LARRY McGINITY

The Panama Canal Expansion: Its significance for changing patterns in shipping, world trade and regional growth – An Art as a Derivative (AAAD) report, first written in June 2014, and updated October 2016 in the light of Brexit

From a geopolitical perspective, changing the Panama Canal is fundamentally a change in geography, a fact that will change logistics dynamics throughout the Western Hemisphere for the foreseeable future. Stratfor, Global Intelligence Report

The Panama Canal pre-expansion

The Panama Canal was opened on August 15th, 1914, to provide a means of transiting from the Atlantic Ocean to the Pacific and vice versa. This enormous maritime engineering project cost $375 million and shaped global shipping routes and patterns of world trade over the next 100 years. The Canal evolved to serve 140 maritime trading routes between 80 countries. Pre-2016 it was estimated that a total of 5% of all global maritime trade transited the Canal.

However, the Canal came under mounting pressure from increased shipping flows. The rapid expansion of trade over the last 30 years, from northeast and eastern Asia to the United States, and from the U.S. Gulf and East Coasts to Asia, overloaded the Canal's system of locks and channels.

In peak season, there were frequently 7- to 10-day delays for ships to gain access to the 50-mile transit. Each day spent idle cost up to $50,000 depending on size of ship and type of cargo. This was clearly an unwanted extra cost and adversely affected product pricing, placing extra strain on margins for shipping companies.

For ships carrying cargoes such as vehicles or apparel, where arriving at market at a specific time is essential, these delays led many manufacturers and their shippers to adopt a number of alternative strategies: to participate in a complex and expensive preferential tariff system – with long-notice and costly transits an option – or to sail other routes.

But besides congestion, the Panama Canal had one insurmountable problem: its dimensions. The size of its locks and the breadth and depth of its channels were not designed for the size of ship increasingly used on intercontinental routes. To illustrate, over 1900 of the world's largest dry bulk carriers were unable to transit the Canal. That is why the Panama Canal Authority (ACP) embarked on The Panama Canal Expansion Project.

Project Data

The Panama Canal Expansion, also referred to as the Third Set of Locks Project, was formally begun on September 3rd 2007. The anticipated opening was delayed from late 2014 a number of times, due to problems with the concrete setting, labour disputes and funding shortfalls. It was officially inaugurated in June 2016.

The project was a phenomenal engineering task and entailed these key aspects:
• Constructing a new set of larger locks and feeder channels on both the Atlantic and Pacific sides, with super-rapid filling
• Extending 11 already existing locks
• The widening and deepening of existing channels, such as the Culebra Cut, and the excavation of new channels to a minimum width of 225 metres with a depth of 15 metres
• Raising Lake Gatun's operating level by 45 cm
• Constructing a 2.3-km dam separating Lake Miraflores from the new Pacific Lock channel

The expansion project has, in effect, added a third lane for shipping.

Maximum ship size pre-2016: Length – 294.1 metres
                                               Width  – 32.3 metres
                                               Draft  – 12.04 metres

Ships within these dimensions were known as Panamax ships and carried up to 4,500 TEUs (twenty foot equivalent containers).

Expanded Canal ship size: Length – 366 metres
                                           Width – 49 metres
                                           Draft – 15.2 metres

Vessels previously too large for the Canal were known as either Post-Panamax (capacity 4–8,000 TEUs) or New-Panamax ships (capacity 12–13,000 TEUs). Both these ranges can now make the transit. Triple E (capacity 18,000 TEUs) are too large for the expanded Canal. This represents just 2% of global shipping cargo.

Expansion – Implications for Global Trade Increased Cargo Efficiency

The previous maximum capacity for transiting containerized vessels was 4,500 TEU (twenty-foot equivalent units). The new locks permit ships carrying about 13,000 TEU (depending on weight and configuration) to transit. Hence transport costs may lessen due to increased economies of scale, and ships previously unable to transit because of size, either using the long duration Cape passage or the Suez route, now have an alternative.

It is predicted that tonnage growth using the expanded Canal will be 3% annually, doubling tonnage figures 2005–2025. The International Monetary Fund has estimated that the ability for larger ships to transit the canal will reduce global shipping costs by $8 billion per annum.

One thing is certain – while this may not be the biggest project, it is, more importantly, the one that has the largest impact globally. JOC Sailings

The previous capacity limit for bulk carriers was 85,000 dwt; this has increased to 140,000 dwt. According to figures for 2011, some 40% of Canal cargo was in bulk, 40% of which was grains, 14% coal and 14% ores and other materials.

Now, some 98% of global shipping will be able to make the passage between the Atlantic and Pacific Oceans.

Enhanced Inspection and Security Protocols

In view of the greatly increased capacity of cargoes, including volatile substances, in transit, inspection protocols have been expanded to meet security requirements. Without going into excessive detail about these, it is important to state that a significant aspect of the costs of transit stem from a highly developed system of transit support and inspection. All ships now enter and leave the new Atlantic series of locks (Agua Clara) and the Pacific locks (Cocoli series) under their own engine power and rudder, aided by up to four tugs for advancing and positioning. Before commencing any transit within the Canal system, a thorough inspection of a ship's documentation about its classification, load lines (essential to the new transit system), and crew's number and capability takes place.

All ships will be subject to OP Notice to Shipping N-1-2015 protocols:

• International Tonnage Certificate (ITC-69)
• PC/UMS Documentation of Total Volume
• Load-line Certificate
• Ship Classification
• Minimum Crew/ Fitness Certificates

Likely Impact on Transport Routes and Economic Development

The two principal effects of larger ships transiting the expanded Panama Canal will be  1) a reduction in gross transportation costs and 2) changes in ship operations and transportation service designs. U.S. Dept. of Transport, Maritime Administration Report

It is very likely that expansion will draw shipping from existing routes. Previously, those ships crossing from northeast Asia that were too large for the Canal, and were bound for markets in the densely populated east central and eastern United States, docked at the major West Coast ports, such as Los Angeles/Long Beach or Oakland, and then used inter-modal transport (rail, road). Known as the "land bridge", this system was time-efficient (a 3.3-day saving over the Panama Canal transit), but could suffer from delays due to harsh weather, peak-time warehousing congestion or labour disputes. Around 500,000 people are employed in all aspects of the West Coast docking, warehousing and transport sectors.

A major expansion of the Panama Canal is raising alarms in Southern California, where business, labour and public officials are warning that the project threatens to dent the region's role in international trade. Los Angeles Times, 20/12/2011

However, ports on the U.S. West Coast had the advantage of a deeper draft capacity and were already able to cater for New-Panamax ships. Ports on the Gulf of Mexico, such as Houston and New Orleans, and on the Eastern seaboard, Miami and New York/New Jersey, embarked on programmes to extend their facilities, dredging deeper channels as well as adapting their wharfs and cranes were necessary. The Port of Miami has invested more than $2 billion in infrastructure upgrades, hoping to expand on its role as "bridge of the Americas". It sees the expansion as key to its growth.

If I were running a port on the West Coast, I would be on the alert, because the expansion of the canal is going to benefit the Port of Miami and other ports on this coast. Juan Kuryla, spokesperson Port of Miami

Many ports anticipate not only inward-bound increased tonnage from larger ships transiting the Canal, but also increased tonnage through growth in certain key market areas, such as grain and gas products heading from the U.S. to Asia.

The West Coast has done well with Asian trade over the last 30 years. This will make things more competitive. Matt Gresham, spokesperson Port of New Orleans

For carriers currently running Suez services from Hong Kong/Yantian to the U.S East Coast with intermediate stops at hubs in the Strait of Malacca, the Indian Ocean and the Mediterranean, switching to the Panama Canal route can offer faster transits to the New York market. U.S Dept. Transport, Maritime Administration Report (phase1), November 2013

Markets for Energy

Crude oil and petroleum products, including liquefied natural gas (LNG), represented 14.7% of total cargo tonnage transiting the Canal in 2012. It took 41 days for Post-Panamax LNG carriers to sail from the Gulf Coast to Asia. With the expanded Canal in operation this will be cut to just 25 days.

Previously, just 6% of the world's LNG carriers could transit the Canal; the ACP calculated that figure would rise to 86% after expansion. This will clearly have an effect on shipping routes from the Gulf Coast to northeast Asia, where demand for LNG is strong and prices high.

And for the tanker fleet the figures were hardly better: just 16.4% of global fleet and 6.8% of tankers on order could transit. After expansion these figures were forecast to rise to 56.4 and 44.4% respectively. (Figures from Silvia de Marucci, ACP's liquid bulk senior analyst)

The timing and convergence of two unrelated events – the Panama Canal expansion and the unlocking of North American shale resources – will have extraordinarily positive effects for U.S. producers and LNG terminal owners and their counterparts in Asia who purchase LNG. John Hutchko Jr. Wisan Offshore & Marine (USA), Inc quoted in Rigzone 16/05/13

AAAD would add that the timing of the Brexit may, in the long term, be a further unanticipated factor on shipping patterns, stemming from the new trade agreements that the UK will have to secure with Pacific Rim countries, Australasia and South America.

Increasing requirements for LNG and LPG (liquefied petroleum gas) by Japan, particularly in the wake of the Fukishima shutdown, will undoubtedly grow. The global LPG market is 30% larger than LNG, with propane and butane popular for cooking and heating in Asia-Pacific countries. Isaac Arnsdorf (Bloomberg) has argued that the freight costs between Louisiana and Japan will be reduced by as much as 30%, thanks to expansion.

From the perspective of the U.S. economy, the Panama Canal [expansion] is not only an alternative to West Coast routing of Asian trade. The Canal is a critical connection with Central and South American economies. Report of U.S Dept. of Transportation, Maritime Administration

Chile recently completed its Quintero LNG Terminal and commenced importing LNG from Trinidad & Tobago's deep-water Fort Point LNG in July 2012. Prior to expansion, these shipments had to take the long and treacherous Cape Horn route; these supplies may well see the Canal as a safer, more efficient alternative.

While the opening of the Panama Canal will lead to unexpected changes to energy trade flow, it will surely accelerate energy arbitrage between the U.S. and Asia. The opportunities appear to be more related to LNG and LPG than coal and oil. Neil Beveridge, Bernstein Research, quoted in Financial Review 8/10/2013

Mineral Export Patterns

The impact of expansion may also affect mineral exporters as far away as northern Australia. The distance from the Port of Brisbane to China's Port of Dalian is only 4,460 nautical miles, but more than double that (9,908nm) from the McDuffie Terminal, Port of Mobile, Alabama. However, with New-Panamax ships fully operational, virtually halving cost-per-ton carry costs, the distance disadvantage will still remain, but the vessel size advantage will disappear [with the completion of the Panama expansion]. David Gambrel, CoalAge.com

Colombia's coal is very low in sulphur emissions and this is of particular interest to China, which is increasingly taking its chronic pollution seriously. Colombia is set to grow its mining by 200 million tons over the next 10 years and 'capsize' bulk carriers of 175,000 dwt (with load restrictions) may well choose to transit the Canal. Port Technology Edition 53

In the future we foresee trade growing between Asia and Latin America with east Asia sourcing more and more raw materials out of Latin America. Jorge Luis Quijano, ACP administrator, quoted FT.com 25/08/13

Mineral exporters in Chile and Peru will weigh up the costs of continuing to take the long Cape route instead of crossing the Isthmus. However, bulk carriers in particular have learnt since 2008 that "slow steaming" can make significant savings in fuel costs, and with cargoes that are not time-critical, this may well continue to be the case.

The biggest competition for coal being imported to China is Indonesia. It has a tremendous advantage over places like Colombia because of transportation issues, but the expanded Canal just might change that analysis. Robert I. Lax, emerging markets analyst quoted Minyanville 17/08/12

Growth in Grain

Some 17% of world grain products pass through the Canal at present and 90% of these are from the United States. Pre-expansion, 44% of soybean exports from the U.S. transited the Canal. China is set to become the world's largest importer of corn as an animal feed, since Chinese meat consumption – a result of increasing affluence – has increased by 27% since 2001. Furthermore, the U.S. Department of Agriculture predicts a further increase in Chinese meat consumption of 30% by 2024.

A Rabobank report predicts that expansion will lead to a 12% decrease in transport costs for grain from the Corn Belt to Asia. The bank's analyst Will Sawyer also predicts that increased cargo capacity and reduced costs will greatly improve the cost position of the U.S. versus Brazil, Argentina and other grain exporting countries in Eastern Europe.

However, Mariá Eugenia Sanchez, specializing in dry bulk cargoes for the ACP, sees trade growth in Latin America, and particularly Brazil, expanding via the Canal:

Once the planted area in Brazil for soybean and other agricultural products expands north of Matto Grosso, and the roads, waterways, and railways develop towards northern ports, it will make sense to move these products through the Panama Canal for destinations in Asia.

Indicative of the likely increase in South American grain exports transiting the Canal is that the leading commodities handler Archer Daniels Midland Co. announced back in the summer of 2013 that they had bought an un-named minerals port in the Brazilian state of Pará. It will be converted to exclusively handle grain exports.

Panama: Hong Kong of the Americas?

Panama has been described as one big port on two oceans. Leading multinational companies, such as Caterpillar, Dell, Cemex and Proctor & Gamble, have set up their regional HQs in the country. The nation hosts five fibre-optic cables and claims to have the best digital interconnectivity (outside the U.S.) of any nation in the Western Hemisphere. On the Atlantic side, Colón Free Zone is the world's second biggest re-export centre, rebranding, packaging and warehousing products from around the globe.

Notes of Caution

There were a number of commentators who considered the positive forecasting prior to the Canal's opening as excessive, if not unfounded.

Peter Malpas of Braemar Seascope cautioned that bulk carrier use of the Canal would not show marked growth. Most bulk trades have no reason to use the Canal. Shippers have always wanted a reliable and low-cost freight for commodities. They've never wanted cargoes that quickly, they want them cheaply.

Canal tolls will submit to upward pressure due to the need to make returns for the project's backers, though the framework is still being developed and formalized by the ACP. Bulk carriers feel at a disadvantage, as the value of their cargoes is not equivalent to the same weight of motors, for example, and tolls have traditionally been set according to weight not content.

Currently the toll is based on the ship's capacity, but we are trying to move to a system related to what the boat is carrying. Rodolfo Sabonge, Planning Director PCA (FT Aug 2013)

A report published in 2011 by Prof. Jean-Paul Rodriguez and Dr. Theo Notteboom of Hofstra University dampened down what they considered an over-positive mood surrounding the development. While what is known is fairly straightforward, such as the operational characteristics of the expanded canal, this is by far supplemented by what remains uncertain – namely, trade flows, shipping network configurations, and the growth of the amount of transhipment in the region.

AAAD would add that this can be further emphasized given the slowdown in the Chinese economy.

Back in April 2013 Moller-Maersk, the world's largest shippers, announced that they would cease using the Panama Canal and adopt the Suez route to Asia.  The economics are much, much better via the Suez Canal simply because you have half the number of ships, said Soeren Skou, Maersk Lines CEO. One of the reasons for why this is happening now is that the cost for passing through the Panama Canal has gone up. At the end of the day, it comes down to cost. Kyunghee Park, Bloomberg 11/03/2013

And Ken Erikson from Informa Economics equally feels that the Canal will be skewed to high-cost freight: If one considers that a 4500 TEU vessel transiting the canal today pays a toll of roughly $450,000 while a dry-bulk vessel with grain pays a toll of about $155,000, the ACP will want to attract container transits.

Since the financial crisis, shippers have sought even greater economies of scale, and a further note of caution must be sounded over ship sizes. The new Suezmax carriers will be too big to transit the Canal (unless, it is thought, restricted in their loads). Moller-Maersk, for example, currently have 20 of these super ships on order.

Implications post-Brexit

It is clearly possible to overestimate the implications of the expansion project as an engine of economic growth and changing shipping patterns. However, it is also clear that many key participants in agriculture, commodities and transport are making forward judgements based on the Canal’s doubling in capacity. Lower transportation costs, increased rapidity of transit, and a more time-assured supply of finished products and materials will impact on regional growth.

One consequence that AAAD foresees is that Caribbean deep-water ports, such as Freetown Container Port, Caucedo, and The Port of Kingston, may well benefit from an increased role as 'hubs' in a hub-and-spoke arrangement with shallow-draft ports in Brazil, Venezuela, Colombia, the Gulf and southern East Coast of the U.S.

The Panama Canal Expansion Project is an economic fundamental and should be of interest to operatives engaged in trading all asset classes. This highly significant project became operational on Sunday, 26th June 2016, just three days after the British people delivered their verdict in the in/out Europe referendum. Clearly, the momentous European affair took media precedence over the reshaping of global trade routes.

However, in the period ahead, and in the light of the popular choice, the significance of the Panama Canal Expansion will have increasing impact, since in the process of securing new global trade agreements, the economies of transport will come to the fore. As the UK seeks, throughout the period of Brexit, to develop deeper economic ties with emerging markets in the Pacific Rim, Australasia and the Americas, a full and comprehensive understanding of the Canal expansion as a geographical game-changer, and its implications for shipping costs, commodity pricing and soft diplomacy is essential.

A report by Art as a Derivative, October 15th, 2016

Larry McGinity, 2016

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