Canal Expansion Deadlock Risks Growth

The Panama canal's US$5.3bn expansion looks set to be delayed further as Spanish builder Sacyr , leader of the Grupo Unidos por el Canal (United Group) consortium, stated on December 30 that work on the vital third set of locks element of the project will be halted unless cost overruns are met by the Panama Canal Authority (PCA). Sacyr's statement gave a 21 day period for an agreement to be reached before it would halt work; however, the PCA has subsequently rejected the suggestion that it is obliged to meet the US$1.6bn of cost overruns, nearly half of the initial contract's worth of US3.1bn.

Won in 2009 by the consortium consisting of Sacyr, Italian Salini Impregilo, Belgian Jan de Nul and Panama's Constructora Urbana, the locks are the key element in the plan to double the waterway's annual capacity from 300mn tonnes per annum to 600mn. Crucially, the expansion of the Panama Canal may permit 88% of the global liquefied natural gas (LNG) vessel fleet to pass through when completed, which will have a dramatic impact on international LNG market. The Panama Canal route would save significant amount of time and costs for LNG buyers and producers, particularly relevant for US and Japan. Presently, the canal can accommodate only 8.6% of the world's existing LNG fleet.

The cost overruns in the construction of the third set of locks stem from United Group reportedly being forced to use more expensive, higher-quality concrete in the works, flawed geological studies and labour disputes - factors which the consortium believe were unforeseen and should be addressed by the PCA honouring existing agreements. However, the canal authority state that these issues fall outside of the contract signed with United Group and as such they are not responsible for meeting the incurred costs. This is contrary to United Group's belief that under Panamanian law, the canal authority is responsible for absorbing those cost overruns.

Delays Threaten Impressive Growth
Construction Industry Value, US$bn (LHS) and Real Growth (% Change Y-o-Y)

The Panama canal's US$5.3bn expansion looks set to be delayed further as Spanish builder Sacyr , leader of the Grupo Unidos por el Canal (United Group) consortium, stated on December 30 that work on the vital third set of locks element of the project will be halted unless cost overruns are met by the Panama Canal Authority (PCA). Sacyr's statement gave a 21 day period for an agreement to be reached before it would halt work; however, the PCA has subsequently rejected the suggestion that it is obliged to meet the US$1.6bn of cost overruns, nearly half of the initial contract's worth of US3.1bn.

Won in 2009 by the consortium consisting of Sacyr, Italian Salini Impregilo, Belgian Jan de Nul and Panama's Constructora Urbana, the locks are the key element in the plan to double the waterway's annual capacity from 300mn tonnes per annum to 600mn. Crucially, the expansion of the Panama Canal may permit 88% of the global liquefied natural gas (LNG) vessel fleet to pass through when completed, which will have a dramatic impact on international LNG market. The Panama Canal route would save significant amount of time and costs for LNG buyers and producers, particularly relevant for US and Japan. Presently, the canal can accommodate only 8.6% of the world's existing LNG fleet.

The cost overruns in the construction of the third set of locks stem from United Group reportedly being forced to use more expensive, higher-quality concrete in the works, flawed geological studies and labour disputes - factors which the consortium believe were unforeseen and should be addressed by the PCA honouring existing agreements. However, the canal authority state that these issues fall outside of the contract signed with United Group and as such they are not responsible for meeting the incurred costs. This is contrary to United Group's belief that under Panamanian law, the canal authority is responsible for absorbing those cost overruns.

The canal authority have stated that they will make use of existing contractual mechanisms to ensure completion of the project, although agreeing to United Group's proposal represents the canal authority's lowest-cost option for getting the locks completed in the shortest possible time, according to the consortium. The threat to halt work on the third lock is the latest in a long line of delays which have pushed back the completion date, as expected, now officially pushed back to Q215 ( see 'Panama Canal Expansion In Troubled Waters Due To Labour Dispute', 18 January 2012).

Delays Threaten Impressive Growth
Construction Industry Value, US$bn (LHS) and Real Growth (% Change Y-o-Y)

Further delays in the construction of the expanded canal will have significant impact on the country's construction industry growth over the short-term. In real growth terms Panama has dominated the regional growth story and was set to continue to do so until 2016 according to our forecasts, by which time the fuel behind that growth - the Panama Canal expansion- will be dissipate. Over 2013 we estimate that real growth in the construction industry value of Panama reached nearly 26% y-o-y.

We forecast this to be 20% in 2014, the only market in Central America that will have double-digit growth. We estimate that the canal project is adding about 25-30% of industry value each year and as such, any delays or loss of productivity on site will impact output in the construction industry. We have already factored the delays into our forecasts, however, should the halt in construction due to cost disputes be a prolonged one, we will be looking to shift our construction forecasts along, with lower growth in 2014 and higher growth in 2016, when we are currently forecasting a 20% contraction in construction industry value. If construction of the canal were to be delayed, it could avoid the deep recession we are forecasting in Panama's construction industry, as the US$1bn-plus Panama City metro project is due to begin in 2016.

Another potential beneficiary of a completion date being pushed back is the US East Coast ports, many of which have been struggling to prepare their harbours and landside infrastructure in time for the first post-Panamax vessels to come through the canal. BMI's Shipping team believes that any delays in construction will buy ports such as Savannah and Miami more time to complete the extensive expansion and dredging works needed to receive these vessels.

However, such an event may prove troublesome for the United Group's finances. The project has been seen as a key addition to Sacyr's construction order book at a time when the company has struggled in its domestic Spanish market. Sacyr, whose debts at the end of September were three times its market capitalization, has staked a lot on the canal expansion, and depends heavily on its foreign business. The company made 55% of its revenue outside Spain in the first nine months of 2013, and Panama contributed 25% of the US$1.78bn in international sales. The news of the cost overrun dispute sent Sacyr shares plunging by more than 18% as trade opened on the Madrid stock exchange.

Canal Risks Evident
Sacyr Share Price

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Sector: Infrastructure, Shipping
Geography: Panama
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