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Feature: California dreaming ... of more US-flag tankers

California is a land of contrasts and paradoxes. If the GDPs of US states were compared to those of other countries, California would have the eighth largest economy in the world, on a par with that of Italy or Canada. The Golden State accounts for 13% of the total US GDP and one in nine new cars in the country are sold in California. Yet California’s per capita energy consumption ranks 47th in the nation. The state's comparatively low use of energy at a personal level is due primarily to its mild climate and its rigorous energy efficiency programmes. Allied to these energy efficiency efforts is the world’s most demanding regime for the control of emissions of polluting substances.

Natural gas, light oils, renewables and, to a lesser extent, nuclear power account for the vast bulk of the state’s energy mix. Coal and heavy residual fuel oil hardly register on the radar. Most of the oil processed in Californian refineries is provided to the market in the form of high-specification transport fuels, i.e. gasoline, diesel and aviation kerosene. The state’s refineries account for two-thirds of the crude oil processing capacity available on the North American West Coast.

The state used to have a particularly prolific oil-producing industry of its own but dwindling reserves and restrictions on oil drilling have curtailed this output. This loss was, for a time, compensated for by tanker deliveries of Alaskan North Slope oil, but the North Slope fields too are now in the throes of long-term decline.

California is still the third largest producer of oil amongst the US states, with an output of approximately 550,000 barrels/day, about one-half its highest-ever level. However. Californian oil production has been in decline for almost three decades and that of Alaska since the turn of the millennium. As a result the Golden State’s imports of foreign oil – primarily from the Middle East – have risen from about 5% of consumption in 1992 to almost 60% today. Saudi Arabia, some 11,4000 miles distant, is now the largest supplier of Californian oil.

The state’s aggressive environmental policies are expected to have an even greater impact going forward. State government officials believe that by 2020 some 20% of transport fuels consumed in California will come from non-petroleum sources, notably natural gas and renewables. Further improvements in automobile efficiency standards are also set to reduce demand for oil-derived fuels. California’s refiners are having to evaluate this changing scenario and to decide how they may have to reconfigure their plants as a result.

Another influential factor is the rising output of shale oil and gas across the country. The shale revolution has eased the US dependence on foreign oil and gas and introduced the alluring possibility of nationwide energy self-sufficiency. Key elements of this bright new tomorrow are significant US exports of gas in the form of LNG and a greatly reduced reliance on foreign oil.

California itself possesses one of the many sizeable deposits of shale oil discovered in the US. According to the federal government, the Monterey Shale formation holds up to 15 billion barrels of recoverable oil. Ironically, however, that resource could be legislated out of contention. In Autumn 2013 the State Governor’s Office signed into law the nation's toughest regulations governing hydraulic fracking of shale formations, requiring the disclosure of chemicals used, groundwater testing and other oversight measures.

California’s oil refiners stand at the juncture of these tectonic plates of strict environmental controls and the demand for clean petroleum products as transport fuels. Faced with the prospect of handling a different mix of crude oil feedstocks, reconfiguring their output slates and adapting to changing market needs, which way do they turn? And how will these developments impact tanker shipping?

Because long-distance pipeline deliveries are prohibitively expensive, rail shipments of Canadian and domestic US shale oil, particularly from North Dakota, are starting to reach California in growing volumes. Crude-by-rail deliveries to California totalled 1 million barrels in 2012 and climbed to 6 million barrels in 2013, equivalent to about 1% of the state's total consumption. Oil transported from these inland shale plays has the advantage of being of the same light, sweet quality as that shipped from Alaska and Saudi Arabia.

On top of these developments at least six new crude oil storage and rail/barge offloading terminals have been proposed for locations near Californian refineries. If these major projects are realised, they could boost the state's crude-by-rail shipments to 25% of total demand. Such a volume of rail tank car traffic would considerably curtail the requirement for tanker shipments from the Middle East.

Nevertheless, California being California, rail freight is proving not to be straightforward option. Although the oil shipped by rail is competitively priced, a handful of incidents involving derailments of crude oil block trains in North America over the past two years have aroused suspicions. Several of the planned US West Coast projects based on the construction of crude-by-rail unloading terminals are facing permit delays due to public opposition.

The other option for delivering the new-found volumes of US shale oil to California’s refineries is by means of seagoing tanker. This option is stirring up interest as a means of realising commercial and strategic benefits from the rising volumes of shale oil now being exploited in the vast Texas deposits such as Eagle Ford and Haynesville. The fact that there is no oil pipeline linking the US Gulf to California adds to the interest in the sea route.

Shipping these new volumes of Texas oil from US Gulf ports to California via the Panama Canal undoubtedly holds good commercial potential. However, the US Merchant Marine Act of 1920, otherwise known as the Jones Act, restricts the movement of goods between US ports to US-flag ships built in the US, crewed by US citizens and owned by US citizens. Such conditions restrict the permitted fleet to a limited number of ships.

The ocean-going Jones Act tanker fleet consists of about 85 vessels, all of which are fully employed. The controls imposed by the Jones Act effectively mean that US-flag tankers command freight rates up to 10 times those currently pertaining for a tanker engaged in international trade. As a result of the high running costs for domestic vessels, a barrel of Texas crude oil arriving in California by sea would be roughly equivalent in price to a barrel of Saudi oil and slightly less than a barrel transported overland by rail.

Californian refiners hopeful of having a high percentage of Texas oil in their future crude mix are looking to the advantages that competition and economies of scale could bring. Competition would be fostered by new ship construction in the US and having a larger pool of domestic tankers to choose from.

It is important that the newbuilding orderbook includes some larger tankers because the opening of the enlarged Panama Canal in 2015 will enable economy of scale benefits to be achieved. The new Panama Canal fleet is also likely to be bolstered by a redeployment of some of the tankers now serving the Alaska trade.

US-flag oil tankers are currently infrequent users of the Panama Canal. Records show that only two such ships used the waterway in the last six months of 2013. The situation is ripe for change, however. Californian refiners used to seeing their Jones Act tanker deliveries arriving from the north could soon be shifting their glances southwards in search of inbound vessels laden with domestic crude oil.

Editor's Note: Mike Corkhill is a technical journalist and consultant specialising in oil, gas and chemical transport, including tanker shipping and chemical logistics. A qualified Naval Architect, he has written books on LNG, LPG, chemical and product tankers and is currently the Editor of LNG World Shipping.
Source: BIMCO