How a Century-Old Law is Fueling an American Building Boom

Photo credit: Flickr/rabiem22

Thanks to a maritime law from the 1920s America's oil boom is fueling a building boom for U.S. shipyards. However, while that law has created an upsurge in the shipping industry, it has refiners fuming because it's adding cost and putting some at a competitive disadvantage to foreign competitors.

The law is called the Merchant Marine Act, but it's more commonly known as the Jones Act. It requires that all goods transported by water between American ports must be carried in U.S. flagged ships, be constructed in the United States, and be owned and crewed by U.S. citizens or permanent residents. Think of it as the ultimate buy American law. Its impact is still being felt nearly a century after passage.

Because of the law, U.S. shipyards are constructing 10 supertankers and have another 15 under contract. That's a huge building boom especially when considering that there are only 75 similar ships in the nation right now.

There is only one reason why this nearly 100-year-old law is even being discussed these days. The U.S. oil production boom has dramatically altered the landscape for how crude oil is transported. With U.S. pipeline infrastructure already filled to the brim, refining companies are turning to ships to move oil out of congested areas like the Gulf Coast in order to offset foreign crude imports along the East Coast. However, in order to do that refiners need to comply with the Jones Act.

Refiner Phillips 66 (NYSE: PSX  ) for example, has already purchased two Jones Act ships as part of its strategy to move cheaper crude oil to its refineries. The slide below details the great lengths the company has gone through to improve its margins.

Source: Phillips 66 Investor Presentation (link opens a PDF)

I would like to point out that the Jones Act tanker pictured on the slide is delivering crude oil from the Eagle Ford shale in Texas. Phillips 66 ships crude from Eagle Ford to its Bayway refinery in New Jersey in an effort to push more expensive Brent-priced crude out to boost profits.

The problem refiners have with the Jones Act, other than the increased costs of buying American, is that some are using a loophole of sorts to send U.S. crude oil further north to Canadian refineries using foreign-flagged vessels.More detail on this loophole?In fact, crude oil exports to Canada are now riding a 13-year high and are double the rate seen last year. Some of this is from rail shipments, but more oil is being moved through U.S. ports to Canada.

Valero (NYSE: VLO  ) is one of the refiners taking advantage of this situation. The company is using lower-cost foreign-flagged vessels to ship Eagle Ford crude to its refinery in Quebec. The map on the following slide shows just how much of an economical advantage this is for the Valero.

Source: Valero Investor Presentation (link opens a PDF)

Notice how it costs just $2 per barrel to ship crude to Canada, while it's $5-$6 per barrel to ship it to East Coast refiners. It's that differential that has frustrated refiners including Phillips 66 and Delta Airlines (NYSE: DAL  ) , which bought a refinery in New Jersey last year. Some refiners even consider the law to be rewarding foreign competitors and are seeking to have the Jones Act modified.

One foreign competitor  taking advantage of the price disparity is Suncor Energy (NYSE: SU  ) . Canada's biggest oil and gas producer has had oil shipped to its refinery in Montreal. However, as much as East Coast refiners fume about this, crude's time aboard ships heading to Canada could be short-lived.

The whole debate of unfair advantages could become a moot point if TransCanada (NYSE: TRP  ) builds the Energy East pipeline. That pipeline would send Canadian crude oil from the oil sands to Canadian refineries in the east. In fact, that pipeline is one of the future solutions that Suncor hopes will help enable it to convert the Montreal refinery to 100% inland sourced crude oil. It could turn out that America's reluctance to approve TransCanada's Keystone XL could be what actually pushes oil that could have gone to U.S. refiners to Canadian refineries instead.

In the near term, the Jones Act is fueling a building boom for U.S. shipyards. While that has some refiners fuming, it's still a good problem to have as it means we are getting less oil from overseas. Further, while some Canadian refiners are able to skirt the law, it's probably short-lived as pipelines are still the cheapest way to transport oil. So, if the U.S. really wants to keep oil and gasoline prices down, we'll simply have to allow more pipelines to be built. Even then we'll be creating new winners and losers.

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