LNG Business Plan 20130220

LIQUEFIED NATURAL GAS (LNG) Terminal BUSINESS PLAN

2013 February

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CONTENT Summary .......................................................................................... 3 LNG terminal project ........................................................................ 9 LNG terminal technology and infrastructure ...................................... 10 LNG terminal and marketing business model ..................................... 20 Business model of the LNG terminal ....................................................................... 20 LNG import and marketing business model ........................................................ 21 Project organization .......................................................................................................... 24 Implementation plan of the LNG terminal ......................................... 25 Project funding .............................................................................. 31 Need of funds for start-up of the LNG terminal business ........................... 31 Financing of the LNG terminal business (from 2015) ................................... 34 LNG import and trade financing activities............................................................ 35 Cost and benefit analysis of the LNG terminal ................................ 36 Ensurance of alternative gas supply to Lithuania ............................... 37 Ensuring competitive pricing ........................................................... 38 Benefits of the LNG terminal ........................................................... 40 Benefits of the LNG terminal for the State .......................................................... 40 Benefits of the LNG terminal to consumers of natural gas ........................ 42 LNG terminal benefits to the company implementing the project ......... 44 LNG supply market review............................................................................................ 45 LNG use for ship fuel (bunkering) – the additional activity .................. 48 Possibilities of cooperation with Latvia and Estonia ............................ 49 SWOT analysis .............................................................................. 50

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Summary The National Energy Strategy (further referred to as a Strategy) which was approved by the Seimas of the Republic of Lithuania on 26 June 2012 Resolution No. XI-2133 and on 18 January 2007 Resolution No. X-1046, defines the basic strategic provisions and their directions of implementation by 2025, where the main attention is focused on ensurance of energy security and in particular long-term natural gas supply. Today Lithuania is dependent on a single external supplier of imported natural gas. To eliminate the energy isolation in the gas sector and implement 20 October 2010 European Parliament and Council Regulation (EU) No. 994/2010 on gas supply security measures, Member States of the European Union were obliged to comply with directive N-1 standard of infrastructure in securing alternative gas supply sources. LNG terminal – one of the key projects to ensure energy security, which creates the conditions for the emergence of the natural gas market, and brings economic benefits to the State, consumers and the company executing the project. The Law on Liquefied Natural Gas Terminal of the Republic of Lithuania dated 12 June 2012 (No. XI2053) establishes the general principles and requirements for the construction, operation and exploitation of a liquefied natural gas terminal in the Republic of Lithuania and forms a legal, financial and organizational framework for the implementation of the project on a liquefied natural gas terminal. Lithuania currently imports natural gas from the outer sole supplier of natural gas in accordance with the rules, pricing and terms of this supplier. Without possibility of choice, there is no gas market. When the LNG terminal project is implemented, the Lithuanian natural gas customers will get the opportunity not only to purchase natural gas from different suppliers, but also to choose from new products: short-term gas supply contracts at market prices and new pricing principles (i. e. without linking gas prices to oil prices). The purpose of this business plan is to present the importance of LNG terminal project, economic benefits of natural gas to consumers, the company executing the project, the State and to provide technical solutions and the principles of terminal business model. LNG terminal – the project ensuring an alternative natural gas supply, which: • will help to resolve historically unfolding the problem of dependence of Lithuania on a single external supplier of gas from Russia (gas is supplied by one gas pipeline, which passes through Belarus); • will reduce OAO Gazprom possibilities to use its dominant position and to exercise the gas pricing policy, the price of gas imported to Lithuania is one of the highest in Europe and significantly exceeds the gas prices in international markets; • will create an opportunity for gas market participants to take part in the international gas markets and thus to reduce the average price of imported natural gas; • will provide an opportunity to choose new market products – short-term contracts with a pricing mechanism not linked to oil prices and take advantage of the global gas market opportunities; 3

•

will provide alternative gas supply routes, by implementing European Union directive N-1 standard of infrastructure, which will be launched on December 2014.

The main aims raised to the LNG terminal project are: • to start LNG terminal no later than 2014, December; • to develop an alternative source of supply of natural gas; • to create an opportunity for Lithuania to self-sufficiently supply itself with natural gas needed to meet the demand of the first necessity; • to create conditions for development of gas markets in Lithuania and the Baltic countries and create opportunities for short-term gas purchase contracts and open the option for pricing not linked to the oil product price; • to provide an opportunity for Lithuania to participate in the international gas markets. The maximum technical regasification capacity of the LNG terminal will be 4 bcm per year, which can be utilized as follows: 1. when in 2013 SC Lietuvos dujos constructs the gas-main branch „Jurbarkas – Klaipėda“, the terminal will supply up to 2 bcm gas into the system per year; 2. after replacement of gas-main branch „Klaipėda – Kuršėnai“, and increasing its diameter from 300 mm to 700 mm, the terminal will be capable to supply 4 bcm gas into the system per year and, if necessary, will supply gas throughout the country (except for peak consumption in winter periods). LNG terminal type and size Floating Storage and Regasification Unit - FSRU (170 thousand m3 volume, with regasification equipment) was contracted on 2 March 2012 from Hoegh LNG, signing 10-year lease agreement with the purchase option. FSRU type, as compared with the onshore terminal, has been chosen taking into account: • 50 percent lower capital investment; • 2 year-shorter period of the project implementation; • more flexible technology (FSRU can be moved to another location). LNG terminal size of 170 thousand m3 was chosen according to the following: • LNG supply costs due to economy of scale of a larger LNG terminal are lower over 40 percent, compared to the smaller terminal; • the larger terminal ensures longer period (10–20 days) of first necessity consumer needs, without LNG resupply; • Construction costs of LNG terminals differ only 10–15 percent, depending on sizes. The project business model • LNG terminal and its business will be held in the State-controlled company. 4

•

Established LNG terminal infrastructure (FSRU, jetty infratsructure and gas pipeline, connecting the terminal to the gas grid) will be transferred to State-controlled natural gas transmission system operator and assigned to the natural gas infrastructure.

25 percent rule Currently there is no competition in the Lithuanian natural gas market. Gas is bought from one supplier with fixed terms and pricing. Natural gas supply contracts are concluded exclusively for long-term in such way binding to the sole external supplier without leaving any options for an alternative. Therefore: • when LNG infrastructure is created, it is also necessary to create regulatory environment that allows access to the global natural gas market opportunities; • to promote the efficient competitiveness of natural gas supply sources and to ensure LNG terminal’s activity (i.e., LNG terminal technological capacity needed to continuously and effectively meet the country's natural gas demand), imported natural gas quantity through the LNG terminal must be at least 25 percent of total consumption of natural gas in the Republic of Lithuania per year; • the 25 percent rule, in order to ensure competitive equality, will be applied equally both to the gas, supplied through the LNG terminal and through the pipelines; • 25 percent rule shall prevent the current monopolist from concluding long-term contracts with suppliers and delaying of gas market introduction into the country; • in order to protect the interests of gas consumers in Lithuania, the Government of the Republic of Lithuania will establish through the LNG terminal and pipelines imported and in the internal market of Republic of Lithuania consumed natural gas price cap; • when suppliers will get used to the new opportunities opened by LNG terminal and gas market is fully developed, the 25 percent rule will be withdrawn.

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Project economics Supplying 2 bcm LNG (maximum throughput of the infrastructure from 2015) and taking into account actual market prices of 2012 (National Balancing Point Exchange) Lithuanian consumers would save up to 0,4 bn. LTL per year; Influence of all fixed business costs and investments into LNG terminal will amount to 2–3 percent (5– 7 ct per m3) in the final price of natural gas tariff. After 10 years, when FSRU is redeemed, influence of terminal’s costs will reduce by 50 percent; Utilization of the LNG terminal for the needs of other Baltic countries, infrastructure costs would decrease proportionally for consumers in Lithuania. Lithuanian consumption (bcm)

Russian gas price 2012 average (LTL/1000 m3)

LNG price* with transportation and LNG terminal costs (LTL/1000 m3)

Lithuanian expenditures on gas (bn. LTL)

The current situation By OAO Gazprom imported gas

3,0

1329

By OAO Gazprom imported gas

1,0

1329

Imported LNG gas

2,0

3,99

Alternative

Total

1,33 1130

2,26

3,0

3,59

Ekonomic benefits (bn. Lt)

0,40

*(2011 average NBP + transportation costs)

Influence of all fixed business costs and investments into LNG terminal will amount to 2–3 percent (5– 7 ct per m3) in the final price of natural gas tariff. After 10 years, when FSRU is redeemed, influence of terminal’s costs will reduce by 50 percent; Utilization of the LNG terminal for the needs of other Baltic countries, infrastructure costs would decrease proportionally for consumers in Lithuania. Project investments Demand of LNG terminal project investments is estimated to be LTL 613 million. These investments will be made by SC Klaipėdos Nafta and Klaipėda State Seaport Authority using their own and/or borrowed funds. Investments of Klaipėda State Seaport Authority will amount to LTL 160 million, and will be used for port dredging works and construction of jetty infrastructure. Klaipėdos Nafta investments*, LTL million 2012 1. Project management and infrastructure testing (incl. cost 30 of LNG for testing purposes) 2. LNG terminal gas pipeline and gas metering station -

2013

2014

Total

78

116

224

53

88

141 6

design and construction 3. LNG terminal jetty suprastructure design and construction Total: 30 *according to project FEED prepared by the lead advisor Fluor

29

59

88

160

263

453

Project financing AB “Klaipėdos nafta” (KN)

LNG Terminal Trading Activities

LNG Terminal Infrastructure Demand for financing and guarantees $US 50 M guarantee for the FSRU operating lease

Potential resources

Collateral

$US 50 M

 Accounts receivable from gas tariff (from 2015)

commercial bank guarantee

250m LTL

450m LTL Investments in:  Project management

Loan from an institutional (NIB, EIB, EBRD) or commercial bank (for 20-25 years)

 Gas pipelines

200m LTL

 Jetty facilities

compensation of investments via gas tariff (FY2013-2014) Approved.

 LNG Terminal tangible assets

Demand for financing and guarantees

Potential resources

bank guarantee for gas supply

guarantee from a commercial bank

 200m LTL State guarantee

Collateral

 KN guarantee/ oil terminal assets and cash flows  LNG Terminal trade accounts receivable and inventories  Guarantees from key buyers

investment in Working Capital

credit facility from a commercial bank

 Guarantees from export credit agencies

100m LTL KN cash investment

Project investments are going to be finaced from the following sources: • LTL 250 million will be borrowed from Lithuanian and/or international financial institutions; • LTL 200 million will be natural gas consumers’ funds, i.e., revenue from the additional component to the upper limit of the natural gas transmission tariff (the LNG terminal premium) in 2013 and in 2014 (funds from the LNG terminal premium collected from gas transmission tariff in 2013 will amount to LTL 113,798 thousand). • The Company will also secure LTL 120 million overdraft facility for cashflow management purposes until long-term financing is secured in relation to the fact that cash inflow from LNG terminal premium will come after 5 months from the relative investment period. • The financial resources of the Company during the project period could amount to about LTL 100 million. The Company could allocate these funds towards financing the gas trading activities through LNG terminal. • Besides, the Company is going to address commercial banks for: (1) a bank guarantee in the amount of $ 50 million intended for securing the performance of the contract for the lease of the FSRU, (2) a bank guarantee intended for securing the performance of the gas supply contract, (3) a bank loan intended for formation of the working capital necessary for gas purchasing. • Also, seeking to secure proper performance of possible financial obligations to financial institutions, the Company has submitted an application to the Ministry of Energy of the 7

Republic of Lithuania, asking it to address the Ministry of Finance of the Republic of Lithuania for including a limit of State guarantee intended for financing loans for investments into the LNG terminal infrastructure (LTL 200 million), into the draft Law of the Republic of Lithuania on Approval of the Financial Indicators of the State Budget and Municipal Budgets for 2013. The requested limit was included into State Budget of 2013. Environmental Impact Assessment Regional Environmental Protection Department of Klaipėda by the Ministry of Environment of the Republic of Lithuania on 22 October 2012 has granted development consent on construction and activities of Liquefied Natural Gas Import Terminal and Related Objects of Infrastructure in the southern part of Klaipėda State Seaport nearby Pig’s back Island. The aforementioned consent finalised the procedure of environmental impact assessment on LNG terminal project. LNG terminal project implementation plan LNG Terminal launch

2011 Q1 FSRU

Q2

Q3

2012 Q4

Q1

Q2

FSRU lease agreement

2013

Q3

Q4

Q1

Q2

2014

Q3

Q4

Q1

Q2

Q3

2015 Q4

Q1

Construction of FSRU and delivery to the Port of Klaipėda

Port dredging by Port of Klaipėda

Jetty

Pre-project study

Pre-project study

Gas pipelines

Jetty EPC tender

Design and onstruction of jetty (EPC) by Port of Klaipėda and Klaipėdos nafta

Pipeline EPC tender

Design and connection LNG Terminal to the gas grid (EPC)

Construction of gas main Jurbarkas – Klaipėda by Lietuvos dujos Environmental Impact Assessment (EIA)

Process items

Territory planning and construction permit Preparation of Project financing structure and loan procurement

Project financing

State guarantee Arrangement of LNG supply

Gas trading

Arrangement of NG sales

Legal environment assurance

Law on LNG Terminal

Finished

Testing and commissioning works

Rules on gas supply diversification In progress

Performed by third parties

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LNG terminal project

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LNG terminal technology and infrastructure Basic function of LNG terminal is to receive and store LNG, to gasify and deliver it to the magistral network. When choosing a terminal technology, two opportunities were evaluated: FSRU technology and onshore terminal. Executing the LNG project, FSRU technology was selected for the following reasons: • 50 percent lower capital investments; • 2 year-shorter period of the project implementation; • more flexible technology (FSRU can be moved to another location or used as a LNG carrier). In 2010 by decision of interdepartamental work groups, the most appropriate underlying location of the LNG terminal was chosen – the southern part of Klaipėda seaport at Kiaulės Nugaros island. LNG natural gas technical part of the terminal project includes: A. acquisition and delivery of FSRU with a regasification facility to the harbor of Klaipėda, and connection with the pipeline; B. upgrade of the harbor infrastructure for the LNG terminal (harbor dredging, jetty construction, equipment installation); C. LNG gas pipeline connection with the gas pipeline (construction of 17 km high pressure pipeline to the gas transmission system). Figure No. 1a. The LNG terminal project components High pressure loading arm

High pressure gas pipelines 18 km Jetty LNG carrier

Floating Storage and Regasification Unit (FSRU)

FSRU

Jetty

LNG storage capacity: 170.000 m3 Regasification capacity: ~11 mmcm/day Leased from Höegh LNG for 10 years with a purchase option

Gas metering station

Offshore jetty facility located in the southern part of the Port of Klaipėda

Gas pipelines

18 km long and 700 mm wide gas pipeline that connects FSRU to the gas grid; Includes 3 km of horizontal directional drilling under the lagoon

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Figure No. 1b. The LNG terminal project location

Baltic sea

Jetty and FSRU

Pig’s Back island

Gas pipeline

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6

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A. FSRU with a regasification facility FSRU is a LNG natural gas tanker with a built-regasification facility. Klaipedos Nafta signed 10-year FSRU lease with a purchase option agreement with Norwegian company Hoegh LNG on 2 March 2012. Figure No. 2. The main characteristics of FSRU

Manufacturer of the FSRU – Hyundai Heavy Industries; Date of manufacture – 2014. The main characteristics of FSRU: Length – 294 m, width – 46 m, draught – 12,6 m; Cargo tank – 170 000 m3 (membrane type).

FSRU is designed to operate at the following scenarios: • continuous supply of gas to the gas transmission system; • at the same time to receive imported gas and to supply it into the gas-main; • at the same time to supply gas into the gas-main and to fill smaller tankers with LNG; • LNG import; • LNG export; • trade, receiving/delivering LNG to other ports. Parameters of FSRU Comprehensive market analysis was made choosing FSRU. The main criteria for choosing a new ship were: • Small ships of 60.000 m3 storage capacity have limited availability in the market. The average size of floating gas carriers is 125 000–150 000 m3. Distribution of ships depending on size: • up to 130 thousand m3 – 69 pcs. • 130–160 thousand m3 – 249 pcs. • over 160 thousand m3 – 89 pcs. • The vast majority of old ships are MOSS type (spherical tanks) that are visually polluting the environment. When ships are constantly in the port, visual pollution is an important criterion of selection. • The proposed small-capacity ships are 20–30 years old. To convert them into the floating container with a regasification facility is risky due to the technical condition (corrosion, resistance). 12

•

• • •

Converting old small-capacity ships, raises the problem of installation of regasification facility on board. Due to space constraints evaporators should be installed on the ground that would require additional investments and land plot. Older ship design useful life is 30 years, when the new designs are 40 years. Old ships are subject to greater LNG losses due to evaporation, which makes up 0.2 percent per day, while the new ships LNG loss is from 0.1 to 0.15 percent per day. Ship’s external dimensions differ not as much compared to the storage capacity: Table No. 1. Characteristic data of LNG ships Dimensions \ ship’s 75.000 volume Name of a ship Cheikh El Mokrani Length of a ship, m 220 Width of a ship, m 23 Draught of a ship, m 9,8 Loss of gas, m3 150

•

• •

•

138.000

170.000

Exelerate (2005) 277 43,5 11,5 215

Hoegh LNG 290 46 11,6 250

The old ships due the old technology (used steam turbines) are less effective, i.e., consume more fuel and carry less cargo. In addition, the crew composition working on board is the same; i.e., variable costs are proportionaly higher than that of new ships. Increased volume makes FSRU more flexible for cargo acceptance, regasification, and LNG trade. Considering that most of currently floating LNG carriers are of 140 000 m3 volume, therefore it is likely that carriers of similar size will be coming to Klaipėda. Acquiring FSRU of lower volume than the entering gas carrier, will raise a problem of gas carrier demurrage. Berthed at LNG ship-storage, a gas carrier will have to wait until FSRU containers will be able to take the rest of the cargo. It may take several days and can be expensive, given that the cost of chartering the ship is 115 000 US dollars per day or more. Having larger FSRU may reduce transportation costs, because if FSRU has smaller tanks than a LNG carrier, additional lease costs will be incurred as LNG carrier would not be able to unload all quantity of LNG.

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Figure No. 3. LNG transportation costs (in millions of LTL)

Source: Hoegh Ltd.

The supplier of FSRU was selected by public procurement, in which 3 major participants have participated, always competing in this type of projects, they are: Norwegian Hoegh LNG, Golar LNG, and the American Exelerate. Hoegh LNG was selected due to attractive price and technical characteristics of FSRU. Table No. 2. The main parameters of FSRU

The main parameters of the ship 170,000 m3 volume

Increased volume of liquefied natural gas storage with a regasification facility makes it more flexible for cargo acceptance, LNG regasification and LNG trading, in order to exploit favorable market conditions: • Liquefied natural gas storage with a regasification facility must be higher than incoming LNG carriers; • The cheapest way is to supply gas with 130,000 to 160,000 m3 capacity tankers, which make up 61 percent of tankers in the world; • Compared to the lower capacity terminal (i.e. 90,000 m3) due to economies of scale transportation costs to LNG terminal are smaller by 44 percent; FSRU prices vary slightly, depending on the size. For example, SC Klaipėdos nafta offered in a public tender LNG storage capacity of 130,000–170,000 m3 with a regasification facility and offered lease prices were very close.

Regasification capacity

The maximum capacity is 4 bcm of natural gas per year.

The newly built ship

More efficient work, durability, and less pollution to the environment: • Less loss of gas and more efficient fuel consumption per year (70 mln. 14

• • Security

LTL lower costs every year); Built to work in northern conditions; Estimated useful life – 40 years, compared with up to 30-year useful period of the old generation ships.

The new FSRU has installed the most modern security system that meets the strictest safety requirements (SIGTTO).

It was decided to lease liquefied natural gas storage with a regasification facility rather than buy directly from the shipyard for the following reasons: Table No. 3. Comparison of FSRU purchase and lease

Criteria

Purchase

Funds

Construction works of FSRU in the shipyard would cost about 250 mln. EUR. Therefore, it would require a huge initial capital investment. The Payments set out over 10 years, Company could not immediately pay funded from the Company’s business. the total amount, therefore, would State funds are not required. require public funds. Funding for the project would take additionally 1,5 years.

Business risk

Since the moment of purchase of the facility, the owner would assume the risk of equipment failure costs (in the current case – Hoegh LNG Ltd).

During 10-year lease period, all risks associated with unforeseen costs for repairs of facility shall be borne by the ship owner (Hoegh LNG Ltd).

Ship design

Lithuania does not have the experience in LNG ship design; employment of specialists would be expensive (additionally 50 mln. EUR).

Hoegh has its own specialists which have designed flotilla of LNG ships and 4 FSRU’s. Service is included in the lease price.

Lithuania does not have the experience to service FSRU.

Hoegh leased FSRU will be staffed with a professional crew. During the term of lease the Company will gain necessary experience.

Ship management

Lease

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Time

Until the end of 2014, for the construction of LNG ships there are no available shipyards. It would be possible to acquire one only after 2016. None of 11 potential manufacturers have offered a contract with ship’s delivery on December 2014.

Hoegh Ltd. has a contract with a shipyard in South Korea since 2009. In the initial round of negotiations, all suppliers of the FSRU offered only the lease option, it is a standard practice in this market, and thus, LNG industry is still considered as a new one. As a result the Company also managed to get an offer with a purchase option at the end of the lease period.

B. Required changes to the harbor infrastructure For safe entrance of LNG ships into the harbor of Klaipėda up to to Kiaulės nugaros island, it is necessary to fully complete the planned inner harbor channel dredging works and additionally deepen the water area of LNG vessel in its turning basin area. The harbor channel dredging is the responsibility of Klaipėda State Seaport Authority (hereinafter referred to as KSSA), Harbour dredging works have already been foreseen in the strategic plans. According to cooperation agreement signed on 5 July 2012 between Klaipėdos nafta and KSSA, KSSA is obligated to finish dredging works and transfer LNG terminal construction site until end of June 2013, when the construction of jetty and pipeline starts. KSSA has successfuly finished port dredging works tender, which also includes dredging of LNG terminal site, and has signed an agreement with the contractor which had won the tender. KSSA started dredging works in February 2013. KSSA will carry out navigational surveys and will prepare relevant changes for the rules of the harbor. Navigators and vessel traffic service operators will be trained in the use of new navigational systems related to the leading of LNG carriers up to the LNG terminal. Next stage adaptation of the harbor infrastructure would be construction of the LNG terminal jetty, where the FSRU will be moored. The entering LNG carriers will be moored to the FSRU and LNG will be unloaded to the FSRU using transmission sleeves. The jetty infrastructure and suprastructure consists of: high pressure platform, service platform, mooring landings, air bridges, observation towers, control rooms, fire protection equipment, technical service cranes, and high pressure gas transmission sleeves as well as other necessary equipment. In May 2012 LNG terminal jetty front-end engineering design was prepared. In August 2012 LNG terminal jetty design and construction tender was launched. The contract with the tender winner is expected to be signed in March 2013. Design works are scheduled to be performed until June 2013, construction works – until the III quarter of 2014. 16

C. LNG terminal connection with the gas-main Route length of the LNG terminal’s connecting gas pipeline with the gas transmission grid is about 18 km, of which 3 km are under the Curonian Lagoon. The beginning of the route – the northern side of Kiaulės Nugara island, where parking plot of the FSRU is assigned. The LNG terminal’s pipeline connection to the gas transmission grid will be near Dauparų village, at the gas distribution station DSS2 operated by Lietuvos Dujos. Diameter of the planned pipeline is 700 mm, capacity – 11 mln. m3 per day, allowing the maximum capacity utilization of the LNG terminal. In May 2012 LNG terminal pipeline front-end engineering design was prepared. In July 2012 LNG terminal pipeline design and construction tender was launched. The tender winner was announced on 21 December 2012 – a consortium between Kauno Dujotiekio Statyba and Šiaulių dujotiekio statyba.

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Capacity of the LNG terminal Capacity demand depends on three main criteria: • General country’s gas demand; • The needs of the most sensitive natural gas consumers; • Constraints of Lithuanian natural gas infrastructure (capacity of gas-mains). Total demand for natural gas Lithuania has a number of key gas-consuming sectors: households, energy, industry, and other. Most of the natural gas is used in thermal energy production (from 0,5 to 2,2 bcm per year) and the industry that uses natural gas as a raw material, which has a continuous, low seasonal gas flow (about 0.7–1.5 bcm per year). Total demand of Lithuania’s natural gas makes up around 3 bcm/year. Large and unique user, using natural gas for raw material needs, is SC Achema which consumes up to one third of the total country’s amount.

Source: Department of Statistics

Ensuring of the first necessity supply The primary goal of the LNG terminal is to ensure the first necessity supply of natural gas to consumers, i.e. public and domestic users, production of heat and industry, which must be ensured uninterrupted gas supply. Consumers of the first necessity consume an average from 0.9 to 1.5 bcm per year. Monthly consumption varies greatly – during the cold season consumption may be five times more than in summer. The diagrams below show that Lithuania’s natural gas consumption is characterized as high seasonality, especially excluding SC Achema (in Lithuania the highest recorded daily consumption of natural gas – 18.2 bcm, i.e. instantaneous equivalent of almost 7 bcm per year of consumed gas quantity). 18

Source: Department of Statistics

LNG terminal will ensure that during the coldest winter the first necessity needs of consumers will be met even in the disruption of supply from Russia. Constraints of natural gas infrastructure Lithuanian natural gas transmission infrastructure is adapted to supply gas in the east-west direction (through Belarus system of gas-mains), so without increasing the current capacity of the pipelines, the maximum capacity to supply gas from the LNG terminal will reach around 2 bcm per year, because the system of gas-main is not sufficiently developed. Upgrading pipeline branch Klaipėda-Kuršėnai in the north, it would be possible to use the maximum capacity of the LNG terminal (up to 4 bcm per year).

Source: SAIC

Taking into account the above reviewed criteria, during the medium term 2 bcm capacity of the LNG terminal per annum will ensure natural gas supply of the first necessity.

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LNG terminal and marketing business model Business model of the LNG terminal LNG terminal project is scheduled for completion on December 2014. Implementing the project, two independent activities will be created: 1. LNG terminal – a part of gas supply infrastructure system, after the Project is implemented, will be passed to the State-controlled transmission system operator; 2. LNG import and trade – a share of gas trading and supply market remains to Klaipėdos Nafta. The basic functions of the LNG terminal: 3. LNG storage, regasification and gas supply to the country’s gas-main networks; 4. Other services of the terminal: LNG fuel supply to small consumers (ship fuel, reserve fuel for boilers, small power plants). The LNG terminal facility will complement and enrich the country’s current natural gas supply infrastructure, creating opportunities for diversification of supply, reducing dependence on a single external supplier of natural gas, increasing the security of gas supply and fulfilling the EU directive N1 standard of infrastructure (assumptions for Lithuania’s self-sufficiency are dependant on natural gas required to meet the demand of the first need). Natural gas suppliers in Lithuania will be able to get the best price by comparing prices in the international gas markets and OAO Gazprom prices.

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Figure No. 7a. Business model of the LNG terminal

For effective performance management and transparency of processes, activities are intended to be separated. The above diagram illustrates the LNG terminal and the volume of trading activities and relationships in between them. LNG terminal operating costs are to be included in the gas transmission tariff. According to 2011 consumption volumes divided by the terminal operating costs would result in around 5 ct/m3 additional cost for gas consumers. After 10 years, the terminal costs would fall 50 percent due to the repaid financial obligations associated with financing of the project.

LNG import and marketing business model For effective performance management and transparency of processes LNG import and trading activity was separated from Klaipėdos Nafta on 17 December 2012 by establishing a subsidiary LITGAS UAB. The subsidiary will lease the LNG terminal infrastructure and will import LNG to the Lithuanian market and, if needed, to the bordering markets. Taking into account the Lithuanian natural gas sector needs, a trade enterprise shall have the following objectives: • to reduce natural gas prices in Lithuania, participating in the international LNG markets; • ensure access for the Lithuanian gas customers to world markets and availability of short-term and long-term gas supply contracts without linking prices to oil product indexes. 21

Figure No. 7b. Import and trade enterprise business model of the LNG terminal

LNG supply assurance Only real import of LNG natural gas through the LNG terminal will create competitive conditions for OAO Gazprom to reduce the price for supplied natural gas to the Republic of Lithuania, or at least not to increase it. LNG supply model directly depends on the Company achieving its objectives: • Free capacities of the LNG terminal would be used for trade in the spot markets at an attractive LNG price and needs of natural gas customers. The LNG terminal will balance regasification quantities to customers through the use of Latvian Inčukalns underground gas storage capacities; • Having more favorable LNG prices that are lower than the Government’s established price cap, in accordance with requirements of the 25 percent rule, LNG terminal would supply (in compliance with the short or long term contracts) 0.6–0.7 bcm of LNG for the Lithuanian consumers. 25 percent rule Currently, Lithuania does not have a natural gas market. Gas is bought from one supplier with fixed terms and pricing. Natural gas supply contracts are concluded exclusively for long-term in such way binding to the sole external supplier without leaving any options for an alternative. Therefore: • as LNG infrastructure is created, it is also necessary to create regulatory environment that allows access to the global natural gas market opportunities; • to promote the efficient competitiveness of natural gas supply sources and to ensure LNG terminal’s activity (i.e., LNG terminal technological capacity needed to continuously and effectively meet the country's natural gas demand), imported natural gas quantity through the LNG terminal must be at least 25 percent of total consumption of natural gas in the Republic of Lithuania per year; • the 25 percent rule, in order to ensure competitive equality, will be applied equally both to the gas, supplied through the LNG terminal and through the pipelines; 22

• •

•

25 percent rule shall prevent the current monopolist from concluding long-term contracts with suppliers and delaying of gas market introduction into the country; in order to protect the interests of gas consumers in Lithuania, the Government of the Republic of Lithuania established a price cap of through the LNG terminal and pipelines imported and in the internal market of Republic of Lithuania consumed natural gas; when suppliers will get used to the new opportunities opened by LNG terminal and gas market is fully developed, the 25 percent rule will be withdrawn.

Currently Gazprom supplies all Lithuanian consumers with natural gas and in many cases has a longterm gas supply contracts. The largest gas user SC Achema has entered into a direct long-term contract with OAO Gazprom. In order to maintain influence in the Lithuanian market, OAO Gazprom in the short term can provide attractive offers to the major customers, and thereby prevent the LNG terminal from entering the market. Temporary mandatory 25 percent natural gas supply regulation through the LNG terminal (accordingly 25 percent binding supply mechanism would be also for the gas supplied through pipelines) would be useful to prevent OAO Gazprom from concluding long-term contracts with suppliers, thus, eliminating any opportunity of LNG introduction to the Lithuanian natural gas market. This would allow consumers to have access to the LNG markets, choosing their own long-term or short-term contracts, when it is beneficial. So, over time, when the Lithuanian consumers gain the experience to work with LNG market opportunities and after the intensification of gas market relations, 25 percent temporary rule will be withdrawn. So, in order to ensure real alternative to natural gas supply, the Government of the Republic of Lithuania on 29 February 2012 adopted a resolution no. 219 which approved minimal import quota through LNG terminal of 25 percent from volume of annual domestic natural gas consumption for natural gas suppliers in Lithuania. On 12 June 2012 the Parliament of Lithuania adopted LNG Law. It states the general principles and requirements for construction of LNG terminal in the territory of the Republic of Lithuania. Its activities and operation are set forth at the highest legal level, as well as legal, financial and organizational conditions for implementation of LNG terminal project have been created.. Business regulation As well as infrastructure activities, LNG import and trading activities would be regulated by laws. Government or, on behalf of it, the National Price and Energy Control Commission (NPECC) would determine a price cap. It would apply to through the LNG terminal imported and in the Lithuanian domestic market consumed natural gas amount which must represent at least 25 percent of the total consumption in the Republic of Lithuania per year. The controlling authority must also approve terms and conditions for calculation and estimation of of the natural gas price cap. When determining through the LNG terminal imported natural gas price cap, The Government of the Republic of Lithuania will evaluate the optimal variant for the Republic of Lithuania, which would result in maximum benefit to the State and natural gas consumers. 23

Project organization The Government of the Republic of Lithuania on 21 July 2010 by Resolution No. 1097 approved that Klaipėdos Nafta can begin development of the project of liquefied natural gas terminal. Klaipėdos nafta was assigned due to the company’s financial capacity to complete the preparatory works of the project and the possibility of using the experience gained in managing the oil terminal in Klaipėda. Klaipėdos Nafta is responsible for both infrastructure development for LNG as well as import and trade business establishment. It is planned to transfer LNG terminal activities with the assets, rights and obligations to the Statecontrolled gas transmission system operator. Klaipėdos nafta could further develop LNG natural gas import and trading activities. Figure No. 8. Project development scheme

Besides implementation of the LNG terminal project the Company was entrusted with total project coordination including work coordination delegated to other bodies, which also includes KSSA. 24

Implementation plan of the LNG terminal Preparatory works of the LNG terminal: • On 30 June 2011 an agreement was signed with a leading adviser Fluor, which is involved in the overall project implementation and will provide technical-engineering services, permit procurement assurance services, project implementation and management services; LNG market and supply, business and financial advisory services. • The project was structured, concept of the project was prepared and key parameters were validated. • On 16 December 2011 assessment reports of the development plan and strategic environmental impact assessment (SEIA) were prepared and approved. These confirm that the LNG terminal project complies with the provisions of National Energy Strategy. Performed SEIA confirms that the project is feasible to implement in Klaipėda Seaport. • Strategy of LNG supply and natural gas sale was prepared and presented. • Study of navigation and mooring of FSRU and LNG carrier was completed. List of key tasks completed related to LNG terminal: 26 April 2012

Marine and Pipeline FEED completed.

May-September 2012

Navigational analysis of LNG ships was completed and navigational parameters of LNG ships in Klaipeda Port were determined, on the basis of which Klaipeda State Seaport Authority shall execute amendments of Navigation rules.

May 2012

LNG terminal project business plan was presented.

12 June 2012

Law on Liquefied Natural Gas Terminal was enacted by the Parlament.

June–August 2012

Geological investigation for construction of LNG jetty and pipeline in the Port.

3 July 2012

Procurement for Natural Gas Pipeline System Engineering, Procurement and Construction (EPC) works was announced. On 21 December 2012 the winner of the tender was announced.

5 July 2012

Signed a General Bilateral Cooperation agreement with Klaipeda State Seaport Authority on construction of jetty of LNG terminal and dredging works of Port water area.

14 August 2012

AB „Klaipėdos nafta” and Klaipeda State Seaport Authority signed an additional agreement to General Bilateral Agreement on rules and conditions of investment and compensation of investement. 25

24 August 2012

Procurement of LNG terminal project port Infrastructure (jetty) with suprastructure (equipment) engineering and construction works was announced. On 10 December 2012 initial tender offers were received and negotiations with tender participans started.

12 September 2012

A request was submitted to the Ministry of Energy of the Republic of Lithuania to address the Ministry of Finances of the Republic of Lithuania to include a State guarantee limit of LTL 200 million, intended for security of loans for investment into LNG terminal infrastructure, into the State budget of 2013. On 20 December 2012 the Law of Approval of Financial Indicators of State Budget and Municipalities’ Budget was adopted which included the requested State guarantee limit.

September 2012

Land property for construction of gas metering station (GMS) was purchased.

October 2012

LNG terminal Safety Report, version 1, was prepared which will be supplemented with solutions of basic design and will be submitted to authorities for approval.

12 October 2012

Klaipeda State Seaport Authority announced procurement of port dredging works. On 21 December 2012 final tender offers were received.

22 October 2012

Regional Environmental Protection Department of Klaipėda by the Ministry of Environment of the Republic of Lithuania has granted development consent on construction and activities of LNG terminal and Related Objects of Infrastructure in the southern part of Klaipėda State Seaport nearby Pig’s back Island. The consent finalised the procedure of environmental impact assessment on LNG terminal project.

October 2012

AB “Klaipėdos nafta” and AB „Lietuvos dujos” signed an agreement on installation of tie-in point for connection of LNG terminal to transmission grid.

November 2012

Main terms and conditions for connection of LNG terminal to transmission grid of AB “Lietuvos dujos” were approved.

9 November 2012

Procurement of Overdraft facilities was announced. On 21 December 2012 initial tender offers were received.

9 November 2012

Procurement of financial services (long term loan and performance guarantee) was announced. On 13 December 2012 applications of the suppliers were received.

23 November 2012

Following the order of the European Commission, analysis of LNG supply 26

to the Baltic region was prepared. It indicated that Lithuania selected the best technological solution which corresponds to regional LNG terminal parameters with the lowest costs of the terminal construction and operation, in comparison to potential terminals of Latvia, Estonia and Finland. December 2012

Concept of special plan of LNG terminal construction and SEIA was approved.

December 2012

Process of detailed planning regarding land property for GMS was started.

December 2012

A feasibility study was completed titled Analysis of quality changes of natural gas and estimation of suitable parameters for consumers in transmission system operated by SC Lietuvos Dujos.

17 December 2012

Established and registered a new subsidiary LITGAS UAB, which will engage in trade of LNG and supply of natural gas.

19 December 2012

Comfort letter regarding LNG terminal project was signed by the Minister of Energy.

Planned LNG terminal works for 2013-2014: • To complete process of territory planning for LNG terminal infrastructure (special plan, detailed plan and land servitudes) – 3rd quarter 2013; • To finalize negotiations with LNG suppliers and to sign long-term LNG supply agreement - 1st quarter 2013; • To sign LNG sale agreements and to ensure sales of purchased LNG, in compliance with Rules for Diversification of the Natural Gas Supply – 1st and 2nd quarters 2013; • Permission for construction works and approval for basic and detail designs of LNG terminal pipeline and jetty – 3rd quarter 2013; • To start preparatory construction works and to start construction of LNG terminal jetty and pipeline – 3rd quarter 2013; • To complete construction of LNG terminal infrastructure – 3rd quarter 2014; • Arrival of FSRU, connection to gas pipeline and preparation for operation – 4th quarter 2014; • Commissioning and start-up works in Klaipėda Seaport – 3rd quarter 2014; • To start LNG terminal operation in December 2014.

27

Figure No. 9. LNG terminal project implementation plan LNG Terminal launch

2011 Q1

Q2

Q3

2012 Q4

Q1

Q2

FSRU lease agreement

FSRU

2013

Q3

Q4

Q1

Q2

2014

Q3

Q4

Q1

Q2

Q3

2015 Q4

Q1

Construction of FSRU and delivery to the Port of Klaipėda

Port dredging by Port of Klaipėda Pre-project study

Jetty

Pre-project study

Gas pipelines

Jetty EPC tender

Design and onstruction of jetty (EPC) by Port of Klaipėda and Klaipėdos nafta

Pipeline EPC tender

Design and connection LNG Terminal to the gas grid (EPC)

Construction of gas main Jurbarkas – Klaipėda by Lietuvos dujos Environmental Impact Assessment (EIA)

Process items

Territory planning and construction permit Preparation of Project financing structure and loan procurement

Project financing

State guarantee Arrangement of LNG supply

Gas trading

Arrangement of NG sales

Legal environment assurance

Law on LNG Terminal

Finished

Testing and commissioning works

Rules on gas supply diversification In progress

List of major legal acts governing the LNG terminal: Date Legal Act 15 February Resolution by the Government of the Republic of Lithuania “On Construction of 2012 Liquefied Natural Gas Terminal” (State Gazette, 2012, No 25-1166, No 83-4387) 29 February 2012

Resolution by the Government of the Republic of Lithuania “On Ensurance of Obligatory Activity of Liquefied Natural Gas Terminal” (State Gazette, 2012, No 291297).

26 June 2012

Resolution by the Parliament of the Republic of Lithuania “On Adoption of the National Energy Independence Strategy” (State Gazette, 2012, No 80-4149).

Performed by third parties

Impact on LNGT project The Government approved that Klaipėdos Nafta would continue the implementation of the LNG terminal project in the Republic of Lithuania. The Government approved minimal import quota through LNG terminal of 25 percent from volume of annual domestic natural gas consumption for natural gas suppliers in Lithuania. LNG terminal project is the strategic priority project intended to ensure stability and diversification of natural gas supply, to reduce natural 28

Date

12 June 2012

16 October 2012

22 October 2012

7 November 2012

6 November 2012

Legal Act

Impact on LNGT project gas prices, and to create natural gas market. Law on Liquefied Natural Gas Terminal General principles and requirements (State Gazette, 2012, No 68-3467). for construction of LNG terminal in the territory of the Republic of Lithuania, its activities and operation are set forth at the highest legal level, as well as legal, financial and organizational conditions for implementation of LNG terminal project have been created. Resolution by the Government of the Obligatory requirements applied to Republic of Lithuania “On Adoption of the procurement of LNG which is Procedure for Procurement of Liquefied delivered to LNG terminal. General Natural Gas Delivered to the Liquefied requirements of public procurement Natural Gas Terminal” (State Gazette, 2012, are not applied to LNG No 122-6151). procurement. Resolution by Klaipeda Region Resolution granted consent on Environmental Protection Department of the construction and activities of LNG Ministry of Environment of the Republic of Import Terminal and related Lithuania No (4)-LV4-3270. infrastructure. Resolution by the Government of the Procedures were set on Republic of Lithuania “On Approval of the implementation of rules of Rules of Diversification of the Natural Gas diversification of syupply of natural Supply” (State Gazette, 2012, No 132gas imported and consumed in 6708). internal market of the Republic of Lithuania, including requirements for practical implementation of 25 percent rule (obligatory requirement for natural gas suppliers to ensure import of natural gas through LNG terminal). Amendments by the Parliament of the Amendments allow changing land Republic of Lithuania on Forest Law No Iuse purpose from forest land into 671 land of other usage, when it is set forth in special plans of projects of extraordinary state importance.

29

Changes of regulatory environment during the project implementation: Date Legal Act Impact on LNGT Project Resolution by The National Control NCC approved calculation 28 Commission for Prices and Energy (NCC) methodology and inclusion of costs September on “Amendment of methodology for of construction of LNG terminal 2012 calculation of cap prices for transmission into the price (tariff) of transmission and distribution of natural gas” of natural gas in the form of LNG (State Gazette, 2012, No 115-5856). terminal premium. Resolution by the NCC “On Adoption of NCC determined rules of 9 October Rules on Administration of the Funds administration of the funds collected 2012 Allocated for Full or Partial Compensation through natural gas transmission of Costs of Construction and Operation of tariff and required for compensation the Liquefied Natural Gas Terminal” (State of costs of construction and Gazette, 2012, No 118-5973). operation of the LNG terminal. Resolution by the NCC “On Approval of the NCC decided to compensate part of 19 October Funds for the Year 2013 for Full or Partial costs of construction of LNG 2012 Compensation of Costs of Construction and terminal for 2013 equal to LTL Operation of the LNG Terminal” (State 113,798. This amount will be Gazette, 2012, No 123-6229). included into price of natural gas transmission service as LNG terminal premium. Resolution by the NCC “On Correction of NCC approved LNG terminal 26 October the Cap Prices for Transmission and premium – supplementary and 2012 Distribution of Natural Gas by Lietuvos integral constituent in the cap price Dujos AB and Approval of the of transmission of natural gas, for Supplementary and Integral Constituent compensation of costs of LNG (Costs for the LNG Terminal) in the Cap terminal construction in 2013 which Price for Transmission of Natural Gas for amounts to LTL 37.53 for 1000 m3 the Year 2013” (State Gazette, 2012, No (excl. VAT). 126-6375). NCC approved requirements for 21 December Resolution by the NCC “On Approval of Requirements for Rules of Use of the LNG rules of use of LNG terminal. 2012 terminal” (State Gazette, 2012, No 154Klaipėdos Nafta has prepared and 7972). approved these rules on 31 January 2013.

30

Project funding Need of funds for start-up of the LNG terminal business During the project implementation, the largest investments are as follows: • Lease (acquisition) of the floating LNG storage with a regasification facility; • Harbor dredging, jetty construction and preparation of jetty facilities; • Construction of the pipeline linking the terminal with the gas-main; • Preparatory design, obtaining permits, project management and

other

works;

Total investment demand before the start-up of the LNG terminal is about LTL 613 million.. FSRUwith a regasification facility is the largest investment of the project. It will be leased, eliminating the need for additional funds from financial institutions or the State budget. According to the agreement, the lessor of FSRU will take on infrastructure operations risks and provide supervision services. This is especially important for Lithuania, which does not have that type of equipment maintenance experience. .

Below is a comparison of contract terms of similar transactions concluded in recent years.

31

Figure No. 11. Prices for a lease of FSRU’s on the market

Until the start-up of the LNG terminal at the end of 2014, Klaipėdos Nafta will perform preparatory works: project organization and obtaining the necessary permits, LNG terminal connection with the gas-main, construction of jetty facilities and start-up works (total LTL 453 million). Start-up works include testing of LNG terminal infrastructure which will require first supply of LNG amounting to LTL 120 million. Most likely part of costs will be recovered on sale of used LNG, however for purposes of simplification, it is assumed no costs will be recovered. Table No. 4. Klaipėdos nafta investments for the LNG terminal project Klaipėdos Nafta investments*, LTL million 1. Project management and infrastructure testing (incl. cost of LNG for testing purposes) 2. LNG terminal gas pipeline and gas metering station design and construction 3. LNG terminal jetty suprastructure design and construction Total:

2012

2013

2014

Total

30

78

116

224

-

53

88

141

-

29

59

88

30

160

263

453

Source: project FEED prepared by the lead advisor Fluor

Jetty infrastructure construction and harbor dredging works are entrusted1 to Klaipėda State Seaport Authority, which is required to adapt existing and build new infrastructure objects in Klaipėda harbor (total funds needed LTL 160 million). KSSA will finance their investments from own and borrowed funds.

1

2012-02-15 Resolution of The Government of Lithuania on LNG Terminal Construction

32

Financing capability of the LNG terminal by Klaipėdos nafta In order to compensate the said investments, the Company is going to raise funds from the following sources: a) about LTL 250 million would be funds borrowed from Lithuanian and/or international financial institutions (international financial institutions require State guarantee); b) about LTL 200 million would be natural gas consumers’ funds, i.e. revenue from the additional and integral component to the upper limit of the natural gas transmission price (the LNG terminal extra) in 2013 and in 2014 (the LNG terminal extra funds collected from gas transmission tariff in 2013 would amount to LTL 113,798 thousand). The National Control Commission for Prices and Energy (hereinafter, the “Commission”, NPECC) in its meeting of 19 October 2012 approved a draft of the investments planned by the Company into the liquefied natural gas terminal, installation of its infrastructure and connection. Preliminarily, by 2015 these investments will amount to approximately LTL 453 million. The Company will also secure LTL 120 million overdraft facility for cashflow management purposes until long-term financing is secured in relation to the fact that cash inflow from LNG terminal premium will come after 5 months from the relative investment period. Besides, the Company is going to address commercial banks for: (1) a bank guarantee2 in the amount of $ 50 million intended for securing the performance of the contract for the lease of the FSRU, (2) a bank guarantee intended for securing the performance of the gas supply contract, (3) a bank loan intended for formation of the working capital necessary for gas purchasing. The financial resources of the Company during the project period could amount to about LTL 100 million. The Company could allocate these funds towards financing the gas trading activities through LNG terminal. Also, seeking to secure proper performance of possible financial obligations to financial institutions, the Company has submitted an application to the Ministry of Energy of the Republic of Lithuania, asking it to address the Ministry of Finance of the Republic of Lithuania for including a limit of State guarantee intended for financing loans for investments into the LNG terminal infrastructure (LTL 200 million), into the draft Law of the Republic of Lithuania on Approval of the Financial Indicators of the State Budget and Municipal Budgets for 2013. The requested limit was included into State Budget of 2013. The Company notes that all the data given in this notification are preliminary and planned, but not yet final, and may change during the implementation of the project (if the project will be implementable).

2

According to 2012-03-02 agreement between Klaipėdos Nafta and Hoegh LNG on acquisition of LNG FSRU

33

Table No. 5. LNG terminal project financing scheme AB “Klaipėdos nafta” (KN)

LNG Terminal Trading Activities

LNG Terminal Infrastructure Demand for financing and guarantees $US 50 M guarantee for the FSRU operating lease

Potential resources

Collateral

$US 50 M

 Accounts receivable from gas tariff (from 2015)

commercial bank guarantee

250m LTL

450m LTL Investments in:  Project management

Loan from an institutional (NIB, EIB, EBRD) or commercial bank (for 20-25 years)

 Gas pipelines

200m LTL

 Jetty facilities

compensation of investments via gas tariff

 LNG Terminal tangible assets

Demand for financing and guarantees

Potential resources

bank guarantee for gas supply

guarantee from a commercial bank

 200m LTL State guarantee

Collateral

 KN guarantee/ oil terminal assets and cash flows  LNG Terminal trade accounts receivable and inventories  Guarantees from key buyers

investment in Working Capital

(FY2013-2014) Approved.

credit facility from a commercial bank

 Guarantees from export credit agencies

100m LTL KN cash investment

Financing of the LNG terminal business (from 2015) Selected purchase method of the Floating Storage and Reregasification Unit (FSRU) is an operating lease agreement with a purchase option after 10 years (2025) to purchase for its residual value , set in the time charterer party agreement. FSRU operating lease costs and other fixed LNG terminal operation costs will be financed from the natural gas tariff, controlled by the NPECC. The redemption amount of the FSRU will be financed by financial institutions as the LNG terminal operator would have an established track record of operation which would allow borrowing the required amount by plegung the FSRU.

34

Figure No. 12. LNG terminal income / expenses (mln. LTL) Income

LNG terminal income / expenses (mln. LTL)

Redeemed FSRU Completely acquired FSRU

Lease of FSRU Lease of servicing

Other costs (fuel, deterioration)

Operating costs of FSRU

LNG import and trade financing activities The gas trading company and its profit will bee regulated by the State Price and Energy Control Commission, setting fixed income margins. LNG supply revenues and expenses will directly depend on LNG import volume. The main financing need for the LNG trading company will be necessary guarantees to LNG suppliers as well as financing of working capital. It is planned that the LNG trading company will be able to pledge purchased LNG resources and accounts receivable from sales of LNG to satisfy its financial needs.

35

Cost and benefit analysis of the LNG terminal

36

Ensurance of alternative gas supply to Lithuania Oil, oil products and natural gas in equal proportions amount to 70 percent of total primary energy resources consumed in the country. Unfortunately, no alternative gas supply channel was established over Lithuania’s independence period. The oil terminal Būtingės Nafta is a very good example of how the State can solve the supply security issue, and the relevance of the alternative source of supply, when supply by the main channel is interrupted. It is expected that natural gas at least 20 years will be among the main primary energy sources. In 2020 consumption of natural gas will amount to 1.6–3.7 billion cubic meters (further – bcm) per year.

Source: Department of Statistics, LEI

Source: Department of Statistics

It is forecasted that to meet the demand of the first necessity in 2020 will require 0.9–1.5 bcm of gas. Demand of the first necessity involves supply of gas to domestic consumers, heat production, public institutions, and companies, for which loss of supply of gas would mean the suspension of activities. The largest gas supplier in Lithuania is SC Lietuvos dujos which on 16 December 1999 entered into an agreement with OAO Gazprom valid until 31 December 2015 to supply natural gas to the Republic of Lithuania. SC Lietuvos dujos sells natural gas to both domestic and non-household customers, and occupies about 70 percent of retail gas market. The second largest supplier is JSC Dujotekana, which controls the remaining 30 percent of gas supply market. It has signed a long-term gas supply contract with OAO Gazprom until the end of 2012.

37

Ensuring competitive pricing Lithuania is facing not only the natural gas supply problem – in Lithuania imported natural gas prices are significantly higher than in neighboring EU countries. Lithuania, buying gas from a single external supplier and consuming just 0.6 percent of total gas extracted by OAO Gazprom, does not have a serious negotiating position to reduce the price of gas. In 2012 imported natural gas prices compared with the German gas import prices were on average 15 percent higher. Figure No. 15 Gazprom prices at Lithuanian vs German boarder

Source: Regulator, Index Mundi

Theoretically, all the Baltic countries are subject to the same gas price formula, but Latvia and Estonia, having a stronger negotiating position with OAO Gazprom (Latvia concerning Inčukalns Underground Gas Storage, Estonia concerning the availability to use local fuel – shale), have better natural gas prices. Meanwhile Lithuania, in the absence of real alternatives, pays more than its neighbors. When implementing LNG terminal project, the following objectives will be achieved: • Provided access to the international gas markets – the opportunity to purchase natural gas for the best gas prices and to develop the gas exchange in Lithuania and the Baltic region; • Diversification of supply – consumers would have the opportunity to purchase natural gas from several alternative sources. The lack of alternative supply sources and natural gas price linking to oil or oil products prices results in higher prices than gas prices linked to gas indexes. A map of of gas prices in Europe is provided below for comparison.

38

Figure No. 16. Average wholesale gas prices (H1 2012)

Source: DG Ener

39

Benefits of the LNG terminal Benefits of the LNG terminal for the State Economic The biggest economic benefit of the LNG terminal for the State is expected to be lower natural gas prices for the Lithuanian people and companies. The LNG terminal can ensure a lower price in two ways: direct import of cheaper natural gas, or acting as a negotiating leverage to lower the Russian natural gas prices. Evaluation of the actual LNG prices for 2012, the LNG terminal benefits to Lithuania would reach 0.4 bn. LTL per year. To assess the economic benefits of the LNG terminal, two scenarios of natural gas supply through the LNG terminal are compared: 1. In Lithuania LNG terminal law will be governing the mandatory use of alternative gas supply up to 25 percent of the general national gas consumption. Adjustable minimum quantity of LNG import would consist of up to 25 percent of the general national gas consumption in Lithuania. LNG price used for comparison is 2012 average NBP (National Balancing Point, UK) index price. 2. According to the planned 2014 gas grid infrastructure, the LNG terminal could supply 6 mln. m3 per day, which is theoretically up to 2 bcm per year (2/3 of the total demand of natural gas in Lithuania). Calculated financial results of the possible scenarios: A. Terminal operates at a minimum mode (25 percent = 0.75 bcm): 1. 25 percent of natural gas is imported through the LNG terminal at NBP prices; 2. 75 percent of natural gas is imported from Russia under the existing supply contract prices. Economic benefits  150 mln. LTL/year. Figure No. 17. Economic benefits of the LNG terminal, annual capacity 0,75 bcm/year Lithuanian consumption (bcm)

Russian gas price 2012 average (LTL/1000 m3)

LNG price* with transportation and LNG terminal costs (LTL/1000 m3)

Lithuanian expenditures on gas (bn. LTL)

The current situation By OAO Gazprom imported gas

3,0

1329

3,99

2,25

1329

2,99

Alternative By OAO Gazprom imported gas Imported LNG gas

0,75 Total

Ekonomic benefits (bn. LTL)

3,0

1130

0,85 3,84

0,15

*(2012 average NBP + plus transportation costs)

40

A. Terminal operates at a maximum mode within the existing gas network capacity (~2 bcm): 1. 2/3 of natural gas is imported through the LNG terminal at NBP prices; 2. 1/3 of natural gas is imported from Russia under the existing supply contract prices. Economic benefits  400 mln. LTL/year. Figure No. 18. Economic benefits of LNG terminal, annual capacity about 2 bcm/year Lithuanian consumption (bcm)

Russian gas price 2012 average (LTL/1000 m3)

LNG price* with transportation and LNG terminal costs (LTL/1000 m3)

Lithuanian expenditures on gas (bn. LTL)

The current situation By OAO Gazprom imported gas

3,0

1329

By OAO Gazprom imported gas

1,0

1329

Imported LNG gas

2,0

3,99

Alternative

Total

1,33 1130

3,0

Ekonomic benefits (bn. Lt)

2,26 3,59

0,40

*(2012 average NBP + plus transportation costs)

Figure No. 19. Potential economic benefits of the LNG terminal due to decreased prices for gas

Variable costs of LNG terminal mainly consist of LNG fuel used to produce liquefied natural gas transforming them into the gaseous form (in the reregasification process). In addition, about 10–20 percent (60–120 mln. LTL) of LNG project will be carried out by the Lithuanian contractors and project-related service providers, which will boost the growth of the Lithuanian economy. 41

Ensurance of natural gas supply security The project of the LNG terminal will help to solve historically unfolding problem of Lithuania’s dependance from a single source of gas supply from Russia, (gas supplied from the only gas-main, which passes through Belarus). In case of disruption of one of the natural gas supply sources (analogous to the oil supply from pipeline Druzhba and Būtingės oil terminal model), Lithuania will have access to natural gas through an alternative natural gas source in the country and ensure its stability for the industry. Social benefits Implementation of project of the LNG terminal, will create a direct benefit to the city of Klaipeda: the introduction of further 50–100 work places in construction and during operation of the LNG terminal.

Benefits of the LNG terminal to consumers of natural gas The LNG terminal will allow Lithuania to participate in global natural gas markets. In recent years, the rapidly growing volume of LNG supply, LNG prices in the international exchanges are more attractive than those provided in long-term supply contracts of OAO Gazprom. The ability to gain gas in the international gas exchanges would reduce the cost of gas for consumers in Lithuania. Lithuania’s prices for natural gas purchased from OAO Gazprom are derived from the price formulas, related to oil products, so the price of gas purchased directly correlates with global oil prices and is constantly rising. The natural gas pricing model has been used in Europe in 1980–2005, when the market was dominated by long-term gas supply contracts (twenty years or more) and almost no alternatives were present. In addition, until 2002 oil prices were relatively stable (compared to the period after 2002). It met both the natural gas suppliers, as well as natural gas consumers. Due to the rising prices of oil and oil products, gas delivered under long-term oil-related contracts became uncompetitive in the market, which appeared as an alternative supply of natural gas in the LNG form. Over the past 5 years LNG global trade has increased by about two-times. Along with LNG, development of natural gas spot market transactions began to take shape in the sector. Spot pricing models were developed according to demand-supply principle when price is set in the short period under the prevailing market prices. During the past decade, natural gas exchanges were formed (NBP, TTF, Zeebrugge, Henry Hub), which trade both in LNG and piped gas, and they have formed significantly lower natural gas prices than piped natural gas prices.

42

Picture No. 20. Prices of import and gas markets indexes (2010-2012 LTL/1000 m3)

Source: Index Mundi, gas markets

Further growth in crude oil and oil product prices, according to the pricing principles applied by OAO Gazprom, in natural gas valuation (i.e. linking with the prices of oil products) is not cost-effective alternative to Lithuania. Henry Hub is the index of natural gas trading in the USA. Discovery of shale gas resources and technology of their extraction reduced natural gas prices in the USA, as shown in the picture above. USA is implementing LNG terminal construction projects which will allow it to export liquefied natural gas to Europe and other continents. If it would be possibile to buy gas from Great Britain (NBP index), Netherlands (TTF) or USA (Henry Hub) markets, or buy long-term contracts, where natural gas price is linked to the stock exchange prices, natural gas prices in Lithuania could fall by 20 percent or more. Figure No. 21. Tentative price of gas import

Source: Index Mundi, gas markets

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LNG terminal benefits to the company implementing the project The Government of the Republic of Lithuania on 21 July 2010 by Resolution No. 1097 on the Natural Gas Terminal Development agreed that the company Klaipėdos nafta will begin to develop liquefied natural gas terminal project. Klaipėdos nafta, implementing the LNG terminal project receives: • the possibility to diversify activities; • by investing in profitable project, ensure long-term returns to shareholders. LNG terminal project is recognized as important to the State and thus it facilitates the development of the project: • The National energy strategy approved by the Seimas of the Republic of Lithuania on 26 June 2012 Resolution No. XI-2133 and on 18 January 2007 Resolution No. X-1046. • On 25 February 2009 LNG terminal project approved by the Government in the Programme for 2008–2012. • On 23 June 2010 an interdepartmental working group was established, which drew up proposals for the LNG terminal construction site, technology, and possible funding solutions. • On 21 July 2010 the Government of Lithuania adopted resolution on LNG Terminal Project Development which states that Klaipėdos Nafta will start implementing LNG terminal project. • General Meeting of of Shareholders of Klaipėdos nafta (72.32 percent of the Company shares are owned by the Lithuanian Ministry of Energy) on 26 August 2010 agreed to carry out preparatory work on the project and implement an investment project for construction of the LNG terminal. • On 11 May 2011 interdepartmental government commission was established headed by the Prime Minister for the LNG terminal project implementation supervision. • By the Government Resolution No. 871 of 13 July 2011, LNG terminal project is recognized as a major economic project of the State. • The Government of the Republic of Lithuania adopted Resolution No. 175 of 7 February 2012 on the Government of the Republic of Lithuania on 27 December 2007 No. 1442 Resolution of the National Energy Strategy Implementation Plan for 2008–2012 „supplement“, by which liquefied natural gas (further – LNG) terminal project has been included in the National Energy Strategy Implementation Plan of 2008–2012 and further to be approved for 2012-2016. • The Government of the Republic of Lithuania adopted Resolution Nr. 199 on 15 February 2012 on Liquefied Natural Gas Terminal Construction supporing the Company plans to continue LNG terminal project. The Government Resolution instructed the Ministry of Energy to initiate the General Meeting of Shareholders for amendment of the Company’s Articles of Association that one of the Company’s objectives would be the LNG terminal construction and commissioning, cost effective and efficient operation of the LNG terminal and (or) its subsequent transfer to the Republic of Lithuania controlled natural gas transmission system operator. • Law on Liquefied Natural Gas terminal of the Republic of Lithuania approved on 12 June 2012 No XI-2053. 44

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On 26 June 2012 the Parliament of the Republic of Lithuania passed resolution on Adoption of the National Energy Independence Strategy which sets main Lithuanian energy sector aims and their implementation measures until 2020 as well as development guidelines until 2030 and 2050. LNG terminal project was established as the strategic priority project intended to ensure stability and diversification of natural gas supply and to reduce natural gas prices as well as create natural gas market.

LNG terminal and LNG supply activity will be regulated by the State, so the Company will be provided with a stable income.

LNG supply market review Natural gas currently is the fastest-developing energy resource. Natural gas demand growth is determined by several factors. First, natural gas is friendlier to environment fuel than oil. Second, natural gas supply is more stable. Third, the application of natural gas liquefaction technology has become economically attractive for transportation of natural gas from regions where huge gas reserves were discovered and export of which has not been implemented due to lack of pipeline infrastructure, During the past five years, global LNG trade increased about two times, significantly increasing number of market participants, LNG trading is carried out around the world. Top LNG gas demand is in Asia-Pacific Ocean region, where it is consumed about 60 percent of all produced LNG (2010). The largest LNG exporter – Qatar, in 2010 exported about 79 bcm of LNG. Figure No. 22. Changes in LNG flow

Source: EconGas

Because of its advantages (fast, flexible, independent from the surrounding countries), LNG import and export infrastructure is being developed rapidly. Currently, around the world, more than 46 export and 45 import terminal projects are being carried out. As a result, the LNG market continues to grow rapidly. Meanwhile, ground pipeline projects while in development, are mostly in internal markets. Crossborder gas pipeline projects are often subject to political risks and are usualy delayed (i.e. Nabucco, South Stream). 45

Supply-demand balance Currently LNG demand exceeds supply. This was mostly influenced by the increased flows to Asia, caused by several factors: the natural gas consumption growth in the Indian and Chinese markets (these markets are limited in the gas pipeline infrastructure), Japan’s fuel balance changes after the incident in Fukushima (closed nuclear power plants, nuclear energy was replaced by natural gas). Currently, Japan’s consumption consists of over 40 percent of all Asia LNG demand. However, the situation will return to normal after new gas liquefaction terminals are built: • It is planned that in 2015 Australian export capacity will exceed 80 bcm. Australia will be able to meet growing Asian demand and LNG supply trends will be redistributed positively to the European region. • Due to effective shale gas extraction technology USA is planning to replace existing import terminals with export. USA is planning that terminal capacity will exceed 100 bcm. This change will have a direct impact on trade in the Atlantic basin and is likely to reduce LNG prices. Currently, USA prices (Henry Hub) are the lowest LNG prices in the world. • In the 5–10 year term, new gas liquefaction terminals are planned in Africa, Canada, USA and Russia. After the launch of all planned gas liquefaction terminals, LNG supply will jump to 535 bcm/year (from the current 251 (88 percent). Therefore, long-term projections indicate that supply will exceed demand and may reduce the prices of LNG. Figure No. 23. Projection of natural gas distributrion for 2012–2020 years

Source: Poten&Partners

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LNG pricing LNG global market pricing system is not uniform. LNG prices reflect the country’s “consumer” or regional market situation. In the Atlantic, Caribbean and European markets LNG price is usually associated with the Brent oil price or partly with oil products (gasoline, fuel oil) prices. In recent years, more often contracts of natural gas supply are concluded applying price formula linked to the gas indexes. Figure 24. Differences in the LNG prices according to the region

Source: FERC, Regulator

The gas indexes are formed in the gas exchange centers (hub). The main gas exchange centers, which could be used to link gas supply price for Lithuania: • NBP (National Balancing Point called) – Great Britain • TTF (Title Transfer Facility) – Netherlands • HH (Henry Hub – USA) An important factor is transportation costs in the LNG supply price formula. Depending on the country or transshipment terminal, from which LNG is supplied, transportation costs can vary up to two times.

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Table No. 6. LNG transportation costs, LTL/1000 m3 Transportation cost Central Asia Greece (Revithoussa) Italy (Rovigo) Spain (Huelva) Portugal (Sines) Holland (Roterdamas) Belgium (Zeebruge) France (Montoir) Great Britain (Isle of Grain) USA (Cove Point) USA (Sabine Pass)

149 170 192 196 227 227 217 227 291 330

North Ameriva 51 56 26 29 59 59 50 59 122 158

Nigeria 155 161 111 111 141 141 131 140 166 192

The Fsr East 224 245 268 272 302 302 293 302 368 378

Trinidad 158 163 112 110 131 131 123 130 69 78

North Eats Asia 310 331 354 359 392 392 380 391 456 537

LTL/1000 m3 North Australia Europe 239 133 259 139 285 89 289 85 321 54 321 54 308 69 321 54 383 127 487 173

Source: Icis Heren

LNG use for ship fuel (bunkering) – the additional activity Starting from 2015 due to stricter environmental requirements, ships in the Baltic and North Seas have to use low sulfur fuel. One of the alternative fuel will be LNG containing no sulfur combinations. Establishing LNG terminal bunkering business is considered a commercially attractive activity designed to ensure a stable income. Guiding principles of bunkering: LNG terminal in Klaipėda harbor fills up smaller bunkering vessels (size up to 20,000 m3), which can fill a ship with LNG fuel and service smaller LNG terminals in the Baltic countries. Starting from 2015 in Klaipėda harbor ships could be offered a supply of 66,000 tons of sulfur free fuel a year, which amounts to 140,000 m3 of LNG that would increase the utilisation of the LNG terminal about 10 percent. Small LNG tanks can be installed near ports or electric or gas distribution stations. Such LNG containers can be serviced according to the diagram below. Small LNG storages are from 10 000 m3 to 40,000 m3 of natural gas capacity, accordingly, they can accommodate from 6 mln. m3 to 24 mln. m3. Start of usage of LNG in the Baltic countries, gives possibility to replace backup fuels (fuel oil or shale oil) with cleaner LNG fuel. LNG creogenic container with a volume of 10,000 m3, could supply Vilnius boiler (50 MW) with gas up to 50 days.

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Possibilities of cooperation with Latvia and Estonia The problem of gas supply security is of interest not only to Lithuania but also to other Baltic states. Together with Latvia and Estonia, all three countries are not connected to the gas infrastructure and form the so-called „energy island“ in which the total annual consumption reaches 5.9 bcm per year. Latvia has a limited natural gas supply security due to Inčukalns underground gas storage facility in the central territory of Latvia, and Estonia as an alternative could use domestically excavated shale. Lithuania, however, in this respect is the most vulnerable. One obvious area where Lithuania could cooperate with Latvia is Inčukalns underground natural gas storage in Latvia. In the event of a favorable situation in the global gas markets, LNG could be purchased at low prices, stored in Inčukalns and used when needed. Thus, the Lithuanian LNG terminal would acquire operational flexibility and would allow even better use of the international market opportunities. In order LNG terminal in Lithuania to become a regional project, the general consensus of the Baltic states is necessary. If in Lithuania, Latvia and Estonia gas-main system development was completed, LNG terminal in Klaipėda as an alternative source would ensure gas supply to all three Baltic countries. Figure No. 25. Scheme of regional ensurance of natural gas supply

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SWOT analysis Table No. 7. SWOT analysis Strengths • The selected flexible technical solution min/max regasification from 1.5 to 11 mln. m3/day, respectively, from 0.6 to 4 bcm/year. • Purchased FSRU is one of the most economical of this type of facility: 170 thousand m3 tanks, the latest LNG vapor collection equipment (to 0.12 percent, older ship losses up to 0.2 percent), and combined open-loop evaporation system that enables to save fuel, installed boiler economizers additionally recover heat energy from exhaust gases. • Technology (FSRU) is mobile and can change location, if necessary. • Technology (FSRU) allows use of a FSRU as a tanker. • Sufficient expertise and financial resources to implement LNG project. • LNG terminal increases the reliability of gas supply system due to an additional source of supply. • In 2014 with future pipeline capacity it will ensure the needs of gas consumers even after the termination of gas supply from Russia.

Weaknesses • Gas pipeline constraints: existing gas pipe network – 1 mln. m3/day, 0.5 bcm/year. After construction of gas-main Jurbarkas - Klaipėda – 6 mln. m3/day, 2 bcm/year, insufficient amounts for 100 percent coverage of the Lithuanian needs. • Technical and commercial restrictions: strict LNG supply conditions, also technological regasification minimum of 1.5 mln. m3/day does not allow rapid response to changes in demand. • There are restrictions on trade of LNG minimum long-term LNG supply contract is 0.6 bcm/year, purchasing a lower amount would increase price per m3. • Limited opportunities for gas storage in the LNG terrminal due to the constant evaporation. During a year of absence of operations LNG evaporation would reach 100,000 m3 LNG amounting to 60–70 mln. LTL. • Lithuania does not have gas balancing possibilities, a solution would be to develop an underground natural gas storage facility.

Opportunities • In the instance of oversupply in the world markets there are opportunities to benefit from low-cost shortterm gas contracts. • The availability of gas contracts with prices not linked to oil indexes. • Availability to create a natural gas exchange. • Opportunities to supply LNG to LV and EE markets. • Global LNG and NG market trends, emerging from a separate gas oil market (NBP, TTF, Henry Hub) create opportunities for LNG market prices to have imapct on lower NG price compared to the NG price supplied by OAO Gazprom in Lithuania. • Utilize the regional NG storage in Inčiukalns (LV) and solving of supply and demand schedules discrepancies due to seasonality and using the opportunity to obtain more LNG for better prices in summer, i.e., balancing the supply of NG. • Opportunity of development of the regional LT-LVEE LNG terminal in the ice-free port of Klaipėda. • Development of the LNG bunkering/gas-station network, as LNG is attributed to clean fuels.

Threats • In order to establish a long-term supply contract it is required to plan and coordinate contracts for the LNG tankers ~ 2 years before delivery commences. • The gas transfer system is currently controlled by market monopolist, the risk of technical restrictions for trading exists. • OAO Gazprom has nearly unlimited financial and technological possibilities to offer better supply conditions and prices for competition with the LNG terminal. • OAO Gazprom is a single external supplier dominant in NG markets in Lithuania, Latvia and Estonia. • Weak gas pipeline system in Latvia. • It is necessary to modernize Inčukalns underground gas storage facility for it to be able in spring to supply gas to Lithuania.

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