Frozen LNG: End-of-year perspectives on the sanctioned Arctic LNG 2 project

This time last year there was much focus on the Nordstream pipelines sabotage, high energy prices and market effects. For our end of the year note at this time we decided to share some thoughts on an important industry topic and natural sequel, the status and outlook for the sanctioned Arctic LNG 2 project. Our “rest of the picture” brief here is quite different from the optimistic Novatek view last presented on 29 December, showing GBS1 flaring and two gas compressors working (but two missing!).

This post is extracted from a recently completed Eikland Energy AS advisory report covering Arctic LNG 2 project commercial structure, actual capacity and assessed status of commissioning, and assessment of contracts, sanctions and road forward. Please contact us if you wish a copy of this 9-page report (ref. its table of content at the end of this post) or discuss details.

On December 25 the Moscow business daily Kommersant reported that Novatek will be aiming for 2.6 mtpa (million tons per year) of spot-based LNG exports from the 6.6 mtpa Arctic LNG 2 GBS1 plant. This followed multiple declarations of Force Majeure by international shareholders, term LNG buyers and the venture operating company after the US Department of the Treasury, Office of Foreign Assets Control, OFAC on 2 November 2023 imposed sanctions on the Arctic LNG 2 joint venture company.

There has been some confusion in media regarding the origin, sequence and importance of Arctic 2 project Force Majeure notices. It is clear, however, that Arctic LNG 2 owners, LNG buyers and the operating company alike found that the November 2 US OFAC and earlier sanctions (i.a. September 14) in sum prevented the project to transition to operations as planned. Some Force Majeure parties are likely to have communicated and been somewhat synchronized on the matter, but seeking to determine who started is in our view not important. In any event, Novatek effectively now deems itself to be the venture’s sole owner, LNG offtaker and developer.

What is further relevant is that sanctions on Arctic LNG 2 work, and with OFAC-set divestitures from the joint venture ownership and business to be completed by 31 January 2024, there is also an intent to continue adding measures as necessary to realize desired effects. The entire Arctic LNG 2 venture is now under a complete state of Force Majeure. In addition, Novatek at large will face greatly increased challenges if European countries decide to use the new opportunity to not accept tenders from Russian entities for natural gas, entry capacity and reloading.

Yet despite increasingly clear evidence Novatek and Russia appear to remain in denial and assume that Arctic LNG 2 is on schedule, and that the international market is open to them.

We certainly believe that Arctic LNG 2 GBS1 can produce, but in foreseable time with at best half capacity. Without any solution in sight for its dedicated ship fleet and FSUs the actual output will be negligible. The challenges will persist for an extended period of time, effectively preventing declaration of the commercial operation date. Also, even attempted near term or sporadic sales of LNG are likely to run afoul of the same November 2 OFAC sanctions that have now brought the project structurally and operationally to the brink.

Given the recent negativity surrounding the project, we are not surprised that Novatek on 29 December (Novatek, Belokamenka VK, also reported by B.Seligman) wished to share a positive picture of the plant with flaring and two gas compressors running, from string 1.  Importantly, the string 2 gas compressor stacks are mostly cropped out of the image, but not completely and the wind direction reveals no evidence of operation. Not surprising, because due to the initial sanctions on Russia after the attack on Ukraine three Baker-Hughes LM9000 compressors were not delivered, and the plant is in its current configuration limited to one-string 3.3 mtpa, i.e. half capacity.

We remain skeptical if – of even this reduced capacity – will actually reach the market in the difficult sanctions-dominated environment that Arctic LNG 2 is now in. For symbolics it is certainly possible that Novatek could attempt to swap a suitable cargo loading from nearby Yamal LNG, and necessarily the ship, to Arctic LNG 2 GBS1. Symbolics are important in Russia.

Any cargo will be closely followed and potential LNG buyers risk being charged with providing “material support” to the OFAC Specially Designated Nationals (“SDN”), i.e. Arctic LNG 2. A buyer therefore risks itself becoming an SDN. Similar challenges face SCF (who has already seen the effect of sanctions) and alternative shipowners being explored to taking ownership of the Arc7 ships to bypass the November 2 sanctions on Arctic LNG 2.

In our assessment, therefore, the Arctic LNG 2 project appears at this time largely frozen-in.

Report table of contents:
– FROZEN LNG END-OF-YEAR PERSPECTIVES ON THE SANCTIONED ARCTIC LNG 2 PROJECT
– THE COMMERCIAL STRUCTURE
– GBS1 STARTUP WITH REDUCED CAPACITY
– WHAT ABOUT GBS2 AND GBS3?
– THE LATEST SANCTIONS
– NOVATEK ONSALE SPAS AND ASSOCIATED RISK EXPOSURE
– CONSIDERING THE REACH OF SANCTIONS
– OVERALL ASSESSMENTS