Payment Delays: A threat to the petroleum sector?

Egypt’s petroleum sector leads the nation’s economy in attracting foreign direct investment (FDI). This crucial component of the local economy is driven by partnership agreements between the Egyptian government and contracting companies, including major oil giants like British Petroleum (BP), British Gas (BG), and ExxonMobil, among many others.

Although these companies are drawn to Egypt’s oil and gas sector by the promise of major discoveries and vast profits, government policy has also been shaped around providing a favorable environment with which to attract multinational petroleum companies.

Egypt’s relatively stable political and economic situation since the 1970’s has meant an increase in foreign investment into the sector year after year. Beyond this, however, government cost recovery mechanisms and profit sharing contracts have established the basis for favorable contracts, offering international companies the opportunity to discover and exploit valuable oil and gas resources while remaining exempt from major taxes and fees, and claiming compensation for their work.

Despite this positive environment, it has been suggested that the sometimes-lengthy repayment process stipulated by the Egyptian government has caused problems with foreign firms’ cost recovery and discouraged investment in the sector.

Egypt has specific laws and regulations that guide contractual agreements between the government and the contracting companies it works with. Production Sharing Contracts (PSC’s) have been the model of choice for local oil and gas deals since the 1960’s.

Under a PSC, the state or state-run petroleum company enters into a contract with an independent operator in which the contracting company agrees to finance and carry out all operations for a specific project in return for a specified amount of oil or gas to compensate for their costs, as well as a proportion that represents a share of the profits. Companies pay corporate income tax, which currently stands at 20 percent in Egypt as well as a 10 percent royalty levy.

Normally, if a company signs a PSC and does not discover a commercially viable field, expenses are not covered by the government. If a company does make a discovery within a stipulated period, the PSC remains valid for an average of 35 years, depending on specific contract terms, and the partner company recovers expenses by claiming a certain percentage, normally around 40 percent, of total production, calculated in dollars at current export rates. 

The contracting company claims this share until the full amount of investment is recuperated, after which they continue to claim a percentage of profits from the discovery, normally around 15 percent, while the Egyptian government keeps the remainder.

During the period in which the contractor is recuperating its investment, it would claim around 55 percent of total production, while the government keeps 45 percent. Normally the government also absorbs the income taxes and fees for the contractor.

These terms are very favorable for contracting companies, essentially allowing them to claim profits on Egyptian oil and gas discoveries with no expenses, government fees or taxes, and Egyptian government authorities like Egyptian General Petroleum Corporation (EGPC), Egyptian Natural Gas Holding Company (EGAS) and Ganoub El Wadi Petroleum Holding Company (GANOPE), have cooperated with international contractors such as Apache, BP, and BG on a number of projects over the years.
Indeed, a recent change in the terms of the agreement between oil major BP and EGAS sparked controversy as BP managed to obtain extremely favorable terms that some feared would set a new precedent in the local market.

“Caving in to the contractor’s demands has far- reaching ramifications. Not only did it undermine the principle of production sharing prevailing since 1960, it encourages all other foreign firms operating in Egypt to ask for similar amendments. It would, therefore, have been wiser to apply the principle of sole risk which allows the state party to take over the development of the fields when the contracting party defers the development for five years,” petroleum and energy consultant Hussein Abdallah wrote in Al-Ahram Weekly.

Last June, amendments of two agreements for deep water exploration near Alexandria signed originally in 1992 and 1999, were approved by the government, which some felt threatened the autonomy of Egypt’s petroleum sector. The new terms give BP a 61 percent stake in returns during the period of cost recovery, as opposed to around 45 percent previously.

“The production sharing contracts that were introduced in Egypt in the 1960s were a step ahead of the conventional exploration and drilling concessions that had prevailed in the Gulf since 1950s. The bill on the revised terms for the North Alexandria deepwater oil and gas production threatens to turn the clock back to the concession-royalty system. Moreover, with a royalty of 10 per cent, the reduction of the income tax rate from 40 to 20 per cent and the exorbitant prices the government will have to pay for the quantities of the contractor’s share in production in order to meet the needs of domestic consumption, the terms are even less attractive than they were 60 years ago,” wrote Abdallah.
On the whole, foreign contractors in the sector seem to have managed to create very favorable terms for their work on Egyptian petroleum projects. But what happens when the government is sluggish in making payment of the agreed-upon percentage to the contractor?

Delayed Repayment
Work with any government comes with its share of bureaucracy, and profit sharing petroleum contracts in Egypt are no exception. There has been speculation that the government’s failure to provide cost recovery to international petroleum partners has caused frustration and stagnation in the sector, leading to a slowed deal flow and negative international perceptions.

This is just one factor contributing to international appetite for petroleum sector investments in Egypt. Compared to some other petroleum producing countries, Egypt’s laws, regulations and practices are both advanced and efficient, while its economic and political climate is stable and reassuring to investors.
Therefore, although delayed cost recovery could potentially be an issue for contractors working in Egypt, all the signs point to a healthy appetite for investment in the country’s oil and gas sector, and productive ongoing partnerships between major oil companies and Egypt’s petroleum authorities.

Furthermore, the way Egyptian profit sharing petroleum contracts are set up ties cost recovery to discoveries and production by the partner corporation, meaning that the partner company takes the lead in determining when and how quickly they will recover their costs through their pace of work and the production levels of their discoveries inside the country.

Healthy Investment
Even since the onset of the global financial crisis in 2008, Egypt’s petroleum sector has maintained healthy levels of foreign direct investment, even leading other important local industries such as tourism.

By mid-2010, FDI in the sector reached USD 2.8 billion, representing over 30 percent of total FDI inflows into Egypt. These healthy investment levels seem to indicate a growing interest in investing in Egypt on the part of international companies. In 2008-2009, for example, 93 new oil and gas agreements were signed, while 54 existing agreements were extended or modified. In September 2010 alone, three new agreements were signed between GANOPE, the UK’s Dana Petroleum and American Oil Company Apache for exploration in Egypt’s Western Desert. 

As Egypt’s economy grows stronger and stronger following the lifting of the global recession, healthy growth and investment levels can be expected to bolster strong activity in the local petroleum sector.
Petroleum sector contractors seem to be doing well in Egypt, and new deals are clearly forthcoming, but is it enough to keep the investment flowing into the sector at previous high levels into the future? It seems that if the government continues to be willing to grant highly favorable terms to contractors, and if Egypt’s political and economic remain stable, international petroleum companies will be fighting to gain access to local concessions.

As exploration continues, and Egypt’s domestic demand for oil and gas continues to grow, it becomes more and more vital for the Egyptian government to continue attracting new petroleum contracts while implementing laws and regulations that provide for the fulfillment of domestic needs.

The government needs to balance the desire to attract investment with strict contractual terms that assure that Egypt is benefitting from the participation of foreign contractors in the petroleum sector as much as possible. While the terms of the latest BP agreement suggest that contractors may be gaining the upper hand in negotiations, there is no doubt that Egypt’s long term strategy for the petroleum sector will serve the best interests of the county.


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