Mint Explainer: The unprecedented crisis in the Panama Canal hurting world trade

Around 1,000 ships pass through the Panama Canal each month, carrying over 40 million tonnes of goods, accounting for roughly 5% of global maritime trade volumes.
Around 1,000 ships pass through the Panama Canal each month, carrying over 40 million tonnes of goods, accounting for roughly 5% of global maritime trade volumes.

Summary

A severe drought in the Panama Canal is exacerbating the already strained situation the global shipping industry and supply chains are facing because of the Red Sea crisis

The Houthi attacks in the Red Sea and disruptions in the Suez Canal aren’t the only factors hurting global shipping. Amplifying challenges for the shipping industry and global supply chains is a severe drought that’s affecting the Panama Canal, a vital trade route in Central America linking the Atlantic and Pacific oceans. This led to a 36% drop in transits last year, resulting in costly delays and impacting global trade.

Mint delves into the underlying causes of the unprecedented crisis in the Panama Canal, highlighting its significance as a crucial trade choke point in global commerce. Additionally, it examines how these challenges exacerbate the already strained global shipping industry.

What has caused the drought in the Panama Canal?

The Panama Canal is currently experiencing a severe drought attributed to the El Niño phenomenon, characterized by the warming of Pacific Ocean waters occurring every two to seven years. This event significantly disrupts global weather patterns. 

The canal relies heavily on rainfall to replenish its crucial water source, Gatun Lake. However, since 2023, El Niño has disturbed rainfall patterns, resulting in a significant water shortage. Panama also faced an unusually dry October, exacerbating the situation. Gatun Lake serves not only as a vital resource for shipping but also supplies drinking water to millions in Panama. 

This dual role presents a challenge for the country in managing water supply for both shipping operations and domestic needs. In response, the Panama Canal Authority has implemented measures such as reducing traffic and imposing limits on ship size, causing disruptions in shipping routes.

How crucial is the Panama Canal to global trade?

The Panama Canal stands as a crucial linchpin in global trade, providing a vital shortcut for ships transporting essential goods such as energy products, containers, and grains between the Pacific and Atlantic oceans. 

This waterway significantly reduces travel time and costs compared to the lengthy and perilous journey around the southern tip of South America, saving approximately 8,000 nautical miles and 18 days of travel time. Without it, global maritime trade would face substantial delays and increased expenses. 

Around 1,000 ships pass through the canal each month, carrying over 40 million tonnes of goods, accounting for roughly 5% of global maritime trade volumes, with connections to nearly 2,000 ports in 170 countries, according to the International Monetary Fund. 

Furthermore, the Panama Canal holds strategic importance for the US Navy, enabling swift redeployment of naval assets between the Pacific and Atlantic theaters during crises. Throughout history, it has played a pivotal role in major conflicts, including the Cuban missile crisis and the Korean and Vietnam wars, serving as a vital conduit for troop and equipment transport.

For Indian companies, however, the impact of the drought affecting the Panama Canal is not expected to be harsh.

Erez Israeli, chief executive of Dr Reddy's Laboratories Ltd, said the company ships its pharmaceutical products to Europe and the US mainly via Africa, and the drought in the Panama Canal wouldn't affect its supply chain. “The overall impact is not material," said Israeli. 

What are the immediate disruptions caused by the drought?

The Panama Canal Authority’s (ACP) restrictions due to the ongoing drought have already affected global shipping and trade routes. The canal’s capacity has been limited to 24 transits per day, forcing ships to divert to alternative routes, affecting the flow of goods and commodities worldwide.

The diversion to alternative routes is resulting in longer voyages and increased costs. For instance, vessels travelling from Asia to the Caribbean may opt for the longer route around the Cape of Good Hope instead of the Panama Canal. Similarly, ships from the west coast of North America to the Mediterranean Sea may choose the longer Suez Canal route. 

This redirection not only prolongs shipping durations but also incurs additional expenses towards increased fuel consumption, crew wages, and maintenance costs associated with extended voyages. Moreover, congestion and delays caused by the restrictions ripple throughout the supply chain, impacting delivery schedules, inventory management, and ultimately, consumer prices. 

Vessels carrying time-sensitive or high-value cargo prioritise booking canal transit slots. Container ships, crude oil tankers, and liquefied natural gas carriers, benefiting from quicker canal transits, may pay premiums for priority bookings or participate in auctions for preferential treatment.

What’s the overall impact on global trade?

The crises in the Panama Canal, Red Sea, and Suez Canal have caused unprecedented chaos in global shipping, significantly affecting supply chains. With 30% of global container trade passing through the Suez Canal, disruptions are forecasted to inflate global core goods inflation by 0.7 percentage points and overall core inflation by 0.3 percentage points in the first half of 2024, according to JP Morgan research.

Shipping prices have surged, with the average container spot freight rates witnessing a record-breaking $500 increase per container in the last week of December. Rates for Asia to northern Europe freight more than doubled, exceeding $4,000 per 40-foot-equivalent unit. Asia-Mediterranean prices soared to $5,175 per container, with some carriers announcing rates surpassing $6,000 per 40-foot container for Mediterranean shipments. 

The repercussions are already palpable, with several Europe-based auto plants halting production temporarily due to delays in receiving crucial parts from Asia. Auto component makers, particularly those heavily reliant on exports from China to Europe and the US, are also feeling the strain. Insurance premiums have surged, further compounding transit costs. 

Moreover, ships rerouted from their usual paths through the Red Sea, Suez, and Panama Canals are compelled to travel faster to make up for detours, resulting in increased fuel consumption and CO2 emissions, exacerbating environmental concerns.

The escalating cost of shipping is hitting major shipping giants like Maersk, Flexport, CMA CGM, and COSCO Shipping These companies have no choice but to opt for longer alternative routes, further denting their finances. 

On 8  February, AP Møller-Maersk shares plummeted significantly, forcing the company to announce the scrapping of the fifth part of a share buyback plan worth $1.6 billion, attributing the decline in earnings to disruptions from the Red Sea to the Panama Canal.

What are the alternatives to the Panama Canal?

Experts say the water levels of the Panama Canal will continue to be impacted because of the adverse effects of climate change. If the dry season persists, it may prompt governments and shipping companies to seek alternatives to the Panama Canal.

One such alternative that was considered is the Nicaragua route. In 2013, the government of Nicaragua announced the signing of a 50-year concession with a Hong Kong firm aimed at developing a canal capable of accommodating ships over 250,000 tons. However, this plan never materialised.

Another major proposed alternative is the Bioceanic corridor, which involves a series of paved highways and bridges spanning lower South America through Chile, Argentina, Paraguay, and Brazil. This corridor would eventually enable trucks to transport goods from coast to coast rather than relying on ships.

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