Economic Evaluation of the Panama Canal Expansion Project
Francisco Furtado Hamed Pouryousef Raul Pires
Table of Contents
1.
Introduction............................................................................................................................. 1
2.
Panama Canal (brief overview) .............................................................................................. 1
3.
4.
2.1.
Historical works on Panama Canal ................................................................................. 2
2.2.
Main parameters of Panama Canal ................................................................................. 4
2.3.
What is the Lock? ........................................................................................................... 5
Plan and motives of Panama Canal expansion ....................................................................... 6 3.1.
More capacity, more transit ............................................................................................ 6
3.2.
Main technical difficulties of Panama Canal expansion................................................. 8
Overview of the Expansion Program report done by ACP................................................... 11 4.1.
4.1.1.
Environmental costs.............................................................................................. 12
4.1.2.
Financing............................................................................................................... 14
4.2.
5.
Costs.............................................................................................................................. 12
Benefits ......................................................................................................................... 15
4.2.1.
Economic .............................................................................................................. 15
4.2.2.
Operational............................................................................................................ 15
4.2.3.
Social..................................................................................................................... 16
Post Panamax Challenge....................................................................................................... 16 5.1.
Risks and Uncertainty, the problem of forecasting demand ......................................... 17
5.2.
Scenarios ....................................................................................................................... 20
6.
Conclusions........................................................................................................................... 22
7.
Annex.................................................................................................................................... 22
1. Introduction The purpose of this report is to perform an economic analysis on the Panama Canal expansion project that is currently ongoing. We propose a sensitivity analysis on the demand expectations proposed by the ACP (Panama Canal Authorization) in the report1 that was the base for the expansion project. At the time this ACP report was completed the economic crises that the world faces nowadays was not installed and therefore projections made in the report did not foreseen this new developments. We start our report by giving a brief overview of the Panama Canal history, followed by a description of the technical, economic and strategic reasons that support the expansion project taking in consideration what is described in the ACP report. In the last part we present our sensitivity analysis on the demand projections and argument the risks and problems involved if this scenario becomes real.
2. Panama Canal (brief overview) The Panama Canal and its watershed is a significant asset to Panama and the world. The Canal serves as a critical link in the commerce chain, handling 4 percent of total world trade and, more importantly for the United States, 12% of U.S. maritime trade including 40% of all U.S. grain exports. It also plays a key role in Panama’s economy, directly employing about 9,500 people, generating more than $920 million in foreign exchange (approximately 8 percent of the country’s GDP), and contributing about $90 million to the national treasury in 2003.2
1 : Proposal for the Expansion of the Panama Canal Third Set of Locks Project, Panama Canal Authority, April 24, 2006 2 : Evaluation Of Usaid’s Strategic Objective For The Panama Canal Watershed 2000–2005 , Final Report, Us Aid, 2005
1
Figure 1 - International connection through Panama Canal over the world3
2.1. Historical works on Panama Canal The main idea and purpose of construction this canal in 1914 was connecting Pacific and Atlantic Oceans together with minimum maritime distance and the least travel time for ships and ferries according to geographic constrains and limitations in whole North, Latin and South America which prevents passing ships thoroughly and directly from Atlantic to Pacific Ocean or vice versa.
Figure 2 - Geopolitics position of Panama Canal to connect Pacific and Atlantic Oceans4
3 : Panama Canal Expansion, Jeffrey McKee, Coastal Navigation Program Manager, U.S. Army Corps of Engineers, Headquarters, October 8, 2008
2
For centuries, passing easily from American Continent by maritime facilities has been of paramount importance and several historical attempts to find the best way to cross American land by maritime were performed. They are summarized as below5: •
In 1513, Vasco Nunez de Balboa crosses the isthmus of Panama and becomes the first European to see the Pacific Ocean
•
In 1524 Spanish explorer Hernon Cortes suggests that a path across the isthmus of Panama would be a great idea
•
In 1534 The King of Spain wants to build a canal through Panama
•
In 1835 France is given a permit to build a canal across Panama. However first they have to come up with a plan to build the canal. In 1881 they finally start.
•
In 1881 a French company begins construction on the canal. After eight years France gives up on the project. Over 20,000 construction workers died working on the project for France and the company trying to build the canal goes bankrupt.
•
In 1904 The United States begins working on the Canal
•
In 1914 The canal is completed by US intervention and activities
So as it is clear from above, the brilliant role of this canal caused that even some foreign countries from Europe and America tried to build this strategic canal for the past 400 years with different attempts. After starting the canal operation, the management and control of this canal had been performed by US government until 1977 when The United States signed a treaty with Panama and agreed to give Panama control of the canal in 1999. So the Panama Canal has been operating by ACP for last 8 years.
4 : Panama Canal Expansion, Jeffrey McKee, Coastal Navigation Program Manager, U.S. Army Corps of Engineers, Headquarters, October 8, 2008 5 : The Panama Canal, The World’s Most Important Shortcut, By: Michelle Leba Washington Technology Magnet Middle School ,2005
,
3
Figure 3 - Construction works of Panama Canal during1904-19146
2.2. Main parameters of Panama Canal This canal has diversity aspects of creativities and design innovations which named the Panama Canal as one of the most important transportation infrastructure in the world. Some of these main design and operation parameters are mentioned as below: -
This facility is the best shortcut for decreasing travel time in the world for marine journeys. (Near 8000 miles distance declining!7)
Figure 4 - Huge marine travel time saving by Panama Canal accessibility
-
The first canal which was built by lock facilities to follow the natural rise of the land as the level of the watershed instead of following sea level like the Suez Canal.
6 : The Panama Canal, The World’s Most Important Shortcut, By: Michelle Leba Washington Technology Magnet Middle School ,2005
, ,
7 : The Panama Canal, The World’s Most Important Shortcut, By: Michelle Leba Washington Technology Magnet Middle School ,2005
4
-
The canal includes Gatun Lake, an artificially created body of water with a surface of 425 km2.
-
There are three locks: Gatun Locks, Pedro Miguel Locks and Miraflores Locks(following picture). Each hall or chamber in the locks is 304.80 meters long and 33.52 meters wide.
-
Cort Gaillard or Corte Culebra is a large ditch made by human workers 14.5 km in length
-
Ships usually take about 8 to 10 hours to pass through the canal.
-
Due to the size restrictions in the locks, only about 60% of sea-going vessels are able to pass through the canal. However, many ships have been designed specifically to be able to pass through the canal fully loaded and with maximum payload. These are classified as Panamax class ships. The defining dimension is 294 meters in length, 32.3 meters in width and a draft of 12.04 m. By current standards these are mid-sized ships. Updating of the locks to fit larger vessels is still under consideration.(all above statistical resources)8
Figure 5 - Longitudinal section of Panama Canal and the locks placement in both sides of canal9
2.3. What is the Lock? As it was mentioned previously, the Panama Canal is the first canal in the world which has used Lock facility to follow the local land level instead of sea level and according to Figure
8 : http://en.structurae.de/projects/data/index.cfm?id=p00033 9 : The Panama Canal, The World’s Most Important Shortcut, By: Michelle Leba, Washington Technology Magnet Middle School ,2005
5
6, a lock is a part of a canal with gates at each end where boats are raised or lowered to different water levels. When the ship goes through a set of gates into a lock chamber, the water in the chamber is still at sea level. Then more water comes pouring into the chamber through valves. The ship rises like a toy boat in a bathtub filling with water. When the water rises high enough, the ship passes through a second set of gates and enters a small lake. It goes to the next lock and the water is raised again.
Figure 6 - Longitudinal profile of Panama Canal and the level of locks 10
3. Plan and motives of Panama Canal expansion 3.1. More capacity, more transit According to the previous studies done by different organizations and offices, Panama Canal will have some shortage of capacity and capability in future in order to carry different types of ships and ferries thorough Panama Canal. In 2007 more than 200 million tons of different commodities and goods have been carried via Panama Canal according to Figure 7.
10 The Panama Canal, The World’s Most Important Shortcut, By: Michelle Leba, Washington Technology Magnet Middle School ,2005
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Among this huge amount of transit, container transit is the most important commodity type which has grown more than 220% in just over 10 years.
Figure 7 - Different types of commodities carried via Panama Canal in 200711
Figure 8 - Growth of container traffic through Panama Canal over1997- 200712
11 : Panama Canal Expansion, Jeffrey McKee, Coastal Navigation Program Manager, U.S. Army Corps of Engineers, Headquarters, October 8, 2008 12 : The same source.
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The other main reason for expanding the canal is the increasing size of the ships over last century which caused that near 40% of demand couldn’t be able to pass via Panama Canal in current situation13. The growing size of ships is represented below.
Figure 9 - Different capacity and types of ships passing through Panama Canal over the years14
In summary the objectives of the Canal expansion are to: 1. Achieve long-term sustainability and growth for the Canal’s contributions to Panamanian society through the payments it makes to the National Treasury 2. Maintain the Canal’s competitiveness as well as the value added by Panama’s maritime route to the national economy. 3. Increase the Canal’s capacity to capture the growing tonnage demand with the appropriate levels of service for each market segment. 4. Make the Canal more productive, safe and efficient.15
3.2. Main technical difficulties of Panama Canal expansion Regarding the above short description of motives to increase the capacity of Panama Canal, the main difficulty of expanding the canal is related to the lock constrains and accessibilities. 13 :source #7 14 : Panama Canal Expansion, Jeffrey McKee, Coastal Navigation Program Manager, U.S. Army Corps of Engineers, Headquarters, October 8, 2008 15 : Proposal for the Expansion of the Panama Canal Third Set of Locks Project, Panama Canal Authority, April 24, 2006
8
The program for the Canal capacity expansion has three main components, as follows: (1) the construction of two lock facilities – one in the Atlantic side and one in the Pacific side – each with water reutilization basins; (2) the construction of access channels for the new locks, as well as the widening of existing channels; and (3) the deepening of the existing navigation channels and the elevation of Gatun Lake’s maximum operating level. In following schema, the main points of expanding difficulty are shown in longitudinal plan of Panama Canal. In summary, there are 8 major points which should be noticed more during expanding studies and construction works.
Figure 10 - Major points and components of further expansion of Panama Canal16
Each of the new lock facilities will have three consecutive chambers, designed to move vessels from sea level to the level of Gatun Lake and back down again. In designing new locks,
16 : Panama Canal Expansion, Jeffrey McKee, Coastal Navigation Program Manager, U.S. Army Corps of Engineers, Headquarters, October 8, 2008
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the engineer consultant considered the bigger dimension(Wide and height) for carrying new types of ship to accept all the current in operation ships and ferries (Figure 11).
Figure 11 - New dimension of locks appropriated for bigger size of ships17
Each chamber will have 3 lateral water reutilization basins, for a total of 9 basins per lock and 18 basins in total (Figure 12 and Figure 13). Just like in the existing locks, the new locks and their basins will be filled and emptied by gravity, without the use of pumps.18 Also in new lock facilities, because of designing water saving basins, near 7% of the used water volume by new ones, is less than current situation.
Figure 12 - New lock facilities in Panama Canal19
17 : Panama Canal Expansion, Jeffrey McKee, Coastal Navigation Program Manager, U.S. Army Corps of Engineers, Headquarters, October 8, 2008 18 : Proposal for the Expansion of the Panama Canal Third Set of Locks Project, Panama Canal Authority, April 24, 2006
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Figure 13 - Filling and emptying system in Panama Canal is performed by gravity power20
4. Overview of the Expansion Program report done by ACP21 The expansion of the canal was approved by a national referendum in Panama and the construction work is already ongoing. The expansion program is based on the report “Proposal for the Expansion of the Panama Canal” prepared by the ACP, which is the entity that is responsible for managing the Panama Canal. In this section we will describe the main lines of this document, the costs, benefits, motives, technical aspects and other relevant information. By doing this we will provide an overview of what is the expansion program and what assumptions and forecasts it is based on. As said before, the main expansion program goal is to increase the Panama Canal capacity which will allow larger ships, the Post Panamax, to use the canal as well as increase the
19 : Proposal for the Expansion of the Panama Canal Third Set of Locks Project, Panama Canal Authority, April 24, 2006 20 : the same resource 21 Proposal for the Expansion of the Panama Canal Third Set of Locks Project, Panama Canal Authority, April 24, 2006
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canal traffic and efficiency. Obviously this capacity increase can only be justified because it will, supposedly, generate increasing revenue that will rapidly cover the costs and generate profit to Panama and at the same time maintain the Panama Canal as the preferred route for the AsiaNorth America East Cost corridor.
4.1. Costs The total cost estimations for the expansion program is $5,250 million dollars. This estimation includes design, administrative, construction, testing, environmental mitigation, commissioning costs and contingency plans for each of the activities and assumes a 2% average annual inflation. The costs involved in the expansion are described in Figure 14. In the document it is stated that different scenarios for all the involved costs are considered: “The project’s estimated cost considers potential increases in manpower, equipment, operating supplies and materials costs. Possible price fluctuations were estimated and analyzed, particularly for key operating supplies and materials, such as cement, steel, aggregates, fuels and lubricants, among others. A thorough analysis of circumstances and conditions that could produce delays in the construction was also performed, including productivity fluctuations in equipment and manpower, equipment failures, extreme weather events and design changes. The study also assessed the consequences and effects of shortages or timely availability of equipment, materials and personnel for the project.” 4.1.1. Environmental costs The most relevant environmental impacts will be those that are common to every construction project, such as noise, construction equipment emissions, and suspended dust. It is said that the project estimated costs include sufficient resources for reforestation, cleaning and restoration of excavated material deposit sites and work areas as well as for socio-environmental management and follow-up. 4.1.1.1. Forest The expansion of the canal implies that a small part of the forest will be destroyed since there is the need to build new access paths for the locks on the Atlantic and Pacific entrances. However, the damage will not be substantial since the access channels to be built are not extensive and in general, the project will be developed in areas that have already been impacted by a number of
12
Canal projects and activities. Also, no new reservoir will be built and there will be no need to reallocate communities as they are not located in the channels area.
Figure 14 - Expansion program costs
4.1.1.2. Water supply Water requirements for the population and Canal use will be satisfied by building water reutilization basins on each of the new locks. The new set of locks will be composed by a set of 9 water basins that will reduce the water consumption per transit by 7% compared with existing locks. Also, the deepening Gatun Lake’s and Gaillard Cut’s channels, and the elevating Gatun Lake’s maximum operational level will provide additional water supply.
13
Figure 15 - Present and future water consumption and supply
4.1.2. Financing The financing will be the result of combining a reasonable tolls increase with external financing sources so that requirements during the peak construction period are met. Therefore, the expansion project will be financed through a mix of ACP capital contributions and external financing. The amount to come from external financing will depend on (1) investment amounts required by the project; (2) the need to build as fast as it is technically and economically viable; (3) Canal revenues resulting from Canal traffic volumes and the price policy implemented by ACP. An important aspect of the financing process is that there will be no guarantees given by the state of Panama to the external financing contracts undersigned by ACP under the expansion program. They will be guaranteed only by the cash flows the project will generate.
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4.2. Benefits There are several aspects that are evaluated in the benefits obtained by the expansion of the Panama Canal. 4.2.1. Economic The main reason for the project implementation is of course the amount of profit it is projected to generate. The revenues that are expected to be obtained from the canal expansion and the expected traffic demand beyond 2025, adjusted for inflation, will amount to over $6,200 million. It will also increase the Canal market share, particularly in the containerized cargo segment which currently accounts for 40% of the Canal revenues and in this study, is projected to grow more than any other segment. The expansion of the Canal will allow Panama to substantially increase its gross internal product in 2025 with a value around 2.5 times that of 2005 and is equivalent to over 5% average annual growth for the next 20 years. Also, the project is financially profitable as it will produce a 12% internal rate of return. It is anticipated that Canal revenues for the first eleven years of operation with the third set of locks will exceed those of a non-expanded Canal by an average of $1,150 million per year. Should the comparison period be expanded, the difference would be even more dramatic. By increasing the capacity and thus allowing more transit and more people to pass through the canal it is expected that the activities surrounding the Canal will also benefit from the expansion like ports operations, railroad, shipping agencies, fuel sales, tourist operators, the land and intermodal transportation services, the shipyard, the airport and merchant marine activities, legal and financial services, insurance services etc. 4.2.2. Operational The expansion will allow the Canal to improve its efficiency as well as its productivity. Economies of scale will occur due to the use of larger vessels together with the additional capacity of the expanded Canal will allow for the transit of a larger amount of PCUMS tons, with relatively less vessels.
15
4.2.3. Social When studying the effects of expanding the Canal on Panama’s poverty, conclusions where that if the project is executed the number of poor people will decrease by over one hundred thousand people in 2025, as opposed to the no-expansion scenario. Other important contribution of the project will be in terms of generated employment. It is expected that the overall employment will increase 10 to 15% if comparing with the alternative of not performing the expansion program. The Canal expansion’s impact on employment will first be observed in the jobs directly generated by the economic boom that will be experienced during the years of the construction. In that respect, 35,000 to 40,000 new jobs will be created during the construction of the third set of locks. These include 6,500 to 7,000 additional jobs that will be directly related to the works during the construction’s peak years.
Figure 16 - Generated jobs
5. Post Panamax Challenge Like stated before, one of the strongest arguments in favor of this project is to capture further demand, present a better alternative to present competition and prevent new competitors from entering the market (As the Central Americas dry channel or the Arctic route). To capture more demand it´s important to allow that larger ships use the canal, as shown in Figure 18 - Half of current container vessel construction, half of the orders for new ships (containers) are for ships
16
with a capacity larger then PANAMAX22 Moreover, as seen in Figure 17, ports in the US East Coast23 are preparing themselves to receive and handle this kind of “Post-Panamax” ships. So, in order to remain a leader in the Asia – US East Coast route it´s important to address this growing segment of the market.
Figure 17 - Expected infrastructure investments in some of the main ports in the U.S. East Coast for handling vessels larger than Panamax. If the Panama Canal does not expand, these vessels would use the Suez Canal route
Figure 18 - Half of current container vessel construction
5.1. Risks and Uncertainty, the problem of forecasting demand Still, for the moment the canal has been gaining share in the mentioned route, as seen in Figure 19. But the forecasts are that by the beginning of the next decade the share of the canal will start declining and due to increase problems to handle capacity and lower levels of services by
2025
the
share
of
the
canal
will
only
be
of
23%
(
Figure 20). 22 Panamax ships are of the maximum dimensions that will fit through the locks of the Panama Canal. This size is determined by the dimensions of the lock chambers, and the depth of the water in the canal
.
23 The main route that uses the channel is the Northeast Asia – US East Coast
17
Figure 19
Figure 20
So, as the cost benefits analysis made by the ACP show, it would be a good option to build the third set of locks, further it´s stated that this project will not need for state aide, actually during the construction the ACP will keep giving money to the National Treasury and the external financing24 of the project will be repaid in 8 years or less. It´s assumed that, as showed in Figure 21 and Figure 22, the increase in revenue, by increased traffic in the canal and an increase in the tolls and other services will make the investment possible and have a predicted internal rate of return of near 12%25.
Figure 21 24 It´s stated that an important part of the investment will be made with funds of the ACP, so only a fraction of the investment needed will be funded by external sources (that is
from barrowing money) 25 : Proposal for the Expansion of the Panama Canal Third Set of Locks Project, Panama Canal Authority, April 24, 2006
18
Figure 22
The main problem with these statements, from our point of view, is that those cost benefit analysis are based in the assumption of growing demand, and a continuous increase in the traffic, mainly of container ships and vehicle carrier segments. In the documents presented by the ACP it´s even stated that, there is no indication in the studies performed that containership transits through the Panama Canal will decrease26.
Figure 23
The fact is that from 2007 to 2008 there was decreasing demand for the Panama Canal in important segments, namely in the container and vehicle carrier segments, and at least slowing down in the route between Asia and US East Coast (the route supposed to have more potential 26 : Proposal for the Expansion of the Panama Canal Third Set of Locks Project, Panama Canal Authority, April 24, 2006
19
for growth)27. The present financial and economic crisis is slowing down the world economy, and for the next years the traffic of ships will most probably decrease. This disrupts the forecasts in which the economic and financial evaluation of the project was made. Right now should be a moment to reassess this huge investment. If on one side there is a growing number of ships that are too big to use the canal, on the other side the expect revenues from the third set of locks project will be lower then what is assumed in the existing studies (Figure 23 and Figure 24).
Figure 24
5.2. ScenariosÂ
27
See Annex
20
21
6. Conclusions It is our opinion, based on the several documents gathered and research made, that the expansion of the Panama Canal is in fact a necessary step to keep the Canal as a main route in the maritime routes between US East Cost and Asia and thus continue to generate revenue for Panama. By looking at the evidence regarding the growth of the size of the Post Panamax ships and the future orders for this type of vessels and the economies of scale they bring to the companies that operate them, it is a valid strategic option to enable their passage through the Panama Canal. Our concerns are not focused in the question of building the canal but instead in how this mega project will be financed and how some assumptions, namely the demand, can have a negative impact if substantial changes occur in the forecasts. The forecasts made assume that the demand and growth of maritime transportation will continue to grow as the past years and even the worst projections made by ACP point to an increase in the demand. This demand is, in our opinion, overestimated and too optimistic and it does not take in consideration the current world economic situation where the risk of recession is imminent in many of the most dynamic economies. Curiously, an article in the Portuguese newspaper Público28, states that the daily transit of ships in the Suez Canal, has decreased from 62 ships in October to 46 in the November month (explained by the financial crises and also the Somali pirate attacks in the region). The article also refers that the Suez Canal is a main indicator of the world maritime trade indicator. Since the demand directly affects the revenues generated by the Canal and the fact that this revenues are a major financing mechanism for the expansion program, we have serious doubts that this diminishing maritime trade will not affect the cash flows of the project and therefore jeopardize the all finance stability of the program.
7. Annex
28
Economic section of Público from 26/12/2008
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