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Will IMO 2020 pull Asia containers from East to West Coast?

The Panama Canal is designed as a shortcut. It’s the most impressive shortcut ever built in the history of mankind. For shippers sending U.S. liquefied natural gas and liquefied petroleum gas to Asia, it drastically reduces voyage time.

But when it comes to Asian containers being shipped to the U.S., the Panama Canal is not a shortcut. Between Shanghai, China and the Port of Prince Rupert, Canada (which connects via rail to Chicago), it’s 4,678 nautical miles. Between Shanghai and Los Angeles/Long Beach it is 5,708 nautical miles. To Charleston, South Carolina via the Panama Canal, it’s 10,170 nautical miles. To New York/New Jersey, it is 10,582 nautical miles.

In other words, it takes roughly twice as much travel at sea to get from Asia to the U.S. East Coast via the Panama Canal than to the West Coast. Starting on January 1, 2020, this disparity is about to matter much more than it ever has before.

Marine fuel surcharges

On that date, the IMO 2020 rule goes into effect, mandating that sulfur content of marine fuel and emissions cannot exceed 0.5 percent.

Unless a ship has an exhaust ‘scrubber’ installed, this will require operators to switch to ultra-low sulfur fuel, including marine gas oil (MGO), which is expected to be much more expensive than the high-sulfur heavy fuel oil (HFO) used today.

How much more expensive MGO and other ultra-low sulfur fuels will be compared to HFO remains a topic of considerable debate, but there are some estimates that compliance could cost an extra $300/ton of fuel. Container lines are seeking to recoup all of the extra cost from shippers through bunker adjustment factor (BAF) charges.

The BAF will account for voyage distance. Every extra day at sea means more consumption of compliant fuel. Thus, the cost to ship containers from Asia to the U.S. East Coast rather than the West Coast should theoretically increase in relation to the extent that the cost of IMO 2020-compliant fuel exceeds that of HFO.

Moving the East-West Coast ‘dividing line’

For a shipper bringing Asian cargo to the near vicinity of East Coast ports, this won’t matter. A Manhattan cargo shipper will still book slots on vessels transiting the canal and coming into Newark. But the further west you go into the hinterland, the more it will matter.

Prior to IMO 2020, there has been a line of demarcation in logistics decision-making running north-to-south, roughly around the Ohio River Valley down to Nashville, Tennessee. To the east of that line, it makes sense to bring Asian containers by sea through the canal to an East Coast port, then westward via truck. To the west of that line, it makes more sense to bring Asian boxes into Los Angeles/Long Beach, Prince Rupert or Seattle/Tacoma, then use intermodal rail to bring them east (and trucks for the final leg).

Where this decision-making line is ultimately drawn has major financial implications. The further west it moves, the better for the Panama Canal, East Coast ports and trucking. The further east, the better for rail carriers and West Coast ports.

IMO 2020 might tug this line eastward, to the benefit of West Coast terminals. But according to industry experts interviewed by FreightWaves, the equation is not so simple. Even if there is a huge jump in the price of marine fuel, there may not be a significant shift in volume back to West Coast ports and away from the

Panama Canal.

“If you look at this in isolation, and marine transportation fuel goes up and U.S. domestic transportation fuel doesn’t, that would suggest more cargoes would go to the West Coast,” said Jim Blaeser, a director in the transportation and infrastructure practice of global consultancy AlixPartners.

According to Paul Bingham, director of transportation consulting at IHS Markit, “The BAF adjustment upwards in shipping prices could have an impact on East Coast versus West Coast port competition, because the extra sailing distances consumes a significant amount of additional fuel.”

Risk mitigation

But Blaeser emphasized that the decision can’t be looked at in isolation. “Many shippers use the East Coast ports for risk mitigation, so that they don’t put all their eggs in the same basket,” he told FreightWaves.

“Most of the major brands and retailers try to leverage a ‘four-corners’ strategy, where they have freight through the Pacific Northwest, Southern California, Southeast and Northeast. They want to make sure that if there’s a natural disaster, a port strike or extreme congestion, they’re not depending on one gateway.”

Blaeser noted that any shipper decision on which coast to call on is based on a combination of cost, time and risk elements – not cost alone. “If you’re optimizing the cost element, you’re putting more eggs in the least-cost basket,” he said, pointing out that this increases the risk element.

Panama Canal response

“Also, if there was a dramatic flow of cargo going back to the West, those with a vested interest in maintaining East Coast flows – the carriers, the Panama Canal and the ports – would respond,” said Blaeser.

“There are smart people at the Panama Canal. Billions of dollars have been invested in one of the biggest assets on earth. They will not sit idly by and watch their volumes decrease,” Blaeser continued.

FreightWaves specifically asked the Panama Canal Authority (ACP) whether it was concerned that IMO 2020-induced BAF charges would make the Panama Canal route less attractive versus the West Coast route, and if so, whether its latest round of incentives for container lines is related to that concern.

ACP officials did not respond directly to those questions, but they did provide comment. ACP environmental specialist Alexis Rodriguez said that the ACP is “a vocal supporter” of IMO 2020 and acknowledged that “the canal anticipates that the implementation of IMO 2020 may create business and operational disruptions across industries.”

ACP liner services leader Argelis Moreno de Ducreux said that both loaded container volumes and average vessel size to the U.S. East Coast have continued to grow and asserted that the Panama Canal “expects to maintain its market share.”

Congestion and domestic fuel costs

If an IMO 2020 fuel spike does push a material volume of containers to West Coast ports, there would be other offsetting factors, as well. According to Blaeser, “If the IMO 2020 impact was so strong that it started to sway the balance of freight back to the West Coast, those ports would see congestion and other efficiency issues. At the end of the day, there’s only so much cargo the West Coast can handle.”

There is also the very real possibility that IMO 2020 will not affect the price of marine fuel in isolation, but will also hike the price of U.S. diesel. “If all the fuel goes up proportionally [ocean, rail, trucking], you’ve just maintained equilibrium,” said Blaeser.

However, if fuel costs for all transport modes surge in unison, there would be an implied benefit for rail. “If there are higher fuel costs across the board, there’s more incentive for shippers to use slower modes of transportation, so you would see them trading out of trucks into intermodal. There are a lot of shippers that bring containers into Los Angeles/Long Beach and use trucks well into the Midwest. If fuel prices rose overall, more of that would go to rail,” he said.

Shipping decision timing

Yet another factor in the post-IMO 2020 East Coast-West Coast equation involves the timing of the fuel cost impact and how long U.S. shippers believe it would persist.

Ships are required to have compliant fuel in their tanks by January 1, 2020, which means they have to burn off all of their non-compliant fuel by then. For larger ships on longer routes such as container ships traveling between Asia and the U.S., the switch to more expensive compliant fuel will have to begin around October.

U.S. shippers bringing cargo in from Asia have likely already made their routing decisions by now on containers that will be shipped in October. Given that the future spread between the cost of compliant fuel and HFO remains unknown, it’s unlikely that many shippers have preemptively made the switch from the East Coast to the West Coast. If there is a major IMO 2020 fuel price effect, it would more likely affect routing decisions made in 2020.

These decisions may not even happen in 2020, explained Blaeser. “If you switch from the East Coast to the West Coast, it’s not the biggest decision in the world, but it still has an impact on your network. If you’ve established your network, it’s often best not to upset it for something that could be a temporary phenomenon.

“If you look at tariffs, is that temporary? Maybe, maybe not. If it’s temporary, and you change your network, the cost of changing it may be greater than the cost of the temporary phenomenon. I’m not saying IMO 2020 is going to be temporary, but the cost phenomenon – the price shock – might be.”

Even if shippers in the Ohio River Valley ‘dividing-line region’ conclude they made the wrong decision sticking with the Panama Canal-U.S. East Coast route in the last quarter of this year and in early 2020, they may still hesitate to switch to the West Coast route later next year. They may conclude that it makes more sense to stick with the status quo.

Can carriers pass along fuel hikes?

The other big variable is whether ocean, rail and trucking carriers will even have the ability to pass along added fuel costs to shippers. According to Bingham, the IMO 2020 effect must be viewed in the context of the overall supply-demand balance for transportation.

“How much the fuel price increase drives routing changes is difficult to isolate with the complication of other factors affecting the total transportation prices that shippers pay,” he said.

“Continued supply pressure from excess capacity in the world container vessel fleet and the U.S. truck equipment fleet and softness in domestic U.S. rail and truck demand imply weak 2020 pricing power for carriers across those modes of transport,” Bingham explained.

“Ultimately, shippers don’t care about the various shipping mode cost component details, but the total shipping cost combined with delivery time and reliability,” Bingham told FreightWaves. “If other factors contributing to total delivered prices help offset the higher modal fuel costs, their routing decisions may not change much – if at all.”

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