The Baltic countries--including Estonia, Latvia, and Lithuania--occupy a strategic location as transit centers for Russian oil exports. In addition, Belarus is becoming a major transit center for Russian natural gas exports to Europe.

GENERAL BACKGROUND
Estonia, Latvia, and Lithuania--together often known as the Baltic states--have moved rapidly towards European integration since they won their freedom from the Soviet Union in 1991. Alone among the former Soviet republics, the Baltic states were quick to adopt market economies and to implement democratic reforms. As a result, they largely have avoided the economic and political crises that have beset other regions in transition from a centrally planned economy, including the Balkan region and Southeastern Europe.

REGIONAL ENERGY ISSUES
Although not important energy consumers or producers, together the Baltic states occupy a key location for Russian oil exports. Other regional energy issues in the Baltics include Russian natural gas transit and alternative natural gas supplies, energy sector privatization and energy market liberalization, electric grid unification, and integration with the EU.

Regional Natural Gas Supplies
Russia is the main source of natural gas supplies for each of the Baltic states, and the proposed North TransGas project by Russia's Gazprom could bring additional Russian natural gas exports to the Baltics. The project, which would be carried out by Gazprom in conjunction with Finland's Fortum and Germany's Wintershall, would pump natural gas to Scandinavian and German customers via a pipeline beneath the Baltic Sea.

Three options for the pipeline route have been identified: Russia-Finland-Gulf of Bothnia-Sweden-Baltic Sea-Germany; Finland-Baltic Sea-Gotland-Germany; or St. Petersburg-Germany via a pipeline on the bottom of the Baltic Sea. Although none of these options call for the pipeline to transit any of the Baltic states, a pipeline extension to Estonia may be possible and, according to Estonian officials, it may even be desirable for the project's participants, since it could cut down on the costs of part of the subsea pipeline. In addition, Latvia's huge natural gas storage facilities could play an important role in the project, and an extension from the Baltic Sea to Latvia is another possibility.

The Baltics also are looking to diversify their natural gas supplies, and the recent natural gas deal between Norway and Poland  may provide the Baltic states with an alternative supply of natural gas. In September 2001, PGNiG, the Polish natural gas distributor, and the leading natural gas companies from the Norwegian market (including Statoil, Norsk Hydro, TotalFinaElf, ExxonMobil, and Shell) signed a 16-year, $11-billion deal to supply Poland with a total of 2.6 trillion cubic feet (Tcf) of natural gas. A dedicated pipeline will be built to supply Poland, with annual supplies of 88 billion cubic feet (Bcf) to begin in 2008 and rise to 177 Bcf in 2011, lasting until 2024.

Although the deal appears to threaten Poland with oversupply, since Poland does not consume as much natural gas as the deal calls for, the possible re-export of Norwegian natural gas from Poland to the Baltic states would take care of the excess natural gas on the Polish market. Lithuanian and Estonian officials have expressed their interest in receiving natural gas from Poland, which would require the Baltic supply network to be linked to Poland. Approximately 120 miles of pipeline would have to be laid from Poland to Lithuania in order to connect the networks. Estonia wants Lithuania, the new presiding head of the Baltic Council of Ministers, to take vigorous action in issues concerning the establishment of a common natural gas pipeline and natural gas supply.

Russian Oil Export
Latvia's Ventspils port is Russia's primary crude oil export terminal in the north, and both Estonia and Lithuania have important ports for Russian crude oil and petroleum products for export. Transit fees for these oil and petroleum products that are destined for export are an important source of revenue in the Baltic states.

However, Russia is keen to avoid these transit fees by constructing its own oil export terminal at Primorsk, part of Russia's new Baltic Pipeline System (BPS). The Primorsk terminal, with an initial capacity of 240,000 barrels per day (bbl/d), is scheduled to load its first tanker in December 2001. According to various estimates, ports in the Baltic states could lose between 10% and 50% of their current Russian oil export volumes. Nevertheless, projected increases in Russian oil exports, along with increased oil exports from the Caspian Sea region, especially Kazakhstan, appear to ensure that the ports in Estonia, Latvia, and Lithuania will remain important oil export terminals in the future.

Estonian Ports
In recent years, Estonia's ports at Tallinn and nearby Muuga have become major terminals for the export of Russian petroleum products. By the end of 1999, these terminals were exporting over 300,000 barrels per day (bbl/d) of products, rivaling Ventspils as the largest transshipment center in the Baltics. Estonia's ports, which only export petroleum products such as heavy fuel oil, are not reliant on pipelines to deliver supplies. Instead, Estonian transit companies, such as Eurodek Tallinn and Pakterminal, use trains to transport oil products from Russia to Estonian sea ports.

In 2000, Pakterminal handled 8.5 million tons (171,000 bbl/d) of oil products, around 500,000 tons (10,000 bbl/d) more than in 1999, despite a plunge in imports from Russia in the third quarter that forced the company to transit other oil products. In the first nine months of 2001, the company reported handling an average of 182,000 bbl/d of oil products, an increase over the record volumes in 2000. Thus, Pakterminal, Estonia's largest oil transit company, is confident that Russia's Baltic Pipeline System and new port at Primorsk will not substantially cut into its business.

Eurodek Tallinn also is increasing its export volumes after handling 6.2 million tons (124,500 bbl/d) of oil products in 2000. In the first half of 2001, the company handled 3.6 million tons (144,500 bbl/d), and in August 2001, Eurodek opened a new $50-million terminal in the port of Muuga. The 60,000-bbl/d-capacity terminal will allow the company to boost its export capacity. A smaller 16,000-bbl/d-capacity terminal is also being constructed by Alexela Oil in Padiski, with work due to be completed by August 2002.

Overall, a total of 1.8 million tons of oil products passed through the Port of Tallinn during September 2001, and 16.1 million tons (431,000 bbl/d) during the January 2001-September 2001 period.

Latvian Ports
Latvia's Ventspils port is the largest oil export terminal in the Baltics, and both Riga and Liepaja also have ports for exporting oil and oil products. The Ventspils oil terminal can handle about 500,000 bbl/d of crude, and Latvian officials have stated that its throughput capacity could be increased to 1.8 million bbl/d (although this would require about $30 million in investment). Actual exports from Ventspils have been far below capacity, however, due to a bottleneck in Polotsk, Belarus that has limited pipeline flows.

To reduce the bottleneck at Polotsk, the Western Pipeline System joint-stock company was formed in 1998 to help build a second pipeline from Polotsk to Ventspils. The project calls for an additional 360,000 bbl/d capacity by 2005, with backing sought from Russian, Latvian, Belarussian, and Western companies, and additional backing to come from the European Bank for Reconstruction and Development (EBRD).

According to PlanEcon, Ventspils handled 273,000 bbl/d of crude oil in 2000, all of which was Russian crude oil. In the past, Kazakhstan also has exported small amounts of oil via Ventspils, with as much as 13,000 bbl/d of Kazakh crude flowing through the terminal in 1994. Increasing Russian oil exports have limited Kazakhstan's ability to export via Latvia, and Latvia's efforts to reach an agreement with Kazakhstan to export up 100,000 bbl/d via Latvian ports have been hindered by the need to reach an agreement with Russian on rail tariffs and the use of its pipelines.

Although in 2000 Ventspils retained its status as the Baltic port with the largest share of Russian oil exports, competition from other Baltic ports is increasing and eroding Ventspils' market share. In an effort to attract more Russian oil exports, Ventspils Nafta, the company that runs the terminal, has cut its reloading tariffs several times in the past few years. Nonetheless, it is still one of the highest-cost routes for Russian crude oil, and recent reductions in exports could force it to reduce loading charges again in order to stay competitive. Russian companies now pay Latvia in excess of $100 million annually for transit services.

Russia's new Baltic Pipeline System is the biggest threat to Ventspils, since the BPS would allow Russian oil companies to save large amounts of money on transit services and transshipment. Semyon Vainshtok, president of Transneft, the Russian pipeline monopoly, has assured Latvian government officials that the opening of the BPS in December 2001 will not affect the amount of oil loaded at Ventspils, since increases in Russian exports will necessitate the use of both Ventspils and the BPS. Latvia is looking to sell its 43% stake in Ventspils Nafta, hoping that the privatized company will make the port more competitive. Latvia also may offer Transneft a larger stake in LatRosTrans, the Latvian-Russian joint venture that operates the oil and oil product pipelines between Polotsk and Ventspils, in exchange for an increase in the amount of oil shipped to Ventspils.

Lithuanian Ports
Lithuania is positioning itself as a transit center for oil exports from Russia. Lithuania's port of Klaipeda once had been one of the former Soviet Union's primary export outlets for refined products, but its importance has declined in recent years, and Lithuania now ranks behinds both Latvia and Estonia as a petroleum transshipment center.

Lithuania has moved forward with its plan for a $120-million upgrade of the port at Klaipeda, and the country recently built a new $267-million export port at Butinge near the Latvian border. The Klaipeda oil terminal is expanding its product export capability from 90,000 bbl/d to 160,000 bbl/d. The Butinge terminal, which was launched in July 1999, will have a final capacity of 160,000 bbl/d of crude oil for import or export, and 50,000 bbl/d of products.

The Butinge terminal has been beset by problems since it was launched. Since privatizing Mazeikiu Nafta, the company that operates the Butinge terminal, in 1999, Lithuania has been unable to secure enough oil supplies to load at the terminal. Russia's Lukoil, the coordinator of Russian oil exports in the country's northwest, reduced oil supplies to Lithuania after being left out of the Mazeikiu Nafta privatization. As a result, the Butinge terminal exported just 60,000 bbl/d of crude oil and petroleum products in 2000.

Kazakhstan has been ready for a number of years to supply oil to Lithuania, but an agreement between Kazakh oil companies and the Russian side regarding transportation of oil to Lithuania has not been reached. In July 2000, Kazakhstan's Karazhbasmunai and Mazeikiu Nafta signed a three-year oil supply under which Kazakhstan was to supply up to 60,000 bbl/d to Lithuania, but deliveries have not yet begun due to the lack of an agreement with Russia on transportation tariffs.

In addition, an oil spill at Butinge in March 2001 caused tensions between Latvia and Lithuania as winds blew the spill into Latvian waters. Reportedly, a tanker was being filled with crude oil when a cable snapped, resulting in pipes being disconnected and a small amount of oil was spilled into the Black Sea, where it later sunk to the seabed in Latvian territorial waters. Mazeikiu Nafta and the Latvian Maritime Environment Board have argued over the amount of oil spilled and the damage it caused, as well as Mazeikiu Nafta's compensation to Latvia. The Butinge terminal has experienced several additional accidents since the March 2001 oil spill.

In the summer of 2001, Mazeikiu Nafta did sign a five-year agreement with Russian oil major Yukos to export 80,000 bbld/d of crude via its Butinge terminal, and deliveries began in July 2001. From January 2001 to September 2001, the Butinge terminal handled an average of 112,000 bbl/d, up from an average of 75,000 bbl/d during the same time period in 2000.

Electric System Unification
The power systems of Estonia, Latvia, and Lithuania originally were built to be part of the Soviet Union's northwestern unified energy system. After achieving their independence, the Baltic states disconnected from the grid, forming their own national grids. However, the independent national grids continued to run in parallel mode, allowing Latvia, whose power-generating capacity is mainly seasonal hydropower, to import electricity supplies from Estonia and Lithuania when necessary. In 1999, Russia, Belarus, Estonia, Latvia, and Lithuania agreed to re-connect their electricity grids in order to ensure reliable power suppliers for consumers in the five countries. Lithuania, which remained connected to Belarus, Latvia, and Estonia, withdrew from the five-party agreement at the last minute due to political reasons.

The Baltic states' power grids are not connected to the Western European energy grid. As a result, both Lithuania and Estonia, which have excess power-generating capacity, have been limited in their ability to export power. In addition to exporting power to Latvia, Lithuania has exported power to Belarus periodically, but Belarus has been delinquent in its payments for electricity supplies. Belarus owes Lithuania around $50 million for electricity in 1998 and 1999, but after a one-year break, Lithuania agreed to begin power exports to Belarus again in July 2000 after concluding a unique three-way arrangement with Russian and Belarus. Under the agreement, Russia agreed to purchase 2.2 billion kilowatt-hours (Bkwh) of power from Lithuania's Ignalina nuclear power plant for subsequent delivery to Belarus. In exchange, Russia supplied the Ignalina plant with nuclear fuel, while Belarus paid Russia in commodities rather than cash.

In October 2000, Lietuvos Energija, Lithuania's power utility, halted exports to Belarus due to a lack of payment guarantees. Lithuania announced that it is unwilling to export power to Belarus directly without firm payment guarantees. Thus, in February 2001, representatives of Lithuania, Estonia, Latvia, Russia, and Belarus signed a multi-lateral agreement on the parallel work of their energy grids, bringing Lithuania on board to the earlier agreement. The agreement gives Lithuania, which also is looking to link directly with Poland, the ability to transit its electricity via Belarus to other markets such as Slovakia, with which Lithuania recently signed an export contract. In addition, in the spring of 2001, Lithuania and Russia signed a deal on the export of 7 Bkwh of Lithuanian electricity in 2001, 2 Bkwh of which was to be sent to the Kaliningrad Region of Russia and 5 Bkwh to be sent to Belarus.

Estonia, for its part, has been pushing to link its grid to the Western European grid. BALTREL, the Baltic countries' power cooperation organization, also has proposed supplying Sweden and Finland with power generated in the Baltic states. To begin with, this would mean linking the 51-mile stretch of sea between Tallinn and Helsinki via an underwater cable. A consortium of electric companies agreed in September 1998 to build the electricity transmission cable, and ABB (Sweden) has been chosen to lay the 315-MW-capacity cable, beginning in the spring of 2002. The project, dubbed "Estlink," is estimated to cost $100 million and should be ready by the end of 2003. Electricity transmission via the cable could be underway by mid-2004.
 
 

ESTONIA
Since regaining its independence from the soviet Union in 1991, Estonia has moved rapidly to reorient itself to the West, adopting market reforms and luring foreign direct investment, especially from Finland. The country has made substantial progress integrating with the West, gaining membership in the World Trade Organization (WTO), and applying for membership in the EU and NATO. As a result of the rapidity with which Estonia adopted political and economic reforms, the country was invited to begin EU accession negotiations in the first wave of new members, putting Estonia on the fast track to become an EU member.

Russia remains the major power in the region, and because Estonia has a sizable ethnic Russian population in the northeastern part of the country, Estonia's political and economic activities necessarily take into context the country's huge neighbor to the east. In addition, because of its lack of indigenous energy resources aside from oil shale, Estonia still is dependent on Russia for the majority of its energy supplies. After falling into recession in 1999, when the effects of Russia's 1998 financial crisis reverberated through the Estonian economy, Estonia rebounded to post 6.9% economic growth in 2000. Foreign direct investment, which was equal to 7% of the country's real GDP in 2000, has slowed in 2001. Nevertheless, Estonia's economy still is projected to grow by 4.8% for 2001.

Oil
Estonia has no proven crude oil reserves, but polevkivi (oil shale) is abundant in the northeastern part of the country. Oil shale provides over 75% of Estonia's total energy supply, making Estonia the only country in the world where oil shale is the primary source of energy. Oil shale is produced by majority state-owned Eesti Polevkivi (Estonian Oil Shale) near Kohtla-Jarve. Oil shale is consumed for power generation by the Eesti Energia and Kohtla-Jarve Soojus electric companies and for shale-to-oil processing by Kiviter AS, which processes the oil shale to produce about 4,400 bbl/d of distillate liquid fuels. Estonia's indigenous oil shale production, however, is not sufficient to meet the country's demand for oil, which stood at 28,000 bbl/d in 2000 and is projected to remain constant in 2001.

Eesti Polevkivi's is projecting its oil shale production in 2001 to remain stable at approximately 12 million tons a year despite the consolidation and restructuring of several of its quarries. The Narva and Sirgala quarries have been unified into one firm (Narva Quarry), while the Kohtla mine and Aidu quarry are being consolidated into one company as well. Eesti Polevkivi also is planning to close the Ahtme mine and to stop oil shale extraction there in 2002. Nevertheless, oil shale mining continues at the Viru and Estonia mines, and Eesti Polevkivi plans to produce around 12 million tons of oil shale per year until 2006.

The impending closure of another mine follows on the 1999 closure of the Tammiku mine and foreshadows the industry's downturn. After 2006, Eesti Polevki is forecasting its production target will shift downward, to 10.5 million tons per year, as Estonia tries to curb pollution from the oil shale industry in an effort to meet EU environmental regulations. Eesti Polevkivi has indicated that it expects the oil shale industry to continue for another 40 years, but no new mines are scheduled to be built, and Estonia is coming under heavy pressure from the EU to cut back significantly on oil shale production. Estonian politicians have announced they will ask the EU to accord special treatment to oil shale, approaching it the same way that the EU does coal, since the problems of the two natural resources are similar.

In February 2001, Narva Elektrijaamad (Narva Power Plants) and Eesti Polevkivi signed a $73-million supply contract for 2001 under which Eesti Polevkivi will sell Narva Power Plants 9.4 million tons of oil shale this year. In 1999, Narva Power Plants used 85% of the total output of Eesti Polevkivi. According to the terms of NRG Energy's (USA) purchase of 49% of Narva Power Plants from Eesti Energia (Estonian Energy, the country's electric utility), Eesti Polevkivi is now a subsidiary of Narva Power Plants. On top of the cost for the power plants, NRG Energy paid $27.6 million for a 51% controlling share in Eesti Polevkivi, and the U.S. energy firm has committed up to $80 million in investment in the oil shale company, including modernizing the technology used at Eesti Polevkivi and renovating its infrastructure.

Downstream/Refining
Estonia has no refineries, so it must import all petroleum products, either by rail or by pipeline.

Natural Gas
Estonia has no natural gas reserves and therefore must import all of its natural gas for domestic consumption. Currently, Estonia imports all of its supplies via the country's 250-mile pipeline network from Russia, but Estonia is keen to diversify, and Norway is a potential supplier. Estonia's natural gas consumption collapsed from 53 Bcf in 1992 to just 21 Bcf in 1993 as Estonia attempted to reorient its economy to the West, but the country's consumption of Russian natural gas has crept slowly upwards in ensuing years. In 1999, Estonia consumed 35.3 Bcf of natural gas.

Eesti Gaas (Estonian Gas), the former state-owned gas company that was fully privatized in 1997, is the largest natural gas supplier in Estonia. In November 1999, Eesti Gaas, which is owned by Ruhrgas (Germany, 32%), Gazprom (Russia, 31%), Fortum (Finland, 10%), and Itera (9.5%), signed a long-term agreement with Gazprom to supply Estonia with natural gas from 2000-2005. Over 90% of Estonian district heating stations use natural gas, and natural gas is the primary fuel of the Viru Power Station, which produces both heat and power.

Coal
Estonia does not have any coal reserves or coal production, but the country does import a small amount of lignite, mainly for district heating. Throughout much of the 1990s, Estonia's coal consumption was on the decline, with consumption falling from 2.08 million short tons (Mmst) in 1992 to 1.62 Mmst in 1998.

However, with the rise in oil and oil shale prices that began in March 1999, Estonia turned to coal for more of its energy needs, and consumption shot up to 2.27 Mmst in 1999. Preliminary figures for 2000 show a slight decline in the country's coal consumption, and over time, Estonia's coal consumption is forecast to fall even further as the country brings its energy balance in line with EU environmental regulations.

Electricity
With 2.7 GW of electric-generating capacity, Estonia produces ample power to meet its own consumption requirements. The lion's share of this generating capacity comes from Estonia's two oil-shale-fired power plants in the northeast of the country, the 1,610-MW Eesti Elektrijaam and the 1,390-MW Balti Elektrijaam. The two power stations, which together make up the Narva Power Plants, currently supply approximately 95% of Estonia's electricity. Although Estonia has a small amount of hydropower and other renewable energy capacity, the power produced at these facilities costs twice as much as the electricity generated at the oil-shale-fired power plants.

In 1999, Estonia generated 7.8 Bkwh of electricity, which was more than enough to cover the country's overall consumption of 6.8 Bkwh of power. Estonia exports its excess power to Latvia and to northwestern Russia. As Estonia strives to liberalize its energy market in line with EU directives, the country wants the EU to recognize the importance of oil-shale-fired power generation to its economy. If the local power market is opened to imported electricity immediately upon the country's entry into the EU (in keeping with the union's competition policy), Estonian officials are worried that it would lead to a steep drop or even a cessation of oil shale-fueled power generation, creating a social and economic crisis in northeastern Estonia. As a result, Estonia wants the EU to recognize and to accept that the majority of the country's electricity will come from oil shale-fueled power plants until at least 2015.

Prior to 1995, all of Estonia's electricity had been produced entirely by Eesti Energia, the state-owned electric company, but in 1996, the first steps towards privatization were taken with the establishment of the joint-stock company Kohtla-Jarve Soojus comprising Estonia's two smaller oil shale-fired power plants, the Ahtme and Kohtla-Jarve Power Stations. Then, on August 25, 2000, after more than four years of negotiations, the Estonian government finalized a controversial $70.5-million deal to sell a 49% stake in the Narva Power Plants to NRG Energy. As part of the deal, NRG Energy also was to receive a 51% share of Eesti Polevkivi, the state oil shale firm. In June 2001, in an effort to appease domestic critics of the deal, including former Estonian President Lennart Meri, NRG agreed to pay an additional $27.6 million for the stake in Eesti Polevkivi, completing the final sale details.

Under the terms of purchase, NRG committed to investing approximately $361 million in reconstructing and refurbishing the Soviet-era Narva Power Plants and making environmental improvements. In September 2001, Eesti Energia and NRG Energy signed a contract with three international banks for a 14-year, $280-million loan to begin renovation of the Narva Power Plants. Two energy blocks at the Eesti and Balti power plants will be renovated by Finland's Foster Wheeler Energia, with renovation starting with the Eesti power block. In addition, a portion of the loan money will be spent on reconstruction of Eesti Polevkivi oil shale mines.

As a condition of the privatization terms of Narva Power Plants, the Estonian government stipulated that NRG Energy must ensure that the Estonian energy market becomes part of the European energy market. Estonia's power grid is configured to the old Soviet power grid, and as Estonia reorients itself to the West and moves towards EU integration, one of the country's security-political priorities is to create an energy connection to the West European electricity grids. In the meantime, in February 2001, Estonia, Latvia, Lithuania, Belarus, and Russia signed an agreement formalizing their already existing arrangement to cooperate in the power sector by connecting their energy grids and by sharing power supplies.

LATVIA
In the decade since Latvia declared its independence from the Soviet Union, the country has moved rapidly towards integration with Europe. Latvia has applied for membership in both the EU and NATO, and in February 1999, Latvia became the first Baltic state to join the World Trade Organization. In addition, in December 1999, Latvia was invited to begin accession talks with the EU in the so-called "second wave" of EU aspirants, and membership in the organization is a top foreign policy priority.

Relations with Russia still color many of Latvia's activities. In addition to ongoing citizenship questions surrounding Latvia's large ethnic Russian minority, the Latvian economy is tied to Russia's since Latvia is dependent on Russian oil and natural gas exports for its domestic consumption. Nevertheless, Latvia weathered the brunt of Russia's 1998 financial crisis without falling into a recession, and in 2000 Latvia's real GDP growth bounced back to a healthy 6.6%. Most small- and medium-sized enterprises have been privatized, and energy sector privatization and energy market liberalization is underway. With the transition to a functioning market economy nearly complete, the country's real GDP is projected to grow another 6.5% in 2001.

Oil
Latvia has no domestic oil production or refineries, so it is entirely dependent on imports of petroleum products to meet its consumption needs. Since 1992, when Latvia consumed an average of 52,200 bbl/d of oil products, domestic consumption has been on the decline, dipping to a low of 36,200 bbl/d in 1997 before leveling off at approximately 38,000 bbl/d the past few years. In 2000, Latvia imported 38,000 bbl/d of oil products, mostly from Russia, Belarus, and Lithuania, with only a small amount coming from the EU.

In April 2001, Latvia announced a tender for licenses to search, explore, and develop oil deposits in the Latvian territorial waters in the Baltic Sea. The Latvian Development Agency claimed that the licenses covered fields possibly containing up to 733 million barrels of oil, although analysts have estimated the country's possible offshore oil reserves at 300 million barrels of crude oil. On October 31, 2001, the closing date for bids for oil exploration, Latvia announced that one bidder, the U.S.-Norwegian joint venture TGS Nopec, had applied for a license. The non-exclusive exploration license, which will enable TGS Nopec to carry out exploration activities but not oil extraction, is for two years, although Latvia retained the right to extend the term of the license for up to five years.

Bids for exploration and production licenses, which will grant exploration and production rights for up to 30 years, are due by January 25, 2002. Exploration and production in the tract covered by the tenders, which is close to Liepaja, had been delayed for several years due to Latvia's border dispute with Lithuania. In 1996, the Latvian Economics Ministry had issued oil licenses to Amoco (now BP Amoco) and OPAB (Sweden) to explore the Baltic shelf of the then-unidentified tract, but the deals were never signed after Lithuania vehemently protested and the border talks reached a deadlock. Latvian and Lithuanian officials initialed a border agreement in May 1999. Experts estimate that actual oil extraction in the tract will start only in five to six years after oil is found there.

Downstream/Refining
Although Latvia currently has no refineries, Russia's Lukoil has been considering building a small refinery in the country. After Lithuania decided to sell its Mazeikiai refinery--the only only refinery in the Baltics--to Williams International (USA) rather than to Lukoil, the Russian oil giant announced plans to build a $200-million, 40,000-bbl/d-capacity refinery in Latvia as an alternative refinery in the Baltics to compete with the Mazeikiai refinery. However, Lukoil has not set a timetable for when it might construct this refinery.

Natural Gas
Since Latvia has no domestic natural gas reserves, all of the country's natural gas for domestic consumption is imported, mainly from Russia. After fluctuating wildly in the first few years after independence, Latvia's domestic consumption of natural gas remained steady at 45.6 Bcf in 1999. Of this total, approximately 50% is consumed by the country's main electric utility, Latvenergo. Latvia's natural gas consumption is predicted to increase in the coming years as the country aligns its energy consumption patterns with EU directives.

Latvijas Gaze (Latvia Gas) controls the country's natural gas distribution system and its huge underground storage facility near Riga at Incukalns, the only natural gas storage facility in the Baltics and the third-largest storage facility in Europe. The former state-owned company has been restructured as a joint-stock company and has been substantially privatized, with the state holdings in the company reduced to just 8% after another 2% of the government's share was auctioned off in December 2000. Latvijas Gaze's largest shareholders are Gazprom, Germany's Ruhrgas and Eon Energie AG, and Itera Latvija, a subsidiary of Itera.

With a number of large storage facilities that can hold more than 70 Bcf of natural gas, Latvia has the potential to play an important role in Russia's bid to supply natural gas to Scandinavia via the proposed North TransGas pipeline. Latvijas Gaze typically pumps natural gas into the 141-Bcf-capacity Incukalns storage facility during the spring and summer, drawing it down as needed during heating season in the winter. Latvia has a number of other large natural gas storage facilities, and Gazprom exports a portion of the natural gas stored in these facilities to Estonian, Lithuanian, and Russian consumers, while Latvijas Gaze is charged for the natural gas which is distributed within Latvia. An additional 7 Bcf of natural gas was pumped into Incukalns in the fall of 2001 as part of a project to increase the reservoir's storage capacity to 177 Bcf by 2005.

In late-October 2001, the Latvian Cabinet of Ministers approved a concept to liberalize the country's national gas market gradually in line with EU requirements (Latvia has concluded the energy chapter of its accession negotiations with the EU). Drafted by the Latvian Economics Ministry, the concept envisages market prices and promises to open up the market to multiple suppliers; currently, Gazprom is Latvia's only natural gas supplier. The Ministry's plan stipulates that Latvia's energy law should be amended by April 2002 in order to meet the EU directives concerning gas market liberalization. The EU has conceded that Latvia's lack of alternative pipeline routes make it impossible for the country to immediately open up its natural gas market to non-Russian suppliers.

Previously, in May 2001, the Latvian government had rejected amendments to the country's energy law, proposed by Latvijas Gaze's shareholders, that would have stopped natural gas price regulation for industrial consumers. In early October 2001, Latvijas Gaze took the Latvian government to the international court of arbitration over the state's failure to liberate natural gas prices for industrial consumers. Latvijas Gaze claimed that it was unable to recoup its rising production costs without instituting a price increase.

Electricity
Hydroelectricity plays a key role in the Latvian power sector. Nearly 73% of the country's 2.1-GW power-generating capacity is hydroelectric, and hydropower accounted for 68% of all power produced in 1999, with the remainder generated by thermal plants using natural gas and, to a lesser extent, peat and fuel oil. The three hydro plants, Kegums-Plavinas-Riga, constitute the Daugava cascade located on the Daugava River. All three hydro plants have recently been modernized, with the Kegums hydropower station, built in 1939, officially re-opened in August 2001 after $21 million worth of renovation to extend its service life for another 40 years.

Hydroelectric power plants on the Daugava River are Latvia's main power producers, but their output, along with the TEC-1 and TEC-2 power plants that constitute 97% of Latvia's thermal power-generating capacity, is insufficient to cover the country's power needs. In 1999, Latvia produced 4.0 Bkwh of power domestically, but imported power was still necessary to meet the country's electricity demand of 4.3 Bkwh, which was down nearly 43% from the 7.5 Bkwh Latvia consumed in 1992.

With the fluctuations in water levels affecting the output of its hydropower plants, at times Latvia has been forced to import between 30% and 40% of its electricity. According to Latvenergo, the country's state-run electric utility, in the first nine months of 2001 Latvia's electricity consumption grew 2.5% over the same period in 2000, with Latvenergo importing 24% of the total power consumed. Latvia regularly imports electricity from Estonia and Lithuania, both of which have excess capacity. The agreement between Latvia, Lithuania, Estonia, Russia, and Belarus to connect their electricity grids and to share power supplies when needed will give Latvia access to additional electricity imports.

Latvenergo, the country's largest company and the operator of all of Latvia's major hydro and thermal power plants, as well as the transmission and distribution system, was scheduled to be privatized in 2000, but public opposition to foreign ownership forced the Saeima (the Latvian parliament) to amend the country's energy law to prevent the company's privatization. Prime Minister Andris Berzins, who took office in May 2000 promising to speed up privatization, was dealt a major rebuke by the canceled privatization as the World Bank had made restructuring and privatizing Latvenergo by December 2001 one of the conditions for a 3-year, $120-million loan package signed in March 2000.

In October 2000, however, the Latvian government accepted a plan for the utility's reorganization. The reorganization, which will be guided by the EU directive with regard to energy market liberalization, is geared to prepare the utility for free market conditions. The EU directive demands that production, transmission, and distribution of power be separated at least as far as necessary to review their accounting reports and operations as individually and transparently as if they were completely independent companies. Large, so-called "qualified" electric power consumers already can choose alternative suppliers, and actual liberalization of Latvia's electric power market could take place by 2007, according to Latvenergo President Karlis Mikelsons.

Some Latvian privatization officials have warned that Latvenergo's energy distribution system may deteriorate unless there is a new influx of investment. In September 2000, Berzins announced that Latvenergo will increase its energy tariffs by an average of 9% annually over the next 10 years in order to finance renovations and repairs to its electric power generation and distribution system.

LITHUANIA
In March 1990, Lithuania became the first country to declare its independence from the Soviet Union. Since that time, the country has made efforts to reorient itself towards the West, applying for membership in the EU and NATO and taking steps to integrate its economy with Europe. The transition to a market-oriented democracy has proceeded relatively smoothly, although the repercussions of a controversial oil industry privatization in 1999 continue to be felt in the political sphere, with several changes in government in the past two years. In December 1999, Lithuania was invited to begin EU accession talks, and as Lithuania continues to fulfill membership requirements, the country is expected to become a member of the EU later in this decade.
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Relations with Russia still affect much of Lithuania's activities and, like Estonia and Latvia, the country remains heavily reliant on Russia for oil and gas supplies. In addition, as the Baltic state that has conducted the most trade with Russia, Lithuania faced its own economic and financial crisis in 1999 after the government's inadequate response to Russia's August 1998 financial crisis. Lithuania's economic recovery has been slow. Although the country climbed out of recession in 2000 with real GDP growth of 3.9%, the unemployment rate (11.5% in 2000) was at its highest point since independence. The unemployment rate is projected to increase to 12.7% for 2001, but inflation has remained low and economic growth is expected to accelerate to 4.6% for the year.

Oil
Lithuania has 12 million barrels of proven reserves, but the country's estimated total onshore oil resources amount to 337 million barrels, with reserves in the Lithuanian shelf of the Baltic Sea estimated between 220 million and 440 million barrels. Geonafta, Lithuania's oil exploration company, and several joint ventures are undertaking onshore drilling projects in western Lithuania. Minijos Nafta, the country's biggest oil producer, produced approximately 60% of the country's oil in 2000, when Lithuania's overall oil production increased to 4,200 bbl/d at 10 oil fields. Lithuania's oil production is projected to rise to 4,500 bbl/d in 2001, but with an average rate of 66,000 bbl/d of consumption, the country remains a net oil importer. Russia is Lithuania's main supplier of crude oil.

After winning its independence from the Soviet Union, Lithuania reorganized and unified much of its oil industry, creating Mazeikiu Nafta by merging the Lithuania's only refinery (the 263,000-bbl/d-capacity Mazeikiai refinery), Butinge Nafta (which operates a new oil terminal at Butinge that is connected by pipeline to the Mazeikiai refinery), and Naftotiekis of Birzu (which operates the Birzu oil pipeline bringing Russian crude oil into Lithuania via the Russian Druzhba pipeline). The unified company accounts for between 5% and 10% of the country's nominal GDP.

In October 1999, Lithuania concluded a controversial $150-million agreement to sell Williams International (USA) a 33% stake in Mazeikiu Naftu. The deal gave Williams, which committed another $650 million in investment and modernization, operational control of the refinery, pipeline and crude terminal, as well as the right to buy a majority stake within five years. In addition, the Lithuanian government promised to cover a $350-million capital deficit that the company had incurred. The deal also included provisions allowing a 10% stake to be transferred to financial institutions such as the European Bank for Reconstruction and Development (EBRD) and 10% to oil suppliers.

In addition to opposition from Lithuania's citizens, who were upset at the terms of the sale, Russian oil giant Lukoil was dismayed to be shut out of the partial privatization. Lukoil, the coordinator of Russian oil exports to Lithuania, had offered the Lithuanian government guarantees for an annual supply of 120,000 bbl/d of oil, provided that it be given an equal opportunity to participate in the privatization of the Mazeikiai refinery. When Lithuania's government expressed its preference to sell to Williams, Lukoil immediately began reducing oil supplies to the refinery.

Downstream/Refining
As a result, oil supply problems caused several shutdowns of the Mazeikiai refinery in 2000-2001, and Mazeikiu Nafta suffered $40 million in losses in 1999. In May 2000, Williams and Lukoil reached a tentative oil supply agreement, but the deal fell through. In 2000, the Mazeikiai refinery processed 98,000 bbl/d of oil, which was a 7% increase over 1999, but still far below the refinery's 263,000-bb/d capacity. Mazeikiu Nafta and Karazhbasmunai (Kazakhstan) had signed a 3-year oil supply deal in July 2000, with supplies to Lithuania to reach as high as 60,000 bbl/d, but the lack of of an agreement with Russia regarding transportation tariffs has kept the agreement from being implemented.

The continued shortage of crude supplies left Mazeikiu Nafta with another $45 million in losses in 2000, and $18 million in losses in the first quarter of 2001 alone had the company facing possible bankruptcy. In June 2001, however, Williams reached an oil supply deal with Yukos, Russia's second-largest oil company, that should help the refinery overcome its supply problems. According to the 10-year agreement, which Lithuania's parliament ratified in August 2001, Yukos, already the refinery and oil terminal's biggest supplier, will guarantee to supply almost 100,000 bbl/d each year to the refinery, plus an additional 80,000 bbl/d per year for export through the Butinge terminal owned by Mazeikiu Nafta.

In exchange, Yukos received the right to buy 26.9% of Mazeikiu Nafta, becoming an equal partner with Williams, whose stake in the company decreased to 26.9% while the Lithuanian government's stake in Mazeikiu Nafta decreased from 59% to 40.6%. Williams retains management control of the company. Yukos, which provided over 38% of the refinery's supplies in 2000, began providing approximately 72,000 bbl/d to the refinery starting in July 2001. The refinery has a target figure to process 7 million tons of oil (140,500 bbl/d) in 2001, and through the first nine months of the year, Mazeikiai had refined 5.07 million tons of oil (135,757 bbl/d), an increase of 35% over the same time period in 2000.

In March 2000, Mazeikiu Nafta announced that it planned to borrow around $150 million for a modernization project in the Mazeikiai oil refinery. According to the plan, the first stage of the refinery's modernization will cost an estimated $400 million and take four years to implement. The EBRD has expressed its interest in participating in the refinery's modernization since Williams bought its stake in Mazeikiu Nafta in 1999.

Natural Gas
Lithuania has minimal natural gas reserves and no natural gas production, making the country completely reliant on imports. Lithuania consumed 76 Bcf of natural gas in 1999, which is 46% less than the country consumed in 1992 just after its independence. In December 1999, Lietuvos Dujos (Lithuanian Gas), the state-owned company that controls Lithuania's natural gas transmission, distribution, and export operations, signed a long-term agreement with Russia's Gazprom, starting with 53 Bcf in 2000 and increasing to 88 Bcf in 2005.

Itera also has begun supplying the Lithuanian market with Russian natural gas, and in line with the Lithuania's national energy strategy to diversify its supply sources, Lithuania is looking to Poland to supply it with Norwegian natural gas. Poland, which recently signed a 6-year, $11-billion deal to import a total of 2.6 Tcf of natural gas from Norway, hopes to build another part of a natural gas pipeline from Gdansk to Lithuania by 2004.

In October 2001, the Lithuanian government made a final decision on the privatization plan for Lietuvos Dujos. The plan calls for selling a 34% stake to a Western strategic investor and a 34% stake to a Russian gas supplier and its partners in Lithuania. The Western strategic investor, which will receive management control of the company, will be required to upgrade the gas distribution network, to ensure alternative natural gas supply sources, and to integrate the network with Western Europe (since Lithuania currently has no alternative to Russia for its natural gas supplies). The Lithuanian government, which currently owns 92.4% of Lietuvos Dujos, will hold on to a 24% share and sell it later on the stock exchange.

The Lithuanian government attempted to privatize Lietuvos Dujos in 1997, but the privatization failed because the company was not restructured first. In May 2000, the Lithuanian Cabinet of Ministers passed regulations for re-organization of the company, and in early 2001 the government approved privatization of Lietuvos Dujos. However, the privatization is already nine months behind schedule, and delays in reforming the country's natural sector caused have concerned the World Bank, which in June 2001 postponed the extension of a $50-million loan, the second tranche of its $100-million structural adjustment loan. Gazprom, Itera, and Williams International have all expressed interest in bidding in the privatization tender.
 

Natural Gas
Belarus is heavily reliant on natural gas imports from Russia. Belarus produced only 7 Bcf of natural gas in 1999 while the country's natural gas consumption, buoyed by a return to economic growth, rose to 608 Bcf. Due to Belarus's inadequate natural gas pricing structure and payment recovery from consumers, the country has built up large arrears to Russia's Gazprom. In April 2001, Gazprom and Beltransgaz, the Belarussian state-run gas distributor, signed an agreement on restructuring debt for the natural gas supplied to Belarus over 1997-1999.

Under the agreement, $40 million of Beltransgaz's direct indebtedness and $37.2 million of overdue-payment will be paid off over three years by supplying Belarussian tractors and Beltransgaz bills of exchange. Since the agreement, Belarus has paid Gazprom on time, leaving Belarus's total debt to Russia for natural gas at $183 million as of September 2001. Despite Belarus's debts to Russia for natural gas supplies, Gazprom has continued to supply Belarus with natural gas at the low price of $30 per 1,000 cubic meters in 2001.

Russia charges Belarus lower prices for natural gas since Russia receives reduced tariff rates for its natural gas that transits Belarus to customers in Western Europe. Beltransgaz, which operates 3,780 miles of natural gas pipelines in Belarus, charges Russia a transit tariff that is approximately one-third of the tariff in other countries. More than 883 Bcf of Russian natural gas transited Belarus via the Northern Lights and Yamal-Europe I pipelines to customers in Western Europe in 2000, and with the second extension of the Yamal-Europe I pipeline beginning operation earlier in 2001, Belarussian gas transit volumes for 2001 are estimated to exceed 1 Tcf.

Beltransgaz has said that the Belarussian natural gas transportation system is developing so that when the third extension of the Yamal-Europe I gas pipeline becomes operational, and new compressor stations are built, the pipeline's capacity will more than double. Construction of the Krupskaya compressor stations has already begun, and the Minsk and Orsha stations will be built within the next two to three years. By 2005, analysts say, natural gas transit to Europe via the transcontinental Yamal pipeline alone may exceed 1 Tcf.

Additionally, Gazprom announced plans in October 2000 plans to construct a new natural gas export pipeline, the Yamal-Europe II, that would run via Belarus. Gazprom's proposed route for the pipeline would link to the existing Northern Lights pipeline in Belarus and divert natural gas from crossing Ukrainian territory en route to Poland and Slovakia. Ukraine, which transits significant amounts of Russian natural gas to customers in Europe, has been accused of illegally taking Russian natural gas destined for other customers. Russian and Belarussian authorities have stated that the new pipeline will not lower the volume of natural gas pumped via Ukraine, but Poland has not yet agreed to the pipeline route, which would also lower Poland's transit fees fees. The cost of the Belarussian section of the proposed pipeline is put at approximately $70 million.

With Lithuania periodically suspending electricity supplies to Belarus in order to force debt payment, Belarus has turned to Russia as its main source for its power imports. In 2000, Belarus consumed approximately 33 Bkwh, of which 7 Bkwh was imported from Russia. In the first nine months of 2001, Belenerha, the state-owned energy utility, imported 4.8 Bkwh of Russian electricity, with an additional 0.7 Bkwh of power imported from Lithuania. In October 2001, Russia's electricity monopoly, Unified Energy Systems (UES), and Belenerha signed an agreement by which UES will supply Belarus with up to 5.5 Bkwh of electricity in 2002.
 
 

Source: Energy Information Administration
Note: percentages may not add up to 100% due to rounding.
 
 

Source: Energy Information Administration