Cairo reviews gas priorities

31 October 2008
A legal challenge to subsidised gas exports to Israel highlights growing concern over Egypt’s plans to increase prices for domestic industrial users.

Ibrahim Yossri, a former director of inter-national treaties at the Egyptian Foreign Ministry, is challenging Egypt’s commitment to export gas to Israel at massively subsidised prices under a deal signed by Cairo in 2005.

Yossri launched his challenge in a Cairo court on 7 October, claiming the deal is illegal and will cost Egypt $9m a day because the gas is sold at $2 a cubic foot when the market price is about $14 a cubic foot.

His objection to the agreement, which was borne out of the energy supply commitment originally made in the 1978 Camp David accords, offers a perspective on the controversial pricing of gas, an issue that is fundamental to his country’s economic development strategy.

Leaving aside the specific political concerns surrounding Egypt’s supply of gas to Israel, Yossri’s case reflects a wider concern among Egyptians over the supply of cheap energy to foreign nations at a time when Egypt itself is in need of cheap gas supplies.

The commitment to massively subsidise Israel’s oil supply stands out in stark relief at a time when the government is planning incremental increases in the price at which gas is being supplied to Egypt’s own export industries.

In August 2007, Cairo ruled that energy-intensive industries would face pro-rata gas charge rises of 110 per cent, phased over three years.

It has set 2010 as the target date by which energy-intensive industries should pay the full world market rate, while industrial customers of all kinds will have to pay world prices from 2012 onwards.

But these plans may be shelved following pro-tests at the price rises. Cairo announced in June that preparations for any new gas export contracts had been put on hold until 2010, and that the country was embarking on a fundamental revision of its of gas pricing policy, a move that will have an impact on both its dom-estic economic priorities and its export ambitions.

This revisionist strategy is being driven by a growing consensus over the need to refocus Egypt’s use of its gas, to better serve domestic needs, rather than prioritising those of foreign buyers.

The move reverses the strategy that was adopted at the turn of the millennium, when Egypt embarked on a massive drive to expand its foreign sales of gas, either in raw form or as liquefied natural gas (LNG).

LNG is produced at two trains built by the UK’s BG and Malaysia’s Petronas at Idku, and one at Damietta developed by Spain’s Union Fenosa.

Petrochemicals expansion

In 2003, the government also launched a $10bn expansion of Egypt’s petrochemicals sector, led by the Egyptian Petrochemicals Holding Company (Echem), based on using home-produced gas feedstock to establish Egypt as a major international player within two decades.

The country was the world’s eighth-largest exporter of gas in 2005-06, with shipments worth $2.8bn, or 2.6 per cent of gross domestic product (GDP) in that year, up from $300m, about 0.3 per cent of GDP, in 2004-05. Gas exports are projected to reach $4.2bn in 2011-12.

The Arab Gas Pipeline, connecting Egypt to Jordan, was opened in 2003. In February this year, an extension opened connecting the pipeline to Syria.

There are plans to build a branch line to Lebanon and Cyprus, to extend the main network to Turkey into southeast Europe and on to Austria, a plan signed in 2006 by the governments involved.

This year, gas has also started being sent to Israel through a pipeline from Arish to Ashkelon, which opened in February, while Libya, despite its own energy riches, plans to build a pipeline to import gas from Alexandria to Tobruk.

But government planners have gradually come around to the view that it makes sense to expand the supply of gas to the domestic economy, particularly for local consumer use, even if this limits the scope for further export growth.

This has led to the two-year pause in the development of new export arrangements announced by Cairo in June.

This rethink has been partly shaped by political pressures. There have been signs of growing popular resentment at the priority given to exports of gas and gas-based products at a time when most ordinary households still rely on cylinders of butane to cook food.

Although butane prices have been subsidised, this is still an expensive option item for many families.

Moreover, the butane has to be imported from Algeria and thus represents a negative drag on Egypt’s trade balance.

Some consumers remain sceptical about the merits of a switch to domestic gas piped to their homes, fearful that it would cost more.

But from a national point of few, a phased extension of the consumer supply grid would bring benefits.

In 2007, Sherif Ismael, chief executive officer (CEO) of the Egyptian Natural Gas Holding Company (Egas), said that if piped gas was provided to a further 500,000 homes, it would save the use of 10 million butane cylinders a year, sparing the government butane subsidies of £E9bn a year, a figure calculated in early 2007.

Feeling the pressure from consumers to take action on gas supplies, new project plans may be stalled for a year or two by the temporary government ban on export deals.

Still, it seems unlikely that this marks a definitive end to the development of major new gas export or petrochemicals projects.

Oil’s contribution to Egypt’s balance of payments is set to decline from this year onwards. The International Monetary Fund (IMF) projects a fall to $6.6bn in 2011-12, from $8bn in 2008-09 .

Although such forecasts are highly uncertain, given the volatile state of world prices, the trend is clear: Egypt needs to diversify its oil and gas revenues.

Meanwhile, increased petrochemicals output is required to satisfy not only export demand and associated earnings but also the surge in domestic demand for fertiliser, as Egypt seeks to expand its agricultural output.

Market pricing

Under current plans, the government is moving towards a pricing regime that is more market based, at least for industrial and export customers.

Instead of actively subsidising prices to achieve specific policy goals, such as increased export earnings or the expansion of specific industries, the aim is to force these customers to justify themselves on the basis of commercial viability.

There is no doubt that access to cheap energy has helped exporting companies. They have benefited from a 50 per cent subsidy, which has helped Egyptian firms compete with foreign rivals.

The impact on companies of a new pricing regime gradually removing subsidies will be all the more sharp as it runs in tandem with a phased 61 per cent increase in the price they pay for electricity.

Many industrialists are resigned to the policy shift, which reflects a rethink of basic priorities on the part of the government.

Businesses think that, with the right strategy in place, they will be able to live with the new pricing regime.

In May, Moataz al-Alfi, CEO of Egypt Kuwait Holding, which has a 30 per cent stake in the export-oriented Alexandria Fertiliser Company, argued that the business would still be able to protect its margins.

He said the new gas purchase regime it had agreed with the government directly related the charge for gas supply to the price that its end product - gramular urea - fetches on the world market.

Moreover, he noted, even under this revised arrangement, the government had agreed to maintain some element of subsidy. Alexandria Fertiliser Company would still not be paying a full world market price for its gas.

Other petrochemicals groups appear similarly relaxed about the shift in pricing policy.

The combined effect of the two-year freeze on new export projects and the raising of prices for major users will be to free up some space within overall gas output to expand the supply of gas to domestic users.

But there would be no point in radically squeezing the export side because there is a limit to the rate at which domestic gas use can grow.

Gas is already the main fuel used in power generation, accounting for 85-90 per cent of all electricity output by September 2006.

Meanwhile, there is a long way to go before Egypt has a comprehensive gas distri-bution network for domestic consumers and local communities.

It has taken almost three decades to build a network supplying 2.4 million homes, mostly in Cairo and Alexandria, and the construction of links to Upper Egypt has been slow, beset by wrangles over licensing and project development.

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