Gas and grain ships avoid Panama Canal after drought disruption

The Panama Canal is struggling to convince traders of liquefied natural gas and food commodities such as grain to return to the trade route after being forced out by a historic drought last year.

The 110-year-old canal, which has carried goods from US LNG to Latin American crops to the rest of the world for decades, was forced to limit crossings last July due to a lack of rainfall needed to- and operate the locks. It hopes to return to near full capacity in September after months of higher rainfall.

But just 13 LNG ships crossed the channel last month, less than half the number in July 2022, according to shipping think tank Maritime Traffic. Transits by dry bulk vessels also fell by 35% to 129 over the same period.

Panamanian officials played down the impact as other types of vessels, such as container ships, used the waterway at normal levels and the canal’s revenue increased due to intense bidding for a limited number of slots.

But the development highlights how growing supply chain disruptions, including those linked to climate change, threaten to alter and raise the costs of global trade.

It comes amid wider uncertainty over the future of the canal – an important source of revenue for the Central American nation that handles about 5 percent of global maritime trade – as officials grapple with lower rainfall and local demands to protect drinking water supplies.

Last summer’s drought was blamed on the natural weather phenomenon El Niño, but rising temperatures are expected to continue to affect water supplies.

Roar Adland, head of research at shipbroker SSY, said the canal was simply “a less attractive option than in the past” for lower-value goods as it struggled to deliver the same cost and time savings as before.

As the channel forced all customers to reserve slots in advance since the drought, companies faced “additional cost and a loss of flexibility (compared to) the past when you could just show up and wait in line.” he added.

“This can mean structurally smaller transits for the type of low-value, time-insensitive cargo typically carried by (dry bulk carriers).”

At its peak, the canal allowed more than 36 ships a day to pass, but a lack of rainfall forced restrictions that brought the number down to 20 in January this year.

The cost of channel transit has also increased, with a Japanese shipowner paying nearly $4 million to skip the queue, the channel said in November. This meant that, despite the drought, the channel’s revenue grew by 15% in the year to September 2023, with revenue growth expected to be 3% for the next financial year.

Panama Canal Authority Director Ricaurte Vásquez said that while officials could not control the rain, the canal was focused on reliability. The authority will review the prices next month.

“Continuing to raise prices indefinitely is not the way forward, and we are very careful to keep the Panama Canal as a relevant transit route for the entire world,” he said.

This month, the channel allowed earlier pre-booking to help LNG customers who generally use larger Neopanamax vessels, he said.

“They have very precise windows, precise itineraries, and we’ve addressed that with this whole booking process,” he said.

Vásquez said LNG shipping patterns have also changed regardless of the drought, with more U.S. LNG going to European importers looking to replace Russian gas supplies rather than to Asia via the pipeline.

Shipbrokers, who connect traders with ship owners, also said vessels would gradually return to the canal as supply chains readjusted to higher water levels.

But they said LNG traders have become accustomed to using the route around Africa between the US East Coast and Asia, which is much longer but recently more reliable than the canal.

“People have decided that you might as well consider the long term (and) stay away from (the canal) if you can afford it,” said Jérémie Katz, LNG broker at shipbroker Braemar. A customer recently had to find an alternative route after he couldn’t book his desired transit slot, he added.

Bigger trouble may follow. Climate change increases the likelihood of new droughts as global consumer demand and the need for shipping are expected to increase.

Meanwhile, more LNG projects are slated to come online in the US thanks to demand from emerging Asia as well as Europe. For the channel, this could contribute to unmanageable demand.

“The Panama Canal will continue to be a valuable route,” said Alex Froley, LNG market analyst at consultancy ICIS. “But it is likely that many ships will still have to take alternative routes.”

“It can only get worse in some ways,” Katz said. “We have a lot of ships coming in and a lot of volume. It can be a recipe for disaster.”

Panama’s new government, in office since July, is working on a long-term solution to the water crisis, Canal Affairs Minister Jose Ramón Icaza said.

A new Río Indio reservoir would provide enough water for the canal and consumers for the next 50 years, officials said. But convincing locals to approve the mega-project at a time of domestic political turmoil will not be easy.

During its five- to six-year construction process, the canal could face further droughts, Icaza said. “All countries in the world are facing climate change,” he said. “The important thing is to send a message to our customers from afar (that) we are working on a solution.”