The Fuse

Obstacles Trump Optimism for the Eastern Mediterranean Energy Corridor

by Nick Cunningham | August 11, 2015

The leaders of Israel and Cyprus agreed on July 28 to cooperate on energy issues in an effort to accelerate development of offshore natural gas reserves spanning both countries’ territorial waters. “There is palpably renewed energy in our relationship, I mean that figuratively and literally,” Israeli Prime Minister Benjamin Netanyahu said in a statement following his meeting with Cyprus’ President Nicos Anastasiades. He went on to add: “[We] think that by cooperating with each other we can take it out more easily, we can market it better, to the betterment of both our societies.”

But details were vague, and without more specifics there is little reason to believe that the hurdles can be overcome, at least in the near term. That means production of natural gas from the enormous offshore reserves in the Mediterranean may not reach its potential, and the transformational effect hoped for when the discoveries were made is unlikely to come to pass.

The Eastern Mediterranean Energy Corridor

In 2009, Noble Energy and its partners found the Tamar field, which holds an estimated 10 trillion cubic feet (tcf) of natural gas. The following year they topped that achievement with the Leviathan, a giant gas field that could hold 16 tcf, enough to make it the world’s largest gas find in 2010. Noble added the Aphrodite discovery in 2011, a 7 tcf field located in the waters of Cyprus.

The Tamar field now supplies a significant portion of gas for Israel’s electricity market, but that achievement pales in comparison to what many expect the Leviathan to accomplish.

The gas discoveries in the Eastern Mediterranean hold significantly more gas than Israel can consume domestically, leaving quite a bit for export. In addition to eliminating its imports, development could allow Israel to export gas to Jordan, Lebanon, Egypt, and maybe more.

Over the lifetime of the project, the Leviathan gas field could contribute $230 billion to Israel’s GDP. But the potential goes beyond mere economic benefits, and the discovery has been held up as a “game changer” for the region. The gas discoveries in the Eastern Mediterranean hold significantly more gas than Israel can consume domestically, leaving quite a bit for export. In addition to eliminating its imports, development could allow Israel to export gas to Jordan, Lebanon, Egypt, and maybe elsewhere.

There was a prevailing view that a network of pipelines and the associated natural gas sales could economically tie together Israel and its neighbors, providing the region with a new source of energy and even reducing entrenched tensions.

Following an agreement to sell gas from the Leviathan to the Palestine Power Generation Company in 2014, Delek’s controlling shareholder framed the agreement in the context of Israeli-Palestinian peace. “Economic cooperation such as the agreement signed today will lead to prosperity and growth and will contribute to the fostering of mutual respect and trust between Israelis and Palestinians and lay the foundations for peace,” Yitzhak Tshuva of Delek Group said.

“Economic cooperation such as the agreement signed today will lead to prosperity and growth and will contribute to the fostering of mutual respect and trust between Israelis and Palestinians and lay the foundations for peace,” Yitzhak Tshuva of Delek Group said.

Even more ambitious goals lay just over the horizon. A proposed “East Med Pipeline” could connect the Eastern Mediterranean gas to Central and Western Europe. The pipeline would run from the offshore gas fields, through Cyprus, then through either Turkey or Greece, and on to the rest of Europe, establishing an “Eastern Mediterranean Energy Corridor.”

Vice President Joe Biden visited Cyprus in 2014—the highest-ranking U.S. official in more than five decades to visit the island—to express American support for Cyprus’ development of offshore gas. “Cyprus is poised to become a key player…transforming the eastern Mediterranean into a new global hub for natural gas,” Biden said.

In other words, optimists believed that Noble Energy’s gas fields could contribute not only to Israel’s economy, but they could also mitigate some of the most volatile tensions in the Middle East, improve regional energy security, and even allow Europe to reduce its gas imports from Russia.

Dialing Back the Optimism

However, a dose of reality has set in as political and economic complexities have deflated the hype.

The first and most immediate problem lies within Israel itself. Noble Energy’s exploits have been stymied by Israeli antitrust regulators who objected to Noble controlling too much of the Mediterranean gas fields. The scrutiny, along with what industry executives say became an increasingly hostile business climate before Israel’s March 2015 election, has sidelined investment. The government increased taxes and moved to limit the ability for Noble to export gas, as populist pressure pushed for the gas to be used for domestic purposes first.

In May 2014, Woodside Petroleum, an Australian LNG developer, opted against taking a 25 percent stake in Leviathan, as the main partners expressed interest in pipeline exports instead of LNG. However, many think regulatory and tax uncertainty also played a large role.

Noble and its partner, Delek Group, thought they were close to an agreement with Israeli regulators last year that would have resolved antitrust concerns, after they proposed to divest from two smaller gas fields (Tanin and Karish). The emerging deal would have allowed the companies to hold onto the Tamar field and move forward on their real target—the massive Leviathan field.

But that offer languished for months as regulators dragged their feet and then ultimately backtracked on the proposal in late 2014. The top regulator instead preferred a breakup of Noble’s holdings.

In a quarterly earnings call in February 2015, Noble’s CEO David Stover said due to the regulatory uncertainty, “we have suspended essentially all investment in Israel,” putting the Leviathan on hold. “[We] are also prepared to vigorously defend our rights related to our assets in Israel,” he stated definitively. Noble postponed its spending plans for the Eastern Mediterranean, instead focusing its investment assets in the Gulf of Mexico.

Noble postponed its spending plans for the Eastern Mediterranean, instead focusing its investment assets in the Gulf of Mexico.

The delays resulting from Israel’s antitrust regulator led the Palestine Power Generation Company to call off the deal that it agreed to with the Leviathan partners.

Only in the last few weeks has the Israeli government pushed a resolution to the standoff. Under an outlined regulatory framework, Noble and Delek would sell off the agreed upon gas fields and reduce their stake in Tamar from 36 percent down to just 25 percent over the next six years. In exchange, the companies would be assured no antitrust action would be taken against them.

Regional Transformation

These developments could allow the companies to proceed with development of the Leviathan. If and when the field comes online (currently not expected before the end of the decade), there is still the potential for major impacts across the region. Noble and Delek had lined up tentative deals to sell gas from Leviathan when it comes online, including a $15 billion deal with Jordan’s national electric company and a $30 billion gas deal with BG Group in Egypt.

Both countries are in need of energy. Egypt has suffered from energy shortages, causing significant blackouts. This has forced the government to contract for floating regasification units, allowing it to import LNG. Egypt signed deals to import LNG from Trafigura, Vitol, Noble, Algeria’s Sonatrach, and Gazprom. LNG will help Egypt ease its energy crisis in the short term, but it will come at great expense. Thus, linking up to the Leviathan is clearly within Egypt’s interests due to its need for cheaper natural gas supplies.

Many hope that turning the Eastern Mediterranean into an energy corridor could also cement political ties and reduce tension. It could even provide a building block for lasting peace, although such outcomes are rather speculative at this point. There are deep-seated, longstanding sources of conflict between Israel and its neighbors that show little sign of resolution in the foreseeable future. Predictions that an energy project will solve these problems are over the top, to say the least.

East Med is a Pipe Dream

While the Leviathan could have some positive regional impacts, talk of the Eastern Mediterranean becoming a major source of European energy is similarly overblown.

The EU Commission selected the Eastern Mediterranean Pipeline as a “project of common interest,” warranting it further study. The pipeline would run from Cyprus to Crete and then to continental Europe. EU officials are attracted to the idea because it would allow Europe to slash its dependence on Russian gas, and with Greece’s economy mired in deep depression, the East Med Pipeline could be viewed as an economic development project for Southern Europe.

However, there are several reasons this project won’t move beyond the dream phase.

Building a pipeline over such a vast distance, and through deep Mediterranean waters, would be prohibitively expensive.

First, building a pipeline over such a vast distance, and through deep Mediterranean waters, would be prohibitively expensive. The pipeline from Cyprus to Crete alone could cost $20 billion. Second, the politics are dreadfully complicated. The longstanding division of Cyprus stands in the way of a cheaper pipeline route through Turkey. In fact, Turkey flatly objects to the development of gas in Cypriot waters, which it does not recognize—a dynamic that won’t change anytime soon.

There are several LNG alternatives for the Leviathan. An LNG terminal in Cyprus has been looked at. This would allow for more flexibility than a long-distance pipeline and is probably the most economical route for large-scale gas exports. However, the site location at Vassilikos is small, raising engineering questions. Furthermore, Israel wants to ensure it maximizes export revenues and can properly manage the facility’s security, making a terminal outside of Israeli territory unlikely.

An alternative is an LNG facility within Israel, but environmental opposition, interference with tourist destinations, and competition for space with container ports present challenges to this approach.

Limited Energy Hub

The development of the Leviathan, which is again inching forward now that the Israeli government is settling its differences with Noble Energy and Delek Group, could be a significant milestone for the region. It will introduce a very large source of natural gas for Israel and its neighbors, providing an economic boost while offering potentially positive (although largely theoretical) geopolitical benefits.

Energy trade can contribute to positive cooperation, but it is unlikely to single-handedly transform the longstanding points of conflict between Israel and its neighbors.

But talk of a larger “game changer” with the Leviathan is quite clearly overstated. Energy trade can contribute to positive cooperation, but it is unlikely to single-handedly transform the longstanding points of conflict between Israel and its neighbors.

Furthermore, exports to Europe are questionable, if not unlikely. A pipeline is too expensive, and LNG export terminals face technical challenges, not to mention long lead times. As a result, offshore gas in the Eastern Mediterranean will likely remain a regional story, rather than a global one.