Focus: Egypt's energy sector
The approaching changes and challenges in Egypt's energy sector
Wolfram Lacher, Control Risks Middle East and North Africa analyst explores the approaching changes and challenges in Egypt’s energy sector
Senior officials in the Egyptian energy sector are currently at an advanced stage in preparations for a wide-ranging overhaul of the sector. The project to restructure its framework includes plans to set up an independent regulatory agency to control oil and gas purchases and also sales on the domestic and export markets. This fits within the government’s broader goal of reducing energy subsidies and moving towards market-based mechanisms to set prices for foreign companies, Egyptian industry and consumers, thereby seeking to address a number of pressing challenges facing the upstream and downstream oil and gas sectors, as well as energy-intensive industries.
The importance of the successes achieved in Egypt’s energy sector over the past decade cannot be dismissed.
While oil production has stagnated and rising domestic consumption could turn Egypt into a net importer of crude any year now, gas production rose from 14.7bn m3 per year in 1999 to 46.5bn m3 in 2007, while proven gas reserves increased from 0.93 trillion m3 in 1997 to 2.06 trillion m3 at end-2007, the second- and third-largest on the African continent respectively.
Growing gas production has notably enabled the establishment of three LNG trains since 2005, which in 2007 handled around 14bn m3 of LNG exports; as well as the export of pipeline gas, with 2.35bn m3 being exported through the Arab Gas Pipeline to Jordan in 2007 and exports being extended to Syria since mid-2008.
Finally, a pipeline managed by the East Mediterranean Company (EMG) in May 2008 began gas exports to Israel and is scheduled to export 1.7bn m3 per year over a period of 15 years. A significant proportion of gas has gone into domestic consumption, given that around three-quarters of electricity generation (demand for which is growing rapidly) are based on natural gas.
It has also fuelled the rapid expansion of energy-intensive industries such as fertilisers, steel and cement.
Challenges facing the sector
However, developments over the past three years have also exposed a number of important shortcomings and obstacles to the continuation of current policies. First, rising oil prices created a major fiscal dilemma for the government: as the gap between EGPC’s share of oil production from joint ventures with foreign companies on the one hand and domestic consumption on the other widened from 0.8m tons in 2002 to 8.2m tons in 2007.
As the prices at which EGPC imports crude and refined oil or purchases crude from IOCs operating in Egypt increased, the government faced a massive deficit due to the low prices at which petroleum products are sold to domestic consumers. Energy subsidies in the 2007-08 fiscal year ate up EGP60.3bn, or 21.4% of government expenditure and 6.7% of GDP. Although falling oil prices have since considerably reduced the burden of energy subsidies – on which the government plans to spend EGP33.7bn in 2009-10, or around 10% of overall expenditure – a reform of the system for energy subsidies remains imperative, given the medium-term potential for oil prices to rise again.
Second, the low prices at which gas is sold to domestic consumers have attracted major investments into energy-intensive industries. As is also the case for petroleum products used for vehicle fuels, the government has been reluctant to increase gas prices for electricity generation, fearing a knock-on effect on already significant inflationary pressures. At the same time, however, caps on prices for domestically sold gas have made it difficult for EGPC to increase prices for gas bought from IOCs’ production shares and thereby increase their incentives to expand exploration and production. Although the gap between EGPC’s share of gas production and that of its subsidiaries on the one hand and domestic consumption on the other (which makes it necessary for EGPC to buy gas from IOCs) has narrowed over the past decade, it remained substantial at 7.2bn m3 in 2006-07, according to the Institute of National Planning.
With prices for gas purchased by EGPC significantly lower than export prices, domestic demand for gas growing rapidly, and operating costs spiralling from 2004 to mid-2008, IOCs lobbied for higher prices and were partially successful when the petroleum ministry revised prices in early 2008 (though these still remain substantially below export prices).
Third, the multiple functions of EGPC – namely as industry regulator, the obligatory partner in upstream projects for IOCs, the entity that purchases oil and gas from IOCs and the body that distributes and sells crude oil and natural gas to domestic industry, electricity providers and private consumers – together with the pricing constraints outlined above have created a range of institutional inefficiencies, of which the most important has been EGPC’s accumulation of substantial arrears in payments for oil and gas purchased from IOCs.
Unsurprisingly, such arrears represent an issue of major concern among IOCs; EGPC, has taken up loans and earlier this year raised $1.4bn by selling off its interest in the Abu Qir field to Edison; however, the payment problem has persisted.
Finally, rapidly rising domestic consumption and the strategic priority the government has accorded to meeting domestic demand have raised questions about the security of supplies for planned LNG plants, including a second 5m t/y LNG train at Damietta and a possible third train at Idku. The government’s concerns about expanding domestic consumption, together with public controversies over the low price of gas sold to Israel and Jordan, in late 2007 caused petroleum minister Sameh Fahmi to pronounce a moratorium on new gas export deals until 2010.
Availability of supply will remain and could even become more of a concern for the authorities and private investors in LNG plants. To a lesser extent, supply concerns have also impacted on energy-intensive industrial projects; since mid-2008, the Industrial Development Authority has refused to issue new licences for aluminium or fertiliser projects, citing efforts to contain excessive growth in national energy consumption.
Shaking up the sector
The planned overhaul of the energy sector is designed to address a number of these issues. A separate regulatory authority is to be established that would include representatives of the finance and petroleum ministries, as well as former EGPC officials, thereby increasing the finance ministry’s oversight over the notoriously opaque transactions in the sector.
The roles of the new body would comprise managing purchases and sales of oil and gas; setting prices and allocating quantities for domestic consumption; and holding bidding rounds for the upstream and downstream sectors; it would also watch over competition in distribution networks. By stripping EGPC of its regulatory role, confining it to upstream exploration and production, and establishing separate holding companies for refining and distribution of petroleum products, the reform blueprint would separate production from distribution and facilitate EGPC’s access to credit.
The plan thereby not only aims to resolve the problem of payment arrears; it is also designed to lay the groundwork for a liberalisation of natural gas and petroleum products distribution networks, which would be opened up to competition.
The approach matches the government’s goal of increasingly resorting to market mechanisms in the pricing of natural gas supplied to electricity generators, energy-intensive industries and individual consumers. Such moves would further increase the scope for raising prices for oil and gas purchased from IOCs and therefore their incentives to boost exploration and production efforts.
The upcoming reforms stand a high chance of resolving the important problem of EGPC’s payment arrears, though they may partly displace the company’s financial problems to gas and electricity distributors.
However, while the law may be designed to attract private and international companies into the distribution of gas and petroleum products, the liberalisation of prices in these areas will remain limited by socio-political constraints.
Developments over the past years have underlined the political sensitivities associated with the pricing of energy. Minister of Trade and Industry Rashid Mohamed Rashid in mid-2007 announced a plan to increase gas prices for energy-intensive industries (defined as plants using at least 66m m3 of natural gas or 50m kWh of electricity per year, and including industries such as steel, cement, aluminium, fertilisers, paper and glass) from $1.25 per million British thermal units (BTUs) to $2.65 over a period of three years. However, while the target of $2.65/m BTUs would significantly dent the substantial profits made by such industries, it remains at the lower end of the price range at which EGPC purchases gas from IOCs, and would therefore represent a subsidised price, rather than one set by market mechanisms.
Moreover, the government’s sensitivity to the importance of low steel and cement prices for maintaining growth in the construction sector, as well as intense lobbying by energy-intensive industries, in the meantime has led the government to suspend the price rises until end-2009; indeed, Rashid in February ordered a reduction of gas and electricity prices for energy-intensive industries.
Numerous exceptions are granted to particular industries: for example, where petroleum products are used as feedstock – such as in oil refining and fertilisers – prices are linked to the price of the end-product, which in many cases remains administered. This demonstrates that, for high-end industrial consumers of gas and electricity, prices are determined by the interplay of industry lobbying efforts and government concerns over their international competitiveness and impact on domestic economic growth. With regard to individual consumers, socio-economic considerations dominate.
Electricity prices for the wider public have been increased much more cautiously over the past few years and remain heavily subsidised, as do fuels that are commonly used for vehicles. On the whole, recent trends have suggested an increasing divergence in prices administered to different categories of consumers, with the potential for individual deals for specific projects.
In sum, market-based pricing mechanisms for gas and petroleum products are unlikely to take hold in the foreseeable future, in turn limiting the prospects for oil and gas sold by IOCs on the domestic market to move closer to market prices.