TDR January 24, 2024: Stopping Arctic LNG-2: It Takes a Village

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BLUF (BOTTOM LINE UP FRONT)

Welcome to TDP’s second newsletter of 2024. We’d like to begin by thanking Razom We Stand for their indispensable assistance and knowledge in helping to put together our In-Depth story about Russia’s Arctic LNG-2 project (any mistakes are ours, not theirs). In this piece, we look at the saga of Russia’s new flagship LNG project in the Far North that is due to begin commercial production in the coming weeks. The US robustly sanctioned the project in September and November 2023 leading its international partners to cancel offtake agreements and the builder of special ice-class tankers needed to service the project to stop deliveries. Yet a combination of third-party workarounds and Europe’s inability to give up the illusion of cheap Russian energy could still see the project cling to life or even prosper.

In the Digest, we cover the high-profile leak of an official German document related to war plans if Russia were to plan an attack on NATO in the coming months – a scenario not as far-fetched as it initially sounds – as well as Estonian and Norwegian warnings of the need to arm and contain Russia to deter aggression in the near to medium term. We also look at recent comments by Ukrainian President Volodymyr Zelensky that Russia’s arms production is falling but still requires the international community’s concerted action to keep equipment and components out of Russian hands.

In Qui Custodiet, we highlight a proposal to counter and deter Russian acquisition of North Korean and Iranian ballistic missiles by supplying US and European equivalents based in part on Russia’s violation of a UN embargo on the Hermit Kingdom. Also, US sanctions on Iranian funding of the Houthi rebels (the authors of several attacks on Red Sea shipping and Western forces) and Russia’s ghost fleet, arguing that Russia and Iran’s “shadow fleet” of tankers now constitutes a single network funding authoritarian adventurism. In Around the World, we cover problems at one of Europe’s largest ammunition manufacturers caused by strike threats and look at fresh Chinese customs data that shows Russia leapfrogged Saudi Arabia to become China’s largest crude oil supplier in 2023 on the back of sanctions-related discounts. And in Finland, one of Ukraine’s staunchest allies and a new NATO member, local media reports on at least 20 companies that appear to be supplying vital components for Russia’s war machine.

CORRECTION: Thank you for the wonderful feedback on our story in the last issue about Russia’s challenges in sourcing lithium. Multiple readers did rightly take us to task for the figure of around 700 tons for the size of the Russian lithium market, based on a linked article. Well, we should have challenged this number as it is awfully low if we’re talking about lithium carbonate, the standard unit of measure. The real figure should be around 7,000 tons, with this Russian source (the website of the official newspaper of the Russian government) citing a figure of 8,000 to 9,000 tons. Thank you to those who took the time to reach out with the correct data, please continue to do so!

STOPPING ARCTIC LNG-2: IT TAKES A VILLAGE

Depending on what you read, Russian oil giant Novatek’s Arctic LNG-2 project is “on ice” or “undeterred” and “moving towards start-up” within weeks. Its ability to get off the ground in the face of American sanctions is a test of Russian resilience, the US ability to disrupt its supply chain, and the European Union’s resolve to put long-term interests over its continuing addiction to cheap Russian energy.

By way of background, the Arctic LNG-2 project on the inhospitable Gydan peninsula combines two of Vladimir Putin’s long-term strategic priorities, upping Russia’s share of the global LNG market from its current single digits and demonstrating the potential of the Northern Sea Route (NSR) that takes advantage of a fast-warming Arctic to move Russian natural resources to international markets. Russian officials claim it can save up to 40% of shipping time to Asian customers while avoiding the costly and congested Suez Canal. In all, Arctic LNG 2's capacity is meant to reach around 20 million metric tons per year, with 1.6 million tons of stable gas condensate.

Arctic LNG-2 is also a classic example of Russian energy politics pre-2022, with the venture including China (CNOOC and CNPC), France (TotalEnergies), and Japan (Mitsui & Co and JOGMEC). With offtake contracts in place, Arctic LNG-2 had a committed source of long-term funding and an impressive international consortium committed to deepening their dependence on Russian energy. Novatek also had contracts for the construction of the fleet of ice-class tankers needed to deliver LNG via the NSR.

As with so many of Russia’s best-laid schemes, its decision to launch a full-scale invasion of Ukraine in February 2022 has disrupted the project’s progress, but it would be a mistake to conclude it has been stopped in its tracks. In April 2023, members of Ukraine’s parliament sent a letter to the European Commission and the United States Treasury Department urging both primary and secondary sanctions targeting the project.

The US responded to Ukraine’s request in September by targeting entities linked to the project and in November with a sanctions package directly targeting the Arctic LNG-2 joint venture, with a Biden administration official stating in Congressional testimony that the plan is to “kill the project.” In response, the international participants in the venture cited force majeure on their contractual commitments, forcing future sales onto the spot market when commercial production starts.

Going after the supply chain

The sanctions – enhanced by a US presidential order in late December 2023 that strengthens the Treasury Department’s ability to go after financial institutions that work with designated entities – have also threatened the supply of the special tankers needed for the project. As Reuters reported in late December, citing industry sources, a shortage of ice-class gas tankers could hold back the launch of deliveries from Arctic LNG-2. Reacting to these developments, Russia accused the US of “threatening global energy security,” and claimed that third countries in Europe and Asia would face higher energy prices as a result.  

In the meantime, the project faced more bad news as South Korea’s Hanwha Ocean canceled an order from Russia’s Sovcomflot for three Arc-7 ice-class tankers, citing sanctions. French company Gaztransport & Technigaz – the maker of critical membrane containment technology for LNG vessels – also declared in January 2023 that it had terminated work at Russia’s Zvezda shipyard.

Still, despite these moves, High North News reported earlier this month that Chinese suppliers sent two new prefabricated modules to Novatek for Arctic LNG 2 and these are due to arrive in Murmansk in February. Notably, Red Box Energy Services, currently based in Singapore, owns and operates the special vessels carrying the modules. Notably, it reportedly previously operated as RBES B.V., a Rotterdam-based private limited company.

Moreover, while Reuters has reported that the project only had three ice-class tankers for the project as of early January, Russia also has access to an additional fleet of 15 Arc-7 tankers for its existing Yamal LNG terminal. But as the latter has not been targeted with direct sanctions, which allows allies – specifically European, Japanese and South Korean majors –  to continue to buy Russian LNG, it’s not clear these vessels can be spared for long.

To offset this risk, Russia plans to build 15 new tankers at Zvezda if it can obtain critical components from abroad. Further down the supply chain, Ukraine designated Belgian gas company Fluxys (controlled by the Belgian state and shareholding municipalities) as an “international sponsor of war” for providing “storage and transshipment facilities” for Russian LNG from Yamal at its transshipment terminal in Zeebrugge. The US sanctions appear set to cut off this route for Arctic LNG-2, but Ukrainian NGOs have called upon the Belgian government to follow in the footsteps of the Netherlands and the UK and ban the transshipment of all Russian LNG through its ports and urge France and Spain to do the same.

None of these challenges are easy for Russia to overcome. The project will require fresh vessels, equipment and, crucially, long-term financing – on top of servicing around US$9 billion in existing debt. Still, without secondary sanctions and enforcement, Arctic LNG-2 could still obtain access to additional tankers through third countries, with critical LNG membrane technology potentially coming from Europe. With implicit Russian state backing for this priority strategic project, the financing issues may be solvable.

The undead

As it stands, Russia claims the project, with one ‘train’ (production line) already in operation, will begin commercial production within weeks. High North News – a Norway-based publication that is indispensable for following this saga – reported within the last week that Novatek has begun producing LNG and that the first shipments are “just weeks away.” Citing an industry expert, the outlet reported that Novatek could still finish all three trains within two years.

A key challenge was reportedly finding replacements for three LM9000 gas turbines that US energy services giant Baker Hughes could not deliver before sanctions kicked in and it responded to direct Ukrainian appeals to stop its supplies (it had already delivered four). According to the report, the Russian company was able to retool the project to use turbines from China’s Harbin Guanghan.

Whatever ingenuity shown by Russian engineers, many observers believe the project will proceed but, in the words of an analysis by EnergyFlux, it will be “stunted.” It cites estimates that the project will need 21 ships and cannot just redeploy Yamal’s existing fleet beyond supporting the first train reportedly coming online. And the analysis notes that sanctions target two key transshipment points that will complicate efforts to move products to buyers on the spot market. This puts China in the driver’s seat as the most likely buyer and supplier of vessels for the project, challenging the US and allies to use secondary sanctions to stymie this approach. This raises the question of whether this becomes another saga along the lines of Russia’s ghost fleet of oil tankers evading the G7 price cap.

Meanwhile, the European Union has been far slower to act on Arctic LNG-2, instead focusing on measures that limit Russia and Belarus from accessing European gas infrastructure and collaborative gas procurement to build up reserves from other sources. Yet, European purchases of Russian LNG were higher in the first nine months of 2023 than they were in the same period of 2020 or 2021, before the full-scale war.

Against this background, these interim steps demonstrate that many European countries are failing to price in the enormous externalities (in the form of market disruption, not to mention human suffering) of ostensibly cheap Russian energy. A continued lack of resolve in Europe could see Arctic LNG-2 get the fleet vessels it needs, replete with Western technology to meet the production requirements of all three trains after a delay that is disruptive but hardly fatal for a project that Russia has made clear is a national priority. Success in its ambitious LNG export expansion plans would be a steep climb for Russia, requiring it to build an additional four terminals the size of Arctic LNG-2. But even getting Arctic LNG-2 online and anywhere near planned capacity would be a stunning and tragic outcome that would give Putin some of the critical leverage in energy markets as he sought to do with Nordstream 1 and 2.

NB: On January 24, as this newsletter was being published, France’s Le Monde newspaper published an investigative story based on documents that reportedly show that French engineering firm Technip Energies has lobbied the French government to allow it “to avoid a sudden withdrawal from the project.” It should be noted that following a previous Le Monde article in October 2023, the company issued a statement that it “has complied at all times with applicable sanctions in relation to the Arctic LNG-2 project.”  

Germany prepares for the unthinkably inevitable

Bild – Germany’s widest circulation newspaper and a tabloid not renowned for subtlety – created a splash with the publication of a classified government document called “Collective Defense 2025” related to German war plans in the event of a Russian attack on Eastern Europe. On the surface, such a development feels far-fetched, as Russia’s full-scale invasion of Ukraine has demonstrated its strategic incompetence, technical deficiencies, and logistical ineptitude. Yet the German war planners laid out a frighteningly plausible scenario based on Putin’s pre-2022 playbook of hybrid warfare, stirring up unrest among ethnic Russian minorities abroad and leveraging cyberattacks, domestic political divisions in the US and European countries, and its substantial forward-deployed military presence in Belarus. That the document exists is less interesting than the fact it was apparently leaked, as Edward Hunter Christie, an insightful commentator on military affairs, noted recently; this was perhaps a way to wake up lethargic politicians, prepare the public, and put Russia on notice.

The German scenario describes an imminent (and likely more desperate) threat deployed while Russia continues to commit most of its forces to Ukraine. In an interview with The Times of London, Estonian Prime Minister Kaja Kallas outlined a longer-term three-to-five-year threat to NATO’s Eastern flank based on existing intelligence, while both scenarios focus on NATO’s perceived vulnerability in the Sulwalki gap. And Norway’s Chief of the General Staff Eirik Kristoffersson said the country's military has a window of opportunity that “could last one, two, maybe three years,” during which defense spending should be increased to meet the threat. Whatever the time scale, Kallas made clear that unity now and containment over the long term are the only viable strategies to protect the region and avert an even more catastrophic conflict. That unity has proved brittle in recent months amid Russian pot-stirring and Western populists who somehow blame Ukraine for domestic ills. As for containment, the war and US unreliability now and down the line are pushing many European countries to look at local production of arms and materials not only for Ukraine but their own defense.

Zelensky sees a fall in Russian arms output

In his nightly video address on January 9, Ukrainian President Volodymyr Zelensky gained attention for comments that there were "clear signs of a slowdown" in Russia’s arms production. He called on Ukraine’s allies to tighten existing loopholes, stating “For the results of sanctions to be 100%, sanctions loopholes must also be blocked 100%.” Notably, a week later, a senior member of Ukraine’s vaunted Defense Intelligence (HUR) said Russia is currently making around 115 to 130 missiles with a range of over 350 kilometers (217 miles) every month and 100 to 115 shorter-range missiles. As previously noted in this newsletter, estimated Russian production levels continue to outstrip pre-war levels but appear unable to meet demand. Recently, Sergei Chemezov, the head of Russia’s Rostec holding said that output of key equipment had risen over the past two years by 50-fold in the case of ammunition and small arms. In remarks that appeared on the Kremlin website, he also said that tank production had risen seven-fold. These claims seem unlikely. But the more believable Ukrainian figures underline that Russia continues to obtain critical production equipment and components from abroad that keep the plants working.

Disruption in arms supplies to Ukraine has also given Russia critical breathing room for its arms plants, which are operating at maximum capacity. Western policymakers should consider the practical result. Ukraine isn’t going to stop fighting. Rather, the more it finds itself outgunned on the battlefield, the more likely it is to resort to irregular warfare, including going after energy hubs and weapons plants deep in Russia to hit Russia’s revenue streams and munitions supplies. Recent strikes on an oil terminal in St. Petersburg and a defense plant in Tula – home of Russia’s largest small arms maker and other weapons factories – should make clear that Ukraine has this capability.

Slowing North Korea’s supply of missiles to Russia

According to US government public statements, North Korea’s supplies of arms and equipment to Russia began in earnest after the September 2023 meeting of President Vladimir Putin and his counterpart Kim Jong Un. On January 11, the US State Department announced sanctions against three Russian entities and one individual involved in the transfer of North Korean ballistic missiles, as Ukrainian prosecutors have detailed the use of such missiles in Russian attacks over the New Year’s holiday. Military analyst Colby Badhwar, writing in the Insider recently, made the important point that the Kremlin is not buying such weapons out of desperation (see previous story) but to diversify its sources and overwhelm countermeasures. Combined with Iranian missiles, the resultant boost to Russia’s arsenal would pose serious issues for Ukraine’s limited supplies of interceptors. Badhwar proposes that the US counter not through interdiction efforts (impossible given the countries are neighbors) or UN action (the institution has been largely irrelevant throughout the war). Rather, he proposes that the US provide long-range missiles, such as 300-kilometer (190 mile) M39A1 ATACMS and SLAM-ERs capable of returning fire against missile strikes from Russian territory, encourage South Korea to follow this example, and let other allies follow. He argues that this is not escalation, but a reasonable collective international response, and that the practical effect of Ukraine being given the resources to respond with targeted strikes against Russian military infrastructure currently out of range of all but a few drones could be a turning point in the war.

US targets shadow tankers that facilitate Houthi attacks

On January 12, following a wave of US and UK strikes against Houthi facilities in Yemen in response to attacks on commercial shipping, the US Treasury Department imposed sanctions designed to disrupt illicit Iranian financial networks that fund the rebel group, which has controlled Yemen’s capital, Sana’a, since 2014. The designations of two companies – one in Hong Kong and the other in the UAE – and four oil tankers in Iran’s “shadow” or “ghost” fleet send an important signal, as they go after specific vessels that are part of a much wider network maintained by the Islamic Revolutionary Guard Corps-Qods Force to fund its activities and its proxies. Notably, the US Treasury also designated the Emirates-based owner of 18 tankers for violating the G7 price cap on Russian oil last week, underlining the UAE’s role as a hub for shippers financing both Russian and Iranian sanctions evasion. Against the backdrop of Russian-Iranian preparations to sign a new interstate treaty that is expected to cement military and economic cooperation, this overlap suggests that the global shadow fleet constitutes a single network financing the military adventurism of authoritarian powers. Identifying the network of shippers and vessels is an immense but urgent task. Fortunately, both governments and the OSINT community have access to the immense trove of data produced by the global shipping industry to go after these vessels and their owners.

Strikes Threaten One of Europe’s Most Important Ammunition Producers 

Planned strike action at four plants in Finland owned by the Finnish-Norwegian ammunition company Nammo, one of Europe’s largest, are expected to close the factories on the first two days of February. The Finnish Ministry of Defense claims that the strikes, reported by public broadcaster Yle to be a part of a nationwide strike action across multiple sectors in response to recent changes to Finnish labor laws, would not affect the “quantity or quality” of arms supplied to Ukraine, but Nammo’s Executive Vice President for Commercial Ammunition, Raimo Helasmäki, said otherwise. The action has raised fears of disruption to European arms production at a time when the continent is struggling to re-arm and meet Ukrainian demand while US supplies remain hostage to domestic politics. In response, some commentators have called for ammunition production to be declared a critical industry exempt from breaks in production. Notably, this is not the first time Nammo has been in the news for production challenges. Its CEO has complained about the lack of long-term contracts for defense manufacturers and its largest plant in Norway has reportedly struggled to obtain sufficient electricity supply for a planned expansion due to the emplacement of a nearby power-hungry TikTok data center.   

Russia Becomes China’s Largest Oil Supplier in 2023

Chinese customs data released in recent days indicates that Russia has replaced Saudi Arabia as China’s largest supplier of crude oil, supplying 107.02 million metric tons of crude oil last year, equivalent to 2.14 million barrels per day, a 24% increase year-on-year. China is the world’s largest importer of oil and the surge in trade demonstrates that its processors are taking advantage of discounts Russia is offering them to buy its oil in the face of complications raised by sanctions that can complicate payments and shipping. Still, despite the discounts, demand from China and India often pushed the price above the G7 price cap of US$60 per barrel. Indeed, Russia has followed Saudi Arabia in cutting output to support prices, reducing production by 500,000 barrels per day. The result is a steady flow of revenues to the Russian state. With China ignoring the G7 cap and most sanctions, the US and its allies have limited ways to counter this surge in Chinese deliveries. One weapon may be the Executive Order issued in late December and covered in our previous newsletter that targets “financial facilitators” of Russian sanctions evaders. As Bloomberg reported last week, Chinese state-owned banks have begun to curb services to Russian clients. Whether this hits the oil trade directly is not yet clear – after all European countries continue to buy Russian oil within the price cap – but it and similar steps can convince the Chinese to shop elsewhere.

 Finland IDs Companies Selling Tech to Russia

Like its Baltic neighbors across the gulf, Finland has taken one of the firmest stances on Russia’s aggression in Ukraine, formally joining NATO in April 2023. History and an 830-mile border are strong incentives. Yet, as Finnish public broadcaster Yle reported on its website in mid-January, at least 20 local companies have been supplying Russia with technology and other kit needed for its war effort. Notably, the companies are all identified as small, freight-forwarding companies owned by people with “Russian backgrounds.” As their owners have not been convicted of any crimes, Yle’s online reporting did not disclose the names of the firms or their owners. The investigators also reported that at least two companies were linked to Russia’s Federal Security Service (FSB). Company representatives reached by the reporters denied links to Russian military or intelligence agencies. Previously, in December 2023, Finnish Customs reported the arrest of six individuals linked to six companies suspected of violating EU sanctions by supplying nearly 3,500 drones to Russia. The bottom line is that Russia’s European neighbors – generally countries with the most to fear from Russia and the hardest stances – also offer convenient staging grounds for providing the technology it must import in  limitless volumes.