3

Economic Viability of the Maritime Oil Transportation Industry

To assess the effects of OPA 90 on the economic viability of the maritime oil transportation industry, the committee will examine how the industry—including both tankers and oceangoing tank barges —is changing under the impetus of the new legislative framework. Specifically, important changes in the size and shape of the fleet from 1990 to 1994 must be traced, and the likely changes from 1994 to 2005 and beyond must be projected.

From a regulatory perspective, two key economic questions must be addressed.

  • Will there be a sufficient supply of tankers and oceangoing barges to meet U.S. oil transportation needs throughout the transition from single- to double-hull tank vessels?

  • What is the expected effect on transportation costs of the change from single- to double-hull tank vessels?

The discussion in this chapter focuses on acquiring the data and information needed to answer these two questions.

Economic data on the tanker industry are widely available from several sources. However, the numerous sources of data on most topics are rarely in exact agreement. Using the best available data, the committee will undertake the following tasks:

  • determine historical tank vessel demand and forecast future demand

  • determine historical tank vessel supply and forecast future supply

  • compare the projected supply and demand with shipbuilding capacity

  • develop cost data for single- and double-hull tank vessels



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EFFECTS OF DOUBLE-HULL REQUIREMENTS ON OIL SPILL PREVENTION: Interim Report 3 Economic Viability of the Maritime Oil Transportation Industry To assess the effects of OPA 90 on the economic viability of the maritime oil transportation industry, the committee will examine how the industry—including both tankers and oceangoing tank barges —is changing under the impetus of the new legislative framework. Specifically, important changes in the size and shape of the fleet from 1990 to 1994 must be traced, and the likely changes from 1994 to 2005 and beyond must be projected. From a regulatory perspective, two key economic questions must be addressed. Will there be a sufficient supply of tankers and oceangoing barges to meet U.S. oil transportation needs throughout the transition from single- to double-hull tank vessels? What is the expected effect on transportation costs of the change from single- to double-hull tank vessels? The discussion in this chapter focuses on acquiring the data and information needed to answer these two questions. Economic data on the tanker industry are widely available from several sources. However, the numerous sources of data on most topics are rarely in exact agreement. Using the best available data, the committee will undertake the following tasks: determine historical tank vessel demand and forecast future demand determine historical tank vessel supply and forecast future supply compare the projected supply and demand with shipbuilding capacity develop cost data for single- and double-hull tank vessels

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EFFECTS OF DOUBLE-HULL REQUIREMENTS ON OIL SPILL PREVENTION: Interim Report determine capital and the cost of capital required for new shipbuilding integrate the above elements into a required freight-rate analysis for future fleets calculate required freight rates (the rate shipowners must receive to cover operating and capital costs and to realize normal profits) FORECASTS OF TANKER FLEET Historical and Projected Tanker Demand Data for the seaborne movement of crude oil and oil products will be presented in millions of barrels and millions of tons per day (MB/D and MT/D) and in millions of tons per year (MT/Y) (standard units of measurement in the trade) by geographical origin and destination for the years 1990 to 2005 for each of the principal trades. These data, furnished by the PIRA Energy Group, show interregional worldwide seaborne oil movements and intraregional U.S. oil movements. These data will be cross-checked against data from other sources, supplemented by data on non-U.S, intraregional oil movements. The volume of seaborne oil trade will then be converted into required tanker tonnage in DWT per year by route.1 This schedule will represent the demand for tanker tonnage, which will be computed by size (10 to 150 kDWT and over 150kDWT) from 1995 through 2005, which the committee believes will be the critical demand period. Historical tanker fleet data are available from several sources, including Clarkson Research, Drewry, Maritime Strategies International (MSI), and Lloyd's Maritime Information Service. Data on the size and characteristics of the existing tanker fleet will be classified according to vessel type, name, flag (if U.S., whether eligible under the Jones Act),2 year of construction, DWT, hull type (OPA 90 double hull, double side, double bottom, or single hull pre-MARPOL and MARPOL), and cargo capability (clean or dirty). Vessel information should be computerized to facilitate further analysis. Because the Clarkson Research Tanker Register is available in electronic form, it will be used as a primary source. Current Tanker Order Book Tankers on order with shipyards will be identified and added to the tanker database. Information by vessel will include the characteristics identified above 1 A ton, in this context, is a long ton, which is equal to 2,240 lbs. The long ton is nearly equal to a metric ton (often spelled tonne), which is 2,205 lbs. 2 The Merchant Marine Act of 1920 (41 Stat. 988, chapter 250 of Statutes at Large) contains a provision, known as the Jones Act, that requires all domestic waterborne trade to be carried on U.S.-flag vessels. Therefore, crude oil to be transported from Valdez, Alaska, to ports in the contiguous United States must use U.S.-flag vessels.

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EFFECTS OF DOUBLE-HULL REQUIREMENTS ON OIL SPILL PREVENTION: Interim Report as well as the delivery date for each vessel. The order book will be developed based on Fairplay and Clarkson's extensive databases of vessels on order. The projected tanker supply will be based primarily on the mandatory phase-out schedule of OPA 90 and MARPOL. Using the tanker fleet data collected previously, this analysis will produce a profile of the tanker fleet by segment and year through 2015, reflecting tanker retirement mandated by OPA 90 and MARPOL. The tanker age profile, together with information on the hull of each vessel and the mandatory phase-out dates included in OPA 90 and MARPOL, should be sufficient to determine the phase-out profile for the current tanker fleet and noncomplying new construction. Tanker Supply, Demand, and Shipbuilding The supply and demand schedules developed by the committee will be matched, a capacity utilization rate will be derived, and an equilibrium range of capacity utilization will be estimated. Frequent changes in oil trade forecasts make it difficult to develop an estimate of demand. With the help of the order book data, however, it will be possible to project firm estimates of capacity utilization rates through 1997 and perhaps 1998. Thereafter, the difference between the schedules of projected required tonnage and projected available tonnage (after mandated phase outs) will be used to estimate the volume of new double-hull tanker construction and the reconstruction of single-hull units necessary to balance supply and demand. A recent study (Wilson and Gillette, 1994) provides information on current and prospective supply and demand balance for U.S. tankers and barges in the oil products trades. This supply and demand equilibrium analysis will be supported by historical data on freight rates and vessel earnings. Although the committee does not intend to forecast market-driven freight rates, 3 it is generally assumed that, under competition, any existing or perceived shortage of tankers would cause freight rates to rise to a level sufficient to encourage new tanker construction. (Drewry and MSI estimates of projected freight rates could be of assistance in these analyses.) Scrapping OPA 90 and MARPOL mandate the retirement of tankers at a specified age. Vessels may be converted to double-hull configuration, scrapped because they do not meet OPA 90 or MARPOL requirements, or scrapped for other reasons. Vessels converted to double hull or scrapped because of OPA 90 or MARPOL incur an economic cost. The economic impact analysis must include an estimate of the number of tankers scrapped for reasons other than mandated retirements. A review of the 3 The forecast freight rate is an estimate of a future market rate, which, in a competitive market, is a function of supply and demand for tanker tonnage.

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EFFECTS OF DOUBLE-HULL REQUIREMENTS ON OIL SPILL PREVENTION: Interim Report correlation between maintenance cost and age, the impact of special survey requirements, and the forecast rates of capacity utilization may provide some guidance. Calculating the economic cost of scrapping due to OPA 90 or MARPOL involves estimating the lost market value of tankers that might have continued in service if OPA 90 or MARPOL had not mandated their retirement. Calculating this cost is extremely complex and would be only marginally useful for this study. Instead, the regulatory impact analyses conducted by the U.S. Coast Guard will be used as input. NEW-BUILDING REQUIREMENTS AND MARKET CAPABILITY New-Building Requirements and Shipbuilding Capacity As tankers are phased out under the OPA 90 and MARPOL regimes, it is generally expected that the demand for newly constructed and reconstructed double-hull tankers will rise appreciably. The assessment of the committee, as outlined above, will estimate the volume of this demand. A related analysis will determine if shipbuilding capacity will be sufficient to deliver the required tanker tonnage in the peak demand years. As the projected demand for new tanker construction is expected to rise and peak in the next few years, the shipbuilding capacity will also increase substantially. These increases will be mostly in South Korea, which already has an impressive record in the construction of new tankers of all sizes. In this analysis, estimates of new construction capacity will be calculated by identifying shipbuilding capacity by country, including current, historical, and projected capacities. Representatives of leading shipbuilding organizations in Japan, South Korea, and the United States have made presentations to the committee on this subject. Reports from the Shipbuilders Association of Japan, Japan Maritime Research Institute (JAMRI), and other materials are also available for committee use. Any analysis of new tanker construction capability will have to take into account the effects of the demand for constructing other vessels (e.g., container ships, liquefied natural gas vessels, dry bulk carriers, etc.). The committee will employ the shipbuilding forecasts of non-tanker construction of Fairplay, Drewry, and others, as needed. Capital Requirements for New Double-Hull Tanker Construction The schedule of capital costs for meeting projected requirements for new and reconstructed double-hull tanker tonnage will be calculated for annual deliveries, based on current and estimated future shipbuilding prices. Data on current ship-building prices are available from Clarkson, Platou, and others. Data on future shipbuilding costs have been obtained from Japanese, South Korean, and other

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EFFECTS OF DOUBLE-HULL REQUIREMENTS ON OIL SPILL PREVENTION: Interim Report major shipbuilders. These data will be used to estimate the capital investment required for new and reconstructed double-hull ships. The general estimates of new construction schedules were given to financial experts who appeared before the committee to assist them in estimating the availability of capital to finance construction of new double-hull tankers. COST DATA New-Buildings and Conversions: Double-Hull versus Single-Hull The cost of replacing single-hull tankers with double-hull units includes the cost of constructing new double-hull tankers and the cost of reconstructing older single-hull tankers to conform to OPA 90 and MARPOL requirements. Construction and reconstruction costs, as well as the difference in building costs between new single- and double-hull tankers, will be assessed through contact with shipyards, shipowners, naval architects, and ship brokers. Representatives of major international shipyards have made presentations to the committee, and shipowners and ship brokers have been surveyed. Single-Hull Operational and Structural Modifications The analysis of the cost of required modifications to single-hull tankers that continue trading with the United States is entirely dependent on the regulations developed by the U.S. Coast Guard. At the time this report was written, the U.S. Coast Guard had not published all the expected regulations. The committee analysis of these costs must await the issuance of these regulations. Operating Costs Inputs Aside from the differences in capital costs mentioned above, double-hull tankers will probably have different operating costs in several other respects. The primary method for obtaining cost information is a planned survey of vessel owners (INTERTANKO), the American Institute of Merchant Shipping (AIMS), and major oil company operators. Drewry has detailed data on operating costs for four tanker segments for the years 1986 to 2000, but these data will require a review to ascertain their usefulness to the committee. Specific cost elements and data sources are as follows. Hull and protection and indemnity insurance cost data will be obtained from presentations to the committee by shipowners, insurance brokers, and insurance underwriters. Maintenance cost data will be obtained from presentations to the committee by shipowners, ship managers, ship repair yard operators, and other

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EFFECTS OF DOUBLE-HULL REQUIREMENTS ON OIL SPILL PREVENTION: Interim Report suppliers. The major effect of double hulls on maintenance costs is expected to occur later in the life of the vessel. Because double hulls are relatively new, this cost element will be difficult to quantify. Other operating cost data will be obtained from presentations to the committee by shipowners, ship managers, ship repair yard operators, and other suppliers. Availability of Capital Capital will be needed to finance the replacement of single-hull tankers by new double-hull tankers or reconstructed single-hull vessels. Capital availability will be of particular importance from 1998 to 2002, when tanker retirements reach their peak. Since the average lag between placing a firm order and accepting delivery of a newly constructed tanker is on the order of two to two-and-half years, firm capital commitments must be timed accordingly. Information on capital availability will be obtained from members of the financial community, such as bankers, investment bankers, and other experts. The value of new tanker construction will be determined using the definitive schedule of demand, supply, and market balance. The mandatory phase-out schedule specified in Section 4115 has caused several U.S. Jones Act vessel owners to change the estimated economic life of some vessels, resulting in accelerated depreciation and a decline in book value. This reduction in the operational potential of a ship or fleet can negatively affect the borrowing capacity of vessel owners and reduce their ability to finance the construction of new double-hull tankers. The committee will contact several U.S. flag operators and assess the effect of the phase out on their financial capacity in order to determine the significance of this issue. The required information will be obtained by interviewing selected maritime lending institutions and Maritime Administration (MARAD) officials regarding Title XI loans. The impact of this issue on vessel owners who trade internationally depends on the consistent implementation of OPA 90 and on the worldwide application of MARPOL. REQUIRED FREIGHT RATE ANALYSIS An important component of the analysis of future supply and demand is the estimate of future orders for tankers. Future orders are influenced by the return an owner requires or expects in order to invest in a new tanker. The required return depends on the perceived risk involved in investing in a new tanker. This analysis will attempt to determine the risk and, hence, the required return for tanker investments. The committee will analyze historical and current returns (profitability) for the tanker industry in order to understand the risk-and-return relationship in building new tankers. Liquidity models, adjusted cost of capital assessments, and other techniques will also be utilized. Current and historical tanker rates,

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EFFECTS OF DOUBLE-HULL REQUIREMENTS ON OIL SPILL PREVENTION: Interim Report operating costs, and capital costs are available from a variety of sources, including Drewry, MSI, Lloyd's Shipping Economist, Clarkson, and tanker company annual reports. The development of a two-tiered market, in which higher quality tankers receive higher freight rates, has been predicted in the maritime press since the passage of OPA 90. The committee will determine if an additional premium rate exists for double-hull tankers (a subset of the higher quality tanker fleet). Informarion on this topic will be gathered through interviews with shipowners, charterers, and tanker brokers. The London Tanker Brokers Panel can provide an accurate assessment of spot and term charter rates for vessels with and without a U.S. trading exclusion. JONES ACT TANKERS AND BARGES The committee will acquire and assess key economic data that should reveal the effects of OPA 90 on tankers and oceangoing barges operating under the Jones Act. The committee will also present and estimate historical and forecasted demand, as well as vessel supply information. In addition, ship and barge costs and capital requirements for replacing single-hull vessels will be assessed. Data are available through industry sources and from presentations to the committee by industry representatives. The committee has noted that the barge industry is concerned about the impact of OPA 90 on the early retirement of single-hull oceangoing barges and on the financing of new construction. These concerns will be assessed as part of the review of the tank vessel trade under the Jones Act. FINDINGS An important aspect of the economic effects of OPA 90 and MARPOL on the industry derives from the resulting acceleration in tanker retirements (i.e., the difference in cost between mandated retirements of old tankers and the cost of replacing them routinely). For operators (including oceangoing barge operators) under the Jones Act, the cost of mandated retirements could be significant because some ships that would ordinarily have operated beyond the OPA 90-mandated retirement will no longer be allowed to operate. The committee will calculate the difference in cost between the retirement dates and the associated replacements resulting from OPA 90 and MARPOL. The data required are readily available from a variety of sources. Unfortunately, these sources rarely agree. For answering the two key economic questions at the beginning of this chapter, the committee found the data adequate. However, several gaps in primary data have been identified. Tanker hull types. The existing tanker databases may not include sufficiently detailed information to identify accurately tanker hull types

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EFFECTS OF DOUBLE-HULL REQUIREMENTS ON OIL SPILL PREVENTION: Interim Report (OPA 90 double hull, double side, double bottom, or single hull and pre-MARPOL and MARPOL), as they relate to the mandatory retirement schedule. Maintenance costs. Double-hull tankers will incur the heaviest maintenance costs beginning with the third special survey. This survey is required by the U.S. Coast Guard, classification societies, or the port state for ships approximately 15 years old. Because most double-hull tankers are new, the effects of these costs will not be known for some years. Future shipyard capacity. Shipyard capacity expansion in Eastern Europe and Eastern Asia (e.g., China and Malaysia) is not fully known and is not well described in published reports; but this expansion may be important in meeting future needs. The use of forecasts adds a degree of uncertainty to the committee 's analysis. No single forecast is available that adequately addresses all of the factors influencing the supply and demand for tank vessels. Unfortunately, the diverse sources of data and forecasts that will be used in this study are not all developed from the same basis and will require matching to achieve the optimal output. The gaps in data identified previously will be handled by the committee in the following manner: Tanker hull types. Cross-check data on hull types with brokers and owners and fill gaps through the classification societies. Maintenance costs. Interview tanker owners and shipyards. Shipyard capacity. Determine if the identified future shipyard capacity is adequate to meet the demand for double-hull tankers. It may be necessary to augment traditional trade sources of information about plans for increasing shipbuilding yard capacity by using additional sources (e.g., personal contacts in the industry), particularly in projecting Eastern European and East Asian (including Chinese) capacities. Reliance on forecasts. Compare the various forecasts for consistency. The latest available forecasts will be used, and the committee will also evaluate the usefulness of the forecasts. The gaps in data do not pose a significant problem for the analysis required in phase 2 of the study. The primary concerns of the committee are about the quality and diversity of data, as opposed to availability. Gaps in the data will make reaching conclusions in phase 2 more difficult.