US sanctions pose shipping hurdles for Russian Arctic LNG 2 cargoes to Asian importers

US sanctions on two vessels designed to serve as transshipment terminals for LNG cargoes from Russia's Arctic LNG 2 project are expected to create shipping bottlenecks for market participants, many of whom are Asian companies, according to traders and legal experts.

The US Department of State on Sept. 14 imposed sanctions on Arctic Transshipment Ltd(opens in a new tab), a Novatek-owned Russian company formed to operate two LNG floating storage units to facilitate shipping via the Northern Sea Route for Arctic LNG 2. It also named the two vessels, Koryak FSU and Saam FSU, of which Koryak will be located in the eastern port of Kamchatka and Saam will be located in the west, near Murmansk.

The transshipment is needed because the Novatek-operated Arctic LNG 2 project is located in the Arctic and the first leg of the voyage involves the shipment of cargoes on special LNG carriers that can cut through ice sheets. The cargo then gets transferred to normal LNG carriers at designated terminals for the second leg of the voyage to customers.

Sanctions experts said following the Sept. 14 announcement no LNG carrier will be willing to load from the blacklisted terminals for fear of being named in the US Specially Designated Nationals And Blocked Persons List, effectively throttling transportation options for Arctic LNG 2.

The sanctions also risk parties who may be involved in the supply chain including charterers, vessel owners, shipping companies, commodity traders, brokers, equity offtakers and end-users.

"A wide range of sanctions have been put in place to disrupt Russia's economy and in particular its energy sector. As with existing trade with Russia, customers will need to make sure that they are not exposed to any sanctions that have been applied," Avryl Lattin, a partner at Clyde & Co, said. "For example, Australia's sanctions regime currently prohibits the import, purchase or transport of Russian natural gas products."

Ernest van Buuren, another partner at Clyde & Co said: "A key issue is that many autonomous sanctions regimes have extraterritorial operation so, regardless of where the conduct occurs, there may be exposure to a number of different sanctions regimes in different countries."

Van Buuren said autonomous sanction regimes also vary from country to country.

"We've experienced this with shipments coming out of Russian ports in the Black Sea involving oil. This is a particular concern for multinational companies that may have activities in a number of different jurisdictions," Van Buuren added.

Elevated shipping risks

LNG from Arctic LNG 2 can still be shipped on vessels that operate outside the framework of Western sanctions and shipping insurance. But blocking the use of the transshipment terminals means that the special Ice-class LNG carriers may have to make the full voyage to end-users.

This becomes problematic as several Ice-class vessel orders had been cancelled due to sanctions payment issues, creating an overall shortage of tonnage needed to move the cargoes. Moreover, operating a so-called "shadow fleet" will come with its own risks.

"Those entities which assist or facilitate sanctioned activity in some way, will also be at risk, even if not directly buying, selling or transporting sanctions good or dealing with sanctioned entities," Van Buuren said. "For example, anyone who finances international trade or finances the equipment used in international trade, has an exposure risk."

He said such issues have arisen in respect of shipping and transportation of oil and similar issues could arise with respect to the export of LNG.

"Another point to consider in the context of Russian entities such as Sovcomflot is that where an entity or individual is designated under a sanctions regime, there is a prohibition on engaging in commercial activities with such designated entities or individuals," he said when asked about existing sanctions on Russia's national shipping company that were imposed in Feb. 2022.

Supply chain risks

Arctic LNG 2 has not sold a large portion of its capacity under contracts, and there may be a need to push more cargoes onto the spot market where trading intermediaries could get involved, and cargoes could end up in markets that have already been skirting oil sanctions like India and China.

Van Buuren said trading intermediaries may similarly fall within the scope of Russian sanctions regimes if they are involved in the import, purchase or transport of Russian natural gas products.

"This is common with international trade as it's extremely rare to see a direct sale between the original seller and ultimate user or buyer for commodities such as oil and gas," he said.

"There is also a move by some jurisdictions to impose sanctions with respect to activities undertaken in 'third countries' where there is intention to circumvent sanctions," Lattin said, adding that transshipment of products has been identified as a particular focus for enforcement of sanctions breaches, as is co-mingling of cargoes or processing into something that is sold as a different product.

She said that in terms of precautionary measures, in some jurisdictions, some entities can defend against breach of sanctions laws if they can demonstrate they "took reasonable precautions and exercised due diligence" to avoid breaching sanctions, or they can obtain exemption permits.

Lattin said end-users and importers of prohibited goods can be vulnerable to sanctions breaches, depending on whether they resell the product in another form, disguising its origin.

"Although LNG export from Russia has continued into certain countries, if this starts to compensate Russia for loss of other exports, then governments may decide that sanctions do need to be put in place for LNG as well," she added.

More risks, fewer options

Asia's LNG importers have so far continued their Russian LNG imports under term contracts as these were signed before some sanctions took effect, but the ability to do new business such as spot transactions has been hampered, other legal experts have said.

This still leaves the offtakers of Arctic LNG 2 with more risks and fewer options going forward.(opens in a new tab)

"While there are significant trading restrictions now in place with respect to Russia, the sanctions regimes do not prohibit all trade and investment with Russia," Lattin said. "Companies need to understand their sanctions risk exposure, undertake a thorough risk assessment for their operations, carry out thorough due diligence and constantly monitor the application of various sanctions regimes to their business. This is no easy task."

China's state-run CNPC and CNOOC each have a 10% state in Arctic LNG 2, while Japan's Arctic LNG, which is JOGMEC (75%) and Mitsui (25%), has a 10% stake. Additionally, Novatek signed offtake agreements from Arctic LNG 2 with several second-tier Chinese energy companie(opens in a new tab)s.

Novatek, CNPC, Mitsui has yet to respond to enquiries.

CNOOC said it has been working closely with Arctic LNG 2 partners to progress the project but did not provide further details.