Why Investors Should be Looking To The Russian Arctic For Opportunities

Op/Ed by Chris Devonshire-Ellis

• Northern Sea Passage Route is opening up the Arctic 
• Huge time and cost savings on China-EU shipping 
• Massive Arctic Free Trade Zone announced
• Significant tax and financial incentives  
• Free land use available 

The Russian Arctic might not initially seem the most obvious place for foreign investors to look at, however there is a great deal of regional investment going into the area. There are three principal drivers for this; Global warming; Russian LNG, and China trade. We can examine these and how they are impacting upon Arctic development as follows:

Global Warming

There are good points and bad points to this, the bad being the melting of permafrost resulting in land instability and damage to buildings. Methane gas emissions from a warming tundra also accelerate the greenhouse effect, further compounding the problem. Many flora and fauna species will become extinct. There is no doubt that global warming will wreak serious damage to the Arctic ecosystems and the entire phenomena is a global tragedy. Humans however are an exploitative species, and the warming opens up the long treasured Northern Sea Passage, a trade route that has been in the minds of adventurers and tradesmen for over 500 years.

The Northern Sea Passage

It was the British Muscovy Company that originally raised capital from investors to explore the possibility of a Northern Sea Passage back in 1555. It was the first major chartered joint stock company, the precursor of the type of business that would soon flourish in England and finance its exploration of the world. The Passage was never found viable, but the idea of trade both with Russia and to Asia via the Arctic never left either public, political or commercial imagination. Today, however, the Northern Sea Passage is becoming a sustainable route.

Arctic LNG

The now annual melting of Arctic Ice has opened up the route, which although carries some dangers, is ushering in a new generation of nuclear powered, Arctic capable vessels. Russia is a leader in this technology and is introducing new Icebreakers and Bulk Cargo Ships to handle these conditions.

I introduced both of these vessels in the article Arktika Nuclear Powered Icebreaker Clears Northern Sea Passage Route. 

A major driver in this development are the Russian LNG fields at the Yamal Peninsula in Siberia. “The Power of Siberia” project is by far the largest Belt & Road Initiative deal and involves several pipelines from Yamal to China. Phase one has already been completed and LNG is now being piped to China. Other pipelines are being considered, including via Mongolia.

Such pipelines are hi-tech. They need to be able to withstand temperatures as low as -62 °C (-79.6 °F). Nanocomposite coatings are used to increase the lifetime of the pipelines, which must also be able to withstand earthquakes by incorporating materials that will deform under seismic activity. Internal coatings ensure energy efficiency by reducing the friction of the pipeline’s inner surfaces. The Power of Siberia project alone provides China with enough LNG for the next 30 years.

However the Northern Sea Passage also provides for deliveries by ship and contingency should anything happen to pipeline supplies. India is also a customer for Russian LNG, and the first shipments began in 2018. Indian Prime Minister Modi, ever the businessman, when touring the Vladivostok Shipyards on a trip to Russia last year was impressed by the new technologies, and then asked if India could partner with Russia in the building of the Arctic generation of container ships – India has major yards in both Chennai and Gujarat – where Modi is from. With other Asian economies looking for energy supplies, Yamal LNG provides a clean and effective solution. The Yamal Peninsula is part of the Ob Bay and the Ob River estuary. A decision as to whether the Ob River will be dredged to accommodate more shipping traffic will be decided in December 2021. How much cargo it will send off into the Northern Sea Route isn’t yet clear, but it will mark a new turn in shipping toward the east and to Asia, instead of Europe.

China-Russia Bilateral Trade Growth

Bilateral trade between China and Russia has been increasing, and not just because of LNG. Russia has been forced to look east for new supply routes of its own, and for new markets for its products in the wake of Western sanctions. China too, following the US-China trade war experience, wishes to reduce exposure to US products. Bilateral trade is expected to grow by US$20 billion per annum and reach US$200 billion by 2024 making it one of the fastest growing trade corridors in the world. China has also incentivized Russian companies and traders to sell to and buy from China by cutting profits taxes when selling to China to 15% for Russian companies operating in border Free Trade Zones, while import taxes have been reduced in zones in Suifenhe, a trade zone in China’s Heilongjiang Province. China has additionally signed off a Free Trade Agreement with Russia’s Eurasian Economic Union, which although is currently non-preferential, will mean that when tariff reductions on various import-export products are agreed, trade will boom.

China-EU bilateral Trade Growth

China is the EU’s second largest trade partner, with over €1 billion a day in goods value changing hands. The Covid-19 pandemic has meant that in the absence of air freight, freight train numbers running from China to Europe and back have doubled in 2020. Meanwhile, the opening of the Northern Sea Passage will considerably reduce the time and cost of transporting goods from China to Europe. The distance from Northern Europe to China and vice versa, is about 40% shorter than via the Suez Canal or 60% shorter via the Cape of Good Hope. There are substantial reductions in transportation time, fuel consumption, environmental emission while also eliminating piracy risks. Additional cost savings by generating return cargoes from the Far East make this route doubly attractive. Investments are and will continue to be made to alter supply chains and exploit the Northern Sea Passage from now and for the next decade.

Northern Sea Passage – Supporting Infrastructure

However there is more that is being done to support the route. Russia is installing submarine Arctic high speed digital capability from Murmansk to Vladivostok, as atmospheric conditions in the high Arctic sometimes render satellite use inoperable.

Arctic Rail Network

Russia also intends to exploit its Arctic resources, and global warming makes access easer. However, infrastructure still needs to be either upgraded or built, and critical to Northern Sea Route development are new railway lines. Russia’s new development plan for the Northern Sea Route was signed off by then Prime Minister Dmitri Medvedev on the 21st of December last year, including the development of a new rail line to Sabetta, the main seaport for the Yamal LNG project. The decision whether to build a railroad between Arkhangelsk on the Arctic coast to Syktyvkar and Perm in central Siberia will be decided in 2022. By 2024, the government will decide whether to extend the railways west, from Salekhard on the southern Yamal Peninsula to the town of Novy Urengoy in the Yamal-Nenets Autonomous Region.

The Murmansk transport hub is also included in the plan, and when complete, will be the largest shipping point in Northern Russia. The Transport Hub project is key part of the Strategy for Transport System Development by 2030, a guiding document developed by the federal government. Along with the Sabetta Port in Yamal, it is the biggest infrastructure initiative in the Russian Arctic. Also part of these plans is the construction of a 28 km long railway line on the western side of the Kola Bay. The line will stretch from Murmansk, across the Tuloma River and to Lavna just to the West, and includes the building of a bridge across the Tuloma river. Lavna is being developed as a major sea deep sea port for coal handling, and a capacity of moving 18 million tonnes per annum. Phase 1 of Lavna’s development will see 50% of that capacity put into operation by December 2021.

These proposed routes will provide Northern Sea Passage rail connectivity as follows:

Arctic Airports 

Several Arctic airports, likewise, will get major upgrades. Four are in the process of being upgraded as the government plans for the development of the Northern Sea Route’s infrastructure begin to take shape. These include the airport complex in Amderma (east of the Nenets Region), a base for the development of oil fields, as well as the airport in Pevek (Chukotka). Yakutia’s Chersky airport is also being developed and is not far from the Kolyma river port, which is 130km downstream from the East Siberian Sea and a major processing base. The Keperveyem airport near Bilibino, Chukokta’s third city is also being upgraded and will improve links: only air transport currently connects Chukotka’s capital Anadyr with Bilibino.

Arctic Ports

Arkhangelsk 

Arkhangelsk Port sends and receives lumber, pulp, coal, machinery, metals, industrial and consumer goods, and is the operating base of the Northern Company, performing the maritime transport of the White, Barents and Kara seas, the Northern Passage and overseas lines. There are regular passenger liners from Arkhangelsk to Murmansk, Dikson, Onega, Mezen, Kandalaksha and Novaya Zemlya.

The Port itself has three cargo areas, a container terminal, and a passenger shipping company terminal. The total wharfage is 3.3 km, with berthing suitable for vessels with a draft of 9.2m and a length of 175–200 m. It also has 292,000 m² of warehousing facilities and a 2000m² Bonded Warehouse facility. It can handle 5,762 TEUs at the same time, including up to 200 reefer containers and 2,200 containers with dangerous goods. The Bandwidth container terminal allows 75,000 TEUs per annum.

Arkhangelsk is also being developed as an Arctic Marina. Over 15,000 small-size vessels are currently registered in the Archangelsk Region but existing moorings do not have modern equipment and do not offer a service package for sailors. The project concept is driven by the need to create a facility in Archangelsk for development of tourism, yachting and Arctic expedition tourism in Northern Russia. See more here.

Murmansk

Murmansk port ranks fourth in Russia in terms of processed goods and is the second largest in the northwest of Russia, after St. Petersburg. Murmansk is one of the largest ice-free ports in Russia, has 13 berths and is equipped with the modern handling facilities: 52 gantry cranes with the capacity up to 40tn, one shiploader for handling of apatite concentrate with the capacity more than 1000 th tn/hour, 113 units of fork trucks with the capacity from 1.5 to 32 tonnes. The entire city is classified as a Free Trade Zone and it is Murmansk that is expected to develop as a major hub for the Northern Passage. Current cargo turnover is about 16 million tonnes with this set to double by 2025.

Murmansk has also been designated as the de fact capital city of the Arctic, and is the administrative centre of the Arctic Free Trade Zone (see below). The city is 108 km from the border with Norway, and 182 km from the border with Finland. Flight times between Murmansk and Moscow are 2.5 hours, while the journey by road takes 24 hours. The rail journey is 12 hours. It is the largest city north of the Arctic Circle, with a population of 300,000 which is about 40% of the total population of Arctic dwelling peoples, including Europe, Canada and the rest of Russia.

Murmansk is also set to be the Russian terminus of the Arctic Bridge, a sea route linking it to  the Canadian port of Churchill, in Manitoba. Although the passage has not been fully tested for commercial shipping yet, Russian interest in this project, along with the Northwest Passage is significant, as the route will serve as a major trade route between Russia, Europe, North America and Asia. More about Murmansk as the capital city of the Arctic can be read here.

That status attracts new residents and brings wealth creation opportunities. Russian and other European investors are already making plans to position the city into an Arctic gastronomy hub with Arctic specific bars and restaurants serving the tourism industry. Smart roads are also being built between Murmansk and Kirkenes in Norway, thus creating better access to its neighbor and onto the EU.

Vladivostok

Vladivostok is very close to Russia’s border with both China and North Korea, and is Russia’s main Port opening onto the Pacific Ocean and markets in Japan, South Korea, Canada and the United States.  It is also linked directly to Moscow via the Trans-Siberian railway. It is a Free Port, with low tax incentives for investors (instead of CIT at the usual 20 percent, the Vladivostok CIT rate is 5 percent for the first 5 years, then 12 percent for the next 5 years), and has been heavily invested in by China’s Fesco. It is an increasing center for auto production, as well as containing several casinos, while the Port has all the expected services in place, and has a 200,000 TEU capacity per annum. Vladivostok is also home to the Eurasian Diamond Exchange, where gems from Yakutia, the world’s largest diamond mines are traded and processed for jewelry and industrial use. Numerous international diamond trading and processing companies are established in this zone.

Vladivostok has rail links through to Harbin, Beijing and the China national rail network while flights to Shanghai take just 3.5 hours. Additional information concerning Vladivostok can be seen in the article Vladivostok & The Russian Far East To Be Developed As A Significant East Asian Resource and Trade Hub. 

The Russian Regional Governor for Arkhangelsk Oblast Igor Orlov has stated that Russia’s northwest Arctic coastline will be operational and handling regular shipping by 2025. Chinese investment is already going into Arkhangelsk and Murmansk to further develop the existing facilities. Both are expected to be among the world’s top 50 ports in terms of overall capacity, with them equally capable of handling 30 million tonnes per annum.

Arctic Soft Infrastructure Development

Aside from the hardware, Russia is also installing soft infrastructure into the Arctic. This is designed to motivate and encourage investors and attract new residents as both will be the human capital needed to support regional development.

The Arctic Free Trade Zone

Legislation passed earlier this year has designated the entire Russian Arctic as a Free Trade Zone, and it is subsequently the largest FTZ in the world – it covers almost 5 million square kilometers. While many of the incentives are targeted at the Energy sector, low corporate and individual income tax rates, duty free import of goods and equipment, and free land use rights together with additional regional incentives will see investor interest in the Arctic dramatically increase.

The Russian Corporation for the Development of the Far East is now accepting applications from investors who wish to receive Arctic residency status. This follows on from laws, signed off by President Vladimir Putin earlier this year and drafted by the Ministry, that provide incentives for investors planning new projects in the Russian Arctic zone. This status may be granted to businesses planning projects with investments of at least 1 million rubles (S$14,000).

What is the Arctic Investment Project?
This investment project is aimed at building transport, utility, social, innovation and other types of infrastructure in the Russian Arctic zone. and grants Arctic tax residency to Russian legal entities if they meet the following criteria during the effective period of the treaty on investment in the Russian Arctic zone:

• The entity is officially registered in the Russian Arctic zone;
• The entity has no subdivisions outside of the Russian Arctic zone;
• The entity does not apply special tax regimes under the Russian Tax Code;
• The entity is not a non-profit entity, bank, insurance company, non-state pension fund, professional securities market participant or clearing organisation;
• The entity is not a resident of any special economic zone, territories of advanced social and economic development or the Free Port of Vladivostok, nor a participant in regional investment projects.

The following tax rates are proposed for residents of the Russian Arctic zone:

• 0% for federal tax and 7% for regional income tax activities carried under an agreement on investments in the Russian Arctic zone;
• To the entire tax base, if income from its activities under an agreement on investment in the Russian Arctic zone constitute at least 90% of all taxable income (net of FOREX gain); or
• Only to the tax base arising from the fulfillment of an agreement on investment in the Russian Arctic zone. The selected method must be recorded in the tax accounting policies and be consistently observed over the entire term of the project agreement. It would also require accounting for income and expenses resulting from activities in the Russian Arctic zone separately from income (expenses) resulting from other activities. Lower tax rates will apply starting from the quarter in which the resident of the Russian Arctic zone received Arctic residency status until the quarter in which the taxpayer lost such status.

Arctic Property Tax Benefits 
Property in the Russian Arctic zone created or acquired under an agreement on investments in the Russian Arctic zone would be tax exempt from the registration date of such property until the termination date of respective agreement.

Arctic Land Tax Benefits 
Land in the Russian Arctic zone utilized under an agreement on investments in the Russian Arctic zone would be exempt from land tax. The exemption would be effective during the entire validity period of the agreement, from the first day of the month following the month in which the entity became a resident of the Russian Arctic zone.

Arctic Insurance Contribution Benefits
For residents of the Russian Arctic zone, the tariff on insurance contributions for mandatory pension insurance is 6%. For mandatory social insurance for temporary incapacity or maternity, the tariff is 1.5%, while for mandatory medical insurance, it is 0.1%. Lower rates are applied from the first day of the month following the month in which the entity became a resident of the Russian Arctic zone, and cease to apply on the first day of the month following the month in which it lost residency status.

The Russian Arctic Investment Project tax regime appears attractive, lowering the overall tax burden in Russia while increasing investment appeal. It will boost business activity in the Arctic region and ought to be taken into consideration by foreign investors classed as Russian domiciled subsidiaries.

Reaction To Arctic Residency Status

There are priorities given to existing Arctic residents, who are first in line to apply for such benefits. There has been a significant amount of interest. Residents from other parts of Russia may apply from 1st January 2021 and Foreign Nationals from 2022. When a similar scheme was launched in the Russian Far East, 40,000 people successfully applied.

Free Arctic Land Use Acquistion 
Russia has launched an Arctic Hectare Program, modelled on its successful Law on the Far Eastern Hectare, of 2016. This legislation was introduced by Russian President Vladimir Putin to give 1 hectare, or 2.5 acres of free land in the Russian Far East to Russian citizens and foreign nationals as long as they live there for five years. However, the plan only allows Russian Citizens to own the land. Foreigners can join the scheme, but cannot own the land until 5 years after they have immigrated to Russia. Consolidated groups (of 20 lots minimum) will also be provided with basic infrastructure. The Arctic program begins from June 1, 2021. All land plots will be terrestrial. Applicants may choose from locations in the Murmansk, Nenets and Yamalo-Nenets Regions, in certain districts in the Krasnoyarsk, Arkhangelsk, Komi and Karelia Regions. More details are in our article here.

Karelia Free Trade Zone

Russia’s Ministry for the Development of the Far East and Arctic is supporting Karelia’s initiative to organize a free customs zone in the region’s Arctic districts. It will be a major benefit for potential Arctic investors, working with foreign equipment, according to the Arctic regional Deputy Minister Alexander Krutikov, who stated “The free trade customs zone option will be favorable for companies which require imported equipment.”

Karelia has a 1,340km long border with the European Union and significant relations with neighboring Finland, making this incentive important for boosting bilateral trade with Finland, Norway and Sweden, and for Russian businesses investing in the Arctic to import European equipment. Residents and businesses who pay taxes on revenues, enjoy special income tax rates of 1% instead of 6% for the first five years, and 3% instead of 6% for another five years. Businesses paying taxes on revenues minus expenses, instead of the standard 12.5% profits tax will pay 5% for the initial five years of operations and 7% for another five years.

Export Potential

Russia is a member of the Eurasian Economic Union (EAEU) which also includes Armenia, Belarus, Kazakhstan and Kyrgyzstan. Iran, Serbia, Singapore and Vietnam all have Free Trade Agreements with the EAEU as does China. Negotiations with Beijing are on-going as concerns tariff reductions, and when these are finalized, bilateral trade will boom with obvious opportunities for Russian manufacturing to sell to the China market. Additional FTA are being considered with most of the other ASEAN nations, Egypt, Turkey, and India. When completed, the export potential from Russia to these markets will be significant.

Russia also has numerous Free Trade and Special Economic Zones. Although not all of these are in the Arctic region, they all offer reduced taxes and investment incentives. Our report about Russia’s Free Trade and Special Economic Zones can be found here.

In addition to this, Russia also has a large number of Double Tax Treaties with other countries, which can also be used to minimize taxes when used by foreign investors. Our explanation and report on Russia’s applicable Double Tax Treaties is here: Russia’s Double Tax Treaties.

Summary

As can be seen, there is a huge amount of activity taking place to attract new residents and investors into the Russian Arctic. While the programs supporting this are still in their infancy, and certain details still need to be worked out, the intent is clear.

Immediate opportunities for non-energy business sectors are in logistics, transportation as well as all the services that increasing city populations require, such as general retail, IT support, tourism, fishing and hospitality among others.

There are also trade opportunities, with duty free capabilities in the Arctic Free Trade Zone permitting imported processing equipment and massive export potential for Russian products such as lumber, and associated industries such as furniture manufacturing. Over the next 2-5 years, Russia and the Arctic will emerge as a manufacturing hub for Asia, and to some extent for products that are not sanctionable with the EU as well in addition to existing and sizeable trade blocs like the CIS and certainly the EAEU. For more information about investing in the Russian Arctic, please contact us at russia@dezshira.com

Related Reading

• The Trans-Siberian Land Bridge – The Top 20 Key Cities Linking Vladivostok To Europe
• Free Trade Zones Linking China, Russia & The Eurasian Economic Union