Mikkelsen A., Langhelle O. (eds.) Arctic Oil and Gas. Sustanability at Risk?

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256 E. N. Andreyeva and V. A. Kryukov

In June 2006, the Minister of Natural Resources, Yuri Trutnev, submitted a new

edition of the Underground Resources Law. At present time the new version has

not been approved yet. The main changes apply to rules of foreign access and

investment to resources that are to be developed. The fields with reserves that are

referred to as ‘strategic assets’, may be developed only by organizations that are

under Russian companies’ control (for gas, reserves of more than 50 billion m

;

for oil, more than 70 million tones).

These limitations, however, are not referred to geological reconnaissance. If the

foreign company discovers a field with such ‘strategic reserves’, it should form a

joint enterprise with a Russian company, which would have working control of

the stock share. Although the new edition is not accepted at governmental and

parliament level yet, the President, Vladimir Putin, welcomed these new changes:

‘Now, these new rules make the resource use procedure more transparent, and

these limitations serve the interests of national economic security’.

One of the key problems of implementating major oil and gas projects in

Russia lies in the fact that the current tax system is directed at withdrawal of super

profits resulting from a favorable price climate. Moreover, this tax system does

not take into account the recurring need for large capital investments. The fiscal

regime is not supportive of new capital-intensive projects, such as offshore develop-

ment of the Northern seas shelf, or the on-land fields located at high latitudes.

Operation on the basis of production sharing agreements remains one of the

most attractive forms of investment. But the procedures behind the preparation

and implementation of PSAs are extremely complicated. Before the implementa-

tion can begin, about 28 different coordination and agreement stages have to be

passed through. This, among others, includes statutory acts, auctions in order to

obtain the rights for continental shelf development, adoption to and correspon-

dence with two federal laws and about a dozen regulations at the level of the

RF government, not to mention executive orders (decrees, directions and conclu-

sions on bills). In addition, about 15 sessions of the PSA preparation commission,

15 rounds of negotiations with the investors, over 20 coordination meetings

with ministries and departments, as well as about five expert examinations

(environmental, the Central Committee for Development, the Advisory Council,

the Institute of Legislation and Comparative Jurisprudence and the Ministry of

Economic Development and Trade) are needed. As a result, the procedure of

closing a PSA drags on for two to three years.

All the projects related to development of the oil and gas field in the Russian

Arctic – both onshore and offshore – are export-oriented. Proximity to potential

markets for produced hydrocarbons is useful for several reasons: not just because

of its relative closeness, but also because it is possible to avoid the use of JSC

Transneft’s pipelines. Transneft occupies a monopolistic position in the service

rendering and transportation market.

Another aspect that makes the hydrocarbon production in the North so special

is the significant remoteness of the production areas from the consumption areas.

Therefore, the transportation factor plays a critical role in providing an economically

expedient and acceptable level of production. The main patterns of hydrocarbon

transportation have traditionally included pipeline transportation, and sea transport

of liquid hydrocarbons. Additionally, conversion of gas hydrocarbons to the liquid

state represents another potent alternative. In addition to purely technical functions,

hydrocarbon transportation also plays a significant economic role. It provides new

job opportunities and creates several socio-economic impacts in the Northern

regions. However, most of the impacts are of a short-term nature, mostly during

the period of construction.

The case of the Shtokman and Prirazlomnoye fields illustrates how the

decisions made at the governmental level as well as the extent of state involve-

ment in the leading Russian companies (JSC Gazprom and JSC Rosneft) affect

the implementation of large oil and gas projects in the Russian Arctic.

The original plans in the mid-1990s that were based on active regional partic-

ipation failed to follow through. To a growing extent, a unitary (or paternalistic)

model of the project implementation is about to be created. The real active partic-

ipants are the federal level and the companies owned by the state, while the

constituent entities of the federation and municipalities are to a greater extent

assigned a role of passive recipients of certain indirect benefits from the project

implementation.

Sustainable development in the Russian context: providing

social guarantees

Before sustainable development can be considered, it is imperative for Russia to

emerge from a state of economic and structural crisis. It is the most important

task at hand. However, it is also imperative to take into account the restrictions

imposed by sustainable development defined by scientifically supported ecolog-

ical requirements. Sustainable ecological development is the first restriction.

Should the restrictions be accepted, they should prove to be profitable both

socially and economically (Kondratjev, 2003).

In the mid-1990s, Russia attempted to incorporate the principles of sustainable

development into the process of economic reforms. In 1996, the President’s

Decree ‘On the concept of the Russian Federation’s transition towards sustainable

development’

was published. It was pointed out that the ‘transition to sustainable

development should ensure a long-term balanced solution of social-economic

development and preservation of favorable environment and natural-resource

potential, satisfaction of needs of the present and future generations’.

The basic principles and the main directions of development of the Arctic

Russian regions were determined in 2004 by the Federal Law ‘On the fundamen-

tals of the State regulation of social–economic development of the Russian

Federation’s North’

and in other normative documents. The prime tasks set out

in the documents were focused on providing a solution to the socio-economic

problems of the Arctic regions by modernizing the basic branches of economy,

enhancing their competitiveness and developing transport infrastructure.

Furthermore, these tasks included restricting economic activity in environmen-

tally sensitive territories, maintaining traditional subsistence and conditions for

The Russian model 257

traditional modes of life and nature management of the native minorities of the

North. Additionally, the need for stimulating scientific and innovative activity in

the Arctic, creating international cooperation in the sphere of ecology, science and

engineering was emphasized.

In February 2006, the draft of the ‘The concept of sustainable development

applied to the RF Arctic’ was submitted to the meeting of the enlarged Collegium

of the RF Ministry of Regional Development. It was emphasized that, by the

beginning of the 1990s, the old model of Arctic development based on the prin-

ciples of planned economy, faced serious problems. The RF’s transition to the

market economy made it impossible to continue financing and planning all types

of economic activity and all forms of social support for the population of the

Arctic regions.

The collapse of the Soviet system eventually led to a drastic decline and

deterioration of the quality of life and living standard of the population in a

number of sub-Arctic regions. A low average level of income prevented from

carrying out of people’s different demands, including that for self-dependent

migration. At the same time, the financing the federal migration programs only

in recent years has been cut twice in comparable prices.

The infrastructure that developed during the Soviet era failed to function in an

effective and competitive way. In order to keep maintenance costs to a minimum,

a number of settlements were closed down, and the traffic flows connecting these

settlements, including air transport, dried up. The traffic flow along the Northern

Sea Route has fallen by a factor of 2.5 over the past 15 years and, in the Eastern

part of the Route, the traffic flow is 30 times lower. Dikson and Anderma, two of

many ports along the Arctic cost, have practically stopped functioning; the port

of Tiksi is struggling to survive.

Thus, the most critical issue of sustainable development approach in the Arctic

Russia is providing a long-term solution for socio-economic problems. In the

Russian discourse, this is often referred to as ‘providing social guarantees’ for

inhabitants of the Arctic. In several researchers’ view,

this task requires active

participation of the state, including implementation of large national state

projects and programs, and dealing with the after-effects of the previous model of

planned development for the Arctic regions. All this undoubtedly includes imple-

mentation of major oil and gas projects. The question is to what extent the current

solutions and approaches to development of oil and gas resources in the Russian

Arctic can facilitate changes towards the sustainability in the future.

As Tables 10.3 and 10.4 demonstrate, the economic indicators of volumes and

dynamics of industrial production and investments, budget expenses, and the level of

personal incomes exceed the country’s average in all Arctic regions dominated by

the petroleum industry. Three oil and gas regions – Nenets, Yamal-Nenets and

Khanty-Mansi – are at the top three list of best salary level. In these regions, the

average wages are 3-4 times higher than in other remote regions of the country, while

the level of federal budget supply per capita is 4-6 times higher than the Russian

average. This allows regional authorities to provide stable systems of social security

and participate as co-investors in regional infrastructure projects.

258 E. N. Andreyeva and V. A. Kryukov

Table 10.3 Development indicators for the key oil and gas regions of the Russian North

Region Oil and gas Volume of industrial Gross regional Investments in fixed

production per capita products per capita product per capita capital per capita

(tons of standard fuel) (thousands of rubles) (thousands of rubles) (thousands of rubles)

2003 2004 2003 2004 2003 2004 2003 2004

Russian Federation 9.15 9.67 58.94 78.12 80.74 No data 15.124 18.981

Yamal-Nenets AO 1346.52 1361.97 366.4 569.43 633.58 323.211 302.15

Khanty-Mansi AO 248.18 269.57 419.97 617.12 522.21 112.786 123.499

Republic of Komi 18.09 19.24 70.8 87.84 112.33 25.148 30.171

Nenets AO 263.57 372.86 456.12 803.54 600.93 411.043 363.64

Republic of Sakha 2.49 2.53 102.59 140.43 140.33 32.091 30.836

AO, Autonomous Okrug.

Table 10.4 Development indicators for the key oil and gas regions of the Russian North

Region Tax proceeds Budget proceeds Budget expenditure Average per capita monetary

per capita per capita per capita proceeds of population

(thousands of rubles) (thousands of rubles) (thousands of rubles) (per month; rubles)

2003 2004 2003 2004 2003 2004 2003 2004

Yamal-Nenets AO 230.97 352.89 96.63 102.87 96.58 98.17 15,962 18,868

Khanty-Mansi AO 203.66 363.16 66.52 97.89 66.37 80.09 12,892 14,972

Republic of Komi 32.05 40.98 16.26 20.52 17.19 20.53 7477 9301

Nenets AO 169.02 328.66 70.89 110.62 71.05 88.47 14,197 20,122

Republic of Sakha 25.18 30.36 42.05 45.09 43.79 48.73 8240 9633

Note: Calculated by Regions of Russia, Social and Economic Indicators, 2005: Statistical transactions, Moscow: Rosstat Publishers, 2006; Russian Statistical Annual

2005: Statistical transactions, Moscow: Rosstat Publishers, 2005.

AO, Autonomous Okrug.

The Russian model 261

Petroleum challenges to the environment

There are several social and ecological problems connected with restructuring the

energy sector and the exploitation of oil in the Russian Arctic. In 1995, a member

of the Russian Socio-Ecological Union, Alexei Grigoriev, pointed out the follow-

ing issues that were considered top priority for stakeholders to resolve (Grigoriev,

1995), most of which remain unresolved to this day:

1 Lack of public information and debate. The World Bank Country Assistance

Strategy (CAS), including the section on restructuring the energy sector, is

not publicly available and is virtually unknown to the Russian public. It has

never been publicly discussed, nor has it been debated or approved by the

Russian Parliament. The Russian public has had no opportunity to discuss

whether or not it is necessary to exploit the oil fields. Publicly available

information about the project and the agreements and contracts, related to its

development, is very limited.

2 Implementation of unsustainable strategies. There has been no debate or

discussion of the environmental consequences of the strategy or the imple-

mentation of the energy sector plans. Most projects are not based on an

environmentally sustainable development strategy, but rather on a sharp

increase in Russian oil extraction for export. According to some estimates,

Russian oil reserves will be exhausted in 20 years at the present rate of

extraction. If the attempts to restore lost levels of production succeed, this

will happen even sooner.

3 Increase in greenhouse gas emissions. Ironically, oil and gas projects mean

that donor nations and their taxpaying citizens will invest money to promote

greenhouse gas emissions. This direct investment in global warming will be

much larger than the investments by the same donors and taxpayers to

prevent global warming, for example, in support of Global Environmental

Facility (GEF) projects also managed by the World Bank.

4 Adverse impact on the development of renewable energy sources. An increase

in Russian oil supply to the world market will decrease motivation for indus-

trialized countries, mainly in Europe, to reduce their energy consumption and

develop renewable sources of energy.

5 Environmental destruction. One of the main reasons why most of the Arctic

oil fields have remained unexploited thus far is because of environmental

considerations related to the implementation of projects in a very vulnerable

environment. Any large oil spill will most likely affect downstream areas of

this important region. There is also an obvious risk that oil pollution will

impact the sea and shores of the whole Arctic.

From 2004 to 2006, Russia presided in the Arctic Council. Sustainable develop-

ment of the Arctic is one of the most important issues of this supranational

structure. The practical ways of implementing the principles that lie behind the

sustainable development in each country are constantly under discussion during

meetings of the Council. In March 2006, at a meeting in Salekhard (Yamal-

Nenets Autonomous Okrug), the participants delivered the following statement:

Economic basis of existence in the Arctic Region is not only mineral but

biological resources. Today, it is necessary to advance and preserve the

traditional resources, which fulfill major functions in reproduction of the

system of cultural-economic skills, social stabilization and ethno-saving

significance for the indigenous peoples. The projects that are directed at

development of production facilities of reindeer breeding, fishery, and fur

breeding by the means of modern technology are necessary.

The assistant to the Minister of Economics and Trade of RF, Boris Morgunov, said

the following: ‘There is no sense to accumulate economic possibilities of coun-

tries at the expense of health of the population and their future gene pool. Growth

of the population is a major indicator of steady promoting Arctic communities to

prosperity’.

In turn, the vice-governor of Yamal-Nenets Autonomous Okrug

noted:

Natural resources of our region are great, and environmental themes together

with indigenous people issues like traditional economy and cultural heritage

are of high priority to us. Our okrug may be the model region for pilot

projects for many current themes stated at the Arctic Council meeting.

These statements of top officials give some hope that social and environmental

problems will be considered as the first priority in the twenty-first century.

Unfortunately, the real practice in the resource regions of the Russian Arctic

reveals a different picture. Economic goals and corporate interests dominate,

while the federal government and legislative structures are still discussing the

policies of sustainable development in the Russian Arctic. As a result, much of the

designed mechanisms for implementation of sustainable development remain

declarative and not executed.

However, oil and gas development in the Arctic also represent a major threat to

the fragile Northern environment. The potential environmental impacts can be

enormous and not always predictable.

Thus, according to Turuntaev (2006), the offshore oil and gas production in the

Barents Sea region may lead to purely technogenic earthquakes and also bring

about an increase in natural seismicity and the intensity of deformation processes.

In addition, field facilities themselves may be exposed to seismic events and

geological deformations. Therefore, a greater attention should be given to passive

seismic monitoring. The production of hydrocarbons induces weak seismic

events, which can only be recorded using a highly sensitive seismometer

network.

Among the regions already struggling with major environmental

problems, is the Kola Peninsula around the regional center of Murmansk and its

bordering areas.

262 E. N. Andreyeva and V. A. Kryukov

The Russian model 263

Arctic offshore projects as the economic savior of the

bordering regions

Over the past decades, Russia has witnessed a most interesting evolution of the

arguments in favor of the implementation of oil and gas projects in the Arctic

zone. The debates started at the time of drastic political and economic changes at

the beginning of 1990s. There were several factors that contributed to keeping

this lively discussion going. First of all, the production and technical potential

that many of the Arctic regions possessed in the times of the planned economy

was suddenly not applicable any more. This was especially critical for the mili-

tary and industrial complex in the Murmansk and Arkhangelsk regions.

Following the collapse of the Soviet Union, several regions strived for sover-

eignty. Struggling with chronic budget deficits and shortages in payment, the

regions of the Arctic aspired to implement their own export-oriented projects,

such as production of hydrocarbons and their subsequent delivery for export.

And, as mentioned earlier, the principle of joint jurisdiction really worked

until 2002.

Using offshore projects to rejuvenate the regional economy in the

Murmansk and Arkhangelsk regions

In 1992, the state ‘Russian company for shelf development’ (Rosshelf) was

founded with the participation of enterprises from the military–industrial complex.

In compliance with the RF President’s decree of November 30, 1992, Rosshelf

obtained the license for developing the hydrocarbon fields on the Arctic shelf –

Shtokman and Prirazlomnoye.

The issue of keeping incremental oil and gas

production was not as acute then as it is now. It was assumed that execution of

the projects would contribute to stabilizing and then improving the economic

situation in the Northwestern region of Russia.

Restructuring military defense enterprises to suit the needs of the growing

petroleum industry was intended to establish an industrial framework for the

development of the Arctic shelf fields, which would create about 120,000 jobs.

Furthermore, construction of a fixed offshore platform would provide ongoing

permanent employment for about 10,000 people in the city of Severodvinsk.

Implementation of the project would also result in the retention of the scientific

and technological potential of the state enterprises PA Sevmashpredpriyatiye and

SE Zvyozdochka.

Overall budget receipts at various levels during the implementation of the

Prirazlomnoye project alone were estimated at US$1.9 billion. The Murmansk

and Arkhangelsk regions were considered as potent suppliers of materials and

machinery for drilling operations, field development, transportation of gas and

gas-condensate, construction works, servicing the fleet and social welfare.

Moreover, implementation of the projects was supposed to carry out gasification

of the Murmansk and Arkhangelsk regions, as well as the Republic of Karelia.

264 E. N. Andreyeva and V. A. Kryukov

It was assumed by JSC Gazprom authorities that the realization of the technolog-

ical solutions accepted in the projects of the Shtokman and Prirazlomnoye fields

would give the Russian participants an opportunity to take part in new develop-

ment projects on the foreign shelf.

Starting in 1992, a general policy towards survey, exploration and development

of hydrocarbon fields on the shelf started. It was characterized by heavy involve-

ment of the state in obtaining the rights for using subsurface resources. Preferences

are given to the companies owned by the state, such as JSC Gazprom – at that

moment the Russian Joint Stock Company.

On May 23, 1996, the RF President issued a decree (N765): ‘On creation of the

industrial production base for development of hydrocarbon fields on the conti-

nental Arctic shelf’.

This document not only issued licenses for the

Prirazlomnoye and Shtokman fields to Rosshelf, but simultaneously appointed

the PA Sevmashpredpriyatiye as the general contractor for construction of ice-

resistant platforms. Thus, on the one hand, the requirements for 70 per cent partic-

ipation of Russian contractors stated by the PSA Law were fulfilled, but, on the

other hand, choosing a contractor without any competition placed implementation

of the shelf projects ‘outside the market’. The general contractors were now able

to dictate their conditions to the customer.

The basic centers for Shtokman field development are supposed to be located

in Murmansk and Arhangelsk. The coastal zone of the Murmansk region facili-

tates main infrastructure objects, meanwhile the industrial enterprises of the

Arkhangelsk region become involved in production of the equipment. The

famous plants of the Soviet defense industry (Sevmash, Zhvezhdochka) now have

been partly adjusted to civil production, and their productive and intellectual

potential will play a crucial role in the supply of heavy metal equipment. With a

help of the Norwegian company Statoil, a new center, Sozvezhdie, was opened in

Arhangelsk in the year 2005. Its main purpose is to create a network of equipment

and service supplies for Shtokman’s needs. Moreover, Statoil is planning to invest

US$3 million in socio-economic development programs in the Arkhangelsk

region.

Participation of the Murmansk region in realization of this project will

contribute to the diversification of the regional economy, and its further social

and economic development. An arrangement between Gazprom and the

Murmansk area authorities in 2006 was already in place at the first stage of the

project’s implementation, and it is assumed that the Murmansk regions will

receive annually 1 billion m

out of the total 20 billion m

of gas produced. All of

this will enable gas to be supplied to several large enterprises and private

households in the area.

Prospective plans for a factory producing liquefied gas on the Kola Peninsula

estimate that about US$4.5 billion will be invested in the Murmansk region, along

with creating new job opportunities, as well as rejuvenation of the local and

regional budgets. According to the PSA Law, no less than 70 per cent of all the

equipment and materials orders should be placed with Russian national enterprises

during the development of the Shtokman field.

The Russian model 265

It is also important to mention that future large-scale industrial activity requires

a well-advanced system of power engineering. This suits the Murmansk region

well, as its atomic power station produces excess power and delivers electric

power to the integrated power grid for other regions of the RF, and for export to

Finland and Norway.

In Russia, taking into account the importance and strategic nature of hydrocar-

bon resources in the Arctic, only the spokesmen and representatives of the state

interests are being granted the rights for using subsoil resources. However, in our

opinion, the attempts undertaken in the 1990s to create domestic companies

concentrating in their hands the entire process of preparation and implementation

of such petroleum projects and the implementation of the state programs on the

development of the Arctic shelf appeared unsuccessful.

This can be explained by several factors. Foremost, cooperation with the

world’s leading oil and gas companies on implementing similar projects was

badly underestimated. Severodvinsk and Murmansk have succeeded in facilitat-

ing unique sea defense complexes, which certainly showcases their potential.

However, this cannot be directly applied to the implementation of commercial

projects as development of oil and gas resources in difficult climatic conditions

and in a fundamentally different field of activity. Therefore, one cannot but agree

with the opinion of Academician I. S. Gramberg that ‘neither Gazprom nor any

other domestic gas or oil companies are in position to start development of the

Arctic fields independently. The rigid protectionism in the absence of real invest-

ment opportunities is simply ridiculous’.

The case of the Yamal peninsula

Yamal-Nenets Autonomous okrug is the main natural gas and oil production area

of Russia (Map 10.3). It includes a very large part of the Northern areas of

Western Siberia. About 80 per cent of the Russian oil and gas reserves are located

here. Exploration in the region began in the 1960s, and today the industry faces

the need to develop the most difficult sub-region – the Yamal Peninsula. This area

is characterized by extremely severe natural conditions, high costs and financial

risks, the need for innovative technology, a tense social situation and extremely

high sensitivity and vulnerability of the ecosystems.

The traditional raw material base in this region – the Nadym-Pur-Taz gas area

with its unique fields, Medvezhje, Urengoyskoe and Yamburgskoe – are close

to entering the stage of falling extraction. By 2020, the fields currently being

exploited will produce no more than 30 per cent of the volume demanded. Taking

into account that consumption of natural gas is still growing in the world and in

Russia (where the share of natural gas in the fuel–energy balance was more than

52 per cent in 2005), the main producing company of Russia, JSC Gazprom, has

determined that development on the Yamal Peninsula is essential. Despite the very

complex conditions of development and extremely high costs, the resource potential

of the area will help to solve the growing deficit in gas production of old gas

areas.