The Fed’s inflation battle faces a new challenge: a dried up Panama Canal Ship’s crew

By Laura Curtis, Ruth Liao, and Michael D. McDonald

(Bloomberg) – Federal Reserve Chair Jerome Powell is keeping a careful eye on employment levels, wages, consumer prices and numerous other metrics to see where the US inflation rate might be headed next year.

He might also want to keep an eye on the water level at Gatun Lake.

This is the lake that supplies the Panama Canal locks with the fresh water needed to lift ships on their way from the Pacific Ocean to the Atlantic. However, a severe drought has caused the water level in the lake to drop well below normal, resulting in weight restrictions and increasing surcharges for ships navigating the canal.

It also unsettles economists and supply chain experts. As global supply shortages ease, drought in Panama and worrying weather conditions elsewhere threaten to rekindle some of the chaos of 2021, when a surge in shipping costs and consumer demand led to shortages of goods and helped push U.S. inflation to 4 percent to increase. decade high.

If Gatun Lake levels continue to drop as forecast, the market will respond with higher shipping rates and a scramble to find alternative routes from Asia to the U.S., logistics experts said.

The drought also risks undermining the Fed’s fight to bring inflation closer to its 2% target, said Jonathan Ostry, an economics professor at Georgetown University and a former International Monetary Fund official.

US inflation is gradually decelerating at the Fed’s preferred measure but remains at 4.7% “at levels that are very uncomfortable for central banks,” Ostry said. “And the last thing they need is to tune out unfavorable news about shipping,” as they did in 2021, which he described as “borderline malpractice.”

The Panama Canal Authority is predicts July 31st The water level was 78.2 feet (23.86 meters), surpassing the previous all-time low of 78.3 feet in May 2016 and well below the five-year average of 84.9 feet in July.

To make matters worse, an El Niño system is forming in the western Pacific that is expected to disrupt normal weather patterns by the end of this year. While this can result in heavy rainfall in some regions, in Panama it typically means severe drought and higher-than-normal temperatures. Erick Córdoba, the head of the canal’s water department, said in an interview that El Niño could mean a longer dry season for Panama in 2024, which would also affect water levels.

The drought is already making transport of goods more expensive. Since February, the canal authority has continuously reduced the draft – i.e. how deep a ship can lie in the water. In order to maintain shallower drafts, large ships have to reduce their cargo by taking on fewer containers overall or by sharing the same amount of cargo among more containers. In any case, the result is higher prices for consumer and industrial goods transported through the canal. In response to the proposed limits, some shipping companies also began charging per-box container fees on June 1.

Freight rates will also rise on other routes as low water levels force shippers to look for alternatives – particularly if the peak shipping months of August and September, when retailers stock up ahead of the holiday season, are stronger than expected.

One bright spot is that ocean shipping costs and demand have fallen sharply compared to last year. An oversupply of warehouses with overstocked inventories and concerns about the general economy are slowing down incoming orders. Still, large volumes of freight are being moved, with demand roughly at the same level as in 2019, according to Peter Sand, chief analyst at Oslo-based firm Xeneta AS, which tracks freight rates.

While the Panama Canal was already struggling with water shortages prior to a 2016 expansion that allowed the passage of giant container ships, known as neo-Panamax ships, this year’s drought started earlier and is expected to be more severe than previous ones. Ricaurte Vásquez, the administrator of the Panama Canal Authority, said in a statement May was the driest May since 1950 and that the canal may be forced to reduce the number of ships passing through it to between 28 and 32 each day if things are getting really extreme this year, up from 36 now.

The draft limit for the larger vessels is now 44.5ft, up from the normal 50ft, and is set to drop back to 44ft on June 13th. This could result in a 40% reduction in cargo at Flexport Inc., a trucking company, according to Nathan Strang, head of ocean freight.

When the water level reaches 78.2 feet as predicted by the Canal Authority, the maximum draft drops to 43 feet, reducing cargo capacity even further.

Even if Panama’s drought doesn’t ruin Christmas like the supply chain problems did in 2021, it could still push inflation higher. And if conditions continue to deteriorate, the Federal Reserve, which is expected to suspend rate hikes at its next meeting on June 13-14, may have to resume its campaign to control rising prices, especially given that inflation is picking up proved more persistent than many had hoped. Contributors are consumer goods.

The 2021 shortages, which caused shipping costs to rise six-fold from pre-Covid levels, would have added more than two percentage points to inflation in 2022, said Ostry, the Georgetown economist. “Coal mine transportation costs can be a canary for future inflation spikes” as it takes 12 to 18 months for these costs to hit the economy.

Be Research shows that a 20% increase in shipping costs increases the inflation rate by 0.15 percentage points a year later. Even if shipping costs are lower now than they were during the pandemic, such a rise could undermine the Fed’s efforts to fight inflation and should not be ignored, the economist said.

So far, the Panama Canal limits look similar to 2019, when the last severe drought hit, but whether they will get worse, stay the same or improve over the next few months is not clear, said Zera Zheng, head of the resilience consulting business at the shipping company AP Moller-Maersk. “The pattern looks different to me.”

Global weather conditions are not okay, Zheng said. “If you put the low water level in Panama into the bigger picture, you can actually see that it’s just a signal and there’s likely to be more coming around the world.”

Zheng points to the Rhine in Europe, where high temperatures and low rainfall last year led to delays and increased shipping costs for goods. Earlier this year, areas of Southeast Asia were experiencing their hottest days ever, and low water levels in the Yangtze River, a key inland cargo route in China, are also hampering shipping, she said.

Scientists say climate change is causing Panama to experience more extremely hot weather and milder cool weather. According to the United Nations Intergovernmental Panel on Climate Change, between 2016 and 2020, heat waves lasted an average of 2.6 extra days longer than in the 1985-2005 period. Still, scientists say it’s unclear whether Panama’s droughts will worsen since the country is caught between Caribbean weather conditions that bring more rain and the Pacific that is drier.

The Panama Canal is one of the fastest and least expensive ways to ship grain and other agricultural commodities, as well as consumer goods from China and other Asian manufacturing centers to US ports.

About 5% of the world’s annual maritime trade passes through the canal’s locks. Among neo-Panamax users of the canal, container ships accounted for 45% of traffic in April, followed by LNG, dry bulk and LNG carriers.

According to channel spokesman Octavio Colindres, LNG tankers are not as badly affected by the recent draft changes as the ships are typically only about 37 feet in the water. However, any shortages are a concern as LNG export expansion in the US will begin in the next five years.

Because of the war in Ukraine, LNG supplies, which normally went to Asia via the Channel, have fallen as producers divert supplies to Europe to replace Russian gas. But in the long run, the canal is important as production ramps up, said Fred H. Hutchison, chief executive officer of LNG Allies, the US industry’s trade group, and urged the canal to begin expansion efforts.

If LNG vessels have to avoid the Panama Canal due to shortages or rising costs, the alternatives would mean longer routes around the Cape of Good Hope on Africa’s southernmost tip or through the Suez Canal, adding weeks to the journey.

“Although there are alternatives, the channel for LNG and other cargo is critical,” Hutchison said. “We believe that all parties involved must work together with Panama on further enlargement. The last expansion took a decade, and the next one will likely take just as long – or longer. So let’s move on.”

In September 2020, the Panama Canal Authority invited bids for the design and construction of a new water management system to improve the freshwater supply, which also supplies drinking water to the state capital, Panama City. The agency budgeted $2 billion for the project and received inquiries from 250 potential bidders.

However, work has not yet started, partly because the canal authority announced in June 2021 that it would provide a more detailed concept with the help of the US Army Corps of Engineers so that potential bidders could better estimate costs. In the past, the Canal Authority has explored the possibility of building dams along other rivers in Panama to create additional water reservoirs, discharge water from other locations, and even desalinate it.

Córdoba, the head of the canal’s water department, said the Corps’ recommendations, which will be released, should be available later this month. The canal authority could choose one or more options, he said, and consider creating new reservoirs from nearby rivers that flow into the sea. It is hoped that the new system can be built and operational in five to eight years, Córdoba said.

The drought in Panama could also spell a turnaround for U.S. ports on the East and Gulf Coasts. Reliability has been a top priority for importers and retailers since the pandemic, and many have diverted their cargo from the US’s largest container gateway in Los Angeles and Long Beach to Houston or Savannah, Georgia, in part for fear that labor unrest would cause delays.

As draft restrictions mean shippers have to use more containers and more ships, waiting times are increasing. When the canal is excessively congested, ships can go directly from Asia to the US West Coast or from Asia to the East Coast via the Suez Canal. In any case, the increased demand on other trade routes is likely to drive up tariffs.

“Shippers will find this a serious and uncomfortable disruption to a very busy and busy artery of world trade,” Xeneta’s Sand said. “The transport companies have numerous container ships that they can use on alternative trade routes. So they had better use them now.”

–Assisted by Eric Roston, Kyle Kim and Brian K Sullivan.

© 2023 Bloomberg LP

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