An offshore gas project in the Mediterranean, which could have earned desperately needed revenue for the Palestinian economy, is in ruins after negotiations to sell the fuel to Israel collapsed.

Industry sources blamed Israel for the failure of negotiations with the British multinational BG Group after the Jewish state repeatedly reduced its offer price for the gas.

"This meant that from the off the project would struggle to be economic," one source told The Daily Telegraph.

Israel also insisted on what insiders called "totally unacceptable security controls" by demanding the ability to stop Palestinian gas from reaching consumers in the Gaza Strip.

The failure of negotiations puts back indefinitely the day when the Palestinian economy receives earnings from the Gaza Marine Field, which was discovered eight years ago amid hopes that it could lead to Palestinian economic independence.

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The development comes just days after the international community agreed to commit £3.7 billion over the next three years to bolster the Palestinian economy.

"If confirmed, the loss of potential revenue flows is yet another setback for Palestinian hopes of economic independence," said Nicolas Pelham, a senior analyst for the International Crisis Group.

Industry experts assess the Gaza Marine Field contains natural gas worth about £2 billion, but exploiting it commercially has proved to be problematic since BG Group bought rights.

Palestinian consumers would be first in line for the gas but as their demand was low, BG Group sought a buyer for the surplus.

Even though Israel's growing economy needed gas, Ariel Sharon, the prime minister during the Second Intifada, refused to consider any deal that would generate revenues for his Palestinian enemies.

But Israel's hostility thawed last year after a number of top-level contacts between Britain and Israel, led by Gordon Brown, then Chancellor, who urged the Israeli government to reconsider the deal.

In the summer of last year, Israel committed itself fully to negotiations and BG Group installed a team of experts in an office close to Tel Aviv hoping to sign an agreement within months.

But talks dragged on, bogged down by concerns the royalties paid by Israel might end up in the hands of its enemies from the elected Hamas government.

This issue was dealt with as the World Bank set up a means to ensure funds paid to Palestinians ended up under the control of Mahmoud Abbas, the president of the Palestinian national authority who is trusted as a moderate by the international community.

The final straw came with a legal challenge mounted to any possible deal between the Israeli government and BG Group. It was mounted by a local Israeli gas company and it demanded all negotiations stop.

Israel told BG Group that the case would not succeed but a court ruled against the Israeli government and BG Group adding yet more delay to any possible deal.

BG Group is expected to make an announcement early in the New Year. Having spent £60 million, the company is anxious for a return, so the plan is to try to find a way of piping the Palestinian gas to Egypt where it would be refined and then exported to America and Europe.