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TheStreet Open House

East China Sea, a Treasure for Oil, Is Fraught With Danger

TAIPEI ( TheStreet) -- Looking for oil in the South China Sea is an adventure, but in a fun way U.S. Navy recruiters used to tell us in high school. To probe the nearby East China Sea at the moment might just get your rig shot.

China and Japan thirst after an estimated 60 million to 100 million barrels of oil under the 482,000-square-mile sea east of Shanghai. Add to that 1 trillion to 2 trillion cubic feet of natural gas reserves. Their economies, Asia's two largest, need fuel for manufacturing of just about everything in the world. Both are net importers today.

But since mid-September, Chinese boats have relentlessly challenged the Japanese coast guard's control of eight tiny East China Sea islets that both sides claim. They're called the Senkau islands by Japan and the Diaoyu islands by China. Japan's deal in September to buy the islands from a private owner motivated China's recent rage.

Political analysts say a one-sided move to drill for oil or gas in the surrounding sea comes with so much risk that nothing's going on. China and Japan have discovered plenty of other sources for economic development oil in the meantime. Even the South China Sea, claimed by six governments, has stabilized since summer, letting oil exploration gingerly move forward.

To score from deposits under the East China Sea, your best investments are Hong Kong-listed shares or ADRs of China's ever-aggressive, fearless and well-managed CNOOC Ltd. (0883.HK and CEO), which might just go for it anyway. Hold shares of anyone else reliant on the ocean's bounty.

"While resources are at stake, no one can realistically expect to safely drill for oil or gas if there is a full-on territorial dispute that could get militarized, since oil and gas rigs are inherently indefensible," says Scott Harold, associate political scientist with the American think tank Rand Corp.

A bold move by China or Japan to drill would inflame a diplomatic row that both sides hope to tame so they can get on with mutually productive economic ties that have been strained by the island dispute.

And here's what happened the last time the two sides tried to work together: in 2008 China and Japan had signed a resource-sharing deal for a disputed oil field, called Chunxiao by Beijing and Shirakaba by Tokyo. Then, two years ago, Japan accused China of breaking its word by going ahead on its own.

The threat of conflict means dry revenues for oil companies with too many stakes in the East China Sea. Looking at who had sought oil or gas there previously - as far back as the 1980s -- points to who now might lose out under today's conditions.

CNOOC, a massive Chinese state-run offshore driller, is the most likely to hit a vein under the ocean if China quits sparring with Japan. The aggressive, financially solid company has plenty of state backing and no textbook reason to fail.

CNOOC listed its East China Sea proven oil reserves last year at a pretty slick 18 million barrels and gas reserves at 300 billion cubic feet, according to the U.S. government's Energy Information Administration. The China Petroleum & Chemical Corp., or Sinopec (0386.HK), helps CNOOC on its East China Sea oil projects, the U.S. agency says. Share prices of both Chinese oil-gas giants have risen steadily overall since a global financial crisis trough in 2009. But a mishap at sea could tank investor sentiment.

A number of foreign firms have partnered with China in the ocean since the country began exploring there from 1983, when it found the undersea Pinghu oil and gas field, which yielded 8,000 to 10,000 barrels per day at a peak in the late 1990s.

One partner is Husky Oil China, a subsidiary of Canadian Husky Energy (HSE.TO), which is based in Calgary with oil and gas projects in North America as well as the oceans off China. It has an exploration block in the East China Sea but prefers to highlight a more productive South China Sea tract. The company's share prices have gone nowhere since the world financial crisis, and the East China Sea won't give them much juice in the short haul.

Hong Kong-based Primeline Petroleum Corp. (TSX.PEH) is working with CNOOC on an East China Sea gas field near Taiwan. CNOOC and Primeline aim to build pipelines and a processing terminal in the eastern Chinese city of Wenzhou to process gas from the undersea field. What will the Japanese coast guard say?

BP (BP) two years ago bought a 40.8% stake in an East China Sea that block in 2010, the state-run China Daily newspaper reported. Its global oil peers Shell (RDB.B) and Unocal had pulled out six years earlier, apparently for commercial reasons, from a Chinese-led project in the eastern sea's Pinghu Trough. Smart. CNOOC may auction off other blocks of the East China Sea to foreign oil companies, any of which would be drilling a hole in its foot to accept a bid just now.

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