The search for a relatively secure and reliable source of oil is a driving force for every industrialized nation. The Chinese culminated many years of exploration and planning to begin to take over vast areas of the Pacific and surrounding oceans for the purpose of oil exploration and extraction. In some cases the Chinese came very close to violating many nations territorial claims over disputed areas. One ongoing dispute is the Daihatsu islands, which many nations including Japan and Taiwan claim. Who exactly owns the island chain is not known while all interested parties are able to produce historical and legal justification.
Chinese expansion and risk management
The recent acquisition of Canadian energy company Nexen (TSX:NXY) by China signals a strategic move from onshore operations to offshore oil operations. Several benefits are immediately apparent. For one, China will not have to deal with hostile political environments, which can lead to conflict.
Historically, such conflict has caused delays in getting petroleum products to market as well as ensuring the reliability of pipelines. The issue of corruption within nations that are often politically unstable will be mitigated since these marine oilfields are in areas that are entirely controlled by the Chinese.
Another benefit will be from Nexen's vast experience in the North Sea oil operations. It has developed technology and procedures in one of the most demanding environments while being able to create a profit. This will give CNOOC (NYSE:CEO) an advantage as it will have to rely more on this experience while expanding operations in the South China Sea and Pacific.
Potential challenges to overcome
China will see a challenge to their claims. The potential of piracy and enforcement of rule of law on the high seas will test both the Chinese legal system as well as their naval abilities. In order to do this China will need a robust navy, which could spur neighboring nations to counter-balance those efforts by increasing their naval capabilities. This could start an arms race in Asia that primarily focuses on naval capability and the industries that support such efforts. Building a modern navy is expensive, resource-hungry, and takes decades. Most nations no longer have the shipyards necessary to ramp up such construction operations.
CNOOC will most likely be the lead drilling company. The potential for a catastrophic oil spill and the destruction of ecosystems as well as fisheries could threaten many nations' abilities to export and import fish as a primary food source. It is uncertain what role the United Nations will play in the environmental enforcement of treaties and rule of law. This could spur on various sanctions and prohibitions on oil exploration and extraction operations.
Naval importance and maritime security
Currently Asia is seeing a naval boom while Japan and South Korea are building their navies and taking part in complicated live-fire maritime exercises. Japan's participation is designed to practice the skills necessary in protecting the various island chains in the Southwest Pacific. This is an ambitious extension of their foreign policy. Since World War II concluded Japan has used their military solely as a defense force. Currently, the Japanese military is in a period of transitioning their defense force to a more traditional military, capable of offensive operations. As Asian nations begin to strive for energy independence, their armed forces are keeping parity with the national ambition.
The South Koreans are similarly building their naval capabilities to be on par with Japan's. This all seems to be in direct proportion to Chinese expansionism in the Pacific and using their naval forces to ensure dominance over their oil claims.
With the Pacific oil rush and the potential for an arms race, will coastal China as well as other Asian nations become oil exporters and refinery hubs for an ever-modernizing Asia? And what role will the United States play? Currently, the U.S. Navy is undergoing a massive ship modernization process. Within the next few years Congress will have allocated budget and approved plans for the future of the U.S. Navy's surface warfare fleet. These building projects could take as much as 30 years to fully complete. Is this an indicator that the U.S. hopes to maintain their traditional role as a dominant naval power within the Pacific? Time will tell.
The cost of rapid industrialization
China, like most other communist influenced nations, often leaps into industrialization projects with little regard for environmental safeguards and increasing military presence. Often such projects in the support mechanisms around those projects create geopolitical and economic imbalances. As China enters the potential for political reforms and hopefully more market freedoms, will they also introduce large projects such as this massive oil extraction projects seen in the Pacific with the necessary risk management controls that other Asian, American, and European markets have used as a form of best practices?
Investors can begin to look at the shipbuilding industry to pick and choose their opportunities. Given that the Chinese national shipbuilding companies are in deep trouble, as are most other companies in the industry, investors can strategically choose which companies to help grow.
Shipbuilding in China has gotten a boost in 2013 from an increase in contracts that has engaged 4% of their existing 1,650 shipyards. Investing in shipbuilding spread across those three nations would ensure a greater return on investment mainly due to the high capacity that would give lower costs.
Some of the shipyards awarded contracts are Guangzhou and Chengxi controlled by China State Shipbuilding Corporation and private builders such as Yangzijiang Shipbuilding and Zhejiang Yangfan.
The way forward
China is expanding and meeting the needs of their future energy consumption while mitigating their energy risks. Their ability to exploit offshore oil opportunities will provide a level of security that they did not enjoy while working with production partners in hostile environments. If successful, China will become a leader in oil exploration and export using domestically built oil/LNG carriers.