Oil majors threaten to cut investment in Eqypt's gas sector

23 May 2008
Firms request talks with government over plans to abolish free zone privileges for high energy users.

International oil companies are threatening to cut future investment in Egypt’s gas sector, following the government’s move to abolish free zone privileges for a host of energy-intensive companies.

Two companies involved in major onshore gas and petrochemical ventures have requested urgent talks with the government over the cuts, which were approved by parliament on 5 May.

“We are completely in the dark about these changes and have asked for a formal meeting,” the business development director of one international oil company tells MEED.

He says the imposition of additional customs duties may affect the level of capital expenditure the firm makes in Egypt’s energy sector in the future.

“There could be millions [of dollars] more to pay and that will inevitably impact on whether to go ahead with more joint ventures in the country,” he warns. “We may cut our spending.”

The tax reforms apply to the steel, gas processing, oil refining and gas transportation industries. Cairo argues that these sectors no longer require the incentive of tax cuts.

“Other sectors - the ones that remain in the free zones now - need the incentive of the free zone and they need to remain in a free zone status,” says Finance Minister Youssuf Boutros-Ghali.

“But all of the petrochemical, petroleum and gas industries, because of the structural changes that have happened around the world, no longer need the free zone to operate. This is why we have put them back into the fold of the firms that get taxed normally, with a very reasonable tax rate.”

According to the government, companies in these sectors benefited disproportionately from the previous tax regime as well as from heavily subsidised gas prices. The changes mean they will now have to pay tax at a rate of 20 per cent on their profits.

“Most of the companies that were covered by the new law were more or less expecting that measure because they had been enjoying multiplied profitability compared to the rest of the world,” says Asem Ragab, chairman of the General Authority for Investment (Gafi), the government body in charge of attracting foreign investment to the country.

Ragab estimates they benefited from profit margins that were five to six times higher than elsewhere in the world under the previous tax regime.

However, one executive at a UK oil company heavily involved in the expansion of the country’s gas facilities says this is a spurious argument. “What companies like ours are looking for when we enter a country is a stable investment climate,” the executive says. “We are here for the long term but moves like this from the government make us question our investment commitment, and many other companies are saying the same thing.”

The government argues that double taxation treaties already in place with other countries mean the profits of multinationals headquartered overseas are unlikely to be significantly affected.

“We believe that the final proceeds that the holding companies are facing will not be changed because of the double taxation treaties that we hold with most of these countries,” says Ragab.

“What they do not pay here, they end up paying over there, so we are just shifting the taxes from there to here. It will make a difference to the local partner.”

Gafi manages a total of 1,140 companies under the free zone regime. Of those, approximately 40 will be subject to the new rules, and it says there are no plans to extend this in the future.

“It is a fraction of the pool and the status quo is maintained,” says Ragab. “We are not seeing a second wave. We are not seeing a sequel to this measure.”

The Finance Ministry estimates that the change will bring in an additional $600m in revenues. However, Ragab says it could be in excess of $1bn. Some existing tax breaks, including customs’ duties, will continue for companies already operating in a free zone for three years.

“We have extended the zero customs duties so they will not have to pay back the customs on any fixed assets that have already been acquired in a retroactive fashion,” says Ragab.

The end of the tax break is not the only change that will hit the profitability of companies in the free zones. Adding to their difficulties, the government recently raised gas prices to $3 a million BTUs for energy-intensive industries.

Long-term gas supply contracts between the government and industries that use gas as feedstock will not be affected, but companies using gas as a source of energy are subject to any changes to gas pricing.

“Our current costs have been in the range of $2.65 a million BTUs of gas when the oil price was at $70 a barrel,” says Ragab. “Now it is at $120, so our costs have jumped beyond $3. We had adopted a phased-in liberalisation of energy to reach $2.65 a million BTUs, but we have adjusted that final rate to $3 instead.”

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