China has become Russia’s main foreign partner on liquefied natural gas (LNG) production projects in the Arctic, a development for which a number of political and commercial factors are to thank. China has the world’s fastest growing LNG market, and Chinese companies are open to paying generously for access to resources. Unfazed by the imposition of Western sanctions on Russia, China was willing to provide the money and technology needed to launch new resource projects in the Russian Arctic. The two countries have come to an arrangement giving China a new source of gas and its first large sales of Arctic technologies, and Russia a share of China’s enormous LNG market along with indispensable project funding. The Novatek projects are likely to serve as a model for attracting China to other Arctic resource projects.

Arctic Gas En Route to Asia

With an Arctic coastline that is longer than any other and a claim to a significant share of the region’s resources, it is no surprise that Russia considers the economic development of the Far North to be a strategic priority for the twenty-first century. Yet this endeavor is costly and infrastructurally complex, and Russia lacks the financial and technological resources to go it alone, which has forced the country to turn instead to foreign investors.

The development of Arctic gas resources has necessitated this very approach. In the 2010s, while relations between Russia and the West took a turn for the worse, Moscow and Beijing strengthened their partnership, and the latter became the key foreign player in Russian Arctic projects. As Russia has pivoted to the East, the Yamal LNG and Arctic LNG 2 projects have emerged as the faces of Sino-Russian cooperation in the Far North.

In May 2009, businessman Gennady Timchenko became a Novatek shareholder in a turning point in the Yamal LNG plant construction project. Founded by Leonid Mikhelson in 1994, Novatek had earlier been on its way to becoming a major private player in the Russian gas market. Timchenko, a longtime acquaintance of Vladimir Putin, received 18.2 percent of Novatek shares in exchange for a 51 percent stake in Yamal LNG, which owned the license to develop the massive South Tambeyskoe gas field with its gas reserves of 1.3 trillion cubic meters. As a Novatek shareholder, Timchenko was behind the construction of Russia’s first gas liquefaction plant in the Far North. Five years later, Timchenko would help Yamal LNG yet again by securing China’s support at a critical time for the project.

Moscow had good reason to support the ambitious project. A natural gas liquefaction plant is a complex facility whose construction would trigger a multiplier effect, creating new jobs, diversifying Yamal gas exports, enabling domestic production of some LNG equipment, and increasing cargo traffic along the Northern Sea Route. Hence the many privileges the Russian government bestowed on the project to ensure its success.

Even so, the project could not have been completed without foreign investment and technology. In the early 2010s, Russia had virtually no capacity to create its own LNG facilities. Its only natural gas liquefaction plant was built on the island of Sakhalin by Sakhalin Energy in the 2000s. Gazprom is Sakhalin Energy’s controlling shareholder, while Shell, Mitsui, and Mitsubishi provide the requisite technology and own some of the company’s shares. To develop a project like Yamal LNG, international participation was necessary for addressing a lack of funding and capabilities, as well as securing access to crowded foreign LNG markets.

In 2011, Yamal LNG attracted its first international investor. Total, a French company that was already a Novatek shareholder, purchased a 20 percent stake in Yamal LNG. Chinese investors followed suit. In 2013, CNPC, the state-owned oil and gas company, bought 20 percent of shares in Yamal LNG from Novatek for $960 million. At the same time, CNPC committed to purchasing at least 3 million tons of LNG annually and to securing Chinese financing for the project.

According to participants in the negotiations, the decision to seek investment from China was primarily informed by market factors. In 2013, when CNPC became a stakeholder in Yamal LNG, China purchased 24 billion cubic meters of LNG abroad, making it the world’s third largest LNG importer after Japan and South Korea.1 In 2021, China overtook Japan with its purchase of 84 billion cubic meters. Beijing has taken a keen interest in diversifying its LNG sources. Its main suppliers are Australia, Malaysia, Qatar, and Indonesia, from which gas is shipped via the South China Sea and the narrow Malacca Strait. To diversify both its sources of fuel and the shipment routes, China moved to have LNG shipped from the Russian Arctic. CNPC completed its purchase of Yamal LNG shares in January 2014. Just a few months later, the project found itself in the middle of a geopolitical storm that was sparked by the conflict in Ukraine and which eventually led to the EU and the United States sanctioning Russia.

Western sanctions have been painful for Yamal LNG, coming at a time when the project was trying to secure European credit lines—an estimated $20 billion, according to Mikhelson. Some of the money came from the state’s National Wealth Fund, from which the company received $2.3 billion in late 2015. Another €3.6 billion were provided as credit lines of Sberbank and Gazprombank in spring 2016. But the project still lacked the necessary funds.

Relief ultimately came from China, an achievement in which Gennady Timchenko played an important role. By the time of Novatek’s inclusion on the U.S. sanctions list, Timchenko had already featured in the U.S. Treasury Department’s very first round of designations in March 2014 following Russia’s annexation of Crimea. The next month, Timchenko became head of the Russian-Chinese Business Council (RCBC), which brings together leading Russian and Chinese companies.

That May, in his capacity as RCBC’s Russian co-chair, Timchenko accompanied Putin on his trip to Shanghai, where a number of important documents were signed, including an agreement on the construction of the Power of Siberia pipeline. The visit was intended to demonstrate to the world that Russia had a strong and reliable partner in China even as the former was coming under Western sanctions. While in Shanghai, Putin introduced Timchenko to Chinese leader Xi Jinping as the Russian business community’s effective envoy to China.

Shortly thereafter, in August 2014, Timchenko spoke of the benefits obtained from Russia’s cooperation with China in an extensive interview to TASS. Among other things, he mentioned using China’s UnionPay credit card in light of sanctions precluding the use of Visa and MasterCard, and raised the possibility of getting Chinese businesses to buy shares in Yamal LNG.

Consequently, in 2015, Yamal LNG gained a new Chinese shareholder: the Silk Road Fund (SRF), whose creation was announced by Xi in November 2014. Negotiations between Novatek and SRF began in spring 2015, and in August the parties reached an agreement to sell a 9.9 percent share in Yamal LNG to SRF, a success that Timchenko leveraged his Kremlin ties to ensure.

The deal was finally closed in March 2016. SRF paid €1.087 billion for its stake, and agreed to provide to Yamal LNG a fifteen-year low-interest loan of €730 million. In the end, Novatek was left with a 50.1 percent stake in Yamal LNG, while Chinese state-owned companies collectively held 29.9 percent of shares.

Loans and Technology

The addition of a new shareholder eased Yamal LNG’s financing problems but did not resolve them completely. As Mikhelson told Putin in January 2016, Chinese shareholders invested a total of $5 billion in the project. However, its completion required another $12 billion, funds that Novatek hoped to source from China as well. In 2015, Chinese banks, including state-owned ones, were less than eager to finance Russian projects, despite the closer ties between the two countries. Russian businesses were so taken aback by Chinese banks’ strict compliance with Western sanctions that senior managers at some Russian banks even began to publicly complain about their Chinese counterparts.

Yamal LNG became a rare exception, though not until after a series of tough negotiations. In April 2016, Novatek announced that it had managed to secure $12 billion from Chinese state-owned banks, the creditors being the Export-Import Bank of China (EIBC) and the China Development Bank (CDB), state-owned development banks with no retail business in the EU or the United States. The loan terms turned out to be highly advantageous for Yamal LNG, thanks to interest rates that were even lower than those quoted by Russian banks.

These funds were used to pay contractors. Novatek engaged the services of a consortium consisting of TechnipFMC, JGC, and Chiyoda, which in turn selected the contractors, most of which came from China. According to estimates from Total, seven of the ten shipyards involved in construction were located in China, while 101 of 142 modules were produced there. One of the biggest contracts was signed with the China Offshore Oil Engineering Company (COOEC), a subsidiary of the state-owned oil and gas giant CNOOC that built thirty-six modules for Yamal LNG. Novatek’s contract with COOEC was worth an estimated $1.64 billion—a sum equaling the CDB’s credit line in Chinese yuan. According to CNPC, the Yamal LNG project was serviced by forty-five Chinese companies.

Four LNG tankers jointly commissioned by Japan’s Mitsui O.S.K. Lines and China’s COSCO Shipping for the project were assembled at China’s Hudong-Zhonghua shipyard. These were Arc4 ice class tankers, while the vital and more technologically sophisticated Arc7 tankers were constructed by South Korea’s Daewoo Shipbuilding and Marine Engineering (DSME).

Ultimately, due to the impact of Western sanctions, it was China that became Novatek’s main partner in developing Yamal LNG. A combination of Chinese investments, gas purchase contracts, loans, and technology made possible the completion of this unprecedentedly complex project. For its part, Beijing did not just receive a new gas source and a profitable investment; it also provided its oil and gas technology producers with their first successful contracts in the Far North.

An Attempt at Diversification

Although China’s extensive participation in Yamal LNG as an investor, creditor, and technology supplier proved to be mutually beneficial, it was forced by a confluence of extremely unfavorable circumstances. To avoid excessive dependence on China, Novatek cast a wider net in its search for partners when launching its next such project in the Far North, Arctic LNG 2.

Arctic LNG 2 is one of Novatek’s projects on the Gyda Peninsula in the Yamalo-Nenets Okrug. A gas liquefaction plant will be built about 70 kilometers from the Yamal LNG facilities, on the other shore of the Gulf of Ob in the Kara Sea. The project’s resource base is the Utrenneye gas field, with estimated gas reserves of 1,434 trillion cubic meters. The total capacity will reach 19.8 million tons of LNG annually. According to Novatek’s plans, the project’s first production line will be launched in 2023, and it will be at full capacity in 2025–2026.

The success of the Yamal LNG project convinced many investors of Novatek’s ability to complete complex projects in a timely manner. Total was the first company to purchase shares in Arctic LNG 2, acquiring a 10 percent stake for $2.5 billion in March 2019. Apart from Total, Novatek negotiated with a number of large foreign companies, of which Saudi Aramco was a leading contender. Yet talks that began in 2017 became deadlocked and were terminated in May 2019, reportedly after the Saudis conditioned an offer to purchase a 30 percent stake on a discounted sale price. South Korea’s Kogas was also part of the negotiations, but Seoul did not join the project, fearing sanctions.

In April 2019, at the Silk Road Forum in Beijing, where the Russian delegation was led by President Putin, CNOOC and the CNPC subsidiary CNODC each bought a 10 percent stake in Arctic LNG 2 for slightly more than $4 billion. That June, Novatek signed a deal with a consortium consisting of Mitsui and the state-owned JOGMEC, to which it sold another 10 percent stake for $3 billion. Chinese state-owned companies were once again Arctic LNG 2’s largest foreign stakeholders. Novatek retained a 60 percent stake, although Mikhelson suggested that one more investor might join the project, potentially an alliance of India’s ONGC and Petronet that would hold a 9.9 percent stake.

Chinese loans will play a much smaller role in developing Arctic LNG 2. In November 2021, Novatek announced that it had raised $9.5 billion in debt financing, €2.5 billion of which will be provided by EIBC and CDB. Banks from OECD countries will provide just as much, although so far Novatek has publicly identified only one such institution, the Japan Bank for International Cooperation (JBIC). The remaining €4.5 billion came from Russian state-owned banks.

On the other hand, China will get more gas purchase contracts out of Arctic LNG 2 than it did with Yamal LNG, where its share was around 30 percent. It emerged in April 2021 that Novatek had signed sales contracts for all of Arctic LNG 2’s gas covering the next twenty years of production, primarily with the project’s investors. According to S&P calculations, Total, CNOOC, CNPC, and the Mitsui–JOGMEC consortium will receive about 2 million tons of LNG annually. Considering that there are two Chinese investors, China will receive at least 4 million tons of LNG annually, or 20 percent of the total output. In February 2021, Novatek separately signed a fifteen-year contract with China’s Shenergy Group for annual shipments of 3 million tons of LNG. In June, the Russian company signed a fifteen-year-deal with another Chinese buyer, Zhejiang Energy. As per the agreement, Arctic LNG 2 will supply the Chinese company with 1 million tons of LNG annually. All in all, Chinese companies have purchase contracts accounting for approximately 40 percent of the LNG.

As for the technology contracts, Chinese companies again received a sizable share of this segment, thanks in no small part to previous project experience. While the first three lines of the Yamal plant were constructed with the help of Chinese contractors selected by the designers, the fourth line was built with Russian-made equipment. But in remarks at the Eastern Economic Forum in September 2021, Mikhelson alluded to that line’s poor performance, declaring that the technology was in need of improvement. As a result, Technip FMC, which was put in charge of executing the project in May 2019, has had the equipment manufactured in Asian shipyards.

According to IHS Markit, the contracts were awarded to at least five Chinese manufacturers. Three of them (Penglai Jutal, BOMESC, and McDermott Wuchuan) earlier participated in Yamal LNG. Penglai Jutal will manufacture generators and compressors for the project for $437 million, while BOMESC will supply modules for $610 million. In addition, two new contractors will participate in the project. In August, Wison Offshore & Marine shipped two of four modules to Arctic LNG 2, incidentally the largest in the world. COSCO, China’s leading shipping company, is also involved. Evidently, contracts signed with Chinese companies will be financed with credit lines extended by Chinese state-owned banks.

When it comes to gas tankers for Arctic LNG 2, Novatek will have at least fifteen of them built at the Russian Zvezda plant, which is managed by Rosneft and Gazprombank, in partnership with South Korea’s Samsung Heavy Industries. In December 2019, Mikhelson asked Putin to allow Novatek to order ten Arc7 tankers from abroad, since the busy Zvezda cannot build the vessels required for the project in time. Permission was granted, so the operators have already ordered the new Arc7 tankers from DSME, at whose yard all tankers of this class for the Yamal project will have been built.

As part of the Arctic LNG 2 project, transloading terminals are to be built near Murmansk and in Kamchatka. Arc7 tankers will transport LNG there from Yamal and Gyda. Lower ice class vessels will then deliver the gas to the end consumer. China’s Hudong shipyard can already compete in this segment, but there have been no reports of tanker construction contracts with the Chinese so far.

Conclusion

Based on developments around Yamal LNG and Arctic LNG 2 projects, some preliminary conclusions can be drawn regarding Sino-Russian cooperation on the development of the Russian Arctic.

First, Russia’s interest in partnering with China to develop Arctic resource projects predates the conflict between Moscow and the West and is purely pragmatic. Natural resources, particularly hydrocarbons, will be in high demand in China in the near future. Short transportation routes make this market even more attractive, and gas and oil exports by sea to China will increase traffic along the Northern Sea Route. Russian natural resources can reach the Chinese market more easily with lobbying help from Chinese stakeholders in Russian energy projects. Finally, Chinese companies possess enormous funds, a major selling point for Russian project operators.

Second, China is undergoing a commercial shipbuilding boom, amid which Beijing is looking to boost domestic production with the help of global engineering companies. These factors make Chinese contractors attractive technological partners in the development of the Russian Arctic. Chinese shipyards started receiving orders from Russia even before Western sanctions went into effect. Chinese companies are extremely interested in such contracts, since they view participation in these projects as a means of enhancing their capabilities.

Third, the U.S. sanctions that cut off Russian companies’ access to Western finance certainly increased China’s economic involvement in Russian Arctic projects. China did treat sanctions as a risk factor, yet was able to strengthen its strategic ties with Moscow and win over some of Putin’s close associates through assistance that Chinese state-run financial institutions extended to Russian megaprojects in the Far North.

Fourth, despite unfavorable global conditions, Russia has tried to hedge the risk of excessive dependence on China and therefore sought to diversify its partnerships as much as possible. So far, it has been successful in doing so with Arctic LNG 2, mainly due to active commercial diplomacy and the pursuit of financing from Russian sources.

The development of the Yamal LNG and Arctic LNG 2 projects indicates that China has been and will remain Russia’s main foreign partner in Far North megaprojects for the foreseeable future. At the same time, Moscow is making a conscious effort to be less dependent on its partnership with Beijing and has so far succeeded in this endeavor. The further success of this balancing act will hinge on three factors: the commercial viability of the Russian Arctic project, the dynamics of Western sanctions, and Russia’s progress in import substitution.

This publication is part of a project carried out with the support of the Swedish Foreign Ministry.

Notes

1 This study consisted of in-depth interviews with Russian government officials, employees of energy and finance companies, and energy experts. The interviews were conducted in the fall of 2021. This work also includes information obtained in the course of in-depth interviews with Chinese sources for other research projects in 2015–2020. The coronavirus pandemic made it impossible to conduct in-depth interviews with Chinese sources for this project.

By:
  • Vita Spivak
  • Alexander Gabuev