Russian Arctic offshore plan heats up

In the long term, Rosneft and other companies working on the northern sea shelf will benefit from higher oil prices and investments in the domestic oilfield service sector, writes Jennifer DeLay.

So far, Russia’s attempts to launch large-scale exploration and development of shallow and deepwater fields on the Arctic Sea shelf have had mixed results.

For example, Gazprom tried several times over a period of 20 years to set up a consortium to exploit Shtokman, a massive natural gas and condensate field in the Barents Sea. But it finally put the scheme on hold in 2012, owing to disagreements with foreign partners and concerns about unfavourable market conditions. Likewise, Rosneft’s first attempt to open up the East Prinovozemelsky (EPNZ) block in the Kara Sea foundered in 2011 when TNK-BP, a Russian-based company, blocked its shareholder BP’s bid to join the project.

Rosneft was eventually able to strike another deal on ENPZ with ExxonMobil, but that was not the end of its troubles in the Arctic. In the first half of 2014, it was one of several Russian companies identified as a target in the Western sanctions regime imposed on Russia for its seizure of Crimea and interference in Ukraine’s political crisis. Then in the second half of 2014, it was left reeling by the collapse of world oil prices.

The former was a problem because the sanctions restricted Russia’s ability to secure sophisticated equipment and technologies from the US and European firms that are most capable of supporting exploration and production work at remote sites where harsh weather conditions prevail. The latter, meanwhile, undermined the economic rationale of Russia’s Arctic projects by making them unprofitable.

Under those circumstances, Russian companies’ moves to push back the timeline for beginning exploration and production work at Arctic fields were hardly surprising. Nor was the Russian government’s talk about concentrating on low-cost onshore projects and keeping the Arctic as a reserve for future development.
Lately, though, there have been a few glimmers of hope. Oil prices have recovered somewhat, though they are still far below the levels marked in mid-2014. At the same time, the Russian government is working to build up the capabilities of the domestic oilfield service sector in order to mitigate the country’s dependence on imported equipment and technologies. This report will attempt to determine whether Russia’s Arctic prospects have truly improved as a result of these developments.
 
Breaking the ice 
On a superficial level, Russian Arctic operators’ situation resembles that of the US unconventional oil sector. Both suffered major setbacks as a result of the oil price crash, and both have sought to make technical and technological advances with the aim of reducing their costs enough to justify further exploration and development.

Likewise, players in both arenas have benefited from OPEC’s decision to reduce crude output with the co-operation of Russia and other producers. That move has helped oil prices move back to around US$50 per barrel since last autumn – less than half the level reported in July 2014, but still significantly above the nadir reached in the first quarter of 2016.

Overall, the price rise has been good news for US unconventional developers. In some basins, current market conditions have made shale operations viable once again. For example, companies working in the Permian Basin, where production costs are around US$35 per barrel, are now turning a profit. By contrast, problems have persisted in higher-cost basins such as the Bakken shale, where average production costs are upwards of US$65 per barrel.
Similarly, Rosneft and other companies eyeing Russia’s Arctic Sea shelf are still waiting. Even though prices have risen, they are still below the break-even level, which Russian Energy Minister Alexander Novak recently estimated at US$70 per barrel or more. Speaking at the International Arctic Forum in Arkhangelsk on March 29, Novak said that northern projects would not turn a profit unless crude prices moved into the US$70-100 range.
 
The necessity of invention
Rosneft and its cohorts will probably have to wait to reach this milestone, as many industry experts believe that crude prices are not likely to approach US$70 and remain there until about 2019. In the interim, though, Russia has a number of options at its disposal to help make Arctic projects more competitive.

The US unconventional oil sector’s experience would suggest that this can work. In that region, many companies have undertaken research and development campaigns or have revamped their work plans with the intent of making drilling and other operations less expensive. In many cases, these efforts have succeeded, and as a result, break-even costs have declined over the last two years.

Moscow, for its part, also sees innovation as a means of lightening the burden on the companies that hold offshore Arctic licences. To this end, it has formulated a policy of import substitution – that is, building up the domestic oilfield service sector with the aim of reducing reliance on foreign equipment and production technologies. It has invested in shipyards and manufacturing facilities and has voiced support for corporate plans to establish onshore service bases for offshore operations.

Russian companies – even privately owned firms – have followed the government’s lead on this front. Novatek, for example, is reportedly prepared to invest more than 25 billion rubles (US$447 million) in order to establish a shipyard and marine service base at Belokamenka, a village in the Murmansk region. The company drew up plans for the facility in order to support Arctic LNG, a scheme that envisions the construction of a second onshore gas liquefaction plant on the Gulf of Ob. But local officials have said that the shipyard will make drilling platforms for use at sites in the western Barents Sea as well as ice-breaking tankers for the Arctic LNG project.
 
Returns on investment
It remains to be seen whether public and private investments into such projects will pay off, especially if the US and Europe take a relaxed attitude toward enforcing the parts of the sanctions regime that limit technology transfers and equipment sales. NewsBase Intelligence (NBI) suspects, though, that Russia cannot replicate the US unconventional sector’s success on this front.

For one thing, offshore projects are inherently more difficult, and the difficulties are compounded by the harsh climate conditions of the Arctic Sea shelf. US operators, by contrast, have been working onshore at sites that do not experience such dire winters.

For another, US producers also had the advantage of access to extensive onshore infrastructure networks. Russia, on the other hand, is still working to develop such networks to serve its northernmost hydrocarbon frontier, and such a scarcity will help keep costs high for Russian Arctic projects for at least another 10 years.

Overall, then, the rise in world crude oil prices and Moscow’s efforts to invest in the domestic oilfield service sector have improved the outlook for Russian Arctic projects. They have not, however, brought the high cost of such initiatives down or shortened the timeline for beginning production.

This is not necessarily an urgent problem in the short term, as the Russian government is still treating the Arctic offshore areas mostly as a reserve for future production. In the long term, though, the investments in oilfield service are likely to generate returns. That is, once Moscow gives the green light for accelerating development work in the Arctic, Russian companies will benefit from already knowing where to find the ships, drilling platforms and other equipment needed for northern offshore projects.