Why Is Tension Rising In The South China Sea?

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Includes: AIRYY, BACHY, CCCGY, CMCLY, DNPUF, HPHTF, HRELY, KOTMY, KWHIY, PTR, SNP, THKLY, TMICY
by: One Road Research Company

Summary

33 percent of the world’s maritime traffic belongs to the South China Sea, so this region is vital for international trade. Asian countries are trying to claim parts of the territory.

But China aggressively claims 90% of the region, defying international laws. Not only did it implement land reclamation and build oil rigs, China even sent over its navy.

To portray power, the U.S. sent its own navy to counter China's assertiveness and tried to be the region's mediator, which further intensifies the already sensitive region.

Although no countries want to back off, they all try to avoid military conflicts in order to minimize bloodshed and the negative impact towards international trade.

Yet China's influence over the region grows. Despite being adversaries, Southeast Asia is relying more on China as a trading partner, which will benefit companies that we will recommend in the article.

In this article, we will elaborate how the situation in the South China Sea affects international trade. Specifically, we will point out why the South China Sea is crucial to global trade, how China's pursuit for total control over the region's trade routes and resources has led to rising tensions in recent years, how the U.S.'s involvement can affect certain companies that heavily rely on trade between both sides of the Pacific Ocean, as well as listing out companies that are benefiting the most from the status quo.

Why is the South China Sea Vital to International Trade?

Being surrounded by Hong Kong, the Philippines and Vietnam from the north, east and west, respectively, the South China Sea is an essential global shipping routs and one of the world’s most resource-rich regions. 10 percent of the world’s fisheries, around 11 billion barrels of oil and 190 trillion cubic feet of natural gas are located here.

Source: Business Insider

33 percent of the world’s maritime traffic flows through the South China Sea. This is a crucial trade route for China, Japan and South Korea, being the fastest shipping route between Asia and Europe.

Source: Business Insider

The South China Sea is also a geopolitical melting pot, because China lays claims over the majority of the region, threatening military conflict with multiple countries, and most importantly, the U.S.

The area is claimed by Vietnam, Malaysia, Indonesia, Brunei, the Philippines and China. To further complicate the status quo, even Taiwan claims a portion of the region. However, from China’s perspective, this is not a sovereign state.

How Did Tension in the South China Sea Start?

Nations have the right to claim 200 nautical miles of waters off their coastline. Since part of the South China Sea is over 200 nautical miles from surrounding nations, that portion is regarded as international waters. But with the “Nine Dash Line”, China claims much more than that, 90 percent of the region to be precise.

But the whole area is boiling by dozens of incidents due to countries competing claims and defending their own territories.

Source: UNCLOS, CIA (NASDAQ:BBC)

After China built an oil rig in the contested Paracel Islands in 2014, it and Vietnam clashed. Recently, Chinese rocket launchers were built on a disputed reef to fend off combat divers from Vietnam.

The history of South China Sea’s conflicts spans through many millennia. But the risk of worldwide conflict and international trade is quite new.

Over 250 land masses, including small islands, small piles of sand and submerged reefs, belong in the South China Sea. But when China started reclamation work, transforming artificial islands into naval bases, tensions in the region escalated.

Neighboring countries are concerned over China’s ‘militarization’, believing that Beijing is preparing to control both resources and trade routes in the South China Sea.

China put little effort to reduce tension. It has even threatened to impose an “air identification zone” over South China Sea’s airspace in 2013, meaning foreigner aircrafts need to have China’s permission in order to fly over.

But in 2016, the Permanent Court of Arbitration (an international mediator) forfeited China’s claim. However, without any enforcement of the ruling, Beijing has ignored this decision.

Still, after this news was broadcasted, Brent crude oil futures rose $1 per barrel.

The U.S.’s “Asian Pivot” Adds Up the Tension

These competing claims led the U.S. to become more interested in China’s assertiveness.

American presence in Asia-Pacific became more prominent from 2013. U.S. warships were sent to the South China Sea, enforcing the region’s principles of freedom of navigation.

The USS Chafee, a destroyer, sailed within 12 miles of South China Sea’s disputed Paracel islands on October 10th 2017. Since President Trump came into office, this was the fourth “freedom of operation” mission.

Meanwhile, in another attempt to show military prowess, two American bombers flew over the Korean peninsula.

These tactics are more than just another routine patrol, since they are the most recent moves in the world’s most volatile ‘four-dimensional chest board’.

Yet China claims that the U.S. exaggerates the situation and promotes fear. While the U.S. claims China has violated international law, disregarding freedom of navigation in international waters and plotting for absolute control over the South China Sea.

Disputes in the South China Sea may seem to be on a regional level, but this is the centerpiece behind China and the U.S.’s geopolitical chess game.

In fact, if war occurs, not only will there be bodies lying on the streets, but jobs, markets and investments all over Asia will be affected as well.

The table below shows the top Asian companies that export to the U.S. They will suffer the most if regional conflict influences U.S. trade.

Top Asian Companies Exporting to the United States

Ticker

Company Name

US revenue (%)

Market Cap (US$ Billion)

KRX: 012330

Hyundai Mobis Co. Ltd.

26.03

20.72

OTC: OTCPK:KOTMY

Koito Manufacturing Co. Ltd.

21.49

9.95

KRX: 006040

Dongwon Industries Co. Ltd.

42.48

8.3

KRX: 214370

Caregen Co. Ltd.

25.45

7.32

OTC: OTCPK:TMICY

Trend Micro Inc.

28.01

7.05

OTC: OTCPK:KWHIY

Kawasaki Heavy Industries Ltd.

23.77

5.69

OTC: DNPUF

Sumimoto Dainippon Pharma Co. Ltd.

51.73

5.46

KRX: 085660

Chabiotech Co. Ltd.

67.93

5.25

OTC: OTCPK:HPHTF

Hamamatsu Photonics K.K.

28.61

5.23

OTC: OTCPK:THKLY

THK Co. Ltd.

27.75

4.72

In fact, US$5 trillion dollars of trade in Asia alone can crumble just by one false move.

But the U.S. also finds trade in the Asia-Pacific to be important. This region now accounts for 30% of the total U.S. exports, and it also provides cheap resources and labor that the U.S. needs (to ensure prices for U.S. consumers are low). 70% of the goods Walmart produces is from China. From the graph below, you can see that the South China Sea is home to 6 out of 10 of the U.S.’s major trading partners.

So of course, the U.S. is interested in maintaining peace.

How the South China Sea Games are Played

The South China Sea is now a battleground of pride for China, the U.S. and other smaller countries in the region.

No one wants to back off when the rules on international law and natural resources are stake. The situation is further intensified as Chinese power rises over time, posing a growing threat to the U.S.

Despite international pressure, China pledges to protect its historical claim, threatening to prevent other countries from entering the region. Other countries in turn are testing China’s determination and undermining its claim.

China has told the U.S. to not interfere, and has stated that it will negotiate with other claimant countries one-by-one so that it can be on the high ground during the debate. However, the U.S. prefers the negotiation to take place with all of these countries at the same time.

Vietnam, Malaysia, the Philippines, Taiwan and other countries are squeezing themselves between two superpowers, hoping to not get crushed by either of them. The situation for these smaller countries is like being between the hammer and the anvil. Although many Southeast Asian nations rely on U.S. defense forces, as the graph below shows, the importance of trade with China is growing over time.

The U.S. may be Vietnam’s top trade destination, accounting for 21 percent of exports (US$38 billion), but China is keeping up and by 2030, it will overtake the U.S.

Furthermore, China is Malaysia’s biggest exporter of goods and service (16 percent, equivalent to US$39 billion). Also, US$16.2 billion (21 percent) of Filipino exports go to China, which is more than that to the U.S.

As a result, Chinese companies that depend on trade in the South China Sea will become more profitable as China moves forward to dominate the region.

The chart below shows that Chinese companies are going to profit.

Biggest Chinese Exporters In The Shanghai Composite Index

Ticker

Company Name

Foreign Revenue (%)

Market Cap (US$ Billion)

NYSE: PTR

PetroChina Co Ltd

31.9

31.9

OTC: OTCPK:BACHY

Bank of China LTd

24.72

26.68

NYSE: SNP

China Petroleum & Chemical Corp

22.93

15.75

OTC: OTCPK:CCCGY

China Communications Construction Co Ltd

20.18

5

OTC: OTC:CMCLY

China Molybdenum Co Ltd

56.16

3.43

CH: 601669

Power Construction Corp of China Ltd

22.8

2.83

OTC: OTCPK:CGXYY

China Galaxy Securities Co Ltd

97.73

2.81

CH: 600309

Wanhua Chemical Group Co Ltd

20.86

2.74

OTC: OTCPK:AIRYY

Air China Ltd

34.89

2.6

OTC: OTCPK:HRELY

Qingdao Haier Co Ltd

39.85

2.07

Thank you very much for spending your time to read this article. We hope that it provides you valuable insights when investing in Asia.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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