Interactive Investor

Can gas reserves rescue Cyprus?

22nd March 2013 12:44

Darshini Shah from interactive investor


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Russia has expressed its disinterest in Cyprus's offshore gas reserves after the Mediterranean country asked for €5 billion (£4.25 billion) in return for bonds in energy and other assets.

According to reports, Cyprus initiated discussions over plans linked to its offshore natural gas assets, requesting either direct aid from Russia in exchange for exclusive natural gas exploration rights or via Russian investments in its energy reserves. The gas assets were discovered at the end of 2011.

Both of these options would have given Russian energy firm Gazprom substantial control over Cyprus's hydrocarbon resources.

Why did Russia say no?

Analysts at Bank of America Merrill Lynch believe Cyprus's objectives for large-scale profits from the production of hydrocarbons are "ambitious and could face significant challenges".

Firstly, they say that there are "considerable" challenges to gas production. The oil and gas reserves in Cyprus form part of the Levant sub-salt basin, which extends to the Exclusive Economic Zones of Israel, Syria, Cyprus and the Gaza Strip.

The total recoverable reserves within the basin are estimated to be 122 trillion cubic feet (tcf), of which Cyprus claims to have 60 tcf. So far, only the Aphrodite gas field (seven tcf) has been discovered in Cyprus.

The analysts observe that not only are the majority of the discoveries within Israel's boundaries, but the East Mediterranean area is one of the least explored in the world, with discoveries around 10,000 to 20,000 feet below sea level classifying them among the very few deepwater gas reserves.

"The first drilling attempts in Israel's fields faced significant technical problems and exploration will likely be risky," the analysts stress, predicting the earliest Cyprus could produce gas is 2019/20.

"This is putting any profits several years into the future."

Secondly, transportation of the gas could be an issue. The region is seismically active, making pipeline solutions difficult to implement.

"Last year, Cyprus tried to move forward a venture to lay a 1,400 kilometre long pipeline from Israel and Cyprus to Europe," note the analysts. "The costs for this project are undisclosed but could be as high as $17 billion [£11 billion].

"The proposed pipeline would take gas from the Levant basin first to Crete and then to the mainland. This is technologically difficult to implement as pipe will have to be laid in extreme depths (~3,000 metres)."

An alternative proposal, they say, is to build a pipeline to Israel and from there to Turkey. But negotiations are likely to be "difficult".

The other option in discussion is to liquefy gas in Cyprus in an onshore liquefied natural gas (LNG) plant. The government recently announced plans to construct such a terminal, a €6-10 billion project, to enable LNG exports on ships from Cypriot and potentially Israeli gas reserves.

Finally, the continued conflict between Cyprus and Turkey is complicating matters further. Turkey claims rights to gas production in Cyprus and has ratified its own licence agreement with the Turkish national oil company over the assets.

In early 2012, Cyprus accepted bids for its second licensing round and recently awarded licences to several oil companies. Turkey, however, warned participating oil and gas companies of repercussions, which discouraged some of the majors, such as BP, Royal Dutch Shell and Exxon Mobil, from applying.

"Turkey has never recognised Cyprus as a country or its maritime borders, and its continued opposition to Cyprus developing these assets could make it difficult for Russia to get involved," the analysts add.

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