By Christopher Goncalves, Director, Energy, Berkeley Research Group, LLC (“BRG”)
Once complete, the Panama Canal expansion will open new trade routes linking the booming U.S. shale gas and LNG export industry in the Gulf and East Coast regions to rapidly growing, LNG-dependent countries of East and Southeast Asia.
However, work on the expansion was halted in the first week of February 2014 due to a dispute between the Panama Canal Authority (“PCA”) and the construction consortium led by Spain’s Sacyr, which is carrying out the construction.
The expansion project’s planned cost was $5.2 billion, which included the consortium’s original $3.2 billion bid to install a new set of canal locks. However, the consortium claims to have accumulated a 50 percent ($1.6 billion) cost overrun on this work. As a result, the total project costs for the canal expansion could increase by over 30 percent.
Construction work on the canal resumed on Thursday, February 20, although the two sides have yet to reach a comprehensive agreement. The parties have given themselves three more days to reach agreement on critical issues.
Canal Completion Delay
At this point, the PCA estimates the expansion could be completed at the earliest by December 2015, which is a minor delay from the original July 2015 target. However, in the event that PCA and Sacyr fail to reach a final agreement regarding the costs, the PCA has indicated willingness to turn to a replacement contractor. In such a scenario, Zurich, who provided insurance against the consortium not completing the construction, predicts a delay of three to five years.
Implications for North American LNG
Among 41 North American potential LNG export projects (including expansion projects), 26 are U.S. Gulf Coast (“USGC”) and East Coast projects, with a total capacity of 33.8 Bcfd, that hope to use the expanded canal for LNG exports to Asia.
Under a modest scenario for moderate delay, only slightly longer than the PCA estimates, the dispute could cause a one-year delay of project completion until July 2016. The resulting impacts would probably be minimal, since only one project under construction (Sabine Pass) expects to start operation around 2016–2017.
Under a worst-case scenario, as articulated by Zurich, the delay could be five years, and the expansion would be completed by July 2020. It could have significant implications, since most U.S. LNG export projects plan to start operation before 2020:
• Six USGC and East Coast projects are in the advanced stage of commercial development, either signing initial LNG contracts or selling tolling capacity. The contracted capacity now totals 7.5 Bcfd
• Over 44 percent of the contracted capacity will be sent to Asia, almost 7 percent to Europe, and around 49 percent will be sold to LNG aggregators, which will be included in their global portfolios (which recently tend to target the high-priced East of Suez markets)
• Therefore, delayed Pacific Basin access to USGC and East Coast LNG supplies from the most prolific U.S. shale plays could present an appealing competitive window of opportunity for new exporters from the U.S. Pacific Northwest and British Columbia to place their volumes in the Pacific Basin in the 2015 to 2020 time frame
Implications for Other Suppliers
A sustained delay in completion of the Panama Canal could also have important implications for LNG suppliers around the world:
• In the Americas, Trinidad and Tobago’s plans for exports to Asia could be forestalled, and Peruvian plans for exports into the Caribbean and Europe would be impacted
• In the East of Suez markets, the competitive window of opportunity could widen for term contracts from new LNG suppliers from Australia, East Africa, and the East Mediterranean regions
• Similarly, existing suppliers such as Qatar and Russia, which have been expanding their Asian trading operations, could enjoy a sustained window for high-priced, short-term LNG in the East of Suez markets
Implications for Prices
The canal construction delays could sustain Pacific Basin price differentials between U.S. and Asian prices. Without access to larger volumes of low-cost North American LNG, the growing Asian LNG demand will be served by more limited, higher-priced supplies from competing sources. Thus, a sustained Panama Canal delay could forestall the possible downward price pressure in Asian LNG term contract markets that regional buyers have hoped for.
Meanwhile, if confronted with sustained canal completion delays, the USGC and East Coast LNG exporters will likely flood the European and South American markets with short- and mid-term LNG volumes. This would put downward pressure on prices in the Atlantic Basin.
Implications for Tariffs
Even if the Panama Canal delays are short lived, cost overruns absorbed by the PCA will likely be covered through higher toll fees once the expansion is complete. Prior to the dispute, estimates of the round-trip toll fee ranged between $650,000 and $1 million. This would correspond to a range between $0.20 and $0.32 per MMBtu per round trip for a standard 150,000 cm LNG tanker. If the toll fees are raised proportionately to the increased project cost (i.e., by 30 percent or more), the actual toll fees could end up closer to a range of between $0.26 and $0.42 per MMBtu per 150,000 cm tanker.
Any such tariff increases would take a small bite out of the attractive Pacific Basin arbitrage spreads that drive the USGC and East Coast exports. The overall impact would be marginal, but would affect the long-term cost of arbitrage and eventually, as U.S. prices increase and Asian prices decline, reduce the appeal for LNG sellers, buyers, and traders of USGC and East Coast exports to Asia.