The Egyptian petroleum industry’s top-level executives convene to ponder the future of the sector’s contractual agreements amid the vehement changing winds of the country’s political makeup
When some of the heaviest hitters of the Egyptian oil and gas sector gather under one roof, it is only natural for the most pressing issues troubling the sector to rise organically to the fore. When these personalities represent different sides of the equation, namely governmental entities and different private companies, it is inevitable for battle lines to be drawn across the table. This is what happened when Egypt Oil & Gas took the decision to bring together some of the biggest players in the sector to discuss the future of oil and gas agreements in the country.
The discussion extended for hours, shifting from stumbling blocks to proposals to points of contention, all in the context of refining the Egyptian petroleum sector and the agreements framework that guides its dealings. The difficulty of producing a balanced system that preserves the country’s sovereign rights and simultaneously provides an enticing prospect for investors was evident in the positions taken and exchanged by general managers and ministry officials during the symposium, but it was abundantly clear that everyone in attendance had their sights set on optimum resource development, if only for the sake of mutual benefit.
The tentatively optimistic spirit of the entire affair was best reflected in former Minister of Petroleum Dr. Hamdy Al Banbi’s opening remarks, as he called on all investors to participate in the sector despite the challenges clearly in place. This is a thread that ran through the entire discussion, as both investors and government officials accepted the obstacles and hindrances that present themselves in drafting agreements, but showed resilience in their will to overcome them and remain active in the sector.
The focal themes of the discussion were clarity, flexibility, and balance. The centrality of these three tenets to the pricing regime of natural gas spontaneously led the flow of the talk to that particular topic, which proved to be one charged with investor frustrations. Geol. Mostafa Al-Bahr, Vice Chairman for Agreements and Exploration at EGAS, was responsible for bringing the issue to the fore as he revealed governmental considerations that would have drastic implications. Geol. Al-Bahr announced that the government was contemplating pushing negotiations for prices in gas agreements until after a commercial discovery has been made, triggering a complex debate revolving around the pricing regimes for natural gas.
The Struggle for Pricing Natural Gas
The Struggle for Pricing Natural Gas The ascendancy of natural gas as a resource and the rise of technology capable of more efficient development of the resource give massive importance to the pricing system governing natural gas transactions. Petzed Chairman Salah Hafez identified the price of gas as the only factor relevant a favorable internal rate of recovery (IRR) during the roundtable discussion, demonstrating just how vital a variable it is to investors.
A portion of the discussion was dedicated to gas agreements already in place, some of which include fixed terms and conditions regarding gas pricing. Geol. Mostafa Al-Bahr, Vice Chairman of EGAS for Agreements and Exploration, and one of the most contributive members to the debate, expressed his openness to the notion of modifying the gas price in extant agreements in order to more effectively develop gas.
Investors in attendance showed appreciation for such a step to be considered; Mr. Ian Barden, General & Country Manager of Vegas Oil, complained of gas contracts his company is currently operating under, which dictate fixed gas prices that have not moved with the times.
The fulcrum of the gas pricing discussion, however, was the gas pricing regime to be implemented in future natural gas deals, on which most of the participants focused their attention. Several widely contrasting opinions were on display, illustrating both the precariousness of the issue and the importance it holds.
It was Geol. Mostafa Al-Bahr’s suggestion of inking agreements with contractors without initially determining the price of gas that sparked the influx of ideas, rejections, proposals and warnings that followed. Geol. Al-Bahr’s view was that each discovery should be dealt with individually following a detailed economic study assessing the different factors that affect gas price.
Thus he suggested that in future gas agreements, price negotiations should be undertaken after a commercial discovery had been made, assuring investors that market price at the time of development would be considered in the negotiations and that pricing would be fair because Egypt ultimately had to remain competitive.
Geol. Abu Bakr Ibrahim, Vice Chairman for Agreements and exploration at GANOPE, agreed that it was possible to postpone gas pricing until a discovery had been made in the case of associated gas discovered with oil, but insisted that deepwater prospects demanded that the price be set even before the concession agreement is signed.
Dr. Al-Banbi warned against the idea, claiming that it presented investors with a vague prospect, asking them to commit an investment with no indication of what will happen once a discovery is made. Many of the investors proved that Dr. Al-Banbi’s point was not unfounded, expressing wariness regarding such an uncertain prospect.
Shell Egypt Chairman Mr. Jeroen Regtien pointed out that pricing post-discovery was a sound concept from a development standpoint, but was not advantageous for an investor such as himself. As an investor, he needs an indication of the gas price before submitting an exploration bid, and an expectation of what the price will be before deciding to conduct an appraisal.
Clarity from the offset is clearly key to investors. Companies such as Statoil are considering making a reentry into Egypt, and according to the company’s General Manager Mr.Anders Kullerud, they will have to make assumptions regarding gas price, which makes it more difficult for them to take the decision to reenter the sector and renders the process of presenting an appropriate bid more challenging.
Mr. Kullerud suggested the introduction of what he labeled ‘principles’ on which to base gas price negotiation, citing the example of a link between gas prices and oil prices. This thought was echoed by Mr. Barden of Vegas Oil, who called for the suggestion to be implemented.
Other investors went further in their ambitions, demanding that the government refrain from setting a price for gas before and after discovery, leaving the task to the oil companies instead. Mr. Miguel Vargas, General Manager of Sipetrol, was one proponent of this concept.
Mr. Vargas cautioned that leaving negotiations until the development stage would leave open the possibility of no agreement being reached at all, even in the wake of a commercial discovery, which would leave the investor empty-handed and leave the ministry of petroleum to do as it sees fit with the discovery. He added that the exploration risk, a substantial factor in submitting a bid, is not taken into account if the pricing is left to post-discovery.
The solution, according to Mr. Vargas, is to leave the process of assessing each block to the international companies while having a certain point of reference in place. Rather than over-regulating this particular aspect of the agreements, the government should let the companies balance their own risk and reward, and select the most competitive offer in the end.
Price de-regulation was a position shared by Mr. Tawfik Diab, Managing Director or PICO International Petroleum and one of the most adamant advents of the idea present at the event. Mr. Diab assured government officials that the government would always get its fair share of the pie, whether from profit share, production share, or simply a larger signature bonus, and so gas pricing should simply be left entirely to the investors, emulating a global market which is largely de-regulated.
Dr. Al-Banbi interjected Mr. Diab’s argument by pointing out that the contracts on offer were almost entirely deregulated, and that only the gas price, the only regulated aspect, is kept under control because of the inconsistencies between oil and gas prices when left to the free market’s whims. Dr. Al-Banbi argued that the a minimum and maximum gas price were incorporated into gas agreements in Egypt in the early 2000s only because prices of oil had jumped tremendously and gas prices failed to reflect such a jump from the range of $20 a barrel to the region of $150.
This argument was rejected by Mr. Diab, however, who claimed that oil prices had not yet reached such heights when the gas clause was introduced, and that the clause was introduced to put in place a floor for gas prices in order to lure investors into the sector. He conceded that this had worked at the time, but could not continue to work in a changing market.
The floor and ceiling model is disliked by Mr. Diab because of the fact that oil and gas service prices are similar. This entails that an oil well would simply be wholly more advantageous for the investor to drill than a gas well, despite the fact that Egypt, according to Mr. Diab, was in need of the gas well. He relayed his understanding of the political pressures pushing the government to adopt such practices, but claimed that they were counter-productive because they were effectively replacing the economic advantage made through this pricing policy with the costs of petroleum products which in the end amount to multiples of the former.
A deregulated market with a link to the Gulf of Suez mix price would’ve allowed the market to balance itself out, according to Mr. Diab, and he called for such a system to be put in place. There were stringent opponents of deregulation to be found in the discussion as well, however.
Mr. Hamed Al-Ahmadi, Chairman of IEMS, saw that not only were a minimum and maximum gas price necessitated, as was a link to the Gulf of Suez mix price, but that gas prices in Egypt should be somewhat normalized.
The concept of pegging gas prices to Gulf of Suez mix, or at least linking them together in any manner, was shot down by Geol Mahfouz Al-Bony, First Undersecretary for Agreements at the ministry of petroleum. Mr. Al-Bony provided the prices of natural gas according to the Henry Hub index and their deviation from Brent prices 4-5 years ago to support his claim that such concept was simply not feasible.
Mr. Al-Bony stated that gas pricing was not magic, and that there was in fact a very simple formula for calculating gas prices if certain variables such as production profile and cost are available. He did not share or empathize with the concerns of many of the investors regarding fixed gas prices or gas price limits. He did, however, recognize that gas pricing was indeed complex in deepwater exploration and production.
The Mediterranean Prospect
Geol. Al-Bony pointed out the fact that there is a myriad of factors affecting gas prices in deepwater areas, and that in these areas, a discovery must be confirmed before a decision is made as to how to share its development. The uniqueness of deepwater development, and the case of Mediterranean deepwater development in Egypt, was recognized by others around the table.
BP’s Vice President for Exploration, Mr. Ahmed Haggras, acknowledged the need for appraisal before a gas price can be determined in the case of deepwater discoveries, unlike onshore and shallow projects, owing to the fact that the economic threshold in deepwater cases is unknown.
Some of the foreign investors in attendance did not warm to the conception of post-discovery pricing in deepwater areas, however, referring to similar disadvantages to the enormous investment required and the guarantees such an investment necessitates. Mr. Jean Pierre Dolla, Managing Director of Total E&P Egypt, argued that it was not possible to ask an investor to invest an amount in the region of $200 million in a deepwater well with no knowledge of the potential returns of the endeavor.
Dr. Al-Banbi supported this position; he judged it unreasonable to ask an investor to part with such huge sums with no notion of what will happen in case of success. Dr. Al-Banbi proposed that some reference, such as the average of 3 market prices, be offered to the investor. He relayed the fear of a potentially ‘cowardly’ manager who would prove troublesome to the investor at the time of negotiating a gas price. Geol. Mahfouz Al Bony attempted to address Dr. Al-Banbi’s concern by proposing similar discoveries and previous development plans as a reference.
The specificity of the deepwater prospects and of Egypt’s Mediterranean prospect, as reflected by the gas pricing discussions, were recognized and voiced by all participants. Geol. Abu Bakr Ibrahim deemed it necessary to remind the attendees that the Mediterranean presented exceptional challenges due to high pressure and high temperatures. Mr. Ahmed Haggras added ‘extremely expensive’ to the list of challenges, along with his claim that the technology to develop some of the Mediterranean’s deepwater resources was not even on the market yet.
Nonetheless, the brimming potential of the prospect was given its due as well. Mr. Haggras informed the audience that all of Egypt’s new resources were in fact in deepwater targets, and Geol. Mostafa Al-Bahr made the claim that ‘deep targets are the future’. As Geol. Al-Bahr went on to say, however, exploiting these resources requires big investments and so big companies.
The necessity of attracting big investments to the Mediterranean was not in doubt by all present, which prompted several of the experts to suggest policies conducive to doing so. Geol. Al-Bahr was of the opinion that current concession agreements may be discouraging investors from developing deepwater and marginal reserves gas, insisting that deepwater and ultra-deep prospect must include special conditions and incentives in their bid rounds in order to draw investors.
Both Mr. Haggrass and Dr. Al-Banbi shared this viewpoint, recommending that extra incentives be added to the bid rounds to render investment in the deepwater Mediterranean uniquely appealing. Mr. Haggrass viewed it as a necessity mandated by the need to balance the money that international oil companies were required to pay in order to participate in the the development of the area’s resources.
Geol. Al-Bahr presented a proposal which found some popularity on the table, namely that contractors be offered the option of selling their profit share as well as any excess gas to the local market. The gas would be marketed in conjunction with EGAS and sold at free market prices, and would use the national grid to reach consumers.
Dr. Al-Banbi in particular welcomed the idea; he favored the notion that the ministry would make a profit by charging the use of the national grid, rather than having to buy and subsidize the gas. He added that the ministry of industry would most probably be willing to buy portions of the gas.
The foreign perspective on the matter was not as optimistic. It is highly improbable that investors would shun the offer of selling gas to the local market, but Mr. Dolla of Total clarified that the companies did not sell gas to the local market because the rules were simply not clear. In the context of a lack of clarity, any extra incentive offered to investors is stripped of its value.
Investors also complained of the agreements model not being particularly compatible with deepwater Mediterranean investments. Shell Egypt’s Mr Jeroen Regtien claimed his company has had to relinquish several of its concessions due to the fact that the current agreements model is simply unsuitable for deepwater areas and so for the deepwater Mediterranean prospects.
The Current Agreements Model:
Amendment or Overhaul?
Deepwater Exploration and development is a new frontier that necessitates the adoption of new terms and provisions in the current agreements model.
Evaluating the extant agreements model adopted in Egypt instigated a heated discussion among the roundtable participants. Representatives of international oil companies (IOCs) presented their justifications for why the current model is in need for amendments. Furthermore, they proposed their visions as to the modifi-cations that could be applied to make the model more attractive for their investments.
Government representatives listened attentively to the various ideas presented, their retorts, however, varied from concurring with some of the points made while objecting to others.
Moderating the entire symposium, former petroleum minister Dr. Hamdy ElBanby initiated the topic stating that Production Sharing Agreements (PSAs) is the “name of the game,” however emphasized that “different geographical areas can have different tender models to suit their characteristics.”
Defending the viability of the current model, Eng. Adel Said, the EGPC’s Deputy Chairman for Agreements, explained that under this model, 426 agreements have been concluded so far, of which 149 are currently in place. In addition, he highlighted the merits of the model, mentioning advantages such as the possibility of license extension, stabilization clauses and tax exemptions.
However, he reiterated Dr. Banbi’s point that “there are cases where the model of the PSA is not the most suitable.”
Originally, PSAs were created for large companies, according Mr. Salah Hafez, Chairman of Petzed Petroleum. But over the course of the time, smaller companies joined in and started operating under the same model of agreements.
Mr. Tawfik Diab, the Managing Director of PICO for International Petroleum Services, had a different take on the matter. He explained that the Ministry of Petroleum should be thinking outside the box and attempt to adopt models that “create incentives for operators in order to keep them interested in investing in Egypt.”
While the economics of the various agreement models may not greatly differ, there is a great benefit to seeking alternative options. Mr. Diab strongly encouraged the adoption of the Royalty Tax model as a way to deregulate the market. Under this model, he illustrated, the “traffic between the operator and regulator is substantially reduced.” Therefore, the operator is not restrained by continuously seeking approvals from the EGPC, which often have a long turnaround time. By doing so, more time can be invested boosting production rates.
Responding to Mr. Diab’s comment, Geologist Mostafa ElBahr, Vice Chairman for Agreements and Exploration for EGAS, explained that while the current model is indeed prevalent, its not the only being used in Egypt. He gave the example of British Petroleum’s operation in North Alexandria, where the company was given the full rights over production, while agreeing to Egypt buying all of its gas output from the block.
Deliberating the ins and outs of the Royalty Tax system, the discussion gradually shifted to the aTotal’s Managing Director, Mr. Jean-Pierre Dolla directed the attention to the absence of an abandonment clause in the existing model, a point that he considered to be of great importance. He regarded the matter as “something that needs to be thought about upfront.” He advised that“ clauses should be made in the contract in order for us [IOCs] to be able to make provisions with cost recovery in due time to help with decommissioning.”
Another point that Mr. Dolla emphasized is that agreements need to be more specific when it comes to using existing facilities to help new players to the market.
Interposing, Geologist Mafouz ElBouny, Ministry of Petroleum’s First Undersecretary for Agreements, stressed that the agreements model is just a model and “it cannot factor in the characteristics of each area,” exclaiming “no model fits all!”
Addressing the strong tide of propositions made in favor of amending the current model, Mr. Abu Bakr Ibrahim explained that amending the preexisting agreements requires seeking an addendum from parliament, which is quite a hassle given the volatility of the political status quo. However, he proposed that if a clear statement is added to the contract that stipulates the usual execution of the agreement “unless a special agreement between the EGPC and the Contractor is in place,” it will allow room for more flexibility without going back to the parliament.
Another issue that was raised by Mr. Dolla was the delay of payments predicament, which happens to be a major concern to many of the IOCs operating in Egypt. Mr. Mostafa ElBahr cleverly handled the issue by explaining that modifying the contract to allow the operator the choice of marketing his own share of production will have a direct impact on alleviating the issue of the outstanding payments owed by the government to the IOCs.
The issue of the amending the current agreements model was passionately debated. While some of the proposed solutions were more drastic than others, there was a general consensus on the urgent need for several amendments to the model in place.
Cost Recovery of New Technologies:
Will the Government Realize the Merit of Quality over Price?
Cost recovery has always been an impediment to the organic growth of the sector. Employing cutting-edge technologies in exploration and development operations requires massive investments, which IOCs are often reluctant to pay due to the uncertainty of recovering their cost. But as we look to the future of sector, we must take in consideration the relative depletion of our main basins, and come to terms with the fact that our remaining resources are situated in deepwater. Thus, the option of employing inexpensive technologies is no longer available.
The shared discontent among IOCs for the high risk they’re forced to assume in employing the technologies, coupled with market’s unfortunate characteristics – being entirely
price-driven rather than quality-driven – is an issue that was hotly pondered in the discussion. Commenting on this issue, Dr. Hamdy ElBanby urged IOCs to seek an open dialogue with the government and work on receiving the needed approvals to avoid the complications that might arise when utilizing very expensive equipment.
Responding to the issue at hand, Geologist Mahfouz ElBouny stressed, “we do not sacrifice any privilege. If there is privilege or merit, we agree with the contractor to use a certain technology whether if it’s a rig, or some sort of new technique. But as a regulatory body, we didn’t sacrifice any specs, especially if they’re technical. If we prove that any technique will save money and has technical and feasibility I think that EGPC, EGAS or GANOPE would not object to approving their use.”
Further, Elbouny added that there has been “several cases where the EGPC and EGAS have approved cost-recovery for new technologies.” However, he also highlighted the obligation to “respect the terms of the PSC in place when it comes to profit share and cost recovery.”
Notwithstanding the approval of a few cases, the issue at hand remains problematic. The growing interest in deepwater exploration and production demands the government’s facilitation to the use of advanced equipment, which can only be achieved by guaranteeing operators their cost recovery.
Mr. Salah Hafez, Chairman of Petzed Petroleum, stressed upon this point urging the government to “give room for companies to allow the identification of the proper technology needed for a certain area.”
In support of the aforementioned point, Mr. Ahmed Haggras, British Petroleum’s Vice President of Exploration noted that the “EGPC and EGAS should pay more attention to promoting new technologies the same way they focus on cost recovery.”
Need Unconventional Terms of Agreements
At his opening speech of the NATC conference, His Excellecy Minister Abdallah Ghorab stated that “Shale gas has become game changer.” Apart from the Mediterranean’s copious deposits of natural gas, the prospects of orthodox hydrocarbon exploration and production are progressively diminishing in Egypt. But the unchartered territories of unconventional resources are abundant in the country and if there was ever a time to start exploiting them, that time is now.
Geologist Mostafa ElBahr noted that developing unconventional resources requires different and more expensive processes and facilities, which is a strong indication that the government is receptive to approving the use of expensive equipment for the sake of development unconventional hydrocarbon resources.
Mr. Jeroen Regtien, Chairman of Shell Egypt, was extremely keen on discussing the prospects of unconventional resources and the parameters to be considered for their successful and efficient development. He noted that whether it’s “shale gas, light-tight oil and tight gas, what these have in common is large number of wells.”
They also share the factor of lengthy development cycles, which necessitate the redefinition of development leases and licenses. In addition the government needs to allow free space to identify the technology needed for exploration and development of unconventional resources.
The government has already taken the initiative of setting up a shale gas committee. Mr. Mahfouz Elbouny even suggested that “if any company has experience with shale gas we [the ministry] would like to receive a template for the model agreement which will help everybody and facilitate the process instead of inventing a new one.” Still, the government needs to provide more incentives through adding provisions in the contracts to specifically encourage investors to endeavor on unconventional development.
Towards More Attractive
As for bid rounds and granting concessions, all the attendees of the roundtable stressed that there should be more clarity regarding license extensions because it’s difficult for operators to heavily invest in infrastructure without knowing whether they would have access to such infrastructure after the expiry of the development lease.
Sipetrol’s General Manager, Mr. Miguel Vargas, remarked that companies are hindered by long delay of military permits. In response, Mr. Elbouny explained that the government cannot declare a firm and specific date for bid rounds because military approval is one card that is totally outside of their dominion.
Due process takes time, he added, which is why companies need to have their budgets and other documents ready for when military approvals are granted. Statoil’s General Manager, Mr. Anders Kullerud, proposed issuing several bid rounds each year as done in Norway. ElBouny retorted that issuing more than one bid round a year would create competition between the government’s petroleum entities, which is not in the benefit of the country as a whole. However, he admitted that there is an effort that can be done to reduce the cycle time between issuing the bid round and awarding the block.
Concluding the discussion on bid rounds, Mr. Salah Hafez emphasized that deregulation is necessary not only in the agreements, but also in the undisclosed system of implementing them, which defeats the spirit of production sharing agreements.
The uncertain new ground Egypt finds itself treading following a reboot of the political system presents its own set of unique challenges to the Egyptian petroleum sector. In light of its complete grip on national headlines, it was all but inevitable for Egypt’s new post-revolutionary parliament to find its way into the discussion.
In fact, Dr. Hamdy Al-Banbi saw to include the topic in his opening remarks. He predicted that the country’s new parliament was certain to apply pressures on the EGPC and the ministry of petroleum, and appealed to government entities to exercise patience in dealing with the new politicians. Dr. Al-Banbi placed the task of educating and explaining the workings and needs of the industry on the minister of petroleum and his assistants.
He deemed this education essential, commenting that the new parliament must stay up to date and be knowledgeable with regards to such a vital industry. The call for patience when dealing with the new parliament was echoed by Eng. Hamed Al-Ahmadi, and Mr. Jean-Pierre Dolla repeated the notion that the country’s new legislative body must be educated.
The theme of education was not exclusive to the politicians. Geol Abu Bakr Ibrahim declared that not only the new parliament, but the entire country must be made aware of the oil industry’s specifics and what it requires to develop successfully. Mr. Jeroen Regtien similarly advocated the education of the new parliament as well as “a large part of the population,” in order to avoid the pitfall of having proposals and rejections for the betterment of the sector constantly rejected.
Dr. Al-Banbi advised that the legal framework be changed in order to make room for the classification of different areas (deepwater, shallow, etc.) for the sake of justifying the differences between different areas. This will save the trouble of having to explain to the energy committee of the new parliament the anomalies present in what is offered in different areas, which are necessitated by their different geographies. The integration of the idea into the legal procedure will sidestep this complication
Dr. Al-Banbi was not entirely pessimistic regarding the new parliament, however. He assured investors and government officials alike that it will not be a problem due to the high level of awareness already present in Egypt regarding the oil business. He went on to suggest that presentations and invitations to visits and trips should be extended to the energy committee.
By Mohamed El-Bahrawi & Ahmed MaatyDownload