US Sanctions Having Impact on Russian Arctic LNG Project

Given the geopolitical context and Russia's economic strategies, Novatek's Arctic LNG-2 project emerged as a pivotal area for energy sector advancement and international influence for Putin. Thus, the opposition from the US serves as an intriguing case to comprehend the mechanics behind sanctions.

What is the Arctic LNG 2 project?

The Arctic LNG 2 project, led by Russian oligarchs Leonid Mikhelson and Gennady Timchenko, aims to substantially increase Russia's natural gas exports to global markets. The proprietors of Novatek hold influential positions within the upper echelons of the Russian government and play a significant role in strategic decision-making.

A pivotal element of this initiative is the amplification of LNG production. In 2022, Novatek's initial operating terminal, Yamal LNG, exhibited remarkable financial performance, boasting revenues of EURO 8 billion, nearly doubling its profits and revenues year-on-year.

The subsequent phase in the company's blueprint involves inaugurating and streamlining the functioning of Arctic LNG-2. It aims to augment LNG production by an additional 20 million tonnes per year by 2026. This venture doesn't just impact Russia's economic terrain; it holds substantial ramifications for the global energy market, environmental concerns, and geopolitical relations.

Why is it so important to Russia?

By 2030, Russia envisions scaling up its overall LNG exports to 100 million tonnes annually, while also constructing four new substantial terminals. Throughout this timeframe, the LNG export expansion program holds immeasurable significance for the nation. Importantly, energy resource imports to the European Union have surged to their peak levels in the past three years. Notably, in November 2023, Russian LNG imports to Europe soared to a new high, reaching 1.75 million tonnes.

As a pivotal industry player, Novatek sets its sights on doubling its export capacity. The slated launch of the initial phase of the Arctic LNG 2 terminal by the end of 2023 and the outlined plans to achieve nearly 20 million tonnes of LNG annually by 2026 underscore the strategic prominence of this project.

In 2022, despite the sanctions, Russia witnessed an 8% surge in liquefied natural gas production. The nation persistently expanded its LNG provisions to Europe and global markets, leveraging the infrastructure of European ports.

In 2022, despite the sanctions, Russia witnessed an 8% surge in liquefied natural gas production.

Amidst restrictions and sanctions last year, Western companies still delivered cutting-edge components for the Arctic LNG 2 project and offered engineering services for its initial phase construction. If Russia continues its successful evasion of sanctions or secures equipment suppliers in China, the final two phases of the project might conclude. This advancement would enable Arctic LNG 2 to yield 19.8 million tonnes of LNG annually, aligning closely with the Kremlin's strategic objective of exporting 100 million tonnes of LNG yearly through the Northern Sea Route.

International companies like France's TotalEnergies, China's CNPC and CNOOC, and a consortium of Japan's Mitsui and JOGMEC have been actively engaged in the Arctic LNG 2 project. However, the involvement of certain companies has sparked investigations and raised concerns.

For instance, Baker Hughes, an American company that provided turbines for the initial phase of construction, ceased its operations in Russia following appeals by Ukrainian NGOs to the Scottish government. These appeals focused on grant funding for the turbine manufacturer and requested disclosure of their activities.

Ongoing investigations are scrutinizing additional international entities involved in the project. German and Austrian media have spotlighted Linde, engaged in joint ventures in Russia after the Crimea annexation, supplying critical components for natural gas cooling. Despite escalating sanctions, Linde persisted in fulfilling contracts in Russia post the 2022 illegal invasion of Ukraine, prompting increased attention and scrutiny.

In a separate incident, engineering firm Technip took over management of the Arctic LNG 2 project in 2019, breaching US sanctions against Russia's Novatek. Even after these sanctions were enforced, Technip continued supplying equipment to Russia, contravening restrictions in efforts to meet Russian demand.

These narratives illustrate a complex web of collaboration involving companies from various nations, persisting in operations or technological provision despite the pressures of sanctions and geopolitical limitations.

How the sanctions were imposed

In September 2023, the United States altered its sanctions strategy, broadening its scope to target entities linked to the project. These measures encompassed Russian companies, their subsidiaries, and newly established firms in third countries. For instance, entities in the United Arab Emirates were importing equipment bought from European companies into Russia, effectively circumventing the sanctions.

These sanctions, initiated on September 14, marked the initial move in constraining Russia's future energy pathways. Additionally, the US Department of State expanded the sanctions list, for the first time, including individuals directly engaged in the development, operation, and ownership of the Arctic LNG 2 project.

On November 2, 2023, the US Department of State and the Office of Foreign Assets Control (OFAC) directly imposed sanctions on ARCTIC LNG 2 LLC, the operator overseeing the new LNG terminal project.

The results of the sanctions are critical for the project

The French swiftly reacted to the sanctions. TotalEnergies stated it's evaluating the impact of the new US sanctions on Russia's Arctic LNG 2 project, where it holds a direct 10% stake and a 21.5% interest through its investment in Novatek. Since March 2022, it has ceased reserving gas reserves for Arctic LNG 2 and stopped investing in the project. The company had already written off a substantial amount—recording a EUR 3.7 billion impairment in the first quarter of 2022 and a total asset write-down of EUR 13.5 billion during the same year.

The Japanese followed suit in considering their position. Mitsui & Co., Ltd., a private company, engaged in Arctic LNG 2 through its joint venture Japan Arctic LNG B.V., partnering with the state-owned JOGMEC. Mitsui mentioned studying the sanctions' implications while affirming compliance with agreements and international regulations, including sanctions and vowed cooperation with the Japanese government. In the Russian LNG sector, the balance of investments and loans amounts to EUR 108 million, with guarantees totalling EUR 1.5 billion. The estimated adverse risk stands at EUR 1.5 billion after provisions and insurance claims, still falling within the controlled financial balance.

Initially, Leonid Mikhelson’s partners adopted a wait-and-see stance. However, it seems that the legal manoeuvres didn't yield results, and no loopholes were discovered. Consequently, the partners commenced withdrawing from the project, with the Koreans being the first to do so.

On December 26, it was revealed that Samsung had halted the construction of gas carriers for Russia's Arctic LNG 2 project due to US sanctions. Initially, the company had contracts for the construction of 15 LNG carriers, but work on 10 of them has now been suspended. Samsung Heavy Industries ceased the production of equipment for these LNG carriers.

The agreements entailed constructing these vessels at the Zvezda shipyard in Primorsky Krai. While the hulls of 5 LNG carriers were shipped to Russia under special permission from the South Korean government, construction on the remaining 10 was halted due to the imposed sanctions.

Termed as the SN2366 project, these LNG carriers were specifically designed for transporting LNG across the Arctic Ocean. They boasted a cargo capacity of 172,600 cubic meters and were equipped with the special Arc7 ice class, ensuring optimal performance under Arctic conditions.

Indeed, South Korea's involvement in developing the Russian LNG tanker fleet holds a pivotal position. Korean icebreakers are virtually irreplaceable for this purpose. The project hinges on this fleet, and without it, the project's functionality faces significant challenges. Consequently, other participants began to withdraw from their involvement in the project.

The sanctions were a culmination of collaborative efforts by Ukrainian, American, and European politicians and diplomats, buoyed by active public engagement and investigative journalism.

The imposition of new US sanctions prompted TotalEnergies, China's CNPC and CNOOC, and the Japanese consortium Mitsui and JOGMEC to declare a force majeure situation. This declaration inhibits their ability to fulfil financial commitments and honour the LNG supply contracts associated with the project. Each shareholder held specific allocations within the project—NOVATEK, as the primary shareholder, was allocated 12 million tonnes annually, while foreign participants were each assigned 2 million tonnes.

Under these new circumstances, Arctic LNG 2 might be compelled to sell its gas via the spot market as foreign participants express their inability to honour contracts due to the sanctions.

Notably, Chinese companies have made attempts to circumvent sanctions through formal channels. CNPC and CNOOC formally petitioned the US Treasury Department's Office of Foreign Assets Control (OFAC) seeking exemption from the sanctions imposed on the Russian Arctic LNG 2 project. However, there's been no response from US authorities yet. Japanese companies have initiated a similar process, while Spain's Repsol also declared force majeure.

The situation remains tense: despite the sanctions, the initial phase of Arctic LNG-2 commenced LNG production by the end of December 2023. With the pressing issues surrounding long-term contracts and constrained storage capacity, Novatek might have no choice but to sell gas through the spot market. What's more, it might need to offer discounts simply to sustain operations. This scenario could entice numerous buyers in Europe and the Far East, considering that we're looking at approximately 2.6 million tonnes from the initial phase alone.

The US Treasury is yet to decide on exemptions for China and Japan. However, we remain hopeful for consistent decisions based on prior determinations by the US.

Financial hurdles pose a significant challenge. According to Kommersant's report in June, the Arctic LNG 2 project's cost surged by approximately 17% to EUR 22 billion, attributed to the requirement for additional equipment. Shareholders were initially expected to cover this increase, but with TotalEnergies halting investments in Russian projects post the Ukraine conflict, NOVATEK now faces the task of sourcing the required financing.

The rejection of sanctioned terminal LNG by foreign shareholders might result in a shortfall of long-term contracts, potentially risking default on EUR 8.6 billion in external financing.

The sanctions were a culmination of collaborative efforts by Ukrainian, American, and European politicians and diplomats, buoyed by active public engagement and investigative journalism.

This underscores the significance of cooperative action in countering Russian aggression and preventing further economic and political interference in Europe. Nonetheless, this endeavour remains challenging, demanding meticulous attention and careful analysis to identify all nodes in the chain of circumventing sanctions and Russian intermediaries.