South China Sea tensions leave oil potential untapped

Jul 12, 2016 12:00 AM

Among the many questions to come out of Tuesday’s ruling on the South China Sea: What does it all mean for the potentially vast reserves of oil and gas that lie beneath the disputed waters?

The U.S. Energy Information Administration estimates the South China Sea holds 11 billion proved or probable barrels of oil—roughly equivalent to Mexico’s proven reserves—and 190 trillion cubic feet of natural gas, a significant sum for a region where energy demands continue to grow quickly.

Yet the oil market has reacted calmly to the ruling. Neither China nor anyone else is close to developing the resources beneath the waters. And while the South China Sea is a major oil supply route, the decision is unlikely in the near term to have much immediate effect on vessels that pass through the region, analysts said.

“There is a lot of oil that passes through, but China is not going to do anything more aggressive than they already have been...I don’t see much that has changed,” said Peter Lee, oil and gas analyst at BMI.

In this May 7, 2012 photo released by China's Xinhua News Agency, Haiyang Shiyou oil rig, the first deep-water drilling rig developed in China, is pictured at 320 kilometers (200 miles) southeast of Hong Kong in the South China Sea.


In this May 7, 2012 photo released by China's Xinhua News Agency, Haiyang Shiyou oil rig, the first deep-water drilling rig developed in China, is pictured at 320 kilometers (200 miles) southeast of Hong Kong in the South China Sea.

Internationally traded Brent crude fell 50 cents, or 1%, in Asia trading hours Wednesday, after rising Tuesday following new forecasts on global production.

Disputes over who owns what in the contested waters have stalled and obstructed exploration and drilling for many of the resources. Aggressive enforcement by Chinese maritime authorities of its claims has scared away many foreign investors whose technology and capital are needed to develop the reserves.

Tuesday’s ruling by a tribunal of the Permanent Court of Arbitration in The Hague is unlikely to change that situation, according to energy analysts and scholars. While the tribunal invalidated many of China’s claims to exclusive rights to South China Sea waters and their resources, the ruling is enforceable only through international pressure, and China has said it won’t budge.

One risk, said Michal Meidan, a China analyst at the consultancy Energy Aspects, is that a strong response from China to reassert claims in the ruling’s wake could in turn prompt more navy patrols from the U.S.

That would raise “the risk profile of the region at a time when the world is already quite jittery post-Brexit,” she said.

The U.S. Energy Information Administration says nearly one-third of global crude oil and more than half of liquefied-natural-gas trade passes through the South China Sea. Energy traders in the days and weeks ahead will watch for any evidence that increased tensions could threaten its crucial shipping lanes.

Another issue will be how aggressively oil drillers choose to test—and how China, Vietnam and the Philippines respond. China National Offshore Oil Corp. counts the South China Sea as one of its important production bases, and has claimed energy blocks in waters also claimed by Vietnam.

Erica Downs, a senior analyst at the political risk consultancy Eurasia Group, said a Chinese response to the ruling is likely, though a sharp uptick in tension over resources in the near term is unlikely. Back in 2014, a Cnooc subsidiary was at the center of a tense, monthslong dispute with Vietnam over drilling in waters claimed by both countries, an incident that touched off anti-Chinese riots in Vietnam and drew deep concern from Washington over China’s behavior.

“China is likely to respond to the ruling in some fashion, but dispatching a rig to disputed waters is by no means the only option,” said Ms. Downs.

Cnooc didn’t respond Wednesday on whether the ruling would affect its drilling plans in the South China Sea.

Joint development of resources in disputed waters has long been viewed by experts and some political leaders in the region as a way to ease disputes over who owns what. Christopher Len, a senior research fellow at the National University of Singapore, said that despite the legal ruling, the answer to energy exploration in disputed South China Sea waters required greater political cooperation and compromise among claimant countries.

That may prove difficult in the near term if tensions continue to rise. For energy companies, they “will have to weigh the potential financial rewards against the political risks they are likely to face” in disputed waters, he said. “Given today’s low oil prices, I doubt there is any enthusiasm for such risky undertakings.”

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