05 November 2012

Visit Notes: Cyprus - 2nd November 2012

On 2 November, I spoke in Nicosia at a conference organised by ACCA and the Cypriot accounting community on the occasion of the Cypriot Presidency of the EU. The principal speaker was Finance Minister Shiarly, President of ECOFIN.

I also had the opportunity of conversations with an Opposition Member of Parliament as well as various officials and journalists. The event was organised by the ACCA rep in Cyprus – who happens to be the wife of a well-placed independent runner in the Presidential election next February. 

The natural gas discovery

The most startling aspect for me was the realisation of the magnitude of the recent natural gas discovery. The implications for the geo-politics of the entire Eastern Mediterranean region and the EU’s energy security are profound.

The government’s Director of Energy described the late-2011 find in block 12 (of 13 to the south and east of the island) as holding 7 trillion cubic feet (TCF) of gas. 1 TCF is enough for the island’s needs for perhaps 20 years. But this discovery is only part of a string in the entire area – with gross reserves now running at 35 TCF. Encouragingly, all the data he supplied tallied precisely with data publicly reported by the listed US oil exploration company that has done the drilling.

Cyprus, Lebanon, Israel and Egypt (but not Turkey) all recognise the Law of the Sea and have agreed international boundaries of their Zones so that drilling can proceed with legal certainty. Israel and Egypt have each drilled 400-500 wells so the geology is now reasonably understood. There is an exchange of information with Cyprus that allowed the first Cyprus well to hit gas. In answer to my question about discoveries between Cyprus and Turkey, the Director replied that no-one has provided him with any geological information about the sea north of the island.

There are about 14 structures in the Cypriot area that have 'promising' structures, and three blocks are now being licensed for drilling. (Subsequently Turkey has announced that any oil companies involved in Cypriot drilling may be excluded from future activities in Turkey.) Block 12 is a deep well - at around 6,000 feet – and they are planning to drill right through the gas zone to about 10,000 feet where there is a significant chance of oil. The significance to the EU is that EU gas reserves were said to be around 30 TCF and potential reserves in the Cyprus blocks could range up to 60 TCF.

Developing these finds will be expensive as perhaps half the revenues will go on costs and they need perhaps €10 billion to start selling the gas. So it could be 2017/18 before gas flows even produce domestic electricity. The schematic drawings of pipelines went to Greece (via Crete) and Italy – not Turkey. 

The Troika

Negotiations with the Troika are the current top priority but the government’s negotiating position is very tightly held. At the outset, there was cross-party discussion on a counter-proposal to the Troika but the opposition has not been informed of progress. Minister Shiarly could not stay for lunch as he had to call the Troika to continue negotiations. Technically, the Troika is not yet planning a visit but it is clear that negotiations are continuous. Apparently, the Minister told the Greek speakers that “we will certainly agree” with the Troika and by the 12th November – but that date seems optimistic to me at this stage. There are several well-publicised political red lines but two seem economically critical: banking recapitalisation and the use of future gas revenues.

Banking re-cap: As with Spain, a loan-by-loan assessment is underway and being done by Pimco. The full results are not due until mid-January. It was said that perhaps 30-40 per cent of the bank loans are to Greek borrowers and that Pimco is ascribing a nil value to any loans where the documentation is not in perfect order – frequent amongst the Greek loans. I put a question to one of the senior accountants about potential losses and he deflected this to a bank regulator in the audience. His reply was that losses could be in the €6-12 billion range. That sounded as if he was quoting the media … but it is higher than most media comments.

If the Greek loans really are so large, and with such big write-offs, then these numbers still sound rather low! The Minister is reported to have said that they would agree an upper boundary with the Troika and then finalise later. (However, the subsequent Der Spiegel article (link) about Russian mafia being the chief beneficiaries of an EU bailout has underlined my long-standing fears that this was going to be a very difficult political debate that is a long way from finished.)

Use of gas revenues: Cyprus has already negotiated one loan from Russia and media reports have suggested they would try to do that again. However, this now seems unlikely as Russia is unwilling to accept that any new loans would be junior. Indeed, they want Cyprus to exclude language about junior loans from the Troika agreement (very unlikely in my view!). The other reason why Russia may be unwilling to offer loans is that the security will undoubtedly be the future gas revenues. The Troika allegedly wants all these revenues paid into a separate company on behalf of the official debt holders so they would be unavailable to service Russian debt.

Conclusions

The existing, proven gas reserves add a geo-political dimension that may change radically if new discoveries confirm the scale of the possible reserves (and how far west does this gas province extend?). But the politics of an EU-bail out of “Russian money launderers” will be very difficult in Germany – given that the final decision on any use of ESM funds may be taken by a vote on the floor of the Bundestag. The Pimco report on the banks' capital needs may be revealing on this, and the February 2013 Presidential election may turn out to be pivotal – but can the government finance itself until then?

© Graham Bishop