Boundary disputes: South China Sea

Jeannie Stell

August 1, 2015

Offshore assets in the South China Sea are ripe for further development, but territorial challenges are common. Focusing on Vietnam, Jeannie Stell talks to Quynh Anh, partner at Mayer Brown, for an overview of the political conditions, contract details and royalty rates that can affect energy development.

 

The South China Sea (SCS) offers potential for significant natural gas discoveries, creating incentive for countries to secure large sections of the area for domestic production. Yet, the region has historically been a source of conflict among its shoreline countries. In some cases, oil and gas exploration and production companies have initially been permitted to explore for oil and natural gas by one country, only to later be denied access by another country.

For example, Vietnam claims ownership of the Paracel and Spratly islands, although the extent of its territorial and maritime claims in the SCS are not delineated in text or on maps.

However, in 1974, China seized all of the Paracels. But, Hanoi claims that, because France controlled both island groups starting in the 1930s, Vietnam succeeded to those rights after independence. Brunei, China, Taiwan, Malaysia, and the Philippines disagree with that claim.

Last year, in what has become known as the “Haiyang Shiyou 981 Standoff,” tensions between China and Vietnam rose to the surface when CNOOC moved its Haiyang Shiyou 981 semisubmersible oil platform to waters near the disputed Paracel Islands, which resulted in Vietnamese efforts to prevent the platform from establishing a fixed position. Initially, the Shiyou 981 operators intended to conduct well drilling from May to August 2014. However, on 15 July, China announced that the platform had completed its work and withdrew it fully one month early, thus relieving tensions in the area.

These types of territorial disputes continue as Asia’s economic growth drives liquid-fuels consumption. Total demand by Asian countries outside the Organization for Economic Cooperation and Development (OECD) is expected to rise by 2.6% annually, growing from 20% of world consumption in 2008 to more than 30% by 2035, according to the US Energy Information Administration. Similarly, non-OECD Asia’s natural gas consumption will grow by 3.9% annually, from 10% of world gas consumption in 2008 to 19% by 2035. As a result, Southeast Asian countries are motivated to find and produce more offshore oil and gas.

Furthermore, because Southeast Asian countries such as Vietnam, Malaysia and Brunei lack significant onshore hydrocarbon potential, these countries are significantly driven to invest in offshore production, technology, pipeline networks and drilling. Overall, the majority of the countries’ oil and gas developments are found in shallow water basins because the region has seen limited exploration of deepwater areas, mostly due to a lack of capabilities.

Yet, more recently, finds such as China’s Liwan 3-1 gas field, discovered in 2006, demonstrate the potential of deepwater exploration. As a result, some countries have opted to cooperate in the SCS, such as the partnership between Malaysia and Brunei to explore offshore Brunei waters, and the agreement of Thailand and Vietnam to jointly developed areas of the Gulf of Thailand, despite ongoing territorial disputes.

These success cases contrast with areas of the SCS contested by multiple countries, where such areas have undergone scarce energy development. Differences in political conditions, royalty rates and territorial water disputes continue to interfere with hydrocarbon developments.

Vietnam issues

While SCS territorial offshore disputes continue, and despite the Haiyang Shiyou 981 Standoff, Vietnam can be seen as an example of movement toward international cooperation. However, this was not always the case.

“The escalation of territorial disputes in the South China Sea — which the Vietnamese call the East Sea — have been causing great concerns for the Vietnamese government and international oil and gas companies that have been exploring oil and gas opportunities in Vietnam,” says Quynh-Anh Lam, a Ho Chi Minh City-based counselor for the law and consultancy firm of Mayer Brown. She is a member of the firm’s Global Projects Group.

“While there seems to be no expressed indications that the territorial water disputes alone have adversely affected the oil and gas activities, we understand that certain international oil companies (IOCs) have expressed their hesitance when being invited to bidding rounds for new production-sharing contracts,” she says.

Increasingly, IOCs seem to be under pressure to take sides when expanding in the region, and those with strong political alliance to a particular country would feel inclined to expand in such country. That said, it seems that the territorial disputes are not yet cited as the sole reason for IOCs to exit a particular country.

“In terms of internal political stability, Vietnam is often cited as a stable political regime with leadership committed to achieving socio-economic development. The communist party in Vietnam seems committed to achieving high gross domestic product growth and aims to achieve this by providing a relatively stable political environment, especially when compared to its neighbor countries. In fact, since it first opened doors to foreign investors in the late 1980s, the situation in Vietnam has been rather stable and it has not faced the political upheavals or difficulties experienced in its neighboring countries such as Thailand, the Philippines or Myanmar.” As a result, Vietnam tends to be an attractive area for energy development and investment.

Activity in Vietnam

For example, in March, PetroVietnam formed a joint venture with Italy’s Eni and signed two production-sharing contracts for exploration of blocks MD-02 and MD-04 offshore Myanmar. Eni operates the joint venture with 80% interest, PetroVietnam holds the remaining stake.

The MD-2 Block is in the southern part of the Bay of Bengal in the Rakhine basin, about 135km west of the Yadana field, the major offshore discovery in Myanmar. The block covers 10,330sq km in waters 500-2400m deep. MD-4 Block is in the Moattama-South Andaman basin, about 230km off the coast, west of the Yetagun gas field. The block covers 5900sq km in waters 1500-2200m deep.

Among other various other joint ventures, PetroVietnam is working with ExxonMobil, which has two operating licenses under production-sharing contracts for the Da Nang and Vung May blocks offshore central and southern Vietnam.

Royalty rates

The current contract royalty rates in Vietnam that are applicable to oil production range from 7% to 29%, says Lam, which are applicable to production of 20,000 b/d or higher, whereas the royalty rates applicable to gas production range from 1% to 10%, applicable to production of 5 MMcm/d or more.

Although the royalty rates applied in Vietnam appear to be higher than other oil- and gas-producing countries in the SCS region, the contracts are contingent upon the production volume of a particular oil or gas field. For example, the operators of an oilfield producing less than 20,000 b/d or operators of a gas field producing less than 5 MMcm/d could enjoy royalty-free production in Vietnam.

With this royalty structure, and continued cooperation between Vietnam leaders and various NOC and IOC energy companies, today’s offshore territorial disputes could become less prohibitive in the future.