October 14, 2008

US Support for Lithuanian LNG Plant Indicative of Frenetic Attempts to Reduce Russian Gas Dependence

Following the military conflict in Georgia and the potential 'loss' of the EU-US backed 'fourth corridor' of energy supplies from the Caucuses/Central Asia, liquefied natural gas is rapidly gaining traction across European states as a strategic supply option. Yet it is the US, as much as the EU, that is driving renewed interest in LNG in Europe.

The bluntest example of such a trend is in Lithuania, where the US has pledged $800,000 to fund a feasibility study for a new liquefied natural gas (LNG) terminal with a capacity of 1.5-2bcm, alongside an additional three offshore sites to reduce overall dependence on Russian gas. Although the plant remains at a highly formative stage, its construction could potentially begin by 2013-14, albeit under close state ownership.

Russian dependence

Security of supply is very high on the agenda for Lithuania, which has long been dependent on Russia for almost all of its energy needs. Oil for the country's sole refinery, Mazeikis Nafta, has historically been supplied by Moscow via the Druzhba pipeline, which was cut in July 2006 due to technical reasons. Since then, crude has been supplied via the Butinge Terminal. The Baltic States' power system works in parallel with the Russian north-western power system, and has no possibility of operating separately at present. Nuclear fuel for Lithuania's only nuclear power plant is also imported solely from Russia. The added problem for Lithuania is that the plant is planned for closure by 2009 due to EU safety concerns, which will sharply increase gas demand beyond the 3.8bcm already consumed.

Unsurprisingly, Lithuania only has a single gas supplier, Gazprom, which also owns a 40% stake in the Lithuanian state gas company, Lietuvos Dujos, alongside Germany's E.ON. The upshot is that, although a new LNG plant might help to meet some of the demand while diversifying supply options, it is unlikely to provide any kind of definitive escape route from dependence on Russian gas.

LNG uptake overlooks supply-side risks

Despite this, a number of other European member states, most notably Poland and Germany, are also starting to look afresh at LNG options as a potential path to offset Russian dependence. Berlin has been actively pursing bilateral Algerian supply deals should 'ostpolitik' turn sour, while Poland is looking to reduce its dependence on Russian supplies. Clearly, in reality, the point is not so much to reduce overall dependence on Russian gas, which remains a structural reality for European supplies, but at the very least to open up more potential supply options while complicating Russian-North African relations.

But with LNG supply-side constraints showing little sign of abating due to contractual wrangling inhibiting upstream investment and Middle East, Asian and African producers using more and more gas to fuel domestic growth, LNG is highly unlikely to hold 'all' of Europe's energy security answers. Rather than focusing on LNG, the EU would be better off looking at the root of its core weakness - a fragmented gas market. This allows Russia to discriminate among European importers and leaves small countries in Central and Eastern Europe highly exposed, with similar trends seen in the south from Sonatrach. But even if Europe does move towards a genuinely integrated internal gas market to reduce bilateral pressures from key suppliers, this is likely to be too little, too late for Lithuania.