Arctic developments have great potential, but are they worth the risks?

By Debbie Carlson: Sept. 7, 2015

As climate change melts some of the Arctic’s permafrost, natural resource companies and shippers are eyeing the potential to develop a region that is receiving renewed public attention from President Barack Obama’s trip to Alaska.

According to global management consulting firm A.T. Kearney’s Global Business Policy Council, worldwide investment in the region could reach $100 billion over the next decade. The Northwest Passage and Northern Sea Route could potentially decrease travel times between the U.S., Europe and Asia by 40 percent, while the value of hydrocarbon deposits – crude oil and natural gas – located in the U.S. Arctic alone could exceed $1 trillion. The region is also home to rich metal deposits.

Some of it has already begun. Erik Peterson, partner and managing director at A.T. Kearney’s Global Business Policy Council, says 71 ships crossed between Asia and Europe in 2013, versus just five in 2010.

Earlier this summer, the Obama administration gave Royal Dutch Shell (ticker: RDS) approval for exploratory drilling in the Chukchi Sea north of Alaska, and Obama plans to ask Congress to speed up plans to build a new icebreaker to patrol Alaska’s coast. In Canada, Scandinavia and Russia, some metal-mining companies have operated for a few years.

“Given the low oil prices and the oil glut, we’re not thinking about it today, but the expectation is that in the next 20 to 50 years, this is going to be a major producing area with a lot of jobs and a lot of power,” says Phil Flynn, senior energy analyst at the PRICE Futures Group in Chicago.

Yet investors need to be careful if they want to buy into the few companies that seek to do business at the North Pole. The harsh climate, potential geopolitical concerns and changes in attitudes to mitigate climate change can all be factors that affect companies. Further, low commodity prices have some companies putting holds on their exploration plans.

The flurry of attention on Obama’s trip to Alaska comes after the U.S. took over the chairmanship of the Arctic Council, an eight-nation council that also includes Canada, Denmark, France, Iceland, Norway, Russia and Sweden.

“The operative question is how does this administration, in the light of the president’s declarations and comments, as well as the policy with respect to allowing Shell to do exploratory drilling in the sea, factor into whatever chairmanship agenda he has over the coming year?” Peterson says.

Investors should consider Obama’s dire warnings about climate change and his decision to allow Shell’s drilling. Environmentalists claim hypocrisy, but Peterson says Obama is seeking a balance between the serious concerns about climate change and implications for the Arctic, while working with other nations seeking to exploit resources in the region.

“The stakes between these various countries are enormous. It is no easy task by any means,” he says.

Shell is the only oil major planning to explore in the Arctic, and no one is producing oil there right now, Flynn says. Other oil majors, such as Total (TOT), ExxonMobil Corp. (XOM), Chevron Corp. (CVX), ConocoPhillips Co (COP) and Statoil (STO) have put their Arctic plans on hold because of the low oil prices.

“As time goes on and market conditions change, and if Shell is successful, there will be a lot of interest in that area,” Flynn says.

Investors should know, however, that Shell isn’t loved by analysts. For example, in a research note, Morningstar analysts say because of previous missteps, Shell “is far more likely to remain a laggard than become a leader among the oil majors for the rest of this decade.”

Despite the potential to tap plenty of energy in the Arctic, John Person, president of NationalFutures.com and a long-time energy-market watcher, is skeptical.

“I think there are safer, better, cheaper ways to get at oil at this point of time. … And if they didn’t go after Arctic oil when it was $150 a barrel, they sure aren’t going to when oil is at $45 a barrel,” he says.

Miners have had more success in the Arctic. Russia’s Norilsk Nickel (NILSY) operates in the Arctic, and Canadian miner Agnico Eagle Mines (AEM) has two Arctic-area mines, one in Canada and one in Finland.

Adrian Day, chairman and chief executive officer of Adrian Day Asset Management in Annapolis, Maryland, says Agnico Eagle’s Meadowbank mine in Canadian province of Nunavut is one of the company’s top-performing assets, but it had some issues ramping up production because of the harsh weather environment. Even small problems can be magnified when dealing with such a remote location.

“They had a famous fire in the kitchen. Normally you wouldn’t even think about a fire in the kitchen in a mine, right? It wouldn’t be news, but that cost them $18 million because they had to evacuate people,” he says.

The lessons Agnico Eagle learned in building the Meadowbank mine will be applied elsewhere, Day says, citing comments by the company’s management. Day owns Agnico Eagle stock and says it’s one of the best mining companies.

Regarding Norilsk Nickel, Citi Research analysts say the company has access to “world-class” nickel, copper and platinum group metal deposits in the Russian North. They rate the firm’s stock at neutral, given the unlikelihood that nickel prices will rise.

Investors who consider buying stock in companies operating in the Arctic need to consider the potential impact on valuations if environmental damage happens because of mining or oil drilling. When the Exxon Valdez oil tanker ran aground in Alaska, cleanup was hampered by harsh weather conditions. Any accidents in the Arctic would be difficult to clean up, not only because of the weather, but because of the remoteness of the location.

Peterson also points out the potential for geopolitical concerns between competing nations in the Arctic, pointing out the tensions between Norway and Russia over the Spitsbergen archipelago (also known as Svalbard) over resource rights that date back to the 1920s.

“It’s a perfect example of the blend of geopolitics and resources development that is likely to occur time and time again in the future,” he says.

Day says at this point in time, it’s probably too narrow for investors to consider a portfolio based around Arctic natural resources.

“Certainly the potential in the Arctic is enormous, but the costs are commensurate,” he says.

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