Maritime disputes in South China Sea threaten existing and future oil and gas operations

13 Mar 2015

Maritime disputes in South China Sea threaten exis...

On 2 March, the Philippine government ordered UK-listed company Forum Energy to suspend its operations in its SC 72 drilling block off the coast of Palawan, citing force majeure due to an ongoing dispute with Beijing. A number of other offshore blocks under exploration in Malaysia, Brunei, Vietnam and elsewhere in the South China Sea are vulnerable to similar disruption and legal uncertainty as a result of unresolved territorial disputes. Continuing disputes and the increasing projection of maritime power in pursuit of territorial claims in the South China Sea will continue to undermine projects, lowering interest in blocks and delaying the development of the region’s oil and gas resources.

The suspension of Forum Energy’s operations in the SC 72 drilling block comes amid an ongoing arbitration case at the UN, filed by Manila against Beijing in January 2014. The Philippines is seeking arbitration consistent with the 1982 UN Convention on the Law of the Sea in order to resolve the status of the disputed Spratly Islands, but Beijing has rejected the case and insists it should be resolved through bilateral negotiations. Forum Energy said it was ordered to halt operations by the Philippine Department of Foreign Affairs and the Philippine Coast Guard prior to requesting force majeure, casting doubt over the viability of operations in other contested areas. The Philippine authorities, who had previously granted Forum Energy the exploration licence, said the order was issued because the arbitration case remains pending. According to the company, it had already spent around USD 22.5 mn in SC 72 and will now review its other concessions in the Philippines and likely delay operations in other disputed areas.

The suspension comes despite the company’s attempts to cooperate with Chinese authorities in managing the territorial dispute to enable drilling to take place in the Philippine-awarded block. Forum acquired almost 140,000 sq km of seismic data for the Sampaguita gas field in March 2011 to identify leads, and originally planned to drill jointly with the China National Offshore Oil Corporation (CNOOC) in an attempt to mitigate the risk from the long-running dispute between Manila and Beijing. At the time, Beijing warned against foreign oil companies making bids on SC 72 in the Philippines, and Chinese vessels initially disrupted Forum Energy’s attempts to explore the area, prompting the Philippine Air Force to deploy planes to the contested region. In June 2014 two Chinese hydrographic ships were sighted near the site by the Philippine military, causing President Benigno Aquino III to reiterate concerns over China’s potential plans to commence drilling there. However in September 2014, Forum Energy announced that it would go ahead with drilling on its own as CNOOC had failed to respond to its proposal, with drilling set to start in March 2015. The suspension ordered by the Philippine Department of Energy—which followed Manila’s criticism of China’s land reclamation work in the Spratly’s on 23 February—will now delay Forum’s drilling operations for at least a year, highlighting the operational risks posed by geopolitical and diplomatic tensions. Irrespective of whether tensions subside, weather conditions and the onset of the typhoon season mean that drilling is only possible during a short window of time generally between March and May each year.

There are a number of other potential areas of dispute in the South China Sea, and the ongoing expansion of China’s land reclamation projects is likely to escalate tensions further. China has continued building in the Spratlys since the case was filed, with satellite imagery from January and February 2015 displaying large-scale construction projects including suspected airfields and ten-story high buildings. This expansion raises concerns for operators off the coast of Malaysia’s Sarawak and Sabah, where Malaysia and its state-owned oil and gas company PETRONAS have awarded drilling blocks to several operators, including Murphy Oil Corporation, Royal Dutch Shell and Total. For instance, the Balai Cluster fields off the coast of Sarawak lie within Malaysia’s Exclusive Economic Zone, but are also within China’s “nine-dash line” that demarcates the area of the South China Sea claimed by Beijing. At present, privately owned Chinese conglomerate Fosun holds the rights to explore acreage near the Balai Cluster, following the purchase of Australian energy company Roc, and any attempts to develop these interests by Fosun would necessitate partnering with PETRONAS. This would require the Chinese company to recognise Malaysia’s claims over the disputed territory, a move that is likely to prompt condemnation from Beijing and create uncertainty for operators interested in the block. A precedent for such action exists; Beijing has frequently denounced Hanoi’s attempts to award blocks in disputed areas in an effort to discourage foreign participation.

Sino-Vietnamese disputes over the Paracel Islands have also hampered exploration activities and remain a critical point of bilateral and regional tension. The contested areas include the Song Hong and Phu Khanh basins, and previous confrontations between Chinese ships and Vietnamese vessels suggest a high likelihood that operators in disputed waters could face harassment and disruption. In May 2014, Beijing-owned China National Petroleum Corporation (CNPC) moved a deep-sea oil rig into the contested region, prompting several months of small-scale skirmishes that saw tens of Chinese ships ram and fire water cannons on Vietnamese vessels. The coming months preceding the typhoon season—which typically runs between May and November off the Vietnamese Coast—are ideal for operating rigs in the region, and there remains a potential for a resurgence in tension as operators resume exploration and production activities in disputed areas. CNPC announced in July 2014 that it had found oil and gas shows during its previous drilling in the area, but it has not yet confirmed any plans to continue exploration activities in 2015.

China has moved in recent years to consolidate its claims over the Spratly and Paracel islands, and monitoring this process is critical for anticipating operational disruption and diplomatic flashpoints for oil and gas companies. Beijing’s growing military and commercial presence in the region will facilitate and support more aggressive claims. The government has prioritised deep water resource exploitation and drilling as a long-term goal—demonstrated by its large-scale and long-term investment in deep water rigs and other equipment it seeks to deploy in the South China Sea—and it is likely to expand its oil and gas footprint in the South China Sea. This will continue to fuel tensions and could result in further delays to operations in disputed areas, discouraging foreign investment. The Forum Energy suspension demonstrates that diplomatic escalations can prompt costly and long-term delays for operators, and Beijing’s increasing land reclamation projects suggest that such disruptions will become increasingly common in contested blocks. Further seismic studies and exploration in the South China Sea are also likely to create new disputed areas, which will likely delay the exploitation of any new discoveries.

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