OPA 90 and the Shipowner

OPA 90 and the Shipowner David M. Bovet Mercer Management Consulting, Inc. 33 Hay den Avenue Lexington, Massachusetts 02173 ABSTRACT: OPA 90 is significantly impacting the business of U.S. and international tanker owners engaged in the U. S. trades. This paper delineates the affected segments of the oil shipping industry, the salient regulatory elements stemming from OPA 90, the financial and operational impacts that result, and the strategic choices open to shipowners. Regulatory areas addressed include liability and compensation, financial responsibility, new ships, existing vessels, and vessel response plans. Strategic issues and action items are suggested for individual owners and industry groups. The Oil Pollution Act of 1990 (OPA 90) is having a tremendous impact on the international oil shipping business more so than any other single piece of legislation. The act's passage in August of 1990 has sparked a continuing series of dramatic hearings, discussions, debates, and complex rule-making processes, resulting in a period of unprecedented turmoil for international tanker operators. The sheer scope of the act itself and the myriad ways in which it seeks to improve tanker safety, reduce the chances of major oil spills, and improve the response to any such spills has understandably taken the chief regulators (in this case, principally the U.S. Coast Guard) some time to analyze and implement. The oil shipping industry itself has also spent considerable time in digesting the legislation, pondering its implications, and beginning to address the new requirements. At this point, two years later, the major features of the act's implementation are becoming clear. A number of regulations have been published, either in proposed or final form; industry participants and observers have submitted comments by the hundreds; and the direction of the regulatory thrust has become evident. We are therefore at a favorable juncture at which to review the scope and key aspects of the act and its ensuing regulations from the perspective of the shipowning community. It should be noted, however, that the regulatory situation continues to evolve and, as this paper is being written (September 1992), additional changes are clearly under way that will need to be incorporated into the paper before its presentation in March of 1993. The first section of this paper reviews the historical, current, and projected situation with regard to the U.S. oil trades and the international and domestic fleets serving those trades. The second section outlines the challenge of OPA 90 from the shipowner's perspective, focusing on several of the key areas of regulatory change. The third section discusses the act's impacts and strategic implications for the shipowner. U.S. oil trades and fleet OPA 90 owes much of its significance to the fact that the U.S. market accounts for about 30 percent of total world seaborne oil movements. Few tanker owners and operators can afford to ignore developments in the vast U.S. market. As of 1990, the United States imported more than 300 million tons of crude oil per year, making it one of the foremost destinations (along with Europe) for waterborne oil in the world. In addition, products are imported directly into the United States, and a substantial domestic movement of oil takes place, both crude from Alaska to the lower 48 states and products along the east, west, and gulf coasts of the United States. The composition of the U.S. waterborne oil trades is summarized in Table 1. Looking ahead, we observe that the importance of waterborne oil transportation in U.S. waters is certain to increase. Our projections indicate that imports of oil (both crude and products) into the United States will double during the next 25 years, from a level of 450 million tons in 1990 to 960 million tons in the year 2015 (Figure 1). Coastwise movements, on the other hand, are expected to decline gradually. This downturn primarily reflects the gradual depletion of the Alaska North Slope reserves and the very slow growth of coastwise products distribution. The direct delivery of petroleum from overseas is expected to replace, to some extent, domestic coastwise moves of products in the years ahead. The U.S. trades are dominated by certain tank vessel sizes. International crude oil movements, for example, are most frequently undertaken using vessels in the Aframax-size category, Suezmax vessels, very large crude carriers (VLCCs), and ultra large crude carriers (ULCCs). Products are generally carried in handy-size vessels (Figure 2). The impact of OPA 90 on shipowners varies according to vessel size. Owners active in the handy-size, Aframax, and ULCC vessel classes are the most affected. In each of these cases, the U.S. trades represent between 20 and 35 percent of the world total volumes (Figure 3). Another significant shift in the U.S. oil trades and indeed in the worldwide pattern of seaborne oil distribution is the growing role of independent shipowners in the world tanker fleet (Figure 4). After the major oil companies embarked on a tanker-ordering spree in the early 1970s resulting in a buildup of the fleet that continued through the late 1970s the oil price shocks of 1974 and 1979 caused them to make sharp reductions in their tanker ownership as well as their long-term involvement in the tanker market. Oil companies basically opted to concentrate their resources on the exploration and production side and on the refining and retailing ends of the business. The huge capital requirements and the high risks involved in tanker ownership, coupled with low freight rates in the early 1980s, discouraged oil companies from investing in tankers. As a result, their direct ownership of tankers decreased substantially throughout the 1980s. Simultaneously again as a consequence of low freight rates the oil companies reduced their long-term relationships with independents so that the time-chartered portion of the fleet diminished as well. The growth in tanker tonnage in recent years has occurred chiefly through orders placed by independent shipowners, with a significant portion involving spot-chartered vessels. The percentage of vessels directly owned by the major oil companies has thus declined from about 33 percent in 1968 to 20 percent in 1991. Independent shipowners now dominate the U.S. oil trades. The share of oil volume transported by independent shipowners varies by trade. However, independent shipowners account for more than three-fourths of the total volume of oil delivered to the United 733

734 1993 OIL SPILL CONFERENCE Table 1. U.S. waterborne oil movements, 1990! Crude oil/dirty products Clean products Subtotal Inland Total International 408 105 513 Coastal 162 118 280 Total 570 223 793 100 893 ^ (x] Crude Imports Product Imports 1. In millions of metric tons States accounting, for example, for 81 percent of U.S. receipts of crude oil (Figure 5). In the U.S.-flag trades, independent shipowners account for slightly more than half of the oil volume moved coastwise and two-thirds of the oil volume moved inland by barge. Thus, the reaction of independent shipowners to OPA 90 will be critical in ascertaining the overall effect of the legislation on the industry and indeed on the U.S. economy. 5-29 30-49 50-64 90-144 145-199 200-299 300+ Vessel Size Category (thousand DWT) Figure 2. Size of vessel used for U.S. international oil transport, percent of volume moved in 1990 Challenge of OPA 90 OPA 90 is changing life for the shipowner in many ways. Numerous aspects of the act bear significantly on them (Figure 6). We will focus on five challenges that OPA 90 poses for shipowners: liability and compensation, financial responsibility, new ships, existing vessels, and vessel response plans. Liability and compensation. OPA 90 has greatly raised the liability levels for shipowners involved in an oil spill incident and has introduced a new and complex compensation system. On the liability side, OPA 90 introduces an eightfold increase in shipowner liability levels, from the $150 per gross ton level previously in effect under the Clean Water Act to $1,200 per gross ton (Figure 7). This liability level is already in place for shipowners trading to the United States. OPA 90 specifically does not preempt individual states from establishing their own liability regimes (many of which provide for unlimited liability in the event of oil spills). The shipowner's right to limited liability is also invalidated in cases of gross negligence or willful misconduct, if any federal regulations are contravened, or if the shipowner does not cooperate fully with the authorities. Thus, the overall implication is that shipowners' liability under OPA 90 is effectively unlimited. This prospect of limitless liability greatly increases the risks of trading in U.S. waters, as shipowners are well aware. On the other hand, the compensation system introduced offers several complexities as well. First, a one billion dollar Oil Spill Liability Trust Fund has been established under OPA 90 to ensure that spill victims will receive adequate compensation. This amount is in addition to the shipowner's liability. Claimants can file with the trust fund after 90 days. This provision, however, creates confusion with regard to claims adjustment: In the initial weeks and months following an oil spill, it will not be certain who, in fact, is going to be paying these Below Handy Panamax Aframax Suezmax VLCC ULCC Handy Size Class Figure 3. U.S. oil trade as percent of world total, by vessel size Million 350 DWT 1,000 ^^^^^^^^^ Co-Owned 100 Independent - Time Chartered ^^^^B 50 O' 1968 1973 ^Independên^^potChartêred^^^B 1978 1983 1988 1991 Coastwise Figure 4. Changing ownership of the world tanker fleet 1990 1995 2000 2005 2010 2015 Figure 1. U.S. oil imports and coastwise transportation

ECONOMICS 735 Crude Coastwise International (by volume) ///////^^^^^^ B Independents k f////v/fl^^^^^l 13 Others Domestic (by volume) Product Inland Figure 5. Independent shipowners dominate the U.S. trades Figure 6. OPA 90 challenges to the shipowner 0 150 Gross Tons (thousands) Figure 7. Liability is high and the compensation system is complex I claims the responsible party (the shipowner) or the government under the trust fund. The Coast Guard has published a notice of proposed rule making (NPRM) on this subject but has not completed mechanisms to address how this trust fund will operate and the manner in which claims will be handled. The combination of the Exxon Valdez incident, OPA 90, state laws, and recent court decisions has led to higher claims settlements in U.S. oil spill cases. An analysis of crude oil and dirty products spills from tankers and barges in U.S. waters indicates that the average cost per ton of oil spilled increased only modestly, from a level of $11,900 per ton between 1972 and 1980 to $13,900 per ton during the period from 1981 to 1988. However, during the most recent time period (1989 to 1991), this cost has nearly doubled to $25,900 per ton. These figures are all stated in constant 1992 dollars. Furthermore, these costs cover only cleanup and third-party damage costs. They do not include natural resource damage costs, for which only very incomplete data are available. Many of the major cases involving natural resource damages are still being settled, and the results are not yet final. But what is certain is that natural resource damages are specifically claimable for the first time under OPA 90, and that will lead to a great increase in the amounts of money claimed and paid. At present, the National Oceanic and Atmospheric Administration (NOAA) is developing guidelines for the estimation of values for both use and nonuse natural resource damages. They potentially include the very controversial use of contingent valuation methodology (CVM) in evaluating nonuse effects. This technique is fraught with difficulty and may not be properly applied in the typical marine oil spill situation. The outcome of NOAA's rule making in this area is not yet known. On the other hand, a number of individual states including Washington, Oregon, Alaska, and Florida are also developing formulas to address natural resource damages. The values estimated through various techniques can be substantial. In the case of Florida, for example, the amounts estimated for natural resource damages can reach as high as $8,000 per barrel of oil spilled, depending on the nature of the resource affected. In summary, an oil spill in U.S. waters can entail catastrophic business consequences for even the most well-financed shipowner. In addition to these virtually unquantifiable liabilities, the shipowner could be subject to fines, penalties, and prison terms as well. All of this raises the potential costs of an oil spill into the billions of dollars, entailing the likely ruin of the unfortunate shipping company involved. Financial responsibility. There is no resolution as yet to the thorny question of financial responsibility. The Coast Guard's proposed regulations (NPRM, dated September 26, 1991) are unworkable as proposed for several reasons. First, the traditional method of obtaining the required evidence of financial responsibility is from the protection and indemnity (P&I) clubs. The P&I clubs are refusing to have their continued insurance used as evidence for the certificates. Second, individual vessel owners, by and large, cannot meet the self-insurance tests required of them, as an alternative, under the proposed regulation. Third, oil tanker charterers are generally either unwilling or unable to provide the blanket guarantees that might constitute another solution to this problem. Congress is not interested in changing OPA 90 at this point to resolve the impasse. Congressional intent is clear: Legislators want the private sector to make substantial financial resources available, through the responsible party, in the event of an oil spill. Meanwhile, the Coast Guard believes it lacks the authority to work a regulatory solution to this issue. Coast Guard officials claim that the act effectively ties their hands and prevents them from seeking a more innovative solution to the problem. Since vessels cannot enter U.S. waters without a valid certificate (once the new rule is implemented), the outcome of this issue is of great significance to shipowners. The ultimate impact of the financial responsibility issue is manifold. First, a "train wreck" may ultimately occur in which most shipowners and oil flows would be prevented from moving in U.S. waters (Figure 8). We believe that some 80 percent of the international crude volume flowing into the United States and 67 percent of international products would be placed in jeopardy if the proposed rule making were to be implemented as now proposed. In the absence of P&I clubs providing the certification, the shipowners could not meet the requirements themselves. A second potential outcome would be a wholesale restructuring of the entire U.S.-oriented shipping industry. Under this scenario, a

736 1993 OIL SPILL CONFERENCE International Crude International Product Operators Volume Operators Volume In Jeopardy Figure 8. Financial responsibility impasse could bar oil and oil products from U.S. waters select few oil majors would either purchase or guarantee the independents' carrying capacity required for their own oil movements. The result would be that numerous small and mid-sized operators who constitute the vast majority within the industry would be forced out of business, and their assets sold to a few, much larger companies. The potential for control of the market by a few large operators, resultant price hikes, and other anticompetitive effects is clear if such a scenario were to develop. In short, the certification of financial responsibility issue remains unresolved. This impasse has lasted since the fall of 1991. We await further developments with interest, but feel that, in the absence of change either by the Coast Guard or the P&I insurers, major impacts on the industry are likely if the government moves to implement a new rule. This issue affects the industry as a whole, however; and there is little that an individual owner can do to protect himself at the present time. New ships. The third area of impact, that of new vessels, is dominated by the phase-in of double-hull tank ship designs. Based on an analysis of the age of the existing fleet, the OPA 90 phase-in schedule, and estimates of the behavior of individual shipowners, we estimate that about half of the U.S.-trading international tankers will be doublehull vessels within ten years (Figure 9). The phase-in rate of double-hull tonnage varies for different vessel sizes due to the current age structure of the fleet. But in general, we anticipate that the vast majority of tankers will be of double-hull design by the early part of the 21st century. We also expect that all single-skin U.S.-trading vessels will have been replaced by double-hull vessels in the year 2015. Existing vessels. A critical area, which has so far received less attention than other aspects of OPA 90, involves those structural and operational measures currently under consideration for application to existing tank vessels. An advance notice of proposed rule making (ANPRM) was released by the Coast Guard on November 1, 1991. It indicated that a variety of measures were under consideration. Structural measures under consideration for retrofit include double-bottom, double-sides, smaller tanks, segregated ballast tanks, protectively located segregated ballast tanks, rescue tanks, and under-pressure systems. Operational measures which might require changes include hydrostatic loading, training, navigation equipment (e.g., geographic positioning system), tug escorts, and second officer on bridge. The final shape of these regulations remains undecided at this point. A regulatory impact analysis (RIA) is currently under way. The notice of proposed rule making (NPRM) is expected to be released by the U.S. Coast Guard later in 1992. We advise shipowners to pay close attention to this set of regulations. While most eyes have been focused on the phasing in of double-hull tankers and on immediate issues such as financial responsibility and vessel response plans, the thrust of this regulatory area will be to obtain the maximum environmental protection in the short term, consistent with economic and technical feasibility. Therefore, it is incumbent on shipowners to watch these developments closely, because they could affect the earning capacity of their existing vessels significantly, influence their strategies for vessel replacement, and affect their plans for trading to the United States. Vessel response plans. Shipowners face major requirements with regard to enhanced oil spill response planning and capability. The Coast Guard has addressed this area through a ground-breaking application of the negotiated rule making process (Reg Neg). This process extended from January of 1992 through the fall of 1992 and is now virtually completed. The Reg Neg process stimulated extensive discussion of specific regulations with industry and environmental interests and with other interested parties over a period of many months. The result has been a complex but essentially workable set of regulations addressing the need for vessel response plans. The latest development at the time of this writing has been the release of a Navigation and Vessel Inspection Circular (NVIC 8-92), dated September 15, 1992, which provides interim guidance to tank vessel owners for the preparation of vessel response plans (VRPs). For the first time, tank vessel operators are being required to draft plans for dealing with an oil spill incident. The cutting edge of the requirements is that extensive shore-based cleanup resources must be retained, under contractual agreements, by shipowners for each area in which a vessel may operate. The naming of a "qualified individual," authorized to activate the response effort and the needed funding, is another OPA 90 innovation. Finally, extensive spill drills and exercises are required. Plans are due by February 18, 1993, and response capability must be in place by August 18, 1993. Summary. OPA 90 is now firmly taking shape. Already in place are tough new liability limits and scope, unlimited states' rights, a doublehull construction phase-in schedule, and vessel response plan requirements. Regulations are still pending in at least three additional areas: certificates of financial responsibility, existing vessel structural and operational measures, and natural resource damage valuation. We have reached a critical juncture for tanker owners, both international and domestic. They must all meet numerous requirements in short order as a prerequisite to continued trading to U.S. ports. At the same time, tanker owners must consider international regulations 100% 80 60 40 20 ff / ^ T WÊÊ 30-49 KDWT «P* \ \ w\\ \ 1990 1995 2000 2005 2010 2015 III 65-89 KDWT WUÊ 90-144 KDWT \>^\ 200-299 KDWT Figure 9. Double-hull tanker share of U.S.-trading fleet

(e.g., the International Maritime Organization's Regulation 26), regulations of other nations, and, very importantly, regulations being produced at the state level in the United States. These formidable challenges are forcing shipowners toward the essential task of setting future investment and trading strategy. Form ECONOMICS 737 Table 3. Sustainable competitive advantages Source Timing Scale Linkage Shipowner impacts and responses What do these challenges mean for tank vessel owners? OPA 90 affects shipowners in a number of significant ways. Asset values will decline due to the artificially accelerated phaseout dates for single-skin tank vessel tonnage. Operating costs will increase due to additional safety, spill prevention, and response measures imposed by Congress and regulatory authorities. The risk of financial ruin for tanker owners or operators is greatly increased. A single catastrophic spill incident today will almost certainly bankrupt the average, and even large, independent vessel owner. Long-term partnerships with charterers will increase. The closer linkage between independents and oil company charterers will be required to ensure that the charterers' safety standards are met and that the money is provided to carry out the investments needed. Quality will increase in the long term, but may either increase or decline in the short term. It is clear that major oil companies and many other charterers wish to ensure quality in the long term, which they will provide through substantial investment in new vessel designs, in greater efforts to prevent spills, and in greatly enhanced preparedness to respond to spills if and when they occur. However, other traders and actors in the marketplace have a decidedly short-term view. These players may be more interested in operating tonnage that barely meets requirements and may be focusing instead on insulating their corporate assets from the individual vessels for example, through the establishment of single-ship operating companies. These operators may accept the greater risk of going out of business but mitigate that risk to themselves by offering only substandard maintenance and failing to provide any long-term commitment focusing instead on short-term profits. Therefore, the outlook for quality in the U.S. trades in the short and medium term is mixed, although the overall trend will certainly be positive, over time, due to the more stringent measures now implemented through the regulations. Independent tanker owners in particular face tough strategic choices in the U.S. trades. A number of decisions confront these operators if they elect to trade in the U.S. market. Their decision is, of course, entirely their own. However, given the importance of the U.S. market, most operators must give very serious consideration to participating in it and to deciding how active their role will be (Table 2). We have already witnessed a variety of decisions in light of OPA 90. Some reputable operators have ceased making regular deliveries of oil products to U.S. ports. Several oil companies have sold their tanker tonnage. Other operators have stopped serving particular states or regions viewed as posing unacceptably high liability risks. Other owners, however, are returning to the U.S. market, largely due to the poor trading conditions elsewhere. Operating costs increase significantly for vessel owners under OPA 90. If we focus only on insurance and response planning, the figures are already quite substantial. P&I insurance For $500 million, $0.41 per gross ton per voyage Lower cost per investment Higher price per share Economies of Economies of Economies experience scale from integration First-mover differentiation Leadership differentiation Synergy differentiation For additional $200 million, $0.30 per gross ton per voyage Per additional year, $1.60 per gross ton Vessel response plan Plan preparation: $25 thousand to $600 thousand per fleet Plan maintenance: $5 thousand to $50 thousand per fleet Major response: $50 thousand per fleet Local response: up to $20 thousand per vessel Qualified individual: $10 thousand to $100 thousand per fleet Drills (vessel): $3 thousand to $15 thousand per vessel Drills (tabletop): $2 thousand to $75 thousand per contractor Drills (field): $30 thousand to $150 thousand per drill In addition, the forthcoming structural and operational measures for existing vessels are certain to boost operating costs yet again for the typical tank vessel operator. These increased operating costs are significant in the current weak market. A small Suezmax tanker, for example, trading from West Africa to the U.S. gulf is already experiencing negative net cash flows. With revenues at worldscale 50 and voyage costs at $5.6 million per year, the net cash flow at present conditions is approximately negative $600,000 per year. Increased operating costs stemming from OPA 90 will consist, at a minimum, of the following: P&I increment: $120,000 per year. Vessel response plan and related capability: one-time, $25,000; ongoing, $50,000. Structural/operational: unknown at this time. These additional operating costs of some $200,000 per year are highly significant in a situation where cash flows are already negative. Yet there is no evidence so far that U.S.-trading tankers are commanding any premium on world markets over non-u.s. trading routes. What strategy can tanker owners pursue under the present circumstances? Basically, owners must sustain their own competitive advantage. Defining a strategy thus involves identifying fundamental strengths in terms of being the first with a new service, new equipment, new attention to quality or safety, or new management systems; or being the largest fleet and thus experiencing scale economies; or by being the most integrated, perhaps, into other terminaling and downstream activities. As Table 3 shows, only a limited number of sources and forms are of true sustainable competitive advantage. Many tanker owners will not be able to tap sufficient sources of competitive advantage to survive Industry Issues»COFRs» Existing Vessels > NRD Non-Use Values Shipowner Strategic Issues U.S. Market Stance Charterer Relationship Quality/Safety Levels Table 2. Strategic choices for international owners in U.S. trades Decisions U.S. market Cargoes, ports Operating changes Equipment Legal Insurance Options Remain, exit, reenter All, selective Major, minimum Double-hull, existing Status quo, reorganize P&I, excess, other Shipowner Action Items Risk/Reward Assessment VRP Preparation Insurance Review Ongoing U.S.-Based Support Figure 10. Major OPA 90 issues for shipowners

738 1993 OIL SPILL CONFERENCE into the late 1990s, when we foresee an eventual market upturn due simply to the scrapping of an aging fleet and continued reasonably strong demand. Thus, a key challenge to survival will be for tanker owners to identify their competitive niche and exploit it to its fullest. In summary, shipowners face major issues under OPA 90. Tanker operators wishing to continue to serve the U.S. market will be required to make key decisions and act in accordance with those decisions. Several overriding issues can be addressed successfully only at the industrywide level (e.g., certificates of financial responsibility). Each shipowner must then address key strategic issues for himself, such as whether to remain in, leave, or reenter the U.S. market. In any case, shipowners should consider a number of action items at the present time. They revolve around a detailed assessment of the current risk and reward structure in the industry, the preparation of vessel response plans, the careful review of insurance provisions, and the selection of U.S.-based support services to ensure continued smooth operations in the U.S. market (Figure 10). In a practical sense, these elements constitute the locus for shipowner action at the present time. The challenges are great, but opportunity lies ahead for shipowners innovative and bold enough to identify new means of capitalizing on their own competitive advantage. Whatever else can be said about the 1990s, they are certain to be years of substantial challenge for tanker owners determined to meet today's new environmental safety standards.