Insight: Conflict looms in South China Sea oil rush

Within hours, a Philippine surveillance plane, patrol ships and light attack aircraft arrived in the disputed area of Reed Bank in the South China Sea. By then the Chinese boats had left after chasing away the survey ship, Veritas Voyager, hired by U.K.-based Forum Energy Plc.

But the tension had become so great Forum Energy chief Ray Apostol wanted to halt two months of work in the area.

"They were so close to finishing their work. I told them to stay and finish the job," Sabban, who heads the Western Command of the Philippine Armed Forces, told Reuters at his headquarters in Puerto Princesa on Palawan island.

Over the next few days, President Benigno Aquino would call an emergency cabinet meeting, file a formal protest with China, and send his defense secretary and armed forces chief to the Western Command in a show of strength.

The March 2011 incident is considered a turning point for the Aquino administration. The president hardened his stance on sovereignty rights, sought closer ties with Washington and has quickened efforts to modernize its military.

A year later, Forum Energy is planning to return. Top company executives told Reuters the company intends to sail to Reed Bank within months to drill the area's first well for oil and natural gas in decades, an event that could spark a military crisis for Aquino if China responds more aggressively.

The U.S. military has also signalled its return to the area, with war games scheduled in March with the Philippine navy near Reed Bank that China is bound to view as provocative.

"This will be a litmus test of where China stands on the South China Sea issue," said Ian Storey, a fellow at the Singapore Institute of Southeast Asian Studies. "They could adopt the same tactics as they did last year and harass the drilling vessels, or they might even take a stronger line against them and send in warships."

A decades-old territorial squabble over the South China Sea is entering a new and more contentious chapter, as claimant nations search deeper into disputed waters for energy supplies while building up their navies and military alliances with other nations, particularly with the United States.

Reed Bank, claimed by both China and the Philippines, is just one of several possible flashpoints in the South China Sea that could force Washington to intervene in defense of its Southeast Asian allies.

OBAMA PIVOT

President Barack Obama has sought to reassure regional allies that Washington would serve as a counterbalance to a newly assertive China, part of his campaign to "pivot" U.S. foreign policy more intensely on Asia after a decade of war in Iraq and Afghanistan.

Obama brought up the South China Sea at an Asia-Pacific summit in Bali last November, and had a surprise one-one-one with Chinese Premier Wen Jiabao on the subject, although Beijing had insisted the issue should not be on the agenda at all.

"As Southeast Asian nations run to the U.S. for assistance, Beijing increasingly fears that America aims to encircle China militarily and diplomatically," said Stephanie Kleine-Ahlbrandt, Northeast Asia Director for the International Crisis Group. "Underlying all of these concerns is the potential that discoveries of oil and natural gas beneath the disputed sections of the South China Sea could fuel conflict."

The area is thought to hold vast untapped reserves of oil and natural gas that could potentially place China, the Philippines, Vietnam and other claimant nations alongside the likes of Saudi Arabia, Russia and Qatar.

Manila is beefing up its tiny and outdated naval fleet and military bases, adding at least two Hamilton-class cutters this year and earmarking millions of dollars to expand its Ulugan Bay naval base in Palawan.

It's no match for China's fleet, the largest in Asia, which boasts 62 submarines, 13 destroyers and 65 frigates, according to the International Institute for Strategic Studies.

China last month launched the fourth of its new 071 amphibious landing ships that are designed to quickly insert troops to trouble spots, disputed islands, for example.

The U.S. Navy has announced it will deploy its own new amphibious assault vessels, the Littoral Combat Ships, to the "maritime crossroads" of the Asia-Pacific theater, stationing them in Singapore and perhaps the Philippines.

Washington's renewed presence in the Philippines, a former U.S. colony that voted to remove American naval and air bases 20 years ago, follows the U.S. announcement last year of plans to set up a Marine base in northern Australia and possibly station warships in Singapore.

Manila is talking about giving Washington more access to its ports and airfields to re-fuel and service U.S. warships and planes. The two countries will conduct war games off Palawan island in late March -- focusing on how to deal with a takeover of an oil rig in the South China Sea.

'SOUNDS OF CANNONS'

China has warned oil companies not to explore in the disputed South China Sea, over which Beijing says it has "indisputable sovereignty." Chinese ships have repeatedly harassed vessels that have tried.

After ExxonMobil discovered hydrocarbons off the coast of Danang in central Vietnam, an area also claimed by China, one of China's most popular newspapers warned in October that nations involved in territorial disputes should "mentally prepare for the sounds of cannons" if they remain at loggerheads with Beijing.

Despite the threats, the Philippines and Vietnam have continued to explore for oil and natural gas further offshore in the South China waters, driven by persistently high oil prices and more advanced deep-sea technology.

The Philippines has reported as many as 12 incidents of Chinese vessels intruding into its sovereign waters in the past year, an unusually high number, Sabban said.

In one of the most serious incidents last October, a Philippine navy ship seized Chinese fishing boats after colliding with one of them, prompting protests from China for their return.

At least 12 Chinese fishermen have been arrested over the past year. Half of them remain in detention in Palawan.

"China has no right to tell us that we should first ask for permission from them to explore the area," Sabban said. "We have explored that area back in the 1970s, so why can't we explore it now? We knew that there is a substantial deposit of natural gas even before all of these things started."

Manila says Reed Bank, about 80 nautical miles west of Palawan island at the southwestern end of the Philippine archipelago, is within the country's 200-nautical mile exclusive economic zone. Beijing, however, believes it is part of the Spratlys, a group of 250 uninhabitable islets spread over 165,000 square miles, claimed entirely by China, Taiwan and Vietnam and in part by Malaysia, Brunei and the Philippines.

While China prefers to solve the disputes one-on-one with its smaller Southeast Asian neighbor, Washington has sought to internationalize the issue, given that half the world's merchant fleet tonnage sails across the sea and around these islets each year, carrying $5 trillion worth of trade.

"If we don't develop our positions in our exclusive economic zone, then we will only be giving it away and will be at the losing end," Eugenio Bito-Onon, the mayor of Kalayaan islands in the Spratlys, told Reuters at a coffee shop in Puerto Princesa.

China's oil exploration has been limited in the South China Sea with less than 15 deep sea wells drilled so far. Chinese offshore oil and gas specialist CNOOC Ltd, along with international partners Canada's Husky Energy and U.S. company Chevron Corp., plan to step up exploration in the area but focus mainly in the north, staying away from the politically sensitive waters to the south.

Estimates for proven and undiscovered oil reserves in the South China Sea range from 28 billion to as high as 213 billion barrels of oil, the U.S. Energy Information Administration said in a March 2008 report. That would be equivalent to more than 60 years of current Chinese demand, under the most optimistic outlook, and surpass every country's proven oil reserves except Saudi Arabia and Venezuela, according to the BP Statistical Review.

OIL MANDATE

General Sabban said the necessary patrol ships and surveillance planes will be provided to protect Forum Energy's exploration vessels in Reed Bank.

"We have a mandate to protect all oil companies exploring in our territory," he said. "We don't exactly escort them, but we are in the area to deter any outside force from harassing them."

Forum Energy, whose majority shareholder is the Philippines' top miner Philex Mining Corp., plans to spend around $80 million through 2013 to explore the Sampaguita gas field in Reed Bank, covered by Service Contract 72.

The field is estimated to hold at least 3.4 trillion cubic feet of natural gas, with the potential for five times that amount. That is at least 25 percent bigger than the nearby Malampaya gas field, operated by Royal Dutch Shell, which fuels half of the power needs for the country's main island of Luzon.

The Philippines is eager to further increase its natural gas production to meet growing domestic demand for gas-fired power, which is estimated to surge to 5,000 megawatts per day in 2016, from the current 2,700 megawatts.

"There is no question that there is gas there. We already know one or two locations we would like to drill on," said Apostol, Forum Energy's president, in an interview. "If the first drill is a bonanza, there might be a need to drill back to back."

The company said it is closely coordinating its Reed Bank plans with the military and the energy department, hoping to send drill ships by the fourth quarter.

"We are aware of the implementation risks that have to be taken into account when we contract the drilling services," said Forum Energy's executive director Carlo Pablo. "We have to have plans in case of delays in operations, on mitigating cost overruns, and contractual penalties that may be imposed."

A flotilla of ships could soon follow Forum Energy in disputed waters, with Manila later this year awarding two offshore oil and gas exploration contracts in territory also claimed by China.

That could well keep the phones busy for Sabban and his sailors at Western Command for some time to come.

(Reporting by Randy Fabi in Puerto Princesa and Manuel Mogato in Manila; Editing by Bill Tarrant)