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Developing competition and security of supply in the Baltic gas market: Q&A

Posted by on 04 July 2019
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The Baltic region has been a key testing ground for competition between Russian pipeline gas and US LNG. Historically reliant on Russian gas, the Baltic states have sought to diversify their imports to head off any risk of politically motivated supply disruptions.

An equally important strategic objective has been closer integration with the European energy market.  To assist with this goal, a single entry-exit zone has recently been agreed between Estonia, Finland and Latvia, intended to promote the development of a regional gas hub.

However, considerable progress is still required on both fronts. The Baltic remains an illiquid market with limited sources of supply. In Estonia, extensive state involvement in the energy sector has placed a halter on competition and limited market growth.

In a recent paper published by the International Centre for Defence and Security, Professor Andrei V. Belyi of the University of Eastern Finland argued that Estonia needs to embrace free market principles and flexible LNG infrastructure to bring down prices, improve its energy security and assist with the transition to a low carbon economy.

In the following interview with Belyi, we discuss some of the conclusions of his paper.

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Q: To what extent does the new entry-exit zone introduced in the Baltic region further the broader energy goals of the European Union? Are there any inconsistencies?

Belyi: Generally, the EU gas target model foresees gas market integration and considers regional entry-exit zones as an intermediary step before a fully integrated gas market by 2025.

However, we observe that a full Europe-wide market integration is a very difficult task to implement. Network companies often face headwinds to agree on revenue sharing and on common entry-exit points.

Difficulties have emerged even between the Baltic states: Lithuania decided to postpone its participation in the entry-exit zone because of the transit pipeline from Belarus to Kaliningrad from which Lithuania collects transit fees. A common entry-exit zone agreement would require sharing the transit fees as well, whereas Lithuania is willing to keep the fees for itself.

Furthermore, the ideal target model requires a common virtual trading platform. Estonia, Finland and Latvia agreed to have a common entry-exit zone, but a common virtual platform is still needed.

Estonia and Latvia concluded an agreement to have a common balancing platform by 2020 and Finland is expected to join by 2022. The question remains whether Lithuania finally integrates into this market, particularly after the expiration of the transit agreement with Russia for supplies to Kaliningrad.

Thus far, without Lithuania in the deal, a virtual platform would logically exclude Lithuanian traders. However, there is a Get Baltic platform offering services for Lithuanian, Latvian and Estonian gas traders. Now Get Baltic is attempting to open a branch in Finland and it may coordinate activities with new structures foreseen by Estonia, Latvia and Finland.

Alternatively, we may see a situation similar to booking for hotels, where various competing platforms offer services (for trade services in our case).

What remains important is to stimulate small non-incumbent companies to participate in the market. So far, market fragmentation remains either low or non-existent in the three countries under discussion.

Estonia has seen a decline in market fragmentation since 2015 even despite the privatisation of Eesti Gaas. Our report actually argues that focusing on domestic market structures and favouring competition are the key prerequisites for a successful regional market.

Q: You’ve been quite critical of the Klaipeda LNG terminal. What lessons can future Baltic projects learn from Klaipeda?

Belyi: Long term supply agreement and elevated charter rates for the FSRU made the Klaipeda LNG project non-flexible in terms of trading. The core lesson: don’t underestimate a general trend in gas markets towards decentralisation and innovation.

LNG technologies evolve very quickly. Only a decade ago LNG was considered to be only for large scale supplies shipped over long distances. This market chain indeed requires capital-intensive infrastructure with long-term commitments on the buyer’s side.

Now, you have to factor in small scale LNG and direct use of LNG as a cryogenic fuel. LNG can be shipped even in small volumes by containers – which is what occurs among others between a small-scale LNG plant in the Russian Pskov region and Estonian gas companies Alexela, Eesti Gaas and Jetgas.

The new market context also reflects new opportunities for LNG purchase from either Russia (especially from Vysotsk terminal) or the US (from storages located in Poland). By assuming that LNG is in short supply and by subsequently concluding a long-term deal, Klaipeda LNG didn’t provide a success story in terms of market development.

The future LNG terminal in Paldiski, north-western Estonian port, has a chance to be built aiming at different supply conditions.

Q: When you look at the really liquid markets – for instance western Europe or the US – it’s no coincidence that they’re also very large markets. How much of a challenge does the Baltic region’s low natural gas consumption present for promoting further liquidity?

Belyi: Low gas demand is the core challenge. However, incremental gas demand exists in the power sector as well as in the transport sector (both road and maritime transport). Bigger gas demand will also attract innovation into new gas technologies, like biomethane and hydrogen.

Our report highlights an unexpected success with biomethane integration into CNG market in road transport. Biomethane now accounts for 40% of Estonian CNG market.

Q: Does gas have a role to play in helping Estonia meet the objectives of its National Energy and Climate Plan once this is formally adopted later this year?

Belyi: I can’t talk about the document as I didn’t see its final version. However, the initial version of the National Energy and Climate Plan doesn’t relate the energy transition to the gas markets, maybe partly because natural gas has been considered as a dirty fuel alongside heavier fossil fuels.

Most of the focus on energy transition has been around support to renewable electricity generation. However, industrial communities increasingly realise that a shift to 'full electric' economic structures would be too expensive for industries, transport and households.

Just compare electricity-based heating with gas-based heating at households. The difference is even bigger for industrial processes. So, we also observe that a positive image of natural gas is now returning because gas constitutes a viable alternative to going 'full electric'.

New gas technologies (biomethane and hydrogen) are reinforcing the place of gas in the economic transition. You may have noticed that on 18-19 June the European Centre for Policy Studies hosted a Low Carbon Economy Forum, where a large part of the debate was allocated to new 'blue' (biomethane) and 'green' (hydrogen) gases.

These debates observed in Brussels reveal that our conclusions in the report are relevant. Gas demand and gas markets need to be stimulated in order to allow further penetration of new gas technologies and make the energy transition more economically competitive.

Q: You write that greater liberalisation of energy markets can help to promote energy security, but concerns about security are one of the primary reasons many states feel reluctant to relinquish control over the energy industry. How does reduced state involvement promote energy security?

Belyi: It is what happens when policy-makers put a cart before the horse. The state-driven security approach often leads to excessive investments in infrastructure, hence increasing the costs of energy security and sometimes decreasing the willingness-to-pay for security.

Markets can provide an optimal balance for price relations between suppliers and buyers. Also, markets reduce the need to consider the physical origin of gas. An illustrative example can be provided by the oil products sector. This market works well and therefore nobody cares where the oil products come from. In an ideal market the same should happen to gas supplies.

Q: How do the energy security concerns differ for smaller markets like the Baltic states compared to large European importers like Germany?

Belyi: Of course the Baltic states are more concerned about supply dependence on Russia than Germany is. When Lithuania attempted its independence from the Soviet Union, the small republic experienced a full energy blockade.

This and other historical memories play a significant role in shaping security considerations. However, we also observe that Russian gas exports are increasingly fragmented. Novatek has become a valid competitor with Gazprom and other non-Russian suppliers.

In addition, smaller traders, like Cryogaz, have entered into the game. Then, since the EU anti-trust monitoring against Gazprom and the European Commission’s subsequent decision on Gazprom, the latter committed to respect EU competition norms for contracts and will link gas prices to other European hubs.

Hence, market-related security risks have been reduced in the aftermath of the case. Risks of physical disruptions are also very low. Cutting gas supplies is costly because it requires the operation of compressor stations without any market output.

It seems that Gazprom didn’t have a positive economic experience during the major gas transit crisis with Ukraine in 2009.

Q: What do you hope Estonia’s energy sector will look like in ten to fifteen years?

Belyi: Certainly, a bigger role for gas in electricity generation. Although decentralised renewable electricity generation will also grow, natural gas turbines will help to mitigate issues of intermittency inherent to renewable energy production.

I would also opt for a full transition of Baltic maritime transport to LNG, a shift which would reduce greenhouse gas emissions by 40-60% in this emissions-intensive sector and would annihilate sulphur emissions in the Baltic basin.

And of course, a bigger share of CNG in road transport with a growing share of biomethane (and even hydrogen) in it.

Network with producers, carriers, regulators and industry experts from across the European gas market at the LNG Shipping conference - part of London International Shipping Week.

LNG Shipping

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