Historical Overview and Governmental Rationality
Ranking an impressive twelfth among global exporters in 2009, Egypt initiated natural gas production in the 1980s with a mere 30 billion cubic feet of gas to accommodate domestic consumption.  These figures increased steadily over the coming years to reach 518 billion cubic feet in 1999 and 867 billion cubic feet in 2001.  Egypt was clearly becoming an energy powerhouse and the surplus was valuable on international markets at the time. Over the next decade, production continued growing through the one trillion cubic feet mark accompanied by a parallel growth in domestic demand. Production growth eventually allowed for a surplus of roughly 536 billion cubic feet in 2010 as global prices were simultaneously falling.  Even so, in 2011/12, this surplus generated $1.96 billion in revenue according to the Egyptian Central Bank.  For better or worse, those days are behind us.

The realities described above force even casual observers to wonder what forces have pushed Egypt to import natural gas rather than continue to export a surplus. Is domestic consumption actually increasing at a rate that much faster than theoretical production capabilities? Frankly, this is highly unlikely and, to the degree that it might be true, the reality is not entirely a function of domestic issues. More likely, perceived complications within the natural gas sector are resulting from a peculiar coincidence of domestic economic and political factors in combination with the externally imposed disincentives to update and expand productive capabilities.  Most obvious among these is the reality that the post-financial crisis era has caused a bear market in natural gas thereby persistently suppressing international prices to levels not seen since the 1990s.

According to major natural gas producers operating in Egypt, domestic demand did rise steadily during the last five years with 55% of this demand originating from the electricity sector.  This, coupled by a stagnation of production, created the need to import in order to fill an extant domestic deficit. The slowing of production was of course, to a substantial degree, brought about by political unrest and resulting decreased output by BG, Dana Gas, and Apache. Simultaneously however, this decrease in production and waning desire to export is also a rational result of international price changes. Fundamental laws of economics note that when the price of a good falls, one should quite rationally produce less of it.  Further, one should certainly not export that which is produced at historically low international prices. These facts become doubly true when faced with rising domestic consumption needs that would necessitate the import of more expensive alternative energy sources.  In this way, Egyptian governmental action in the sphere of natural gas is quite rational.  However, this rationality should not be seen as ubiquitous or ongoing.

Proven Reserves, Irrationality, and The Egyptian Economy

As of 2011 Egypt has proven reserves of 77 trillion cubic ft of natural gas, which amounts to nearly 30 years of consumption not accounting for growth in production, changes in demand, pressure depletion, and other factors such as exploration outcomes.  In spite of this, Egypt is clearly not acting to exploit these reserves.  To some degree, as noted above, this makes rational sense.  However, the historically low price of natural gas resulting from a global economic slowdown is simultaneously correlated with a low international price for capital. As Warren Buffet is fond of saying, it is the wise investor who is”greedy when others are fearful, and fearful when others are greedy.” Given this maxim, a collapsing international natural gas price, while it may rightly encourage domestic consumption, should also encourage investment in the development of a resource that will inevitably experience a price rebound. The question should then become focused upon how Egypt might finance rational investment during a time of relatively low capital costs.

The answers to this specific question can, of course, only be understood within the construct of large-scale investment viability, which relies prominently upon future exploration.  This, according to industry experts, is becoming increasingly expensive due to the depletion of shallow reserves and the necessary switching to deeper, higher temperature, and more costly methods to extract natural gas.  Indeed, according to Marwan El Sayed, former Financial Manager at Shell International, “The issue is not that there are not sufficient reserves, the issue is the lack of developed reserves”.  El Sayed further notes that, “Such required facilities to provide processed and developed reserves are very costly at billions of dollars.”  Of course, it is very important to note that these costs, while high, are quite likely substantially lower now than they will be as the global economy recovers over the next decade.

Further, this short run financial barrier to reserve development will result in Egypt importing one billion cubic feet of natural gas every day over the last half of 2013.  This will be done at an annualized cost of $3.65 billion and represents the most obvious present period loss associated with Egypt’s uncertain investment climate.  Perhaps even more unfortunate is that Egypt’s bold plan to start importing natural gas does not come without the need for further foreign investment as Egypt must construct a LNG (liquefied natural gas) import or receiving terminal to follow its chosen path.  This project alone will cost roughly $3.7 billion dollars.  Of course, as discussed elsewhere in recent issues of Egypt Oil and Gas, the country’s ability to attract this investment has been impeded by its growing reputation for not paying its due to foreign energy sector partners.

Of course, this unfortunate budgetary constraint is partially a result of the expensive but necessary subsidization of various consumer good and imported petroleum products. The outcome of this continued policy has also been a delayed IMF loan and readily observable currency depreciation in formal and black markets.  Ironically, in a rather circular manner, this has only continued to worsen the initial payment difficulties.

When examining one side of this budgetary challenge, Egypt’s natural gas subsidies totaled LE 10 billion during the fiscal year 2009/2010 and were embodied in the fields of power generation, industrial production, and residential consumption. This means that subsidy reduction or elimination may conceivably lead to the closure of factories that can no longer cope with their rising expenses.  This might in turn deter foreign investors, which will result in more complications to the present currency situation. Similarly, lifting the subsidization of natural gas will also impact households in two different ways.  First, this impact will be rather direct as many households in Egypt use natural gas rather than butane bottles for cooking.  An indirect impact will also exist as natural gas is the main fuel used to generate Egyptian electricity.  According to CEDIGAZ’s, the electrical sector consumes 54 percent of Egypt’s natural gas which means that subsidy elimination will feature prominently in higher household electricity bills. Similarly, the industrial sector consumed 29 percent of Egypt’s natural gas production in 2009 which means that subsidy elimination will also impact the price of consumer goods directly.  What’s more, all cars running on natural gas will feel this subsidy elimination crunch as will the increased number of new taxis and buses servicing major Egyptian cities. This reality will impact the economy of intercity transport and the price of all goods transported by natural gas powered vehicles.

The paradox is clearly that subsidy elimination may yield enough social unrest to cause a decline in Egypt’s foreign investment…but only subsidy elimination will allow repayment of Egypt’s financial obligations towards foreign gas companies and the reassurance offoreign investors.  This circularity is undoubtedly what recently prompted IMF official Carlo Cotterelli to note that, “You need to compensate the poor for the loss of subsidies, but at the same time, you also save money because you are not subsidizing the rich.”  This statement very obviously represents an important softening of IMF rhetoric surrounding theliberalization necessary to go forward with Egypt’s 4.8 billion dollar loan deal.

The “Switch” and Geopolitical Outcomes
Interestingly, the Egyptian switch from net exporter to a net importer of natural gas will not only impact the domestic economy but also the economies of countries that were formerly consumers of Egyptian output. In fact, in at least one case, it seems quite clear that this was a secondary political objective behind the rationally driven domestic policy change.

Egypt started exporting natural gas in 2003 with the volume increasing rapidly after the completion of the Arab Gas Pipeline (AGP) in 2004 and the construction of other export facilities such as the Damietta LNG trains in 2005.  Egypt historically exported natural gas throughthe controversial AGP pipeline providing gas to Israel, Jordan, Syria, and Lebanon, with recent additions extending the pipeline to Turkey and even European markets. Perhaps not surprisingly, the pipeline has been attacked at least 12 times since the 25th of January Revolution.

Prior to the attacks, roughly 40 percent of Israel’s gas consumption and 80 percent of Jordan’s power generation derived from Egypt’s gas supply.  Further, Egypt also exported natural gas in the form of Liquefied Natural Gas (LNG) through Damietta and Edko. Egypt’s exports of LNG go primarily to Europe followed by the USA, Korea, and Japan. While it is highly doubtful that Egypt’s declining natural gas exports will have a substantial impact upon European countries with substantial natural gas imports, the regional impact of domestic Egyptian consumption could be substantial, not just from economic perspective, but also geopolitically.

Egyptian importation of natural gas and the continued refusal to regionally export has forced Israel in particular to seek alternative energy sources.  The result has been a rather intense desire to develop the Leviathan, Tamar, and newly discovered Tanin gas fields. These rational objectives, given Egypt’s actions, have substantially modified economic and political relationships between Israel and Korea, Turkey, and Cyprus. Far from the intended consequence of Egyptian governmental action, the inability of Israel to import inexpensive Egyptian natural gas may actually result in a more globally integrated Israel. Simultaneously, Egypt is missing a global opportunity to invest in its natural gas infrastructure, is forced to choose between domestic liberalization and currency devaluation, is losing credibility with foreign investors, and is becoming politically marginalized due to self-imposed economic isolation.

Given the very obvious and immediate political cost of its actions, it is beyond imperative that Egypt at least benefits economically in the longer term.  Therefore, the proper policy action today is to first resolve the budget crisis.  This means they the government must at least increase the efficiency with which subsidies target ONLY the poor.  These savings can then be used to pay creditors and secure the forthcoming IMF loan.  This will be used (along with recent regional assistance) to enhance capital investment while international prices are relatively low.  Incentives must then be put into place to transition domestic industry to natural gas so that they might capitalize upon presently low commodity prices and increasing domestic production.  Finally, the resulting small surpluses must be exported if only to maintain Egypt as a player in the regional political sphere.  As the global economy recovers, Egypt will then have “been greedy when others are fearful”, invested in a commodity that it can utilize over the long term, built credible relations with foreign investors, and avoided alienating itself from regional and global consumers.  This sort of action and foresight can only be described in one way…..revolutionary in spirit.