Cairo will have to tackle dysfunctional subsidies and resolve pricing disputes in order to shrink the shortage of gas
On 4 September, Egypt was hit by an unprecedented power cut that saw electricity output collapse by 39 per cent, causing paralysis across Cairo, the Nile Delta and the countrys southern provinces.
In the capital, the outage knocked television stations off air and caused three metro lines to freeze, briefly trapping commuters in trains. Operating rooms and x-ray machines in hospitals were rendered useless, and water supplies were cut to whole swathes of the city.
The black-out was the biggest in a series of outages that have plagued Egypt of late. It is a symptom of a crippling gas shortage that is causing huge problems for the country and its newly installed military-backed government.
Gas demand in Egypt has risen rapidly in recent years as the population has grown, but production has failed to keep up. Output is actually decreasing, falling almost 10 per cent between 2011 and 2013.
Driving this decline is the reluctance of international energy companies to invest in Egyptian assets; production has slowed at some fields and many projects have been put on hold during three years of political turmoil and falling profits.
Recent government efforts to revive production have resulted in several optimistic pronouncements by the Oil Ministry. The latest came on 10 September, when it was announced US oil and gas company Apache had signed two new exploration agreements. Oil Minister Sherif Ismail stated 35 agreements had been signed in total and another 15 oil and gas exploration agreements would be signed in the coming days.
However, companies on the ground warn that little progress is being made in reality.
These announcements are partly political, says one senior oil executive, who requested anonymity as he is not authorised to talk to the media. If you do not have enough gas, you have power cuts, and then you have to announce you are going to do something about it some projects will come as announced and others will not.
A case in point is the BP-operated $10bn project to develop its offshore North Alexandria concession in the Nile Delta. On 26 June, Ismail said the UK firm and Egypt had restarted the scheme, but this was later denied by BP, which said the terms of the deal being offered by the government were not satisfactory. Negotiations were still ongoing in mid-September.
BP is not alone in pushing for better commercial conditions. Nearly all the major international operators in Egypt are demanding higher prices, according to senior officials linked to state-owned energy companies that have spoken to MEED under condition of anonymity.
Low prices paid by the government for domestically produced gas is discouraging further investment in Egyptian assets, as is failure to pay domestic producers on time. At the end of June, Cairo owed a total of $5.9bn to foreign operators.
As negotiations between oil companies and the government continue, analysts are warning that the Egyptian governments failure to fast-track the North Alexandria project and others like it could lead to severe economic problems in the near future as gas production continues to dwindle.
The decline in production is already causing havoc for local businesses, with frequent power cuts affecting productivity and inflicting extra costs for many small firms, which now use expensive diesel generators for reliable electricity supplies.
In April, Suez Cement, a subsidiary of Italys Italcementi and one of Egypts largest producers, said irregular supplies of natural gas to its facilities had cut production by 50 per cent.
Another cement producer, Misr Beni Suef Cement Company, said it had received a letter from the government informing it that natural gas supplies to its facilities would be completely cut off in May.
Even more damaging is the impact on Egypts petrochemicals sector, which employed about 7,600 people and produced 5.6 million tonnes of petrochemical products in 2011, according to Egyptian Petrochemicals Holding Company (ECHEM) data.
In 2002, ECHEM unveiled a 20-year, $10bn Petrochemical Master Plan, which outlined plans to increase the production of petrochemicals to 15 million tonnes a year by 2022.
One of the key assumptions this plan was based on was that the industry would derive a competitive advantage from Egypts cheaply produced natural gas.
Now, this cheap gas is no longer available and petrochemical projects worth an estimated $25bn are on hold, with many citing concerns about natural gas feedstocks, as well as economic and political risk.
The delays to projects, which are likely to prove to be de-facto cancellations in some cases, do not bode well for the wider Egyptian economy.
Schemes such as ECHEMs $3bn olefins plant in Suez were hoped to encourage the establishment of downstream manufacturing companies and other related businesses, indirectly creating tens of thousands of jobs.
The gas crisis is already sending shockwaves through the economy and the adjustment is likely to render a lot of existing plants in the petrochemicals sector uncompetitive in the long term, says Robert Campbell, an analyst at the UKs Energy Aspects.
The countrys industrial base is extremely reliant on extremely cheap energy, he says. Once that support has gone there will be a painful restructuring.
Ismail announced in June that Egypt would import natural gas until domestic production is ramped up and the country becomes self-sufficient once again. But so far, attempts to agree on regular imports have failed to produce results, with Cairo reluctant to pay international prices that would put extra pressure on its already stretched finances.
Egypt is teetering on the brink of an economic crisis and has only managed to remain solvent thanks to an inflow of more than $20bn in aid from Gulf countries such as Saudi Arabia and the UAE. In 2013, the governments deficit stood at 14 per cent of GDP.
Under the plan outlined by Ismail, it will take five years until Egypt is producing enough gas to meet domestic demand. Failure to kick-start projects now means the shortfall may go on for far longer, wrecking extra damage on the economy.
At the heart of Egypts gas crisis is the dysfunctional subsidy system. Under current contracts, domestic gas producers have to give the government first refusal on gas sales and agree to sell gas to the authorities at prices as low as $4 a million BTUs, far lower than international rates.
This has historically helped to support Egypts subsidy system, allowing it to pass on the lower gas price to consumers and industry, but now these contracts have become the key sticking point in the battle to ramp up Egyptian production.
Maximilian Fellner, general manager of RWE Dea Egypt, which owns stakes in some of the countrys biggest gas field developments, says increased prices for gas producers are essential to resolve the current crisis.
Fellner says revised deals would provide an incentive to get gas projects up and running, and will work out cheaper for the government in the long run, compared with paying international prices for liquefied natural gas (LNG) imports that are likely to cost as much as $15 a million BTUs.
Cuts to fuel subsidies were made in July, but Fellner says further reductions are necessary to increase Egypt General Petroleum Corporations (EGPCs) ability to pay operators on time and win back the trust of international oil firms.
There is a slight improvement in the situation, which should lead to an improvement in the payments, but it doesnt mean the problem is solved . There is light at the end of the tunnel, but its a long, dark tunnel, he says.
Both increased gas prices and further reductions in subsidies are delicate political issues.
The Egyptian public is wary of foreign companies profiting from the countrys natural resources and when the new parliament is voted in before the end of the year, it is likely to come under pressure to make fiscal terms for oil companies more onerous, not less.
Any more attempts to reform the subsidy system are also likely to prove problematic as the military-backed government attempts to navigate Egypts volatile post-revolution political environment.
Julys cuts pushed Egypts annual headline inflation rate to 11.4 per cent in August, putting further pressure on low earners while unemployment remains high.
Officials are unlikely to want to make further cuts in the near future for fear the rising cost of living could impact the popularity of President Abdul Fattah al-Sisi.
Its a huge problem, says Campbell. Until the population can be convinced this move will ultimately benefit them, which I think most people will be deeply cynical about, its hard to see them supporting it.
Unfortunately for Al-Sisi, failing to provide reliable energy supplies is also a tried and tested route to unpopularity.
Power cuts and fuel shortages played a key role in stirring resentment against Al-Sisis predecessor, Mohamed Mursi, ahead of his removal.
Over coming months, the governments ability to push through further reforms and engage international oil companies at the same time as keeping a lid on civil unrest is likely to prove to be a key test of its resilience.
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