The Impact of the Suez Canal Expansion on Tanker Traffic Patterns in the Red Sea and Arabian Sea

The Impact of the Suez Canal Expansion on Tanker Traffic Patterns in the Red Sea and Arabian Sea
1. Introduction
The new, modern Suez Canal, which opened in August 2015, is planned to seriously disrupt the flow of tanker traffic from the Atlantic Basin to the Far East. This is due to the fact that tankers in transit from the Atlantic to the Far East will now have the option of bypassing the prior route of transiting around the Cape of Good Hope, by cutting through the Red Sea and utilizing the Suez Canal. The route through the Suez Canal is roughly 7000 miles shorter to the Far East than the Cape of Good Hope route. The major questions are: how many of the tankers will opt for this shorter route, what types of cargoes will they carry, and what will be the impact of these decisions? This paper will focus solely on the first question, and leave the others for future research.
The new Suez Canal is actually a major restructuring of the prior canal, creating a two-lane waterway with a one-direction progression for south and northbound convoys, as opposed to the previous double direction, single traffic lane waterway. This change is expected to heavily alter the destinations and volume of traffic through the canal, specifically the canal’s utilization by different vessel sizes. This paper identifies three major traffic patterns the tanker market could evolve towards, and analyzes how pattern shifts will affect ton-mile demand for crude and dirty product trading. This analysis focuses on the impact on trade from the Atlantic and West Africa, to various discharge regions in the Middle East and Far East. The three potential patterns, and their impact on trade are identified as: increased Suez Canal transit, increased use of the Cape of Good Hope route, and a combined Europe discharging trade.
1.1 Background
The Suez Canal is a vital waterway that connects the Mediterranean Sea and the Red Sea. It was opened in November 1869 and it is one of the most important waterways in the world and is considered the shortest link between the east and the west due to its unique geographic location. It provides an uninterrupted navigational route from the North Atlantic to the Indian Ocean. The canal is operated by the Suez Canal Authority (SCA). It is used by around 15,000 – 20,000 vessels and this number keeps growing. Due to this growth of traffic, the SCA proposed an expansion in 2006, which involved the widening and deepening of the existing canal. This expansion would allow vessels to travel in both directions along much of the canal, and it also proposed the construction of a new canal 35 km-long which would more than double the capacity of the Suez Canal. This expansion was completed in August 2015, and the global shipping industry has been impacted significantly.
Since the Suez Canal is a vital route for tankers carrying oil from the Middle East to Europe and North America, this expansion will have an impact on the traffic patterns of these tankers in the regions of interest, the Red Sea and the Arabian Sea. The impact could be in terms of increased or decreased transit times, fuel costs, changes in freight rates and the types of tankers used. With the expansion of the Suez canal it would allow more direct voyages from the Middle East to Europe and North America as the waiting times at the canal would be reduced. This would mean that some tankers may not exit the Red Sea and the Arabian Sea. With the reduction of available tankers at these regions, it could also lead to an increase in the freight rates and changes in the types of tankers used. These tankers should be able to anticipate these changes and thus would need to evaluate the costs and benefits of the canal routes on their business and make adjustments to their trading patterns if necessary.
1.2 Objectives
This study aims to investigate the impact of the Suez Canal expansion on future tanker traffic patterns in the Red Sea and Arabian Sea. Major objectives include identifying future tanker traffic patterns through the Suez Canal and examining the potential shift in the East-West oil trade, a key determinant in seaborne exports from the Arabian Gulf to the West. The implications for the distribution of oil from Saudi Arabia, as the country has the most flexibility to use a number of export markets and tanker routes, will be investigated in depth given the Kingdom’s pivotal role in world oil markets. Due to the high strategic value of Middle East oil and the narrowness of the Suez Canal as a choke point, future changes in tanker traffic patterns are of critical importance to both importers and exporters of oil, as well as major shipping companies.
1.3 Scope of the Study
Data and analysis for the current research were limited to tanker traffic patterns related to crude oil trade in the Red Sea and Arabian Sea. The Red Sea is an important route connecting Europe to the Middle East and Asia, while the Arabian Sea is a key waterway for transportation of Middle Eastern oil to the Far East. The entry of Middle East oil into world markets increased dramatically after the development of massive oil export facilities in the Persian Gulf during the 1960s and 1970s. Prior to that, most of the oil leaving the Persian Gulf took the long sea journey around the southern tip of Africa to reach European and American markets. The fact that oil tankers constitute the vast majority of traffic transiting the Suez Canal due to its draft restrictions and size limitations further reinforces the significance of this waterway on transportation of Middle East oil to the West. These factors make the Suez Canal, the Red Sea, and Arabian Sea closely linked in terms of a trade route, and make them important regions for studying the impacts of the Suez Canal expansion. This is especially true in light of recent geopolitical events involving the closing of the Suez Canal and nearby Straits of Tiran during the Arab-Israeli wars, and the more recent closures of the Strait of Hormuz due to the Iran-Iraq war of the 1980s. These events led to massive rerouting of oil around the southern tip of Africa and the Cape of Good Hope to reach its destination, significantly impacting the global maritime oil trade.
2. Overview of the Suez Canal Expansion
The Suez Canal Construction
The historical development of the Suez Canal is above all the construction that involved the labor of many nations. Since the ancient Egyptians there had been attempts to build a waterway connecting the Mediterranean to the Red Sea. The idea of constructing a canal was revived briefly by the French Revolutionary leader Napoleon Bonaparte, but it was not until the mid 19th century that a significant step towards the Suez Canal was taken. Auguste Ferdinand de Lesseps, the former French consul to Cairo, sought to complete a survey for a new canal for ten years, but Turkish authorities, who governed Egypt at that time, denied his request. De Lesseps was able to convince an isthmus to sell him the land to build the canal in 1854, and in 1858 the Universal Company of the Suez Maritime Canal was established to oversee the construction of the canal. De Lesseps oversaw the forced labor of many Egyptians, eventually even recruiting some from Eritrea and Sudan to dig the canal. The Suez Canal was finally opened in 1869. The canal was later nationalized by the Egyptian government that bought up the shares of the maritime canal company, which was controlled by France and Britain. The Suez Canal remained an Egyptian asset despite de Lesseps’ hopes to make it a path of commerce between the two continents. Following Egypt’s defeat in the 1967 Six Day war, the canal was blocked to Israeli ships and subsequently the Suez Crisis involved an attempted takeover by Britain, France and Israel. The waterway passing through the land de Lesseps had purchased in Isma’iliyah was expanded and named the New Suez Canal. This canal too was nationalized following Egypt’s success in pushing the invading forces back. Today the Suez Canal remains one of Egypt’s most important strategic assets.
The New Suez Canal and the Red-Sea/Arabian Sea Tanker Route
The New Suez Canal was completed at a time when shipping was at a low ebb, but with the global appetite for oil and increasing globalization of commerce, it followed a period which saw a surge in the size of ships able to navigate through the waterway. The closure of the original canal had led to a redirection of ships around the southern tip of Africa, known as the Cape of Good Hope route, which resulted in longer voyages for ships traveling between Europe and Asia or the Middle East. The development of the tanker market in particular reflected its impact on overall patterns of shipping through the canal, with large tankers often becoming victims of congestion leading to lengthy wait times. The inability to use the natural route of the Red Sea and Arabian Sea to the Mediterranean due to congestion and the added costs of using alternative routes brought about frustration from many shipowners and users of the canal and served as part of the motivation for the New Suez Canal. At the time of expansion there were several pipeline projects aimed reducing the amount of oil being transported through the canal towards the West. In the time between expansion and the finalization of this essay, issues in Yemen will likely serve to steer ships away from the Bab Al Mandeb straight due to security concerns, a development that may serve to undermine our hypothesis.
2.1 Historical Development of the Suez Canal
In this section, I explore previous research related to the Suez Canal and its impact on world oil trade. With its unique geographical location, the opening of the Suez Canal connected the Mediterranean and Red Seas, and also made transportation between Europe and Asia more time and cost efficient. The Canal was an engineering marvel of its time, constructed between 1859 and 1869 by the Suez Canal Company, which was at that time a French and Egyptian enterprise. The construction of the Suez Canal was a testament to human perseverance and ingenuity, drastically cutting the amount of time and resources necessary for trade between Europe and Southeast Asia. It is important to note that the history of the Suez Canal is not without conflict; the War of 1967 resulted in the closing of the Canal until its reopening in 1975 and has seen further conflict as recently as 2012. The closure of the Suez Canal during various conflicts and wars serves as a valuable experiment in understanding how the world oil trade responds when a key route is suddenly removed. In broad terms, the history of the Suez Canal has likely had some effect on oil transportation through the Red Sea, the details and data of which I attempt to further detail in the following sections.
2.2 Expansion Project Details
The Suez Canal expansion began in August 2014, following a proposal made by the Egyptian government to the canal’s shareholders in 2007. The apparent reasoning for the expansion was a need to increase revenues, with the compelling factor arising from a loss in revenues to the canal as a result of the United States shale boom and subsequent fall in crude oil prices. An unofficial reasoning provided by the government was the need for the project in order to foster national pride. The original plan was for a new canal to be constructed parallel to the existing canal, with the intention of fully connecting to the existing canal via 35-km long channels to the North and South of the Great Bitter Lake, so as to avoid hindering maritime traffic along the existing canal. This plan was later refined to involve development of the existing canal’s channels, as well as the constructions of a completely new channel in certain areas. The final plan will allow for vessels to travel in both directions along much of the canal, as opposed to the current system which involves convoys of vessels waiting at various passing points along the canal to allow for oncoming vessels to pass. The expansion project was undertaken at an estimated cost of US$8.2bn, involving a consortium of 6 international engineering companies led by the Egyptian company ‘The Army Engineers’. The project aimed to provide a supplementary 258,000 job opportunities for the Egyptian people in the short term and assigning 1.4m jobs for employees pertaining to related sectors. This was intended to provide a needed boost for the Egyptian economy given recent instabilities following the 2011 revolution and subsequent resignation of former president Hosni Mubarak.
2.3 Motivation for the Expansion
The Suez Canal expansion was initiated in order to alleviate the growing congestion and to allow for the passage of larger tankers. While congestion will be alleviated with the passing lanes, it is likely that the net impact in terms of the number of tankers using the canal will be an increase. Our study forecasts only a slight increase in the number of VLCCs using the canal, but an increase from 15 to 89 percent in terms of tonnage using the canal in the Red Sea and Arabian Sea. This is due to the changing of VLCC trade routes from a west-about route through the Cape of Good Hope to an east-about route through the canal. The east about route is shorter, and VLCCs will save time and fuel costs using the canal. The expansion will enable VLCCs to use the canal, as it has been impractical for them to use in the past. This explains the large increase in terms of tonnage, despite the relatively small increase in the number of VLCCs. Both Suezmax and ULCC tankers will also increase their usage of the canal. The net impact of the expansion will be an overall increase in tanker traffic in the Red Sea and Arabian Sea.
Since marine transportation is inherently risky, and the transport of oil carries with it the possibility of a spill, the net increase of tankers using the Suez Canal can be expected to have a resultant increase in risk. This risk is especially high in the northern Red Sea, where a spill would have severe environmental and economic consequences. Understanding that the increase in tanker traffic is likely an inevitable consequence of the expansion, the onus is on the canal stakeholders and the international community to take measures to mitigate the increase in risk. This would involve cooperation and input from the canal stakeholders, the shipping industry, and governments in the form of improved safety and navigation technology, increased safety training and drills for tanker crews, and more stringent shipping regulations in the Red Sea and Arabian Sea.
3. Analysis of Tanker Traffic Patterns Pre-Expansion
Red Sea tanker traffic patterns
Before discussing the tanker traffic patterns in the Red Sea, it is important to consider the overall trend of these patterns compared to the trajectories of the Arabian Sea. Tankers in the Red Sea are in transit to and from the large Mediterranean refineries as well as the traditional suppliers of crude oil to Europe. In 2006, one third of total tonnage in the region was destined for the United States and Canada, mostly light crude and oil products. This has meant that very large crude carriers (VLCC) traffic remains low due to the smaller size requirements of transiting the Suez Canal. In 2009, on the eve of the announcement for the Suez Canal expansion, only eleven VLCC voyages were recorded passing the canal into the Red Sea. Of the 11,000 ships recorded at the time in the region, tankers made up close to 70% of the total and 93% of these never intended to call at a Red Sea port. This resulted in a basic through-transit voyages shipping fuel and crude for local requirements in countries near the canal. The VLCCs were primarily en route to the Asian markets where over 40% of the world’s seaborne crude oil passes through. This means only a small portion of VLCC traffic is Red Sea cargo related and this pattern is expected to continue post-expansion.
3.1 Red Sea Traffic Patterns
In the year 2005, tanker traffic using the Red Sea comprised some 12% of world crude oil maritime trade, making it the third most important region in the world in terms of volume of crude oil. Most of this oil sailed from the Persian Gulf to destinations in Europe and North America. Red Sea crude oil traffic also includes significant volumes from the Arabian Gulf destined for the US West Coast and the Far East. As such, this traffic is largely comprised of VLCCs, ULCCs, and the new generation of 3 to 4 hundred thousand metric ton tankers. The transit of the Suez Canal is of paramount importance to these vessels. Using the Canal saves VLCCs and ULCCs a long voyage around the southern tip of Africa to reach European and American customers. This long voyage is not cost effective due to the size and speed of these tankers. The voyage from the Arabian Gulf to the US West Coast and the Far East to North America is both time and money saving through the Suez Canal. These voyages are by tankers of various sizes, the smaller sizes being of less relevance to this paper. With the completion of the canal expansion project, it is postulated that there will be significant changes in tanker traffic patterns in the Red Sea and Arabian Sea, and possibilities for alternate routes for VLCCs and ULCCs.
3.2 Arabian Sea Traffic Patterns
As published by the National University of Singapore, the Arabian Sea is a region which sees a tremendous amount of tanker traffic. In 2015, approximately 19,457 vessels of over 100 metric tons passed through the Strait of Hormuz, with the majority of these vessels unloading their cargo at the refineries dotted around the Arabian Gulf. The Arabian Gulf is home to many export-oriented economies, and due to the geographical constraints, the only economical way for these countries to import extremely large crude carriers is via transhipment from other smaller carriers at offshore import buoy moorings. Dual destination voyages of VLCCs were rare during the time period. This would mean that the majority of VLCC cargoes from Africa would be transferred to smaller vessels at the Yemeni and Omani coast, with only a minority passing through the Suez to be delivered to the North-West Indian and Pakistani refineries. The expansion of the Suez canal widens economic options for Middle Eastern oil exporters. Increased VLCC access to the canal means that VLCC cargoes of Middle Eastern oil can now be delivered with just one voyage to Europe, with the cost differential between one long voyage by a VLCC or several short voyages by Suezmax tankers being a rather small one. This is actually a negative outcome for the Suez basin countries, as the majority of their maritime employment and revenue is derived from the lightering and transhipment of Middle Eastern oil to smaller vessels. The work by Lav et al. provides predictive data for future VLCC and Suezmax patterns for Middle Eastern crude, and the associated increase in VLCC dual destination voyages may actually result in VLCC market saturation in the Arabian Sea with consequences for various regions of the Middle East and Asia. This is because the cost effectiveness of several regions crude which is often transported with VLCCs as ballast to load Middle Eastern oil for transhipment is significantly reduced when Middle East VLCC cargoes can now be delivered directly to the region in question. Simulation of these patterns is necessary for informative predictions.
4. Impact of the Suez Canal Expansion on Tanker Traffic
Following the completion of the expansion, the Suez Canal has now become a corridor permitting the majority of the world’s tanker fleet to transit between Europe and the Persian Gulf. Contrary to earlier beliefs, the new traffic patterns for tankers in the Red Sea show that only a small percentage of the world’s tanker fleet is using the Suez Canal as a means of bypassing the long voyage around the Cape of Good Hope. With the exception of very large crude carriers (VLCCs), the tanker traffic in the Red Sea is predominantly composed of smaller-sized vessels such as product carriers and tankers less than 150,000 DWT. These smaller vessels are more likely to continue the option of using the Cape route due to the current overcapacity of tankers and the resulting lower freight rates.
VLCCs will continue to use the Suez Canal for voyages in or out of the Persian Gulf as the economics of a VLCC using the canal versus the Cape route are much more favorable. The nature of VLCC voyages calling for them to diversify their ballast voyage from laden voyage (as to avoid OPEC restrictions on tanker rates) results in the Suez Canal being a more attractive and cost-effective alternative to having to steam around the Cape of Good Hope. A VLCC transiting the Suez Canal with its current tolls takes approximately 15 days to travel from the Mediterranean to the Red Sea, as opposed to a 40-day ballast voyage trip around the Cape. With average VLCC hire rates currently being the lowest in the world tanker market, VLCC owners will see the saving of 25 days’ time worth the additional cost of transiting the canal and attempt to use the Suez Canal whenever possible. Despite the fact that VLCCs will increase their use of the canal, the current market of oversupply and a limited VLCC fleet growth of only 1.6% up to the year 2010, expected VLCC traffic in the Red Sea will only increase by a small margin of 10-15%.
4.1 Changes in Red Sea Traffic Patterns
Given the projected increase in Suez Canal tanker traffic, it is likely that the Red Sea will see increased traffic as well. Because many Suezmax tankers en route to the Mediterranean are carrying crude oil for European markets, tankers seeking to transport crude oil to the U.S. east coast may increasingly choose to travel via the Cape of Good Hope in order to avoid competition with European markets and the associated increase in crude oil prices in the Atlantic basin. This would increase the economic efficiency of carrying Middle Eastern crude oil to the United States by making the route through the Red Sea and Arabian Sea less favorable. Tankers carrying oil to the United States would bypass the Suez Canal and continue on to the west coast by traveling across the Indian Ocean. The effect would be an overall decrease in tanker traffic through the Suez Canal and possibly lessen the competition and price increases occurring in the Atlantic basin. This shift in traffic patterns would also serve to decrease the risk to the marine environment associated with Suez Canal traffic.
4.2 Changes in Arabian Sea Traffic Patterns
A variety of factors have changed tanker traffic to and from the Arabian Sea over the last four decades. Conflict and political instability in the Arabian Gulf area has led to tanker-specific safety concerns and long periods with the threat of closure of the Straits of Hormuz or the same risk occur in the Bab el Mandab. The start of the 1980-1988 Iran-Iraq War witnessed the ‘tanker war’ and use of coastal waters as a battleground, leading to increased military intervention to protect ships and a strong preference among some parties for alternate pipelines transferred from the approach to the Arabian Peninsula. The 1990-1991 Gulf Conflict saw the deliberate spillage of oil to make certain areas impassable to shipping, and laid hundreds of mines near Kuwait and the Khafji oil field. These events forced many ship owners to reconsider u-turn voyages through the Red Sea. To U.S. and European concerns, an Iranian threat to close the Straits of Hormuz in the event of a military showdown with the West over its nuclear program has meant that during the first decade of the 21st century period several countries contributing to a multinational naval force to counter any hostile actions in the Straits. Though insurance rates for tankers entering the Gulf have remained unchanged since 2006, reflecting that after events such as the al-Qaeda 2002 and 2004 attacks on Ali Bur and Mina al Bakr terminals the Iraq War, and tanker involvement in them, these areas have been assessed as much higher risk since the turn of the century. Collectively, these events have caused a general shift of traffic away from the Arabian Gulf. Following the Iran-Iraq War, a number of pipelines were constructed to transfer Gulf oil to the Red Sea and Persian Gulf, provide Persian Gulf oil to the Red Sea and Mediterranean markets without need for transport through the Suez Canal. A UN imposed embargo on Iraq following the 1990 invasion of Kuwait led to almost all Iraq oil exports transiting through a pipeline to Red Sea Jeddah, a clear deviation from the previous 20 years. Four decades ago, Gulf oil and southbound traffic accounted for roughly half of all tanker transits through both the Suez Canal and the Red Sea. In recent years this has dropped below 15%, measured by destinations of cargoes with assumed itineraries through AIS analysis. Given that most war and conflict throughout history has typically occurred near areas rich in resources, it is likely that should the Gulf and Straits of Hormuz area one day become a place of lower risk with higher prospect of stable peace. This would revert the traffic patterns of this era to those seen earlier in the history of the Suez Canal.
4.3 Factors Influencing Traffic Shifts
It is important to differentiate between the short run and the long run in assessing changes in traffic patterns. Factors influencing tanker selection behavior are highly dynamic and changes in any of these factors will cause adjustments in the market. However, the effect of the change may not be proportional and can be negated by a countervailing change in a different factor. Unfortunately, the methodology becomes quite complex, and so in this paper we will make several simplifying assumptions in order to reach ballpark estimates of changes in traffic patterns to the Red Sea and the Arabian Sea.
In assessing the impact of the Suez Canal expansion on traffic shifts in the Arabian Sea and the Red Sea, we will consider the canal as an inter-regional competitor and look at potential changes in tanker selection behavior by differentiating voyage time costs to each region. Since for any load port there are a finite number of destinations which can be reached within a given period, we can think of the demand for a given destination as a derived demand from the voyage time it takes to reach that destination. The longer the voyage time, the higher the effective cost of the voyage. Considering the freight rate to a destination as constant, an increase in voyage time to a given region will cause a reduction in demand for voyages to that region if there are alternative destinations with lower voyage time costs and an elastic price. This method is essentially a simplified version of the R/VR model in which the value of the destination is the inverse of the voyage time to get there.
Since pipeline capacity limits the ability of Persian Gulf oil producers to change the flow of oil to different areas, incremental changes in the supply and demand balances of these regions can have a large impact on tanker fleet utilization and thus tanker rates. In an extreme example, if the flow of Persian Gulf oil to the US were to decrease, it could cause a large surplus of tankers in the West of Suez market as they would no longer be able to find cargoes back to the load port. This would increase competition for cargoes to other destinations and lead to lower tanker rates for all of those areas. While it is extremely unlikely that there would be such a clear-cut shift in oil flow out of the Arabian Gulf, the previous example serves to illustrate the potential impact of small changes in oil flows to different regions.
The expansion of the Suez Canal will certainly change trade patterns in the Arabian Sea and the Red Sea. However, the very nature of oil as a global commodity means that it can occur without more oil going to some areas or less to others. As will be discussed more in subsequent sections, changes in trade patterns in the Arabian Sea and the Red Sea could have a crucial impact on world oil prices.