Drought at the Panama Canal - Delay, Rising Prices, and other knock-on effects on Global Trade

The Panama Canal is facing a severe drought, with water levels in the canal at their lowest in decades. The decreased water level in the canal is attributable to the reduction in rainfall in Panama, and according to statistics from the Panama Canal Authority and the Smithsonian Tropical Research Institute, the area surrounding the canal is currently witnessing one of the two driest years in Panama’s recorded history. It is estimated that water levels in the Gatun Lake, which feeds the canal, have reduced by almost 10 feet when compared against the usual water levels during this period.

Background

In circumstances where the Panama Canal accounts for 6% of global trade, the drought in the Panama Canal has the potential to disrupt supply chains and significantly extend transport times. The Panama Canal is a critical element in the global supply chain particularly on the US East Coast to Asia and the Europe to US West Coast and Canada routes. In 2022, more than 14,000 vessels with 518 million tons of cargo transited through the Panama Canal.

Response

The Panama Canal Authority has therefore implemented various water conservation tactics to ensure that water levels do not reduce further and that the canal does not run out of water. In 2020, a freshwater surcharge was implemented which applies to all vessels over 125 feet in length that transit through the Panama Canal. This imposes a fixed fee of US $10,000 per transit and a variable fee calculated on the basis of the canal levels at the time of transit.

In August 2023, the canal also implemented a measure capping the number of vessels passing through the route to a maximum of 32 per day. On 30 September 2023, in an updated notice, the Panama Canal Authority announced that it will reduce the maximum number of vessels permitted to transit through the waterway to 31 per day. It is anticipated that there will be further reductions in daily transits.

The Panama Canal Authority has further implemented strict draft restrictions. In early May, officials adjusted the size limits for vessels travelling through the Panama Canal. Under normal conditions, the canal operates with a draft of 15.24 meters. However, authorities confirmed that vessels will be limited to a draft of up to 13.56 meters, with a further reduction to 13.4 meters when necessary. It is understood that these measures will last at least ten more months, through late 2024.

These measures have been implemented to reduce the amount of freshwater used by the locks of the Panama Canal, which lift and lower vessels between the different levels of the canal. The water in the locks comes from Gatun Lake, an artificial freshwater lake that lies 28 meters (85 ft) above sea level. Every time a vessel passes through the locks, 55 million gallons (250 million litres) of freshwater is used and then released into the sea. Reducing the number and draft sizes of vessels that can transit the canal per day therefore conserves water within the Panama Canal lock system.

Impact

While these measures are important in conserving water levels in the canal, they have inevitably created congestion and a bottleneck in the Panama Canal. On 22 August 2023, it was reported that more than 200 vessels were waiting to pass through the Panama Canal. It is also reported that it is taking vessels much longer to pass through the Panama Canal, with wait times of up to 6 days or more leading to increased voyage times. It is understood that the Panama Canal Authority has created an auction system that allows shippers to bid for priority passage. However, these queue jumps come at a high price as shippers have paid exorbitant fees to expedite passage and cut the queue. Avance Gas was recorded as paying US $2.4 million in late August to skip the long waiting line.

There are also reports of container vessels being required to lighten their load based on the draft restrictions. These container vessels have therefore discharged their additional cargo and transferred the cargo by rail to the other side of the canal. Experts say this problem will likely last through 2024 and will not be solved anytime soon.

Legal/Insurance Issues

Transferring cargo by rail is not without its risks, and there is potential for increased claims for damage to cargo when loaded on to the railway and subsequently reloaded on to the vessel. A significant amount of cargo claims arise from the loading and discharging of cargo and the increased handling of the cargo increases the risks of damage to the cargo. We, therefore, anticipate a slight increase in the number of cargo claims made to insurers. There is also room for delayed delivery where there are delays or issues with the railway line.

In terms of insurance claims, coverage will always be fact specific and dependent upon the particular terms and conditions interpreted under the applicable law on which specific coverage advice will need to be obtained.

Generally speaking, where cargo is insured against all risks of loss and damage on standard terms such as the Institute Cargo Clauses (A) subject to English law and practice, the insurance is against risks of accidental physical loss or physical damage to the cargo from external causes and the risk of the cargo being prevented by an insured peril from arriving at the insured destination (usually referred to as loss of the adventure).

There is limited cover for certain classes of expense that are closely linked to the operation of covered physical risks, namely general average, salvage, sue and labour or forwarding charges.

However, such standard insurance will generally not cover financial losses incurred by reason of interruption, disruption, delay, extra cost, loss of market or the insolvency or financial default of the carrier.

Although the insurance may continue during the ordinary course of transit or during delay or deviation beyond the control of the assured, or any variation of the adventure under a liberty in the contract of carriage, if the contract of carriage or insured transit is terminated short of destination, or if the assured changes the destination, the insurance will terminate unless prompt notice is given to the insurer.

Disruptions caused by the drought may lead to breaches of contract or even frustrate the contract of carriage. If necessary, and should the delay become indefinite or prolonged, the carrier may need to divert from the intended voyage. While there are already discussions regarding using the Suez Canal in Egypt or the Cape of Good Hope in South Africa, these routes will significantly increase voyage times and will likely lead to an increase in cargo claims as a result of delay.

When such issues arise, it is crucial to act promptly and strategically to protect your interests. In our experience, early identification of these issues is key to minimizing losses that may arise. Clyde & Co has experience of protecting the interests of cargo insurers in relation to claims for delay and we will be happy to answer any questions about the issues raised in this article.