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Cairo tries to calm riled Riyadh

A delayed and much-needed $23bn oil-products package from Saudi Arabia to Cairo is part of a complex political narrative with few signs of an easy fix

Egypt's growing political independence is propelling a fundamental shift in its historical energy alliance with regional hegemon Saudi Arabia, and the change brings the potential to scar. A growing list of political irritants for Saudi Arabia is likely the reason the kingdom halted a $23bn oil-products package last October, just a few months after it agreed the five-year supply deal in April.

Riyadh was rankled by Egypt's reluctance to back the Saudi-led coalition against multiple groups opposing the Yemeni government since 2015, notably the Houthis, a Zaidi Shia group from northern Yemen. But relations were particularly soured in October following Egypt's support of a Russian UN draft resolution on Syria and an offer by Iran, Riyadh's primary rival in the region, to supply Cairo with oil products. A deal with Tehran would help plug Egypt's oil-supply gap and help transform the countries' oft-awkward relations into a more collaborative dialogue. It would also likely dash Cairo's bid to accelerate Riyadh's delivery schedule.

Saudi Arabia's sensitivity to Egypt's political loyalty is no shock. The kingdom has long provided Cairo with financial support and backed President Abdel Fattah al-Sisi's military coup in 2013.

Trying to unwind tensions in December, Egypt's foreign minister, Sameh Shoukry, publicly reaffirmed the country's "special relationship" with its powerful ally and the Egyptian government approved the controversial transfer of two islands, Tiran and Sanafir in the strategic Gulf of Aqaba, to Riyadh. The island transfer, which needs approval from Egypt's higher administrative court, sparked protests in Egypt last April. Opponents said the deal was a land sell-off, as it was announced at the same time as Egypt received another aid package from Saudi Arabia. Riyadh's delayed oil products also forms part of a financial-aid package in which Egypt will receive funding for those products, to be repaid over 15 years at 2% interest.

Under the products deal, Saudi Aramco increased supply from 0.5m tonnes a month to 0.7m t/y, or about 180,000 barrels a day. The volumes are split between 400,000 tonnes of gasoil, 200,000 tonnes of gasoline and 100,000 tonnes of fuel oil. The agreement was to be a corner-stone effort by Tarek el-Molla, Egypt's petroleum minister, to slash the cash-strapped country's soaring fuel-import bill. The cheque came to $8.6bn in the 2015-16 annual budget.

Cairo's efforts to limit the financial guesswork in the energy budget are being hampered by state company EGPC's need to issue a growing number of oil tenders for spot cargoes to help meet domestic demand. Demand in the first nine months of 2016 was 9.2% higher than in the same period last year, according to the International Energy Agency. Consumption in September averaged 0.95m b/d, which is 125,000 b/d higher a year earlier. It is expected to average 0.93m b/d in 2017 and Egypt's appetite will only intensify: the country's population of 92.2m is forecast to rise to 100m by the early 2020s. Cairo needs Riyadh to play ball.

But Saudi Arabia must also consider the ricochets of its political plays. The decision to pause Egypt's oil products package echoes the kingdom's resolution to halt production at the 300,000-b/d Khafji field in the Neutral Zone in October 2014 amid discord with Kuwait, which equally shares the zone. Only now, nearly 30 months later, are tangible signs emerging that production at Khafji and neighbouring Wafra, also in the Neutral Zone, may resume.

Lower oil prices have particularly exposed the kingdom's economic Achilles' heel and most likely encouraged Saudi Aramco to pencil in an IPO for next year, which could raise up to $100bn. Crucially, the IPO could knock down the bricks of the impenetrable wall that has always hidden the Kingdom's oil and gas reserves data. In the meantime, Riyadh garnered some diplomatic gold stars for orchestrating the first global oil deal between Opec and non-Opec producers since 2001 and for taking unprecedented steps to reduce energy subsidies.

Major changes this year-political, economic and social-will continue to transform the Saudi Arabia that the energy market and investors are so familiar with. As the kingdom enters uncharted territory, Riyadh must manage its allies with care and use its power plays wisely.

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