On thin ice: thawing permafrost dampens Russia’s economic growth prospects

As permafrost across more than half of Russia thaws, critical oil and gas infrastructure is becoming defective. If Moscow fails to curb its dependence on fossil fuels, it risks losing power and influence on the geopolitical stage

On thin ice: thawing permafrost dampens Russia’s economic growth prospects
More than half of Russia’s entire territory is covered by permafrost – ground with a temperature that remains at or below freezing point for more than two years 

There are many reasons why one might decide against buying a house in the Siberian city of Norilsk: the Sun doesn’t rise for three months each year; the name of the neighbouring town translates as either ‘forbidden place’ or ‘death valley’; and it’s so cold that the bodies of the Gulag prisoners who built it are said to be perfectly preserved beneath a memorial at the foot of Mount Schmidtikha.

It’s fair to say that it’s no place for the faint-hearted. At the very least, buying a house in such a dark, icy wasteland should be good value for money, but even this is no longer the case. “The population of the city used to be 300,000, give or take,” Nikolay Shiklomanov, Associate Professor of Geography and International Affairs at the George Washington University, told World Finance. “Nowadays, it’s 180,000… so you would expect that the housing market should be pretty light – that there should be lots of empty spaces – but now they’re experiencing some acute housing shortages because so many of the buildings there are critically deformed.”

Norilsk is the largest city in the world to be built on permafrost – ground with a temperature that remains at or below freezing point for more than two years. Now, as the Earth’s climate warms, that permafrost is melting. In fact, approximately 60 percent of the city’s buildings have been damaged by thaw and 10 percent have been abandoned. The foundations of Norilsk – which was built in the 1930s during Russia’s push for industrialisation in the Siberian and Yakutia regions – are sinking and eroding, causing walls to crack, roofs to crumble and pipes to burst. As Shiklomanov explained: “The city was built cheaply and quickly. Obviously, nobody considered climatic changes.”

While GDP and employment in petrostates such as Saudi Arabia revolve around oil and gas revenue, Russia has a relatively diversified economy

Warming to the idea
The unenviable situation Norilsk finds itself in is not a unique one within Russia. More than half of Russia’s entire territory is covered by permafrost. As this ground thaws, it’s not just buildings that are in danger, but also pipelines and other oil and gas infrastructure vital to Russia’s economy.

Alexander Krutikov, Deputy Minister for the Development of the Russian Far East and Arctic, predicts that the economic loss resulting from the thawing of permafrost could be as high as RUB 150bn ($2.34bn) a year. It’s difficult news to swallow for a nation with climate commitments deemed “critically insufficient” by the Climate Action Tracker, and whose leader has consistently denied the existence of global warming.

Until recently, President Vladimir Putin argued that global warming was good news for Russia. At the 2017 Arctic: Territory of Dialogue international forum, he claimed it would result in “more favourable conditions for economic activity” in the northernmost reaches of the country. This idea isn’t as far-fetched as it might seem. In his bestselling book 21 Lessons for the 21st Century, historian and philosopher Yuval Noah Harari explained how Russia could stand to benefit from climate change: “Whereas higher temperatures are likely to turn Chad into a desert, they might simultaneously turn Siberia into the breadbasket of the world.”

But this year, the leader of the world’s fourth-largest greenhouse gas emitter changed his tune on climate change. Although Putin continues to insist the phenomenon can’t be confidently attributed to human activity, he admitted in June 2019 that Russia was warming 2.5 times faster than the global average. “This is a major challenge for us,” he said. “This is the reason for the floods and for permafrost thawing in the areas where we have fairly big cities. We must be able to understand how to react.”

According to Shiklomanov, global warming could affect as much as a fifth of infrastructure across the permafrost area by 2050, costing Russia approximately $84bn, or 7.5 percent of its GDP. As the tundra melts, underground methane is released, causing gas pipelines to explode. At the same time, Russia’s shoreline is eroding by an estimated four metres annually, increasing the risk of damage to offshore infrastructure. “All that coastal infrastructure is extremely important and exceedingly vulnerable,” Shiklomanov told World Finance.

Russia’s coast currently witnesses an accident involving power stations, nuclear-powered icebreakers, chemical facilities or communications installations every three months. Needless to say, Putin’s new stance on global warming is a huge paradox: by curbing greenhouse gas emissions, he hopes to keep feeding and expanding an emissions-producing oil and gas industry. As the leader of the world’s second-largest oil exporter (see Fig 1), though, this position makes a certain amount of sense – arguably, the sector is simply too important for Russia to lose.

Greasing the wheels
Russia is sometimes referred to as a petrostate, but as analysts like Michael Bradshaw – a professor of global energy at Warwick Business School – point out, this obscures the specific and complex role that oil plays in the Russian economy: “Russia has a fairly substantial economy that is not resource-based. However, it’s increasingly clear that large sectors of the industrial economy are tied one way or another to the resource economy.”

While GDP and employment in petrostates such as Saudi Arabia revolve around oil and gas revenue, Russia has a relatively diversified economy. For example, the services sector makes up a larger share of Russia’s GDP than oil and gas (see Fig 2). Nonetheless, oil and gas revenues are still crucially linked to the non-oil economy in Russia, accounting for 40 percent of government income, according to the International Renewable Energy Agency (IRENA).

The wealth generated by oil and gas – known as oil and gas rents – is extracted by the state and channelled into strategically important sectors or the economy more broadly, either in the form of taxes paid to the government or as subsidies for other goods and services. This system, however, means Russia can only prosper so long as oil prices are high.

As such, its economy is extremely vulnerable to sudden changes in oil demand and supply. “If you go back to the 1980s, one of the factors that led to the eventual collapse of the Soviet economy was the fall in oil and gas prices and the loss of substantial rent to the economy,” Bradshaw told World Finance. “That volatility, of course, continued through the 1990s and 2000s, at times supporting the Russian economy and at times punishing it.”

One obvious way of reducing Russia’s exposure to oil shocks is through economic diversification, but such reform is made difficult by the fact that non-oil sectors are so heavily reliant on oil and gas rents. Moreover, beneficiaries of this system are reluctant to change the status quo. “Russia has been spectacularly unsuccessful in seeking to diversify its economy,” Bradshaw explained. “There’s been an awful lot of rhetoric, particularly under [Dmitry] Medvedev’s presidency, but very little change.”

To maintain government income in the short term, Russia has to keep expanding oil and gas production. Currently, the need to do so is urgent. Russia’s main oil and gas fields are depleting: according to the Financial Times, West Siberia, a critical oil-and-gas-producing region, has seen a 10 percent decline in output over the past decade. What’s more, a 2016 report by the Wilson Centre showed that Russia is increasingly dependent on production from its more remote East Siberian and Arctic offshore fields. Covered almost entirely by permafrost, these are some of the most inhospitable regions on the planet.

A pipe dream
As the Arctic sea ice retreats, the Northern Sea Route becomes more navigable to the world’s superpowers. With a fifth of its territory inside the Arctic Circle, Russia has long envisioned itself as the gatekeeper of this sea lane. Although the Northern Sea Route will never be as integral to global trade as the Suez Canal, it could nonetheless become an important passageway between Europe and Asia, saving freight companies millions of dollars and weeks in travel time.

Russia is convinced that its economic future depends on Arctic exploration. As well as opening up a globally important shipping route, the melting sea ice makes it easier to access rich supplies of fossil fuels. The US Geological Survey estimates that the Arctic may be home to as much as 20 percent of the remaining oil and gas reserves on Earth. On the surface, Russia would seem to be making great progress towards seizing these resources: in late 2018, energy giant Novatek finished building Yamal LNG, a $27bn liquefied natural gas (LNG) plant. By 2030, Moscow expects it to produce 60 million tons of LNG each year.

But extracting oil and gas in such a hostile environment with limited infrastructure is far from easy. “These are very capital-intensive areas where returns are not expected before 10 to 20 years of development,” Pami Aalto, a Jean Monnet professor at the University of Tampere, told World Finance. Consequently, oil and gas companies have to make large investments up front to carry out production, meaning they are often dependent on both government subsidies and foreign technology.

In this regard, Russia has faced some major setbacks. EU and US sanctions – imposed after Russia’s annexation of Crimea – limit the country’s ability to secure funding for new oil projects and import the hi-tech equipment needed for Arctic exploration. As Aalto points out, this presents a significant hurdle to Russia’s Arctic oil ambitions: “It is not feasible to explore, extract and develop much without international partners. In the Arctic, 80 to 90 percent of technology has been foreign, compared to 40 to 50 percent elsewhere in Russia before import substitution policies started big-time in 2014… Russian actors have been forced to [borrow] old equipment from Asia, and it is not in plentiful supply.”

At the same time, Moscow is struggling to provide the necessary subsidies as a result of budgetary constraints. According to the Kremlin, Russia needs to invest over $200bn in Arctic infrastructure between now and 2050 to make its ambitions a reality; so far, it has stumped up just $14bn. The thawing permafrost will only add to the required expenditure, as companies are forced to adapt their infrastructure and account for soaring repair costs.

Frozen in time
Economic activity in Russia’s Arctic territory accelerated under former Soviet Union General Secretary Joseph Stalin, who believed that Russia could achieve economic independence from the West by industrialising the resource-rich North. As these settlements grew, Siberia became the crowning glory of Soviet Russia – the communist state had tamed the frozen wastelands, creating economic powerhouses in a region where free marketeers would never have dared venture.

Infrastructure can be adapted to help reduce thawing, but this is expensive, particularly when done at scale

Putin is eager not to see the region’s economic prowess diminished. According to The Wilson Quarterly, Russia’s industrial base in the Arctic Circle currently accounts for up to 20 percent of the country’s GDP and nearly a quarter of its export revenues. And Putin is piling on the incentives to boost investment in the region: in addition to setting up the FPV, a special economic zone along its eastern coastline that offers tax and customs privileges, Russia awards 2.5 acres of free land in the Russian Far East to any citizen or foreigner willing to live there for at least five years.

However, the thawing permafrost raises questions over the viability of economic investment in the region. Infrastructure can be adapted to help reduce thawing, but this is expensive, particularly when done at scale. Moreover, it doesn’t stop the permafrost from thawing. With this in mind, Putin’s attempt to relocate citizens to these areas is not dissimilar to Indonesia or the Philippines encouraging migration to their shrinking coastlines.

“Nobody in their right mind in Russia will ever even consider building something like Norilsk again,” Shiklomanov said. “Now the question is, how do they maintain it? And should they maintain it or not?” Some analysts would argue not. Over the past few decades, there has been a steady exodus of people from the Far North and Far East to the bright lights of Moscow and St Petersburg. The small mining town of Vorkuta in the Komi Republic, for example, has a dwindling population of about 60,000 residents, down from 217,000 in the late 1980s.

One of the most basic reasons people are shunning these Arctic cities is the severe conditions. The coldest temperature ever measured outside Antarctica was recorded in the Yakutia region of Siberia. The other problem is that these cities are extremely remote – it takes 40 hours by train to get from Vorkuta to Moscow.

In their book The Siberian Curse: How Communist Planners Left Russia Out in the Cold, Fiona Hill and Clifford Gaddy argued that cities in the Far North and Far East are a hangover from the Soviet Union, and that Russia must abandon them for the sake of economic progress: “People and factories languish in places communist planners put them – not where market forces would have attracted them. Russia cannot build a competitive market economy and a normal democratic society on this basis.”

In many ways, these cities are frozen in time – snapshots of a Soviet past. Few people moved there by choice; most were driven there by fear and ideology. Under Stalin, hundreds of thousands of people – many of whom came from Baltic countries – were deported to this remote and hostile territory. As Gulag prisoners, they built Norilsk and other cities like it. Repopulating these areas feels like a step into the past – one last desperate attempt to relive the days of Soviet industrialisation.

Until recently, Russian President Vladimir Putin argued that global warming was good news for the country

The cold, hard facts
If Russia’s ambition to repopulate the Far North and Far East is backwards-looking, then so is its drive to exploit the fossil fuel resources there. Over the past decade, the cost of renewable energy has fallen drastically; assuming this trend continues and nations remain committed to decarbonisation, then it’s highly probable that the world will soon phase out fossil fuels. Consequently, the reserves of oil and gas that Russia is so desperately trying to retrieve from beneath the permafrost will decline in value.

“We are looking at a future of constrained demand and continuing supply,” Bradshaw told World Finance. “In that world, where oil prices are lower… new production in Russia outside of the established regions – be it in East Siberia or offshore – could be more expensive. In other words, you’re ploughing a lot of money into supporting an oil and gas industry that’s delivering less and less income.”

In 2017, Royal Dutch Shell CEO Ben van Beurden predicted that oil prices would peak in the late 2020s or early 2030s, after which point the industry should expect oil prices to be “lower forever”. In this future, the nations still economically dependent on oil and gas rents could see their power and influence on the geopolitical map wane. In its 2019 report, A New World: the Geopolitics of the Energy Transformation, IRENA described how the transition could “profoundly destabilise countries that have not prepared their economies sufficiently for the consequences”.

While Saudi Arabia is trying to curb its dependence on oil through its diversification plan, Vision 2030, Russia has no such strategy. In fact, Russia doesn’t seem to even acknowledge the importance of relinquishing fossil fuels. “They are, in true ostrich fashion, burying their heads in the ground – or firmly in the permafrost as it melts,” Bradshaw said. To demonstrate this, Bradshaw points to a case in 2014, when low oil prices – as well as US and EU sanctions – compelled Russia to develop its shipbuilding sector as a means of economic diversification. Even then, its diversification plan still benefitted the oil and gas sector, with ships being built to facilitate offshore production.

Russia has chosen to continue its resource dependence at the expense of long-term economic growth opportunities. Its plans to push industrialisation in its most inhospitable regions indicate that the country is yet to move beyond its Soviet past and set its sights on becoming a knowledge economy, rather than a resource-based one. In a world where oil and gas are no longer the arbitrators of global economic power, Russia could find itself falling further behind nations that prioritise alternative energy resources and technological progress.