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A Natural Gas Sector Reform. Are We Going the Right Direction?

Interview of “Verslas ir politika” (“Business and Politics”) with a councillor of the Lithuanian Gas Association, a head of JSC “Lietuvos Dujos” Strategic Development Department, Saulius BILIUS

Gintautas KNIUKŠTA

A Natural Gas Sector Reform
A Natural Gas Sector Reform

How would You briefly describe a main business of JSC “Lietuvos Dujos”?

The main business of JSC “Lietuvos Dujos” covers natural gas purchase (import) and sales to its clients, transmission and distribution services, sustainable development of Lithuania’s natural gas supply infrastructure, most of which are owned by the company.

The company supplies gas to power generating enterprises, industrial and agricultural companies, natural gas consumers of commercial and residential sectors. JSC “Lietuvos Dujos” transmits natural gas by transit to the Kaliningrad Region of the Russian Federation. The company has 550 thousand customers and 1,700 employees. In total, JSC “Lietuvos Dujos” operates 1.9 thousand km of gas transmission and 8.1 thousand km of distribution pipelines.

Member of the Seimas, K. Masiulis, states that “Gazprom” controls all networks in Lithuania and does not do anything for Lithuania to have any alternative to Russian gas.

I can argue that this is a complete untruth. Let’s start from the fact that “Gazprom” does not control all the networks. The company was privatised in two stages. Through public international tender, the following worldwide energy companies became its shareholders: in 2002, the consortium of “Ruhrgas AG” and “E.ON Energie AG” (Germany) acquired a block of 34% shares (presently, the shares are owned by “E.ON Ruhrgas International GmbH”); in 2004, the natural gas supplier JSC “Gazprom” (Russia) acquired 34% of shares.

“BNP Paribas”, a bank of irreproachable character, an adviser of the Government of the Republic of Lithuania in both privatisation stages, still refers to JSC “Lietuvos Dujos” privatisation transaction as a model in Eastern Europe.

Another unique aspect of this transaction in the Lithuanian history of privatisation, I would say, is that, in addition to the State, JSC “Lietuvos Dujos” shareholders have contributed additional 128 million LTL to the company, thus, providing substantial support for the new company’s development stage. Thanks to the shareholders’ efforts, the company’s share in the natural gas supply market has been significantly increased, that, in turn, even more has raised its value.

I can responsibly state that “Lietuvos Dujos” is currently the most efficiently managed energy enterprise in Lithuania. Minister of Energy of the Republic of Lithuania has acknowledged this fact as well. This is an example of indeed successful privatisation. Besides, a comparison of the company’s privatisation transaction amount with the current value of JSC “Lietuvos Dujos” reflects the huge contribution made by private shareholders to the company’s current value creation.

In addition to the shareholders’ contribution, a half of the company’s profits was allocated to investments and development for a long time after the privatisation. Since 2002, a total investment amounts to nearly 1 billion LTL.

Let’s talk about specific investments. For instance, rumours about the construction of the liquefied natural gas (LNG) terminal are spread in the market for more than a year…

At the very beginning of discussion of the terminal construction possibilities, various institutions have declared that JSC “Lietuvos Dujos” should not engage in this project. According to them, this should be operated by another company, the purpose of which would be to create an alternative to gas, supplied by “Lietuvos Dujos”. Therefore, the claim about the company’s failure to build the terminal is completely unreasonable. However, I would like to note that the LNG terminal is a gas infrastructure unit, the activity of which is to be controlled by independent regulators as provided by EU legislation.

Is case of Lithuania, the National Control Commission for Prices and Energy is responsible for it. Before making a decision to invest, any investor wishes to get acquainted with a control mode of the future object. However, a document, defining the control mode of the terminal, is still unavailable; though, we have been raising the issue for several years.

It should be noted that the gas in Lithuania had been much cheaper than in other European countries for a long time. A terminal, rather than a pipeline, is a means of access not to regional but to global natural gas markets. The presence of infrastructure of the alternative product supply does not guarantee the import of the product, while the price – definitely does.

All the power links in Europe, which could be built on a commercial basis, have been already built. The Privatisation Agreement of JSC “Lietuvos Dujos” assumes the obligation to connect natural gas pipelines of Lithuania and Poland when certain appropriate economic prerequisites are created.

The European Commission is obliged to envisage so that no isolated markets would left by 2015. This means that natural gas systems in all European Union countries should be merged into one integral system.

On JSC “Lietuvos Dujos” initiative together with its partners in Poland and the European Commission, the project on Lithuania-Poland gas pipeline connection was “revived” in 2009. The first stage of the research works is being carried out by an international audit and consultancy firm “Ernst & Young”, the report on the works of which we should receive on 1 July of this year. The research is funded by the European Union, “GAZ-SYSTEM S. A.“, and JSC “Lietuvos Dujos”. All the works are carried out in accordance with the schedule, agreed with the partners and the European Commission.

Jurbarkas-Klaipeda gas pipeline construction is planned in the National Energy Strategy. The company launched implementation of the project in 2007. The strategy stipulates that the half of the project will be financed by the structural funds of the European Union in order to reduce a negative financial impact of the project on natural gas consumers.
As rules for financial management of the EU Structural Funds have not yet been fully developed in Lithuania, besides, in order to accelerate the implementation of the project, the company had been promised that a half of investment made would be refunded by the European Union. However, upon the accomplishment of the first stage of the project from Sakiai to Jurbarkas, it was declared that EU funding could not cover the accomplished works.

This year, after long peripeteias, the Government has decided to “retrieve” the money. We have the necessary projects and construction permits for the whole gas pipeline route; we have announced tenders for construction works and purchase of pipelines. As soon as the money gets on the company’s bank account, the construction will immediately commence.

A serious challenge to the Lithuanian energy sector was the shutdown of the Ignalina NPP. The Government had estimated that, upon the shutdown of the nuclear power plant, the natural gas would serve as the primary fuel for electricity generation up to the new NNP commencement, so, it ordered our company to create a natural gas supply capacity, corresponding to 5 billion cubic meters of natural gas consumption in Lithuania.

Therefore, gas-compressor station has been constructed, without which exploitation of Sakiai-Klaipeda pipeline connection would be impossible. Half of the gas-compressor station capacity is necessary for Lithuanian consumers – this share was funded by JSC “Lietuvos Dujos”.

Another half of the station capacity is used for natural gas transit to the Kaliningrad Region. Transit increase tool is also foreseen in the National Energy Strategy – it guarantees gas supply security and reliability to Lithuanian consumers. Therefore, claims that the investments were made “only in the development of Kaliningrad Gas Corridor, irrelevant for Lithuania,” are completely unreasonable. We carried out obligations stipulated for us by the Strategy.

In accordance with the Law on Natural Gas, our company accumulates a certain amount of gas for our household customers, which could be used in case of crisis. We have gained the opportunity only because the natural gas assessment centre has been built on the Lithuanian-Latvian border on JSC “Lietuvos Dujos” initiative and funding.

This gave us the opportunity to take advantage of Latvia’s natural gas storage and to guarantee an alternative way of natural gas supply to Lithuania in case of extreme situations.

The Seimas has approved a gas sector reform for legalised projects. The Government suggests to amend the Law on Natural Gas to separate gas supply from the pipeline control. According to the legislators, this is the only way to get free of dependency on a single gas supplier “Gazprom”. How do You evaluate this Government’s initiative?

I am not a politician, thus, let politicians solve the political debates and decisions; while, I’ll try to answer about its relation to the EU’s declared objectives and business aspects.

In fact, the amendment of the Law on Natural Gas is subject to the goal to transfer the Third Energy Initiative of the European Commission to the Lithuanian natural gas sector legislation. The Third Directive describes a relatively wide range of potential or alleged shortages of natural gas markets in certain European countries; also, it states that the Second Energy Package on market liberalisation in Europe has failed to eliminate these shortcomings.

The problem of the European Commission is not that it issues multiple legal acts but that it fails to implement them. The same thing has occurred in case of the Second Initiative. Besides, certain countries interpreted and implemented the Second Directive in their own way by selecting “convenient” aspects and “forgetting” the other ones; national market regulators in separate European countries either lacked skills and competencies or were extremely dependent on the national political will and simply could not carry out their intended activities and functions.

It is silly to expect that the law will be implemented earlier than its due dates are stipulated (for obvious technical or organizational reasons). Therefore it is not surprising that much time before the due date of implementation of tools, provided for in the Second Directive, as well as considering other above mentioned aspects, the research, initiated by the European Commission, has demonstrated that not everything is done yet and the market is not operating as planned.

It is surprising that the accusation was implied on enterprises that, in turn, has promoted a new EU initiative. It is important to note that the new initiative was inspired not by actual wrong actions of integrated gas companies but by the assumptions that they could take such actions.

As already mentioned, the main goal of the Third Energy Package is to create a competitive market. By preparing the documentation package, EU has considered that since certain countries have an isolated market with no background for any alternative gas supply, it makes no sense to talk about effective competition and to implement beforehand corresponding tools in these markets stipulated by the Third Directive.

Consequently, the European Commission has proposed to these markets a business separation exception – until the creation of conditions for alternative gas supply.

Four of the Baltic states – Finland, Estonia, Latvia, and Lithuania – are isolated markets. The first three countries have taken advantage of the exemption proposed by the EU, while Lithuania decided to refuse the exemption.

The Third Directive provides that one of the tools to ensure non-discriminatory activities of natural gas suppliers in a certain market is an efficient separation of natural gas transportation and gas supply (trading) activities, so that there could no doubt that a company, both owning transportation networks and operating as a natural gas supplier, can discriminate its competitors, engaged exclusively in natural gas supply.

The Third Directive stipulates three following models of the effective separation: ownership unbundling, an independent system operator, and an independent transmission operator. The above mentioned Directive unequivocally states that any of the three models is sufficient for the effective separation of the activities.

Lithuania has chosen the most rigid model – ownership unbundling. Definitely, the state is sovereign and can choose any natural gas market reform model under the Directive. However, the choice should be based on market estimates and an advanced assessment of its effects on various consumers.

It is obvious that a company’s separation into several enterprises causes additional costs both for the enterprises and consumers. We can see around us, in other European countries where one or another business separation has already taken place. In truth, it should be noted that in Lithuania there was not only recorded any case of abuse, described in the Third Directive, but there are even no objective assumptions for such circumstances to arise.

On the other hand, the separation of business activities is meaningful only when a consumer can actually choose from several alternative sources of supply. Rushing in performance of these reforms in Lithuania cannot be justified by any arguments.

The additional costs, caused by the separation of businesses until the creation of alternative sources of supply, will be shouldered on consumers.

There are claims that the separation it intended so that the current natural gas system transportation owners could abuse the situation and obstruct the construction of the terminal or refuse to connect to the transmission system, when it will be built, or after being connected, could prevent the transportation of imported natural gas through the terminal to consumers.

I would suggest to such claimers to get acquainted with the applicable Law on Natural Gas. The Law on Natural Gas does not provide any option for enterprises in terms of connecting or not connecting to the system – this is mandatory. The State regulates all the connection terms and prices; any refusal to connect to the system is fined by quite a heavy penalty, whereas, the connection remains mandatory.

Current Lithuanian laws guarantee the use of the network to any customer or supplier. The so-called “Third Party Access” (TPA) operates in Lithuania since 1993. JSC “Lietuvos Dujos” imports to Lithuania only about 40 percent of all the gas consumed in Lithuania. Other gas is imported by other suppliers or customers who have concluded direct agreements with natural gas suppliers.

Since 1993, the company “Lietuvos Dujos” has not received from regulatory authorities any warnings, complaints, or penalties due to inappropriate operation of business. Both the natural gas transportation terms and prices are established by the State. Thus, any ​​discrimination or wrong operation, in principle, is impossible in this sector.

A project on a new natural gas law, which is in process of development, covers a number of provisions and tools which have nothing to do with the Third Directive on Natural Gas, the market liberalisation, or, in general, the business logic. The Third Directive, which is to be transferred into the national legal framework, is an integral document based on certain logic. The development of the law does not assume to take from the Directive only what you like to, or to mix multiple concepts into one and expect a good product.

Considering a new law on natural gas, it is promised that its enactment and separation of JSC “Lietuvos Dujos” will guarantee the natural gas market liberalisation and demonopolisation in Lithuania.

It is worth noting that the enactment itself does not guarantee anything. Talking about demonopolisation – natural gas transportation is an ordinary monopoly. Regardless of who owns the gas pipeline – the State or a private owner – the gas transportation will remain the monopoly. Meanwhile, demonopolisation  in a gas supply activity is subject to availability of alternative gas supply routes and the sector regulatory environment.

Currently, natural gas transportation and supply activities are regulated by the State. As the gas transportation business is a natural monopoly, it is normal that it is and will remain regulated. Besides, the level of investment in the energy systems is determined by consumer demand and control mode rather than the issue of ownership, as it is common to perceive.

First and foremost, demonopolisation in the gas supply sector means deregulation of supply, i.e., deregulation of the gas supply prices for all consumers. This, as well, is provided by the EU directives.

Here the problem arises: an immediate implementation of the Third Directive is announced seeking to liberalize the market. At the same time, it is declared that the regulation may not be refused seeking to protect consumers. Any new supplier cannot enter to the regulated markets, since the regulation provides a competitive advantage to a current supplier.

Vicious circle? Yes, until it is understood that the market regulation means a zero risk for business, that is, the highest prices for consumers.

The National Control Commission for Prices and Energy predicts that natural gas prices will shoot up by almost one third this year that will inevitably result in more expensive centralized heating. Is it possible?

As for the gas prices, according to the Privatisation Agreement, the natural gas import price depends on the prices of alternative fuels in the Lithuanian market.

The main alternative fuel in Lithuania is fuel oil, which may be used by about 90 percent of Lithuania’s electricity and heat manufacturers without any additional investment. Currently, we are observing increase in prices of both petroleum and its products in worldwide markets, as it responds to gas prices.

Would the natural gas terminal rescue Lithuanian consumers? Would gas become cheaper?

The promotion of shale gas in the USA had a significant impact on European prices; therefore, liquefied natural gas, acquired by USA, was directed towards Europe or distributed in other worldwide markets. Again, this was an additional pressure on gas sellers. How long this situation will last – it is difficult to predict, still, it is not going to last forever.

Demand for natural gas is growing; however, is not yet clear when supply-demand balance gets stabilized. Very important factors are the overall global economic recovery, disaster in Japan, and related German and Italian decisions on nuclear energy.

This definitely does not mean that we do not need an alternative source of natural gas supply. We have a stable opinion that the source is essential and it must meet needs not only in Lithuania but also throughout the Baltic region.

A presence of a monopoly in the market, in particular, regarding a gas enterprise, is currently just devastating, since there is a constant routine issue of justice in price. While a consumer does not have a real chance to compare the price of the proposed product from two independent sources, no persuasions of consumers, that the price is just, will not help.

Do you think Lithuania will ever be able to manage without Russian gas?

Natural gas is the cleanest and most convenient fossil fuel to use, with a doubtless perspective such as a bridge, connecting the present energy with the future renewable, clean, and sustainable energy generation, pursuant ambitious European energy goals.

Gas is an essential raw material for chemical industry; in the future, I think, we will find much more of its potential applications. Therefore, for the next several decades, the demand for gas will persist in Lithuania.

The Government has paid attention to existence of shale gas mines in Lithuania. If scientists confirm the gas stocks, which theoretically should be in south-western Lithuania, could it substantially change the energy situation in Lithuania?

One of the key issues in the United States of America is that entrails of earth are owned by a land surface owner. On the other hand, there is much of unused land, where shale gas mining holes can be drilled.

Is shale gas promising in Europe? This issue concerns those countries, where shale gas mines are anticipated, and landowners of those countries, since it is necessary to drill a huge number of mining holes. Will they allow to drill the mining holes on their land? If yes, what size of compensation will they demand? And there are even more questions.

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