February 23, 2015

The Baltic-Nordic Region and the Future European LNG Market

Floating storage regasification unit (FSRU) "Independence" is docked at the liquefied natural gas (LNG) terminal in Klaipeda port October 27, 2014. Lithuania will be able to survive without Russian gas after its LNG terminal opened today, redrawing the energy map for the Baltic states. The floating LNG import terminal at the port of Klaipeda means the end of the supply monopoly of Russia's Gazprom and isolation from global gas markets.
Floating storage regasification unit (FSRU) "Independence" is docked at the liquefied natural gas (LNG) terminal in Klaipeda port October 27, 2014. Lithuania will be able to survive without Russian gas after its LNG terminal opened today, redrawing the energy map for the Baltic states. The floating LNG import terminal at the port of Klaipeda means the end of the supply monopoly of Russia's Gazprom and isolation from global gas markets.

Liquefied natural gas (LNG) can become a key alternative source of supply in the event of serious pipeline gas shortfalls across the EU. However, for this to happen successfully, the EU needs to develop a Europe-wide LNG strategy based on a common approach and common framework.

While LNG markets in Western Europe in general function effectively, the further east one goes, the less this is the case: western EU member states have invested heavily in terminals and regasification plants, whereas the member states in Central and Southeastern Europe (CEE/SEE)—especially those in the Baltic region—are still striving to end their dependence on a single gas supplier and connect to the EU’s gas pipeline network and finally become one of the energy market players. Europe is not yet equipped to move LNG at maximum import capacity due to lack of inter-connections, thus CEE/SEE regions are still isolated from the major LNG import points. The political nature of the gas pipelines linked to Russia prompted some of leaders to seek for alternative sources of supply. “We’re going to need LNG” became a popular notion and spread with unprecedented speed among policy makers in the Baltic, CEE and SEE regions. The future of LNG trade in these regions is significant for both strategic – to weaken Russia’s monopoly power – and commercial reasons.
By contrast, the approach towards LNG in Western Europe rests on the notion “we’ll buy LNG when we can optimize the purchase,” which underlines a key difference in energy sectors across the EU. LNG—a flagship of growing flexibility in the global energy trade—became a way for the Western European gas hubs to maintain liquidity and thus promote competitive pricing. The liquidity—and thus, the flexibility—of the gas market depends on two factors: 1) ability to be easily transported, which requires infrastructure to move, allocate gas and manage congestions; and 2) ability to store the gas, which helps to balance seasonal variation in supply and demand.
With LNG, leading energy market players can react faster to shifts in gas demand or changes in gas prices, when prices are low or demand insufficient, they can store the gas, reselling it later when it is profitable. Many Western EU countries (e.g., Belgium, France, Italy, Portugal, Spain, and the UK), have become leading LNG deal-makers in this way. Spain—the biggest LNG trader in Europe—made considerable profit on reselling LNG when the global price of gas was at its peak and its internal gas demand bottom rocketed.
Of course, responding to market trends is not always easy. The Fukushima nuclear crisis in Japan caused a spike in Asian demand for natural gas; the resulting tight market left the majority of LNG import facilities in Europe severely under-utilized (only 24% of capacity was used in 2013). Yet, starting from mid-summer 2014 the gap among natural gas prices in different regions of the globe has shrunk to its narrowest since 2010 (see the Graph), as faltering demand in Asia combined with rising supply across the board has fueled convergence. New LNG export projects in Australia—of which 50% remain un-contracted—can provide additional supply to the spot market. Together with the US impending increase in export capacity, this could mark the end of a period of tightness in gas and return Asian prices to European levels once again. This would thus increase the availability of LNG volumes for Europe.
There is a definite future for LNG spot and contract trade in some parts of Europe, but the EU should still connect and integrate more deeply the gas balancing points across the Union. Overall, national energy markets across the EU vary in consumption and gas demand – a backbone for Estonia and other countries in the region in seeking to obtain competitive pricing. Accordingly, a one of the key goals for the Baltic region is to bring about LNG competition, which is a critical step in unifying regional gas markets. This key goal has already been effectively achieved in the electricity market in the Baltic-Nordic region, after Estonia, Latvia, and Lithuania joined the Nord Pool Spot power market.
In order to see LNG supplies reach the Gulf of Finland and Gulf of Riga, the Baltic states should also work to finalize the infrastructure first. Lithuania was first to do so in December 2014 after it imported the first cargoes to the newly launched Klaipėda floating liquefied natural gas terminal (FLNG). It thus finally diversified the source of its energy supplies and minimized Gazprom’s political leverage. But not only is the initial capacity of the terminal (0.5 billion cubic meters, or bcm, annually) too small, but even after a planned expansion of the terminal and improvements to interconnectors with Latvia (and hence indirectly to Estonia), the capacity of the terminal—3 billion cubic meters (bcm)—is still too small for the region as a whole, thus might not create a “spillover effect”.
However, after it comes online in 2016, the Polish LNG terminal at Świnoujście—together with the planned GIPL pipeline to Lithuania—could solve this problem and create a bigger market. The fact that even Ukraine is planning to import LNG from Polish terminal after the required modernization of the cross-border interconnector is completed underlines the degree of market liquidity that Świnoujście is expected to bring to the region. But by themselves, neither Klaipėda nor Świnoujście can be game changers for the region without two further factors: 1) more cross-border trade after the terminals are online, and 2) a legal spot trade platform.
The list of Baltic LNG endeavors is not limited to Klaipėda or Świnoujście. After the 3-year-long struggle between Estonia-Finland about which country would host the terminal, both countries finally decided to go ahead with their own small-scale terminals and probably one bigger regional one. We can predict that the Nordic-Baltic region will develop a small scale LNG trade that would mainly cover bunkering and local industries while still lowering the total amount of Russian gas in the supply mix. A positive aspect of such small- scale LNG trade is that it is based on “off the grid” and is highly flexible; this will in particular serve industrial customers located close to the coast.
Lithuania’s LitGas has already announced it is considering establishing a bunkering business together with Norway’s Statoil on top of the Klaipėda terminal. Finland expects to cover 25% of its gas demand via small-scale LNG, a considerable figure given that the country currently imports 100% of its gas demand from Russia. Manga LNG (to be completed in 2017), Pori (2016), Rauma (2017) in Finland and Muuga (2017) LNG project planned to be build in Estonia by the world’s largest terminal group Vopak are the first steps towards developing such a market. Skangas, the leading investor in Manga and Pori, has already booked LNG shipments from Belgium’s Zeebrugge terminal – one of the busiest in Europe. Finnish-Baltic market at 10 bcm would be large enough to support gas trading hub(s) provided the Balticonnector is built, thus have a potential to attract LNG for an affordable price. The geographic proximity of Finland, Estonia to the most developed spot traders and gas hubs in Europe (i.e. in Belgium ZTP, Netherland’s TTF, German’s Gaspool, UK’s NBP) could provide at least a lower LNG shipment fee. Why not seize such an opportunity?
While a virtual spot trade platform to bring Baltic energy traders to Northwest spot market does not yet exist, it could be quickly launched given sufficient commercial and political interest. The political driving force of the countries in the Baltics and further regions definitely develop a solid bargaining position vis-à-vis Gazprom for long-term contracts. Lithuania’s president stated clearly at Davos that “[g]lobal trends show that the era of gas pipelines is over.” While this may be slightly overstated, it is nonetheless a clear signal that countries and companies are ready to adapt to new sources and enter new markets such as LNG. The volume of flexible LNG—that is, cargoes without contractual commitments—delivered to Europe (e.g., to France, Spain, and the UK) has the potential to rise in 2015 together with the upcoming US LNG export projects, and the trend is expected to continue from 2016. European policymakers together with private sector leaders should work to ensure that these positive steps forward become the foundation for developing functioning markets and trading platforms throughout the European Union—especially in previously isolated areas like the Baltic.

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