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Egypt gives IOCs hope despite major challenges

Despite the major operational challenges they face, international oil and gas companies (IOCs) with interests in Egypt have some cause for comfort

It is not simply that the Egyptian authorities have promised that by 2017 it will have fully serviced arrears, totalling an estimated $6 billion, owed to energy investors. Government efforts to boost state coffers without recourse to aid from the Gulf are also a cause for optimism. 

In a dramatic move to partially fix Egypt’s much criticised subsidies programme, the authorities increased petrol prices by between 40% and 80% (depending on the grade of fuel) in early July. Energy subsidies have conventionally accounted for one-fifth of all state spending in Egypt. 

Debt reduction

Higher taxes on cigarettes and alcohol, combined with plans to phase in electricity price rises, should likewise allow the government to service a greater amount of IOC debt while increasing much-need spending on health and education. 

Finance minister Kadry Dimian maintains that energy subsidy cuts in the 2014/15 budget should save the government as much as $5.59bn. This, however, is far from enough. As of July this year, Egypt’s budget deficit stood at  $33.7bn, equivalent to 12% of GDP. In these circumstances, the government’s scope to service both outstanding and accumulating new debt owed to IOCs without the prop of Gulf aid remains limited, unless the Egyptian authorities ignore the risk of public backlash and continue slashing subsidy expenditures this year and next. 

Increased pressure from Gulf state sponsors could well force the Egyptian government – which has on numerous occasions underlined its commitment to painful but necessary reform – to bite the bullet. While providing unflinching moral and financial support to president Abdel Fattah al-Sisi in his crackdown against the outlawed Muslim Brotherhood, the Saudi, Emirati and Kuwaiti authorities have been looking to wean the Egyptian government off Gulf hand-outs. 

Figures from May 2014 show that Gulf oil producers gave the Egyptian government at least $6bn in free fuel since former president Mohammed Morsi was toppled by al-Sisi. In May, Egypt’s president stated that total financial assistance from Saudi Arabia and other Gulf states since 30 June 2013 exceeded $20bn. Although private energy investors are clearly happy with the prospect of further subsidy cuts, they will likely continue to demand that more be done to protect their interests. 

Public statements by BP Group – which produces about one fifth of its natural gas in Egypt – highlight its inability to boost liquefied natural gas (LNG) volumes and sales. In a July release, BG Group stated that: “In the absence of concerted action from the Egyptian government, the future commercial operation of Egypt LNG remains at risk.” The company’s production of natural gas in Egypt reportedly halved in the first six months of 2014.

Such complaints derive, in part at least, from the authorities’ drive to absorb oil and gas supplies into the domestic market rather than export amidst acute domestic fuel shortages and electricity blackouts. 

Indeed, BG announced force majeure on its Egyptian operations after the government diverted gas (from joint venture operations involving state counterparts) earmarked for export to the domestic market. The level of debt owed to IOCs by the Egyptian state derives from the fact that these players earn more from the sale of supplies abroad.

Two months later, Spanish major Gas Natural Fenosa initiated international arbitration proceedings against the Egyptian government over the suspension of an LNG plant it jointly owns with Italy’s Eni and state-owned EGAS and EGPC. The company was likewise unable to meet its export obligations.

The extent of the dip in exports is nothing to shrug at. Government figures show that Egypt’s natural gas exports fell by 80.94% in April year on year, while gas production diminished 14.66% in the same period.  

Notwithstanding the politically controversial prospect of gas imports from Israel, Egypt’s energy squeeze will continue in the medium and longer term as the population continues to expand rapidly. The country’s population (at least 85 million) is projected to expand by 1m a year until at least 2030. Egypt’s thirst for oil and gas will continue to increase at a rapid rate.

It is little surprise therefore that the Egyptian government has started putting in place plans to establish new infrastructure to help alleviate the immediate energy supply crisis – most notable an LNG import terminal near the Red Sea port of Ain Sokhna. 

The terminal – which should be operational in the second half of 2014 – will have a storage capacity of 170,000 cubic metres. Agreements have already been reached for a number of LNG cargoes. Yet, the preferred option is for foreign investors to boost output and engage in new exploration, thereby reducing the need to import supplies from abroad. 

Increased investment

Despite the country’s debt problem, a number of majors have looked to expand their activities in Egypt. Notably, in a June 2014 local press interview, Shell Egypt’s chairman Jeroen Regtien stated that the company hoped to make investments of up to $500m in exploration and development over the current fiscal year, up from $400m in 2013/14. 

This initiative contrasts with Apache’s decision to sell one third of its Egyptian assets to China’s Sinopec. Apache Egypt’s vice president Tom Maher said the company’s decision to sell was driven primarily by the need to restructure its portfolio.  

Leaving a company’s strategic needs aside, whether IOCs decide to sustain, expand or reduce the size of their footprint in Egypt will ultimately depend on their success in negotiating with the authorities, on the terms of individual production sharing agreements and the pace at which state debt is paid off.

Anthony Skinner, director, MENA practice, Maplecroft 

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