NO EXISTING NONSUBSIDIZED OPERATOR WOULD BE HURT

In our original bulk subsidy proposal, which we circulated to this Committee on August 7th, we had proposed that the new per-diem program be made applicable to existing "Jones Act" and other ships as well as to new ships in order to bring the entire bulk merchant marine under a single program immediately. In part this was motivated by a desire to enable the existing non-subsidized fleet to participate in the program. However, we subsequently learned that a number of the non-subsidized operators and the Shipbuilders Council would have adopted and supported our perdiem-program if it were made applicable only to new ships.

Accordingly, we are prepared to suggest to the Congress that the program be made applicable only to new ships, that is "Jones Act" ships presently under construction or built hereafter.

The capital cost of the most expensive existing ships was approximately $400 per deadweight ton and the interest rates at the time they were financed were approximately 8 percent. Today the ship that we are building at Bethlehem Steel costs about $1,300 per deadweight ton and the current Title XI interest rate is 11.4 percent. This translates into a time-charter rate differential of almost $13 per deadweight ton per month. An existing non-subsidized operator can charter his vessel to an oil company at almost $13 per deadweight ton per month less that we could charter our new vessel being built in the Bethlehem Steel Sparrows Point yard. For a 50,000 deadweight-ton vessel, they could charter their vessel at over $600,000 per month less than we can charter our vessel. In short, a new vessel, built under the per-diem subsidy program, could not possible compete with, much less hurt, an existing "Jones Act" vessel.

We are pleased to advise the Committee that a unified position has been reached with the non-subsidized operators in the Bulk Council of the National Maritime Council on this per-diem approach subject to a size limitation on tankers in the domestic trade to 60,000 deadweight tons or less. That position will be officially reported to the Committee by the National Maritime Council in its testimony. The Maritime Administration has a record of about 85 old, small, obsolescent vessels, built prior to 1962, which must be scrapped or transferred foreign prior to the full application of the IMCO environmental requirements in 1985. Also, many vessels that would remain viable units of the domestic fleet will be required to curtail their cargo carrying capacity due to the requirement for segregated or dedicated ballast space on the vessel. This will create a significant shortfall in tanker tonnage in the coastwise trades. In addition, in the foreign trades there is already a growing scarcity of small and intermediate sized vessels, particularly for the nearby foreign trades or the trades between Libya and Algeria and the U.S. East Coast. Accordingly, in our view, new ships built within the next few years should be ready to fill the gap created by the scrapping of domestic tonnage and the already developing shortage of smaller ships in the foreign trades. But charter rates generally must increase to cover the very much higher capital costs of new construction. This will only mean that the existing efficient "Jones Act" fleet will be able to earn significantly higher profits, even though new ships are put into the trade, so long as the new ships are on a full domestic capital cost basis.

CONCLUSION

The foregoing is a program which is far more cost effective than the present CDS/ ODS program and will greatly enlarge the United States-flag share of its foreign commerce. In the process, it will save the government substantial costs in moving Public Law 480 and other preference cargoes. We believe that in addition to the ships which we could undertake to build, a number of major United States-flag operators would follow us in enlarging their United States-flag bulk fleets.

We have a number of additional suggestions relating to cargo reservation, to conversion of steam turbine powered vessels to diesel powered vessels and to modification of capital construction fund provisions to define a strictly coastwise vessel as a "qualified" vessel so that tax-deferred deposits in our CCF funds can be utilized to purchase or pay mortgage principal upon strictly coastwise ships. We would also support provisions permitting U.S.-flag subsidized vessels to repair abroad without subsidy or in the United States with subsidy according to operating and economic necessities. And, of course, our per-diem subsidy type program requires certain technical modifications to the Merchant Marine Act, most of which are contained in the attachment to this testimony. These and other suggestions are being advanced before this Committee by other witnesses. I thought it appropriate to direct my testimony to the centerpiece of our program, namely, the per-diem subsidy.

I appreciate the Committee's affording me the opportunity to present our views here today.

STATEMENT OF Kominers, FORT, SCHLEFER & BOYER

A NEW BULK VESSEL PROGRAM

The President's Inter-Agency Task Force on Maritime Policy, although it has not produced a meaningful overall maritime program, has apparently agreed on a legislative proposal designed to develop a U.S.-flag bulk cargo fleet carrying capability. The content of that program basically derives from a Maritime Administration concept originated about two years ago, which was intended to help correct the most conspicuous failure of the Merchant Marine Act of 1970-the failure to build and develop a bulk cargo fleet under U.S. flag.

The President's program contemplates that (a) bulk vessels built with construction-differential subsidy could be sold foreign after 10 years of age, subject to deposit of the proceeds of sale into a capital construction fund and provision for construction of replacement tonnage; (b) owners operating under operating-differential subsidy contracts would have the option to repair vessels overseas without subsidy or in the U.S. with subsidy; (c) ownership of a dry-bulk carrier under operating-differential subsidy contract would neither bar nor require a waiver for foreign-flag operations by the operator or related interests; (d) both dry and liquid U.S.-flag bulk carriers under operating-differential subsidy contract would be permitted to operate in foreign-to-foreign trade.

This program contains some useful ideas and should be implemented. The provisions of (b), (c), and (d) could be put into effect under existing law and, in fact, (d) has been. But in any case this limited program is not likely to produce any new vessel that would not otherwise be built, because it does not address the three basic obstacles to the development of a U.S.-flag dry-bulk, OBO and tanker fleet. Nevertheless it is heartening that at the highest level of the executive branch it has apparently been decided confirming the policy of the 1970 Act-that the United States shall have a bulk cargo carrying Merchant Marine.

This memorandum describes the three basic obstacles to the construction of a significant number of U.S.-flag dry-bulk, tanker and OBO vessels and proposes specific actions to deal with them. It also addresses the special problem of the disadvantage that the steam-turbine power plant in existing U.S.-flag vessels suffers in competition with foreign-flag diesel-powered ships. This is a serious problem and must be solved; the fuel cost differential on a 90,000 deadweight-ton tanker is now about $9,000 per steaming day or about $2.5 million per year. Finally, the memorandum discusses the type of bulk ship that should be encouraged by the program, so as to mesh military and commercial needs.

The obstacles to construction and operation of a bulk fleet (as used throughout the balance of this memo the term "bulk" vessel is used to include dry-bulk vessels, tankers and OBOs) are (a) the fragmentation of the present programs, and the consequent fragmentation of the bulk fleet, which restricts the cargo markets in which any particular ship can compete; (b) the lack of requirement or incentive to replace obsolescent ships as a condition of participation in the preference programs, the Soviet-grain subisdy program, or the coastwise trades; and (c) the inherent impracticality of constructing, at very high current capital cost, a new bulk ship to compete in the world market with ships built in an earlier stage of world inflation and therefore not only enjoying much lower original capital and interest costs but also having already been fully or partially depreciated over the years of operation. The two actions proposed herein as the backbone of a new program are (a) the substitution of a single program in place of the various existing subsidy and preference programs, to be made applicable and readily available to all independentlyowned, U.S.-flag vessels which are within their statutory or reconstructed economic lives or are to be built, and allowing them to move freely into and out of subsidized operations as they shift from foreign to domestic trade and back (Since this program was originally proposed we learned that a number of non-subsidized operators and the Shipbuilders Council of America would like the program to apply only to new ships. We would go along with this modification.); and (b) the entering into of bilateral agreements with foreign governments in accordance with the pending omnibus legislation but with the provision that if, after a reasonable time, the executive branch is unable to negotiate bilateral agreements covering a sufficient amount of bulk cargo to stimulate the construction of an adequate bulk fleet, the Secretary of Commerce be directed to develop by regulation a limited cargo reservation program for bulk ships.

We begin with a brief description of the bulk cargo fleet and the major markets into which it is divided. The principal bulk cargo markets are: first, the vast, worldwide, commercial bulk cargo trades transporting crude oil, petroleum products, grains, ores, bauxite, coal, scrap iron, raw sugar or similar cargoes in the foreign commerce of the United States and between foreign countries; second, the U.S. coastwise trades which include the trades between continental United States ports and between Alaska, Hawaii, Puerto Rico and the continental United States; third, the U.S. cargo-preference foreign trade (principally grains financed by AID or the Department of Agriculture), charters to the Military Sealift Command, and the Strategic Petroleum Reserve; finally, the U.S.-Soviet grain trade, which is a subsidized trade, open, however, to otherwise unsubsidized vessels under short-term subsidy contracts.

Within these markets the United States has two quite separate bulk fleets. One is not directly subsidized (except in the Soviet-grain trade) and is confined by economic constraint to the domestic, Soviet-grain, and cargo-preference trades; the other is operated under operating-differential subsidy contracts and is confined by law or contract to the commercial foreign trade, the Soviet-grain trade and the Strategic Petroleum Reserve lift. The one fleet competes in restricted trades unaffected by foreign-flag competition; the other strives to compete in the world market suffering the enormous disadvantage of much higher fuel costs. The unsubsidized operator may own and operate foreign-flag ships; the subsidized operator may not. The unsubsidized operator is not obligated to replace its vessels; the subsidized operator is. Therefore, the former operates vessels having an average age of over 27 years, while the latter is composed of ships under six years old. These two U.S.-flag fleets have different economic concerns and frequently deep divisions and conflicts exist between them.

The only way to bridge permanently the division between the subsidized and nonsubsidized bulk operators and to create an effective bulk-vessel policy is to disassemble the fragmented system of aids-cargo-preference, Soviet-grain, the insulated domestic trade, and foreign trade subsidized operations-and substitute a single program available to all independently-owned, U.S.-flag, bulk vessels. The objective should be to create one modern fleet, subsidized in the foreign commerce, not subsidized in the domestic, moving freely between the two, and to reserve to U.S.flag vessels a small percentage of foreign-trade bulk cargoes for a specified period of years to offset the initially higher capital costs of new vessels.

A pattern for such a program exists in the Soviet-grain program in which substantially all U.S.-flag bulk vessels have participated. The owners of the nonsubsidized, or so-called "Jones Act" fleet, enter into short-term subsidy contracts when they are in the Soviet-grain trade-contracts which include fuel subsidy as well as "depreciation" and "interest" subsidy. Those contracts also provide that the vessels drop all subsidy as soon as they leave Soviet-grain service, and are permitted to go back into the domestic and preference trades.

The major defects of the Soviet-grain program from the standpoint of building a viable bulk cargo fleet are that there is no vessel replacement obligation and that routine waivers are granted from the restrictions of section 605(b) of the Act which, except upon a special finding that the public interest would be served, prohibits the payment of operating-differential subsidy on vessels that are older than their economic life. This program has resulted in a missed opportunity and in a significant and conspicuous waste of public funds. Large amounts of operating subsidy have been paid to permit obsolete vessels to continue to operate with no undertaking on the part of their owners to replace the vessels. Without the program many obsolete vessels would probably have been scrapped. Similarly, in the cargo-preference trades hundreds of millions have been paid in premium rates (a form of operating and capital subsidy) with no obligation by the recipients of this form of subsidy to build replacement ships, and in fact none have been built. The cargo preference program, like the Russian grain subsidy, has protected inefficient tonnage. This waste in subsidizing overaged, inefficient vessels should cease with a well conceived new program.

What then is the main outline of a program that would create a cohesive U.S.-flag bulk merchant marine composed of modern and efficient ships? First, all independent operators of U.S.-flag, bulk, ocean-going vessels which are within their statutory or reconstructed economic lives should be able to obtain 20-year operatingdifferential subsidy agreements predicated on the Soviet-grain type subsidy.3 (As indicated above, because of the views of the Shipbuilders Council of America and

125 years in the case of a dry cargo vessel and 20 years in the case of a tanker.

* Including tug-barge units, whether on a tow line or integrated unit.

Those subsidy provisions are set out in 46 C.F.R. § 294.1 et seq.

certain non-subsidized operators we are prepared to limit this part of our program to new ships, including "Jones Act" ships now under construction, of 60,000 dwt or less.)

This was the original plan of the 1970 Act and was frustrated by the requirement to freeze, and ultimately to dispose of foreign-flag vessels owned or operated by the subsidized company or its affiliates. All vessels built after enactment of the program would be built at full domestic cost-i.e., without construction subsidy-but the construction cost differential between U.S.-built ships and foreign-built ships would be equalized by a depreciation and interest element in the operating subsidy. For example, if a ship were built at a domestic cost of $50 million and a foreign cost of a foreign competitive ship were determined to be $25 million, the depreciation on the U.S.-flag vessel would, on a 25-year life, be $2 million per year or $5,479/day. The foreign ship would incur only $1 million per year in depreciation or $2,740/day. The per diem difference would be added to the daily operating-differential subsidy in lieu of CDS. The same would be done with respect to the daily interest cost on the additional capital cost. In addition the standard operating subsidy would be paid on a daily basis. But the subsidy would be paid only for days the vessel was operated in international commerce. Vessels built under the program would be subject to a 17year ODS contract with an option to extend for an additional three years if a replacement vessel were contracted for prior to the end of the 17th year. There could be no injury to existing non-subsidized vessels because the capital cost and interest rates on the newest of the existing non-subsidized fleet is less than half that of any new vessel. For example, the non-subsidized vessels built at the National Steel and Shipbuilding Company for the Overseas Shipholding Group cost about $400 per dwt; a 47,000 dwt vessel under construction at Bethlehem Steel's Sparrows Point Yard for our group will cost us almost $1,300 per dwt. In addition our interest rate on this very much higher capital cost will be about 11 percent whereas in the early 1970's the interest rate, on the lower capital cost, was about 8 percent. This translates into a time charter rate difference of over $9 per deadweight ton per month on interest charges alone. In addition the new ship has depreciation expenses of $3.75 per deadweight ton higher than the existing ship for a total rate disadvantage of $12.75 per deadweight ton. In the tanker charter market a few cents per dwt per month can make the difference in obtaining a charter and hence the new ship cannot possibly compete with the existing ship in the domestic trade.

There would be no restrictions as to trade in the subsidy contract. The vessels would be permitted to enter the U.S. coastwise trades freely but would go off subsidy from the time they began to load cargo for the domestic trade until they either loaded cargo for a foreign voyage or departed in ballast for a foreign port to load cargo.

The restrictions of section 506 would be inapplicable to any bulk vessel. Sections 605(c) and 805(a) providing for hearings would be made inapplicable to the ownership or operation of bulk vessels. Section 804 of the Act should be repealed with respect to bulk vessels that are not owned, operated, or chartered for more than 10 years by a company which directly or through affiliates transports its own cargo in full shipload quantities. Section 901(b) of the Merchant Marine Act, 1936 (the "Cargo Preference Law"), would be amended to provide that a bulk vessel that is older than its statutory or reconstructed economic life (as determined by the Maritime Administration) shall not be considered to be a "privately owned United States-flag commercial vessel" for purposes of that section, unless its owner or a person controlled by, controlling, or under common control with, the owner or the vessel has a binding contract with a U.S. shipyard to construct a replacement vessel and then only until the replacement vessel is delivered. Section 607 of the Act should be modified to provide that a bulk vessel would be a "qualified vessel" whether or not it operated in the strictly coastwise trades with respect to deposits and investments made prior to or after enactment of the legislation.

Such a program should effectively eliminate the economic causes for the bitter divisions between the subsidized and nonsubsidized segments of the bulk merchant marine. All independent operators of U.S.-flag bulk vessels would be on the same footing.

We turn next to the second major requirement for an effective bulk program— namely a small assured reserve of cargo until average capital costs on the world market catch up with capital costs for new construction. Assuming that the "depreciation" and "interest" element of the per-diem operating subsidy proposed ade

4

This is to enable owners to new vessels built under the program to distribute profits under Maritime's conservative dividend policy after complying with the Title XI reserve fund requirements and still have a strong incentive to replace the new vessel.

Except for those restrictions applicable to all U.S.-flag vessels under departmental orders T1 and T-2.

quately covers the differential between the cost of building a ship in the United States and in the low-cost foreign shipbuilding center, a new vessel nevertheless faces a severe competitive disadvantage in the world market for bulk cargoes. The world market is composed of say 7,000 to 10,000 bulk vessels, many of which were built 10 to 15 years ago, when the cost of construction was less than half of what it is today, and interest rates were much lower. Those vessels are fully or largely depreciated.

In time, worldwide inflationary pressures on ship construction costs combined with scrapping and obsolescence of old vessels will force the average construction cost of ships on the world market to the point where new, recently-built U.S.-flag ships are on a competitive capital cost basis after depreciation and interest elements of subsidy.

Associated with capital cost is also the cost of capital, that is, the interest factor. In 1971 and 1972 interest levels approximated 8 percent per annum for long-term Title XI bonds including the guarantee fee. Today interest costs, including guarantee fees, are probably around eleven percent and rising. Twenty-five percent higher interest costs applicable to much higher capital costs make it impossible for a new U.S.-flag bulk vessel to compete effectively on the world market when delivered by the shipyard.

Some assured cargo is necessary to enable a new U.S.-flag, bulk vessel to sustain itself until the time world capital and interest costs catch up. Some such cargo would be available to the subsidized vessel because it could enter the domestic trades, without subsidy, or the traditional cargo-preference and Soviet-grain trades; but since the program calls for injecting a significant number of subsidized ships into the protected trades cargo volumes would be insufficient to sustain both the existing non-subsidized fleet and the new fleet for the five to eight years required for average capital and interest costs on the world market to catch up.

We, therefore, support the proposals that have been made to and by this Committee for encouraging the negotiation of bilateral cargo-sharing agreements with foreign governments which ship to or receive from the United States significant volumes of bulk cargoes. Further, we strongly urge the Committee to include in such legislation a provision that, in the event the executive branch of the government is unsuccessful in concluding bilateral agreements covering a sufficient volume of bulk cargo to stimulate the construction of an adequate U.S.-flag bulk fleet, the Secretary of Commerce be directed to develop by regulation a limited cargo reservation program designed to achieve that objective.

This reservation should apply to petroleum cargoes, iron ore, bauxite, coal, scrap iron, logs, lumber, raw sugar and similar bulk and neo-bulk commodities that move in full ship-load quantities in U.S. import and export foreign trade. The prices of these commodities would not be affected because pricing would be controlled by the much larger percentage of the total volume that moves on foreign-flag vessels. Moreover the increase in cost of transportation for the reserved portion of those commodities would neither relate to the operating costs, which would be subsidized, nor to the entire capital and interest cost, but only to the differential between the capital and interest cost of new U.S.-flag ships and of the average foreign-flag vessel. Indeed some part of that differential might be made up through increased efficiency of new vessels based on lower manning requirements, lower fuel consumption costs and similar operating efficiencies.

Administering such a reserved cargo provision requires some study, but as bulk and neo-bulk commodities, other than agricultural exports, are usually shipped or received by large industrial corporations these problems should not be difficult. Small importers and exporters could be exempted, much as small refiners were to be exempted in the now-aborted oil cargo preference legislation. Broad discretion could be conferred upon the Secretary of Commerce to promulgate regulations implementing the provision and to grant waivers upon a clear showing that U.S.flag bulk vessels were not available.

The best way to analyze the cost of the per diem-subsidy approach with the traditional CDS/ODS program is on a per ship basis. Assuming that the construction-cost differential is 50 percent, that the ODS payments for operating costs only are $4,000 per day, that the interest rate is 11 percent, that the useful life of the vessel is 25 years and that under the new program the vessel would operate in the domestic trades six months out of the year, the comparative costs would be as follows for a $50 million vessel: