08 May 2016 Egypt impact on Cyprus and Israel (Part II) by Charles Ellinas

Last week I analysed the rapid developments in Egypt’s gas projects. Since then the production volumes I presented were reconfirmed at the Offshore Technology Conference in Houston.

In fact, two of the presenters said that gas production in Egypt is expected to increase by more than 90bcm by 2022, with increasing future prospects.

The outcome of these developments is a dramatic reversal of fortunes for Egypt from gas shortages to self-sufficiency and exports. This week I analyse the impact of these developments in Egypt on the hopes of its neighbours Israel and Cyprus, and their plans to export their gas to Egypt.

 

Commercial challenges

European and global spot gas prices are in the range $4-$5 per mmBTU and are expected to stay low beyond the end of this decade. The main reasons for this are:

  • a LNG glut, expected to persist well into the next decade, with more and more already committed LNG plants coming into production
  • massive increases in shale gas production in the US, keeping gas prices in the US around $2 per mmBTU and fuelling LNG exports, adding more to the global glut. Russian piped gas to Europe is down to $4 per mmBTU.

Gas from Israel and Cyprus exported to be liquefied at Egypt’s two idle LNG plants at Idku and Damietta, for export to Europe, cannot compete with these prices.

Noble is selling gas in Israel at over $5 per mmBTU and would expect a similar price for gas at Leviathan or Aphrodite for export to Egypt. By the time the cost of pipelines to take the gas to Egypt, and the costs of liquefaction and then transportation and regasification in Europe are added, the price of gas delivered to Europe will be over $8 per mmBTU, well in excess of European and global gas prices.

European gas demand is well-supplied by piped gas from Russia and Norway at prices other gas suppliers cannot compete with. US LNG is also making inroads in Europe providing additional flexibility and complementing Russian and Norwegian gas rather than competing with them. Gas from Israel or Cyprus cannot compete with these.

Statoil’s CFO confirmed recently that the European natural gas market is well supplied by pipeline gas from Norway and Russia and expects only limited impact from US LNG. If US LNG with a gas cost of $2 per mmBTU cannot compete with Russian or Norwegian gas, how can Israel and Cyprus with a gas cost of $5 per mmBTU expect to do so?

 

Impact on Israel

Not only do the above commercial challenges make Israeli gas exports to Egypt difficult, but also the ongoing regulatory problems and the rift between Egypt and Israel caused by the ICC arbitration decision.

Israel’s High Court ruled on March 27 that the gas regulatory framework deal struck between the government and Noble/Delek is illegal, as its central piece, the stability clause, is unconstitutional. The stability clause was meant to ensure that, over a 10-year period, future governments do not enact regulatory changes in taxation, antitrust limitations and export quotas that undermine this deal.

This problem still remains unresolved, but discussions to resolve it are ongoing. Options include granting guarantees to the gas companies or to the financing banks, changing the stability clause, providing a security net or even enacting new laws. However, progress is slow, without a clear way forward emerging yet.

The ICC arbitration decision adds another degree of complexity. This was made in December last year and it dealt a blow to Israel’s fast-diminishing hopes to export gas to Egypt. ICC awarded $1.76 billion to Israel’s Electric

Corporation against Egypt’s EGAS as compensation for halting gas supplies in 2012. Egypt promptly launched an appeal and stopped all gas import negotiations with Israel. There are informal contacts, but the process is stuck.

Earlier this month, the US State Department made attempts to broker a solution by apparently pushing Israel to drop the case, but there was no clear outcome.

In any case, Egypt’s increasing prospects to achieve self-sufficiency and resume LNG exports have taken the incentive and urgency out of such negotiations. Loss of the Egyptian market leaves Israel with increasingly limited options to export its gas. Exports to Turkey would be a good option, but this requires restoration of diplomatic relations between Israel and Turkey, which is on the cards but making slow progress. The other pre-requisite is a Cyprus solution, which, even though making progress is equally slow.

FCNG or FLNG would offer export flexibility as these would be under the full control of the exporting country, i.e. Israel, but FLNG is capital-intensive and Noble is cash-strapped.

Leviathan could be developed in two phases:
Phase 1: Domestic market + FCNG exports to regional markets – could be achieved by 2019
Phase 2: Exports to Turkey, with no time constraints
Should exports to Turkey be stopped, Phase 1 could be a fallback.
Then of course there is the option of taking up a Russian request to bring Gazprom into the development and export of Leviathan gas. But that poses its own geopolitical challenges.

 

Impact on Cyprus

The commercial challenges described in this article also affect gas exports from Cyprus to Egypt. Even though negotiations at country and company level have been ongoing since 2014, it is unlikely that they will be completed successfully. Price issues are just too challenging.

And then there are the Cyprus problem negotiations. A fortuitous lull in any and all hydrocarbon activities would remove a potential bone of contention.

Cyprus’ export options are also limited without Egypt. Turkey would be an option, but only after a Cyprus solution. Exports to regional markets using FCNG would be another option, but so far it has not received serious attention.

It is hoped Total will be successful with their planned exploratory drilling in Block 11 early next year, even if the Turkish survey ship Barbaros makes its customary appearance. But even if it is successful, this will not change the current situation. Gas exports from Cyprus will have to await global gas price recovery and a solution.

However, additional gas finds will re-open the option of an LNG plant at Vasiliko as a longer-term option, possibly in 10 years when LNG prices pick up and make it commercially viable.

The hotbed of activity in the East Med is Egypt. It is currently suffering from self-inflicted energy shortages, but it has revamped its energy sector strategy and is on a successful drive to increase oil and gas production.

The outcome of all these developments is a dramatic reversal of fortunes for Egypt from gas shortages to self-sufficiency and exports. Israel and Cyprus missed their opportunities. They now have to await new opportunities, and hopefully take them when they appear!

Dr Charles Ellinas is a non-resident Senior Fellow, Eurasian Energy Futures Initiative, Atlantic Council

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