of crude oil a day. Today that number has dropped 21% to 7.4 million bbl. per day, a direct result of increased domestic oil production, which rose from 5.3 million bbl. per day to 8.7 million bbl. per day (64%) during the same time period, even as demand stayed relatively flat.1

Across the continental U.S. and Canada, pipelines traditionally provided the most economical method for moving crude and refined product from producing markets to consuming markets; in 2014, 70% of all crude and petroleum products were moved by pipeline in the U.S.2 Because much of the rapid growth in crude oil production is now occurring in areas that previously had minimal production, such as North Dakota (the Bakken) and landlocked South and West Texas (the Eagle Ford and Permian shale plays), the market does not have sufficient pipeline infrastructure to connect these new sources of supply with the refineries that convert it into gasoline, diesel and other petroleum products. The lack of adequate takeaway capacity has caused companies to scramble for new transportation routes and methods.

As such, waterborne transit is playing an increasingly important role as an alternative and/or complement to transportation by pipeline, rail and truck. For example, the quantity of crude oil moving by barge on the Mississippi River increased nearly twelvefold between 2008 and 2013 from 3.9 million bbl. to 46.7 million bbl., according to the U.S. Energy Information Administration; tanker shipments between the Gulf Coast and eastern Canada have grown at an even faster rate.3

For many transportation routes, moving crude oil by boat for at least one leg of the trip is the most efficient option; it is one-third the price of rail transportation due to economies of scale and provides flexibility for both coastwise and river shipments given the range of vessels of various shapes and sizes. Ships can carry much larger volumes than rail: two medium-sized inland barges carry as much as a 100-car train (70,000 bbl.). An added incentive to use waterborne transit is that many of the largest U.S. refineries (as seen in the Crude Oil Transportation Rates graphic later in this article) were built along the Gulf Coast and Mid-Atlantic coastal regions in order to cut down on transportation costs for crude oil imports. New transportation routes have thus developed along both U.S. coasts, the Hudson River and the Illinois Waterway to handle the higher crude oil volumes.

Despite measurable economic benefits to using barges and vessels, the domestic shipping industry continues to face significant capacity challenges. Transportation between the Gulf and New England is experiencing severe bottlenecks; the port of Corpus Christi, Texas, is congested, with crude supply exceeding takeaway capacity; and there is still no set shipping route between the Gulf and California. With only 45 crude oil tankers and 41 large barges in the Jones Act fleet, there are not enough eligible ships to alleviate the glut and connect the growing energy supply to end markets where it is demanded. Utilization rates have reached between 90% and 95% – the maximum achievable rate when accounting for maintenance and transportation time between ports.4

The Legacy of Underinvestment

The lack of development and modernization in the Jones Act fleet stems from decades of underinvestment. Utilization of the fleet dropped off substantially after WWII and did not pick up again until the 1973 oil crisis put immense pressure on the U.S. to become more energy independent. In 1978, Alaskan oil production began to expand, creating demand for Jones Act ships to move crude from Alaska to the West Coast refineries – spurring fleet growth and utilization rates to wartime highs. But since the early 1990s, that Alaskan production has declined by 46%, causing ship demand to fall as well. Growth of the fleet was also stunted by the passage of the Oil Pollution Act of 1990, which required tanks to be built with double hulls to guard against spills – a direct response to the Valdez environmental catastrophe in 1989.

Sluggish demand for new ships pre-shale revolution certainly contributed to a contracting domestic shipping industry, but capital costs to expand the fleet and operating costs imposed by the Jones Act have further constrained its growth. Due to their competitive advantage in labor costs and material inputs, Asian countries make up the vast majority of the global oceangoing tanker market share, with Korea at 60%, China at 30% and Japan at 8% as of 2013.5 In contrast, Jones Act ships, which must be constructed on U.S. soil, are at a competitive disadvantage globally given the higher labor and material costs: in November 2013, Matson Inc. placed a $418 million order for two Jones Act ships, roughly five times what it would cost to build the tankers in Asia.6 In June 2014, Philly Tankers AS ordered two vessels for a contract price of $250 million; modeled on the Hyundai Mipo Dockyard design, a South Korean product, the vessels cost only $73.2 million combined when built in Vietnam.7

CMU_December_2015_U.S._Flag_Tanker_Fleet

Even after a Jones Act-compliant ship is built, the day-to-day expense to operate it continues to outpace peers. Because U.S. ships must be manned by a crew comprising 75% American citizens, June 2012 research by the U.S. Maritime Administration (MARAD) found that the cost of operating a Jones Act ship was 3.7 times that of a foreign-flagged vessel, primarily due to standard of living, wage rates and insurance requirements. Another study found that crewing costs alone add an additional $15,000 per day to U.S.-flag operations.8 As such, the U.S. shipping industry has struggled to compete on the international market, with Jones Act-constructed ships being used predominantly for domestic transport. Due to high costs and muted demand, the average age of the Jones Act fleet is almost 20 years old.

But that has now all changed. The limited number of vessels has intensified the race to secure shipping capacity, pushing charter prices up dramatically in recent years. Coastal tankers, which could be chartered for $30,000 per day in 2000, now cost on average $75,000 per day. It doesn’t stop there: in May 2014, ExxonMobil renewed its annual charter with the 339,000-barrel American Phoenix tanker at the rate of $120,000 per day. An equivalent foreign-built, foreign-flagged vessel averages only $21,244 per day to charter.9

With higher demand propelling higher costs, orders for new tankers are now at all-time highs. For the last 11 years, only one tanker was constructed per year; there are currently 11 tankers scheduled for delivery by 2016. Sustained demand from the energy industry will most likely drive additional growth, but even in spite of the influx of new tanker orders, demand still exceeds supply.

CMU_December_2015_Crude_Oil_Transportation_Rates

Creative Circumvention

Across industries, compliance with the Jones Act has incentivized some seemingly impractical business practices over the years in order to avoid its costs.

In the 1960s and 1970s, the lumber industry in Washington and Oregon lobbied for the repeal of the Jones Act, claiming that the act hindered its ability to compete with Canadian producers, who were undercutting American producers’ prices due to lower transportation costs. Since American producers could not remain competitive in their domestic markets, the East Coast simply imported its lumber from western Canada instead of buying from the U.S. Pacific Northwest. Congress refused to repeal the act, and as a result, all forest products that Washington and Oregon ship today are still exported internationally – while all the forest products the East Coast receives by vessel are imported from greater distances.

More comically, NPR reported that a cattle rancher in Hawaii flies his cows on airplanes to the mainland instead of dealing with the Jones Act. As the reporter Zoe Chace quipped, “When cows fly, it means there’s some serious market distortion.”

During the 1920s, Jones Act ships would sail to foreign ports for repairs due to significantly lower costs. In order to prevent such outsourcing, Congress passed the Tariff Act of 1930, which instituted a 50% tax on repairs executed abroad. Nevertheless, a 2013 MARAD report found that most U.S. ships still travel to foreign yards for maintenance because the cost remains lower, even with the tax.

In the energy sector, these inefficiencies have become especially pronounced, with producers trying to avoid domestic shipping when possible. Between January 2013 and March 2014, twice as much Gulf Coast crude was shipped by water to Canada in non-Jones Act-eligible vessels than to the Northeast U.S. (Under the Energy Policy and Conservation Act of 1975, U.S. producers can only export crude oil to Canada.) Refineries in the Northeast, meanwhile, imported fuel from Canada, Nigeria and Saudi Arabia, among several other countries worldwide.

Refineries in California have also typically found it cheaper to import crude oil rather than to receive domestic waterborne shipments. It is estimated that the transportation cost of one barrel from the Bakken to southern California by rail and barge would be approximately $14 per bbl.: $9 per bbl. to Pacific Northwest ports by rail and $5 per bbl. by coastal vessel to southern California refineries. In contrast, it is only $2.30 per bbl. to ship oil from the port of Basra in Iraq to Long Beach, California.10

Some Gulf Coast refineries have even developed a “triangle trade” to circumvent the Jones Act’s “domestic port to domestic port” clause. They are shipping refined product to the Bahamas where some minimal additives are mixed in before it is shipped to New England. As long as the additives are blended into the product, it is considered international trade, and they can use international tankers to deliver it to the Northeast. This circuitous path highlights that despite the inefficiency, it is still more cost-effective than using a Jones Act tanker.

CMU_December_2015_Time_Charter_Rates

The Future of the Jones Act

There continues to be a debate over the necessity of the Jones Act in today’s market, pitting those who believe in its strategic importance from a national defense perspective against those who blame it for muted competition and higher energy costs at the pump. Pundits have argued that an unhampered energy sector would create more jobs than the Jones Act is saving; the U.S. shipping industry specifically may lose ground to foreign competitors, but the economy as a whole may see net positive job growth. Economist Joseph Stiglitz looked into the economic impact of the Jones Act and estimated that every job saved by the Jones Act costs a quarter of a million dollars, with the legislation costing American citizens over $1 billion every year.

On the other side of the argument, supporters look to the origin of the act, citing it as necessary to protect the United States Merchant Marine and to maintain domestic shipbuilding capabilities. Military commanders and labor unions are united in their steadfast support of the act. The Navy has repeatedly issued statements to Congress opposing the repeal of the Jones Act, stating that “for decades, U.S. merchant mariners have provided essential support for the U.S. Navy during times of war and national crisis.” Furthermore, in the interest of national defense, the act is essential to maintaining a domestic “maritime industrial base of shipyard and repair facilities.”

The argument for instilling government protectionism in the interest of national defense dates back centuries. Even Adam Smith, the father of laissez-faire economics, argued that “when some particular sort of industry is necessary for the defense of the country, [it will] generally be advantageous to lay some burden upon foreign, for the encouragement of domestic industry.” Smith was an ardent supporter of the Navigation Act, which was quite similar to the Jones Act in trade conducted with British ships. He stated that the act “very properly endeavors to give the sailors and shipping of Great Britain the monopoly of the trade of their own country. ... As defense, however, is of much more importance than opulence, the act of navigation is, perhaps, the wisest of all the commercial regulations in England.”

Labor unions also vigorously support the act, viewing it as a jobs bill. In 2011, the private shipbuilding and repairing industry directly provided 107,240 jobs in the U.S. The industry in total – including direct, indirect and induced impacts – is credited with creating 402,010 jobs, $23.9 billion of labor income and $36 billion in GDP.11 The unions are determined to prevent manufacturing offshoring to Asian markets and so have been instrumental in lobbying to ensure the Jones Act’s survival.

In large part because of the jobs it creates and preserves for constituents, the Jones Act receives bipartisan support in many states. Senators from states with thriving maritime industries cite its success: “Maritime is one of the largest industries in Louisiana, behind oil and gas and agriculture,” said Sen. Mary Landrieu in May 2014, “but we wouldn’t be standing here today to tout this economic prowess of the maritime industry in Louisiana if it weren’t for the Jones Act. The Jones Act is a jobs act – pure and simple.” On the other side of the aisle, Sen. Marco Rubio of Florida agrees, acknowledging that “Florida’s maritime industry is a national leader in economic opportunity and job creation.” Other states acutely feel the burden of the Jones Act, such as Hawaii, which is dependent on shipments from the continental U.S. Sen. Sam Slom recently noted that shipping a standard 40-foot container from Los Angeles to Honolulu, a distance of 2,558 miles, costs $8,700, while it costs about $790 to ship the same container from Los Angeles to Shanghai, a distance of 4,936 miles.12 In January 2015, Sen. John McCain filed an amendment to repeal the Jones Act, which he called “antiquated.” But his push was defeated, a demonstration that the policy has strong support among a broad coalition of marine professionals, unions, shipyards and military officials, who favor it for ensuring that the nation maintains a domestic commercial industry.

Conclusion

While the economic benefits of the Jones Act are concentrated, the costs are diffuse, reducing the probability that the act will be overturned or amended in some fashion in the near term. If oil production continues to grow as projected, the costs may become concentrated enough to incentivize affected parties to challenge the status quo. In the meantime, corporate America seems to think that the act will not be overturned anytime soon. As just one of a string of energy-related companies investing heavily in Jones Act vessels, Kinder Morgan announced a $1 billion investment to establish a Jones Act fleet in January 2014, and in August 2015, announced a $568 million deal with Philly Tankers LLC to add four additional tankers by 2017.

Cabotage laws have traditionally been common worldwide; however, some regions appear to be liberalizing their marketplaces. The EU ensures that any transport service within a member state can be hired by other member states. Even China, notorious for its state-run enterprises, has permitted foreign-registered vessels to trade between Shanghai’s Free Trade Zone and other Chinese ports. For the U.S., it is a matter of whether the bottlenecks become so severe that the economic demand to revise the Jones Act can no longer be ignored and reaches a point where it trumps the national defense priority. From an economic perspective, the act does create large cost inefficiencies. But at its root, and in an ever-changing geopolitical landscape, perhaps there does still exist a need for shipyards and experienced shipbuilders to protect U.S. citizens and the country’s economy – hence the discussion over its future continues.

For New Jersey in winter 2013 to 2014, there was no debate. Desperate for the salt from Maine, the state requested an exception to the rule, filing for a waiver typically reserved for extreme emergencies or matters of national defense. The state was swiftly denied by the Department of Homeland Security. Two weeks later, a barge was finally contracted, though it only had one-fifth of the necessary capacity for road salt and had to make multiple deliveries over the course of a month. After all was said and done, what should have been a $500,000 delivery ended up costing the state $1.2 million. Though tardy and inefficient, New Jersey’s delivery of rock salt was made by an American-built, -flagged, -owned and -crewed vessel.

This article is an update of its original version, published in October 2014 as part of the CMU’s Spotlight series.

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© Brown Brothers Harriman & Co. 2015. All rights reserved. 2015.

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1 Source: U.S. Energy Information Administration, March 2015.
2 Source: Congressional Research Service, December 2014.
3 Source: Congressional Research Service, July 2014.
4 Source: RBN Energy, March 2014.
5 Source: Congressional Research Service, July 2014.
6 Source: Drewry Maritime Research, November 2013.
7 Source: Maritime Trade Intelligence, http://maritimeintel.com/philly-tankers-a-step-closer-to-purchasing-its-first-vessels/, June 2014; World Maritime News, http://worldmaritimenews.com/archives/120043/damico-orders-eco-handysize-pair/, April 2014.
8 Source: United States Maritime Administration, September 2011.
9 Source: BIMCO, May 2015.
10 Source: Oilgram Price Report, January-April 2014 reports.
11 Source: United States Maritime Administration, May 2013.
12 Source: Associated Press, “Hawaii, Alaska, territories team up on Jones Act,” March 2014.