Gas Geopolitical Rivalries

Gas reserves vary considerably in both composition and thermodynamic state. Accurate knowledge of the phase boundary and pressure-volume-temperature (pVT) behavior of these gases at pressures well above atmospheric pressure is of interest for several non-chemical reasons.

Gas reserves increased by approximately 250 percent during the past 10 years, due primarily to the discovery of a limited number of large conventional gas fields in previously unexplored areas. During the past 5 years an apparent plateau in gas reserve additions has prevailed. From present evidence, the USSR, Middle East, China, and the offshore areas of the world appear to offer the greatest potential for providing future gas reserves.

The Next Eastern Mediterranean Gas Producers

According to the Oxford Institute for Energy Studies, a report published by the German Marshall Fund of the United States, Bassam Fattouh and Laura El-Katiri examined the prospects of Lebanon turning into a natural gas producer and exporter.

The discovery of sizable gas resources in the Levant Basin, a geological structure that straddles the territorial waters of Cyprus, Israel, the Palestinian Territories, Lebanon, and Syria, has the potential to be game-changing for the East Mediterranean region.

Hitherto net energy importers, these countries are now faced with the prospect of long-term energy self-sufficiency and the development of a new revenue stream for the economy. With the resource potential of the Levant Basin believed to be much higher than the 35 Tcf of gas discovered recently, the East Mediterranean is now the focus of much interest on the part of major upstream investors.

However, in the short to medium term, the development and monetisation of these resources present stakeholders with a set of challenges originating in the region’s complex political make-up, as well as in the fact that their energy and gas utilization policies are still work in progress, over and above the technical difficulties relating to the development of these resources.

Lebanon’s exclusive economic zone forms part of the Levant Basin, which has been estimated to hold up to 122 trillion cubic feet of recoverable natural gas, in addition to some 1.7 billion barrels of recoverable oil.

The development of its hydrocarbon reserves would enable Lebanon to reduce its dependence on imports of oil products, which in 2012 constituted more than 97 percent of its total primary energy supplies.

The government is keen to diversify Lebanon’s energy mix away from oil to strengthen its security of supply and to reduce air pollution. But gas production is not likely to begin before the mid-2020s. Until then, Lebanon would need to import all its gas requirements in order to increase the share of natural gas in the energy mix.

The commercial development of Lebanon’s hydrocarbon reserves faces many internal and external challenges. Lebanon’s hydrocarbon sector and its institutional and regulatory framework are still in their infancy. Deadlock in Lebanon’s sectarian political system has led to long delays in the country’s hydrocarbon development and produced a volatile regulatory environment.

The country suffers from weak administration, widespread corruption, and a poor business climate. As yet, Lebanon has no proven gas reserves, and until 2005 it did not have any gas infrastructure at all.

 The international community has a strong interest in ensuring that Lebanon’s potential hydrocarbon wealth brings benefits to the country and the region and does not become an additional source of tension.

Lebanon's Oil and Gas Drilling to Begin in 2019

The U.S. Energy Information Administration estimated in 2010 there were 122 trillion cubic feet of undiscovered natural gas resources in the east Mediterranean basin.

Lebanon will begin exploratory drilling for offshore oil and gas in 2019, Energy and Water Minister Cesar Abi Khalil said, as the country hopes to find resources to shore up its indebted economy.

"This is going to create a new sector in the economy," said Abi Khalil. "And it is going to secure a local source for energy."

Lebanon's economy is mired in debt and struggling to grow as the civil war in neighboring Syria stretches into its seventh year. The conflict has paralyzed trade and pushed some one million refugees into Lebanon.

The country has been slow to capitalize on geological survey findings from 2011 indicating a strong possibility of mineral resources in its offshore waters. Its government has been crippled by political deadlock emanating from the crisis in Syria as parties butt heads over taking sides in the war.

It is not certain whether companies will find reserves in Lebanese waters. But a bid, accepted by the Lebanese government, by a consortium of international oil and gas giants to explore two sectors in the eastern Mediterranean reflected the potential for a windfall, said Mona Sukkarieh, a political risk analyst at the Beirut-based consultancy group Middle East Strategic Perspectives.

"If they choose to proceed with exploration and drilling, then we are talking about a lot of money," said Sukkarieh.

The consortium's members are Eni from Italy, Total from France and Novatek from Russia. Lebanon's government approved the necessary licenses.

The country's share of revenues from oil and gas sales will measure between 55 and 71 percent, said Abi Khalil. The window for exploration will be open for up to six years. The contracts with the three companies will were signed in early 2018.

A major finding in Lebanon's southernmost waters could raise the possibility of a dispute with its neighbor Israel. There are over 800 square kilometers of waters claimed by the two countries which are technically at war.

Abi Khalil said exploration would proceed in "Block 9", one of the two sectors open for drilling, in any case.

"It is our right to explore in all our southern blocks, we are determined to exploit this national wealth," he said.

Several companies told Lebanon's Petroleum Authority in 2013 they considered Block 9 the most promising, according to Sukkarieh.

Gas is expensive to extract. A major finding could spur investment in Lebanon's failing energy sector that civil society activists say is rife with corruption. Lebanon experiences rolling blackouts on a daily basis, despite massive subsidies to its national electricity company. The World Bank says transfers to the 'Electricite du Liban' account for a staggering 40 percent of the debt the country has accumulated since 1992.

Abi Khalil said "politicians were working on developing a national sovereignty fund to invest resource revenues in a transparent manner.

Lebanon’s Bank Deposits up by $4.7 billion

The financial results of the Lebanese banking sector saw growth in customer deposits and assets in the first six months of 2018 compared to the same period of last year, according to Bank Audi’s Lebanon Weekly Monitor.

“Lebanon’s banking sector witnessed healthy activity and earnings growth in this year’s first half amid sound deposit inflows, higher placements at BDL [Banque du Liban] and rising net interest margins on the back of increased capitalization, while lending activity remains contractionary year-to-date even though it somewhat gained some ground in the last couple of months,” the report said.

Customer deposits grew by $4.7 billion in the first half of this year, in line with average first half growth of the previous five years, to reach $173.3 billion at the end of June.

“This has been favored by a pickup in deposit collection as banks offered enticing returns on deposits in the local currency and amid higher interest rates cross-currencies in general following the further tightening of the U.S. Federal Reserve’s monetary policy,” the report said.

The report was alluding to the fact some Lebanese banks offered their clients attractive returns if they converted their dollar deposits to pound deposits, for maturities ranging from one year to five years.

“Latest banking sector figures suggest a yearly increase in the average Lebanese pound deposit interest rate by 114 basis points between May 2017 and May 2018 to reach 6.71 percent and a yearly increase in the average U.S. dollar deposit interest rate by 49 basis points to reach 4.11 percent,” the report said.

It added the spread between pound and foreign exchange deposit rates rose from to 2.60 percent at end-May 2018.

“In parallel, the spread between the dollar deposit rate and the three-month Libor rate declined from 2.41 percent to 1.79 percent over the same period. So far this year, deposit growth is being driven almost equally by lira and FX deposits (42 percent and 58 percent of total deposit growth respectively) whereas last year the increase in deposits parked at banks was overwhelmingly driven by FX deposits,” the report said.

In addition, the combined assets of all Lebanese commercial banks in the first six months of 2018 went up by 6.71 percent to $234.6 billion.

“Also part of the recent Central Bank swap operation, Lebanese banks’ acquisition of sovereign Eurobonds from BDL resulted into an increase in banks’ sovereign FX bond portfolio by $2 billion (circa 13 percent) year-to-date to reach $16 billion at end-June 2018,” the report said.

Banque du Liban Secures $1.4 billion in New Deposits

The Lebanese central bank has secured up to $1.4 billion in five-year deposits from private investors overseas, boosting dollar reserves in one of the world’s most-indebted countries and easing concerns that it could struggle to repay its debts and defend its currency, reported Bloomberg.

Riad Salameh, the Governor of 'Banque du Liban' (BdL) said that the central bank remains committed to preserving the Lebanese pound’s peg of about 1,507.5 to the dollar, in place for more than two decades and has ample cash to do so.

“Contrary to what is being said, the supply of dollars is ample in the market, today the central bank has closed deals of deposits with private, non-resident institutions, whereby in the second half of August our reserves went up by $1.4 billion to reach $38.6 billion,” said Salameh.

His comments are likely to go some way toward reassuring investors increasingly worried about dwindling inflows of cash from abroad and political divisions that have slowed the pace of fiscal reforms needed to unlock $11 billion in inter-national aid pledged to revive the country’s economy.

Last week, Fitch Ratings downgraded Lebanon’s credit ranking deeper into junk territory, taking it down to "CCC". Credit-default swaps have scaled record highs in recent weeks as investors fret that Lebanon’s day of financial reckoning is looming.

He said the central bank had already set aside $1.5 billion to cover in cash on behalf of the government the next maturing Eurobond in November 2019.

To keep its banks stable and able to defend the peg, this tiny, open economy has for decades relied on deposits that are constantly replenished mainly by the millions of Lebanese living abroad. According to Goldman Sachs, those inflows dropped as fears of an impending banking crisis rose, with deposit growth entering negative territory in May for the first time in more than a decade.

"Promises of assistance from Saudi Arabia and Qatar, energy-exporting Gulf Arab countries that helped pull Lebanon back from the brink in decades past, have yet to materialize," Salameh said.

The International Monetary Fund estimates that Lebanon’s public debt burden will rise to near 180 per cent of economic output by 2023 but the government has never defaulted on its debts despite rolling political crises and even war.

Investors to Take a Big Hit if Lebanon Restructures its Debt

In the bleak, yet unlikely scenario of Lebanon restructuring its debt, foreign investors would recover 35 cents on the dollar, senior Goldman Sachs economist Farouk Soussa notes in his report. 

As Lebanon continues to thread the path of unsustainability and economic collapse, Goldman Sachs undertook an analysis of the country's debt recovery values in the event of a restructuring of its sovereign debt, based on a case implying a haircut for Lebanese Eurobonds.

Given a current debt/GDP ratio of 150 percent, this implies a "haircut of around 65 percent of the debt, or a recovery value of 35 cents on the dollar," assuming a long-term growth rate of 2.6 percent YoY and a decrease in interest rates follow. 

In the case of a restructuring taking place in the context of a sharp devaluation in the Lira, the leading economist notes a sharper negative impact on the expected recovery value, lowering it from 35 cents to 27 cents on the dollar. 

Lebanon has found itself in hot water in recent years, amid the ongoing Syrian civil war and lawmakers' inability to implement wide-ranging reforms to curb government spending and the ever increasing sovereign debt. 

Reducing the requisite fiscal adjustment to more achievable levels remains unlikely, he says, maintaining that it would require either a sharp reduction in interest rates or a substantial pick-up in growth prospects, "both of which, may be possible but are largely outside the control of policy-makers", and are highly dependent on regional economic and political developments. 

"The exposure of Lebanese banks to the sovereign (local debt and Eurobonds), amounts to some LBP55trn, almost double the LBP30trn capital base of the banking system. If the government were to apply a haircut of 65%, this would render the banking system insolvent," he says.

To mitigate the harm to the banking sector, some have alluded to a haircut on deposits (similar to the Cyprus experience) and the application of capital controls, yet Soussa argues that this avenue remains far-fetched to conserve Lebanon's reputation as a safe banking haven, "crucial to its ability to continue to attract diaspora deposits."

Despite the Lebanese financial system holding enough FX liquidity to "finance its deficits under the current circumstances for the next couple of years," the regional political turmoil coupled with the threat of a Hezbollah-Israel flare-up has rattled investors' confidence in the economy. 

In recent month, Lebanon's economic outlook took another hit after another global rating agency revised its standing from stable to negative amid the government's increasing twin deficit.

Fitch Ratings, one of the big three credit rating agencies alongside Moody's and Standard & Poor's, also reaffirmed Lebanon's "B-" to "CCC" appraisal, a sign of the "government deficit and debt dynamics."

The Central Bank has continuously undertaken drastic operations to weather fiscal challenges, with the latest being a swap of Treasury bills held by BDL with newly MoF-issued Eurobonds in the amount of $5.5 billion, around $3 billion of which were subsequently sold (along with enticements) to banks.

This was done to raise BDL's foreign exchange reserves, which reached around $44 billion by the end of June 2019.

Shaking up Europe’s energy map

For a year, the talk in Lebanon and Israel has been about war: the long-awaited confrontation between the “Zionist entity” and Hezbollah, spearhead of the resistance.

Aside from drones and other skirmishes, the missile-launchers, have been silent. Instead, quiet shuttle diplomacy from a Trump administration hardly renowned for such measures has engineered one small step in the opposite direction.

At some point in the near future, Israeli and Lebanese negotiators are due to meet with Hezbollah’s accord at a United Nations base to thrash out a longstanding argument over the delineation of their sea border. The prize is access to newly discovered Mediterranean gas-fields which can only be safely exploited once the threat of war is removed.

Egypt

Egypt was an importer of natural gas as recently as 2016. But a massive discovery of gas in 2015, in the Zohr field off Egypt’s coast by Italian energy firm Eni, could make Egypt the region’s most important gas exporter and hub. Zohr is the Mediterranean’s largest gas field and has since been developed, with production starting in January 2018.

At the same time, the Egyptian government is planning on launching 11 new gas projects and positioning itself as a regional hub for international gas trading and distribution. Meanwhile, the Egyptian army has upgraded its arsenal and training program. It’s all part of the government’s plan to regain; through the East Mediterranean Gas Company the owner and operator of the Arish–Ashkelon pipeline, a joint company of Mediterranean Gas Pipeline Ltd which belongs to "Evsen Group of Companies", the Israeli company Merhav, PTT, EMI-EGI LP, and Egyptian General Petroleum Corporation; its strategic regional role that was lost due to the Arab Spring and the political crises that followed.

Cyprus and Greece

Cyprus has been a bright spot for exploration, with a string of giant gas discoveries in recent years. These include ExxonMobil’s Glaucus in 2019 and Eni’s Calypso fields in 2018. There’s also the more developed Aphrodite plot, which was discovered in 2011 and is projected to have a net revenue of US$9.5 billion over 18 years from selling gas through Egypt’s Idku terminal.

But Cyprus is a divided state. The Greek side, the Republic of Cyprus, is the only side that is internationally recognized and, as a result, has sovereignty over the island’s territorial waters and exclusive economic zone, which is the neighboring sea area that a country has rights to.

The northern, Turkish side, however, lays claim to gas in these waters and is getting support from the Turkish government in its efforts.

Turkey

There have been no big gas discoveries made in Turkey’s part of the eastern Mediterranean but it has sent ships into the coastal waters of Cyprus to drill for gas. Turkey says it will continue drilling for gas in these waters if the internationally recognized Greek Cypriot government does not accept a cooperation proposal put forward by Turkish Cypriots.

In response, Cyprus and Greece issued an arrest warrant for any Turkish drill ships obstructing their gas operations, and the two countries have called on the EU to punish Turkey for its actions.

Turkey’s brinkmanship must be understood in the context of attempts by Egypt, Greece, Cyprus and Israel to create a regional energy architecture that will exclude Turkey from the eastern Mediterranean natural gas market. Agreements between Egypt and Cyprus would lead to the sale of gas from the eastern Mediterranean to Europe, bypassing Turkey and Russia’s pipelines.

Israel

Israel is adding further weight to Egypt’s potential as Europe’s new gas hub. The discovery and development of gas fields off the coast of Israel in the last 20 years has resulted in an abundance of gas, which the country is trying to use to its geopolitical advantage.

Israel has also built a strong relationship with Greece and Cyprus. The three countries conduct joint military exercises and coordinate on security operations in the eastern Mediterranean.

They are also now collaborating to build a US$7 billion gas pipeline from Israeli and Cypriot gas fields through the Greek island of Crete and into Italy, in order to feed other European countries. This plan will become even more profitable if more natural gas reserves are discovered through the ongoing gas exploration activities around Crete.

Gas has also opened the door to talks with Lebanon, a country Israel has historically been at loggerheads with. Officials from both sides have agreed to discuss their sea border in talks mediated by the US. Newly discovered Mediterranean gas fields can only be safely developed when there is no threat of war between the two sides.

So, clearly, Israel’s offshore gas reserves are highly valuable to its economic and strategic concerns in the region. It has gone to great lengths to ensure its existing gas fields are secure as a result, and has also made agreements with Egypt and Jordan to sell surplus gas.

Russian fears

Traditionally, Russia has been Europe’s main supplier of gas, giving it significant influence over Europe.

These developments are clearly worrying Russia. Russia, mainly through its oil and gas giant Gazprom, provides 37% of Europe’s gas supplies and Europe’s energy dependence has paid off for Russia.

The very real risk of losing this influence could result in military conflict. Turkey recently completed the purchase of a Russian anti-aircraft system. This will create a significant power imbalance in the region and give Ankara an advantage in controlling the airspace, especially in disputed areas.

Greece fears that Turkey may deploy the system along its southern coast, near places where Turkish naval forces already escort vessels to explore gas deposits in the eastern Mediterranean. As a result, the Greek armed forces are on high alert. Greece, along with the Egypt-Cyprus-Israel bloc seem to have US and EU backing, with Turkey being warned not to complete its purchase of the S-400 system.

A Stage for Armed Conflict

The efforts of individual countries to access the gas fields in the south-eastern part of the Mediterranean make the area very vulnerable to new conflicts and war and can also lead to a dispute within NATO and affect Europe’s energy security, putting the EastMed pipeline in question. The war for natural resources is looming large.

The first problem is the relationship between Cyprus and Turkey. Ankara, the only capital which recognizes North Cyprus, says that all activities related to the extraction of gas in the Cypriot area are an encroachment on the interests of North Cyprus.

While Turkey does not recognize agreements between Cyprus and other countries on the issue of economic exclusive zone (EEZ) or licenses for gas exploration in Cypriot territorial waters, Nicosia holds the opposite opinion.

Ankara, through the Turkish Petroleum Corporation (TPAO) puts forward claims that it is entitled to look for gas and oil in Cypriot waters and has the right to defend its interests there. Cyprus issued a number of concessions to various mining companies on more than half of the blocks (i.e. parts of the economic exclusive zone on which companies could explore gas or oil) located within the Cypriot EZZ.

President Erdo?an warned Cyprus and international gas exploration companies that the violation of Turkish interests would have bad consequences.

In the middle of February 2018 the warning was made good and so the Saipem 1200 mining vessel operating for Italian company – Eni was blocked by Turkish ships. Italy responded by sending a military ship to the area. This shows how explosive the situation is now that two NATO member states want to pursue economic goals without backing them with diplomacy.

It is worth mentioning that also in recently a Turkish coast guard boat rammed a Greek patrol ship in the Aegean Sea, which shows that the Turkish government is willing to use military force.

Gas Rivalries

The deepening cooperation between Cyprus, Greece, Israel and Italy regarding the EastMed gas pipeline project is another flashpoint. The new pipeline, whose aim will be to supply gas from the Caspian Sea to Southern Europe, would weaken the transit role of the Turkish TANAP.

Another potential conflict is the one between Turkey and Egypt over the rich Zohr gas field discovered only in 2015. Ankara does not recognize the 2003 Cypriot-Egyptian EEZ accords and the 2013 sea border agreements between Cairo and Nicosia, which assign the Zohr gas field to Egypt. At the beginning of February 2018, the Egyptian government warned Turkey that further interference in this area would be met with a decisive reaction.

The relations between Turkey and Egypt are already strained. Though Turkey was a supporter of the Egyptian Brotherhood and Mohamed Mursi, who took power in Egypt in 2011, nowadays there is no love lost between Ankara and Cairo, because in 2013 the Trukey-friendly government was toppled. In a 2016 interview, President Erdo?an gave vent to his anger, calling the current Egyptian President Abdel Fattah al-Sisi, a “putschist” who killed thousands of his own people.

The sea area between Israel and Lebanon is the most explosive area, which extends along the edges of three Lebanese gas exploration Blocks: 8, 9, 10 of which Block 9 is said to be the most profitable and is claimed by Israel.

In the first half of February 2018, Lebanon signed a contract for exploratory and production works with Italian Eni, French Total and Russian Novatek. Since the works are to be carried out in Block 9, Israel described Lebanon’s action as “very provocative”, paving the way for a military showdown. In response to it, the Hezbollah leader Hassan Nasr Allah threatened to target Israeli offshore gas platforms.

The Israeli media are already speculating about the third Lebanese war and suggest that the Hezbollah attack on Israel is inevitable. In mid-February, US Secretary of State Rex Tillerson declared that Washington could help resolve the dispute between Israel and Lebanon, but Hassan Nasr Allah refused to have talks with the United States, a dishonest broker. Hezbollah is supported by Iran as is Lebanon by Turkey.

Tel Aviv accuses Ankara of supporting Hamas, while Turkey says it merely defends Islam and Palestinians. The presence of Israeli troops in Cyprus is perceived by President Erdo?an as interference in the Turkish sphere of influence. It was in June 2017 that Israeli commandos carried out the largest military exercises so far, aimed at counteracting a possible annexation of Cyprus by Turkey.

Gas deposits in the Eastern Mediterranean attract the attention of European, Russian, Iranian, Turkish and American armed forces. Cyprus occupies here a strategically important place. The number of players is a sum of the countries directly involved and their allies. Gas, like crude oil, has the potential of igniting a new wave of violent encounters between enemies and friends.

Yet development of eastern Mediterranean resources is far from straightforward because of the cocktail of political risks and rivalries involving the countries concerned.

“The exploitation of gas reserves could change dramatically the political and economic climate in the eastern Mediterranean,” says Emmanuel Karagiannis, an energy security specialist at King’s College London. “At the same time it has the potential to exacerbate decades-old border disputes and generate new tensions.”

The incentives for co-operation are strong but so too are the barriers. Whatever happens, it looks like Europe’s energy map could look very different in a few years….

Food for thought!