Gas on Troubled Waters

By Rem Korteweg

The discovery of natural gas resources beneath Cypriot waters is complicating the region's politics. If poorly managed, the development of Cypriot gas could harden political divisions on the island and increase tensions with Turkey. But, if well-managed, it presents a rare opportunity to improve relations on the island, advance the region's diplomatic and economic outlook and produce a foreign policy victory for Europe. The central question is how Cyprus should bring its natural gas to market. The EU has mainly focused on the contribution that eastern Mediterranean hydrocarbons can make towards meeting its energy objectives, but it should push for a Cypriot export option that favours regional stability and promotes reconciliation on the island. A tricky diplomatic chess-game waits.

The partition of Cyprus is a stain on the idea of a Europe that is ‘whole and free', and is a huge irritant in the EU's relations with Turkey, an increasingly important partner on energy and foreign policy matters. A solution to the Cypriot stalemate could unblock EU-NATO relations: Turkey and Cyprus have been preventing the two organisations discussing strategic issues together or making full use of each other's assets. The EU and NATO co-operate with one hand tied behind their backs, harming Europe's security.

In 2011, US-based Noble Energy announced the discovery of a natural gas field, dubbed Aphrodite, in Cyprus' south-eastern maritime zone. Initially its size was assessed at around 5 to 8 trillion cubic feet (tcf), but a second appraisal drilling in 2013 corrected this estimate downward to 4.1 tcf. (By way of comparison, Europe consumes nearly 18 tcf annually.) Nicosia wants to export much of its gas to attract foreign capital and alleviate the burden of the €10 billion IMF-EU bailout it received in March 2013 (and an earlier Russian loan of €2.5 billion). The Cypriots desperately need economic growth: the recession-hit economy is expected to contract by nearly 8 per cent in 2013 and unemployment stands at 20 per cent.

Cyprus must find a way of bringing its gas to market. Among the possible options, the cheapest, a short pipeline from Cyprus to Turkey, is unrealistic. Although a gas pipeline could theoretically be part of any political negotiation between Ankara and Nicosia, the two sides are not talking, trust is absent and Nicosia would be unlikely to cede any control over its crown jewels to Ankara.

Relations between the two sides are very poor. Turkey and the unrecognised Turkish Republic of Northern Cyprus have staked claims on parts of the waters surrounding the island, including areas suspected to be gas-rich (for a map of the overlapping claims, see page 7 of this publication from the Oxford Institute for Energy Studies). Exploration is proceeding, however, with France's Total and Italy's ENI among those involved. Without an agreement on maritime boundaries, this will increase tensions with Turkey. Ankara does not recognise the government in Nicosia and has threatened military force if Cyprus allows drilling in the disputed maritime zone. Until now, no discoveries have been made in contested waters. But ENI (in a consortium with South Korea's KOGAS) expects to start drilling this year in areas which the Turkish Cypriots claim. The sale of several other areas has been delayed because Ankara claims parts of them. To underline its seriousness, in early 2013 Turkey suspended some of ENI's Turkish operations in retaliation for its Cypriot move. Turkish grandstanding is unlikely to lead to a military conflict, but Cyprus has taken precautions and is strengthening its defence relationships, including with Israel and Italy, and is set to procure two French naval vessels. So for the time being a pipeline to Turkey is impossible.

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Nicosia says that economic decisions should not be stalled by politics and is pushing ahead with the development of its resources. It has an interest in marketing the gas as soon as possible; energy analysts expect that global gas prices may start to fall in the next decade as new sources, such as US shale gas, become globally available. Cyprus' energy minister Yiorgos Lakkotrypis has estimated profits for Cyprus from the Aphrodite field to be between €8.8 and €13.2 billion.

The second export option is a pipeline to Greece via Crete. In October 2013, the European Commission designated the proposed EastMed pipeline a ‘project of common interest', potentially making it eligible for EU funding. The European Commission is championing an agenda to diversify its energy imports away from Russia and considers gas from the eastern Mediterranean, including Cyprus, a welcome alternative. The EastMed pipeline would bypass Turkey, denying Ankara further influence over Europe's energy supply as a transit country. (If the EU chooses to import gas from the Caspian, or from Iraq or Iran, Turkey is the transit corridor.) However, because of the depth of the Mediterranean, the EastMed pipeline raises engineering challenges which could make costs prohibitively high. Also, the pipeline would do little to reduce Cypriot-Turkish tensions.

Nicosia's favoured option is to construct an LNG terminal at Vassiliko, in southern Cyprus. An LNG terminal would give Cyprus maximum export independence, allowing it to sell its gas globally - including to the lucrative Asian market - rather than tie itself by pipeline to one customer. An LNG terminal could turn Cyprus into a regional energy hub in the eastern Mediterranean; Israel (or even Lebanon and Syria) could eventually export gas through a Cypriot terminal. Extending a pipeline connecting the Aphrodite field and the LNG terminal to Israel's neighbouring offshore gas fields would be relatively straightforward.

Much will depend on the amount of gas available. At a recent conference in Nicosia, energy experts from across Europe questioned the viability of the LNG terminal. Cypriot gas discoveries may be insufficient for the development of even a small-scale LNG plant. Noble Energy has admitted that 6 or 7 tcf would be needed to warrant the required investment of €8-€10 billion. Cyprus either needs to find more gas, or attract gas from its neighbours to feed into the LNG terminal.

One of those neighbours, Israel, has made the largest discoveries so far in the eastern Mediterranean, including the 18.9 tcf Leviathan field and the 10 tcf Tamar field. The Israeli High Court has decided that 40 per cent of Israel's natural gas resources will be made available for export.

For Israel, constructing a pipeline to Turkey is the cheapest option, but is geopolitically complex. Diplomatic relations between Ankara and Israel have slowly improved since Israel's prime minister Benjamin Netanyahu apologised for the Gaza flotilla incident but Turkey still maintains that Israel must pay compensation to the victims. However, an Israeli-Turkish pipeline is in Ankara's interest. Not only would Israel's sizeable resources contribute to satisfying Turkey's growing energy demands, but it would also strengthen Turkey's role as a transit country.

A Israeli-Turkish deal would not preclude Israel from co-operating with Cyprus either, as the government of Israel has indicated that it favours a combination of export options. It is unlikely that Israel will opt to export all of its gas through a Cypriot LNG terminal, as this would make Israel's exports vulnerable to Cypriot politics and security issues. But it may export some.

All this creates the possibility of a grand bargain between Turkey, Israel and Cyprus. Nicosia would receive a share of Israeli gas exports to process through its LNG terminal, making it economically viable, and in return Nicosia would acquiesce to an Israeli-Turkish pipeline crossing its exclusive economic zone. Turkey would secure more access to gas, and Israel would have diversified its export routes. This mutually beneficial deal could calm the waters between Ankara and Nicosia, and encourage reconciliation on the island. Although difficult, it is the option that would produce the best economic, political and strategic benefits for most parties concerned, including the EU.

Russia, however, might be a spoiler in such a triangular arrangement. The Russian government has a commercial and political interest in maximising the amount of Russian gas that reaches Europe and restricting the amount of non-Russian gas. Russian energy firms have been making inroads in the eastern Mediterranean, in particular by securing gas exploration rights in Syria and flirting with Lebanon. In early 2013 Gazprom signed a deal to export LNG from Israel's Tamar field. So far no Russian energy company is active in Cyprus offshore, but Russia still has significant economic and political influence on the island. The EU should remain aware of Russian commercial and political efforts in the region.

Cyprus' ability to export LNG greatly depends on Israeli choices. For if political obstacles continue to stand in the way of an Israeli-Turkish pipeline, Tel Aviv might simply develop an LNG terminal of its own (floating offshore or at an onshore location), making a Cypriot LNG plant obsolete. The EU should continue to engage with Israel, and energy companies like Noble Energy, throwing its weight behind regional co-operation around an LNG terminal in Cyprus. The EU's foreign policy service should also work together with the United States to help improve political and economic relations between Israel and Turkey, in particular a possible pipeline.

The EU should think strategically about linking its energy and foreign policies. Brussels should use its leverage of being the most likely destination of natural gas from the region. When making its assessment of Cyprus' gas export options, it must consider the impact on regional stability and the potential to achieve progress towards Cypriot reconciliation. If not, the story of Cypriot natural gas may become another tale of missed opportunities.

Rem Korteweg is a senior research fellow at the Centre for European Reform.

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