By Charles Ellinas
The granting by the government last week of the Aphrodite gas-field Exploitation Licence for 25 years to the Noble Energy, Delek and Shell consortium is a milestone in the development of hydrocarbons discovered in the Cyprus EEZ. Not only it is the first such licence, but it enables the consortium to enter negotiations with Egypt’s Idku LNG plant to secure a gas sales contract for this gas.
Understandably, this generated considerable euphoria even to the extent of talking about the immense profits to Cyprus, estimated to be $9.3billion over the life of such a contract – based on an oil price of $70/barrel.
But let’s try to put this in context. First, the application by the consortium for an Exploitation Licence is a contractual requirement – otherwise it might have to relinquish the gas field. It does not mean that it will immediately proceed with development and production. This requires the successful completion of a number of important steps: Design of all required facilities to get a better handle over costs; Drilling at least one more appraisal well to estimate more accurately Aphrodite’s gas reserves; negotiations with Idku to secure a gas sales contract; Securing the required investment.
And if all this works out, reach a Final Investment Decision (FID), which will then enable the project to proceed to construction. Provided this whole process proceeds smoothly it may take three years, to reach FID by 2022. Construction of all facilities may then be completed in another three to four years, with first gas exports by 2025-2026.
But there are serious challenges on the way to FID, which will not get any easier with time.
First is the state of global gas markets and prices. We hear frequently how Europe is looking eagerly to receive East Med gas to diversify its supplies away from Russia. Right now two major gas pipelines are close to completion to deliver vast quantities of cheap Russian gas to Europe, in addition to competing LNG from the US, Russia and Qatar. Russian gas can be delivered at $4/mmbtu (about 1,000 cubic feet) and still be profitable – a price East Med gas cannot beat. In particular, Nord-Stream-2 will deliver 55 billion cubic metres (bcm) of gas annually, with the full support of Germany, financed by leading energy companies from France, Germany, the Netherlands, Britain and Austria.
European spot gas prices are now about $5/mmbtu, having averaged about $4/mmbtu over the year. At such prices East Med gas would not be economically viable.
We also had the bomb-shell announcement by the European Investment Bank (EIB) that as of 2021 it will cease funding oil and gas projects and concentrate on green projects. In fact EIB will manage the EU’s new climate transition fund to support the European Commission’s (EC) new green agenda. Based on a number of presentations by EC officials at key conferences in Europe during the last three months, the new EC climate change policies are expected to lead to a 15 to 20 per cent decline of EU gas demand by 2030, increasing to 65 to 85 per cent by 2050 – keeping prices low.
This is not a market that will need or support new gas supplies, unless of course such gas can be supplied at low prices and be able to compete with incumbents, such as Russian gas.
The picture in Asia is not any better. Spot LNG prices are now close to $7/mmbtu, but over the year these averaged just over $5/mmbtu. And even then they are considered to be expensive. Trade wars and the slowing down of the Chinese economy have reduced growth of gas demand in Asia. Nevertheless in future Asia will still need more gas.
All this is happening at a time when a plethora of LNG projects are coming on-line. In fact over the next ten years LNG projects totaling about 1,100 million tonnes/yr are at various stages of planning, chasing an expected growth in global LNG demand of about 100 million tonnes/yr by 2030. Most of these will not reach FID.
This is the global gas market and price environment which East Med gas needs to penetrate and secure gas sales. It will not be easy unless East Med offers gas at low and competitive prices.
For Cyprus to make $9.3billion profit, even if reserves are 4.1 trillion cubic feet – which is not certain – profit alone from the gas sales contract with Idku must be $4/mmbtu. To arrive at a gas sales price to Idku one must add all recoverable costs, the production facilities and pipeline costs, the cost of finance and operations. And to arrive at a gas sales price to a customer in Asia, the additional costs are Idku liquefaction and operation costs, transport to Asia and profit.
Based on the global gas prices I presented above, and starting with a profit expectation of $4/mmbtu, this is not possible. Average annual prices in Asia must exceed $8/mmbtu to make East Med gas sales viable. And even then profits would be very low.
Egypt’s gas progress
But these are not the only challenges. Egypt has taken measures to improve its energy market that have now led to surplus gas for export. In addition to Zohr soon reaching full production capacity of 33 bcm/yr, a plethora of smaller gas fields and new small discoveries are adding to this surplus. Egypt has also built new CCGT power plants with over 50 per cent increase in efficiency in comparison to older plants, needing much less gas to produce the same amount of electricity. It has also embarked on an ambitious and so far successful renewable energy programme to produce 20 per cent of its electricity from cheap renewables by 2022. These are leading to surplus electricity, but also surplus gas.
As a result, Idku is now operating at full capacity and next year Damietta is expected to do the same with gas from Zohr. In fact during August-October Idku was unable to export LNG because it could not compete with the very low global prices at the time, and had to reduce production.
This is the market into which Aphrodite’s consortium will be attempting to sell its gas. By no means easy or assured, except if it is prepared to sell at low prices, lower than competing Egyptian gas.
So if the global markets are challenging, other options must be considered. These include the idea of an LNG plant at Vasilikos by combining all discovered gas resources into a single consortium. This will require new discoveries during the forthcoming drilling round, which is quite likely as prospects look good. But even then Cyprus LNG will still need to compete in the very competitive global markets I described above. A dose of reality in expectations is needed here.
Another option is to look to regional markets. But this requires resolution of regional problems, including the Cyprus problem.
Dr Charles Ellinas, @CharlesEllinas is Senior Fellow, Global Energy Center, Atlantic Council