Panama Canal: More Questions Than Answers

Panama Canal: More Questions Than Answers

As the Panama Canal expansion nears completion, shippers could gain a viable all-water alternative for transporting product from Asia to U.S. East Coast and Gulf Coast ports. Is there a boom on the horizon?

What goes around comes around. It’s an adage that accurately reflects the ebbs and flows of global supply chains. Economic cycles trigger shifts in sourcing patterns as new manufacturing locations come online and consumption markets grow. Then there is the Panama Canal. As its centennial coincides with the expansion of a third set of locks, the Canal is poised to charter a new reckoning for 21st-century shippers. What goes around comes around.


Prelude to Expansion: U.S.-Panama Free Trade Agreement

Investment and development have picked up at ports on the U.S. East and Gulf coasts, and specifically in the southeastern United States. Industry prognosticators have suggested a subtle container volume shift from the U.S. West Coast to the East Coast—mere percentage-point gains that could create a cargo bonanza in places such as Miami, Savannah, Charleston, and Norfolk.

There is precedent for this shift, although it was largely unfulfilled. A decade ago, following the 2002 West Coast port strike, industry began exploring Asia-to-U.S. East Coast routings. In 2005, increasing congestion at West Coast ports—combined with growing capacity constraints and greater demand for supply chain predictability—compelled global shippers to stay the course. While ports such as New York/New Jersey and Savannah experienced marked gains, a seismic shuffle in East Coast-West Coast container trade balance predicted by some failed to materialize.

Today, speculation outside the East Coast is grounded by reality. Ocean carriers and shippers undoubtedly stand to gain economies when larger vessels transit the Canal. A bifurcation in asset use will likely occur as mega containerships load and unload at fewer ports, and smaller feeder ships ferry freight from transshipment hubs.

What remains to be seen is how ocean carriers adjust their services and rates across the country—adjustments that will ultimately be predicated by whether shippers find enough total landed cost gains in all-water transit to the East Coast versus traditional West Coast intermodal landbridge designs.

While businesses are exercising caution as they consider how to prepare for a Panama Canal surge, equal intrigue exists regarding how this trade could play within the broader global framework. All-water East Coast routings provide yet another viable option for transporting product into the United States—and in this day and age, shippers can never have too many options. But ongoing development in Panama, a coalescing business case for near-sourcing, and South America’s economic awakening may ultimately be the forces that tip the balance in favor of one direction—or both.

Circumnavigating Labor Unease

The International Longshore and Warehouse Union’s latest threat of
strike at the Ports of Long Beach and Los Angeles has put industry on
notice – if it wasn’t already. During the summer of 2012, a contract
standoff pitting East and Gulf Coast ports against the International
Longshoreman’s Association (a resolution that is still pending) forced
many shippers to plan for possible disruptions.

One Georgia-based importer that spoke with Inbound Logistics acknowledged shifting some domestic production back to China so it could bring more finished
goods through its West Coast facility rather than the Port of
Savannah. A California ports strike might turn that scenario on end.

Similar narratives are unfolding across the country as the hint of labor discord continues to feed contingency machines. There is reason for concern. The 2002 West Coast ports lockout stranded freight-laden ships at sea for 10 days during the busiest shipping season of the year. At the time, one consultant pegged the total economic impact at $5 billion, while more conservative estimates came in closer to $1 billion. Today, with the threat of a fiscal cliff looming, any further work stoppage at U.S. ports will send an already sputtering economy into a tailspin.

The current labor predicament demonstrates a need for sourcing and transportation flexibility. And that’s what brought the Panama Canal into focus a decade ago.

“Beginning with the ports strike in 2002, shippers began diversifying to other ports—and that remained a trend the past 10 years,” says David Twist, head of research for San Francisco-based industrial real estate developer ProLogis. “Over time, more capacity has flowed to the East Coast.”

Ten years removed from the crisis, the Panama Canal still remains on the horizon. All-water sailings to the East Coast—with the added benefit of slow-steaming to reduce fuel use and cost—pose new intrigue. The expansion project is creating more buzz, and poses more supply chain risk than in 2002.

“Because the strike happened a decade ago, people forget,” says Jose Acosta, vice president, public affairs and strategy, UPS Latin America. “The Panama Canal shift will not be cataclysmic; it will be gradual. Companies will dip their toe in the water to see how it works, and how they can manage that balance going forward.”

Many logistics experts share Acosta’s opinion. The Panama Canal expansion brings flexibility to the table in terms of unlocking capacity and alleviating a critical global bottleneck. In effect, it creates a counterbalance to West Coast-centric sourcing strategies. Asia at large, and China specifically, command U.S. interests and resources, with many companies making significant long-term investments there.

Surveying the Options

Even compared to 10 years ago, new transportation options are emerging on the West Coast of North America, mitigating latent capacity and congestion concerns. British Columbia’s Port of Prince Rupert, for example, is the closest deepwater North American port to Asia, and has direct intermodal connections to the U.S. Midwest with Canadian National Railway. In Mexico, the Pacific Coast ports of Lázaro Cárdenas and Manzanillo provide back-door access to the U.S. Southwest. Even the U.S. East Coast-Suez trade has grown as Asian manufacturing continues to migrate west, and India’s economy slowly opens up.

What has changed is that U.S. shippers and importers are looking at the supply chain from a strategic advantage standpoint. They are taking a more analytical approach to optimizing inventories and costs, and streamlining the entire process.

“The Panama Canal gives us options to create flexible solutions,” explains Kim Wertheimer, executive vice president, strategic development for global logistics solutions provider CEVA Logistics. “Shippers are concerned about labor disruptions on the West Coast. So we’re working with them to assess current routings and economics to find options that enable them to improve transit time speed and velocity; total landed costs; and supply chain reliability in terms of minimizing disruptions and dwell times.”

Leaning on Supply Chain Flexibility

Shippers are considerably more exposed to risk today than they were in 2002. On the whiplash end of a major economic recession, companies can’t afford any supply chain disruptions that threaten the bottom line—especially during the lucrative holiday season.

More telling, companies have been running much leaner in the past few years, a consequence of the flush credit, bloated inventories, and fixed networks that exacerbated their vulnerability when the recession grabbed hold in 2009.

“Although inventory-to-sales ratios don’t indicate this, industry is trying to become more sophisticated and run tighter on inventory,” says David Caines, president of Kenco Logistic Services, a Chattanooga, Tenn.-based 3PL. “Companies are more sensitive to any supply chain wrinkle that creates a bigger wake.

“Companies see the Panama Canal expansion as an opportunity to add new elements into their network optimization studies—factors they wouldn’t have considered before,” he adds. “It’s part of the conversation as companies look forward three to five years and plan what they will do with their networks. But I don’t see many pushing to be first in line.”

Kenco recently secured its first port-related new site contract going into Savannah for a Chinese manufacturer. The customer is taking a three-pronged approach in how it brings product into the United States, specifying Los Angeles, Savannah, and New York/New Jersey as ports of entry. It plans to serve those markets directly from those ports.

While Kenco hasn’t seen a marked port-centric shift among its clients, shippers are favoring smaller facilities in more locations. “A company may specify that it doesn’t want just an east-and-west presence, a two-node network,” Caines says. “It may want a five-node network with a smaller footprint in each city. That is the trend.”

While Caines cites the Chinese manufacturer as a classic example of what companies might do, he doesn’t expect a tidal wave. Shippers are exploring all their options. Whether it’s shipping through the Panama Canal and coming up the East Coast, or going through Prince Rupert and using the intermodal landbridge to access Midwest markets, companies want to create agility and identify secondary and tertiary positions to flow product.

That’s also why Wertheimer sees shippers turning to all-water options through the Panama Canal as a matter of contingency, rather than a permanent East Coast-West Coast balance. Cost remains the most critical component in any sourcing decision, especially for commoditized trades where margins have been razor- thin over the past few years. When the expanded Panama Canal comes online, ocean carriers will have to weigh the economics of serving East and West Coast ports—and shippers will have to follow suit.

“Typically, ocean transit from Asia to the U.S. West Coast takes about 12 days,” Wertheimer says. “Intermodal adds another five to eight days to the East Coast or Southeast—so transit time is 18 days on average. It takes 24-plus days through the Panama Canal. That makes a big difference in cost and inventory implications. And West Coast intermodal infrastructure is well-developed by comparison.”

Building in Reliability, Scalability

Whether shippers are seeking sourcing balance or merely creating another transportation contingency by exploring Panama Canal routings may be a matter of semantics. Either way, building more reliability and scalability into global networks is compulsory. Some companies are looking at new global markets they can source from and sell into, while at the same time creating overlaps and redundancies in their supply chains. This places equal burden on domestic networks to flex with changing supply locations.

The reverse logic also holds true. Companies that have built scalability into their U.S. domestic networks—whether through multiple ports of entry, variable-cost-driven 3PL partnerships, or fixed assets in strategic locations—have more latitude to adapt their sourcing activities.

Acosta, like others, says human nature will dictate how companies react to the Panama Canal expansion. “People like familiarity, so they won’t jump off a cliff,” he says. “But once the Panama Canal opens, someone will take advantage of the idea. If it adds to their profit margin, then others will follow. There could be an incremental increase, then companies will seek a balance somewhere in between.”

Companies that are thinking about the Panama Canal today are inevitably looking at the future state of their supply chain—perhaps prioritizing investment in the Southeast to tap a rapidly growing consumer base or serve as a stepping stone into the Latin American market. The real potential of the Panama Canal may have less to do with the Canal itself than with Panama at large.

Latin America’s Singapore

As much as industry sources remain guarded in their assessment of the Panama Canal’s effect on U.S. distribution patterns moving forward, they have fewer reservations about Panama’s prospects.

“President Ricardo Martinelli and others have a vision of what they need to do in Panama—and it’s not just about the Canal,” says Acosta. “They want to transform Panama into something akin to what Singapore has become for Asia. Its strategic location in the region will be important in terms of enhancing the Canal and making the country a logistics hub.”

Acosta, who has met with President Martinelli and Colombia President Juan Manuel Santos to discuss their respective countries’ roles in facilitating trade throughout the region, is bullish about Panama’s potential as a major redistribution hub. The leaders have an infrastructure plan in place for improving ports, airports, road networks, and technology. All these factors tie together with the goal of making this hub vision a reality.

While transforming Panama into Latin America’s Singapore may be stretching the realm of possibility—given the city-state’s unique combination of business and cultural discipline—the ambition is striking, if not contagious. It frames Panama in a much different context: as a global pivot, not simply a conduit for trade. This could be the catalyst that puts a different spin on how U.S. companies view the Panama Canal.

While offshore business over the past decade has been largely focused on Asia’s labor cost differential, that dynamic is now changing. China’s wages have risen. U.S. shippers are looking more closely at total landed costs and near-sourcing opportunities that reduce transportation expenses and boost speed to market. The possibility of holding inventory in Panama for redistribution—or any other value-added manufacturing or contract logistics activity—presents a new dynamic that affects sourcing strategy, mode utilization, and DC network alignment.

“If you throw Panama into the equation, you have to think about inventory management and the total cost of logistics,” explains Acosta. “It places a greater emphasis on the rest of the supply chain—what companies do with technology to manage inventories, just-in-time strategies, brick-and-mortar investments, and back-office costs, among other considerations.”

Familiar Territory

Other benefits to operating in Panama are its dollar-based economy and wide use of English. Both are consequences of more than 80 years of U.S. occupation in the Canal zone.

“Panama is familiar,” says Acosta. “It provides a comfort level to business people who seek continuity to invest. That drives U.S. foreign direct investment, and creates a pivot to penetrate South American markets.”

Wertheimer has also seen an uptick in discussions about Panama as a distribution point, especially with regards to providing direct access from Asia and North America to South America.

“CEVA often brings containers through the West Coast into Miami, then redistributes from Miami to Latin America,” he explains. “A need for continued infrastructure development exists within Panama, as well as ocean and air carrier services that would be able to support this growth.”

Now that the long-awaited U.S.-Panama Trade Promotion Agreement has finally entered into force (see sidebar), even stronger incentive argues for U.S. investment in Panama. The agreement—which removes most barriers to trade between the United States and Panama, and will greatly benefit American consumers and manufacturers alike—follows the U.S.-Colombia trade pact that went into effect in May 2012. Momentum is building in Central and South America that will no doubt keep U.S. companies tuned in to changing developments.

The Winds of Change

Change is the operative word. So much variability exists in today’s supply chain that companies are compelled to keep their options open. Economic starts and stops at home and abroad are rapidly shifting supply and demand dynamics. Fluctuating fuel prices continue to be a concern. A rash of natural disasters, on top of recurring labor strife, has placed a premium on risk assessment and management. Much as security became a part of standard operating procedures following the Sept. 11 attacks, contingency planning is now an expectation of the “new normal.”

What impacts the Panama Canal expansion will have on U.S. sourcing and transportation strategies and distribution alignment is currently moot. For myriad other reasons, successful companies are building flexibility into their U.S. networks so they can respond to supply and demand shifts as economically and efficiently as possible. This prepares them to explore new U.S. and Latin American markets if the business case supports investment.

The trend toward transportation and logistics outsourcing will only grow. And perhaps more than in previous years, the decision is not exclusively tied to economy. Rather, the incentive for working more closely with third-party logistics providers, forwarders, carriers, and brokers—and investing in technology—will also be predicated by a need for variable-cost flexibility, market agility, demand responsiveness, and risk aversion.

“Companies that operate a DC and put up bricks and mortar are tying themselves to inflexible infrastructure for their logistics needs,” says Acosta. “They can’t adjust those fixed costs if demand changes. Companies have to be adept at growing and shrinking with demand, and being able to manage variable costs at a higher rate than before so they can scale operations as needed.”

That sensibility holds true now, and will likely remain germane in three years when the Panama Canal expansion is complete. If nothing else, ongoing speculation about the efficacy of all-water routings to the U.S. East Coast presents shippers with a platform to re-evaluate their supply chain networks.

Predicting the Unpredictable

Currently, the Panama Canal expansion raises more questions than answers. But given the current economic environment, shippers are no strangers to forecasting the unpredictable.

If Panama’s development potential as an Americas distribution hub materializes as some suggest, it could be the game changer that completely reshapes how companies look at opportunities in South America and elsewhere. And it could be the trigger that ensures a more fixed focus on Panama Canal transits, and perhaps a more balanced East and West Coast sourcing paradigm.

What goes around may come around—and stay.

Prelude to Expansion: U.S.-Panama Free Trade Agreement

The lengthy drama surrounding the U.S.-Panama Trade Promotion Agreement finally came to a cathartic ending on Oct. 31, 2012 when, after six years of negotiations, the pact entered into force. For the U.S. agriculture and manufacturing industries especially, the free trade agreement (FTA) promises to increase trade activity between the two countries—and it couldn’t happen at a better time, given the Panama Canal’s imminent expansion.

The agreement, which was originally negotiated in 2006 and ratified by Panama’s National Assembly one year later, was finally approved by Congress in 2011, then signed into law by President Obama—along with the Colombia and Korea FTAs. Much of the delay was attributed to the United States re-negotiating finer points for Congressional consent, and Panama ironing out details regarding intellectual property rights and tariff rate quotas. But U.S. businesses were impacted the most by these recurring stops and starts, says Jon Fee, partner in Washington-based law firm Alston & Bird.

“Goods from Panama already came into the United States duty-free under the Caribbean Basin Economic Recovery Act of 1983,” Fee explains. “What really mattered was U.S. exports to Panama. Companies in the United States were champing at the bit trying to get duty-free access to agriculture and consumer goods markets in Panama.

“On the day the agreement went into effect, 87 percent of consumer goods exported from the United States to Panama changed from dutiable to non-dutiable,” he adds.

While the Colombia and Panama FTAs together don’t even come close to the scale and scope of the United States’ pact with Korea—given the size of Korea’s economy and attractiveness as a market for U.S. goods—growing trade cohesion in Central and South America bodes well for future U.S. activity in the region.

“Panama is surrounded by U.S. free trade partners—all of Central America, Colombia, and Peru,” says Fee. “U.S. interests will find it easier to trade in that region because FTAs tend to harmonize some trade rules among all U.S. partners.”

Trade harmonization among Latin American countries has always been a sticking point for economic development. Cross-border freight regulations are notoriously nebulous and restrictive, thwarting best-laid plans for growing intra-regional commerce.Better synergies with U.S. trading partners and continuing U.S. foreign direct investment will only help standardize regulatory policy across borders, and enhance transportation and distribution networks.

With the Panama Canal expansion three years away, and Panama digging its own foundation as an Americas logistics hub, building new platforms for business to engage in a more seamless fashion will have a positive impact on U.S. growth in the region.

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