A year ago, Rosneft’s Vostok Oil megaproject in the Arctic was heralded as the next frontier for Russia’s oil industry, comparable in scope to the development of the Western Siberian oil basin in the 1970s and the Bakken tight oil formation in the US over the past decade. Now, over three months into Russia’s war in Ukraine, Vostok Oil’s prospects have dramatically dimmed. With Russia’s Urals blend now branded as toxic, and the EU targeting a 90% embargo on Russian oil imports by the end of 2022, the pressing question is what Russia can do to find new markets for its existing production, let alone for additional barrels in the future.
Vostok Oil comprises a cluster of large fields in Russia’s north Krasnoyarsk region, holding a combined 6bn tonnes (44bn barrels) of oil and substantial gas resources, according to Rosneft. The company claims this is enough to support 2mn barrels per day (bpd) of oil production, and up to 50mn tonnes per year (tpy) of LNG. Yet the project’s remote location, thousands of kilometres from existing infrastructure, always meant it was not going to be an easy undertaking. In February last year, Rosneft CEO Igor Sechin told Russian President Vladimir Putin that Vostok Oil would cost as much as $160bn to implement.
The infrastructure requirements for Vostok Oil are staggering. A huge seaport would need to be constructed to handle its exports, along with some 800 km of new pipelines, 2,000 MW of power generation capacity, 3,500 km of new power lines, two airports and various other infrastructure. This is not to mention the 6,500 or so wells that will need to be drilled to bring its oil out of the ground.
Realising it could not foot this bill on its own, Rosneft reached out to international investors. In December 2020 it closed the sale of a 10% interest in Vostok Oil to Trafigura, with the global commodities trader purportedly securing a $7bn Russian loan to finance the deal. It went on to sell a further 5% to a 75:25 joint venture between trading groups Vitoil and Mercantile & Maritime. Traders were a natural choice of partner, as they could leverage their vast trading networks to find a market for Vostok Oil’s supply. Rosneft also reached out to investors in Asia, but no deals emerged.
Days after Moscow launched its invasion of Ukraine, however, Trafigura said it was putting its shareholding in Vostok Oil up for review. And on June 10, the trader said it had completely written down its initial €1.5bn ($1.6bn) investment in the project. For their part, Vitol and Mercantile & Maritime have been silent on their plans at Vostok Oil for the time being.
Nevertheless, the odds are against Rosneft that it will be able to find anywhere near the investment it needs to see Vostok Oil through to completion in the near term. Western banks have closed their doors to the financing of Russian oil and gas, and even financiers in so-called “friendly” countries like India and China have shown reluctance to commit to new projects in the country, despite the opportunities that the withdrawal plans of Western oil majors present, through fear of falling foul of sanctions, as well as the general uncertainty.
Rosneft has also lost access to Western oil and gas equipment, services and technology that it depended on for challenging and capital-intensive projects in the past. Russia’s drive to localise these products and services was launched in 2014 after the West first began imposing sanctions on the country, and has yielded limited results. But those sanctions were nowhere near as severe as the current restrictions, only forbidding Western companies from providing goods, services and financing to certain Russian offshore and unconventional projects. Now sanctions have essentially cut the entire Russian oil and gas sector off from Western support. Over time, Russia’s localisation programme is likely to pick up pace, out of necessity, but it is likely to take years for the country to build up the same capabilities as Western service firms, contractors and suppliers.
Meanwhile, the Russian state has far less capacity to provide Vostok Oil with financial support in present circumstances. State financing and lavish tax breaks have been essential in getting large-scale Russian oil and gas projects in the Arctic off the ground over the years. A case in point is Novatek’s $27bn Yamal LNG plant, where the state essentially paid for all support infrastructure, and offered over a decade of tax incentives. Having already reined in such fiscal support during tax reforms introduced last year, the government will likely look to extract even greater revenues from the sector to support the Russian economy and its population during the present hardship.