Subject: A Blueprint for Cooperation on Oil and Gas Production in the South China Sea
From: "CSIS Asia Maritime Transparency Initiative" <[email-masked]>
To: <[email-masked]>
Date: Wed, 25 Jul 2018 18:08:07 +0000
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July 25, 2018
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** A Blueprint for Cooperation on Oil and Gas Production in the South China Sea
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This is the second product of the CSIS Expert Working Group on the South China Sea (https://amti.csis.org/expert-working-group-scs/) , which seeks to chart a feasible model for claimants to manage their maritime disputes.

Competition for oil and gas resources has repeatedly triggered standoffs between claimants in the South China Sea in recent years, especially between China, the Philippines, and Vietnam. The last serious attempt to cooperate on this front was the trilateral Joint Marine Seismic Undertaking of 2005 to 2008, which was allowed to expire amid political controversy and questions about its constitutionality in the Philippines. Since late 2016, the Philippine and Chinese governments have been discussing joint development of hydrocarbons at Reed Bank, but there has been little apparent progress despite optimistic official pronouncements. Independent experts and prominent jurists in the Philippines have said any such scheme would likely be unconstitutional based on the strict provisions in the country’s charter demanding that the government protect the nation’s rights to offshore resources.

The U.S. Energy Information Agency estimates that the South China Sea holds about 190 trillion cubic feet of natural gas and 11 billion barrels of oil in proved and probable reserves, most of which lies along the margins of the South China Sea rather than under disputed islets and reefs. The U.S. Geological Survey in 2012 estimated that there could be another 160 trillion cubic feet of natural gas and 12 billion barrels of oil undiscovered in the South China Sea. Beijing’s estimates for hydrocarbon resources under the sea are considerably higher, but still modest in relation to China’s overall demand – the country’s oil consumption in 2018 is expected to top 12.8 million barrels per day.

For Vietnam and the Philippines, however, access to energy resources in the South China Sea is crucial. Block 06.1, part of the Nam Con Son project near Vanguard Bank, supplies about 10 percent of Vietnam’s total energy needs. The Philippines generates about a third of the electricity for its main island of Luzon from a single source, the Malampaya gas field, which is expected to cease production by 2024. Unless an alternative is found—and Reed Bank is the only good option currently on the table—the Philippines will need to either import significant amounts of natural gas at greater costs, rapidly incorporate other energy sources into its power supply, or face severe shortages.

Cooperation on disputed oil and gas resources is more difficult, both legally and politically, than for fisheries or environmental management (https://amti.csis.org/coc-blueprint-fisheries-environment/) . Unlike for fish, there is no provision in the United Nations Convention on the Law of the Sea (UNCLOS) mandating that states cooperate to manage oil and gas resources in a semi-enclosed sea like the South China Sea. UNCLOS articles 74 and 83 do say that in the absence of a final delimitation of maritime boundaries, states should exercise mutual restraint and establish “provisional arrangements of a practical nature” to manage their disputes, which offers a narrow foundation for compromise. But successful bilateral joint development agreements for oil and gas in disputed waters are relatively few, and there are no cases of fully operational “provisional arrangements” involving three or more parties. Nonetheless, finding a way forward is necessary if the claimants hope to
defuse tensions and avoid harming their energy security.

Despite the obvious difficulties, it is possible for claimants to cooperate on oil and gas development in the South China Sea in a manner that would be both equitable and consistent with international law as well as the laws of all involved parties. Doing so would require considerable creativity and a greater willingness to compromise, especially by China, than has been evident to-date. Such an agreement would need to be framed so that all parties could claim it was consistent with their interpretations of both domestic and international law. Most difficult would be finding a way for Beijing to reason that such cooperation was consistent with its assertions of “historic rights” while at the same time ensuring that Manila could uphold its 2016 award from an arbitral tribunal in The Hague and all coastal states could maintain jurisdiction over their continental shelves.

Striking that precarious balance would require some politically difficult but legally feasible concessions up front. First, China would need to accept that being guaranteed a share of the profits from oil and gas resources throughout the South China Sea would be enough to satisfy its demand for “historic rights.” This would mean accepting a system in which other claimants exercise jurisdiction by licensing oil and gas exploration so long as Beijing shares in the spoils. This should be possible, given that no Chinese law, official statement, or government document has ever clarified exactly what historic rights Beijing claims.

Second, all claimants must be willing to forego pursuing oil and gas drilling based on entitlements from the disputed islands and reefs of the South China Sea. Fisheries management areas (https://amti.csis.org/coc-blueprint-fisheries-environment/)  around the reef systems could provide a politically palatable way to cordon these features off from exploration without dealing with their legal statuses or delimitation issues. For China, which sees the islands as fully entitled to exclusive economic zones and continental shelves, this could be internally justified as a magnanimous gesture and act of good faith. Beijing could reason that even if the disputed features were islands under article 121.3 of UNCLOS, any equitable delimitation of boundaries with the much longer coastlines of the Southeast Asian states opposite them would result in their EEZs and continental shelves being reduced to small enclaves around the features. For the other claimants, agreeing to forego drilling
around the disputed reefs and islands based on the need for environmental conservation should prove a politically palatable rationale to focus petroleum exploration and development on areas closer to their coasts.

These concessions would need to underpin the agreement without being spelled out in its text. That would allow each party to agree on the mechanisms for cooperation while still using different domestic legal justifications for doing so.

To that end, claimants should agree to:
1. Establish a joint venture, in the form of a new commercial entity, in each South China Sea littoral state involving that claimant’s national petroleum company and as many of its counterparts from the other claimants as are interested in investing. Each joint venture’s sole business will be exploration and production of South China Sea hydrocarbon resources off that country’s coast. There are already successful models of joint ventures among state-owned petroleum companies operating in the South China Sea, but a multiparty corporation established by parties to a dispute would be groundbreaking.
+ These corporations should seek to acquire petroleum licenses for new offshore blocks in the South China Sea offered by the countries in which they are headquartered, either via production sharing agreements or service contracts, depending on the domestic law of the tendering state. This would ensure that all parties have the opportunity to benefit from oil and gas production throughout the South China Sea.
+ The joint ventures should seek to purchase stakes that their individual member-companies already hold in petroleum licenses in the portions of South China Sea with which they are concerned. Existing contracts that coastal states have with other parties would not be affected, but the corporations should seek to acquire those licenses when they are relinquished by the current operators. The corporations should also seek to purchase minority stakes in commercially producing blocks in which the current operator is unlikely to relinquish the license any time soon.For a survey of oil and gas blocks that have been licensed by the Southeast Asian claimants or that are currently open for bids, see the map below. This map will be updated to include China’s offshore blocks and provide details about operators, stakeholders, and production information.
+ Claimants should publicly agree that decisions by the joint ventures to invest in specific blocks in the South China Sea would have no impact on territorial claims or the eventual delimitation of maritime boundaries, and could not be construed as recognition of the claims of any party by the other members of the joint venture. To this end, an explicit non-prejudice clause should be incorporated into the agreements creating the joint ventures and in all contracts into which they enter.
+ Each claimant would be guaranteed the right to invest, through their national oil companies, in each of the joint ventures, but would be under no obligation to do so. This means that one claimant, such as China, might have a company invested in each of the joint ventures while another might invest in only one or two. Any claimant that does not have its national oil company invest in a given joint venture at the time of its establishment should be welcome to do so in the future. Conversely, each company should be free to divest its stake in any given joint venture at any time (though only to the other national oil companies).
+ Equal ownership stakes by each company involved in the joint venture might be preferable in some cases, while in others some might wish to invest more or less depending on their capabilities and interests. These details should be left up to negotiation and adjustment as needed. Similarly, the details of how each corporation makes investment decision and which stakeholder(s) acts as the operator in any given project should left to negotiation among the national oil companies. Profits from the joint ventures’ operations should be shared based on each partner company’s stake in the corporation.

https://amti.csis.org/a-blueprint-for-cooperation-on-oil-and-gas-production-in-the-south-china-sea/

2. Agree that all South China Sea littoral states may license petroleum exploration and production within 200 nautical miles of their coastlines pending the eventual delimitation of maritime claims. In areas of overlap, unless a previous bilateral agreement has been reached, a median line should be used to determine which state has the provisional right to license exploration and production. This arrangement is detailed in the map below.
+ Claimants should publicly agree that the establishment of offshore blocks would have no impact on territorial claims or the eventual delimitation of maritime boundaries, and could not be construed as recognition of the claims of others. Any licenses issued by the coastal states should also incorporate a non-prejudice clause specifying that this provisional arrangement will have no effect on the final delimitation of boundaries.
+ The licensing process would operate according to the domestic laws of the coastal states. In some cases, governments could simply grant licenses to the joint venture engaged in hydrocarbon exploration and production off its coast, while in others competitive bidding might be necessary. Even in those cases requiring bidding, the joint ventures would have considerable advantages—political and otherwise—over competitors.
+ The coastal state that tenders a license acquired by one of the joint venture corporations would enjoy the same share of profits (the majority in most cases) and the same right to taxation as it would in tendering the license to any other company. This would guarantee that the littoral states benefit most from the resources off their coasts while still allowing all members of the joint venture a share in the profits.
+ Any existing joint development frameworks, such as those between Malaysia and Brunei off the latter’s coast or between Malaysia and Vietnam near the entrance to the Gulf of Thailand (see map), would remain unchanged. The newly-established joint venture would seek to acquire licenses in these areas as any oil company might, while the coastal states would tender licenses and split profits according to their preexisting agreement.

https://amti.csis.org/a-blueprint-for-cooperation-on-oil-and-gas-production-in-the-south-china-sea/

3. Agree to forego oil and gas exploration in protected fisheries zones covering the vital reef systems of the South China Sea, including the Spratly and Paracel Islands, Scarborough Shoal, and Luconia Shoals, as determined by a multilateral body of independent experts and regional officials (see Blueprint for Fisheries Management and Environmental Cooperation (https://amti.csis.org/coc-blueprint-fisheries-environment/) ).
4. Undertake a joint oil and gas survey, performed by one or more of the corporations, of the area of seabed in the center of the South China Sea beyond 200 nautical miles from the coastlines as a provisional measure. This would serve as an acknowledgment some areas beyond 200 nautical miles are subject to overlapping extended continental shelf claims by the coastal states while other areas might be entirely beyond any continental shelves and therefore constitute part of the common heritage of mankind.

This blueprint represents a consensus among the members of the South China Sea Expert Working Group at CSIS acting in their personal capacities and not as representatives of their home institutions.

**
CSIS Expert Working Group on the South China Sea
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CSIS’s newly-launched working group on the South China Sea brings together prominent experts on maritime law, international relations, and the marine environment. The members seek consensus on realistic, actionable steps that claimant states and interested parties could take to boost cooperation and manage tensions at sea. The group meets regularly to tackle issues that it considers necessary for the successful management of the South China Sea disputes and produces blueprints for a path forward on each. Through this iterative process, the group hopes to produce a robust model for managing the disputes that would be both legally and politically feasible—in effect, a blueprint for an eventual code of conduct (https://amti.csis.org/isnt-coc-youre-looking/) .

The working group is chaired by AMTI director Gregory Poling and includes a diverse set of experts from claimant states and interested countries, including the United States. All members take part in their personal capacities, not as representatives of their home institutions. They are invited to join the group based on their subject matter expertise and ability to reach creative compromises with other members. The group’s membership will continue to expand as it tackles additional topics necessary for the management of the South China Sea disputes.

Outcomes:

A Blueprint for Fisheries Management and Environmental Cooperation in the South China Sea (https://amti.csis.org/coc-blueprint-fisheries-environment/)

A Blueprint for Cooperation on Oil and Gas Production in the South China Sea (https://amti.csis.org/a-blueprint-for-cooperation-on-oil-and-gas-production-in-the-south-china-sea/)

Members:

Jay Batongbacal (https://amti.csis.org/author/jbatongbacal/) , University of the Philippines
Zack Cooper (https://amti.csis.org/author/zcooper/) , AEI
Tara Davenport (https://amti.csis.org/author/tdavenport/) , Yale University
Donald Emmerson (https://amti.csis.org/author/demmerson/) , Stanford University
Matthew Funaiole (https://amti.csis.org/author/mfunaiole/) , CSIS
Bonnie Glaser (https://amti.csis.org/author/bglaser/) , CSIS
Michael Green (https://amti.csis.org/author/mgreen/) , CSIS
Brian Harding (https://amti.csis.org/author/bharding/) , CSIS
Bill Hayton (https://amti.csis.org/author/bill_hayton/) , Chatham House
Murray Hiebert (https://amti.csis.org/author/mheibert/) , CSIS
Hong Nong (https://amti.csis.org/author/nhong/) , Institute for China-America Studies
Christopher Johnson (https://amti.csis.org/author/cjohnson/) , CSIS
Isaac Kardon (https://amti.csis.org/author/ibkardon/) , U.S. Naval War College
Carmen Ablan Lagman (https://amti.csis.org/author/clagman/) , De La Salle University
Evan Laksmana (https://amti.csis.org/author/elaksm/) , Centre for Strategic and International Studies, Indonesia
Joseph Chinyong Liow (https://amti.csis.org/author/jliow/) , S. Rajaratnam School of International Studies
RADM (Ret.) Michael McDevitt (https://amti.csis.org/author/mcdevitm/) , Center for Naval Analyses
John McManus (https://amti.csis.org/author/jmcmanus/) , University of Miami
Elina Noor (https://amti.csis.org/author/enoor/) , Asia-Pacific Center for Security Studies
Prashanth Parameswaran (https://amti.csis.org/author/pparameswaran/) , The Diplomat
Gregory Poling (https://amti.csis.org/author/gpoling/) , CSIS
Clive Schofield (https://amti.csis.org/author/cschofield/) , World Maritime University
Amy Searight (https://amti.csis.org/author/asearight/) , CSIS
Andrew Shearer (https://amti.csis.org/author/ashearer/) , CSIS
Rashid Sumaila (https://amti.csis.org/author/rsumaila/) , University of British Columbia
Vo Si Tuan (https://amti.csis.org/author/vstuan/) , Vietnam Academy of Science and Technology
Tran Truong Thuy (https://amti.csis.org/author/ttthuy/) , Diplomatic Academy of Vietnam
Chi-ting Tsai (https://amti.csis.org/author/chiting/) , National Taiwan University
Zhu Feng (https://amti.csis.org/author/zhufeng/) , Nanjing University

Recent Analysis

The Dangerous Quest for a Code of Conduct in the South China Sea (https://amti.csis.org/the-dangerous-quest-for-a-code-of-conduct-in-the-south-china-sea/)  by Huong Le Thu

The Next Phase of Philippine Military Modernization: Looking to External Defense (https://amti.csis.org/the-next-phase-of-philippine-military-modernization-looking-to-external-defense/)  by Renato Cruz de Castro

Quadrilateral Cooperation as Seen from Japan: Distraction or Assurance? (https://amti.csis.org/quadrilateral-cooperation-seen-japan-distraction-assurance/)  by Ryosuke Hanada

Guerrilla Warfare Over the South China Sea: Updating Vietnam’s Doctrine (https://amti.csis.org/guerilla-warfare-over-south-china-sea-updating-vietnams-doctrine/)  by Nguyen The Phuong

In Search of the Indo-Pacific: Commentary from 2018 IISS Shangri-La Dialogue (https://amti.csis.org/search-indo-pacific-commentary-2018-iiss-shangri-la-dialogue/) by Don Emmerson

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