Economic Opportunities in the Arctic Fuel Geopolitical Competition

December 22, 2020 | Arctic

Executive Summary

Geopolitical Interests Arise as Arctic Economic Development Accelerates

  1. Geopolitics enter the Arctic as Russia reactivates and expands military bases, the U.S. and NATO conduct military exercises above the Arctic Circle and China demands a seat at the table in the Arctic Council.
     

  2. Economic competition picks up as Russia presses ahead with the development of oil and especially LNG in the Arctic, while U.S. investments in this sector remain limited as a result of regulatory and financing challenges.
     

  3. Transportation of Russian LNG to Europe and Asia drives up shipping activity to record levels. The trend will slow down as the International Maritime Organization (IMO) bans fuel shipping in the Arctic, as of 2024.

Watch out for

  • Winter LNG shipment to test feasibility of year-round delivery to Asia in February 2021
     

  • International ban on Arctic Heavy Fuel Oil to be enacted in June 2021
     

  • Russian Novatek’s Arctic LNG 2 plant in Russia’s Kara Sea opening in Q3 of 2022
     

  • LNG transshipment hubs built near Murmansk and Kamchatka by Q4 2022

Key Figures

  • Arctic LNG represented 6.4% of global LNG production in 2019, expected to rise to ca. 10% by 2023-2024
     

  • Nearly $100bn have been invested in the development of natural resources and infrastructure to date
     

  • Shipping along Russia’s Northern Sea Route grows rapidly from 30m tons in 2020 to an estimated100m tons by 2030.
     

State of Play

Investments in Arctic Oil and Gas Resources Continue to Accelerate

Global energy prices, the pace of sea ice melt, and the level of international cooperation or conflict between Arctic states determine the scale of economic development in the region. The facilitated access to the Arctic Ocean due to climate change is spurring commercial interests, since the Arctic contains significant reserves of natural gas and crude oil. In Russia, the natural gas company Novatek looks to complete its second LNG (liquefied natural gas) plant in the Arctic by 2022. In Alaska, the Trump administration decided to auction off new lease areas in shallower waters closer to the shore. The European oil and gas company Shell expressed interest in returning for new offshore exploration after it ended an unsuccessful, but costly exploration in 2015. The risks of Arctic hydrocarbon exploration became visible in May 2020 when 17,500 tons of diesel oil spilled from a storage tank in Siberia. Concerns over the use of heavy fuel oil (HFO) prompted the International Maritime Organization (IMO) to finalize a ban on this type of fuel in Arctic shipping. The ban starts in 2024 with some waivers until 2029. The regulation obliges shipping companies to use cleaner and more expensive distillate fuels. The ban will apply across the Arctic Ocean, including Russia’s Northern Sea Route, where traffic grew 15-fold since 2010.

Key Issues

Changing Geopolitics as Arctic Turns into Navigable Ocean

Over the past two decades, the Arctic sea ice declined by nearly 50%. By the middle of the 21st century the Arctic Ocean will, at least during the summer, become seasonally navigable. New routes of communication will shorten shipping lanes between Northern Europe and East Asia and improve access to the region’s natural wealth. Energy resources, both onshore and offshore, are the primary driver for Arctic economic development. The bulk of resources are located within the Exclusive Economic Zones (EEZ) of the five Arctic coastal states (Canada, Denmark, Norway, Russia, and the US).
 

The region’s economic potential resulted in the re-emergence of Arctic geopolitics. Russia refurbished abandoned Cold War-era military installations and constructs bases and airfields, able to accommodate the nation’s largest military aircraft. It deployed modern weaponry, including S-400 surface-to air-missiles and constructed long-range radar installations. Offensive weapons, such as cruise missiles, were added to coast guard icebreakers in Norway as well as Russia. The U.S. and NATO conduct military exercises above the Arctic Circle. In 2018, the Harry S. Truman became the first nuclear aircraft carrier to operate in the region since the 1980s. In May 2019 a speech by U.S. Secretary of State, Mike Pompeo, at the Arctic Council’s Ministerial meeting pointed to the emergence of hard security concerns. It referred to ‘illegitimate’ Russian claims to the Northern Sea Route and further criticized China’s expanding Arctic interest. Beijing invests heavily in Arctic research, including a new state of the art icebreaker, and identifies as ‘a near Arctic state,’ a definition the U.S. vehemently rejects. Such developments raise the question of where the securitization of economic interests ends and when the militarization of the region begins.

 

The primary governing body of the region, the Arctic Council, has limited influence to appease the emerging geopolitical challenges. It focuses on environmental issues and does not discuss security issues. The coalition encompasses eight Arctic States (Canada, Denmark, Finland, Iceland, Norway, Russia, Sweden and the U.S.). China and the EU have been admitted to the Council as ‘observers’ over the past decade. The ‘race for the Arctic’ is a misconception since ownership of the region’s natural resources is well defined. Most boundary disagreements have been settled or will be adjudicated by the International Tribunal for the Law of the Sea. 

Arctic Economic Development mainly takes place on Russia’s Shores

Natural gas and crude oil exploration are the primary industries present in the Arctic. Although, the Arctic holds substantial mineral resources, primarily in Greenland and Canada, which may become economically feasible to exploit in the future. Three projects are already taking place in the Russian Arctic: Novatek’s Yamal LNG plant, supported by Chinese and French interests, Gazprom’s ice-hardened offshore oil platform Prirazlomnoye and Gazprom’s Novy Port oil terminal. Future Russian LNG projects are scheduled for the end of 2022 and before the end of the decade. The majority of Arctic LNG production is destined for Europe, with limited summer and fall shipments going to Asia. However, long-term supply contracts will ship up to two thirds of production to Asia, primarily China. For the other four coastal states, Arctic resources are less important. Some production already exists in the region, for example Canada’s Mary River iron ore mine on Baffin Island and Alaska’s Red Dog zinc mine. In Norway’s Arctic, which is ice-free year-round, two projects are underway: Equinor’s Melkøya LNG plant and ENI’s Goliat oil platform. Conventional LNG and oil tankers deliver products primarily to Europe, although there have been some LNG deliveries to Asia.

 

Political motivations affect business developments in the Arctic. Oil production remains limited due to public opinion and regulatory hurdles, especially in the U.S. Financing is becoming harder to secure as major U.S. banks are unwilling to provide loans. Arctic oil and gas exploration is a major economic driver for Russia, as the country generates around 20% of its exports above the Arctic Circle. However, a joint venture to develop reserves in the Kara Sea between Rosneft and Exxon failed following Western sanctions against Russia in 2014. The economic relevance of the Arctic will rise and so will competition over its strategic location and abundance of resources.

Strategy Group AGORA