Eurozone Crisis Impacts Cyprus's Natural Gas Dreams

Cyprus, thrilled to be taking over presidency of the European Union on 1 July, has a more immediate problem. Several of the largest banks there last month were essentially downgraded to junk status.

On May 22 New York and London-based Fitch Ratings Ltd. downgraded to junk status some of the bonds issued by the Cyprus Popular Bank, Bank of Cyprus and Hellenic Bank, the island's three main financial institutions. On 24 May Moody's credit agency confirmed Fitch Ratings Ltd.'s evaluation of Cyprus Popular Bank, also downgrading its rating.

Wait, it gets worse - Central Bank governor Panicos Demetriades said that Cyprus is struggling to find $2.49 billion to inject into Cyprus Popular Bank (known on the island as Laiki Bank), its second largest lender, by a 30 June deadline. Adding to the apocalyptic scenario, since Cyprus doesn't have its own money to recapitalize the bank, it's possible cap in hand options include asking for assistance from Brussels, even though the EU is struggling with fiscal meltdowns in Greece and Spain, approaching the Russian Federation for loans, or attempt to tap into Greek bailout funds already allocated by the European Central Bank.

And it's going to be a tough slog for Cyprus Popular Bank to scare up such capital, given that not one but two credit agencies have downgraded them to junk bond status.

During an interview Demetriades noted, "clearly, the closer you get to the deadline, the less unlikely (asking for EU bailout money) becomes," before adding that it was "crunch time."

President Demetris Christofias said his country had been engulfed by large exposure to Greece, commenting, "I don't want to absolutely exclude it."

One of the first casualties of the Cypriot fiscal crisis is likely to be Nicosia's dreams of developing its offshore natural gas reserves, not that they haven't already been engulfed in political controversy.

In 2010 the U.S. Geological Survey estimated that the Mediterranean's Levant Basin Province, covering offshore waters of the Gaza Strip, Israel, Lebanon, Syria, Cyprus and the Turkish Republic of Northern Cyprus (TRNC), could contain as much as 122 trillion cubic feet (tcf) of natural gas. USGS Energy Resources Program Coordinator Brenda Pierce said, "The Levant Basin Province is comparable to some of the other large provinces around the world, and its gas resources are bigger than anything we have assessed in the United States."

It hardly takes a crystal ball to predict that the discovery would set off a feeding frenzy of interest and maritime claims and counter-claims. In short order Turkey was warning Cyprus over its drilling activities, while Israel's interest in offshore waters angered Lebanon. Stress between Turkey and Cyprus dated back to 2003, when the Republic of Cyprus signed a deal with Egypt over drilling rights and continued to expand cooperation in 2007 with Syria, Lebanon and Israel, ignoring the TRNC in the process.

Politics also impacted the debate. On 31 May 2010, an unprovoked assault by Israeli Shayetet 13 Naval Special Forces commandos in international waters on six civilian vessels attempting to deliver humanitarian aid to Gaza resulted in the deaths of eight Turkish civilians and an American. Despite Turkish insistence that Israel apologize for the assault Tel Aviv has steadfastly refused to do so, leading to a deep freeze in Israeli-Turkish relations that persists to the present day.

And last month, after Cyprus announced that 29 companies had made 15 bids for exploratory drilling in a second round of licensing to exploit offshore oil and gas deposits Turkey threatened reprisals against companies bidding for the oil and gas contracts, the Turkish Foreign Ministry stated, "The companies ... which cooperate with GKRY (the Greek Cypriot administration] will not be included in energy projects in Turkey in the future."

And the turmoil in Syria is also complicating the overall picture, as on 22 June Syria downed a Turkish jet off its coast, which Damascus claims was two miles from its coast but that Ankara insists was well outside Syria's 12-mile territorial waters.

While international energy companies are known for taking risks, the current political and economic issues involved in drilling for potential hydrocarbons in the eastern Mediterranean has more layers than a baklava. Few companies will want to invest the necessary capital in such a risky venture if the host country's economy is in such a parlous state.

Given how overextended Brussels already is in coping with Greece and Spain, Cypriot politicians had better hope then President Putin is in a generous mood.

By. John C.K. Daly of Oilprice.com