Offshore wind update: The U.S. Jones Act and key challenges

Trading Straits

Alice Colarossi and Julia Norsetter discuss how the Jones Act poses challenges for the development of offshore wind projects in the U.S. They explain the contents of the Jones Act, provide commentary on its implementation, and discuss solutions that have been used to overcome its restrictions.

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Transcript:

Intro: Trading Straits brings legal and business insights at the intersection of the shipping and energy sectors. This podcast series offers trends, developments, challenges, and topics of interest from Reed Smith litigation, regulatory, and finance lawyers across our network of global offices. If you have any questions about the topics discussed on this podcast, please do contact our speakers.

Julia: Good afternoon. Welcome back to Trading Streets. My name is Julia Norsetter, and I'm here with Reed Smith council, Alice Colarossi , and we're ready to talk about the Jones Act and offshore wind. Hi, Alice. How are you doing today?

Alice: Hi, Julia. I'm doing very well. Thank you. How are you doing?

Julia: Hey, I'm doing great. So I was thinking we could just jump right in here. So what's kind of the latest on the U.S. offshore wind market? Where do things currently stand?

Alice: Yeah, well, it is a mixed bag. I think we see a lot of uncertainty, but also a lot of potential. So on the one hand, the U.S. offshore wind sector is still very far behind the European and the Asian offshore wind sectors. We're also far behind the goals that the Biden administration had set for the sector back in 2021. So the goal was to have 30 gigawatts of offshore wind capacity in the U.S. by 2030. People refer to it as the 30 by 30 goal. But according to the latest reports that I have seen, the U.S. Should only have about 16 gigawatts of offshore wind capacity by 2030. So that's just a bit more than half of the 30 by 30 goal. I would also mention that the two leading candidates for the U.S. Presidential election have quite opposite views on the significance and the future of the U.S. offshore wind sector. And therefore, there is a lot of uncertainty in the near future, how many federal leases will be available for offshore wind projects in the next few years, and so on. So it is really a challenging environment. But on the other hand, there's a real push among players in that field to try to catch up with the rest of the world and the Biden 30 by 30 goal. So according to recent reports, we could reach that 30 goal as early as 2033. So we may not be that far behind after all. And the Biden administration has approved several major offshore wind projects very recently, perhaps in an effort to achieve as much as possible before the end of the current term. And another significant development that I think we should talk about today is the construction of the very first U.S.-flagged, Jones Act-compliant wind turbine installation vessel by Dominion Energy in Texas. That's a unique, first-of-its-kind vessel. The sea trial just took place in May. That was a major milestone in the construction project. And that Dominion vessel is expected to start installing offshore wind turbines, in Virginia just next year in 2025.

Julia: Terrific. Well, thanks for setting the stage there, Alice. I really appreciate it. You mentioned the recent sea trial of the first Jones Act-compliant wind turbine installation vessel. For those of our listeners who may not be familiar with the Jones Act, could you kind of explain what it means for a vessel to be Jones Act-compliant, and in particular, what this means in the U.S. offshore wind sector?

Alice: Yes, of course. So the Jones Act is what we call the Merchant Marine Act. It's a U.S. law that dates back to 1920. So the Jones Act requires that all vessels, all ships that carry any type of cargo between points in the United States must be U.S. flagged, so U.S. Registered, as well as U.S. built, U.S. owned, U.S. controlled, and mostly U.S. crewed, subject to some limited exceptions. So when I just say that this will be the first wind turbine Jones Act compliant installation vessel, I mean that that will be a vessel that satisfies all of these U.S. requirements. And the technical term here is that the vessel will be U.S. documented with a Coast West Trade endorsement. The implication is that the vessel will be qualified to engage in the Coast Trust trade and so, I mean, carry goods, merchandise, and passengers between ports in the United States. So the Jones Act, the basic rule is that it applies to ports within three nautical miles of the U.S. coastlines. So when you carry goods between U.S. ports or between ports within three U.S. Nautical miles of the coastlines. However, its application was extended as a result of an amendment to the Outer Continental Shelf Lens Act in 2020. So now the Jones Act also applies to energy projects that are attached to the U.S. Outer continental shelf, including offshore wind farms. And therefore, all vessels that carry wind turbines and equipment, which are really a type of cargo rights, all vessels that carry those wind turbines and equipment from U.S. ports to U.S. Offshore wind farms, those vessels must be Jones Act compliant, meaning U.S. Flagged, U.S. built, U.S. owned, U.S. controlled, and mostly U.S. crewed. And yeah, as I mentioned, that Dominion vessel will be the first Jones Act compliant. Offshore wind turbine installation vessel. As of today, there are no such vessels in the market. So the industry is relying on non-Jones Act, non-U.S. Wind turbine installation vessels to build wind farms in the U.S. But in order to build U.S. Offshore wind farms with non-U.S. vessels, the developers have to be extremely careful in order to avoid violating the Jones Act. So specifically, because these non-US vessels are not allowed to transport any type of cargo, including offshore wind farm components between points in the U.S., what typically happens is that the non-U.S. vessels bring the wind turbines directly from a non-U.S. port to the U.S. installation site. And then they remain completely stationary there at the U.S. Installation site during the entire installation. And they rely on smaller vessels that are Jones-like compliance in order to go back and forth between a closer U.S. port and the installation site to bring all the wind turbine components. And to also bring the offshore workers that will do the installation and so on. So people refer to this system as the feeder solution because the smaller U.S. Vessels essentially feed the non-U.S. installation vessel at the installation site. It's really not an ideal solution, to be honest. I mean, for several reasons. One of them is that it requires a lot of ship-to-ship transfers in offshore waters where the conditions can be quite challenging.

Julia: Thanks for that, Alice. lease, there's really quite a few challenges to that feeder solution. I really appreciate you explaining it. So are there other Jones Act offshore wind vessels that are currently being built aside from the Dominion vessels?

Alice: Well, in terms of wind turbine installation vessels, the Dominion Vessel is the only ongoing construction project that has been publicly announced as far as I know. There was another project to build another very similar Jones Act compliant wind turbine installation vessel, but that other project was canceled at the beginning of 2020. I believe the reason was that, I mean, basically the high costs of construction made the project not profitable enough. It was for financial reasons that it was canceled. Because in the case of the Dominion vessel, it's probably worth mentioning that the cost of construction is expected to be more than $600 million. And that's about twice what it would cost to build the same vessel in, say, South Korea instead of the U.S. So the Jones Act U.S. build requirements really increase a lot the cost of construction. And because of that higher cost of construction, those Jones Act vessels must then charge higher charter rates. And those rates won't be competitive outside the U.S. And that's a problem because the U.S. offshore wind market is still quite small. And so there's a limited market to keep those vessels busy. So it's possible that the Dominion vessel will be seen as some sort of test case. And if it's successful and the U.S. Offshore wind sector finally really takes off, we may see other investments in other wind turbine installation vessels in the U.S. But as of today, it's the only I'm aware of. But in the meantime, I should mention that there are other investments in other types of U.S. offshore wind vessels, smaller ones. For example, investments in crew transport vessels as well as offshore maintenance vessels. Those are smaller, I mean, they are smaller investments too, and they tend to be more versatile and easier to reconvert for different uses than wind turbine installation vessels, which are extremely specialized. There's also the first Jones Act compliance work placement vessel that is currently being built. It will be used to strengthen the foundations of U.S. Offshore wind projects, as well as some other specialized projects, such as septic cable installations, I believe. And the keel of that first Jones Act replacement vessel was just laid in May. So that's another exciting development for the industry.

Julia: Thank you. Is there room for non-U.S. players to invest or otherwise participate in these offshore vessel construction projects, despite the complications posed by the Jones Act?

Alice: Well, the scope of what non-U.S. players can do is really limited because of the Jones Act. But there are certainly options for them to get involved in this highly specialized market. So the first thing worth mentioning here is that the Jones Act requires that gross trade qualified vessels must be owned by either U.S. Individuals or entities that are at least 75% U.S. owned at each tier in their ownership chain. So this means that there can be a minority 25% non-U.S. Shareholder in the vessel-owning entity. This also means that tiered corporate structures can be used to a certain extent to allow more non-U.S. Interests into the ownership group by essentially diluting the non-U.S. Participation into several tiers. But U.S. persons will still have to own the majority of the stock in the aggregates when all tiers are considered, and U.S. Persons must also retain absolute control over the vessel-owning entity. And then while there are also other strategies that have been successfully used to allow non-U.S. Persons to participate in Jones Act investments, one of them is to give those non-U.S. persons convertible warrants instead of equity to remain below the Jones Act threshold of 75% of U.S. ownership equity. And then another approach is to rely on what we call the leasing exception to the Jones Act. Under the leasing exception, the owner of a Jones Act vessel can have non-U.S. Shareholders, even be above the 25% threshold, as long as that owner is a passive owner of the vessel. And it is in the business of leasing or other financing transactions, but it is not in the business of operating vessels, and it bare-board charters the vessel that it owns to a Jones Act compliant U.S. Citizen for a period of at least three years. So I'm giving here really a brief overview of the different strategies that have been used, but I want to make it very clear that I'm not describing all of the underlying requirements. And really, before making plans based on any of these options, market players should discuss with council whether they qualify and which strategy is best for them. And I will also say that aside from these options in terms of making equity investments, it's also possible for non-U.S. Persons to finance Jones Act vessel construction projects by extending loans. So the Jones Act does not require that the lenders be U.S. citizens. Non-U.S. lenders can extend loans, but they should be mindful of the limitations that the Jones Act creates on their enforcement options. So if there is a default under the loan, non-U.S. Lenders can foreclose on a share pledge or a preferred ship mortgage, but they will be restricted in their ability to take control of the owning entity or the vessel for the simple reason that they cannot own and control the vessel or its owner under the Jones Act. So once again, there are strategies that can be used to address this issue, and that's something that should be considered in advance and discussed with counsel.

Julia: Wow, there sure is a lot to consider. So is it possible you think that the U.S. will relax the requirements of the Jones Act to alleviate this burden that you describe on the offshore wind industry?

Alice: Well, there really is a lot of uncertainty on that type of policy questions in the U.S. Today, I think, for, I mean, for several reasons, including obviously the U.S. Presidential elections in the fall, and also the fact that the U.S. Supreme Court just overturned its Chevron precedent, I think it was last month, So under Chevron, U.S. Courts gave substantial deference to the interpretation that federal agencies like the Coast Guard, CBP, and Merit made up laws such as the Jones Act. But now in the post-Chevron environment, we could see a number of legal challenges and changes in the way the Jones Act is construed and implemented. But I think it's fair to say that it is extremely unlikely that the Jones Act requirements will be relaxed anytime soon. The Jones Act is really entrenched in the U.S. shipping industry. And any attempt to soften the law or the implementing regulations has been met with a lot of resistance in the past. Jones Act lobbies is very strong in D.C. But I also think it's worth noting that there are other strategies that the U.S. Government can use and has used to facilitate the expansion of the fleet of U.S. flags offshore wind vessels, aside from relaxing the Jones Act requirements. And one recent development that's worth mentioning here is the 2022 amendments to the Federal Ship Financing Program, what we call Title 11. That 2022 amendment designated offshore wind supports on maintenance vessels as vessels of national interest and because of this amendment offshore wind vessels now have priority treatment when applying for the private loans that the U.S. Government guarantees under title 11 and these loans have terms that are very favorable for borrowers including low interest rates, So this is another tool that players in this market should really consider using to finance investments in offshore wind, Jones Act vessels.

Julia: Well, thanks for helping provide some clarity for all of this, Alice. It's really terrific information. But you know, that's all the time that we have for today. So we're grateful to our listeners and hope you can join us for the next session of Trading Straits.

Alice: Thanks, Julia.

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