South China Sea’s ‘Troubled Waters’ Complicate Oil Exploration Efforts

Posted on September 29, 2012

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While Asia’s two largest economies shadow-box in the East China Sea, unresolved territorial claims in resources-rich waters immediately south are complicating oil and gas developments aimed at meeting the region’s rising energy needs.

China and five other countries – Vietnam, the Philippines, Taiwan, Brunei and Malaysia – claim ownership to all or parts of the strategically-vital South China Sea, which provides 10 percent of the global fisheries catch and carries $5 trillion in ship-borne trade, equivalent to half the world’s shipping tonnage.

“With Asia’s growing appetite for oil and natural gas in deepwater areas, tensions have recently intensified between China and its neighbors Vietnam and the Philippines,” said HSBC analysts led by Thomas Hilboldt, Asia-Pacific Head of Oil, Gas & Petrochemicals Research, in a report on September 14.

Diplomats are scrambling to ease tensions between China and Japan, believed to be the worst in decades, over disputed islands – Senkaku in Japan and Diaoyu in China – in the East China Sea. Competing territorial claims in the South China Sea are adding to the strained regional geo-political backdrop, creating a legal minefield for energy producers who’re considering, or who already have, bought stakes in prospective oil and gas blocks in the area.

“Oil majors contemplating investment need a primer in international law as well as an appreciation of the historical and political background before they venture into this region,” wrote Tim Taylor QC, a partner at international law firm SJ Berwin, in a guest post in the Financial Times’ ‘beyondbrics’ column on September 19.

ExxonMobil, which has acquired Vietnamese blocks in the South China Sea, said last October it found oil and gas in its second exploration well, the Wall Street Journal reported in June.

Chinese state-owned energy giant CNOOC [CEO  202.73    -3.02 (-1.47%)   ] and the Vietnamese and Philippine national oil companies have offered international investors oil acreages in disputed waters in the South China Sea. That’s seen by some as a bid to further their national primacy and raises questions about who gets what if an asset is seized should relations deteriorate.

Parag Khanna, senior research fellow at New America Foundation, calls it “commercial nationalism”— where commercial agreements are created “to asset de-facto sovereignty like in Kurdistan and South Sudan,” raising expropriation risks.

A far more practicable solution would be the creation of “a shared technocratic special economic zone that ensures transparent profit-sharing.” Achieving this, Khanna argues, is not difficult. “It’s politics and national pride that’s getting in the way.”

The lack of a coherent framework of international rules and boundaries complicates matters for businesses. The United Nations has attempted to reach an inclusive multi-lateral framework but with little success.

Law of the Sea

The U.N. Convention on the Law of the Sea (UNCLOS) adopted in 1996 established a 200 nautical mile Exclusive Economic Zone from the shorelines of all coastal states on the South China Sea, granting them sovereignty over all the resources within this area, including the sea and seabed. But UNCLOS only required countries with overlapping claims to resolve them through good faith negotiations, and has yet to resolve any ownership disputes.

In May 2009, the U.N. Commission on the Limits of the Continental Shelf (CLCS) set a deadline for the submission of claims for extended continental shelves beyond 200 nautical miles. However, a joint submission by Vietnam and Malaysia resulted in a protest by China, stoking the most recent tension in the South China Sea.

China has continued to assert its sovereignty in the South China Sea using the so-called ‘Nine-Dash Line’, a U-shaped delineation based on historical records, apparently dating back hundreds of years.

“A legally binding supranational agreement to guide future development has numerous obstacles,” HSBC noted, though “CNOOC is considered to be well-positioned to benefit from significant upstream discoveries in the disputed sea.”

The Chinese energy state-owned giant already has a sizeable offshore footprint in the region. CNOOC has “significant exposure,” according to HSBC, “including resources in disputed areas.” At the end of 2011, 18 percent of CNOOC proved reserves were located in the Western South China Sea and 16.3 percent in the Eastern South China Sea.

In 2011, 15.2 percent of the oil and gas produced by CNOOC came from the Western South China Sea and 16.2 percent from the Eastern South China Sea. “While CNOOC’s production is located in undisputed areas, CNOOC Corp’s recently auctioned nine blocks are within waters contested by Vietnam, thus drawing protests from PetroVietnam and Vietnam’s government.”

It’s not hard to see why southeast Asian nations and, China in particular, are eager to stake their claim to overlapping maritime territories given potentially vast hydrocarbon reserves lying in rock formations in depths of around 1,500 meters.

More than ten oil basins in the South China Sea’s continental shelf hold an estimated 23 to 30 billion tons in oil reserves and 20 trillion cubic meters of natural gas, according to China’s Ministry of Land and Resources. That’s enough to supply China’s hydrocarbon demand for more than 50 years based on 2011 crude and natural gas consumption, explaining why, according to HSBC, “China is so intent on resource ownership rights.”

That Empty Feeling

October 2, 2012: Chinese construction efforts on Woody Island (one of the disputed Paracel Islands) have been accelerated. The workers are building a base that will be the center of Sansha, a new Chinese municipality (city). Sansha is actually Woody Island and dozens of smaller bits of land (some of them shoals that are under water all the time) in the Paracels and the Spratly Islands to the south. In fact, the new “city” lays claim to two million square kilometers of open sea (57 percent of the South China Sea).

This is part of a strategy based on the ancient principle that, when it comes to real estate, “possession is 9/10ths of the law.” It’s the law of the jungle, because all the claimants are armed and making it clear that, at some point down the road, force will be used to enforce claims. The nations bordering the South China Sea, and the new city of Sansha, are creating alliances and trying to persuade the United States to lend some military, or at least diplomatic support to opposing an increasingly aggressive China.

This aggression is popular inside China, where the government has increasingly been playing the nationalist card. All Chinese know their recent history. In the 19th century the corrupt and inept imperial government loss control of much of China (Hong Kong, Manchuria, and so on) to better armed and aggressive foreigners. Then the communists took control over 60 years ago and began to win China some respect. Now China is asserting its ancient claims on adjacent areas, like the South China Sea. But those ancient claims also include control of Vietnam, Taiwan, the Philippines and much of the Russian Far East. Asserting ancient claims is how the two World Wars began.

After secret diplomatic talks with China, the Philippines announced it would not send more troops to the disputed Spratly Islands. There are already a hundred Filipino marines based in the Spratly Islands and it’s unclear what the Chinese said to prevent more troops from being sent.

There is growing evidence that corruption and unreliable economic data is causing growing financial problems in China. There has been massive overbuilding, which has been impossible to hide. All those unoccupied residences and commercial buildings are very obvious. These were all built with loans from state-owned Chinese banks. The government refuses to reveal how badly the banking system has been hurt by all the obvious (and less obvious) bad loans.

There is a lot of corruption in China and several provinces and one major city (Dongguan) are talking about bankruptcy because they cannot borrow enough money to keep their unprofitable operations going. Sort of like what happened in Greece, but on a much larger scale. A major financial crisis could limit the loans needed to keep economic growth going. But it’s become clear that much of the economic growth in the last decade was created by building stuff that was not needed and is non-productive. Manufacturing and exports are declining and, despite the absence of government data, there is growing unemployment. The Chinese stock market has declined 20 percent in the last year and the holdings of the richest Chinese have gone down by a third in the same period.

The Chinese government has had problems in halting the growing number of anti-Japan demonstrations. These were allowed to start last month to put pressure on Japan over some disputed islands. The government has helped keep alive the memory of Japanese atrocities during World War II and the 1930s. Japanese troops and civilians behaved badly in China after Japan defeated Russia in a 1905 war. China inherited Russian “concessions” (Chinese territory the Chinese government had been forced, at gun point, to allow foreigners to operate in). Japan expanded this territory and essentially took control, with the object of making northern China a part of Japan. This sort of thing was very unpopular in China back then, and still is. Some Chinese journalists have called on the government to take military action, but this is not likely. That’s because the Chinese government has shown an aversion of actually fighting anyone.

September 30, 2012: Canada reported Cyber War attacks on two large energy firms and China is the chief suspect. The attacks may have something to do with Chinese attempts to buy large Canadian energy companies. Stealing secret operations data would make it easier to buy those firms, or at least make an offer most favorable to the Chinese.

September 29, 2012: In western China (Qinghai province) a Tibetan man burned himself to death to protest the Chinese occupation. In the last few years, over 40 Tibetans have burned themselves to death in protest, but the world is not really paying attention. There was a major uprising in 2008 which was quickly and brutally put down. Areas where Tibetan resistance is most active are flooded with additional police and the Chinese troops stand ready to crush anymore insurrections. The sixty year old Chinese plan for cultural assimilation of the Tibetans proceeds. This is how the Chinese empire has expanded for thousands of years, and all around the periphery of China there are unassimilated groups, most of them too small to bother with. The Tibetans are numerous enough to target for cultural assimilation.

September 27, 2012: Chinese politician Bo Xilai has been dismissed from the Communist Party and now faces prosecution for corruption. Bo was dismissed last August when it became obvious that he was at the center of a huge web of corruption. The government found itself having a hard time with damage control. Bo Xilai’s wife was subsequently convicted of murdering a British businessman, and given a suspended death sentence. She will most likely be out of jail in five years or so, in return for keeping her secrets to herself. Bo Xilai and his wife were at the center of numerous corrupt schemes, an arrangement that is increasingly typical in China. For the ruling families, corruption is a family affair, with everyone taking part. The state-controlled media would not discuss this, but most Chinese will. The Bo Xilai case is a major embarrassment for the communists.

September 26, 2012: In the United States a Chinese citizen is being prosecuted for trying to export restricted materials to firms working for the Chinese Air Force.

September 25, 2012: South China Sea disputes are heating up as Taiwan sends more patrol boats to the disputed (with China and Japan Senkaku islands). This resulted in Japanese and Taiwanese patrol boats fighting each other briefly at close range using water cannon. This is part of a problem caused by China’s neighbors refusing to accept Chinese claims to the entire South China Sea.

China was particularly angry because last month the Japanese government purchased the Senkaku islands from the Japanese family that had owned them since the 19th century. China and Japan are also sending small warships to patrol contested parts of the disputed Diaoyu (in Chinese) Islands (Senkaku in Japanese and Tiaoyutai in Taiwan). The islands are actually islets, which are 167 kilometers northeast of Taiwan and 426 kilometers southeast of Japan’s Okinawa and have a total area of 6.3 square kilometers. Taiwan also claims the islands, which were discovered by Chinese fishermen in the 16th century, and taken over by Japan in 1879. They are valuable now because of the 380 kilometer economic zone nations can claim in their coastal waters. This includes fishing and possible underwater oil and gas fields.

For China, the islands are a valuable source of fish, which Chinese fishing boats taking over 150,000 tons a year from the vicinity of the Senkakus. China fears that Japan might try to prohibit Chinese fishing in the area. A conservative Japanese political group built the lighthouse in 1986, to further claims of Japanese ownership. Currently, the Japanese have the most powerful naval forces in the region, and are backed up by a mutual defense treaty with the United States. China was long dissuaded by that, but no more. China is no longer backing off on its claims, and neither is Japan. So these confrontations are becoming more serious. Taiwan is not considered a serious contender in this dispute, but is showing up anyway.

September 23, 2012: China commissioned its first aircraft carrier, the Liaoning (formerly the Russian Varyag). This 65,000 ton, 305 meter (999 feet) long ship apparently performed well during over a year of sea trials. All preparations have been made for flight operations, which do not appear to have taken place yet (except perhaps for helicopters). It’s unclear when flight operations for jet fighters will take place. China is believed to be building the first of several locally designed aircraft carriers but little is known of this project. The only official announcements have alluded to the need for two or three aircraft carriers, in addition to the Liaoning. Construction of such large ships has not yet been seen in any shipyard and the government has said it is not building another carrier.

September 19, 2012: Japan reported hacker attacks 19 major websites, mainly those belonging to government agencies. China is the chief suspect as the websites were often defaced with messages asserting Chinese claims on islands Japan also has claims on.

For the first time Chinese media mentioned that Chinese politician Bo Xilai was under investigation for corruption.

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