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Russia and Norway lead slow Arctic development

However the region will remain a marginal energy producer for decades

Less than a decade ago the logic of Arctic oil and gas exploration looked irrefutable. The world needed more energy and the region offered explorers the last great untapped frontier. Arctic oil, some speculated, would help ease global supply tightness, keeping the market from overheating.

In July 2008, as oil prices were trading at record highs, the US Geological Survey (USGS) released a survey showing the Arctic held oil and gas reserves of 412 billion barrels of oil equivalent. This amounted to 13% and 30% of the world’s remaining undiscovered oil and gas, respectively, the Survey said. Those numbers captured the mood.

A rush to assert sovereignty over the Arctic followed. Russia had already staked its claim, when Artur Chilingarov, an explorer, planted a flag on a chilly bit of seabed in 2007. Canada led other Arctic littoral states in making its own claim to the region. Mainstream media liked the tale. Some predicted that the rivalry over the region could get nasty.

As an oil and gas frontier province, however, the Arctic has not lived up to its billing. It certainly holds energy – decades of production in Alaska and Russia’s development of the Yamal peninsula proves that. But, outside Russia, drilling progress in the ice has been glacial.

Shell’s decision in January not to proceed with a planned exploration programme offshore Alaska was just the latest example of the region’s problems. Shell’s efforts had already cost it one rig, the Kulluk, which ran aground on Sitkalidak Island, in 2012. Now the company has decided that it can better spend its money elsewhere.

Drilling in the Arctic is eye-poppingly expensive. Eurasia Group, a consultancy, reckons that a single producing well in the region can cost up to $900 million. Shell had already sunk billions in a fruitless campaign. The risks are just as great. In some parts of the Arctic, the drilling season lasts just 106 days each year – assuming the weather behaves. Flowing ice, storms and high winds make it the world’s most inhospitable place to look for oil. The dangers of an accident lurk everywhere. If you include measures designed to stop a Deepwater Horizon-style disaster, such as allowing time to build a relief well in case of a blow out, the drilling season would, in reality, be just a month and a half long.  

Drilling in the Arctic comes with a degree of desperation. The majors, in particular, need the kind of reserves on offer in the region. A recent report from Platts, a price-reporting agency, calculated that the combined output from the seven biggest Western oil firms fell for the fourth consecutive year in 2013. In 2009, they produced 12.7% of the world’s supply. Last year, just 10.4%. The list of drilling destinations that offer these companies the kinds of reserves that would help them reverse this trend has shrunk in recent decades. Cracking the Arctic could do it.

But as Petroleum Economist’s survey of the Arctic this month suggests, the region’s day in the sun is some way off. Back when the USGS released its survey, the Arctic genuinely felt like the last major play in town for the oil industry. The rise of shale gas and tight oil has ruined that assumption.

When the survey was published, for example, North Dakota’s output was around 76,000 barrels a day (b/d). In December 2013, it average 863,000 b/d. Thanks to hydraulic fracturing in the Eagle Ford shale and Permian basin, Texas’s oil output in the same period has gone from 1.1m b/d to more than 2.7m b/d.

Looking elsewhere

Other opportunities are also on the horizon. Mexico’s decision to open its upstream to foreign investors, China’s shale, Canada’s oil sands, East Africa’s offshore, the East Mediterranean and even conflict-hit Iraq all offer investors bountiful reserves in more benign operating environments. Iran may soon join the queue, too.

For now, the high risks and brutally high costs of the Arctic mean large-scale development will only really happen where it has the backing of governments. Despite their claims to the region, however, only Russia and more recently Norway have really offered much succour to explorers. For Russia, unlike the others, the Arctic is both a natural destination and a necessary one. As Western Siberia’s oilfields mature, it needs to open the new frontier, both to maintain oil production at today’s levels and to ensure it can fill pipelines with lucrative gas. The government wants 5% of the country’s oil output and 10% of its gas to come from the Arctic by 2035.

This won’t be easy. Andrey Shishkin, an executive at Rosneft, says development of the Russian Arctic will be comparable to the Soviet space programme. It won’t be cheap, either. Novatek, the country’s leading independent gas producer, and its partner Total will spend around $27bn to build their Yamal liquefied natural gas (LNG) project by 2017. The development is a true feat of engineering, requiring everything from ice-breaking LNG carriers to facilities built on stilts above the permafrost.

Gazprom’s Yamal developments are even costlier. The company has already sunk about $50bn on the peninsula, where it hopes to produce as much as 360bn cubic metres a year of gas by 2030.

High cost

Figure 1: Arctic resource
Figure 1: Arctic resource

Getting there will set it back another $70n, believe analysts. Rosneft and its partner ExxonMobil may have to spend similar amounts in the Kara Sea, which could hold 85bn barrels of oil. Igor Sechin, the Rosneft’s president, has said Russia’s total investment in the Arctic could eventually amount to $400bn.

Norway’s Arctic adventure is still in its early stages. Of 100 wells drilled in 2013, only six yielded discoveries. Of those, it is likely only two will be brought into development. However, the Norwegian authorities say interest in Barents acreage on offer in the newly announced 23rd licensing round is high.

The length of time it took to develop the Snøhvit gasfield, which feeds the Hammerfest LNG plant, the only producing LNG facility north of the Polar Circle, is a lesson in both the time needed and deep pockets required to successfully produce in the Arctic. The field, in the ice-free southern sector of the Norwegian Barents Sea, was discovered in 1984, yet only came on stream in 2007, at a cost of $8bn.

Big plans do not necessarily translate into big realities. The history of development in the High North is riddled with grand plans that turned sour, from Canada’s idea to pipe gas from the Mackenzie Valley into the US, to Gazprom’s Shtokman LNG project in the Barents Sea.

Shell’s decision to back away from its Arctic exploration campaign this year said something about its troubled experience there. But it said even more about the industry’s changing view of the Arctic. Real development is probably decades away.

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