The rights stuff in oil islands now

Energy companies should consider the SPV route in light of the China-Japan island rights disputes

Images of Chinese citizens overturning a Japanese-manufactured police car are a startling demonstration of the seemingly spontaneous civic anger about Japan’s territorial claims to five uninhabited islands and three rocks in the East China Sea (and in a separate row in the South China Sea), known to the Japanese as the Senkaku Islands and to the Chinese as the Diaoyu Islands.

The economic interest at stake is not the barren rocks, but the surrounding hydrocarbon potential. Oil majors contemplating investment need a primer in international law as well as an appreciation of the historical and political background before they venture into this region.

The South China Sea dispute rose in tempo in 2009 after grumbling along for 30 years. In fact, there was a concrete legal reason: 13 May 2009 was the deadline for states to make claims to extend their rights to exploit the seabed for hydrocarbons under the 1982 UN Convention of the Law of the Sea (Unclos).

What needs to be understood about Unclos is:

l Standard issue for coastal states is 12 nautical miles (nm) of territorial water projecting from their low-tide baselines, stretching out to 200nm of an Exclusive Economic Zone (EEZ). They must permit submarine cables, maritime passage and overflight, but can bag the hydrocarbon and mineral wealth.

l If you can lay claim to an island you get 12 miles around it.

l If you can persuade the UN’s Commission on the Limits of the Continental Shelf (CLCS) that yours goes out beyond 200nm into undisputed seabed, you could get extra EEZ. If there is a dispute between states, the commission lacks jurisdiction.

l If states do not like the submissions to the CLCS, they put in to the UN secretary-general a document known as ‘note verbale’.

l States can opt out of Unclos dispute resolution, and China did.

l If it is a sovereignty dispute over land, Unclos is the wrong set of rules – one is into customary international law and the hand of history.

The Unclos template favours Japan’s archipelagic geography over China’s continental coastline, but there are other states with a dog in the fight – Vietnam, Philippines, Malaysia, Brunei and Taiwan.

Administration of the islands was handed back to Japan from the US in 1972. Around this time oil was discovered and China advanced its claim on historical grounds going back to the 15th century.

The worry is whether China’s growing confidence and economic power, with the West hobbled by recession, may lead to aggression.

The Confucian view sees binding dispute resolution as disharmonious and rejects it. This view is virtually bound to win in these cases, where there is no compulsory dispute resolution mechanism and the question of whose legal arguments are in the right is theoretical.

An astute chief executive of an oil and gas major should get his legal department to seek advice on structuring investments through special purpose vehicles (SPVs) to take advantage of bilateral investment treaties that may give leverage to seek compensation from an international arbitration tribunal if investments become expropriated.