Egypt’s natural gas quagmire
 
 

On May 5, at the height of a heat wave that brought electricity blackouts back to Cairo with a vengeance, news of a potential gas export deal from Israel to Egypt spurred a media frenzy.

The operators of Israel’s Tamar natural gas field announced that they had signed a letter of intent to pipe the fuel to the Italian-Spanish consortium Union Fenosa’s liquefaction plant in Damietta, located on Egypt’s Mediterranean coast.

The plan is far from a done deal, but even in its embryonic state, the news came as a jolt to Egyptians, creating enough noise to prompt a denial from the Cabinet. The letter of intent between the companies is non-binding, and any plans to build a new international pipeline would require regulatory approval on both sides of the border.

Until 2012, Egypt exported its surplus natural gas to Israel, rather than the other way around, at below market prices. The recent role reversal underscores the deep problems in Egypt’s oil and gas sector.

Like its neighbor to the north, Egypt is rich in petroleum resources. But despite its wealth of untapped gas reserves, Egypt has been struggling to attract enough investment in oil and gas to meet its own energy needs, let alone ink new export deals.

Earlier this year, officials announced that Egypt will soon be a net importer of natural gas, which is the main source of power for Egypt’s electricity plants and many of its factories. The natural gas shortage has left businesses and homes across the country vulnerable to power cuts and fuel shortages, exacerbating an economic crisis and causing widespread public anger.

While the power cuts seemed to be tapering off in late April, they made a ferocious comeback this past week, and will likely worsen as the peak consumption summer months hit.

“It’s certainly reached crunch time now. We’ll be waking up to the reality that Egypt is now in a natural gas deficit,” says David Butter, an energy analyst and associate fellow at Chatham House think tank. “Production has fallen quite quickly because of depletion and lack of investment. Demand has simultaneously increased, and changing that situation is going to be very difficult,” he adds.

The gas deal announcement came on the heels of another piece of corporate news that sheds light on why the country may face difficulties luring investors. In its quarterly financial filings, UK-based energy company British Gas (BG) revealed that it had not exported a single cargo of Egyptian LNG since the beginning of the year.

Meanwhile, the Egyptian government has racked up an additional US$200 million in unpaid bills, with its total unpaid debt to BG climbing to $1.4 billion, $700 million of which is past due.

The announcement was just the latest in a string of bad news from BG, whose chief executive Chris Finlayson resigned on April 28.

In January, the company declared force majeure, saying it was unable to meet export contracts because Egypt’s government was diverting too much gas for domestic use.

Like all multinational energy companies in the country, BG operates under a production sharing agreement with the Egyptian government. The company provides the capital and expertise needed to locate and develop Egypt’s petroleum resources. In exchange, it’s entitled to a share of the gas it finds, some for export, some to be sold domestically. The remainder goes to the Egyptian government for local use — or, in years past, to sell to other countries, including Israel. By January, however, the government was taking virtually all of BG’s gas for domestic use, prompting the declaration of force majeure.

BG’s latest results indicate the situation has not improved. In the first quarter of the year, it was producing 660,000 barrels of oil equivalent per day — a 35 percent drop from the previous quarter, but still enough that is should have been exporting via its liquefaction plant at Idku, on the Mediterranean coast. However, it did not export any gas in the first three months of 2014, and expected only one shipment by the end of June.

Despite the company’s troubles, in late January executives were still insisting that they remained committed to the Egyptian LNG plant at Idku. This month, the company is taking a harder line.

“In the absence of concerted action from the Egyptian government, the future commercial operation of Egyptian LNG is increasingly at risk,” said Andrew Gould, BG’s interim executive chairman, at a conference with analysts on May 1.

In the pipeline

The news at Egypt’s other natural gas export terminal, west of the Suez Canal in Damietta, is no better. Production there has been at a standstill since last year. This February, Union Fenosa, the Spanish-Italian consortium that owns 80 percent of the plant, filed a lawsuit against Egypt at the World Bank’s International Center for Settlement of Investment Disputes.

It is this plant, standing idle due to the government’s gas diversions, where Israeli gas would be processed, if a deal is completed between Union Fenosa and the developers of the Tamar Field. Lead developer Noble Energy anticipates a 15 year contract, with some 440 million cubic feet sold per day.

According to Butter, it wouldn’t be unlikely to see a similar deal at Idku, where BG currently owns a stake.

“That would utilize the energy export facilities, which are now lying idle for some time. There would be some kind of transit revenue coming from that, which could possibly pay for imports at the same time,” he says.

“It will have to be argued politically, and sold by the government as something that’s in Egypt’s national interest,” Butter added.

However, as Robin Mills, head of consulting at Dubai-based Manaar Energy, points out, “Technically, it is entirely feasible. Politically, it is very difficult.”

Any deal with Isreal would be highly controversial, but it would come at a time when even deals to lure investors to Egypt are likely to draw criticism.

“Coming up with a package for foreign oil and gas companies that is going to really attract them to invest a lot is going to be something that could be criticized on nationalistic grounds,” says Butter.

Egypt’s penchant for racking up debt and taking more than its contracted share of gas have done little to improve its image as a safe destination for oil and gas companies. “It sends a very negative signal for investors,” says Mills.

This puts Egypt on the back foot when it comes to signing new oil and gas deals.

“The government is saying, ‘sorry we can’t help you with payments, so you’re just going to have to be patient.’ Well, that generally doesn’t work in a negotiation, to ask someone to do something and not get paid for it,” said Mark Fenton, general manager of Dana Gas Egypt at a March conference.

 “We accept that there’s a shortage of money. But what they can do is look at their contracts, and negotiate a change to the contracts whereby the company is more incentivized to invest,” Fenton said.

At its latest licensing round, in February, Egypt did indeed offer new perks to companies, including Dana Gas, which signed up for the rights to explore new gas concessions. In a departure from previous practices, companies will be allowed to bypass the government and sell gas directly to end-users like steel plants. Under the new contracts, companies will also be able to negotiate gas prices after determining the cost of discovery, rather than committing to a fixed price upon signing.

Such concessions are an anathema to critics who feel Egypt already sells itself too short when negotiation production sharing agreements. However, just about anything appears to be more politically palatable than the one solution analysts agree is the surest way to resolve the problem: removing energy subsidies, which currently eat up more than 20 percent of Egypt’s budget.

Egypt’s fuel subsidy bill totaled LE99.6 billion in 2013/2014 fiscal year, of which 40 percent goes to diesel, 23 percent to butane gas and 8 percent goes to natural gas. While this largesse may have been possible to sustain when Egypt had an energy surplus, the government is now left to buy fuel on the global market and resell it domestically at a loss. The Ministry of Petroleum, which should be a cash cow, is now some $6 billion in debt to oil companies.

Electricity is in effect subsidized twice, with producers getting fuel at below cost, and reselling electricity at less than the cost of production. Electricity authorities are left short on cash for fuel and maintenance, let alone building much needed power plants — that this is unsustainable is made clear every time there’s a power cut.

Lifting subsidies will not be easy, with both businesses and consumers across the socioeconomic spectrum accustomed to cut-rate power. “With the economy depending on being able to gain access to energy at cheap prices, reform like that also has to have a proper social safety net included within it,” says Butter. “It’s not something that can be done very easily or very quickly.”

But, experts say, subsidy reform may be inevitable. “The government is going to just have to bite the bullet and do it,” says Mills.

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Isabel Esterman