REFINERY'S PROBLEMS UNLIKELY TO CAUSE ECONOMIC

C O N F I D E N T I A L SECTION 01 OF 02 VILNIUS 000711

SIPDIS

SIPDIS

STATE FOR EUR/NB, EUR/NCE, EB/ESC
DOE FOR HARBERT
DOC FOR 4231/IEP/EUR/BOHIGIAN
NSC FOR GRAHAM, MCKIBBEN AND COEN
TREASURY FOR LOWERY, LEE AND COX

E.O. 12958: DECL: 07/31/2016
TAGS: ENRG ECON PREL LH RU
SUBJECT: REFINERY'S PROBLEMS UNLIKELY TO CAUSE ECONOMIC
CRISIS IN LITHUANIA

REF: A. VILNIUS 645 AND PREVIOUS


B. WARSAW 1336

Classified By: Classified by Economic Officer Scott Woodard for reasons
1.4 b and d


1. (C) SUMMARY: The problems Lithuania's Mazeikiu Nafta oil
refinery (MN) is facing in obtaining crude supplies are
unlikely to cause a major economic crisis here, according to
several public and private sector officials and analysts.
Although the refinery is Lithuania's largest economic entity
and accounts for more than a quarter of Lithuania's exports,
these officials and analysts told us that the macroeconomic
consequences of even a total supply cut off to MN would be
ameliorated by Lithuania's low unemployment, taxes that the
GOL would continue to collect on imported gasoline, and
continued strong, consumption-driven GDP growth. Our
interlocutors emphasized that politicians and other
non-economists tend to overemphasize MN's importance to
Lithuania's economy. Lithuania's political class, however,
sees the country's dependence on Russian energy as a major
vulnerability, and not just as an economic issue. END
SUMMARY.

-------------- --------------
LOOKING AT A WORST-CASE SCENARIO: MAYBE NOT SO BAD
-------------- --------------


2. (C) We recently spoke individually with several private
and public officials to discuss the possible macroeconomic
consequences of a total supply cutoff to MN (reftels). These
officials included the director of the central bank's
Economics Department, the chairman of MN's Board of Directors
and former vice-minister in the Ministry of Economy, an
advisor to the prime minister on energy matters, and senior
analysts/advisors at two of Lithuania's top banks. All gave
surprisingly congruous conclusions about the macroeconomic
effects of a supply cutoff to MN: this scenario would not
cause a crisis for the Lithuanian economy.

--------------
HOW BIG IS MN, REALLY?
--------------


3. (C) Raimundas Kuodis, Director of the Economics Department
in Lithuania's central bank, told us on July 28 that
politicians and other non-economists tend to exaggerate MN's
importance to Lithuania's economy because they rely on a
production- or "turnover"-based calculation to estimate MN's
contribution to GDP. This kind of calculation, he said,
concludes that MN is responsible for about five percent of
Lithuania's GDP. He told us that a value-added approach, on
the other hand, leads to the conclusion that MN creates only
about one or two percent of Lithuania's GDP. The two bank
analysts told us that they estimated that MN contributed
three percentage points to Lithuania's GDP.

--------------
MN AS A TAX ISSUE
--------------


4. (C) All of our interlocutors emphasized that the GOL would
not suffer a major loss of tax revenue in the event that MN
faced a supply cutoff. They noted that Lithuania would still
consume imported gasoline, which would continue to generate
excise tax revenue for the GOL. Kuodis noted that many
Lithuanians believe MN pays far more taxes than it actually
does, because they do not realize that Lithuania's tax laws
require MN to collect excise taxes directly from the gas
stations it supplies. The end result is that while it
appears that MN pays a large amount of taxes, in truth it
merely collects revenues for and turns revenues over to the
GOL. If MN were unable to supply Lithuania's gas stations,
he said, the GOL would simply collect the excise tax on
gasoline at a different point in the supply/delivery chain.

--------------
EMPLOYMENT EFFECTS
--------------


5. (C) Mazeikiu Nafta directly employs more than 3200 people,
making it the largest private employer in Lithuania. A

VILNIUS 00000711 002 OF 002


supply cutoff could potentially throw many of these
individuals out of work. Again, however, our interlocutors
were unconvinced that this would cause a major crisis for the
Lithuanian economy. They noted that Lithuania's low (and
rapidly dropping) unemployment rate (6.4 percent in Q1, down
3.8 percentage points from Q1 2005) has created a labor
shortage and argued that MN's highly skilled labor force
would have little problem finding new work (in Lithuania or
elsewhere in the EU). Any measurable impact would be
temporary, and limited to the geographic area around Mazeikai.

--------------
INFLATION
--------------


6. (C) There was some difference of opinion about the impact
this scenario would have on inflation in general and on
gasoline prices in Lithuania, specifically. Kuodis, noting
that MN supplies gasoline to the Lithuanian market at import
parity prices, said that he would not expect the price of
gasoline to increase much if Lithuania's gas stations started
relying on imported gasoline. The market, he said, is very
competitive. One of the bank analysts, however, said that he
would expect gasoline prices to rise as much as 20 percent if
Lithuania needed to import all of its gasoline. An increase
of this magnitude would have multiplier effects throughout
the economy, raising production costs and further
complicating Lithuanian efforts to qualify for inclusion in
the eurozone under the Maastricht criteria. Our
interlocutors all agreed, however, that upward pressure on
prices is increasing across the whole of the economy for many
reasons, and that an increase in gasoline prices would be
only one factor among many contributing to increasing
inflation.

--------------
EXTERNAL SECTOR EFFECTS
--------------


7. (C) The loss of output from Lithuania's largest exporter
would negatively impact the trade balance and the balance of
payments, but not by as much as one might think, according to
Kuodis. (Refined oil products have been Lithuania's top
export product for several years.) He said that most of the
value in refined oil products like gasoline comes from the
value of the crude itself, and that the refinery only has a
value-added of about 10-15 percent on a product like
gasoline. The increase in gasoline imports, he said, would
therefore be largely, albeit not completely, offset by the
decrease in crude imports -- except for this 10-15 percent,
an amount that he said would not constitute a major crisis
for Lithuania's economy. (A ten percent decrease in the
value of Lithuania's exports of refined oil products would
translate into a loss of about 2.7 percent of total exports,
or about USD 331 million.)

--------------
COMMENT
--------------


8. (C) There is no doubt that a cutoff of Russian crude to
Lithuania would create problems -- both economic and
political -- for the GOL. An end of pipeline-supplied crude
to MN could harm the country's largest private enterprise,
slow growth, exacerbate inflationary pressures, and aggravate
the trade deficit. As long as MN retains the ability to
supply its refinery via its Baltic Sea terminal at Butinge,
however, a Russian supply cut-off would not bring the economy
to its knees.


9. (C) This dispassionate conclusion by some of Lithuania's
leading economists, however, is not shared by Lithuania's
political class, who views the country's dependence on
Russian energy as a security, rather than an economic, issue.
For them, the current supply contretemps evince Lithuania's
vulnerability to a powerful neighbor that unabashedly uses
energy resources as a weapon to further hegemonic political
objectives.
KELLY