Institutional Investor 2013-6-7 MITCHELL BELFER WAS ATTENDING AN energy conference at the University of Nicosia last November when he was struck by the way Cypriots talked about the country’s offshore gas field. Cyprus’s debt problems had yet to seize the attention of European officials and global markets, but local energy experts and academics were already attributing almost mythical powers of salvation to the field, dubbed Aphrodite after the Greek goddess of beauty.
“They knew the crisis was coming, and they assumed they could export their way out of it by exporting gas,” says Belfer, head of the international relations department at Metropolitan University Prague, who was in the capital, Nicosia, on an academic exchange. “They talked about how ‘our gas’ was not to be shared, not with Northern Cyprus or the European Union, and that export sales would come streaming in before the collapse. I wasn’t prepared for that kind of hubris.”
Cypriot self-intoxication had been mounting for years, along with the country’s global profile and living standards. In 2001 it was designated an advanced economy by the International Monetary Fund. Later, the government rebuffed attempts by the United Nations and the European Union to reunify the island in 2004, allowing Cyprus — the ethnic Greek country that occupies the southern two thirds of the island — to join the EU that year and leaving out the breakaway Turkish republic in the north. Nicosia fostered the country’s growth as an offshore financial center, transforming Cyprus from a sleepy Mediterranean enclave into a banking haven for Russian oligarchs. It forged a strategic alliance with Israel and outmaneuvered Turkey to negotiate an Exclusive Economic Zone (EEZ) with other countries, including Lebanon and Egypt, guaranteeing it a generous share of the Eastern Mediterranean’s gas riches. Cyprus joined the euro zone in 2008.
Over the past few months, however, Nicosia has been devastated by the downfall of its economy and wrong-footed by geopolitical turns. A sharp decline in local property prices and steep losses on holdings of Greek government bonds left Cyprus’s banks on the verge of collapse earlier this year, with the government incapable of rescuing them. Desperate to avoid the draconian terms of an EU bailout deal, Nicosia appealed to Moscow for assistance, offering a share of Cyprus’s energy resources in compensation, only to be turned down. The government was forced to turn to the EU and the IMF for a €10 billion ($13 billion) bailout in late March.
Under the terms of its bailout, Cyprus faces years of austerity and a dramatic shrinking of its banking sector, including the winding down of Laiki Bank, the country’s second-largest lender. It’s not surprising that Cypriots are looking to offshore gas to provide a lifeline.
Aphrodite is believed to contain as much as 8 trillion cubic feet of gas, enough to support the country’s 850,000 inhabitants for a century or generate up to $80 billion in export earnings, based on current prices. Cyprus will have difficulty exploiting the field, though. Officials exclude the idea of a pipeline to Turkey because of icy relations between the two governments. Nicosia wants instead to build a liquefaction plant to export its gas by ship, but such a plant could cost half of the country’s gross domestic product to build and would be expensive to operate.
Other developments also threaten Cyprus’s ability to exploit its energy resources. Just as Cyprus was finalizing its bailout deal, Israel and Turkey declared that they had agreed to settle a four-year-old diplomatic feud; that rapprochement revived talk of a natural-gas pipeline between the two countries that could effectively undercut the value of Cypriot gas. Meanwhile, Egypt’s new Islamist government has called for an extension of its EEZ borders at Cyprus’s expense.
Cyprus also confronts a threat from the shale-gas revolution in the U.S. and elsewhere, which some energy experts think will usher in a new era of cheap fuel. Aphrodite, which officials believed would save Cyprus, now seems to offer at best a distant hope.
“Hydrocarbons are not an immediate out for Cyprus,” says Laura Le Cornu, a partner at Strata Insight, a Nicosia-based oil and gas consulting firm. “The Russians did not give them an out, the EU would not consider Aphrodite as collateral, and there are high expectations now for a pipeline between Israel and Turkey. Whatever obstacles Cyprus faced before are even more prominent now.”
The country’s plight is at least as daunting as that of any of the other recipients of EU-IMF bailouts. The EU specifically aims to prune Cyprus’s financial sector, which had swollen to eight times the size of the country’s GDP, making it too big to save. The sector has already shrunk by a third, and it will diminish further as officials wind down Laiki and impose stiff haircuts on uninsured depositors. The government is raising taxes and shedding employees in a bid to help bring down the debt. Economic output is forecast to contract by 12.5 percent over the next two years — and that’s if the bailout is successful. In April, Nicosia announced it would sell $400 million in gold from its reserves to help repay creditors.
The aftershocks of the EU plan have been so traumatic that residents are comparing their reduced conditions to the deprivations that followed Turkey’s invasion of Cyprus and the island’s subsequent division 40 years ago. “The war did to Cyprus physically what the bailout will do financially,” says Le Cornu.
Considering those circumstances, it’s not surprising that Cypriots have focused on Aphrodite’s potential. Developing the gas field could give their country a lifeline. The EU should have an equal interest in seeing the gas field brought on stream given that its member states are eager to reduce their dependence on Russian natural gas. Cyprus, which many residents like to refer to as “the eastern frontier of Western civilization,” could be a politically stable source of energy. Nicosia has already issued drilling licenses to two major European energy companies: Italy’s Eni and France’s Total. Cyprus hopes to be pumping gas for customers at home and abroad by the end of the decade.
By opting to develop Aphrodite unilaterally, however, the country has denied itself the cheapest and most efficient way of tapping export markets. The best chance of maximizing Aphrodite’s resources, analysts and academics say, is for the island’s Greek and Turkish sides to unite, economically and politically, and share in the spoils. But such a scenario seems far-fetched.
“This should be a win-win situation,” says Hubert Faustmann, an associate professor of history and political science at the University of Nicosia. “The best option is to solve the Cypriot dispute and build a pipeline through Turkey. Instead, Nicosia is going ahead with a plan to distribute liquefied gas. If fuel prices end up going down, what will the Cypriots do?”
MODERN CYPRUS WAS BORN IN 1974, when, after years of rising ethnic tensions between Cyprus’s Greek and Turkish communities, Cypriots working with the support of Athens staged a military coup that they hoped would lead to a union with Greece. In response, Turkish forces invaded the north of the island and established the Turkish Republic of Northern Cyprus. Since then the island’s majority Greek and ethnic Turkish populations have lived in separate realms. The prosperous, Greek-dominated Republic of Cyprus, which accounts for a majority of the island’s residents, commands de jure sovereignty over the island and its coastal waters, while the isolated and impoverished Turkish Republic of Northern Cyprus is recognized only by Ankara.
When Aphrodite was discovered nearly three years ago, Cyprus set about developing the field with little regard for its northern neighbor. This provoked Turkey’s government, which has never recognized the Republic of Cyprus or its maritime borders. Ankara has declared it would respond forcefully to continued energy exploration unless the “inherent and equal rights” of the Turkish Cypriots to hydrocarbon finds are respected. It has proposed that the two sides either suspend development of Aphrodite pending a resolution to the island’s long-standing political divide or jointly develop and manage its resources under U.N. supervision. It has also proposed that Cyprus export its gas to Europe via undersea pipeline to one of Turkey’s main ports. Nicosia has rejected both offers.
Cyprus strengthened its ties with Israel just as relations between Ankara and the Jewish state cratered in May 2010, when Israeli commandos killed nine activists aboard the Mavi Marmara, a Turkish-flagged relief ship bound for Gaza. Earlier this year Ankara warned it would act against any moves by Cyprus to develop Aphrodite unilaterally, particularly if it did so with help from Russia, Turkey’s historical rival.
Another risk factor is the vague definition of some of the EEZs, which give states special rights of exploration under United Nations maritime law. Portions of the Egyptian and Israeli zones overlap, for example. In March an Egyptian parliamentarian declared that Aphrodite lies within Cairo’s zone; Parliament is now considering a draft law that would redraw the country’s maritime maps accordingly. “If the proposed law passes, tensions in the Eastern Mediterranean arising from this newfound natural resource could further escalate,” warned the Signet Institute, a Cairo-based think tank, in a March bulletin.
Analysts generally discount the risk of a military clash over Aphrodite. By awarding drilling licenses this year to Eni and Total, while retaining Texas-based Noble Energy to explore its reserves, Cyprus shrewdly aligned its interests with those of companies from three member countries of NATO, to which Turkey also belongs. Having ruled out a pipeline to Turkey, however, Nicosia is developing a risky and expensive alternative: a liquefied-natural-gas, or LNG, terminal to process fuel for transport by ship. Such facilities can cost more than $10 billion and take a decade to build. They are also expensive to operate given the amount of energy they consume. Banks are reluctant to finance them without 20-year forward contracts from buyers.
According to estimates by the Peace Research Institute Oslo, the gas in Aphrodite’s block 12, where Noble Energy made its initial strike, would be worth about $50 billion after investment costs if it was liquefied. The institute estimates that the same gas would be worth $69 billion if it was pumped through a pipeline to the port of Ceyhan on Turkey’s southern coast, a regional hub for oil and gas. “An LNG terminal is a massive financial undertaking,” says Laura El-Katiri, a research fellow at the Oxford Institute for Energy Studies. “The economy will benefit in that a lot of money will pour into Cyprus and that will generate some jobs, but it certainly won’t solve the country’s problems immediately. Given that quite massive costs will need to be recovered initially, Cypriot LNG may not show profits until after 2020.”
A Cypriot-Turkish pipeline would suit the Europeans better. EU countries, having experienced periodic cutoffs of Russian gas supplies from 2005 to 2009 because of feuding between Russia and Ukraine, have identified Turkey as a vital transit point for fuel. Nicosia, however, insists that a Turkish option is out of the question for both security and diplomatic reasons. Officials cite the occasional times Ankara has shut off gas shipments to Greece as proof that Turkey cannot be relied upon. In addition, says former Cypriot Foreign minister Erato Kozakou-Marcoullis, Cyprus should not reward a country that does not recognize its legitimacy as a sovereign state.
“I’ve said many times that a pipeline could provide the basis for goodwill and negotiations and that it would make a good means of distribution,” says Marcoullis. “But that’s provided the Cyprus issue is resolved.”
Marcoullis says Nicosia will leverage its investment in an LNG terminal by promoting itself as a regional liquefaction hub for neighboring Israel and perhaps Egypt and Lebanon. “We envision maximizing profits through cooperation among these countries in the export of natural gas and oil,” she says. “The Europeans are very interested in this approach, but we also plan to export to Asia.”
The odds against Cyprus’s succeeding at that approach are steep. There is no LNG terminal in the world that processes gas from multiple countries, experts point out. Israel is unlikely to be the first country to entrust a foreign partner with its feedstock. Nor is it clear that Israel, with proven gas reserves of some 34 trillion cubic feet from its Leviathan and Tamar fields, will choose to export at all. Despite the allure of foreign sales, the Jewish state is constrained by the need to ration its reserves against the prospect of a national emergency. Should Israel export its gas, it is likely to avoid long-term contracts that would deplete its resources faster than spot trades or short-term sales agreements, analysts say.
Either way, Israel has the luxury of time to decide which course to choose. “Israel is nowhere near making a decision this year,” says Oxford’s El-Katiri. “And when it does, it will likely take a different approach than Cyprus. In the end, everyone’s on their own.”
Even Noble Energy, which discovered Aphrodite, appears to be wavering in its commitment to Cyprus. After drilling an exploratory well in September 2011, the company declared that a second test well, to firmly establish the scope and quality of the gas, would be drilled in December 2012. When that date passed, Noble Energy said it would finish the job beginning in April. In February the company conceded it would miss that date as well, citing equipment problems. In an April interview with the Cyprus Mail, Noble CEO Charles Davidson said the second test well would “most likely” be drilled in June. Such delays have prompted speculation about the true size of Aphrodite, and about Noble Energy’s desire to develop it. (Phone messages and e-mailed requests for comment by Noble Energy, both to Nicosia and to the company’s Houston headquarters, were not returned.) There are rumors that Noble Energy — which in 1998 discovered Israel’s Leviathan field and which has equity stakes in Israel’s reserves — is stalling for time to find a buyer for its 70 percent share of the drilling rights to Aphrodite. At the moment, energy analysts say, Noble Energy executives are working overtime to persuade the Israelis to green-light gas exports.
“Right now Cyprus’s main assets are controlled by a company that is not prioritizing them, and that is creating some commercial drag,” says Benjamin Gage, an analyst at PFC Energy, a Washington-based energy consulting firm. “If the Cypriot government finds more reserves, maybe it can tempt Noble back to Aphrodite.”
The potential is there. According to the U.S. Geological Survey, the Eastern Mediterranean is estimated to hold 122 trillion cubic feet of undiscovered and technically recoverable natural gas and 1.7 billion barrels of oil. Eni and Total beat out a pack of other bidders eager for licenses to prospect in Cypriot waters. Should they discover a field that is close in size to Aphrodite, the additional capacity would justify the expense of liquefaction.
“Eni and Total came in on the assumption that there will be additional resources,” says Michael Leigh, a senior adviser to the German Marshall Fund of the United States, a nonprofit organization devoted to transatlantic issues. “If Nicosia makes the right decisions, it can be exporting gas by 2019 and generating the kind of high-tech upstream and downstream industries that can promote Cypriot independence from the financial sector.”
But global energy markets may not be willing to wait that long. In February, for example, Israeli media reported that Turkish conglomerate Zorlu Holding, in league with Western multinationals, was lobbying Israel for access to its gas reserves via a pipeline that by some estimates would cost about $2 billion and take about three years to build. Despite strained ties between the two countries, according to Israeli daily Haaretz, Israel was considering Turkey’s appeal “because other options have become less attractive as well, with Greece’s economic crisis worsening and the cost and engineering challenges of LNG proving difficult.”
The Haaretz report appeared several weeks before Turkey — with U.S. President Barack Obama as mediator — accepted an apology from Israeli Prime Minister Benjamin Netanyahu for the Mavi Marmara incident. Since then the Turkish press has been heralding a rapprochement between the two countries, with a Turkey-Israel gas pipeline as its centerpiece. As Taner Yildiz, Turkey’s minister of Energy and Natural Resources, told reporters at an energy conference in April, “The reason for Israel’s apology was not energy projects, but the consequence could be energy projects.”
Such an outlook may be premature. As the German Marshall Fund’s Leigh points out, Netanyahu’s apology was “an important step, but only the first step” in what could be a fitful process of settling such matters as compensation for the families of those killed in the Mavi Marmara incident. Just days before he accepted Netanyahu’s gesture, Turkish Prime Minister Recep Tayyip Erdog˘ an publicly compared Zionism to a “crime against humanity” — hardly the language of reconciliation, notes Leigh. “What has happened so far is too preliminary to change the geopolitical calculus of the Middle East,” he says. “The relationship between Israel and Cyprus will continue. The apology has not changed it.”
Nevertheless, beyond Erdog˘an’s rhetoric lies a thicket of shared interests between Turkey and Israel and the unimpeachable logic of a shared pipeline. In a bid to reduce its dependence on rivals Russia and Iran for imported fuel — Ankara imports some $60 billion of foreign energy supplies each year — Erdog˘an has appealed to Iraq’s northern Kurdish population, which has claims on enormous gas and oil reserves. (Iraqi Kurdistan is also thought to host Israeli army officers who train and advise the Kurds’ Peshmerga militias.)
Cutting an energy deal with Iraq’s semiautonomous Kurdish region would antagonize both Iraq’s Shiite government, which regards any hydrocarbon resources within Iraq’s borders as its own, and Iran, which has developed a politically powerful and commercially lucrative relationship with its Arab neighbor. Anything that pains Tehran — and Iran’s besieged ally, Syria — is welcomed by Israel. Facing a common set of adversaries, Israel and Turkey have strategic as well as economic incentives to turn to each other, at least for the sake of energy security, some analysts say.
“Turkish-Israeli discord is largely for show,” says Metropolitan University Prague’s Belfer. “Erdog˘an has had to burnish his anti-Zionist credibility with moderate Sunni rebels in Syria he wants to guide to power there once the civil war ends. All things being equal, it’s in Israel’s best interest to have a relationship with Turkey rather than Cyprus and the EU.”
Just as Cypriot officials invested an evangelical faith in Aphrodite’s capacity to help their country ride out the debt crisis, so too did they dismiss warnings that a warming of Turkish-Israeli relations would pose a major setback to its energy ambitions. As Strata Insight’s Le Cornu puts it: “If the Israelis decide to cooperate with Turkey over Leviathan, the momentum may prove too difficult for the Greek Cypriots to resist. A Turkish-Israeli pipeline could then become the principal channel for gas exports for the Eastern Med.”
As if there aren’t enough challenges to the viability of Cypriot gas exports, Cyprus also has to reckon with the looming American shale gale, as some are calling the rise in U.S. gas production. According to the U.S. Energy Information Administration, annual production of natural gas grew by nearly 19 percent between 2007 and 2011. Output is expected to rise a further 50 percent by 2040. Economists estimate that hydraulic fracturing, or fracking, a controversial but productive way to release new supplies of oil and gas from shale rock formations, could allow the U.S. to become a net gas exporter by 2020. A government study released in December concluded that gas exports would be a “net economic benefit” to the country. Plans for new LNG terminals that can process fuel for export as well as domestic use are well under way.
What’s good news for America and other presumptive shale-gas giants, energy analysts say, could be ominous for Cyprus. “With the LNG option, as opposed to a pipeline to Turkey, Cyprus risks entering a more competitive market in the future due to the long lead time to complete such a facility,” says Le Cornu. “There have been significant gas discoveries in Mozambique, Iraq may emerge as a major supplier, and there is also the potential downward impact on prices from shale gas.”
Price negotiations between energy distributors and suppliers are already factoring in expectations of a shale-gas boom. Crucially, the industry’s tradition of indexing long-term prices to petroleum rather than the lower LNG spot prices may be changing. According to a study released in March by Peace Research Institute Oslo, Korea Gas Corp. late last year reportedly agreed to buy fuel from a U.S. company at a price based on bids for LNG. The report also cites a July 2012 contract signed by a German energy company and Russian gas giant Gazprom “in which the lower price of LNG spot prices appears to have played a part.” If such a trend continues, cautions Global LNG Monitor, an industry newsletter, some of the more costly LNG projects will not be built.
Similarly, gas deposits that are expensive to develop, such as those deep underwater, may become unattractive to suppliers, industry experts say. According to the PRIO study: “More difficult areas tend to be exploited when prices are high. Thus, if global gas prices come down and this affects the current and future profits of oil and gas companies, there could be less interest in conducting further exploration in the more expensive deep-water areas such as the Eastern Mediterranean.”
SINCE TURKEY’S INVASION OF Cyprus 40 years ago, delegations from both sides of the divide have met more than 50 times to resolve the island’s partition, to no avail. The most recent and promising effort was led by former U.N. secretary general Kofi Annan in the run-up to Cyprus’s entry into the EU. A referendum on a draft agreement held in April 2004 was passed by Turkish Cypriots but turned down by the Greek side. Many officials in Ankara, Turkish Cyprus, New York and Brussels still blame Greek Cypriot leaders for not doing enough to sell the plan to their constituents.
The Turkish minister for EU affairs, calling for a revival of talks to resolve the Cyprus question, pointedly noted in February that “if three out of four Greek Cypriots had not rejected the [U.N.] plan, today the Greek Cypriots wouldn’t have been on the verge of bankruptcy and the EU wouldn’t have had an energy crisis.”
For years Cypriot elites on both sides of the island’s divide have yearned for a foreign intervention — by the U.S., the Russians or the Europeans — to impose a settlement. Ironically, the crippling demands contained in Cyprus’s rescue plan may represent the closest thing to a deus ex machina.
“We hear more talk, positive signals from France and Germany, about how it makes much more sense to transport gas through Turkey,” says Özdil Nami, a Turkish Cypriot and a participant in several negotiating rounds with Nicosia. “The troika can make it clear that a Cyprus-Turkish pipeline can become a catalyst for reconciliation. Besides, the Europeans want cheap gas, and they won’t get it if it comes liquefied.”