A Tale of Two Canals

MAINBRACE: March 2024

Ordinarily, over 36,000 merchant ships pass through the Suez and Panama Canals each year representing about 30 percent of the world’s merchant fleet tonnage. This year, both canals face extraordinary events beyond their control, which are affecting vessel transits and arrivals across the globe. Following Hamas’ attack on Israeli citizens and Israel’s retaliatory response, Houthi rebels in Yemen funded by Iran have launched missile and drone attacks on merchant ships in the Gulf of Aden (“Gulf”) as they enter and depart the Red Sea. In response to these attacks, numerous major container carriers, as well as major oil and gas tanker operators and car carriers have suspended transits through the Gulf, and the United States is spearheading a multinational task force (Operation Prosperity Guardian) now heading toward the Gulf to protect the world’s merchant fleet. Meanwhile, the Panama Canal’s Lake Gatun is suffering from an unprecedented drought causing significant delays for vessels transiting between the Gulf of Mexico and Pacific Ocean. Currently, traffic flow is about 75 percent of normal capacity. Water levels have plunged due to El Niño, a variant of the El Niño/Southern Oscillation (“ENSO”) that generates above-average water temperatures across the eastern equatorial Pacific Ocean every two to seven years. 

These two canals are vessel traffic choke points. Recall the container ship Ever Given closed the Suez Canal for six days in 2021 when it plowed into the canal’s east bank and completely blocked traffic north and southbound. That closure slowed trade between Europe, the Middle East and Asia. Similarly, the decision by major merchant vessel operators to suspend Suez routes will require the affected vessels to transit around South Africa’s Cape of Good Hope adding thousands of freight miles and numerous days of delay to their respective transits. For vessels transiting to Europe, the added voyage duration will increase the air emissions subject to the European Union’s Emissions Trading System (“ETS”), which took effect Jan. 1, 2024. Fifty percent of such air emissions will be subject to ETS taxation. Further, for those vessels willing to take the risk, additional war risk premiums (“AWRP”) provide coverage for transits through high-risk areas with charterers directing the vessel through such areas bearing the burden.

With the advent of drone strikes and the easy availability of anti-ship missiles in the hands of Iran’s proxies, we can expect these maritime attacks will not stop, at least until Israel’s military warfare in Gaza ends. These attacks also signal a new day in guerilla warfare at sea. Previously, security concerns were limited to piracy attacks by small bands of Somali raiders. Now such attacks can take place at long range at relatively low cost from positions ashore that may prove elusive to find. We should expect Iran to use this new platform to hound the global merchant fleet whenever it sees fit.

In Panama, water conservation measures started in January 2023 and the Panama Canal Authority (“ACP”) imposed traffic restrictions on July 30, 2023, that continue to the present day, though ACP has signaled its intention to slightly raise the number of vessels authorized to transit the canal in the new year. Vessels have stacked up on both sides of the canal with delays reaching as many as 17 days in August 2023. Freight rates have climbed significantly as a result. For example, the EIA reports that rates for very large gas carriers (“VLGCs”) traveling the Houston-to-Chiba, Japan route hit their highest rate ($250 per ton) at the end of September since published rates started in 2016. The rates fell in October as VLGC charterers stayed out of the market because of the higher rates. Other petroleum product carriers and grain ships are experiencing disruptions as well. Reuters reports that bulk grain freight rates have climbed at a time when U.S. exports of corn and soy are ordinarily at peak season, and U.S. gasoline cargoes were half as much in November than the same time last year. U.S. Gulf refiners have responded by lowering bulk gasoline prices to move product and avoid inventory buildup, which has contributed to lower gasoline prices at the pump. 

Vessels can avoid Panama Canal delays by paying an added fee to jump the line, but the cost is steep and usually prohibitively expensive. For vessel operators, the only other alternatives are to travel around South America or negotiate the cost of delays with charterers. Such costs fall outside the typical demurrage penumbra because they do not relate to delays during cargo operations. Arguably, they are costs brought about a force-majeure event for which charterers are not accountable. Yet, voyage charterers are pressed to accept responsibility for some or all these delays, failing which disponent owners (that is, time or bareboat charterers) are free to consider rerouting around Cape Horn or through the Straits of Magellan. Yet, disponent owners will incur the costs of supplying bunker fuels for such voyages for which voyage charterers are not responsible, creating a disincentive to reroute. The compromise solution is for the parties to share the cost of delays at the Panama Canal.

The simultaneous delays at the Suez and Panama Canals are unprecedented, and save for U.S. gasoline prices, assuredly will lead to higher transportation costs for the carriage of goods that will flow down to consumers. While the combined effects create supply-chain shocks worldwide, the global merchant fleet is already adapting as are commodities suppliers looking to alternative methods to deliver goods or markets in which to deliver them. Fortunately, the impacts should not prove as pernicious as the pandemic’s supply-chain disruptions. 

This article is one in a series of articles written for Blank Rome’s MAINBRACE: March 2024 edition.

This article was first published in Texas Lawyer on January 4, 2024.

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