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* Cyprus faces stark choice between Europe and Russia
* Gas exploration already fuelling wider regional tensions
* At worst, outcome for Europe and island bleak
By Peter Apps and Henning Gloystein
LONDON, March 21 As it tries to play Russia off
against Europe to salvage its economy, Cyprus has embarked on a
high-stakes poker game that could see almost everyone lose.
Its banks shattered by exposure to Greek debt, the island
state urgently needs a way of bailing out its financial system.
Cypriot policymakers hope they can begin to monetize as yet
undeveloped offshore gas fields and position themselves as a
vital source of energy for Europe.
However, such income is still years away and delusions of
becoming the Qatar of the eastern Mediterranean in the 2020s may
prompt Cyprus to overplay its hand now.
In the coming days, Nicosia may have to choose between a
European bailout that punishes savers - including both ordinary
Cypriots and much richer Russian investors - and a deal with
Moscow with as yet unknown strings attached.
At worst, it could emerge with its financial system - by far
the biggest contributor to the economy - in ruins along with
relations with its closest allies.
"Cyprus has always been complicated," said James
Ker-Lindsay, a senior fellow at the London School of Economics
and expert on the 50-year-old conflict between Greek and Turkish
Cypriots. "But this is by far the most complex it has been.
"They are in trouble. They may not want to make these
decisions, they know they have to."
The implications go well beyond Cyprus. Images of shuttered
banks and lines at cashpoints could spark bank runs elsewhere in
Europe, endangering the stability of the single currency.
In the background, a long-simmering conflict between the
Greek Cypriots in the south and the Turkish Cypriots in the
north of the divided island worries the rest of the region.
Greek Cypriot officials hoped speeding up gas exploration
would help them out of a financial hole. But in doing so, they
have raised tensions with the Turkish Cypriots who want a joint
approach and a share of the revenue.
Turks and Greeks, Israelis and their neighbors are all
discovering potential reserves along their disputed borders.
In Washington and Brussels, there are fears that increasing
strains between Cyprus and Turkey could lead to confrontation.
"Cyprus may set the tone for the rest of the eastern
Mediterranean," says Eric Thompson, director of strategic
studies at the Center for Naval Analyses, a U.S.
government-funded agency that advises the U.S. military.
"It is where the financial crisis and the gas issues come
together. And it is also where they become immediately
STILL BETTING ON EUROPE
So far, some 200 billion cubic meters of natural gas worth
$80 billion at current prices have been discovered in the
Aphrodite gas field in Cypriot waters, although the figures
still have to be audited.
That would be enough to cover around 40 percent of the
European Union's annual gas consumption. Cyprus hopes to start
exporting in 2018, but energy analysts say extracting the gas
will prove more costly and slower than Nicosia thinks, and
Cypriot supplies may run into a global glut, with shale gas
plentiful by then in North America, Russia and even Europe.
Successive Cypriot governments have viewed closer ties with
Europe as central to their strategy to hold back Turkey and
prosper as a bigger regional player.
Working closely with Israel, they aimed to sell eastern
Mediterranean gas to a Europe keen to wean itself off dependency
on sometimes politically unreliable supplies from Russia.
Cypriot officials say European companies were deliberately
prioritized over Asian and other rivals in granting new drilling
rights, with the newly elected government of President Nicos
Anastiades keen to lean further toward Europe.
That, one official told Reuters last week, could extend to
easier access to Cypriot military bases for any European
Many western states have used the island as a logistics hub
to support operations in Iraq and Afghanistan. Former colonial
power Britain retains two sovereign bases there but refrained
from using them for air strikes on Libya in 2011 out of
sensitivity to Cypriot opposition.
The bases are also a listening post for eavesdropping on
communications around the Middle East, although intelligence
satellites have made such outposts less important.
Until news of Saturday's bailout broke, most Greek Cypriots
would have endorsed ever closer European relations.
But with the initial bailout terms - which would have seen
even the smallest savers lose more than 6 percent of their
deposits - denounced as a little better than robbery, anger at
the EU and Germany in particular has soared.
Having committed billions to bailing out other fringe euro
zone economies, northern European taxpayers have little appetite
for more. That is especially true for Cyprus which Slovak
Finance Minister Peter Kazimir told reporters has a business
model based on "low taxes, network of lawyers and accountants,
as well as hidden 'shadow' companies."
Worried by what it sees as an increasingly assertive Russia,
some believe Germany is hoping a bailout will ultimately reduce
Moscow's influence on the island and elsewhere in Europe.
If recent days are anything to go by, however, it may have
had the opposite effect.
Cyprus is not the first indebted European island to turn to
Moscow in hope of help in a financial storm. Iceland did so in
2008 as its currency and banking system imploded, angering
allies who saw the NATO member as trying to sell itself out to
Russian interests barely a month after the Georgia war.
In the event, Russia did not bite, preferring to leave the
struggling country to the International Monetary Fund and
European Union. Cyprus, however, has long had closer ties with
Moscow based on business interests, a shared antipathy towards
Turkey and similar Orthodox Christian faith.
WHAT PRICE FROM MOSCOW?
No sooner had news of the bailout terms broken on Saturday
than rumors began to circulate suggesting that Russia - and gas
giant Gazprom in particular - might offer an alternative deal.
Gazprom denies any such plan. But a host of ideas are now
circulating in Moscow and Nicosia, many of them complex and
involving gas fields, Cypriot banks and real estate.
Russia could certainly be attracted by access to Cypriot
gas, tightening its grip on European supply.
A strategic relationship with Cyprus could make it harder
for Western states to use the bases for any military action in
Syria, and even offer the Kremlin an alternative Mediterranean
port should ally Bashar al-Assad lose his civil war.
Whether such a deal would work as well for Cyprus, however,
is another question. Barred from NATO by a Turkish veto, the
island was officially "unaligned" during the Cold War but has
shown little appetite to be a direct Russian satellite.
A bailout from Moscow might solve the immediate banking
crisis but greater Russian sway over Cypriot banks could scare
off their Russian clients. Many moved money to Cyprus precisely
to avoid unreliable Russian banks, rapacious tax officials and
the reach of the Russian state itself.
Fed up with bailing out Mediterranean states and perhaps
confident they can ring fence collapse in Cyprus - which makes
up less than 0.2 percent of the Eurozone economy - European
powers may decide they can afford to let Cyprus fail.
How bad a Cypriot bankruptcy might be for the rest of Europe
is, as yet, far from clear.
Earlier this week, one London-based fund described the
Cyprus bailout as the euro zone's "Franz Ferdinand moment,"
comparing it to the assassination of an Austrian archduke in
Sarajevo that sparked World War One in 1914.
"That might be an overstatement," said Fiona Hill, a former
senior official on the U.S. National Intelligence Council and
now head of the Europe Program at the Brookings Institution.
"But it's a very serious situation. You went to bed on
Friday night thinking that the Eurozone would survive and woke
up on Saturday (after the bailout) wondering how it can."
(Additional reporting by Henning Gloystein and Oleg Vukmanovic;
Editing by Paul Taylor)