Thursday, August 11, 2011

Pirates vs. Congress: How Pirates Are a Better Bargain

I was sent a copy of remarks made by Stephen M. Carmel, Senior Vice President of Maersk Line, Limited given August 3rd, 2011 at the Commander Second Fleet Intelligence Symposium. After reading these remarks, I emailed Steve and publish them here with his permission.

These are his personal views and not those of Maersk Line Limited, nor those of the very diverse shipping industry. The title was provided by me. Enjoy.
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Good morning Ladies and Gentlemen. Thank you for inviting me to share my perspectives on piracy with you today. First let me say right out of the gate I am no fan of pirates. Do not like them at all in fact, contrary to what many may perceive from my remarks on the topic. Pirates do impose a cost on our business that we would rather not bear if possible so it is something I worry about. But, while worrying about pirates I also worry about the effect of MARPOL Annex VI and the cost of complying with increasingly harsh emissions control requirements, something that will cost our industry roughly $6 Billion a year to comply with now and that figure will go up as tighter standards kick in in the 2014 time frame. I worry about the requirement to cold iron in LA, something that is very expensive and disruptive. And since while common for Navy ships to go on shore power, commercial ships never do it and are not fitted with a system to do so, a modification is required that will cost the equivalent of one ransom for each ship it is done on.

I worry about things like a proposal fronted by the World Bank, UNEP and others for a $50/ton carbon tax on ships bunkers, which will cost our industry about $17.1 Billion dollars per year. I worry about invasive species related ballast water mandates which will cost our industry approximately $15 Billion a year and I worry even more about California not going along with federal ballast water control mandates and instead implementing their own program at even greater cost to us. So tree huggers and environmentalists are costing us a heck of a lot more than pirates ever will, but interestingly I don’t see anyone agitating for the Navy to get underway to get the quasi-failed state of California under control. But if any of you are up for the mission I’d like to see it.

I worry about the cost of fuel where each dollar increase in bunkers costs our industry well over $300 million a year and over the last 2 years the cost of fuel has gone up about $120 / ton meaning something on the order of a $36 Billion per year increase in fuel costs for the industry. I worry about Ad Valorum tax – a protectionist tax designed to benefit US shipyards we must pay on repairs on our ships done outside the US. My company alone paid over $10 Million in Ad Valorum tax last year – so US shipyards are doing way more damage to us than pirates are. I’d ask for the Navy’s help on getting US yards under control but based on what I read about the Navy’s adventures in shipbuilding, you’re having a tough time with them too. Maybe we would jointly be better off partnering on a strategy to deal with that threat instead of pirates since it is worse for both of us.

I worry about bad policy such as the requirement for 100% scanning of containers imposed by congress in the “Implementing the requirements of the 9/11 commission Act”, a requirement which the European Commission estimates will cost the global economy 150 billion Euros or about 215 billion dollars per year were it to be implemented by all our trading partners. With that single act congress potentially does 20 times more damage to the global economy than pirates do by even the most ridiculous estimates of the cost of piracy, and in the process actually degrades maritime security rather than improves it.

I worry about the politically motivated “war on ear marks” which has brought dredging in this country to a near halt, meaning that ships loaded with our agricultural exports leaving the Mississippi are light loading by upwards of 2 feet, many ports on the East Coast will be unable to accept the larger ships an expanded Panama Canal could bring this way, and upwards of half the ports in the Great Lakes will soon close due to lack of adequate water depth, something that will not be good for industrial activity in the heartland, exports, and by extension our business. All this not to mention the $3.1 Trillion dollars the American Society of Civil Engineers now says it will cost to repair our country’s crumbling infrastructure upon which our business, and yours by the way, depends. And that number does not allow for expansion of infrastructure to accommodate economic growth, a critical issue for us in the shipping business, that number is only to repair and upgrade what we have now. The actual investment needed for accommodate growth over the next 30 years is more like $6.6 Trillion. Next to $6.6 Trillion needed to recover from shortsighted politicians pirates barely register as an irritant.

I worry a heck allot more about bad policy than I do bad guys, bad policy being easier to inflict and harder, and expensive, to recover from once it happens. And speaking of bad policy specifically as relates to pirates, there can be no better example than the Executive order which most believe heads us down the slope towards making ransoms illegal, which in my view is breathtaking in its shortsightedness. That would remove the only tool that is available to us that has proven effective at resolving a piracy incident. Making ransoms illegal is unenforceable, will increase the violence against the crew, will criminalize the victims, and will do nothing to deter pirates. Hostages are a commodity to pirates and they will always find a buyer. The care and feeding of hostages is an expensive investment on the part of pirates, an investment they have every expectation of receiving a return on. In the event we make ransoms illegal they will not stop being pirates, they will adapt their business model and find new buyers, maybe not at the same level of compensation, but it will beat starving on the street in Mogadishu, their other alternative under our current policy. Depending on the nationality of the crew perhaps selling them to an ideologically motivated group who would have no intention of ever seeing them go home might turn a few bucks, or maybe selling them into the very active slavery market. That would also of course mean that only those hostages useful for those purposes would be worth the investment of keeping alive. In short, the EO is a fine example of breaking a model without thinking through how the pirates will adapt and what we’d do about that, a topic I’ll return to again in a minute.

So, there are lots of things I worry about and lots of things that impose costs on our business that I’d rather not have to deal with; piracy is one, but not the only one and certainly not the worst. On any one of them if we can get someone to provide some relief, that’s great, including piracy. But piracy is not some existential threat to this country, or the maritime industry. That has, and is, my central massage when thinking about piracy. We must keep it in perspective. Piracy today is not remotely as bad as it was during the days of the Barbary Pirates to which it is usually and foolishly compared. Piracy then represented a true threat to the security of a young US. Today piracy has zero direct effect on our economy and I have yet to hear anyone articulate anything approaching a valid national interest that justifies the costs, and risks to US lives, of that mission beyond that it is the traditional role of the US to ensure stability in the global regime from which the US benefits in an overall way. In fact piracy has had no real impact on international trade.

Traffic through the Suez Canal is near record levels according to data from the Suez Canal Authority, global supply chains through that region remain intact and we are not diverting around Africa to avoid pirates, although when bunkers are cheap enough we’ll do it to avoid Suez Canal Tolls, since below about $300/Ton going around Africa is actually cheaper and now that we’re all slow steaming time is less of an issue. Charging around at 24 knots on our big containerships is largely a thing of the past, and sadly so are $300/ton bunkers.

It is interesting to note that the US government, in the form of the Maritime Administration is itself a source of incorrect information regarding the diversion bit, which is important as virtually every “cost of piracy” calculation relies heavily on some assumed diversion inefficiency to have any level of a “wow factor” attached to it. I can tell you that Maersk, the largest container company in the world, does not divert around Africa and I don’t know of any major carrier that does. Anyway – the Maritime Administration has on their web site a cost of piracy point paper which is again reliant on diversion for its major impact. They reference the cost of diverting a 300k ton tanker as one example, but the only problem there is of course a 300k ton tanker can’t get thru the Suez so would always go around the cape anyway so the real cost of diversion is zero, and we’ll come back to tankers in a minute. They also talk about the cost of diverting containerships. When pressed for data on how many containerships are actually making such a diversion they are silent – don’t even answer me. So, take that sort or argument with a bulker load of salt and even the US government itself contributes to the voluminous amount of misleading to patently false information floating around about that.

Unfortunately for us freight rates on the Asia / Europe trade route – the only international route directly impacted by piracy, are not where we’d like them to be due to over capacity and weakening demand, so it is nonsense so say consumers are paying increased costs due to piracy. Shipping companies, in the face of weak fundamentals search for any mechanism to extract an extra nickel out of customers, including things like bunker adjustment factors and now piracy surcharges – which thanks to frothy news headlines shippers “understand”, but in the end it is the total cost of shipping a box that counts and that is not going up.

And in fact is down considerably from the peak in 2006 just before the financial collapse. More to the point, the routine peak-season surcharge that would normally be applied to that route this time of year has been delayed several times because peak season volumes are not materializing – an indicator of a bad Christmas retail season in the US and consequently very bad news for the US economy. So, from a system perspective, piracy is not an issue. That is an important point – we need to view the effects of piracy from a system level, but the highly emotional nature, the human drama associated with a specific piracy incident leads the general public to view it from a specific individual occurrence perspective and generalize that, rather than from a true system level perspective, a giant mismatch in perspective and effect. Piracy is a cost of business just like many other costs of business and business can manage it, just as they do the others. Piracy is a little different though because unlike emissions targets or bunker prices, piracy gets the general public excited, provides politicians a risk free platform for pontificating, all of which provides some of our industry an opportunity to burden shift rather than take responsible measures to protect their ships.

I assume everyone here knows the basic statistics – piracy is a very rare event considering the volume of traffic that moves through the area. The probability of any specific ship being attacked is remote, and for the types of ships that actually move the majority of international trade even more so, approaching zero. Attack success rates have fallen into the 14% range. But we’ll not belabor the obvious at this point and instead dwell a little on the issues that hide behind the numbers – the rest of the story as Paul Harvey would say.

From the US perspective it is difficult to see how piracy affects our economy or international trade in any significant way. Trade between Asia and the US all goes via the Pacific. In fact the US Maritime Administration says that 80% of traffic through the Gulf of Aden represents trade bound for, or coming from, Europe. By comparison, only roughly 5% of US containerized trade as measured by volume flows through that region (much less when measured by value), with India being the largest component of that. That trade moves on large, fast containerships, a type of ship that is rarely even attacked and has never been hijacked. Of the oil moving out of the Persian Gulf that everyone rings their hands about, the overwhelming majority of it that moves through pirate waters is bound for Europe, and in fact virtually no oil bound for the US out of the Persian Gulf moves via the Suez Canal. Only about 14% of US crude imports come from the Persian Gulf region according to the US Energy Information Agency. That oil moves around the Cape because that is commercially the best way to do it and has been for a very long time - oil coming to the US generally moves in ships too large to get through the Suez.

It is a curious fact that people connect 2 points on a map and assume that just because a particular route is shorter that it is cheaper. That is simply not the case in international shipping where economies of scale represent a major, if not biggest, cost consideration. The fact is that loading 2 or 3 million barrels on a VLCC or ULCC and taking it around Africa to the US is a cheaper way to move oil to the US than loading 1 million bbls or less on a tanker that can fit through the Suez Canal even though the Suez is shorter. This by the way, is one of many mistakes people make when thinking about shipping through the Arctic, where shorter is neither faster nor cheaper and the Northwest Passage will never be viable as a large scale transit route, but that’s a different soapbox.

Back to oil from the Persian Gulf – how much does piracy add to the cost of a gallon of gas in the US? Is the US consumer actually affected? - a relevant question if this is all about protecting the US economy. First off – forget all those ridiculous news items about the cost of insurance – marine insurance is very complex and does not lend itself to one sentence summaries, they will almost certainly be misleading. The most expensive type insurance related to piracy is K and R, which no one forces anyone to buy.

Insurance for us is like insurance for you – the cost is driven by what you are insuring, the risks you are ensuring against, and the portion of that risk you are willing to bear yourself. Some insurance we are required by law to have – liability insurance for oil pollution for example, just as you are required to have liability insurance for your car. But for most insurance it’s up to the consumer what he wants to buy hence what he has to pay. Absolute certainty is expensive and if that’s what you’re after it will cost you. One way to look at it is like when you rent a car the rental agency offers you the opportunity to buy insurance from them at an astronomical rate. Most don’t need it because credit cards or personal auto insurance policies provide that coverage. But if you decide to take it anyway because you want to be absolutely certain you will never pay a nickel if something goes wrong, you really don’t have any right to complain about the cost of insurance when renting a car. I would also note that insurance companies site piracy policies as one reason profits are way up this past year. The way insurance companies make money writing policies is to collect premiums on policies they don’t pay claims on, which should tell you something about the actual risk.

Rather than pay for very expensive insurance it would probably be better to do something that ensures your ship does not get hijacked to begin with. That something would be armed security, which is so far at least, 100 percent effective. From personal experience hiring highly trained (in fact all ex- US SOF folks) as security on our ships I can back of the envelope it for you. It is two weeks from Ras Tanura, Saudi Arabia to Capetown, which would be the section of the trip you would need security on. A team sufficient to protect the ship costs about $5000 per day all inclusive, for a total of $70,000. On a 2 Million BBL VLCC that means security to get it to the US costs about 3.5 cents per bbl. While it varies a little by grade of crude, a rule of thumb is that each BBL of crude will produce about 20 gallons of gas. That means piracy adds a little less than 2 tenths of a cent to the cost of a gallon of gas, or a nickel or so to a 25 gallon fill up. This as opposed to the approximately 43 cents per gallon or $10.75 in taxes you pay on a 25 gallon fill up. Once again that Pirates vs. Congress damage comparison sneaks in there and pirates seem the better bargain. If anyone is up for the mission of protecting us from Congress there’s another one I’d like to see. In short – the average US consumer, and tax payer, is not at all impacted by piracy.

There is no doubt that armed security is an effective way to prevent any specific ship from being pirated – this does not deal with the problem with piracy however – just shifts it to those who are least willing to look after themselves, ironically also the ones most likely to whine for government solutions.

But there are a few things to remember when discussing the arming of ships that are worth mentioning. At my company we are very worried about liability, so only employ people we know can keep their heads under pressure, and are not prone to shooting people who should not be shot (an actually hitting the people that should be). So they are all former SEALS. We also limit the types of weapons they can have on board. The result is we, a responsible operator, have the best trained, but very expensive, operators in the world with a limited, but effective amount of weaponry the operators themselves chose. But that’s our choice, there is no international standard on the training or vetting of shooters, or even any requirement they are different than the normal crew. Nor is there any international standard on what types of weapons are considered appropriate. Nor, by the way, is there a US flag state standard for either shooters beyond having a TWIC card, something every AB has, nor limits on weapons and actually no useful guidance on training. That is all up to us.

If there is nothing for US flag, you can imagine what exists for your average flag of convenience. In fairness both the US Coast Guard for US flag, and IMO for the international community do have general, and voluntary guidelines. Neither is specific, binding, or useful in any way. It is a curious fact that virtually everything else we do has some rule or regulation that governs it, an inspection protocol to insure compliance, and a certificate we have to post to demonstrate to the world that we do what we’re supposed to do. We lose an inch of draft to all the certificates we carry around for everything except the use of deadly force, which is apparently so trivial that it can be left up to individual businesses to do as they wish, or do nothing at all and just whine for more Navy protection.

Remember too that the push, hence permission, to arm applies to everyone, not just US or trusted partner country ships, and once armed they are armed everywhere they go, not just the Horn of Africa. Absent any regulatory limits, they are pretty much free to arm however they see fit and give those guns to whoever they want. So from a port security perspective and as we push other countries to accept armed US flag ships into their ports, what happens when a Maltese registered ship with an international crew from unsavory places, armed to the teeth with heavier weaponry than MLL allows- but armed IAW their flag state approved ISPS required security plan piracy annex - what happens when that ship shows up in Norfolk and sails past the Navy base with the world watching from a reciprocity perspective.

And we do worry a great deal about disruptions to our ships in foreign ports as a result of being armed, again remembering once armed, they are armed everywhere they go. There is no internationally accepted process for the entry and clearance of armed merchant ships, instead we are at the mercy of arms import and export laws everywhere we go. We have no doubt that we are violating arms trafficking laws fairly consistently since such laws are convoluted, differ by country, and were certainly not written with armed merchant ships in mind. In fairness to the rest of the world, so far we have only had problems in one port, where our weapons were confiscated but the ship not held up, that port being Charleston. Ironically that happened on the very same day a very senior official at the state department gave a speech stating that arming merchant ships was the only way to deal with piracy off Somalia.

Lastly I would note there is no internationally agree framework for dealing with liability issues, where if we shoot a pirate off a US flag ship there is nothing to prevent that aggrieved pirate from suing us in a Pakistani court and having our ship arrested next time it shows up in Karachi. Unlike you folks, our ships do not enjoy sovereign immunity and port state authorities are free to board, search, and arrest our ships and crew at their discretion and/or whim. There has been some legislation passed in the US providing such liability protection, which of course is very helpful for piracy off the coast of New Jersey, but does nothing to help us where it actually matters. At this point the single most helpful thing regarding piracy (aside of course from solving Somalia) the worlds governments can do would be to push through IMO a rule set that standardizes training and certification of shooters, a standard weapon set, and international protocols for entry and clearance of armed merchant ships in ports and a standard framework for liability cover. That to me would be a heck of a lot more useful than banal calls for the worlds Navy’s to do more.

That leads to the cost of piracy. There are lots of very big numbers circulating about the cost of piracy, and they do not come with any sort of breakdown or analysis, and are generally produced by entities with a particular point of view they are trying to support, and most are very difficult to believe. For example, One Earth Foundation published a wildly quoted report a couple months ago that calculated the cost of piracy as being between 7 and 10 billion, but the largest component of that cost was the supposed cost of routing around Africa of ships that otherwise would have gone through the Suez, where the authors arbitrarily assume 10% of traffic is rerouting. In other words their single largest component of cost is a total plug unsupported by anything other than the conclusion they had predetermined to reach. There is no basis for that assumption, and it fly’s in the face of the Suez canal authority showing record levels of traffic, but it was just accepted as reasonable by an uncritical public.

The numbers that seem to be most frequently cited are a cost of piracy in the 6 to 8 billion range. While I personally take the number with a large grain of salt, we’ll assume it’s true for this discussion. First to keep it in perspective, the international shipping industry earned $380 billion in 2009 carrying $10.5 trillion dollars worth of international trade - 1 trillion of it going through the GOA region. So the cost of piracy number looks a little less large when placed in proper context. If it really did cost $8 billion to secure the smooth flow of $1 trillion worth of trade personally I’d say we’re getting a good deal. Also remember the other costs of business governments inflict on us I mentioned at the opening and the cost of piracy looks outright inconsequential.

But then if we look a little deeper a curious item to note is that the cost of piracy is 6 to 8 billion, but in 2009 the total ransom payments were $74 million according to the US GAO. Using the low end of the cost of piracy then pirates themselves only made 1.2% of the money earned in the pirate industry and of course less than that at the high end of the piracy cost estimate. If piracy started because Somali’s thought they were getting cheated by international fishing fleets they must really be pissed at how much they are losing out in the piracy business. By the way, while $74 million might sound like allot of cash in a country like Somalia – again you need to place it in context of the very large and surprisingly active informal and largely cash based economy that exists in Somalia. In contrast to the $74 million in ransoms you have $1.6 Billion that enters Somalia every year through remittances and the Somali Khat industry which an article just published in the Somaliland times estimates at $180 million per year are examples. I don’t see an outcry to get hawala’s in Minneapolis under control though.

So, if piracy is costing that much money but pirates themselves are only earning 1% of it, allot of money must be going other places besides pirates. Piracy is indeed a big business these days, and as the numbers suggest, pirates themselves are a very small part of it. The piracy conference for profit circuit alone is a big money generator and if pirates knew how much money people were making talking about them they’d quit being pirates and go on the speaking circuit. There is no shortage of people lining up to sell us the latest in anti-pirate gizmo’s ranging from goo guns to exploding fouling nets to even jars of killer bees (no kidding, that was a real sales pitch). The number of people who earn a good living off exploiting a fear of pirates is very large and all to be unemployed if piracy ever gets solved, meaning there is a vast army of people in whose economic benefit it is to make everyone think piracy is bad and getting worse.

What we end up with is a Horn of Africa piracy industry that is not insignificant, but in the context of the other economic activity in the actual region, not out of proportion huge, but appears to be much more significant as a business elsewhere in the world with the overwhelming amount of money made by people other than actual Somali pirates.

I often hear in rebuttal to my arguments that piracy has been getting more violent and that the old model of piracy for ransom no longer holds. That is probably partially true. When all this first started piracy was a relatively clean business with a well defined model operating under a clear rule set that, while we might not have liked it, we all, pirates and shipping people, understood it. In exchange for there being no violence on our side pirates themselves minimized violence to the crew. It was pure business, no one got hurt, industry paid a ransom and we got the crew and ship back, end of story.

In the world of insurance by the way, when probability is low and outcomes when an event happens are predictable, the risk is quantifiable, easily priced, and not exorbitant to insure. From the very start in response to criticism of that model from government folks I have often warned that Somali’s are adaptive, tough, and not easily deterred. If you are going to destroy a model that, while distasteful, keeps things at a tolerable level and keeps people from getting hurt, you should have something to replace it with. If not you will give the pirates free range to devise what the next model will be on their own. They will not simply stop being pirates because it gets a little sporting for them and whatever model they come up we will like much less than the one we had. But that is exactly what happened, the old model was blown up with no thought into what goes next, and everyone seemed surprised that things evolved they way they did.

But from my perspective this is the expected result in reaction to things the international community did to begin with. It is indicative of the sort of knee jerk policy development regarding piracy here, from an insurance perspective, while probability remains low, the predictability of outcome in the event of an occurrence is much less, meaning a risk that is harder to quantify hence more expensive to insure, and we did that to ourselves. Doing nothing until the international community was ready to take on Somalia as an issue rather than poke around aimlessly at the symptom would have been better, as what existed before was better than what we ended up with. In the end, without an overarching strategy to deal with Somalia, and piracy as one component of that overarching strategy, dealing with piracy alone is difficult to justify given limited and shrinking resources, at best likely to be ineffective and could potentially make things worse.

So, with that I’ll wrap up. Piracy is a pain, but a manageable one that must be kept in context. Nothing I have said should be taken to mean I do not understand the very real suffering of the crews actually hijacked. But my perspective is one of the system as a whole, and international response needs to be oriented around ensuring the stability of the system. I would also add that nothing I have said should be taken as not being truly appreciative of the work the Navy does for us and the international shipping community around the world. I personally have a close and active connection to many Navy missions, and my company collaborates frequently with the Navy on many things of mutual interest. I am simply expressing a realist view that we make a lot of demands on your time and resources. Time and resources that are shrinking and given the budget environment we are in, that situation is not likely to get better any time soon. It is therefore incumbent on us to make sure our demands represent the absolute best use of your limited resources from a system level, overall good perspective, not from the parochial, industry specific “what makes us the most money” perspective that some in our industry take.

I would certainly like to see piracy gone, but the only way that’s going to happen is if Somalia itself is tackled as an issue for the international community. Until then the largest impacts are on the East Coast of Africa region and the land locked countries that depend on East Africa ports such as Mombasa. Clearly all Africans have a stake in dealing with Somalia and I’d certainly like to see them do more there, but an interesting and yet to be fully fleshed out impact of the fall of Quadafi is that he provided a very large if not dominate amount of funding for the African Union, the group with troops on the ground in Somalia now. The AU was already suffering from a funding crisis before the Libyan uprising so it remains to be seen how well, if at all, the AU will be able to continue to operate, which of course impacts Somalia and piracy. It is an interesting connection that the uprising in Libya could actually make piracy worse. The other potential impact is on Asia / Europe trade, although there is no data to support the claim that that trade has actually been adversely impacted in any way. There is no direct US national interest that I have ever heard articulated. Unless and until Somalia the issue is coherently dealt with, the best things the international community can do are first avoid doing things that make it worse, and second, provide the legal and regulatory framework necessary for responsible ship operators to protect themselves.

Thank you.

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