Evaluating the risks of natural gas

As the U.S. and other large nations experience the benefits of a natural gas boom, smaller countries — from Tanzania to Cyprus — are hoping to reap the rewards too and use the resource to spur their economies. But in a new study, MIT researchers warn them to proceed with caution.

“While natural gas is often cheaper than oil and gives off fewer emissions, developing the resource comes with risks, especially for smaller nations,” says Sergey Paltsev, an author of the study and a principal research scientist at the MIT Energy Initiative. “The cost for these smaller nations makes up a larger portion of their economies, so before spending the money, they need to have the proper expectations.”

In collaboration with the Cyprus Institute, the MIT researchers take an independent look at the economics around developing the resource using Cyprus as an example. They find that it will take the country about five years to put their natural gas resource to use, and the required investments will make up to a quarter of the country’s Gross Domestic Product (GDP).

“That’s a substantial amount of a country’s economy dependent on a resource that has proven to be unpredictable in the past,” says Paltsev, who is also the assistant director for economic research at the MIT Joint Program on the Science and Policy of Global Change. “Natural gas development is so new to such regions, and the global gas market is changing so rapidly, that there’s a large amount of uncertainty.”

This is the message the researchers will bring to a November meeting with Cyprus decision-makers, meant to help the leaders plan a path forward with realistic expectations in mind.

The case of Cyprus

What’s happening in Cyprus is a good model for other countries like it that are exploring natural gas, according to Paltsev.

The small nation has been teetering back from a near collapse of its banking industry and searching for revenue. When a major natural gas reserve was discovered off its coast two years ago, Cyprus leaders saw it as a golden opportunity.

The latest estimate of the resource at that site, given earlier this month, shows about 5 trillion cubic feet of gas. To put that into context, the researchers cite a 2013 BP report showing the global supply of natural gas to be about 6,600 trillion cubic feet, with Russia’s reserves alone being 1,160 trillion cubic feet.

“These numbers tell us that, while this is a significant find for a country the size of Cyprus, it’s only a small fraction of the global resources,” says Francis O’Sullivan, the director of research for the MIT Energy Initiative. “Most likely, Cyprus will never be a major player in the global gas markets, but that doesn’t mean natural gas can’t benefit the country’s economy if developed properly.”

One trillion cubic feet of natural gas is enough to meet the needs of 5 million households for 15 years, according to the American Gas Association. With the population of Cyprus being just around a million, the study shows that Cyprus has enough natural gas to power the country for nearly a century — while significantly reducing its use of foreign oil.

LNG versus a pipeline

An ample resource for domestic use, the Cyprus government has made plans to build a Liquefied Natural Gas (LNG) plant and export the resource to such place as Europe and Israel.

LNG has been the preferred option over building a pipeline because of political tensions in the area. The island has been divided since the mid-1970s, with Turkey occupying the northern half.

While a clear political maneuver, building an LNG terminal would also create jobs and raise revenue. Depending on the tax scheme, it may raise $1.5 billion in taxes. Still, it would cost about $6 billion to build, for a country that has a GDP of about $25 billion. The cost of building an LNG terminal is far more than the cost of building a pipeline, though LNG offers greater flexibility to adjust production to changing natural gas prices and market supplies — perhaps outweighing the upfront costs.

“The discovery of natural gas has created exciting opportunities for Cyprus and could transform the country’s energy system and position in the region,” O’Sullivan says. “But the cost of developing the resource makes up about a quarter of the country’s economy. That’s not insignificant, and it’s a major risk if it fails.”

O’Sullivan and Paltsev warn that even projects that start out having clear economic gains can become less profitable because of poor technical planning and execution or bureaucratic and regulatory delays.

“Prices change, projects get delayed, overrun costs pile up. These are all unforeseen risks that can come up and must be properly mitigated,” Paltsev says.

The study, funded entirely by the Cyprus Research Promotion Foundation, is part of a larger report that will further take into account the changing dynamics of the regional and global gas markets — giving a comprehensive view of the implications for the long-term development of natural gas in Cyprus and other like nations. The researchers expect to finish that larger report in August 2014.