LNG Project Progress Further Threatens Russian Dominance


BMI View: The European Investment Bank's decision to grant Klaipedos Nafta a long-term loan for its liquefied natural gas (LNG) import project is a boost for its development. It could create the certainty needed for the Lithuanian firm to seal long-term supply deals with potential sellers, which would in turn boost the confidence of the private sector in the commerciality of this terminal. Progress in an import terminal in Lithuania is a step towards the reduction of the Baltic region's dependence on Russia for gas exports and further dampens the long-term market outlook for Gazprom in Europe unless it revises its pricing formula.

Lithuania's goal to reduce it gas dependence on Russia has taken a big leap forward with the European Investment Bank (EIB) 's decision to give majority state-owned Klaipedos Nafta a 20-year loan for its liquefied natural gas (LNG) import project. The loan, valued at US$111.9mn, will cover 50% of the infrastructure investment costs of the project, which involves building pipeline and facilities to connect LNG delivered the floating storage and regasification unit (FSRU) to the Lithuanian gas grid.

This is a major victory for Klaipedos Nafta, after it failed to secure EUR73mn (US$93.6mn) in loans and US$50mn in guarantee from commercial banks for the project in March 2013. According to Reuters, banks had doubted the profitability of the project on concerns that Russia's Gazprom , which supplies Lithuania with nearly all its gas requirements, would reduce its prices to undermine Lithuania's attempt to diversifying its sources of gas imports.

The energy ministry had approved of Klaipedos Nafta's decision to apply for an EUR81mn (US$103.8mn) loan from the EIB in June 2013. The EIB stated that its loan to Klaipedos Nafta is 'critical for Lithuania to diversify and secure its energy supply' and is in line with a wider attempt by the European Union (EU) to decrease its member states' dependence on Russia for gas. Like the Southern Corridor gas pipeline project and support for Poland's Swinoujscie LNG import terminal, Lithuania's first LNG project will serve a similar purpose.

Breaking Free From The Iron Grip

Lithuania's gas demand has rapidly i ncreased since the complete closure of the Ignalina nuclear power plant in December 2009, as part of its accession agreement to the European Union. As the power plant had provided at least 70% of its power needs, Lithuania had to turn to other sources of energy for electricity. Besides an increase in electricity imports, it also ramped up its imports of gas. However, infrastructure limitations meant that it could only obtain ga s from Russia via the Soviet-era Minsk-Vilnius gas pipeline.

Nuclear Shutdown Boosts Gas Demand
Lithuania Gas Consumption, 2001-2015

Its gas dependence on Russia has intensified tensions between the two countries. Lithuanian energy minister Jaroslaw Neverovic had openly criticised Russia for inflating the price of gas sold to it such that Lithuania pays 'one of the highest, if not the highest in the EU'. According to Neveroic, Lithuania is paying US$500 per thousand cubic metres (mcm) for Russian gas - or about US$13.40 per mn British Thermal Units (mnBTU). This is about US$100/mcm (US$2.68/mnBTU) more than Russian contract prices to Germany, and about US$3.70/mnBTU more than UK National Balancing Point (NBP) Day-Ahead spot prices at the time of writing.

Overcharged
Comparison Of Selected Gas Prices (US$/mnBTU)

A LNG import terminal is one of the means through which it hopes to reduce its energy dependence on Russia, even as it looks to build a new nuclear power plant and increase its renewable energy footprint to improve its energy security. It has also planned a gas interconnector with Poland, through which it can receive gas supplies from Poland from German gas exchanges.

To quickly make LNG imports available by December 2014, Klaipedos Nafta has chosen to loan a FSRU from Hoegh LNG for ten years at a cost of US$689mn over the duration. The Lithuanian company plans to buy the FSRU after 10 years. This terminal will have an initial capacity of 2bn cubic metres (bcm) per year - about two thirds of the country's gas consumption in 2011 - scalable to 4bcm per year when Lithuania's gas pipelines are upgraded to meet an increase in gas flow.

Regional Hub

Although Klaipedos Nafta still has to finance the remai ning 50% cost of its LNG development , the EIB's loan - indication of the EU's political backing for the import project - could improve its chances of finding other sources of capital. Moreover, some funding certainty could also see pending long-term supply contract talks that Klaipedos Nafta have with potential suppliers move ahead. In 2011, it signed a memorandum of cooperation with Cheniere Energy, which is about to be the first exporter of US LNG to non-FTA countries when its Sabine Pass comes online in 2015. According to that agreement, Cheniere was to guarantee gas supplies at prices 30% lower than that offered by Gazprom. A final deal between the two companies has yet to be made, though Klaipedos Nafta confirmed that talks were still ongoing in October 2012. Lithuanian president Dalia Grybauskaite also disclosed in an April 2013 interview with Reuters that Norwegian national oil company (NOC) Statoil had shown interest in supplying Lithuania with LNG.

Concluding talks on these long-term supply deals would guarantee that the LNG import terminal would indeed be utilise and boost private confidence in its commercial viability. This could help Lithuania's first LNG import project meet its 2014 start-up target and move it a step closer to wringing free of reliance on Russian gas. It would also put the country ahead of its other Baltic neighbours as Baltic countries compete to be the region's LNG hub, along with the infrastructure investment and trade benefits this status could bring along. At present, Estonia and Finland are still competing for EU funds to build a LNG import terminal along their respective shores.

Russian Response

As a Baltic LNG hub looks increasingly likely to emerge, this puts pressure on Russia, which could find itself pushed out of the Baltic market which it had long dominated. It will be a further blow to the country as its core gas market in Europe comes under threat :

  • The recent selection of Trans-Adriatic Pipeline (TAP) to deliver Azeri gas into Europe looks set to put the EU's Southern Corridor gas plan into action, and threatens to take away at least 17bcm per year of gas demand away from Russia when it comes into operation in 2019 as planned ( see 'TAP: Short-Term Windfalls And Long-Term Strategy', July 1 ) .

  • The start-up of Poland's Swinoujscie terminal by 2015 could reduce demand by another 5bcm.

  • Unless Russia dramatically cuts its prices to Lithuania, it could lose at least 2bcm of demand from the Baltic region when the last of Lithuania's long-term gas supply contract with Russia - signed by Lietuvos Dujos with Gazprom - expires in 2015.

Part of Russia's strategy in response to Europe's efforts at diversification is to direct its attention to the Asian market. The Kremlin has supported the pick-up in pace of negotiation between Russian firms and Asian companies for long-term gas contracts, which most recently manifested in President Vladimir Putin's statement that the country would take the historic step of 'gradually liberalising' its gas export policy and end Gazprom's monopoly in this matter ( see 'End Of An Era For Gas Exports', June 24 ) .

However, Russia has not given up on the European market. Gazprom is pushing ahead with its South Stream pipeline project targeting the Central and Eastern European market while looking to expand the capacity of its Yamal-Europe and Nord Stream pipelines in a bid to maintain market share in Europe. It has also recently announced that it will revisit a proposed LNG export project along the coast of the Baltic Sea in Leningrad, though it will specifically target the shipping market for LNG sales.

Nonetheless, we continue to question the economics and highlight political risks associated with these projects, which could have limited effects in reversing Gazprom's fortunes in Europe unless the Russian gas behemoth revises its pricing formula to one more favourable to its European clients ( see 'South Stream's Tough Battle For Europe's Pipeline Spotlight', May 20; 'Yamal-Europe 2 Faces Political Test', April 22; and 'Current Economics Make Questionable Case For Nord Stream Link', April 10 ) . Progress with Lithuania's LNG project further dampens Gazprom's long-term outlook in the continent.

This article is tagged to:
Sector: Oil & Gas
Geography: Lithuania, Russia