Baltic Energy Sources: Diversifying Away From Russia – Analysis

By Simon Hoellerbauer*

(FPRI) — “From now on, nobody will dictate us the price for gas – or buy our political will,” said Lithuanian President Dalia Grybauskaitė at the opening ceremony of the Klaipėda Liquefied Natural Gas (LNG) terminal in October 2014. The Baltics’ historic dependence on Russia for natural gas had allowed Moscow to charge high prices and made the Baltics’ gas networks vulnerable to Russian influence. Estonia, Latvia, and Lithuania have moved to increase their independence from Russian gas. The LNG terminal represents is only one of the measures implemented to achieve this goal. They have also sought to integrate their gas networks with one another and with Europe. Since President Grybauskaitė’s statement, the Baltic states have moved even closer to a more secure gas market, though much remains on the agenda.

Baltic Reliance on Russia for Gas

Baltic States and Russia. Source: Wikipedia Commons.
Baltic States and Russia. Source: Wikipedia Commons.

Until they began addressing their dependence in the past few years, the Baltic states depended on Russian gas for three main reasons. First, Lithuania, Latvia, and Estonia inherited their entire gas infrastructure from the Soviet Union, so after the three countries’ independence, their networks were disconnected from the rest of Europe and received gas only from Russia. This situation made them susceptible to gas cut-off. Second, because of the constraints imposed by this infrastructure, until recently, the Baltic states depended almost entirely on Russia for their natural gas imports, paying some of the highest prices in Europe. Third, Russian state-owned energy company Gazprom maintained a considerable stake in the natural gas companies of the Baltic states, owning 37% of Estonia’s Eesti Gaas (a further 10% was owned by another Russian gas company, ITERA), 34% of Latvia’s Latvias Gāze (16% also owned by ITERA), and 37% of Lithuania’s Lietuvos Dujo at the point of its greatest involvement in 2014. These ownership levels gave Gazprom considerable say in the policies and strategies employed by these companies. After 2014, however, Gazprom began to sell its shares due to new European regulatory requirements.

The three countries are addressing each of these issues. Lithuania, which consumes more gas than Estonia and Latvia, was the first to combat the region’s dependence on Russia. It leased a floating gas storage and regasification vessel from the Norwegian shipping company Höegh LNG for ten years at a cost of 430 million euros and constructed the onshore infrastructure necessary to connect the floating terminal to Lithuania’s gas network for 131 million euros. Stationed in the port of Klaipėda, the vessel lets Lithuania import liquefied natural gas. LNG is transportable by ship, eliminating the need for overland pipelines to obtain gas. Because the EU was more interested in a regional, not national, LNG terminal, it did not provide financial support for the project. Even without this support, the terminal, Klaipėda LNG, began operating in December 2014.

In the same year, Lithuanian state-owned gas company Litgas signed a contract with the Norwegian gas supplier Statoil to import .54 billion cubic meters (bcm) of gas per year between 2015 and 2020. Statoil and Litgas later extended the contract for five more years, although for the lower annual amount of .35 bcm. Two more Lithuanian companies, gas supplier Lietuvos Duju Tiekimas and fertilizer maker Achema, signed short-term contracts with Statoil in 2016, bringing the total amount of LNG regassified at Klaipėda LNG in 2016 to over 1 bcm—which meant that in 2016, Lithuania imported more natural gas from Norway than it did from Russia for the first time in its history.

With an annual regasification capacity of 4 bcm, the terminal can cover a significant portion of the Baltic region’s natural gas demand. However, in 2016, only 29% of the terminal’s capacity was used. Some have questioned the economic viability of Klaipėda LNG because demand for natural gas in the Baltics is falling. The three Baltic countries had a combined demand of 5.11 bcm in 2012, but consumed only 4 bcm in 2015, a drop caused by the growing role of biomass fuels in electricity production, sparked by the high natural gas prices offered by Gazprom. Usage of the terminal has fallen in 2017 compared to 2016 so far.

In addition, Lithuania’s lease on the terminal expires in 2024, so Lithuania must decide whether to buy the vessel or renew the lease, a decision that will be easier to make if the EU decides to support it financially. AB Klaipedos nafta, the company managing the terminal, is hoping to use Klaipėda LNG as the starting point for a small-scale LNG network in northern Europe, shipping small quantities of LNG where it is needed in an attempt to make the operation more economically sustainable. For this to succeed, however, demand for LNG must rise, and the surrounding countries must invest in their own infrastructure. Despite these challenges, the terminal introduces competition for Gazprom into the Baltic gas market and makes it possible for Lithuania to export gas to the other Baltic states. Some gas from the terminal has already been sold to Estonia and even to Poland and Ukraine. Most importantly, it makes it possible for natural gas to be imported in the case of a Russian shut-off.

Increased Connections to Europe

Estonia, Latvia, and Lithuania also have worked to improve their connections to Europe. Under the auspices of the Baltic Energy Market Interconnection Plan (BEMIP), an EU initiative intended to facilitate the integration of the Baltic energy market into Europe, the EU granted significant funding for two projects, the Balticconnector pipeline between Estonia and Finland and the Gas Interconnection Poland Lithuania (GIPL).

GIPL Map (Source: Bearas/WikiMedia Commons)
GIPL Map (Source: Bearas/WikiMedia Commons)

The EU has also provided 18.7 million euros in financial support for improvements to the pipelines between Latvia and Estonia. The Balticconnector pipeline, which costs 250 million euros to build, 187.5 million of which has been granted by the EU, is currently still in the planning stages, with an expected completion date in 2020. Crucially, the Balticconnector will allow gas to flow in both directions, depending on demand. GIPL is expected to cost 444 million euros, of which up to 266 million euros will be covered by the EU. This pipeline is slated to begin construction this year although it is not expected to be completed until 2021.

GIPL is a much larger project. Whereas the Balticconnector involves 146 km of pipeline, GIPL consists of between 487 and 534 km. GIPL recently ran into problems with the planned path of the pipeline, showing that much work remains. Once the pipelines are complete, however, the Baltic states will no longer qualify as energy islands and will be tied into the European gas network.

The EU has also indirectly helped to push Russian gas interests out of the Baltic. As part of the Third Energy Package passed in 2009, the EU mandates that member states unbundle their gas markets—separating control of energy generation and supply from its transmission. The goal is to prevent one company from squeezing competition out of the market by unfairly dominating infrastructure. Lithuania and Estonia both initiated unbundling in 2012, completing the process in 2014. Although Gazprom fought unbundling in Lithuania, the company eventually acquiesced after arbitration and a large fine from Lithuania’s competition authority. Gazprom subsequently sold its shares in the Lithuanian state gas company in 2014 and in the Estonian state gas company in 2016. Gazprom acquiesced ostensibly to adhere to the legal requirements imposed by the Third Energy Package, although the potential of added competition and the lack of control over a liberalized market implied diminished returns for Gazprom. Although the Latvian gas company Latvias Gāze, influenced by Gazprom, resisted unbundling longer than its neighbors, in April 2017, Latvia’s gas market was liberalized, with Latvias Gāze expected to be unbundled fully by year’s end. Gazprom, however, still holds a significant stake in the company, and in August 2016, it signaled that it is reconsidering selling its shares. Thus, Gazprom’s ability to affect Baltic gas policy and development has been reduced through these new polices.

Balticconnector Map (Source: Balticconnector.fi)
Balticconnector Map (Source: Balticconnector.fi)

Importing LNG, increasing connections with the rest of Europe, and decreasing Gazprom’s corporate influence work together to decrease the Baltic states’ dependence on Russia for natural gas. Klaipėda LNG, for example, is only free from Russian influence via Gazprom due to the unbundling reforms and will only be economically viable if Balticconnector and GIPL are completed successfully. Each measure alone would probably not be enough, but together, they represent a leap forward for Baltic gas security. And although progress toward decreasing energy dependence from Russia has historically been hampered by lack of cooperation and differing levels of commitment by the three countries, even these obstacles may soon disappear. In December 2016, the prime ministers of Estonia, Latvia, and Lithuania agreed to establish a unified Baltic gas market by 2020. In early 2017, the major Baltic gas operators agreed to implement an Implicit Capacity Allocation model beginning in summer 2017. This type of model facilitates the trading of natural gas between the three countries (and Finland, once the Balticconnector is completed) representing the first step toward full market integration.

Cutting the Cord

The fact that many of these projects are still ongoing means that the way forward is still somewhat unclear. There is cause for optimism, however. Russia has thus far only minimally attempted to impede changes in the gas sector, mainly via Gazprom. Indeed, the Baltic countries represent a very small market for the Russian company, so it could cope with losing their business. Nonetheless, Russia can be expected to fight such measures to retain its gas investments to use for future foreign policy purposes. Because Finland represents a much larger market, however, with an annual demand larger than that of the Baltic states combined, attempts to draw Finland into the Baltic gas network, as is planned, could rouse greater Russian resistance. Indeed, Gazprom has tried to ensure that any EU-supported regional LNG terminal would be located near Finland, where it has greater influence.

Russia has only cut off gas to a Baltic country once. It did so in 1993, purportedly to punish Estonia for unpaid debts, but, in reality, Russia did so in response to Estonia’s passing of a law that required non-citizens— who at the time were primarily ethnic Russians—to apply for residency or leave the country within two years. The issue goes deeper than the risk of a cut-off, however. Gazprom charged the Baltic states considerably more for gas than the rest of Europe. In addition, it is always risky to depend solely on one supplier for a product or service. Political or economic instability within Russia could also endanger the supply of gas to the Baltics. Diversification via better connections to Europe and more varied sources of gas is an achievable goal that can ensure that the Baltic states will be able to buy gas from Russia because they want to, not because they must.

About the author:
*Simon Hoellerbauer is an Associate Scholar in the FPRI Eurasia Program

Source:
This article was published by FPRI


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Published by the Foreign Policy Research Institute

Published by the Foreign Policy Research Institute

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One thought on “Baltic Energy Sources: Diversifying Away From Russia – Analysis

  • June 15, 2017 at 12:05 pm
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    LNG costs a lot more then Russian natural gas. And Russia will always be your neighbor. Why pay the extra cost for LNG ?

    Reply

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