The discovery of hydrocarbons within Cyprus’s exclusive economic zone in December 2011 put the Republic of Cyprus on the world energy map and was embraced with wide enthusiasm. The findings have since been followed by plentiful developments that seek to transform the initial surprise into a well-founded aspiration of becoming a producer and exporter of hydrocarbons.
The oil and gas exploration area is of 51,000km2 and is located in the south of Cyprus. This area has been separated into 13 exploration blocks.
To date, six licences and production sharing contracts (PSCs) have been applied for and obtained. The local authorities are considering other applications to award licences for the remaining blocks.
The recently formed state-owned Cyprus Hydrocarbons Company (KRETYK) has been given the mandate to manage Cyprus’s hydrocarbon resources and proceeds. The company also represents Cyprus in PSCs and deals with potential investors in relation to the construction of a liquefaction and export facility.
Further discussions between the Cypriot government and relevant entities concerning the infrastructure necessary for the transportation and liquefaction of gas are currently ongoing. These point to a period of at least five years until the essential facilities that can enable Cyprus to export on a desirable scale are established.
II LEGAL AND REGULATORY FRAMEWORK
The prospecting, exploration and exploitation of hydrocarbons in Cyprus are governed by several national legal instruments. Given that Cyprus is a Member State of the European Union, it additionally follows the Community acquis relating to oil and gas activities.
i Domestic oil and gas legislation
Relevant legislation includes the Law on Regulating the Electricity Market of 2003 No. 122(I)/2003, which establishes the Cyprus Energy Regulatory Authority (CERA).
In addition, the Laws on Regulating the Natural Gas Market of 2004–2012, No. 183(I)/2004 (30/04/04), No. 103(I)/2006 (21/07/2006), No. 219(I)/2012 (28/12/2012) and No. 199(I)/2007(31/12/2007) are also part of Cypriot legislation. These laws were passed to bring the internal natural gas market in line with the EU Directive 2003/55/EC. The latter was, however, repealed and replaced with new Directive 2009/73/EC. Cyprus secured several deviations from this because it is regarded as an isolated market. The deviations will come to an end once Cyprus’ internal natural gas market ceases to be isolated.
The Hydrocarbon (Prospection, Exploration and Exploitation) Law of 2007
(No. 4(I)/2007) incorporates EC Directive 94/22/EC into domestic law.
The Hydrocarbon (Prospection, Exploration and Exploitation) Regulations of 2007 and 2009 (No. 51/2007 and No. 113/2009) are the regulations that determine the licences that can be obtained and provide guidance on procedural and application matters.
The Ministry of Commerce, Industry and Tourism – Energy Service (MCIT) is responsible for granting licences for prospection, exploration and exploitation of hydrocarbons as well as overseeing any activities that are directly related to these.
The Cyprus Energy Regulatory Authority (CERA), following the Natural Gas Law, No. 183/2004 (the Natural Gas Law) is to regulate the natural gas market.
The state-owned Natural Gas Company company (DEFA) has been given a wide mandate regarding the natural gas market in Cyprus. DEFA is responsible not only for the import and storage of natural gas in Cyprus but also for its distribution.
Regulator’s enforcement powers
CERA is responsible for handing out licences regarding the import, storage or gasification of natural gas. However, following the Law on the Regulation of the Natural Gas Market 2004 as amended by Law 199(I)/2007, DEFA, the sole entity responsible for the import and supply of natural gas in the market of Cyprus, was established. As a result of this monopoly, the role of CERA as a regulator responsible for issuing licences regarding the above activities is currently suspended.
CERA is, moreover, responsible for examining and regulating the possibility and implementation of an interconnection with another Member State.
The regulatory authority also has rather a significant influence over the market as it should maintain a sustainable balance between supply and demand of gas in the local market. To this end, misuse of a dominant position within the market will be prevented. Following an EU directive on the matter, assessing the supply and demand in the market includes ensuring smooth market conditions in cases of emergency and unforeseen crises.
CERA is also responsible for providing the technical design and operation minimum standards for the connection to the network. This covers other natural gas infrastructure.
It should be kept in mind, however, that all public authority decisions may be challenged by means of judicial review and thereby examined by the Supreme Court of Cyprus.
European Union legal framework
Directive 94/22/EC of 30 May 1994 on the conditions for granting and using authorisations for the prospection, exploration and production of hydrocarbon: identifies the procedure that should be followed for granting licences to ensure a transparent modus operandi. It additionally elaborates on time and geographical restrictions of authorisations.
Directive 2009/72/EC of 13 July 2009 on common rules for the internal market in electricity seeks to secure an obstacle-free EU market for the sale of electricity and stipulates the policies that should be followed to ensure a free market where competition flourishes. In that regard, it calls for the furthering of cross-border interconnections that will ultimately guarantee a supply of all energy sources at competitive prices for the benefit of the European consumer. The Directive also tackles the above issue having in mind sustainable climate policy arguments.
Directive 2009/73/EC of 13 July 2009 on common rules for the internal market in natural gas repeals Directive 2003/55/EC and aims to more efficiently segregate supply and production activities from network operations.
Regulation (EC) No. 715/2009 of 13 July 2009 is based on the conditions for access to the natural gas transmission networks and rewrites the natural gas transmission and trades rules in order to remove any barriers to competition.
Regulation (EU) No. 994/2010 of 20 October 2010 on measures to safeguard security of gas supply acts as a vote of confidence to the Union’s ability to maintain a constant supply of gas within the internal gas market. The regulation puts a mechanism in place by which national and community authorities coordinate in order to deal with emergency situations. The ultimate goal is to prevent a supply disruption for protected customers, which includes households, social services and small enterprises.
The Commission’s Decision of 24 August 2012 amends Annex I to Regulation (EC) No. 715/2009 of the European Parliament and of the Council on conditions for access to the natural gas transmission networks (2012/490/EU).
Cyprus is a party to several international conventions. These include:
- a the International Arbitration in Commercial Matters Law 1987;
- bthe New York Convention for the Recognition and Enforcement of Foreign Arbitral Awards 1958;
- c the United Nations Convention on the Law of the Sea (UNCLOS); and
- d the United Nations Commission on International Trade Law (UNCITRAL) Model Law on International Commercial Arbitration of 21 June 1985.
Cyprus has initiated and concluded several bilateral agreements with neighbouring states. This includes the delimitation of the Exclusive Economic Zone of Cyprus with Egypt, which reflects the median-line principle as encompassed in the UNCLOS 1982 agreement. Cyprus and Egypt have capitalised on their cooperation with a framework agreement expanding on the development of a cross-median line concerning hydrocarbon resources. Other agreements have been signed on a political level with Israel, such as the ratification of the Delimitation Agreement by Law of the Exclusive Economic Zone and Israel, as well as with Lebanon. Cyprus and Egypt have also entered into a framework agreement regarding the development of cross-median line hydrocarbon resources.
Double tax treaty network
Cyprus has developed an extensive network of double tax agreements with almost 50 countries, ensuring that the same income is not taxed in more than one country. Under these treaties, entities registered in Cyprus will not only enjoy tax exemptions within Cyprus, but will additionally profit from analogous exemptions within other treaty countries.
The licensing regime in relation to hydrocarbon activities in Cyprus is governed by the Hydrocarbons (Prospecting, Exploration and Exploitation) Law 4(I) of 2007, as amended by Laws 126(I)/2013 and 29(I)/2014 (the Hydrocarbons Law) and supplemented by the Hydrocarbons (Prospecting, Exploration and Exploitation) Regulations of 2007 and 2009 (the Hydrocarbons Regulations). The above specify three types of licences that can be applied for and obtained. These relate to hydrocarbon prospecting, exploration and exploitation. Each licence pertains to a particular exploration block. The legal framework also provides the criteria that need to be fulfilled so that the applicant can be deemed eligible for each licence. Under Community Law 183(I)/2004, the transmission and distribution of gas without a licence is a criminal offence.
There are three types of licences that can be awarded:
- a Hydrocarbon prospecting licence: this licence grants its holder the right to attempt to locate hydrocarbons in a geographical area by any appropriate method other than drilling. This licence is subject to a statutory maximum term of one year.2
- b Hydrocarbon exploration licence: the exploration licence can be obtained for up to three years3 and may be renewed for up to two terms, each term not exceeding two years, given that the licensee has satisfied its obligations in relation to a current exploration term. In every renewal of the term of the exploration period, the licensee must surrender at least 25 per cent of the initial surface of the licensed area. This licence covers gravity, 2D/3D seismic surveys and magnetic surveys, as well as one exploration drilling. If hydrocarbons are discovered, then the licensee is granted an exploitation licence.
- c Hydrocarbon exploitation licence: granted initially for up to 25 years and can potentially be renewed once for a further 10 years. It covers both exploration and exploitation if commercial hydrocarbons are discovered.
i Licensing rounds
The invitation for the initial licensing round related to the exploration and exploitation licences for Block 12 was announced on 15 February 2007.
The first exploration licence for Block 12, which covers an area of 4,600 square kilometres, was granted to Noble Energy International in the first licensing round in October 2008. In October 2013, Noble Energy had placed the resource estimation in the specific gas field in the range of 3.6 to 6tcf.
A second bid round was concluded on 11 May 2012 for the 12 remaining offshore blocks. Interest was shown from 15 consortia/companies (a total of 29 different companies), which placed 33 applications for nine blocks.
The ENI-KOGAS consortium was given licences for Blocks 2, 3 and 9 in January 2013. The following month, Total E&P obtained licences for Blocks 10 and 11 but relinquished the licence for Block 10. ENI-KOGAS commenced exploration drilling in 2014, but a few months ago the said company asked the Republic of Cyprus for a two-year extension (i.e., until February 2018) to re-evaluate the geological model on which it based its initial estimates. The state, after having found the proper legal framework to satisfy the company’s request, decided to start negotiations on the two-year extension for hydrocarbon exploration in Cyprus’ Exclusive Economic Zone (EEZ).4
Recently, the Republic of Cyprus announced the commencement of the third licensing round for offshore exploration Blocks 6, 8 and 10 in its exclusive economic zone.5 The efforts and perseverance of the President, Nicos Anastasiades, and of the Minister of Energy, Giorgos Lakkotrypis, to market the third licensing round were fruitful and led to a positive outcome.6 In fact, eight energy companies filed six bids for the three offshore blocks as follows: Block 6: ENI/Total, Block 8: ENI, Cairn/Delek and Block 10: ENI/Total, ExxonMobil/Qatar Petroleum (QP), Statoil. The importance of Block 10 stems from ENI’s discovery of the giant Zohr field off the coast of Egypt located very near Cyprus’ EEZ.
ii Type of instrument used
The specific conditions and requirements for the exploration and exploitation licences are incorporated in a contract agreement established between the government of Cyprus and the licensees. Such a contract may take the widely used form of a PSC or a concession agreement or both, or any other form of the arrangement of those used in the hydrocarbons industry. PSC was first used for the agreement between the government of Cyprus and Noble Energy International with respect to Block 12.
A model PSC can be found at the website of the Ministry of Energy, Commerce, Industry and Tourism of the Republic of Cyprus.7 The main clauses of the model PSC include the minimum exploration work programme; cost of oil and gas recovery; transfer – assignment; change of control; profit percentages; minimum annual training budget; performance guarantee and annual surface fees.
iii Licence limitations
The holder of a licence should ensure that all operations are carried out in a manner that shows respect to the environment and is in line with the current environmental legislation such as the International Convention on Civil Liability for Oil Pollution Damage. Good industry standards provide an attestation to this. Cyprus has followed Directive 2001/42/EC, transposing it into national law. It subsequently performed a strategic environmental assessment (SEA) to bring out and highlight any effects that the activities relating to hydrocarbons might have. Authorised parties are expected to comply with the SEA.
Furthermore it is obligatory, as stipulated by the model contract, for the licensee to ‘remove all equipment, installations, structures, plants, appliances and pipelines from the licensed area’.8 This should be coupled with all necessary site restoration activities in accordance with good international petroleum industry practices and take all necessary measures to prevent hazards to human life, the property of others or the environment’.9 This default position could be varied by the Minister of Energy, Commerce, Industry and Tourism (the Minister), who may also demand the issue of a guarantee for a determined amount or the setting up of a reserve for future abandonment and restoration expenses.
IV PRODUCTION RESTRICTIONS
i Restrictions on exports of oil and gas and on production entitlements
There are no restrictions on exports of oil and gas or on production entitlements. However, the annual work programme and development plan for each reservoir are accepted by the government and in this context the production needs to be approved.
ii Requirements for sales of production into the local markets
Through the provisions of the PSC model, the government may impose requirements for sales of production into the local markets. However, the Cypriot market is too small and the discoveries are already too large.
iii Law applicable to price setting
With regard to provisions applicable to price setting, the model PSC provides in general that the arm’s-length principle must be followed.
V ASSIGNMENTS OF INTERESTS
Any licences and rights stemming from them can be assigned or transferred. This, however, is subject to consent from the Council of Ministers of Cyprus. As Regulation 12(1) of the 2007 Regulations stipulates, for such a transfer, a written application must be made to the Minister. The Minister will in turn submit an opinion to the Council of Ministers, which will reach a decision.
The Council will consider whether the assignee or transferee possesses the adequate know-how, experience and resources to carry out the relevant activities. Possible national security issues will also be examined.
Moreover, the Council may decide to impose conditions on the original licence. The Ministry of Energy, Commerce, Industry and Tourism can provide guidance to the relevant application.
Despite it being the first time that Cyprus is deploying the natural resources found within its EEZ, various international energy companies have previously used Cyprus in order to benefit from the favourable and attractive taxation terms as well as the high standard of services that Cyprus has to offer.
At the moment there is no tax regime in Cyprus specifically for the oil and gas industry, although the tax authorities will provide such guidance in the future. For the time being, all contractors must abide by the taxation legislation currently in place in Cyprus.
This follows the EU VAT Directive as Cyprus is part of the EU Customs Union. The current principal VAT rate is 19 per cent. It should be noted that, as the PSC provides, corporate tax is held to be included within the profit share that belongs to the government. Subsequently, the contractor’s share is corporate tax-free.
It should be noted that profits arising from the activities of a permanent establishment (such as oil and gas exploration sites) in Cyprus will be exempt from any taxation in Cyprus.
Cyprus also has several double taxation treaties with other countries, as mentioned above.
VII ENVIRONMENTAL IMPACT AND DECOMMISSIONING
i Environmental impact
Considering the potential impact that oil and gas operations might have on the environment, the legal framework stipulates an assessment of such operations. The relevant EU legislation is Directive 2001/42/EC, which was transposed into national law by the Assessments of the Effects on the Environment of Certain Plans and/or Programmes Law 140(I) of 2005.
The law requires an SEA to be executed so that the effect of hydrocarbon exploration and exploitation activities can be identified at an early stage. The SEA’s role is to identify, describe and evaluate the likely significant effects on the environment of implementing hydrocarbon exploration and exploitation activities as well as bind all the licensees to follow and comply with the results and recommendations of this assessment.
The environmental report that was prepared by Maritime Communication Services Inc., Aeoliki Ltd and CSA International Inc., can be located on the website of the Ministry of Energy, Commerce, Industry and Tourism.10 Contractors and subcontractors are equally required to comply with the findings of the SEA.
Hydrocarbon operations are further regulated by the general laws and regulations of Cyprus on environmental protection, health and safety. It is therefore obligatory for every authorised party to conduct the relevant activities in a safe and environmentally acceptable manner and to follow best international industry practices.
Contractors are also obliged to carry out a preliminary environmental impact assessment study prior to any exploration operations. This should be supplemented by a full environmental impact assessment study prior to any exploitation work. In other words it should be ensured that hydrocarbon operations are conducted in an environmentally acceptable and safe manner, consistent with the environmental legislation and the good international industry practice.
The removal, disposal or reuse of any structures used during the relevant processes is again guided by the terms of the model PSC. The contract requires the authorised party to obtain the approval of the Ministry of Commerce Industry and Tourism before proceeding with decommissioning.
For that to happen, contractors must put forward a decommissioning plan, together with any expected expenditure at least six years before the expected date of the decommissioning of a block or as soon as possible before the termination of any exploitation area. A consultation period between the parties, where amendments to the suggested plan are submitted, may follow.
A reserve fund should be established in order to safeguard the effective completion of any decommissioning activity. The fund should be deposited in a bank account and approved by the Ministry. In the event decommissioning costs prove to be greater than the amount reserved, any such costs are to be covered by the contractor. If costs are lower, on the other hand, any excess amount will be payable to the government.
VIII FOREIGN INVESTMENT CONSIDERATIONS
For oil and gas operations in Cyprus investors may choose to either establish a branch of a foreign operation or a local entity.
ii Capital, labour and content restrictions
The European internal market framework guides the movement of capital. Therefore, there are no limitations on the entry of foreign capital in Cyprus, other than those limitations stemming from international sanctions, terrorist financing or money laundering legislation.
Cyprus is party and signatory to the Schengen Agreement. There are thus no restrictions on the ability of companies to employ Cypriot or EU nationals. For workers that are not EU nationals, it is obligatory that they hold a residence permit or temporary visa that would enable them to work in Cyprus.
It is nevertheless stipulated in the model PSC that once operations begin the contractor shall ensure priority employment for Cypriot and EEA personnel and contribute to the training of those personnel in order to allow them access to any position of skilled worker, foreman, executive and manager.11
Cyprus follows a European Council 2003 Framework Decision concerning corruption. The decision targets acts of both active and passive corruption and imposes criminal liability on those responsible.
There are also rules related to oil and gas activities passed by the European Parliament in 2011 that seek to shield consumers from abuses in wholesale oil and gas trading. The rules prescribe the independent monitoring of energy trading within the Union with the overall aim of combating anti-competitive practices.
This is further reinforced by the European legislation on Energy Market, Integrity and Transparency, which applies to all energy trading activity in the Community and criminalises market manipulation and insider information used. To achieve this, the Agency for the Cooperation of Energy Regulations will supply Member States with details of breaches of the aforementioned laws.
IX CURRENT DEVELOPMENTS
In August 2015, Italy’s ENI discovered the ‘largest’ offshore natural gas field in the Mediterranean off the Egyptian coast and also very close to Cyprus’ Block 11 of the EEZ by using the drillship Saipem 10000. The Zohr will possibly be able to meet Egypt’s own natural gas demands for decades to come and hence will probably affect Cyprus positively. The Cypriot government had announced through its Minister of Energy, Yiorgos Lakkotrypis, that it is currently investigating whether the Zohr field extends into Cyprus’ EEZ. Should the Zohr field indeed extend into Cypriot waters, it is believed that the Cypriot and Egyptian governments will work closely towards jointly developing the reservoir. Furthermore, another impact that the Zohr field had on Cyprus is that Saipem’s pipelayer Castoro Sei is anchored at the Limassol port in Cyprus last July and will remain there for six months, utilising the port’s services. Therefore although the platform will be working for Zohr, this will have a positive impact on Cyprus’ economy such as on the local business, the port itself, the airports, hotels and restaurants. This indicates not only the right infrastructure, which Cyprus has, but also that this may encourage other companies to choose the Limassol port for their activities in the eastern Mediterranean.
Moreover, the cooperation that already exists between Cyprus and Israel in the field of energy may provide the option in the near future, and once the Cyprus problem is resolved, to pipe the gas through Turkey to southern Europe. This should be done quickly since the discovery in Egypt may be an indicator that there is more gas to be found in the Levant basin and in Cypriot waters. ENI-KOGAS is scheduled to continue drilling Block 9 of Cyprus’ EEZ and thus the possibilities of finding additional reserves remain high.
In addition, the government of Cyprus recently formed the National Geostrategic Council and the Energy Council, staffed by experts and academics who will provide guidance in relation to energy matters. In conclusion, ENI-KOGAS’s presence in Cyprus’ EEZ and particularly in Block 9, along with the recent discovery by Noble Energy in the Aphrodite field and the discovery of the Zohr field located near Cyprus, are sufficient reasons to be optimistic about the near future.
Another recent development in Cyprus is the agreement signed in late August 2016 between Cyprus and Egypt that involves the transfer of gas from Cyprus to Egypt though an undersea pipeline. The ‘new deal’ will support the sale of Cypriot natural gas to buyers in Egypt, provide certainty to investors and complement the relevant commercial discussions that are under way.
1 Nicolas Th Papaconstantinou is a partner at Papadopoulos, Lycourgos & Co LLC.
2 Article 8 of the Hydrocarbons Regulations.
3 Article 9 of the Hydrocarbons Regulations.
4 Cyprus Mail, ‘Cabinet authorises new negotiations with ENI-KOGAS’, 19 August 2015, http://cyprus-mail.com/2015/08/19/cabinet-authorises-new-negotiations-with-eni-kogas/.
5 Ministry of Energy, Commerce and Tourism of the Republic of Cyprus, http://www.mcit.gov.cy/mcit/mcit.nsf/dmlhcarbon3_en/dmlhcarbon3_en?OpenDocument.
6 Cyprus Mail, ‘Cyprus to take its pick for Block 10 in EEZ’, 7 August 2016, http://cyprus-mail.com/2016/08/07/cyprus-take-pick-block-10-eez/.
7 Ministry of Energy, Commerce and Tourism of the Republic of Cyprus, www.mcit.gov.cy/mcit/mcit.nsf/dmlindex_gr/dmlindex_gr?OpenDocument.
8 Regulation 16 (1)(a)No. 51/2007 and No. 113/2009.
9 Ibid. Regulation 16(1)(b).
10 Ministry of Energy, Commerce and Tourism of the Republic of Cyprus, www.mcit.gov.cy/mcit/mcit.nsf/dmlindex_gr/dmlindex_gr?OpenDocument.
11 Article 25.1 of the Model Exploration and Production Sharing Contract.