What price Cyprus interim gas?
Based on recent press reports, including this newspaper, the interim gas supply saga is about to come to a conclusion. The Natural Gas Public Company (DEFA) has made a decision and final negotiations are about to start with the successful bidder. It is worth reviewing how the numerous attempts so far started and how we got to the current situation. And to sound a warning on this latest attempt to arrive at an acceptable and financially beneficial contract.
We intend to dedicate an article to the historical review of the interim gas solution in next week’s edition to highlight the tortuous path through this process and draw lessons to be learned.
What is at stake
The two shortlisted tenders are from consortia led by Dutch Vitol and Greek M&M. The deal will be to deliver liquefied natural gas (LNG) to Cyprus and regasify it using an floating, storage and regasification unit (FSRU) at Vasilikos. The amount of gas will initially be 0.7 billion cubic metres (bcm) per year rising to 0.95 bcm over the seven-year life of the contract. There is a further provision allowing the contract to be extended by another three years.
At the time when the tender was launched in January 2014 the government indicated that it hoped to attract bids between $10-$11 per million British thermal units (mmBTU), below the estimated $12/mmBTU price to ensure reductions in the price of electricity. It also expected that importation of gas to facilitate cheaper power production would act as a stopgap from 2016 to 2024, with an optional extension period to 2026, until local resources become available.
Concerns
Given the time taken to come to a decision, the gas delivery start date may now be 2017-18. Even if a contract is signed next month, it will take over two years before LNG can be delivered to Cyprus and LNG imports will continue to 2025 or to 2027. There are a number of concerns that arise from this:
- Escalation in the price of LNG during the lifetime of the contract and how this is dealt with in the contract.
- Timing of availability of gas from Aphrodite and how this will be accommodated – the Minister of Energy said that this is expected to be in 2019, on completion of the Egyptian deal.
Because of the relatively short duration of this contract, the successful tenderer will probably procure the LNG from the spot market. Currently prices are about $7-$8/mmBTU. Adding to this the cost of the FSRU, permanent facilities at Vasilikos, operating costs and profit will take the price of gas delivered to EAC to close to $11/ mmBTU – still below the threshold cost of $12 to lead to reductions to the price of electricity.
However, LNG prices usually have some linkage to the price of oil, either through direct indexation or indirectly. It is expected that within two to three years the price of Brent crude will rise from its present $60-$65 per barrel to about $80. This coincides with the expected first delivery of LNG to Cyprus. As a result, by then the price of LNG may rise to $10/ mmBTU. This would take the price of gas delivered to EAC close to $13, ie above the $12 threshold.
In addition, there is a glut of LNG now, increasing further as more LNG from Australia and the US enters the market. However, projections indicate that by the turn of this decade, ie half-way through this contract, LNG demand will exceed supply, with LNG prices going further up.
So, it is not the impact on the price of electricity at current LNG prices that matters, but the impact of prices during the lifetime of the contract.
How is escalation in the price of LNG during the lifetime of the contract dealt with? Unless there is a strict escalation formula built into the contract, there will be a point at which the LNG supplier may request a review of prices, leading to potential problems. What is the review mechanism? How transparent and auditable is it and what would be the impact on electricity prices? It would be ironic if early in the life of the contract any perceived benefits are not only eroded, but, more importantly, are reversed.
This is a contract of immense public interest. It requires transparency and disclosure of information to demonstrate what would Cypriots by paying for electricity between 2018 and 2024, in relation to the price of LNG, and how these prices compare without this contract.
Timing of Aphrodite gas
The Minister of Energy said recently that gas from Aphrodite is expected to be available in 2019, following completion of the Egyptian deal in the near future.
With Noble expecting $5-$6/ mmBTU at the Floating Production Storage and Offloading (FPSO) platform and allowing for the cost of the pipeline, etc, Aphrodite gas delivered to Vasilikos may be about $8-$9/mmBTU. Because of the provisions of the production sharing agreements, out of an estimated $3/ mmBTU profit about $2 will be Cyprus’ share. In other words the net cost to Cyprus of its own gas from Aphrodite could be $6-$8/ mmBTU. This could lead to substantial reductions in the cost of electricity. It is clear that delivery of Aphrodite gas to Cyprus must be expedited – 2019 would be a good start!
If this is achieved though, we may still not benefit from it. We may be locked into an LNG import contract at least to 2025 with prices substantially higher, unless it has reasonable and enforceable break-out clauses. However, as I have noted before, there are doubts that the Egyptian deal will materialise at all.
Questions
A number of serious questions arise.
- What reductions in the price of electricity would be achieved during the lifetime of the interim gas supply contract?
- How is escalation in the price of LNG dealt with in the contract?
- How will it be ensured that if LNG prices rise, as expected, Cypriots will not be paying more for electricity?
- Can we bring Aphrodite gas to Cyprus by 2019? Or by when?
- If we do, can we break out of the LNG import contract without penalties?
- What is the impact on the development plan for Aphrodite?
It would be ironic if we start exporting gas by 2019, or in any case before 2025, whilst we are locked into importing LNG – expensively!
In Cyprus often major projects end up in courts because of poorly defined contracts. This would be a good candidate to follow the same route, unless the LNG price escalation and break-out clauses are defined clearly and unambiguously. Issues of major public importance require transparency – this contract would make a good start.
Charles Ellinas is a hydrocarbons business consultant
Source: http://in-cyprus.com/what-price-cyprus-interim-gas/
