Liquification of Plans and Tertiary Sanctions Effect: How and why Russia lost its prospects in the global LNG market

The revenues from Russian liquefied natural gas (LNG) exports sharply increased in 2022-2023. However, as Europe and global energy markets coped with declining pipeline gas supplies from Russia, this sanctions window began to close. Having realised the need to increase LNG exports much too late, the Russian authorities adopted a long-term programme to develop the industry, exactly 11 months before the full-scale invasion of Ukraine began. Although this programme envisaged localisation of production of the relevant equipment in the medium term, the complete ban on exports of large-scale liquefaction technologies and equipment to Russia has put an end to these plans. And, at the beginning of 2024, not only the means of LNG production, but also the means of LNG transportation from Russia fell under sanctions. 

Russian companies and the government remain optimistic and intend to achieve technological sovereignty in LNG production. However, these plans are unlikely to materialise: from the mid-2020s, a number of major LNG projects will be launched around the world, which will seriously change the balance of supply and demand in the global market. But even if, despite all the obstacles and delays, the Russian projects start working, their toxic products will not be in demand for the most part. Thus, the LNG market, along with the arms and metals markets, will turn out to be another export niche in which Russian producers are threatened with a significant deterioration of their positions or even complete marginalisation as a result of the current war.

Sanctions pause

In 2022, after the start of the war, Russia increased its exports of liquefied natural gas (LNG) by 8.6% to 32.9 million tonnes. According to Breugel, about 40% (13.5 million tonnes) of these supplies went to EU countries, which were forced to increase their purchases of Russian LNG in order to replace Russian pipeline gas. In 2023, Russian LNG supplies to Europe fell slightly (to 12.5 million tonnes), according to the European Commission's data for last year. At the same time, thanks to abnormally high prices in 2022, the revenue of Russian LNG suppliers to the EU increased almost fivefold, to €15.8 billion, as noted in a report by the Warsaw-based Centre for Eastern Studies. In 2023, it fell to €8.1 billion amid a significant drop in gas prices. At the same time, according to the Centre for Research on Energy and Clean Air, the total revenue of Russian companies from the sale of liquefied natural gas last year was €16.7 billion ($18 billion; the Federal Customs Service last estimated revenues from LNG exports in 2021, prior to the war, when they amounted to $7.3 billion).

Thus, during the two years of the war, Russian companies entered the top three largest LNG suppliers to Europe, providing about 15% of its European purchases and earning €23.9 billion from this. This, of course, did not compensate for Russia's losses from the reduction in pipeline supplies, but allowed it to maintain fourth place in the world among LNG exporters — after the United States, Qatar, and Australia — with an 8% share (according to the Russian authorities).

However, this year the European Commission intends to achieve a reduction in purchases of Russian LNG, according to European Commissioner for Energy Kadri Simson, as cited by Bloomberg. For this, European authorities need assurance that the United States, which account for about half of all LNG deliveries to the EU (39 million tonnes out of 84), will at least maintain them at the same level. In 2022-2023, the global energy market, and the European market in particular, was under stress from the cessation of Russian pipeline supplies, and therefore abandoning Russian LNG was almost impossible. By the end of 2023, it became clear that the market situation was stable and the pause of sanctions against Russian LNG coming to an end, so the window will start to close gradually. The European Commission is developing legislation that will gradually reduce Russian gas supplies, including LNG supplies, to zero, as reported by the Financial Times.

At the beginning of 2024, pressure on Russian LNG projects was also intensified by the US. In February, the operator of the Baltic LNG project, as well as the company Globaltek, created for gas liquefaction on the coast of the Sea of Okhotsk, the shipyard Zvezda, and structures of Sovcomflot, to which Novatek ordered ice-class gas carriers for Arctic LNG 2, were included in the sanctions list. Essentially, these sanctions destroyed the logistical scheme of Novatek's new plant, the first phase of which had been constructed by the end of 2023 and even started producing LNG. In early April, it was announced that Novatek had suspended production at this plant; according to Reuters, at least until the end of June. The company and its foreign partners have notified their clients, including the Chinese Shenergy Group and Zhejiang Energy, as well as the Spanish Repsol, about force majeure.

A failed strategy

In the 2000s, Putin and his inner circle refused to believe in the future of LNG, insisting that there was no reasonable alternative to pipeline supplies under long-term contracts and investing in pipeline construction (totalling some €27 billion). As a result, nine years passed between the launch of the first LNG project, Sakhalin-2 (2009), which was initially oriented towards supplying Japan, and the launch of the second, Yamal LNG (2018). It was only in the mid-2010s that assessments began to change, resulting in the new projects that are now almost complete. But it was not until the early 2020s that it was realised that Russia needed an aggressive strategy to increase its share of the global LNG export market.

In March 2021, 11 months before the full-scale invasion of Ukraine, Russian authorities approved a long-term LNG development programme that envisaged increasing LNG production to 140 million tonnes by 2035. The document included projects to build more than 20 plants, including the flagship project of Russia's largest LNG producer Novatek's Arctic LNG-2 in the Yamalo-Nenets Autonomous District (20 million tonnes), Gazprom's Baltic LNG in Ust-Luga (13.3 million tonnes; launch was scheduled for 2024) and several Rosneft projects planned for 2027-2035. As a result, Russia's share of global LNG exports was expected to reach 20% by 2030. 

However, almost immediately after the Russian invasion of Ukraine, Western countries imposed a ban on the supply of LNG production technologies and equipment to Russia. Even then, some experts warned that this would put an end to plans for a sharp increase in LNG exports, as the main equipment for large-scale liquefaction is produced in 'unfriendly' countries; almost all the relevant technologies were imported. Due to the sanctions and the withdrawal of the German company Linde, the contractor and supplier of LNG production equipment, the launch of Baltic LNG had to be postponed for two years, until the end of 2026. 

Although it was clear that the first target of the long-term programme (45-65 million tonnes of LNG by 2024) was no longer achievable, in the summer of 2023 the Ministry of Energy insisted that Russia was still planning to increase LNG output to 120-140 million tonnes by 2035, and in October they specified that, by that time it could capture about 30% of the world market, i.e. export about 200 million tonnes per year against a global demand of 650 million tonnes. These statements were in line with the official Kremlin doctrine, according to which the war and sanctions in general do not have a significant impact on the development plans of the Russian economy or even contribute to a fuller realisation of its potential. Novatek's management also claimed until recently that it was not abandoning its plans and would build a new plant — Russia's largest — within the agreed timeframe (by the end of 2023) because the company had managed to obtain all the necessary equipment before the sanctions were imposed. 

However, in November 2023, the US placed Arctic LNG-2 on the sanctions list, which deprived the plant of most buyers from Europe and Asia. US Assistant Secretary of State for Energy Resources, Geoffrey Pyatt, bluntly stated that the goal of the new sanctions was to 'kill this project’. According to him, the US Treasury is tracking business structures involved in Arctic LNG-2 in order to impose increasingly tough measures against them. Further 'tightening of the screws' will either stop the implementation of the project or make it unprofitable, he said.

The force majeure announced for Arctic LNG-2 is a 'wake-up call' for all future Russian LNG projects, Jason Feer, a partner at transport and brokerage firm Poten & Partners (which handles LNG supplies), told Reuters. The first phase of the new plant was at its most advanced stage and other projects will be even more difficult to realise, he warned.

From import substitution to import elimination

The problem was evident from the very beginning. Russia does not have the technology and equipment either for large-scale gas liquefaction projects (more than 1 million tonnes per year) or for its subsequent transportation. The country's first LNG plant, Sakhalin-2, was built almost entirely by foreigners (Anglo-Dutch Shell and its partners). Novatek launched Yamal LNG using American Air Products technology, which was also used for Rosneft's Far East LNG and other Russian projects.

Due to Western sanctions, Novatek had to reconfigure the first stage of Arctic LNG-2. By that time, the US company Baker Hughes had managed to supply the company with only four of the seven gas turbines needed to power the project and liquefy gas. The missing three turbines were replaced with five Chinese analogues, and the plant began operating (until a complete shutdown in April) at 50% capacity. Gazprom announced at the end of last year that it had found replacements for the German Linde equipment for its Ust-Luga plant among Russian suppliers, including Rosatom and heat exchanger manufacturer Severnye Tekhnologii. However, this will surely affect the project's cost, which was estimated at around $26 billion.

'In order to ensure the technological independence of the Russian liquefied natural gas industry,it is necessary in the medium term to ensure the development of production of missing equipment categories', as stated in the government's long-term programme. This was supposed to be facilitated by a 'large-scale programme of localisation of equipment production' for both liquefaction and transportation of gas, the successful implementation of which 'will require comprehensive state support and financial support for the implementation of a whole range of measures', the document stressed. In other words, in the spirit of pre-war times, the long-term strategy envisaged a programme of state support for 'import substitution'. However, none of the programme’s authors, of course, anticipated that all these projects could lose any possibility of obtaining imported equipment just 11 months later.

As part of import substitution, Novatek developed the 'Arctic Cascade' technology back in 2018, which is used in the fourth stage of Yamal LNG, but it was designed to produce only 0.9 million tonnes of LNG per year. Due to the need for debugging, the launch of production had to be postponed for almost a year and a half, until May 2021. In 2023, the development was upgraded to produce up to 3 million tonnes of LNG per year, and the company received a patent for a new liquefaction technology called Arctic Mix (with a capacity of more than 6 million tonnes per year), the equipment for which is to be manufactured by Atomenergomash, Rosatom's machine-building division. However, neither the modernised Arctic Cascade nor the new technology has been put into practice so far. 

Nevertheless, Novatek recently said that the Russian LNG industry could become independent of Western technologies and equipment by 2027-2028. The Ministry of Industry and Trade estimated the cost of financing the 'road map' for the creation of Russian equipment for LNG projects at more than 24 billion rubles by 2030, which means that the timeframe for gaining 'technological independence' is being pushed back even further. China has some experience in the production of LNG equipment, but it lacks experience in designing and building such plants. Hopes that Russia will be able to create its own technological chains for the production of equipment seem elusive, but to abandon these plans would mean giving up government funding for the associated programmes.

Quest for delivery

But production problems have been compounded by a new challenge: the shortage of ice-class tankers, without which it is impossible to transport LNG from Yamal and other Arctic projects, especially in winter. Currently such tankers are predominantly built at shipyards in South Korea, which has already refused to serve Russian customers. In Russia, the construction of tankers of this class is being attempted by the shipyard Zvezda, created with the participation of Rosneft, which received an order from Arctic LNG 2 for the construction of 15 vessels (over 70% of the fleet needed for the project). At the same time, it was supposed to use special containers for LNG transportation produced by the French engineering company Gaztransport & Technigaz (in 2023, it announced a complete withdrawal from Russia), as well as Western engines and propulsion systems (azipods) for ships and other imported equipment. In February 2024, Zvezda itself was placed on the US sanctions list. Andrei Klepach, the chief economist at VEB, said that Russia will not have the infrastructure required for the industry, including ice-class gas carriers, any earlier than 2030. 

Due to the lack of ice-class tankers, Novatek is considering reducing the capacity of Arctic LNG-2 by a third (from 20 to 13 million tonnes per year), Reuters reported in early April. At the same time, the company may use the equipment for the third stage in its other project, Murmansk LNG, which is planned to be built in the ice-free port of Murmansk (it requires conventional LNG tankers — not ice-class). The investment decision to construct this plant has not yet been made; it is not expected to be operational until 2027 at the earliest. 

Moreover, Russia may have problems with the purchase of conventional LNG tankers, which are much harder to find than oil carriers. As we have previously written, Moscow has managed to build up a shadow fleet, which, according to some estimates, includes 1400 vessels and allows Russia to continue supplying the global market while bypassing sanctions (→ Re:Russia: Rusty Business). However, the global number of gas carriers is much smaller than the number of oil tankers: according to the International Gas Union, in 2023 there were 9000 ships in operation worldwide carrying oil and oil products, and only about 700 gas tankers of all types. This will significantly complicate the search for traders and shipowners willing to work 'under the radar', as noted in the Centre for Eastern Studies report. 

In the event of the further expansion of Western sanctions, companies from Russia will not be able to place orders for conventional gas carriers at South Korean and Japanese shipyards. However, Chinese shipyards are unlikely to abandon large Russian clients like Novatek completely, as this is a new 'scale of business' for them, notes Viktor Katona, an expert at the analytical company Kpler. However, he specifies that there is a long queue for the construction of gas carriers: Korean shipyards are already only accepting orders for 2028-2029, and Chinese enterprises, in addition to existing orders for 2026–2027, can produce only one or two vessels.

Fatal tardiness and the tertiary effect of sanctions

While Russian authorities continue to discuss the prospects of achieving full sovereignty in the LNG production sphere, and government officials propose (according to Kommersant) building plants in hopes of a future sanction ‘thaw’, the proposed expenditures may prove futile. Even if some of the problems are somehow resolved in the coming years, Russian LNG is highly likely to be late for the global market.

Russia was already lagging behind in capacity expansion even before the invasion. However, according to the Global Gas Infrastructure Tracker, of the 240 LNG export projects in various stages of development, 23 are in Russia, accounting for almost 25% of the world's total new production capacity. However, Russia's invasion of Ukraine and problems with Russian pipeline gas have sharply boosted the push for new projects, especially in the US, where it takes just 2.5 years to start production, as stated in a study by Wood Mackenzie in August 2022. Starting in 2025, several new large-scale liquefaction facilities are expected to be launched globally, primarily in the US and Qatar, which could lead to oversupply, the International Energy Agency's (IEA) World Energy Outlook 2023 noted.

By 2030, global LNG capacity could grow by almost 40%, to 650 million tonnes, due to projects that are already under construction or for which final investment decisions have been made. If projects where such decisions have not yet been made are added, S&P Global Commodity Insights estimates that global capacity will increase to nearly 700 million tonnes by 2030. At the same time, Shell, which is the world's largest liquefied natural gas trader, in its annual review, forecasts that, by that time, demand may only increase to 600 million tonnes, and by 2035, to 650 million tonnes (according to other forecasts, in 2030 demand will only reach about 550 million tonnes, and in 2035 it will not exceed 600 million tonnes).

The projected surplus of LNG means that Russia's ability to enter new markets is very limited, notes the IEA. The agency's analysts expect Russia's share of international gas trade (presumably referring to pipeline gas), which was 30% in 2021, to halve by 2030. However, none of the analysts dare to forecast what its share in the LNG market will be. Against the backdrop of US sanctions, in their recent forecast, experts from Poten & Partners decided to leave all new Russian LNG projects out of the picture. If Russia fails to address the problems caused by sanction restrictions and LNG production remains at the current level (about 32-33 million tonnes per year), its share of the world market in 2030-2035 will drop to about 5%. And this is not the worst-case scenario, given the transportation problems and the final rejection of Russian LNG in Europe. In fact, Russia's place in the LNG market, despite possessing, according to OPEC estimates, nearly a quarter (23%) of all confirmed gas reserves in the world, will remain marginal.

It is commonly believed that Western sanctions did not lead to the collapse of Russian exports and that Russia only needs to restructure logistics and redirect supplies to non-European markets. However, the experience of sanctions suggests a different likely trajectory. The effect of the sanctions is not instantaneous, but measured and oriented towards a gradual restructuring of markets.

In the first stage, Russia indeed loses, sometimes only partially, access to premium markets in developed countries. In the second stage, the tightening of sanctions leads to further reduction or elimination of supplies to premium markets and exacerbates problems in other markets, but not at the level of country-level restrictions, but at the level of relationships with customers. In the third stage, competitors of Russian suppliers become more active, seeing opportunities to expand their own market share in the situation.

This could be termed the tertiary effect of sanctions. As we previously discussed, the prospect of such a scenario is probable or almost inevitable for Russian metallurgical exports (→ Re:Russia: How Steel Cools) and arms exports (→ Re:Russia: Bad Weapons for the Poor and Unfortunate). The LNG market can also be placed in the same category. Although the 'tertiary effect' is of a delayed nature, its main feature is that it transforms political decisions into economic costs and leads to long-term market effects that will persist even if sanctions pressure is reduced.