Russia’s economy has propped up Putin amid Western sanctions, but a key weak spot is emerging in the Arctic

Russia’s economy has propped up Putin amid Western sanctions, but a key weak spot is emerging in the Arctic

Russia’s fortress economy has proved remarkably resilient to an onslaught of Western sanctions. Two years after the Kremlin’s invasion of Ukraine, it continues to fund a costly war and to prop up President Vladimir Putin. 

But there’s at least one spot where the pain is very real.

The Novatek PJSC-led Arctic LNG 2 facility, on the icy Kara Sea, is a key part of Moscow’s plans to boost exports and replenish coffers. For months now, it has been ready to ship liquefied natural gas to new markets, alternatives to the once-lucrative European pipeline trade.

And yet, the vast new $25 billion operation is sitting virtually idle, the first piece of Russia’s energy production complex to be effectively curbed by US restrictions.

Russia has long sought to increase its share of the global LNG market, but the war and the subsequent sharp drop in overland exports to Europe have reinforced the importance of these ambitions. Moscow wants to expand LNG output three-fold by 2030, adding at least $35 billion in annual revenue.

Thanks to older operations, Russia is currently the fourth-largest LNG exporter globally, but restrictions on the flagship Arctic LNG 2 are crimping its aspirations to go further. More worrying for Moscow, they’ve provided a blueprint for any future Western efforts to rein in the Kremlin’s gas income by targeting operations like Yamal or Sakhalin II in the Far East — still delivering to customers in Europe and Asia.

“US sanctions are working surprisingly well,” said Malte Humpert, founder of the Arctic Institute, who has been monitoring Russia’s expansion in the region for over a decade. “Here, they’re really ahead of the curve. They blocked Arctic LNG 2 before it even started production, blocked the vessels before they could be delivered. With everything else, like oil or the shadow fleet, it’s always reactive.”

Since the Biden administration imposed sanctions on the Arctic LNG 2 facility last year, buyers in China and India — places that have bought and traded Russian oil, working around existing constraints — have refused to buy even discounted LNG. Lawyers in Singapore and London, meanwhile, have recused themselves from involvement in the project. 

Even shipbuilders have been tangled in the curbs, with vessels worth hundreds of millions of dollars currently stuck at dry docks in South Korea. No one can buy or lease them. The gas, meanwhile, remains trapped at the facility.

Unlike oil exports, which have continued to flow despite a price cap and other limitations with help from a vast “shadow fleet”, LNG is trickier to keep moving, in large part because of the more complex technology required to load and ship the super-cooled fuel. 

Now the European Union, which still leans on Russian LNG and has been reluctant to restrict imports, is preparing to roll out some measures of its own. Europe isn’t outright prohibiting the fuel, but the bloc’s discussions signal that gas is no longer off limits as the war enters a third year.

Up for debate is a plan to ban the use of EU ports to re-export Russian supplies destined for third countries. That matters because Russian LNG plants in the Arctic region are exceptionally remote, so the fuel is usually first delivered to Belgium or France for re-export to Asia or another European port. Restricting this practice will stretch Russia’s shipping fleet to breaking point.

The White House’s National Security Council began turning its attention to crippling Russia’s LNG expansion plans in 2023, about a year into the war, according to people with knowledge of the strategy. Officials there teamed up with the US State Department and Department of Defense to pick a target, eventually homing in on the Arctic LNG 2 project. They then brought it to the Treasury.

Now, as part of a wider plan to stop Russia from developing any new energy projects that might contribute significant revenue, the US wants to ensure the Arctic venture is “dead in the water,” as Geoffrey Pyatt, Assistant Secretary of State for Energy Resources, told a conference last month. 

There are good reasons for White House officials to target the facility, co-owned by the Japanese government, Chinese state-owned oil companies and France’s TotalEnergies. While it certainly irks important allies, freezing Arctic LNG 2 has the benefit of hurting Moscow while causing only limited ripples in global natural gas markets. No less important for the Biden administration as an election nears, the fallout for US consumers is contained.

There are other advantages for Washington. LNG trade requires expensive specialized ships that can be tracked with satellite data, making the creation of an alternative fleet nearly impossible. While there are roughly 7,500 oil tankers today of varying sizes, the entire LNG industry is closer to 700.

Then there’s the fact that Arctic LNG 2 requires a unique type of ship that can glide through thick ice. There were 21 ice-class tankers ordered for the operation, including vessels owned by South Korea’s Hanwha Ocean Co. and Mitsui OSK. These are now struggling to find new owners. Of course, Russia can bring in its own capacity and LNG carriers are being built at the Zvezda shipyard — but even those have been delayed by sanctions. 

“The biggest single constraint on the development of Arctic LNG 2 is the availability of tankers. That’s the weak spot in the Russian overall strategy,” said Thane Gustafson, a professor at Georgetown University who has monitored Russia’s fossil fuel expansion for decades.

“The longer term outlook is clouded by the fact that the primary mission, which was to develop LNG for East Asia across the Northern Sea Route, is at this moment not possible.”

Russia holds the world’s largest share of natural gas, with about 20% of proven reserves, but it still needs to turn that into revenue. New pipelines are simply not being built fast enough to reroute sales, leaving only LNG — which Putin himself has identified as the future of the fuel.

The Kremlin says it wants to export over 100 million tons of LNG per year by 2030, up from about 31 million last year — with or without sanctions. Arctic LNG 2 is not the first project to be hit with restrictions, and limits on technology transfer and hydrocarbon exploration equipment back in 2014 have spurred some local alternatives.

Yet even the government is beginning to recognize the scale of the challenge as sanctions accumulate and technology proves slow to replicate. Figures in an Economy Ministry document published earlier this year and seen by Bloomberg suggest that production could in fact stagnate through 2027 under a conservative scenario, levels that would imply Arctic LNG 2 may not rapidly ramp up. 

None of the traders and analysts surveyed by Bloomberg expected the facility — which has only completed construction (and started) one of three production trains — would reach full capacity while sanctions remain in place.

Novatek, the company behind it all, is pressing on. Founder Leonid Mikhelson, Russia’s fourth-richest person and a close Putin ally, succeeded in completing construction of the first stage of the Arctic LNG 2 project last year — defying industry expectations that missing technology would hold it back. New supply chains were built after companies like France’s Technip Energies left the project, with parts and equipment were brought in from engineering yards in China.

“The fact that we have become a target of sanctions is a signal of how they assess our competencies,” Mikhelson said at the XVI Verona Eurasian Economic Forum in November, shortly after the project was sanctioned.

But now he needs to contend with the potential departure of more foreign partners as constraints tighten — and to find customers.

Novatek has hired staff in China to try to drum-up business and sent officials to India in February, according to people with knowledge of the matter. No concrete deals have yet materialized, the people added.

The next test will come in the summer, when Novatek aims to ship its first LNG cargo from Arctic LNG 2, taking advantage of ice thin enough to use a regular vessel, according to the people, who requested anonymity as they are not authorized to speak to the media.

“There will be ad hoc voyages, but that’s really limited,” said Humpert, of the Arctic Institute. “Where does Russia go from here?”

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