Egypt’s Energy Trap

Egypt’s energy sector is in profound disarray, at a time when the Egyptian economy would desperately need the proceeds from functioning energy production and trade. Declining reserves and falling production, coupled to surging domestic energy demand have since 2008 turned Egypt into a net importer of oil and oil products. Egypt’s economy continues to rely on its hydrocarbon sector for some 8% of GDP, and export receipts – now primarily for natural gas – continue to contribute up to 10% to government revenues. Rising domestic demand for energy, however, and Egypt’s rapidly declining gas production raise increasingly pressing questions over the country’s long-term status as a gas exporter. Egypt’s domestic gas crisis is as much the consequence of historical mal-planning as it is the short-term consequence of the country’s past two years of political turmoil. The Egyptian government now faces decisive times, and it is up to policymakers to determine whether Egypt’s gas sector will be a contributor to the economy’s gradual recovery, or whether it will remain part of the Egypt’s wider economic problems.

Above-ground versus below-ground problems
Egypt’s natural gas resources, albeit not of the size of some of the world’s largest producers such as Iran, Russia, or Qatar, compare principally favourable to many of its Levantine and Middle Eastern neighbours. In 2012, Egypt’s proven natural gas reserves amounted to some 2 trillion cubic metres (tcm), down 0.2 tcm from previous years but significantly more than in the beginning 2000s, when Egypt became a significant North African gas exporter. The US Geological Survey estimates total recoverable gas resources in the Nile Delta at 6.3 tcm, and while these numbers are subject to future exploration work, they indicate that Egypt’s gas history need not stop just here. By contrast, Egypt’s natural gas production has actually been in decline since 2009, when production peaked at around 62.7 billion cubic metres per year (bcm). We are expecting Egypt in 2013 to produce below 60 bcm, much below what was originally expected by this time.

Egypt’s production decline was by no means inevitable. Like many other gas producers, including in North Africa, Egypt faces rapid depletion rates in many of its existing reservoirs, rendering consistent investment in new reserves essential to maintaining and expanding gas production. Many of these new reserves consist in higher-risk, higher-cost areas, particularly the offshore Nile Delta, where access to more sophisticated technology and foreign capital are key contributing factors determining the pace at which new resources enter the Egyptian gas market. The political turmoil following Egypt’s 2011 revolution has considerably implicated these offshore developments, directly through temporary shut-downs in production, but more structurally by depriving the Egyptian government from essential fiscal resources to meet various contract commitments towards its international partner companies in charge of developing these resources.

In reality, however, Egypt’s post-revolutionary turmoil merely accelerated the severity of existing long-term issues present in Egypt’s wider domestic energy sector for a decade at least. Successive post-Mubarak governments have inherited a gas sector characterised by the conflicting needs of Egypt’s surging domestic energy demand and existing export contract commitments to a range of Egyptian gas customers. Accelerated by the country’s economic growth, rising population numbers and income rates, as well as rising living standards among the urban upper and middle classes, Egypt faces energy consumption rates growing around 7% per annum over the last ten years. A relict of Mubarak’s energy planning, most of Egypt’s energy needs are met by oil and natural gas, with a partial contribution of hydropower in electricity production.

A history of exceptionally low domestic energy prices – many multiples below international prices and increasingly below the long-run marginal cost of production for more costly oil and gas production projects – has systematically distorted Egypt’s domestic energy market, which suffers from extremely low levels of industrial energy efficiency; and subsequently much wasteful energy consumption, including by energy-intensive industries and high-end energy users. Energy access, by contrast, remains incomplete, with some 3 million Egyptians lacking access to even basic electricity. Surging domestic energy consumption has meant the government has been forced to divert a growing share of its natural gas production to the domestic market, where low domestic, rather than high international prices are paid.

While rational from an immediate political point of view, the choice to divert more gas into the domestic sector is highly problematic from an economic point of view, where the real value of Egyptian gas lies in its export. Egypt’s precarious fiscal situation means Egypt needs its natural gas exports to generate income and foreign currency, and this income is unlikely to be generated at home. Egypt’s foreign oil and gas companies, too, need exports of Egyptian gas, in order to compensate their project expenditure. The need to divert rising shares of gas to Egypt’s domestic market hence further deprives international investors of cash, leading to lacking investment in new phases of existing projects – the reason for a number of project delays over the past months that have led to the fall in Egyptian production. Continued political instability, until recently adjoined by Egypt’s Muslim Brotherhood-led government which publically asserted its intent to “squeeze foreign companies” has proven further unhelpful to address the economic causes of weakening investment into the country’s upstream sector.

Policy reconsiderations needed: energy subsidies
While at least part of Egypt’s current gas woes are inherited from the previous Mubarak regime, it is the current Egyptian government which will need to resolve the repercussions of more than a decade of poor policy planning. One of the most pressing areas for policy reform is undoubtedly the overdue adjustment of domestic energy pricing structures, which remain an essential part of Egypt’s energy sector problems. If Egypt continues to divert increasing volumes of its own gas production to its domestic market, production companies will need to be compensated on a cost-recovering basis, allowing for some profits, in order to ensure consistent investment in new capacity. Similarly, if Egypt moves ahead with plans to import gas as a stop-gap measure, either by pipeline or more medium-term via LNG, regional or international prices will have to be paid, leaving the Egyptian government to cover the difference between its domestic and import/sales prices.

That the mounting burden of Egypt’s energy subsidies is entirely unsustainable already is evident from the current fiscal year: total energy sector subsidies for 2012/2013 are expected to reach EGP 115bn ($16.8bn), about a fifth of total government expenditure, three times the spending on education and seven times expenditure on health serves, and exceeding the country’s overall $9.8bn planned fiscal deficit. By comparison, the IMF loan which Egypt has been in negotiations about for nearly a year, would offer the country merely $4.8bn, less than a third of the country’s energy subsidy bill; while international lenders’ and donors’ aid packages pledged by the European Union, Saudi Arabia, Qatar, the UAE and Turkey currently amount to some $14bn – virtually all to be consumed by energy subsidies if Egypt does not manage to reduce its expenditure on energy subsidies considerably.

Reforming domestic energy prices is a delicate task, made no easier by Egypt’s current political climate under which any political step perceived to be against the interest of the masses is likely to trigger yet more protest. Credible governance, which couples the reform of domestic prices to an overhaul of Egypt’s by all means ailing social welfare system may sound a daunting task for any new government but will likely prove essential to calming down the public in view of rising living costs. Iran’s high-profile 2010 domestic energy price reform may serve as an example worth looking to. But the reform of Egypt’s domestic energy prices also offers a real opportunity of reforming those elements of the economy which form the backbone of the kind of remedies Egypt’s protesters in reality demand: a fairer distribution of incomes and economic rewards, and more universal access of all Egyptians to essential services such as housing, food, health and education, rather than priority access of Egypt’s industries to cheap fuel. Egypt has made tentative steps into this direction by revising fuel prices in late 2012 and early 2013, but these reforms remain small steps and have so far been unaccompanied by parallel social safety measures.

… and long-term exports
Over the long-term, Egypt will also need to reconsider its priorities for the allocation of its domestic hydrocarbon production. Allocating increasing shares of domestic gas production to the domestic market may be a short-term measure, but over the long-term this policy is likely to further erode the state’s income unless domestic prices follow international prices more closely. Questions such as the role of alternative energies, such as renewables and nuclear power, and reviews to ensure systematic energy efficiency improvements may help Egypt’s economy not only lower demand growth – and hence investment needs and opportunity costs – but also carry along opportunities for new sectoral employment for Egypt’s young and highly skilled population. Free Egyptian gas for export, such policies may entail economic benefits along the line, but will require a stable government able to look beyond the immediate needs of Egypt’s currently entrapped political system.

Bridging Egypt’s short- and medium-term gas shortages will also require a lot more economic pragmatism than is currently the case. Qatari and Russian proposals to supply Egypt’s LNG contracts as a stop-gap measure while Egyptian LNG plants fall short of feedstock may be a brief interlude, rendering Egypt much dependent on goodwill and economic rationale elsewhere in the world. This interlude is unlikely to provide the sort of solution Egypt may need for the next few years, however, during which Egypt’s production is unlikely to recover and during which domestic energy demand is expected to continue to rise at high rates. For the next one to two years, Egypt may be well advised to look beyond these options, including at the big white elephant in its eastern neighbourhood, Israel. While political objections may yet come in the way of any directional change in this matter, reversing once flowing gas from Egypt to Israel would probably constitute the most economic short-term solution to Egypt’s current gas woes.

Egypt’s  most   immediate  problems, mostly glaring fuel, gas and electricity shortages require speedy attention, meaning the new administration will need to act, and act quickly, to resolve further exasperation due to declining living standards tied to energy access. Without doubt, this will be no easy task, and will require skilful, firm and transparent governance by whoever will rule Egypt over the next years. However, in view of Egypt’s dwindling reserves of both natural gas and oil, letting the country’s gas sector drift is no longer an option. Egypt’s precarious economic situation stands arguably at the core of the past two years’ of political turmoil and the toppling of the Mubarak regime, making genuine, structural economic reform a fundamental prerequisite for any political normalisation within the country. Egypt’s energy sector, and its governance, will play a critical role in this, and one that is likely only to increase over the coming years.

Not for circulation or quotation

By: Laura El-Katiri, Oxford Institute for Energy Studies


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