Northern Sean Route Development (Jsimm@Posri.Re.Kr)

Special Report | Korea-Russia Economic Cooperation in the Far East Research Institute Special Report

Imm, Jeong-seong _ Senior Principal Researcher, POSCO Research Institute Northern Sean Route Development ([email protected])

Oh Young-il South Korea Should Find Strategic Partners to Make the Most of the Northern Sea Route _P76

Park Hyun-wook Shipbuilding, Steel and Shipping Industries will Benefit from Northern Sea Route Development _P82

Lee Sung-woo Uncertain Fees, Lack of Ports of Call: Daunting Tasks Lie ahead for Commercialization of the Northern Sea Route _P86

75 SPRING 2014 VOL.14 POSRI Chindia Plus Quarterly 76 Special Report | Current Status of Arctic Ocean Development Research Institute

Oh Young-il _ Senior Principal Researcher, POSCO Research Institute [email protected]

South Korea Should Find Strategic Partners to Make the Most of the Northern Sea Route

Arctic Ocean development will bring significant changes to the global economy, from resource development and new shipping routes to new business opportunities. Korea can also expect some benefits. Recently, Korea has seen mounting interest in the Arctic Ocean. However, government policies and corporate strategies related to developing the region should be dealt with in a cool- headed manner. What we need now is objective analysis to bridge the gap between rosy projec- tions and reality.

Fact Sheet

An Overview of the Arctic Ocean •The area above latitude 66°33"North •Lies north of the timberline •Average temperature of less than 10°C in July (the hottest month) Size •12 mil.㎢ (55 times the size of the Korean Peninsula, 3% of the total area covered by the world’s oceans) •70% is an abyss more than 1,000 m deep, the remaining 30% is continental shelves •21 mil.㎢, including continents (6% of the Earth’s surface) Population •4 mil. residents (Arctic Human Development Report) •50% is Russians, the rest are native peoples, incl. Inuits and Yupiks

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Now that the Northern Sea Route and resource Currently being developed by Russia’s Novatek, development in the Arctic Ocean have become a the South Tambey field will export gas in the form reality, neighboring coastal states and major coun- of LNG from 2018. But in order to do that, the tries are turning their eyes to the Arctic Ocean in Northern Sea Route (NSR) must be developed order to gain the upper hand in the region. The first. As Russia wants to enter into long-term con- South Korean government also has such an inter- tracts for LNG exports through the NSR, it is trying est in the region that it has placed participation in to persuade South Korea, China, and Japan—the Arctic Ocean development on the national agen- potential buyers of Russian LNG—that shipping da. Interest has run especially high in the govern- through the NSR is safe. That is why Russia is ment and the private sector after South Korea sending an upbeat message to the world about gained permanent observer status on the Arctic navigation along the NSR. Council last May.

Keen interest in the NSR Resource development triggers Arctic Ocean development Currently, East Asian ocean freight shipping from Asia to Europe travels through the Suez Canal via Arctic Ocean development involves many areas Hong Kong and Singapore. Compared to the Suez and specialties including resource development; Canal, crossing the NSR can reduce the navigation polar navigation; ice-strengthened (ice-class) ship- distance by 40% and the travel time by ten days. building; special equipment and IT technology for Economic benefits are still low as navigation navigating during the long darkness; port develop- through the NSR is possible only in the summer ment; steel for energy in the polar regions; and season and cargo shipping is not easy due to high ship repair yards. Among these, resource develop- icebreaker escort fees and insurance premiums. ment has driven Arctic Ocean activity the most. However, global logistics routes will face sweep- To be more precise, Russian resource developing changes in 2017 when a 100-day shipping sea- ment in the Arctic Ocean. Fierce competition on the Northern The Arctic Council son becomes viable for commercial shipping. The Arctic Circle is home to nearly a quarter of Objectives and Major Activities With high expectations for the future, some the world’s untapped oil and natural gas—90 bil- Sea Route occurs behind the •Established in 1996 Korean port cities—Donghae and Samcheok in •Chair: Canada (Chairmanship rotates every two years) lion barrels of oil and 1,669 trillion cubic feet of scenes. Some Korean port cities, •Six Working Groups are high-ranking intergovernmental meetings Gangwon Province followed by Ulsan, Pohang natural gas. The region is also known to have on Arctic Ocean development focusing on issues such as Arctic and Busan—have joined the behind-the-scenes monitoring and environmental protection abundant reserves of gas hydrates, iron ore, nick- such as Ulsan, Pohang and Busan, competition to become ports of call for the Arctic Eight Member States Ocean. They intend to become ocean freight el, copper, uranium, and other minerals. Approxi- are attempting to transform them- •Coastal states: U.S., Canada, Russia, Norway, Denmark (Greenland) mately 40 out of 60 large-scale crude oil and natu- •Non-coastal states: Sweden, Finland, Iceland hubs to Asia and Europe, an area which has been ral gas fields in the Arctic Circle are concentrated selves into logistics hubs for the Permanent Observer States dominated by the ports of Hong Kong and Singa- in Russia, but only the South Tambey field located France, Spain, Germany, U.K., Poland, Netherlands, South Korea, pore. Port development promotes not only the Arctic Ocean China, Japan, India, Singapore, Italy on the Yamal Peninsula is bearing visible results. construction industry, but can also boost the lo-

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cal economy if shipyards, ship suppliers, bunker (NGOs). But the North Pole has no concrete inter- than actively engaging in Arctic Ocean develop- fuel stations, and various recreational facilities are national agreement. The Arctic Council that gov- ment out of concern for native peoples living in Differences between the South and all in place. erns policies concerning the Arctic Ocean allows the polar region. North Poles Competition will soon begin at the international only eight member states to participate fully in its South Pole North Pole level: the Far East ports of Russia which insists deliberations. In 2008, five states bordering the Continent More than 80% is territorial that 60-70% of the NSR is its coastal territory; Chi- Arctic Ocean announced the Ilulissat Declaration A clear approach based on waters or economic zones of na’s Port of Shanghai, the world’s largest container which mainly aims to block any “new comprehen- the coastal states objective analysis port; and the ports of Hong Kong and Singapore, sive international legal regime to govern the Arctic Almost no conflicting N o concrete international views under the Antarc- treaty or regulation which have long been regional shipping hubs. Ocean” while solidifying their rights on the Arctic Korean local governments have recently unveiled tic Treaty And North Korea’s Najin Port, an area jointly being Ocean and declaring their intent to strengthen their harbor modernization plans one after anoth- Open to non-consultative Only open to member states; developed by Russia and China, is another candi- their footing on resource development and eco- er in preparation for the NSR, apparently envisag- parties and NGOs for Ilulissat Declaration discussion date that should not be overlooked. nomic issues. ing container freight being transported from Ko- However, each Arctic Council member has its rea to Europe. However, they must consider that own interests in the Arctic Ocean. First, Russia has most of the freight shipped along the NSR is bulk Ripple Effects of Arctic Unstable governance makes shown its strong will to play a leading role in the cargo from Russia to Northeast Asia. If they are Ocean Development on Industry realizing the NSR elusive region, emphasizing that the Arctic Ocean is overly optimistic in projecting the timing for acti- above its continental shelves. This demonstrates vation of the NSR, their harbor facilities may end Resource Development As resource development in the Arctic Ocean how Russia is desperate to develop gas in the Arc- up sitting idle despite tremendous investments in may contribute in some way to stabilizing raw ma- tic Ocean and make active use of the Northern harbor facility repairs. Meanwhile, Korean con- terial prices, it would surely be welcome to re- Sea Route in order to counter U.S. shale gas devel- struction companies are increasingly showing in- Need to Develop Steel Demand source-importing South Korea. If the NSR is development. Aside from Russia, Norway is the country terest in port development in the Russian Far NSR for Resource for Energy in the Transportation Polar Regions oped, Korean ports with geographical advantages that benefits most from Arctic Ocean develop- East. They should know that port development are highly likely to benefit. Moreover, the ship- ment. On the basis of good neighborly relations, related to the NSR must focus on ports in North- building and steel industries may also benefit from Norway has reached an agreement with Russia on ern Russia, such as Murmansk Port and Sabetta Port Development Fueling rising demand for special steels tailored to the po- the demarcation of their maritime borders and has Port, rather than those in the Russian Far East. Vessel Supplies Navigation & IT Devices lar regions for resource development and opera- the largest number of operations in the NSR. Nor- This is also because of the very nature of cargo Development of Port Cities tions in the Arctic Ocean. way is also building a national logistics base in the shipping on the NSR. Shipbuilding for the Arctic Ocean However, some variables remain before such Arctic Ocean. On the other hand, the U.S. main- Although Korea has earned a more favorable Special Steels high expectations are realized as the international tains a lukewarm stance, because active resource footing since gaining permanent observer status Repair Shipyards Ship Financing community has a complicated web of interests in- development in the Arctic Ocean could negatively on the Arctic Council, it has very limited areas for tersecting in the Arctic Ocean. Though the North impact its booming shale gas industry. In addition, leadership. Therefore, it is important to forge stra- Pole may seem similar to the South Pole, the two the U.S. is partially limited in using the NSR as it is tegic alliances with those countries that are able to are actually governed by very different conditions. the only Arctic Council permanent member that play a leading role in developing the Arctic Ocean. The South Pole has a concrete international agree- has refused to ratify the United Nations Conven- But this also requires concrete goals. Rather than ment, called the Antarctic Treaty, which is open tion on the Law of the Sea (UNCLOS). And Cana- vague expectations or following trends, Korea for discussion to consultative parties, non-consul- da, which currently chairs the Arctic Council, is fo- needs a comprehensive perspective on Arctic tative parties and non-governmental organizations cusing only on environmental protection, rather Ocean development.

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Park Hyun-wook _ Senior Business Analyst, HMC Investment Securities [email protected]

Shipbuilding, Steel and Shipping Industries will Benefit from Northern Sea Route Development

The Arctic Ocean is said to hold underground 22% of the world’s undiscovered oil and natural gas re- sources. Resource development is underway in part of the Arctic Ocean and will become more active in the future. Such active resource development will impact primarily the shipbuilding, steel, and shipping industries.

Competition for new technologies provides opportunity for South Korean purpose ships suitable for navigation at the polar re- won orders for jack-up rigs specially designed for an expanding market could provide great opportu- shipbuilders gions, such as icebreaker LNG carriers, is expected exploration in the North Sea, which has a harsh nity for South Korean shipbuilders in the future. to grow. South Korean shipbuilder Daewoo Ship- environment similar to that of the Arctic region. The resource development landscape at the Arctic building & Marine Engineering has firm orders for 16 Such experience is an important asset for South is changing from onshore development to offshore icebreaker LNG tankers worth KRW six trillion in the Korean companies responding to future demand Long-term demand for steel pipes development, and from Pipeline Natural Gas (PNG) first quarter of 2014. Such technology and experi- in the region. for energy to rise to Liquefied Natural Gas (LNG). Under such chang- ence will lay a foundation for South Korean ship- The floating LNG market is also anticipated to ing circumstances, further orders will be placed for builders to stake an early claim to the market. grow in the long term. Floating Liquefied Natural Demand for steel materials in energy applications, plants and special-purpose ships necessary for off- Singapore’s Keppel, the world’s leading manu- Gas facilities require no onshore plant to develop mainly developing and transporting natural gas shore resource development, including jack-up rigs facturer of special jack-up rigs for resource devel- offshore natural gas, thus reducing costs by 20-30%. and oil, is also expected to rise in the long term. and other offshore drilling units, LNG vessels, and opment, is known to have started building a jack- United States-based Shell, the company most ac- Total demand for steel pipes to be used in Arctic FLNG (Floating Liquefied Natural Gas) units, which up rig for the project. While the jack-up rig market tively involved in FLNG projects, is examining projects from 2013 to 2018 is estimated at around are offshore plant units that drill, refine, liquefy, is expected to prosper in the future, there have ways to apply this technology in the Arctic region. 10.2 million tons. As the total world demand for store and transfer natural gas at sea. been no reports of South Korean shipbuilders win- But SHI and DSME are the only two companies in steel pipes is currently 120 million tons, this trans- Once developed, offshore natural gas is exported ning orders for jack-up rigs in the Arctic. But last the world to have taken orders for FLNG facilities. lates to an increase of only 1.4%. While that figure in the form of LNG. Therefore, the market for special- year, Samsung Heavy Industries (SHI) and DSME As one FLNG unit costs more than USD two billion, may seem small at first, demand for steel pipes to

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The second summit between President Park and Putin may help the two countries enhance their strategic partnership.

be used in Arctic projects is concentrated in Rus- alize visible structural changes. By using the NSR, main to negotiate with Russia to make icebreaker sia, where such demand will grow by 11% each the navigation distance between Northern Europe escort fees more realistic. Major Global Oil Companies’ Upstream Investments and Crude oil Production year. With the U.S., the largest steel pipe market and East Asia can be reduced by about 30% com- Container shipping can be carried out only on for Korea, trying to raise trade barriers on South pared to the Suez Canal route. As travel times de- a specific route during a specific period. As the (USD 1 bil.)  Upstream investment (L) (Toe/d) 140 Crude oil production (R) 14600 Korean steel pipes, Russia could provide new op- crease, costs will also drop. According to domes- thawing season is only three months, it is hard for portunities for South Korean steel pipe manufac- tic and international researchers, the unit cost of South Korean container ships to qualify for regular turers. This is meaningful because South Korean shipping through the NSR, if fully opened, is esti- liner status. And due to environmental restrictions, steel pipe exports to Russia have traditionally mated to fall by 14-21% compared to the current large-scale vessels can operate only on a limited 70 13600 been low and increased sales could reduce risks cost of shipping through the Suez Canal. basis. For the moment, Northern Sea Route devel- from regional concentration. The biggest hurdle for using the NSR is high opment may not have a significant impact on As orders for offshore structures, icebreaking icebreaker escort fees. Russia currently charges South Korea’s shipping industry. In the long run, tankers, and icebreaking LNG carriers increase hefty icebreaker escort fees for container ships however, importing natural gas and oil from Rus- 0 12500 with Arctic development, South Korean shipbuild- traveling through the NSR. In order to keep con- sia will provide opportunity for some South Kore- 4 5 6 7 8 9 10 11 12 Source : BP, Chevron, Shell, Exxon Mobil, HMC Investment Securities ers will take more orders and demand for thick tainer shipping costs competitive, challenges re- an shipbuilding companies. plates will go up. If steel companies and shipbuilders jointly respond to demand to develop technol- Shipping Distance Between Busan and ogies for steel materials for energy, they will also Major European Ports contribute to stabilizing demand for and supply of (Knot)  NSR  Suez thick plates in Korea. 140 Regaining Leadership in Resource Development Container shipping under structural and E&P in the Deep Sea and the Polar Regions 70 transformation Global energy companies such as ExxonMobil and Shell have made significant progress in resource develop- As energy development projects continue in the ment and E&P (exploration and production) in the Arctic Ocean region. In cooperation with Russian companies Arctic, the Northern Sea Route (NSR) will draw including Rosneft, offshore development projects in Russia will begin exploration from 2015. International Oil Companies (IOCs) that have lost the initiative in shale gas development technology cannot sit idly by as develop- 0 considerable interest as a channel for transporting ment continues in the deep sea and the polar regions. Upstream investment by E&P companies in new oil and Bremen Rotterdam Antwerp Lisbon Valencia natural gas and oil produced in the region. But in Source: KMI, HMC Investment Securities gas fields has increased significantly compared to where it stood before the financial crisis, demonstrating their terms of container shipping, it will take time to re- strong will to secure new oil and gas fields. Although Arctic development requires massive funding and entails high risk, losing the leading edge in the supply market could gravely threaten the survival of IOCs and countries like Russia, which are highly dependent on the energy industry. Therefore, they will continue to make large investments in order to secure new oil and gas fields at the North Pole and control related technologies. In the long term, this will intensify competition in the energy supply market, resulting in lower, more stable energy prices. This is also likely to change the gas market from a sellers’ market to a buyers’ market. And if such trends continue, utility companies that generate power from LNG and coal may be able to secure gas and coal at low prices. Bird’s eye view of Samsung Heavy Industry’s icebreaking LNG carrier

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Lee Sung-woo _ Head of International Logistics Research Division, Korea Maritime Institute [email protected]

Uncertain Fees, Lack of Ports of Call: Daunting Tasks Lie ahead for Commercialization of the Northern Sea Route

Stena Polaris operated by Hyundai Glovis on the Northern Sea Route. On October 22, 2013, Hyundai Glovis be- came the first South Korean shipping company to successfully navigate the Northern breakers themselves, most of the reasons appar- rates to boost freight volume. If the freight volume Sea Route (NSR). Some 35 days after load- ently involved supply and demand for Russian through the Northern Sea Route increases, the ing 44,000 tons of naphtha at the Russian icebreakers. Russia has four more new nuclear- NSR could see a replay of what has been happen- port of Ust-Luga, the Swedish-owned, Korean- powered icebreakers in the pipeline and plans to ing with the TSR. operated Stena Polaris arrived at the South build another eight. Taking into consideration the Currently, Russia imposes an average tariff of Korean port of Gwangyang. This is truly a Russian national character and the country’s finan- five USD per ton for NSR cargo traffic. This tariff can meaningful event as it demonstrates the possibili- cial situation, however, the shortage of icebreakers go up or down through negotiations with Russian ty for commercial freight travel through the NSR. along the NSR is likely to continue for a while. authorities, who currently keep the tariff low in or- Still several issues clearly remain to be resolved. der to attract vessels to the NSR. Though such cas- es are rare, the NSR cargo tariff can be significantly Russia’s unstable pricing reduced through negotiations. The Russian govern- Ongoing shortages of icebreakers ment needs a tremendous amount of funds for the are under repair, only three are currently in opera- Part of the freight from Northeast Asia to Europe is construction and operation of icebreakers. Ulti- Initially, the estimated travel time was 30 days, but tion. In 2013, 710 applications for navigation transported through the Trans-Siberia Railway mately, the only way to raise such funds is to col- it actually took five more days. The delay was at- through the NSR were filed with Russia’s Northern (TSR), which crosses the country from east to lect them from vessels traveling through the NSR. tributed to an extended wait for a Russian icebreak- Sea Route Administration (NSRA). Of those, 629 west. Freight volume on the TSR has been fluctuat- er escort. One should bear in mind that navigating were approved but only 71 actually resulted in tran- ing over the past decade, mainly due to Russia’s the NSR requires a Russian escort because about sit through the NSR. There may have been many inconsistent, seesaw-like pricing. If the flow of Severe shortage of ports of call 60% of the NSR is owned by Russia. Russia current- reasons for travel not to be completed despite ob- goods increases, it raises freight rates to make ly has five nuclear-powered icebreakers. As two taining permission. Except for problems on the ice- profits; if the cargo traffic falls, it discounts the Most long-distance routes have ports of call, inter-

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The development of the Northern Sea and commercialization of the NSR should be dealt with from a realistic point of view.

mediate ports where ships customarily stop for with a view to protecting the Arctic environment. The average area covered by icy Arctic waters over the past 35 years transshipment of cargo, refueling, repairs, and Under this mandatory code, shipping companies (Unit: 1 million ㎢) emergencies. As the Northern Sea Route is fairly would have to replace their existing freight vessels 13.0 Has Arctic Sea Ice long with a distance of 15,000 km, it desperately to use the NSR. Of course, in response to global calls 12.0 needs such ports. The NSR has 19 ports of call, but for cleaner energy, South Korean shipping compa- Increased Again? not a single one functions properly. Port develop- nies are replacing conventional vessels with envi- 11.0 ment and remodeling on a massive scale would ronment-friendly ones; however, in reality it is im- be a prerequisite for the NSR to become more ac- practical to change all vessels at once. In addition, 10.0 The New York Times reported on Sep- tive. However, it is questionable how much the travel through the NSR requires vessels to be ice-re- tember 21, 2013 that sea ice in the Arctic 9.0 Ocean increased last year compared to Russian government will pay for port development sistant or equipped with ice-breaking functions, 1978 1983 1988 1993 1998 2003 2008 2013 to assist foreign ships navigating through the NSR. which can also be quite expensive. Ultimately, ship- Source: National Snow & Ice Data Center, www.nsidc.org, Dec. 4, 2013 the year before, according to data collect- ed by the U.S. National Snow and Ice Data As the NSR has unique environmental condi- ping companies must bear in mind the steep initial Center (NSIDC). In 2012, 24% of the Arctic tions brought about by the severe cold weather, investment required to make proper use of the NSR. Ocean was covered with ice by the end of those conditions must be factored in urban devel- One can easily anticipate another problem. ment of the Northern Sea and commercialization the September melting season while the opment, energy supply, construction of harbor While consignors may welcome reduced shipping of the NSR should be dealt with from a realistic coverage area rose to 36% in 2013. This loading and unloading facilities, and other works. times, this will also lead to idle vessels for the ship- point of view. Rather than considering the NSR a runs counter to the general projection For example, the Northern Sea coastal area is ping companies. This will eventually reduce ocean “golden route” where commercialization can be that the Arctic will see ice-free summers prone to liquefaction, with soil deposits melting in freight rates. realized right away and freight traffic will rise sig- by 2030. However, scientists at NASA and the summer until the ground looks like a sponge, Compared to the conventional shipping route be- nificantly overnight, South Korea should take a the NSIDC said that much of the ice added in 2013 is thin and slushy, a far cry from thus making it impossible for ordinary concrete tween Europe and Northeast Asia, the Northern Sea gradual approach to the NSR from a mid-to-long- the thick Arctic ice of the past. As Arctic structures to stand. This means that operating fa- Route is shorter by 8,000 km. This means that de- term perspective, if it wants to make the most of it. sea ice has been melting in a cyclical pat- cilities should be tailored to such harsh weather mand for ships operating between the two regions In this light, South Korea needs to build a logistics tern—declining for several years and in- conditions. It is a daunting task to find any one will be affected, and a surplus of vessels will result network based on ongoing resource development creasing for several years—this year’s in- who will do such work even with a lot of funding for that 8,000 km span. One should not overlook that projects in Far East Siberia, China’s three north- crease does not change the general and advanced technology. the hasty commercialization of the NSR will pose a eastern provinces, Mongolia, and other northern melting trend of Arctic sea ice, they added. risk of demand reduction not only to South Korean areas. When the inland logistics networks are companies, but to global shipping firms as well. properly in place for importing to and exporting Shipping companies’ deepening agony from these regions, the NSR will be able to accom- modate freight needs, and subsequently logistics Shipping companies should also take into account The need for a realistic approach infrastructure. Moreover, South Korea should international conventions on environmental protec- to NSR strengthen its bond with East Asian user countries tion among other things when navigating through in order to gain the upper hand on governance the NSR. The Polar Code, soon to be released by the While the Northern Sea Route is important for the with Northern Sea coastal states, to take the lead International Maritime Organization (IMO), is highly national interest and at the top of the economic in environment-friendly shipbuilding technology, likely to ban the use of bunker C fuel oil for ships agenda, commercialization of the NSR will likely and to establish close cooperation with Russia. operating in polar waters. This would be aimed at be for naught without preparations for and solu- These are key prerequisites for South Korea to promoting the use of light oil or liquefied natural gas tions to the issues mentioned above. The develop- commercialize the Northern Sea Route.

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