Hawaii State Task Force Recommends Jones Act Exemption

By Michael N. Hansen – The Hawaii State Department of Business Economic Development and Tourism (DBEDT) released its Hawaii Refinery Task Force Final Report on April 28, 2014.  The report recommends, among other things, the State seek a Jones Act exemption to prepare for permanent closure of the State’s two small petroleum oil refineries.

Hawaii Governor Neil Abercrombie (D) established the 30-member Task Force by Executive Order No. 13-19 dated February 19, 2013 to identify the challenges and risks if one or both refineries in the State were permanently closed.  The Task Force was attached to the DBEDT’s Hawaii State Energy Office for administrative purposes and two private sector consultants – ICF International and Poten & Partners Inc. – were contracted to provide technical support and compile the Task Force report.

Gov. Neil Abercrombie endorsed the Task Force’s Final Report in the official press release announcing its public availability, “This final report validates the importance of a sustained and reliable energy supply for the people of Hawaii.”

A Tale of Two Refineries

There are two oil refineries in Hawaii located at Kapolei, Oahu Island; each is served by separate offshore moorings sited at Kalaeloa Barbers Point.  The refinery operated by Chevron Corporation (NYSE: CVX) was built in 1962 and currently has a capacity of 54,000 barrels (bbls) per day.  PAR Petroleum Corporation (OTC: PARR) through its wholly-owned subsidiary Hawaiian Independent Energy Inc. (HIE) operates a 94,000 bbl/day refinery originally built in 1970 as Hawaiian Independent Refinery Inc. by Pacific Resources Inc.

Formation of the Task Force was prompted by the previous owner  Tesoro Corporation (NSYE: TSO)’s plans to close what has become the HEI refinery.  Tesoro announced their closure decision in January 2013 after searching unsuccessfully about a year for a buyer.  After several months of shutdown, referred to in the Report as the Tesoro transition period,  PAR Petroleum purchased the former Tesoro refinery in September 2013, and resumed regular operations thereafter.  (See UHERO, Breaking down Tesoro’s refinery closure, 12/29/2013.)

Although the PAR Petroleum purchase seemingly saved the former Tesoro refinery from permanent closure, the combined capacity of the two refineries — approximately 150,000 blls/day – is greater than local demand.  As such, the two refineries are collectively operating at significantly less than full capacity and the conventional wisdom is that both refineries cannot continue on this basis.   This would seem especially true, if, as currently projected, local demand for petroleum products and residual fuel oil (RFO) continues to decrease over time particularly with the anticipated introduction of alternatives such as liquefied natural gas (LNG) and renewable fuels.

Given the real potential for refinery closures, the Task Force determined that a Jones Act exemption allowing foreign flag tankers to carry petroleum cargoes in the domestic Hawaii trade would materially help to mitigate the effects.  This was stated in Section 3.1.6 Jones Act of the Report (pages 39 – 42) as one of several recommendations: “Explore actions to allow Hawaii fuel supply to utilize foreign flag vessels from domestic ports in lieu of Jones Act vessels in order to expand supply sources into the state at more competitive prices.”

We would add such an exemption would not only be valuable in the instance of refinery closures, but should also be actively pursued in the absence of a closure to lower the costs and extend the life of ongoing refinery operations to benefit consumers, tax payers and businesses in the State.

Jones Act Waiver versus Exemption

The report erroneously uses the language of a “Jones Act waiver” to identify what they in fact meant, that is a “Jones Act exemption.”

A Jones Act waiver is a temporary administrative action, the authority for which is provided in statute specifically to address national security situations. An example is the waiver granted in November 2012 by the Obama Administration in the wake of Hurricane Sandy. Typically a waiver allows foreign flag ships to lift certain domestic cargoes, for shipment between defined places, and complete discharge of those cargoes all within a limited period of time, which is usually not more than a week or two..

An exemption is the customary term for a permanent exclusion from a federal cabotage statute such as the Jones Act (Section 27 of the Merchant Marine Act of 1920 as amended).  An exemption must be enacted through a bill for an act which is passed by the Congress and signed into law by the President.  Use of “waiver” to in fact mean an “exemption” is confusing because “waiver” has such a specific and well-defined meaning in law.

This discrepancy between waiver and exemption was brought to the attention of Mr. Tom O’Connor, primary contact for the Task Force contractors and a principal of ICF International.  In response to our email questions seeking clarification of this and other aspects of the Report’s Jones Act section, Mr. O’Connor advised: “It should be referred to as an exemption.  The intent was that Hawaii would appeal to get an exemption to the Jones Act to allow access to more fuel sources at reasonable costs in the event refineries would close.”  He added “. . . (T)he intent would be for [foreign-flag] ships carrying petroleum fuels [from the U.S. Mainland] to Hawaii (gasoline, diesel, jet, RFO, etc).”   He further noted the Task Force’s purpose in writing the Jones Act section  ”. . . was to advise the State to be prepared to act to request an exemption in the event refineries closed.”

Mr. O’Connor correctly added in respect of true Jones Act waiver, “. . . the closure of a refinery could not be considered an emergency.”  Thus acknowledging a Jones Act waiver, as defined under existing law, would be highly unlikely if not virtually impossible to obtain under the circumstances of a refinery closure in Hawaii.  And, we would add, even if obtained, it would be of very limited usefulness in a situation of refinery closures necessitating a permanent solution.

Use of Jones Act Tanker Ships in the Hawaii Trade – Refineries Continuing to Operate

The Report addressed the current use of Jones Act qualified crude oil and other tankers in the Hawaii trade and correctly stated, “In recent years the petroleum industry in Hawaii has had limited need for Jones Act vessels as part of the supply chain to Hawaii consumers. Virtually all crude deliveries are on foreign flag vessels (North Slope crude oil is rarely processed in Hawaii) and the primary import product, jet fuel, is typically delivered on foreign flag vessels from Asian markets.”

As the Report didn’t explore the potential for future domestic crude oil supplies to the Hawaii refineries if they continued to operate (which seems probable especially in the short to medium term), we defined the situation and asked Mr. O’Connor what he thought the Jones Act ramifications might be under this scenario.

We noted, previously, from the late 1970s through the mid-2000s, a majority of the crude refined in Hawaii was from the Alaska North Slope (ANS) via the Trans-Alaska Pipeline System (TAPS) and shipped from the tidewater at Valdez, Alaska.  Today most of the crude oils refined in Hawaii are light sweet crudes imported primarily from South East Asia.  There are several reasons for the change, including: (i) declining production in the Prudhoe Bay oil field (the source of ANS crude); (ii) scrapping of older Jones Act crude tankers as a result of the Oil Pollution Act of 1990 (OPA 90) that were well-suited for the Hawaii market size-wise; and, (iii) the need for lower sulfur inputs to meet Hawaii Clean Energy Initiative (HCEI) and federal Environmental Protection Agency (EPA) mandates.  This could change again in the future with current exploration of the Chukchi Sea (a marginal sea of the Arctic Ocean off Alaska) and possibly in the Arctic National Wildlife Range (ANWR).

In response to our description of possible future domestic crude oil developments to supply the Hawaii refineries, Mr. O’Connor wrote, “These are possible options, however we were also anticipating that the movement of Bakken crude to the west coast through several rail to vessel locations (three at Grey’s Harbor, Washington and one at Vancouver, Washington) could have value for Hawaii refiners.”  (The Bakken formation underlies parts of North Dakota and Montana.)

In either case, whether for ANS or Bakken crudes, to take advantage of these domestic developments, the Hawaii refineries  would need access to reasonably priced AFRAMAX crude carriers.  Only a permanent exemption would provide such access.  (AFRAMAX tankers are crude carriers with a cargo capacity of between 80,000 to 110,000 deadweight tonnes (dwt) in metric measurement.)

The report did describe the current use of Jones Act clean product tankers to move petroleum products and distillate stocks between the Hawaii and U.S. West Coast refineries and markets.  Mr. O’Connor agreed that this is an important function given that the Hawaii market is among other things gasoline limited and the exchange is necessary for the successful operation of the Hawaii refineries.  This function could be made far more efficient through a permanent Jones Act exemption and again lowering refinery operating costs and petroleum product pricing in Hawaii.

Supply of Petroleum Products and Residual Fuel Oils – Refineries Permanently Close

A primary focus of the Report in respect of the Jones Act is:  What might be the situation if one or both refineries closed necessitating the importation of all petroleum products and residual fuel oils from overseas foreign and domestic sources?

The report answered that question stating, “Under an import‐based fuel supply regime, it will be important for Hawaii suppliers to have access to the broadest market for petroleum products. During the Tesoro transition period, virtually all products imported were foreign, primarily from Asia but also from as far away as Europe. Tesoro indicated that domestic supply was not competitive, in part due to Jones Act restrictions and cost versus foreign flag.”

Mr. O’Connor commented regarding the situation of a future import-based supply regime without a Jones Act exemption, “The alternative [to a Jones Act exemption] would be exposure to most supply from the Asian market, which is forecast for high demand growth.”

That is, in the future, under a scenario with the two Hawaii refineries permanently closed and replaced by a product import regime, the likely source of refined products and RFO for Hawaii would be Asia due to the high Jones Act domestic transportation costs.  (This despite Asian load ports being significantly more distant than U.S. West Coast ports by factors of 2  and 3.)  This would put the State at a clear disadvantage as Asia is expected to experience strong demand growth and competing for petroleum products in the Asian market could prove unpredictable and expensive.  As a result, Mr. O’Connor believed it would be important to have a Jones Act exemption to access domestic petroleum product and RSO supplies at a reasonable cost.

A Jones Act Exemption Alternative

In discussing the prospects for a Jones Act exemption, the report accurately states the probable position of the Jones Act industry in regards to an exemption from the flag requirement of the Jones Act: “Hawaii already receives a tremendous amount of critical products using Jones Act vessels, including food, automobiles, consumer goods, etc. The cost of receiving these goods via Jones Act vessels is already borne by Hawaii consumers every day, as evidenced by shelf prices for these goods. So, why should petroleum be treated any differently?”

The Task Force was right to conclude that their foreign flag tanker exemption would definitely raise the ire of the Jones Act industry making it difficult to obtain.  In response to our questions, Mr. O’Connor said that they didn’t consider more modest exemptions such as from the U.S. build requirement of the Jones Act.  Furthermore, he said they were not aware that a build exemption is the reform currently advocated by four (4) resolutions introduced in the 2014 session of the Hawaii State Legislature and another resolution adopted by the Legislature of Guam on April 15, 2014.

An alternative to seeking a foreign flag tanker exemption in the Hawaii trade as recommended by Governor Abercrombie’s Task Force, we would encourage the Governor and his Administration to seriously consider supporting the Hawaii Shippers Council’s more modest noncontiguous trades Jones Act reform proposal.  This would exempt the Alaska, Guam, Hawaii and Puerto Rico trades from the U.S. build requirement of the Jones Act.  The other requirements of the Jones Act – U.S. flag, U.S. ownership, U.S. crew and U.S. management – would remain in place.

Because the Hawaii Shippers Council approach is not limited to tanker ships, it  would provide broader relief across all manner of goods shipped from the Mainland to Hawaii without more controversially allowing foreign flag ships into the domestic trade.  Also it could not be criticized for singling out just petroleum cargoes, as the Task Force suggested their proposed exemption would.

The reason the Hawaii Shippers Council has focused on the U.S. build requirement is because the primary cost driver in the Jones Act trades is the extraordinarily high cost of domestic ship construction.  U.S. ship construction costs are now well documented to be five times as great as for comparable ships built in South Korea and Japan. (Today Japan, S. Korea and China build more than 90% of the world’s oceangoing ships over 1,000 gross tons.)  This has led to an artificial scarcity of ships in U.S. domestic trades, creates a very high barrier to entry, and significantly reduces the contestability of the domestic seaborne trades

We again invite Governor Abercrombie to join with us and support a modest Jones Act reform that would benefit all sectors of the State’s economy and provide the broadest assistance to all the people of Hawaii.

Michael N. Hansen is the President of the Hawaii Shippers Council. Reach him at pacmar@hawaiiantel.net The Hawaii Shippers Council (HSC) is a business league organization incorporated in 1997 to represent cargo interests – known as “shippers” – who tender goods for shipment with the ocean carriers operating the Hawaii trade.

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