INTERVIEW: Panama Canal Authority warns of water insecurity beyond historic drought

Bottlenecks caused by drought conditions that have plagued the Panama Canal since end of last year, could soon come to an end with the arrival of rains in May but climate variability is expected to continue impacting the global trade lane beyond this latest crisis, according to the waterway's operator.

Faced with increasingly irregular and severe weather patterns, some water conservation measures could be made permanent, while long-term preservation measures for the canal should be a priority for the new Panamanian presidency, administrator of the Panama Canal Authority, told S&P Global Commodity Insights on the sidelines of the Rotterdam World Energy Congress April 24.

The authority made an unprecedented move to restrict shipping transits through the waterway last year. For refined products, the canal acts as a key shortcut for about 225,000 b/d diesel and gasoline flowing from the US Gulf Coast to Pacific Latin American markets. The canal is also a key chokepoint for LNG and containers.

As daily transits through the canal were cut from around 36 to 22 in December, freight rates shot up for both containers and tankers as they sought to reroute around Africa.

With rains expected in May, there are hopes that the restrictions will be eased. On April 16, the authority announced its intention to increase daily transits from 24 to 32 from June 1 -- with 24 Panamax slots and 8 larger Neopanamax slots. From June 15, a 44-foot draft restriction for Neopanamax vessels will be increased to 45.

But Vasquez cautioned that the plans remain subject to rainfall, warning that weather forecasts become more opaque beyond 50 days ahead.

"It's an issue of handling expectations -- if you generate an expectation that La Niña is going to come in June, Panamanians will forget about the drought and people will think that we will go back to business as usual," he said April 24.

Water levels at the Gatun Lake were recorded at 80.5 feet as of May 2, according to data from the Panama Canal Authority, or ACP, below the five-year average of 82.5 feet, though levels are projected to reach 82 feet by July 2, moving closer to historical norms.

Lessons learned

Although transit volumes could be normalized soon, the canal authority is aiming for more permanent operational changes.

Tasked with allocating fewer transit slots, the ACP pivoted from a first-come, first-served model, to a booking system, auctioning off unused slots. Before the current crisis, around 70% of transits were booked in advance, a share the authority plans to permanently increase after reopening to enhance the canal's reliability even further.

"You should no longer have a situation where you have a first-in, first-out rule for vessels waiting there," said Vasquez, adding that wait times were cut by 10 hours in Q1 2024 relative to 2023 levels, thanks to the new booking system. Moving forward, all crossings would ideally be booked 96 hours before transit, he said, though the authority is yet to announce any official measures.

A daily auction process could become another legacy of the crisis, Vasquez said, suggesting slots could be allocated five-seven days ahead.

During the crisis, crunched supplies saw a single transit slot fetch $4 million at auction, excluding a canal toll of $500,000 -- a cost translating to a 50% hike for round trip transporting LNG, according to S&P Global analysts.

"Auctions will remain, but for a smaller universe," said Vasquez, adding that slot allocations should be market driven, while congestion premiums should soon deflate.

Trade reshuffle

Without stratification by segment, auctions favor high-value businesses such as LNG haulage, he added.

However, LNG traders remain uncertain when increased transits could support returning cargoes to the canal. Arbitrage economics continue to favor short-haul shipments from the US Gulf Coast to Europe, according to market sources, while shippers continue to route via the Cape of Good Hope to deliver USGC supplies to North Asia.

Platts, part of S&P Global Commodity Insights, assessed LNG freight rates from the USGC to Japan/Korea at $1.57/MMBtu on May 3, down to almost a sixth of levels late November. But shippers have said that at just a 60 cents/MMBtu premium, shipping around the Cape of Good Hope remains a "cheap enough" option in the short-term without the risks of delay or lack of booking slots.

Clean tanker flows could also be set to rebound as flows from the US Gulf Coast to Latin America opt for the Panama Canal route, sources said, though shippers will remain watchful for signs of falling booking premiums as they weigh their return.

Meanwhile, container and dirty freight transits could take longer through the canal, sources have said. For container lines, an 8 mt weight restriction among many carriers through the canal could incentivize continued routing around the Cape of Good Hope, while for dirty tankers the ACP's incoming 45-foot draft restriction will deter fully-laden Aframax and Suezmax transits at 48 feet and 55 feet respectively.

Climate risk, expansion plans

The El Niño phenomenon -- which heats up the Eastern Pacific Ocean -- has become an increasingly challenging factor, according to the canal authority, while rainfall has increasingly shifted from areas the canal was designed to capture.

Construction of a new reservoir would provide longer-term security for the shipping artery, Vasquez said, though construction would demand support from government and communities living in watershed areas.

Water scarcity in Panama became a key election issue ahead of a presidential vote May 5, as drinking water scarcity and reduced revenues from the canal topped the agenda for voters.

A victory for former public security minister Jose Raul Mulino means the ACP will await news of legislative support for its new reservoir construction plans, which could take four-six years to become operational, according to its estimates. Yet as the new administration inherits a growing fiscal deficit, funding for new developments remains a key challenge.

According to IMF forecasts, Panama's GDP growth is set to slow dramatically on the year, dropping from 7.3% in 2023 to 2.5% in 2024. The closure of the country's largest mine last year has mounted pressure on the canal for revenues, having previously accounted for around 3% of the country's GDP.

As the ACP eyes the canal's reopening, Vasquez said the canal had been "top of mind" for all parties, and expressed optimism that revenues would rebound soon. "For the quarter closing Dec. 31 net income was slightly above budget, but we've been depleting that surplus from January-March," he said. "As we go to 32 [transits], we go back to budget, because we budgeted for 31.5 transits per day".