Horizon Line’s vessel modifications bring light to an interesting and somewhat mysterious equation. MarPro takes a closer look.
Jones Act rules are tricky, but a close reading (and interpretation) can yield savings for cash-strapped shipowners. Around the time of the Q1 2012 earnings season, Horizon Lines, battered but still trading over the counter, revealed in a regulatory filing: “During 2012, we expect to spend approximately $24.0 million and $18.0 million on capital expenditures and dry-docking expenditures, respectively. Such capital expenditures will include vessel modifications, rolling stock, and terminal infrastructure and equipment.” Most importantly, it offered that: “We have commenced our plan to dry-dock three of the vessels utilized in our Puerto Rico tradelane in China during 2012. Despite the significantly higher transit costs to get to Asia, we expect these dry-dockings will enable us to make high quality cargo modifications and other enhancements to our core Puerto Rico fleet that will be instrumental in ensuring service integrity for our customers.”
No other detail is provided, forcing analysts into the realm of rough estimations in trying to re-cast the economic calculations made by planners at Horizon Lines. The business case compares two costs. The cost of putting the vessels into a U.S. yard (likely in the U.S. Gulf or Atlantic Coast), involves a small deviation, plus the costs of the requisite yard work. The Far East alternative involves a lengthy and non-remunerative transit to China (plus the costs and additional out of service time on the return leg), the expenditure on the actual work, and a customs duty (50% of the cost of the work).
This revelation of the upcoming Chinese dockings, buried deep within its 10-Q (a quarterly report), highlights an issue that has featured in recent dialogues about the cabotage side of the Jones Act. The vessels in Horizon’s Puerto Rico trade are old; its service is handled by four ships of between roughly 1400 and 2200 TEU, built from 1968 to 1974. The announcement’s hint of “modifications” points the discussion toward the Jones Act’s “Second Proviso”, a set of regulations stemming from a group of bills initially enacted in 1956, at the urging of U.S. yards, after owners of U.S. built Jones Act vessels had modified them abroad. After further amending legislation in 1960 and 1988, the latest “Rebuild” language was inserted in the Code of Federal Regulations (at 46 CFR 67.177) in the mid 1990s (after the 1988 language was overturned in a District court case).
A Look at the Rules
Essentially, the rules look at the weight of foreign steel work compared to the vessel’s lightship weight prior to the work; less than 7.5% is allowed, between 7.5% and 10.0% may be allowed (at the discretion of the U.S. Coast Guard), and anything above 10% is not allowed. A second test involves the addition of a “Major component” which is subject to a ceiling of 1.5% of the pre-work lightship weight. In recent years, foreign work on a number of Jones Act vessels has fueled controversies around these rules. The roster of challenges include work done on Matson Lines’ containership Mokihana, and questions surrounding a flock of OPA-related tanker cases: Seacor’s Seabulk Trader and Seabulk Challenger (both still trading after double hull retrofits in China), Keystone’s Delaware Trader, and U.S. Shipping’s Philadelphia and New York.
Most recently, in March, 2012, the Coast Guard rejected a petition filed 14 months earlier by an adhoc coalition that included various organizations and Jones Act owners (including Horizon Lines). This group had petitioned to change the wording of the statutes regarding foreign yard work. The petitioners, who had represented diverse and opposing viewpoints, sought to clarify “…what types and amounts of foreign shipyard work on vessels are and are not permissible under the Jones Act.” The group noted that the greatest confusion surrounded the precise rules and definitions in the application of the “Major component” test. The Coast Guard’s decision not to revisit the CFR rules (http://www.gpo.gov/fdsys/pkg/FR-2012-03-20/html/2012-6588.htm) cited a trail of legal cases that had fashioned what it said was a clear understanding of the rules- labeled as ambiguous by the 12-member coalition. The Coast Guard also pointed to the minefields surrounding proprietary commercial data that might be revealed in the inevitable legal dust-ups that ensue after owners submit confidential information supporting determinations on rebuilds.
Horizon Lines’ estimated drydocking expenses for 2012 will be in line with historical numbers. In 2010 and 2011, Horizon Line amortized $15.0 million and $15.4 million, respectively, for drydocking on its income statements, based on a thirty month cycle. Actual drydocking payments (for an average of six vessels/ year) have ranged from $12.5 million annually (2011) to $19.1 million (2010) in recent years.
The real “savings” for Horizon Line, searching every crevice of its operations for liquidity, will come from the capital investments on the vessels, probably in the range of several million dollars, each. Domestic yard work is more expensive than work done in Asia. What isn’t crystal clear is how much more expensive that domestic work is. Given the extra time and expense to send vessels half way across the world for refurbishment, one has to assume that it is very substantial.
A rough proxy for the order of magnitude differential in the price of yard work can be seen from variations in newbuild vessel prices. The cost of a newbuild “Aframax” tanker in an Asian yard was estimated variously by brokers at around $60 million at roughly the same time that reports pegged the price tag of two SeaRiver vessels to be built in a leading U.S. yard at around $200 million, each. The cost of a foreign built Aframax is now estimated to be under $50 million.
Exact capital budgets are closely guarded (note the Coast Guard’s wording in their denial: “... virtually all applicants consider the information submitted to the Coast Guard in connection with requests for foreign rebuild determinations to be highly proprietary”), but planners likely evaluated the capital cost savings against the incremental cost of positioning the vessels to Asia. This would include the not-so-insignificant extra round trip transit time on the order of six to seven weeks (compared to repositioning into a U.S. yard) that would also give rise to additional fuel costs, Canal transit expenses (each Panama transit could be on the order of USD $150,000 to $200,000), as well as the out of service time. However, in the planners’ calculus, these costs were outweighed by the capital cost savings, where the price tag on domestic work would be at a multiple of that done in a Chinese yard.
Analysis: And a Look Ahead …
Horizon Lines has been through a massive balance sheet restructuring. After dodging numerous financial bullets, management of cash flows is crucial.
Earlier this year, it announced that it had agreed with debt-holders, and with Ship Finance Limited, on the elimination of $188.4 million, net, of debt. Its CFO, Michael T. Avara, had said: “The significant deleveraging resulting from these transactions greatly improves the Company’s cash flow and liquidity, allowing for greater financial flexibility and stability.”
Careful navigation around the “Second Proviso” will be imperative in Horizon Lines’ quest for smoother sailing as the carrier performs work that includes modification of holds and hatches for carrying both conventional and reefer boxes.
Looking beyond things like cell guides and brackets, the strategy here points to the broader issue – work in domestic yards costs substantially more than doing work in foreign yards, even after not-insubstantial positioning and repositioning costs are considered. In these tough economic times, other Jones Act owners will likely be looking closely at how Horizon Lines fares.
(As published in the 3Q edition of Maritime Professional - www.marinelink.com)