A Roadmap to the Renaissance of Petroleum Agreements

In times of political instability, such as those currently rocking Egypt, solid ground is needed in order to weather the storm. One of the few remaining patches of solid ground in the Egyptian economy is the country’s petroleum sector, which has fared far better than other sectors in dealing with last year’s tumultuous events. Therefore, taking advantage of the sector’s relative stability could be instrumental in alleviating some of the pressure straining Egypt’s ailing economy. In order for the sector to fulfill this role, further development of its various aspects is necessary.

The key to catalyzing growth in the sector is increasing Foreign Direct Investment via formulating effective strategies aimed at improving Egypt’s competitive advantage. To this end, a review of the entire framework within which agreements with foreign investors are inked is essential in rendering the sector a more attractive prospect for said investors. While the extant system is not a complete calamity, there is definitely room for improvement; certain adjustments and optimizations, if applied swiftly, could go a long way to successfully steering Egypt’s petroleum sector through these difficult times, as well as increasing its efficiency in the long term.

The extant mechanism of concession is bid rounds is supposed to guarantee efficiency through competition, allowing investors to freely compete for concessions by attempting to meet the government’s criteria. However, the effectiveness of the mechanism is marred by the fact that the government’s criteria are often ambiguous. The selection criteria attached to any given bid round is not made clear to investors, which limits their ability to accurately assess the potential of their investment. Therefore, the government must clearly relay its requirements so as to remove unnecessary obstacles from the investor’s path.

Streamlining entry into the Egyptian petroleum sector is central to increasing the sector’s competitive edge, but a reassessment of some of the policies adopted in drafting fiscal agreements is equally important. The relinquishment of exploration acreage by the investor, that is to say, the government’s reclamation of all acreage deemed unusable by the investor is commonly required at the end of the exploration period. The length of such period typically offered to contractors operating in Egypt is in the range of 8 to 10 years, which is a relatively long timeframe for exploration operations, and is accompanied by the possibility of generous extensions. This policy may seem beneficial, as it is an attraction point for investors. The effect it could have in the long-term should not be neglected, however, as it may impede the sector’s pace of development by slowing down exploration activity.

The government should look to offer more balanced agreements, combining attractive timeframes with optimal exploratory efficiency, in order to maximize exploratory activity. Heightened exploratory activity raises the potential for heightened output for the petroleum sector as a whole, which in turn makes the sector more attractive for investors.
The way in which government take (the government’s share of production) is organized within the agreements could similarly be geared towards maximizing competitive advantage.

The continued instability currently characterizing the Egyptian political arena coupled with the uncertainty that engulfs the country’s political future are understandable sources of anxiety for investors. In such environment, investors will consider long-term returns on their investments to be impossible for any authority to guarantee. Consequently, investments that bring quicker returns and thus are more immune to political turbulence will seem more favorable.

The concept of government take in Egypt could be modified to lean towards increasing investor take in the earlier stages of the contract. This would necessarily entail that government take in the earlier stages would decrease, but it would provide a sense of security for the investor and counterbalance the fear of political instability. It should be noted that the government’s share in the investments is no more secure from political volatility than that of the investor. Should this model be implemented, the government could end up suffering the same fate it is trying to protect investors from if the political situation takes a turn for the worse. Nevertheless, this is a risk that should be considered, if only to counter the negative effect of the political situation on the sector’s attractiveness.

The competitive nature of the petroleum industry inherently compels market players to engage in competitive drilling campaigns, and amid the race for expansion and acquisition of a larger market-share. Petroleum companies are always in a perpetual search for efficient methods to maximize output as a way of increasing their profit margins. However, as drilling continues to sprout across Egypt at a rapid rate and the progressive depletion of most of the country’s onshore basins, the prospect of cross-lease complications due to a shared reservoir becomes inevitable. A common remedy for this type of conflict of interest is the process of reservoir unitization

Unitization is the joint, coordinated development of a petroleum reservoir that extends across more than one development lease by all the parties with vested interest in said reservoir; it is the best mechanism for assuring the maximum recovery of hydrocarbons in the most efficient manner.

Granted there hasn’t been a significant number of domestic cases where two (or more) development leases shared a common hydrocarbon reservoir; that does not, however, negate the inevitability of such problem becoming more prevalent in the future. 

The essence of the problem lies in the absence of clear legal guidelines to regulate this obstacle if or when it arises in Egyptian contractual agreements. Instead, all the legal statutes pertaining to unitization barely brush on the core issue; the only clear legal provision relating to the matter of unitization or joint-production agreements only cover the case of adjoining an exploratory well to a development lease located in the same concession owned by the same contractor.

In any other case, Egyptian legal statutes are often vague in regulating the issue, particularly in the case of a shared hydrocarbon reservoir between two competing operators.  Even when the case concerns the development of a reservoir extending into a non-leased area, the agreements lacks a clear mechanism to manage the case in a method that maximizes potential outcome while balancing the investor’s satisfaction.

Consequently, when the problem is actually encountered, the parties involved resort to forming a customized agreement in order to preserve their respective interests, especially due to the fact that IOCs are only subject to labor laws and not the entirety of Egyptian law. However, the extant agreements model adopted in Egypt is devoid of the suitable provisions to meticulously regulate the problem production allocation in the case of cross-lease reservoirs.

The discourse is further complicated in offshore cases, where lease demarcation is more difficult to define. In addition to the abundance of stranded natural gas formations offshore that stretch horizontally for lengthy distances, naturally raising the probability of extending beyond one geographical lease.

If a mutual satisfactory agreement cannot be reached between the parties involved, the EGPC attempts to mediate. Failing to do so, the dispute is escalated to international arbitration.

What is evident from the strategy currently employed to tackle the issue is the absence of visionary planning for the future of petroleum development, an unfortunate aftermath to years of employing contractual agreements that are rather inflexible, ones where room for modifications and amendments to cope with the inherit changes of the market is nonexistent.

An oft-mentioned impediment to the sector’s growth is the issue of subsidization, a policy that dissuades potential investors from seeking contracts in Egypt. However, calls for a complete cessation of petroleum product subsidization in Egypt are naïve at best and dangerous at worst. An abolition of subsidies in a country with Egypt’s sociopolitical makeup would trigger rampant popular dissent and thus could potentially have disastrous ramifications, particularly during the economic turmoil the country is currently undergoing.

A more prudent solution would be a reassessment of the system by which subsidies are implemented. Extant agreements force the investor to sell gas at subsidized domestic market prices. This policy should be discontinued so as to relieve the investor of having to share the burden of domestic economic problems. The agreements should instead give the investor the freedom to pursue pricing strategies consistent with those of mature global markets. Such an amendment to the current policy would in turn boost the sector’s competitiveness while sidestepping potential political complications that would arise from the removal of subsidies.

The legal and regulatory framework that governs relations between the Egyptian government and foreign investors in the petroleum sector is neither terminally flawed nor loss-inducing, but the potential for improvement and optimization is clearly there. Modifications could facilitate the process of investment, maximize output, and create a more investor-friendly milieu, all of which would provide Egypt with the competitive edge it needs in order to realize the sector’s full potential.

By EOG Team


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