Panama's Canal Reacts to Water Crisis

Panama’s recently expanded Canal faces unprecedented challenges from climate change and shifting trade patterns. But, 20 years after Panama took back control of the asset, the country is already working on protecting its future…

In recent years, Panamanian governments have been keen to stress that Panama is more than just a canal. But while it’s true there is more to Panama than the Canal, there is no denying that the strategic, interoceanic waterway is the country’s lifeblood. That’s an economic fact, where Canal-related activity accounts for 40% of GDP, but also a cultural one. Ever since the Spanish created the first trans-American dry canal – a donkey train bringing gold from the Pacific to the Atlantic – in the 16th century, Panama has been a key spot on the global trade map. That’s shaped Panama’s open, dynamic culture by giving its people constant exposure to international flows of people, goods and ideas. It’s also why the country exists today, with the US keen to support Panama’s 1903 break from Colombia to build the Canal.

One of the proudest moments in Panama’s history came when it took control of the Canal from the US on the 31st of December 1999. Meanwhile its impressive stewardship and expansion of the Canal since then has earned it international respect. It’s no exaggeration to say that the Canal is as important to Panama as oil is to Saudi Arabia or copper is to Chile. Which is why the emerging threats of climate change and changing trade patterns are so serious for the country.

Less water

In recent years, less rainfall in the Canal’s drainage basin has led to lower water levels in the Canal. In both 2019 and 2020 that’s caused draft restrictions to be placed on ships, which means the largest vessels can’t transit the canal with a full load. Every one-foot reduction in draft is equivalent to 350 loaded containers, so less cargo means less revenues. So far, the Canal has probably lost between $30million to $40million because of the restrictions. That’s a painful hit for Panama, which spent most of the last decade carrying out a $5.25billion expansion programme intended to increase the Canal’s revenues. “The simple fact is that it’s raining less where we need the water - in the canal watershed”, says Carlos Urriola, CEO of Manzanillo International Terminal, an SSA Marine transhipment port on the Atlantic side of the Canal that handles almost 2 million containers per annum. “All these years the whole strategy of the Canal has been simple: during rainy season we finish with highest possible water level on the lakes, so we can survive the drier season from February to May when the rains stop. But this year the rainy season hasn’t been that strong and if we don’t finish with the lake at the maximum capacity we could be in trouble. That will be exacerbated if we have an extended dry season.”

It’s hard to imagine that the small tropical country, divided by a canal, dotted with lakes and surrounded by the world’s largest oceans could ever lack water. But the challenge is that the Canal is linked to two lakes, Gatun and Alajuela, that are also the main sources of drinking water for the 2 million people that live in Panama City’s greater metropolitan area. That means that sea water can’t be passed through the Canal, making it dependent on the rain that falls in its watershed. And that rain is becoming more inconsistent. Ricaurte Vásquez, the new administrator of the Panama Canal Authority (ACP by its Spanish acronym), made an instant impression on the logistics sector with a series of public talks in October, that highlighted water as the Canal’s main strategic challenge.

"drought and climate change are real…"

“The drought and climate change are real. We have contrasting weather patterns with dry spells followed by floods that are different to what’s always happened in this country. In the last ten years Panama’s rainfall has reduced continuously. Apart from a few exceptions, we can see that every year it has rained less than the one before. And when it does rain, we have strange storms, like Otto in 2016, that impact the Canal’s operation. So, it’s not just raining less, it’s raining differently and that creates a challenge for the sustainable operation of the Panama Canal.”

The falling supply has been exacerbated by rising demand. Not from the Canal, which uses the same amount of water now as it did in 1966, despite the fact is moves much more cargo. But from drinking water, which has shot up with Panama’s rapid economic and population growth. Sharing its water source with citizens doesn’t just create technical challenges, it also creates political ones. Vásquez makes it clear that drinking water will always take priority. “The Panama Canal Authority knows that, above and beyond anything else, providing water to our community is more important that moving a ship.”

Global competition

Less water means draft restrictions and that creates uncertainty for shippers. If that’s not corrected in the long-run it could undermine Panama’s position as a global maritime hub. “A one-off hit to the Canal’s revenue isn’t that important”, says Urriola. “But it also impacts the flexibility that Panama offers as a logistics hub. The Suez Canal doesn’t have these problems, so it starts to look better by comparison.”

“The limitation on draft is going to happen again in 2020 for a second consecutive year. That will force shippers to start evaluating Panama’s reliability as a route. They will start to think that they can only rely on us for nine months of the year. I remember how we used to laugh when we heard of supposed future competition from the Arctic shipping routes. We never took it seriously because we knew that one cold winter would close the Arctic. Ironically, now we are worrying about becoming a seasonal shipping route. Obviously that danger is a long way off, but we need to make people aware of it now so that solutions are found. At present it’s just a temporary draft restriction but that is dangerous because it forces shippers to find alternatives for our dry season. Once they do that there is a risk that those alternatives start gaining traction throughout the year.”

It’s an unfortunate time for Panama’s Canal to start becoming unreliable. For starters, ports all along the US east coast and in the Caribbean have invested hundreds of millions of dollars in upgrading their facilities to handle the larger ships passing through the expanded Canal. But more serious is the ongoing trade war between the US and China. Donald Trump’s imposition of import tariffs on Chinese goods has already forced some manufacturers to shift production from China to other low-cost countries. That means that global supply chains are being redesigned precisely as the Panama Canal falters.

"It’s an unfortunate time for Panama’s Canal to start becoming unreliable…"

“The trade war is only exacerbating a deeper trend, where we are seeing lower-end manufacturing moving out of China and heading south to places like Vietnam and Bangladesh”, says Urriola. “The trade war may have accelerated that process but it was happening anyway. All of the new manufacturing countries are closer to the Suez Canal, which makes it a more attractive route for shipping companies. We’re in the middle of a strategic shift of global trade routes, which makes it vital that Panama demonstrates its reliability for shippers.”

This danger isn’t lost on Vásquez. In October 2019, shortly after assuming the position he gave a frank presentation to industry insiders in Panama, where he laid out the threats facing the Canal. As he noted that day, in terms of overall tonnage, the Panama Canal is still performing strongly, with numbers up in 2019. But within those numbers there is a shift, as the lucrative container business is becoming a smaller share of Canal cargo, while LNG and LPG shipments increase. Indeed, gas tankers now make up almost 40% of canal traffic, as the US increases its energy exports to Asia. The problem with that, warns Vásquez, is that commodity shippers are more sensitive to transport costs than containers. As a result, the Canal will earn less per transited tonne, if LNG shipments continue to increase their share.

The challenge for the Panama Canal, indeed for the country’s entire maritime sector, is to develop new businesses. For example, it could become an LNG hub for Latin America, helping to add more value to the increasing amount of gas passing through the Canal. In our logistics article elsewhere in the report, we look at the emerging niche businesses that can leverage the traffic passing through the Canal. However, those new concepts can only work if the Canal retains its strong position in global trade. The Canal is the backbone of Panama’s economy. So, while it’s true that the country has the potential to create new hubs, it needs to ensure integrity of its main asset. As Urriola puts it: “A reliable Canal gives us a stronger negotiating position to handle the changes in global trade routes.”

Solutions

In the short-term the ACP is already taking measures to conserve water. It has stopped generating power from its hydroelectric plant and where possible it is putting two ships through the locks at the time. It is also sending forecasts to shippers in Asia, so they don’t overload the vessels before setting out for Panama. But these steps only mitigate the impact from the lack of water. Given that climate change and demand for drinking water are not going to go away, it’s clear Panama has no choice - it must find extra water for the Canal.

Fortunately, it has already begun to look for some answers. After the particularly bad El Niño of 2015/2016 the then government created a national water committee (Conagua, by its Spanish acronym), which together with the Environment Ministry (MiAmbiente) has commissioned studies into possible solutions. One option is to pipe water from existing reservoirs that are outside the Canal’s hydrological basin. Another study is looking at building new reservoirs inside the Canal Zone. The final option is to build desalination plants that will convert seawater into brackish water. However, desalination plants are energy intensive and costly to run, which mean they could be viewed as unsustainable.

"Fighting climate change is no easy task yet Panama has managed the Canal well since the US handover 20 years ago…"

Results from the studies are expected this year. Vásquez knows he needs to act quickly, to reassure shippers, however, he’s also aware that any solution needs to be long-term if it is going to provide genuine reassurance and ensure the Canal’s position in global supply chains. “It’s not just a case of finding the water for this year, the next one or for five more years”, says Vásquez. “The challenge is how to resolve the water demand for the next 50 years. Moreover, these need to be environmentally and socially sustainable solutions that will drive Panama’s development. The ACP is working with all the other key stakeholders to face this issue.” In February the ACP implemented a 'water tax' of up to $10,000 on ships passing through the Canal. The extra revenue will be earmarked for building the infrastructure needed to boost water levels.

Fighting climate change is no easy task yet Panama has managed the Canal well since the US handover 20 years ago. “When we took control of the Canal in 1999 there were a lot of doubts, both internationally and at home, that Panama would be able to keep it running”, remembers Urriola. “Then once it was proven that Panama could operate the Canal, people didn’t believe that we could handle the massive expansion project. That was successfully completed in 2016 and now people are questioning our ability to integrate all of the different elements of our logistics platform and solve the water problem. Given our track record I am confident that Vásquez will succeed.” The Canal’s importance to both the country and global trade routes, means both local and international investors will be hoping that Urriola’s confidence is well placed.