The Pandemic Depression
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On August 30, the Italian state-controlled energy company Eni announced the discovery of a “supergiant” gas field off the coast of Egypt. According to initial assessments, the Zohr field contains 30 trillion cubic feet (Tcf) of natural gas (equivalent to 5.5 billion barrels of oil), making it the largest ever discovery of gas in the Mediterranean. This is welcome news for Egypt's struggling economy and fragile political situation. It also creates new challenges and opportunities for the country's neighbors and for outside powers such as Vladimir Putin's Russia. Additionally, it provides powerful economic incentives for Cypriot reunification. As the United States takes stock of what Egypt's good fortune means for the region, it should find much cause for celebration.
The Zohr field is the latest in a series of large offshore gas discoveries in the eastern Mediterranean. In 2009 and 2010, Israel celebrated the discovery of the Tamar and Leviathan fields, which together hold up to 26 Tcf of natural gas. Adjacent to Leviathan, in Cyprus' exclusive economic zone, lies the 7 Tcf Aphrodite field, discovered in 2011. Once developed, these deposits could satisfy both countries' domestic electricity needs for decades and open new opportunities for exports.
While its neighbors were experiencing a gas bonanza, Egypt fell on hard times. Historically the second-largest gas producer in Africa, with 77 Tcf of proven reserves, in recent years Egypt has become a net importer. With falling production unable to keep up with rapidly growing domestic demand, and political turmoil slowing exploration and investment, the country experienced regular power outages. Because the Hosni Mubarak and Mohamed Morsi regimes both fell during periods of regular power cuts, the government of President Abdel Fattah el-Sisi views these outages as a national security threat. To keep the lights on and quell potential unrest, Cairo has shifted energy from industry to residential areas, signed deals to import expensive liquefied natural gas (LNG), and accumulated a growing debt to foreign oil and gas companies.
Given this bleak backdrop, it is not surprising that one Egyptian politician described the Zohr discovery as a “gift from God.” The offshore field increases Egypt's existing gas reserves by almost 40 percent. Eni plans to fast-track the field's development, with drilling set to start in 2016 and production in 2017, putting Egypt on course to become energy independent by 2020. Because of relatively low development costs and abundant existing infrastructure, production can move ahead at a time of historically low energy prices.
Egypt faces a choice as to whether it should try to use Zohr's resources to reassert its place on the export market or simply keep the gas for domestic use. Unsurprisingly, on this point, Egypt and Eni disagree. Petroleum Ministry spokesman Hamdi Abdelaziz has emphasized that “all the production will go to internal consumption.” But Eni chief executive Claudio Descalzi has suggested that the field may also provide new supply options for Europe.
Even if it manages to overcome these challenges, Egypt will find itself entering an already overcrowded international marketThe domestic option has several advantages. Other than the need to build a new pipeline from the field to the Egyptian coast, the infrastructure requirements for domestic consumption are minimal, allowing Egypt to move the gas to market sooner. Output from Zohr would save Egypt at least $2 billion per year in fuel imports and help pay down the country's debts. Enhanced energy security should help increase political stability at home. That said, the temptation to export will be difficult for Egypt to ignore, with production at Zohr projected to exceed domestic demand by 2020. At that point, Eni will also begin to see the export market as potentially more lucrative.
Still, in contrast with the cheap-and-quick domestic option, bringing the gas to European markets would require a significant investment in infrastructure. There currently exist no pipeline routes connecting Egypt with mainland Europe, and new ones, presumably through Turkey, will need to pass through partially contested waters. The alternative is to reopen Egypt's dormant LNG shipping facilities. Exporting the gas by boat would give Egypt more flexibility in export routes and destinations, but the added costs of liquefaction, storage, transportation, and regasification could make Egyptian gas prices less competitive, particularly against cheap Russian gas in Europe. Even if it manages to overcome these challenges, Egypt will find itself entering an already overcrowded international market, on the heels of new discoveries in the United States, the lifting of sanctions on Iran, and stiff competition from major regional players such as Qatar.
ISRAEL'S PLAN B
If the find is good news for Egypt, it will be less well received in Israel. Before Zohr's discovery, Israel had signed letters of intent to export about a quarter of Tamar's production and a significant proportion of Leviathan's to two LNG plants in Egypt and another deal to provide gas to Egyptian industrial companies. These exports were supposed to help pay for Leviathan's development, which has remained on hold since 2010 because of regulatory and political gridlock in Israel. Zohr has rendered such plans mostly moot, leaving Israel with one less market for exports and, potentially, a new regional competitor.
Jerusalem has thus started scrambling for a plan B. To export LNG by ship to European and Asian markets, Israel would need access to liquefaction facilities, such as those in Egypt. But if Egypt decides to export its own gas after meeting domestic demand in 2020, its two LNG plants will already be operating at full capacity, removing that option for Israel. The high price tag of building new LNG facilities from scratch in Israel would likely deter their construction at current oil prices. The alternative is to build a gas pipeline to Europe through Turkey. This route would need to pass through Cypriot waters, but Cyprus has so far opposed this option because of ongoing tensions with Ankara.
Cyprus, too, has had a hard time bringing its offshore gas to market. The 2013 banking crisis slowed investment, and Nicosia's strategy for developing the Aphrodite field until recently centered on Egyptian exports. In February 2015, Cyprus signed a preliminary accord to deliver offshore gas to Egypt through a new undersea pipeline, with exports projected to begin in 2022. The Zohr discovery has effectively removed this option from further consideration.
By way of a plan B, Cyprus has two possibilities. First, it could develop LNG facilities jointly with Israel, but the economic viability of such a project is doubtful under present market conditions. Alternatively, Cyprus could sell gas to Europe via a pipeline through Turkey. Yet here, too, there are problems. Northern Cyprus, occupied by Turkey since 1974, claims co-ownership of the island's natural resources. Officially, Turkey does not recognize Cyprus' maritime boundaries and has challenged Nicosia's claim to the Aphrodite field. The prospects of a northern route—and any trade with Turkey—depend on whether ongoing talks between Greek and Turkish Cypriots result in the island's reunification.
The Zohr discovery has raised hopes in some Western circles that the new supply options can help Europe reduce its energy dependence on Russia, which in 2013 accounted for 71 percent of gas imports to central and eastern Europe. Such an outcome is unlikely. Under the most optimistic scenario, Egyptian gas will not reach the European market for another seven to ten years. Even then, Egypt will not be able to shake Russia's market dominance. With total proven gas reserves of 1,680 Tcf, Russia exported about 5 Tcf to Europe in 2014 alone. Egypt cannot compete on that scale unless significantly more gas is found.
Although Russia does not see the Egyptian discovery as a major challenge to its energy strategy in Europe, Zohr does affect Russia in other, more localized ways. Along with Israel and Cyprus, Russia also stands to lose a gas export market, having recently signed an agreement to transfer 3.5 million tons of LNG to Egypt over two years. Yet Russia's interest in Egypt's domestic energy market reaches well beyond LNG. In late August, Putin announced Russia's participation in the construction of a nuclear power plant in Egypt, and Russian energy firms have been eyeing undersea pipeline construction contracts to help bring the Egyptian gas to shore. Since Western powers imposed sanctions on Russia over the conflict in Ukraine, Moscow has been actively courting Egypt as a potential economic and military partner. The new discoveries are more likely to reinforce than impede this approach.
The United States has been a relatively minor player in current eastern Mediterranean affairs. After Sisi removed Morsi in a military coup in 2013, Washington kept Egypt's government at arm's length and has spent the last few years preoccupied with other challenges, such as the self-proclaimed Islamic State (also known as ISIS) in Iraq and Syria and Russian actions in Ukraine. Despite this relative disengagement, recent events have important ramifications for U.S. interests in the region, most of them quite positive.
New domestic energy supplies can help Egypt confront a growing Islamist insurgency in the Sinai peninsula more effectivelyFirst, the discovery of the Zohr field greatly enhances Egypt's energy security and Cairo's ability to provide public goods to a restive population. By reducing the potential for social unrest from power cuts and resulting economic shocks, new domestic energy supplies can help Egypt confront a growing Islamist insurgency in the Sinai peninsula more effectively and ultimately become a net exporter of security in the region.
Second, although Zohr presents a setback for Israel's energy strategy, the U.S. ally's long-term energy prospects remain bright. Exporting Israeli gas to Egyptian LNG installations was a controversial proposition from the start, and even if Leviathan's gas will serve only the domestic Israeli market, it will still ensure Israel's energy independence for several decades to come.
Third, the Zohr discovery creates powerful economic incentives for Cypriot reunification. With exports to Egypt off the table, Nicosia's ability to develop the Aphrodite field will depend more than ever on rapprochement with Turkey and Northern Cyprus. If reunification talks succeed, Cyprus will also likely lift its opposition to an undersea pipeline route to Turkey from either Israel or Egypt. Even if eastern Mediterranean gas is insufficient to offset Russia's market dominance, the prospect of it reaching European markets through Turkey would be a boon for all parties involved, creating additional stakeholders for a unified Cyprus.
Finally, the scale of the new Egyptian gas deposits is a highly promising development for future gas exploration in the eastern Mediterranean. The possibility of new oil and gas discoveries in the region will enable littoral states to meet their domestic consumption needs more easily, while putting further downward pressure on global energy prices. An energy-abundant future may pose challenges of its own, but it is good news for the region’s economic and political stability. Washington should welcome the discovery of the Zohr field.