ExxonMobil’s Drilling Campaign in Russian Arctic Shows Sanctions Lack Bite

North Atlantic Drilling’s semi-submersible rig, West Alpha, photo: Seadrill

By Stephen Bierman and Eduard Gismatullin

Aug. 8 (Bloomberg) — Sanctions, what sanctions?

Exxon Mobil Corp. will start drilling a $700 million well in the Arctic Ocean tomorrow, Russia’s government said, showing that for all the talk of action against Vladimir Putin’s oil industry, the largest U.S. energy company is undeterred.

As Russia’s relations with Europe and the U.S. deteriorated to the lowest point since the Cold war over the conflict in Ukraine, the European Union imposed a third round of sanctions last week, restricting the export of equipment used for offshore oil production. That doesn’t impact Exxon’s plans because the contract to hire the rig was signed before the measures were announced.

Developing the Arctic is vital for Russia, where energy provides half the state’s revenue, to maintain oil production near a post-Soviet high of more than 10 million barrels a day. For Exxon, where output fell to a five-year low in the second quarter, a discovery would offer a vital new source of crude.

“The well is very important, it’s probably one of the most interesting wells in the global oil industry for many years,” James Henderson, a senior research fellow at the Oxford Institute for Energy Studies, said in a phone interview.

After more than two year’s planning Exxon and its partner OAO Rosneft, Russia’s state oil producer, will start drilling the Universitetskaya prospect tomorrow, the Kremlin said in a statement today. Putin will give the signal to start Russia’s northernmost well accompanied by Rosneft Chief Executive Igor Sechin, who’s subject to U.S. sanctions himself, and Exxon Mobil Russia head Glenn Waller.

Ship Tracking

The press offices of Exxon and Rosneft didn’t respond to requests for comments.

Universitetskaya is the first of as many as 40 offshore wells Rosneft plans by 2018 to test the potential of the unexplored the Arctic Ocean. The geological structure targeted by the drilling is roughly the size of the city of Moscow and may contain as many as 9 billion barrels of oil, enough to supply the world for almost three years, according to a presentation on Rosneft’s website.

“It is an anomaly in the current situation and just how long major western companies, such as Exxon, can carry on doing this, is anybody’s guess,” said John Lough, a London-based associate fellow at Chatham House, a London-based foreign policy research group. “They are light sanctions at the moment in terms of the energy industry.”

The West Alpha rig, leased by Exxon from Bermuda-based Seadrill Ltd., is currently in Kara Sea about 72 miles off the coast of Novaya Zemlya, according to data compiled by Bloomberg.

Iceberg Free

Drilling will take about 70 days, a period that should be sufficient to assess the reserves of any discovery, Rosneft’s head of offshore, Zeljko Runje, said on a call with analysts last week. The area is relatively free of icebergs, meaning work is ready to start, he said.

Longer-term, the sanctions announced last week may start to slow the development of the Arctic shelf, said Edward Chow, a senior fellow at the Center for Strategic and International Studies.

“Sanctions were not designed to stop this, but overall the project is bound to slow down as would all long-term, high-risk projects of this sort until how sanctions are enforced and their duration are clear,” he said.

Banning Food

Russia has responded by banning food from the EU and U.S. yesterday and threatened to limit overflights from Europe to Asia. That means that in the future, Exxon-led crews on drilling rigs may not even be able to eat food from America. Air travel will be no problem as the only way to reach the remote deposit is a four-day sail from Murmansk, the Arctic’s largest city.

Tensions with Russia will make companies pay more attention to risk, said Richard Mallinson, an analyst at Energy Aspects Ltd. in London.

“A company could put a lot of money into a country and sanctions could reach point where you couldn’t carry on, like in Iran,” he said in a telephone interview. “I’m not saying we’re on that path yet with Russia. But from the company’s point of view they have to have an eye on what level of risk there is and whether its acceptable.”

The Exxon-Rosneft cooperation also includes $300 million investment in Russian shale pilot projects, which now risk being suspended, Rosneft Chairman Alexander Nekipelov said on July 29. Exxon has come under pressure and showed surprising perseverance, Nekipelov said at the time.

Exxon and Rosneft have also invested in a new platform this year to expand oil production at the Sakhalin-1 project in Russia’s Far East.

U.S. Intelligence

David S. Cohen, U.S. Treasury Undersecretary for Terrorism and Financial Intelligence declined to comment on Exxon’s work in Russia on a call with reporters this week.

“We are in close contact with U.S. businesses with respect to all of these sanctions” programs, Cohen said, while declining to discuss the details of those conversations with specific companies.

Exxon’s decision to press ahead with exploration means it maintains plans for development, according to Mallinson. At the same time reciprocal sanctions and Russian troops massed near the Ukraine border have companies legitimately concerned about risk, he said.

“That has big implications for Russia’s future production prospects, if the sanctions do remain in place and companies do scale back plans,” Mallinson said.

–With assistance from Margaret Talev in Washington.

Copyright 2014 Bloomberg.