Russia’s Arctic Resources Trump Sanctions

The West’s inability to stop the revenue stream for gas production may prove consequential to the war in Ukraine

Russia’s Arctic Resources Trump Sanctions
Russian President Vladimir Putin (C), accompanied by Novatek chief Leonid Mikhelson (2nd L) and Russia’s energy minister Alexander Novak (L) on Dec. 8, 2017 / Alexey Druzhinin / SPUTNIK / AFP via Getty Images

On Feb. 24, the Yakov Gakkel, a 3-year-old, ice-class tanker, departed from Montoir Port, France, for Sabetta Port within the Arctic Circle in Russia. For as long as the war in Ukraine has raged on, the Yakov Gakkel has made four return trips to Montoir Port and has since moved on to ports in Spain and Belgium, delivering one of Russia’s principal revenue generators: liquefied natural gas, or LNG.

Russian President Vladimir Putin’s former chief economic adviser, Andrei Illarionov, suggested in April that the war in Ukraine could be stopped “within a month or two” if there were a full embargo on Russian oil and gas.

If only things were that simple. Unlike Western consensus on cutting off Russian oil supplies, five months into the war, there is no full embargo on Russian gas — and there is unlikely to be one. Not only is Europe too dependent on Russian gas, but in recent weeks, Russia has also turned the tables by cutting off its gas supplies to Europe. And this has come without a decline in enthusiasm for the war in Ukraine, obvious from the recent strikes on Kyiv. Even efforts to transition to “green” energy may not stymie Russia’s resolve — a stark reminder of what’s at stake for a world dependent on LNG.

Russia is the world’s largest exporter of natural gas, and Russian natural gas accounted for almost 40% of European gas demand in 2021. This has locked Europe and Russia into a symbiotic relationship of supply and demand such that a full embargo on LNG is not possible, and where there are sanctions on the industry, they do little to dissuade Russia from stopping the war in Ukraine.

In fact, Russia may just hold the geopolitical upper hand. For the past several years Russia has committed to its gas industry through investment and infrastructure development, reaping the benefit of the $1 billion a day that Europe pays Russia for its gas. This development has come in the form of massive projects in Russia’s Arctic region, with on- and offshore drilling, ports, airports and rail service transforming near ghost towns into modern urban centers. Exploitation of the Northern Sea Route (NSR) has been critical to this. Although it attracts far less attention than other global shipping routes, it would be folly to underestimate the potential of the NSR. As a route that connects Asia to Europe, the NSR is strategically significant. And because travel time between these two continents is 13 days shorter compared with the route via the Suez Canal, the NSR is also lucrative, saving between 30% and 40% in time and fuel costs. And thanks to climate change, year-round shipping on the NSR has become possible. With 90% of Russia’s gas reserves located in Yamalo-Nenets Autonomous Region in the far north of the country and the Arctic coast on its doorstep, Russia’s control over the NSR could prove consequential against sanctions and the West’s efforts to stop the war in Ukraine. That Russia regards its Arctic region as a national security priority and has been “future-proofing” its gas industry ahead of the so-called energy transition should give Western governments pause.

A consortium of companies, supported by the Russian government, is more than halfway through a 5-year, $10 billion investment designed to capitalize on the NSR and bolster its strategic significance. And just before Russia’s full-scale invasion of Ukraine, Rosatom (the state-owned atomic energy corporation) committed a further $18 billion to the development of the NSR through 2030. Russia’s largest private gas producer, Novatek, has also invested heavily in the Arctic region. Novatek is the majority shareholder among an international consortium of investors in the Yamal LNG project, which is estimated to have cost about $27 billion. The Arctic 2 LNG project, for which Novatek is again the major shareholder, is expected to cost $21 billion.

Since the end of February, Putin appears determined to push ahead with plans in the far north. “Taking into account all kinds of external restrictions and sanctions pressure,” Putin said, “special attention must be paid to all projects and plans related to the Arctic. Not to postpone them … but instead, we must respond to attempts to curb our development with maximum increase of the work rate on both current and upcoming tasks.” Putin is particularly keen to see the construction of a northern railway, part of a megaproject called the Northern Latitude Passage, which will play a vital role in facilitating the transportation of cargo across the country and to northern ports for both domestic consumption and export.

Despite setbacks brought on by the partial embargo on the Russian gas industry, it’s largely business as usual for Russia’s biggest gas companies. For example, after Russia formally recognized Donetsk and Luhansk regions in eastern Ukraine, Germany halted the Nord Stream 2 gas pipeline project. The move was significant because Germany receives half its gas supply from Russia, and the project would have eased pressure on gas prices in Europe. But gas supplies continued under the first phase of the program, Nord Stream 1. Ironically, the only decline in supply of Russian gas to Europe was imposed by Russia itself under its rubles-for-gas payment scheme.

TotalEnergies similarly announced at the end of March that, in line with EU sanctions, it would stop providing capital to the Arctic LNG 2 project, for which it holds a 21.64% interest. This came after the company announced in early March that it would not provide capital for future projects in Russia and condemned the country’s aggression in Ukraine. But just like Germany with the Nord Stream project, the French company’s condemnation didn’t extend as far as severing its partnership with Novatek. TotalEnergies maintains its 19.4% interest in Novatek and continues its involvement in the Yamal LNG project.

As progress nears to a halt on the almost completed Arctic LNG 2 project, production output at Yamal LNG increased during the first quarter of 2022 compared with the same period in 2021, and over the winter months, Novatek has sought to boost production to 120% of original capacity at the Yamal plant. Meanwhile, all 15 of Novatek’s ice-class tankers that transport LNG from the Yamal project have been traveling back and forth from Sabetta to ports in France, Spain, the Netherlands, Belgium and Denmark without interruption as the war in Ukraine grinds on. As the season changes, LNG shipments to Asia are getting underway.

The U.S., which is not dependent on Russian energy, has banned all oil and gas imports, while the U.K. plans to phase out oil from Russia by the end of 2022. As for gas, the U.K. government said it will end importation “as soon as possible thereafter” — so there is yet to be a definitive plan to halt it. Still, Putin has directed the government to diversify exports away from Western markets and reorient these to fast-growing markets in the south and east.

If the goal of sanctions is to hamstring Russia’s gas industry and starve it of its ability to continue the war in Ukraine, then things are not going to plan. Besides being unable to impose an embargo on Russian gas, the sanctions already in place are hurting electorates in Western countries through sharply rising fuel prices and inflation. The West is in a difficult position: Leaders may want to hurt Russia, but they can’t afford to lose political support at home for doing so.

But for Ukraine, it’s far worse. Thousands of lives have been lost, millions have been displaced, while Russia adds billions to its war chest through LNG sales.

Energy experts have touted the transition to so-called green energy to cut dependence on Russian gas. But as a potential solution, this is no silver bullet. As Russia has restricted gas supplies to Europe, countries such as Germany, Italy, the Netherlands and Austria have signaled they will switch to coal — long considered a “dirty” fuel, antithetical to green energy — as the priority has shifted to quick solutions to meet heating demands this winter. Even if there is a future energy transition, LNG is set to play a key role because it can be burned to produce hydrogen energy, a renewable, noncarbon resource. The Russian government had been preparing for this transition long before Feb. 24, having taken steps to adapt to shifting energy demands and maximize its gas resources over the longer term.

Before Western sanctions were a factor, the Russian government produced a low-carbon development strategy for the period up to 2050, which includes major investments in hydrogen and ammonia production. At the recent COP26 climate summit in Glasgow, Putin, like a number of world leaders, announced that his country would become carbon-neutral by 2060. But the government’s ambitions don’t stop there: Russia also aims to hold at least a 20% share of the global market for hydrogen production.

In August 2021, the Russian government approved a concept for the development of hydrogen energy, and in October, Prime Minister Mikhail Mishustin committed more than 9 billion rubles ($145 million at current exchange rates) over three years to fulfill this goal. With its vast gas reserves, the Arctic region will be a prime focus of this investment. From the outset, the government stated that there would be incentives to the industry for developing this technology, such as special investment contracts, subsidies and compensation to cover the costs of scientific research.

Like the other industry leaders in Russia, Novatek has taken steps to develop hydrogen, no doubt seizing government incentives, and has confirmed pilot projects to produce blue ammonia and hydrogen using natural gas. In June 2021, Novatek signed a memorandum of understanding with its long-term partner TotalEnergies to develop carbon-capture and storage solutions as well as explore opportunities to develop ammonia and hydrogen using the “significant low-cost resources of the Yamal and Gydan peninsulas” — the two areas where their gas projects are concentrated. In December 2021, Novatek made similar agreements with German companies Uniper and RWE to produce and supply low-carbon ammonia and hydrogen to European markets. The partnership with RWE also includes the supply of LNG and carbon-neutral LNG.

If hydrogen is to play a role in the future of clean energy, it’s difficult to not see Russia involved in some way, especially as a full EU embargo on Russian gas seems unlikely. Under a changing climate and a transition away from fossil fuels, the geostrategic significance of Russia’s NSR may grow, and it could make little difference whether the shipping corridor is used to transport gas, hydrogen, ammonia or any other cargo if it is the faster and cheaper way to deliver goods to Europe and Asia alike. At this point, the opportunity to get cheap and clean energy may supersede moral questions about supporting Ukraine against Russian aggression.

As far back as the mid-2000s, Russia was developing infrastructure in the Arctic specifically to exploit its vast natural resources and the NSR. The region has taken on such strategic significance that the regime prioritizes it under its national security agenda. Sweden’s and Finland’s expected accession to NATO will only heighten Russia’s perception that its Arctic region requires military defense. And there can be little doubt that those in power are ready to use the shipping corridor, as they have with their gas supplies, to serve their interests, whether that be to provide — or deny — Western and Eastern markets the resources they rely upon. In contrast to Russia’s westward expansion into Ukraine, Russia’s Arctic ambitions may be lesser known. But if they are fulfilled, the long-term impact could pose no less a threat to the ongoing war, geopolitics and the environment — sanctions be damned.

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