World trade faces unfriendly fire: a story of two canals

It has just got dearer and become more dangerous to ship goods.

| 6 min read

The Baltic freight index has taken a sharp upwards move in recent days, reflecting tensions in the Red Sea approach to the Suez Canal. The tensions have been mounting for some time, following the Hamas attack on Israel and the Israeli military response against Gaza.

The Houthi forces in Yemen have decided to attack neutral shipping where they claim it has links to Israel in an effort to put pressure on Israel to end its war against Hamas. Their greatest prize to date in pursuing this violent task has been the hijacking of the Galaxy leader vehicle transporter ship and the detention of its crew of 25. Efforts to negotiate the return of crew members for the Christmas holiday period failed. The Houthis are showing off the vessel and saying they will keep the hostages until there has been a change in Gaza.

Since mid November there have been around 26 reported attacks on ships mainly by drones and other weaponry directed from the shore. Off the coast of Yemen the narrow Bab al Mandeb Strait provides a focus for firing at the passing vessels. There are also raids in small boats.

The international response

On Wednesday the United Nations passed a resolution condemning these attacks. The US has assembled Operation Prosperity Guardian, a naval force of allied ships and personnel aiming to intercept incoming fire against vessels and to counterattack where naval or cargo ships are at risk from Houthi attacks. US helicopters saw action against attack boats, sinking three and saving a merchant vessel. The core of the US naval force in the region is the Eisenhower carrier group. There are allied destroyers and frigates closer to the Houthi military centres in the Red Sea.

How has this affected freight costs?

Some freight carriers have decided they cannot take the risk of a stray drone damaging their ship or of a sudden attack threatening the vessel with hijack and have diverted cargoes to longer sea routes that avoid Suez and the Red Sea. The main east-west route is all the way round the Cape of Good Hope at the southernmost point in Africa.

Freight costs have risen as it means more capacity is taken up with longer voyages to achieve the same deliveries, whilst insurance terms and costs have also been affected. The Cape route also has its dangers with bad weather and the actions of West African pirates.

What does the near future look like?

It looks as if the threats to the Suez route will only go away when there are positive developments in Gaza. The allied naval force should be able to contain most of the threats to neutral shipping with their sophisticated tracking and interception capabilities. So far it has worked well, but there is always the danger of a stray weapon or attack getting through. The force is being increased which should add to the protection and make it less likely a large merchant ship can be hijacked again. Some freight lines will continue to reroute, and freight rates and insurance will still have to reflect these unpleasant realities. Some insurers will not insure, some require a war premium or amend the other terms.

Problems at the Panama Canal add to shipping woes

Meanwhile the Panama Canal, suffers from reduced capacity for different reasons. This represents a crucial route when moving between the Atlantic and Pacific oceans. The alternative is a major long detour around the continent of South America via Cape Horn, the southernmost tip of South America.

The canal system is sustained by feeding fresh water into the system from nearby lakes. Every time a vessel passes through the series of locks it takes with it substantial freshwater which finds its way to sea as the transit is completed, though more is now retained and recycled during passage. There have been low levels of rainfall in Panama and water resources are scarce and the authorities have had to ration water to the canal as a result.

It means they now limit the numbers of ships that can make the passage and have reduced the water level making it impossible for the largest ships to use the canal at all. The latest January advice is a limit of 24 vessels a day instead of the 35 or so in normal times. Draft is at 44 feet instead of 50. The main problem is the level of water in the Gatun feeder lake which is also a source of water for the local population.

More rainfall would ease this issue. There may also need to be longer term engineering work solutions. The last expansion of the canal with additional locks improved retention of freshwater during transit. The USA and China are the principal users of the canal and have agreed to its operation by Panama with strict neutrality and guaranteed access for users.

The impact is world wide

World trade relies on these two canals for important long-distance freight. Around 10% of world freight uses Suez and 6% Panama. The canal share of container freight going long distances, especially between China and the west is much higher. We will watch the developments in both places carefully. So far, the interruptions and delays to trade have been manageable though costs have risen recently.

It is important that Operation Prosperity Guardian prevents deaths and ship loss, and that the Panama authorities work away at solutions to their water shortage. We assume both canals will continue to allow passage of substantial trade volumes, whilst accepting that they will be unable to meet all potential demand for the time being. Rises in costs thus far, although a concern, are nothing like the experience during the pandemic disruption.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

World trade faces unfriendly fire: a story of two canals

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