Energy Security in the South China Sea

Forget about the Middle East, Syria, or renewed NATO tensions with Russia over the Arctic or Ukraine. When you Google search ‘World War 3 in …’ it auto-completes either as China, or the Pacific, or the South China Sea. This is the result of a proliferation of op-eds and reports that predict a renewed superpower conflict in the region, potentially spilling over into a wider, systemic confrontation.

There are several reasons why such analyses are proliferating. Territorial demarcation, Aerial Defense Identification Zones (ADIZ), Exclusive Economic Zones (EEZ) and territorial waters are largely contested in the area, owing no less to China’s unilateral assertion of its nine-dash line, substantially stretching both demarcations at the expense of other countries in the region. In addition, China has employed an unorthodox approach to furthering its territorial demands by building man-made islands into the reefs and shoals in the sea. But ADIZ/EEZ dispute is just the tip of the iceberg, as there are other additional components that render the nine-dash line or ADIZ/EEZ designations important sources of conflict. One of these is the question of hydrocarbons, which, due to EEZ disputes, haven’t yet been properly explored. Energy Information Administration (EIA) predicts that there are 11 billion barrels of oil and 190 trillion cubic feet (tcf) of natural gas and control over extraction and export rights of these reserves are cited as one of the main sources of conflict there. The other variable is the volume of trade, which passes through the strategically important Malacca Straits in Malaysia, into South China Sea, measured at 5.3 trillion US dollars as of 2015 (%32 of aggregate world trade). Transit security is also crucial in terms of connecting tanker trade (especially Middle East-origin) to the South China Sea. Japan for example, imports 80% of its oil from the Middle East, whereas for China, this figure is 39%, all of which pass through the Malacca Straits.

From an energy security point of view, there is much to be alarmed of. Although neither 11 billion barrels of oil, nor 190 tcf gas is significant enough compared to other, much larger reserves in the world, the main game in the South China Sea is to deny other countries exploration and extraction rights there. This zero-sum approach is further exacerbated by the competition over Spratly and Paracel islands, controlling the strategic bottleneck that leads to the Malacca Straits and in turn, controlling around third of the world trade – and significant portion of the Middle East-origin hydrocarbon transit. Therefore, South China Sea contains all three components of an energy insecurity regime: risk of disruptions in supply, stressed energy transit and disputed demarcations.

Supply and Transit Insecurity: Energy flows through the safest and least resistant route. This motto accurately captures the main principle of energy supply and transit policy. While insurmountable geographic elements such as seas and mountains are the first considerations in planning for a pipeline or export route, the rest of such planning looks at war, conflict, likelihood of sabotage or inter-state spoilers such as tense diplomatic tensions. Often, a financially rational, geometrically straight pipeline needs to be tweaked and turned in order to avoid conflict-prone geographies or countries with bad diplomatic relations.

But what happens when you have only one geographic opening between two larger hinterlands and you can’t avoid or go around it? That is called a chokepoint; in our case, the Strait of Malacca – the naval opening, which connects entire East Asia to Europe, Middle East and Africa. The alternative to Malacca Strait is to go around entire Australia, extending the journey for week, as no other nearby strait has the width and depth required for large cargo vessels. To that end, Malacca Strait is not only about Chinese or Japanese supply security, but also demand security for dominant producers exporting there in the entire Persian Gulf. Overall, Asia consumes around 40% of the world’s oil production and 75% of oil exports from the Middle East.

Furthermore, any disruption to the supply and transit of hydrocarbons impairs Asia’s ability to export refined hydrocarbon products such as diesel, lubricants, wax, asphalt and sulphur, leading to a substantial price increase in a wide range of hydrocarbon-based sectors. As these disruptions will further fluctuate government controlled oil stocks, oil product exports, infrastructure operating costs (pumping or liquefaction units) and shipping costs; thus, a substantial regional (and even global) GDP growth slowdown will be inevitable. In other words, Malacca Straits, is the world’s largest volume global energy chokepoint, whose disruption would have disabling effects on Asia’s trade. Although China’s ‘one-belt one-road’ (OBOR) initiative aims to bypass Malacca Straits through a ground trade route, that chokepoint is still vital for other countries in the South China Sea.

Demarcation and Delimitation: Maritime territorial disputes in the South China Sea involve six parties – Malaysia, China, Vietnam, Philippines, Taiwan and Brunei. While the substantial portion of the dispute seems to be China’s unilateral assertion of its ‘nine-dash line’ claim, other countries too have long-standing ADIZ/EEZ disputes. Demarcation-delimitation tensions emerge from two sub-disputes: exploration-extraction rights over offshore oil and gas reserves in the South China Sea and the control of Paracel-Spratly island groups to oversee Malacca’s northern opening. China’s nine-dash line, as well as its policy of constructing man-made islands can be interpreted as its attempt to extend its EEZ further into the area with predicted oil and gas reserves. Through these islands, Chine seeks to dominate the north-bound opening of the Malacca Strait, as well as claiming exploration and extraction rights over the hydrocarbon reserves.

The area of dispute is also vast. With around 394,000 square miles of contested territory, South China Sea is the largest disputed territory in the world. Especially regional rivals to China, such as Japan and South Korea aim to internationalize the dispute as a way of leveraging against China’s dominance. US allies in the region are also significantly dependent on the presence of the US Navy on close stand-by to prevent a unilateral exercise of force by China and to deter Chinese naval pressuring of the Malacca Straits and islands that lie in the north. The balance of power in the area has so far prevented a halt in hydrocarbon trade, but growing escalation and subsequent tensions between militaries, render both the islands and the waterways as critical flashpoints. Rather than choosing to go to war, both sides are worried about the prospects of an accident or provocation escalating into retaliatory moves. To complement this build up, political rhetoric is also significantly amplified for domestic purposes, leading to a discursive security dilemma on all sides.

South China Sea is therefore, not only a regional tension, but also an increasingly global one, which directly threatens commerce, finance and growth across a large part of the world. Yet, there are three reasons why a large-scale war in the South China Sea is unlikely:

• A tense détente is better for GDP growth than an outright war. Even though China is trying to minimize its dependence on the Malacca Strait by creating OBOR, a fully functional OBOR that can completely diversify away from Malacca is still long way ahead. This means that a war in the South China Sea is a ‘lose-lose’ situation, which will be avoided at all costs, despite sustained tensions.
• Risk premium for all shipments going into the South China Sea is forcing logistics and transportation companies to find alternative routes to access the region. If tensions escalate further, there will be a substantial logistics diversion from the Malacca Straits into OBOR-related routes or even increased reliance on air cargo shipments. This will automatically and paradoxically lower the stakes in the South China Sea.
• Both sides are too evenly matched to risk a full-scale war. China and to some degree, Russia, are up against the US, Japan, South Korea, Taiwan, Vietnam and Philippines (even though Duerte is shifting policy in favor of China, so far opinion polls are in favor of the US). The magnitude of military power on both camps will force provocations or mistakes to be looked-over, rather than escalated. There may be a case against this argument, pointing to a similar systemic setting with evenly matched sides before World War I. Yet, competition over raw materials and markets is not the primary source of dispute here, as both variables are already well-provided during this time of peace, than a hypothetical war.

Overall, South China Sea will continue to be a high-tension political zone for the foreseeable future, but these tensions are unlikely to escalate to the point of war. If anything, such tensions will lead to a diversion of focus into alternative transportation means and trajectories, lowering the stakes around north of Malacca Strait.