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Egypt: oil firms taking the rough with the smooth

Modest increases in Egypt's oil and gas reserves are keeping IOCs interested, despite concerns over investment terms, writes Digby Lidstone

LEGEND tells that anyone who drinks the waters of the Nile is bound to return one day to Egypt. But the same cannot always be said of those who have sampled the local oil and gas.

Cairo has had a fickle relationship with international oil companies (IOCs) over the years, at times courting foreign investment, at other times repelling oil majors with new taxes and layers of red tape. Interest in Egypt's modest reserves of oil and gas has also waxed and waned with the rise and fall of energy prices (see Figure 1).

The Egyptian energy sector is emerging from one of its periodic bouts of uncertainty. Investors remain puzzled over the government's policies, after it subjected energy companies operating in free zones to an unexpected tax in mid-2008 and later called a halt on any new gas-export projects. After strenuous lobbying by the likes of BG and BP, both long-time investors in Egypt, the government agreed to improve the terms under which it buys gas from foreign players, but the incident left a bad taste in the mouth of many prospective investors.

A test of confidence will come in the spring, when state-owned EGPC announces the results of its latest licensing round, for which bids were submitted in November. EGPC tendered eight blocks, while its sister organisation, Ganoub el-Wadi Petroleum Holding – which oversees the energy sector in the south of Egypt – offered three blocks.

The bid round is the first since late 2008, when state-owned Egas had a mixed showing for seven Mediterranean offshore blocks. On the one hand, both BP and BG participated in the bidding and each won a concession – in marked contrast to a previous round in 2006, which they both boycotted, citing the poor terms on offer. On the other hand, only four of the seven exploration blocks received sufficient bids.

Yet Egypt continues to offer just enough to keep investors hooked. Apache, which has invested more than $8bn in the country in the past 15 years, continues to strike lucky on its patch in the Western Desert. The US' independent reported its fourth successful oil strike in its West Kalabsha concession in January, which it says could boost production from the area up to 20,000 barrels a day. Meanwhile, the UAE's Dana Gas, a comparative newcomer, last month announced its ninth successive oil discovery in a year in the Komombo concession.

Egypt's onshore fields are, for the most part, small and scattered and have tended to attract oil companies with perseverance and an eye for strategic, long-term investment. These include regional companies such as Dana and those from further afield, such as Lukoil of Russia. Western majors, for the most part, concentrate on the Mediterranean and Nile Delta, where most of the largest gasfields have been discovered so far, and the Gulf of Suez, home to numerous ageing oilfields and the scene of recent exploration activity.

Thanks to this distribution, development and operation costs are high, particularly for deep-water gasfields such as Scarab, Saffron, Simian and Sapphire, where operators have had to develop innovative subsea collection and distribution networks to bring gas to shore. But the biggest obstacle to investment remains the government.

The first half of the past decade was, by and large, a good time for the Egyptian industry. Under Sameh Fahmy, the country's technocratic oil minister, government institutions were streamlined and new ones created to encourage exploration of new areas such as the Mediterranean and the southern desert; the once-onerous process of awarding acreage to foreign companies was speeded up and tax incentives were introduced. This period also saw the emergence of a gas-export industry – its crowning glory the two liquefied natural gas (LNG) plants, at Idku and Damietta, on the Mediterranean coast.

This intensive period of exploration is beginning to bear fruit. Proved oil reserves rose by 5% during the 2008-09 fiscal year, reaching 4.4bn barrels at the end of June. Proved natural gas reserves had risen to 77.2 trillion cubic feet (cf) by July last year, an increase of 1.2 trillion cf on the previous year, putting Egypt in the middle tier of gas-rich countries, which includes China, Malaysia and Kazakhstan.

Gas production reached about 2.1 trillion cf in 2008 (see Figure 2). About 30% of this is now exported – mostly as LNG or through the Arab gas pipeline to Jordan. But the domestic gas market is growing quickly, fuelled in part by Egypt's fast-growing population of more than 80 million. In the five years to 2012, power demand is expected to have risen by more than a third.

Strong domestic energy demand has in turn put a political onus on the government to husband its gas wisely. During the high energy prices of 2008, opposition parties also claimed the government was losing money because of unfavourable export contracts. The twin pressures led to a freeze on any new export deals, forcing the Spanish-Egyptian consortium, Segas, to put on hold plans to expand its Damietta LNG facility. The government is expected to review its decision this year.

The Egyptian government retains an equivocal relationship with foreign investors. While the property seizures of past decades are now few and far between, the authorities can still subject foreign firms to arbitrary rulings – as they did 18 months ago with a 20% tax on companies based in local free zones, which led Egyptian Kuwaiti Holding to abandon plans for a $2.2bn refinery at Ain el-Sokhna. The decision was a response to local unrest over rising food and fuel prices, and was taken to pay for an increase in certain subsidies and public-sector pay.

Despite its subsequent volte face over gas prices, the government is still reluctant to improve the terms on offer to IOCs. It is stuck between appeasing public pressure and balancing its budget; and maximising long-term revenues by encouraging foreign energy investment.

Yet despite the occasional bumpy period, Egypt's reserves and production continue to climb. The results of November's bid round should indicate how willing IOCs are to take the rough with the smooth.

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