The government must weigh support for subsidies against the need for more sustainable development

Thanks to their lengthy development cycles, Egypt’s oil and gas fields have continued to attract foreign investment steadily over the past three years, in spite of the broader instability in the country. The reserves remain extensive enough to ensure continued interest in them for years to come. Nevertheless, there has been a plateau in production levels and, due to rising consumption, shortages of crucial supplies of natural gas in the domestic market. As a result, the government has been keen to ensure a competitive investment environment to boost inflows in the years to come. Doing so will require addressing the pricing discrepancy and cash flow issues that the country’s subsidised energy programme have resulted in, but the low production costs and developed processing infrastructure do mean Egypt’s long-term potential is notable.

Bidding

Since the revolution of 2011, the country has taken a number of steps to assess the level of international interest in its oil and gas sector. In September of that difficult year, the Egyptian General Petroleum Corporation (EGPC) pressed ahead with the scheduled bidding of 15 exploration blocks located in the Gulf of Suez, Eastern Desert, Western Desert and the Sinai sedimentary basins. An original closing date for bids in January 2012 was extended to the end of March in order to allow more companies to participate, and by October 2012 the EGPC was in a position to announce the results of its bid round. Out of the 15 blocks, 11 attracted bids and were subsequently awarded by the EGPC, which collectively amounted to some 10,500 sq km of the 18,000 sq km initially on offer.

However, the protracted nature of the bidding round, coupled with the lack of suitable bids for four of the offered blocks, sparked a debate on the attractiveness of Egypt’s hydrocarbons sector for investors. The sector has largely avoided the civil unrest which has dampened investor enthusiasm elsewhere, yet the rates at which the EGPC, the Egyptian Natural Gas Holding Company (EGAS) and Ganoub El Wadi Petroleum Holding Company pay for the percentage of the product, which international oil companies (IOCs) are contractually bound to deliver, is low compared to other large markets. This is especially so given the higher cost of production for offshore fields, where much of the gas lies.

According to industry estimates, offshore gas producers receive on average around $2-3 per million British thermal units (mBtu), compared to the rate of above $10 per mBtu obtainable by companies operating in the UK’s gas fields or $17 per mBtu payable for supply from Asia. The idea of altering pricing arrangements for IOCs with concession agreements in deepwater blocks has been floated as a possibility. To this end, EGAS has already taken some steps to address the pricing mechanism: in 2013 it altered the rate at which it will buy gas from producers from $2.65 mBtu to a varying schedule of between $3.95 and $5.88 per mBtu.

Debt

The challenge of pricing extends beyond merely the rates which the government pays to producers; it also ties into broader cash flow issues. Egypt’s deteriorating fiscal position over the past three years has presented the Ministry of Petroleum (MoP) and related agencies with a significant challenge. The government’s generous subsidisation of gas and refined products – in a situation where the EGPC and EGAS purchase gas at a rate linked to international prices and then make it available on the domestic market at much lower rates – means it can often be difficult for the EGPC to keep up with its payment schedule. “The rates at which the EGPC buys its gas are just below the market price, as the product does not need to be shipped. But this is still much higher than the price at which, under the subsidised rate, it is being sold domestically. This situation is unsustainable in the long term,” Magdi M Nasrallah, professor and chair in the Department of Petroleum at the American University in Cairo, told OBG.

The question of subsidies is certainly a complex one. Subsidy reform is essential to reducing the government’s recurrent expenditures and tackling Egypt’s structural fiscal deficit (see Economy chapter). However, a resolution of the country’s debt to IOCs could also unlock more potential. Mark Fenton, general manger of Dana Gas, told OBG, “If the receivable issue was solved, the country would be in a comfortable position to increase liquefied natural gas and gas production, while decreasing its imports from neighbouring countries.”

The country’s large lower-income population means that adopting a new policy that would cause an increase in prices is a sensitive issue. However, following the presidential elections earlier in the year, in July 2014 the government announced significant subsidy cuts across a range of fuels. The move resulted in major increases in cost for consumers: diesel grades rose 64-78%; natural gas, on which most of the nation’s taxi fleet relies on, saw a 175% increase; and 92-octane petrol was made 40% more expensive. In the case of higher grade 95-octane petrol, the modest price rise of 6.8% reflected the fact that the subsidy on this product was almost completely removed in November 2012.

New Round 

As the government moves to improve and reduce the market distortions caused by subsidies, the MoP has pushed ahead with new bidding rounds for exploration agreements to expand upstream output. At the close of 2013 the EGPC and EGAS launched a simultaneous bidding round for exploration blocks in what is one of the largest international auctions since the 2011 revolution. The 15 blocks offered by the EGPC are clustered in the Gulf of Suez and the Western Desert, five of them offshore, comprising a total area of 31,107 sq km. The EGAS tranche, meanwhile, is made up of seven blocks, five of which are offshore. Both bidding rounds had an initial closing date of May 19, 2014. However, in April 2014 the EGPC announced that this deadline was to be extended until July 3, 2014.

A string of announcements came in September 2014 as several firms announced what blocks they had been given. Dana was granted rights to the North El Salhiya and El Matariya onshore gas blocks, while France’s Total was awarded the North El Mahalla block. Italian firm Eni won three licences, namely, offshore blocks North Leil and Karawan and onshore oil block South-West Melehia. Italy’s Edison and Petroceltic jointly signed up for North Port Fuad, and Edison also formed a partnership with Germany’s RWE-Dea for the East Ras Fanar and Northwest El Amal blocks in the Gulf of Suez.

Keeping It Going 

Significant capital flows are still being directed towards key upstream development. According to the MoP, between October 2013 and May 2014 a total of 32 new oil and gas exploration deals were signed with a “group of major oil companies” for an estimated value of about $2bn, while BP announced plans for a $10bn investment in its existing fields over the next five years.

Although the precise scale of the EGPC’s debt to IOCs has not been revealed, both the EGPC and EGAS have shown a willingness to cooperate with IOCs while a long-term solution to the agencies’ liquidity problems is sought – one idea is to grant firms the right to export a certain volume on their own terms so they can receive revenue directly from third parties. Such short-term compromises are likely to remain a feature of the market in 2015, as IOCs and the state keep an eye on long-term sustainability.

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The Report: Egypt 2014

Energy & Utilities chapter from The Report: Egypt 2014

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