The Surprising Cause Of Oil's Next Big Price Spike

The dispute over island rights in the South China Sea has made the area one of the most contentious in the globe.

• The disputed southeast of Asia waterways are primed to be the next hotspot influencing oil prices
• If tankers were prevented from traversing the South China Sea, the oil supply to China, South Korea, Vietnam, Taiwan and Japan would be immediately impacted

By Ellen R. Wald 

May 11, 2015 - Chinese land reclamation of Mischief Reef in the Spratly Islands in the South China Sea. 

Geopolitical events in the Middle East (even so much as an empty threat by Saddam Hussein to aim Scud missiles at Israel) used to cause the price of oil to spike. 

Now it seems that a certain equilibrium of instability in the Middle East is already priced into oil. Last week, when a Houthi controlled, Iranian sponsored, Yemeni ship rammed into a Saudi naval vessel near a key maritime thoroughfare for oil, the price oil did not flinch. 

The disputed waterways southeast of Asia, however, are primed to be the next hotspot influencing oil prices.
Key areas of the South China Sea are currently claimed by China, the Philippines, Malaysia, Vietnam and Brunei.

China, however, has made the most expansive claim, and China is currently asserting its ownership by moving sand from the bottom of the ocean onto a reef near a small archipelago of islands directly at the center of the contested area in order to station military and commercial interests there. 

China is, in essence, building new islands that are already starting to house military equipment and personnel. 

The other claimants have small installations and/or landing strips in this area as well, but none as extensive as China’s.
The disputed area is valuable, because the territorial waters around the islands provide 1) mineral and natural resources (including oil deposits) and 2) control over the commercial maritime traffic in the South China Sea. 

According to the oil tanker tracking website, TankerTrackers.com, “More than 15 million barrels transit [the South China Sea] on a daily basis as tankers make their way from the Middle East, through the Straits of Malacca, past Singapore and head northbound towards China, Japan, South Korea and Taiwan.” 

They see the body of water as “the single most important maritime chokepoint for the flow of oil.”

Source: U.S. Energy Information Administration analysis based on Lloyd's List Intelligence, Panama Canal Authority, Eastern Bloc Research, Suez Canal Authority, and UNCTAD, using EIA conversion factors Note: All estimates in million barrels per day. Includes crude oil and petroleum products. Based on 2013 data.

What would happen to the price of oil in the event of a geopolitical flare-up in the South China Sea?
If tankers were prevented from traversing the South China Sea, the oil supply to China, South Korea, Vietnam, Taiwan and Japan would be immediately impacted . 

The price of oil to those areas would spike, and the region would experience shortages. 

However, because oil is a global commodity and the market is impacted by speculation, oil prices around the world would also rise. 

It is possible for tankers to circumvent the South China Sea entirely, but these alternative routes are lengthy and add additional expenses that would be passed on to the consumer.

Although the Trump administration has not yet expressed specific policy intentions regarding the South China Sea, Secretary of State Rex Tillerson took a hard line towards China during his confirmation hearings. 

He said, “China’s island-building in the South China Sea is an illegal taking of disputed areas without regard for international norms” and told Congress that “We’re going to have to send China a clear signal, that first, the island-building stops and, second, your access to those islands also is not going to be allowed.”
Some are concerned that a tough policy by the Trump administration will lead to a blockade, although in a later memo to the Senate, Tillerson clarified his earlier remarks.
“China cannot be allowed to use its artificial islands to coerce its neighbors or limit freedom of navigation or overflight in the South China Sea. The United States will uphold freedom of navigation and overflight by continuing to fly, sail, and operate wherever international law allows.” 

Tillerson appeared to express that the primary goal of the U.S. is maintaining open shipping lanes in the area. 

As investors focus on oil production rates and demand data, energy prices are always susceptible to serious fluctuation based on geopolitical events – and not necessarily those located in the Middle East.