With President Obama’s media-flooded trip to the Arctic Circle in September, the cold but hotly contested region enjoyed a surge in the level of attention it generally recieves. This heightened scrutiny was indeed deserved, but for reasons far more compelling than a flashy photo-op with a press-savvy Commander-in-Chief.
The Arctic is going to play a critical role in the economic and geostrategic future. The reasons why can be summed up in two words: hydrocarbons and Russia. Consider the undersea irredentism Russia has practiced in the region since the early Oughts, bringing a claim in 2002 to the United Nations -- one renewed this summer -- that if granted would radically increase its potential territory on the Arctic seafloor. It’s not a shock Russia wants as big a piece of undersea real estate there as it can persuade the international body to grant it. According to recent U.S. Geological Survey estimates, some 30 percent of the world’s undiscovered natural gas and 12 percent of its undiscovered oil are located in the region. The Arctic seafloor is also predicted to contain valuable deposits of gold, tin, manganese, and diamonds, very likely high-grade deposits that could in theory be accessed by undersea miners like Nautilus Minerals. (See our previous coverage of them here.)
So there are untold riches to be found in the far north, and for Russia, whose economy is reliant on hydrocarbons, obtaining new supplies of them remains a major imperative. For the moment, however, the economics of that imperative look iffy with the oil price down at its current levels -- though Russian oil majors continue to press ahead even as prices scare off their non-Russian counterparts. Russia’s Lukoil and Rosneft are currently engaged in a legal battle with each other over an exploration license on the remote Taimyr Peninsula, between the Kara and Laptev Seas -- a license for which Lukoil paid $29.1 million and which is thought to be a stepping stone to much richer offshore deposits. Gazprom has turned on the pumps at a second well in its Prirazlomnoye field, the first (and only) offshore oil project in the Russian Arctic. The Yamal LNG project, one of the largest industrial undertakings in the region, continues apace, although Russian owner Novatek appears to be selling down its majority stake to raise capital: the economic sanctions against Russia have left it hard up.
But it’s not all go-go times for the Russians. The huge oil find announced by Rosneft in 2014, to be developed in a joint venture with Exxon using rigs and equipment from North Atlantic (majority owned by Seadrill), has been scrapped due to the beleaguered oil price and sanctions imposed on Russia by the U.S. and the E.U. This led to the cancellation this year of a $4.1 billion deal between Rosneft and North Atlantic Drilling. It’s worth noting, however, that the project didn’t die completely. Rosneft’s recent announcement that it plans to restart Kara Sea drilling in 2016 may betray the same forward-at-any-price mentality Gazprom, Lukoil, and its other colleagues in the sector display.
A sickly oil price and biting sanctions are powerful forces, but they are not invincible and permanent. Crude is cyclical and sanctions under the Obama administration seem to be negotiable, at least with respect to Iran. That said, the Arctic is unlikely to save the oil and gas industry in the near term, both because of the political and macro environments and because, even at the best of times, projects there still command much higher capital expenditures than their more conventional cousins, with an average break-even cost of $78 per barrel, the highest in the sector. So the Russian companies fighting forward in the space seem to be responding not to the market but to signaling (or directives) from their government that they need to be doing business in the Arctic long-term.
That signaling is not subtle. It was perhaps most clearly codified in the 2013 release of Russia’s official Arctic economic strategy; it has been confirmed by the military infrastructure Russia is now putting in place to solidify and protect its northern presence. Currently underway are a $150 billion investment in fighter jets, a deployment of surface-to-air missile batteries specially modified to function in the harsh weather conditions that prevail in the region, and the creation of a military and civilian satellite monitoring system to be deployed between 2020 and 2025 (to name just a few marquee projects). This adventurism does not get the same kind of coverage as Putin’s forays into Georgia, the Ukraine, and now Syria, likely because it has not yet broken into open warfare. But the intense focus his government has put on the region will bring with it some immediate economic impacts. Russia’s aerospace and defense sector, for example, must be jumping with joy. That $150-billion fighter-jet buy will go into the coffers of KNAAPO and Oboronprom, the manufacturers of the Sukhoi and Kamov planes Putin and Sergei Shoigu plan to master the frozen skies with. RTI Systems, the highest-performing part of chipmaker RTI Group (in turn part of mega-conglomerate Sistema), will be handling the development and deployment of that ominous-sounding monitoring system. The project itself does not carry a huge price tag -- it’s estimated at $93 million -- but if RTI succeeds, this will give it and its ultimate corporate parents a foothold in what is going to be a booming sector over the next 10 to 15 years.
Getting into the Russian aerospace and defense business is a risky venture for foreigners, given the closeness between industry and government that prevails there and Vladimir Putin’s insatiable appetite for power. But Russia’s military buildup will, in time, create significant pressure on another hegemonic power -- the U.S. -- to match it in force projection. So far, this has not occurred; indeed, between the U.S.’s lackluster efforts on the military side and its belated entry into Arctic hydrocarbons, Russia looks to be well ahead in the race for local dominance. But the U.S. seems to be emerging from its slumber: in late August and early September, news bubbled up of a big earmark in the U.S. Coast Guard budget for the construction and purchase of a new icebreaker ship at $1.2 billion, part of a push from the Obama administration to step up its game. Due to protectionism built into military procurement processes, that money is all but certain to go to a U.S. firm. A leading candidate would seem to be Huntington Ingalls, which built the most recently constructed icebreaker for the U.S. government. (General Dynamics has also expressed interest.) But a more interesting and longer-term play in that space might be the Nordic Arctic nations, which have more developed icebreaker sectors as well as greater reserves of technical know-how and intimate experience in dealing with subzero maritime conditions. The CEO of Finland’s state-owned Arctia shipping, for example, recently advertised Finland's hunger for U.S. icebreaker business, claiming to be able to get a ship built and into operation for 10 percent of the cost of his colleagues in America. Norway’s Havyard might also be a winner of the U.S. effort to close the icebreaker gap -- there’s nothing like the threat of losing an important geostrategic battle to overcome procurement protectionism.
Sam Munson is managing editor of The Octavian Report.