The Energy Angle of the Cyprus Crisis

Cyprus could be a test. Lessons learned from Cyprus could frame the options considered for other troubled states. The leverage is energy.

Cyprus sits near one of the world's newest discoveries of oil and natural gas. The U.S. Geological Survey estimated that the newly discovered oil and gas basins shared by Egypt, Israel, Cyprus, Lebanon, Syria, Turkey and Greece contain at least 122 trillion cubic feet of natural gas and 1.7 billion barrels of oil.

Actually, these discoveries are not so new. Geologists have been aware of untapped oil and gas throughout the Mediterranean. Until new drilling technologies appeared, most of the region's deposits were considered inaccessible. No more.

As new technology appeared, so did vast amounts of new oil and gas reserves. Unsurprisingly, most Eastern Mediterranean nations began arguing about sovereign rights over those resources. In the middle of those arguments are the U.S. and Russian oil and gas companies, including Houston-based Noble Energy (NBL) and Russia-based Gazprom.

Bankers are stepping in and engaging in dispute resolution. Their solution is to require defaulting debtor nations to relinquish their control over their sovereign oil and gas assets, including exclusive economic zones (EEZs). The blueprint for this plan first appeared during the Greek debt crisis.

Greece could have solved its public debt crisis through the development of its sovereign gas and oil reserves. The value of Greek reserves could bring the country over $250 billion. Instead, the Greek government was forced by the International Monetary Fund and European Union to sell off its ports and public companies in order to reduce state debt. Among them were Greek state oil and gas companies.

The Republic of Cyprus could also solve its public debt crisis through the development of its sovereign gas and oil reserves. Like Greece, Cyprus seeks help from the IMF and EU.

This time, Gazprom wants to join in on the bailout-for-oil party. Burned by Cyprus' proposed bank tax, the Russians want to protect assets and seize new opportunities.

Last weekend, Gazprom offered the Republic of Cyprus a plan whereby the company would restructure the country's banks in exchange for Cyprus granting Gazprom natural gas exploration rights in nation's EEZ. Unlike the IMF, Gazprom can back up its refi offer with warships.

It turns out that Russia recently dispatched a permanent group of combat ships to the Mediterranean Sea. EEZ disputes between Cyprus, Turkey, Greece and Syria can be resolved with encouraging help from an interested and well-armed third party: Russia.

The Mediterranean story seems familiar. We have an island nation in financial trouble. Economic offers and threats are lobbied against that nation's sovereignty. The government is left to do one thing: Find the least bad option.

Jump to the other side of the world, and we find a similar story. There is another island nation in financial trouble, which finds itself in a troubling dispute with China. It is engaged in a territorial dispute about tiny and uninhabited islands in the East China Sea (the Senkaku/Diaoyu Islands). The issue is not really about culture, fish or timber; it is about EEZ, oil and natural gas.

According to National Geographic, the oil sitting under the South China waters is over 200 billion barrels. That is about five times more than the Gulf of Mexico reserves.

China believes the East China Sea is also home to one of the world's largest natural gas deposits. China believes it contains about 250 trillion cubic feet. While this is unconfirmed, analysts believe the natural gas reserves in the disputed region are "considerable."

Unlike Greece or Cyprus, Japan has not requested a bailout, at least not yet. But like its Mediterranean counterparts, Japan finances are a mess, and its economy desperately needs energy. Worse, a well-armed predator is lurking off its shores.

While Japan and other sovereign governments may struggle, drillers and producers could become winners. Noble Energy, Apache (APA), Anadarko (APC) and similar companies will be granted access to new fields. Israeli companies such as Delek Group will partner with the majors to develop Levant, Plio-Pleistocene and other reservoirs. Competing with these firms will be Russian and Chinese producers.

Oil and natural gas assets can provide a bridge loan to failing economies. Unfortunately, for many policymakers, that option is discovered late in the game. As a result, Cyprus and Greece are forced to take a haircut by handing over valuable assets for what amounts to pennies on the dollar.

California has yet to learn that lesson. Today, the state sits on vast and untapped reserve of oil that rivals Texas and North Dakota. Yet California drowns in debt and taxes while the oil remains untouched.