Tim Gosling in Prague
Lithuania pulled down the curtain on several years of bitter feuding with Gazprom on an emotional day in December when it launched its new terminal to receive liquefied natural gas (LNG) - the first alternative to Russian gas in the Baltic region. However, that only put the fight onto a new footing: Vilnius is now pushing to turn the politically led project into a viable economic venture; Moscow is looking to exploit any weakness.
20th century events bequeathed the Baltic states of Estonia, Latvia and Lithuania an isolated post in the EU, with infrastructure links heading east only. Its status as an "energy island" in the EU left the Baltic region entirely dependent on Russian gas, with Gazprom controlling the supply and the pipelines in all three states. Playing the role of pioneer, Lithuania took on its giant neighbour in 2012, wrestling the gas grid out of Moscow's grip in a vicious fight.
That opened the way for the arrival in the port of Klaipeda late last year of the Independence - a floating LNG terminal with a capacity of 4bn cubic metre (cm), leased at a reported cost of €52mn per year from Norway's Hoegh. However, the terminal, known in the trade as a floating storage & regasification unit (FSRU), was a politically-led project, Mantas Bartuska, CEO of state-owned operator Klaipeda Nafta, admits to bne IntelliNews. "The LNG terminal is a game-changer in the Baltic region that was purely driven by security supply considerations," he admits.
The higher costs of LNG make it tough to compete with gas that's sent down pipelines; the gas needs to be turned into a liquid, transported by ship or rail, and then turned into gas again at the other end. But Brussels' Energy Union strategy "makes it clear that the EU will explore the option of LNG despite the price constraints," notes Tatiana Romanova of St Petersburg State University in a recent research paper,
That's because LNG offers supply flexibility and, especially for the isolated Baltic markets, a link to global gas prices. Gazprom is currently fighting a European Commission lawsuit over what Brussels claims are the Russian state company's anti-competitive contract terms that limit cross-border trading between states and the indexation of gas prices to oil. Until the arrival of the Independence, Russia supplied 100% of the Baltic region's gas.
But Vilnius needs to reduce the losses being incurred by the Independence quickly. The strain on the small country's budget, major companies and population expose Lithuania to Russian mischief.
By ending Russia's dominance of its gas market Lithuania is already being compensated somewhat for the higher cost of LNG, argue some analysts. In 2013 the country was paying the highest price in the EU for Russian gas, $500-plus per 1,000 cm according to many estimates; six months ahead of the launch of the Independence, Gazprom agreed to a cut of up to 23% on the current contract, which runs out at the end of 2015, notes independent Baltic energy analyst Andres Mae.
The LNG alternative has also given Vilnius leverage in talks on a new gas supply deal. "The LNG platform has operating costs of €60mn-70mn per year,' Bartuska notes. "The Gazprom discount is worth €200mn, so the project has already paid off handsomely." However, efforts are now underway to "optimize" the costs, he adds.
Vilnius has asked the Norwegians to allow it to buy the terminal earlier than the 2025 date stipulated in the lease, but Hoegh refused, according to reports in early August. Lithuanian Prime Minister Algirdas Butkevicius has claimed a purchase would help save around €70mn over the 30 years that Lithuania expects to be operating the facility.
Meanwhile, Klaipeda Nafta plans to take advantage of the low borrowing costs across Europe. Local media reports the company is preparing to take on a long-term loan of €300mn, with a final decision to be made in the autumn.
"Quantitative easing is very much driving that effort," Bartuska says. "As a state-owned company, we would expect any loans to be well priced. Bonds are also an alternative." Energy Minister Rokas Masiulis claims the move could cut the LNG platform's costs by up to 25%.
However, Lithuania needs to do more, as Butkevicius has made plain. "Now the LNG facility's costs are fully included in a natural gas supply security charge, which is added to the price of natural gas," the PM explained in August. "Our assessments show - and it's very important given the decrease in natural gas consumption both in Lithuania and the Baltic countries - that the share of infrastructure costs may increase."
The PM's comment on consumption levels is key. The Independence needs to sell more gas if it wants to trim its losses. A lot more.
The 4bn cm annual capacity of the terminal - equivalent to around 80% of Baltic demand - is anything but stretched. Norway's Statoil is contracted to deliver 0.54bn cm per year to 2020, but Vilnius is already reportedly seeking "flexibility" on the deal. While Lithuanian gas supplier LitGas has signed seven non-binding supply agreements with other LNG producers, new supplies are unlikely to be arriving in the near term, unless the company can whip up more customers.
Gazprom is more than aware of the challenge for the Independence, and the pressures it creates on Vilnius. On top of a 5% security supplement on gas prices, Lithuania's major consumers are very unhappy the government is forcing them to support the terminal via special installation and exploitation fees. Chemicals company Achema has refused to pay and is in the midst of a legal fight over unpaid fees reportedly close to €100mn.
Achema claims the charge is a threat to its financial health. Recent reports that Russian peer Eurochem was sniffing around Achema - which accounts for around half of Lithuania's annual gas consumption - drew a quick and sharp response from the very top. Lithuanian President Dalia Grybauskaite pledged in late July that the government would block any such deal.
Whether a genuine approach, Lithuanian paranoia, or a simply a typical piece of Russian mischief, the issue illustrates the vulnerabilities that will persist whilst the Independence fails to pay its own way. "It's very important to utilize the LNG terminal's capacity," notes Bartuska. "We want the LNG supplement paid by companies to be as low as possible."
The wider Lithuanian population will feel the pain late next year, which of course will do little for government support. Gazprom is currently paying compensation for overcharging Lithuania for gas in past years. A chunk of that cash is currently being used to cap household bills, but it will run out in autumn 2016.
However, Gazprom's trump card is next door.
Efforts to raise revenues of the Independence are being stepped up. Klaipeda Nafta announced in recent weeks that it will invest in an onshore distribution station from where it can load gas onto trucks to supply consumers not connected to the country's pipeline network. And in July it signed a memorandum of understanding with Norway's Statoil to set up a maritime operation to ship gas around the region, with similar targets - particularly in the Nordic countries - in mind. "There are several small-scale LNG terminals planned," says Bartuska. "Our terminal is perfectly situated as a hub to build that market." However, there's competition there; Finland's Gasum told bne IntelliNews last year that it's working on a similar strategy.
Klaipeda Nafta is also eyeing opportunities further afield. It hopes that the planned GIPL pipeline linking it to Poland will open the way for it to supply customers on a wider European scale when it opens in 2019. It is also pushing a - rather unlikely - bid to sell gas to Ukraine by sending it through Belarus. While Bartuska admits the going is tough, he says the company hopes to "weave its way through" the politics.
However, the key for any Baltic LNG project is the development of a liberalised regional gas market. At around 5bn cm, total annual demand in the three Baltic states could keep the Independence running at full capacity. While that is not the vision, points out Bartuska, Lithuania has no choice but to push to make inroads into its neighbouring markets.
However, while Lithuania managed to sell around 60mn cm to Estonian customers in the first four months of the year, its reach is constrained by Latvia. The region's second largest consumer at around 1.3bn cm per year, Latvia sits in the middle of the three and, most crucially, hosts the region's strategic gas storage facility Inculkans.
Yet national utility Latvijas Gaze is controlled by Gazprom. Unsurprisingly, it's not keen to play ball. Under a privatisation agreement, the company controls all supply and pipelines in the country to 2017, and it has stated categorically it will not buy any gas from Lithuania. "The Baltic market is very small," Bartuska laments. "Without Latvia, it becomes even smaller."
While Latvijas Gaze has allowed small volumes through to Estonia, its control in Latvia is a clear obstacle to the creation of any regional market. Bartuska prefers to focus on the small steps. Although Latvia made it "difficult" to open the trade, "the first gas transfers to Estonia were important," he insists. "It was the first step towards a liquid market, and proved the case to gas traders."
However, as energy analyst Reinis Albotins points out: "If market participants cannot access Incukalns, then there is no effective market in the Baltic states."
That, in turn, makes Gazprom's control of Latvijas Gaze key. Yet unlike Lithuania and Estonia, which pushed the Russian giant out of their pipelines using the legislation in the EU's Third Energy Package over the past couple of years, Latvia has put up little fight. Riga's energy legislation states the gas industry must be unbundled by April 2017, but there's little confidence that will happen.
The country's "politicians and decision-makers [gave] in to the interests of Gazprom," when they voted last year to delay the move by three years, notes Albotins. "The gas lobby is very strong and confident. It's quite sure it can achieve any decision it needs."
That leaves Lithuania's efforts to increase energy security vulnerable to Russian lobbying next door in Latvia, where Gazprom has its regional headquarters. It may be that in bowing out of the fight in Lithuania and Estonia, the Russian state-controlled giant realised it stood a better chance of scuppering efforts to drive Baltic energy independence from a stronghold in the midst of the region.
Lithuania's Independence could be facing a struggle to boost its activity then. Just 15% of the terminal's capacity is currently being used, and a significant rise in that is unlikely in the immediate future, with "market conditions unclear", Bartuska admits. LitGas has booked the same capacity for 2016, he notes.
While in economic terms Gazprom is unlikely to worry too much about losing such a small market as the Baltics, the leverage that its dominance hands Moscow has only taken on new significance over the last couple of years as the standoff with the West over Ukraine has deepened. Until Latvia frees up its pipelines and storage facility, Albotins believes, "gas remains the dividing factor among the Baltic states".
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