Gazprom and China’s ‘Breakthrough’ in the Russian Arctic

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Gazprom and China’s ‘Breakthrough’ in the Russian Arctic

The economic and political logic behind Gazprom’s use of a Chinese drilling rig in the Arctic.

Gazprom and China’s ‘Breakthrough’ in the Russian Arctic

The “Kolskaya” oil drilling rig is pictured in the Kola Bay near Russia’s northern seaport of Murmansk in this November 27, 2010 file photo. The Nanhai-8 rig is currently deployed to Kola Bay.

Credit: REUTERS/Andrei Pronin

On June 27, 2017, Russian mass media headlines announced “China’s breakthrough in the Arctic.” The reason for the positive headlines was the signing of an agreement of cooperation by Murmansk Governor Marina Kovtun and General Director Alexey Davydov of Gazprom Geologorazvedka, a drilling company owned by Gazprom. Notably, the signing took place on board the Chinese deepwater semi-submersible drilling rig Nanhai-8, which entered the Kola Bay a week earlier. The Nanhai-8 rig can operate at water depths up to 1,400 meters and can drill as deep as 7,600 meters.

The appearance of the drilling rig in Murmansk was due to Gazprom decision’s to hire it for drilling assignments in the Arctic Sea. In November 2016, the energy company announced a tender for a 3D seismic survey in the Kara and Barents Seas, and early this year Gazprom already declared its plans to resume drilling in the Kara Sea. The drilling rig Nanhai-8 was chosen by the Russian energy company to take part in the drilling in the Leningradskoye field in the Kara Sea. The C1+C2 reserves of the field have been estimated at 1.05 trillion cubic meters of gas and 3 million metric tons of gas condensate. The approximate cost of the leasing contract is $71,640 million.

The choice of the Chinese rig is one of the few existing areas of Sino-Russia Arctic energy cooperation, despite the support expressed by Russian senior government officials and the fact that both Russia’s leading energy companies, Rosneft and Gazprom, have been in talks with Chinese energy companies concerning cooperation in the Arctic region. What were the major driving motivations and interests for Gazprom to choose the Chinese drilling rig?

Gazprom’s Economic Incentives

Adopted in 2008, amendments to the Federal Law On Subsoil Resources limited the number of companies able to work offshore in Russia. The amendments provide access to offshore activities only to legal entities with five years’ experience in developing deposits on the Russian continental shelf; established in accordance with the legislation of the Russian Federation; and having more than 50 percent of its charter capital owned by the government. In practice, only two Russian energy companies met the new requirements: Rosneft and Gazprom. Therefore, other energy companies were pushed out of the contest for Arctic shelf extraction licenses.

As the result, the licenses were mainly divided between the two state-owned companies; currently, Rosneft represents the major player on the Russian continental shelf, controlling 55 licenses, whereas Gazprom has 41. Both companies launched geological surveys in 2014; however, the sanctions introduced by the United States and European countries against Russia the same year, which restricted exports technology for deep-sea drilling on the Arctic continental shelf and fossil fuels extraction, forced a halt to many drilling and geological activities conducted by the Russian companies. According to the Ministry of Energy of the Russian Federation, 68 percent of the equipment imported by Russian energy companies was now banned. The Russian companies, therefore, lost the opportunity to receive foreign investment and cutting-edge technology to develop their offshore projects.

As a result, Gazprom and Rosneft approached the Federal Subsoil Resources Management Agency with a request to amend and prolong their license terms, including the Arctic offshore licenses. The Ministry of Natural Resources and Environment agreed to adjust the companies’ obligations for the 35 blocks in the Arctic, but the suspension of drilling activities and the monopoly of the two state-owned companies added to the existing criticisms concerning offshore sector development within the Russian political and business sectors.

Over the past several years, the Ministry of Natural Resources and Environment has been advocating for the liberalization of the Federal Law On Subsoil Resources and for an increase in the number of the energy companies that could gain the right to work on the Arctic continental shelf. One of the reasons behind the Ministry’s stance is that the Russian government considers the Arctic a future strategic resource base, which is declared in the two strategic Arctic political documents: “The Fundamentals of State Policy of the Russian Federation in the Arctic for the Period up to 2020 and Beyond” (2008) and “The Strategy for the Development of the Arctic Zone of the Russian Federation and National Security for the Period up to 2020” (2013).

According to Minister of Energy Aleksandr Novak, currently, in the Arctic zone, Russia produces up to 93 million tons of oil per year, which accounts for 17 percent of total production. Forecasts indicate that oil production on the Russian Arctic continental shelf by 2030 might increase up to 2.2 million barrels of oil per day. However, apart from the imposed Western sanctions, there are several internal issues that might hamper prospective offshore oil and gas development, and impose additional burden on the energy companies.

First, seismic surveys in the most promising waters of the Arctic Seas, outside of the Barents and Pechora Seas, have covered no more than 0.15 square kilometers per 1 sq km. For the Eastern Seas, the figures stands at less than 0.1 sq km to 1 sq km. Second, Minister of Natural Resources and Environment Sergey Donskoy announced that in 2017, financing for geological exploration from the federal budget would be reduced by 5 percent in comparison in 2016. In other words, the Russian government expects the energy companies to invest their own funds in geological exploration and fulfill their obligations under the previously issued licenses.

Several private and state-owned Russian energy companies, including Lukoil and Zarubezhneft, have addressed the government several times requesting an end to Gazprom and Rosneft’s monopoly on offshore activities in the Arctic. Currently, the Russian government has shown little sign of changing its position. However, the two companies’ inability to comply with the obligations under the issued licenses might influence the government to review its position. A small step in this direction came when the Ministry of Natural Resources and Environment temporally suspended new rounds of licenses for the country’s continental shelf. One of the declared reasons for the decision was the delays in Gazprom and Rosneft’s Arctic projects.

Under these conditions, Gazprom’s decision to resume drilling in the Kara Sea might be backed by the existing pressure to comply with its license obligations and to avoid any possibility of losing its monopoly on Arctic offshore activities. Another possible factor is that Gazprom needs to replace depleting fields and increase its resource base to guarantee its status as a reliable energy supplier and outpace growing rivalry from other Russian companies. Apart from economic factors, geopolitical reasons might have impacted the company’s decisions.

The Geopolitical Landscape

After the collapse of the Soviet Union, the Russian Arctic suffered years of neglect until the early 2000s, when there was a revival of interest in the region associated with the start of Vladimir Putin’s presidency. Since then, Russia has increased its activity in the region through reestablishing its military presence in the region, boosting its economic activities, and enhancing its Arctic diplomacy, including active participation in the work of the Arctic Council. Such policies were aimed to achieve several internal and external policy goals. First, in terms of internal interests, Russia has tried to assert its sovereignty in the region and guarantee its energy security. Second, the Russian government linked its large-scale and ambitious Arctic development with the goal to reassert Russia’s great power status inside the country and on the international arena.

In this case, Gazprom’s resumption of drilling activities in in the Kara Sea is in line with the official political interest of projecting an image, both domestically and internationally, of Russia as the leader in on-land and offshore energy development in the Arctic region. Gazprom has already been engaged in several activities aimed at promoting Arctic energy development. Nearly a year ago, the leading players of St. Petersburg football club Zenit staged a photo shoot at the Arctic oil platform Prirazlomnaya, located in the Pechora Sea and operated by a Gazprom’s subsidiary Gazprom Neft. In July this year, the national Russian channel NTV broadcast the film “Zenit-Prirazlomnaya: First in the Arctic,” telling a story about the resulting football match involving Zenit football players and the platform workers in the Arctic Ocean. Since Prirazlomnaya is the first and currently the only field in the Russian Arctic shelf where oil is actively produced, such advertising endeavors create an image of Russia as a leader in the Arctic development and send a message of Moscow’s strong economic interests in the region with prospects for cooperation.

At the same time, the Russian government’s interests in benefiting from greater bilateral collaboration with China might stand behind Gazprom’s choice to use the Chinese drilling rig Nanhai-8. After the Ukraine crisis and the ensuing geopolitical tension between Russia and Western countries, Moscow has become more motivated in enhancing its relations with Asian countries. Cooperation in the Arctic region represents an area of Sino-Russia relations where, despite certain challenges associated with legal issues and uncertainty stemming from China’s lack of an official Arctic policy, the interests of the two states are in line for now. China shares an interest in diversifying its marine trading routes and energy exporters, and currently, Chinese companies are assessing the future benefits of investment in Arctic development. The Russian government, meanwhile, has ambitious plans to boost its socioeconomic activity in the Arctic region and needs investment and technology for its ambitious shipping and energy projects. According to Vitaly Krukov, director and analyst at Small Letters, the short-term solution for Russia’s shortage of offshore technology and equipment might be technology acquisition and equipment purchases from China.

In 2016, the Federal Subsoil Resources Management Agency and China Oilfield Services Limited signed an Agreement of Cooperation. The Agreement outlines the development of long-term collaboration between the two companies in the field of marine seismic surveying in Russia and abroad. China Oilfield Services Limited already has experience working with Russian energy companies. In 2016 Rosneft, in partnership with the Norwegian energy company Statoil, drilled exploration wells in the Sea of Okhotsk using China Oilfield Services Limited’s semi-submersible rig Nanhai-9.

To sum up, Gazprom’s choice to hire a Chinese drilling rig addresses Russian official policy goals and interests. First, the company’s decision goes in line with the official Russian external policy for enhancing bilateral relations with China. In addition, Gazprom’s choice is a manifestation of the company’s own interests in developing energy cooperation with the Chinese companies. Such cooperation is not limited to investment, but might have a positive impact on future negotiations on energy deals between Russia and China.

Second, the resumption of Gazprom’s activities in the Kara Sea provides the company with economic and political benefits to combat criticism concerning the company’s inability to comply with its obligations. Moreover, in terms of geopolitical benefits, the offshore activity of Russian companies in the Arctic Sea contributes to Russia’s image as the leading country in Arctic economic development.

At the same time, the recently announced drastic cuts to Arctic programs spending from 209 billion rubles ($354 million) to 12 billion rubles ($20 million) raise questions concerning the future of Russia’s Arctic policy implementation.

Nadezhda Filimonova is Assistant to the Vice Rector for Development at the Russian State Hydrometeorological University.