Rosneft (OTCMKTS:ROSN.ME), the state-owned Russian oil giant, has announced plans to actively pursue development of a vast production and transportation network throughout the Arctic. The declaration follows a meeting between its Chairman and CEO Igor Sechin, and President Vladimir Putin. However, the bombast begs the question: is the strategy economically viable, or a bid to bolster Russia’s global energy position regardless of cost?
The plan from Rosneft’s perspective is simple: unlock the 1.5 billion tons of oil in Russia’s Far North by developing an “Arctic Cluster” of oil and gas fields. Rosneft’s prospective projects will also help Russia establish a long-sought-after North Sea Route (NSR), which would cut the distance of shipping lanes between key ports in Europe and the Far East by as much as 40%.
Rosneft already operates several promising sites in Russia’s Arctic region including the Vankor field (together with Bharat PetroResources Ltd) and Suzunskoe field. The latter reached its 70-millionth barrel of oil produced since 2016. But these are just the initial pieces of Rosneft’s grand Arctic plan.
While the energy resources are there, project and operating costs in the harsh Arctic could prove prohibitive to full-scale development. US-imposed sanctions limit Russia’s ability to borrow funding in dollars for new oil projects, scaring off oil majors like Exxon (NYSE:XOM) and BP (NYSE:BP) and the investment flows they bring with them. Sanctions also prevent Russia’s oil and gas industry from accessing the high-tech drilling and surveying equipment needed to exploit Arctic resources.
For the cluster to be realized, Rosneft will also need to invest in several icebreakers and a complementary fleet of Arc7 tanker vessels to ensure year-round sea access to production offloading terminals. Comparable icebreaking ship designs explored by the United States Coast Guard are estimated to cost around $700 million.
At present, Rosneft has an outstanding contract with the Zvezda shipyard for 25 vessels, including one “leading” icebreaker, four supply vessels, 10 Aframax tankers, and 10 shuttle tankers. While Russia holds the greatest number of icebreakers in the world – about 45– there are still not enough Arctic-worthy vessels available to meet Putin’s dream of a Northern Sea Route for shipping.
As for Putin NSR aspirations, development is expected to require upwards of a $160 billion in foreign investment towards everything from mineral mining to infrastructure. But, access to resources like coal of the Taymyr and oil in the Payakha field would increase Russian Arctic shipping capacity to 80 million metric tons per year by 2024. By comparison, around 120 million metrics tons of cargo entered the Port of New York and New Jersey. Essentially, Putin wants to build a major metropolis-scale operation in the barren Arctic parallel to the development of oil and gas infrastructure by Rosneft.
The NSR would create new export avenues to European and Asia-Pacific oil markets, boosting Russia’s position as the Big Three oil powers, after the U.S. and Saudi Arabia.
However, it is unclear if there are sufficient benefits to justify and sustain full-fledged Arctic oil development, especially when considering staggering upfront costs. Cost blowouts are a serious threat to an Arctic project’s goal of achieving the industry average of 15-20% IRR (internal rate of return). In addition, peak oil demand could come as early as 2025 according to Royal Dutch Shell CEO Ben van Beurden, permanently ending the era of high oil prices.
Rosneft and Putin’s plans for the Russian Arctic are ambitious to say the least. Yet, the Russian leadership insists upon pushing North with the hope that climate change will ease their march – as the ice caps melt, barriers to northern shipping recede. This will also bring severe infrastructure setbacks as frozen ground melts into marsh and older pipelines begin to sink, but new projects are designed with this variable in mind.
Rosneft has already begun to construct housing units to accommodate the projected 20,000 workers that will be required to service the Arctic economic zone. In 2019, some 1,400 flats should be completed with another 3,600 planned by 2030.
To address upfront costs, Rosneft is searching for partnerships with foreign and domestic oil companies as well as funding from non-Russian entities. In conversation with Putin, Sechin mentions Gazprom (OTCMKTS:OGZPY) shipping contracts and the Yermak joint project with BP as evidence of a team approach to transportation and production logistics.
Investors from Western and Southeast Asian countries, and especially China, have been drawn to the consolidated assets pool of the cluster development. If secured, and if the sanction threat alleviated, these investors might provide a much-needed capital injection to mobilize resources and facilitate the growth of related industries. Putin’s plans to develop the Arctic Circle and control a lucrative NSR will not happen otherwise.
Samuel Oswald and James Grant contributed to this piece.