29 September 2014 Cyprus LNG plant: Ithaca or Calypso’s enchanted island?

The ITE East Mediterranean Gas Conference in Paphos on September 9-10 underlined what a difficult job is faced by the energy minister, George Lakkotrypis, in making what is probably the single most important decision for the Cyprus economy in the next 20 years.
I count at least seven options for gas exports: land-based liquefied natural gas (LNG); floating LNG (FLNG); marine compressed natural gas (marine CNG); pipeline to Egypt; pipeline to Greece; pipeline via Turkey to the EU; or, end-product (electricity) to the EU via an electricity cable to Greece.
One might think of Cyprus’ most popular minister as the Homeric hero, Odysseus, shipwrecked after Troy and trying to find his way home to Ithaca. For LNG fans, Ithaca is the land-based LNG plant; the sirens are all the other options.
To avoid being lulled by the sirens’ beautiful calls and thereby dashed on the rocks, Odysseus has to stuff up the ears of his crew with beeswax and get them to tie him to the mast. The more he signals to them to let him free and follow the sirens, the tighter they have been instructed to bind him.
He gets past the sirens and eventually (after a lot of diversions), he finds his way home to Ithaca.
But what if the land-based LNG plant is in fact Calypso, the lovely braided nymph who keeps Odysseus as a captive lover for seven years and thereby delays his journey home?
The reason why it is not easy to decide whether the LNG plant is Ithaca or Calypso’s enchanted island is because each of the significant uncertainties about the gas demand, gas supply and gas prices in the coming years.
The following paragraphs outline my take-outs from the conference.

European gas demand will remain slack
Despite the fallout from the Ukraine crisis, no one expected European gas demand to rise significantly, unless there were a change in carbon dioxide (CO2) emissions taxes to make coal less attractive than it is today. Germany, in particular, has been ramping up consumption of coal as it prepares to phase out nuclear power by 2022.
Yet predictions are also shaky. Uwe Fip of E.ON Global Commodities said that scenarios for EU gas demand are extremely wide, ranging from 200 billion cubic metres (bcm) to 600 bcm, compared with demand of around 440 bcm today.
“The future of the European natural gas market is highly uncertain,” he said.
Nevertheless, Russia was still expected to remain the dominant supplier. Jennifer Coolidge of CMX Caspian and Gulf Consultants said that the sanctions on Russia would not affect supply until after 2020.
Doubts were also raised about Egypt as a long-term market for liquefying gas. Egypt has 77 trillion cubic feet (tcf) of proven gas reserves—far more than Israel and Cyprus. Changes in subsidies will reduce domestic demand and Egypt is seeking investors.

Asia to remain the most attractive market
The general consensus was that Asia will remain the most attractive market for gas in terms of demand. But there will be a great deal of competition on the supply side.
US LNG is expected to reach 75 bcm per year, Australian LNG is expected to reach 80 bcm, while Mozambique is expected to reach just under 70 bcm. To give you an idea of size, German demand in 2013 was 84 bcm, while total EU28 demand was just under 440 bcm.
Competition means that there is an imperative to move fast. Speaking of the Asian market, Mel Ydreos of the International Gas Union said, “The market will not stand still. There is urgency to get involved and sign contracts.”

Gas prices: some price convergence but Asia will retain premium
There was also agreement that the fall in Asian gas prices would continue. Most commentators talked about an Asia price of around $12/mbbtu—significantly lower than the peak of around $18 in mid-2012 but also lower than the latest spot price, which was around $14.5/mmbtu for November contracts, according to the ICIS East Asia Index.
The fall in price will be for a number of reasons. Japan plans to re-start some of its nuclear reactors; Australia will start ramping up supply; and the recent agreement between China and Russia to supply 38 bcm via pipeline will temper demand for LNG. In addition, China has also commissioned 28 nuclear reactors to add to the 21 it already has.

LNG is the highest threshold for profitability
Price matters because the cost of production affects break-even prices. According to Sergey Paltsev of MIT, the break-even prices vary from as low as $3.29 for a pipeline to Turkey and as high as $9.75 for (land-based) LNG sold to Europe and $10.25 for Asia. Ashna Rahman of Platts also spoke of a profitability threshold of around $9/mmbtu for winter sales to Europe. At the end of August, Europe LNG spot prices were only just over $9/mmbtu.
The threshold is higher for land-based LNG because the costs of construction are enormous: $6bn for the first train, $3bn for each train after that and, by some estimates, another $10bn in related costs including the 30% of gas gobbled up in the energy-intensive liquefaction process. The total cost of $20bn is close to Cyprus’ GDP in 2013 of $22bn (EUR 16.5bn).
By contrast, the world’s first FLNG plant under construction, Shell’s Prelude, is estimated to be costing $12bn. Moreover, the smallest FLNG plant, Exmar offshore Columbia, is currently being built for as little as $300m, according to Olivier Benyessaad of Bureau Veritas.
However, FLNG capacity is small compared with a land-based LNG plant. Even the mighty Prelude is only expected to be able to export 3.3 MPTA (million tonnes per annum), compared with 5 MPTA for a single-train LNG plant.
Taking the low estimate of 3.6 tcf for the Aphrodite field in Block 12 and deducting 30% lost in the liquefaction process, I estimate that Aphrodite has the capacity for 2.6 MTPA.
This is closer to the capacity off the INPEX Abadi FLNG plant, which Benyessaad cited at a cost of $5.4bn. This is in waters of 1000 m rather than 2000 m for Aphrodite. Add another 50% for the depth and one might be looking at a cost of around $8bn for an Aphrodite filed.
According to my rough estimate (see table) that might bring the break-even price down to as low as $4/mmbtu for FLNG.

Land-based LNG will depend on ENI-Kogas
However, the land-based LNG option remains attractive because of all the other things that would come with it.
Stavros Spanos of Hyperion Systems Engineering noted that a land-based LNG terminal has much bigger network effects. Not only would it create jobs for construction workers (who will probably not be Cypriots), it would also create jobs for service companies.
More interestingly, it could create a whole new industry of gas industry products such as methanol, said Spanos.
Thus, a land-based LNG plant will allow Cyprus to be a true regional hub for energy.
The only way to beat the price uncertainty that affects the viability of a land-based LNG plant is with higher volumes. According to my own estimates published for Sapienta Country Analysis subscribers in June, the profitability threshold for a land-based LNG plant is 7 tcf if prices remain the same, but it rises to 10 tcf if they fall by 20%.
This is why so much hope is being put on the ENI-Kogas drilling, which will start any day now.
It is also why our Homeric hero Lakkotrypis will remain tied to the LNG mast until December or January, when the preliminary ENI-Kogas results are in. . Read on