The Spratly Islands Standoff: Its Impact On The O&G Industry

The Spratly Islands Standoff: Its Impact On The O&G Industry

The territorial dispute surrounding the Spratly Islands – which sit on blocks of potentially rich oil and gas resources – has reached a boiling point, as recent watershed developments in a ministerial conference of Southeast Asian nations demonstrated.

The 45th ASEAN Ministerial Meeting (AMM) in Cambodia that kicked off on July 9 this year, will be remembered as the first ever meeting that did not issue the customary joint statement at the end of the summit since the annual event's establishment in 1967. The diplomatic failure resulted as the summit's chair, Cambodia, refused to include several paragraphs in the draft statement that highlighted recent run-ins at the Scarborough Shoal, which is part of the Spratlys. The Philippines and Vietnam rallied their regional neighbors to push for those inclusions, which references incidents involving their ships and Chinese vessels, but Cambodia argued that such mention of bilateral disputes was not appropriate for the communiqué.

In recent years, Phnom Penh has swung towards a pro-Beijing stance, with Cambodia's economy increasingly tied to China's, The Straits Times reported on July 16, 2012. In 2011, Cambodia received $1.2 billion in foreign direct investment (FDI) from China, more than double the combined FDI from its Association of Southeast Asian Nations (ASEAN) neighbors.

After the summit, Vietnam issued a strongly-worded statement on the website of its Ministry of Foreign Affairs on July 13, 2012. "Chinese fishermen's activities around the Spratly archipelago are illegal and violate Vietnam's sovereignty," the statement read.

The Philippines issued a statement the following day stating that it "deplores the non-issuance of a joint communiqué."

Malaysia followed up with its own statement on July 17, 2012, stating that it had "tried very hard to work towards reaching a compromised language on the South China Sea issue … but member states were not able to reach a consensus."

The recent rancor surrounding this territorial dispute brings to light far-reaching implications for the oil and gas industry. The issues of which state-backed companies one should work with and which projects one should pursue in the South China Sea are fast becoming problems, and hurdles, which oil and gas companies will find themselves grappling with.

Geography and Natural Resources of the Spratly Islands

The Spratly Islands are a group of hundreds of small islands, reefs and atolls sited in the South China Sea occupying an area roughly the size of California, but have a combined land area of less than two square miles.

So what prize could this inhospitable archipelago offer that several nations find themselves embroiled in the ongoing maritime tussle? Oil and natural gas.

The archipelago has seen much contention primarily because its location in the South China Sea straddles vast blocks of potential oil and natural gas reserves. According to a published paper in 1997 by the American University Washington D.C, oil and natural gas reserves in the contested waters surrounding the Spratly Islands were estimated at 17.7 billion tonnes. In comparison, Kuwait's oil and natural gas reserves amount to some 13 billion tonnes. However, as of now, there has been no commercial oil and gas exploration and appraisal activities to reaffirm such offsite estimates, data from the Central Intelligence Agency's World Factbook updated on June 30, 2012 states.

The resource potential of the Spratly Islands, coupled with overlapping claims, had resulted in contesting countries awarding foreign exploration rights in the same offshore areas surrounding the islands. A well-documented example took place in 1992.

In May 1992, China National Offshore Oil Corporation (CNOOC) and US-based Crestone Energy signed a cooperation contract for the joint exploration of the Wan'an Bei-21 block, a 9,712 square mile-section (25,155 square kilometer-section) in the South China Sea that includes the Spratly Islands. A portion of Crestone's contract covered Vietnam's offshore blocks 133 and 134, where PetroVietnam, PetroStar (USA) and ConocoPhilips Vietnam Exploration & Production agreed to evaluate prospect. The exploration contract was contested by Vietnam, and it led to both countries demanding for the cancellation of the other's contract.

From Colonial Masters to the Communists

The French first attempted to exercise its sovereignty on the Spratly Islands in the 18th century through the state-backed Bac Hai Company of colonial Vietnam. However, the French colony's reign did not last long. In 1932, Vietnam saw its claim over the Spratlys contested by China when it sent the French government a memorandum disputing Vietnam's sovereignty.

In 1941, China sent its troops to Taiping Island, the largest island of the Spratly Islands. In 1947 – the year which industry watchers view as the defining point – China produced a map with nine undefined dotted lines, and it claimed all the islands within those lines.

Since then, the Philippines, Brunei, Malaysia and Taiwan, alongside with Vietnam, have joined in the fray, disputing China's, as well as each other's version of territorial lines circumscribing the Spratly Islands.

Present-day Confrontations

While the standoffs--mainly between China, Vietnam and the Philippines--have been at best uneasy in the past, they appeared to have reached the point of near-military confrontation this year.

In April this year, the Philippines got into a row with China when it discovered Chinese fishing boats were spotted on the coast of the Scarborough Shoal, an outcropping of rocks in the South China Sea which both countries claim territory over.

President Benigno Aquino said in a statement on July 2, 2012, that the Philippines could place a request to the United States to deploy US P3C Orion spy planes over the South China Sea to help it better police the region.

Meanwhile, before its spate with the Philippines could be resolved, state-backed CNOOC on June 25, 2012, announced it would open nine offshore blocks in the South China Sea for joint cooperation with foreign companies.

Seven of the offshore blocks are sited in the Zhongjianan Basin, while two are located in areas covering the Wan'an Basin and the Nanweixi Basin. Vietnam lays claim to all of these offshore blocks as well.

The dispute over the nine offshore blocks, likely in part linked to previous tensions between the two countries, led to Vietnam's publication of a statement on June 30, 2012 that "condemns CNOOC's action".

China responded with a concerted launch of four combat-ready patrol ships to the disputed area on July 1, 2012.

No oil companies have responded publicly to CNOOC's offer, and both of the countries have not yet reached an amicable resolution on the latest dispute.

The two incidents escalated into the watershed event in ASEAN's history, the failure to issue a joint statement at the end of the 45th AMM.

Going Forward Into 2H 2012

The diplomatic misstep of the 45th AMM shows the urgent need for ASEAN to come to a consensus on how to deal with such bilateral disputes that some of its members are facing. Beijing is insistent on negotiating with disputant countries on a one-on-one basis, has still not accepted the dispute settlement mechanisms under the United Nations Convention on the Law of the Sea.

This means that the deadlock surrounding the Spratly Islands is here to stay and perhaps intensify in the years to come. Industry players should keep a lookout for bilateral progress between China and individual ASEAN nations, as such events may offer opportunities within parcels of the Spratlys in a cooperative framework.

In the near-to-medium term, it is unlikely that the entire zone can be apportioned amongst contesting states as China would not back down from the entirety of its demands. And even if ASEAN solidarity manages to find its footing again, the possibility of offshore exploration projects will remain far in the distant future for oil and gas majors as China and the regional bloc battle for ultimate supremacy of the Spratly Islands.


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