For many years, the public debate has assumed that replacing oil with natural gas would automatically produce substantially lower electricity prices. That assumption was reasonable when the Vasilikos LNG import project was expected to cost around €300 million.
It becomes far less certain when the investment required to deliver gas has increased several-fold.
From gas price to electricity cost
Natural gas remains a more efficient fuel than heavy fuel oil. Combined-cycle gas turbines convert around 55 per cent to 60 per cent of the fuel’s energy into electricity, compared with around 35 per cent to 40 per cent for conventional oil-fired steam units. Gas-fired generation also produces significantly lower carbon dioxide emissions, reducing the cost of purchasing EU Emissions Trading Scheme allowances.
These advantages still exist. The problem is that they are increasingly offset by the much higher cost of delivering the gas itself.
Assuming LNG costs $8/MMBtu and annual throughput is approximately 0.7 bcm, the estimated cost build-up is shown below.
Cost component US$/MMBtu)
Delivered LNG 8.0
Infrastructure capital recovery 5.5–6.5
Operations, maintenance and financing 1.5–2.0
Operational penalties (cargo size, utilisation, boil-off) 0.5–1.0
Gas delivered to power stations 15.5–17.0
This means that infrastructure costs account for almost half of the final delivered gas price. Very few LNG import projects operate under such conditions.
What does this mean for electricity generation?
To answer that question, the gas cost must be compared with the cost of continuing to generate electricity using oil.
Using a Brent crude oil price of $70/barrel, together with current estimates of fuel oil prices, generating efficiencies and carbon costs, the comparison is approximately as follows.
Generation option Estimated cost (€ /MWh)
Existing oil-fired generation 120–145
LNG using revised Vasilikos project 125–145
This is the electricity generation charge EAC charges for producing and supplying electricity, before fuel adjustment and network charges.
These figures are necessarily approximate because they depend on future carbon prices, oil product differentials and power plant dispatch. Nevertheless, they illustrate an important point.
Instead of producing dramatically cheaper electricity, imported LNG under the revised project economics may produce electricity at almost exactly the same cost as the existing oil-fired system.
Under less favourable market conditions – higher LNG prices, lower terminal utilisation or further increases in project cost – it could even become marginally more expensive.
The impact on consumers
Electricity generation costs represent only part of the final electricity tariff paid by households and businesses. Transmission, distribution, system services, supplier costs, renewable energy obligations and VAT are added afterwards.
Consequently, a small change in generation cost translates into an even smaller change in the final electricity bill.
Under the assumptions used here, consumers should not expect electricity bills to fall compared with current levels. That is a very different outcome from the substantial reductions that were originally expected when the project was first announced.
Could higher gas demand improve the economics?
Yes. The economics of the terminal improve rapidly as throughput increases because fixed costs are spread over a larger volume of gas.
For example:
Annual throughput Estimated infrastructure cost
0.7 bcm US$7–8/MMBtu
1.0 bcm US$5–6/MMBtu
2.0 bcm around US$3/MMBtu
Unfortunately, Cyprus is unlikely to consume anywhere near two bcm of gas annually during the next decade.
Existing combined-cycle gas turbines at EAC and PEC are expected to require only about 0.7-1.0/yr, depending on electricity demand and the penetration of renewable energy.
This leaves the terminal significantly underutilised throughout much of its operating life.
The importance of commodity prices
One conclusion from this analysis is that future electricity prices become much less sensitive to the international LNG market than many assume.
If LNG prices increase by $1/MMBtu, the final delivered gas price increases by approximately the same amount.
However, when infrastructure costs already exceed $7/MMBtu, fluctuations in LNG prices become relatively less important than the fixed cost of the terminal itself.
In other words, once the project reaches its current cost level, the economics are driven more by capital recovery than by international gas markets. This is an unusual position for an LNG import project.
Looking beyond the sunk costs
None of this implies that natural gas has lost its strategic value.
Gas still offers: lower emissions, greater generating efficiency, improved fuel diversification, enhanced security of supply.
The question is whether the present project remains the least-cost way of obtaining those benefits.
Economists distinguish between sunk costs, which cannot be recovered, and future costs, which remain under the control of decision-makers.
The money already spent on the project should not determine whether it proceeds. What matters is whether spending several hundred million euros more will produce sufficient economic benefit to justify the investment.
That requires comparing completion of the current project with alternative ways of supplying gas to Cyprus. That I will do in the final article of this series.
Conclusion
The reassessment of the Vasilikos LNG import project leads to one unavoidable conclusion: The international price of LNG is no longer the principal determinant of the cost of gas delivered to Cyprus. The dominant factor has become the cost of the infrastructure itself.
A project originally intended to lower electricity prices may still achieve important environmental and strategic objectives, but its ability to deliver cheaper electricity has been significantly weakened by cost escalation, delays and the relatively small size of the Cypriot gas market.
This does not necessarily mean the project to convert power generation to natural gas should be abandoned.
It does mean that Cyprus should now compare completion of the existing project with alternative gas supply options using exactly the same economic criteria.
Only then can policymakers determine which solution delivers the lowest-cost, most secure and most flexible gas supply for the country. That is the purpose of my final article.
This is Part Three in a series of three articles on LNG imports. (Part One) (Part Two) -
