Blue Waters, Black Oil in the South China Sea

China has so far chosen stability over conflict in the energy-rich sea it shares with several southern neighbors

No Asian country with territorial claims in the blue waters of the South China Sea – and claims to the black oil far beneath the waves – has installed a single oil drill in the heart of the disputed region.

To date, only the sea's continental shelves and coasts of sea-bordering countries have been explored and exploited for oil and natural gas. These sites can be found off the eastern shores of Vietnam, east of Malaysia, north of Indonesia and Brunei, west of the Philippines, and south of China.

International oil giants dominate oil and gas production contracts signed with Southeast Asian countries around the South China Sea. The most radical development has been in Vietnam, where the former Mobil Oil Corp. was the first to discover oil off the southern coast in 1975.

Over the next decade, the country's oil major PetroVietnam and the Soviet concern Zarubezhneft formed Vietsovpetro to jointly develop an oil field called White Tiger.

Today, PetroVietnam remains the country's largest oil company in a sector considered a national economic pillar and a key provider of foreign exchange.

Another country keen on South China Sea oil development is the Philippines, which has a relatively small oil industry. Several exploratory wells drilled in cooperation with international companies have failed to bear fruit.

Nevertheless, the Philippines in late June announced that it would hold international tenders for exploration rights in several blocks in parts of the South China Sea that China claims.

Malaysia's talk about the sea is less about sovereignty than boosting production. Its wells nationwide extracted about 750,000 barrels per day in 2007 and 693,000 daily in 2009. Most of the oil came from the South China Sea, according to the Energy Information Agency (EIA) of the United States.

Malaysia exports about 190,000 barrels daily, with about one-third of that amount shipped to the United States, said the agency.

China, meanwhile, extracts from the China South Sea about 290,000 barrels a day, according to data on the website of the U.S.-based public policy organization Global Security.

The organization said Malaysia is now daily producing about 645,000 barrels, Vietnam 180,000 barrels and Indonesia 46,000 barrels. Altogether, it said, about 1.37 million barrels are pumped from the China South Sea floor every day.

At the same time, the organization's data said, Malaysia is the top natural gas producer – grabbing 1,300 billion cubic feet (bcf) a year, or more than half of the China South Sea's total gas production – while China produces only 141 bcf.

Sources told Caixin that Chinese government leaders have long grappled with questions over whether to defend territorial rights in the South China Sea or seek stable relations with its neighbors in the region. Developing China's oil and gas interests would lead to friction with neighboring countries, the sources said, and so far the government has opted for stability.

China's policy faced new challenges after the United States announced a year ago efforts to establish a formal legal process for resolving territorial disputes involving the sea and, by extension, its underwater resources. Some Southeast Asian nations afterward raised new claims of sovereignty. And in June, the Philippines and Vietnam conducted military exercises that raised tensions.

U.S. Secretary of State Hillary Clinton said her country "has a national interest in freedom of navigation" in the area. But China sees the U.S. stance as interference in its own backyard.

China says it has indisputable sovereignty over the sea's islands and surrounding waters. But these claims clash with those of the Philippines, Vietnam, Brunei and Malaysia in areas of the sea believed to contain vast oil and gas deposits.

Cautious CNOOC

For political as well as technical and commercial reasons, Chinese oil companies have taken a more cautious approach toward tapping the region's resources than their counterparts in Vietnam, the Philippines, Malaysia and other countries.

But recent oil-related developments among Southeast Asian countries with claims in the sea prompted executives at China National Offshore Oil Corp. (CNOOC), the country's largest offshore oil and gas producer, to reconsider　its　strategy of sitting back and watching other countries move forward.

A former high-level CNOOC executive suggested the company start jointly developing oil fields in the sea with state-owned energy giants China National Petroleum Corp. and China Petrochemical Corp. He said the companies should also consider giving foreign companies larger stakes in projects to explore oil reserves under the sea.

The former executive said the Chinese government should offset commercial risks of drilling in the sea by establishing a fund to support the oil companies. The fund could help speed up deep sea exploration and exploitation.

At the same time, CNOOC is an international company stressing cost effectiveness and responsibility toward shareholders. Thus, its executives say, any moves to explore and develop deep-sea oil fields must be reasonable, not rash.

China's offshore oil industry was born in the South China Sea, but the Vietnam War forced the sector's drillers to shift to the northern Bohai Sea. In 1986, though, state-owned CNOOC returned to southern waters and built its first drilling platform.

That was just four years after CNOOC's founding. It's now China's third-largest oil company, and 23 of its 44 offshore projects in the South China Sea, Bohai Sea and East China Sea are handled in cooperation with foreign oil companies.

Foreign companies that sign production sharing contracts with CNOOC must meet strict criteria. The company requires a 51 percent stake, while foreign companies not only bear all exploration risks but can expect no more than 49 percent of any profits.

Still, CNOOC's risks in the South China Sea are significant, since the area with deep-sea drilling potential is at most 3,000 kilometers from the mainland. He Wei, an analyst at investment bank BOCOM International, noted that among other things staffing changes are complicated when an oil platform is located far from shore.

The company is also still developing deepwater technology. CNOOC Deputy Chief Engineer Zeng Hengyi said production is no problem for the company at depths of about 300 meters, but drilling in 3,000 meters of water is problematic..

Exactly where to drill for oil in the vast sea is another unanswered question. Some say the sea is as rich as the Persian Gulf, with potential oil reserves of up to 30 billion tons, about 70 percent of which is in deep-water regions.

But an EIA report based on data from the Geological Society of America pegged the sea's oil reserves at only 3.8 billion tons.

Indeed, a high-level CNOOC source told Caixin that geological surveys so far have failed to prove that the sea is anything like the Persian Gulf in energy potential. "Because no wells have been drilled to date," he said, "it's very difficult to prove exactly how much oil and gas is there."

CNOOC's caution is also tied to an experience in the sea in the 1990s that came close to triggering war.

It happened in 1994, when the Chinese and Vietnamese navies exchanged gunfire in the sea near the Wan'an basin west of the Nansha Islands and 280 kilometers from the Vietnamese shore.

Two years earlier, CNOOC and a U.S.-based oil company called Crestone had signed a production sharing agreement to drill in the area, which was said to be rich in oil and gas.

Vietnam claimed the area and challenged the Chinese project, prompting the naval exchange when Crestone began exploration operations. CNOOC pulled out of the project and has been cautious about drilling in the South China Sea ever since.