Tension in the South China Sea

Oil Companies Shun South China Sea As Geopolitical Tensions Rise

Oil Price,

3 January, 2015

The South China Sea is continually paraded as a region rich in oil and gas deposits; however, no one really knows what’s there with any degree of accuracy. Furthermore, these possible deposits are shrouded in conflict that will not abate anytime soon, and will most likely worsen with an intensification of the security competition between China and the United States along with its regional allies, which is tightly related to these disputes.

The available exploration information in the South China Sea is either limited or old. So, there are assumptions, but evidence is shaky. The EIA estimates there may be nearly 11 billion barrels of oil and 190 trillion cubic feet of natural gas in proved and probable reserves all based on 2013 estimates and of course, 2013 prices. Not only were these reserves thought to be somewhat inflated at the time, but given the lower pricing currently available, this is potentially far less.

Much of these proved and probable reserves also reside in uncontested areas of the South China Sea, making for safer, albeit potentially difficult investments. This is an important distinction to make since we should be focusing on the contested areas of the South China Sea when referring to the current feasibility of oil and gas operations in the South China Sea. The core disputes in the South China Sea revolve around the Spratly and Paracel Islands, along with various shoals throughout the region typically located closer to the Philippines.

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So, what deposits do these areas contain? Not much. The Spratly Islands do have some moderate, confirmed deposits but even these areas are not fully explored, and the known figures are contentious. Estimates range anywhere from 800 million to 5.4 billion barrels of oil in the Spratly Islands and associated shoals. 

These estimates are imprecise, and the only work that was being conducted there has ceased. A recent casualty of this conflict was the UK-based Forum Energy, which was forced to cancel their joint work with the Philippines in developing a bloc in contested territory after the Chinese voiced concern. This turn of events was so negative for the company, they even had to delist their shares from the London Stock Exchange. And, the Paracels don’t even seem to have any serious oil and gas deposits at all. There aren’t any confirmed resources in the area, nor do geological formations predict any significant finds in the immediate region, according the USGS.

If oil and gas deposits are only ancillary factors driving these disputes in the South China Sea, then what is? The main driver here is territoriality and security for China and the other competing states in the region. The underlying fundament for both is nationalism, which heavily constrains all competing states from compromise. And, as time goes on, compromise becomes even more difficult. So, the issue of energy has become intertwined with this contest for territory, leading, for instance, heads of national oil companies to refer to their oil platforms as “mobile national territory” in their speeches.

This security competition leads to troubling dynamics emerging in the region, which is economically the fastest growing in the world and responsible for nearly all oil demand increases over the past several years. The main concern is a rising power, China, potentially upsetting the regional security order, which in turn makes all other states in Asia feel less secure. This triggers a reaction from other states whereby they must counter that rising power in order to maintain their own security, fueling the potential for a conflict spiral.

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China also likes to exercise escalation dominance, a practice used heavily by the Soviet Union during the Cold War, and what the strategist Edward Luttwak likes to refer to as “localized escalation dominance” in the case of China and its regional relations. In this sense, China will seek to settle these conflicts on favorable terms by sharply escalating a conflict at each level, putting the onus on the opposing side to escalate further into more dangerous territory. This means the situation has a greater chance of escalating quickly and spiraling out of control.

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China is determined to gain as much military control over the South China Sea as possible, not necessarily to protect the sea lines of communication, but to provide a certain amount of strategic depth in their maritime environment, which has been a perennial weakness for China ever since the decline of Chinese naval power after the voyages of Zheng He in the 15th century.

Outside of the catastrophic potential for open conflict between China, the United States, and regional allies, there is another more probable implication of this spiral. In the age of nuclear weapons, those same weapons induce a healthy dose of caution in all belligerents, and rightly so. This also means that involved parties will instead likely be pulled into some form of economic warfare with China before any possible conflict would break out, proving difficult for some states in region. Think trade and currency wars before localized conflicts. he point is, the first step would be economic warfare causing great pain throughout the region.

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More immediate, any drilling or investments in the region would have to be carefully considered before any escalation in the region, economic or otherwise. If exploration or drilling were to commence in areas contested by China, expect to see harassment of the operations, impediments to work, and other state sponsored indirect and asymmetric means to discourage effective operations.

Another key concern for any investments would be China related business interests. Western companies that may wish to explore and develop in contested waters will be putting other business interests at risk that may be tied to China or other Chinese entities. Think global joint ventures and access to fields and markets within China’s mainland that may be denied. This is not to be taken lightly since Chinese oil companies are involved in nearly every resource rich emerging market, and the capacity of the Chinese market is quite large.

There is a strong possibility that the region will witness increasing geo-economic conflict between China, neighboring countries, and the United States. As a result, the South China Sea will likely become caught in the middle of increasing tensions and posturing throughout the Asia-Pacific. In short, there are very serious long-term dynamics shaping the investment climate in the South China Sea that should give any investor pause.

By Ryan Opsal of Oilprice.com