The US has imposed new sanctions on Chinese oil and gas giant CNOOC. Image: Twitter

The US government has officially sanctioned China’s third-largest oil company and largest offshore petroleum producer, China National Offshore Oil Corporation (CNOOC). The executive order prohibits US individuals and companies from transacting publicly traded securities of “Communist China military companies” – companies that are in some way affiliated with the People’s Liberation Army.

It is not clear why CNOOC was targeted. Interpretative guidance may be forthcoming. But the apparent reason for sanctioning CNOOC under this order is its involvement in China’s unilateral exploration and drilling in disputed areas of the South China Sea.

If this is the reason, the US is using a rather loose and expansive definition of companies that are “affiliated” with China’s military. CNOOC said that it was “shocked and regretful,” that the action was based on “false and inaccurate” information, and that it is now “comprehensively assessing the impact of the situation on the group.”

CNOOC Group focuses on the exploitation, exploration and development of oil and gas offshore China, along with its subsidiary COOEC (China Offshore Oil Engineering Company). The company is owned by the Chinese government. One subsidiary, CNOOC Limited, is listed on the Hong Kong, New York and Toronto Stock Exchanges; another, China Oilfield Services, is listed on the Hong Kong and New York Stock Exchanges.

CNOOC’s foreign operations account for about one-third of its total production. This includes projects in the Gulf of Mexico and Guyana, where it has a joint venture with ExxonMobil.

As of end-November US investors held about 16.5% of CNOOC’s shares. Apparently this order will force these investors to divest. The sanctions may hurt its stock value and could severely damage the company’s reputation. Indeed, to survive in the long term CNOOC may have to split up or terminate some of its businesses.

Although the proposed prohibition on US investors owning securities in the company would not begin until November next year, the news was followed immediately by a decline of CNOOC Ltd’s stock by 14%. One analytical company downgraded CNOOC stock citing the risks of a ban on US owned stock or possibly a prohibition on any connections with US businesses.

A CNOOC pipeline in China. Image: Facebook

But the executive order may not initially be too serious a blow to CNOOC because it is so far limited to divestment (joint-venture investments are apparently not prohibited), American holdings are relatively small, and there is uncertainty as to whether it will be continued by the incoming Joe Biden administration. Also CNOOC may take certain measures to mitigate the risk.

But there may be blowback. CNOOC owns some US oil and gas fields and partners with companies such as ExxonMobil Corp on some overseas projects. It also uses American technology and equipment. So the sanctions or the fear of their expansion will have some US domestic effect.

But there is the much bigger potential problem of retaliation by China. ExxonMobil has also undertaken drilling in areas claimed by both Vietnam and China. What if China retaliates by sanctioning ExxonMobil for undertaking exploration and drilling in areas it claims, such as in Vietnam Blocks 118 and 119? China has threatened retaliation against ExxonMobil before for doing what the US now alleges CNOOC is doing.

In 2008, Beijing warned it against proceeding there, suggesting that its business in China could be at risk. Again in 2011, soon after ExxonMobil announced a discovery in Vietnam’s Block 118, China warned “foreign energy companies” against exploring in disputed areas.

In May 2014, CNOOC Ltd moved a CNOOC Group-owned drilling rig, Haiyang Shiyou 981, into the area and drilled just east of Vietnam’s Block 119. Vietnam claimed the rig was operating in its exclusive economic zone (EEZ), while China maintained that it was operating in its waters.

Both have reasonable claims to the area in dispute. China claims the Paracels and has occupied them since 1974. It argues among others that Vietnam recognized its claim in a 1958 letter from Vietnam’s premier at the time, Pham Van Dong, to China’s then-premier Zhou Enlai.

If China owns the Paracels and is entitled to a 200-nautical-mile EEZ and an extended continental shelf, China has a legitimate claim to part of Vietnam’s claimed EEZ and continental shelf. According to the US State Department, Vietnam uses a baseline for its EEZ and continental-shelf claims in the disputed area that does not conform to UNCLOS (United Nations Convention for the Law of the Sea) stipulations.

A US naval officer looks through binoculars on the bridge as the Arleigh Burke-class guided-missile destroyer USS Mustin (DDG 89) conducts routine operations in the South China Sea. Photo: US Navy/Mass Communication Specialist 3rd Class Cody Beam

Until a ruling or a boundary is forthcoming, this area is disputed, and according to the Guyana-Suriname precedent, neither country should unilaterally proceed with exploitation. That means ExxonMobil’s drilling in these contracts let by Vietnam would be just as legally questionable as that of CNOOC’s drilling there. But the US seems to be implicitly taking Vietnam’s side in its various relevant disputes with China including this one.

ExxonMobil is America’s third-largest company and is heavily invested in China. Its holdings range from gas marketing to petrochemicals. Indeed, it is now building a US$10 billion petrochemical complex in China.

If China does retaliate against ExxonMobil, it may prohibit any business dealings with it similar to its ban on business transactions of any kind with American arms suppliers to Taiwan. Worse, it could stimulate a rethink in China regarding its economic interdependence with the US.

China may conclude that the US has lured it into the global capitalist system and is now using it to punish and manipulate it. Indeed, China may come to regret the day it adopted “capitalism with Chinese characteristics” and act accordingly. If so, these escalating sanctions would be a pyrrhic victory for the US.

This move by President Donald Trump’s administration during his lame-duck period will make it more difficult for President-elect Joe Biden to revive relations with Beijing. But Biden could reverse this particular executive order before too much damage is done. Indeed, whether he does so or not may be a good litmus test of his administration’s approach to China. Will it be an improvement or more of the same?

Mark Valencia

Mark J Valencia is an internationally recognized maritime policy analyst, political commentator and consultant focused on Asia. Most recently he was a visiting senior scholar at China’s National Institute for South China Sea Studies and continues to be an adjunct senior scholar with the Institute. Valencia has published some 15 books and more than 100 peer-reviewed journal articles.