Prirazlomnoye

For Big Oil, the Arctic represents the great white hope, a virgin frontier with enormous resource potential. An extensive assessment of the Arctic’s probable oil and gas resources undertaken by the US Geological Survey in 2008 estimated that the massive region could host as much as 90bn barrels of oil, 1,669tn cubic feet of natural gas and 44bn barrels of natural gas liquids, of which around 84% is likely to be found offshore.

The trend for receding Arctic ice and the lure of huge reserves have been enough to stoke significant interest from the oil and gas industry, which up until relatively recently was united in its view that Arctic exploration is a smart move – it was simply a case of out-debating environmental groups and winning over the Arctic-adjacent governments in the US, Canada, Greenland, Norway and Russia, which have generally agreed to the principle of developing the Arctic’s resources, if not its execution or regulation.

Arctic risk: the perfect storm?

But the harshness of the Arctic environment and the volatility surrounding its exploration by oil companies has made it a chancy investment even at the best of times, despite the confidence of majors like Royal Dutch Shell, ExxonMobil and Chevron. Even as a 2012 Chatham House/Lloyd’s report on Arctic opportunities trumpeted the region’s potential to attract $100bn in investment up to 2022, it acknowledged that "given the high risk/potentially high reward nature of Arctic investment, this figure could be significantly higher or lower."

"Arctic conditions will remain challenging and often unpredictable," the report summarised. "Many of the operational risks to Arctic economic development – particularly oil and gas developments, and shipping – amplify one another. At the same time, the resilience of the Arctic’s ecosystems to withstand risk events is weak, and political and corporate sensitivity to a disaster is high."

For the last few years, a potent mix of environmental, geopolitical and market-based conditions have developed that might constitute a perfect storm working against the oil and gas industry’s ambitions in the Arctic. When Leonin Fedun, vice-president of Russia’s second largest oil company Lukoil, which is part-owned by the pro-Arctic oil Russian government, was asked about Arctic exploration by the Financial Times in 2013, his response seemed like a wider reflection of the industry’s flagging momentum in the region.

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"If someone asked me to invest money in Arctic exploration and development, I wouldn’t give a kopeck [one hundredth of a Russian ruble]," he replied. "We have many more investment opportunities that carry less risk."

While most agree that the exploitation of the Arctic’s hydrocarbon resources will likely take place at some point in the future, circumstances today – including environmental resistance, the plummeting oil price and tensions between Russia and the West over the Ukraine crisis – are likely pushing the timeline back by years, if not decades.



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Technical challenges and environmental concerns

While the other major obstacles preventing rapid Arctic development are serious but unusual events that could be expected to improve over time, the technical challenges of operating in the Arctic – and outrage over the environmental consequences if something goes wrong – have dogged the industry’s efforts in the region since the beginning, and show no signs of letting up.

These logistical and safety challenges – which include unpredictable weather and sea states, a short summer operating window, moving sea ice and the extreme difficulty of responding to a spill – have already had an off-putting effect on oil majors, with Total declaring itself against Arctic oil drilling because, as the company’s late CEO told the Financial Times, "a leak would do too much damage to the image of the company" (it should be noted that the company is still pursuing opportunities to develop Arctic gas deposits, which it sees as a lower-risk endeavour).

Similarly, no national government wants to earn the world’s disapprobation by allowing a massive oil spill in the Arctic on its watch. The US has sold Arctic exploration licenses off the coast of Alaska to the likes of Shell, ConocoPhillips and Statoil, but continued uncertainty over the federal government’s environmental regulations in the region have delayed exploratory drilling programmes by both Conoco and Statoil.

Shell was the company to push ahead with its Alaskan offshore drilling campaign in 2012, but a number of worrying incidents – including the grounding of oil rig Kulluk -brought the programme to a premature intermission, with no exploration carried out in 2013 or 2014. "The recent grounding of Shell’s Kulluk oil rig amplifies the risks of drilling in the Arctic," said the US House of Representatives’ Sustainable Energy and Environment Coalition in a statement in early 2013. "This is the latest in a series of alarming blunders, including the near grounding of another of Shell’s Arctic drilling rigs, the 47-year-old Noble Discoverer, in Dutch Harbor and the failure of its blowout containment dome, the Arctic Challenger, in lake-like conditions."

Incidents like this have prompted the US, already cautious after 2010’s disastrous Deepwater Horizon oil spill, to propose stronger regulatory requirements for operating in the Arctic, on top of delaying a large number of lease sales. The regulatory proposals, revealed in February, include the need for companies to ensure they can contain a blowout in Arctic conditions without undue damage to the marine environment, an essential acknowledgement of the region’s harsh conditions that has discouraged industry investment. "[The federal government has] imposed numerous obstacles and regulatory challenges, creating economic uncertainty for exploration and production companies," wrote Jeremy Price of conservative lobby group Americans for Prosperity in an editorial for Alaska Dispatch News.

Oil price woes

"Arctic conditions will remain challenging and often unpredictable."

Beyond the core conundrum of logistical difficulties and ecological concerns, several sources of volatility have emerged in the last year that make Arctic exploration an even more gruelling challenge.

Most obvious is the plummeting oil price, with the values of WTI and Brent crude tumbling from $100 or more in summer 2014 to less than $50 at the start of 2015. This price shock has sent the industry reeling; companies across the board are cutting capital expenditure to weather the storm.

High-cost, high-risk exploration projects like those in the Arctic, where the development of exploratory wells can cost as much as $500m apiece, have been on the chopping block as the industry retreats into a cost-saving holding pattern. Many analysts believe an oil price of around $80 a barrel will be necessary to justify the costs of Arctic production, an unlikely prospect in the short term.

High oil prices have previously provided a cushion of high returns to compensate for risky and costly Arctic projects, but in 2015, with prices at their lowest since the historic 2008 oil price crash, many companies are pulling the plug on Arctic activities until prices rally. Statoil announced in early 2015 that it would be ramping down its Arctic efforts for now, and has handed back three of its four licenses off the west coast of Greenland – a move echoed by Dong Energy and GDF Suez, which have also made their exit from the country’s waters. Chevron has similarly attributed "economic uncertainty in the industry" for its decision to put its drilling plans in the Canadian Arctic on the back burner.

"Pretty much all companies – even the big, financially sound companies – are looking at very much reduced cash flows for the coming year," Ernst & Young oil and gas analyst Foster Mellen told KUCB’s Lauren Rosenthal in January. "So discretionary spending such as high-risk, high-cost exploration is probably the first to be put on the shelf."

Russian sanctions

With its environmental regulatory regime generally considered less stringent than many other Arctic nations and its president, Vladimir Putin, determined to tap the Arctic’s resources, Russia seems the most likely candidate to push forward with an accelerated programme in its northern waters. Indeed, in April 2014, state-owned energy company Gazprom shipped Russia’s first Arctic oil from the Prirazlomnoye field in the Pechora Sea, a shallow water operation that could help inform the development of more ambitious Arctic projects.



Created in January 2012, the programme has brought together major players to build on existing technologies.


But Russia’s prospects in the region have suffered a setback in light of the West’s economic sanctions over the ongoing Ukraine crisis. As part of the sanctions, all US companies were ordered to halt operations that would aid the country’s five major energy companies in producing oil from Russian deepwater, Arctic offshore and shale projects by 26 September 2014.

The sanctions completely disrupted a collaboration between ExxonMobil and Russian oil giant Rosneft, halting joint drilling operations at the Universitetskaya-1 well – the most northerly well in the world – and depriving Rosneft of Exxon’s West Alpha drilling rig, which returned to Norway in October. The partners had already discovered oil in the Kara Sea, which is estimated to contain as much oil as Saudi Arabia.

Rosneft announced early this year that it would not continue drilling in 2015 as it will have to find a replacement for West Alpha, pushing back its estimates for commercial production beyond 2020. While it will reportedly take 18 months to lease and possibly upgrade a replacement rig for the icy Arctic environment and fine-tune the project for a new platform, perhaps a larger problem is the country’s relative lack of offshore expertise, which is why it sought Western partners in the first place.

With Rosneft determined to push ahead with its Kara Sea operations in 2016 despite its limited experience and the need to bear the huge drillings costs without Exxon’s support, environmentalists are concerned that a major environmental disaster could ensue. Such an event might well spell the end of Arctic operations on an industry-wide level, meaning that Russia could represent both the main proponent of, and the biggest threat to, the industry’s Arctic ambitions.

As Statoil’s executive VP of exploration Tim Dodson said at an Arctic conference in London: "What we’re facing is, from my perspective, an industrial challenge, it’s not a company challenge. If one of us fails, we all fail."

Despite all these risks, it seems nothing short of an environmental catastrophe will stop the industry’s Arctic exploration efforts in their tracks. Despite its Alaskan setbacks in 2012 and $15bn of spending cuts over the next three years, Shell wants to resume Arctic drilling in summer 2015. Cairn Energy has been actively drilling offshore Greenland, though it has made no commercial discoveries yet after spending $1.2bn in 2010 and 2011. And the low oil price and Russian sanctions are situations that can be reasonably expected to improve as the market rallies and cooler heads prevail in Ukraine. Arctic oil might not be stopped outright but it will be pushed back, and given the technical and environmental uncertainties that continue to dog Arctic drilling programmes, perhaps striking a note of caution is the best move for the future of the industry and the fragile Arctic eco-system.

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