Will business climate in the Arctic change for better?

Oil Price
Will business climate in the Arctic change for better?

In the wake of the recently organized Arctic Summit in Arkhangelsk and Rosneft getting drilling activities underway in the Laptev Sea, one cannot help but think that Russia is carrying out a comeback to the offshore Arctic region. Such a policy turn might seem counter-intuitive, as EU and US sanctions still restrict Western companies (with more sophisticated know-how) from participating in Russian Arctic projects, but even more importantly, this happens against the background of Russia’s Energy Minister A. Novak declaring that Russian producers in the Arctic need a crude price of at least 70 USD per barrel to be profitable. But how much of it is mere political posturing and what represents a genuine change for the better in Arctic’s fickle business climate? Such a question asks Oil Price in its article Low Oil Prices Won’t Deter Russia From Arctic Drilling.

Rosneft, Russia’s primary oil operator (i.e. the only one apart from Gazprom’s oil subsidiary) in the Arctic, resumed its activities in the most northerly of seas, by drilling the Central-Olginskaya offshore well in the Laptev Sea. Rosneft also stated that it intends to resume drilling in the Barents Sea next year and in the Kara Sea within two years, thus committing itself to conduct drilling works across the entire Russian section of the Arctic. The political facet of such a move is evident – demonstrating that sanctions did not succeed in putting a crimp in Russia’s oil sector, whilst leaving the door open for Arctic projects in cooperation with ExxonMobil (expected to be revived in 2019) or Statoil, ongoing, albeit at a relatively slow pace (Recently, the US Treasury Department,  after consulting with President Donald Trump, decided not to exempt Exxon and other US companies from the sanctions regime for Russia, by allowing them to drill in Russia, VK).

President Putin himself ordered the beginning of drilling operations at the Central-Olginskaya field, emphasizing Rosneft’s role in developing the Arctic’s resources. Yet there is a twist of irony in that Rosneft boasts about being the only Russian company conducting drilling operations in the Arctic offshore, as apart from Gazprom no one else has the right to do so under the current legislation. In view of this, it is interesting to see how the Arctic revival coincided with Russia’s Ministry of Natural Resources and Environment push for a liberalization of offshore license granting. Under the current legislation dating back to 2008, only state-owned Gazprom and Rosneft have the right to conduct drilling and exploration in Russia’s offshore zones, leaving even global majors like LukOil or Novatek out of bounds.

The Natural Resources Minister S. Donskoy reiterated his vision that fields within Russia’s territorial waters, i.e. 12 nautical miles from the shore, be opened up to private companies. This would not solve the Arctic issue for Russia, as most really attractive fields and formations are further off into the sea (e.g.: the most recently discovered Pobeda field is 250 km from shore, whilst the 3.9 TCm Shtokman is 550 km away), yet it would present at least a ray of hope that Russia’s offshore will not be completely deprived of competition.

As of yet, however, there is only one producing oil field in the Russian sector of the Arctic offshore – the Prirazlomnoye field of Gazprom Neft, whose breakeven costs now hover around the 70 USD per barrel mark, mentioned by Russia’s Energy Minister. With crude prices, even for the new ARCO grade (24° API, sulfur content of 2.3% and low paraffin content), still some 15 USD from the desired level, the field has been producing at a loss for three years already. Russia is in no way alone in its hardships to give momentum to its Arctic projects – the Goliat field in Norway is estimated to be profitable only if prices do not fall below 90 USD per barrel for many years. Canada, in a joint movement with the White House, has banned Arctic offshore drilling altogether, which was not driven solely by environmental concerns, but by the recognition of the dearness of such an endeavor.

Thus, the latest flurry of action from Russia’s Arctic region contains several underlying messages. It is one of Rosneft, Russia’s most powerful oil company, the largest national oil company (NOC) of the world, conquering new frontiers. It is telling that the adjacent Vostochno-Taimyrskiy block was appraised by LukOil, yet its more bountiful continuation initially labelled Khatangsky block was awarded in December 2015 to Rosneft without any auctioning procedures by a government decree. Simultaneously, the Russian government demonstrates that it can endure financial losses by granting preferential terms to companies drilling in the Arctic (no export duties, preferential mineral extraction tax of 4.5-5%).

Nevertheless, one should expect many U-turns in the Arctic and many unexpected twists – for instance, the Prirazlomnoye field, currently producing some 75,000 bpd has managed to find its customers in W-European countries like the Netherlands or United Kingdom, however, if production will go up, Russian companies ought to do some preliminary work so as not to oversaturate the European market and find buyers elsewhere, too.

Ironically, even if in the medium term oil prices surpass the 70 USD per barrel threshold, Arctic oil will still have a very serious competitor within Russia – namely, Arctic gas. Although many past mega-projects remain in the cold, such as the Shtokman gas field (reserves of 3.9 TCm), initially thought to supply LNG to the United States only to be caught flat-footed by the U.S. shale gas revival, others have enjoyed the firm backing of Russian authorities. One of such is the Yamal LNG project of Novatek, whose first cargo will most likely be delivered by October. Yamal LNG is exempted from export duties and property tax for the first 12 years, is subject to reduced profit tax and has seen massive government support in the form of multi-billion loans from state-owned banks and infrastructure development in Sabetta. If everything goes well, after the commissioning of Yamal LNG, Novatek will begin to bring online Arctic LNG-2, which would raise Russia’s Arctic LNG output capacity to 33.6 million tons annually (17.6 and 16 million tons, respectively). Although the now-producing Prirazlomnoye project has also been palpably backed by Russian authorities, new Arctic oil projects are unlikely to be prioritized over LNG projects, which are seen as a core element of Russia’s energy policy in the years to come.