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Cairo looks to increase upstream efforts and ease IOC pain

With foreign oil companies owed about $6 billion, Egypt's interim, military-backed government must make tough choices as it looks to keep production and investment flowing

For a nation that has experienced a series of damaging political ruptures, unprecedented levels of street violence, a cataclysmic fall-off in tourism and the rapid depletion of its foreign exchange reserves, Egypt isn't doing too badly.

Since the military leadership ousted the elected Muslim Brotherhood president Mohammed Morsi in early July, Cairo has been inundated with promises of financial support from wealthy Gulf states eager to throw hard cash to bolster the new administration formed by General Abdul al-Sisi, the Egyptian Armed Forces chief.

Commitments of more than $12 billion have come from Saudi Arabia, Kuwait and the United Arab Emirates, in a mix of cash, central bank deposits and oil products, to stave off pressure on the currency. This comes on top of the $7.5bn in loans and grants extended by Qatar during the lifetime of the Morsi government.

The Gulf funds have bulked up Egypt's foreign reserves to an estimated $18bn, providing sufficient fiscal breathing space for the interim administration as it firefights problems on a number of fronts.

For international oil companies (IOCs) looking to secure repayment of an estimated $6bn owed by the authorities from their Egyptian operations, the injection of Gulf cash provides a silver lining.

With the Gulf money in their pockets, along with substantial volumes of fuel, Cairo has a bit of spare cash to keep the IOCs happy. The government is reported to be in talks with IOC chiefs, requesting they ramp up upstream efforts in exchange for more rapid repayment of the estimated $6bn owed by Egyptian General Petroleum Corporation (EGPC) and its subsidiaries to foreign companies.

Finance Minister Ahmed Galal has said the offer on the table amounts to a rescheduling of the debts in a way that "gives the companies an amount of liquidity that allows them to invest and make discoveries to benefit production".

This follows the announcement in early September from the respected and experienced new petroleum minister, Sharif Ismail, that the government was drawing up a "timetable and new mechanisms" to reschedule arrears.

The oil company arrears have been level at $6bn since the former president Hosni Mubarak's days. Osama Kamal (briefly oil minister under Morsi) agreed the basic repayment schedule aimed at getting arrears paid off by around 2016 and all payments current two years later.

The lengthy list of companies awaiting payment - including BG, BP, Apache, Edison, Eni and Dana Gas - underlines the urgency of getting payments moving, particularly when the domestic demand/supply situation is so tight.

BP alone is owed $1bn in overdue receivables, as part of a wider $3bn. Eni has claimed $800m is owed to it. BG meanwhile said in July it was owed $1.3bn by Cairo, of which $600m was overdue.

With such sizeable sums in play, companies are understandably reluctant to commit to long-term investment programmes.

However, the surge of Gulf cash has sweetened a bitter pill for the IOCs. In June of this year, Qatar announced that it two of the five LNG cargoes it would send to Egypt over the summer months would be allocated to compensate for BG gas that had been diverted for domestic use, under a broader gas-swap arrangement tying Egypt, Qatar and the IOCs together.

Despite this relief, BG was forced to issue a warning over 2014 milestones related to Egypt's continuing political and social instability. It said Phase 9a of West Delta Deep Marine (the area that provides gas for trains 1 and 2 of Egyptian LNG at Idku) has suffered delay, resulting in first production commencing later than expected in 2014, provided no further disruption is caused to the programme. 

Idku exports have fallen in the past two years as the government diverts more feed gas to domestic consumers.

BG has a particular need for payment, says analyst Peter Hutton of RBC Markets, as it is getting close to 25% gearing. "BG doesn't want to see that build up from a financial point of view."

The truth is that Egypt's late payment crisis is not a recent phenomenon, and nor can it be blamed on the Morsi administration, for all the legitimate criticisms of its cack-handed economic management.

Patience will still be needed. "BG recognises that the upheaval in Egypt and the logistical challenges. It's just harder to get the approvals,"says Hutton.

The delayed payments are a byproduct of the state's financial plight, but it is fundamentally linked to the issue of subsidies, says one IOC official with experience of Egypt. "It can be quickly remedied if the Egyptian government receives a cash injection from somewhere, but the problem will likely persist if the Egyptian domestic energy market remains structurally unchanged," he says.

The authorities need to address the strong demand growth, the domestic supply obligation on IOCs, artificially low domestic prices, and price differentials borne by the like of EGPC and Egas. 

Though the current investment climate in Egypt is not especially attractive, foreign companies are unlikely to break for the border just yet. "There's a general view among IOCs that this moment isn't the right one to make decisions on whether to withdraw from Egypt," says Laura el-Katiri, a MENA energy specialist at the Oxford Institute of Energy Studies. "Foreign companies want to observe the situation a bit longer, but they are putting pressure on the Egypt government and we're already seeing some of the companies refusing to invest above certain investment values on key projects."

The authorities have said that they would attempt to remedy the situation quickly, but it's not an easy task regardless of who is in power - though the anti-Morsi putsch may prove to be a positive development. "The difference between the Morsi government and the current administration is that outside donors may be willing to dispense cash more generously and more efficiently than before to prop up the military-backed government," says the IOC official. 

The late payment is a prominent - but by no means the only - gripe on a long list of challenges confronting the country's oil and gas sector.

Egypt has been suffering from ever-worsening gas shortages since Mubarak's overthrow in February 2011. These forced it to halt gas exports to Israel in April 2012 and shut down the Segas LNG plant at Damietta due to feedstock constraints.

Despite the damage wrought to Egypt's economy, gas consumption has continued to rise thought the past two years, growing 5.7% in 2012 to 52.6bn cubic metres (cm), according to BP Statistical Review figures. Just five years ago, consumption just scraped 40bn cm. Gas production in 2012 was estimated at 60.9 billion cm, a decline of 1.2 % over the previous year. With less than 8bn cm primary gas surplus - compared to 20bn cm in 2009 - Egypt is finding it a struggle to keep its industries and power stations supplied with sufficient feedstock.

The crude oil situation is no different. Egypt's crude oil consumption has outpaced production since 2010, and the country consumed 744,000 barrels a day (b/d) in 2012, when production was just 728,000 b/d. "The key problem is the domestic demand growth for energy and that is fuelled by natural processes like growing income ranges, rising living standards, and more people use electricity," says El-Katiri. "The Mubarak regime underestimated that demand growth and overestimated what they could realistically ramp up in terms of production, and the current government has inherited that."

Cairo also needs to create a viable incentive structure for IOCs to invest in increasingly expensive offshore projects. Twenty years ago, Egyptian and oil and gas was cheap and easy to produce. No longer.

El-Katiri predicts that the government will be forced to change the domestic contracting framework, fully compensating foreign companies for the risk they take, introducing more reward schemes for higher risk developments. "They might need to reconsider company shares under production sharing agreements, otherwise the companies will leave or do just the minimum they have to produce based on existing contracts."

The IOC official argues that there is no specific fiscal incentive needed to keep the foreign companies on board. "Domestic energy prices represent the main issue that needs addressing if both domestic demand is to be managed more pro-actively and upstream investment is to be more attractive for IOCs," he says. 

Despite all this, Egypt is still an attractive prospect, as Chinea's Sinopec's willingness to pay $3.1bn for one-third of Egyptian operations in late August attests.

But the reality slowly dawning on policymakers is that Egypt is unlikely to be able to sustain its position as an energy exporter, even if it gets a handle on the current turmoil. 

There are other - albeit politically unpalatable - solutions to hand. The future for Egypt oil and gas may lie in using Damietta and Idku as export terminals on behalf of Israel.

This may appear far-fetched, but has some basis in reality. The partners in Israel's offshore gas developments have already confirmed that they are discussing exporting gas to East Mediterranean countries, including Egypt. "The Israeli gas option shouldn't be overlooked," says El-Katiri. "From a purely economic point of view it could be lifeline, as it would be relatively low cost gas and the infrastructure is already in place - whereas to import LNG, Egypt would have to build a costly new import infrastructure," says El-Katiri.

Reversing the flow of gas from Egypt to Israel will prove a tough political sell. But in a rapidly shifting regional situation, such prospects should never be discounted.

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