Russia's Arctic Dreams Have Chinese Characteristics

The most significant geophysical event on our planet since the end of the ice age is taking place today—the opening of the Arctic. As the High North maritime environment warms, the Arctic Ocean’s abundant energy, minerals, fish stocks, and other natural resources are becoming increasingly accessible, while new potential maritime routes promise to reduce shipping times and costs and accelerate ties between major commercial centers. These new opportunities for energy development, natural resources extraction, and shipping suggest that the region risks becoming an arena of intense competition, tension, and potentially even confrontation, not only between the United States and its two near-peer strategic competitors—China and Russia—but also among other Asia-Pacific states with observer status in the Arctic Council.

Without question, the Arctic Ocean region is emerging as a new geopolitical and geoeconomic landscape with significant security and environmental implications for the United States as well as for U.S. allies and partners in Europe and Asia. Whether the region remains a venue for multilateral cooperation and sustainable development or becomes an arena for great-power competition is highly uncertain. Aside from the impacts of a warming climate, two key geopolitical developments will shape the Arctic’s future: (1) Russia’s extensive extended continental shelf claims and its willingness to abide by an impending “recommendation” by the UN Commission on the Limits of the Continental Shelf (CLCS), and (2) the role of China as a strategic player and self-described “near Arctic” state whose ambitions are highly uncertain. By analyzing and monitoring Sino-Russian energy cooperation in the Arctic as a signpost, concerned stakeholders and policymakers can draw inferences about the potential for broader strategic collusion between Russia and China in the Arctic that could challenge regional security, multilateral governance, and international law.

Russia’s Ambitions in the Arctic

Russia’s vast landscape dominates the Arctic, with its northern coastline spanning nearly half the circumference of the Arctic Circle. Even so, Russia has spent the past fifteen years working diligently to further increase its share of the Arctic through the addition of 1.2 million square kilometers (463,000 square miles), an area almost three times the size of California.[1] Russia’s extended continental shelf claim reaches 150 nautical miles (nm) beyond its exclusive economic zone (EEZ) into the international waters of the Arctic Ocean as far as the North Pole. Moscow initially submitted its claim to the Lomonosov and Mendeleev Ridges in 2001, which the CLCS noted lacked sufficient documentation. After several years of additional research, Russia submitted a revised claim in August 2015 that included the Mendeleev elevation, and in February 2016 it added the Chukchi high plain to the claim.[2]

On August 8–12, Russia presented its revised claims before the CLCS. However, it will likely take years for the CLCS to make a final recommendation, which will not be legally binding. Should the commission find in favor of Moscow, Russia’s options would be to either unilaterally assert its rights to the extended continental shelf or engage in bilateral negotiations with Canada and Denmark, which have also made claims to this area. (The United States has signed but not ratified the UN Convention on the Law of the Sea, or UNCLOS, and therefore has not officially presented any extended continental shelf claims.) Such negotiations would likely take years, if not decades, to finalize. While an extended continental shelf provides rights to the subsea and subsoil resources, it does not confer sovereignty or jurisdiction over the superjacent waters. Finally, even if Russia’s claims are upheld by the CLCS, it would still likely take decades to commercialize resources in this contested area.

The time and resources that Moscow has dedicated to pursuing its extended continental shelf claims over the past fifteen years signal the Arctic’s strategic importance in Russia’s long-term planning. As the earth warms, access is slowly opening in the Arctic to vast amounts of undeveloped oil and natural gas, minerals (including copper and iron ore), and fishing stocks that will serve as a resource base to fuel Russia’s rent-seeking political economy for decades. Russia is specifically looking to Arctic oil and natural gas to help offset declining production from mature fields in Western Siberia in order to sustain output levels at post-Soviet highs and keep state revenues flowing. According to a report from the National Petroleum Council, Russia holds 58% of the Arctic’s undiscovered petroleum resources: 30.5 billion barrels of oil, 1,144 trillion cubic feet (tcf) of natural gas, and 27.5 billion barrels of natural gas liquids.[3] Meanwhile, the U.S. Geological Survey estimates that the Lomonosov Ridge could hold an additional 1.1 billion barrels of technically recoverable undiscovered oil and 7.16 tcf of natural gas.[4] These volumes are sizeable in their own right but relatively modest compared with the already abundant resources in Russia’s existing Arctic zone.

Overall, most of these oil and gas resources are located in shallow water near the coastline or onshore. Given the challenges in operating in the deepwater offshore Arctic, Russia is prioritizing development of the shallow waters of the Barents and Kara Seas, as well as onshore on the Yamal Peninsula in conjunction with a planned expansion of the Northern Sea Route.

Russia’s Wary Look East

As the warming of the Arctic Ocean opens a new maritime space, it is inviting commercial and strategic competition from non-Arctic states in Asia. In 2013, the Arctic Council, whose members consist of Canada, Denmark (including Greenland/Faroe Islands), Finland, Iceland, Norway, Russia, Sweden, and the United States, granted “permanent observer status” to China, India, Japan, Singapore, and South Korea. At first Russia resisted this move, but it reluctantly consented once these non-Arctic states pledged to recognize the territorial sovereignty of the eight members as well as the application of UNCLOS to the Arctic Ocean.

A key driver of Russia’s long-term Arctic strategy is to defend its perceived sphere of influence in the Arctic and its extended continental shelf claims against the threat of internationalization led by these Asian observers, particularly China. Russia’s extended continental shelf claims overlap with the international waters of the Arctic Ocean’s high seas. Known as the “donut hole,” this central area is beyond the reach of the five Arctic-state EEZs (belonging to Canada, Denmark, Norway, Russia, and the United States) and is considered part of the global commons. Non-Arctic states, particularly Asian observers, look to these international waters for opportunities to secure a strategic foothold in the region and harvest their perceived fair share of Arctic resources.

While China has not yet articulated an official Arctic policy, it claims to be a near-Arctic state with legitimate rights and interests in the Arctic. In 2010, retired rear admiral Yin Zhuo notably declared that “the North Pole and the sea area around the North Pole belong to all the people of the world.”[5] This statement has been frequently interpreted by analysts on both sides of the Pacific to mean that China believes that no country can have sovereignty over the Arctic. This interpretation has had a long shelf life, given that Beijing has not yet clarified the scope of its interests and ambitions in the region.

History has repeatedly demonstrated that Russia and China will remain strategic competitors regardless of their many shared interests. However, since 2014, the combination of low oil prices and targeted sanctions by the United States and European Union have significantly restricted Russia’s plans to develop Arctic oil and natural gas. Without access to key technologies from these countries and international financing, Arctic greenfield projects will not likely be realized. Despite Russian concerns over China’s long-term ambitions regarding the Arctic’s global commons, China is positioning itself as an indispensable partner in the development of Russia’s Arctic zone.

Nowhere is this more evident than with the Yamal liquefied natural gas (LNG) project, which symbolizes the growing asymmetry in the energy relationship between Russia and China. Located deep within Russia’s Arctic zone, the project has been subject to sanctions targeting Arctic development generally and Novatek specifically. As a result, the project’s ability to move forward has been largely dependent on China’s participation throughout the value chain, including as an upstream equity partner, strategic investor, lender of last resort, LNG buyer, tanker operator, and even equipment supplier.

Chinese investors hold a combined 29.9% equity position in Yamal LNG.[6] Under a deal struck in 2015, China’s Silk Road Fund secured LNG cargoes from the project through a 9.9% equity stake for $1.4 billion and a fifteen-year loan for 730 million euros. China National Petroleum Corporation (CNPC) acquired a 20.0% equity stake in 2013 for an undisclosed amount. The remaining stakeholders are Novatek (50.1%) and Total (20.0%). The $27.5 billion project was ultimately saved from the impact of sanctions by China’s state “policy” banks that have agreed to provide $12.2 billion as part of two fifteen-year loans from the Export-Import Bank of China ($10.7 billion) and China Development Bank ($1.5 billion).[7]

Meanwhile, exactly how much Yamal LNG is destined for final delivery to China is uncertain. Yamal’s three LNG trains are expected to produce 16.5 million tonnes per year (mtpa) by 2020, with the first 5.5 mtpa train planned for start-up in 2017.[8] Nearly 96% of future cargoes are presold under long-term year contracts: Total Gas and Power (4.0 mtpa), CNPC (3.0 mtpa), Novatek Gas and Power (2.4 mtpa), Spain’s Gas Natural Fenosa (2.5 mtpa), and Gazprom Marketing and Trading Singapore (2.9 mtpa).[9] Approximately, 86% percent of these cargoes are expected to be delivered to Asia-Pacific markets.[10] Some cargoes will likely be sold on European and Middle East markets, while other Asia-bound cargoes will find their way to Japan and South Korea, as well as to growing markets in South Asia and Southeast Asia.

To deliver this Arctic gas to global markets, fifteen ARC-7-class icebreaking LNG carriers are being constructed by Daewoo Shipbuilding and Marine Engineering. Nine of these will be operated by joint ventures involving Chinese companies: six will be operated by Teekay LNG and China LNG Shipping (Holdings), and three by Mitsui OSK Lines and China Shipping (Group). With one cargo loaded every 38 hours on average, each tanker is expected to make about fourteen voyages per year: four to five via the summer route and nine to ten via the winter route.[11]

While Yamal LNG will be shipped year-round, even these special tankers will only be able to safely and reliably transit the Northern Sea Route east to Asia from June to November. Known as the summer route, the voyage from Yamal to Shanghai is approximately 4,900 nm and takes 16.5 days. In comparison, the route from the Persian Gulf to Shanghai is about 5,600 nm and 15.5 days. For the remainder of the year, LNG will be shipped west to Europe via the so-called winter route. From there, most cargoes will be transshipped to Asia via the Suez Canal, extending the voyage from Yamal to Shanghai to 13,700 nm.[12]

New Model for Arctic Development?

The question going forward is whether Yamal LNG is a potentially transformative model for Russian-Chinese energy cooperation in the Arctic or if it is merely a one-off occurrence driven by sanctions avoidance. To be sure, China’s extensive involvement in Yamal LNG throughout the value chain represents a new development. Russia has long seen China as a key growth market and source of investment, yet prior to sanctions it was reluctant to offer Chinese companies equity positions in major upstream projects on the scale of Yamal LNG.

While China positioned itself as an indispensable partner in Yamal, it is not yet a preferred partner. Instead, Russia has preferred to partner with mostly international oil companies (IOC), which, in addition to finance, bring to the table the business acumen, cutting-edge technology, and project management experience to develop resources at lower cost. Rosneft’s deals with Statoil, Eni, and ExxonMobil that were signed in 2012, and stalled by targeted sanctions, demonstrate this preference. Even when Rosneft has contracted with China Oilfield Services Ltd. to conduct exploratory drilling in the Sea of Okhotsk and seismic surveys in the Barents Sea, it has done so in the context of its strategic partnership with Statoil. Should sanctions be lifted, Rosneft will quickly seek to resume its strategic partnerships with IOCs.

To the extent that Yamal LNG represents a transformative model for Sino-Russian cooperation in the Arctic, then Chinese companies may more frequently partner with IOCs in the future rather than just serve as sanctions-driven substitutes. Second, Chinese companies may also become more deeply involved throughout the value chain, rather than just being the lenders of last resort and a downstream market. These two possible outcomes are likely to be driven by China’s strategic interests in the Russian Arctic as a resources base and the ambitions of China’s national oil companies to become commercially competitive with IOCs by acquiring Arctic operational skills and technology.

However, the scope and durability of China’s role in the Arctic can only be tested once sanctions are lifted. Even then, China will face increasing competition from other Asian national oil companies, in addition to IOCs, as the Arctic becomes internationalized and more integrated with East Asia. In particular, Russia is looking to develop partnerships with the other Asian observer states—India, Japan, Singapore, and South Korea—rather than risk the Arctic becoming a resource appendage to China. Ultimately, China’s role in the region may be limited by Russia’s need to hedge against the risks of a Chinese monopsony.

Endnotes

[1] Ragnhild Grønning, “Russia Presents 1.2 Million Square Kilometers Arctic Claim to the UN,” High North News, February 11, 2016, http://www.highnorthnews.com/russia-presents-1-2-million-square-kilometers-arctic-claim-to-the-un.

[2] Submissions are available from the Division for Ocean Affairs and the Law of the Sea, Office of Legal Affairs, United Nations, http://www.un.org/depts/los/clcs_new/commission_submissions.htm.

[3] National Petroleum Council, “Arctic Potential: Realizing the Promise of U.S. Arctic Oil and Gas Resources,” March 2015, http://www.npcarcticpotentialreport.org/pdf/AR-Part_1-Final.pdf.

[4] Philip Budzik, “Arctic Oil and Natural Gas Potential,” U.S. Energy Information Administration, October 2009, http://www.legis.state.ak.us/Basis/get_documents.asp?session=28&docid=741.

[5] Linda Jakobson and Jingchao Peng, “China’s Arctic Aspirations,” Stockholm International Peace Research Institute (SIPRI), SIPRI Policy Paper, no. 34, November 2012.

[6] Novatek, “IFRS Consolidated Interim Condensed Financial Statements (Unaudited) as of and for the Three and Six Months Ended 30 June 2016,” 12, http://www.novatek.ru/common/tool/stat.php?doc=/common/upload/doc/NOVATEK_FS_6m2016_ENG_FINAL.pdf.

[7] “Update 2: Russia’s Yama; LNG Gets Round Sanctions with $1 2 Bln Chinese Loan Deal,” Reuters, April 29, 2016, http://www.reuters.com/article/russia-china-yamal-idUSL5N17W2G8.

[8] Stuart Elliott, “Yamal LNG Now Contracted to Sell 100% of Future LNG Output: Novatek,” Platts, May 9, 2016, http://www.platts.com/latest-news/natural-gas/amsterdam/yamal-lng-now-contracted-to-sell-100-of-future-26437664.

[9] “UPDATE 1-Russia’s Novatek Signs LNG Supply Contract with France’s Engie,” Reuters, June 2, 2015, http://af.reuters.com/article/energyOilNews/idAFL5N0YO36020150602.

[10] “Yamal LNG Project Signs Contracts for Sale of 96% of LNG It Produces,” Tass, March 17, 2016, http://tass.ru/en/economy/863064.

[11] Suryan Wirya-Simunovic (presentation at 28th Gastech Conference and Exhibition, Singapore, October 2015), http://www.gastechnews.com/wp-content/uploads/2015/10/Wirya-Simunovic-Suryan_MOL.pdf.

[12] See Wirya-Simunovic.