The PRC’s South China Sea Gamble: Regional Investments as a Signal

The PRC’s South China Sea Gamble: Regional Investments as a Signal

The PRC’s South China Sea Gamble: Regional Investments as a Signal

While Chinese efforts to change the strategic dynamics in the South China Sea have drawn headlines and the focus of strategic thinkers around the world, business leaders continue to be bullish on the region. Investment flows reveal that the promise of the world’s fastest growing region far outstrips concern over the potential major crisis that would be unleashed by China attempting to assert direct control over the Asia Pacific’s waterways. Association of Southeast Asian Nations (ASEAN) countries would seem to have little defense against efforts by China to close down shipping lanes in the South China Sea, yet they continue to be darlings of foreign investment. Indeed, the ASEAN countries collectively hold the largest stockpile of US FDI of anywhere in Asia– more than China, India, and Japan combined. Why? Because presently, the sheer value and volume of trade in the region massively outweigh the strategic rewards that China would win by closing it off.

The South China Sea is called “the world’s busiest waterway,” and China claims 90 percent of it on the basis of the  “Nine-Dash Line,” a historic claim made by China in 1947. However, Brunei, Indonesia, Malaysia, the Philippines, Taiwan, and Vietnam also claim land features, resource rights, or exclusive economic zones in the same area. To underline its claim, China is building an ambitious network of militarized bases in places that take advantage of a series of half-forgotten rocks and shoals to create airbases and militarized hard points that expand their reach and give credence to their claims.

This has raised concern in some quarters about China’s ability to control, and, in the event of a conflict, shut down the flow of commerce and, perhaps more crucially, to interdict the flow of energy shipments to US allies like South Korea and Japan. Taiwan likewise relies heavily on the South China Sea and the Strait of Malacca for its global shipping.

The South China Sea is the busiest sea trade route in the world, with $3.3 trillion in trade annually passing through its waters. The Malacca Strait, the passage from the Indian Ocean into the South China Sea, carries approximately 25 percent of all traded goods of all kinds: 25 percent of all oil that travels by sea, and one third of all global trade in liquefied natural gas. The Malacca Strait itself is only 1.5 nautical miles wide at its narrowest point, and would seem to be the most vulnerable target for a blockade.

The economies of Asia are fueled by Middle Eastern crude oil, the majority of which passes through the Malacca Strait and the South China Sea. China has risen to become the world’s biggest oil importer, with more than 50 percent of it coming from the Middle East. In 2016, China imported 80 percent of its oil imports through the Straits of Malacca.  Japan and South Korea import more than 80 percent of their crude oil from the Middle East, and at least 20 percent of their natural gas as well. Both countries brings at least 60 percent of their total energy resources through the South China Sea, as does Taiwan. Around three trillion cubic feet of liquefied natural gas goes through the South China Sea to Taiwan, South Korea, and China.

Taiwan is heavily dependent on receiving trade and energy flows from Europe, the Middle East, and South Asia through those same South China Sea, Singapore Strait and Malacca Strait shipping routes.  Additionally, much of Taiwan’s various export products flow out through the South China Sea in the opposite direction.

In a similar way, 95 percent of China’s trade is transported by sea, and the Indian Ocean to South China Sea route is its most important waterway, accounting for more than 60 percent of its foreign trade and an enormous portion of its resource imports. The closing of the South China Sea would hit China just as hard, if not harder, than any other country in the region. China also harbors substantial worries about the ability of the US and its allies to close off key routes that would deprive it of access to key imports of energy and basic materials such as iron ore.

We have a good example of how the closing of key waterways can affect the cost of trade. The Suez Canal was closed for 8 years because of the 1967 Arab-Israeli war. Studies conducted on affected countries indicated that an increase in shipping distance of 10 percent, produces a corresponding drop in trade of 5 percent. Countries that are more dependent on waterborne trade will be more affected, and there are few countries as  reliant on the transit of goods by sea as China.

Even if a conflict did close the busy Malacca Strait and the South China Sea to waterborne traffic, the Lombok Strait route from the Indian Ocean to the Java Sea adds distance to any travel between the Indian Ocean and countries like Japan and Korea, but is still manageable. The Lombok Strait is deeper than the Straits of Malacca, so it can also accommodate larger ships that draw more water. Studies have indicated that, if forced to deliver all shipments through the Lombok route, Japan’s annual oil import bill would rise by something in the order of $600 million, less than one half of one percent of Japan’s annual import cost, and around $270 million for Korea. These costs would not run as high for Taiwan, with the shorter distance to travel through the Philippine Sea.

For Australia, nearly two-thirds of Australia’s exports travel through the South China Sea, but most of this cargo is bound for China. A disruption of trade with Australia’s other trading partners would still require the re-routing of exports to Thailand, Vietnam, and Taiwan, but that represents less than 6 percent of Australia’s exports.

When a closer look is given to how shipping actually flows through the South China Sea, countries which initially seem tremendously vulnerable, such as Indonesia, Vietnam, Thailand, Taiwan, and the Philippines, are served mostly by “coast-hugging” routes which avoid the area within the “Nine-Dash Line” and wouldn’t be as easy for China to shut down, as they are closer to coastal defenses.

Much of this traffic would still be vulnerable to a closing of the Malacca Strait, but a CSIS report estimates that the cost of a complete closure of the Malacca Straits and re-routing through the Lombok Strait would cost in the order of $119 million per week, while a larger diversion that forced vessels to sail completely around Australia before entering the Philippine Sea would carry the much higher cost of $400 million per week.

While these costs are of course significant, they would be borne disproportionately by China, who relies so heavily on seaborne trade. The awareness of this vulnerability is part of the drive for China to expand its military options via manufactured bases in the sea, and to create the “Belt and Road” initiative . The overland railway and pipeline projects of OBOR may eventually ease China’s dependence on seaborne trade slightly, but it will almost certainly remain the most important method for bringing goods to market.

Control of the South China Sea is not only about trade, of course. It is also about resources. The South China Sea is home to plentiful fishing grounds, and Chinese fishing boats working in waters claimed by ASEAN countries have drawn headlines and local outrage in recent years. Commercial fishing represents around 3 percent of Indonesia’s GDP and almost 2 percent for Malaysia, the Philippines and Thailand, but the South China Sea fishery is currently not on a sustainable path.

While the South China Sea has around 7.5 billion barrels of proven oil reserves, it is reputed to hold untold further riches beneath its depth, with some Chinese estimates placing its reserves as high as 130 billion barrels of oil, with over 190 trillion cubic feet of natural gas. These estimates are widely disputed, but would put the region’s reserves among the world’s largest.

These are significant finds, of course, but would exclusive access to them be worth the cost of disrupting China’s massive foreign trade? Unlikely, when by playing a long game China can pressure individual claimants into favorable joint venture terms, and when China has had great success at destabilizing ASEAN unity on the issue of the South China Sea through the support of non-claimants like Cambodia.

With tension high and so many military resources committed to the region, the possibility of an accidental conflict which metastasizes into an ongoing series of stop and start disruptions in trade is a more substantial worry, but not a significant enough one to deter investment.

The main point: While the rise of Chinese power certainly requires a reassessment of threats and norms throughout the Asia-Pacific, and a genuine conflict between China and any other state would be massively destabilizing, China’s dependence on the free flow of goods and resources through the Straits of Malacca and the South China Sea make any effort to blockade or obstruct these waterways a gamble not worth taking.  Peace is also in the interest of Taiwan and the rest of Northeast Asia, which rely heavily on the South China Sea as a passageway to receive oil shipments, as well as export their goods to South Asia, the Middle East, and Europe.