Workshop Review: Arild Moe—Russia’s Policies Concerning Energy Resources in the Arctic

by Joe Ralbovsky and Brandon Hightower

The following report is based on a presentation given by Dr. Arold Moe to ENERPO students at the European University at St. Petersburg in the spring of 2013. Dr. Moe is Deputy Director and Senior Research Fellow at the Fridtjof Nansen Institute (Oslo).

Russia has tremendous energy resources—an important point of leverage in both economic and political terms. Despite the power this brings, Russia is rapidly depleting its old reserves and its new onshore deposits present challenges for the following reasons: they are small, difficult to access in geological terms, and located in remote areas. Because of these factors, offshore deposits have become more significant in terms of Russia’s thinking regarding its long-term energy exporting strategy, especially in the past decade.

In particular, based on geological assessments, it would appear that the Russian continental shelf has significant energy resources in the Arctic. In the context of petroleum production, it is important to note the use of ‘resources’ and not ‘reserves’ – the latter is used to denote a find that has been confirmed by drilling. This distinction is important because claims of unproven resources can misrepresent actual energy reserves. With this in mind, one should be cautious when hearing reports about unconfirmed energy resources.

Compared to other oil producing nations, Russia lags far behind in developing its Arctic resources, which is particularly worrisome given that it requires 10-15 years to make a reserve fully operational. From a political perspective, a goal sufficiently far in the future can be beneficial for a number of reasons. In particular, a politician might no longer be in office and political accountability is not a consideration, and this might help to politicize the publication of potential ‘reserves’ in optimistic terms.

…ambitious plans to develop massive unproven resources in the Arctic might be constrained by actual industrial capacity.

Russia has proclaimed ambitious goals for the development of the Arctic, including the use of Russian shipyards and Russian industrial capacity. This is an understandable goal, but the limited number of potential producers lacks the experience necessary to produce Arctic-related oil platforms on a widespread scale. Therefore, ambitious plans to develop massive unproven resources in the Arctic might be constrained by actual industrial capacity. Russian yards have not been able to complete platforms on a timely schedule and sometimes do not even manufacture the entire drilling platform. This complicates Russian efforts to explore the Arctic.

Exploration of petroleum resources in the Arctic began in the early 1980s, and has been fairly limited overall. Exploration of the Barents Sea has been more widespread, and substantial expectations of Soviet/Russian reserves followed. Early discoveries in the Barents Sea were not only large for the Soviet Union/Russia, but Norway also made some significant discoveries in this area, albeit to a lesser extent. Initial findings fueled expectations that Russia would accelerate development of energy reserves, but other issues took precedent in the late 80s and early 90s. In particular, funding for such projects was difficult to secure.

In order to overcome this deficiency, there was talk of issuing competitive licenses for exploration and production since then, but such programs have never materialized to a meaningful extent. However, a big development took place in 2008 when a legislative change was made, giving two companies – Gazprom and Rosneft –monopolies on offshore activities. Since then, it has been impossible for other Russian companies to launch new offshore exploration campaigns on their own initative. From a Western perspective, such behavior can be viewed as “dysfunctional” for the energy sector since it discouraged competition and resulted in inefficiency. In reality, this behavior must be understood in the broader context of national interests and political considerations.

The companies included offshore exploration in their long-term strategies, whereas the government seems to have preferred offshore activities being prioritized in the short-term. 

Gazprom and Rosneft are very large companies whose production is primarily onshore. Therefore, the prospect of offshore production was not prioritized given the potential risks and associated expenses. The companies included offshore exploration in their long-term strategies, whereas the government seems to have preferred offshore activities being prioritized in the short-term. Given the lack of development and exploration by 2009, certain authorities, including the Ministry of Natural Resources, started to express concern about the lack of progress.

This caused the government to establish a list of Russian policy priorities which are the following: increase exploration and output, and to secure state control of energy-related industries. These priorities are not necessarily compatible and might even work against one another. The current lack of offshore production in Russia’s Arctic can be taken as evidence of this. Regardless, of the approximately 15 discoveries of potential reserves in the Arctic, it is not likely that all of them are commercially recoverable and this presents challenges.

In addition to natural impediments to the development of resources, there are other factors which limit Russia’s development in the region. For example, the Prirazlomnaya field in the Pechora Sea was discovered in 1989 and construction of an ice-resistant platform began in the northern ship- building yard at Severodvinsk in 1995. Given lack of experience with building oil platforms, construction took approximately 16 years and production was delayed. The platform was finally put into place in August of 2011, but production has not yet begun. Recent developments indicate that Gazprom Neft is interested in buying the platform and production rights from Gazprom with the hope of beginning production in the second quarter of 2013 – thereby commencing Russia’s production of its offshore resources.

One gas field in the Arctic, the Shtokman field, has attracted the most attention. Having been discovered in 1988, it remains one of the largest gas fields in the world. Unlike Prirazlomnaya, Shtokman is located quite far from shore and that delayed serious discussion about developing the field until 2003. At that time, two circumstances created a desire to develop the field: 1) offshore drilling technology had improved to the point where it was thought to be technically feasible to develop a field so far from shore, and 2) gas prices began to rise. These events, coupled with projections about increases in U.S. imports, generated a lot of interest in developing the Shtokman field.

In the few years following 2003, steps were taken to proceed with developing the Shtokman field and international oil companies were invited to discussions with Gazprom. In the process of establishing a consortium, it seemed that Gazprom changed its mind in 2006, initially giving the appearance that previous efforts were going to fail. However, in 2007, Gazprom established a special-purpose company, Shtokman Development AG, in which it owned a 51% stake. The remaining 49% of shares were sold to Total (25%) and Statoil (24%). As it was structured, Shtokman Development AG would primarily act in a technical sense and be responsible for developing the field, while Gazprom would actually be selling the gas.

This arrangement seemed to be a win-win situation, and the foreign partners hoped that Gazprom would be able to secure state support for reduced taxes as an incentive to proceed with production. This support did not fully materialize, but there was another development which proved to be a more significant barrier for the project: the gas market changed. Between 2008 and 2010, the so- called “shale gas revolution” in the U.S. caused dramatic changes and, given its domestic production of gas, effectively caused the largest LNG market to disappear.

These changes caused Gazprom and its partners to consider all of their options before proceeding with a capital-intensive project like Shtokman. One of the initial alternatives for delivering gas to customers was building pipelines through the Baltic Sea to supply the European market, and exporting the remaining 50% of the gas as LNG to the European market. These options were feasible in practical terms, but the price drop which accompanied increased U.S. production generated a lot of resistance to proceeding with the project. Ultimately, the decision was made in 2012 to put the project on hold, and it is reasonable to assume that its status will not change for a few years.

As Russia was discussing its plans for developing its Shtokman field in the Arctic, an ongoing disagreement with Norway about how to divide the Barents Sea along the coasts of both countries remained unresolved. Although the Shtokman field was not within the contended area, it was expected to be the first major production project in the Arctic and that others would eventually follow, including some within the disputed area.

The area emerged because, in the 1970s, the law of the sea developed in a way that gave coastal states a right to adopt a nautical part of the continental shelf. During this time, 200 nautical miles was established as the standard method for determining an exclusive economic zone (EEZ) and how to divide bodies of water along the coasts of two countries. At this point, fishing territories were the primary concern of policymakers and the thought of discovering hydrocarbons in the Arctic was not yet a salient issue. Unfortunately, the establishment of EEZs did not create a clear way to divide bodies of water between two countries, so Norway and Russia supported two separate ideas about how to divide the Barents Sea. Norway supported a boundary that was further East (closer to Russia), while Russia supported a boundary that was further West (closer to Norway). This caused both sides to feel that the other was claiming too much territory for itself and a dispute ensued. In the 1980s, both sides agreed to terminate their energy exploration activities in the disputed area and the issue remained unresolved for decades.

After years of failing to reach a compromise, it came as a surprise to many outside observers that an agreement was reached in 2010. The decision, known as the “Delimitation Agreement,” was made to divide the disputed area into equal parts – with Russia and Norway both conceding part of what they had claimed previously. In Norway, this generated interest in determining what was behind Russia’s decision to compromise on its previous claims. It was recognized that Norway and Russia have enjoyed a positive relationship for several years and they have longstanding cooperation on the management of fish stocks in the Arctic, and this was thought to have played a significant role in facilitating the settlement.

Despite potential reasons for this optimistic view, many Norwegians believed that Russia’s willingness to reach an agreement must have had something to do with energy, and Russia wanted to pursue development of its energy resources in the disputed area. From this point of view, the dispute had to be settled and Russia felt that circumstances were appropriate to do so in order to move forward. There are still other Norwegians who believe that the aforementioned motivations for Russia to settle the dispute are inadequate. Because of the monopoly situation on offshore exploration, there was little evidence that either of the state-owned companies (Gazprom or Rosneft) was pushing for a settlement in order to begin exploration in the disputed area. Additionally, it would appear that the decision came from the presidential administration and did not result from the consideration of outside viewpoints.

Given the conflicting Norwegian perspectives about Russia’s motivations to settle the dispute, what was really behind the decision to compromise? According to Dr. Arild Moe, Deputy Director of the Fridtjof Nansen Institute, “…the main driver had to do with foreign policy considerations.” His assertion is based on the fact that the territory regime in the Arctic is based upon the United Nations (UN) Convention on the Law of the Sea. This Convention allows claims for extended EEZs to be made for up to 350 nautical miles from shore if a coastal state can prove some sort of geological connection between the seafloor and the mainland.

The Continental Shelf Commission (CSC) is the body within the UN which is responsible for handling such claims. As a technical body, the CSC receives documentation from coastal states and evaluates claims for extended EEZs, eventually determining if they have merit or not. This is relevant because Russia wants to claim a large portion of the Arctic based upon a geological connection. In the delimitation agreement with Norway, Russia cited the fact that the dispute with Norway needed to be resolved so as not to hinder its case before the CSC. Thus, Dr. Moe believes that Russia’s reorientation is because it realizes that the Convention on the Law of the Sea “…is of extreme value for Russia.” Therefore, Russia has an interest in utilizing the Convention in order to maximize its gains in the Arctic.

It should be pointed out that, in the case of the Arctic, an alternative to the Convention on the Law of the Sea had been promoted for a number of years. Support for such a “special regime” was voiced by the European Parliament and by China. Both expressed interest in changing the existing regime as well. Not surprisingly, the states with an existing

claim in the Arctic supported the notion that no changes be made to the existing regime. The aforementioned Delimitation Agreement between Norway and Russia shows that existing international law allows the most complicated disputes to be solved. The existing regime works well for Russia and its broader foreign policy considerations, so the agreement undermined arguments supporting the need for a revised regime in the Arctic.

This was a clear demonstration of Norway’s desire to begin development in the region, and it inspired Russia to issue exploration and development licenses to Rosneft for most of its share of the disputed area. 

At this point, it is important to distinguish between the drivers behind the agreement and the implications of the agreement. With a clear-cut boundary, Russia and Norway could decide how to approach their respective parts of the Barents Sea. In the event that a reserve was discovered which crossed the boundary, it was decided that a case-by-case agreement would be reached about how to develop that particular reserve. This means that both sides would have to agree about how to develop shared reserves – effectively giving both a veto concerning future developments.

Having reached an agreement concerning the settlement of disputes in the Arctic, economic feasibility and technical considerations remained formidable obstacles to the development of reserves in the Arctic. Despite this, Norway commenced exploration of the Arctic minutes after signing the agreement. This was a clear demonstration of Norway’s desire to begin development in the region, and it inspired Russia to issue exploration and development licenses to Rosneft for most of its share of the disputed area.

Despite its inexperience developing offshore reserves, such a decision was made in accordance with Rosneft’s monopoly status. Realizing its lack of experience, Rosneft signed several agreements with foreign companies in April of 2012: one with ExxonMobil in the Kara Sea, one with ENI for the southern part of the formerly disputed area, and one with StatOil for the northern part of the formerly disputed area. Given these developments, the period of uncertainty and inactivity in the Arctic became a thing of the past.

However, the joint ventures require that the foreign companies bear the high initial costs of exploration. This is considerable given that the cost of drilling one exploratory well in the Arctic can exceed $100 million.

Foreign companies were pleased with these changes as they were able to secure more favorable agreements than were possible in the case of Shtokman. However, the joint ventures require that the foreign companies bear the high initial costs of exploration. This is considerable given that the cost of drilling one exploratory well in the Arctic can exceed $100 million.

Despite the considerable cost of investing in developing the Arctic, the potential for returns is thought to offset the associated financial risks, and Russia is hopeful that potential discoveries of recoverable resources will support the needed investment. It remains to be seen what will happen with Russia’s policies in the Arctic, but Norway has been active in pursuing its development strategies there. Regardless, the development of petroleum resources in the Arctic will be evolving for years to come. Russia is also increasingly affected by what other international actors are doing in regard to the Arctic. China, in particular, is working to build relationships with members of the Arctic Council, potentially in hope of using influence to influence decisions in a manner that would secure Chinese interests, even though China is not one of the recognized Arctic States. That said, China has applied for observer status, and will formally be able to have access to information as it becomes available. That said, the extent to which this is helpful for China is fairly limited, and Russia is still a strong advocate for governing the Arctic being left exclusively to Arctic states.

Rosneft’s focusing on exploration of unconventional oil, especially, hints at an individual agenda, but because of the capital intensive nature of its efforts, it is impossible for the firm to act alone in pursuing these leads.

Perhaps a more pressing threat to Russia’s energy sector and arctic development in particular is the rule of state dominance in their approach to partnerships as well as internal projects. This has been affecting Rosneft in particular. Recent years have seen a growing influence of the company, which is likely linked to state control, but not entirely. Rosneft’s focusing on exploration of unconventional oil, especially, hints at an individual agenda, but because of the capital intensive nature of its efforts, it is impossible for the firm to act alone in pursuing these leads. Besides Rosneft, however, Russia has generally been far behind in exploring new frontiers, and this might be partly due to the fact that decisions have to be taken on a very high level. As a result, frontiers like the Arctic have developed very slowly for Russia.

International market trends have also been influencing Arctic development, but not to the extent one might think. While it is true that China and India have been rapidly increasing their energy budget, the way Russia has attempted to prepare itself to meet those new demands is to shift resources in a way that improves efficiency. Because the Arctic is a relatively new area of interest, there has not been a huge shift of resources or direction towards it. However, with the advent of foreign investment and foreign firms teaming up with projects in the arctic, things might start to change.

As it stands, Rosneft has serious capacity issues, particularly if it is expected to handle all of the offshore projects. In this sense, projects and partnerships with foreign companies are acting more as a source of potential cooperation than competition, particularly because many of the licenses are rather far away from each other. While there might be some competition between foreign companies, it is likely that Rosneft will mostly benefit from learning new techniques and the introduction of foreign capital into the region as a whole.

Currently, only a handful of companies are really excellent at extracting resources deep offshore, and even fewer would be well-equipped to handle the Arctic. Some companies, such as those from China, are considering becoming more invested in the Arctic, but right now, what they really have to offer is capital and political attention rather than experience or technical expertise. Other, more experienced companies like Schlumberger, Halliburton, Exxon, ENI, Statoil, Shell, and BP are better positioned to really compete for work on the continental shelf, especially because of the large amount of competition in offshore technologies that the industry has seen develop of late.

In the field of gas developments, Russia is also likely to see large impacts as a result of the development of LNG – either abroad or at home. Although there is a lot of potential for projects like Shtokman, a lot will be based on both overall energy strategy and the initial costs of developing technology, creating a system of infrastructure to transport the gas, (whether by boat or by pipeline). These costs are staggering, so there is typically a high level of risk of running into problems that make it cost-prohibitive before even beginning production.

Russia has so far entertained the idea that their energy companies are still capable of doing it themselves. 

One important development in the energy market has been the transfer of control over the needed technology from the energy companies to technology-specific companies. While most of these technologies are available for purchase either as a whole package, or as a service that a tech company would provide, Russia has so far entertained the idea that their energy companies are still capable of doing it themselves. One of the major values in having international partners comes from the direct sharing of technologies and building competencies through shared projects. Still, Russia has proven to be pretty hesitant in actually committing to buying these technologies, and it is still very apparent that Gazprom has a long way to come before it is capable of overcoming the technology barrier on its own.

Russia also has some ground to cover in business and monopolization strategies. For example, in Norway, after the beginning of serious offshore development, there was a policy that required direct transfer of experience and technology to Statoil. All of the initial projects were transferred, and helped to give Statoil a competitive edge. In addition to smart policies like this, Russia should really work on explaining what it is they do with their energy industry. After the resolution of the Norway dispute, the Duma failed to effectively communicate to the public why they chose to act as they did. As a result, many people saw the bilateral agreement as a concession, and blamed Medvedev’s government for giving away what was considered to be Russian territory. Internal politics and the playing of the nationalist card have really turned what was a mutually beneficial development into something seen as a major loss. Fixing this could not only help to get public support on important decisions, but might also improve the overall approach of developing energy issues.

In both internal decisions about investment strategies and how they treat international partnerships, Russia has quite a long way to go before it becomes a really exciting place for investment. Up to now, the development of the Russian Arctic has been moving at a glacial pace. Perhaps with technological development occurring as independent projects or through partnership programs with experiences companies, Russia will finally have both the tools and investment systems it needs to exploit what could be a critical resource in the coming years.

Dr. Arild Moe is the Deputy Director and Senior Research Fellow at the Fridtjof Nansens Institutt. His main research interests include the Russian oil and gas industry, the regional dimension in the Russian petroleum sector, offshore activities in the Barents Sea, Russian climate politics, and Arctic politics.

Brandon Hightower is an MA candidate in the ENERPO program at the European University at St. Petersburg.

Joe Ralbovsky is an MPA/MAIR candidate at the Maxwell School of Citizenship and Public Affairs, and will be receiving his CAS from EUSP in the ENERPO program.

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