3 Risks facing the expanded Panama Canal

3 Risks facing the expanded Panama Canal

The newly expanded Panama Canal faces serious risks from competitors, climate change, and changes in the shipping industry, which could result in instability.

After a nine year expansion project, the Panama Canal re-opened on June 26th, heralding a new era for the vital international transit artery. The expansion project, originally slated to be completed in 2015, saw delays, strikes, and cost overruns, which brought the mega-project’s final cost to $5.2 billion. Panama is banking on the expanded canal boosting growth, yet there exist sizable risks to Panama’s hopes.

While Panama’s GDP has seen impressive growth rates in recent years, these have shrunk substantially, from 10.8% in 2011, to a record low of 4.6% in Q1 2016. Unemployment has also crept up from 4.5% to 5.1% during the same time; figures which will only increase now that the canal expansion is finished. Furthermore, the government’s budget deficit has almost doubled to negative 4.2%.

The canal expansion – an outlay equivalent to 10% of GDP in 2015 dollars – is obviously a major factor behind these numbers; yet this merely highlights Panama’s need for the venture to pay off. The expansion was in full swing come the 2008 financial crisis, with Panama seeing reduced traffic as a result of both global trends and construction. Moreover, despite the significant increase in GDP in the last 15 years, Panama remains the second most unequal nation in Latin America. Failure to make good on the canal’s investment is likely to lead to political instability.

Climate change threatens Panama Canal operations

As construction on the Panama Canal began to wrap up in late 2015, the waterway saw a massive traffic jam, as a traffic spike coincided with poor weather, leading to over 130 ships stuck in anchorage for ten plus day delays, resulting in a slew of complaints from shipping firms. While congestion due to construction is unremarkable, the role of weather highlights a growing problem for the canal.

The Panama Canal has been upgraded to accommodate larger vessels up to 12,500 Twenty Foot Equivalent Units (TEU). Previously the canal’s limit was 5,000 TEU – a TEU refers to one standard shipping container.

Bigger, heavier ships require more room, and the canal was deepened as a result. The problem facing the Panama Canal is that its new capacity is now even more dependent on adequate water levels. In April, the effects of El Nino resulted in less rainfall, thus under-supplying the canal’s feeder lakes, notably Lake Gatan.

As a result the water level dropped some three meters, and the canal authority had to limit ship sizes, causing rerouting and cost overruns for ships already in transit. As Frank Townsend of the University of Florida (ret.) states“If you suddenly say we’re not going to let you get in with a 15 meter draft, I can’t put as many containers on the ship as I want to. So basically I’m back to square one, I’m back to my 4,000 containers.”

As the frequency of drought conditions and the severity of El Nino increases due to climate change, the Panama Canal will increasingly be forced to limit ship size, thus negating much of country’s rationale for the canal’s expansion. Panama will be forced to invest in expensive pumping solutions, or operate an unreliable transit system – the latter option a death sentence in the just-in-time era.

Competition from alternate routes

Alongside climate change, the Panama Canal also faces competition from different shipping routes. While much has been reported on China’s efforts to build a mega-canal in Nicaragua, such as canal would likely divert some traffic, but it would also face the same water level problems cited above.

The real competition comes from the Suez Canal, which can accommodate far larger ships, and crucially is a direct link between the Red and Mediterranean Seas. The Suez has no locks, and thus is not at risk to water level changes from climate nor seasonal changes.

One may assume that Panama has a monopoly on Western hemispheric trade, yet this not the case. The canal was originally constructed to facilitate trade between South America and the U.S, and between the West and East Coast of America. At the turn of the 20th century, trade with Asia was still negligible. Yet as international trade focuses more on Asia, routes from the new global hubs such as Hong Kong, Singapore, and Shanghai are equidistant to America’s East Coast regardless if one goes via Suez or Panama.

Given the choice, shippers will use larger ships and head through the Suez. Granted the Panama expansion will shave off 16 days for ships previously unable to transit the canal, yet ironically this creates tensions with shippers. Jean-Yves Brion, of Boconti Shipping explains: “not only will charter hire revenues decrease in view of shorter duration, but with shorter trips the total sea days will be less, and thus weigh extra on the already heavily oversupplied market.”

Shippers are battling an eight year downturn, and as a result, Panama faces lost revenues from its position as the leading flag of convenience for international shipping.

The new Panama Canal is already too small

Panama renovated the canal in order to accommodate the ever larger vessels that ply the seas, yet given shipbuilding trends, they may have done too little, too late. The Suez Canal was deepened in 2009, thus further increasing its lead over Panama, and the latest generation of ships dwarf Panama’s capacity.

Shipping companies such as Maersk have already launched vessels in excess of 19,000 TEU, far above the Panama Canal’s new limit. Unfortunately, Panama cannot simply widen and deepen the existing canal, because these new ships are longer than the canal’s individual locks, meaning that the entire canal would have to be rebuilt in order to accommodate said ships.

Economies of scale, combined with until recently high oil prices have seen a shift towards ultra-large vessels in order to reduce operating costs, reduce carbon footprints, and increase efficiency. Vessels larger than 12,000 TEU were virtually unheard of as recently as 2010, yet they now comprise the fastest growing portion of the global fleet, and the third largest group by tonnage.

Climate change, shipping trends, and competition from the Suez all pose serious challenges to Panama’s ambitions. It is very uncertain whether the new Panama Canal will turn out to be a bright spot or a bottleneck.

About Author

Jeremy Luedi

Jeremy is a widely referenced political risk expert and weekly columnist for Global Risk Insights (GRI). Jeremy's writing has been featured in Business Insider, Huffington Post, Nasdaq.com, The Japan Times, MSN Money, and Yahoo Finance. His work also has been quoted and recommended by Time Magazine, Politico, Transparency International, and Greenpeace, among others.