It will be noted that although import requirements and related tonnage requirements grow substantially over this time period, the potential increased use of larger vessels will dramatically hold down the number of vessels calling at U.S. ports. The total number of foreign flag vessels in 1980 and 1985 is projected to be less than the number of foreign flag ships estimated for 1975. This is a function of two factors. First, the foreign flag ships account for 77 1/2 percent of import coverage in 1975 and only 70 percent in 1980 and 1985. Secondly, the significant growth in the use of large ships and the consequent reduction in the need for smaller vessels make it possible to cover substantially higher tonnage requirements with fewer vessels in 1980. U. S. VERSUS FOREIGN TRANSPORTATION COSTS As mentioned, the projected U. S. tonnage outlook assumes there will be no U. S. port restrictions on the use of large vessels for the importation of foreign oil supplies. An appraisal of vessel construction and operating cost data shows a decided cost advantage for the larger ships. The dramatic difference between large and small vessel costs is shown in Figure 9. This figure shows both U. S. flag and foreign flag transportation carried. In contrast the cost between a U.S. flag 30,000 ton vessel and a foreign flag 390,000 ton vessel is $4.00 per barrel of cargo carried. The cost differential between U.S. flag and foreign 390,000 ton tankers is estimated to be about $0.50 per barrel. These cost differences take on added significance when one considers that the average size vessel which called at U.S. East Coast ports in the early 70's was about a 29,000 tonner. It is obvious from Figure 9 that the operating cost difference between U.S. and foreign vessels shrinks substantially as vessel size increases. As already mentioned, these data have been calculated on the assumption there are no U.S. port restrictions respecting vessel size. If vessel size limitations do, in fact, prevail, the economies of scale presented in Figure 9 will not be realized and flag expansion, however accomplished, will carry the burden of higher costs. In a subsequent section of this report data will be presented to show the cost differences between U.S. flag expansion through cargo preference legislation and U.S. flag expansion via direct subsidies under the Merchant Marine Act. Figure 10 shows the investments and operating costs used in developing Figure 9. The operating costs also include wages, insurance, repairs, stores, bunkers and port charges based on representative current U.S. and foreign statistics escalated to the year 1976. Several important points can be noted from this table. First, the investment for a U.S. ship is about 70% more than the foreign ship. Second, the operating costs of the U.S. ship are from 40% to 60% higher than the foreign vessel depending widen. In assessing the cost of flag expansion it has been assumed the 1976 cost disparity will prevail in all time periods. To obtain a reasonable assessment of the cost of a subsidized expansion of the U.S. flag fleet, foreign vessel costs have been compared to unsubsidized U.S. vessel costs. Further, for simplicity the capital costs of the respective vessels have been annualized at an 8 percent recovery factor for a 20 year vessel life. It is appreciated that construction differential subsidies are paid to U.S. shipyards at the time the vessel is built. Because of the annualized capital recovery approach, the cost of expansion via subsidy as presented in this report, does not separately identify the amount or timing of required construction differential subsidy payments to U.S. shipyards. The per barrel operating cost data shown in Figure 9 have been converted to annualized ship cost data and are presented in Figure 11. This chart shows that the annual operating costs increase quite markedly with increases in vessel size. This is primarily due to the higher capital recovery and insurance cost components related to the greater investments for the bigger vessels. For example, the annual costs for the foreign flag and U.S. flag 30,000 ton tankers are estimated to be $2,864 M and $4,748 M respectively. The investment-related cost components for the U.S. flag vessel approximates only 40 percent of the annual cost. By comparison the annual costs for the foreign flag and U.S. flag 250,000 ton vessels are estimated to be $8,322 M and $12,882 M respectively. The investment-related cost components for the U.S. flag vessel approximates almost 75 percent of the annual cost. The cost of U.S. flag expansion for maining six months) of the proposed mandate with U.S. flag vessels amounts to 408 million dollars. By 1980 the estimated cost reaches a level of 707 million dollars and attains, by 1985, a level of 779 million dollars. 1975 1980 1985 First, cargo preference legislation will cause the creation of a protected market for U. S. flag vessels. As has already been pointed out earlier in this report, there will not be enough U. S. flag tankers available to meet the proposed legislative requirement either currently or in the foreseeable future. In this kind of environment the basic laws of supply and demand would dictate that U. S. flag owners could command, and get, a premium for their vessels. While a precise level of premium is difficult to quantify, the estimate for this factor is assumed to be only 20 percent of the normal base operating cost of U.S. flag ships. When considering the recent wide fluctuations in market rates during periods of tight vessel availability, the premium factor used in this analysis must be deemed a conservative one. As shown on the chart, this market premium imposes almost 200 million dollars of added cost of expansion via cargo preference legislation in 1975. By 1985 this premium cost exceeds 400 million dollars. Second, as emphasized by the Department of State, one of the real dangers of cargo preference legislation is that it will encourage others, including the oil exporting countries, to impose similar flag restrictions in retaliation. If a major trading country such as the U. S. adopts flag discrimination, others will surely need little more than our example to justify similar action on their own. Most of the major trading nations of the world do not have flag restrictions on international ocean movements. Foreign imitation undoubtedly would have the effect of increasing transportation rates to above normal levels for the foreign flag component of U.S. import coverage (required after meeting the mandated levels of U.S. flag coverage). If the governments of oil exporting countries were to mandate the use of their national fleets for oil exports, and there is a similar mandate for the U.S. fleet, both markets would be captive. There would be no competitive forces acting to hold down charter hire costs. In fact, one might reasonably expect an oil exporting government to raise the charter hire to at least equal U.S. flag levels. The effect of foreign imitation on freight costs is difficult to predict. The cost estimate for this factor assumes the increase would only be 25 percent of the basic foreign flag freight operating costs. In the light of recent demands for oil price increases by petroleum exporting nations, this premium factor must also be judged conservative. This imitation cost for the cargo preference expansion case is estimated to be approximately 600 million dollars in 1975, growing to approximately 800 million dollars by 1985. Third, as flag restrictions by both importing and exporting nations proliferate and vessels become fixed and limited to certain trade routes, supply systems would become inflexible, thereby creating transportation inefficiencies which would raise costs. As vessels become locked into specific trade routes, the transportation system would lose its ability to cope with supply changes, seasonality effects, demand swings either up or down and the inevitable ship bunching caused by a variety of factors including weather. The cost estimate for the inflexibility factor conservatively assumes the increase would only be 5 percent of the basic U.S. and foreign flag fleet operating costs. In 1975 this cost for the cargo preference flag expansion case approximates 100 million dollars. By 1985 the added cost approaches 200 million dollars. These potential added cost factors, i.e. the protected market premium for U.S. flag coverage, the added cost of foreign imitation and the cost of inflexibility are real and lead to the inescapable conclusion that U.S. fleet expansion via direct subsidy is the preferred route. This is more dramatically illustrated in Figure 13 which shows the cumulative cost of U.S. flag expansion through 1985. In determining these costs, the annual expansion costs for the non-reference years were calculated by interpolation. The chart shows a fairly gradual rise in the estimated cumulative cost of expansion via merchant marine subsidies. By 1985 this expansion cost totals about 7 billion dollars. By comparison the slope of the line for expansion via cargo preference legislation is quite steep. This expansion cost is estimated to total in excess of 22 billion dollars. In view of the unprecedented peacetime prosperity which U.S. shipyards are currently enjoying, a "Forced Draft" expansion under cargo preference would inevitably have a powerful inflationary impact on the U.S. economy and would worsen this already critical domestic problem. This analysis warrants the conclusion that the cargo preference proposal cannot be justified. The higher costs of flag expansion via cargo preference legislation must necessarily result in higher oil prices to the nation's consumers of energy. These higher costs, initially, will be added to the refiner's costs for imported crude oil. Transporting raw materials to the The U.S. petroleum industry is material source, combined with changing costs and the competitive factor, make it difficult to isolate and show empirically the effect of any single item on product prices. However, it is only logical that if transportation costs are increased through cargo preference legislation, prices to consumers must be higher than they otherwise would have been. Alternatively, the cost theoretically could be absorbed by the industry in reduced profits. In considering this alternative the current profit situation of the U. S. petroleum industry must be evaluated. The "Energy Memo" published by the Petroleum Department of the First National City Bank in October 1973 provides valuable insight on this subject. It points out that during the first half of 1973 the "hunger for energy" caused an annual increase in earnings of major U.S. oil companies of 38 percent. The gain, however, is measured against a period of weak earnings in the oil industry. It also was not significantly better than the earnings of U.S. manufacturing industry as a whole which showed an annual gain of 32 percent. The report further states that in contrast to an average annual gain of 6.5 percent in net income for the period 1962-1972, the gain in net income between 1971 and 1972 was only 1.6 percent. It is clear that recent announcements of substantial increases in net income by the U.S. petroleum industry cannot ignore the weak base to which they referenced. The Federal Trade Commission Quarterly Financial Report indicates the same general results for the U. S. petroleum refining industry. It shows that during 1972 the |