Seattle Port White Paper

Gnostam LLC PO Box 960Inverness, CA 94937

February 15th, 2012 Newsletter

Improving Economic Performance through Research

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Given the strategic importance of the Port of Seattle to the Pacific Northwest’s economic sustainability as a viable manufacturing and trade hub for Northeast Asia, it is somewhat shocking that while billions have been earmarked for the redevelopment of the Seattle Waterfront, no investment has been earmarked for the extension of the rail spur to allow direct dock loading from Terminal 18. Rather these containers are shipped by private contractors on very rudimentary, inefficient and polluting trucks to the rail head one mile away. Notwithstanding the recommendations in the Governor’s Container Port Initiatives Work Group recommendations of January 2009, we still have no strategic plan for the port expansion, nor has there been substantive progress with the Washington State Office of Financial

EXECUTIVE SUMMARY:

The conclusion from the study of the existing literature is that the Port of Seattle is not taking advantage of the very large economic opportunity as an alternative West Coast port to Los Angeles, Long Beach, which is operating almost at capacity. The growth in the global trade between Northeast Asia and the Northwest Coast of the United States is likely to be the single largest trade route in the world by value. Seattle lies most strategically on the Great Circle route to Northeast Asia, the fastest growing economic region in the world. There are competitors to Seattle in the Pacific Northwest, namely Prince Rupert and Vancouver, BC as well as Los Angeles Long Beach.

SEATTLE’s PORT: WHITE PAPER ON HOW TO INCREASE THE ECONOMIC TRACTION THE PORT

HAS ON THE LOCAL ECONOMY.

Management [OFM] objective of enhancing the amount of freight cargo moving in and out of the State of Washington while respecting requirements for clean air and energy efficiency. By the admission of the OFM, air water and rail traffic decreased by 0.9% from 2007 to 2008 while highway freight traffic increased by 6.7% from 2002-2007. Rail cost per ton mile is 0.025¢, while trucks are 10 times less efficient and far more polluting. Marine is most efficient at 0.007¢.

The Pacific Northwest -- a Global Traffic Hub:

Seattle has a premier location in terms of its global geographic position. The greatest global logistics corridor in the world is the “Great Circle” route from Northeast Asia to

the US West Coast and onto the big population markets of the US East Coast. Shippers have a choice. They can transship on the West Coast, [with the ports of choice being Los Angeles and Long Beach, [LA/LB]: Seattle is a distant third choice on the West Coast]; or ship through the Panama Canal. The Canal route takes a lot longer, [7-10 days] but requires less handling and is more reliable in terms of certainty of delivery date. The alternative is to transship and move containers in particular onto the US freight rail system. While the Asian Trade is expected to continue to expand, the infrastructure of the LA/LB Port is almost at capacity [operating at 88% capacity]. Seattle and Tacoma both operate well below 55% capacity. In view of capturing the opportunity for more container and bulk commodities traffic, Prince Rupert in British Columbia has invested in a state of the

Tons Miles shipped by Marine Transport: Source UNCTAD. Share of Container has gone from 18.8% in 1970 to 31.7% in 2008

Source: Transport Canada Pacific Coast Container Terminal Competitiveness Study 2011

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Notwithstanding the huge increase in port traffic and capacity from China, Seattle has shrunk on West Coast, a testament to a strategic misunderstanding of the N E Asian- East Cost US trade.

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art Container Port that adds to the bulk commodity capabilities of Prince Rupert, and has a fully integrated modal transport system with Canadian Railroads as a long distance rail carrier of containers to Chicago. This new entry into the “Container Trade” by Prince Rupert is a very serious threat to the viability of Seattle as an alternative to LA/LB, especially because the rail land route to Chicago from Prince Rupert has far less elevation gain than the route to Chicago from Seattle.

Drivers of Trade and ContainerizationThe main driver to the huge Container ports that have sprung up in China and Asia hasbeen the economies of scale of going from the Current “Panamax” container ships with a mximum capacity of 4,500 TEU to the

“Post Panamax” giants that will not be able to transit through the Panama Canal until 2014. Even then, ships with greater length than 366 meters, 49 breadth and 15 meters depth will not be able to transit the Canal. Because the economies of scale in shipping on a 20,000 TEU ship are so great, this makes the North American land-bridge competitive again, something not lost on the government of British Columbia, [BC], which has invested over 750 million to extend the Fairview terminal wharf by 800 meters maintaining a 17 metre minimum water depth, increasing the dock area to 165 acres. This should enable Prince Rupert to double the number of super post-Panamax cranes and supposedly create an additional 725 person years of employment. This under estimates the real impact on

Souce Drewry Shipping Consultants. Maritime shipping is sensitive to fuel costs as they represent between 45 and 50% of operating costs with limited opportunities to mitigate outside slow steaming. Maritime shipping with less fuel price sensitivity than trucking and rail, implies that higher energy prices are likely more to trigger the consideration of routing options that have a port call the closest possible to the destination of the shipments. The other variable for very large ships is the sophistication of the receiving port infrastructure, turnaround speed and intermodal integration. Port of Seattle lags other major West Coast ports in this respect.

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Bird (1963) developed a theoretical model of port infrastructures evolution. Based on his research into the evolution of British ports, Bird’s five stage model demonstrates how facilities in a typical port develop over several decades and even centuries. The stages are:

▪ Setting. Until the industrial revolution, ports remained rather rudimentary in terms of their terminal facilities. Port-related activities were mainly focused on warehousing and wholesaling, located on sites directly adjacent to the port (1).

▪ Expansion. The industrial revolution triggered changes that impacted on port activities. (2). As the size of ships expanded, shipbuilding became an activity that required the construction of docks (3). The integration of rail lines with port terminals enabled access to vast hinterlands with a proportional growth in maritime traffic. Port-related activities also expanded to include industrial activities which occurred downstream.

▪ Specialization. Construction of specialized piers to handle increased freight volumes such as containers, ores, grain, petroleum and coal (4), expanded warehousing needs significantly. Larger high-capacity ships often required dredging or the construction of long jetties granting access to greater depths. This evolution required several ports to increase capacity, migrating activities away from their original setting. Reconversion opportunities of port facilities to other uses (waterfront parks, housing and commercial developments) were created (5).

Local conditions do produce differences in detail. There are sufficient similarities to make the Anyport concept a useful conceptual tool. One of the features that Anyport brings out is the changing relation between ports and their host cities. Instead of only stressing the port infrastructure development, this emphasizes the changing linkages between the port and the city. One of these urban linkages is the redevelopment of old port sites for other urban uses, such as Docklands in London and Harbor front in Baltimore. Expansion is possible in Seattle as operating conditions allow the existing sites to be extended or modified, with Consolidation of several existing berths to provide new expanded facilities; and the potential establishment of a super terminal.

Port Expansion Model’s

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Maritime Transportation Rates for a 40 ft Container, between selected ports 2010Source Drewry Shipping

Main Container Ports in North and South America with volume of TEU traffic per major maritime hub.

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employment, as the port is a huge productivity gain for the West Coast of Canada in its attempt to capture and attract more trade to BC. Prince Rupert is 4,642 nm from East Asian ports [South Korea], while Seattle is 5,101 nm, only 10% further. But what Prince Rupert has is the intermodal rail infrastructure with Canadian National that allows for highly competitive trans shipment to the US hinterland in Chicago that Container Ship operators need in order to justify the capital investment necessary for the Post-Panamax ships. The order of magnitude of the cost savings that derive from the increase in size from 4,500 TEU, [current Panama Canal container ships] to 12,000 TEU is illustrated as follows.

The incentive to use larger of 10,000 TEU containerships that were introduced in 2007, was that fuel and port charges account respectively for 50% and 21% of annual operating costs, while manning costs remains constant. However, annual operating costs per TEU drop by more than one half to $1,449. This is illustrated in the

diagram below which shows the impact of increasing the size of vessels on the operating costs. The figures are from Drewry Shipping Consultants Ltd., for 2008 and show that the total annual operating costs per TEU for a 4000 TEU vessel are approximately US $ 2,314/TEU, while for a 10,000 TEU the annual operating costs fall by more than ½ to US $ 1,413 per TEU. Given this industry is very price sensitive, the pressure is on for operators to build ever bigger ships that will reach 20,000 TEU. It is likely that the annual operating costs per these ships will be in the region of US $ 800 per TEU.

This will bring more pressure on Port infrastructure. The growth of the massive Super Ports like Shanghai, Hong Kong, and Busan will mean that these ports, if they are built on the West Coast of the United States, will have to be capable of handling transshipments in a timely and cost effective manner.

The rise of the Mega Port handling > 5 million TEU’s. 10 ports in Pacific Asia handled more that 10 m TEU’s per annum. Shanghai, Hong Kong and Busan handled > 12 m TEU.

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One of the major implications of the growth of super-ports and of containerization is that they create the need for large scale trans-shipments. Seattle is clearly affected by this shift to mass containerization economics, as the infrastructure necessary to compete effectively is completely different to that in place at the moment. Perhaps this can be illustrated by the following. The composition of the container growth reveals a growing share of the function of transshipment and an enduring share of the movement of empty containers in the range of 20% of all containers handled. While the transshipment incidence was around 17% in 1990, it climbed to more than 28% in 2008. This reflects the growing complexity of the maritime network and the trade interactions it supports.

The challenges for a Port the size of Seattle is particularly acute as it needs to invest heavily in an intermodal yard, especially for the Terminal 18 “inside” Container terminal.

If we examine what the most successful port

in the USA, [LA/LB] has done to connect its port to the hinterland we see that 68% of the traffic is bound to long distance inland locations. Local congestion and constraints in infrastructure expansion invite mitigation strategies, such as consideration of where the cargo is bound to, but also its logistics. For LA/LB, there are two main options for inland flows:

▪ Rail option. Containers are directly loaded on an intermodal yard and placed on a train, via an on dock rail yard. Alternatively, maritime containers can be drayed to a near dock or an off-dock rail yard. The containers thus enter the local road system with the ensuing congestion and pollutant emissions (noise, particulates). LA/LB Port has mitigated the rail access issue, by the Alamada 20 miles rail corridor linking the port cluster to the major rail yards of BNSF and UP near downtown in 2002.

Port TEU movements 1985-2008: Source Drewry Shipping. In 13 years the growth has been 122% compound annually. This has been 10 x the growth of Chinese GDP in the ßsame period.

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Transloading option. Mainly because of container leasing agreements and a larger inland transportation load unit in North America (the 53 foot domestic container) a significant amount of transloading activity takes place in the vicinity of the port cluster. Maritime containers are brought to a distribution center (transload center) where typically the contents of three maritime containers are transloaded

into two domestic containers. The maritime containers are then brought back to the port terminals. The domestic containers can either be trucked to their final destination or brought to a rail terminal to be loaded for an inland bound train (e.g. Kansas City or Chicago). It was estimated that in 2009 45% of the containers imported through Los Angeles / Long Beach were transloaded into domestic containers.

Specific Seattle Port Problems:

The port is suffering financially as a result of the severe downturn in trade following the global financial crisis of 2008. In early 2012 several new cranes will be delivered to

Terminal 18 and Terminal 5, care of SSA, a Goldman Sachs owned company that will spend $27 million on buying the new Post Panamax cranes necessary to unload the bigger ships. In return for making this investment, SSA will no longer pay the port an $11.60/container fee, and will be able to charge its own fees to unload larger ships, and more containers. Essentially SSA is betting that it will be able to recover its costs and make serious profits if it is able to unload > 500,000 containers in 5 years. In my estimation SSA will easily achieve this breakeven in less than 18 months. Clearly this is a deal done in desperation by the Port of Seattle’s director of seaport leasing and asset management, Michael Burke.

Taxpayers in the State of Washington support the Port of Seattle. The loss of the Port’s revenue source is a serious matter, as reducing funding flexibility will impact the Puget Sound taxpayers. The business model should allow for the Port to capture revenues in more ways than

Container Maritime Freight Rates from 1993 to 2009, US $/TEU: Source UNCTAD

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one, especially as the container business is highly cyclical – tied to world trade flows.

Impact of Global Economics on Seattle’s business opportunities.

There appears to be a business case for investment in upgrading the Port of Seattle infrastructure to a world class level. Seattle is blessed with a great location in the Northern hemisphere, at the cross roads of the heaviest container trade in the world. Of the 432 m TEU global trade, 56 million was intra-Asia, 21 million transpacific. This is expected to more than double if we have an economic recovery in 2015. The economics of post Panamax container ships mean that there will be a drive to push the size of container ships to 20,000 TEU’s which would be bigger than the maximum 12,000 TEU that the 2014 new Panama Canal locks can handle. Seattle can be integrated by rail into the US Northeast.The main investment concerns of this otherwise very strong business case are:

1. The unbalanced nature of the East West trade that has been evidenced by the global financial crisis. There has been a significant slump in the West to East trade, with an increase of “empties” as demand from Asia

has waned post 2008, even as intra Asia and North South trade has increased;

2. The rise of the West Coast of Canada as a hub for container bulk commodity exports to North Asia does pose a threat to Seattle as a viable hub, especially as the infrastructure [rail and crane] in Prince Rupert is superior to that of Seattle;

3. Seattle is a transport hub for the coastal trade to Alaska, but this has been a declining industry;

4. North of Seattle there is substantial opportunity to integrate liquified natural gas and pipeline complex that could be the source of export to Asia.

In closing there is a substantial economic case to be made for the avoidance of managing the Port of Seattle into negligent decline. There are positives that can and should be leveraged to spur growth for this region.

Bibliography:

Credits: Jean-Paul Rodrigue et al The Geography of Transport Systems, Hofstra University, Department of Global Studies & Geography. Professor Rodrigue is the source for the excellent graphs for this paper, as is credited for these. The conclusions and any errors are mine alone.Governor’s Container Ports Initiative: Recommendations of the Container Ports and Land Use Work Group, Washington State 2009;Transport Canada: Pacific Coast Container Terminal Competitiveness Study 2011Office of Financial Management, State of Washington , Land use around the Port of Seattle, 2009;State of Washington Office of Financial Management. Land Use and local finance 2005.EC (2005), ExternE: Externalities of Energy - Methodology 2005 Update, Directorate-General forResearch Sustainable Energy Systems, European Commission (www.externe.info).EDRG (2007), Monetary Valuation of Hard-to-Quantify Transportation Impacts: Valuing Environmental, Health/Safety & Economic Development Impacts, NCHRP 8-36-61, National Cooperative Highway Research Program (www.trb.org/nchrp); at www.statewideplanning.org/_resources/63_NCHRP8-36-61.pdf.

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Private Sector Investment in Port Terminals

Changes in value or world Merchandise 1950-2009

Four major port holdings have substantial global assets of about 45 dedicated port terminals each; Jointly, they controlled through various equity stakes 177 dedicated maritime container terminals in 2010.

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Explosion of Container Trade. Is this sustainable? Global Container Throughput 1970=100

Source: Population and GDP from World Bank, World Development Indicators. Exports from World Trade Organization.

Container port throughput compiled from Containerization International

Singapore Rotterdam $ Cost per TEU, “experience curve”. 2008 Source Germanischer Lloyd. Singapore and Rotterdam are among the largest container ports in the world. We clearly see the effect of economies of scale where the Port terminal has made the investments for 18,000 TEU ships.

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Monthly value of Exports from Selected Traders 2006-2010;Source: WTO

The rail route from Seattle to Chicago is most efficient of through the North, CN owned infrastructure. This is a serious constraint for Seattle.

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The information and any statistical data contained herein have been obtained from sources which we believe to be reliable, but we do not represent that they are accurate or complete, and they should not be relied upon as such. All opinions expressed and data provided herein are subject to change without notice. Gnostam LLC and/or its shareholders, directors, officers and/or employees, may have long or short positions or deal as principal in the securities discussed herein, related securities or in options, futures or other derivative instruments based thereon. The securities mentioned in this report may not be suitable for all types of investors. ALL investments involve different degrees of risk. You should be aware of your risk tolerance level and financial situations at all times. Furthermore, you should read all transaction confirmations, monthly, and year-end statements. Read any and all prospectuses carefully before making any investment decisions. You are free at all times to accept or reject all investment recommendations made by the Gnostam LLC. As you know, a recommendation, which you are free to accept or reject, is not a guarantee for the successful performance of an investment and we are expressly prohibited from guaranteeing accounts against losses arising from market conditions.

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