The Petroleum Ministry is pulling out all the stops in its efforts to portray Egypt as a land of opportunity for international oil companies (IOCs). Since late February, it has announced a plan to pay $6.3bn to IOCs to settle arrears on sales of natural gas and oil to the government. It has also signed more than 20 exploration agreements and announced bid rounds for a total of 22 blocks.

The February cabinet reshuffle was also positive for the energy sector. It saw Sherif Ismail retained as energy minister and the appointment of Hany Kadry Dimian as finance minister, who is more committed than his predecessor to tackling energy subsidies. He is also in favour of private investment in infrastructure through public-private partnership projects.

One of the first things the new electricity minister, Mohamed Shaker, did was to set dates for receiving bids for the 2,250MW Dairout independent power project (IPP) (19 May) and the 250MW Gulf of Suez wind farm IPP (18 May). The Finance Ministry will provide guarantees, meaning the projects should be well received by the market.

Mounting concerns

But this flurry of activity has not been enough to disguise the concerns mounting over Egypt’s energy sector, with power cuts during the traditionally low-demand winter months reflecting the shortage of fuel for electricity generation. The announcement of new deals to secure petroleum products supplies from Gulf Arab donors also points to the inability of local refineries to meet demand.

A statement by the UK’s BG Group at the end of January, which blamed problems in its Egypt operations for a drop in its global earnings, cast further doubt on the country’s energy prospects. Adding to the gloom was a Reuters report citing a petroleum ministry forecast that Egypt would face a natural gas deficit for the first time in the coming fiscal year.

“The refining sector has been slow to adapt to the shift in demand from fuel oil to lighter products”

The problems besetting the energy sector have been aggravated by the political turmoil of the past three years, but their roots go back well into the Mubarak era and beyond. The shortfall in natural gas supply can be traced to the stalling of upstream investment in the mid-2000s as IOCs sought improved commercial terms, which the government resisted. On the petroleum products side, the refining sector has been slow to adapt to the shift in demand from fuel oil to lighter products. And the financial viability of the entire sector has been compromised by the government’s failure to enact reforms of the subsidies system.

BG’s CEO Chris Finlayson announced on 3 February that the company had declared force majeure to customers and creditors of its Egyptian liquefied natural gas (LNG) plant, as it will not be able to meet in full its supply commitments. This, he said, was owing to factors beyond its control – in this case, the diversion of natural gas to Egypt’s domestic market.

BG is one of the largest natural gas producers in Egypt, although its output has been slipping in recent years. Part of its production is contracted to be delivered to the domestic market, but the fields it has developed in the West Delta Deep Marine (WDDM) block were designed to feed about 1 billion cubic feet a day (cf/d) of gas into two LNG trains at Idku, east of Alexandria. However, as domestic demand has now risen to almost match available production, BG has been obliged to allocate most of the block’s output to the local market. The company said government assurances that these diversions would be capped at 650 million cf/d had not been honoured; hence the force majeure notice.

Finlayson said Egypt was still an important, albeit declining, source of cash flow for BG and the company is pressing ahead with the development of production phase 9a in WDDM, which will add about 10,000 barrels a day of oil equivalent (roughly 55 million cf/d) in net output for BG. However, his choice of words in responding to a question about whether BG would remain in Egypt did not reflect any obvious enthusiasm.

“I would not at this stage go straight to the point of saying this is a country where we should no longer be invested,” he said.

Surplus exports

According to the 2013 issue of BP’s Statistical Review of World Energy, Egypt produced 60.9 billion cubic metres of natural gas in 2012, compared with a peak of 62.7 billion cubic metres in 2008, while consumption reached 52.6 billion cubic metres. This left an exportable surplus of 8.3 billion cubic metres, less than half the amount available in 2008 for the Idku and Damietta LNG plants and the pipelines to Israel and Jordan.

The Israel line closed in 2011, and there has been little gas exported to Jordan over the past three years. The Damietta LNG plant, which relies on natural gas supplied from the Egyptian Natural Gas Holding Company, has been dormant for months, and Idku operated well below capacity during 2013. BG’s customers received five LNG cargoes supplied by Qatar on Egypt’s behalf, but that arrangement stopped soon after the army’s removal of the Doha-supported former president, Mohamed Mursi.

The Petroleum Ministry has now indicated that Egypt will soon have no surplus natural gas for export, a situation reflected in BG’s force majeure notice to its customers.

“Egypt has reached a point where it cannot meet its own natural gas needs from domestic production”

In early February, Reuters cited internal ministry documents as saying that natural gas production would average 5.31 billion cf/d during the 2013/14 fiscal year, ending on 30 June. That is equivalent to annual output of 54.9 billion cubic metres, almost 10 per cent lower than the BP figure for 2012. The ministry said consumption would be 4.95 billion cf/d in 2013/14, and was forecast to rise to 5.57 billion cf/d in 2014/15, when it would exceed forecast production of 5.4 billion cf/d.

Importing LNG

The ministry forecasts indicate Egypt has reached a point where it cannot meet its own natural gas needs from domestic production. The situation will improve from 2016, assuming that BP meets its revised start-up date for the West Nile Delta project, which is designed to produce up to 1 billion cf/d. In the meantime, the government faces a shortfall.

Importing LNG is one option to fill the gap, and the government has encouraged private-sector energy firms to draw up proposals. The relatively high market price for LNG, compared with domestic prices, has been a complicating factor. Another option is to increase the use of alternative fuels for power generation and industry. There is already evidence of a rise in consumption of diesel and light fuel oil in power stations. An environmental protection framework to allow the use of coal as a replacement for natural gas in cement plants is also expected to be finalised by September.

Even with a recovery in natural gas production after West Nile Delta comes onstream, Egypt’s two LNG complexes are likely to remain idle for some time, unless natural gas imports are of a sufficient scale to create a supply surplus. One potential source of such imports is Israel, where the government and operators of offshore gas blocks are looking at options for marketing their own surplus gas. Connecting offshore Israeli fields to Idku or Damietta would be a cost-effective way to import LNG, but such a scheme would need to be underpinned by agreements between the Israeli and Egyptian governments, which could face political obstacles.

Natural gas accounts for just over half of Egypt’s total energy mix, and about 60 per cent of gas consumed is used for power generation. One quarter is used by industries, and only a negligible amount is consumed by the residential sector. However, almost half of Egypt’s electricity is consumed by households, virtually all of which receive power at heavily subsidised prices.

One of the main reasons for the arrears on the Petroleum Ministry’s payments to IOCs for natural gas supplies is the backlog on the payments due from the electricity sector for the gas provided to power stations. The arrangement the ministry announced at the end of 2013 to settle the $6.3bn it owes to IOCs includes $3bn to be paid in instalments over three years. This package is supposed to be part-financed by monthly instalments of about $160m to be paid by the electricity ministry.

Of the remainder, $1.5bn was to have been paid immediately – $1bn from the Central Bank of Egypt, plus the equivalent of $300m in Egyptian pounds and $200m in reimbursed signature bonuses – while the final $1.8bn is up for discussion.

The Petroleum Ministry’s financial position has been further undermined by the cost of subsidising diesel, gasoline, fuel oil and liquefied petroleum gas (LPG). These subsidies have grown to account for about one-fifth of total budget spending. This problem is aggravated by the mismatch between production capacity and demand. Refineries are now heavily configured towards producing fuel oil and naphtha, whereas the main drivers of demand growth are LPG and gasoil/diesel.

Diesel production

This imbalance is being addressed by the Egyptian Refining Company (ERC), a joint venture of local private interests (including project originator Citadel Capital), Qatar Petroleum, Egypt General Petroleum Corporation and Gulf Arab financiers.

ERC will process fuel oil produced at the Mostorod refinery of Cairo Oil Refining Company to make lighter products more suited to the modern structure of demand and environmental standards. About two-thirds of the output of Mostorod consists of fuel oil, for which demand has declined in favour of diesel. ERC will buy the entire fuel oil output of the existing refinery and process it to make diesel and other product for the local market. It aims to produce 4.1 million tonnes a year, of which more than 2.3 million tonnes will be Euro 5 standard diesel.

The project is scheduled for completion by the end of 2016, and will play an important part in improving the financial situation of Egypt’s energy market. However, its own viability will depend on the gap being closed between the domestic sales price of gasoil and the international price. The government’s plans indicate it intends to close that gap, at least initially through rationing access to subsidised fuel and charging world market rates for the remainder.