Sea of Trade

Meg Chesshyre

April 1, 2014

“The South China Sea is not the new Persian Gulf. It should just be thought of as an important part of the supply picture of this region,” Alexander Metelitsa, an economist at the US Energy Information Administration (EIA), told delegates at IP Week in London. Meg Chesshyre listened in.

“The South China Sea has a lot of problems, a lot of difficulties with production, at the same time there is not actually all that much there in terms of meeting the Asian demand,” says EIA economist Alexander Metelitsa. The EIA estimates that there are about 11 billion bbl of oil and 190 Tcf of natural gas in proven and probable reserves. The oil is similar to the amount of oil in Mexico and the gas amounts to two-thirds of reserves in Europe, not including Russia (Fig. 2).

People also tend to think of the South China Sea in terms of territorial disputes, but this is not really a good way to look at the broad energy supplies in the region. “When you look at the map (Fig. 1), you see that the majority of proved and probable reserves are not in the contested regions of the Paracel Islands Sea of trade and the Spratly Islands, but, rather, close to the coasts of the coastal countries far away from the disputed areas.

“You might ask, but what about undiscovered resources? What about these massive gas and energy resources hidden in the disputed islands? Again, based on the best geological investigation from the US Geological Survey, we estimate there is not all that much potential for resources in these areas. We are talking reserves of maybe 100 Bcf of natural gas in the Spratly Islands, enough to power Hong Kong for a few days, and virtually no oil and gas reserves in the Paracel Islands. In terms of undiscovered resources, we are talking maybe a few billion barrels of oil, maybe, maybe not, and maybe 100 Tcf of natural gas maybe not (Fig. 3).

There might also be the potential for unconventional natural gas, for instance, natural gas hydrates in the Paracel Islands and in other parts of the South China Sea.

China, and to a greater extent Japan, are investing a lot of time and energy in bringing these unconventional resources to market, but the technical problems are extremely large. The EIA does not see this area as being a significant source of natural gas hydrates production, but continues to expect the South China Sea to be a conventional oil, but mostly natural gas, producing region for the foreseeable future.

The established oil producers in the area–Indonesia, Malaysia, Brunei–are seeing a lot of declining fields, and are investing more to keep these fields going. The investment is not meant to expand production, but is meant as a rearguard action. The South China Sea supplies are being used to fill in the gaps in their own rising demand, and it will not be enough. They are going to have to complement those supplies with trade of other kinds.

Major crude oil trade flows in the South China Sea (2011),MMbbl/d image: EIA

Rough seas

South China Sea exploration is particularly difficult because of the sea itself. It is a tough place to do business. There are submarine valleys, strong currents, a high pressure environment, and typhoons. The producers are, however, are getting better at dealing with some of these issues. Production was only down for a few weeks after the devastating typhoon Haiyan in the Philippines last November. Storms that have hit the Gulf of Thailand have only knocked out production for weeks at a time.

Cooperation, rather than competition, helped. The majority of production takes place in the Gulf of Thailand area, the Malaysia area, and, to a somewhat lesser degree, in the Pearl River Basin, in China. The countries that have actually looked past their territorial disputes, or settled them, have had the most production success. Brunei and Malaysia settled their territorial disputes in 2009, and entered production sharing agreements. Despite not having settled their dispute, Thailand and Malaysia have agreed to work together in a joint development area.

There are a variety of different ways that companies and countries approach drilling in the area. These range from service agreements in the Philippines–where foreign companies come in and take on the risk of drilling themselves– to investing in offshore assets globally, to build up technical expertise, which China has been doing.

“We call this the ‘sea turtle’ strategy,” says Metelitsa, where China National Offshore Oil Corporation (CNOOC) and other companies are going out and investing, not so much to keep market share in these other areas, but really to have the technical knowhow, the technical expertise, to come back and build up their own market share, particularly in the South China Sea region. So we are seeing the most technically advanced production being done by China, especially with deepwater natural gas drilling in the eastern part of the South China Sea.”

Major LNG trade flows in the South China Sea (2011) Tcf, image: EIA

Energy choke point

If the South China Sea isn’t that important in terms of its production, Metelitsa says, its “true importance lies in its trade, particularly in the Strait of Malacca. The EIA calls the strait one of the world’s energy choke points.”

It is a critical energy trade route, the shortest route between Africa and the Middle East suppliers to Asia. It sees about 15MMbo/d passing through it, while the most important energy route, the Strait of Hormuz, sees about 17MMbo/d. The Strait of Malacca is very comparable, with extremely large amounts of oil feeding Hong Kong, Japan, and Korea and some other countries (Fig. 4).

“What we don’t see on these trade routes are large slots of intra- south China Sea trading,” Metelitsa says. It is really the external trade coming in through the Strait of Malacca, and to some degree through the Sunda and Lombok Straits as well. It is a similar picture for LNG trade, which is increasing (Fig. 5). “Here we see about half of the world’s LNG trade coming through the Strait of Malacca and the South China Sea region as whole, totaling about 6 Tcf of natural gas a year, and that figure is rising, with most of it going on to Japan, the biggest consumer in the area, with other parts going to South Korea and China as well”

In terms of security of supply, some countries are beginning to react to this sitiation, particularly China, which is financing a pipeline to Myanmar. This may have some impact in the medium term, but these are still marginal sources of production and marginal gas and oil amounts. For the time Fig. 4: Major crude oil trade flows in the South China Sea (2011), million barrels per day. Image: EIA. Fig. 5: Major LNG trade flows in the South China Sea (2011), tillion cubic feet. Image: EIA. Fig. 3: Share of estimated world undiscovered conventional oil and gas resources (2012). Image: EIA. being, the Strait of Malacca and the South China Sea will continue to be a critical trade route.

“The oil and gas on top of the sea is more important than that under the sea,” Metelitsa concludes. “This is a trade route area first and foremost... We are going to see that increasing both in terms of oil and in terms of LNG.”