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Strategic Investors Should Love Maritime
Revitalizing the United States maritime industry is good for the world
Ocean shipping is a large, if silent industry. It’s not consumer facing. Incentivized to lower costs, opacity benefits the industry. Labor is cheaper when conditions are unmonitored. Where emissions go uncounted, there is less pressure to expend capital on efficient propulsion systems and sustainable practices. International maritime law is difficult to enforce since most maritime operations occur on open seas, far from regulator oversight.
90% of traded goods (by volume) are moved by ocean freight. But since the industry lives in the shadows, it’s rarely talked about. This lack of attention has shielded maritime from disruption by challengers and startups. Resultantly, there is room for maritime to expand as a transportation medium.
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Data to study the global maritime industry is limited. Nevertheless, what I have found has been nothing short of remarkable: an industry reminiscent of other protected industries (e.g., space and airlines) and one that just might be on the cusp of a revolution.
Nowhere are maritime opportunities more pronounced than in the United States. This is, in part, because the industry has been idle for so long. It is also because a robust maritime industry is critical to United States resiliency in the next era. But most importantly, the United States has developed several core competencies that could be transformative if applied to maritime.
A thriving United States-based maritime industry would be good for non-US stakeholders as well. For the United States maritime industry to achieve its potential, it must be globally competitive. That’s only possible if protectionist American trade laws are liberalized. Opening the United States maritime market means welcoming foreign investment and knowledge transfer. Perhaps by way of partnerships with non-US bodies that can assist with manufacturing & supply chain development.
Building a robust maritime industry in the United States may prove to be a once-in-a-generation opportunity for entrepreneurs and investors.
Part 1: Why Has the United States Become Uncompetitive in Maritime?
In 2021, the United States economy produced 24% of global GDP. The country also imported 14% of global trade volume (in dollars). Yet, the goods that the economy produced and exported were not transported on ships controlled by the United States. That’s because, United States flagged vessels carry just 1.5% of waterborne imports and exports by tonnage, and much of that capacity goes to shipments that must move on American ships—specifically, 100% of military imports and 50% of non-military government-owned cargo.
Given these numbers, the United States maritime industry is small. In fact, the GDP impact from the domestic maritime industry in 2019 was $42 billion or 0.2% of total United States GDP.
Maritime comprises three sub-sectors: shipbuilding, ship operations, and ports. In 2021, the global shipbuilding industry was worth nearly $150 billion. China, South Korea, and Japan build more than 90% of the world's ships. As of March 2022, the United States shipbuilding industry held just 0.24% of future orders.
As for shipping operations, less than 1% of ships sail under the flag of the United States. This compares to the approximately 5% of ships that sail under the Chinese flag. Furthermore, the three “big” alliances (i.e., 2M, Ocean Alliance, and The Alliance) account for more than 80% of total maritime container capacity. Of carrying capacity, the United States owns just 2.5% of the world's cargo fleet (in Dead Weight Tonnes - DWT).
The potential United States market for maritime extends beyond the country’s international trade needs. In fact, the United States may have the largest addressable domestic market for ocean freight. The country has incredible access to populated coastline. Specifically, 40% of the United States population lives in coastal areas, which account for less than 10% of total land area. The United States also contains two states and five territories primarily accessible via water (e.g., Alaska, Hawaii, Puerto Rico, Guam, etc.). However, despite its geographic advantages, only 2% of United States domestic freight travels by sea, compared to 40% in Europe.
Why has this happened? The reasons are threefold. First, protectionist United States maritime policy has had the opposite of its intended effect. It has throttled the industry, rather than empowering it. Second, alternatives became available, albeit at a higher cost. Whether in the form of road, rail, or foreign carrier, alternative modes of transit move goods that would otherwise be transported by water. Third, entrepreneurs and capital providers have largely ignored the sector in the United States. This may be because the industry is not consumer facing and is not an obvious opportunity. It may also be due to a belief that United States labor costs would not permit it to compete effectively.
The Jones Act mandates that domestic shipping service vessels are built, owned and flagged in the United States. It also requires ships to be staffed by United States persons. The Foreign Dredge Act of 1906 applies the same requirements to dredging vehicles. The intent of both was to create a healthy and thriving United States maritime industry, but the opposite has occurred.
As for dredging, the United States hopper dredging fleet has a collective capacity of seventy-four thousand cubic meters, compared to the nearly one million cubic meters controlled by European dredging operators. Dredging will be highlighted further in a future piece, but we will now refocus on shipping.
The effect of these acts is obvious. Comparable United States-built ships cost between six and eight times more than foreign-built ships (e.g., $190-330 million vs. $30 million). In 2010, direct operating costs of United States ships were 2.2 times greater than those of foreign competitors. To say nothing of the economies of scale and efficiencies born of larger and newer ships. Ships that the United States has not produced and does not operate. In unit costs, a TEU shipped from the Northeast to Puerto Rico costs $3,063. A journey of a similar length (e.g., to the Dominican Republic) costs an average of $1,595 or 90% less than the domestic trip.
Although the United States industry has shrunk, global maritime shipping has grown. Since 1980, global maritime trade by volume is up nearly 300%. The 20 carrier list, which controls more than 90% of ocean capacity includes no United States based carriers. In lieu of its own carriers, the United States relies on foreign carriers for import and export activity. Can you imagine the uproar if it did the same for its foreign air service needs?
Source: Figure 1.5 of UNCTAD Review of Maritime Transport 2022
As for the domestic freight market, the United States fleet comprises 96 large merchant-type vessels today, down from more than 1,000 ships in 1960. This has resulted in an increasing number of goods shifting to road and rail transportation that could otherwise go by water. During this period, the volume of domestic ocean freight has declined more than 60%, while other modes of transportation have grown. The volume of goods transported by railroads, oil pipelines, and intercity trucks grew 48%, 106%, and 217%, respectively.
Ecologically and economically, this solution is a poor mix. Per tonne moved, road or rail emit 17-50% more carbon than waterborne transit. Trucks account for just 10% of vehicle miles traveled, but are responsible for more than 75% of road costs.
Where domestic goods must move over water, they do so at a high cost, either through expensive ocean carriers or by air. The cost of shipping has also incentivized the imports of foreign goods when domestic ones are available. In fact, Massachusetts imports LNG from Russia and other countries rather than Texas or Louisiana. Port-hopping is another technique that shippers use to serve domestic ocean markets, albeit inefficiently. This loophole allows foreign shippers to operate between two domestic ports with an international stop in the middle. For instance, a carrier might operate from San Juan to New York via Halifax.
The net effect is that the United States has lost any leadership that it once had as a shipbuilding nation. Along the way, the country’s maritime knowledge base has vanished as well. This includes an understanding of modern best practices in ship and port operations. Economically, United States-based producers of ships and ocean shippers serve captive or subsidized markets, which has created a monopolist environment for United States maritime producers. In microeconomics, the profit-maximization condition for a monopolist is the point at which marginal revenue meets marginal cost. Here, the profit-maximizing condition is lower than demand. In other words, the United States market for ships and shipbuilding is a monopoly. Correspondingly, the market is underserving addressable demand.
Figure 11.2 - the profit maximization by a monopolist (pg 442 of Besanko, Ronald R. Braeutigam’s Microeconomics - 4th edition)
Over time, the United States maritime industry has fallen behind. To get it going again, the United States should repeal both the Jones Act and Foreign Dredge Act. It should subsequently support maritime startups with export policy and technology investments. Bonus points for soliciting foreign investment in the United States maritime industry, which would undoubtedly expedite United States learning on the subject.
Part 2: Does Maritime Matter to the United States in a Post-Globalized World?
The impetus for my current maritime-related work is the trend of de-globalization. De-globalization is antithetical to globalization and is defined as the process of diminishing interdependence and integration between certain units around the world. The trouble is, as discussed in this previous post, globalization is not over. Nevertheless, the role of global trade and its impacts on maritime are changing.
Regardless of how they change, maritime will remain critical to the United States economy. To understand how, let us examine Antoine Frémont's "Is globalization a threat to maritime transport?" In this paper, Frémont outlines three scenarios for the global shipping industry. They describe a spectrum of possibilities, all of which rely on ocean shipping.
In a worst-case scenario, crises ensue (e.g., a hot war between the United States and China). This marks the end of East-West trade and initiates deeper regional trade ties. Meanwhile, global lanes (i.e., routes) cluster over the Atlantic and intra-Asia, north-south trade increases both in Asia and the Americas, and absent Western trading partners, China deepens relations with the Middle East and Africa.
The net effect in this scenario is less trade and global economic pressure. Consequently, the maritime industry would fail to meet global sustainability targets. This is at least in part due to inconsistent regional enforcement of emissions rules. The Europeans would enforce strict emissions rules that would create economic pressure because green technologies would not yet be mature enough to be in service at scale. For its part, port infrastructure would remain strategic to central government policy. Correspondingly, states would continue to provide debt and political support for port operations.
In the best-case scenario, multilateral negotiations would outline a road forward, which would clear the path for maritime's trajectory to remain mostly unchanged. Regionalization would still occur to a certain extent as nations work to secure strategic supply chains. This is essential and unavoidable given the lessons from the COVID-19 pandemic. Meanwhile, current geopolitical tensions reinforce the need for alternatives to globalized supply chains.
This best-case scenario sees two competing spheres of power in maritime: one centered on Asia and including the Pacific east and west lanes, and another as a European cluster with its heart in the Mediterranean. The latter would control Atlantic lanes. These spheres would push each other to decarbonize the maritime industry. Sustainable transportation could cause the unit costs of shipping to rise. Strategic port infrastructure would also expand under support from national governments. This would include the building of off-shore ports to ease coastal congestion.
Frémont's third scenario sits between the other two. Here, he assumes that recurring tensions will cause a suboptimal maritime order. Maritime traffic would shrink, and traffic volumes would decline as parties failed to align on mutually beneficial objectives. These might include expanding sea lane access, security reinforcement, or port expansion investments. Decarbonization efforts would also lack alignment, as each sphere of power would enforce its own standards. As a result, maritime emissions would likely fall short of Paris Accord targets.
The deglobalized world might be better described as a reorganized one. The United States will still have global and domestic shipping needs, even if the lanes traveled shift. In her book, Homecoming, Rana Foroohar describes a need for resilience. Here, she means resilience with regard to the supply chain, domestic sourcing, and manufacturing capabilities, all of which are competencies that the United States traded for efficiency provided by globalization.
Foroohar identifies several industries that the United States should develop for a resilient future. They include agriculture and food, modern manufacturing, care (e.g. healthcare, early childhood education, etc.), and processing chips. These are important but so is safe, sustainable, and cost-efficient transport. The lack of resiliency in maritime exposes a great vulnerability in American transportation.
Militarily, the merchant fleet is also woefully inadequate to support a hot war. Notably, the Cato Institute described how vulnerable the United States fleet is in its 2018 critique of the Jones Act:
"When U.S. forces were deployed to Saudi Arabia during Operations Desert Shield and Desert Storm, a much larger share of their equipment and supplies was carried by foreign flagged vessels (26.6 percent) than U.S.-flagged commercial vessels (12.7 percent). Only one U.S.-flagged ship was Jones Act compliant. In fact, the shipping situation was so desperate that on two occasions the United States requested transport ships from the Soviet Union and was rejected both times. So scarce were merchant mariners that the effort required the services of two octogenarians and one 92-year old sailor."
Part 3: United States Investors and Entrepreneurs Can Change the World (of Maritime)
For strategic reasons, the United States should have a healthy maritime sector. Creating one would entail activating the flywheel on a startup ecosystem in which investors deploy capital to good ideas and entrepreneurs use that capital to build. Entrepreneurs would then push regulators for a favorable export policy environment, thus widening the market for United States ships and shipping services. These activities would generate returns, which would lead investors to deploy additional capital. Accordingly, the wheel turns.
Achieving favorable export policy likely means accepting foreign players into domestic service. In other words, repealing of the Jones Act and Foreign Dredge Act of 1906. The pressure from the global competitive environment would serve to fuel ambition at United States firms. Policy reform could then accelerate by aligning startup aims with other government interests (e.g., repealing the Jones Act for ships that meet certain emissions standards).
As described earlier, the United States has lost the comparative advantage that it once had in maritime. American firms, though, have established several other attributes that could benefit maritime operations. New players must leverage these comparative advantages to win in the maritime sector.
Examples of applicable advantages are numerous.
For instance, airlines in the United States have built enviable process power. Southwest Airlines famously pioneered its 10-minute turnaround. This allowed the airline to fly its same schedule with three aircraft rather than four. To make this happen, enplaning passengers lined up on one side of the jet bridge, while deplaning passengers passed on the other. The lack of assigned seating sped things up as well. Meanwhile, pilots and flight attendants jumped in to provision and clean the aircraft during a turn. Many of these traditions are still alive at the company. Other companies in the space, such as United Airlines, have found success digitizing every aspect of their operation. Human process improvement coupled with technology are critical to efficiency. Employing these learnings could help United States-based maritime startups leapfrog incumbents.
First-principles thinking and vertical integration have also contributed to disruption in traditionally incumbent industries. SpaceX's entry into the launch market is a good example.
The backbone of the United States launch industry is SpaceX's Falcon 9 rocket. Notably, SpaceX spent $390 million to develop its Falcon 9 program. That is 4-10x cheaper than NASA's own estimate for a similar program. A full accounting of how Elon Musk accomplished this is difficult to come by, but here are several of the drivers (sources: Austin Vernon Blog, LiftOff):
1. Component & manufacturing cost discipline
Using raw material costs as a guide, SpaceX compares raw material costs and the cost of buying the finished product off the shelf. The delta highlights two things: the cost of refining and manufacturing the part, and the margin in the supply chain. Those two areas represent a cost-saving opportunity. Separately, vertical integration saves money and controls destinies. By acqui-hiring the team at a machine shop that was shutting down, SpaceX halved its manufacturing costs. This also removed the incentive for the machine shop to work for any other customer.
2. Reusing rocket stages for multiple launches
The first stage of a rocket is the largest. Correspondingly, stage one can represent up to 75% of the cost of a rocket. Traditionally, rocket manufacturers dispose of the first stage of the rocket after launch. SpaceX is the first company to pioneer reuse of its stage one boosters. A feat it accomplishes through precision landings of stage one boosters on drone ships.
3. Increasing utilization
Processes are best implemented for frequent use. Lowering launch costs means more launches. This, in turn, means that people and equipment get better at launching frequently. Accordingly, they become more efficient, and each individual launch costs less. Fixed costs are also spread across multiple launches, which further lowers unit costs.
4. Using cheaper materials
Stainless steel alloys comprise the structure of Starship (i.e., SpaceX’s upcoming heavy lift rocket). These are 60-80% cheaper than the aerospace-grade aluminum often used. This example represents how SpaceX’s team has found low cost alternatives to incumbent material choices.
5. Using cheap fuel
Someone should conduct a similar analysis regarding the costs of ship-building processes in the United States. This will undoubtedly identify opportunities for build efficiency.
In the decade since 2010, investors poured more than $220 billion into mobility technology. The United States held the largest share (40%) of invested capital and companies. The autonomy and software sectors received the greatest investment. Other technologies on the top 10 list include batteries, charging, and semiconductors.
Investments in these and other areas should be considered for maritime applications. My next piece will describe the technologies that can have the biggest impact on maritime.
Ultimately, it is time to rebuild the United States maritime industry, and capital allocators and startup founders are the right people to make this happen.
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