Suddenly, it’s all happening in the Eastern Mediterranean.

After years of delay, confusion and dwindling hopes, the efforts to develop the offshore natural gas Israel discovered in 2009-2010 — especially the giant Leviathan field — are back on track. This rebirth began late last year, but it is the slew of developments in recent weeks which seems to signal a move into much higher gear.

If Israel’s potential as an energy producer is this time fulfilled, it will impact everything from regional geopolitics to the commercial prospects of the specific American, Israeli and Greek-Cypriot energy companies now engaged in exploration and production. But that remains a very big “if.”

The most significant of the recent developments serves to illustrate how complex and multifaceted the Eastern Mediterranean energy story is — as well as why nothing about it should be taken at face value.

On August 8, Egyptian President Abdel Fattah al-Sisi signed into law a measure that will allow Egyptian private companies to import natural gas. The immediate reaction, reflected in media reports and analysts’ updates, was that this move opens the way to the sale of gas from the Leviathan field to Egypt — thereby providing the major export market that the Leviathan project badly needs to ensure its viability.

Not only would the consortium that owns Leviathan rake in profits, but also the Israeli government — which has adopted a policy earmarking Leviathan’s production for export — would benefit from royalties on sales and taxes on the profits. Best of all, from Israel’s point of view, opening up a large export market such as Egypt would generate interest on the part of more foreign energy companies in the new round of licenses that the Israeli government is currently offering for exploration in its EEZ (exclusive economic zone, extending 200 miles from its coast), including areas close to the Leviathan field.

All of those desirable things might indeed happen — but first there is a long list of problems to be addressed and resolved. First, importing Israeli gas to Egypt may now be legal, but that very fact may strengthen the already significant domestic political opposition within Egypt to expanding commercial ties with the Jewish state.

Then there is the matter of physically getting the gas to Egypt. One possibility is to bring it ashore in Israel and then via pipeline through Jordan — but this would offer an easy target for Islamic terrorist groups, as had already occurred in 2011-2012, when Egypt was exporting its gas to Israel and Jordan.

An even more basic question is whether Egypt actually needs to import Israeli gas. If it were available immediately, the answer might be yes, because Egyptian domestic production is currently insufficient to meet its requirements. But by the time Leviathan enters production — probably in 2020 — Egypt will have no need for imports, thanks to its own giant field, Zohr, which Italian energy firm ENI discovered in 2015 and, after a remarkably rapid development schedule, is likely to bring online in 2018.

There is an alternative scenario for Leviathan gas to be sold to Egypt. First, it could be pumped directly there, via an undersea pipeline — possibly linking up with the infrastructure being built for the Zohr field. In any event, the gas would not be earmarked for the Egyptian domestic market, but rather for re-export after being converted to LNG (liquefied natural gas) in one of two large LNG facilities in Egypt that are currently sitting idle — because Egypt’s burgeoning domestic demand has left nothing to export.

However, even this creative approach may not work, for very prosaic reasons. The costs of building a pipeline, converting the gas to LNG and then shipping it — whether to Europe or the Far East — may make it uncompetitive in today’s low-price energy markets, and hence make the whole scheme unviable.

But this is the Middle East, and things don’t necessarily follow what looks like the obvious path. Thus, the Egyptian law that seemingly paves the way to a major deal between Egyptian companies and the Leviathan consortium may prove to be the factor that pushes Turkey’s president, Recep Tayyip Erdogan, to support a deal ensuring that the bulk of Leviathan’s production goes to Turkey. Erdogan has had a volatile relationship with Israel over the years, but he wants to supplant Egypt as the leader of the Sunni Muslim world. Furthermore, Turkey — unlike Egypt — could really use Israeli gas imports.

The Wider Context

To fully understand this latest development in the Leviathan saga, it needs to be seen in a wider context. It comes one year after a revised “framework agreement” was reached with Texas-based Noble Energy, Israel’s Delek Group and Ratio Petroleum Energy — the companies that compose the Leviathan consortium — and the government, thereby enabling the Leviathan project to move forward again.

If Israel’s potential as an energy producer is fulfilled, it will impact everything from regional geopolitics to the commercial prospects of the energy companies now engaged in exploration and production.

That agreement ended almost five years of public debate within Israel, which saw the laws governing taxation and royalties levied on natural resource firms revised and the rates increased. Even so, a fierce prolonged public debate ensued over whether and how to develop the major gas finds made in Israeli waters in 2009 and 2010 — primarily the Tamar and Leviathan fields. Much of this debate focused on regulatory oversight of the energy sector and whether it was possible to achieve genuine competition in it.

While these arguments raged, the global energy sector changed dramatically. Roee Zass, a partner and head of the energy and utilities practice of TASC, an Israel-based consultancy, explains: “After production at Tamar started in March 2013, the development of both Tamar and Leviathan was blocked by political, regulatory and other issues. During that period, global energy prices — both oil and gas — fell sharply. This reduced the economic viability of exploration and drilling projects and, as a result, the level of activity fell all over the world. Another very important recent development is the emergence of the U.S. as an exporter of natural gas, after previously being an importer.”

Thus, while Israel was sorting out its policies, the prospects for exporting Leviathan gas were deteriorating. Nevertheless, following the completion of the framework agreement, the Leviathan consortium was able to concentrate on moving ahead with developing the field. To this end, each of the companies lined up its share of the financing needed for the first stage of the project, totaling $3.6 billion.

This enabled the companies to announce their FIDs — Final Investment Decisions — committing them to proceed with the project as planned. These, in turn, set in motion the process of planning, drilling, and installing production platforms and pipelines that would enable the consortium to meet its new target date for bringing Leviathan online, namely “late 2019.”

Welcome as the recent renewal of development activity may be, there still hangs over it the question of whether the major clients lined up by the consortium to date are sufficient to make Leviathan a viable project.

On the one hand, the facts seem to speak for themselves. “Had the contracts with the Israeli clients and, especially, the Jordanian electricity company not been signed, there would have been no FID,” says Zass. But he is careful to qualify that assessment by stressing that “these contracts suffice to underpin ‘Stage A’ — the first stage of the development of Leviathan, which envisages production of some 12 BCM (billion cubic meters) — but no more than that.

“Stage A is therefore assured, with the effort to achieve additional contracts aimed at improving its profitability. But beyond that is Stage B, which is aimed at pushing output up to 21 BCM. The additional demand that would make Stage B practical has to come from export deals,” Zass notes.

Others, however, believe that even Stage A is not yet assured. Gal Luft, co-director of the Washington, D.C.-based thank-tank IAGS (Institute for the Analysis of Global Security) and a consultant to governments on energy issues, asserts that the financing for Stage A of Leviathan is itself conditional on lining up more export contracts. “The current set of contracts is insufficient to justify the investment required to develop Leviathan. There is simply not enough demand.”

Michael Barron, a London-based independent consultant who formerly worked with British Gas in the Eastern Mediterranean, largely agrees with Luft’s pessimistic outlook. “There is still a long way to go on Leviathan. The big issue is to find a market big enough to take the bulk of the potential gas production – and that has not yet been resolved.”

Why then was the FID taken and how is the project moving ahead if its future is so murky? “The consortium took the FID without having the major buyer it needs because, in the short term at least, that is not critical,” explains Barron. “In the next six to nine months, the amount of spending needed is not so large. Only in the second quarter of 2018, after completion of the front-end engineering and design, will it be time for ‘big money’ investments – and by then a buyer must be found. If not, delays will begin, albeit minor ones initially.”

Candidates and Prospects

Who might this “major buyer” be? Put differently, where might the demand for natural gas, needed for the full development of Leviathan, come from? Given the Israeli government policy to allow the consortium to export most of Leviathan’s production, the list of potential major buyers is actually quite short.

In the immediate East Mediterranean region, these are Turkey and Egypt. Slightly further away is Europe, where southern or eastern European countries could provide the necessary demand. Finally, there is the East Asian market, accessing which is more difficult, but potentially possible.

Turkey: The country and market that has usually topped the list of likely buyers of Israeli gas is Turkey. Almost everyone agrees that from a commercial and economic point of view, this is the deal that almost writes itself, especially from the perspective of professional economists.

The view from the Turkish side is summarized by Bulent Gultekin, a professor of finance at Wharton who served as governor of the Turkish central bank in the 1990s, and as advisor to numerous governments in Europe and Asia. His analysis starts from some key facts and then examines – and rejects – a series of frequently raised objections to the idea of Turkey providing the missing demand for Leviathan.

“The current set of contracts is insufficient to justify the investment required to develop Leviathan. There is simply not enough demand.” –Gal Luft

“There are several undeniable facts: First, the production capacity of Leviathan exceeds Israel’s potential demand; second, Turkey is the largest potential buyer — it is the second largest buyer of Russian gas (after Germany) and also buys from Azerbaijan and Qatar, to diversify reliance on Russia; third, buying Israeli gas via a pipeline should be cheaper for Turkey than Russian gas, which is the commercial factor to add to the strategic one.”

But a pipeline from Leviathan to Turkey would have to traverse the EEZ of either Syria or Lebanon – which is a non-starter for Israel-sourced gas – or the EEZ of Cyprus. The latter presents no political problem from the Israeli side, but Cyprus is itself a divided country so that, from a legal and practical perspective, piping Leviathan gas through Cypriot waters – let alone via a facility on Cyprus itself — would require resolving the decades-long Cyprus dispute between Turkey and Greece.

That, however, does not faze Gultekin, who believes that “if a pipeline was built with Turkey as the sole buyer, then the Cyprus issue would not be a problem”. Nor would the volatile and often vituperative relations between Erdogan’s Turkey and Israel, which led to a rupture in diplomatic relations for several years, although commercial ties were largely unaffected. Overall, he concludes, “in the long run, irrespective of foreign policy considerations, it is in both countries’ interests to do the deal – and these are both very pragmatic countries. I don’t see the political issue as critical. Rather, from Turkey’s point of view, the commercial and strategic rationale should outweigh all other considerations.”

Looking at the Turkish option from an Israeli perspective, Zvi Eckstein, economics professor at the IDC in Herzliya, comes to similar conclusions.

“There is a very strong Turkish interest in having a pipeline to Turkey,” he concurs. “The Turks want this as a strategic counterbalance against Russia and Iran. The key question is whether Erdogan is willing to focus on those long-term interests. Erdogan’s son-in-law is energy minister and also runs the presidential palace. Do he and Erdogan have an interest to do a deal with Israel?”

Eckstein also does not think that Erdogan’s sympathy for the Palestinian cause and frequent tirades against Israel and its premier, Benjamin Netanyahu, will prevent a deal. He is even more cynical about the gap between rhetoric and action. “As soon as the pipeline is constructed and the gas flowing, Erdogan will be able to say whatever he wants about Israel and/or Netanyahu — it won’t make any difference.”

In addition to the strategic consideration, Eckstein stresses the macroeconomic dividend that would accrue to Turkey from Israeli gas – which he calculates could reduce Turkey’s current account deficit by as much as 1% of GDP per annum. The rate of return that a pipeline offers Turkey is so high, Eckstein thinks, that despite the domestic political and geopolitical risks entailed, Turkey’s leaders must go for it.

Israel, too, should prefer Turkey over the alternatives available – first because of its potential size as a source of demand. “The Turkish market consumes some 50 BCM per annum,” notes Zass, so that “from a purely economic commercial perspective, this is a very interesting deal.”

But that doesn’t make it a slam dunk. Zass identifies three main obstacles blocking the realization of this deal. First and most prosaically, there are significant technical problems involved in building a pipeline over 500 km long deep beneath the sea. Indeed, as Barron notes, “a pipeline from Leviathan to Turkey would be much longer than one to Egypt, and the topography of the seabed is more difficult to negotiate — so the investment expense is greater.”

The issue of finance is Zass’s second point: A pipeline to Turkey would require billions of dollars and, under the current risk profile of the project, who would be willing to provide this money? Last, but hardly least, both the financiers and the users of this projected pipeline will demand that the Turkish and Israeli governments sign a bilateral agreement that effectively ‘ringfences’ the pipeline from any future diplomatic or political spats between them.

Zass, however, does not view any of these problems as insuperable. “Yes, there are many risks,” he notes, “but all investments — especially in energy projects — have risks,” and in this case at least, as Eckstein noted, the risks have commensurate financial and economic rewards.

“From Turkey’s point of view, the commercial and strategic rationale should outweigh all other considerations.” –Bulent Gultekin

Egypt: Given the latest twist in Egyptian energy policy, it may be that Egypt has supplanted Turkey as the leading candidate for the elusive “major deal” that Leviathan needs. But in several important respects, Egypt has always had advantages over Turkey as a better target market for Leviathan gas. It’s physically nearer, and the al-Sisi government has a much better relationship with Israel, notably in the area of security cooperation against terrorist groups operating in the Sinai Peninsula and the Gaza Strip, than does Erdogan’s Turkey.

In the immediate euphoria that followed the discovery of Leviathan in 2010, Egypt looked to be a strong potential buyer of Israeli gas, but the years of delay – and the political upheavals in Egypt during 2011-13 – enabled a very different situation to emerge. Yet the key ‘game-changer’ has not been domestic Egyptian politics or the confusion in Israeli energy policy, but rather the 2015 discovery of the enormous Zohr field in offshore Egyptian waters. If ENI succeeds in bringing Zohr online in 2018, Egypt’s domestic demand will be covered for at least several years.

Nevertheless, as noted, Egypt still offers an alternative to selling Leviathan gas to Turkey or any other country in the region — by restoring to use one or both of the two large LNG plants in Egypt – one in Damietta, owned by the Spanish company Union Fenosa, and an Egyptian-owned one near Alexandria.

The Leviathan consortium could sell the gas to these plants, after piping it the relatively short distance to Egypt and then, once liquefied, ship it either to Europe or the Far East. Everyone, including the Egyptian government, would gain in this scenario.

Unfortunately, however, the collapse of energy prices in 2014-2015 may well have rendered this complex but promising idea non-viable and thereby effectively ruled out Egypt as a potential market, whether for itself or as a transit point. “Egypt now has its own discoveries to exploit and therefore won’t rush to buy from Israel,” says Luft, adding that “there is neither the economic viability nor a suitable political climate to embark on costly pipeline projects.”

Zass agrees. “In our opinion, current low gas prices plus the costs of liquefaction and transportation combine to make this option uneconomic. In any event, a pipeline project to Egypt would also require a bilateral agreement between the governments — although that ought not to be a problem.”

Barron is somewhat more optimistic about the Egyptian option, which he notes was the brainchild of his former employer, British Gas (which has since been acquired by Shell). “This option is cheaper than a pipeline to Turkey, because the LNG plants exist and are ready and waiting — if the Egyptian government allows their use.”

In fact, Barron reckons, “it might be more economical to get Leviathan gas to Europe via Egypt in the form of LNG, than through a long pipeline directly from the gas fields, because of these cost-reducing factors.”

Strikingly, while everyone interviewed for this article agreed that the Egyptian decision to allow gas imports was good news for the Leviathan project, no one viewed it as a decisive change. Even Barron, the most positively-oriented toward the Egyptian option, stresses that the potential advantage Egypt offers is relative: “Egypt is easier and cheaper — but not easy or cheap.”

Europe: Putting Europe on the map as a possible market for Leviathan gas suggests a middle path between the distant option – both geographically and now commercially – of shipping LNG to the Far East, and the “local” options of piping the gas directly to Turkey, Egypt and Jordan.

Yet even in Europe a complicated mix of strategic, commercial and technical factors are at work, giving rise to conflicting assessments as to the viability of the European option. Barron is more positive about Europe, noting that “Europe is a potential market, because it seeks access to non-Russian gas. Turkey could serve as a conduit for this gas to Europe, in addition to, or instead of, being a market itself.”

However, he immediately inserts a caveat: “Both for Europe and Turkey, Russian gas will always be cheaper than Israeli gas. That’s because Russia benefits from economies of scale and from having completed its investments, which are therefore sunk costs, whereas Israel and other potential producers are starting from scratch and need to invest in production and pipelines.”

Zass takes an emphatically negative stance toward Europe, stating that “in our opinion, the option of a pipeline to Europe, whether directly or via Turkey, is overambitious at current natural gas prices.”

Radical Alternatives

The clear conclusion is that there are no easy and straightforward solutions to the problems facing Leviathan’s owners in their search for major foreign buyers. That opens the way to more radical thinking which independent analysts — if not yet the Israeli government and the consortium companies – are willing to engage in openly.

“New companies will not come to Israel and explore unless and until they see an export market. The licenses are entirely bound up with the need to develop Leviathan via export markets.” –Zvi Eckstein

Luft, for example, believes that the policy decision to earmark Leviathan’s gas for export is flawed and needs to be revisited and revised. “Beyond the fact that no ‘anchor customer’ has been secured — nor, in my opinion, is any such buyer likely to be secured — stands the failure of the Israeli government to stimulate domestic demand for gas.

“A glaring example of this failure is that although there is a national program to reduce oil dependency in the transportation sector, natural gas is currently not in use at all as automotive fuel in Israel — not even in buses. Meanwhile, the fall in oil prices has diminished the desire of the industrial sector to switch from oil to gas. All that is left is the power sector, which has switched to gas but is not big enough to generate the size of demand required to justify the development of Leviathan.”

Salco Kleerekoper, founding partner of TASC, is more hopeful regarding future domestic Israeli demand, although for now, he notes, “Israeli demand is pretty much fixed. The Israeli market is limited, and this fact underlies the Leviathan business plan, which demands that the gas be exported. Even looking ahead, there is commercial doubt as to the size of demand. However, the energy ministry is now focusing seriously on developing future demand, because there is much that can be done in the local market.”

The continuing challenges and problematic outlook that still envelop Leviathan are casting deep shadows over the Israeli government’s current efforts to sell new exploration licenses. To make matters worse, on August 20, two small Israeli exploration companies, Isramco and Modi’in, announced that they were returning to the government two exploratory licenses they had held for six years. The companies noted four reasons behind this move, but analysts felt the primary one was the lack of an export market, even if the drilling was successful and discovered another large field.

Indeed, Eckstein sees a clear link between finding the missing major buyer for Leviathan gas and the prospect of other companies coming to explore in the eastern Mediterranean. “New companies will not come to Israel and explore unless and until they see an export market — and so the licenses are entirely bound up with the need to develop Leviathan via export markets.”

On the other hand, he rejects the claim that foreign energy companies have been deterred by the prolonged period of legal, fiscal and regulatory resolution in Israel. “These issues have been addressed and resolved by the revised policy framework agreed between the government and the consortium in 2016,” he says, so that the rules going forward are clear.

Kleerekoper concurs that the policy framework signals “a maturing and stabilization on the Israeli side,” and he also identifies “a strong desire on the part of government officials and regulators to push ahead. But sometimes they are overly optimistic about what can be achieved,” he concludes.

In other words, even if from the Israeli side the obstacles have been removed, neither the current situation in the global natural gas market nor its future prospects are conducive to the development of Leviathan, let alone to additional exploration in Israeli offshore waters.

“The wider background to all the options for the sale of Leviathan gas,” says Barron, “is that the world LNG market is currently saturated, thanks to new supplies from the U.S. and Australia. Qatar, too, is undertaking a large-scale increase in its LNG production — as well as other projects that are under way across the world, and still more on the horizon. Therefore, Leviathan will have lots of competition.”

Luft is gloomier still. “The Israeli gas finds should be viewed through a fundamental context of resource abundance, low price environment and strong competition from more competitive suppliers,” he says. “The world is drowning in gas. There are many options that are better and cheaper than Israel, and even they can’t make it.”

It therefore seems that, although it is possible to identify the numerous and varied strands – commercial, regulatory, strategic, technical and technological, local and global — that are intertwined in the knotty issue of the Leviathan field, it is still impossible to unravel the knot and separate the strands. One of them could lead to a bonanza, but no one is sure which, let alone when.