G-8 Summit Hangover in Central Europe

Russian Crude Oil to Lithuania Cut by Damaged Pipeline - Again

by James Angelus

The Russian diplomat in Warsaw had a strange smirk on his face when he tried to explain the cut-off of Russian crude oil supplies on 29 July to Lithuania’s sole refinery, Mazeikiai, the largest on the Baltic Sea surrounded by Scandinavia and Northern Europe. “We need time to repair the damaged pipeline,” he smiled, “it will take time.” The damage he refers to was front page news in Western media two weeks ago as Russia’s environmental agency caused a stir by announcing a “major catastrophe” near the Russian-Belarussian border, as the main oil pipeline to Lithuania sprang a leak.

The first reports from RosPrirodNadzor (Russia’s Natural Resources Oversight Agency) said that a “huge” oil leak covered an area of about 10 square kilometers with half the amount seeping into the water table. Finally, it appeared, the government was subscribing to Western norms of transparency by diligently reporting this “catastrophe” immediately after the accident. But it was later discovered that the spillage amounted to less than one rail tanker car would carry affecting about 450 square meters of land. “It will take 2 years to repair,” the diplomat affirmed, again with that strange smirk on his face.

Actually the Russian state-owned pipeline monopoly, Transneft, says it will take only one year and nine months to repair. The whole 70 km section of the pipe has to be replaced. Even with a twin pipeline leading to the refinery through Belarus it is “too risky” to keep one line open as repairs are made on the ruptured twin although the flow to Belarus continues uninterrupted. The latest statements by Transneft president Simon Vainshtok infer that this northern spur of the Druzba line may be shut down permanently as major parts of the 42-year old system are replaced and as Russian crude is shifted south toward the Black Sea and eastward toward China.

The G-8 Summit in July, headed for the first time by Russia with elaborate ceremonies in St. Petersburg, was supposed to demonstrate that Russia was a mature state and would not use energy as a foreign policy tool to blackmail its neighbors. The Summit was to feature a new arrangement on energy security with the European Union to stop these kinds of incidents. The basis of this agreement has been the Energy Charter which calls for third party access to markets and distribution channels. What Gazprom has done in the West, for example, by buying distribution networks in Germany and Slovakia and Hungary, among many others deals, would be offset by Western access to Russia’s pipeline system. Unfortunately, the Summit ended without any agreement at all, except a more emphatic Russian ‘niet’ to ratify the Energy Charter they signed a few years ago and confusion in the EU about what to do.

In the meantime the new owner of Mazeikiai, PKN Orlen in Poland which beat a couple of Russian majors and Kazakh oil companies in May for the tender to take over fallen Yuko’s stake, has been scrambling to find suppliers via tankers through the Baltic Sea. Orlen’s president Igor Chalupec said this week that the company “wishes to express its hope that there are not any non-business related reasons behind the reported pipeline failure. If that were the case, Russia could not be perceived as a trustworthy supplier of energy resources. PKN Orlen is deeply convinced that Transneft will soon remove the pipeline failure and resume oil deliveries via the pipeline. Any prolonged interruption of pipeline deliveries might result in Transneft’s loss of its reputation as a reliable partner.”

This was actually the third time Russia cut its crude supplies to the Baltic states since their independence from the Soviet Union in 1991, each time driven by Russian oil interests to force their way into ownership positions in these strategic assets on the Baltic Sea. In 1999 the American company Williams bought a controlling interest of the Mazeikiai refinery with strong Russian opposition, leading to the collapse of the Lithuanian government at the time. Lukoil, now viewed as a fair player in international markets with public listings in London and ConocoPhillips as a minority shareholder, cut off crude supply to the refinery in protest, forcing the eventual sale to a user-friendly privately owned Yukos in 2002. In 2003, Transneft cut supplies to the oil export terminal Ventspils in Latvia as it attempted to privatize, which only survived by getting its crude via rail carriers that Transneft did not control. The privatization process is still “in progress” with several bidders, including perhaps PKN Orlen, in the running after Transneft feigned little interest.

For Orlen, the prospects of its purchase of Mazeikiai are now in doubt. The EU Commission has to rule on the deal by March and market jitters from the cutoff already caused Morgan Stanley to sell 2.6 million shares in Orlen which reduced the company’s market value by 2% overnight. They can opt out of the deal if the market value of the refinery falls, or if dividends are not forthcoming, which may be exactly what the Russian strategy is. Lithuanian Prime Minister Gediminas Kirkilas is quoted as saying in March this year that a Russian diplomat warned him that the oil supply might dry up if the “right” bidder did not win the tender. Already Mazeikiai has lost half its production – which provides 10% of the country’s GDP – and seen its market value slashed.

The latest news is that the Lithuanian government may begin ‘repairs’ on the main transit artery between Russia and its Kaliningrad enclave unless Transneft can fix the pipeline soon. This rail link across Lithuania is the primary means for Russians to access Kaliningrad – a source of trouble before between the two countries and the European Union – that could spark an international row.

The vodka toasts to “energy security” at the G-8 Summit only a few weeks ago, a welcome meeting of the boys after Gazprom’s cut-off of gas to Ukraine, Moldova, and Georgia in the last year alone, are a faint memory now, with a hangover in Central Europe that bodes ill for the future. Energy is not getting more secure any time soon in this part of the world.