December 13, 2012

Public debate on the Baltic LNG terminal: a step in the right direction

Previously confined to a narrow audience of specialists, the issue of the gas market in Estonia and the Baltic states has recently garnered broader attention. Numerous articles have appeared in the Estonian media discussing the proposed LNG terminals in Paldiski, Muuga, Sillamäe and in other countries in the region. Unfortunately, by focusing on the terminals in isolation, this media coverage has too often failed to provide the necessary context for the discussion of these LNG projects—which are a key element in a broader strategy of contributing to energy security by diversifying sources of supply and establishing a liquid natural gas market where prices are determined by supply and demand. Without this context, the risks and opportunities for Estonia and Estonian consumers can therefore remain unclear for the wider public.

13.12.2012, Mart Raamat (ICDS intern)*
Previously confined to a narrow audience of specialists, the issue of the gas market in Estonia and the Baltic states has recently garnered broader attention. Numerous articles have appeared in the Estonian media discussing the proposed LNG terminals in Paldiski, Muuga, Sillamäe and in other countries in the region. Unfortunately, by focusing on the terminals in isolation, this media coverage has too often failed to provide the necessary context for the discussion of these LNG projects—which are a key element in a broader strategy of contributing to energy security by diversifying sources of supply and establishing a liquid natural gas market where prices are determined by supply and demand. Without this context, the risks and opportunities for Estonia and Estonian consumers can therefore remain unclear for the wider public.
Developments in the Baltic regional gas sector should be considered within the context of the EU’s new energy policies. The framework for current EU energy policies—the Third Energy Package —emphasizes the need to diversify energy suppliers and to establish a common energy market. Currently, the Baltic region (including Finland) is 100% dependent on Russian-sourced gas supplies; eliminating this “Baltic energy island” is one of the key priorities for EU energy policy. Connecting regional gas- and electricity transmission infrastructure to a common EU energy grid is foreseen in BEMIP (the Baltic Energy Market Interconnection Programme). But in contrast to the situation in the electricity sector, where some developments have already been implemented, the reforms in gas sector are only in the initial stage.
There have been two new transmission pipeline proposals for connecting EU with the region: Finland-Estonia , and Lithuania-Poland; however, neither construction nor even any detailed planning processes have begun with either project. In order to accomplish the goals of the EU’s energy policy and create a gas transmission grid between continental Europe and Baltic region, both pipeline projects should be completed.
One point of concern about expensive infrastructure projects is the size of the market. If it would consist only of Lithuania, Latvia and Estonia, the aggregate yearly demand of 5.5 bcm would be discouragingly small for private investors. However, with the completion of the Balticconnector (Finland-Estonia) pipeline, the resulting regional market of 10 bcm per year represents a far more attractive commercial proposition. Accordingly, there has been quite a lot of interest from various private firms and consortia in investing in a regional LNG terminal. .
Another point of concern is strategic. Since the terminal represents one of the best ways of increasing the region’s energy independence, it must be assured, as Elering CEO Taavi Veskimägi has pointed out, that the LNG project will not fall into the hands of the existing monopolist, Gazprom.
A regional LNG terminal would help to break Gazprom’s iron grip over, and enhance the security of supply of, Baltic gas markets, provided the terminal is part of a broader system that allows new gas supplies to move freely to consumers throughout the region in response to prices determined by supply and demand. In this respect, Baltic governments should avoid political quarrels over the exact location of the LNG terminal and move forward to strategize on how to connect their energy systems. Interconnections among the Baltic countries exist already, but must be expanded by investments in cross-border transmission capacity, as foreseen by the BEMIP programme.
Provided that intra-Baltic transmission links are upgraded, and that commercial and governmental actors recognize their shared interest in creating a regional energy market with high liquidity, it matters little which country ends up “getting” the LNG terminal; customers in all three states are guaranteed to benefit from market-based access to natural gas imports regardless. Yet, to look at the media’s reporting on this, it is a zero-sum game in which a Latvian “win” is a loss for Estonian consumers. The general public is left with an impression that, whatever it takes, Estonia must be the location of the terminal – otherwise Estonian consumers would lose in comparison with their neighbors.
Instead of focusing solely on the location of LNG terminal, media coverage ought to include a wider discussion about the importance of this infrastructure project not just for national energy security, but for household consumers as well. As mentioned above, the terminal will increase the security of supply for the entire region. However, if the eventual LNG terminal operator concludes a long-term supply contract with fixed prices with only one supplier of LNG, it would not create a functioning regional gas market: the current monopolistic situation would be replaced with a market of only two major suppliers who have rather similar and inflexible prices. Therefore, the regional LNG terminal itself does not guarantee the emergence of market-based competitive pricing that would lower gas bills for consumers.
In conclusion, the current discussion on the LNG terminal is misguided, focusing on just one aspect of the critical strategic challenge to the regional gas sector. While the location of the terminal remains an important choice to be made, the more important factor in determining future regional energy security is developing effective operation requirements and regulatory background to guarantee that the terminal will clear the way for the market forces of supply and demand to determine natural gas prices. This will result in lower natural gas prices for consumers, as market forces break the link between natural gas and (more expensive) oil prices that Gazprom prefers. The underlying goal of all three countries, with strong support from the EU, should therefore be the emergence of a hub-based trading system of natural gas, where genuine price liquidity can emerge as has already occurred in the North Sea Basin. This will require cooperation to put in place the necessary physical and regulatory infrastructure, which should include not only an LNG terminal in one of the three Baltic states, but the Polish-Lithuanian gas inter-connection as well, which will provide additional diversified gas supplies from the Polish LNG terminal in Świnoujście (to be completed in the middle of 2014), as well as from the North Sea’s existing natural gas trading hubs.
*ICDS intern Mart Raamat is currently an MA candidate at the EuroCollege of the University of Tartu.

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