Oil and politics, the Lithuania round

WARSAW, Poland — Poland and Lithuania used to be part of the same country, both suffered under Soviet occupation and are both members of the European Union. So they should be close allies. But a misbegotten Polish investment in a Lithuanian refinery — intended to cement that relationship — is driving them apart.

In 2006, PKN Orlen, Poland’s largest state-controlled oil company, spent $2.3 billion to buy the Mazeikiu refinery. The refinery was owned at the time by Yukos, the troubled Russian energy giant.

The Russian government was keen for one of its oil companies to take control of the refinery, which made the Lithuanians wary, and fed Polish ambitions of playing an important political role in the region.

The venture never made all that much commercial sense for the Poles, but then-President Lech Kaczynski, who was killed in an April plane crash, was keen on the deal. Kaczynski was intent on forming close ties with as many ex-Soviet republics as possible as a way of weakening Russia. The refinery would be the largest foreign investment in Lithuania and cement warm relations with the small Baltic state.

But the investment began to go wrong almost from the beginning. As the deal was closing, a fire devastated the refinery. Then the Russian Druzhba pipeline which supplies the refinery conveniently broke down — and has not yet re-opened. The refinery was built to process Russian crude and export it via a port on the Baltic Sea, but its business model was upended and now Mazeikiu has to process crude delivered by sea and rail, then send it back by the same route.

After paying a total of about $3.7 billion to take full control of the refinery and upgrade its technology, Orlen has been left with a facility that steadily loses money and an uncomfortably high level of debt.

To make matters worse, the Poles have run into a roadblock from the Lithuanians, who seem to be backtracking on their earlier eagerness to have a non-Russian investor in the refinery. In order to secure access to the Baltic Sea, Orlen has asked to buy the oil terminal from the Lithuanian government, but it has refused, citing national security concerns. Without that assurance, the Poles will not build a 60-mile pipeline to the sea.

The Lithuanians are also dragging their feet on repairing a 12-mile stretch of railway that allows Orlen to export oil to neighboring Latvia. The Poles wanted the line fixed this year, but the Lithuanians will do it only in 2012, once they get funding from the European Union.

The Lithuanians argue that the tensions over the refinery are not harming relations. In a radio interview, Egidius Meilunas, the former Lithuanian ambassador in Warsaw, said that it is “untrue and unfair” to allege that Lithuania has been creating problems for Orlen. “We are more than paper allies,” he says.

But the Polish view is very different.

“This is how the 'strategic partnership' with Lithuania ends. I hope that few Polish politicians will repeat that phrase,” writes Jaroslaw Gizinski in an editorial in the Polish edition of Newsweek, adding that the refinery investment “has awakened an atavistic nationalism in Lithuanians which has incorporated all their views on Poland.”

Angry Polish officials also point to old irritants like Lithuania's refusal to allow the large Polish minority in their country to write their names using Polish rules of spelling, and the lack of progress in returning property confiscated from Poles under more than four decades of communism.

Historically the main foes of Lithuanian nationalists were Poles, not Russians. Although hundreds of thousands of Lithuanians were murdered when the Soviets invaded their country in 1940, the small country has traditionally felt a threat from Poland.

The two nations were joined into a single confederated state for centuries, before Poland-Lithuania was gobbled up by its neighbors in the late 18th century. Although they were partners in what for a time was Europe's largest country, modern Lithuanians feel that their ruling class lost their language and culture and became Polish. They are also angry over the period between the two world wars, when Vilnius, now their capital, was a Polish city.

The increasing friction over the refinery may well end up driving the Lithuanians back into the arms of the Russians. An exasperated Orlen recently hired Nomura, the investment bank, to look at options regarding Mazeikiu, which range from Orlen staying put, to the company selling a minority of its shares in the refinery, to simply selling the whole thing.

The likeliest buyers in the event of a sale would be one of the big Russian oil majors, and analysts expect that the Druzhba pipeline would very quickly come back on-stream if that were to happen. Sensing Orlen's weakness, the Russians are putting out signals that they are willing to pay as much as $1.5 billion for the refinery, which would leave Orlen facing an embarrassing loss — and ties between Lithuania and Poland in tatters.