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Lithuania announced on March 2 that it will lease a Norwegian Floating Storage and Regasification Unit in 2014. The unit, an offshore liquefied natural gas (LNG)
degasification ship, theoretically could provide more than enough natural gas to meet Lithuania's needs. The relatively new technology, which is mobile and able to
be leased, helps small countries avoid the large up-front costs of building LNG facilities and thus could change the energy landscape for coastal countries in Russia's periphery. However, Moscow will retain significant influence over Lithuania's energy supplies in the near term.


Theoretically, the ship's output will exceed Lithuania's annual natural gas consumption. Lithuania also announced that it would respond to Russian state-owned energy company Gazprom's latest lawsuit with a counter-claim. Gazprom's litigation counters Lithuania's efforts to seek compensation for Gazprom's violation of the EU Third Energy Package, which forbids bundling export, transport and distribution chains in the natural gas industry.

These two developments illustrate Lithuania's drive to gain some degree of energy independence from Russia. For some time, LNG has been the most viable option for
Baltic countries trying to wean themselves from piped Russian natural gas, but building LNG facilities is costly, and the European Union is reluctant to finance expensive infrastructure projects. These factors, combined with regional tension over how to pool resources, kept delaying LNG projects. Lithuania's leasing of an FSRU, which allows Vilnius to avoid the initial financial burden required to build an LNG terminal, could thus pave the way for great changes in the field of energy in Russia's periphery.

The FSRU will give Lithuania (and any other country that pursues the same path) greater leverage in negotiations with Russia. If Moscow wants to maintain a level of
strategic control over energy in the Baltics, it must make some concessions in renegotiating the contract prices for pipeline natural gas deliveries. But in the short term, Moscow will retain significant influence over Lithuania's energy supplies.

Lithuania's Energy Challenges and the LNG Solution

Natural gas has always figured prominently into Lithuania's energy profile, but it
became critical to Vilnius in 2009, when Lithuania's only nuclear power plant was
decommissioned. The Ignalina nuclear power plant had provided more than 70 percent
of Lithuania's yearly electricity supplies. However, when the plant was
decommissioned, Lithuania dramatically increased its reliance on natural gas, which
now accounts for 81 percent of the country's electricity generation -- a 28 percent
increase from 2008. Lithuania relies on natural gas for more than 30 percent of its
primary energy consumption, and 56 percent of its imports are destined for
electricity generation.

With no natural gas reserves of its own, Lithuania must import the 3 billion cubic
meters (bcm) of natural gas it consumes each year, all of which comes from Russia.
But Moscow's influence on Lithuania's energy sector is not limited to the supply
sector; Gazprom controls 37 percent of Lietuvos Dujos, Lithuania's natural gas
importer and distributor. Lithuania also serves as a throughway for natural gas
deliveries to the Russian exclave of Kaliningrad.

Lithuania traditionally has had a troubled relationship with Russia, particularly
regarding energy. Vilnius was the first government to try to prosecute Gazprom in a
European court over the company's violation of the EU Third Energy Package.
Lithuania is also seeking to improve the terms in long-term natural gas delivery
contracts through pricing renegotiations with the Moscow-controlled firm. However,
Lithuania likely will remain dependent on Russian natural gas for the majority of
its electricity needs in the foreseeable future. The Ignalina plant is not likely to
be replaced, and there is considerable EU opposition to a revival of coal-based
power generation. Other plans, like creating a Poland-Lithuania pipeline link, are
still theoretical.

Vilnius is undertaking a long-term expansion of its basic natural gas
infrastructure, including the development of Lithuania's first natural gas storage
facility and the tightening of the national pipeline support system. This expansion
is being enacted not because Lithuania plans to rely on more Russian natural gas,
but because it is part of Vilnius' plans to find alternative ways to import natural
gas from other sources.

LNG is really the only viable alternative to piped natural gas for Lithuania. LNG
technology allows the natural gas to be condensed into liquid form and shipped
around the world using tankers. LNG is traded at spot price (although contracts are
often drafted for high volumes and for the sake of convenience) and provides an
alternative to piped natural gas. However, LNG needs to be regasified at an import
terminal once it is unloaded from a tanker. The onshore facilities required for this
are quite expensive to build and usually require an initial investment of more than
$1 billion.

Lithuania cannot afford this type of project on its own and has sought financial
help from the European Union (as have its two Baltic neighbors). The economically
troubled Europeans have offered to help with the construction of a regional LNG
facility shared by Lithuania, Latvia and Estonia. However, the Baltic states have
not agreed on where or how to share a strategic asset, such as an LNG import
terminal. Through the more accommodating Latvian government, Moscow played an
important role in making sure the Baltic countries could not reach an agreement.
Lithuania finally broke the stalemate with its announcement that it would lease an
alternative, independent LNG import system.

FSRUs: Game-Changers for the Baltics?

On March 2, Lithuania signed a 10-year contract with Norwegian LNG services company
Hoegh for the annual processing of more than 1 bcm of natural gas. Hoegh will lease
Lithuania an FSRU that will be moored at the ice-free port of Klaipeda. Operations
are slated to begin in 2014 at a cost of $50 million a year (not including the
actual LNG purchases).

FSRUs, which are modified LNG tankers, can store a large amount of LNG (the Hoegh
ship can store 170 thousand cubic meters) and serve the same function as an onshore
regasification plant, transforming the LNG so that it can be pumped into the regular
distribution network. FSRU technology is relatively new; the first ship of its kind
was retrofitted from an old LNG tanker in 2008, and the first purpose-built FSRU was
inaugurated in 2011.

Unlike their onshore counterparts, FSRU terminals are mobile and can operate on a
leasing schedule. This means contracting nations are spared the large up-front
development and construction costs of an onshore terminal and can instead make
smaller annual payments. Moreover, FSRUs can be built at half the cost and in half
the time as onshore facilities. These benefits are very attractive to Lithuania,
which has been struggling with both the costs of financing an exclusive LNG onshore
terminal and the difficulties of reaching a political agreement on sharing one with
its neighbors.

Like onshore LNG terminals, FSRUs require a pipeline link to the distribution
network and storage facilities. Vilnius seems to be addressing this issue with its
latest infrastructure development efforts. Chief among the planned projects are the
construction of a high-volume domestic pipeline in 2012 and the construction of the
country's first large underground storage facility.

The FSRU Lithuania is leasing is capable of regasifying 11 million cubic meters of
natural gas per day. Over the course of a year, the ship theoretically could process
more than 4 bcm of natural gas -- 25 percent more than Lithuania's annual
consumption -- though the current contract stipulates a 1 bcm annual output by 2014.
The contract will allow Lithuania to reduce its dependence on Russian natural gas by
nearly 50 percent.

Russia's Position

Gazprom's monopoly over natural gas exports and Lithuania's increased dependence on
Russian natural gas since the closure of the Ignalina nuclear plant have led
Lithuanians to pay among the highest prices in Europe for Russian natural gas.
Additionally, the strategic nature of natural gas deepens the concern for any nation
within the area affected by Russia's resurgence.

Russia's strategy to counter an undesirable LNG facility in the Baltics has been to
exploit and encourage the political disagreements among the Baltic countries by
using Latvia, whose government is closely aligned with the Kremlin.

Vilnius naturally has made it a priority to find independent leverage to use against
Moscow in contract price negotiations. The ongoing lawsuit against Gazprom for its
breach of the EU Third Energy Package is an example of this struggle for bargaining
power, one that has only been moderately successful, since the chain of suits and
countersuits could take years to resolve.

A contract for an FSRU with the potential of unilaterally out-supplying Russia sends
a message to Moscow, indicating that Russia could lose not only a customer but also
one of its main strategic inroads in a highly sensitive region. As a result, Russia
will have to be more accommodating in future negotiations, pricing its natural gas
competitively compared to the still relatively expensive LNG.

Lithuania's FSRU lease is the latest in a series of similar pitfalls for Moscow
(Poland's construction of its Swinoujsce onshore LNG terminal, for example), which
sees LNG cutting down on the high profit margins from its sales to European
customers. But Moscow retains a great deal of leverage in Lithuania's energy sector,
especially in the short term. Until 2014, Lithuania will still depend on Russia for
all of its natural gas imports, and even after 2014 Gazprom will continue to control
a large portion of the distribution network within Lithuania. The FSRU deal, while
certainly significant for Lithuania, will not mean an immediate, drastic change.
Rather, it will create a gradual shift in energy politics as Lithuania and Russia
continue their pricing negotiations.

As technical advances and the opening of the U.S. shale natural gas export market
are expected to lower LNG prices, conditions could improve for coastal nations
dependent on Russian natural gas. FSRUs could well be the answer for such countries
that want to obtain an advantage in negotiations with Moscow and independently
achieve some energy security at a manageable cost.

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