China and the Philippines could begin exploiting long-untapped energy reserves in the South China Sea, according to reports coming out of this week's meeting between Filipino President Rodrigo Duterte and high-ranking Chinese officials — including a Thursday sit-down with Chinese President Xi Jinping — in Beijing. How soon that may happen remains unclear, however, as Duterte cautioned reporters that he has not been empowered by his Congress to finalize any energy exploration deal with his Chinese counterparts.
Earlier reports by Philippine newspaper the "Inquirer" suggested that Beijing and Duterte were set to enter into an agreement to explore for energy sources in a part of the South China Sea close to the Philippine coastline. China has long sought to exploit what it believes could be more than 100 billion barrels of oil and hundreds of trillions of cubic feet of natural gas lurking beneath the South China Sea. However, a litany of overlapping territorial claims in the region by the more than half-dozen nations rimming the South China Sea has rendered broad energy development there a nonstarter.
The fact that potential joint development of offshore energy deposits in the region is even being discussed underscores the tectonic shift in regional foreign policy undertaken by Duterte since winning the Filipino presidency in May.
The Philippines, long a U.S. ally in the region, has moved away from its bilateral ties and military entanglements with the United States and instead embraced a budding new friendship with China, long a regional rival. A joint energy-exploration deal between China and the Philippines could serve as a way to dodge thorny questions of national sovereignty and begin extracting energy wealth from the South China Sea, potentially setting a precedent for future energy development deals.
The U.S. Geological Survey estimates the South China Sea region holds reserves of some 11 billion barrels of oil and 190 trillion cubic feet of natural gas. China National Offshore Oil — the state-owned energy company responsible for offshore energy exploitation — provides a much rosier estimate, predicting the region holds some 125 billion barrels of oil and 500 trillion cubic feet of natural gas.
Neither estimate is insignificant for a region woefully dependent on imported oil and natural gas. China is the second-largest consumer of oil after the United States and critically dependent on imports to feed its energy demands. Japan and South Korea are likewise dependent on foreign oil to keep their economies humming. Booming growth in Southeast Asia has pushed the region to emerge as a net oil and gas importer as well.
The Philippines, too, faces a looming energy shortage. The nation's main island of Luzon depends heavily on the Malampaya gas field, an energy deposit estimated to hold perhaps another decade's worth of energy before running out. Given that it can take half a decade or longer to bring a major new energy project online, the clock is ticking for the Philippines, which could experience rolling brownouts on Luzon — home to the capital, Manila — if new energy sources are not tapped.
One potential source is the Reed Bank, an underwater mountain off the Philippine coast believed to hold significant oil and gas deposits. The Reed Bank falls exclusively in the Philippines' exclusive economic zone, which according to the UN Convention on the Law of the Seas (UNCLOS), places it firmly in the Philippines' possession. China, however, doesn't see it that way.
Developing the South China Sea's energy reserves has proved problematic for decades, in part due to China's sweeping territorial claims. China's so-called "nine-dash line" encompasses much of the strategic waterway, conflicting with the various territorial claims of other Asian states, including the Philippines, Vietnam, Malaysia, Brunei and Taiwan. Reed Bank, like many other contested areas, falls within the nine-dash line. Under Duterte's predecessor, the Philippines challenged China's claim at the Permanent Court of Arbitration at the Hague, which ruled in July under UNCLOS that China's claims are invalid. China has refused to accept the decision.
These types of conflicting claims and the political risk associated with them have made exploration and development of even nearby uncontested areas difficult, as energy companies and foreign investors seek to steer clear of international entanglements. "I have not seen anyone go into these developments in any meaningful, substantial way," said Clara Gillispie, senior director of trade, economic, and energy affairs at the National Bureau of Asian Research. "There's been a number of starts and stops. But in terms of breakthroughs in collaborative, joint efforts or in terms of pure Chinese development, I think we're still talking about what could happen rather than what is happening."
Joint development between the Philippines and China could reverse the trend toward disputes and conflict in at least one corner of the South China Sea, though it will likely take much more than a deal between the two states to open the wider South China Sea for exploitation.
"I think the biggest factor impacting exploration activities, or lack thereof, in the South China Sea are the low oil prices that we've seen for the past two years now — that's been big disincentive to do exploration activity there," said Erica Downs, a senior analyst at the Eurasia Group. "Plus, nobody knows exactly how much energy is there."
At press time, the Brent crude-oil price was $51.37 a barrel, way off its historic peak of $139.05 a barrel in June 2008.
To lure foreign energy companies and their deepwater drilling technology into the region, things will have to change economically, said Michal Meidan, a China analyst at the London offices of consultancy Energy Aspects. "If you had proven reserves and you knew this was a very attractive resource, the story might be different," she said. "But prices would need to go up considerably, which is not likely — we'd need to go back to at least a 100-dollar-a-barrel kind of world." Prices currently hover around half that.
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Circumstances would have to adjust on the political stage as well. China has floated various other attempts at joint development deals previously, "but those kinds of agreements have been very tenuous in the past," Meidan said, adding that the region would require some kind of internationally agreed-upon code of conduct for joint exploration, something that seems unrealistic at the present time.
Disagreements over who owns what in the South China Sea have long stoked tensions there, exacerbated in recent years by China's building of artificial islands in areas like the contested Spratly Islands, a cluster of 14 islands and more than 100 submerged reefs (and claimed in part by Malaysia, Taiwan, China, the Philippines and Vietnam).
These islands, complete with military installations and runways that can accommodate combat aircraft, lie far from China's continental shores. Nonetheless, China has claimed in many cases that these manufactured islands confer rights to 12 nautical miles of territorial waters surrounding each island and in some cases exclusive economic zones extending up to 200 nautical miles away from these disputed island outposts.
If honored, these claims would give China de facto territorial control over much of the South China Sea. July's ruling by the court of arbitration at The Hague offers some degree of international backing to those disputing Chinese claims and its nine-dash line. A warming relationship between China and the Philippines — and particularly a successful joint-development deal allowing both countries to begin extraction of the South China Seas energy wealth — could prove a first step in changing the entrenched political reality in the region. It might also help China validate its territorial claims elsewhere in the region.
The territorial disputes over the South China Sea are about much more than energy resources buried in the seabed. More than $5 trillion in global trade passes through the strategic waterway annually, including the vast majority of the imported oil on which Japan, China and South Korea rely. China sees control of the waterway as a key security concern — not just in terms of national defense but also in terms of energy and economic security.
The linking of various nations' energy security with political tensions in the South China Sea has driven an uptick in military activity in the strategic waterway. Over the past several weeks, the United States (along with the Philippines), Indonesia and a consortium of nations, including Australia, Malaysia, Singapore, New Zealand and the United Kingdom all conducted separate military exercises in or around the South China Sea. China and Russia also conducted joint naval drills in the region. The Indonesian Air Force's two-week exercise was that nation's largest to date in the South China Sea. Meanwhile, defense budgets have experienced a pronounced uptick across the region as nations bordering the sea look to bolster and modernize their armed forces with new patrol boats, submarines and aircraft.
The uptick in military spending doesn't necessarily spell looming confrontation or an outright arms race, analysts say. In fact, the risk of a major conflict in the South China Sea remains relatively low, as the economic fallout would be widespread. But the increased tempo of military activity by a growing number of actors heightens the risk of a mishap or misunderstanding between militaries that could quickly escalate.
"There's still a low likelihood of a conflict because that's bad for everyone," said Meidan, the China analyst. "But the chance of an accident are greater than they have been in the past."
— By Clay Dillow, special to CNBC.com