Business operations in the South China Sea

Business operations in the South China Sea

April 2023

Understanding the complexities

The South China Sea (SCS) is a hotly disputed region of strategic significance to many countries, none more so than China.

China has territorial disputes with its regional neighbours regarding the demarcation of territorial waters, which in recent years has led China to become increasingly assertive and aggressive in advancing its territorial claims in the SCS, not least because of its economic criticality to Chinese prosperity.

$3.5 trillion of global trade pass through the SCS, via the Straits of Malacca and Singapore (SOMS) every year, comprising two-thirds of China’s maritime trade volume, 40 percent of Japan’s, one-third of all global trade, and one-third of globally traded liquified natural gas to China and Japan. Moreover, each relies on Iran and Arab states for 80 percent of all oil imports. When understanding the criticality of the SCS and the SOMS to China, it is understandable that China will seek to ensure that these straits remain open, which Beijing interpret as requiring increased militarisation. Interestingly, it appears counterproductive for China to continue such destabilising aggression in an effort to stabilise and ensure the openness of globally critical trading lanes. Such aggression has led to tensions and military standoffs with SCS nations, particularly Vietnam, the Philippines, Malaysia, and Japan. What furthers such regional tensions is the increasing polarisation seen amongst SCS nations with their chosen respective superpower partners. Naturally, Chinese economic relationships benefit recipient nations immensely. Notably, China is the Philippines’ largest trading partner, with $29.1bn worth of bilateral trade in the first nine months of 2022.

However, China’s aggression in seeking to secure natural resources has created a tense imbalance in the region, one which many nations have sought to restore by allying with the US.

SCS nations are increasingly having to walk a tightrope between Chinese economic cooperation and US military partnership. Such a dispute requires businesses to understand the impacts of SCS developments in order to successfully navigate the fluid security environment and ensure business continuity.

What happened?

June 13th 2020

US Secretary of State Mike Pompeo denounces China’s unilateral claim, claiming that it has no lawful right to assert maritime and economic claims of the region. This is a turning as the dispute had remained regional and relatively stable until this point. With the US’ claims, the dispute transformed into an international dispute.

April 24th 2021

Similarly, the diplomatic service of the European Union published a statement expressing its support of the ASEAN nations. Notably, China is not part of the ASEAN alliance. Conveying the international dimensions of the dispute.

September 11th 2021

Japan and Vietnam sign a deal that will significantly improve Vietnam’s defence, particularly its maritime capabilities. Interestingly, Vietnam, until this point, had traditionally sourced its military capabilities/hardware from Russia. This change clearly illustrates the increasing polarisation and militarisation of the region and Vietnam’s increasingly pro-active stance regarding its territorial claims in the SCS.

June 25th 2022

Similar to its changing stance in the SCS, Vietnam opened its ports to foreign naval ships. This action seemingly increases Vietnam’s defensive posture in the SCS without having to risk provoking increased Chinese naval activity in their waters, as the presence of foreign navies in Vietnamese ports will likely act as a deterrent to Chinese aggression.

August 2nd 2022

China’s military drills in response to U.S. House Speaker Nancy Pelosi’s visit to Taiwan disrupted key sea and airspace in the Taiwan Strait. Shipping vessels and planes were forced to find alternate routes in the region.

September 24th 2022

”We are a US ally, we are in a strategic location. We are so near that if anything happens in Taiwan we will be involved,” said General Emmanuel Bautista, former chief of staff of the armed forces of the Philippines. Philippines and USA announced doubling the number of troops in joint exercises, which comes in response to increased Chinese activity IVO Taiwan.

December 15th 2022

Despite having an inferior dredging and landfill capability, Vietnam reclaimed a total of 2.2 million square meters throughout the last decade. Whereas, China, during 2013-2016, managed to reclaim 32 million square meters. Here the disparity of their respective capabilities is clearly shown. Nevertheless, Vietnam maintain their territorial claims to the SCS and display their courage in the face of China.

December 22nd 2022

Indonesia and Vietnam came to an agreement on their respective EEZs, in a move that clarifies boundaries in the contested region.

January 5th 2023

In what can be perceived as a response to the above event, China deploys the world’s largest coastguard vessel, ’the monster’, to the vicinity of Indonesia’s resource-rich Natuna Islands.

February 2nd 2023

The Philippines grants US troop access to a total of 9 military bases in the Philippines to push back against aggression and illegitimate claims of China in the SCS.

February 6th 2023

CCG also manoeuvred dangerously close, about 150 yards (137 metres), to block the Philippine coast guard’s BRP Malapascua patrol vessel from approaching the Philippine-occupied Second Thomas Shoal.

February 10th 2023

Japanese Prime Minister Fumio Kishida and Philippine President Ferdinand Marcosjr agreed to transfer air surveillance radar systems to the Philippines and provide training for related personnel as concerns grow about the situation in the East and China Seas and strongly opposed the actions, including force or coercion that may increase tensions.

February 12th 2023

A Chinese Navy survey vessel entered Japan’s territorial waters near islands in Kagoshima Prefecture, this marks the seventh incursion by a Chinese survey ship into waters off Kagoshima since November 2021.

February 13th 2023

CCG ship temporarily blinded Filipino coastguard crew on patrol IVO Second Thomas Shoal.

February 22nd 2023

Australia and the Philippines discussjoint patrols of SCS. Talks were part of the Philippines’ broader effort to seek support against China’s claim over almost the entire South China Sea. Enabling Australia to patrol Filipino waters, in light of the recent AUKUS deal, where Australia has UK nuclear-capable submarines, would cause unease in Beijing.

March 1st 2023

Malaysia’s Prime Minister Anwar Ibrahim continues the country’s traditional non-aligned stance towards siding with superpowers, instead preferring to place belief in the multilateralist approach offered by Association of Southeast Asian Nations (ASEAN) as a method of resolving the SCS dispute, claiming that the sensitive complexity of the dispute requires a comprehensive approach in order to realise an amicable solution.

March 25th 2023

A CCG ship and a Vietnamese fisheries patrol boat apparently had a tense encounter coming as close as 10 meters to each other, according to data from Marine Traffic, a ship-tracking website. The CCG vessel was the same one that had previously shone a laser at the Filipino coast guard ship.

March 27th 2023

A Vietnamese naval ship tracked a CCG vessel in the SCS. Remarkably it sailed through blockades in Russiah-operated gas fields in Vietnam’s EEZ. Starting in November 2022, China has been increasingly expanding its shipping routes through Vietnamese territory.

April 1st 2023

The latest incursion is of Chinese aircraft entering Taiwanese airspace, seeing Chinese fighterjets and one military drone crossing the median line in the Taiwan Strait in a 24-hour period.

April 6th 2023

Beijing, following Taiwan's President Tsai Ihg-wen meeting US House Speaker Kevin McCarthy in the US, has vowed a ”resolute response” and sent warships into the waters around the self-governed island.

So what?

Supply chain disruption

Shipping vessels or transport planes will be forced to find alternative routes to their destinations in order to mitigate the risks of being involved in maritime standoffs. An alternative route into the SCS for vessels would be via the also risky, typhoon-prone Luzon Strait. However, this would add several extra days to ocean travel time, which would increase fuel costs, ship and individuals’ travel insurance premiums, the living and operating costs of the crew, and likely result in a tanker shortage.

Obstructed access to manufacturing capabilities

Given that, as of December 2022, China accounted for approximately 28.7% of global manufacturing output, an obstruction in the SCS which impeded access to ports and airfields, would have significant impacts on business continuity. In the short term, product scarcity would inflate consumer prices. Whereas prolonged obstruction could realise a long-term effect of welfare losses in affected nations as increased trade costs must be subsidised.

Chinese state sequestering foreign business assets

Given the increasing polarisation taking place in the SCS between nations and, naturally, the specific nationalities of those businesses who trade with SCS nations, China may seek to make an issue of the national links that a trading company has in order to compel/leverage change in business operations. The acceptable product loss should be at the foremost of businesses' minds when re-evaluating their stock numbers abroad.

Restriction or loss of market access

In addition to the potential sequestering of assets by the CCP in the case of escalation in the SCS, a prolonged restriction or loss of market access, namely to China’s manufacturing capability, is posed to businesses operating in the region. A diversification of manufacturing locations or friend-shoring should be entertained.

What if?

The aforementioned timeline has portrayed an image of the state of the maritime conflict between China and the SCS states in recent years. This serves as the starting point for the development of scenarios of possible future trajectories of the SCS maritime conflict. Hence, the most likely scenario and the most dangerous scenario are offered.

Most likely

Short-medium term

Maintenance of the status quo is highly likely in the SCS throughout 2023. The SCS remaining obstruction-free facilitates economic prosperity, not only for SCS nations but also for China. This scenario assumes no increased involvement from international actors, although confrontations between SCS nations occur often. Therefore, incidental supply chain disruptions are expected.

Long term

As long as regional nations’ economies do not suffer from the CCP’s regional aggression in the SCS, regional relations are likely to remain stable but tense. However, Southeast Asian countries’ economies have become increasingly reliant on their economic ties with China. In the long term, this might be used as leverage by China in competing for SCS territory.

Most dangerous

Short-medium term

In the short term, China will continue carrying out aggressive actions in the SCS. China is facing a number of internal future challenges, such as population decline. Additionally, the current war in Ukraine could function as a diversion for China. Such events could result in more frequent disruptions of the SCS shipping lanes, realising product scarcity, price inflation, and welfare losses in nations.

Long term

The abovementioned events could motivate Western countries, particularly the US, to militarily protect their regional allies. The US has allies in Japan, South Korea, the Philippines, Australia and Thailand. The involvement of other international stakeholders could escalate the SCS conflict even further; see, for instance, the recent China-mediated diplomatic rapprochement between Saudi Arabia and Iran.

What now?

Many SCS nations have stepped up oil and gas development in the SCS, with China, Vietnam, Malaysia and Indonesia all having announced or started new offshore projects. As such, and given the continued CCG presence in the region, future confrontations are all but inevitable.

It is increasingly likely that within the coming years, with the continuation of military stand-offs, the economically vital region for the global economy will become increasingly polarised, resulting in elongated maritime shipping routes, increasingly perilous transit for crews and cargoes, and significantly more expensive to navigate, not only requiring increased economic capital but political.

In order to successfully navigate developments in the SCS, business leaders should adopt comprehensive and continuously analytical approaches to SCS developments, some of which are:

  • Continuous re-evaluations of acceptable risk when assets transit the region, bearing in mind the potential Chinese sequestering of assets.
  • Near/Friend-shoring, (relocating business critical infrastructure to friendly or geographically closure nations) in order to reduce the risk posed to product flow by an obstruction.
  • Conducting comprehensive due diligence measures, including focused screening checks, regarding potential business partners and their employees. Particularly as many western nations will seek to implement tighter export controls on Chinese companies, their associates, or those located in the vicinity of the SCS.
  • Explore alternative transport methods that limit the potential of serious business disruption, especially in markets of mining and raw material export.
  • Explore alternative sourcing for manufacturing materials as China holds a significant share of the world’s rare earth deposits.
  • Frequent comprehensive monitoring and reporting on regional developments by experienced risk consultancy companies in order to accurately interpret developments regional developments.

Proximities can help you gain these key insights and turn them into tangible material. Using our ‘What?’, ‘So What?’, ‘What if?’ and ‘What Now?’ narratives, we help partners and clients not only understand the importance of trends and events but, more specifically, to understand what it means for you and your business from strategic to operational consequences. Curious and interested to see how we could help you? Don’t hesitate to contact us, we will be happy to support you.

Proximities: We translate global risks into actionable solutions.

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