Contents 1. EXECUTIVE SUMMARY INTRODUCTION COMMODITY CARGO AND COST- SHORTEST ROUTES... 5

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2 Contents 1. EXECUTIVE SUMMARY INTRODUCTION COMMODITY CARGO AND COST- SHORTEST ROUTES INVENTORY REDUCTION AND TIME- SHORTEST ROUTES IMPACT OF THE PANAMA CANAL EXPANSION CONCLUSIONS ACKNOWLEDGEMENT APPENDIX... 17

3 Table of figures Figure 1: North America divided into regions according to which port should be used for least- cost travel from/to Shanghai Figure 2: The red line separates that portion of North America closest to a west coast port from that closest to an east or Gulf Coast port Figure 3: Chicago is a large market that falls close to the boundaries of four ports: Tacoma/Seattle, Los Angeles/Long Beach, Baltimore, and Savannah. The red circles are proportional to city populations Figure 4: North America divided into regions according to which port is time- closest to Shanghai Figure 5: Imports from China in $/Kg by East and West coasts ports according to USA trade census data Figure 6: New East- West divide assuming a 15% discount on the sea portion of the all- water route through the Canal (red line) Figure 7: A 20% reduction in the price per TEU makes the Suez route more attractive for northern ports between New York and Norfolk and nearly cost indifferent for the ports of Charleston, Savannah and Jacksonville when compared to the Panama Canal.. 13 Figure 8: North America divided into regions according to which port is cost- closest to Rotterdam.... 2

4 The Panama Canal and the Race Among US East Coast Versus West Coast Ports John J. Bartholdi III and Amar Ramudhin Georgia Tech Panama Logistics Innovation & Research Center January 2014; revised August Executive Summary The widening of the Panama Canal, scheduled for completion in 2015, may fundamentally change the flow of Asian goods imported to the US. Ports all over the East Coast of the US are racing to upgrade their infrastructure to be ready for the bigger ships that will be coming through the Canal. These ports will then be better equipped to compete with the larger West Coast ports for goods from/to Asia. This struggle between US West Coast and East Coast ports will re- direct some of the flow of cargo from Asia and so re- allocate economic opportunities. Here we examine this struggle from the points of view of transportation cost and of inventory cost and conclude that not all US ports are affected equally. Some ports are thrown into very particular struggles and may be surprised to find out who their competition is. We show the west- east divide for cargo from Asia under various pricing scenarios and conclude that although price is an important factor for the attractiveness of the maritime route through the Canal, the safety and reliability of this route are key elements to enable its sustainable growth. 2. Introduction In 2006, the Panama Canal Authority estimated that 38% of the Northeast Asia U.S. trade was through the Canal to the East Coast ports, 61% through the West Coast intermodal system, and the Suez Canal had only a 1% share 1. Currently, about 65% of all containerized cargo from China still enters the US from the west coast, especially through the ports of Los Angeles and Long Beach 2. From there it travels, mostly by rail, to points east for further distribution. Most of the remaining 35% travels through the Panama Canal and then north to East Coast ports near the population centers 3. This all- water route can be cheaper to the 1 Proposal for the Expansion of the Panama Canal Third Set of Locks Project, Panama Canal Authority, April Note that according to another study (USDA, 2010), in 2006, the West Coast accounted for 75% import from Asia, with only 19% to the East Coast ports through the Panama Canal, with the rest (6%) going through the Suez Canal. The difference between the two sets of statistics might be due to the list of countries included in the definition of Asia vs. Northeast Asia. 2 Based on 2013 data from the US Census Bureau.

5 East Coast because it does not require additional handling to transfer to and from rail; but it takes longer and so shippers have more days of inventory in transit and thus higher inventory costs. The widening of the Panama Canal, scheduled for completion in 2015, may fundamentally alter the costs of transport and so potentially re- jigger supply chains from Asia. This has frequently been described as a struggle between US West Coast ports and East Coast ports as these ports try to broaden their areas of dominance and redefine the west- east divide for cargo from Asia. Here we examine this struggle and find interesting details. We conclude that this struggle does not affect all ports equally. Some are thrown into very particular struggles and may be surprised to find out who their competition is. The question of where exactly lies the US west- east divide has been the object of numerous studies, debate and speculation 4. We show how the dividing line for cargo from Asia changes under various land/sea pricing combinations and predict the effects of an increase in flow through the Suez Canal. We conclude that although price is an important factor for the attractiveness of the maritime route through the Canal, the safety and reliability of this route are key elements that will result in sustainable growth. We consider two types of shipments, that sent by the cheapest route and that sent by the fastest route. 3. Commodity cargo and cost- shortest routes Commodity cargo is of relatively lower value and transportation represents a significant portion of the total investment. Such cargo is typically shipped by the cheapest route. Consider shipments from Shanghai to the US. Figure 1 divides North America into regions 5 according to which port provides minimum cost transport for shippers to/from Shanghai: Tacoma/Seattle, Oakland, Los Angeles/Long Beach, Houston, Miami, Jacksonville, Savannah, Charleston, Baltimore, Norfolk, or New York/New Jersey. Each region contains one port, and that port lies on the least expensive path of goods movement from Shanghai to any point within the region. Figure 1 shows that it is 3 The US Census Bureau reports data at port level and hence it is possible to distinguish between East and West Coast ports but not by routes (Panama vs. Suez). But as of January 2013, the services through the Panama Canal accounted for 72% of Asia- US East Coast TEU capacity whereas the remaining 28% was through the Suez Canal. Since then some services have shifted to the Suez Canal. 4 See the Appendix for examples. 5 This is a construct known as a Voronoi diagram.

6 cheaper to serve most of the Midwest through the ports of Tacoma/Seattle and Los Angeles/Long Beach than through any of the other ports. Figure 1: North America divided into regions according to which port should be used for least- cost travel from Shanghai. To construct this figure we have assumed travel as the crow flies. This is optimistic because it means, in effect, that each region has the very best transportation system possible, so that freight can travel directly from any port to any location. We expect this to become more true over time as transportation infrastructure is improved. We have further assumed that moving freight overland is nearly six times 6 more expensive than moving it by ship Of course our assumptions are only approximate and so Figure 1 is only approximate. Land transportation prices will vary by port based on volume and, because freight is transported on trucks and rail, the boundaries will not really be smooth lines. But the important thing for us is not the exact shape of a boundary, nor the size of a region. The important fact is that there is a boundary: Any port will be cost- preferred for locations that are close enough. What is important is the topology of the region and in particular what other regions are immediate neighbors. The boundary between two regions represents the front line in an economic struggle between two ports contending for business. We refer to the region surrounding a port as its natural catchment area, where one would expect it to have a competitive advantage under our model of transportation costs. 6 Based on the November 2013 Shanghai Container Freight Index, the cost of moving a 40 container to US East Coast or US West Coast port was approximately the same at a rate of $0.26 per mile while the spot market intermodal land price was about $1.50 per mile

7 An interesting feature of the topology is that it scarcely changes for any realistic value of the relative costs of ship and truck/rail 7 as can be seen in Figure 2 where the land travel price from Tacoma/Seattle was increased by 15%. In all such cases, the natural market region of the ports of Los Angeles and Long Beach borders that of the port of Oakland. The red line in Figure 2 indicates the divide between regions for which inland transport is cheaper through a West Coast port and those for which it is cheaper through an East Coast port. Figure 2: The red line separates that portion of North America closest to a west coast port from that closest to an east or Gulf Coast port. The race to upgrade capacity can be seen as an attempt by Western ports and Western rail to push the red boundary further east, while the Eastern ports and Eastern rail are attempting to push it back west. Each wants a bigger region, with more population and so more business, for itself. From Figure 3 it can be seen that ports directly contend where their catchment areas abut. From this point of view, to the extent that there is a struggle between coasts, it is really a struggle between Los Angeles/Long Beach on the West Coast and Houston on the Gulf Coast, and between Tacoma/Seattle on the West Coast and Baltimore on the East Coast. All other ports compete more directly with their neighbor ports on the same coast. For them, any improvement in cargo- handling or hinterland transportation would likely take business from their neighbors and not from the opposite coast. This is most 7 Or even, in many cases, the identity of the distant port. Compare Figure 1 with Figure 8 in the Appendix, which shows the regions of low cost for shipments to/from Rotterdam.

8 clear for Miami, which competes only with Jacksonville, and is thus removed from any East Coast- West Coast competition. It can also be seen that Oakland and Norfolk occupy similar positions on their respective coasts. Each is caught between neighbors to the north and south that hem in its competitive region. This means that these ports need to be much more efficient than their neighbors and/or have better hinterland connectivity to increase their catchment areas. Each port has incentive to expand its competitive region, but the costs and benefits are not symmetric. If a port such as Los Angeles/Long Beach reduces its costs, it takes business from four neighbors over a very large area. In contrast, cost reductions at the port of Miami would win increased market only from Jacksonville and only along the Floridian peninsula. For Miami, winning an extra hour s travel worth of business is not likely to amount to much. The more neighbors a region has, the more competitors for the business within that region. For example, Oakland has only two natural competitors (Tacoma/Seattle and Los Angeles/Long Beach) while Savannah has five (Jacksonville, Houston, Los Angeles/Long Beach, Baltimore, and Charleston). In general, competition among ports is fiercer on the East Coast, where ports typically have more competitors and where large metropolitan areas lie close to boundaries. Figure 3: Chicago is a large market that falls close to the boundaries of four ports: Tacoma/Seattle, Los Angeles/Long Beach, Baltimore, and Savannah. The red circles are proportional to city populations. When considering the population within each region we can again understand the greater intensity of competition among ports on the east coast, where moving a

9 boundary only a short distance can encompass a much greater population and so more freight. From this point of view (Figure 3), Tacoma/Seattle and Los Angeles/Long Beach have a greater incentive to improve operations than do East Coast ports. If they can push the red line eastward, it will be into areas of greater population density, including the metropolitan areas of Dallas, San Antonio, and Austin. In contrast, if Baltimore, Savannah, and Houston push the red line farther west, it will be into sparsely populated regions of the US and so will not bring much return. Chicago has a large population and so is an attractive market. Figure 3 shows that it is contested by four ports whose regions meet nearby: the ports of Tacoma/Seattle, Los Angeles/Long Beach, Savannah, and Baltimore. Even Norfolk could make a play for it. Similarly, St. Louis lies close to the regions of Los Angeles/Long Beach, Houston, and Savannah. Table 1 shows the potential contenders for the major cities that are close to the west- east divide. Cities Austin, Dallas, San Antonio St- Louis, Chicago, Milwaukee Other observations: Contenders Los Angeles/Long Beach and Houston Los Angeles/Long Beach, Tacoma/Seattle, Baltimore, Houston, Norfolk, Savannah Table 1: Potential contenders for major cities close to the west- east divide Many large distribution centers are located within a corridor along the mid- Atlantic that includes Memphis, Lexington, and Cincinnati for which Savannah could be the preferred port for East Asian freight. Despite its smaller catchment area,, Norfolk moves a lot of goods to the Midwest because of a good intermodal connection to that region. It is an excellent example of a port that has successfully overcome its distance handicap to attract and distribute higher volume of goods than its neighbors (see Table 2). 4. Inventory reduction and time- shortest routes If inventory is sufficiently expensive it becomes more important to move it quickly, to reduce the expense of in- transit inventory. Figure 4 shows the dominance of West Coast ports when it is important to get product quickly from East Asia.

10 Figure 4: North America divided into regions according to which port is time- closest to Shanghai. Figure 5: Imports from China in $/Kg by East and West coasts ports according to USA trade census data. For most of the US it is faster to ship through Tacoma/Seattle than through any other port. The only exception is Southern California, for which it faster to ship through Oakland. Once again this figure is only approximate as it assumes straight- line distances to all destinations inland. In actuality, the ports of Los Angeles/Long Beach distribute a lot more goods to the Mid- West and to even some of the more Eastern cities because of good hinterland connectivity by two of the largest class 1 railways in the US: Union Pacific and BNSF. When speed is important, the East Coast ports cannot compete for East Asian product. This fact is confirmed by Figure 5, which shows the evolution of the average value per kilogram ($/kg) of goods imported from China by West Coast ports and East Coast ports since The value per kg of goods imported through the West Coast ports have remained at least 40% more than the East coast ports since 2003.

11 5. Impact of the Panama Canal Expansion The race to upgrade the ports on the East Coast of the US is a direct consequence of the expansion of the Panama Canal. Once the expansion is completed in 2015, ships up to the New- Panamax class with roughly TEUs will be able to sail through the Canal. It has been conjectured that these bigger ships will reduce the price per TEU along the all- water route, increasing the area served by the East Coast ports and pushing the west- east divide further to the west. Figure 6 shows the new divide assuming a 15% reduction in the sea portion of the travel 8. As can be seen, most of the region gained is sparsely populated and therefore will be a small gain for the East Coast. in aggregate, favoring Baltimore at the expense of Tacoma/Seattle and Houston at the expense of Los Angeles/Long Beach. Another thing to note is that any reduction in cost of sea travel will shift the dividing line farther in the north than in the south, because sea travel is a larger component of transportation costs through the northeastern ports. On the other hand, an increase in cost to transit the Panama Canal would shift the dividing line to the east, and equally for all ports. Figure 6: New East- West divide assuming a 15% discount on the sea portion of the all- water route through the Canal (red line). Shipping lines are now receiving many of the newer and larger vessels that were ordered in the heyday before the crash of and it is certain that these larger vessels will be introduced on the all- water route from Asia to replace the older Panamax 8 An 8000 TEU vessel has operating costs up to 17% lower than a 4000 TEUs vessel according to the Proposal for the Expansion of the Panama Canal (2006). 9 Post- Panamax vessels make up 48% of the cellular fleet capacity today and as of January 2013, they represented 77% of total capacity on order.

12 vessels 10. In spite of the new vessels being more energy efficient, they will have to carry more cargo and it has been conjectured that, for a given rotation, this consolidation may result in fewer stops (possibly only one or two) along the East Coast ports to be more cost effective. This would mean that some ports, especially those that are not yet ready for the big ships, will lose out. Analysis of Table 2 reveals that, except for Jacksonville, all of the East Coast ports have at least one service with a TEU Post- Panamax vessel. Furthermore, these TEU vessel services make at least three stops at different East Coast ports and one service (MSC Golden Gate) stops at six of the seven East Coast ports under consideration. Although in general it is true that larger ships tend to make fewer stops, the above observations seem to alleviate the risk that larger vessels will imperatively make only one or two stops on East Coast ports. Furthermore, the high number of services from Asia to most of the East Coast ports indicates that there is room for some service consolidation without any significant degradation of service level to these ports. Table 2: US Ports throughput, readiness and number of service from Asia. The Number of Service from Asia as well as Largest Ship From Asia as listed in Compair Database as of January * Since the data was obtained, the TP7 service from Maersk has moved to the Suez Canal. To receive the New- Panamax class vessels, a port must have a depth of at least 50 feet and be equipped with Super Post- Panamax cranes capable of loading and unloading these ships. All the West Coast ports are ready for the bigger vessels whereas the race is on for the East Coast ports, with only Norfolk ready and Baltimore soon to follow. As can be seen from Table 2, Charleston, Jacksonville and Savannah will not be ready to accommodate the larger New- Panamax class vessels coming through the Canal if it opens in 2015 and, once again, it is feared that these ports might lose cargo to the New- Panamax ready ports. This will be most damaging for Savannah as it is the East Coast port with the most services from East Asia (15) and is one of the main contenders in the 10 A Panamax ship is the largest container vessel that can traverse the Panama Canal today and has a capacity of about TEUs.

13 west- east struggle as well as a contender for goods to the Chicago area. However, Savannah already handles TEU vessels 11 and if the larger vessels coming through the Panama Canal on its services do not exceed this limit, it will continue to thrive and may even benefit from the lower price per TEU on the all- water route. All of the ports on the East Coast have at least one service from Asia coming through the Suez Canal and usually these services use larger Post- Panamax vessels. As the ports on the East Coast upgrade their capacity, the Suez route becomes more attractive since it can accommodate larger vessels over the New- Panamax limit. This could be the single biggest threat for the Panama Canal, not just because larger vessels mean potentially a lower price per TEU but also because this route offers more potential for filling the larger vessels as they can consolidate goods from Asia to US, Europe, Middle East and North Africa and pick up more en route. From Shanghai, the distance to the East Coast ports along the Suez Canal is 15 25% longer than through the Panama Canal and hence a 25% reduction in price per TEU via the Suez Canal would completely wipe out the cost advantage of the Panama Canal even if the latter remains faster (Figure 7). And as production in Asia moves towards South China, Malaysia, and Vietnam the Suez route will become even more attractive. Figure 7: A 20% reduction in the price per TEU makes the Suez route more attractive for northern ports between New York and Norfolk and nearly cost indifferent for the ports of Charleston, Savannah and Jacksonville when compared to the Panama Canal. 11 Which is double the size of the current Panamax limit.

14 6. Conclusions It should be emphasized that this analysis is only suggestive. We assumed that transportation cost is proportional to distance or to time and that freight travels directly, without detour or interruption. Despite these simplifications, some general insights hold true: In particular, it is too broad to say that the competition is between ports of the West Coast and ports of the East Coast. First, the competition will be for commodity product only. When speed is important, the West Coast ports win. Furthermore, some ports will be affected more than others. On the West Coast Los Angeles/Long Beach and Tacoma/Seattle will feel the East- West competition most; and Baltimore and Savannah will feel it most on the East Coast. And this competition will focus on winning business in the Chicago area. It is a fact that larger ships will be coming to the US East Coast ports since the shipping lines will replace the older Panamax vessels by the newer and larger, more cost effective, vessels to return to profitability. We have already started to see alliances between the shipping lines to make better use of their available capacity. This will result in a consolidation of services to the US East Coast ports. For example, the P3 alliance consisting of Maersk, MSC and CMA CGM could replace three weekly services from Asia by a single weekly service with a larger vessel. This means that the East Coast ports must not only have deeper channels and berths for the larger vessels but must also triple current capacities to load, unload, store, and move containers inland. This is a challenge as it involves numerous stakeholders, organizations and logistics operators. In its 2006 proposal for the expansion of the Panama Canal 12, the Panama Canal Authority predicted that during the next twenty years cargo volume transiting the Canal would grow an average 3% per year, doubling the tonnage of 2005 by These projections, together with the fact that the Canal is nearing its maximum capacity and that shipping lines are investing in larger post Panamax vessels, were the main motivations for the Canal expansion project. The expanded Canal promises to be more efficient, with plenty of capacity to maintain its competitiveness to capture future demand. However, cargo growth through the Canal has been relatively flat in recent years due mainly to the recession. But cargo from/to US East Coast still represents 54% of all cargo going through the Panama Canal. While the Panama Canal expansion triggered the race for the East Coast ports to be Post- Panamax ready, this race could turn out to be disadvantageous to the Canal as the upgrading of US East Coast ports opens more 12 Proposal for the Expansion of the Panama Canal Third Set of Locks Project, Panama Canal Authority, April 2006

15 opportunities for the Suez Canal to US East Coast bound cargo. Larger vessels will require more cargo and shipping lines could deploy new services that consolidate cargo to the US East Coast from several ports starting from Shanghai to ports further south such as Singapore, that lie at the inflexion point for routes through the Suez Canal or Panama Canal, wiping out the distance advantage of the Panama Canal. Finally, it should be emphasized that this analysis has been done from the point of view of freight moving from East Asia to the US market. For freight moving in the opposite direction the ocean portion of the trip is much cheaper because of the need to balance the flow of containers. The effect is to shift the catchment areas of the ports eastward, to the advantage of US West Coast ports.

16 7. Acknowledgement The Georgia Tech Panama Logistics Innovation & Research Center is funded by the Government of Panama through SENACYT. The authors would like to thank the analysts of the Center for their hard work and dedication.

17 8. Appendix Estimates of service areas for West Coast and East Coast ports West Coast versus East Coast seems to be a common theme in discussing the effects of widening the Panama Canal. Source: Figure 5 from A Competitive Analysis of Panama Canal routes by R. Ungo and R. Sabonge, IAME 2011, Santiago de Chile Source: canal- expansion/

18 Source: Princeton Consultants, via WorleyParsons The market share demarcation line for discretionary cargo could shift further west with an expanded Panama Canal. Existing Panama Canal System After the Panama Canal Expansion Source: Panama Canal Authority Source: Jones Lang LaSalle, Perspectives on global supply chains, Spring 2011

19 Commodity shipments from Rotterdam Figure 8 shows the region of cost-nearness surrounding each port for cargo to/from Rotterdam. The general topology is unchanged but shifted considerably. Some observations: Montreal and Baltimore have become much more important Houston serves a larger region, but much of it is sparsely populated. Tacoma and Los Angeles/Long Beach play a greatly diminished role. Figure 8: North America divided into regions according to which port is cost-closest to Rotterdam.