How could Panama Canal restrictions affect supply chains?

The situations at the Panama Canal and Suez Canal are rapidly evolving and inherently uncertain. As a result, this article and the data and analysis it sets out should be treated as a best-efforts perspective at a specific point in time, which seeks to help inform discussion and decisions. The article does not set out economic or geopolitical forecasts and should not be treated as doing so.

Since its opening in 1914, the Panama Canal has played a vital role in world trade. An estimated 2.5 percent of global seaborne trade sails through its locks in an average year.¹Calculation based on estimated tonnage traversing the Panama Canal (according to the Panama Canal Authority) as a percentage of total estimated traded tonnage (according to Clarksons). In 2023, there were more than 14,000 vessel transits on this pathway between seas.²“Statistics,” Panama Canal Authority, accessed January 4, 2024.

The operation of the canal’s locks (which use gates to raise or lower water levels in different sections of the canal) depends on water from Gatun Lake. Severe drought conditions in the region have lowered the lake’s water levels, leading the Panama Canal Authority (ACP) to restrict the daily number of ship transits. Prior to these restrictions, an average of about 36 vessels per day moved through the canal.³Christine Murray, “Panama Canal operators to cut ship crossings as drought worsens,” Financial Times, November 1, 2023. In its most recent guidance, the ACP announced that transits will be limited to 24 slots per day, as of January 16, 2024.⁴“Panama Canal to increase daily transits to 24 starting in January,” Panama Canal Authority, December 15, 2023. All vessels hoping to cross the canal will need to pay a booking fee, either in advance or through an ACP auction.

Reducing the volume of canal transits by about one-third will reshape seaborne trade flows. Roughly 100 million tons of cargo (equal to about 35 percent of the cargo that traversed the canal in 2022) could be affected. Many ships could divert to alternate routes. This could mean longer sailing durations and increased costs.

The situation at the canal is in flux: the ACP has updated its guidance multiple times in response to rainfall events in the region, and it has yet to offer definitive guidance on when its restrictions will be lifted. In the meantime, companies whose supply chains are dependent on the canal will need to find ways to adapt.

This disruption coincides with uncertainty surrounding the Suez Canal—another important global trade transit point—as destabilization in the Red Sea region has spurred some shipping companies to pause Suez crossings. The combined impact of simultaneous slowdowns at these two major canals could be significant. When a grounded container ship blocked the Suez Canal for just six days in 2021, an estimated $9.6 billion dollars in trade was held up each day, creating knock-on effects in the global economy.⁵Mary-Ann Russon, “The cost of the Suez Canal blockage,” BBC, March 29, 2021.

Below, our analysis examines how a Panama Canal slowdown could affect various trade segments and stakeholders.⁶McKinsey simulated the global maritime network for all traffic before and after imposed canal restrictions, based on historical voyage and transit information, using inputs such as operating, financing, and inventory costs for each of more than 105,000 commercial vessels. Forecasts optimize for lowest total cost for each vessel and point-to-point load combination. We’ve modeled for the short term, based on typical trading patterns, but over time we expect sourcing decisions to shift in response to the ACP’s restrictions (and potentially also in response to developing conditions around the Suez).

Latin America and the East Coast of the United States are particularly reliant on the canal.

A major trade route connecting North Asia and the East and Gulf Coasts of the United States passes through the Panama Canal. All told, about 14 percent of seaborne trade into and out of the United States sails through the canal.

Several Latin American countries are even more dependent on the canal for their imports and exports. As this exhibit shows, some of these countries rely on the canal for roughly a quarter or more of their total seaborne trade.

For the nation of Panama, the canal is an economic engine. The canal directly contributed about $2.5 billion to Panama’s national treasury during fiscal year 2022. Including indirect contributions, the canal generates more than 6 percent of Panama’s GDP.

There is limited time to prepare for the disruption that supply chains will likely encounter.

Trade moving through the Panama Canal rose steadily in the late 20th and early 21st centuries as ships’ increasing size brought more cargo capacity. When wider canal locks opened in 2016—accommodating significantly larger vessels dubbed “Neopanamaxes”— more cargo moved through the canal, even though the number of transits was essentially unchanged.

Now, in the space of less than a year, the tonnage crossing the canal could be cut by roughly one-third. This would represent an abrupt and significant change for supply chains. The planning period to make adjustments for affected stakeholders—including ship and cargo owners—could be brief.

Restrictions could lead to diverted cargo.

Faced with limited canal transit slots, ships could opt to divert to different routes. A ship traveling from Asia to the Caribbean that would typically cross east through the Panama Canal, for instance, could instead go west around the Cape of Good Hope, at the southern tip of Africa.

A ship traveling from the west coast of South America to the Caribbean, which would typically go through the Panama Canal, could instead cross through the Strait of Magellan, at the southern tip of South America.

A ship traveling from the west coast of North America to the Mediterranean Sea, which would typically cross east through the Panama Canal, could instead go west through the Suez Canal.

Thousands of transits could be diverted.

There could be nearly 4,000 fewer Panama Canal crossings as a result of the restrictions.

If trade patterns remain unchanged from pre-restriction norms, we estimate that about 2,000 annual transits—primarily involving dry-bulk carriers and roll-on/roll-off, or ro-ro, ships—could divert away from the Panama Canal to the Cape of Good Hope, at the southern tip of Africa.

Roughly 1,000 annual transits—largely involving dry-bulk carriers and chemical tankers—could be diverted from Panama to the Strait of Magellan, at the southern tip of South America.

If ocean carriers employ the same ships typically used for Panama Canal transits, they could be less likely to divert ships through the larger Suez Canal. But container carriers could respond to Panama Canal restrictions by switching to larger ships. Typically, this would cause transits via the Suez to become a more viable option, due to these larger ships’ greater cargo capacity (taking advantage of the Suez being wider) and fuel efficiency (making longer trips less cost-prohibitive). However, uncertain conditions in the Red Sea region could influence decisions regarding Suez transits.

Cargo diversions could increase transport costs.

No matter where ships might divert to, costs will very likely increase. Longer journeys are more expensive (due to factors such as fuel usage) and create more inventory-holding costs associated with onboard cargo.

New routes could increase the total ocean transport costs of trade currently moving through the Panama Canal by about 5 percent, or an estimated annual $1.1 billion. Additionally, these new routes will likely slow ships’ journeys by about 20 percent: many ships that used to traverse the canal (taking on average 22.6 days to reach their destinations) could opt to sail different routes, which would likely take on average four more days.

Cost effects could vary widely by category.

The restrictions that the ACP is enacting will likely not affect all supply chains equally. Some ships could be willing to pay for limited canal transit slots, because of potential benefits from the quicker journeys that the canal enables. Other ships could find it now makes sense to avoid canal fees by diverting to other routes.

Most container ships already pay an extra fee to use the reservation system that secures them priority canal transit slots. They’ll likely continue to do so after the new restrictions are in place. Other ships that similarly derive significant cost benefits from quicker canal transits—such as liquefied natural gas carriers, which have high operating and inventory-holding costs—could also be willing to pay for priority bookings, participate in the auction process that allows them to buy places in line, or both.

Other types of ships with lower daily operating costs and less valuable cargo on board—ships that, prior to the restrictions, generally traversed the canal without paying extra for priority booking—could find it cost-prohibitive to use the canal now that they’ll need to pay extra to secure a slot. Dry-bulk carriers (carrying cargo such as grains and coal) and general cargo ships (carrying unwieldy items such as wind turbines or locomotives) likely fit into this category.

A dry bulker incurs about half as much in operating costs for an additional day at sea as a container ship. Meanwhile, the value of dry bulk tends to be far lower than that of the cargo on a container ship. Lower operating and inventory-holding costs make it more likely that a bulker will be willing to make a longer voyage in order to avoid canal booking fees.

The worst Panamanian drought in decades has created uncertainty about when canal operations will return to their normal pace. In the meantime, it’s crucial that affected parties assess the repercussions. Different sectors could experience very different consequences from the ACP’s restrictions.

Below are some selected takeaways of importance to various stakeholders:

• The canal restrictions will likely result in across-the-board cost increases, regardless of how affected parties react. Costs like these are often passed through to customers—eventually making their way to final consumers.
• The disruption for liquefied natural gas tankers, crude oil tankers, and container ships could, on the whole, be less severe than for many other shipping segments, since these ships might be expected to either continue making use of priority booking for Panama Canal transit slots or switch to larger ships and use the Suez Canal instead.
• Perishable cargo that would typically be carried aboard refrigerated ships could be switched into refrigerated containers (carried aboard container ships) as an alternative in cases where the potential for spoilage rules out longer transit times. This change could lead to a substantial overhaul of some supply chains, but it could be a necessary solution—especially if the canal disruption is protracted.
• Based on our analysis, approximately half of liquefied petroleum gas transits might need to be rerouted. Given the magnitude of disrupted volume, the effects on these exports to Asia from the Gulf Coast of the United States could involve significant economic costs for affected parties.
• Commodity traders might benefit from assessing the expected impact of longer sailing times and higher costs and building it into their models. Note that these longer journeys could involve higher inventory levels, and those higher inventory levels could create demand for more storage capacity on land.