Russia is gradually developing its Arctic LNG strategy

Russia is gradually developing its Arctic LNG strategy

Due to its geographic location, natural resource extraction in the Arctic circle is strategically important for Russia’s overall energy strategy. At the same time, Russia is gradually shifting away from the traditional state-controlled gas trade through pipelines and is increasing its LNG production. Therefore, how Russia will further develop its LNG strategy in the Arctic circle is likely to result in significant changes in global LNG trade flows.

LNG as a new segment of Russia’s overall gas strategy

Traditionally, Russia’s natural gas has been traded via pipelines from Western Siberia to Turkey and Europe, and Gazprom used to enjoy monopoly over the entire supply-chain of Russian gas export. However, since 2009, Gazprom is struggling to adapt to the challenges posed by global economic crisis and the advent of US shale gas, which have led to increasing competition in both the domestic and export markets. Its share of production has declined significantly from around 80% in 2009 to around 64% in 2016. Meanwhile, LNG production capacity continues to increase. In 2009, when the Sakhalin-2 project, Russia’s first LNG export terminal, went online, it provided just about 4 percent of the world’s total LNG capacity. When Yamal LNG reaches its full capacity early next year, it will almost double Russia’s annual capacity to about 26 million tonnes, which is approximately 10% of world-wide LNG exports.

Government support also plays an important role in the development of Russia’s LNG projects. As part of the decision to promote LNG exports, the government’s 2013 actions included the cancelation of export duties on new Arctic offshore oil and gas projects. The state-owned company Rosneft and the private company Novatek also received permits for LNG export in 2013. This kind of export liberalization is a notable development, as it changes the traditional structure of Russia’s gas market that is based on state-controlled exports through pipelines.

The leading role of the Arctic region in Russia’s LNG strategy

According to the US Geological Survey, two thirds of Russia’s oil and gas is expected in Russia’s exclusive economic zone (EEZ) off its Arctic coasts. Therefore, the successful development of Arctic LNG is crucial for Russia’s future perspective as one of the globally leading LNG producers alongside Qatar, Australia, and the US.

LNG projects in the Arctic region significantly increase Russia’s overall LNG production. The Sakhalin plant’s two units produce approximately 10 million tonnes of LNG annually. On the completion of a third unit, the total output capacity at Yamal LNG will be approximately 15 million tonnes, scheduled for mid-2019.

International cooperation is becoming increasingly desirable in the LNG development of the Arctic region. Despite sanctions, the technological and logistical challenges of gas extraction in the climatically harsh Arctic circle have led Russia to seek outside investments and technology transfer from American and European companies. In May this year, French giant Total, which already holds a 19-percent stake in Novatek and participates in developing the Yamal project, announced new plans to buy a 10-percent stake in the Arctic LNG 2 project. In October, Saudi Arabia also announced that it is ready to invest $5 billion in the Arctic LNG 2 project.

The LNG development in the Arctic region has also helped private companies get third-party access to the gas export. Large amounts of undiscovered Arctic natural resources give private companies like Novatek opportunities to specialize in new technologies like LNG. These technologies serve as an alternative to engaging in the raw exploitation of traditional deposits, which are already exhausted by large state-owned companies. Novatek, which operates mainly in the Arctic circle, has consistently demanded the dismantling of the gas export monopoly. As a result, the Novatek-led Yamal Project has been provided direct access to the gas market without using Gazprom’s pipeline systems.

Strategic implications on the supply and demand sides of LNG trade

On the supply side, Gazprom’s role in LNG trade is likely to be further marginalized by Novatek. Its inherent structural problems, such as the high tax burden and the duties to perform for state interests, remain hurdles for the growth of its stock value. Gazprom’s results in the LNG business are far from its goals because of its weak  approach to LNG development, such as the attempt to limit the role of foreign companies and conflicts between its LNG projects and pipeline exports. With Vladivostok LNG and Shtokman LNG at the very high end of the cost curve, it is possible that Gazprom could have no new LNG projects by 2025. As a privately-owned company, Novatek, on the other hand, suits both the interests of investors and the Russian state by heavily investing in Arctic LNG plants with huge production capacities. It has also strengthened ties with Chinese investors amid US sanctions against Russia, therefore securing more financing options.

On the demand side, Russia’s long-term strategy is to utilize its Arctic waterway to export its LNG to Europe on a year-round basis and to Asia-Pacific markets during an extended navigation season beyond summer. Due to the fact that many European countries are landlocked or have short coastlines, in the near future LNG is not expected to replace pipeline gas in the European market because of high infrastructure costs. However, Russia’s LNG export to the Asian markets will continue growing because of the geographic advantage and Asia’s growing strategic focus on LNG. In 2015, over 70% of the global LNG trade went to Japan, South Korea, China and other Asian countries. The role of LNG in Japan expanded significantly after the nuclear accident in Fukushima in 2011. The country is aiming for a leading and initiating role in the creation of a global LNG market through a diversification of suppliers and third-party access to regasification facilities. JGC of Japan have already signed an Engineering and Procurement Contract (EPC) with Novatek to provide infrastructure support. China is another potential buyer of Russia’s LNG.

In July of this year, Novatek delivered the first ever LNG cargo to China via the Northern Sea Route, which drastically cuts delivery time to Asian consumers. China’s National Energy Administration said China National Petroleum Corp (CNPC) will start lifting at least 3 million tonnes of LNG from Yamal starting in 2019.

About Author

Yueyi Chen

Yueyi Chen is a graduate student at the Center for Eurasian, Russian and East European Studies, School of Foreign Service, Georgetown University. She currently focuses on energy issues and geopolitical risks of foreign investments in Russia and Central Asia. She holds a B.A. Degree in Russian Languages and Culture at Fudan University in Shanghai, China and has the experience of studying abroad in Moscow, Russia.