In Egypt, Reforms Seek to Revive the Natural Gas Sector

7 MINS READApr 21, 2015 | 09:00 GMT
An Egyptian man watches a liquefied natural gas carrier pass through the Suez Canal.
(-/AFP/Getty Images)

Egyptian President Abdel Fattah al-Sisi is making strides in reforming Egypt's natural gas sector. Earlier this month, the Hoegh Gallant, a floating storage and regasification unit, arrived at the Gulf of Suez port city of Ain Sokhna. Egypt has attempted to lease such a facility for several years, and with the aid of multilateral institutions and Gulf countries, it finally finalized a deal for the unit in November 2014.

Egypt has struggled to maintain its natural gas production levels, while domestic energy consumption has risen by more than 50 percent over the last decade. Energy subsidies have only accelerated domestic consumption, which for natural gas now totals more than 50 billion cubic meters per year. Production growth has stalled in response to a lack of investment, and Egypt's policy of selling expensive imported energy at low prices on the domestic market has drained the country's coffers.

Al-Sisi has begun taking steps to address Egypt's energy dilemma, at least in the natural gas sector, which will in turn affect the country's industrial and power generation sectors. In July 2014, he significantly curtailed a number of the subsidy programs burdening Cairo's finances, leading to several deals with international oil companies whose projects had been stalled due to a lack of funds and confidence that payments would be made. While these changes bode well for a revival of Egypt's natural gas sector, the country will remain limited in its ability to bring down the costs of increasingly expensive imports and subsidies of other goods, including oil and food. 

Al-Sisi's reforms target two of the primary factors dragging the Egyptian economy down: massive subsidies and crushing debt. Prior to the reforms, Egypt spent more on fuel subsidies than on education, health and infrastructure combined. In 2013, some 22 percent of the budget (equivalent to 7 percent of the country's GDP) went toward fuel subsidies, while an additional 8 percent of the budget funded electricity subsidies. Along with food subsidies, these programs have contributed to a significant depletion of Cairo's financial resources.

The solution to this problem is clear: Remove or reduce subsidies. However, al-Sisi's predecessors — the interim Supreme Council of the Armed Forces government and former President Mohammed Morsi — never had the political capital needed to relax subsidies. The military government was aware of its temporary status and did not want to shoulder the blame for unpopular (but much-needed) economic reforms, while Morsi's government was mired in political controversy and paralyzed by a number of constraints. By comparison, Egyptians have given al-Sisi a wide berth to implement the reforms needed to fix the economy since his electoral victory last May.

Artificially low prices are at the root of Egypt's energy dilemma, and removing the subsidies will help the country at least partially reverse its dependence on energy imports. Though al-Sisi plans to remove subsidies completely over the next three to five years, this timetable is likely too optimistic. His government is made up largely of loyalists rather than the technocrats needed to enact the reforms, hurting his ability to efficiently reduce food and energy subsidies. Still, the president's attempts to enact change thus far have yielded positive results: By the second half of 2014, government expenditures on fuel subsidies had dropped to 45 billion Egyptian pounds (around $6.2 billion), down from 65 billion pounds the previous year.

Al-Sisi will face perhaps greater difficulties in reforming sectors other than natural gas. While his efforts could successfully boost natural gas production, the same cannot be said for food or oil production. The country's consumption of both food and oil is rising and will continue to do so as the Egyptian population expands by a projected 10 million people over the next eight years. Oil production has been stagnating and shows no sign of increasing, as most new energy discoveries in Egypt are natural gas deposits. This means the country will likely become a significant oil importer as its population grows. Likewise, Egypt's imports of wheat — the backbone of the Egyptian diet — and other staples such as maize will increase alongside the population, while limited water resources hamper domestic agriculture.

The strain that food and energy subsidies are placing on Cairo's finances has trickled down to the Egyptian Natural Gas Holding Co., which has been unable to pay international companies for their energy supplies and has forced such firms to sell to the domestic market at artificially low prices. As a result, Egypt has seen investment from international companies wane. Part of al-Sisi's plan for economic reform includes reducing and eventually eliminating all of Cairo's outstanding debts to foreign oil companies. Already, Egypt has repaid some $5 billion, and the government plans to pay the remaining $3.1 billion it owes by mid-2016. But the bulk of Cairo's payments are being financed by international lenders, particularly banks and wealthy Gulf countries, meaning that the Egyptian government is merely delaying painful repayments.

Problems in Egypt's Natural Gas Sector

Natural gas and liquefied petroleum gas account for around 35-40 percent of Egypt's petroleum subsidies, but they are also the products that Egypt has the most ability to produce domestically. The country's sluggish gas production in recent years has not been caused by a lack of reserves, but by price.

Since 2008, international oil companies operating in Egypt have typically received no more than $2.65 per one million British thermal units (mmbtu) of natural gas, compared to around $7.00 per mmbtu on the international market. Because the majority of Egypt's undeveloped natural gas resources are located in deep-water basins in the Mediterranean Sea, and because deposits are often small, the costs of producing Egyptian gas usually outweigh the revenues international oil companies make when Cairo forces them to sell the gas on the Egyptian market.  

Al-Sisi, who has other sectors to consider when picking and choosing where to make subsidy cuts, must try to find a price point that both attracts international investment and remains below international LNG prices so that Cairo does not have to continue subsidizing fuel. Egypt has made significant progress in reaching new deals with international oil companies that are beneficial to both sides. For the companies, such deals set a higher price of natural gas that will yield greater revenues, while Egypt gets guarantees that nearly all of the gas produced will go to the domestic market. BP, for example, agreed to invest $12 billion in the massive North Alexandria project in its West Nile Delta concession in exchange for a price that is reportedly double the original $2.65 per mmbtu. BG Group is finalizing a deal of $5.88 per mmbtu for the natural gas it produces from the West Delta Deep Marine concession.

The improvement in financial terms and debt repayments has increased the amount of energy projects being sanctioned in Egypt. The North Alexandria project will develop 5 trillion cubic feet of natural gas resources and eventually produce about 1 billion cubic feet of gas per day — equivalent to one-fifth of Egypt's current production. Italy's ENI is also in the process of finalizing a deal that is expected to bring Egypt $5 billion of investment in energy projects over the next five years. Additionally, BP and other companies have announced that a number of stalled projects will move forward.

The Need for Imports Remains

Despite the moves toward revitalizing Egypt's natural gas sector, legacy production is likely to fall over the next five years, while consumption will continue to grow (albeit more slowly). Egypt will therefore need to import other supplies of natural gas, at least in the interim period until its own production ramps back up.

The Egyptian government has spent much of the past six months securing access to LNG imports. Cairo issued a $2.2 billion tender for 75 LNG cargoes that will total about 10 bcm over the next two years, roughly enough to cover the country's supply gap while Egypt resumes and begins profiting from LNG exports. However, Egypt has made it clear that it does not want to import LNG over the long run; Cairo signaled this when it leased the Hoegh Gallant floating storage and regasification unit for only five years and signed import contracts with international companies that will expire within a few years. The high price of LNG, combined with Egypt's natural gas-heavy resources, make LNG attractive as an export opportunity for Egypt. But Cairo will have to convince international oil companies that it will pay them the agreed-upon rates within a reasonable time frame. Since Egypt's most consistent source of revenue remains regional partners, particularly Qatar and Saudi Arabia, foreign companies will likely remain hesitant to sign contracts with Egypt since their fulfillment would depend on Cairo's relations with its neighbors.

Over the longer term, Egypt would prefer to import energy via regional pipelines, which would be cheaper than LNG. Neighboring Cyprus and Israel recently discovered large offshore deposits of natural gas that could be prohibitively expensive to export outside the region, making Egypt a prime candidate to buy those supplies if the infrastructure can be built. Cairo is therefore looking to import Cypriot and Israeli natural gas over the longer term, but it will have to use LNG imports to meet its energy needs until those projects fully materialize.

In the meantime, al-Sisi's reforms have begun to show signs of progress, but they are only in their beginning stages. He has managed to create a sense of stability, reach new deals and repay some debts, but it remains to be seen whether Egypt will be able to maintain its momentum. Additionally, despite the encouraging developments in Egypt's natural gas sector, the country will continue to rely on imports of other products such as oil and food. Cutting those subsidies would force Egyptians to pay international prices, and the resulting blowback would challenge al-Sisi's popularity. As a result, al-Sisi will likely leave some of the subsidies in place, and the strain on Egypt's finances will worsen as consumption continues to rise.

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