Double trouble: The global economy is being choked

December 20, 2023

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Even before the Houthis choked shipping traffic through the Red Sea, shipping costs were rising because of challenges within one of the world’s two key transport choke points. Now the other is threatened.

The Panama Canal, which handles about 5 per cent of world trade and is a key piece of infrastructure for trade between North America and Asia, is drought-affected – the worst drought in nearly three quarters of a century – and has had to slash both the number and the draughts of vessels moving through its complex series of locks.

More than 12 per cent of the world’s trade passes through the Suez Canal.Credit: Bloomberg

Now the Suez Canal, which plays a far more vital role in global trade – more than 12 per cent of the world’s trade passes through the canal – is being impacted by the flow-on effects of the conflict in the Gaza Strip, with the Iranian-backed Houthis attacking more than a dozen vessels.

Most of the major shipping companies have either diverted their ships away from the Red Sea or are considering re-routing them around the southern tip of Africa, the Cape of Good Hope.

The attacks have been occurring at the southern end of the Red Sea, off the coast of Yemen, in the narrow Bab el-Mandeb Strait. The Suez Canal is at the northern end of the Red Sea.

The Suez Canal, the key point in the trade route between Asia and Europe, had been benefitting from the reduced volumes and increased costs of ships using the Panama Canal, with about 50 ships a day using the canal and more than $US1 trillion ($1.5 trillion) a year of products moving through it before the attacks began impacting the traffic. Now both the key choke points in global shipping have been throttled.

Just as the issues affecting the Panama Canal have caused diversions of traffic and increased the time and costs of moving goods between North America and Asia, so will the effective closure of the Suez Canal increase the time and costs of the Asia-Europe round trips.

Re-routing ships around the Cape of Good Hope adds about 40 per cent to the distances ships will have to travel, at an estimated additional cost of around $US1 million, mostly for the extra amount of fuel required. It will also weeks to the journey.

Insurance premiums have already blown out because of the increased risks and, for those diverting around the Cape of Good Hope, the extra time and distance. War risk premiums for those braving the Red Sea have leaped almost 1000 per cent.

With the Suez Canal handling more than 20 per cent of the world’s container traffic, 12 per cent or so of the seaborne oil trade and around 8 per cent of the international shipments of liquified natural gas, that will have significant implications for global supply chains.

It is helpful that, after the severe disruptions generated by the pandemic that played such a significant role in soaring inflation rates in major economies, supply chains had reverted to pre-pandemic levels of functioning and costs.

The Panama Canal has been hit hard by droughtCredit: Bloomberg

There will, however, be an increase in shipping costs, an increased demand for oil because of the longer routes, and disruptions to the flow of goods because of the additional time required to move them from their points of origin to their destinations.

The question marks over the severity and duration of the impact of the Houthis’ attacks on the Suez Canal and the potential for a wider regional conflict will have a particular influence on oil and gas prices.

The oil price has risen – it is up about $US6 a barrel to around $US79.50 a barrel in the past week (albeit, way below the near-$US100 a barrel prices experienced in late September) – and gas prices in Europe spiked after BP announced it was pausing all its Red Sea shipments.

Some Middle Eastern producers ship oil through the Red Sea and Russian oil shipments to Asia via the Suez have rocketed since Europe, formerly its largest energy market, sanctioned Russian oil and gas in response to the invasion of Ukraine.

Russia has recently started opening up an Artic route to China, aided by the changing environment in the ice-prone region but, to date, the volumes shipped have been experimental and modest.

Because of its response to the war in Ukraine, Europe is now highly reliant on LNG from the Middle East and Asian markets to replace its former dependence on Russian pipeline gas. It faces delays and significantly increased energy costs if the threats to safe passage to and through the Suez are protracted.

If energy and transport costs rise and supply is disrupted as a consequence of the Houthis’ actions, there will be inflationary effects, albeit at this stage probably quite modest effects.

The caveats to that conclusion, of course, are whether the US-led response, a multinational naval taskforce that will try to protect ships in the Red Sea, is successful and whether that intervention serves to draw Iran more directly into the conflict.

The last time the Suez traffic was impacted significantly was in March 2021, when the Ever Given one of the world’s largest container ships, somehow wedged itself across the canal and caused a very lengthy queue of ships either stuck in the canal or waiting to enter it.

The blockage was cleared within a week but added to the existing supply chain issues caused by the pandemic.

Today, in a slowing global economy with more normal supply chains and shipping volumes, there will be time and costs added by the re-routing of ships and their cargoes but the pandemic-era shortages of labour, goods and ships experienced at the height of the pandemic that exacerbated the economic effects aren’t present.

That suggests the impacts of the effective closure of the Red Sea and Suez Canal to much of the world’s shipping are probably containable, albeit that, in such a volatile region and in such volatile and unpredictable circumstances, it’s impossible to reach definitive conclusions.

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Double trouble: The global economy is being choked

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