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Sunday, 26 October 2014

Valuing Cyprus’ gas

Cyprus will struggle to make gas math work

Cyprus’ latest ideas for wiggling out of its financial fix include bundling future gas revenues into a national “solidarity fund”. But Breakingviews calculations suggest the gas discovered to date isn’t worth enough to plug the country’s 5.8 billon euro ($7.5 billion) funding gap.

Drillers operating off the Cyprus coast think they’ve found 196 billion cubic metres of the fuel lying under deep water. It’s a big find, but the gas isn’t worth anything stuck in the ground. Cyprus wants to build an LNG facility to extract it. The value of such a project depends on gas prices, the size and cost of the infrastructure that eventually gets built, the margins received on gas produced, and the discount rate applied to future cashflows.

On optimistic assumptions for project costs and gas prices, an 18 billion cubic metre per year LNG facility - big enough to supply about a quarter of Germany’s current annual gas needs - might be worth about $7.8 billion today.

That would plug the gap, but assuming a project life of 25-30 years, Cyprus and its development partners would need to have access to at least 450 bcm of gas to justify building a project that big. That’s more than double the gas discovered to date, not all of which is likely to be recoverable.

Without big new discoveries, a smaller 5 bcm per year facility might be feasible, but it would be worth less than $2 billion on the same estimates for project costs and gas prices. But at today’s implied medium-term European gas price of $10 per mbtu, and assuming construction costs in line with other recent offshore LNG projects, such a small project probably wouldn’t be worth building.

Either way, gas may not be enough to save Cyprus.

Run the numbers

Cyprus

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