What are the best options for Cypriot and East Med gas exports?

By Adam Lomas, Castor & Partners

The discovery of gas and the potential for more discoveries in the eastern Mediterranean bring with them the hope for regional stability and the development of a hydrocarbon infrastructure based in Cyprus which will long outlive the potential benefits of just the Aphrodite field.
However, in order to realise this there is a need for realism and very good strategic planning, and to date this has not been visible.
The recent economic pressures experienced by Cyprus make the delivery of the Cypriot gas even more important, but the economic crisis has also brought with it the difficulties which are likely to be encountered in financing a highly complex and capital intensive project.
But let us be quite clear: on their own, the reserves in the East Mediterranean are not huge. Current estimates of global gas reserves are some 6,600 trln cubic feet, of which Russia accounts for some 1,200 tcf, Qatar 880 and Turkmenistan 620.
A recent report by the U.S. geological survey estimates the reserves in the area at 120 tcf. These are not yet reserves, because they haven’t been “discovered” or proven. Cyprus’ actual reserves are zero, despite the recent drilling of an appraisal well in the Aphrodite field, although estimates place the probable reserves at 5 to 8 tcf.
Close by, Israel has some 26 tcf, including 17 tcf in Levathian which is some 36 miles from Aphrodite. Cyprus on its own may not warrant the building of a massive infrastructure, but the region together can well have the potential for the building and maintaining of an infrastructure together which could outlive the production of any of the hydrocarbons discovered so far.

THE NORTH SEA SUCCESS
In this context I would like to draw attention to the position of Cyprus, placed as it is between the gas producing nations to its south and an energy hungry Europe to the north, as well as to draw a parallel with the North Sea. The governments involved had the strategic foresight to build an energy backbone in the North Sea, which long after the major fields have been produced is still providing revenue to the UK Treasury, through transit tariffs. There are very large amounts of “stranded” gas in Iraq, which were previously planned for evacuation through a war-torn Syria, which could be economically exported through a pipeline to the North. But perhaps I am raising hope and expectation too high to suggest that the countries in the region could be persuaded to discuss the possibilities of the economic benefits which could be achieved if ancient rivalries were put aside.
Let’s look at the steps necessary to monetise the Cyprus gas. Currently the plans for the gas which has been discovered in the Cyprus EEZ are for a single train LNG plant. The economics for such a plant are complex and require looking at a number of variables. In general, there are two ways of selling LNG, one is on fixed-term contracts (which in 2012 accounted for 65% of the world market) and the other is a spot market which is still (relatively) small but has been growing in recent years from 10% in 2000 to some 30% in 2012.
Spot price markets have the potential for higher prices in an upswing market, but the risk of lower returns in a downturn. The majority of spot price gas is sold to Far Eastern markets (mainly Japan and Korea), and the spot price until recently has been high due to a number of factors, including the recent nuclear disaster in Japan. This situation is unlikely to persist, and the likelihood is that the price of gas will drop in the foreseeable future due to the emergence of shale gas as an economic source in the United States which wants to become an exporter in the near future, reducing imports and the coming on line of significant reserves under construction in the Middle East and Australia, both of which are closer to the Far Eastern markets. This does not preclude the possibility that Cyprus gas has economic potential, but a number of factors will need to be carefully managed to ensure that any LNG project is economically viable.
The most important variables in any LNG project are:
– The capital cost of the building,
– The cost of the feed gas,
– The plant utilisation or “uptime”,
– The timeline for project delivery,
– And the fiscal regime.
Although very little has so far been published about the plans for the LNG plant, we are given to understand that Noble is working in close collaboration with the government to produce a strategic plan – which in any case is a pre-requisite for the economic aid which is being provided by the international lenders.

COST OF LNG PLANT
Current estimates have placed the cost of the LNG plant (single train) at 5-6 bln US$. This is in the low range of projects which have been completed anywhere in the world and the current market for capital construction projects is overheated. It is unlikely that any long term contracts would be easily negotiated on the basis of a single train, given the need for maintenance and the possibility of mechanical breakdown. A second train would increase cost and any delay in the project would increase costs further. The break-even sales cost of the gas could quite quickly be overtaken by the cost of an LNG project which was not executed with extreme precision.
The cost of the feed gas will be determined by the cost of development of the Aphrodite field, which have so far not been disclosed publicly by the operator, estimated from 2.0 $ per MMbtu to 4.0 $, but the cost of similar offshore development projects elsewhere has been as high as 6 $ per MMbtu, depending on water depth and geological complexity.
The uptime of the plant is extremely important, and will be dependent on the skill of those operating the plant, whilst the skill of the Cypriot workforce is not in question. The experienced skill base required to run a complex LNG plant is not yet apparent in the country and there is so far little evidence of a structured plan to build that skill base, both of which would be required by an operator wishing to take the risk of building an LNG plant in Vassilikos. The alternative will be that the workforce will be mainly expatriate (which may well be the only alternative in the early stages) which will have knock-on effects on Cypriot employment.
Any project delay will have a significant downside on the economics of the project, and any investor willing to take the large risks involved in delivering a successful LNG project will look to a government and/or National Oil Company for quick decision making, clarity on the legal infrastructure and fiscal regime. The current situation with ongoing re-structuring of the key departments involved in energy distribution in Cyprus and the National Oil Company will not be seen as evidence of the speed required.