Permafrost thaw weighs on Russian businesses

The impact of climate change on Russian mining and energy companies that operate in permafrost areas is a risk that must be integrated into the analysis process. By Willem Visser, Emerging Market Corporate Credit Analyst, T. Rowe Price

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For several decades, temperatures in Russia have exceeded the world average. As a result, permafrost – the layer beneath the Earth’s surface made up of earth, rock and sand held by ice – which covers more than half of the country, is thawing. This phenomenon is not new in Russia, but the situation is expected to accelerate due to the constant rise in temperatures since 1970.

Companies operating in these areas are impacted by this climate change, as it presents a material risk and can weaken foundations and even damage infrastructure. Their investment costs are expected to increase as more checks will be required than in the past. Maintenance and measures to reinforce facilities may also be necessary, putting a strain on companies’ budgets. Upstream activities of the oil and gas industry are vulnerable, with production close to 90% for gas and 30% for oil in permafrost areas. The risks for the gas industry are all the greater as the gas must be treated near production wells before it can be transported. Companies with intermediary activities in the oil and gas industry are also potentially at risk, as transportation is by rail and pipelines that traverse large sections of permafrost.

Examine the level of vulnerability

For businesses exposed to the risk of a thaw, we assess three key factors:

• Location of infrastructure: some regions are more vulnerable than others. Companies with assets in the Yamal, Pechora, and Yakutia regions are at greater risk, as permafrost there is made up of ice which generally thaws more easily.

• The condition of the assets: to what extent have the support facilities deteriorated? The age of the infrastructure is also key because a modern business is expected to better withstand the risks of thaws and temperature changes.

• Investment capacity: a company’s balance sheet is analyzed. In general, most Russian issuers have strong financial profiles and should be able to absorb additional investments. In some cases, they may seek to offset the higher costs by reducing dividends or raising funds by issuing new bonds.

The assessment of these three key factors allows companies to be classified according to their level of vulnerability. The impact of climate change on Russian mining and energy companies that operate in permafrost areas is a risk that must be integrated into the analysis process, as it is likely to result in higher future investment costs. Our analysis in this sense helps us assess the level of vulnerability and how it might affect the long-term economic viability of a business.

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