Climate Change and the Long-Run Economic Health of the Arctic

Although one may decry the environmental circumstances that allowed it to happen, the economic possibilities of the Arctic have never been more interesting. Warming temperatures and receding summer ice coverage have expanded the menu of economic opportunities that the region could previously support, and countries and companies around the world have taken note. According to a 2008 U.S. Geological Survey assessment, the Arctic holds 13 percent of the world’s undiscovered oil resources (approximately 90 billion barrels of oil) and 30 percent of the world’s undiscovered gas resources (approximately 1,669 trillion cubic feet of natural gas and 44 billion barrels of natural gas liquids). As receding sea ice and technological investments render the Arctic region increasingly accessible, this vast reserve of resources has become an attractive commercial opportunity for multinational corporations and state-run entities alike. According to estimates by Northern Economics, an Alaska-based economic consulting firm, oil and gas extraction in Alaska’s Beaufort Sea and Chukchi Sea sites alone are estimated to be capable of generating between $193 and $312 billion in state and local tax revenue through 2057, assuming oil prices remain between $65 and $120 per barrel. Even at the current $55 a barrel Brent Crude benchmark, Alaska and the regions around the two sites still stand to bring in roughly $165 billion in tax revenue from these two sites alone. Additionally, these two sites stand to bring an average of over 28,000 jobs to Alaska from now until 2057.

In addition to oil extraction, mineral- and other resource-extraction exploits promise greater economic returns with a warming Arctic. In Alaska alone, exports of mineral resources (such as gold, lead, zinc, etc.) generated $1.3 billion in 2010, and it is estimated that one mine, the Red Dog mine in northern Alaska (which accounts for 5 and 3 percent of the global zinc and lead production respectively), “has contributed $558 million to the statewide economy and $66 million to the Northwest Arctic Borough” between 1989 and 2011. Receding summer ice has also expanded the area available to fishing, and yields have grown steadily in recent years.

In the United States, much of the Arctic extraction activity has come following federal land leases to the highest-bidding commercial company. Between 2003 and 2007, the Bush Administration issued 241 leases covering over a million and a quarter acres in the Beaufort Sea, receiving $97 million in bids. In 2008 alone, 487 leases covering almost 3 million acres of the Chukchi Sea were issued for a total for $2.66 billion. In 2011, the Obama Administration authorized three more areas in Alaska to be available for leasing between 2012 and 2017, but these lease sales were later postponed due to environmental concerns. In addition to the initial revenue from bids, federal, state, and local taxes all allow the U.S. to extract revenue from the process.

Unsurprisingly, the United States is not alone is the race to capitalize on newly-extractable Arctic resources. In Russia, where as much as half of state revenue is derived from oil, the government offers special tax rates to encourage Arctic exploration and drilling, in addition to funding university research on special drilling methods and materials, such as supermagnets. Russia has also planted their flag at the bottom of the Arctic Ocean at the North Pole, symbolically indicating their intention to maintain a presence in the region. Concurrently, Norway has recently offered a new round of oil leases in the Barents Sea, continuing an over 50 year practice of selling off drilling rights in explored areas. For its part, Finland looks to capitalize on the rush for Arctic resources through its world-leading icebreaker industry. In Greenland, optimists are even suggesting that tapping into its vast Arctic reserves might allow Greenland to become financially self-sufficient enough to formally split with Denmark and become an independent nation.

        Though Greenlandic independence powered by oil extraction may be a slight oversell, for a region like the Arctic that has never seen large-scale economic activity, the ability to capitalize on existing reserves of natural capital represents an unprecedented opportunity for development. However, the abundance of natural capital in a given region can prove to be a curse if not managed proactively. A resource curse – or alternatively referred to as “Dutch Disease”, named after the role that oil wealth played in the decline of the Dutch manufacturing sector – refers to the tendency of communities to over-invest in a specific profitable sector of the economy at the expense of maintaining a diversified and stable long-run portfolio. While lucrative in the short-run, this approach tends to concentrate wealth in small communities and discourage balanced long-run growth. When the resource is non-renewable, such as oil and natural gas in the case of the Arctic, the country or region with Dutch Disease finds itself unable to compete in the long-run, as the region’s natural capital has not been properly re-invested into more sustainable economic endeavors. In a previous issue of The World Mind, Deborah Carey described this counterintuitive phenomenon in the context of Africa.

        While it is difficult to definitively diagnose a given country or region with Dutch Disease, the data coming out of much of the Arctic region is symptomatic of a resource curse. In Alaska, a full 36.8 percent of the state’s 2010 foreign export earnings came from mineral resource extraction. More strikingly, petroleum extraction and other mining directly accounted for 30.6 percent of Alaska’s Gross Regional Product (GRP) in 2012, including the value added from transporting the resources across the state via pipeline. Indirectly, taxes on petroleum and mineral activity contribute the lion’s share of the state’s revenue, rendering the state budget heavily dependent on external demand for the state’s oil, gas, and minerals. For comparison, only 0.4 percent of Alaska’s 2012 GRP could be attributed to non-fish or oil extraction-related manufacturing, and only 6.2 and 1.9 percent can be attributed to health care/social work, and financial/insurance services respectively.

        A similar story is also playing out in Russia, where over half (51.7 percent) of the entire Russian Arctic region’s GRP in 2012 came exclusively from the extraction of petroleum and other natural resources. In contrast, a mere 4.0, 3.0, and 0.1 percent of GRP came from the manufacturing, healthcare and social work, and financial and insurance service sectors respectively. Like Alaska, much of the economic benefit from resource extraction is realized by companies located outside of the region, and the local population realizes little economic benefit outside of what any local taxes levied may pay for. Not only do Arctic Russia and Alaska to rely heavily on natural resource extraction for generating wealth, but the wealth generated by resource extraction in these areas is not being re-invested in other, more sustainable sectors of the economy, but transferred out of the region entirely. Just as over-investment in oil production led to the neglect of other sustainable Dutch industries in the 1960s, it appears as though Alaska and Russia – who together make up over 60% of the land area of the region – appear to be forgoing a sustainable growth plan in exchange for the promise of short-term riches.

        However, while diagnosing Dutch Disease is difficult on its own, it is equally difficult to propose a workable cure for a region so rich in natural resources and capital-starved in just about every other sector. Nevertheless, some Arctic countries seem to be developing more balanced portfolios. Sweden’s Arctic region, for instance, relies on petroleum and mineral extraction for only 10.9 percent of its 2012 GRP, compared to 11.7 and 11.8 percent on manufacturing and healthcare and social work respectively. Others, such as Canada, have ensured that local regions receive transfers from southern regions in exchange for petroleum and mineral extraction.

        Yet, in order to construct a compelling long-term growth plan for the Arctic that does not rely exclusively on non-renewable resource extraction, one must identify other comparative advantages that the region may exploit in lieu of resource extraction. Surprisingly, some argue that electronics manufacturing and data storage have a natural long-term home in the Arctic, simply due to the Arctic’s year-long cold temperatures. The idea is that the natural, year-round cold of the Arctic substantially reduces the cost of keeping electronics from overheating, thereby reducing a major cost involved in large-scale data storage. With the global data center construction market expected to increase from $14.6 to $22.7 billion and the global fiber optics market expecting to grow 9.5% by 2020, the gains are there for Arctic countries who are able to exploit their unique climatic advantage. Tech giants like Facebook and Google both seem to be convinced of the advantages of Arctic cold, as the former recently opened a data center in Luleå, Sweden, to service its European traffic, and the latter has begun the process of repurposing an old paper mill in Hamina, Finland, to serve as a data storage center.

        Not to be outdone, the Finnish government has already taken significant steps toward developing an electronics manufacturing operation in Oulu, a university city in northern Finland. Feeding off of the pre-iPhone success of Nokia (a Finnish company), Oulu has become a regional hub for the electronics industry. Though the city and region endured a painfully long period of contraction after the 2008 crisis and Nokia’s significant loss of marketshare, it has appeared to have bounced back. According to local economic development officials, over 500 tech startups have opened shop in the area since 2014, helping to support about 17,000 high-tech jobs, including around 7,500 in research and development. Additionally, Nokia and the University of Oulu recently announced their intent to collaborate on a new project to develop a 5G test network, which will include a 5G hackathon in June, promising to attract top tech talent to the Arctic town.

More ambitiously, the algorithmic stock trading industry may also be moving North in the near future. Quintillion, an Irish fund administration company, is currently heading phase 1 of a project to build an underwater fiber optic cable network that connects London with Tokyo through Canada’s Northwest Passage. Currently, it takes about 230 milliseconds for data to travel through the network of cables connecting London to Tokyo through the Suez Canal. However, Quintillion claims that its cable will cut this time by just over 26% to around 170 milliseconds, simply by virtue of the shorter distance that the data must travel between points A and B. While this speed boost may offer little more than a nice convenience for most users, to algorithmic stock traders this slight speed advantage is everything. Given that traders in this industry have historically fought to be physically closer to financial centers, it is not inconceivable that the existence of a faster cable in the Arctic may entice this industry to move North, giving Arctic regions a realistic chance to woo traders (and their tax dollars) to their cities. In addition to Quintillion’s Northwest Passage cable, the Finnish government and the Russian company Polarnet have discussed plans to build a submarine cable from Europe to Tokyo via an eastwardly route around Northern Russia, though the plan looks to be impossible without financial backing from the Russian government. Regardless of the ultimate profitability of submarine cable projects like these from the perspective of algorithmic stock traders or city governments, the provision of fast, high quality internet needed in order to facilitate meaningful economic and human development is a boon for the Arctic region that is already being realized.

        Of course, transitioning from an economy driven by resource extraction to a digital economy hosting premier electronics manufacturing, data storage, and high-speed trading operations is not straightforward or guaranteed. Perhaps the Arctic climate will keep companies from being able to attract top tech talent, or the data storage or electronics manufacturing markets do not grow as quickly as anticipated. However, if Arctic governments are serious about pursuing healthy long-run growth, they must find a way to keep from over-investing in natural resource extraction, no matter how tempting the short-run gains from doing so may be.