China threatens Philippine energy security

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The Malampaya gasfield guarantees Philippine energy security, but it runs dry soon and gas producers fear new fields are too near to the South China Sea.

About 80 km off the northwest coast of Palawan Island in the South China Sea is the Malampaya natural gas field, the Philippines’ main domestic source of energy. Once piped ashore, its natural gas fuels five power plants, which provide half of the electricity supply for the Philippines’ most populous island of Luzon and the national capital of Manila.

But by the mid-to-late 2020s, Malampaya is expected to run dry. If the Philippines is to keep Luzon’s lights on and its national economy growing, then it will need to develop new sources of energy before the current one is depleted. New fields to guarantee Philippine energy security are however, too near to the South China Sea.

Given the Philippines’ desire to phase out its coal-fired power plants and the small size and relatively high cost of renewable ones, the country’s only reliable and cost-effective source of energy is natural gas. But with no onshore reserves, that means turning to the waters of the South China Sea. Unfortunately for the Philippines, most energy companies have refrained from bidding on the offshore blocks that Manila has offered. The reason why is not because they fear that the blocks will yield no economically viable natural gas reserves. Rather, it is because they do not want to bear the security risks that come with energy exploration in waters that are within or even close to China’s self-proclaimed nine-dashed line in the South China Sea. In view of China’s recent aggressive behavior toward foreign exploration vessels, that is understandable.

Swerving Strategies

How to deal with China in the South China Sea is an issue that has dogged Philippine leaders since China occupied Philippine-claimed Mischief Reef in 1994. Over the years, they have responded with very different strategies. In 2011, then-Philippine President Benigno Aquino took a hard line. He procured $118 million in additional military spending to specifically defend Malampaya.[1] He also boosted military cooperation with the United States and took China to task over its South China Sea claims at the Permanent Court of Arbitration (PCA), which ruled in the Philippines’ favor in 2016.

But immediately after the ruling, Aquino’s successor, Rodrigo Duterte, abruptly changed course. Instead of confronting China, he sought to accommodate it. He reasoned that Manila could get far more from Beijing with a carrot than a stick. And so, he “separated” the Philippines from the United States, set aside the PCA ruling, and ordered his administration to find a way by which China and the Philippines could conduct joint energy exploration in the South China Sea. A year later, Duterte outlined a deal to do so near Reed Bank, a part of the South China Sea which both countries claim. Both have also been interested in energy exploration there; China surveyed the area in the late 2000s, and the Philippines followed suit in the early 2010s.

Initially, China was receptive to such a deal, but negotiations between the two countries have ground to a standstill. Manila has sought a deal whereby Chinese and Philippine oil companies would conduct joint energy exploration of Reed Bank, presumably under the auspices of the Philippine government. However, from Beijing’s perspective, that would be tantamount to accepting Philippine sovereignty there. Moreover, Beijing is probably none too keen on Manila’s desire to keep 60 percent of the net profits from any joint venture, a stipulation under Philippine law governing natural resource deals with foreign entities.

In the meantime, China militarized the islands that it occupies in the Spratly archipelago; Chinese navy and coast guard ships have routinely sailed within the 12-nautical mile limit of the Philippines’ territorial waters; and Chinese vessels continue to harass Philippine fishing boats in the South China Sea. In one case in June 2019, a Chinese vessel, suspected to be part of China’s maritime militia, rammed a Philippine fishing boat, sinking it and leaving its 22 Filipino sailors adrift at sea. (Eventually, a Vietnamese boat rescued the survivors.) The incident, near Reed Bank, forced Duterte to take some action. In August, he ordered that all foreign ships sailing through Philippine waters must gain permission from Manila first. Whether Chinese ships will comply remains to be seen. But that seems unlikely if recent Chinese maritime behavior is any indication.

In May and again in July, a Chinese coast guard ship repeatedly interfered with Malaysia’s energy exploration and production activities near Luconia Shoals, off the coast of Borneo. At about the same time, China sent the Haiyang Dizhi 8, a survey ship, into the waters off Vietnam. That triggered a tense week-long standoff between Vietnamese naval and Chinese coast guard vessels. After the Haiyang Dizhi 8 withdrew, tensions subsided. But a month later, it returned and sailed even closer to Vietnam’s coastline. Taken together with the June revelation that China likely conducted an anti-ship missile test in the South China Sea, it would seem that Beijing has little interest in being conciliatory.
Doubling Down, Again

Throughout his tenure in office, Duterte has had to play down aggressive Chinese behavior as part of his accommodative policy toward China. When China built military facilities in the Spratly Islands, Duterte tried to deflect public concern by claiming that the facilities were directed against the United States and would have no impact on Philippine claims in the South China Sea. He also blamed his predecessors for their failure to build stronger military forces that he could have used to deter China. Their laxity, he argues, is what has limited his options in dealing with China.

Hence, Duterte has not given up on his pro-China strategy. Duterte visited Beijing in August 2019 in another attempt to make something of it. Perhaps through face-to-face discussions, Duterte could persuade Chinese Chairman Xi Jinping to rein in his country’s maritime conduct in the South China Sea. To press home his point and probably to placate his domestic critics, Duterte brought up the PCA ruling with Xi. Unsurprisingly, Xi brushed it aside. “We will not budge,” he responded according to Duterte. “We own [the South China Sea]. Why should we talk to you?”

By the end of their meeting, the two leaders papered over their differences and affirmed their mutual interest in joint development of energy resources in the South China Sea. Indeed, they pledged to “form committees to advance oil exploration talks.” Of course, it was not the first time they said they would do so. Duterte and Xi even signed a memorandum of understanding to do just that in November 2018. Clearly little progress has been made in the intervening ten months. And, while China can afford to wait for the right conditions to strike a deal, the Philippines does not have the luxury of time.

Digging a Deeper Hole

The clock continues to tick on Malampaya. The Philippines Department of Energy has tried to entice energy companies to bid on exploration blocks near Malampaya and elsewhere in the South China Sea, but to no avail.[2] With China’s fortified islands and warships just over the horizon, only Shell, which operates the offshore platform atop Malampaya, has expressed any interest in doing so. With no other competing bidders, Shell is likely to angle for economic concessions from Manila to compensate it for the security risks it will have to assume.

All that puts pressure on Duterte to do something to improve the Philippines’ perilous energy security situation. No doubt that is why he has continued to push for some sort of deal with China. While that deal remains elusive for the moment, some of Duterte’s domestic critics worry about what might happen if he is successful. They fear that Duterte could strike a deal with China that would implicitly legitimize Chinese claims in the South China Sea and undermine the Philippines’ hard-fought legal victory at the PCA. No matter what, any deal with China to produce natural gas in the South China Sea would leave the Philippines, at least in some part, reliant on China for its energy.

A successful deal could also be a cause for concern among other claimants in the South China Sea, like Malaysia and Vietnam. With a joint energy exploration deal in hand, China could pressure them into similar arrangements. Such a deal might even help strengthen China’s position in the ongoing negotiations over the code of conduct in the South China Sea between China and the countries of ASEAN.

On the other hand, should no deal with China transpire, any Philippines-sanctioned energy exploration activity in the South China Sea would likely face active Chinese harassment. As a result, the trouble the Philippines has had in attracting energy companies to explore in the region’s waters is unlikely to change. More likely, the whole area, including Reed Bank, would remain unexplored. That would ultimately drive the Philippines to search for new sources of energy abroad.

Terminal Dependence

The most readily available source of energy for the Philippines is ship-borne liquefied natural gas (LNG) from places like Australia, the United Arab Emirates, and the United States. Sensing that opportunity, several companies have laid plans to build LNG regasification terminals in the Philippines. Costing hundreds of millions of dollars, such terminals convert transported LNG back into its gaseous state for use in power plants and homes.

While that may sound like a good solution, it is also a solution that makes the Philippines dependent on foreign energy. No longer producing its own natural gas, the Philippines would become more exposed to factors that are beyond its control, from volatile LNG prices to political risk. While the Philippines can somewhat mitigate price risk with long-term futures contracts, it cannot avoid the added costs from the construction of expensive LNG terminals. As for political risk, the Philippines would be wise to carefully consider from which countries it obtains its natural gas supply. Clearly many Eastern Europeans wished they were not as dependent as they are on Russia for their natural gas.

Of course, if Duterte successfully strikes a deal with China to explore for and produce offshore natural gas, LNG terminal investments in the Philippines could suffer. Indeed, investors in LNG terminals must bet that either no deal will come to pass or that Philippine energy demand will outstrip any potential offshore production in the South China Sea to lock in Philippine energy security. Looking ahead, three efforts have already received Manila’s approval to build LNG terminals since late 2018.[3] One is led by First Gen, a Philippine power firm, and Japan’s Tokyo Gas. Another is led by Australia’s Energy World Corporation. And the last is led by China National Offshore Oil Company (CNOOC), one of China’s three giant state-owned energy firms. Recently, the Philippine National Oil Company, the Philippines’ state-owned counterpart, joined CNOOC’s effort. All have laid out cautious plans, and, so far, none have progressed beyond the earliest stages of construction.

Peculiarly, China would stand to benefit in two ways if it continues to stymie Philippine energy exploration and production in the South China Sea to guarantee the country’s security. First, CNOOC’s costly investment in a new LNG terminal would have a far better chance of paying off. Second, the Philippines could become dependent on CNOOC’s (presumably Chinese) supply of natural gas. (Of course, it would be particularly galling to Filipinos if CNOOC, one day, chose to source its LNG from a Chinese-controlled offshore natural gas field in the South China Sea.)

Regardless of whether the newly formed committees between China and the Philippines reach an agreement to jointly explore the South China Sea by November, as the Philippine ambassador to China hopes, the outlook for Philippine energy security will remain murky. Duterte is correct: he does have few options available to him. But simply pointing out that fact does little for the Philippines. His predecessor, Aquino, arguably started with an even weaker hand than Duterte did. But Aquino cleverly overcame that weakness by using the PCA to bring international pressure on China and constrain its actions that threatened Philippine energy security in the South China Sea. Duterte may have few options, but he is likely to have even fewer in the future unless he makes more of them.

This analysis was published by the Foreign Policy Research Institute. The author, Felix K. Chang, is a senior fellow at the Institute. He is also Chief Strategy Officer of DecisionQ, a predictive analytics company in the national security and healthcare industries.

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