Cyprus Oil and Gas Update

Anyone familiar with the oil and gas sector can see that this is a highly simplistic scenario:

​

1. Any recovery will be based on the ability of downstream operators to use the gas, either for electricity production (which could theoretically be partially exported via the InterConnector, only if additional power generation capacity were built), or for exports using an LNG plant, or exports via pipeline to Israel, Egypt or Turkey. Absent a downstream strategy, production cannot take place.
    

2. Production in Cyprus on a major scale cannot start before 2017, taking into account the time necessary to build either an LNG plant or an export pipeline network (or some combination of the two), together with offshore production rigs and supporting infrastructure. By 2020, natural gas prices are forecast to fall still further as massive offshore gas projects come onstream in Australia and other countries. Australia, for instance, has seven massive LNG projects worth over $ 200 billion under development. Pricing is highly volatile, albeit in both directions.

 

Geopolitical Update

​

The geopolitical landscape has changed entirely since the first Cyprus Oil & Gas article in May 2012:

​

1. In March-April 2013, Cyprus accepted a Eurozone / IMF / ECB bailout (covered extensively on this website) which led to the crippling of the country’s banking sector and significantly weakened Cyprus’ ability to negotiate and operate as a sovereign state. Strict Troika oversight on public spending means that the government’s negotiating position in critical areas is weakened. Key issues, such as the Cyprus LNG plant construction, will be determined not only by the low production estimates and the long drilling programme, but also by the lack of national financial capacity.
    

2. In late 2013 the Yanukovich government in Kiev was overthrown, and in 2014 Russia seized Crimea and supported a low-intensity separatist movement in two other Ukrainian oblasts, Luhansk and Donetsk. This has created hostility between Ukraine, NATO and the European Union on the one side, and Russia on the other, leading to a round of embargoes and sanctions by both sides. As a result, Russia is channelling increasing quantities of natural gas to China via overland pipeline, while Russian sales of gas to Europe have been disrupted by deliberate means by both sides of this conflict. It is expected that natural gas supplies and prices in Europe will remain volatile. In this environment, the attractiveness of Cyprus and Israel as “stable” European suppliers will be increased.
    

3. Turkey continues to claim Cypriot sovereign areas, and has sponsored an exploration programme of its own which conflicts with accepted international law. The election of Tayip Erdogan as Turkey’s first directly-elected President with 52% of the overall vote has consolidated his position. Together with continuing instability in Syria and Iraq, it is expected that this will consolidate his position, leading to continued interference by Turkey in Cyprus’ sovereign affairs.
    

4. The European economic recovery remains weak. The 2009 economic crisis has seen the continued rationalisation of European industry, with energy-intensive factories continuing to merge, close or move offshore. Sectors such as building industry, steel, aluminium and other metal-processing industries have seen factory closures and layoffs. It is unlikely whether such losses can be reversed in the near future. This in turn has led to declining energy demand and prices (at least in the short term). The situation has also been complicated by strong performance from renewable energy, where the EU has set a target of having 27% of total energy consumption from renewables by 2030. Some countries, such as Germany, have already reached this target on certain days.
    

5. In a positive note for Cyprus, progress has been made with the Sisi Government of Egypt in settling the maritime border between the two countries. The final maritime border was agreed by President Sisi in September 2014. This clears the way for Cyprus to consolidate its Exclusive Economic Zone (EEZ), and removes another obstacle in the way of hydrocarbon development.
    

6. Within Cyprus, the former President, Dimitris Christofias, was voted out of power in February 2013, and was replaced by President Nikos Anastasiades, of the centre-right DISY party. The current government faces significant problems managing its coalition in the face of drastic legal and fiscal reforms demanded by the Troika of creditors, and faces significant difficulties in handling key issues. One of these issues is energy policy.

 

Conclusions

​

Cyprus’ effort to develop its oil and gas reserves has met with significant headwinds thanks to technical issues, internal weaknesses and geopolitical risks.

​

On the technical side, the relatively slow rate of exploratory drilling by oil majors reflects uncertainty in natural gas development in the eastern Mediterranean and the global energy market. The rise of US shale gas and the impending commissioning of massive natural gas projects in Australia leads many observers to forecast declining natural gas prices. Given the risks in the eastern Mediterranean area, most majors have focussed drilling resources in other regions.

​

On the policy side, Cyprus has made a consistent, long-term effort to develop oil and gas resources, centred around attracting exploratory drilling, and positioning an onshore LNG plant as the focus of commercialisation strategy. The relatively low resource estimates from Block 12, together with the slow rate of drilling by other groups, means that decisions on this objective will be delayed for at least another 12 months. Cyprus’ domestic political scene has seen considerable turbulence in technocratic appointments and public sector coordination. Its bail-out programme and the destruction of the offshore banking sector have significantly increased country risks for future development.

​

On the geopolitical side, the main short-term risks will be the progress of economic and political relationships between the European Union and Russia following the Crimea/Ukraine conflict. The latest sanctions round by the EU will exacerbate tensions in the energy sector, and may lead to lasting damage in terms of Russia’s energy and financial engagement in Cyprus. This may also lead to renewed impetus in developing Cyprus’ oil and gas reserves as an alternative means of supply to Russia. This scenario, however, will require a considerable up-front investment, while the overall size of Cypriot resources is, to date, nowhere near the amount necessary to offset Russia as an energy supplier.

​

Philip Ammerman

© All rights reserved