Modelling the demand and supply of natural gas from Cyprus and Israel

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Modelling the demand and supply of natural gas from Cyprus

and Israel

MJ210X - Degree Project in Energy Systems Analysis

Master Thesis Report

Constantinos Taliotis - taliotis@kth.se

Student

MSc Sustainable Technology

Mark Howells - mark.howells@energy.kth.se

Supervisor and Examiner Energy Technology Department Division of Energy Systems Analysis

Master of Science Thesis

KTH School of Industrial Engineering and Management Energy Technology EGI-2012

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Master of Science Thesis EGI: March-October 2012

Modelling the demand and supply of natural gas from Cyprus and Israel

Constantinos Taliotis Approved 14 December 2012 Examiner Mark Howells Supervisor Mark Howells

Commissioner Contact person

Abstract

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1 - Introduction

Between the years 1973-2009, the world’s final consumption of natural gas has experienced a considerable increase, leading to a subsequent increase in its import price over the years (IEA, 2011a). Furthermore, natural gas is an energy source, whose demand has been rising and is expected to show even greater increase in the future. As the most environmentally-friendly form of fossil fuel, it is highly likely that it will gain a lot of favour in the short term, while a global competition for available gas reserves may arise (Lochner and Bothe, 2009). There were numerous cases where countries invested a great amount of capital and time to develop the appropriate infrastructure to allow export or import of natural gas. This was done in the form of construction of pipelines or liquefaction plants (Victor, Jaffe and Hayes, 2006). A number of developed areas of the world, such as Europe, United States and Japan, currently rely to a great extent on imports for their natural gas needs, and this dependency is expected to further increase in the next two decades (Lochner and Bothe, 2009). Countries like Germany are currently rethinking of how to develop their energy system in the future and under certain scenarios (Keles, Möst and Fichtner, 2011), natural gas could prove to be a very competitive part of the solution. This clearly means that natural gas suppliers will be able to benefit economically from the projected rise in demand by promoting trade with such regions.

1.1 - Energy demand and security of supply for Europe

Energy security is of the utmost importance for the European Union (EU), which has proposed an action plan to ensure the energy future of the continent. In order to promote sustainability, the EU has decided to reduce greenhouse gas emissions by 20%, increase the share of renewable energy consumption to 20% and improve energy efficiency by 20%, in comparison to 1990 levels. This has to be achieved by 2020.There are five key considerations that need to be addressed by the Energy Security and Solidarity Action Plan (European Commission, 2008), which are described below.

Infrastructure development and diversification of energy supplies:

This involves developing new gas pipelines and further connections between electricity grids of countries within the continent, as well as with regions surrounding the continent, such as the Middle East and Caspian region. There are also concerns about the current situation of natural gas supply for the European market, while it is suggested that countries should look into the prospect of acquiring liquefied natural gas (LNG) as an alternative primary fuel (European Commission, 2008).

External energy relations:

Relations with neighbouring countries that currently act as suppliers of fossil fuels or can be mediator countries, such as in the development of gas pipelines, are of particular significance. Since producer countries are mainly outside the European Union, interdependence through cooperation for respective security of demand and security of supply can be developed for mutual benefit (European Commission, 2008).

Oil and gas stocks and crisis response mechanisms:

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Energy efficiency:

The goal of the European Union for 2020 is to achieve an energy savings of 20%. This will be achieved by fulfilling four objectives. First and foremost, the primary focus should be given to buildings and transport, which have the greatest potential for energy savings. Secondly, the competitiveness of European industries should be enhanced by improving their energy efficiency, especially in cases of energy and resource-intensive sectors. Thirdly, the energy efficiency of production and distribution of energy should be improved, for example by promoting cogeneration, district heating and cooling. Finally, National Energy Efficiency Action Plans can be used to assess the progress in each country and deal with the unique circumstances that could be in place (European Commission, 2011).

Promoting use of the union’s indigenous energy resources:

Another important aspect deals with taking advantage, to the highest degree possible, of the energy sources within the European Union. Currently, most of the energy is imported from outside the union and perhaps the best way to tackle this is development of renewable energy. Carbon Capture and Storage facilities will be developed in the future in order to be able to use native fossil fuel reserves, without impeding the climate change goals (European Commission, 2008). Therefore, potential fossil fuel reserves in a European state would play an important part in achieving this goal.

It is thus clear that energy security is a topic of great importance in Europe. In light of recent discoveries of hydrocarbons and especially natural gas in the Eastern Mediterranean, it can be argued that in the near future the European energy market may benefit in most of the aspects mentioned above.

1.2 - The case of Cyprus and Israel

The countries of Israel and Cyprus have been taking steps in the past few years to ensure their energy future for the coming decades. These two countries seem to have the potential to become important players in supplying Europe’s energy demands in regards to natural gas. Even though Israel had made small discoveries of oil and natural gas in the 1950s, the most significant discoveries started in 1999, when natural gas reserves were discovered offshore. Natural gas production in Israel started in 2004, with most of it being used by some of the country’s power plants, which were adjusted to use gas instead of oil as a feedstock. Since then, a few major discoveries have been made offshore, with the most important ones being the Tamar field, which holds about 240 billion m3 of gas, and the Leviathan field, with an estimated reserve of 450 billion m3 of gas (Ministry of Energy and Water Resources, 2012). The natural gas extracted in Israel is consumed by local power plants. Due to the fact that the extraction of the native reserves is still at an early stage, until 2010 it was not yet sufficient to cover the nation’s needs. The Israel Electric Corporation (IEC) essentially generates all of the country’s electricity. In 2010 the share of fuels for electricity generation was 61% for coal, 36.6% for natural gas, 1.5% for diesel oil and 0.9% for fuel oil. With the exception of natural gas, Israel primarily relies on imports for its energy requirements. It is interesting to note that in 2010 56% of the natural gas used by IEC was native, while the rest was imported from Egypt via a marine pipeline. Coal is imported from Africa, South America, Asia and Australia (IEC, 2012).

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(no.12 named Aphrodite) available for exploration (Energy Service, 2011). The reserve in this area is estimated to hold about 140 to 225 billion m3 of gas (Watkins, 2012). A second licensing round for exploration was announced by the Government of Cyprus and applications by fifteen oil and gas companies were handed in on May 11th 2012, thus opening up exploration efforts for all the available offshore plots. Among the corporations that showed interest are global giants, such as Total from France, Petronas from Malaysia and Gazprom from Russia (Reuters, 2012).

Similar to Israel, Cyprus is an energy importer. Currently there are no grid connections going to and from the island, so it cannot trade electricity with surrounding countries. It was estimated that during the years 2011-2012, renewable energy sources would correspond to 4% of the electricity generation of Cyprus (CERA, 2011). The rest of the electricity would be generated from fossil-fuelled power plants; the vast majority from burning heavy fuel oil and to a lesser extent diesel (EAC, 2011). All of the fossil fuels used on the island are being imported.

The cooperation of Israel and Cyprus along with Greece in the field of energy has been illustrated by the announcement of the development of an undersea electricity cable with a capacity of 2000 MW. This cable will connect Israel to Cyprus and then Greece, from where it can be utilized by the European market (Financial Mirror, 2012). Furthermore, there are thoughts of developing a plant for the production of LNG in the south coast of Cyprus, where natural gas from both countries could be processed before being shipped for export. As can be seen, there will be very interesting developments in the greater energy sector of the region, which could emerge as an important supplier of natural gas and electricity for Europe.

1.3 - Aims and Objectives

In this project, the effect that these natural gas finds will have on the two countries, and particularly the way in which they can best be utilized by the two countries, was assessed. This was achieved by making estimations of how the systems will respond under different scenarios in the future. The following aspects had to be considered in each of the scenarios to reach constructive conclusions:

 The share of different energy sources in the two countries’ electricity production and how that evolves over time.

 The fate of the extracted natural gas from each country.

 The amount of exported electricity and LNG from each country and the choice between selling electricity to Europe via the electrical connection versus natural gas in liquefied form to the global market.

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2 - Methods

The project was primarily achieved by conducting energy modelling for Cyprus and Israel. This was done by constructing the current power generation systems and predicting how they could develop in the future. The modelling work was carried out using MESSAGE (Model for Energy Supply Strategy Alternatives and their General Environmental impacts). This software was initially designed by the International Institute for Applied Systems Analysis (IIASA) and was then optimized by the International Atomic Energy Agency (IAEA, 2007). MESSAGE helps in the design of models for energy systems for countries and regions with the purpose of optimizing them. This is achieved by selecting the best possible solution out of a variety of alternatives. It can combine technologies and energy sources in energy chains, thus enabling the user to construct a model from resource acquisition to final energy demand. A set of constraints is added to investigate different scenarios or to simulate aspects that occur in the actual system modelled. These constraints can include limitations on new investment, fuel availability and trade, environmental regulations and total capacity installed for different technologies (IAEA, 2007).

2.1 - Data collection and transformation

The data required for input in the model was primarily retrieved from the responsible authorities of the two countries, namely the Electricity Authority of Cyprus (EAC) and Israel Electric Corporation (IEC), along with information from reports from the International Energy Agency (IEA). The vast majority of information retrieved had to be changed to the appropriate units used by MESSAGE. Additional information regarding the potential steps that could be taken by the two countries was acquired from news media, such as statements made by government officials following meetings regarding the matter of gas reserves’ exploitation.

2.2 - Scenarios under consideration

In order to investigate how the two countries’ systems will respond under different circumstances, a variety of scenarios was selected for assessment. The identification of scenarios which would be of the highest interest was done, having in mind potential situations that might arise in the future. Also, it was clear that the dilemma between using the available natural gas for the sale of electricity or LNG should be focused on. Therefore, the chosen scenarios are the following:

1. The prospect of an additional cable to sell electricity to Europe. 2. Increasing exported LNG prices compared to stable electricity prices. 3. Increasing exported electricity prices compared to stable LNG prices. 4. Introduction of stricter carbon emission regulations.

5. The effect different gas extraction rates may have on the two countries’ systems. 6. The effect increasing fossil fuel, and hence electricity, prices may have on the

systems. At the same time this would give an indication of the potential of electricity from renewable energy sources (RES) becoming an attractive alternative in such conditions.

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Table 1 - Adjustments to model variables for scenario evaluation Related

Scenario

Description Aspect or variable changed relative to baseline scenario

1 Second electricity

cable to Europe

Additional cable of 2000MW to be built in 2020

2 Stricter carbon

emission regulations

Carbon tax (US$/tonne CO2)

2011-15 2016-20 2021-30 2031-40 2041-50

0 20 40 60 80

3 Higher LNG prices -

stable electricity prices

Price of LNG ($/kWyr) 284 a +25% (355) +50% (426) +100% (568) +150% (710) 4 Higher electricity prices - stable LNG prices

Price of exported electricity ($/kWyr) 1055 b +25% (1319) +50% (1583) +100% (2110) +150% (2638) 5 Different gas

extraction rate limits in both countries

Maximum annual gas extraction rate (MWyr)

Cyprus

10000 7500 5000 15000 20000

Israel

40000 30000 20000 60000 80000

6 Increasing cost of

imported fossil fuels (coal, heavy fuel oil, diesel, natural gas) and exported LNG and electricity

Cost of imported fuels, exported LNG and electricity (% change)

2011-16 2017-22 2023-30 2031-40 2041-50

0% +25% +50% +75% +100%

7 Petrochemical

production

Allowing gas-to-liquids production for export purposes a - Used EU average for LNG import prices into Europe in USD/Mbtu for summer 2011 (IEA, 2011b)

b - Used Greece end-use Electricity prices for industry in USD/toe for 2Q2011 (IEA, 2011b)

In order to assess the selected scenarios, the appropriate variables, which would be changed in each case, had to be identified. These variables along with the fluctuating values are shown in Table 1 above.

2.3 - Model Assumptions

Before constructing a model of the two countries, certain assumptions had to be made regarding potential future developments in infrastructure. The main assumptions were the following:

 The extraction of natural gas from the reserves of Cyprus commences in 2015. Some limitations are placed in the first few years in the use of this gas for power generation, which are later removed completely.

 Cyprus does not import natural gas at any point in time, but simply uses oil until it is able to rely on its own reserves. This was done due to the fact that the government of Cyprus withdrew its original interest in importing LNG after discovering native reserves (Reuters, 2011).

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 Liquefaction of natural gas starts in 2015 for both countries. This date could potentially prove over-optimistic. However, the dates do not play a big part in the modelling outcome, as the project attempts to show how different investment strategies could affect the system.

 The default value for discount rate of 10% was used to conduct the modelling work.

 It was assumed that the same working conditions apply both for Cyprus and Israel, in regards to input for the model’s load regions. Even though the week is divided differently in the two countries, the model used the standard Monday-Friday as the week’s working days. Likewise, seasonal demand for electricity was assumed to be the same for the two countries, as the climate is quite similar in both.

 For future power plant development, only the cheapest and most efficient way of handling each fuel was chosen, for simplicity purposes. For instance, new gas-fired power plants in Cyprus are all assumed to be equipped with combined-cycle gas turbines.

 No transportation costs were added to the export of LNG or GTL products. This is due to the fact that no particular export locations were chosen and since the costs increase with distance, the model’s complexity would increase greatly if they were to be included.

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3 - Results

In order to build the actual model within MESSAGE, a conceptual model based on the current electricity systems of Cyprus and Israel was built, along with how it could potentially develop in the future with regional infrastructure, electricity grid connections and exports of LNG and electricity. This is shown in Figure 2, for which the codes can be found in the Appendices B and D.

Once all the scenarios were run, the most representative results were chosen to help reach constructive conclusions. In this section these results are shown for the chosen scenarios, while a comparison is made to assist in the evaluation of the conditions that apply in each situation.

3.1 - Baseline Scenario

In this scenario, the conditions that currently apply for both countries, as well as the most likely courses of actions, were modelled. Therefore, the electricity generation systems of Cyprus and Israel were constructed via MESSAGE based on information from 2010. Also, the natural gas reserves discovered so far were added to the model, corresponding to approximately 7 trillion cubic feet for Cyprus (Watkins, 2012) and 28 trillion cubic feet for Israel (Ministry of Energy and Water Resources, 2012). Major development projects, such as the construction of the electricity cable for sales to Europe and a liquefaction plant for sales of LNG were added, and the model was allowed to run until 2050. The model was allowed to invest in an LNG terminal in both countries, even though in reality a common plant may be built in just one of the counties. It should be noted that for the final electricity demand of the two countries projections were made either based on trends in the past decade for Israel (IEC, 2011) or based on projections for the following decade for Cyprus (TSO, 2012) and are highlighted in Appendix B. The prices for the exports were assumed to be 9.5$/MBtu, assuming sales to Europe, for LNG and 120$/MWh for electricity, assuming sales to Greece (IEA, 2011b). The most significant results are shown below.

3.1.1 - Cyprus

The local production of electricity in this small island changes drastically with the incorporation of natural gas as an energy source. This is expected to occur in 2015 and over a short amount of time it completely replaces oil as the primary fuel for electricity generation. As can be seen in Figure 1, most of the electricity generation after 2015 depends on natural gas. The stepwise development of new gas-fired power plants, observed in the first few years, is due to limitations added in the model, so as to make it more realistic.

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Figure 2 - Potential regional reference system depicting electricity systems of Cyprus and Israel along with natural gas exploitation and exports. IStoCYTrans ISGAS_RES EMGAS_LIQCY EUGAS EUTrans CYtoEUTrans CYGAS_RES _{Transmission2} EMGAS_LIQIS IStoEUviaCYTran s ISDUMMY ISDUMMY ISPV ISBIO ISWIND ISCSP ISDUMMY ISOIL_IMP ISDIES_IMP ISPRDESEX ISJGTDESEX ISSUOILEX Distribution Transmission

Primary Secondary Tertiary Final

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Renewable energy sources contribute to a significant extent, especially at the beginning, but as the use of natural gas rapidly increases, it dwarves the percentage from renewable sources. The big increase of electricity generation observed in the period 2022-2044 is due to electricity sales to Europe. It should also be mentioned that Cyprus does not import any electricity from Israel at any point in time.

It is also interesting to see how the natural gas reserves are exploited over the years. Immediately after extraction commences, which is assumed to be in 2015, a portion of the gas is sold as LNG while the remainder is used to meet electricity demand in the island (Figure 3).

Figure 3 - Fate of natural gas reserves from Cyprus (GWh). It is used either for power generation or for liquefaction.

The assumption is, though, that a liquefaction plant will be built in the years prior to 2015, so it can be utilised as soon as natural gas becomes available. This is the case for Israel as well, while even though a limitation of LNG production of 15 million tonnes per annum was introduced for each of the two countries, their combined production seems to just exceed that number, even when production is at its highest.

3.1.2 - Israel

The situation in Israel seems to be different from Cyprus, in that coal is not completely substituted by natural gas. As can be seen in Figure 4, for the first two decades there is an increase in the share of natural gas, but as the reserves diminish, coal returns as the dominant energy source. Biogas contributes for the most part below 1% of the total electricity generation. In 2043, the last of proven reserves run out, so there is dependency on imports of natural gas once again (Figure 5). It should be mentioned that an import limitation of about 44 000 GWh was placed on Israel to limit potential overdependence from outsiders.

Figure 4 - Projected electricity generation in Israel over the modelled period (GWh). 0 20000 40000 60000 80000 100000 2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2031 2033 2035 2037 2039 2041 2043 2045 2047 2049

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Figure 5 - Supply of natural gas for power generation purposes in Israel (GWh). Perhaps one of the most interesting results from Israel is the fact that even though there is plenty of natural gas to cover local needs, it seems preferable for it to sell a significant amount as LNG and use cheap coal to cover its own demand. Similar to the case of Cyprus, most of the natural gas is converted to LNG and sold (Figure 6). However, unlike Cyprus, Israel completely runs out of natural gas in 2043. Again, this can be attributed to the existence of the cheap alternative of coal.

Figure 6 - Fate of natural gas reserves from Israel (GWh). It is used either for power generation (blue) or for liquefaction (red).

3.1.3 - Exports

The discovery of natural gas in the Eastern Mediterranean was welcomed and gave a reason to governments and public of the two countries to be very optimistic, especially in a time of economic crisis. This optimism stems from the prospect of acquiring revenue via exports of LNG and, to a lesser extent, electricity. Figure 7 shows the possible extent of these exports. It is clear that based on current prices, it is more profitable to sell LNG rather than electricity. However, the results indicate that both countries will sell a relatively small portion of electricity to Europe. At the beginning, Israel makes almost full use of the cable’s capacity to export electricity, but then Cyprus also contributes partially, up to a point where Israel stops and Cyprus makes use of about 35-40% of the cable’s capacity. When it comes to LNG sales, the amounts are quite large for the relative size of the two countries, as already mentioned previously. 0 20000 40000 60000 80000 100000 120000 140000 160000 2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2031 2033 2035 2037 2039 2041 2043 2045 2047 2049 Imported Native 0 50000 100000 150000 200000 250000 300000 350000 400000

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Figure 7 - Exports of electricity and LNG from Cyprus and Israel in GWh.

A comparison was also done between the baseline scenario and a scenario in which no gas reserves are available to any of the two countries. Figure 8 below shows the energy system costs of these two scenarios, calculated based on the following equation:

Cost = Infrastructure investment costs (power plants, transmission system, LNG terminal,

GTL plant) + operation & maintenance costs + fuel costs + Import costs - Export

revenue.

This basically indicates the total system cost, taking into account potential revenue from exports. The higher the line is on the graph, the more costly the system is. Therefore we can see that a significant improvement is achieved by both countries when natural gas reserves become available.

Figure 8 - Costs of the energy system of the two countries over the projected period in the baseline scenario and the “No Native Gas Reserves” scenario, in million USD.

In order to make the above figure clearer, the total system cost of each country in the baseline scenario was subtracted from the scenario without gas reserves. The result is shown below in Figure 9. It is worth noting that by observing this figure it appears that Israel is profiting a lot more than Cyprus. This can be attributed to the fact that in the model used, Israel has four times more natural gas reserves and hence is able to export more gas; the proven reserves are expected to increase for both countries in the future. However, since the liquefaction facilities

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are likely to be built in Cyprus, in reality it remains to be seen what kind of agreement will be reached by the two countries. It is possible that Cyprus will be able to raise its profits based on a profit sharing agreement and through the use of transport tariffs. Similar figures are available for all the scenarios in Appendix A.

Figure 9 - Cost savings achieved when exploiting gas reserves in the baseline scenario, in million USD.

3.2 - Assessment of selected scenarios

In this part of the report the most important results from selected scenarios as shown in Table 1 were looked at in order to see how the model responds in each situation. This is helpful as it allows for proper evaluation of likely circumstances and the appropriate decisions regarding investments that can be made, thus maximizing revenue, in this case from the exploitation of the natural gas reserves of the two countries.

3.2.1 Evaluating the introduction of the CO2 taxation system

In the scenario where CO2 taxes are implemented, as suggested in Table 1, there are differences compared to the baseline scenario, but not as much as anticipated. In Cyprus, the combustion of natural gas drops slightly, while the combustion of oil decreases by about 18%, followed by an increase of 20% of electricity from renewable sources (Table 1 in Appendix A), while the rest of the island’s demand is satisfied by small imports from Israel (Table 2).

In the case of Israel, combustion of coal drastically decreases to 56% its previous share, which is substituted by a less polluting fuel; natural gas (Figure 1c). It is interesting to note that there is no increase in electricity produced from renewable sources in Israel. This could mean that even though coal is quite dirty, the low import price of this fuel allows the country to rely on it for a considerable part of its electricity generation. This can also be seen by the fact that electricity exports only drop by about 5% (Table 2 in Appendix A). Therefore, one could argue that the taxation system selected might not be strict enough to promote green electricity.

3.2.2 - The choice between exported electricity and LNG

This section deals with the results from scenarios 3 and 4 as shown in Table 1. As already discussed previously, based on the current circumstances, it appears more profitable for the two countries to sell LNG rather than electricity, as the cable’s capacity is not used to its full extent for the majority of the time. This is also clear from the electricity generation by energy

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source in Table 1 of Appendix A and total amount of exports shown in Table 2 of Appendix A. When the capacity of the cable is allowed to double in the first assessment scenario, the amount of electricity sold to Europe from Cyprus doubles. However, the corresponding amount from Israel shows an increase of about 38%, which is an indication that LNG is more profitable at current prices.

It is interesting to see that as the price of LNG was increased, even by 25%, Cyprus completely shuts down its electricity exports and diverts that amount of natural gas, as well as some natural gas previously used for its own power generation, into LNG sales. It is also quite interesting to see that Cyprus starts importing minor amounts of electricity from Israel as the price of LNG increases (Table 2). This means that it seems preferable to sell its natural gas as LNG and cover those minute needs by imports.

Of course, as the price of LNG is increased further, Israel is more reluctant to sell electricity and also prefers to export LNG, which is reflected in both Table 2 of Appendix A and Table 2 just below, in the main body of the report. It is thus obvious that the amount of LNG exported by both countries increases with rising LNG prices. It can thus be argued that it could be preferable for the two countries to sell LNG to Asian countries rather than Europe, as the prices there are much higher (IEA, 2011b).

Table 2 - Percentage of imported electricity from Israel for Cyprus.

Scenario Imported

electricity (%)

Scenario Imported

electricity (%)

Baseline scenario 0 Higher electricity prices (+50%) 0

Additional cable 0.41 Higher electricity prices (+100%) 0

CO2 tax increase 1.43 Higher electricity prices (+150%) 0

Higher LNG prices (+25%) 1.25 Different gas extraction rates

(-25%)

1.43

Higher LNG prices (+50%) 1.19 Different gas extraction rates

(-50%)

1.43

Higher LNG prices (+100%) 1.07 Different gas extraction rates

(+50%)

1.43

Higher LNG prices (+150%) 1.07 Different gas extraction rates

(+100%)

1.43 Higher electricity prices

(+25%)

0 Increasing imported fossil fuel

costs and exported LNG and electricity prices

0.77

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Figure 10 - Exports in the scenario of higher electricity prices by 25% (GWh).

Nevertheless, as the price of electricity increases, the amount of electricity exported by Israel also increases and finally reaches higher amounts than the baseline scenario, once the price is doubled. It can thus be concluded that if the price of LNG is reduced or if the price of electricity is increased, the two countries may have to compete for the right to sell their electricity to Europe via a common electricity link.

Table 3 in Appendix A also gives valuable insight into how each scenario affects the choice between liquefying natural gas and using it for electricity generation.

3.2.3 How different extraction rate limits affect the systems

When developing the scenarios, it was decided to look at how lower or higher extraction rates could affect the two countries. In the baseline scenario the annual extraction limit was set to 87 600 GWh for Cyprus and 350 400 GWh for Israel, which is four times that of Cyprus to represent the larger natural gas reserves discovered up to this point. These values were selected with the assumption that the reserves would be depleted at the end of 25 years if the maximum rate of extraction would be reached for 25 years.

When the extraction rates are reduced by 25%, Cyprus and Israel show a preference towards using natural gas for power generation purposes rather than liquefying it (Table 3 in Appendix A). This has a great impact on the exports of the two countries, as LNG sales decrease by 23% for Cyprus and 62% for Israel (Table 2 in Appendix A). However, electricity sales of Cyprus almost double, while those of Israel decrease by about 5%. This can probably be explained by the fact that in Israel electricity production from coal drops by 73%, which means that it prefers to use its own natural gas mostly for its energy demands, since the supply is lower than before. This is a clear indication that electricity produced from indigenous gas is less costly than imported coal. These trends are even greater when the extraction rates are reduced by 50% of their original value, with the exception that Israel does not produce any LNG in this case.

When the extraction rates are allowed to increase by 50 and 100%, the results are exactly the same in both cases. As a matter of fact, the peak annual extraction for Cyprus is 95 635 GWh for Cyprus and 391 490 GWh for Israel (Figure 11), which shows that the originally selected limits are quite reasonable.

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Figure 11 - Fate of natural gas (GWh) for each year in Cyprus (left) and Israel (right) in the scenarios with 50% and 100% increase of extraction rate limits.

In this scenario liquefaction of natural gas shows an increase of 8% in Cyprus and a decrease of 26% in Israel. When it comes to power generation, there is a 10% decrease in Cyprus and a 32% increase in Israel. In the case of exports of electricity, there is a 23% decrease for Cyprus, while the increase for Israel is only 0.2%. This means that Israel uses the excess electricity produced by natural gas to substitute a substantial amount of electricity previously generated by coal (Table 1 in Appendix A). It can thus be concluded that extraction rates have an enormous effect on how natural gas can best be exploited. There is no clear answer as to which extraction rates are more suitable, but perhaps a steady rate of extraction might be the best choice.

3.2.4 - How increased fossil fuel import costs and exported electricity and LNG prices affect the systems

In this scenario all prices of fossil fuels, LNG and electricity were increased according to the scheme shown in Table 1. Therefore, the only methods of electricity generation that remained unaffected were production with indigenous native natural gas and renewable energy sources. In the case of Cyprus, this lead to a decrease in LNG exports by 30% and an increase in electricity exports by 124%. However, for Israel, LNG exports decreased by 9% and electricity exports decreased by 35% (Table 2 in Appendix A). At the same time, power generation by the use of natural gas increased in Cyprus by 38% and 11% in Israel (Table 3 in Appendix A).

The reason for such a decrease in Israeli exports is once again the substitution of coal by natural gas for use within the country. Perhaps the most significant result in this scenario is the decrease of LNG exports and subsequent increase of electricity exports from Cyprus. Even though the percent increase is the same for both export goods, electricity seems to gain more favour than before. The reasons behind this are not clear, but they may have to do with the high investment cost of liquefaction. It should be highlighted though that LNG remains the primary export good of both countries. Another important aspect is that of the considerable increase, proportionately, of the share of renewable energy sources, which will be discussed in the following section.

3.2.5 - The aspect of renewable energy sources

In this section we look at the contribution of renewable energy sources from the various scenarios conducted in the modelling work. Before going into assessing the corresponding results regarding this topic, it should be mentioned that the results for Cyprus are more realistic than Israel’s, as bounds were placed according to the limitations and strategies adopted by the government (CERA, 2011). When the scenarios were developed, it was

0 20000 40000 60000 80000 100000 120000 2011 2014 2017 2020 2023 2026 2029 2032 2035 2038 2041 2044 2047 0 50000 100000 150000 200000 250000 300000 350000 400000 450000 2011 2014 2017 2020 2023 2026 2029 2032 2035 2038 2041 2044 2047

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expected that once the results were produced, the scenario with the highest contribution from renewable energy sources would be that of the CO2 tax implementation. However, it was proven that this was not the case. Even though this scenario led to an increase of 20% of renewable electricity generation in Cyprus, it had no effect in Israel.

On the other hand, increasing the fossil fuel and electricity prices had the greatest effect on both systems, as seen in Figure 2 of Appendix A, and was the only scenario which brought about investment in wind energy in Israel. Nevertheless, it should be made clear that in this scenario, in the last two years Cyprus runs solely on renewable energy, of which 91% is from concentrated thermal solar plants. This is of course extremely unlikely to occur and is a weakness of the model.

There are also other scenarios in which renewable energy sources show considerable increase in electricity generation (Table 1 in Appendix A). As the price of LNG increases, the total amount of electricity from renewable energy sources also increases. This means that at higher LNG prices, it is more cost-effective to sell natural gas as LNG and produce electricity with renewable sources. Similarly, as the price of exported electricity increases, electricity generation from renewable energy sources increases as well. This means that it becomes more attractive for investors to develop renewable energy projects for the purpose of exporting electricity. Therefore, in case there is an increase in demand for either of the export goods from the two countries, there will be greater availability for funds to promote such projects.

3.2.6 - The prospect of petrochemical production

As a result of the price difference between natural gas and oil products in the world market (de Klerk, 2012) and the discovery of gas reserves in areas away from demand (Perego, Bortolo and Zennaro, 2009), the possibility of converting natural gas into more transferable and competitive products has been gaining a lot of attention. Gas-to-liquids (GTL) plants have been in operation long enough to prove their commercial viability. The largest plant currently in operation was constructed in Qatar by Shell, and produces 140,000 barrels of GTL products per day, among which are 120,000 barrels of oil of natural gas liquids and ethane (Shell, 2012).

The interest towards GTL production seems to be increasing in various areas of the world (Stanley, 2009; Velasco et al., 2010). In this last scenario, the alternative of GTL production by Cyprus and Israel was investigated. A plant with a small capacity of 17,000 bbl/day was added to the system for each of the countries and the model was run. The basic assumptions for this scenario are shown in Appendix D.

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The results of this section have been separated from the previous sections, as the conditions are quite different and the aspect of particular significance is whether the export of GTL products is a viable alternative. In Figure 12, the way in which the electricity generation system of the two countries could evolve over the projected period is shown. However, the most important information is contained in the following figures.

Figure 13 - Fate of natural gas (GWh) for each year in Cyprus (left) and Israel (right). In Figure 13 above, the fate of extracted natural gas in each of the countries can be seen. It has to be highlighted that in both cases the amount of natural gas converted to petrochemical products is equal to the maximum allowed quantity set in the model for the entire time of operation; 22 years in Cyprus and 20 years in Israel, which is shorter than the set lifetime for the plants. This is a strong indication that petrochemical production seems to be profitable, based on the used prices and assumptions. It is also interesting to note that export of LNG is halted one year after GTL exports are stopped, in both countries. This is due to the upcoming depletion of the two countries’ natural gas reserves.

Even though in this scenario GTL products are being exported, the majority of exports from the two countries is still LNG (Figure 14). Of course this is probably so due to the limitation placed on petrochemical production. However, there are a few important aspects that need careful consideration before deciding to invest in liquefaction or GTL plants. First of all, space could be an issue, especially in the case of Cyprus, which is a small island that currently relies to a great extent on tourism. The construction of projects of such magnitude will most likely occur along the coast, so as to make shipping easier. Since there are already questions about the location of the proposed LNG plant in Cyprus (Wallace, 2011), finding a location for an additional GTL plant might offer some difficulty.

Secondly, security is another important issue. The Eastern Mediterranean is a very volatile region and neither Cyprus nor Israel can feel completely comfortable, at least with some of their neighbours. Therefore, costs for guarding facilities of huge significance could be quite high and having to protect two such locations undeniably raises overall expenses. Lastly, but perhaps most importantly, price fluctuations of oil and natural gas could affect GTL attactiveness in the future. When the price gap between the two commodities is larger, the economic incentives for investment in GTL projects increase (de Klerk, 2012). This is the case with the current prices. However, if prices for natural gas start to increase at a much faster pace than for oil, it will make more sense to invest in liquefaction plants and simply export LNG. Hence, the risk is rather high, so the responsible authorities of the two countries should carefully go through future price projections and make the appropriate decisions.

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Figure 14 - Exports of electricity, GTL products and LNG from Cyprus (navy blue, red and dark blue respectively) and Israel (orange, purple and green respectively) in GWh.

3.2.7 - No Native Gas Reserves Scenario

As already mentioned previously, in order to be able to compare with the current state of the two countries’ systems, it was decided to develop a scenario in which the two countries had no access to own natural gas reserves. The model was run and the results shown below in Figures 15 and 16 were given. It is clear that oil, in the case of Cyprus, and coal in the case of Israel seem to take over the electricity mix of the two countries, which is quite similar to the present situation. It is very interesting to observe that even though the model was allowed to invest in the cable that will connect the two countries to the European continent, none of the two exported any electricity throughout the projected period. This is a clear indication that Israel and Cyprus will only export electricity to the European market once they are able to exploit their own natural gas reserves.

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4 - Conclusions

It is clear from the results above that the discovery of natural gas reserves in Cyprus and Israel can lead to major changes in the power generation of the two countries, while it will bring about construction of infrastructure to allow transformation and export of natural gas products. These gas discoveries will bring about major economic benefit for the two countries. It is estimated that the undiscounted total savings achieved by the two countries during the whole projection period add up to about 182 billion USD; the corresponding figure with a discount rate of 10% reaches 24 billion USD. These figures do not include revenue from selling electricity within the local systems at a considerably lower cost nor any other socioeconomic aspects, such as the creation of jobs or the development of related industry. When it comes to choosing between selling electricity or LNG, with their current prices, it appears to be more profitable to export LNG. However, even a slight increase of 25% in the price of electricity makes it more attractive, but still not as much as LNG. On the other hand, an equivalent increase of 25% in the price of LNG completely outperforms electricity, as Cyprus stops exporting it entirely. The doubling of the cable’s capacity bringing electricity to Europe leads to the conclusion that this is a possibility worth taking into consideration down the road. This also gives great potential to the investment of renewable energy projects for the export of electricity. Similarly, if the prices of imported fossil fuels, exported LNG and electricity increase, the contribution of electricity generation from renewable energy sources could also increase significantly. In the event of an introduction of strict carbon emission regulations, natural gas becomes even more attractive as the primary fuel for electricity generation. In this case, renewable energy sources do not increase as much as one would imagine.

The gas extraction rates used in the baseline scenario seem to be reasonable if a constant rate is preferred. However, if fluctuations in extraction are not a problem, then the maximum annual extraction rate could be increased slightly to meet the peak demand, as seen above. The production of petrochemicals is one alternative that is quite attractive with the current prices of oil and natural gas. However, with a potential decrease in the price difference between these two commodities, the profit margin can diminish, so careful actions should be taken having this aspect in mind.

It should be noted that the model used has some weaknesses. For instance, the option of importing natural gas was not given to Cyprus. Of course, Cyprus could import natural gas from Israel for the time being, until Cyprus extracts its own natural gas, since they will most likely cooperate in the exploitation of their reserves. Another weakness of the model is the exclusion of transportation costs. Nonetheless, this relatively small cost would not be anticipated to make very big changes to the model results.

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References

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[Accessed on 2nd March 2012].

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Perego, C., Bortolo, R. and Zennaro, R., 2009. Gas to liquids technologies for natural gas reserves valorization: The Eni Experience. Catalysis Today 142: pp.9-16.

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Velasco, J.A., Lopez, L., Velásquez, M., Boutonnet, M., Cabrera, S. and Järås, S., 2010. Gas to liquids: A technology for natural gas industrialization in Bolivia. Journal of Natural Gas Science and Engineering 2: pp.222-228.

Victor, D.G., Jaffe, A.M. and Hayes, M.H., 2006. Natural Gas and Geopolitics: From 1970 to 2040, New York: Cambridge University Press.

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Appendices

Appendix A - Detailed Scenario Results

1 - Assessment of selected scenarios

Table 1 - Total electricity generation for Cyprus and Israel for each major energy source, throughout the projected period (2011-2050).

Cyprus Israel Scenario Gas (GWh) Oil (GWh) Renewables (GWh) Gas (GWh) Coal (GWh) Renewables (GWh)* Baseline scenario 433 141 40 112 30 224 1 906 192 1 860 510 28 146 Additional cable 618 397 38 683 30 313 2 094 973 1 759 670 28 146 CO2 tax increase 423 383 32 966 35 506 2 716 361 1 045 769 28 146 Higher LNG prices (+25%) 259 239 40 029 41 557 2 059 099 1 661 407 28 146 Higher LNG prices (+50%) 235 199 62 141 43 668 1 916 230 1 765 857 28 146 Higher LNG prices (+100%) 207 807 85 336 48 303 1 645 821 2 010 336 28 146 Higher LNG prices (+150%) 187 375 105 768 48 303 1 593 411 2 062 746 28 146 Higher electricity prices (+25%) 614 275 37 111 38 591 2 581 119 1 120 075 28 146 Higher electricity prices (+50%) 631 261 37 111 39 117 2 598 837 1 104 804 28 146 Higher electricity prices (+100%) 648 247 37 111 41 745 2 598 638 1 213 781 28 146 Higher electricity prices (+150%) 648 247 43 566 41 745 2 598 638 1 215 762 28 146 Different gas extraction rates (-25%) 563 712 32 966 34 781 3 338 351 424 570 28 146 Different gas extraction rates (-50%) 390 162 32 966 34 781 3 243 969 583 918 28 146 Different gas extraction rates (+50%) 389 630 34 217 37 409 2 591 766 1 180 795 28 146 Different gas extraction rates (+100%) 389 630 34 217 37 409 2 591 766 1 180 795 28 146 Increasing imported fossil fuel costs and exported LNG and electricity prices

597 354 34 110 66 587 2 269 169 1 409 350 39 008**

*The amount shown here represents the maximum allowed biogas production.

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Table 2 - Total exports from Cyprus and Israel in each scenario, throughout the projected period (2011-2050).

Cyprus Israel

Scenario LNG (GWh) Electricity (GWh) LNG (GWh) Electricity (GWh)

Baseline scenario 1 124 072 150 434 4 386 202 202 004 Additional cable 748 741 326 511 4 050 381 278 427 CO2 tax increase 1 143 843 144 404 2 990 178 193 259 Higher LNG prices (+25%) 1 476 402 0 4 653 234 157 060 Higher LNG prices (+50%) 1 525 107 0 4 979 299 123 254 Higher LNG prices (+100%) 1 580 604 0 5 511 715 100 736 Higher LNG prices (+150%) 1 621 999 0 5 658 294 100 736 Higher electricity prices (+25%) 757 091 327 609 3 270 094 144 065 Higher electricity prices (+50%) 722 678 344 245 3 232 870 146 230 Higher electricity prices (+100%) 688 264 362 878 3 232 870 242 439 Higher electricity prices (+150%) 688 264 369 010 3 232 870 244 191 Different gas extraction rates (-25%) 859 534 276 718 1 659 900 193 958 Different gas extraction rates (-50%) 601 103 111 846 0 251 417 Different gas extraction rates (+50%) 1 212 226 115 025 3 225 574 202 484 Different gas extraction rates (+100%) 1 212 226 115 025 3 225 574 202 484 Increasing imported fossil fuel costs and exported LNG and electricity prices

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Table 3 - Fate of extracted natural gas in each scenario, throughout the projected period (2011-2050). Cyprus Israel Scenario Liquefaction (GWh) Power generation (GWh) Liquefaction (GWh) Power generation (GWh) Baseline scenario 1 183 234 923 739 4 617 055 3 810 847 Additional cable 788 148 1 318 825 4 263 559 4 164 342 CO2 tax increase 1 204 045 902 928 3 147 556 5 280 348 Higher LNG prices (+25%) 1 554 107 552 866 4 898 141 3 529 759 Higher LNG prices (+50%) 1 605 376 501 597 5 241 367 3 186 533 Higher LNG prices (+100%) 1 663 793 443 179 5 801 805 2 626 094 Higher LNG prices (+150%) 1 707 367 399 606 5 956 099 2 471 800 Higher electricity prices (+25%) 796 938 1 310 035 3 442 204 4 985 697 Higher electricity prices (+50%) 760 713 1 346 259 3 403 021 5 024 878 Higher electricity prices (+100%) 724 489 1 382 484 3 403 021 5 024 875 Higher electricity prices (+150%) 724 489 1 382 484 3 403 021 5 024 875 Different gas extraction rates (-25%) 904 773 1 202 200 1 747 263 6 680 633 Different gas extraction rates (-50%) 632 740 832 081 0 6 320 027 Different gas extraction rates (+50%) 1 276 027 830 945 3 395 341 5 032 553 Different gas extraction rates (+100%) 1 276 027 830 945 3 395 341 5 032 553 Increasing imported fossil fuel costs and exported LNG and electricity prices

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(b)

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(d)

Figure 1 - Percentage of electricity from gas-fired plants from total electricity production in Cyprus (left) and Israel (right) for the following scenarios: (a) baseline, (b) additional cable, (c) CO2 tax and (d) increasing fuel import costs and exported LNG and electricity prices.

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Figure 2 - Percentage (%) of renewable energy from total electricity production in Cyprus (left) and Israel (right) for the following scenarios: (a) baseline, (b) additional cable, (c) CO2

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2 - Economic parameters

2.1 Energy system costs of each scenario

In this section we look at the total costs of the energy system in each of the countries. Basically, this shows the balance between the system costs and revenue from exports. Any profits made from selling electricity within the local market are not taken into consideration. Negative values indicate that the system remains profitable even without this revenue stream. The peaks observed are due to large investments happening at that specific point in time, such as liquefaction or GTL plants in 2015. In the first graph of each figure the system costs of the respective scenario are compared to the system costs from the scenario in which no natural gas reserves are available to the two countries. The second graph simply shows the costs savings achieved when exploiting gas reserves, calculated by subtracting the respective scenario from the scenario without gas reserves. It should be mentioned that all costs shown here are undiscounted.

Figure 3 - Costs of the energy system of the two countries over the projected period in the baseline scenario and the “No Native Gas Reserves” scenario (top) and cost savings achieved

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Figure 4 - Costs of the energy system of the two countries over the projected period in the additional cable scenario and the “No Native Gas Reserves” scenario (top) and cost savings

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Figure 5 - Costs of the energy system of the two countries over the projected period in the CO2 tax scenario and the “No Native Gas Reserves” scenario (top) and cost savings achieved

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Figure 6 - Costs of the energy system of the two countries over the projected period in the higher LNG prices (+25%) scenario and the “No Native Gas Reserves” scenario (top) and

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Figure 10 - Costs of the energy system of the two countries over the projected period in the higher electricity prices (+25%) scenario and the “No Native Gas Reserves” scenario (top)

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Figure 14 - Costs of the energy system of the two countries over the projected period in the different extraction rate (-25%) scenario and the “No Native Gas Reserves” scenario (top)

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Figure 15 - Costs of the energy system of the two countries over the projected period in the different extraction rate (-50%) scenario and the “No Native Gas Reserves” scenario (top)

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Figure 16 - Costs of the energy system of the two countries over the projected period in the different extraction rate (+50%) scenario and the “No Native Gas Reserves” scenario (top)

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Figure 17 - Costs of the energy system of the two countries over the projected period in the different extraction rate (+100%) scenario and the “No Native Gas Reserves” scenario (top)

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Figure 18 - Costs of the energy system of the two countries over the projected period in the increasing imported fossil fuel costs and exported LNG and electricity prices scenario and the

“No Native Gas Reserves” scenario (top) and cost savings achieved when exploiting gas reserves (bottom), in million USD.

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Figure 19 - Costs of the energy system of the two countries over the projected period in the petrochemical production scenario and the “No Native Gas Reserves” scenario (top) and cost

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2.2 - Expenditure vs Revenue

In this section the total costs of each country’s system are compared to the revenues for the same scenario over the entire projected period. Costs include all investment and operation and maintenance costs for all the technologies at all stages, as well as fossil fuel import or extraction costs. Revenue only includes the income made from selling export goods, such as LNG, electricity and GTL. This category does not include any profit or savings gained from the utilization of native natural gas for local power generation purposes. All the costs shown here are undiscounted.

Figure 20 - Expenditure and revenue of the system in Cyprus (left) and Israel (right) over the projected period in the baseline scenario, in million USD.

Figure 21 - Expenditure and revenue of the system in Cyprus (left) and Israel (right) over the projected period in the additional cable scenario, in million USD.

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Figure 22 - Expenditure and revenue of the system in Cyprus (left) and Israel (right) over the projected period in the CO2 tax scenario, in million USD.

Figure 23 - Expenditure and revenue of the system in Cyprus (left) and Israel (right) over the projected period in the higher LNG prices (+25%) scenario, in million USD.

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Figure 28 - Expenditure and revenue of the system in Cyprus (left) and Israel (right) over the projected period in the higher electricity prices (+50%) scenario, in million USD.

Figure 29 - Expenditure and revenue of the system in Cyprus (left) and Israel (right) over the projected period in the higher electricity prices (+100%) scenario, in million USD.

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Figure 31 - Expenditure and revenue of the system in Cyprus (left) and Israel (right) over the projected period in the different extraction rate (-25%) scenario, in million USD.

Figure 32 - Expenditure and revenue of the system in Cyprus (left) and Israel (right) over the projected period in the different extraction rate (-50%) scenario, in million USD.

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Figure 34 - Expenditure and revenue of the system in Cyprus (left) and Israel (right) over the projected period in the different extraction rate (+100%) scenario, in million USD.

Figure 35 - Expenditure and revenue of the system in Cyprus (left) and Israel (right) over the projected period in the increasing imported fossil fuel costs and exported LNG and electricity

prices scenario, in million USD.

Figure 36 - Expenditure and revenue of the system in Cyprus (left) and Israel (right) over the projected period in the petrochemical production scenario, in million USD.

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2.3 System savings

In this table the total system savings achieved in comparison to the No Native Gas Reserves scenario throughout the whole projected period are shown. These savings are calculated based on a discount rate of 10%.

Table 4 - Total system savings with discount rate of 10%.

Scenario Savings (million USD)

Baseline scenario 24,133 Additional cable 32,393 CO2 tax increase 29,597 Higher LNG prices (+25%) 33,551 Higher LNG prices (+50%) 46,972 Higher LNG prices (+100%) 75,970 Higher LNG prices (+150%) 105,854

Higher electricity prices (+25%) 33,325

Different gas extraction rates (-25%) 35,038 Different gas extraction rates (-50%) 35,086 Different gas extraction rates (+50%) 27,635 Different gas extraction rates (+100%) 27,635 Increasing imported fossil fuel costs

and exported LNG and electricity prices

41,752

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3 - Capacity investments

3.1 - Baseline Scenario

Figure 37 - Total Installed Capacity of each technology in Cyprus (MW).

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3.2 - No Native Gas Reserves Scenario

Figure 39 - Total Installed Capacity of each technology in Cyprus (MW).

Figure 40 - Total Installed Capacity of each technology in Israel (MW).

Note: The diesel plants that are visible in both scenarios refer to existing plants that are no longer used for power generation and are slowly decommissioned.

Modelling the demand and supply of natural gas from Cyprus and Israel