Logistics in Focus: U.S. Waterways by Max Schlubach

Logistics in Focus: U.S. Waterways By Max Schlubach

For more than 200 years, tugboats, towboats and barges have plied the United States’ vast inland river system, its Great Lakes and its three coasts. This distinctly American industry has built the coast of the Great Lakes into a global manufacturing center, enabled the U.S. to become the world’s largest wheat exporter and, today, provides the flexibility needed to become a major oil producer. Yet despite the critical role that it plays in the U.S. economy, the inland and coastal maritime industry is little known outside of the transportation sector.

14 Brown Brothers Harriman | COMMODITY MARKETS UPDATE The tugboat, towboat and barge industry is the largest segment Jones Act Vessel Type of the U.S. merchant maritime fleet and includes 5,476 tugboats erries Taners and towboats and 23,000 barges that operate along the Atlantic, . Pacific and Gulf Coasts, the Great Lakes and the inland river sys- . tem. The industry is fragmented and, for the most part, privately owned, with more than 500 operators either pushing, pulling or Dry Cargo otherwise helping move waterborne cargoes through the United Towoats . States’ waterways. The industry is bifurcated into inland and coastal sectors, which have little overlap due to the different vessels and licenses required to operate in their respective environments.

The tugoat towoat Recent market dynamics, particularly in the energy sector, have and arge industry maes u the maority s of December 31, 201. resulted in seismic shifts in supply and demand for the U.S. of the Jones At fleet. Source: U.S. rmy Corps of ngineers. water transportation sector. This article looks at the current state of affairs in the market, with a focus on barges. Mississippi, Missouri, Tennessee, Hudson and other major riv- erways. Typically, towboats push barge tows of up to 15 barges Inland and Coastal Sectors through locks and around river bends to deliver agricultural com- Before delving into recent market trends, it may be helpful to give a modities to export markets in New Orleans, crude oil to refineries brief overview of the market structure in towing and barging. There along the Gulf Coast and coal, chemicals and building materials to are effectively five main markets in the U.S. water transportation industrial sites throughout the inland river system. On the Lower industry: inland tank barge, inland dry cargo, coastal tank barge, Mississippi River, where there are no locks to restrict tow size, mas- coastal dry cargo and coastal ship assist. sive towboats powered by up to 10,000 horsepower engines can transport 40-barge tows toward the Gulf of Mexico.1 At today’s coal Inland towing companies, which comprise roughly 60% of the price, a 15-barge tow carrying 22,500 tons would be transporting U.S. towing fleet, operate vessels called towboats or pushboats. a little under $1 million worth of coal. Towboats have square bows that are used to push groups of barges lashed together on the Columbia-Snake, Illinois, Ohio, 1 The Lower Mississippi River begins at the confluence of the Ohio and Mississippi Rivers in Cairo, Illinois, and flows nearly 1,000 miles to the Gulf of Mexico.

BARGE TYPES Inland Liquid Cargo Tank Barge Coastal Oceangoing Tank Barge 297 Feet Long 550 Feet Long 1,000,000 Gallon Capacity 225,000 Barrel Capacity Carries: Petroleum Products, Petroleum, Carries: Petroleum and Fertilizer, Chemicals, Orange Juice Petroleum Products

Open Dry Cargo Barge Covered Dry Cargo Barge 195 Feet Long 195 Feet Long 1,530 Ton Capacity 1,500 Ton Capacity Carries: Coal, Steel, Ore, Sand, Carries: Grain, Soy Beans, Salt, Sugar, Gravel, Lumber Paper Products, Packaged Goods

CARGO CAPACITY

Barge 15-Barge Tow Jumbo Hopper Car 100-Car Unit Train Large Semi 1,500 Tons 22,500 Tons 10,000 Tons 10,000 Tons 26 Tons 52,500 Bushels 767,500 Bushels 350,000 Bushels 350,000 Bushels 910 Bushels

Source: Celtic Marine Corporation.

Issue 2 2016 15 Coastal towing companies constitute the remaining 40% of the Tank Barge and Tugboat Annual Construction U.S. towing fleet and operate vessels called tugboats. Tugboats 350 have high, pointed bows and are used to transport goods coast- 300 wise – over the open ocean between ports – or to assist oceangoing 250 vessels docking within a harbor. Tugboats engaged in commodity transportation are traditionally designed to transport a single large 200 barge either “on the hawser,” using a thick cable up to 2,000 feet 150 long, or “in the notch” by pushing a barge from behind. Constructed Total 100

Articulated tug-barge (ATB) units are the industry’s newest vessel 0 class and consist of a purpose-built tug and barge that rigidly con- 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014 nects to create a single vessel that looks and handles like a ship. Tank Barges Towing Vessels Source: U.S. Coast Guard. They offer higher speeds of up to 12 knots (14 mph) and are almost exclusively built to handle petroleum products.2 Furthermore, ATBs Coincident with the surge in U.S. shale oil production volumes can be the size of a small oil tanker carrying as much as 330,000 from 2010 to 2015, barge operators saw tremendous demand barrels (bbls) of petroleum and are powered by up to 16,000 horse- for crude transportation. The trend can be witnessed in the power engines – nearly three times the typical 6,000 horsepower total domestic crude oil delivered to refineries by barge, which engine of modern heavy freight locomotives. At today’s crude grew by a factor of five between 2010 and 2015 to 250 million prices, an ATB with capacity of 300,000 bbls would be able to bbls annually. In anticipation of continued crude oil production carry about $14 million worth of crude oil. growth, between 2010 and 2015, tank barge operators placed a record number of new orders for barges. In addition, the industry Tugboats engaged in ship assist work in teams to guide ships recently completed a 25-year phaseout of single-hulled barges, safely within a harbor. While older ship-assist tugs have tradi- which are no longer permitted to carry petroleum products as tional rear-facing propellers, newer, more sophisticated tractor of January 2015. As a result, the tank barge fleet is now the tugs have swiveling Z-drive propulsion systems that allow them youngest segment of the industry and will likely remain as such to pull or push in any direction. Z-drive tugs have also become in coming years as more vessels are completed and delivered. common on the inland rivers, where maneuverability is of height- ened importance. These vessels typically have between 2,000 Tonnage Carried on Internal U.S. Waterways and 6,000 horsepower engines. 60

Drill Down: The Tank Barge Sector 55 The tank barge sector is driven by the production and transportation of four main types of bulk liquid commodities: refined 50 petroleum products (50%), crude oil (30%), agricultural and pet- rochemicals (10%) and black oil and asphalt (9%).3 The fortunes 45 of tank barge operators have tended to follow crude production 40 levels in recent years. While operators have the flexibility to real- Millions of Short Tons locate barges across product types as demand fluctuates, the Tonnage 35 process of cleaning and preparing barges for different products 12-Month Moving Average can be cost-prohibitive and time-consuming. 30 2000 2002 2004 2006 2008 2010 2012 2014 2016

Source: U.S. Department of ransportation.

2 A handful of dry bulk ATBs exist; however, the vast majority are designed to carry petroleum products. 3 Source: U.S. Army Corps of Engineers.

16 Brown Brothers Harriman | COMMODITY MARKETS UPDATE

1 The Lower Mississippi River begins at the confluence of the Ohio and Mississippi Rivers in Cairo, Illinois, and flows nearly 1,000 miles to the Gulf of Mexico. Failing a drop in foreign crude oil production, the most likely outcome of a 20% increase in Jones Act tanker capacity is a drop in coastal chartering rates.”

Issue 2 2016 17 Age of Towing Industry Fleets THE JONES ACT

50% Tank Barge Fleet The Merchant Marine Act of 1920, colloquially referred to as 45% Dry Covered Barge Fleet

40% Dry Open Barge Fleet the Jones Act, is a 96-year-old maritime law stating that all 35% Towing Vessel Fleet goods transported by water between U.S. ports must be car- 30% 25% ried by U.S.-flagged ships that are built domestically, owned 20% by U.S. companies and crewed by at least 75% U.S. citizens.

Perentage of leet 15% 10% 5% The Coast Guard’s new Subchapter M regulation, finalized on June 0% 0-5 6-15 16-25 26-35 36-45 Older 20, 2016, is a major event for the entire towing industry. In it, the Age of leet in Years Source: U.S. rmy Corps of ngineers. Coast Guard establishes safety regulations governing the inspection, standards and safety management systems of U.S. waterway Forces Shaping the Industry towing vessels. Under the rule, every U.S. towing operator must Several converging forces are likely to drive further industry obtain a certificate of inspection (COI) for every tugboat and towboat consolidation in the coming years. Previously surging crude oil it operates. To comply, companies must choose to either have all production volumes, insufficient pipeline takeaway capacity and vessels regularly inspected by a Coast Guard official or implement a closed market prompted a historic rise in orders of inland and a companywide safety management system (SMS) that is audited coastal Jones Act tank barges and ships. In the coastal market by an independent organization. Both options pose economic and in particular, 17 new product tankers and ATBs with a combined logistical challenges for companies, and compliance expenses are capacity of more than 4.5 million barrels will be delivered to Jones estimated to be $100,000 per vessel or more for those without an Act operators in the next 18 months, boosting fleet capacity by existing SMS.5 However, larger companies, including members of 20% before the end of 2018.4 Failing a drop in foreign crude oil trade associations such as American Waterways Operators, have production, the most likely outcome of a 20% increase in Jones SMS already in place and will face little incremental cost in comply- Act tanker capacity is a drop in coastal chartering rates. U.S. ing with Subchapter M. Observers expect Subchapter M to drive waterway operators are no strangers to the boom-bust cycles industry consolidation as compliance costs weigh on operators ill- that characterize the shipping industry, but the forthcoming capac- equipped for the new regulatory regime. ity shock aligns with new regulatory requirements, as well. Tugboat, towboat and barge operators have weathered many Crude Oil Movement by Barge and Pipeline storms over two centuries. Moreover, this epoch will not be

300 3,000 the last trying time for an industry that has endured advances in technology, competition from trucks and trains and a mar- 250 2,500 ket that can refuse to cooperate with even the best-laid plans. 200 2,000 It is with that spirit of adaptation that we can expect Jones Act 150 1,500

MMbbls MMbbls carriers to continue to sail on, following William Arthur Ward’s 1,000 100 advice that “the pessimist complains about the wind; the opti- 50 500 mist expects it to change; the realist adjusts the sails.” 0 0 2000 2003 2006 2009 2012 2015

Barge Transportation (left-hand axis)

Pipeline Transportation (right-hand axis) Source: nternational nergy gency.

4 Source: RBN Energy, “Flirtin’ With Disaster - The Coming Oversupply of Jones Act Tankers and 5 Source: MarineLink.com, “US Workboat Market: Domestic Drivers,” June 30, 2016. ATBs,” June 19, 2016.

18 Brown Brothers Harriman | COMMODITY MARKETS UPDATE 46 CFR Subchapter M Timeline

JUNE 2016 Subchapter M is published.

JULY 2016 Subchapter regulations are effective, but several requirements are delayed for two years or after a vessel is issued a certificate of inspection (COI).

JULY 2017 Vessels built on or after this date are considered “new vessels,” and a COI is required before entering service.

JULY 2019 Twenty-five percent of a company’s fleet must have a valid COI, except for companies with only one existing towing vehicle.

The towing vessel’s owner or managing operator must implement a health and safety plan.

JULY 2020 Fifty percent of a company’s fleet must have a valid COI.

Companies with only one existing towing vessel must obtain a COI.

JULY 2021 Seventy-five percent of a company’s fleet must have a valid COI.

JULY 2022 One hundred percent of a company’s fleet must have a valid COI.

YEAR 7 to YEAR 11 Five years after the issuance of an initial COI, existing vessels must comply with enhanced requirements.

JULY 2027 Subchapter M implementation is expected to be complete.

Source: U.S. Coast Guard and the Federal Register.

Issue 2 2016 19 Brown Brothers Harriman & Co. (“BBH”) may be used as a generic term to reference the company as a whole and/or its various subsidiaries generally. This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries. This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented. This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. All trademarks and service marks included are the property of BBH or their respective owners.

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