The Arctic is the final frontier for Russian E&P. The territory holds an estimated 48bn bl of oil and 43tn m³ of gas reserves, more than any other country with an Arctic foothold. But low energy prices are piling the pressure on Arctic projects, which already operate in difficult conditions—not only in terms of high capital costs due to complex terrain and cold weather, but also because of Western sanctions.

The Russian government sees exploitation of its Arctic reserves via LNG as the crux of its Energy Strategy to 2035, released in April. The plan includes tripling domestic LNG output by 2024 and the optimisation of exports through the Northern Sea Route, a major trade passage north of Russia that will further open up as ice sheets melt.

And while the oil price slump has threatened to delay Moscow’s grandiose Arctic energy plans, certain projects remain on track. Russia’s Arctic developments bet on long-term growth in oil and gas demand, a revenue timeline that should be relatively insulted from current market weakness.

The IEA now expects oil demand to recover to pre-crisis levels in 2022, while gas demand growth—despite record retrenchment in 2020—should return in the long-term, in part as a result of increased global coal-to-gas switching for power generation. However, gas prices will be a major long-term concern for Russia’s Arctic LNG projects. Prices have suffered lows from a supply overhang and remain vulnerable to more volumes due to come online in the 2020-23 period.

But Mark Gyetvay, CFO of Russian independent gas producer Novatek, said in May the company’s upcoming Arctic LNG 2 project would benefit from possible delays to LNG projects elsewhere. The firm’s existing Yamal LNG is exposed much more to oil price dynamics than gas, given its mostly oil-linked long-term contracts. But when Arctic LNG 2 comes online in 2023, 50pc of its cargoes will be sold on a spot basis, says Gvetvay, meaning the price of global gas benchmarks will be much more important for its economics.

Helping hand

Moscow has introduced a slew of tax exemptions to foster continued oil and gas developments in the Arctic despite the economic downturn. As of March 2020, Arctic LNG investments are excluded from the mineral extraction tax (MET) for the first 12 years, and the tax has been reduced to 5pc for Arctic offshore oil projects for the first 15 years.

Tax breaks are a much-needed cushion for Russian oil companies, given crude hovering around $40/bl. Lower prices stymied Q1 earnings for state-owned Rosneft, which recorded its first quarterly loss since 2012 and cut 2020 investment by 20pc in May. Rosneft still began exploratory drilling in May as part of its RUB10tn ($143mn) Vostok oil project, which aims to increase output to 115mn t/yr by 2030, from an initial 25mn t/yr by 2024.

State-controlled producer Gazprom Neft is reviewing the timing of upcoming Arctic investments but says its current schedule remains unchanged. It began drilling at its Kharasaveyskoye gas field in the Yamal Peninsula this month and hopes to start production in 2023, with its offshore Kamennomysskoye field following in 2025.

The first stage of Arctic LNG 2 was on schedule and 19pc complete, according to Novatek. The project made FID in September 2019, and the first train, with a capacity of 6.6mn t/yr, is still scheduled to launch in 2023.

A Covid-19 outbreak in May near Yamal LNG stalled operations at the site after many workers were infected, leading to closure of the nearby airport at Sabetta. But the crisis seems to have left construction of Arctic LNG 2, situated on an opposing peninsula, mostly unscathed.

Novatek hopes to retain its reputation for efficiency after the timely construction of Yamal LNG in 2017, a complex operation rolled out in temperatures as low as -50°C. It is eager to maintain the momentum with the addition of two more LNG trains, each of 6mn t/yr, by 2024 and 2026—with no delays announced so far

Novatek has still trimmed 20pc from capital spending in 2020, but the cuts target oil projects rather than LNG. In February, construction of Yamal LNG’s fourth train—with a smaller capacity of 900,000t/yr—faced delays, but its launch is still expected sometime this year.

Hurdles ahead

Despite tax breaks, reduced Western investment appetite challenges Russia’s Arctic oil and gas plans. While Western companies have been able to circumvent some restrictions, it will be more difficult if the US Congress passes the Defending American Security from Kremlin Aggression Act, which would prevent US-Russian partnership on oil and gas projects.

Particularly given the sanctions threat, Novatek will rely ever more heavily on the success of its Russian-built liquefaction technology. Known as ‘Arctic Cascade’, it is planned to be used for fourth train of Yamal LNG and could potentially allow future projects to skirt sanctions on Western equipment. The technology is designed for very cold weather and will also be used in the company’s 5mn t/yr Obskiy LNG project on the Yamal Peninsula, initially expected onstream in 2022-23 but now delayed to 2024-25.

Rebeka Foley is an analyst at political risk consultancy Prism

petroleum-economist.com