After Arctic LNG 2

The world recently celebrated the new year with a fireworks display over Sydney’s Darling Harbour and the Times Square Ball Drop in New York City. In the weeks before these festivities took place, the much smaller world of LNG observers witnessed its own fireworks display of breaking news and the proverbial dropping of the ball by Novatek’s three-train, 19.8 million metric tons per year (mmty) Arctic LNG 2 (ALNG2) project on Russia’s Arctic coast.

Original article link: https://open.substack.com/pub/energist/p/after-arctic-lng-2?r=24q63h&utm_campaign=post&utm_medium=web

In just a short time, Novatek went from producing its first drop of LNG at ALNG2 on December 19 to issuing force majeure notices to its clients on December 21 after the United States imposed sanctions on ALNG2’s operating company in early November, effectively toxifying the project.

The force majeure was Novatek’s response to the latest sanctions but also to years of its Western partners’ incremental exits, which have deprived the venture of irreplaceable technology and logistical support. Seb Kennedy of Energy Flux and I published an article with help from Mehdy Touil titled Russia’s stunted LNG coup, arguing that ALNG2 will be able to produce gas at reduced capacity with Western tech already in place on Train 1 and non-Western tech to eventually get Trains 2 and 3 online.

However, ALNG2 still faces the impossible task of bringing gas to market. The latest sanctions have extinguished any hope of continuing Western and Asian support for building the twenty-one highly specialized Arc7 icebreakers needed to shuttle ALNG2’s gas out of the Arctic region. ALNG2’s limited fleet of two or three vessels is still undergoing sea trials. Argus Media estimates that ALNG2 will require a minimum of four Arc7 carriers to lift the entire offtake of Train 1’s 6.6 mmty of LNG.

Despite this Arc7 gap, the latest sanctions, and Novatek’s likely shouldering all of the project’s financing, the Russian gas giant is pushing on with production and is expected to make its first delivery in the coming weeks. It recently received the final prefabricated module from China to complete Train 2 by the end of 2024. Even after Novatek’s force majeure, Russia’s Deputy Prime Minister Alexander Novak had said that ALNG2 was still operating as planned. But the question of how this gas will reach its destination remains.

So what are Novatek’s options for ALNG2 after sanctions?

Before I get into it, I’ll mention that turning toward the illicit trade of LNG is not one of Novatek’s options. In Russia’s stunted LNG coup, Seb and I threw out an idea that cargoes from ALNG2 could go the way of the crude and products so-called dark fleets to skirt the US financial system: obfuscation, ship-to-ship-transfers (STS) and other subterfuge. Soon after, Mehdy Touil published a piece explaining why this is unlikely. Global LNG shipping has limited export/import points, well-established operators, a limited global fleet (only 700 vessels compared to oil’s 5,700+), and long-term contract structures that make it improbable for a dark fleet to emerge.

The dark fleet idea is also untenable because dark vessels typically come from the secondhand market, in which shadowy traders snatch up ageing vessels and exploit them well past their shelf lives. Kpler, a data firm, maintains that Novatek’s only chance to expand the ALNG2 fleet is to buy on a secondary market. But this market for LNG carriers largely doesn’t exist, and certainly not for ice-class carriers. GIIGNL’s 2023 Annual Report illustrates the shortage of older, high-capacity carriers that would make a secondhand market possible.

Source:GIIGNL

There is just too little similarity to the global crude and products shipping markets. Mehdy writes a compelling narrative with which I fully agree and to which I don’t have much to add except on the transshipment/STS section, discussed below. I would highlight that even if part of the 700-vessel global fleet were to participate in illicit trade, there still would be the Arc7 gap. Only fifteen Arc7 carriers operate today - all are serving Novatek’s Yamal LNG project. Some of these may be borrowed for ALNG2, but Russia’s newest and largest export facility will need all twenty-one of its planned fleet.

So it seems that unlike many Western sanctions strategies on whole sectors, the targeted sanctions on ALNG2 will prove effective even before they officially come into force at the end of this month.

Yet Novatek pushes on. Could this be just another optics play from a Russian producer? Meaning, does Novatek seek to prove to a domestic audience and customers that it can overcome Western antagonism?

Or, is there a world in which we can imagine some options for Novatek?

I sat down with Mehdy’s analysis and some of my own thoughts to come up with four possibilities. The first looks at alternative icebreakers that can facilitate icebreaking capability. The second expands on Mehdy’s reasoning against transshipment and STS. The third imagines some hypothetical spot market customers. And the fourth is a catchall case enabled by the changing global order.

1. Alternative icebreakers

I talked to Ben Seligman, a project specialist for Arctic oil and gas development, about ways Novatek could potentially compensate the incomplete ALNG2 Arc7 fleet. Beyond the Arc7s that ALNG2 could borrow from Yamal LNG, there are currently no other Arc7 LNG carriers available in the world.

Seasonal ice variability is a big factor in determining access to ALNG2. Novatek sometimes uses ice class 1A tankers (Arc4) to offtake gas from Yamal LNG in the low-ice season. But this class, operated by the Greek company Dynagas, has an opaque ownership structure that may or may not expose it Western sanctions.

Another possibility would be to use conventional icebreakers to escort LNG carriers to and from the ALNG2 site. As one example, last summer the LNG carrier Fedor Litke was led by the Russian nuclear icebreakers Sibir and Arktika from Yamal LNG through the tricky Vilkitsky Strait en route to Northeast Asia.

Icebreaker Escort Route - Yamal LNG to Northeast Asia

Last year Rosatom, operator of Sibir and Arktika, announced that it was planning to launch year-round navigation along the eastern Northern Sea Route (NSR) to bring vessels laden with Novatek gas to global markets. Year-round shipping is a key component of Putin’s plan to transport 200 mmty of LNG along the route by 2030.

It is yet to be seen whether Russia can ramp up the production of escort icebreakers. Rosatom is planning to build 153 icebreaking and ice-class vessels. But like the ALNG2 fleet, Rosatom has come under Western sanctions that deprive the company of hard-to-replace technologies.

In the short term, it is unlikely that Novatek will be able to source Arc7 vessels or increase escort capacity. Russia’s Sovcomflot has been working to onshore its Arc7 shipbuilding capabilities, but success seems far away.

1. Transshipment and STS

On transshipment and STS, Mehdy mentions that transferring LNG between carriers at sea is, “a delicate operation requiring close coordination and expertise,” especially in remote regions. Even so, Novatek’s most viable transshipment floating storage unit (FSU) hubs located at either ends of the NSR also fell victim to Western sanctions, which render them largely unusable, as Seb and I discussed in Russia’s stunted LNG coup. These transshipment hubs are crucial in minimizing the opportunity costs of having Arc7s deliver cargoes far outside their specialized operating environment along the NSR.

However, that still leaves the option of direct STS. Novatek has had success with STS along the NSR for the past decade. In November 2018, the Sovcomflot-operated LNG carrier Pskov completed the first of LNG STS transfer off the port of Honningsvåg, Norway involving a cargo from Yamal LNG, the first of one hundred STS transfers completed within the first six months of the practice. Over time Novatek has managed to bring STS operations closer to Yamal LNG and continues STS operations on the Western terminus of the NSR from Yamal LNG to Asia during the risky high-ice season. In early December 2023 the Hong Kong-flagged LNG Dubhe picked up a cargo from the Arc7 class tanker Nikolay Urvantsez in the Murmansk region, sailed through the Suez Canal, and made a port call in Dapeng, China on January 11, where it most likely unloaded its cargo.

It seems like Novatek might have some success at ALNG2 by transferring cargoes in open waters. But its past success has largely taken place on the western side of the NSR involving shipments to Europe and distant Asian destinations. Most importantly though, transshipment and STS require that demand meets supply. In other words, for transferring cargoes to be successful, there needs to be conventional carriers in the market with the risk tolerance to take aboard sanctioned LNG. This requires looking at parties with existing long-term contracts and potential spot market players with the appetite to take on supplies from ALNG2.

1. Spot Market

ALNG2’s five non-Russian equity partners declared force majeure at the end of December 2023 following Western sanctions placed on the project. Other independent parties including Spain’s Repsol, trading powerhouse Vitol, and a few Chinese energy companies with special purchasing agreements (SPA) also received force majeure notices from Novatek. France’s TotalEnergies, an offtake partner with a 10% stake in the project, said earlier this month that it had initiated its force majeure and would not offtake LNG from ALNG2 this year.

It is unclear whether ALNG2’s other equity partners in Japan (10%) and China (20%) will follow TotalEnergies’ lead. They are currently waiting on a response from the U.S. Treasury’s Office of Foreign Assets Control (OFAC) to be granted sanctions waivers, an improbable story. But Japan is thought to want a full exit, according to one well-informed source who also highlighted that Tokyo still has Sakhalin-2 and Yamal LNG as reliable options. Further, Mitsui, a joint partner in Japan’s 10% stake, recently pulled its employees from the project.

The likely scenario is that Novatek will have to sell cargoes from ALNG2 on the spot market, with a ‘toxicity’ discount applied. LNG from Train 1 can be sold under contracts extending up three months directly by ALNG2 or via intermediaries that are willing to take on the risk.

This naturally raises the question of to whom will cargoes be sold?

China is the most likely contender. Beijing already has long-term agreements with ALNG2, but Chinese traders and conglomerates could still benefit from additional discounted rates. However, China doesn’t need any more Russian gas, so it can’t really be a reliable option for Novatek.

Appetite for risk is also tricky to gauge. Noncompliance with US sanctions can hurt a country’s economy and most gas importers choose to go along with what Washington says. But what about those who don’t? Are there any countries that could use a bit of spot gas from Russia that are willing to take on the risk? Do they already cozy up to Moscow? Can they work around the dollar-dominated financial system? The following section is strictly hypothetical, but provides some thinking beyond ALNG2, as the title implies.

What if? - Imagining new markets

I’ve identified one place that could fit the hypothetical model: Myanmar. Last year Moscow and Naypyidaw marked the 75th anniversary of diplomatic ties. Over the past decade-and-change the two countries have been moving closer together, especially in gaining ‘mutual diplomatic validation’ against international opprobrium brought on by Myanmar’s military coup in February 2021 and Russia’s invasion of Ukraine just one year later.

The coup in Myanmar forced Western energy companies out and left energy infrastructure badly damaged. Rolling electricity blackouts have become quotidian. Myanmar’s leadership has turned primarily to Russia to find solutions: it began importing cheap Russian crude - from almost zero to 8.36 million barrels between March and June 2023. Last year, the two capitals signed a memorandum of understanding (MoU) to develop nuclear infrastructure. The Russian energy industry is also working out how to help develop inland and offshore oil and gas prospects.

But LNG has a very long way to go, although it may be desperately needed. Myanmar’s domestic gas production, which is primarily exported to Thailand and China, has been in decline for some time while domestic demand in the power sector has increased. Over 92% of Myanmar’s natural gas demand goes into the grid, making up a 35% share of power generation in 2020. Myanmar’s natural gas master plan contends that LNG will be needed to close the supply/demand gap.

Production Outlook of Existing Offshore Fields (Myanmar)Source:Economic Research Institute for ASEAN and East Asia

According to Global Energy Monitor data, Myanmar currently has no LNG import capacity nor does it have any new capacity proposed. The nation has previously shelved projects with a combined four million tons per year of capacity, but these projects have failed largely because they are unable to secure bankable power purchase agreements from power plants.

Shelved LNG Projects (Myanmar)Source:Frontier Myanmar

Toward the end of 2019 Myanmar did manage to arrange an emergency LNG-to-power capacity supply chain during an electricity crisis when a joint venture between China’s CNTIC and Hong Kong’s VPower Group used FSRUs to shuttle gas to local power stations. But this short-term solution succumbed to instability caused by the junta’s coup and higher LNG prices over the past two years. All LNG-to-power capacity has since shuttered as business conditions have become unmanageable. It seemed that Myanmar’s LNG ambitions died yet again.

So what does this all mean for ALNG2?

This hypothetical customer serves as a model to which Novatek could, speculatively, one day in the distant future sell its molecules. Although Myanmar has no established import terminals, it does have a roadmap in place for LNG offtake development and has displayed an ability to swiftly establish LNG-to-power arrangements by employing FSRUs. And perhaps as important is its alacrity to work with Moscow to bypass Western-imposed sanctions.

The country’s military leadership has been exploring ways to work around the US dollar by adopting Chinese and Russian currencies. It has previously discussed using Russia’s Mir bank card for electronic payments, allowing for direct exchange between the rouble and the Myanmar kyat. And where this publication is most concerned, since 2022 Myanmar has been paying for Russian oil products in roubles and is ready to do the same for gas.

Of course, many things must take place before Arctic gas enters this market: Myanmar needs import capacity, either on land or offshore. It also needs the capital to pay for freight on LNG carriers that operate outside the US financial system. But this is extremely difficult because most LNG carriers and FSRUs are owned by Western companies, and Moscow’s only FSRU is tied up servicing the Kaliningrad exclave. Then there is the question of how a country such as Myanmar would get land-based LNG import capacity online without Western help - it may need to enlist China, whose support for Myanmar has been waning and whose appetite for risking US sanctions is uncertain.

Myanmar’s projected natural gas demand by 2040 is 11.8 Bcm per year, roughly 8.73 mmty, about 44% of ALNG2’s nameplate capacity. But again, much needs to happen before a real market to materialize.

There may be other longshot countries that fit the model. Cuba, which also has no import capacity, could benefit from Russian LNG after years of blackouts caused by the country’s decades-old oil-to-power plants. In the past two years, ties between Moscow and Havana have deepened akin to the golden age of partnership in Soviet times. Bilateral trade has soared, too. And to work around Western sanctions, the two capitals have begun to settle projects in roubles. Cuban citizens can now use Russia’s Mir system for financial transactions.

While Cuba’s path to importing LNG might be even longer than Myanmar’s, the value of this exercise was to imagine potential outcomes in a geopolitically changing world. Unpredictability engenders fence-sitting nation states to form adaptable foreign and economic policies that hedge against the unknown future distribution of global power. Energy security is an exigency of governance, and failing to provide it can erode trust in leadership and lead to shifting alliances.

1. Some unknown future

International energy relations are not immune to this changing world order. This gets us to imagine a world where governments change their mind on sanctioning Moscow, motivated by supply/demand constraints and the political desire to keep the global natural gas market as liquid as possible.

Take Nord Stream 2 as an example. Germany long benefited from reliable and relatively inexpensive gas from Russia to the extent that it supported the now-defunct subsea pipeline even after Russia invaded Crimea in 2014 and committed other sinister acts that directly violated Germany’s sovereignty. And the United States, which had long opposed the project, waived sanctions under the Biden administration to repair Washington’s ties with Berlin, enabling Gazprom to complete the gas connection in 2021.

Of course, the 2022 invasion of Ukraine is undeniably more egregious than Crimea. It finally forced Europe to (almost) get its act together and ditch Russian molecules. But Nord Stream 2 offers lessons about how far governments will go to achieve energy security and meet political ends even in the West. Administrations come and go: Biden’s waived sanctions to mend relations with a historic ally, but a second term for Trump - a Putin sympathizer - could theoretically see OFAC sanctions lifted.

Global supply and demand will also evolve as the world navigates the impacts of climate change and acts on the urgency to move toward cleaner energy. Just this month, the United States announced that it was pausing new Department of Energy (DOE) approvals for new LNG export projects as it evaluates the climate implications of adding to America’s LNG might. Washington became the world’s largest LNG exporter in 2023 and was a lifeline for Europe as it forfeited Russian supplies.

But customers around the globe now worry about the stability of future LNG supplies from the United States. Buyers in Asia have begun to explore alternative supplies. As such, additional volumes from Russia could one day ameliorate a supply crunch.

And what about LNG carriers? There could soon be an oversupply of LNG shipping capacity, which frees up ageing tankers to be scrapped or sold to shady entities and used for dark fleet purposes. Sure, today’s secondhand fleet is close to non-existent, but in one or two decades from now that is certain to change.

Conclusion

The purpose of this article is not to be sanguine about ALNG2’s future prospects. Those prospects are indeed very bleak. But Russian optimism and adaptability have been key in keeping the country afloat since it became the world’s most sanctioned nation following the invasion of Ukraine in 2022. Yet Russia continues to grow, for now. The IMF just projected the Russian economy to grow 2.6% in 2024, but longer-term prospects are less positive.

The purpose is instead to imagine ways that Novatek can still get gas to market from ALNG2 in the mid to long-term. Of course, this article did not take into consideration that ALNG2 will face heavy capital constraints after its backers pulled out following the force majeure. In fairness, ALNG2 could run out of funds before it can adapt to new sanctions.

There is a lot that will come after ALNG2. Imagining how market conditions, technological configurations, and the global order can change may be valuable for staying one step ahead of the Kremlin as it struggles to hold on to its dream of one day becoming a global LNG superpower.