Investing in the Arctic is a high-risk venture. The harsh climatic conditions of the "last energy frontier" coupled with limited availability of infrastructure translate into high capital and operating costs. Given these challenges, the Arctic still remains very attractive to the industry.
The region above the Arctic Circle accounts for about six percent of the Earth's surface, but it potentially holds around 22 percent of the world's undiscovered conventional oil and natural gas resources.
Arctic drilling is not new, and the existence of hydrocarbon resources in the Arctic has been known for decades, but only recently has the opening to full-scale development become technically and economically feasible given the current and expected prices of oil. Eight nations have Arctic territory - Canada, Denmark (including Greenland and the Faroe Islands), Finland, Iceland, Norway, Russia, Sweden and the United States.
Within this territory, about 61 large oil and natural gas fields have been discovered, according to the U.S. Energy Information Administration. Fifteen of these 61 fields have not come online; 11 are in Canada's Northwest Territories, two are in Russia and two are in Alaska.
Additionally, two of these participating nations hold the most resources. The West Siberian Basin reportedly holds around 133 billion barrels of total oil resources and the Arctic Alaska holds roughly 72 billion barrels of total oil resources, according to the U. S. Geological Survey (USGS). Furthermore, around 41 percent of the Arctic oil resources and 70 percent of gas resources are in Russia.
Considering the amount of resources Russia holds, the country has intensified the development of the vast hydrocarbon resources of its continental shelf. Gazprom and Russia are currently the only companies allowed to receive new licenses to explore Russia's continental shelf, according to Ernst & Young's "Arctic Oil and Gas" report. These two companies hold the majority of licenses – 29 for Rosneft and 16 for OAO Gazprom – with the licenses mainly located in the Okhotsk, Kara and Barents Seas.
Licenses to exploit subsurface resources in the Arctic and Far East seas will be split between these two companies in 2020, with about 41 licenses belonging to Rosneft and 32 to Gazprom, according to Ernst & Young estimates. The main targets for Rosneft are projected to be the Barents shelf and Okhotsk seas, while Gazprom is expected to concentrate on Kara sea projects.
What is Russia's Arctic Status?
Gazprom, holding the world's largest natural gas reserves, has been pursuing a large project in Russia's Barents Sea – the Shtokman gas field. Discovered in 1988, the gas and condensate field is located in the central part of the Russian sector of the Barents Sea shelf in a water depth of around 1,050 and 1,115. The field holds about 3.8 trillion cubic meters of gas and 53.4 million tons of gas condensate.
But the company shelved the project in the second half of 2012 due to rising costs and the expected market for much of the LNG dwindling considering the North American shale boom. Statoil, once a partner in the project, has withdrawn from the Shtokman project, writing off $336 million of investment after failing to reach agreement on the investment terms by a June 2012 decision.
The decision to rethink the project underscores the huge challenges faced by energy companies trying to access the oil and gas reserves in the region.
"All parties have come to the conclusion that financing is too high to be able to do it for the time being," Vsevolod Cherepanov, head of Gazprom's production department, told Reuters at an oil conference in Norway.
The decision could be reviewed "only when conditions on the market change: either prices should rise, or costs should go down," said Gazprom's spokesman Sergei Kupriyanov, according to the Financial Times.
But the Russian Arctic still remains attractive to the industry. The recent agreement between Rosneft and ExxonMobil Corp. will seek to develop three fields in the Arctic with recoverable hydrocarbon reserves estimated at 85 billion barrels in oil-equivalent terms for a total investment of around $500 billion. Rosneft would control a 67 percent stake in the joint venture, while ExxonMobil would control the remaining stake.
The partnership between the two companies strengthened when another Arctic deal was signed in February 2013. The agreement provides Rosneft, or its affiliates, an opportunity to acquire a 25 percent interest in the Point Thomson Unit, which covers development of a remote natural gas and condensate field on Alaska's North Slope, the companies said in a joint statement.
"The agreement is significant for the industry, it's kind of a win-win situation," Foster Mellen, senior strategic analyst in Ernst Young's oil and gas practice told Rigzone. "It opens up to the industry the last potential resources, but at the same time it provides Rosneft the expertise and technology from a well-established company while ExxonMobil has access to a region that Western companies aren't privy to."
As part of the deal, ExxonMobil will add seven more licenses to develop hydrocarbon resources on Russia's Arctic shelf to the three it acquired from Rosneft in 2011.
"The agreements signed today take the unprecedented Rosneft and ExxonMobil partnership to a completely new level," said Rosneft President Igor Sechin in a April 2012 statement. "The acreage in the Russian Arctic subject to geological exploration and subsequent development increased nearly six-fold."
Arctic Financial Costs
With 85 percent of the discovered resources and 74 percent of the exploration potential as gas, a joint Wood Mackenzie –Fugro Roberston study in 2006 concluded that the Arctic is a gas province. Investment in natural gas is more capital intensive than in the case of oil. While crude oil is relatively east to transport by pipeline, tanker or even trucks, the physical nature of gas makes its transport significantly more expensive.
Considering North America's shale boom, many in the industry are wondering if now's the time to explore the region.
"Currently, we would describe the gas business as a very intense, gas-on-gas competition," Mellen said. "That's going to make things preferable for the lowest cost gas producers and those are unlikely to be in the Arctic. If conditions stay where they are now - able to produce at a fairly reasonable cost - Arctic gas in general is going to be challenged. These resources are going to be very difficult to extract, very costly, and complex," said Mellen.
Russia's Energy Ministry took heed of this and outlined a new tax policy designed to attract $500 billion in investment in offshore Arctic energy projects over the next 30 years. The proposed regime would set tax terms for each project depending on their location in Russia's Arctic offshore zones, reported Reuters, where operational conditions vary widely.
Royalties and profit tax would be set after an assessment of costs two years into each project. The government has also granted a series of tax holidays to encourage exploration in new regions such as Eastern Siberia, reported Reuters, but these tax breaks were often granted on an ad hoc basis and then amended or scrapped.
"We managed to come to the agreement with the Ministry of Energy and with the Ministry of Economic Development. We settled all the differences and agreed how the new legislation will work," Deputy Minister of Finance Sergey Shatalov said in a December statement.
Under the new legislation, operators of shelf projects will be granted tax relief from 5 to 15 years, including tax breaks on export duties as well as import duty and VAT for purchased equipment. The Ministry of Energy proposed to classify shelf projects in four levels from basic to Arctic so as to implement proper tax breaks. The same tax policy will be applied to oil projects, launched from 2016.
However, at least 70 percent of offshore projects are to remain under Russian ownership.