Political and Reputational Risk Factors in the Arctic

(from Lloyd’s Report 2012: Arctic Opening – Opportunity and Risk in the High North)

Many of the political and reputational risk factors associated with Arctic development are common across frontier developments. However, the political importance of the Arctic in domestic politics, the high international public profile of the Arctic region, and the region’s environmental sensitivity could increase the potential impact of these risk factors. Levels of political risk vary widely across the region, depending on the stability of the rule of law and quality of the legal framework, the role of government bodies in shaping liabilities and influencing outcomes and the perceived likelihood of state appropriation. In Greenland, where oil and gas exploration has widespread public support, the political risks associated with development may be considered relatively low. In Russia, where appropriation of assets and political interference in commercial arrangements has affected oil and gas investments in the past, political risk is perceived to be much higher.

Reputational Risk

The high-profile and controversial nature of Arctic developments attracts a degree of reputational risk to Arctic investments, even without any environmental or other harm being caused (l). Should a problem occur, damage to a company’s reputation is likely to extend far beyond the jurisdiction in which it occurs. Even if culpability or negligence cannot be legally proven, or if the fault is shown to lie with contractors or partners, the primary company’s reputation is likely to be harmed. This could potentially result in closer scrutiny and political opposition to that company’s role in other jurisdictions, as well as possible exclusion from the jurisdiction in which the event occurred. The social Arctic licence-to-operate is hard to win and easy to lose.

Companies investing in the Arctic should also be mindful of the reputational risks of being seen to benefit from the impacts of climate change, as once development is established in the Arctic it will become harder to take action to reverse the effects of climate change. With shareholders taking an increased interest in environment issues (li), the decision to invest in the Arctic region may lead to greater shareholder scrutiny.

Regulatory and Legal Risk

In jurisdictions with high levels of litigation, court action can be highly effective in preventing or delaying drilling. In northern Alaska, litigation successfully prevented Shell from exercising its exploration rights under an offshore Arctic licence for several years.

Given the sensitivity of Arctic development, there is greater risk from changes in regulation or investment frameworks, following either a change of political leadership or a specific risk event, even one in which the company is not itself implicated. The moratoria on Arctic drilling in the United States and Canadian Arctic following the Macondo disaster are a case in point. More broadly, a public and government reassessment of the balance between competing economic forces – such as between fishing and offshore oil and gas development – could provoke some regulatory shift.

Given the trans-border nature of potential environmental risk events, a company would have to consider not only the implications of a risk event in one jurisdiction, but also the possibility of the involvement of multiple jurisdictions.

Domestic Political Risk

Political support for Arctic development, particularly in the mining and oil and gas sectors, varies considerably between and within Arctic states. Levels of political support are generally high in Greenland. They are much lower in the US and Canada as a whole – though generally high in Alaska and in Canadian territories that stand to gain employment or revenue through development. In Russia, central government support is critical in order to create tax and incentive structures that encourage the national strategic priority of maintaining or expanding oil and gas exports. As anywhere in the world, Arctic projects ultimately depend on the support of the communities and countries in which they operate. Without this, development cannot take place.

In 2006 Royal Dutch Shell negotiated the rights to operate the Sakhalin II project to drill for hydrocarbons on the Russian-owned Sakhalin Island. However, Russian regulators then claimed to have found environmental inconsistencies that required the suspension of the project. It has been suggested that Shell was then put in a position whereby it needed to sell its majority stake in the project to Russian-owned Gazprom in order to “resolve” the environmental difficulties and to maintain the Shell license in the region¹ . Although Sakhalin is not located within the Arctic as defined by our report, the uncertain political and regulatory environment means that a previously agreed drilling licence could be confiscated in any number of the hydrocarbon fields in the Arctic region.

Geopolitical Risk

Operations in the Arctic are exposed to the same range of political and geopolitical risks as in other parts of the world, including terrorism, though these are relatively much lower than in some frontier areas of development. For the foreseeable future, all offshore developments will take place in areas that are unlikely to be subject to territorial dispute between Arctic states.

However, in addition to the uncertainties outlined in section 2.5 there are a number of scenarios that could lead to dispute, drawing in or directly affecting private companies:

• If exploration licences were granted in the disputed areas of the Beaufort Sea, companies that began active drilling in that area could find themselves exposed to political disagreement between the US and Canada.

• If the Svalbard authorities allowed exploration and drilling for oil near the Svalbard archipelago on terms that signatories considered to be in breach of the Svalbard treaty, then geopolitical tensions might rise, with consequences for investors.

• In a situation of military tension between Arctic states, whether resulting from Arctic political disagreements or from a spillover from non-Arctic geopolitical competition, Arctic installations might be exposed.

• Terrorist actions could target Arctic installations with substantial commercial and environmental consequences.

However, at the time of writing these are relatively unlikely scenarios. Managing and mitigating them depends on additional state surveillance of land, sea and air communication and co-operation between the military forces of Arctic countries, adequate constabulary capability across the Arctic, a clear understanding between Arctic states of the scale and role of military forces and, in extremis, sufficient military forces to protect economic assets.

For Arctic shipping the political and geopolitical risks are somewhat different. Disagreement over the legal status of the Northwest Passage and potentially over the status of Russian Arctic waters could lead to claims that double standards are being applied, or to claims of a contravention of the Law of the Sea (LOS) provisions, including those relating to “ice-covered waters² ”. To the extent that Arctic states – particularly Canada and Russia – seek to apply special regulations on shipping in the Arctic, above and beyond any internationally agreed conventions, there is scope for disagreement (lii).

Footnotes:

(l) These reputational risks are widely recognised by companies operating in the Arctic and by governments.

(li) See PWC report (2011), Shareholders press boards on social and environmental risks http://www.ey.com/Publication/vwLUAssets/CCaSS_social_environmental_risks/$FILE/CCaSS_social_environmental_risks.pdf

(lii) This would include regimes such as the Canadian Arctic Waters Pollution Prevention Act (AWPPA) which place additional requirements on shipping in Arctic Waters.

Charles Emmerson, Glada Lahn, 2012, Political and Reputational Risk Factors in the Arctic, Lloyd’s.©