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IOCs face choppy South China Sea conditions

Beijing's determination to exert its influence in the South China Sea is causing problems for oil companies active in the region

An increasingly assertive foreign policy over maritime rights claims is bringing China into conflict with its neighbours. In March of this year, Spain's Repsol was forced to suspend drilling in the Red Emperor block, a $200m oil and gas development off Vietnam's southeast coast, after state-owned PetroVietnam—under Chinese pressure—requested a halt to activities. That prompted Repsol to lodge a compensation claim for the suspension of drilling on a field where it has been active since 2009, and which contains 45m barrels of crude oil and 172bn cubic feet of natural gas.

China's resurgent maritime nationalism is focused on the so-called nine-dash line, the resource-rich U-shaped stretch of water that reaches as far as the James Shoal, 2,900km (1,800 miles) from mainland China. The nine-dash line comprises a large area of Vietnam's exclusive economic zone, which, under UN-backed maritime convention, should give Hanoi the sole right to decide what it does with the hydrocarbon resources there. For China, however, these areas are a core national interest and Beijing shows no sign of compromise.

IOCs won't be able to ignore the fallout from this burgeoning geopolitical squabble. "Red Emperor, which we expected to produce around 25,000 barrels a day at peak, would have been a fairly material project for Vietnam in terms of bringing new oil production on stream. The project would have boosted Vietnam's oil output by 15%," says Andrew Harwood, research director at consultancy Wood Mackenzie's Singapore office.

Much of Vietnam's more prospective acreage is overlapped by claims from China, says Harwood. "Given China's increasing efforts to have an influence on exploration in these blocks, operators could face challenges in drilling exploration wells and developing subsequent discoveries."

Rosneft stands firm

What's particularly significant, says Harwood, is that the Red Emperor move represents an escalation in the type of projects that China is trying to influence. Repsol planned to develop a discovery and bring it on stream, but has effectively been prevented from doing so.

25,000 b/d—Lost potential from abandoned Red Emperor project

Repsol isn't the only oil company to feel the heat. Russia's state-held Rosneft has also found itself in Beijing's sights, after acquiring a block off Vietnam relinquished by Moscow-based TNK-BP. Rosneft's Vietnamese unit started drilling in mid-May at the LD-3P well, part of the Lan Do (Red Orchid) offshore gasfield in Block 06.1, 370km south-east of Vietnam. This is also within the area outlined by China's nine-dash line.

Unlike Repsol, Rosneft has so far shown no sign of mothballing its drilling rigs. As with fellow Russian energy giant Gazprom, Rosneft has a number of sizable projects in Vietnamese waters that are in areas claimed by China.

The proposed venture may be small enough for the Chinese to politely ignore. "The Rosneft project has been in production since 2002, so they were just looking to drill another production well to maintain output at the field. But we understand the well is going ahead," says Harwood.

Silence from Kremlin

Ever-closer Sino-Russian relations, built around China's growing appetite for Russian crude oil, may also provide Rosneft with insulation. Beijing bought 800,000 b/d of Russian oil in 2017, and is its largest individual consumer. Rosneft is also present in a string of Chinese investments. A messy falling out over Vietnam would affect both sides.

Until now, the Kremlin has been uncharacteristically quiet about Rosneft's Vietnamese venture. But the company may feel sufficiently emboldened to continue with the development. Rosneft has shown a strong risk appetite in other conflict regions, such as in Iraq's semi-autonomous Kurdistan region. The firm turned a blind eye to the Iraqi government's strict opposition to IOCs cutting deals with the Kurdistan Regional Government. Cognisant of Moscow's regional influence, Baghdad has refrained from making a big issue out of it.

Claims that Rosneft may ultimately stand to benefit as European companies such as Repsol downgrade their activities may be exaggerated. But there's no denying that it enjoys strong support from its home government. By contrast, European governments "typically don't provide the same level of backing on the international stage—and that may have had an impact in Vietnam," says Harwood.

The next steps in this complex and increasingly fraught conflict are uncertain. China's policy of obfuscation is likely to continue, say regional analysts.

"In theory, none of this should be happening as Vietnam and China have both signed and ratified Unclos (the UN Convention on the Law of the Sea)," says Bill Hayton, an associate fellow at think tank Chatham House's Asia-Pacific programme, and author of The South China Sea. "China hasn't ever made the nature of its claim exactly clear, and this is part of the problem."

Hanoi caves in

Hanoi has only limited tools at its disposal if it wants to fend off the Chinese and has shown a marked reluctance to raise the stakes with its neighbour. "While Vietnam has spent billions buying attack submarines and missiles, and has beefed up its air force, when it came to a direct challenge to its sovereignty at sea they didn't use any of these tools at their disposal-they caved in," says Hayton.

That leaves Vietnam's oil and gas ambitions in a quandary. Much of its existing producing areas are maturing, so if the country wants new hydrocarbon resources it will have to look further afield. Yet that will also put it into potential conflict with a regionally aggrandising China.

"China has never clearly explained the nature of its claim, and this is part of the problem"—Hayton, Chatham House

Other resource holders in China's sights have taken note. The Philippines is a case in point. The country won a favourable ruling in 2016 against China in an arbitration case brought under Unclos. It dismissed China's ambition to create a network of linked territorial and economic seas under its control. But such judgements have been ignored by China.

The Philippines' largest island, Luzon, sources much of its gas from the Malampaya offshore gasfield, which is jointly operated by Shell and Chevron. That field is maturing and could be depleted within nine years, prompting Manila to look elsewhere for future gas supplies. One plan under consideration is to run a pipeline from the Reedbank gasfield to Luzon, to keep gas flowing to its power stations. If China were to block that scheme, it would leave the Philippines government facing a sizable gap to meet its power generation needs.

The government in Manila has seemingly changed tack this year, adopting a more constructive attitude towards Beijing. It has indicated its willingness to work with China on a joint initiative to explore for oil and gas in waters which have been claimed by both sides.

Other resource holders in the region will need to find a way of working around an increasingly assertive China. "Oil companies looking at new investments in areas located under Indonesia, Malaysia or Brunei jurisdictions will face an additional element of risk, which might deter them, or at least make them think twice," says Hayton.

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