Overcoming challenges of the Egyptian downstream sector caught between arrears and a lack of feedstock.
By Salma Essam
The Modernization Program promises a new approach, yet, with every positive step comes a challenge. Egypt’s main objective for the downstream sector is to attract foreign direct investments to counterbalance the fact that the country’s refining output declined by 28% from 2009 to 2013, according to the World Refining Association’s report – The Future of Egypt’s Downstream Industry, published in 2015.
Facts Global Energy has linked the decrease in the output to the Egyptian government’s policy that permits the foreign oil producers to export more crude oil as a form of reimbursement for the Egyptian General Petroleum Company’s (EGPC) financial arrears. As a result, the volume of domestic crude oil allocated for domestic refineries dropped. This is one of several challenges that the Oil Ministry’s modernization agenda seeks to tackle in a comprehensive way.
Following the events of 2011, the finances and available capital presented a major concern. The state of political unrest has rendered the investor less confident in the Egyptian industry. Many foreign investors were wary of getting involved in a country where the political situation was not completely stable. Therefore, many projects found it difficult to obtain necessary investments for developments, including those in the downstream sector.
The confidence of foreign investors lagged behind even after the partial economic recovery that Egypt has seen. The main reason being the large amount the country spends on oil subsidies, which have turned out to seriously impact economic revival. In the fiscal year of 2013-2014, the Egyptian government spent $18.2 billion on oil subsidies. In the following year, the plan to lower the cost, subsidies carved out almost 50% less from the state budget in the total amount of $9.2 billion. Even though the subsidies expenditure is decreasing, they still add to the government’s budget deficit, which in effect contributes to the EGPC’s incapability to repay its dues for foreign investors.
Whilst bringing down subsidies is one of the novel challenges Egypt has taken upon itself to tackle at a gradual pace, the impact of this measure could accelerate downstream development projects. In other words, the government would then be able to grant more money to EGPC necessary for its dues to foreign companies and open a door for new development projects. This would lead to further investment commitments and more petroleum products would reach the Egyptian market, reducing costly imports of petroleum derivates. Yet, this operational framework encounters further challenges on logistics level.
A key issue of concern is severe lack of feedstock. Most of Egypt’s petrochemical capacity is set up to use natural gas as its feedstock. World Refining Association’s report said that electricity production has the lion share of natural gas utilization, which accounts for over 60%, leaving Egypt’s petrochemical producers with a sever lack of feedstock. Furthermore, the country has witnessed a sharp decline in natural gas production that had turned Egypt from an exporter to a net importer. From 2012 to 2015, natural gas production declined from 60.9 billion cubic meters to 45.6 billion cubic meters. Couple this with the fact that considerable natural gas discoveries in deepwater have been undeveloped since that the government offered IOCs low prices to produce the gas and the scope of this challenge mounts and can only be tackled through an all-embracing program.
The access to feedstock has been another major point of concern for all refining and petrochemical industries in Egypt. Many of the country’s refineries operate under their real capacity due to the age of the refineries and the old technologies used. National refineries’ annual operational capacity is 33mt/y of petroleum, yet they are currently using merely 26.3mt/y, which, in essence, leaves the estimated unused capacity at 6.7mt/y of crude oil. The Oil Ministry’s new strategy introduces a broad program that would enable the downstream sector to successfully resolve all these challenges.
In order to achieve this, yet another aspect of downstream activities is left to be addressed; a lack of efficient communication between the government and IOCs with regards to the performance and the need of the market. Communication is essential for stimulating foreign investments since that it helps paint a clear picture of the status of the Egyptian downstream industry. When there is inefficient exchange of critical information between the two sides, investments may be lower than the potentiality of the market. For example, if the demand on polypropylene is twice as high as supply and this information is not delivered to investors, it is highly likely that production will not be adjusted to cover the gap. In contrast, if communication channels are designed purposefully, it is highly likely that an investor who is considering building a factory would increase his production to meet the demand.
Given the complexity of the Modernization Program and how the Oil Ministry mastered to interconnect different segments of the oil and gas industry transformation, it appears that the government is doing its best at containing all the existing challenges in a timely and efficient fashion.
Even though the lack of feedstock remains a question for the refining sector, Egypt estimates to hold some 4 billion barrels of proved oil reserves, which, in combination with new oil discoveries, will likely increase the country’s feedstock capacity in the near future. At present, Egypt’s natural gas industry is witnessing a prosperous period as the new discoveries, like Zohr, proved to be game changers. During the fiscal year 2015/2016, EGAS recorded 14 new discoveries that made the total reserves reach 31.5tcf of natural gas and 38mb of condensates. The increase in natural gas reserves will inevitably increase the refineries’ feedstock.
Similarly, the country has begun to pay back the huge debts owed to international operators. The government has partially resolved this issue by reaching an agreement with IOCs to pay back regular monthly amounts that were agreed upon. This will lead to a reduction of the amount of domestically produced oil that foreign producers can export. Hence, there is optimism for foreign investors. And the International Finance Corporation (IFC) confirmed this by stating that “Egypt is as an attractive market,” also in downstream projects. If giant IOCs such as BP and Eni are able to develop their projects and sell their output at better prices to the local Egyptian market, then the downstream sector, represented in the refineries and petrochemical plants, will benefit from added feedstock.
By reforming the subsidies and paying government debts, Egypt should no longer have problems with delayed or cancelled payments. The attractiveness of the investment landscape in Egypt for the IOCs is inevitably on the rise. It is thus fair to say that the future of Egypt’s downstream industry looks positive.