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High Stakes Brinkmanship at the Panama Canal

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Courtesy ADP
Last summer's optimism as huge gates arrived on-site has vanished as contractural negotiations have turned rancorous.
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Ferdinand de Lesseps arrived in Panama in 1879 as the most famous engineer in the world. He had accomplished the impossible: the construction of the Suez Canal. Five years later, de Lesseps' reputation was in tatters.

The French-backed attempt to build a canal through Central America collapsed after gross financial mismanagement and a vast underestimation of the project's environmental complexities. It would take another three decades for a canal to be completed.

While the controversy over cost overruns that has engulfed the Panama Canal's $5.2-billion Third Lane Expansion is vastly different than the one de Lesseps faced, the Frenchman's experience more than a century ago serves as a warning. Failing to find solutions risks an enormous delay in time, money and reputation for all those involved.

And the stakes today are unimaginably higher. Over the past century, the waterway has been a lynchpin for global commerce, and the importance of its continued operation is now of critical international importance. In 2012, the canal saw a record 333.7 million tons of goods shipped through its locks. The prospect of an expansion that will allow the passage of post-Panamax vessels and double that waterway's capacity has been anticipated across the globe for almost a decade.

When the Panama Canal Authority (ACP) launched the expansion project in 2007, optimism prevailed, but there were concerns the effort was too ambitious for the quasi-governmental agency. When the ACP chose to unify both sets of locks into one enormous contract, many thought the risks involved had been dangerously amplified. Eyebrows raised farther when the consortium Grupo Unidos Por el Canal (GUPC) won the work with a bid more than a billion dollars under the next-lowest offer.

From the very start of the locks work, the consortium has struggled to meet the high standards required for the concrete mix. Two years ago, the schedule slipped by six months, triggering a $573-million claim that has yet to be resolved. The breaking point seems to be a December letter the ACP sent to the consortium demanding a response to a series of problems on the project. GUPC responded with a threat to stop work on Jan. 20 unless financial relief was provided.

The canal authority insists the contractor must use the contract's arbitration process to press its claims. GUPC argues the overruns are so large that, without financial assistance, it must suspend operations. Initially, both sides fired off strongly worded public statements accusing the other of acting unfairly. Since then, a series of meetings have resulted in more conciliatory public statements.

Earlier this month, the ACP proposed a joint-payment solution that would advance GUPC $283 million to continue work as long as certain conditions were met. The contractor balked, insisting a much greater amount was needed but later agreeing to push back the stop-work deadline to Jan. 31 as the details of a co-financing agreement were discussed. Since then, negotiations have been behind closed doors.

The standoff is a zero-sum game for both parties if negotiations fail to reach a compromise. While the ACP says it has the financial resources to finish the project, the completion date likely would be extended by years. A delay could affect their bottom line. The financing of the expansion project is being underwritten by increases in tolls; these increases, in turn, have been met with increasing resistance by the shipping industry and are not likely to be received any more warmly in the future.

For GUPC to walk away would be a devastating blow for the parties that comprise the consortium, which includes Spain's Sacyr, Italy's Impreglio and Belgium's Jan de Nul. Not only would they still face long legal battles over the financial aspects of the contract, the global reputation for the companies would suffer severely.

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