Capital Link February 24-25 Jones Act/U.S. Flag Shipping Conference

The U.S. has the largest economy in the world and the largest navy in the world, but only the 21st largest merchant marine.?Just after the end of WWII, we did actually have the largest merchant marine in the world.?There are structural reasons behind that decline, including growth in U.S. income and the emergence of flags of convenience.?The U.S. is certainly not alone among industrial economies in seeing declines in their merchant marine fleets.?The British, French and others have all also seen declines in the merchant vessels flying their flags.??

But those facts shouldn’t give us any solace.?America’s situation in the world and its need for a sufficient merchant marine is unique.?Now is a particularly good time to take actions to stop the decline and to start seeing actual organic growth.?I’ll outline a framework with specific examples of how I believe we can do just that.????

More than eight decades ago the U.S. itself was the catalyst for the establishment of flags of convenience driven by its own national security interests.?Just as the initiative that gave rise to that move was linked to national security, the actions and initiatives we should undertake today to grow the ships flying the U.S. flag are directly related to our national security interests.??

There has been a groundswell of change just in the last few years on the importance of our merchant marine.?Much of this relates to China.?In addition, in the last year everyone has learned about what results from a maritime supply chain not operating as it should.?Maritime supply chains are more critical to our military than to our economy.

We should set a tangible goal of moving up the leader board of cargo ships ranked by the flag they fly.?That goal would establish a clear metric that is forward looking and compares us to all other flag registries.?For example, setting our sights on having the 16th largest merchant marine by 2030 is a stretch target, but it is an attainable goal.????

There is something about a tangible goal of putting a bold stake in the ground that galvanizes focus, effort and initiative.?Committing to having the 16th largest merchant marine in the world by 2030 would have us displacing Italy, which has no discernable advantages in shipping compared to us.??

Focus starts with reminding Americans on the continuing importance of the U.S. flag merchant marine.?As an industry, it is in a special position because of the national security role that it plays.?America is not alone in seeing this.?There is no ambivalence in China on whether a strong merchant marine should be an integral part of their national security strategy.?The relative size of their merchant marine is in synch with their Navy, as both are #2.??

Earlier generations of Americans readily recognized the national security role of our own merchant marine, in no small part because we wouldn’t have won our greatest conflict without it.?Unfortunately, awareness of this role has dissipated with succeeding generations.?

It is incumbent on people listening to my remarks and others with subject matter expertise to speak out and to educate the public and everyone in a policy making role that our merchant marine still plays a vital national security role today.?This is particularly true given recent efforts by certain parties to tear down our merchant marine by spreading misinformation.??

Nobody knows precisely what the future holds, but we most certainly know that any projection of military force will require a supply line that can only be provided with certainty by our own merchant marine.?Not having an adequate merchant marine isn’t a problem…until it is a problem.?And at that point, it’s a real big problem.??

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Awareness and effort by more elected officials in Washington will translate into additional government support for our merchant marine.?While this will be driven by recognizing its national security role, it can also be influenced by what they hear from you and the public on the continuing importance of a U.S. flag merchant marine.??

Projects like the recent Tanker Security Program involving 10 ships to target specific identified shortcomings need to be funded and replicated.?The subject of direct government support is controversial, but the simple truth is that the withdrawal of previous support is the proximate cause for much of the reduction in the number of U.S. flag vessels operating today.?At the same time we’ve withdrawn support, other countries have sharply stepped up direct support of their merchant marines.??

For instance, just one Chinese shipping company has disclosed total direct government subsidies of over $1.6 billion in the fifteen years it has been partially owned by the public.?

The daily operating cost difference of a U.S. flag vessel compared to a typical foreign flag vessel is currently $13,689.?To put that difference into perspective, the subsidies needed to launch the 10 ship Tanker Security Program would be equivalent to two-thirds of 1/100th of 1% of our current national defense budget.?

Those 10 ships could not only play a critical role in any one of a number of situations, but they would provide jobs for hundreds of American mariners.?Having additional seagoing billets for the highly trained seafarers that come out of our maritime academies needs to be a top priority.?That program should be a template for other needed vessels.?When we build back our merchant marine, we positively impact the pipeline of experienced mariners.?Any further decline there could have dire consequences.?No matter the number of cargo ships on hand, American mariners will be needed to operate them.

Given these facts, it is imperative that adequate sealift capability across a wide range of potential needs is covered.?Like not having enough fuel in a plane, the dreadful consequences of not having enough sealift capability require never getting anywhere near empty.?

It is America in the postwar era where container shipping was invented, the supertanker was born and the design for the bulk carrier was created.?The commercial initiatives that gave rise to the three primary segments in the shipping industry today all came from here.?We need to draw on the thought leadership that still exists in America and tap into the broad array of factors that can help us grow our merchant marine.??

Initiatives related to both our international and domestic maritime segments will benefit from even more linkage with our capabilities and innovations in the road and rail transport sectors.?It is after all just one large interconnected supply chain.?The better the fit between modes in our country, the more efficient and less congested our overall supply chain will be.

It is from these new commercial initiatives that we will have to primarily rely on for growth in our merchant marine.?That requires smart choices on where we focus, both in terms of minimizing disadvantages and maximizing growth.?

In container shipping, costs related to the ship itself are the minority of the overall costs for which the carrier is responsible.?This fact makes container shipping the segment that U.S. flag vessels operating internationally could be the most competitive before taking into account further differentiating characteristics.???

There is now a path where a differentiated U.S. flag container service operating large container ships in the world’s largest trade lane can be successful.?Part of this relates to the geometric increase in the size of container ships.?This change has had the effect of making crewing costs an ever-declining percentage of total costs.??

With those facts in mind, I’ll outline my idea for a new differentiated U.S. flag container service that I believe would be commercially successful in the large transpacific lane.?It will be based on a weekly Asia to West Coast service with five vessels in a 35-day rotation.?We’ll focus just on the relevant numbers.?The incremental operating cost per TEU for U.S. flag vessels can be calculated using the $13,689 daily differential.?That calculation will be based on just loaded boxes using 90% utilization in the headhaul direction and 30% in the backhaul direction.?Those are typical utilization levels in that trade lane, but below recent experience.??

The average vessel size now in the Asia to West Coast trade lane is around 9,000 TEU, which results in a U.S. flag differential cost of $44 per loaded TEU.?Drewry, a leading maritime research outfit, shows the February 17 spot rate from Shanghai to Los Angeles was $5,341 per TEU.?That puts the differential at eight-tenths of 1% of the spot rate.?If long-term contract rates that I’d peg at $3,000 per TEU were used, its 1.5%.?

Those percentages are relatively inconsequential.?There will be no attempt here, however, to make the case that the incremental U.S. flag crewing costs are so inconsequential as to not be relevant.?The focus should be on absolute cost differences resulting from any new service, as it is those differences that are sustainable.?It is other cost aspects of the new container service that will differentiate it.?

It should be noted that this is a good time to consider a new service.?The total earnings of the container carriers have set records in each of the last four quarters.?When all results are reported for the fourth quarter of 2021, they will set another record.?My estimate is that net income for the quarter will be $57 billion, which is some 47% of revenue.?That would bring total 2021 industry net income to $153 billion.

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The service will be an express service between just China and the West Coast.?It will move only 53’ containers on ships configured for that purpose.?That size is legal in China and is the same size that has been exclusively used for domestic movements in the U.S. for two decades.?The attractiveness of a weekly service built around 53’ containers will be well received by the Walmarts, Home Depots and Targets.?Configured for 53’s, each equivalent to 3 TEU’s, that translates into 3,000 53’ containers for an average size ship now in lane.?We aren’t suggesting the ship owner absorb the additional operating cost of $44 per TEU or $132 per 53’.?With a unique model that actually takes steps out of the process and reduces both cost and time, that incremental cost can be more than mitigated, as we will show.

The first process that 53’ containers take out is container handling on both the load and discharge side.?A ship configured for 53’s will involve 33% less moves on each end to handle the same amount of TEU’s compared to a ship moving 40’ containers.??The cost per container move is the same whatever the box size.?That cost will be different at various ports, but having 33% less moves will result in a similar reduction in that expense and the time involved.?The larger absolute savings will be at the West Coast ports, but there will be the same percentage savings at the ports in China.?The total amount of these savings will be well above the incremental U.S. flag cost.?In other words, using the equipment size that already works best within America’s domestic transport system, fully inoculates the U.S. flag operating cost differential.??

The next process that 53’ containers take out most of the time only applies to the U.S. side.?It relates to follow-on moves, mostly by rail.?When that happens, it offers even more cost savings than from less cargo handling at the ports.?It is axiomatic that the cargo inside inbound containers to the U.S. eventually ends up where people are.?While some 50% of the inbound containers to the U.S. are discharged at West Coast ports, that coastal range is closer to only 24% of the mainland population.?That fact highlights that a large percent of those containers move on to final destinations in the middle and eastern parts of the country.?The U.S. domestic transport system is highly efficient and most inland movements over 500 miles now move on doublestack unit trains carrying just 53’ containers.?The efficiency of that mode and the 53’ box being the standard for domestic shipments has created major trans-loading activity near all West Coast ports.?In that activity, the cargo in three 40’ containers is unloaded and put in two 53’ containers.?This adds at least $250 per TEU in costs along with 2 to 3 days of time.?However, the inland efficiencies gained in moving 53’s long distances on doublestack unit trains justify that cost and time.?That entire step in the process and the related cost and time is removed if the cargo moves in 53’ containers from China.?It is already in the best size for the most efficient inland move.??

The way the highly efficient U.S. domestic transport system has dealt with 40’ boxes is to stop most of them at the port and make the long follow-on move in much more efficient 53’ containers.??

That unnecessary process is completely removed in the new service.?In an additional benefit, port area congestion is reduced as short drives from port terminals to transloading facilities are eliminated.?The existing trans-loading activity is a major use of local trucking capacity.?The shortage of such capacity is a big contributor to the current West Coast congestion.??

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Don’t expect any existing container carrier to implement a serious 53’ initiative anytime soon.?For an industry that was literally born from the application of innovative thinking, today’s carriers are reluctant to do things that separate themselves from other industry participants.?Many are less familiar with our highly efficient domestic transport system.?What fits seamlessly with our markets will be the focus of the new service.?While the 53’s might not work in other markets, that doesn’t matter, as the envisioned service won’t be in those markets.?It will be focused exclusively on what works best for the U.S. freight market.???

J.B. Hunt is one of the largest freight transportation providers in the U.S.?They went from being the largest truckload carrier to broadening the services they provided by operating doublestack train service between major points throughout the mainland.?J.B. Hunt is the largest owner of 53’ containers in the world with some 100,000 units.?Their largest lane is outbound freight from Southern California moving in 53’ containers with cargo that originally came in marine containers.?They know that market because they are already actively involved in it.?Integrating backwards with a shipping service from China built around 53’ containers is just extending a supply chain they know exceptionally well.?Importantly, that extension would come with a cost advantage relative to traditional container carriers even with higher crewing costs.?The limitation to China isn’t particularly limiting, as China is source of almost half of the inbound boxes coming into the U.S.???

The cost and time advantages of the new service and the ability to have cargo move seamlessly from China to its final U.S. destination in the same 53’ container will be readily embraced by many shippers.?The same shippers have been utilizing just 53’ equipment for all their domestic moves for some time, and they know the loadability of their products in 53’s.?The most focus should be on shippers that can fully utilize all 3,830 cubic feet in a 53’ box.?There is a retailer in Northwest Arkansas well known to J.B. Hunt that happens to be the largest container shipper in the world and I’d anticipate lots of booking interest by them.

J.B. Hunt is in a unique position to gain another cost benefit from the new service.?All the 53’ containers used in domestic intermodal moves, a fleet of some 300,000 units, are now made in China.?Of the tens of thousands arriving each year, the move is generally arranged on the decks of bulkers.?While revenue is sought, it typically just reduces the cost of positioning the equipment.?The divergent movements from non-traditional ports make those moves cost centers and not profit producers.?A regular scheduled service from traditional ports with 53’s completely flips that dynamic.?J.B. Hunt turns a liability for itself and others into an asset.?For the large number of 53’ containers staying in its and others domestic systems, it won’t need to load them back as empties on the backhaul leg.?That saves costs and time.?Those one way boxes certainly aren’t in sufficient number to have J.B. Hunt avoid loading empties back, but it gives them a further inherent advantage in terms of not having to load back as many containers as were discharged.?Nobody can match that and the resulting cost and time savings are meaningful.???

While J.B. Hunt would seem to be ideally situated to initiate the new service, they aren’t the only innovative American company that could do it.?Several involved in domestic transport and knowing the benefits of 53’ containers come to mind.?Amazon, for instance.?Reduced to its core, it’s the world’s largest logistics company and it’s still growing fast.?If Prime Air makes sense, Prime Water makes more sense and it would undoubtedly be focused on 53’ containers for products coming from China to the U.S.?Other domestic freight providers that would be candidates to start the new service include Schneider, Hub Group, Swift and XPO Logistics.?It is conceivable that a major retailer, or a group of them, will also consider launching such a service.?The largest benefit will accrue to the first company to move ahead on a 53’ service between China and the West Coast.?That innovator would no doubt also recognize the marketing benefits of a U.S. flag service as their customers are American companies and consumers.??

Just as the 53’ service to the West Coast would have relative cost benefits, the same could be said for a 53’ service to the East Coast.?To provide weekly service it would require 10 ships.?With the average capacity of around 9,000 TEU now in the lane, that translates into a crew cost differential of $88 per loaded TEU.?That is equivalent to 1.3% of the latest Shanghai to New York spot rate.?That difference would be more than mitigated by the reduced cargo handling from one third less container crane moves.?Further cost advantages would accrue from the efficiency of follow-on inland movements, whether via road or rail.??

The economic benefits of a China to East Coast 53’ service would draw cargo previously discharged as marine containers on the West Coast and trans-loaded into 53’s moving cross country via rail.?The service would offer significant congestion and emission benefits.?It would obviously improve West Coast congestion by bypassing it entirely.?Congestion relates not only to the port area, but also to a dozen go through states unit trains pass in going across country.?The improvement in emissions from such a transition would be dramatic and fits climate goals embraced by many shippers.?The quickest way to reduce the carbon emissions of freight now moving by land by over 90% is to make it freight moving by water.?That happens immediately with 53’ service to the East Coast.????

After container ships, the segment where the incremental U.S. flag crew cost would represent the smallest percent of total cost are LNG tankers.?With the high capital cost of LNG tankers, the incremental crewing cost versus the total operating, fuel and capital cost of a foreign flag LNG tanker is around 10%.?We are becoming the Saudi Arabia of natural gas and a requirement that some portion of that natural resource move on U.S. flag LNG tankers makes sense.?Such a requirement would encourage re-flagging existing vessels, immediately increasing our merchant marine ships and jobs.?Given the relatively modest cost impact, this would be an efficient way to increase the U.S. flag vessels operating internationally in a growing segment.

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To encourage and reward shippers who utilize U.S. flag ships in movements internationally, relevant government agencies should develop programs that recognize and highlight such shippers.?

Amazon has a commercial saying it will be buying $120 billion worth from businesses in the U.S. each year.?Walmart has a commercial saying it would spend an additional $350 billion on U.S. products over the next ten years.?Programs targeted at recognizing freight decision makers and traffic departments can create a virtuous circle benefiting our merchant marine.??????

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On the domestic side, the focus should be on commercial initiatives to transition pure domestic cargo now moving via rail and road to water.?It is a much larger volume of cargo.?It also doesn’t have issues related to shorter distance and existing setup costs at each end that inherently constrain feeding marine cargo.?It goes without saying that transitioning domestic cargo from land to water involves massive emissions and congestion benefits, but that’s an add-on and the lead should always be cost economics.??

There are many, many vessel configurations that result in less linehaul cost per 53’ mile compared to land modes.?While that decreases as size increases, planning must focus on overall cost including the setup costs at each end.?The vessel should be adapted to fit best with minimizing those costs.?Smaller is often better in terms of overall cost and that also improves frequency which is key in drawing freight from other modes.?Consider barges – in all their iterations – and a wide array of smaller vessels built at many efficient Gulf Coast yards.?

Related to setup costs on each end for containers, one template to study and seek to duplicate or even improve upon is the current experience of the U.S. railroads in loading and discharging 53’ containers.?

For instance, a blue water route between southern Florida and the Northeast, with new terminals with no more infrastructure than is needed for shallow draft vessels, is compelling.?It’s a large freight lane where the water miles are less than the land miles.?Such a 53’ service focused solely on domestic freight would offer cost benefits to shippers at the same time it offers emission and congestion benefits to all along the I-95 corridor.?Domestic cargo moving between the Gulf region and the Northeast involves even more land miles, a factor that plays to the advantage of water alternatives.?The folks in the best cost position to serve that 53’ lane are the tanker companies now moving oil on the same route.?They may want to explore moving 53’s on frames above their piping.?That would be a modern version of what Malcom McLean did 66 years ago.??

We have 25,000 miles of navigable inland waterways and moving domestic merchandise freight in some lanes makes sense and is overdue.?A new 53’ service on the Mississippi River is one example of a more cost efficient way of moving domestic cargo that now moves between Chicago, St. Louis, Memphis and New Orleans, all large domestic freight centers.

River service could be initiated by leveraging on the existing commodity tows by developing a system with river barges directly loaded by new freight agents.?When full with 27 53’ containers, they would be lashed into the next large tow that was going their way on the river.?This sort of distributed capacity system lends itself to daily or even more frequent departures that would be attractive to shippers.?The costs would be low enough to be a compelling value proposition to shippers moving 53’s in selected lanes.??

The rails have a lock on domestic moves of new cars, but there are multiple inland waterway lanes where purpose built low profile water trains pulling car capacity units that are linked together one after another would offer lower costs.?One such lane, connecting where cars are built to a large end market, is Erie Canal to the Hudson River and on to New York City.

Our shipyards can build high spec turbine installation vessels for something less than 50% above the cost of the same TIV built in a foreign yard.?The incremental cost of using these Jones Act TIV’s is just 1.4% of the total cost of an offshore wind turbine.?These sophisticated vessels and the growth they represent is a key niche we need to grow.?They make a statement about what we can do in an important future maritime segment.?There should be an all of government effort to support various initiatives involving Jones Act TIV’s and the range of vessels needed for offshore wind projects.?????

The time has come to reverse the decline in the size of our merchant marine.?If anyone needs a tangible reminder of why it is still needed, just turn on CNN and see what Russia is up to.?For obvious national security reasons, we must be assured that in all circumstances we have sufficient U.S. flag ships for sealift and adequate trained mariners to operate them.?More ships means more jobs, and more jobs means we’ll have the experienced mariners if and when we need them.???

Setting a tangible goal of moving up in relative rank replaces a period of consistent decline with one of upward momentum going forward.?To achieve those goals requires focus, effort and initiative.??The area of commercial initiatives is where we need to concentrate.?It is the path to more sustainable organic growth.?An added benefit of such growth is that it may result in more federal government support in a type of virtuous circle.?When we show more what we can do for ourselves, some in DC who haven’t supported our merchant marine may change their views.?????

Making people aware of the national security aspects.??

Promoting more government funding.??

Encouraging commercial initiatives.??

Those are the communications that can and should be had by everyone involved in and supportive of our merchant marine.?In the end, it is the thought leadership of everyone connected with the American maritime industry and the dialog and initiatives flowing out of that which will be key to the future of our merchant marine.?The watchword should be innovation, with a focus on initiatives having the most seamless fit with our domestic supply chain.?

I’m encouraged about that future and the reasons go back to the innovative thinking that has always come out of America on maritime matters.?Just a couple of days ago I got a tangible reminder that is still there.?I was talking with two bright young Kings Point entrepreneurs involved in a startup to move containers in a battery-electric ship with zero emissions.?And the test vessel they will launch next year will be U.S. flag.?If we have more innovative thinkers like that, an upward move going forward will happen.

Thank you.?