Russia Arctic Route to Rival Suez May Aid Sovcomflot IPO: Freight Markets

Russia plans to revive a Soviet-era Arctic sea passage to service energy projects and provide a shorter supply route to Asia for carriers such as OAO Sovcomflot as the shipping line prepares for an initial share sale this year.

Opening the northern sea route may allow state-owned Sovcomflot to speed natural-gas deliveries to China and win cargos between Europe and Asia by offering a quicker alternative to the Suez Canal.

“If Russia gives the green light to develop this as a full commercial transit route, it would make Sovcomflot’s whole investment case completely different,” said Chris Weafer, chief strategist at ING Bank NV in Moscow. “It would make it more attractive to potential investors.”

Sovcomflot, along with companies such as OAO Novatek, is sending test cargoes via the Arctic route, which Prime Minister Vladimir Putin has vowed to transform into a year-round passage. To make it work, Russia must revamp ports, install rescue systems and build icebreakers for as much as 30 billion rubles ($1.1 billion) each to provide safe passage for tankers.

The northern sea route dates to 1932, when the Soviet Union sent the first vessel from Arkhangelsk to the Bering Strait. The route, open from July to November, is about a third shorter than the almost 13,000-mile journey from Rotterdam to Yokohama via the Suez Canal, saving time and fuel.

It also may attract carriers seeking to avoid pirates in the waters of East Africa and “Arab Spring” revolutions in the region around the Egyptian waterway.

Strategic Investor

Russia hired Morgan Stanley (MS) on June 30 to manage the sale of a quarter of Moscow-based Sovcomflot. The deal may take place in October or November, Alexei Uvarov, head of the Economy Ministry’s property department, told reporters last month.

The company has borrowed on international debt markets, selling $800 million of seven-year bonds yielding 5.375 percent last year.

Some shares ideally would be sold to portfolio investors with a block going to a strategic buyer, ING’s Weafer said. That would be consistent with government efforts across the economy to attract international partners with industry expertise while also raising cash.

“That would kill two birds with one stone,” he said. “Natural investors would either be Japanese or Korean shipbuilders.”

So far, there’s been no talk of a strategic sale, Sovcomflot’s Executive Vice President Nikolai Kolesnikov said by e-mail. Andrei Babakhanov, head of the company’s fleet department, said in an interview that it’s too early to assess the benefit of the northern sea route for the company’s value.

LNG Demand

Sovcomflot plans to expand its gas transportation business as energy producers gear up to bring Arctic projects on line later this decade. In 2010, it shipped 70,000 metric tons of gas condensate through the Arctic for Novatek, which plans to start producing liquefied natural gas for sale to European and Asian customers at a project on the Yamal peninsula in 2016.

“Demand for LNG has grown in the east over the past two to three years in China, Japan, South Korea and Singapore,” Babakhanov said. “As Asian demand rises, the northern sea route will become very important strategically.”

The Russian government and private companies may invest 1 trillion rubles in producing gas at Yamal, as well as developing a port and building ships to service the region, Prime Minister Vladimir Putin said outside Moscow today.

Icebreakers in Demand

The OAO Gazprom-led Shtokman project in the Barents Sea, which may contain more than 3.9 trillion cubic meters (137.7 trillion cubic feet) of gas, may begin initial production in 2016. OAO Rosneft, Russia’s biggest oil producer, is developing fields in the Kara Sea that may hold as much as 35.8 billion barrels of potential resources. The Moscow-based company may drill its first well in 2015.

In all, Russia’s Arctic shelf may hold more than 100 billion tons of oil equivalent, according to the Natural Resources Ministry.

Even before tests are completed, demand for the northern sea route is rising. Atomflot, the state operator of nuclear icebreakers that charges commercial shippers for passage, said it has received 15 applications this year, about three times as many as in 2010.

Sovcomflot also plans to send one larger tanker -- 162,000 tons in deadweight -- along the route to China to benefit from economies of scale. For Tarko-Sale, Russia-based Novatek, the route will save 40 percent of the journey time compared with the Suez Canal and will be 20 percent cheaper, according to Babakhanov.

‘More Profitable’ Than Suez

“Northern sea shipping will become a more profitable route than the Suez Canal,” Leonid Mikhelson, Novatek’s CEO told reporters June 17. Russia’s second-largest gas producer may export seven condensate or light crude cargoes via the Arctic to Asia this year, he said.

Eurochem, Russia’s largest nitrogen-fertilizer producer, sent its first shipment of 44,000 tons of iron-ore concentrate to China via the route in July and plans to run monthly trips, logistics director Igor Nechaev said by phone.

Revolutions, Pirates

Moscow-based Eurochem isn’t saving money by using the northern sea route because it’s paying about $50 per ton of cargo for shipping and passage, the same as it would for the Suez Canal, Nechaev said. Still, it halves the time to 25 days and avoids risks stemming from Middle East unrest and pirates.

“There are revolutions in African countries -- you know the situation in Egypt -- hence there is some tension,” Nechaev said. “Sooner or later, shippers will hedge those risks,” he added, saying Eurochem wants a back-up route to the Suez Canal.

Traffic along the Egyptian waterway, which opened in 1869, rose 7.3 percent in the year through April to average 54.5 million tons a month, suggesting the route hasn’t suffered from the violence that toppled President Hosni Mubarak in February.

The number of global pirate attacks climbed 36 percent from a year earlier in the first half of 2011 as attempted hijackings off the coast of Somalia reached a record, according to the London-based International Maritime Bureau.

Tarek Hassanein, an official at the Suez Canal Authority’s media department, didn’t return requests for comment by e-mail and phone.

Breaking the Ice

To ensure safe passage through Arctic waters, nuclear icebreakers are required to smash through ice that’s more than 2 meters thick in parts.

Russia must retire 12 of its 15 nuclear- and diesel-powered icebreakers by 2020, according to the Transport Ministry, which says three nuclear and six diesel vessels, costing a total of 143.5 billion rubles, will be required to replace them.

“We will by all means replenish the country’s icebreaking fleet,” Putin told a meeting of the ruling United Russia party in Yekaterinburg June 30. “The introduction of these ships will allow us to ensure stable, year-round work in the Arctic and the passage of vessels along the entire route from the Pacific Ocean to the Atlantic.”

The future of the northern sea route will depend on Russia’s energy plans in the Arctic and demand among shippers for transit -- neither of which is clear as yet.

“We’re preparing infrastructure and icebreakers,” said Alexander Poshivai, head of shipping at the Federal Agency for Sea and River Transport. “We have to be ready, it’s a strategic route.”

Sovcomflot said it plans to purchase more than a dozen ice- class vessels this decade, betting on Arctic energy cargoes and transit. It calls its test runs along the route an investment in the future.

“Our task is to use large tankers, gain experience and interest clients,” Babakhanov said.

While the company’s role in the northern sea route remains unclear, an expansion of its existing operations may tempt investors, Ivan Mazalov, director of Prosperity Capital Management which manages $5 billion, said by phone.

“A Sovcomflot IPO would be even more interesting if they had another line of business.”

To contact the reporters on this story: Lyubov Pronina in Moscow at lpronina@bloomberg.net Stephen Bierman in Moscow sbierman1@bloomberg.net

To contact the editor responsible for this story: Balazs Penz at bpenz@bloomberg.net

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