La Alianza Marítima. May 3, 2013

Transcription

1 May 3, 2013 La Alianza Marítima

2 Table of Content EXECUTIVE SUMMARY... 3 PURPOSE OF THE STUDY... 3 STRUCTURE OF THE STUDY... 3 KEY FINDINGS... 3 TRANSPORTATION COSTS... 7 OTHER FINDINGS I. INTRODUCTION OBJECTIVE OF THE STUDY STRUCTURE OF THE STUDY II. REVIEW OF THE LITERATURE STRUCTURE AND COMPETITION IN THE INDUSTRY STUDIES ON THE MARITIME INDUSTRY AND THE JONES ACT Subsidy provisions THE JONES ACT AND PUERTO RICO SUMMARY III. MAIN ECONOMIC TRENDS ECONOMIC GROWTH AND KEY DETERMINANTS EXTERNAL TRADE Exports Imports Main markets IV. GROWTH TRENDS AND STRUCTURE OF THE MARITIME CARGO INDUSTRY WORLDWIDE AND IN PUERTO RICO THE CONTAINER-SHIPPING INDUSTRY WORLDWIDE COMPETITIVE POSITION OF THE PORT OF SAN JUAN WITH RESPECT TO THE REGIÓN AND WORLDWIDE IN TERMS OF VOLUME OF CONTAINER TRADE STRUCTURE OF SHIPPING AND TRADE BY TYPE OF VESSEL GROWTH TRENDS AND TRAFFIC FLOWS Movement of domestic trade northbound and southbound by carriers Trade and real GNP growth Page 1

3 4.3.3 Capacity of shipping V. COMPOSITION OF CARGO AND TYPE OF EQUIPMENT NORTHBOUND SOUTHBOUND CONCENTRATION VI. TRANSPORTATION COSTS MARITIME TRANSPORTATION COSTS U.S COSTS IN PUERTO RICO Example of an impact in retail prices: JAC carriers vs. foreign carriers OCEAN FREIGHT RATES VII. SUMMARY OF KEY FINDINGS VIII. SOURCES CONSULTED APPENDIX A PUERTO RICO TRADE APPENDIX B VOLUME OF TRADE AND REAL GNP GROWTH Page 2

4 EXECUTIVE SUMMARY Purpose of the study The main objective of this report is to present an analysis and assessment of the maritime industry over the last decade, its competitive position, the transportation system serving the Puerto Rico/U.S. route (as defined under the Jones Act), the economic and demographic factors that might influence cargo movements, and secondly, an evaluation of recent economic studies on the industry worldwide, and on the economic impact of the Jones Act. Structure of the study The report is divided into four main topics. The first, which consist of the review of the literature, and of economic studies on the impact of the Jones Act on the U.S. and the local economy. The second provides an analysis of the main economic trends characterizing the Puerto Rican economy over the last decade. The third provides an analysis of the market structure and competition of the maritime cargo industry worldwide, the U.S., and in Puerto Rico. The fourth present the estimates of the average transportation costs of the Jones Act carriers service to Puerto Rico. These were derived from data supplied by The Maritime Alliance. Key findings With the introduction in 1956 of container shipping, the container liner shipping industry (CLSI) has become a complex system encompassing a primary transportation service across various points throughout the world. Globalized competition and other market forces have fostered consolidation trends and oligopolistic market structures in the CLSI. According to Sys (2009), the CLSI s market structure lies between a formal collusively oriented oligopoly and a more tacitly collusive one, concluding that globally, the container shipping industry is confronted with increased concentration. Other researchers also classified the CLSI as an oligopoly, due to the price operations of a cartel. In the case of Jones Act carriers, there is an opportunity to address the fact about the ease with which the international transportation community colludes via 3

5 annual conferences that are not subject to antitrust laws, such as the Sherman Act. Although correct that international trade is not subject to normal U.S. antitrust laws, the Shipping Act of 1984/OSRA 1998 does mimic antitrust laws, although with greater ability to collaborate. Jones Act carriers are fully subject to the antitrust laws, while carriers in international trades have more latitude to collude without violating legal standards. The above suggests that eliminating the Jones Act would not place Puerto Rico in a competitive market but instead one characterized by significant concentration. As a matter of fact, more than 40% of the global cargo is concentrated in three lines, Maersk, MSC, and CMA-CGM, and these plus COSCO have 41.0% of the world s liner fleet (in TEU terms). 1 Several studies have attempted to assess the economic costs related to sustaining Jones Act provisions (see chapter II). Nonetheless, the different assessments and variation in the quantity and type of cargo make conclusions difficult to arrive at. Other studies, on the other hand, highlight the economic and employment benefits of the Jones Act, arguing that such benefits outweigh the costs included in most Jones Act cost estimates. The consensus in recent literature suggests that there is a cost premium associated with operating vessels under U.S. laws using U.S. crews, vs. operating vessels using third world crews. This is a key effect of applying the Jones Act to the Puerto Rico and other U.S. domestic markets. Attempts to quantify the economic impact of the Jones Act have been classified by critics as speculative, due to not including all relevant factors in a costbenefit calculus. In the case of Puerto Rico, the effects of the Jones Act remain a contention in the literature. The recent study by Valentin-Mari and Alameda (2012), estimated 1 See Alphaliner (2013). The concentration in the world industry is going to increase. According to recent reports, Hapag-Lloy is in merger talks with Hamburg Sued, which woud create the world s fourth-largest carrier. See Magnusson (2013). 4

6 a cost to Puerto Rico s economy of $537.2 million attributable to the Jones Act in The study has serious methodological limitations: it bases its conclusions on an analysis made on the value of merchandise, not the volume of cargo and total freight costs paid in Puerto Rico. Total Jones Act carriers invoicing does not exceed $710.0 million per year, which suggests that attributing over 75% of that total to the Jones Act is misleading. An additional aspect to take into consideration is that, in the studies in the case of Puerto Rico (including that by Valentin-Mari and Alameda), actual shipping costs of foreign carriers are used and not the costs they would incur if they serve the domestic routes. Entering the domestic trade, non-jones Act carriers would have to comply with all federal laws (wages), and that cost advantage would disappear or at least The 2013 GAO Report Key Findings diminish. and Limitations The recent GAO (2013) study does not provides cost estimates for several reasons, although perhaps its most important finding would be that The effects of modifying the application of the Jones Act for Puerto Rico are highly uncertain. There has been an increase in the size of containers being used, from the traditional 40 size, to 53. In calendar 2011, 26.0% of the Southbound trade (SB) trade was carried in 53 containers. The sum of the Puerto Rico still operates via a closed loop service. This has resulted in dedicated, scheduled, regular shipping services from the Jones Act carriers, which represents an important benefit to customers in Puerto Rico. Any associated cost premium relevant to the Jones Act is highly dependent upon other economic factors, many of which have a much more direct impact upon final freight rates and total transportation costs. Some services between Jones Act and foreign carriers are not comparable, and the degree of substitutability between these has not been estimated. (In section 6.2 of the report an estimate is provided on the costs advantages to P.R.s customers with respect to container sizes, and the impact in terms of costs of downsizing to 40ft containers). The study also finds that because of cost advantages, unrestricted competition from foreign-flag vessels could result in the disappearance of most U.S.-flag vessels in this trade. 1 But the only cost advantage that foreign carriers have with respect to Jones Act Carriers is a labor-cost advantage. As explained in the report (p. 10), that cost advantage would disappear when foreign carriers would have to comply with the same labor rules and requirements as U.S.-flag container carriers. 5

7 45, 48 and 53 equipment was 47.3%, which is 18.3% more than the 40 equipment s trade volume (Data from PIERS). This shift to larger size equipment in Puerto Rico is a significant advantage. 2 The relatively high share of 53 containers in SB (and Northbound) is important for two reasons: (1) the use of bigger containers (53 ) is a key driver in transportation efficiency, as the cost of loading and unloading it is practically similar to a 40 container; (2) among international carriers containers of this size are not widely used, and they are not used in their service with Puerto Rico, which is a key difference between Jones Act carriers and international liners. 3 These sizes of containers (e.g. 53, 48, and 45 ) are not commonly used or available in international trade. The evolution of these container sizes plays a critical role in driving greater efficiencies for shippers and cargo owners: ü The introduction of these sizes has represented a significant complexity to Jones Act carriers, in terms of equipment inventories, vessel design and configurations, rebuilds, and higher costs. ü This constitutes a good example of how Jones Act carriers developed innovative offerings to make transportation services and costs more beneficial to customers, in line with intermodal solutions across the U.S. ü Reversing these benefits in an open, international liner scenario can represent significant incremental costs to shippers and/or consignees, as will be shown below. An upper level estimate could be between a 13% to 43% incremental rate per cubic foot utilization, or more than $80.0 million per year. 4 ü Research on container manufacturing sites and international shipyards indicates that there are no projects in the pipeline for these sizes. 2 For background on the origin of this size of container see Britannia (2011). 3 Some foreign carriers do use it. APL took delivery in 2007 of its first container of this size, for its South China-Los Angeles route. See TI-UP Resource Centre (2007). 4 Estimates based on data provided by La Alianza Marítima. 6

8 International, newly released ships continue to be designed for 20 and 40ft. containers only. Transportation Costs In the studies so far on P.R. s Jones Act trade, the cost dimension of transportation (terminal-to-terminal (TT) and inland) has not been examined explicitly. Thus, for the purpose of this report we have developed estimates of transportation and direct cost impact of Jones Act carriers (JAC), and the economies generated by them with respect to international service. The estimates are based on data supplied by PIERS, corresponding to the period from September 2011 through August They are presented in tables 1 to 3 below. Figure 1 above presents the Figure 1 distribution of the average operating costs by main categories for JAC. The biggest item is that of fuel (25.0%), and the smallest depreciation (5.0%). In other words, for every $1.00 of costs, 25 cents go to fuel. Vessel operations and vessel depreciation percentages are cost categories common to both, JAC and foreign carriers. Of the total annual volume of trade (in FEU s) for the period, SB trade accounted for 81.0%, and 87.0% of the estimated total revenue of the market. The average terminal-to-terminal (TT) rates for Northbound (NB) trade is $1,713 and for SB $2,510. 7

9 Based on current market costs the total annual estimated costs were $668.6 million; adding ROI (a conservative 5%) yields an estimated total market revenue of $703.8 million. Using the cost structure distribution in Figure 1, and based on the two cost items common to both carriers (JAC and international) an estimate is generated of the annual direct impact of foreign carriers in the PSJ, which is $48.5 million (see table 1 above). But a key aspect of a comparative cost analysis with international carriers is the one related to the size of the equipment in use, as mentioned in page 5 above. This is an area in which JAC carriers provide a cost advantage to local businesses compared to foreign carriers should they service the domestic routes. Table 2 presents estimates for the number of container (boxes) that would be required by downsizing 45, 48 and 53ft containers to 40ft ones, and the cost economies due to the use of 8

10 such bigger containers. These would be additional costs that would be incurred by businesses with JAC carriers if they have to use only 40ft containers, the norm with international carriers. The number of additional 40ft. containers that would be required (based on linear ft. differences) is 27,962, and in terms of the additional capacity that would be lost the number of containers would be 35,319. The inland cost (freight) economies (US/PR) that businesses receive with the use of bigger containers is estimated at around $35.3 million per year, with a corresponding savings in rates of $82.0 million. Total economies derived from the use of bigger containers are estimated at $120.8 million, or $424.0/FEU (Forty-foot equivalent unit). Table 3 below presents the estimates of the cost impacts of the different types of services, inland (US and SJU), and maritime (TT), and those related to international services. Total inland costs (freight) were estimated at $313.7 million, with total transportation costs estimated at $1,017.5 million. Inland costs represent 31.0% of the total, with U.S. costs accounting for 22.4%, and SJU inland costs 8.5% respectively. Maritime costs (TT) represent the bulk of the total costs, 69.2%. On the other hand, the cost impact due to international service was estimated at $79.3 million. 9

11 An estimate was made for comparison of what would be the potential increase in costs in the case of one product, imported poultry (fresh and frozen), under JAC and foreign carriers, all the way through the supply chain to retail. Under current JAC trade, the average retail price per pound of poultry was $1.69 (In January 2013); under a foreign carrier, taking into consideration the additional cost impacts derived in Table 3 the price would rise to $1.90/pound retail, an increase of 12.5%. The biggest increase would be in the case of TT costs, 17.0%. Internationally, ocean freight rates have gone through major transformations, stabilized, and moved up at a rapid pace since mid-2011 (see section 4.1 in chapter 4). A comparison between the global freight rates in January of this year of $2,713/FEU, with that estimated for P.R. s domestic trade for 2012, of $1,810/FEU shows that the average rate for international service is 33.0% higher than that for Puerto Rico. In an analysis of the cost structure of U.S. and foreign-flag vessels by MARAD (2011), for all types of ships and for containerships and RO/RO, daily wages or crew costs of U.S.-flag vessels represented 68% of the total vessel operating costs, and account for the biggest cost-differential with respect to foreign-flag vessels. In the case of containerships and RO/RO vessels, the situation is the same, with crew costs (daily wages) for U.S. vessels being 5.5 and 5.2 times higher than foreign-flag vessels respectively. In 2010, crewing costs for U.S.- flag containerships represented 70% of their total ADOC (Average Daily Operating Costs), and 28% in the case of foreign-flag containerships. The above aspect is a key point to take into consideration, if a foreign-flag carrier would transport domestic cargo between PSJ and JAX, for instance. Complying with the same labor rules and requirements as U.S.-flag container carriers do would reduce that labor-cost advantage, which would have a direct impact on their transportation costs. According to a study by MARAD (2011), complying with all the work rules and manning requirements in the U.S. that affect labor productivity and crewing flexibility result in overall crewing costs 10

12 that contribute approximately $12,000 to $15,000 per day to total U.S.-flag operating costs. This would almost erase the difference in ADOC between U.S.-flag and foreign-flag carriers estimated by MARAD at $12,599 in ADOC in The most critical element of transportation and doing business in Puerto Rico is the ability of carriers to arrive on time and deliver the cargo the same day. Jones Act carriers doing business in Puerto Rico have an average rate of 98% on-time arrival/cargo delivery, measured within a two hours tolerance rate. 6 This literally means that when a vessel arrives in the morning, and release most of its cargo by noontime, it will be at the supermarket or manufacturing plant for use the same or next day. Two key aspects are relevant: ü Compared with the current international liners performance of approximately 80%, it represents a big gap compared to the benefits of the close loop of sailings by Jones Act Carriers. 7 ü Simulating today s JAC cargo worth more than $700.0 million in transportation services and more than $6 billion dollars in acquisition value, a 80% service level will force several business costs to dramatically increase, among those; additional warehouse space, utilities, labor, inventory taxes (CRIM), obsolescence costs, cash flow considerations and carrying costs in general. There is another positive economic impact from Jones Act carriers, related to port infrastructure. They have invested through several decades a considerable amount of money expanding or improving the facilities at the Port of San Juan. The Puerto Rico Ports Authority (PRPA) plays a single landlord role, by providing the leased land with no added value benefits, e.g. pavement conditioning, offices, cranes, and other equipment. 5 We were not able to obtain from the JAC carriers a breakdown of their operating costs similar to that in the analysis by MARAD, but its conclusions in this regard would still be valid in P.R. s case. 6 Provided by La Alianza Marítima. 7 See Drewry (2012) and (2013); SeaIntel (2013). 11

13 Contrary to most jurisdictions in the world, the carriers fund most of the infrastructure required to do business at the port of SJU. This represents an estimated investment of more than $250.0 million in current replacement value. The carriers account for more than 75% of the land owned by PRPA, more than $7.5MM in leases, and $12.0 million in steady wharfage and dockage revenues. 8 International Liners doing business in Puerto Rico, as well as in many International jurisdictions, are not bound to contractual arrangements for port land leases and assets, which constitutes a significant revenue risk to port authorities or terminal operators, in the event of change of schedules or simply abandoning service to a particular port. As a matter of fact, more than 25.0% (more than 150,000 TEU s) of the cargo that enters Puerto Rico today comes from international liners that have no direct contractual relationships with the PRPA, and no infrastructure investments in the ports. 9 So far, no government or private entity, including international carriers, has presented a study or proposal as to how international lines can deliver a better service and lower cost proposition to Puerto Rico, on the assumption that the Jones Act is repealed. It has simply been assumed that new entrants would not lower costs. Other findings Globally, growth in container demand moved up, exceeding that of supply for the past two years, as world economic conditions improved, stabilizing in 2011 in line with more stable freight rates. Container trade increased 12.1% in 2010 after contracting in the previous year, with a similar performance in Container trade volumes worldwide, different from domestic trade in recent years, expanded at an average rate of 8.2% between 1990 and 2010, driven by productivity gains and a surge in demand across all trade lanes. 8 Data from the Maritime Division of the P.R. Ports Authority. 9 From La Alianza Marítima. 10 See UNCTAD (2011). 12

14 The Port of San Juan faces several challenges, related not only to cyclical economic factors, but also those pertaining to the industry and domestic service, some of which are: 1. The volume of total container trade handled (in TEUs twenty-foot equivalent units) has declined, from million in 2000 to million in fiscal 2011; 2. Between 2004 and 2011, the total volume of domestic trade (Northbound and Southbound) of the four shipping lines fell, from 834,924 to 627,364 TEUs, and the average capacity utilization in the Southbound trade declined from 94.6% to 76.4% during the same period (see Appendix A); 3. The share of Puerto Rico in the total U.S. Atlantic (plus Houston) container port traffic (in TEUs) went down, from 16.5% in 2000 to 7.6% in fiscal 2011, as the share in coastwise trade in total U.S. domestic waterborne commerce also fell, from 21.2% in 2000 to 18.4% in 2010; 4. Compared to other seaports in the region, in terms of container traffic handled (In TEUs), PSJ s traffic has trended down, while that of its immediate competitor (Dominican Republic) has increased considerably since The above developments took place in the context of a significant growth in container volume worldwide. In 2002, the total number of full containers shipped on world trade routes (excluding transshipment) amounted to 77.8 million TEUs, and by 2015 the volume is expected to reach million TEUs. 11 Maritime transportation plays a key role in the food supply in Puerto Rico, as all the food, agricultural products, and beverages that are imported come via maritime transportation. For instance, on average 50% of the total consumption of key agricultural products is imported (Data for 2009). In some cases, though, the proportion is higher, as in the case of poultry (82%), meats (91%), eggs 11 See Kong Yew Jeremy Kee (2006), p. 24, and UNCTAD

15 (65%), and coffee (59%). For some other staples, like rice, the proportion is 100%. Between 2002 and 2011, the volume of southbound trade of domestic carriers (in FEUs) declined at an annual compound rate of -2.4%. Northbound trade registered a similar but less pronounced trend over time. It is interesting to observe that southbound trade started to decline prior to the onset of the economic contraction (2007 to 2012). This suggests that other reasons were at play in the reduction in trade volume, while northbound trade actually increased in the period Another characteristic of the southbound trade is the high concentration or share that a small number of accounts have in the overall trade. According to data from JOC-PIERS (2012), the top 20 accounts are responsible for 41% of the southbound trade, with the top 43 accounting for 56%. Together with the significant growth in container volume worldwide, international shipping has been experiencing significant increases in the freight rates on the three major routes, Trans-Atlantic, Asia-US, and North America- Latin America. Transpacific freight rates are expected to increase 50% this year, with increases in the rates from $400 to $600 per 40ft. container (FEU), and Maersk recently increased by 30.0% its reefer container freight rates, and Hapag-Lloyd raised its freight rates for all container types by $300 per 40ft. container in its North America-Latin America and Caribbean routes See JOC (2013a), and K. Wallis (2013). 14

16 I. INTRODUCTION Today, the Port of San Juan (PSJ), as will be seen further on, faces some daunting challenges: 13 (1) The volume of total container trade handled (in TEUs) has declined, from million in 2000 to million in fiscal 2011; (2) Data provided by La Alianza Marítima (2012) indicates that between 2004 and 2011, the total volume of domestic trade (Northbound and Southbound) of the four shipping lines fell, from 834,924 to 627,364 TEUs, and the average capacity utilization in the Southbound trade declined from 94.6% to 76.4% during the same period (see Appendix A). 14 (3) The number of container ship and Ro/Ro vessel calls also has declined, from 647 in 2002 to 645 in 2010, with those of containers falling from 482 to 442 in the same period; (4) Total capacity (in FEUs) Source: UNCTAD (2011), p. 91. for containers and Ro/Ro has fallen, from 518,220 in 2007 to an estimated 490,636 in 2011; Regional Competition In Panama, there are plans to build two new ports at Balboa and Rodman. The development of a container terminal at Rodman port was previously estimated to cost $100 million and will have a capacity of 450,000 TEUs. The canal expansion, which is set to be completed in 2014 will allow for much larger although not the largest vessels to transit. In the Dominican Republic, the port of Caucedo, completed its second phase of development in 2011 with an additional 300 metres of quays. The port, which was originally estimated to cost $300 million, now has a handling capacity of 1.25 million TEUs. In Jamaica, the port of Kingston announced plans to extend the port to cater for the expected increased demand once the Panama Canal enlargement is completed. The $200 million project will see dredging works take the port s entrance channel down to 16 metres deep and the quay area extended by 1.5 km. Currently it handles 1.8 million TEUs container freight. 13 Data from: MARAD; U.S. Army Corps of Engineers; American Association of Ports Authorities; The World Bank, Container Port Traffic (2012). 14 Data here has been converted to TEUs from FEUs in order to maintain consistency with other related reports. 15

17 (5) The share of Puerto Rico in the total U.S. Atlantic (plus Houston) container port traffic (in TEUs) went down, from 16.5% in 2000 to 7.6% in fiscal 2011, as the share in coastwise trade in total U.S. domestic waterborne commerce also fell, from 21.2% in 2000 to 18.4% in 2010; (6) Regionally, the position of the PSJ in terms of total container port traffic handled (in TEUs) between 2007 and 2010 has fallen, while that of the Dominican Republic Challenges to the Container Market increased. The Port of and Concept Kingston is handling more container cargo than PSJ (see Table 2 in section 4.2), and; (7) P.R. s Liner Shipping Connectivity Index index (a measure of global trade connectivity), fell, from in 2004 to in Undoubtedly the economic contraction Ships are getting larger and more efficient but the container technology driving business is basically the same as 40 years ago. Modern terminal equipment is becoming widespread, requiring terminal operators to compete more through productivity gains, adopting technology-related improvements. Since technologies have a cycle, there is the question as to what will happen to the container system in the future. Global supply chains are exerting pressures on the container concept; for example, in the way containerized logistics systems are managed. Source: Notteboom and Rodrigue (2008), pp (in the U.S. and in Puerto Rico) has played a key role in these developments. Consumption of durable and nondurable goods, which to a significant extent is satisfied through imports (mostly via maritime transportation), has fallen (meaning less consumption of goods) but there might be other factors at play of a structural nature. 15 The Liner Shipping Connectivity Index is developed by the United Nations Commission on Trade and Development [UNCTAD]. It gives an overall picture of the island s accesibility to global trade (it does not include trade with the U.S.). It is generated from five components: (a) the number of ships; (b) the total container carrying capacity of those ships; (c) the maximum vessel size; (d) the number of services; and (e) the number of companies that deploy container ships on services to and from a country s ports. For each of the five components, a country s value is divided by the maximum value of that component in 2004, and for each country, the average of the five components is calculated. This average is then divided by the maximum average for 2004 and multiplied by 100. In this way, the index generates the value 100 for the country with the highest average index of the five components in value 100 for the country with the highest average index of the five components in See UNCTAD 16

18 For instance, in the case of (1) above, the downward trend was already evident before 2007, the start of the contraction in the Puerto Rican economy. There is also the declining share of Puerto Rico in U.S Atlantic trade, likely reflecting a similar trend in the share of coastwise trade in total U.S. domestic waterborne trade, which is evident before The size of containers has increased in recent years, which might account for the reduction in the number of vessel calls, but there has been a decline also in the capacity of containers and Ro/Ro since By fiscal 2011, according to data from the American Association of Ports Authority (2012), the volume of total container traffic handled (in TEUs) in the PSJ fell by 2.7% from 2010, with the port s ranking among North Atlantic ports falling to 12 from 10 in the previous year. 16 The above developments took place in the context of a significant growth in container volume worldwide. In 2002, the total number of full containers shipped on world trade routes (excluding transshipment) amounted to 77.8 million TEUs, and by 2015 the volume is expected to reach million TEUs. 17 This development has been accompanied by technological improvements, with larger vessels constructed Yet, as Notteboom and Rodrigue points out, the technical concept of a container vessel has not changed dramatically. and the Developments in the liner trade globally In 2009, the top 30 liner carriers reported an estimated collective loss of $19.4 billion from a reported $5 billion profit the year before. In 2010, the same liners are estimated to have earned a combined $17 billion. Profits are forecast to be about $8 billion in The turnaround by 2011 is attributable to the following factors: world is still embracing an old concept the container to deal with the challenges of contemporary global supply chains. 18 After significant losses in 2009, the situation is estimated to having improved in 2010 and ü ü ü Methods adopted by the carriers, which absorbed capacity; A fall in fuel prices, in some cases by as much as 30%; An increase in demand from merchandise trade. Source: UNCTAD (2011), p AAPA (2012). North American Container Traffic: 2011 Port ranking by TEUs. 17 Jeremy Kee Kong (2006), p. 24; Theo Notteboom and Jean-Paul Rodrigue (2008), p Ibid., pp

19 Figure 1 Global Production Networks Production Trade Services Distribution Logistics Networks Consumption Freight integration Source: Adapted from Notteboom and Rodrigue (2008), p Objective of the study The main objective of the study is to provide an analysis and evaluation of the structure of the maritime cargo industry in Puerto Rico, with special reference to domestic trade, and its competitive condition. This also considers transportation costs (to the extent the information has been made available), market structure, traffic volumes and composition of cargo Structure of the study The report is divided into four main topics. The first consist of the review of the literature, and of economic studies on the impact of the Jones Act on the U.S. and the local economy. The second provides an analysis of the main economic trends characterizing the Puerto Rican economy over the last decade. The third provides an analysis of the market structure and competition of the maritime cargo industry worldwide, the U.S., and in Puerto Rico. The fourth presents estimates on transportation costs. 18

20 II. REVIEW OF THE LITERATURE This section presents a review of the studies and reports consulted for this study. It is divided into three main areas: the first, on the industry and market structures, and competition; the second on the U.S. maritime industry and cabotage; and the third on the Jones Act and Puerto Rico, which includes a selection of recent studies with estimates of the economic impact of the law in the U.S. and Puerto Rico. 2.1 Structure and competition in the industry With the introduction in 1956 of container shipping, 19 the container liner shipping industry (CLSI) has become a complex system providing primary transportation services across throughout the world. 20 This system flows along two production chains, one being the firms internal production chain, the other being the maritime logistics chain, with the latter an important enabler of international trade. 21 Globalized competition and other market forces have fostered consolidation trends and oligopolistic market structures in the CLSI. 22 Since the CLSI spreads its cost structure alongside the many operations in the logistics chain, various patterns of vertical and horizontal cooperation have emerged in the industry. 23 According to Sys (2009), the CLSI s market structure lies between a formal collusively oriented oligopoly and a more tacitly collusive one. She studied, among other measures, the firms market share instability, income/output distribution and the Herfindahl-Hirschman index throughout the decade, concluding that globally, the container shipping industry is confronted with increased concentration. 24 Other researchers also classified the CLSI as an oligopoly, due to the price operations of a cartel. 25 The above suggest that leaving the Jones Act would not place Puerto Rico in a competitive market, but further one that is highly concentrated. 19 See M. Levinson (2006), pp Simone Caschili, Francesca R. Medda (2012), p Dong-Wook Song and Photis M. Panayides (2008), Ross Robinson (2002), pp César Ducruet and Theo Notteboom (2012), p See Eddy Van de Voorde, Thierry Vanelslander (2009). 24 Christa Sys (2009), p Nancy R. Fox (1994); Christa Sys, Hilde Meersman, Eddy Van de Voorde (2011) 19

21 Another increasingly important aspect for the CLSI is supply chain control, where port competitiveness is becoming increasingly dependent on external coordination and control of the whole supply chain. 26 Shipping industries look for integration of port capacity into their supply chain in order to increase their competitiveness and reduce costs. 27 Moreover, the existence of significant economic, legal, institutional, and geographic barriers generates hard entry conditions consistent with an oligopoly: this, combined with a highly constrained market and economies of scale, explains the current clustering trend in the industry. 28 The existence of barriers to entry and collusive behavior has led researchers to study the contestability of the maritime industry with no clear conclusions. According to Sanchez and Wilmsmeier (2011), the question as to whether or not the market is contestable cannot be clearly answered and the empirical findings lead in different directions. 29 Alcedo, Moreno & Ibañez (2009) argue that contestability needs to be addressed on a trade-by-trade basis due to the common occurrence of market share fragmentation. 30 The diversity of trade agreements price fixing, cooperative working, slot-capacity combination, among others suggests that the oligopolistic conditions of the maritime industry are multidimensional and cannot be easily circumscribed under a specific type of market contestability. 31 Thus, whether the shipping market fulfills contestability requirements remains debatable. Another important characteristic of the CLSI is the predominance of a standard set of competitiveness determinants, due to the market dynamics and the supply chain orientation of the industry. The particular determinants can be classified into Porter s diamond of competitiveness Valentina Carbone, Marcella de Martino (2003), p See He Haralambides (2002). 28 Peter W. de Langen, Anasthasios A. Pallis (2007); Mike Fusillo (2009). 29 Ricardo J. Sánchez, Gordon Wilmsmeier (2011), p Iñaki Alcedo, Jose Moreno, Itsaso Ibañez (2009), p See, for example, Michael J. Ryan (2000), Michael J. Ryan (2007), and Carsten Fink, Ayadita Mattoo, Ileana Cristina Neagu (2002). 32 Wei Yim Yap (2009), p

22 The literature is fairly convergent on these elements. For example, several studies have emphasized economies of scale as an important competitiveness determinant, whether by ship size or by strategic alliances between carriers. 33 Koay (1994) notes that the CLSI operates in a market where cooperation functions as a compensation mechanism a conclusion shared by other authors. 34 Other determinants include factors of production, such as labor costs, management quality, pricing, and investment in infrastructure, or transshipment possibilities. 35 Finally, the impact of geography and government regulation in the CLSI s supply chain is evaluated by some researchers as both an enabler and an obstacle. 36 These particular areas provide an important part of the competitive edge in the CLSI. 37 Government plays many important roles within and outside the CLSI s supply chain. A study prepared by Booz & Co. for the National Transportation Commission in Australia (2008) outlined several layers of government influence in different modes of transportation: specifically, the port industry is regulated via port ownership, regulations, funding, planning and policies. 38 De Borger and de Bryune (2010) analyzed two specific policy instruments, port access fees and hinterland road tolls, within an integrated logistics market context; they concluded that if the government does not respond to changes in market structure in the logistics industry, welfare losses are likely to be substantial. 39 These studies, alongside others, underline the importance of regulation as part of the inherent policy structure in the emerging logistics cluster, caused by consolidation and vertical integration in the CLSI. 40 Addressing the U.S. regulations helps establish the government planning, regulation and policy objectives that can become competitive advantages or obstacles for the local containerized shipping industry. 33 See Mike Fusillo (2006), and Kevin Cullinane, Mahim Khana (1999). 34 Peng Yen Koay (1994), Abstract; Geraldo A. de Souza, Anthony Beresford, Stephen J. Pettit (2003); Eddy Van de Voorde, Thierry Vanelslander (2009). 35 Jose Tongzon (2007), p. 2; Photis M. Panayides (2007). 36 See Ximena Clark, David Dollar, Alexandro Micco (2002) and ECLAC (1998), pp Jose Tongzon (2007) proposes a more comprehensive framework in line with the determinants discussed here. 38 Booz & Co. (2008), p Bruno de Borger & Denis de Bryune (2010), pp Trevor Heaver, Hilde Meersman & Eddy Van de Voorde (2001), p

23 2.2 Studies on the maritime industry and the Jones Act The primary legal framework for the U.S. domestic trade is the Jones Act. This law restricts domestic shipping to U.S. built, owned and flagged ships which includes repatriation regulations, seamen s rights and cargo preference requirements for U.S. ships, unless availability is not met. 41 It also includes requirements that vessels be U.S. built. Cargo preference refers to the obligation of the U.S. government to ship its international cargo on U.S. flag ships. It does not apply in domestic trades, since the Act requires U.S. flag for all moves. It fulfills two primary strategic objectives: protecting regional commerce from national security threats and ensuring the availability of a skilled maritime labor force. These objectives were introduced in the 2006 National Security Strategy, where the merchant marine serves as an important military asset. 42 It should also be pointed outthat domestic commerce of any kind trucking, manufacturing, hotel services, and shipping is universally subject to domestic laws. It is that fact that creates U.S. costs. The Jones Act unifies the relationship between the U.S. merchant marine and national defense, and constitutes the framework for deployment of a merchant marine in military conflicts throughout the world. 43 Nevertheless, the Act has evolved over time to include narrow exceptions that provide a more modern framework for commerce. Some of these exceptions include waivers for particular trips, specific periods of time, or distinct geographic areas, 44 as in the case of cruise ships between Puerto Rico and the USVI. Several studies have attempted to assess the economic costs related to Jones Act provisions. Nonetheless, the different assessments and variation in the quantity and type of cargo make conclusions beyond a perceived high cost to the economy difficult to obtain. 45 Other studies, on the other hand, highlight the economic and 41 Richard A. Smith (2004), pp ; Cristopher Clott (n.d.), pp National Defense University (2009), p See W.E. Curtis (1992). 44 Katie Smith Matison, Jennifer K. Smith (2006). 45 Fabien Bertho (2011), pp

24 Table 1 23

25 employment benefits of the Jones Act, arguing that such benefits outweigh the costs included in most Jones Act cost estimates. 46 Table 1 above presents a summary of recent studies and their conclusions with respect to the economic costs of the Jones Act in the U.S. and Puerto Rico. Attempts to quantify the economic impacts of the Jones Act it have been classified by critics as speculative due to not including all relevant factors. 47 Applicability of the alleged Jones Act premium on overall transportation costs of goods and services has been criticized as well; for example, the U.S. Transportation Institute (2009) noted that higher local freight rates can be explained by the regulatory and economic environment under which U.S. flagged ships operate. In addition, due to the lack of adequate data, many studies have to assume certain economic conditions or operational constraints, which may not hold in practice. The U.S. Government Accountability Office (GAO), in an assessment of a 1995 ITC estimate, stated: The accuracy of ITC s estimate of the economic impact of the Jones Act is uncertain because of the limitations of the data and the assumptions that ITC used in its analysis. Also, other important factors that were outside the scope of ITC s study, such as the national security and potential federal budget implications, deserve consideration in an evaluation of the benefits and costs of the Jones Act. 48 According to GAO (1998), the main difficulty stems from the lack of data to quantify more realistic cost-benefit estimates in both strategic and economic dimensions of the Act. The question of whetehr the Jones Act is a competitive advantage or disadvantage to firms cannot be clearly resolved. However, its ample legal precedent, defense in legal, political and judiciary branches of government, and the benefits it provides to the U.S. strategic interest, establish a factual permanence of the Jones Act in the United States CLSI. 49 Cost premium or not, maritime firms operating in the U.S. domestic trade will still face the challenge of 46 See, for example, Transportation Institute (2009). 47 American Maritime Partnership (2012), p GAO, (1998), p Robert R. Clower, John R. Harris (1965), p

26 abiding by its regulations, yet staying competitive Subsidy provisions The Merchant Marine Act of 1920 did not provide for subsidy payments to the U.S. flagged merchant fleet; however, it did provide strict cargo preference requirements unless availability was not fulfilled. Further legislative enactments, however, extended U.S. merchant marine provisions to include direct and indirect subsidy payments. PriceWaterhouseCoopers (2011) notes: 50 The Merchant Marine Act of 1936 established direct and indirect subsidies through the Operating Differential Subsidies (ODS) and the Construction Differential Subsidies (CDS) program provided to U.S.-flag vessel owners. These programs were designed to help offset the higher costs of operating under a U.S. flag and constructing vessels in U.S. shipyards, and expired during the mid-1990s. The only specialized research found regarding the effects of the U.S. shipbuilding industry s subsidies is a study by Vambery (1968). Vambery heavily criticized the Operating Differential Subsidies (ODS) and Construction Differential Subsidies (CDS) established by the Merchant Marine Act of 1936, citing many operational and administrative problems as evidence for the programs failure. Current trends in the industry, however, seem to provide evidence to the contrary. For example, MARAD (2011) notes the importance of the Maritime Security Program (MSP) in alleviating the operating cost disadvantage of U.S.-flagged vessels. 51 PriceWaterhouseCoopers (2011) extends this conclusion to the cargo preference requirements in the Jones Act, indicating that: Carriers indicated that preference cargo provide a critical revenue stream that significantly contributes to the commercial viability of U.S.-flag vessels and assists in offsetting the higher operating costs for U.S.-flag vessels PriceWaterhouseCoopers (2011), p. 8. The CDS was repealed, and ODS was reformed by the Maritime Security Program. 51 MARAD (2011), p PriceWaterhouseCoopers (2011), p

27 Legislation offering subsidies or special provisions beyond cargo preference greatly diminished after the ODS and CDS cessation. Direct subsidies ended in 1982, when CDS s funding was terminated. 53 At the moment, the main program to support the industry is the Maritime Security Act of 1996; however, this fund is reciprocal, in that it provides economic assistance in exchange for military assistance of the commercial U.S. fleet. 54 Fritteli (2003) notes that the U.S. commercial fleet is not subsidized directly, and that beneficial government programs beyond insurance are not provided in contrast to other nations subsidy policies. 55 Thus there seems to be a government-neutral regulatory environment inside the Jones Act s protective umbrella. 2.3 The Jones Act and Puerto Rico The literature concerning the impact of the Jones Act on Puerto Rico can be traced as far back as 1965, in a study by Clower and Harris regarding the operating cost differences between U.S. and foreign-flagged ships. That same year, Pesquera [1965] estimated the cost at $48.3 million dollars in her analysis of maritime transportation between the U.S. and Puerto Rico. Later research undertaken by the Federal Maritime Commission (FMC, 1970) suggested cost differences of 10-20% between foreign containerships and those operating in the United States. 56 In 1975, Kaplan estimated a 10-15% difference between U.S. and foreign ship life-cycle costs. 57 However, that same study argued that vessels cost composition had changed due to the rise in fuel prices and cargo handling costs, thus shrinking the cost gap between U.S. and foreign ships. 58 The U.S. Department of Commerce (1979), however, in its well-known study on the economy of Puerto Rico, was skeptical regarding the scope and long-term benefits of a liberalized shipping regime: John F. Frittelli (2003), p Ibid. Jones Act refers to domestic shipping, while the MSP and cargo preference are U.S. maritime promotional programs in international trdae 55 John F. Fritteli (2003), p Federal Maritime Commission (1970), p Jacob J. Kaplan (1975), pp. 1, Ibid. 59 U.S. Department of Commerce (1979), p Hereafter USDC. 26

28 Furthermore, although the Puerto Rican Government sees U.S. shipping services as being inordinately expensive, the opening up of competition to foreign vessels is not viewed as a panacea open international competition could bring greater price instability. In addition, its cost effects are difficult to predict. Other recent studies have further reduced the impact of the Jones Act on Puerto Rico. Quiñones (1990) attempted to explain changes in consumer prices due to the Jones Act, but only found a small increase in particular products. 60 Dávila (2002) measured the cost differential in exports and imports attributable to the Act, but his results were statistically insignificant at standard confidence levels. A 2011 study prepared by Reeves & Associates found that: 61 the total area of cost in question for a Jones Act premium is around 20 percent of the total cost of moving goods between the mainland and Puerto Rico. However, a substantial portion of this vessel cost would still be incurred by a foreign flag operator regardless of nationality. This restates the U.S. Department of Commerce s 1979 conclusion, that similarly, only a small fraction of the total cost of Puerto Rican exports to the main land can be ascribed to the cost differential between U.S. and foreign shipping rates. 62 However, the effects of the Jones Act remain a bone of contention in the literature. For example, the recent study by Valentin-Mari and Alameda (2012), under a flawed methodology, estimated a cost to Puerto Rico s economy of $537.2 million attributable to the Jones Act in Also, the U.S. Maritime Administration (MARAD) estimated that the operating costs of U.S. ships are 2.7 times higher than those of foreign-flagged vessels in a 2011 study 64 a typical starting point for denoting a Jones Act cost. 60 Martha Quiñones (1990); Héctor R. Dávila (2002). 61 Reeves & Associates (2011), p USDC (1979), pp Jeffrey Valentin-Mari, José I. Alameda (2012), p U. S. Maritime Administration (2011), p

29 The new study on the impact of the Jones Act on the local economy, prepared recently by the U.S. GAO (2013), unfortunately does not address, in terms of cost estimates, that issue for several reasons, although perhaps its most important finding would be that The effects of modifying the application of the Jones Act for Puerto Rico are highly uncertain. 65 The following are some of the key findings of the study: 1. One of the main characteristics of the Jones Act is the creation of a discrete shipping market between Puerto Rico and the United States. While in international trade, transshipment and development of multi-string networks of trade are increasingly becoming the norm, Puerto Rico still operates via a closed loop service. This has resulted in dedicated, scheduled, regular shipping services from the Jones Act carrier, which as we have indicated elsewhere, represents an important benefit to customers in Puerto Rico. The study also notes that vessels from the foreign carriers have extensive international operations and their ships stop at multiple ports along their shipping routes across the globe Any associated cost premium relevant to the Jones Act is highly dependent upon other economic factors, many of which have a much more direct impact effect upon final freight rates and total transportation costs. For example, the study notes that the average freight rates of the four major Jones Act carriers were lower in 2010 than they were in 2006, as the recent recession has contributed to decreases in demand. Also, the operating costs of carriers are primarily composed of non-vessel operating costs, which are not directly affected by the Jones Act: in 2011, these comprised 69% of total carrier operating costs Some services between Jones Act and foreign carriers are not comparable, and the degree of substitutability between these has not been estimated. 65 GAO (2013), and p GAO (2013), p GAO (2013), pp. 5 and 13. See also chapter VI of our report, section

30 Economic conditions related to particular markets may also affect the industry, but the study remains inconclusive with respect to the cost premiums, due to data availability concerns Another point emphasized is that transportation costs still remain only a part of the overall pricing structure of goods and services and the latter also varies by type of good. In this regard it states that the prices of goods sold in Puerto Rico are determined by a host of supply and demand factors, similar to freight rates, and therefore, the impact of shipping costs between the United States and Puerto Rico on the average prices of goods in Puerto Rico is difficult, if not impossible, to determine with precision The study also finds that because of cost advantages, unrestricted competition from foreign-flag vessels could result in the disappearance of most U.S.-flag vessels in this trade. 70 But the only cost advantage that foreign carriers have with respect to JAC is a labor-cost advantage. As explained in this report, that cost advantage would disappear when foreign carriers would have to comply with the same labor rules and requirements as U.S.-flag container carriers. Moreover, as demonstrated in section 6.2 of this report, there are costs involved by downsizing 45, 48 and 53ft containers to 40ft containers, which is the standard size used by foreign carriers. 2.4 Summary 1. The container liner shipping industry (CLSI) has become a complex system providing a primary transportation service throughout the world. 2. Global consolidation trends, high entry barriers, and regional cooperation schemes (e.g. trade associations, strategic alliances, etc.) have fostered an imperfectly competitive market with clear signs of oligopolistic behavior, with varying degrees of intensity. The liner shipping market s contestability, however, remains unclear. 68 GAO (2013), p. 18 and GAO (2013), p GAO (2013), p

31 3. The diversity of trade agreements cooperative working, slot-capacity combination, among others suggests that the oligopolistic conditions of the maritime industry are multidimensional and cannot be easily circumscribed under a specific type of market contestability. 4. Government regulation has a multidimensional impact upon the CLSI; thus achieving a stable and balanced regulatory environment in this industry is of primary concern. The chief regulatory framework for the United States- Puerto Rico maritime trade is the Jones Act, that restricts the handling of domestic shipping to U.S. owned, crewed and flagged vessels. 5. Recent studies reflect an emerging consensus that the Jones Act imposes economic or welfare costs to the U.S. economy due to preference requirements, ownership restrictions or excessive labor provisions. Other studies, however, severely criticize the methodologies, scope or applicability of these findings. The lack of available data to quantify more realistic estimates makes arriving at clear conclusions difficult. 6. Subsidy provisions other than cargo preference requirements were not part of the 1920 Jones Act. Nevertheless, subsequent legislation created important direct subsidies, such as the Operating Cost Differential (ODS) and Construction Cost Differential (CDS) subsidies. Amidst heavy criticism and declining competitiveness of the U.S. fleet, these programs were discontinued in the 1990s. Today, the only direct subsidy received by U.S. flagged ships is the Maritime Security Program (MSP) established in 1996, which is a fund given to U.S. ship owners in exchange of permitting the use of their fleet in war operations. 7. There is an important point of contention in the literature regarding the Jones Act s cost to the Puerto Rican economy. Some of the recent studies have included quantitative estimates of either the economy s welfare loss or operating cost differences, but the results remain unclear on many aspects, as 30

32 noted by critics. 71 The recent GAO (2013) report was unable to develop estimates of cost impacts, and concludes that any associated cost premium relevant to the Jones Act is highly dependent upon other economic factors, many of which have a much more direct impact effect upon final freight rates and total transportation costs. 71 See American Maritime Partnership (2012). 31

33 III. MAIN ECONOMIC TRENDS Maritime trade is a reflection, not only of the behaviour of the transportation industry but also of economic conditions. This chapter examines two related aspects: the performance of the local economy, in particular in recent years, and that of external trade, specifically the degree of dependence on imports in the case of food products, which mostly come through shipping. 3.1 Economic growth and key determinants If anything characterizes the economy of Puerto Rico since the mid-2000 s until today, it is the long period of deceleration and recession, the steepest and longest in decades. Prior to 2005, the economy was growing albeit at rates lower than in the previous decades, an average of 1.8%, quite below the average growth rate of 3.4% in the previous five years. Since the onset of the recession (fiscal year 2007), the economy has contracted by 12.8%. A decline in personal consumption, where that on durable and non-durable goods barely increased (an average of 0.3%), mostly as a result of the federal stimulus funds, and in construction investment (-10.4%), have led the contraction in real growth. Figure 1 Another characteristic of the performance of the local economy is a decoupling with respect to that of the Mainland (see Figure 2). Since fiscal year 2005, while P.R. s GNP contractated at an annual average of 1.5%, that of the U.S. s registered 32

34 an increase of 1.4%. 72 Moreover, the lag in response to any improvement in the U.S. economy has increased, as evidenced in Figure 2. Figure External trade Exports Exports of merchandise consist mostly of manufactured products, of which pharmaceuticals and medicines represent 67% of the total. In 2011 they amounted to $57,616 million, down from the $68,555 million in the previous year, as shipments of pharmaceuticals fell. Figure 3 72 U.S. data on P.R. s fiscal year basis, and corresponds to real GNP. 73 Data is presented in nominal prices since the corresponding deflators are available only on a fiscal year basis. Information is from the Puerto Rico Planning Board (2012), Statistical Appendix 2011, tables 23, 24 and

35 3.2.2 Imports Imports of merchandise, which in 2011 amounted to $47,031 million, are more diverse in terms of products than exports. Raw materials and intermediate products (which includes fuels) represent 77% of the total, and consumer goods (which includes food and beverages) 18%. In nominal terms they have increased at an annual rate of 2.1% since Figure Imports of food Imports of food and agricultural products, which in fiscal year amounted to $3,718 million, represented 8.3% of the total, and beverages about 1.0%. Imports of motor vehicles, which have been declining since fiscal 2007, represent 3.8%. Figure 5 34

36 An interesting fact is that, contrary to what is generally believed, according to data from the P.R. Planning Board (2012), the value of exports of food and agricultural products have been exceeding that of imports. In fiscal year 2011, exports exceded imports by $302.8 million Proportion of agricultural products and food consumption that is imported Maritime transportation play a key role in the food supply in Puerto Rico, as most of what is consumed is imported and comes through this mode of transportation. Figures 6 and 7 ilustrates the situation. For instance, on average, 50% of the total consumption of key agricultural products is imported (Data for 2009). In some cases, though, the proportion is quite high, as in the case of poultry, meats, eggs, and coffee (See Figure 6). For some other staples, like rice, the proportion is 100%. Figure 6 Practically all the food, agricultural products, and beverages, that are imported come via maritime transportation, as shown in Figure 7. So, the key elements of frequency and reliability of service are very important for the supply chain of food, in order to insure a steady flow of products. 74 Puerto Rico Planning Board (2012), Statistical Appendix 2011, tables 23 and

37 Figure Main markets Most of the external trade of Puerto Rico is done with the mainland, somewhat less in the case of imports, as the sources of fuels are foreign countries. In the case of exports, 71% are shipped to the mainland and 29% to foreign countries, mostly Europe; for imports, 46% come from foreign countries and 49% from the mainland. Figure 8 36

38 IV. GROWTH TRENDS AND STRUCTURE OF THE MARITIME CARGO INDUSTRY WORLDWIDE AND IN PUERTO RICO This chapter presents, in the first place, a snapshot of developments in the container shipping segment worldwide, as the local industry is part of that industry. Secondly, a comparative assessment of the Port of San Juan (PSJ) in terms of volume and movement handled, relative to that of other regional sea ports. In the third place, an analysis is made of the structure and type of vessels that serve PSJ, together with growth trends and traffic flows of the domestic trade. 4.1 The container-shipping industry worldwide According to a report from UNCTAD (2011), The rapid growth in containerization over the last 20 years is due to a combination of factors such as dedicated purposebuilt container vessels, larger vessels capable of achieving larger economies of scale, improved handling facilities in ports and increasing amounts of components parts being carried in containers. 75 From a year of losses in 2009, the worst ever for the carriers, the industry experienced a turnaround in 2010 which was expected to continue into Figure 1 75 UNCTAD (2011), p

39 The trends in container shipping supply and demand in recent years, is illustrated in Figure 1 above. Growth in container demand moved up, exceeding that of supply for the past two years, as world economic conditions improved, stabilizing in 2011 in line with more stable freight rates. Container trade increased 12.1% in 2010 after contracting in the previous year, with a similar trend expected for Container trade volumes, different from our domestic trade in the latter years, expanded at an average rate of 8.2% between 1990 and 2010, driven by productivity gains and a surge in demand across all trade lanes. In 2010, global container trade increased 12.9%, the highest ever, led by high growth in Asia (See Figure 2). 77 Figure 2 According to UNCTAD s report, container freight rates in 2010 experienced a major transformation, led by an increase in exports and measures adopted by carriers to limit vessel supply; but still they were below pre-crisis levels UNCTAD (2012), p Ibid, p Ibid, p

40 The price that a carrier charges for transporting cargo is known as the freight rate. The freight rate depends on many factors, including the cost of operating the vessel (for example, crew wages, fuel, maintenance and insurance); the capital costs of buying the vessel, such as deposit, interest and depreciation; and the cost of the shore-side operation, which covers office personnel, rent and marketing. Freight rates are not all-inclusive but are subject to numerous additions; for example, the bunker adjustment factor, the currency adjustment factor, terminal handling charges, war risk premiums, piracy surcharges, container seal, electronic release of cargo fees, late fees or or equipment shortage fees. Freight rates are affected by the demand for the goods being carried and the supply of available vessels to carry the goods. In addition to the fluctuations in supply and demand, the bargaining power of the service user (the shipper), the number of competitors and the availability of alternative transport modes also affect price. Figure 3 Figure 3 shows UNCTAD s New ConTex Index, which consists of combined rate freight rates for various container trades. 79 This information corresponds to foreign trade shipping, and not to domestic trade within the U.S., but should provide a 79 This index is a daily index compiled by a panel of international brokers on charter rate fixtures for six container vessel sizes. See UNCTAD (2011), pp. 84, and

41 general idea about rates for the foreign maritime trade of Puerto Rico and in the case of the U.S. The index shows the dramatic two-thirds decline in container charter rates from mid-2008 to April 2009, and its subsequent rebound to near three quarters of the 2008 level by Competitive position of the Port of San Juan with respect to the región and worldwide in terms of volume of container trade One simple measure of competitivenes of the PSJ is its position in terms of container traffic handled, relative to that of other regional ports. Using the most recent data from the World Bank (as provided by each country), one can observe that PSJ s traffic has trended down, while that of its immediate competitor (DR) has increased considerably since Table 1 40

42 Another approach to assessing the overall competitiveness of Puerto Rico's shipping industry is by measuring the integration of Puerto Rico's CLSI to the international maritime trade networks. For this purpose, a useful comparative statistic is UNCTAD's Liner Shipping Connectivity Index (LSCI), which measures the internal and external structure of the foreign-flagged CLSI in a country. 80 Duval and Utoktham (2011) demonstrate the importance of liner shipping connectivity in measuring the impact of non-tariff policy-related trade costs within 92 countries; they conclude that...improving port efficiency (liner shipping connectivity) and access to information and communication technology facilities is essential to reducing trade costs. 81 Wilmsmeier and Hoffman (2008) undertook a similar research. They highlight the high statistical significance of these two elements when included as determinants of freight rates within the Caribbean CLSI. 82 The importance of maritime containerization in a country, as reflected in the LSCI components, has been a characteristic not only of a developed maritime market, but of a developed economy as well. 83 Thus Puerto Rico s LSCI serves as a proxy for its overall level of trade development. Table 2 below presents the indexes for a series of countries in the region, including Puerto Rico, for the period 2004 to Although the report does not provide a breakdown by components of the index, with respect to two of its components it points out that by 2011, the industry continued its consolidation trend: for See footnote above for a definition of the index and its components. 81 Yann Duval, Chorthip Utoktham (2011), p. 2, 22. They concluded that about 25% of the changes in nontariff policy-related trade costs can be explained by the liner shipping connectivity index. 82 Gordon Wilmsmeier, Jan Hoffman (2008), p Theo Notteboom, Jean-Paul Rodrigue (2008), pp

43 2010, the average number of direct service providers per country declined, while the average vessel size increased 38%. 84 Table 2 Before the contraction, Puerto Rico s LSCI consistently outperformed the regional average in connectivity, including or excluding the U.S (see Figure 4). After 2008, however, there is a significant drop in Puerto Rico s index, falling well below the regional averages. On the other hand, the index for the Dominican Republic (DR) rose steadily during the same period, rising above the regional averages and P.R. s after The decline in P.R. s index after 2008 could be due to a reduction in the number of companies that deploy container ships (one of the components), or in the number of 84 UNCTAD (2011), p. 90. We have not been able to obtain the data for the components of the index. 42

44 services. If the trend continues, it will mean that P.R.s link with foreign markets for whatever the reason - will continue to decline. The significant decline noted in recent years will have direct consequences on the competitiveness and subsequent development of Puerto Rican maritime trade Figure 4 Puerto Rico LSCI and Regional Averages, Regional Average (Excluding US)* Puerto Rico Regional Average (Including U.S.) D.R. Source: UNCTAD Stat Database (2012). Note: Regional average: the Caribbean and Central America. See Table 2 for countries. 4.3 Structure of shipping and trade by type of vessel Of the two types of vessels that serve the domestic trade, in terms of TEUs containers accounted for 80% of the total capacity, down from 83% in While the capacity of Ro/Ro increased 22.1% in 2010, that of containerships fell 1.7%. Figure 5 43

45 By type of vessel, almost half of the total calls at the PSJ are from containers, and 15% from Ro/Ro ships (See Figure 6). Figure 6 Moreover, the number of vessel calls of containerships has trended down, from 568 in 2002 to 442 in 2010, but capacity edged slightly up, if one compares 2010 to Figure Growth trends and traffic flows Domestic trade is part of the U.S. Atlantic coast trade. Between 2002 and 2010 the share of Puerto Rico in the total for the Atlantic fell from 6.3% to 4.0%, while that of other seaports in the region increased (See Table 3). That decline was a resut of 44

46 the reduction in the number of vessel calls, but here total capacity is also another relevant and related indicator. Table 3 If all of Puerto Rico s and total Atlantic plus Houston trade were included, the downward trend in P.R. s share was consistent over time (See Figure 8). Figure 8 As mentioned before, that capacity of container ships declined, and as shown in Figure 9 below, and as shown see in the following section, the volume of trade (in TEUs) trended downward. 45

47 Figure Movement of domestic trade northbound and southbound by carriers Domestic trade is handled presently by four carriers: Crowley, Horizon Line, Sea Star Lines, and Trailer Bridge. In the case of the southbound trade, the main carrier is Crowley, with a market share of 32.0%, followed by Horizon Line, with 29.3% of the total. Table 4 Between 2002 and 2011, the volume of southbound trade (in FEUs) declined at an annual compound rate of 2.4%, less during Northbound trade registered a similar but less pronounced trend over time. It is interesting to observe that southbound trade started to decline prior to the onset of the economic contraction (2007 to 2012). This suggests that other reasons were at play in the reduction in trade volume, while northbound trade actually increased ( ). For 2012, 46

48 preliminary data indicates that cargo volume increased at an anual rate of 0.5%, an improvement from the decline of -0.5% in Table Trade and real GNP growth In order to assess the relative significance of Puerto Rico s economic growth to domestic shipping freight movement, a statistical experiment was conducted, taking the island s real GNP and the domestic freight movement of carriers as the main variables for the period 2002 to Freight data used for the latter was an annual series provided by La Alianza Marítima (2012) for northbound and southbound routes, (calendar years). An econometric model was developed for each of these routes, measuring freight movement trends (converted to TEUs) against the trend in real GNP. A logarithmic representation was chosen due to differences in the units of measurement. Figure 12 presents the evolution of each of these series over the time period. The statistical results are shown in Appendix B. 85 Jaime Santiago (2012) (b), and JOC-PIERS data (2012) for

49 Figure 12 The Southbound Freight (SF) model displayed the following characteristics: As seen in Appendix B, Table A, the model exhibits a persistent 2-year lag in its average freight movement throughout the decade. In other words, the model accounted for random economic shocks, which could continue to the following years. This can be attributed to the U.S recession and Federal fiscal policies implemented afterwards, which had a lasting impact on domestic trade. Another explanation could be that the model does not include important U.S. variables that could influence southbound trade behavior. Due to the short length of the time series, we are unable to qualify this as a structural or circumstantial phenomenon. In order to argue that this persistence is a structural feature, it would require a theoretical foundation as to its determinants. The model has an explanatory power, with 78% confidence level and accounting for about 23% of the variability in freight movement. This is in part due in part to the low numbers of observations, which limits the representativeness of the historical trends. However, other macroeconomic and firm-level variables may also have contributed significantly to the 48

50 freight movement s behavior, thus increasing the explanatory power of the model. The most important finding is the low significance of Puerto Rico s real GNP as an explanatory variable of the freight movement, a phenomenon that occurred across all preliminary and final estimations. However, this is not synonymous with GNP not being important; rather, it means that for the decade, no significant direct relation could be traced between real GNP and freight movement. Nevertheless, GNP could be an important indirect variable, as it influences many conditions that could significantly alter freight behavior in terms of demand. Figure 13 The characteristcs of the Northbound Freight (NF) model are presented below: As with the SF model, the model displays a persistent trend lagged 2 years, attributable to the dramatic changes in the U.S. economy during the decade. More data, as well as a stronger theoretical foundation, is needed to ascertain the long-run embeddedness of this trend. While the NF model holds slightly more explanatory power than the SF model, it still fulfills a less-than-95% confidence level, and accounts for only 37% of the total freight movement s variability. As can be seen in Table B, Appendix B, this model shows the same structural weaknesses as the SF 49

51 model; more variables (for instance, the behavior of U.S. demand for local production), as well as a longer time series, are critical to evaluating the data with more realistic estimates. The extremely low significance of Puerto Rican GNP extends the findings of the previous model to northbound routes. The available data fail to demonstrate a significant statistical relation between Puerto Rico s GNP and domestic maritime freight movement. Figure 14 The statistical experiment fails to find compelling evidence of Puerto Rican economic growth being a significant determinant in domestic freight movement. U.S. and global shocks to the economy seem to have had a much more significant and lasting effect upon the domestic freight market than does Puerto Rico s economy Capacity of shipping A key issue in P.R. s domestic trade has been that of capacity utilization, specifically in the case of the southbound trade, which accounts for 81% of the total trade handled by the carriers. Using data from MARAD (2012), an estimate was developed converting to FEUs in order to obtain a measure of excess capacity, and 50

52 of capacity utilization, that includes the two key types of equipment serving Puerto Rico, containers and RO/RO (see Figure 5 above). 86 Between the years 2002 and 2011, with the exception of 2007, total capacity declined, with the capacity utilization rate falling from 86.3% in 2002 to 62.4% in 2010, edging up slightly in 2011, likely reflecting the elimination of the Philadelphia route (see Table 6). Excess capacity has increased considerably throughout the years (see Figure 5 above). 87 Table 6 86 Container vessels account for about 80% of the total capacity, from 83% in Worldwide containership capacity (in TEUs) was up 6% in 2012, as the idle fleet of ships over 500 TEUs increased. See JOC Sailings (January 9, 2013), Container-Ship-Capacity-Up-6-Percent.aspx 51

53 V. COMPOSITION OF CARGO AND TYPE OF EQUIPMENT Domestic trade consists of northbound (NB) and southbound (SB) trade, with SB trade representing 81% of the total trade in This chapter examines the composition of that trade, and its distribution by size of equipment, and port origin and destination. 5.1 Northbound Northbound trade represented less than 20% of total trade in Due to the small share, arranging commodities by groups was not difficult, as most of the goods in this route would fall under the other commodities classification. Since the shares and volume of the commodity groups are heavily dependent upon their original classification, to readapt southbound sectors to northbound cargo would introduce comparability issues, especially in the other commodities classification. Table 1 presents the classification of commodities or products for the top 20. Table 1 Cargo handled in northbound trade was less diverse than in southbound trade. The top 20 commodities handled represented around 71% of the cargo, compared with 52

54 65% for the top 20 commodities in southbound trade: however, the largest shares of volume were 12.4% and 7.6%, around 1.5% lower on average than the southbound trade's largest shares. Excluding general cargo did not change the shares, partly since commodity volumes were smaller in northbound trade than in southbound trade (2,465 FEUs vs. 36,093 FEUs). 88 Overall, NB trade could be considered a composite of secondary goods relative to southbound trade. Its volume is four times smaller that of the latter, with the average volume of its top 20 commodities around 2,000 FEUs (2,092), and it also displays a low concentration of trade per category compared to southbound trade (143 FEUs per commodity vs. 457 FEUs per commodity in southbound trade). 89 In fact, the 'other commodities' classification in southbound trade displayed a FEUs/commodity ratio of 145, remarkably close to that presented by northbound trade hence our conclusion. As seen in Table 1 above, northbound trade was chiefly composed of medical equipment and supplies, drugs, vegetables, flavoring, refrigeration equipment, and beverages. In comparison with southbound trade, only vegetables, beverages, and chemicals had roughly the same share; and even then, their rank in the overall cargo distribution also varies. This can be attributed to each route serving different markets and industries in Puerto Rican trade on the export side. Medical equipment comprised 12.4% of total northbound trade, followed by drugs with 7.6%. The former was handled mainly on 53' containers (62% of trade volume), whereas the latter was primarily shipped via 40' and 45' container vessels. Vegetables and flavors also relied on 40' and 45' containers: however, assorted goods made extensive use of 53' containers, with 52% of general cargo being shipped in this type of vessel, 44% of grocery products, and 92% of grains and flour products. Spirits were the largest item shipped in other types of equipment (23% of total trade handled in other equipment), followed by automobiles (20%). 88 The data corresponds to calendar years 2010 and 2011, different from the one used in the costs estimates. 89 Cargo diversity was measured by a ratio of FEUs to commodities, formed by dividing total trade volume by the number of distinct commodities described in JOC-PIERS data. A large value implies more concentration of trade volume per each commodity type (less diversity), whereas a small value indicates that the added trade volume per commodity is small (more diversity). 53

55 Figure 1 shows the distribution of northbound trade by size of equipment. Northbound trade, like its southbound counterpart, is dominated by 40' and 53' containers, as 31% and 22% of total trade was handled by each type of equipment, respectively. 19.5% of trade was handled by 45' containers, 2% more than southbound trade's share. Loose cargo shipped approximately 12% of the total trade volume, and (on average) handled 14% of each product s volume for the top 20 commodities (calculated from PIERS data). Other types of equipment followed, shipping 11.6% of northbound trade. Once again, the least used type were 48' containers, carrying less than 3% of the trade volume. Compared to southbound trade, 40' containers were far more prominent in northbound trade, while 45' containers increased their share by 2%. The trade volume shares of all other types of equipment did not vary. Figure 1 As shown in Table 2, the distribution by port is slightly more diverse in northbound trade than for southbound trade. While the Jacksonville port clearly dominates overall trade (with 68% of total trade volume), 15% of northbound cargo is also shipped to Pennsauken. Once again, the Jacksonville port's overall cargo distribution has an immense effect upon the overall trade, as is also seen in the southbound trade route. 54

56 Table Southbound As shown in Table 3 below, southbound cargo is chiefly composed of food and grocery products, chemicals, paper and automobiles. Together they represent 46% of the total trade volume. However, this estimate is biased by the fact that approximately 14% of the total SB trade is shipped as general cargo, a category that includes assorted goods from many product types, and is thus not a reliable indicator of cargo composition. Excluding this category from total trade, and computing the shares of the remaining volumes, the share of these four commodity groups is 53% of the cargo, excluding general cargo. Table 3 Food and groceries represented 23% of all trade. Around 47% of this group was shipped in 40' containers, and 24% in 45' containers. Chemicals made up approximately 9% of total trade volume, about the same volume as automobiles. 55

57 While these were more equally distributed than food and groceries among the various types of equipment, 40' containers still played a more important role than other types of equipment: around 2,000 more FEUs were handled by this type of containers than others. In the case of paper and paper products, more than 50% the cargo came in 53' containers, while 25% came in 40ft. containers. The distribution by size of equipment varied largely within each commodity group. For example, food, groceries and chemicals were mainly carried in 40' containers, whereas secondary goods, auto parts and paper were shipped mostly in 53' containers. Medical equipment and non-alcoholic beverages are carried in 45' containers, although these groups are relatively equally shared among 40', 45' and 53' containers. An average of 15% of trade in food & groceries, general cargo, chemicals, and other commodities was handled as loose cargo: the largest individual contributions to this share were by general cargo, followed by grocery products. Automobiles comprise most of the trade carried by other types of containers (67% of trade shipped in other containers) and in general lie outside standard container trade, with 96.6% of automobiles being shipped in other types. Assorted goods comprise a significant share of southbound trade. As stated before, 14.24% of the total FEUs is classified under the general cargo category, but also 22% of total trade was combined as 'other commodities' (see Table 4), due to the categories either being too small (< 1% share of total trade) or too heterogeneous to fit into a particular aggregate. In fact, the largest trade category in 'other commodities' was plastic, and it only composed around 6% of the categories or groups volume, or 2% of total trade. The top 15 goods for other commodities, shown in Table 4 have an average size of roughly 2,100 FEUs, and even then, they only comprise about 54% of this category. This presents difficulties when examining the cargo distribution and/or the cost allocation, since items attributable to a particular good may be found unclassified within general cargo, or may be too specific, forcing aggregation of multiple goods into lumped categories that have differente freight rates. 56

58 Table 4 Figure 2 summarizes the basic distribution by size or type of container in southbound trade. As can be seen, 40' containers are the most important container types, followed by 53' and 45' containers. Both loose cargo and other types of containers handle around 11% and 12% of total trade, respectively. The least prominent role is that of 48' containers, which carry only 3.8% of the total trade volume. The sum of the 53 and 45 equipment trade volumes is 43.5%, which is 14.5% more than the 40 equipment s trade volume. This implies an overall shift to larger size equipment in Puerto Rican container trade. Of special importance is the share of 53 containers used in the top 20 commodities or products. Alone, this equipment represented 26% of the total trade the second most-used vessel type after 40 containers, accounting for 29% (see Figure 2). Of the top 20 commodities, 53 containers ship most of the trade in paper (52%), plastics (68%), grains and flour (60%), auto parts (68%), and furniture (64%). 53 containers are also used for carrying various secondary goods, whose total trade volume usually lies in the 1,000-2,000 FEU range: 53' containers often handled more than 50% of the total trade for each of these products, making for a highly diversified usage of 53 equipment across commodity types. Although 40' containers dominate overall, 53 containers clearly play a major role in the handling 57

59 of Puerto Rican southbound trade which is consistent with the overall shift to larger-size 45 and 53 equipment shown above Figure 2 As shown in Table 5 below, over three quarters of the southbound trade comes through the Jacksonville port, in Florida. It is a significant concentration. It s followed by the port of New York/New Jersey. Table 5 The distribution of container trade by commodity or product reflects high overall concentration, with food and groceries accounting for 22.5% of the total. On average, 77% of the top 15 goods are shipped from the Jacksonville port, as well as 77% of the commodity aggregates. 58

60 In terms of equipment, a significant point is that in calendar % of SB trade came in 53 containers, followed by 25.0% for 40 containers (see Table 6). The distribution of goods from the Jacksonville port is the same in the top 4 commodity groups, which comprise 46% of the overall trade volume. So, 80% of the southbound trade comes through the port of Jacksonville, and the mayority in 53 containers. This fact is important for two reasons: (1) the use of bigger containers (53 ) is a key driver in transportation efficiency, as the cost of loading and unloading it is practically similar to a 40 container; (2) international carriers are not widely using this size of container. 90 Table Concentration Another characteristic of the southbound trade is the high concentration or share that a small number of accounts have in the overall trade. According to data from JOC- PIERS (2012), the top 20 accounts are responsible for 41% of the southbound trade, with the top 43 accounting for 56%. The top 100 are responsable for 71% of the total SB trade. 90 Jaime Santiago (2012)a, p. 20; TI-UP Resource Centre (2007). 59

61 Table 7 60

62 VI. TRANSPORTATION COSTS This chapter presents, in the first place, an analysis of maritime transportation costs for U.S carriers, in the case of container and Ro/Ro equipment, using information from MARAD: the average daily operating costs (ADOC), with a comparison with foreign-flag carriers. In the second place, estimates are included of costs with respect to JAC in the NB and SB trade of Puerto Rico. 6.1 Maritime transportation costs U.S. 91 The data presented here reflects the average daily operating costs for carriers serving U.S. continental, territories, and foreign-flag carriers, as presented by MARAD. 92 Figure 1 Based on this cost data, the total ADOC of a U.S flag vessel was $20,053 in 2010, while that for foreign-flag vessels was $7,454 (see Figure 1). At an aggregate level, in the case of U.S-flag vessels 37.2% were funded by operations, while 42.4% were funded by the subsidy payments from the Maritime Security Program (MSP), which represents over two-thirds of the operating cost differential ($12,599) with foreignflag ships These costs reflect maritime transportation assessment by MARAD. 92 For an explanation of the data sources and methodology, see MARAD (2011), Comparison of US and Foreign-Flag Operating Costs, pp Operating costs refer to those associated with the daily running of a ship. See Table 1 below. 93 The MSP was created in It provides fixed payments to U.S. flag vessels to make sure that they will be available in case of a national emergency. About 64% of the fleet under the program consists of containerships. 61

63 With respect to the type of equipment that serves Puerto Rico, in 2010 U.S. containerships and RO/RO vessels reported average daily operating costs 2.2 and 3.3 times higher, respectively, than foreign-flag vessels (see Figure 2). Figure 2 Figures 3 an 4 below provides an analysis of the cost structure of U.S. and foreignflag vessels, for all types of ships and for containerships and RO/RO. Daily wages or crew costs of U.S.-flag vessels represented 68% of the total operating costs, and account for the biggest cost-differential with respect to foreign-flag vessels. Figure 3 In the case of containerships and RO/RO vessels, the situation is the same, with crew costs (daily wages) for U.S. vessels being 5.5 and 5.2 times higher than foreign-flag vessels respectively. In 2010, crewing costs for U.S.-flag containerships 62

64 represented 70% of their total ADOC, and 28% in the case of foreign-flag containerships (see Table 1). This aspect is a key point to take into consideration, if a foreign-flag carrier would transport domestic cargo between PSJ and JAX, for instance. Complying with the same labor rules and requirements as U.S.-flag container carriers would reduce that labor-cost advantage, which would have a direct impact on their transportation costs. According to a study by MARAD (2011), complying with all the work rules and manning requirements in the U.S. that affect labor productivity and crewing flexibility result in overall crewing costs that contribute approximately $12,000 to $15,000 per day to total U.S.-flag operating costs. This would almost erase the difference in ADOC between U.S.-flag and foreign-flag carriers (see Figures 1 and 2 above). 94 Figure 4 Only in certain costs, like M&R, Stores/Lubes, and Insurance, does the share in total costs for foreign vessels exceed that of U.S.-flag vessels. Nevertheless, in monetary terms they are lower. 94 MARAD (2011), p. 6. We were not able to obtain from the JAC carriers a breakdown of their operating costs similar to that in the analysis by MARAD, but its conclusions in this regard would still be valid in P.R. s case. 63

65 Table Costs in Puerto Rico In the studies so far, on P.R. s Jones Act trade, the cost dimensión of transportation (terminal-to-terminal and inland) has not been examined explicitly. For the purpose of this report estimates were developed of transportation and direct costs impact of Jones Act carriers (JAC), and the economies generated by them with respect to international service. The estimates are based on data supplied by PIERS, corresponding to the period from September 2011 through August The distribution of the average operating costs by main categories of JAC is presented in Figure 5. The biggest item is that of fuel (25.0%), and the smallest depreciation (5.0%). In other words, for every $1.00 of costs, 25 cents go to fuel. Vessel operations and vessel depreciation percentages are cost categories common to both, JAC and foreign carriers. Of the total annual volume Figure 5 of trade (in FEU s) for the period, SB trade accounted for 81.0%, and 87.0% of the estimated total revenue of the market. The average TT (Terminal to terminal) rates 64

66 for NB trade is $1,713 and for SB $2,510. Based on current market costs the total annual estimated costs were $668.6 million; adding ROI (a conservative 5%) yields an estimated total market revenue of $703.8 million. Using the cost structure distribution in Figure 5, and based on the two cost items common to both carriers (JAC and international) gives an estimate of the annual direct impact of foreign carriers in the PSJ, which is $48.5 million (see table 2). Table 2 A key aspect of a comparative cost analysis with international carriers is that related to the size of the equipment in use, as mentioned before. This is an area in which JAC carriers provide a cost advantage to local businesses compared to foreign carriers servicing the domestic routes. As examined in the previous chapter, there has been an increase in the size of containers being used, from the traditional 40 size, to These sizes of containers (e.g. 53, 48, and 45 ) are not commonly used or available in international trade. The evolution of these container sizes play a critical role in driving great efficiencies for shippers and cargo owners in Puerto Rico. The 95 As indicated previously, the PIERS data used in the estimates corresponds to a different period from that used in the previous chapter, but the share distributions remains similar. 65

67 relatively high share of 53 containers in SB (and NB) is important for two reasons: (1) the use of bigger containers (53 ) is a key driver in transportation efficiency, as the cost of loading and unloading it is practically similar to a 40 container; (2) international carriers are not widely using this size of container, which is a key differentiator between Jones Act carriers and international liners. Table 3 below presents estimates for the number of additional container (boxes) that would be required by downsizing 45, 48 and 53ft containers to 40ft, and the cost economies due to the use of such bigger containers. These would be additional costs to businesses with JAC carriers if they have to use only 40ft containers under international carriers. Table 3 66

68 The number of additional 40ft. containers that would be required (based on linear ft. differences) is 27,962, and in terms of the additional capacity that would be lost the number of containers would be 35,319. The inland cost economies (US/PR) that businesses receive with the use of bigger containers is estimated at around $35.3 million per year, with a corresponding savings in rates of $82.0 million. Thus, total economies derived from the use of bigger containers are estimated at $120.8 million, or $424.0/FEU. Table 4 below present the estimates of the cost impacts of the different types of services, inland (US and SJU), and maritime (TT), and due to international service. Total inland freight costs were estimated at $313.7 million, with total transportation costs estimated at $1,017.5 million. Inland costs represent 31.0% of the total, with U.S. costs accounting for 22.4%, and SJU inland costs 8.5% respective. Maritime costs (TT) represent the bulk of the total costs, 69.2%. On the other hand, the cost impact due to international service was estimated at $79.3 million. Table 4 67

69 Figure Example of an impact in retail prices: JAC carriers vs. foreign carriers In Table 5 below, we present a comparison of what would be the potential increase in costs in the case of one product, imported poultry (fresh and frozen), under JAC and foreign carriers. Starting from the data in tables 3 and 4, the increase in the cost components was estimated all the way through the supply chain to retail. Under current JAC trade, the average retail price per pound of poultry was $1.69 (In January 2013); under a foreign carrier, taking into consideration the additional costs impacts derived in Table 3 the price would rise to $1.90/pound retail, an increase of 12.5%. The biggest increase would be in the case of TT costs, 17.0%. Table 5 68

70 This estimate ($1.90) is in all likelihood in the lower range, as it does not take into account the increase in operating costs the foreign carriers would have from complying with all federal laws, as mentioned before, and its imact of freight rates. 6.3 Ocean freight rates Ocean freight rates (OFR) charged by carriers servicing Puerto Rico, reflect market conditions. In the past, rates were established through tariffs submitted to the Federal Maritime Commission. Today, these rates are set jointly by cargo brokers, NVOCC (Non Vessel Operating Carriers), carriers, and importers, so carriers flexibility to increase rates is limited. Internationally, OFR have gone through major transformations, stabilized, but have moved up at a rapid pace since mid According to data from Drewry s Global Freight Rate Index, at the beginning of 2013 global freigh rates saw an increase to an average of $2,513/FEU. 97 A comparison with that estimated for P.R. s domestic trade for 2012, of $1,810/FEU shows that the average rate for international service is 33.0% higher than that for Puerto Rico, which is quite a difference. Figure 7 96 See section 4.1 in this report, and Drewry (2012), section The index is a weighted average of rates across all main trades excluding intra-asia. See Journal of Commerce (2013b). To make it comparable to that estimated for P.R. s domestic trade, a TAC of $200 was added, the same to P.R. s rate. 69

71 VII. SUMMARY OF KEY FINDINGS The following are some of the main findings of the study: With the introduction in 1956 of container shipping, the container liner shipping industry (CLSI) has become a complex system encompassing a primary transportation service across various points throughout the world. Globalized competition and other market forces have fostered consolidation trends and oligopolistic market structures in the CLSI. According to Sys (2009), the CLSI s market structure lies between a formal collusively oriented oligopoly and a more tacitly collusive one, concluding that globally, the container shipping industry is confronted with increased concentration. Other researchers also classified the CLSI as an oligopoly, due to the price operations of a cartel. In the case of Jones Act carriers, there is an opportunity to address the fact about the ease with which the international transportation community colludes via annual conferences that are not subject to antitrust laws, such as the Sherman Act. Although correct that international trade is not subject to normal U.S. antitrust laws, the Shipping Act of 1984/OSRA 1998 does mimic antitrust laws, although with greater ability to collaborate. Jones Act carriers are fully subject to the antitrust laws, while carriers in international trades have more latitude to collude without violating legal standards. The above suggests that eliminating the Jones Act would not place Puerto Rico in a competitive market but instead one characterized by significant concentration. As a matter of fact, more than 40% of the global cargo is concentrated in three lines, Maersk, MSC, and CMA-CGM, and these plus COSCO have 41.0% of the world s liner fleet (in TEU terms). Globally, growth in demand in containers moved up, exceeding that of supply for the past two years, as world economic conditions improved, stabilizing in 2011 in line with more stable freight rates. Container trade increased 12.1% in 2010 after contracting in the previous year, with a similar 70

72 performance expected for Container trade volumes worldwide, different from our domestic trade in recent years, expanded at an average rate of 8.2% between 1990 and 2010, driven by productivity gains and a surge in demand across all trade lanes. Global container freight rates in 2010 experienced a major transformation, led by an increase in exports and measures adopted by carriers to limit vessel supply, but still they were below pre-crisis levels. According to UNCTAD s New ConTex Index, which consists of combined rate freight rates for various container trades, the index shows a dramatic two-thirds decline in container charter rates from mid-2008 to April 2009, and a subsequent rebound by 2011 to near three quarters of the 2008 level. The primary legal framework for U.S. domestic trade is the Jones Act. The Act has evolved over time to include narrow exceptions that provide a more modern framework for commerce. Some of these exceptions include waivers for particular trips, specific periods of time, or distinct geographic areas, as in the case of cruise ships between Puerto Rico and the USVI. Attempts to quantify the economic impact of the Jones Act have been classified by critics as speculative, due to not including all relevant factors in a cost-benefit calculus. Other studies, on the other hand, highlight the economic and employment benefits of the Jones Act, arguing that such benefits outweigh the costs included in most Jones Act cost estimates. The consensus in recent literature suggests that there is a cost premium associated with operating vessels under U.S. laws using U.S. crews, vs. operating vessels using third world crews. This is a key effect of applying the Jones Act to the Puerto Rico and other U.S. domestic markets. In the case of Puerto Rico, the effects of the Jones Act remain a point of contention in the literature. The recent study by Valentin-Mari and Alameda (2012), estimated a cost to Puerto Rico s economy of $537.2 million 71

73 attributable to the Jones Act in The study has serious methodological limitations: it study bases its conclusions on an analysis made on the value of merchandise, not the volume of cargo and total freight costs paid in Puerto Rico. Total Jones Act carriers invoicing does not exceed $710.0 million per year, which suggests that attributing over 75% of that total to the Jones Act is misleading. An additional aspect to take into consideration is that, in the studies in the case of Puerto Rico (including that by Valentin-Mari and Alameda), actual shipping costs of foreign carriers are used and not the costs they would incur if they serve the domestic routes. Entering the domestic trade, non-jones Act carriers would have to comply with all federal laws (wages), and that cost advantage would disappear, as indicated in the MARAD (2011) study cited in chapter 6. The Port of San Juan faces several challenges, related not only to cyclical economic factors, but also those pertaining to the industry and domestic service: 1. The volume of total container trade handled (in TEUs) has declined, from million in 2000 to million in fiscal 2011; 2. Between 2004 and 2011, the total volume of domestic trade (Northbound and Southbound) of the four shipping lines fell, from 834,924 to 627,364 TEUs, and the average capacity utilization in the Southbound trade declined from 94.6% to 76.4% during the same period (see Appendix A); 3. The number of container ship and Ro/Ro vessel calls also has declined, from 647 in 2002 to 645 in 2010, with those of containers falling from 482 to 442 in the same period; 4. Total capacity (in FEUs) for containers and Ro/Ro has fallen, from 518,220 in 2007 to an estimated 490,636 in 2011; 72

74 5. The share of Puerto Rico in the total U.S. Atlantic (plus Houston) container port traffic (in TEUs) went down, from 16.5% in 2000 to 7.6% in fiscal 2011, as the share in coastwise trade in total U.S. domestic waterborne commerce also fell, from 21.2% in 2000 to 18.4% in 2010; 6. Regionally, the position of the PSJ in terms of total container port traffic handled (in TEUs) between 2007 and 2010 has fallen, while that of the Dominican Republic increased (this port plus the Port of Kingston are handling more container cargo than PSJ (see Table 2 in section 4.2); 7. The above developments took place in the context of a significant growth in container volume worldwide. In 2002, the total number of full containers shipped on world trade routes (excluding transshipment) amounted to 77.8 million TEUs, and by 2015 the volume is expected to reach million TEUs. 8. Compared to other seaports in the region, in terms of container traffic handled (In TEUs), PSJ s traffic has trended down, while that of its immediate competitor (Dominican Republic) has increased considerably since With respect to southbound trade, in the case of imports of merchandise, food and agricultural products, which in fiscal year amounted to $3,718 million, represented 8.3% of the total, and beverages about 1.0%. Imports of motor vehicles, which have been declining since fiscal 2007, represent 3.8%. Maritime transportation play a key role in the food supply in Puerto Rico, all the food, agricultural products, and beverages, that are imported come via maritime transportation. For instance, on average, 50% of the total consumption of key agricultural products is imported (Data for 2009). In some cases, though, the proportion is quite high, as in the case of poultry, 73

75 meats, eggs, and coffee. For some other staples, like rice, the proportion is 100%. Of the two types of vessels that serve the domestic trade, in terms of TEUs containers accounted for 80% of the total capacity, down from 83% in While the capacity of Ro/Ro increased 22.1% in 2010, that of containerships fell 1.7%. Between 2002 and 2011, the volume of southbound trade of domestic carriers (in FEUs) declined at an annual compound rate of 2.4%, less during Northbound trade registered a similar but less pronounced trend over time. It is interesting to observe that southbound trade started to decline prior to the onset of the economic contraction (2007 to 2012). This suggests that other reasons were at play in the reduction in trade volume, while northbound trade actually increased ( ). Between the years 2002 and 2011, with the exception of 2007, total capacity declined, with the capacity utilization rate falling from 86.3% in 2002 to 62.4% in 2010, edging up slightly in 2011, likely reflecting the elimination of the Philadelphia route (see Table 6). Excess capacity has increased considerably throughout the years. Northbound trade is dominated by 40' and 53' containers, as 31% and 22% of total trade was handled by each type of equipment, respectively. Compared to southbound trade, 40' containers were far more prominent in northbound trade, while 45' containers increased their share by 2%. Southbound cargo is chiefly composed of food and grocery products, chemicals, paper and automobiles. Together they represent 46% of the total trade volume. 40' containers are the most important container types, followed by 53' and 45' containers. The sum of the 53 and 45 equipment trade volumes is 43.5%, which is 14.5% more than the 40 equipment s trade volume, an 26% of SB trade came in 53 containers, followed by 25.0% for 40 containers. 74

76 The relatively high share of 53 containers in SB (and NB) is important for two reasons: (1) the use of bigger containers (53 ) is a key driver in transportation efficiency, as the cost of loading and unloading it is practically similar to a 40 container; (2) international carriers are not widely using this size of container. Another characteristic of the southbound trade is the high concentration or share that a small number of accounts have in the overall trade. According to data from PIERS (2012), the top 20 accounts are responsible for 41% of the southbound trade, with the top 43 accounting for 56%. In terms of points of departure and destination, the Jacksonville port clearly dominates overall trade (with 68% of total trade volume). Based on the data from MARAD for the U.S., the total ADOC of a U.S flag vessel was $20,053 in 2010, while that for foreign-flag vessels was $7,454. The biggest difference in costs with foreign-flag carriers is that of wages (crew costs). In the case of containerships and RO/RO vessels, crew costs (daily wages) for U.S. vessels were 5.5 and 5.2 times higher than foreign-flag vessels respectively in The above aspect is a key point to take into consideration, if a foreignflag carrier would transport domestic cargo between PSJ and JAX, for instance. Complying with the same labor rules and requirements as U.S.-flag container carriers would reduce that labor-cost advantage, which would have a direct impact on their transportation costs. According to a study by MARAD (2011), complying with all the work rules and manning requirements in the U.S. that affect labor productivity and crewing flexibility results in overall crewing costs that contribute approximately $12,000 to $15,000 per day to total U.S.-flag operating costs. This would almost erase the difference in ADOC between U.S.-flag and foreign-flag carriers estimated by MARAD at $12,599 in ADOC in

77 Total economies derived from the use of bigger containers were estimated at $120.8 million, or $424.0/FEU. Total inland (freight) costs were estimated at $313.7 million, with total transportation costs estimated at $1,017.5 million. Inland (freight) costs represent 31.0% of the total, with U.S. costs accounting for 22.4%, and SJU inland costs 8.5% respectively. Maritime costs (TT) represent the bulk of the total costs, 69.2%. On the other hand, the cost impact due to foreign carriers was estimated at $79.3 million. The most critical element of transportation and doing business in Puerto Rico is the ability of carriers to arrive on time and deliver the cargo the same day. Jones Act carriers doing business in Puerto Rico have an average rate of 98% of on-time arrival/cargo delivery, measured within a two hours tolerance rate. Today s JAC cargo is worth slightly more than $700.0 million in transportation services and more than $6 billion dollars in acquisition value A 80% service level will force several business costs to dramatically increase, among those; additional warehouse space, utilities, labor, inventory taxes (CRIM), obsolescent costs, cash flow considerations, and carrying costs in general. Depending on the commodity, these additional cost can represent an incremental costs of more than 10% on the cost of goods sold, this can be generally estimated at more than $250 million dollars in incremental costs of doing business in Puerto Rico. There is another positive economic impact from Jones Act carriers that relates to port infrastructure. They have invested over several decades a considerable amount of money expanding or improving the facilities at the Port of San Juan. International carriers typically do not invest in port infrastructure. 76

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84 Ximena Clark, David Dollar, and Alexandro Micco (2002). Maritime Transport Costs and Port Efficiency [Working Paper]. In: 6_ /Rendered/PDF/multi0page.pdf Yann Duval and Chorthip Utoktham (2011). Trade facilitation in Asia and the Pacific: which policies and measures affect trade costs the most? [Working Paper], p. 2. In: 83

85 Appendix A Puerto Rico Trade 84

86 85

87 86

88 87

89 Appendix B Volume of Trade and Real GNP Growth 88

90 Table A Table B 89