Cyprus: Lifting the lid on an offshore natural gas bonanza

Dawning of an Energy Exporter

There can be absolutely no doubt that the discoveries will have a transformative impact on the local economy. A country that formerly relied on imported oil to cover 94 percent of its energy consumption requirements and nation once subjected to the EU's highest electricity prices can now contemplate a future of energy autonomy and exports. In the words of Yiorgos Lakkotrypis, Cyprus' energetic Minister of Energy, Commerce, Industry and Tourism, "natural gas discoveries deliver an entirely new dimension to the Cypriot economy affording a range of great opportunities over the short, medium and long term."

"Initially we are witnessing significant investment from international E&P outfits, from independents such as Noble Energy to super-majors like Total, and equally from the types of firms that service the upstream segment of the gas value chain such as Schlumberger and Halliburton," he explains. "Then, in the mid-term, the country will enjoy the revenues accrued from the sale of hydrocarbons on European and global markets. Finally, we should be able to develop a knowledge-based community specializing in oil and gas related services, which can continue to nourish the economy even after our reserves have been exhausted," he asserts.

This is, however, unchartered territory for a nation formerly unfamiliar with the industry, and thus needs careful management. "We must not become sheikhs," exclaims George Shammas, chairman of the Cyprus Energy Regulatory Authority, while unveiling his proposal for a sovereign wealth fund to recycle gas revenues into sustainable, equitable human-centered development. "What we are doing today in the hydrocarbons sphere should be for future generations and provide the foundation for the next cycle of the island's economic growth, rather than regarded as shortcut to solve problems of the past," counsels Evgenios Evgeniou, CEO of PwC in Cyprus.

"To think of it as a silver bullet to solve all of today's problems would be fundamentally the wrong approach," agrees Nicos Papakyriacou, partner and Cyprus oil & gas leader at Deloitte. "The real benefits will come in the mid- to long-term. In the meantime, we must not lose focus by putting all our eggs in one basket and overly relying on hydrocarbon revenues. We must resist the temptation to place all our expectations in this one industry," he warns.

Mighty Aphrodite, Untold Riches

Just how extensive, then, are Cyprus' natural gas reserves? Currently 13 exploration blocks have been drawn up south of the island, the rights to six of which have been awarded during the course of two licensing rounds in 2007 and 2011 respectively. Noble Energy's original headline discovery in block 12, which was subsequently christened 'Aphrodite prospect,' was initially thought to contain some 3.6 tcf (trillion cubic feet) of gas. This figure was very recently raised to 4.54 tcf by Noble's Israeli partners (Delek Drilling and Avner Oil Exploration which together hold a 30 percent stake in the field). The figure for condensate, a liquid byproduct of natural gas that can be sold separately, meanwhile was also raised to 9 million barrels from a previous calculation of 8.1 million.

To date, Aphrodite represents the sum total of proven Cypriot reserves. On its own, this makes for quite a conundrum when it comes to selecting monetization options. On the one hand, the island's domestic energy consumption is too meagre to justify development of the play and thus at least a portion of the gas produced must be exported. On the other hand, the revised numbers still do not come close to the minimum amount of gas which the operator Noble Energy says is needed to make the government's preferred choice of an onshore LNG plant commercially feasible. According to Keith Elliott, Noble's senior vice chairman for the Eastern Mediterranean, the threshold would have to be "well north of 5.5 tcf...preferably between 6 and 7 tcf."

This sobering news, however, has to be considered alongside US geo-seismic survey data that estimates possible total gas reserves in the Levantine and Nile Delta basins at 122 tcf and 223 tcf respectively, not to mention oil deposits equivalent to some 3.4 billion bbl. Also to be considered is the Cypriot government's distinctive exploration and production sharing contracts (EPSCs) that commit the licensee holders of each of the awarded blocks to executing 'aggressive' exploration work programs to short deadlines. In other words, further discoveries, probably of a significant stature, can be expected.

Outlining his exploration roadmap, Minister Lakkotrypis explains that the Cypriot state has signed "three EPSCs with a consortium comprising ENI and Kogas, two with the super-major Total, and one with the Noble / Delek / Avner partnership." Looking ahead, "ENI / Kogas are well underway with a very extensive exploration program, lasting 12 to 18 months depending on findings, while Noble will be drilling at least another exploration well in 2015 and conducting subsequent appraisals of Aphrodite. Concurrently Total is in the process of interpreting the thousands of kilometers of seismic data they have acquired for a completely new zone in the Nile Delta Basin," he explains. "We believe that the next six months will be critical in determining the future direction of the Cypriot gas with additional information on new discoveries imminent," agrees Toula Onoufriou, president of the national oil champion, the Cyprus Hydrocarbons Company (CHC).

Others are even more bullish on discovery prospects. "The Eastern Mediterranean is nothing short of a 'North Sea Mark II'," says Solon Kassinis, managing director of his own energy consultancy and erstwhile director of energy at the ministry. "The Israelis claim to have discovered 37 tcf, while Cyprus anticipates an estimated 60 tcf in blocks that only represent a fraction of our EEZ. Then there is the reserves potential of Greece, Lebanon, Palestine and Egypt to add to the mix...we are all Norwegians now.".

Crowning Piece of the Jigsaw?

Cyprus' true potential in oil and gas, however, transcends upstream production of its hydrocarbon endowments. "What would attract real investment into Cyprus is not so much the reserves themselves, but rather the regional function that the country can fulfill as the primary market outlet for LNG for the entire Eastern Mediterranean region," surmises Kassinis. PwC's Evgenios Evgeniou concurs. "From my perspective, it's very clear: the added-value to be accrued from being part of an energy hub is potentially an even better prospect than the natural gas discoveries themselves. The Eastern Mediterranean and the Levant region are developing as a new frontier in terms of natural gas and oil, and Cyprus has the prospect of establishing itself right at the heart of this cluster," he observes.

With its geo-strategic location at the gateways to Europe, Africa and Asia, the island would certainly seem appropriately situated for performing the role of energy hub to the region. "Cyprus enjoys a number of unique attributes that make it ideally suited: its central geographical placement, its renown for professional services, its fully transparent legislative framework and its reputation for a rule of law that is predictable and stable," points out Minister Lakkotrypis. "If you look at the map, there is only one country that has the political and economic stability to act as the hub and it's us... when you consider the volatility and instabilities afflicting the region, it's little wonder more and more energy companies are looking to Cyprus as a safe and stable base for their regional operations," adds Evgeniou.

Were the island to actually achieve 'hub' status, the economic benefits could be expected to cascade across auxiliary industries such as the engineering and construction sectors. Some international EPC contractors are already contemplating such a scenario. "We see Cyprus' oil and gas outlook as highly promising, expect there to be many related infrastructural projects over the coming years and seek to position ourselves right at the forefront of any such developments," elaborates J&P Energy & Industrial Projects' CEO, Marios Patsalides.

Nor should the significance of Cyprus' EU membership be overlooked. "We are actually the only EU member state in the Eastern Mediterranean making us the obvious candidate as a conduit for channeling Eastern Mediterranean natural gas to European markets," observes Toula Onoufriou of the CHC. In fact, Cyprus actually straddles the crossroads of major energy exchanges, according to VTT Vasiliko general manager George Papanastasiou. "You get greater quantities of diesel consumed in mature Europe and higher gasoline demand in the developing eastern Mediterranean region. Therefore you see middle distillates-diesel, gas oil, jet fuel-making their way over to Europe from the Arab Gulf and trade in gasoline flowing in the opposite direction. This often entails vessels needing to make and break bulk. Cyprus enjoys the double dividend of lying along these critical pathways while simultaneously possessing the sort of deepwater environment where these activities can take place," he analyses.

Whether such grandiose schemes can ever reach fruition remains a moot point. "The main brake is a lack of political will for regional co-operation rather than a shortage of hydrocarbons," laments one industry insider. Only time will tell.

The Market Knows Best: Decoding the Cypriot regulatory regime

Cyprus has so far avoided the 'dash to tax' hydrocarbons that plagues many resource-rich states and this laissez faire stance on taxation seems more than likely to continue. "Cypriot governments are renowned for adopting policies that foster stable and business-friendly regulatory regimes recognizing the economic reality that true wealth for the nation arises from employment and prolific business activity, rather than by heavily taxing specific sectors," explains PwC's Evgenios Evgeniou. "We are an economy based on free enterprise where the private sector forms the backbone of economic activity," adds EY's country assurance and oil & gas leader Stavros Pantzaris.

Indeed, there is no specific regime within Cypriot income tax legislation relating to oil and gas with profits from trading operations instead taxable at the standard corporate income tax level, which in turn ranks the lowest within the EU. Furthermore, many analysts see little need to start tinkering with the existing framework. "Instead of overhauling its tax structures, Cyprus has opted for a profit-sharing contract context. If we follow this trend, there may well be no need to have a specific oil and gas tax system as such. Regarding high-wealth individuals working in this sector however, there could, of course, be new provisions introduced," muse KPMG's Angelos Gregoriades and board member Iacovos Ghalanos.

Meanwhile the government certainly appears well attuned to the need to cultivate the right enabling environment for the fledgling natural gas industry to thrive. In the words of Energy Minister Lakkotrypis, "Cyprus is at a critical juncture in its development path. We are overtly seeking investment and I urge the community to investigate Cyprus as an epicenter of new frontier ventures." So as to incentivize them, "we are hard at work creating a local business climate that these companies will find very much to their liking," he adds, pointing to a raft of new policy measures aimed at fast tracking the permitting process for energy projects and allocating land to energy infrastructure developers at favorable terms.

"Over and above an extensive double tax treaties network, Cyprus ranks 39 out of 189 countries in ease of doing business, has no foreign exchange controls and market entrants enjoy low set up and maintenance costs along with a wide range of supporting services provided by local professionals so the island is truly attractive from a business standpoint," concludes Pantzaris.

Deciphering Cyprus' gas monetization options

Cyprus, to this day, remains an isolated energy island with no interconnections with trans-European electricity and gas networks. The 'great unknown' is therefore how Cyprus can best bring its newfound gas wealth to market. Reserve size will play a decisive role in determining the type and volume of investments made both upstream and downstream, so ultimately much will hinge upon the next round of discoveries. Nevertheless, the following represent the main options currently under consideration:

Liquefied Natural Gas (LNG)

The Cypriot government has been vigorously promoting the concept of a USD 10 billion liquefied natural gas facility to be built by private groups in Vasiliko enabling the country to ship gas to Asian markets and adjust is customer base in line with spot market prices.

Trans-Mediterranean Pipeline

DEPA, the Greek natural gas operator, has been conducting feasibility studies into connecting Cyprus with the Greek Peloponnese via an underwater gas pipeline. Depths exceeding 2,000m combined with an active seismic environment pose substantial technical challenges.

Cypriot-Egyptian Pipeline/FSPO Combination

British entity BG Group has approached the operators of Aphrodite play with a view to securing gas for their Idku LNG plant in Egypt. The proposition comprises a 600km pipeline coupled with a floating production, storage and offloading (FPSO) unit over the gas well.

Gas-to-wire (GtW)

The idea of a 'great 2,000-Mw Eurasia interconnector' has been mooted by a consortium led by DEH Quantum Energy in which natural gas would be converted to electricity within Cyprus then transmitted by submarine cable to European markets routed via Crete and mainland Greece.

Compressed Natural Gas (CNG)

Pipeline-quality natural gas would be compressed to 20 MPa and transported in small quantities by vessel to relatively near markets such as Lebanon and the Greek Islands. This 'more interim' solution would deploy techniques hitherto never commercially tested in the Mediterranean.

Floating Liquefied Natural Gas (FLNG)

Woodside Petroleum, an Australian outfit with LNG expertise, is still pondering an ambitious proposal to construct a floating LNG platform. Again this would be highly capital intensive.

Boom time for Professional Services

Traditionally Cyprus enjoys a strong competitive advantage in the professional services sector especially in ancillary support segments such as audit, tax management and legal consultancy. The sector, whose ascendency actually predated the banking surge of the past decade when the country decisively leapfrogged conflict-torn Lebanon as a preferred business services hub, is now set for another growth spurt as it extends out into the hydrocarbon domain. The island's foremost consultancies are already jockeying for position to attain a slice of the new markets opening up.

"The blossoming of Cyprus as an offshore financial center jurisdiction generated not only substantial short-term income, but also considerable savoir-faire in specialist fields such as accountancy much of which remains to this day. That legacy will prove highly useful when applied to the nascent oil and gas industry," opines KPMG's Angelos Gregoriades. "All the ingredients are already in place towards building a sound industry capability so as to cover the whole range of services for oil companies, from risk management and compliance to business optimization, human capital sourcing and corporate finance capabilities," agrees PwC's Evgenios Evgeniou.

Many of these market offerings will be targeted towards incoming energy firms with a view to mentoring them in their alignment with local tax provisions, the indigenous business context and regulatory sphere. "Our oil and gas tax professionals already work with many of the leading players to help our clients render tax a more controllable and predictable cost in what is, after all, a highly dynamic and ever-changing market," reveals EY's Stavros Pantzaris.

There will also, simultaneously, be much scope for advising the Cypriot state in how to manage and configure what is, in effect, an entirely new industry for the country. "We will be on hand to promote best practice and assist the government in correcting bottlenecks that pose problems for the operators and in formulating the sorts of legal frameworks in order to be able to attract new players to the region," promises Deloitte's Nicos Papakyriacou.

Meanwhile the government's agenda is yet more ambitious: aiming to render the island the 'go-to' focal point for hydrocarbon support services for the entire region. "It makes sense that we develop a specialization in oil and gas services that can then be exported throughout the Eastern Mediterranean. Neighboring states will be commencing their own exploration activities in the near future and the demand for technical, commercial and legal support will be vast. Our aspiration is to position the Cypriot economy so that it provides this scientific expertise, due diligence, business know-how and manpower," declares an ebullient Minister Lakkotrypis.