Igor Hernández
Graduate Fellow, Center for Energy Studies
Adjunct Professor, Instituto de Estudios Superiores de Administración
Ken Medlock, Ph.D.
James A. Baker III and Susan G. Baker Fellow in Energy and Resource Economics
Senior Director, Center for Energy Studies
Michelle Michot Foss, Ph.D.
Fellow in Energy and Minerals, Center for Energy Studies
Anna Mikulska, Ph.D.
Nonresident Fellow in Energy, Center for Energy Studies
Senior Fellow, Kleinman Center for Energy Policy and Foreign Policy Research Institute.
Ted Loch-Temzelides, Ph.D.
Professor of Economics, Rice University
Baker Institute Rice Faculty Scholar
The U.S. oil and gas industry is under stress after the precipitous fall in crude prices resulting from a combination of low demand induced by the Covid-19 pandemic and abundant supply stimulated by the price war between Saudi Arabia and Russia. Several solutions are being considered by different stakeholders. Among other options – i.e. potential three-way agreement with Saudi Arabia and Russia on production cuts, and tariffs on oil imports to the U.S. – there is a renewed discussion over the Jones Act (JA). But has anything changed to indicate that there is enough political will in Washington to make changes to the century-old law?
Let’s consider the details.
The policy, officially known as the Merchant Marine Act of 1920 requires that all goods transported between US ports use ships carrying the US flag. In addition, ships must be constructed in the United States as well as owned and crewed by US citizens and permanent residents. Even the steel in any foreign repair work on a JA vessel must be less than ten percent of its total weight. Originally, the main goal of the JA was to protect the U.S. fleet after the losses it experienced in World War I. Today, JA’s supporters see the law as promoting national security, economic growth and domestic employment allowing the U.S. to better monitor environmental, labor, and safety standards.
But there are substantial downsides to the JA, as the law’s requirements often mean that JA ships cost four to five times as much as those built in foreign shipyards. In addition, a study by the US Maritime Administration (MARAD) found that in 2010, the average operating cost of a US-flag ship was 2.7 times greater than that of a foreign-flag ship. This increases the cost of transportation, leading to higher prices for goods transported domestically, in some cases deeming U.S. production less competitive against imported products. And even though US shipyards hold a monopoly position in a niche part of the market for intracoastal needs, they remain underutilized due to their high cost relative to foreign builders. These factors have resulted in a U.S. fleet that is smaller, older, less modern, and substantially less competitive than fleets in other countries.
Among other sectors, the situation has been detrimental for the U.S. energy industry, as it limits inter-state trade in oil, products, and liquified natural gas. High costs for US-built vessels have resulted in an increasing use of less efficient forms of transportation for crude and products. Even at times of extraordinary demand, we have seen US importing LNG from other countries, including Russia.[1] Noncontiguous U.S. states, like Hawaii or Puerto Rico, are disadvantaged even further, as no pipeline, rail or truck transport of U.S. produced oil and gas can reach them. As a result, U.S. oil and LNG cannot compete there with imports.
This issue becomes particularly salient today, as much of the oil produced in the U.S. cannot compete internationally at ultra-low prices. And high transport costs disadvantage the low-cost U.S. producers, who are already suffering in a low price environment. In addition, excess supply of oil and oil products in the U.S., cannot count on additional tanker storage, as the Jones Act fleet has dwindled over time (Figure 1). In the short-term, this also means that the U.S. shipping industry is not reaping current benefits from the excessive demand for storage from the refineries and energy traders who outbid each other to secure ships to transport crude via waterway for intracoastal delivery to onshore storage facilities, or use the vessels themselves as storage to capture the profit opportunity presented by a market in contango. Indeed, the daily rates of hiring foreign VLCCs more than doubled over the past few weeks, in some cases topping $220K/day, with prospects of even higher rates once available storage tops off.
Figure 1.
Author’s rendition.
CES
Data Source: Bureau of Transportation Statistics.
The domestic transport of oil products has also been adversely affected by the JA. In a recent research paper, using data from 2001 to 2017, Hernandez et al. estimate that, under regular circumstances, using JA vessels costs more than three times the international cost suggested by market sources (around $15,000/day). They also compare what would be the consumer gain and the producer loss from facing foreign competition at international prices. Their results show that consumer gains in the counterfactual absence of the JA (760.9 million dollars/year) would be substantially higher than the losses (1.84 million dollars/year) to producers. This net positive effect comes from lower transportation costs, as well as a significant increase in intracoastal trade. Even a scenario consistent with international rates of $30,000/day for product tankers suggests a net gain of 422.5 million dollars/year. This could be illustrative of the effects for the crude market, where most of the concerns are placed at this moment.[2] While the issue is somewhat less crucial at the midst of Covid-19 pandemic, when international demand and trade has decreased significantly, it can certainly become an important aspect of any economic recovery.
Despite the adverse effects JA has on the U.S. economy, we have recently seen a concerted effort from 50 U.S. legislators from both sides of the isle to discourage the Trump Administration from allowing changes by the U.S. Customs and Border Protection that weaken the JA provisions for non-contiguous regions. Earlier on, even an opponent with the stature of the late Senator John McCain was unable to muster a strong enough coalition to repeal the JA. This poses the question, “Why has eliminating the JA proven so difficult over the years?” Our research suggests that part of the answer goes beyond national security arguments.
Opening US ports to competition from foreign vessels would lead not only to overall efficiency gains, but also to a sharp redistribution of the net benefits. Specifically, we would see benefits moving toward the consumers of shipping services (the shippers plus the final consumers) and away from producers (the JA shipping industry). Even though the total added benefit to the consumers greatly surpasses the losses experienced by the shipping industry, the benefits are highly dispersed across a broad consumer base and, as such, low on a per capita basis. Thus, individuals are much more likely to dismiss the benefits they could incur. In contrast, if the JA was to be repealed, the JA industry would experience losses that, even though smaller in the aggregate, are much larger on per capita basis, and thus perceived worthy to defend vigorously. It is not coincidental that the Jones Act has been supported by large shipping lobbying efforts that are well-organized and run a concerted action against any attempt to weaken the law. As such, they can be highly effective in influencing electoral campaigns and, by extension, policymakers. Altogether this is a complex political economy issue and any solution or change will likely need to involve mechanisms through which winners compensate losers.
So could the Covid-19 pandemic and the need for a rapid economic recovery move the needle in this calculus?
Part of Covid-19 recovery will entail a new round of negotiation on legislation to support infrastructure improvements and expansion. Infrastructure has long been a subject of intense debate – its poor condition in many parts of the United States has been widely acknowledged as an impediment to economic development and growth. Improvements and expansion to roads, ports, harbors and other critical facilities would benefit the domestic energy sector in myriad ways. Moreover, specific initiatives could play directly to wider support for Jones Act reform. These could include support for more efficient utilization of existing shipyards, expanded shipbuilding capacity for state-of-the-art intracoastal transport of feedstocks and products, expanded training of American crews for safety and hazardous materials management and many other aspects of a more robust domestic merchant marine industry. We will be researching these and other possibilities as we monitor developments and emerging policy discussions.
[1] In the case of refined products, Jones Act tankers have added about one to three tanker loads per month in 2017 for shipments to Florida and New England, while tankers bringing gasoline from Europe transported about 30 tanker loads per month.
[2] According to Frittelli (2014), cost of transporting crude oil from the Gulf Coast to the Northeast Region (1,900 nautical miles) was between 5-6 dollars per barrel. The cost from transporting crude from Easter Canada was 1.2 dollars per barrel, and from Saudi Arabia (5,800 nautical miles) was around 1.9 dollars per barrel.
This post originally appeared in the Forbes blog on April 9, 2020.