3rd December 2014

The Nicaragua Canal Commercial and Strategic Interests Disguised as a Megaproject?

Even if the Canal is not built, there may be millions of dollars to be made for those involved, and benefits for Nicaragua.

By Dr. R. Evan Ellis

On November 20, 2014, the government of Nicaragua announced that work on the much discussed Nicaragua Canal project would begin on December 22nd. The revelation in the absence of an overarching environmental impact study, a detailed plan for the project, or a public bidding process to select the firm to perform the work is but the latest chapter in a project whose details have been shrouded in secrecy, and which has generated a new cycle of speculation and suspicion with each passing phase.

Without ruling out that the canal could eventually be built, this article argues that the $50 billion megaproject principally creates a circus of activity, within which both the Hong Kong-based businessman Wang Jing and persons affiliated with the family of Nicaraguan leader Daniel Ortega can make hundreds of millions of dollars in work and commissions on commercial projects in the next several years until the current version of the scheme is ultimately discredited.

The initial focus of the canal project is likely to be the development of a new commercial port at Brito, accompanied by a commercial free trade zone, and possibly an airport near the city of Rivas, projects which are commercially lucrative even if the canal itself is not built.

On July 7th of this year, Brito was announced as the Pacific-coast entrance of the Nicaragua canal. The canal project thus logically requires development of the port, both as a part of the integrated logistics package that the canal would ultimately represent, but also, in order to bring in the heavy machines and material required to build the canal and other related works.

Yet the development of also represents a highly lucrative venture for those who would operate it, those who would construct it, those who own the land upon which it would be built. Sources close to the canal indicate that much of this land is owned by the Ortega family.

Once constructed, there is also a reasonable business case that the port would be a profitable operation. There are currently few major commercial ports on the Pacific Coast of Latin America

between the Mexican port of Lazaro Cardenas in Mexico and the Peruvian port of Callao, with Balboa (Panama) and Buenaventura (Colombia) being the two exceptions. Within this area, Brito provides a natural deep-water port which could be connected to the rest of the region with modest investments in highway or rail infrastructure. The further development of the area as a multi-modal freight consolidation and distribution hub, leveraging the free trade zone and development of the airport at Rivas, would only add to this value.

The postulate that the real near-term project being done in the name of the canal is the development of the Brito-Rivas corridor, reconciles a number of inconsistencies in announcements made about the canal to date.

First, the main Chinese construction partner in the project, China Railway Road, lacks the hydrological experience required to dig a canal possessed by other Chinese companies with a well-established presence in the region such as China Harbour, SinoHydro, or China Water and Electric. Yet China Railway Road does have experience in constructing ports and the highway infrastructure to connect it to the rest of the region.

The initial focus on Brito also would explain how HKND can already have decided to begin construction on the project when no overall environmental impact assessment has been released by the Spanish company charged with the project, Environmental Resources Management (ERM), and when no overarching contract award or financing plan has been published.

Even if the near-term focus is development of the Brito-Rivas area, however, it is likely that work on the canal itself will proceed in some form, insofar as such activity legitimizes and contributes to the perceived value of the other commercial investment projects being done in the canals name as the managers of the project seek investors and political cover.

Such postulate notwithstanding, the possibility that the canal will actually be constructed cannot be ruled out. Were this to occur, there is mounting circumstantial evidence that the venture would be principally financed and worked by Chinese interests, with tacit backing from the Chinese government.

Such indications include the lack of transparency in the contracting process, which makes attracting investment from Western sources particularly difficult for a venture the size of the canal, as well as the previously mentioned detail that no sources of financing or major western participants have been announced, less than a month before the declared start date.

The naming of the Chinese state-owned company Xuzhou Construction Machinery Group (XCMG) as the potential sole-source equipment supplier, with no apparent role for Western companies such as Caterpillar or Volvo (or of Chinese private companies such as Sany Heavy Industries) further suggests that the Chinese government could be the silent partner in the project. This postulate is further reinforced by the mostly-Chinese composition of the team selected to do studies and design work for individual components to date, including the Changjiang Institute of Survey, Planning, Design and Research (for canal design), CCCC Second Harbor Consultants (for port design), China Railway Siyuan Survey and Design Group (for overall project design and roads), the Civil Aviation Engineering Consulting Company of China (for design of the Rivas airport), and Shenzhen lay-out Planning Consultants (to design the free trade zone).

If the project does go forward, it will significantly alter the commercial and political dynamics of the region, and will create new issues between Nicaragua and its neighbors. Costa Ricas current president, Luis Guillermo Solis, has already expressed concern to his Nicaraguan counterpart Daniel Ortega over the possible environmental impact of the canal on Costa Rica, and is likely to take issue

with the contribution of the periodic dredging of Lake Nicaragua that the project will require, on the quantity of silt flowing into the San Juan river, which forms part of Nicaraguas border with Costa Rica. Similarly, Colombia is likely to be concerned by a new flow of commercial ships between European ports and the Atlantic entrance of the Nicaragua Canal; the route passes in close proximity to Colombias San Andreas island and through the nearby cays, whose surrounding waters were the subject of a dispute between Nicaragua and Colombia before the International Court of Justice, decided in Nicaraguas favor in November 2012.

If the canal is completed, its operational control by a Chinese company, and its physical location in a country not well disposed toward the United States would ease PRC concerns that the United States could block passage of Chinese warships between the Atlantic and Pacific oceans, or impede the movement of commercial goods to China in time of conflict.

Yet the more significant strategic advantage accruing to the PRC government would be the ability to work with the administrators of the canal on issues such as pricing, prioritization of ships, and approval of new classes of vessels, as a vehicle for influencing other actors in the region such as the Panamanian government, international shipping companies, and major commodity suppliers such as the Brazilian iron ore producer CVRD, whose bottom line would be affected by the ability to use the Canal.

Whether or not the Canal is completed, it is remarkable how the Canal has proven to be a siren song for some of the worlds most respectable firms, inducing them to put their international reputations at risk in the pursuit of enormous, long term income streams that they believe that involvement with Canal-related activities could represent for their firms. Their logic most likely involves self-assurance that the Canal is simply one professional project more, and that the firms can manage the risks through internal control and the maintenance of ethical standards.

Yet already, the highly respected Washington DC-based firm McLarty Associates has truncated what initially appeared to be a long-term relationship with Wang Jing. While the public explanation given was that McLarty successfully completed the short project for which it was hired (and has not yet been contracted by Wang Jing for further work), such a one-time relationship is somewhat unusual in the consulting world. An alternative possibility is that the questions raised about Wang Jing and the Canal may have made the firms leadership consider the damage that prolonged, high-profile association with the project could have on the reputation of the firm.

In a similar fashion, the reputable Spanish environmental firm Environmental Resources Management (ERM) finds itself called to put its name on a globally scrutinized environmental impact study. Yet the traditional role of such a study in determining whether the project should go forward does not seem to apply in the case of the canal, given that the Nicaraguan government has already announced that work will begin on December 22.

Perhaps most significantly, sources close to the canal project suggest that McKinsey & Company, among the most respected international consulting firms, is currently negotiating with HKND to develop the business case and risk management strategy for the canal, and even more ambitiously, to assume a project management oversight (PMO) role. McKinsey was involved with a preliminary study analyzing the market for the Nicaragua canal using a methodology that some logistics industry experts suggest is based on invalid assumptions regarding the growth and composition of the demand for maritime shipping traffic. If reports of McKinseys plans to move into a major program management role for the canal project are accurate, it would arguably represent a significant gamble for the firm. While the Nicaragua Canal project could give McKinsey ironclad bonafides in the program management market, doing so would likely require the firm to scale up employment in an area in which its service offering is still relatively new, while selling one of the worlds most high

visibility logistics projects, with the risk that the project could collapse in an array of lawsuits and recriminations with the McKinsey name attached to it.

Although it is difficult to anticipate how the canal project will turn out, if it ends badly, it is likely that it will leave in its wake an array of damaged international firms, each of which were willing to suspend disbelief over the project, attracted by the hope of significant gains, and others who escape, having realized enormous earnings.

Construction companies, real estate investors, consultants and lawyers tied to the Ortega family stand to make millions of dollars, even if the project collapses. Indeed, the complex relationships between the multiple companies of the mysterious young Hong Kong billionaire Wang Jing suggest that the pursuit of legal action against him, and his allied investors, would be tied up in the courts for years, if not decades.

Yet sadly, it is likely that the most significant loser will be the Nicaraguan people. The February 2013 enabling law for the canal establishes a legal framework for dispute resolution which establishes mechanisms for arbitration in international courts, committing the reserves of the Central Bank of Nicaragua. It will not be the first time that the aspirations of the Nicaraguan people to achieve development and prosperity through radical action will have been disappointed.

Dr. R. Evan Ellis is professor of Latin American studies with the Strategic Studies Institute of the U.S. Army War College. The views expressed in this article are strictly his own.