Streetwise Professor

March 20, 2013

Under the Sea

Filed under: Commodities,Economics,Energy,Financial Crisis II,Russia — The Professor @ 9:47 pm

One Cyprus scenario that has received considerable hype is that Gazprom will bail out the country in exchange for rights to develop its offshore gas resources.  IMO, this reflects a fundamental misunderstanding of Gazprom’s interests.  If anything, Gazprom has an incentive to pay to ensure that Cyprus’s gas reserves are not developed.

That is, Gazprom has every reason to want the gas to remain under the sea.  Eastern Med gas would compete with Gazprom’s Russian production: if Gazprom controlled Cyprus’s gas, sales from these fields would cannibalize sales of Russian gas.  Meaning that Gazprom has no real interest in developing Cypriot gas-to the contrary.

Obtaining exclusive development rights would give Gazprom the right to not develop, and to prevent anyone else from doing so.  This would suit it quite well, and it might be willing to pay something for that right.  But as desperate as Cyprus is, it has to realize that giving Gazprom control over its gas destiny would deprive it of the future revenue its resources could generate.  It is highly doubtful that Cyprus could negotiate a deal that would effectively compel Gazprom to develop the country’s gas.  Therefore, by dealing with Gazprom it would essentially be writing off any prospect of enjoying the benefits of future gas production.

This means that Gazprom’s interests and Cyprus’s are not aligned: the latter wants to maximize the commercial development of its gas fields, the former has no such interest.  Cyprus’s horizon might be very short, given its pressing financial needs, but it would have to discount the future extremely heavily to make a deal with Gazprom remotely rational.  I consequently deem it very unlikely that Cyprus and Gazprom could reach a mutually beneficial deal.

Development rights to Cyprus’s gas might be valuable collateral for loans that ease the country’s current financial straits.  But Cyprus should look energy firms whose interest is to maximize the commercial prospects of its gas resources, rather than Gazprom, which would like nothing better than to sabotage their development.

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12 Comments »

  1. Obtaining exclusive development rights would give Gazprom the right to not develop, and to prevent anyone else from doing so.

    Some countries, not least Russia, attach clauses to the block licenses which set development and production targets to prevent a licensee from doing this. It was the perceived failure of TNK-BP to meet production targets on the Kovykta field which was the excuse the Russian government used in order to get Gazprom muscled in.

    Comment by Tim Newman — March 21, 2013 @ 2:22 am

  2. @ Tim

    Presumably though Gazprom would just refuse to treat on that basis?

    This is Yerp, though, so surely the answer is simple:

    1/ Cyprus does some deal with Gazprom
    2/ Cyprus takes Gazprom’s money
    3/ Cyprus spends the money
    4/ Cyprus welshes on deal with Gazprom, keeps money.

    Isn’t that more or less what Greece did? They counted the state pension fund as current assets in order to have a small enough deficit to qualify for Euro entry. They wanted to be in the Euro because it made credit available at German prices. They loaded up with cheap debt and spent away, a lot of it on stuff from Germany. Now they don’t want to repay the loans, partly on the grounds that they have given it to Germany already.

    Comment by Green ad Grass — March 21, 2013 @ 4:28 am

  3. @Tim . . . I’m aware of that, but I have my doubts on the ability of Cyprus to enforce such terms. In part because whereas Russia had all the bargaining power in dealing with TNK-BP, Cyprus would be in a much weaker position vis-a-vis Gazprom. The potential for ex post opportunism is pretty acute.

    And as @Green notes, you can’t discount the possibility that Cyprus could try to renege too, perhaps claiming that it entered the deal with Gazprom under duress. They could take a page from the Russian playbook, e.g., Sakhalin II where Putin justified expropriation by claiming that the PSAs were inherently unfair to Russia and exploited Russia’s desperate straits at the time they were negotiated.

    Neither party can really trust the other-at all-and I don’t really see how any deal between them could work.

    The ProfessorComment by The Professor — March 21, 2013 @ 8:04 am

  4. @ green – Rats! You’ve gone and spilled the beans!

    Of course that is what they will or should do. Cyprus’ goal is to get money, if they can beggar someone in the process, or at least give them a shave, so much the better. Not that they are necessarily planning to do this, but it is always best to keep oneself in that position if it becomes necessary (or even expedient, something not unique to the Greeks or any other people).

    One person asked why the Russians felt such a connection to Greek Cyprus. Well, one reason is that they are both Orthodox. Another is that they are both very clanish, developing formal and informal networks with many small groups, each made up of family and close friends, all of which can allied or at least joined together from time to time for common purposes (e.g. on an ad hoc basis). In other words there is a similarity in social organization, though the Cypriots lack a lot of the gangsterish aspects of Russia’s so callled society.

    While this is an overgeneralization, bordering on hyperbole, it has some validity. What the Ruskies don’t realize is that they are still Xenos – a word that has had a BROAD set of meanings over time from (dirty) foriegner to foriegn friend. If there develops a problem between Cypriot and Russian interests, the meaning will shift towards babaros, the old word for foriegner that means barbarian. At that point, all bets will be off.

    Comment by sotos — March 21, 2013 @ 8:08 am

  5. It is not clear who owns the rights to drill. Turkey has insisted that it owns the rights and has said it will defend it’s property with it’s considerable Military. Cyprus has no way to resist if confronted by Turkey. Some development has occurred but firms could be shut out by Turkey in retaliation. I read this information on the Judy Morris Report blog. This situation is a further example of the depths Govs. & the Power Elite will go to keep their Ponzi fiat money scheme going by stealing innocent savers money to prop up their failed experiment. The Fed in the US is doing the same theft in a different way by debasing the dollar thus eroding future purchasing power for the benefit of financial institutions and the profligate government removing moral hazard and allowing the bad actors to remain in power.

    Comment by Bob — March 21, 2013 @ 9:58 am

  6. The other thing about development clauses is that by invoking them Cyprus would need to deal with the court system which would increase the costs of transition to a new developer while adding delays and uncertainty. This was not an issue for Russia because Putin controls the court system and can rely on them to give a reliable outcome. Furthermore, Gazprom could no doubt engage in a variety of “phantom” developments to confuse the issue and stretch the process out any further. Also, Putin would almost certainly engage in retaltiation for taking away development rights from Gazprom as a betrayal of the real deal (as opposed to the nominal face deal).

    Comment by Chris — March 21, 2013 @ 11:29 am

  7. @Chris-All spot on. Exactly what I meant by “It is highly doubtful that Cyprus could negotiate a deal that would effectively compel Gazprom to develop the country’s gas.” Cyprus couldn’t unilaterally declare Gazprom in breach, and any litigation would be protracted and expensive. In the meantime, Gazprom could string out negotiations-no doubt backed by some rather nasty behind-the-scenes intimidation.

    The ProfessorComment by The Professor — March 21, 2013 @ 12:02 pm

  8. > That is, Gazprom has every reason to want the gas to remain under the sea. Eastern Med gas would compete with Gazprom’s Russian production: if Gazprom controlled Cyprus’s gas, sales from these fields would cannibalize sales of Russian gas. Meaning that Gazprom has no real interest in developing Cypriot gas-to the contrary.

    I am not sure that people, who have studied economics in college would agree, Professor. if we followed your logic, Gazprom would have no real interest in developing Russian gas either. It would want to sell as little gas as possible. That way, it could charge more for a liter of liquefied gas than for a 750 ml bottle of Dom Perrignon champagne. :-)

    On a serious note, I think that the amount of Cyprus gas is small, and its addition to the supply side of the world energy market would have no noticeable effect on the world oil/gas prices. Otherwise, the Cypriots themselves would use this gas to get out of their current crisis.

    Comment by Vlad Rutenburg — March 21, 2013 @ 11:07 pm

  9. > Turkey has insisted that it owns the rights and has said it will defend it’s property with it’s considerable Military.

    Yep, I don’t think Cypriots want to see Turks do to them what they had done to Armenians 100 years ago. On the other hand, the Turks may be too busy destroying Kurdistan and Syria to go into Cyprus. Even the USA can’t annihilate more than 2 foreign countries at a time.

    Comment by Vlad Rutenburg — March 21, 2013 @ 11:10 pm

  10. > But Cyprus should look energy firms whose interest is to maximize the commercial prospects of its gas resources, rather than Gazprom, which would like nothing better than to sabotage their development.

    Why would, say, Exxon or BP be any different from Gazprom? Using your “logic”, wouldn’t they too want to minimize their gas production in order to keep oil and gas prices high?

    Comment by Vlad Rutenburg — March 21, 2013 @ 11:14 pm

  11. Why would, say, Exxon or BP be any different from Gazprom? Using your “logic”, wouldn’t they too want to minimize their gas production in order to keep oil and gas prices high?

    BP and Exxon can and do maximise their production. Gazprom wants to maximise its production but is not competent to do so, hence it is sitting on vast reserves it has no idea how to exploit. In addition, Gazprom’s methods of operations make exploiting any such reserves extremely expensive, even if the reserves to not present much of a technological or logistical challenge. The Russian government’s concern is that whilst it’s figuring out how to exploit its reserves, a huge share of the global gas demand will be met by other suppliers – particularly US and European shale gas, but also conventional reserves. If Gazprom can somehow prevent non-Russian gas reaching the market, it gives them more time and (they hope!) increases the gas price to make their own projects economically viable. This does not apply to Exxon or BP because their production is already maximised: they are not sitting on reserves either scratching their heads trying to figure out how to exploit them, or wondering why even simple projects cannot be developed at today’s gas prices.

    Comment by Tim Newman — March 22, 2013 @ 2:40 am

  12. […] have all been about Cyprus’ bailout plan. Yesterday, I came across this article, titled “Under the Sea”, which took my mind back to my history books only to remind me once again what is proved to be the […]

    Pingback by Under the Sea | Gazprom to Rescue Cyprus? | The OTC Space — March 22, 2013 @ 3:11 am

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