By Charles Ellinas
Bloomberg reported in February that Shell is in talks to buy Aphrodite and Leviathan gas for liquefaction at its Idku LNG plant in Egypt for export.
According to Bloomberg Shell is looking to buy 10 billion cubic metres gas per year (bcm/yr) for 10 years, which incidentally is the capacity of Shell’s Idku LNG plant. The Minister of Energy Giorgos Lakkotrypis confirmed these reports during the Eastern Mediterranean Gas Conference (EMGC) organised by Gulf Publishing in Nicosia on March 22-23, adding that the negotiations are quite advanced and he expects that a deal could be reached within a matter of weeks. But he added that the negotiations also involve the Damietta LNG plant, not just Idku, and that low gas prices in global markets are posing challenges.
Shell declined to comment and Noble Energy, who is the operator of both gas-fields, merely confirmed that the company has been and remains in negotiations to supply gas to Egypt’s internal market and LNG plants.
Egypt is also keen for such a deal. The possibility of gas imports from Israel and Cyprus, combined with surplus domestic gas production, could help turn Egypt into a regional gas hub.
But such developments are facing commercial and political challenges that need to be overcome before they can become reality.
Delek has indicated that Shell will buy 6 bcm/yr from Aphrodite and, presumably, 4 bcm/yr from Leviathan. Combining gas from the two fields, which also have part common ownership through Noble and Delek, and pumping it to Idku through a single pipeline could offer commercial advantages.
If such deals materialise during this year, it will take another three to four years before LNG exports start and three years beyond that (due to recovery of investment costs) before Cyprus sees any significant revenues.
But what revenues should be expected for Aphrodite? Gas markets in Europe are price-competitive, with gas prices averaging about $6/mmBTU (British thermal unit). And oil-linked LNG contracts are usually based on a gas price of about 10 per cent of the Brent oil price.
Shell has LNG sales contracts already in place at Idku. The capacity of the plant is about 10 bcm/yr and it started operations in 2005 but ceased exports in 2015 because of lack of gas. The LNG was being exported on long-term contracts to Italy, France and the US. Presumably the contracts in Italy and France are still in place. Egypt’s petroleum minister confirmed recently that priority will be given to fulfill these contractual obligations.
Based on such prices – and allowing for the cost of the pipeline from Leviathan and Aphrodite to Idku, liquefaction, transport to Europe and regasification, as well as Shell’s profits – Shell may not be prepared to pay Aphrodite more than $3-3.50/mmBTU at the platform. Out of this Noble would have to pay the cost of drilling and constructing the production facilities, the operation of the field over 10 years and recover the costs incurred up to now. The profits left at the end of this process are bound to be very modest. Cyprus’ share would be just over 60 per cent, leaving the rest to be shared between Noble and its partners. Shell would also realise additional profits from its Idku LNG contracts. Lakkotrypis has already admitted that low prices are a problem, which supports this analysis.
Such negotiations have been ongoing ever since BG bought 35 per cent of Aphrodite, before it was taken over by Shell in February 2016, but the parties involved could not agree a fair price. The reasons for that – low global gas prices – have not changed.
This is what may be feeding rumours in Cyprus that Noble Energy is insisting on reducing the government’s share in the revenues from the project before going ahead. Lakkotrypis refused to confirm or deny these rumours, but he confirmed that “we have difficulties with the prices.”
The potential sale of Leviathan gas is also facing commercial challenges. The price Noble would be asking for gas at the platform would probably be $4.70/mmBTU, dictated by the price it is charging other customers in Israel. If it offers a lower price to Shell, then it may have to reduce prices to Israeli customers to similar levels. At this level, it would not be possible to reach a deal with Shell.
As the gas pipelines have to cross Exclusive Economic Zones (EEZ) boundaries there would be a need for inter-governmental agreements to facilitate this. This is where the recently signed inter-governmental agreement between the governments of Cyprus and Egypt, which regulates pipelines that extend into their respective EEZs, comes in. This still needs approval by the European Commission.
However, Israel and Cyprus would also need to conclude such an agreement, as well as a unitisation agreement. While the former should be easier, the latter is proving to be a challenge.
A unitisation agreement is needed when a field straddles the EEZ boundary. This is the case with Aphrodite. The group that owns the Ishai block on the Israeli side adjacent to block 12, claims that 6-8 per cent of Aphrodite extends into its block. Cyprus and Noble dispute this.
Cyprus and Israel have been negotiations since 2010 to resolve this issue and have not yet achieved it. Dismissing it is not a way forward.
It has now become urgent for the two sides to conclude the agreements needed to facilitate development of Aphrodite, if the deal with Shell really looks like going ahead. After all, Israel and Cyprus are meant to be in close cooperation.
Almost every option to develop East Med gas is contingent on the need to find solutions to political problems and conflicts.
When asked Lakkotrypis agreed that the intervention of Turkish warships that led to the abandonment of ENI’s drilling plans in block 3 was a bad development.
Since then Turkey’s president and energy minister have repeatedly stressed that Turkey demands joint development of Cyprus hydrocarbons with active involvement by Turkish Cypriots. Otherwise nothing will be allowed to proceed.
The EU and the international community support Cyprus’ right to develop hydrocarbons in its EEZ, with the undertaking that the benefits from discovered resources will be shared fairly between the two communities.
The question that arises, though, is that with such threats looming would international companies and financial institutions proceed to support such projects, or will they go so far but not to the final investment decision phase, preferring to wait and see.
Gas for Cyprus?
Aphrodite has the capacity to produce 8-10 bcm per year. If only 6 bcm is sold to Shell it leaves another 2-4 bcm looking for a buyer. One option is to sell the remainder of the gas to the Egyptian domestic market, similar to the deal struck by Noble and Delek to sell 64 bcm Israeli gas to Dolphinus Holdings at lucrative prices around $6/mmBTU, provided a buyer can be found and Egypt can absorb additional gas.
But the obvious question is that if the minister of energy is confident that the Shell deal is going ahead, then why not bring 1 bcm/yr to Cyprus to satisfy domestic needs. This would be a cheaper option than proceeding with the expensive import of LNG. Building permanent facilities and buying a floating storage and regasification unit to import LNG for an initial five-year period would end up being an expensive undertaking.
There also other potential options to utilise more Aphrodite gas in Cyprus, for example for the production of petrochemicals.
On the other hand, a question that also begs to be asked is, if the proceeds from such a sale are so low, why is the government so keen to proceed with this sale, especially since it is in danger of being a sell-out?
Until recently the plan was to wait until the current drilling round in Cyprus EEZ is complete, assess the quantities of gas and formulate a more coherent and strategic gas exploitation plan. After all, completion of drilling is not that far away and is expected by the end of 2018.
A major discovery in block 10, greater than 15 trillion cubic feet, the prospects of which are reasonable, could alter the gas balance and associated geopolitics in the region. The prospect of substantial gas exports to Europe could put ExxonMobil at the forefront of future gas developments and could rekindle interest in the region. ExxonMobil has already said that should a substantial discovery be made, it is keen to consider the option of an LNG plant at Vasilikos again. As John Royall, chief executive of Gulf Publishing, said at the EMGC conference “what is said in the industry about ExxonMobil is that it is particularly careful in its evaluations and when it decides to invest somewhere, it usually has good chances to succeed.”
At the EMGC conference ENI’s chief exploration officer, Luca Bertelli, emphasised that “we need to find more gas to make East Med of wider interest. We require greater volumes to ensure long term viability.”
He added: “I think we have to go step by step, be realistic, pragmatic. The area is geopolitically complex, we have to find simple solutions and more realistic solutions to make use of these resources.”
Success in block 10 could also lead to increased interest, and even active involvement, by the US and the EU to solve the Cyprus problem, in order to unlock the gas riches of the region.
Waiting to the end of 2018, until all currently planned drilling is completed before formulating exploitation strategies would be a sensible plan to proceed with.
Dr Charles Ellinas is a nonresident senior fellow at the Global Energy Center of the Atlantic Council