Uncertainty, Instability and Political Progress?

Egypt’s unrest will undoubtedly affect the country’s oil and gas sector. The publicly supported military overthrow of former President Morsi left the country in a state of political uncertainty characterized by internal power struggles, civil unrest, and localized violence. The rapid deterioration of political stability in Egypt inevitably flows over into the country’s oil and gas sector. Egypt Oil & Gas spoke to experts, analysts, and operators to assess the current and potential future impacts that Egypt’s unrest may have on the oil and gas sector.

Initial Impact
Investors diligently monitor political and security events since the overthrow of former President Hosni Mubarak in 2011, as the country has been in a perpetual state of uncertainty. Geoff Porter, founder of North Africa Risk Consulting Inc. explained, “IOC’s were well-prepared for the prospect of instability in Egypt. First, it was never certain that Mohamed Morsi’s presidency would be successful or that it would endure. Second, the intentions of the anti-Morsi faction to stage mass protests that would result in Morsi’s ousting were broadcast well in advance…IOCs had ample time to prepare for the likelihood of unrest. Companies make plans to evacuate personnel, shut-in operations, and secure their assets until the companies’ eventual return.”

As violent clashes followed the removal of former President Morsi, oil and gas companies began enacting security measures. BP, BG, Dana Gas, Eni, and Shell evacuated some of their non-essential expatriate staff members.1 Shell confirmed the temporary relocation of some staff members and dependents, as well as undertaking “appropriate measures to ensure the safety of all in country staff.”

The overthrow of Morsi quickly sent shockwaves through the market as the country’s future became increasingly uncertain. Surbhi Arora, a PhD candidate at the University of Petroleum and Energy Studies explained, that the instability in Egypt caused the rise in Brent crude to over USD 100 per barrel. While there was “little effect on oil markets as July 4 was a holiday in the US…the next day the crude prices rose when the reports of unrest in the Suez and Sinai regions were reported,” Arora said.

Nationally, Egypt’s stock market demonstrated gains as Morsi was forced out of office. According to Dr. Gawdat Bahgat of the National Defense University, “the positive reaction… might be explained by expectations of change in economic policy.” During the same period, the Egyptian pound strengthened. Despite the positive response in the domestic economy, Arora cautioned that such gains “may be only short-term unless the transitional government takes measures for its stability.”

Threats to Domestic Production
“The current unrest is obviously not something likely to lead to increased oil and gas production in Egypt, but it may not significantly decrease it either,” informed Dr. Mark Katz of George Mason University. “The main opposition forces in Egypt all have an interest in protecting this industry,” he noted. Thus far, it does not appear that the unrest has had a significant impact on production. Paul Welch, President and CEO of Seadragon Energy Inc. told Egypt Oil & Gas that “production has not been affected by the current unrest and we do not anticipate that it will be.” Welch further noted, “we have doubled our production in the last year even with the unrest so we have been able to manage the situation quite well.”

While no significant impact has been identified thus far, smaller impacts may be present. “To the degree that Egypt relies on expatriate personnel to manage production facilities, there may be a slight decrease in production while expatriate personnel are withdrawn from the country,” cautioned Porter. However, these gaps maybe filled by  “Egyptian counterparts [who] are expected to manage operations in the meantime,” explained Arora.

As evacuations are short-term solutions, long-term measures will have to be explored if unrest persists. Such measures “would likely add to security costs for any given IOC operation in Egypt,” said Porter. “Security costs would not be so high as to deter FDI entirely, but they do make Egypt a less attractive FDI destination for IOCs,” he added.
Stephen Sanders, of the Sanders White & Associates crisis management team, cautioned that further deterioration of security “could present an unacceptable risk to international oil and gas company personnel and even the technical Egyptian workforce… A reduction of available trained personnel, of course, could have a negative impact on production and the development of new fields.”

On the other hand, Mena Cammett, a senior risk analyst at XL Group, explained how “oil companies are unique in that they don’t have the luxury of shying away from risky countries. They have to go where the resources are.” In order to operate in such environments “energy companies should and do dedicate substantial resources to security and political risk analysis in order to meet the challenges,” Cammett noted. An important asset for IOCs is political risk insurance (PRI) which can be used “to mitigate the risk of contracting with host country governments…[but also] to insure investors against the loss of their assets due to political violence,” informed Cammett.

Threats to Suez and Sumed
While clashes following the over-throw of Morsi have been primarily localized, unrest in Sinai may present a larger threat to the industry. Just three days after the ousting of Morsi, a pipeline carrying gas to Jordan was bombed.1 While the perpetrators of the attack remain unknown, the timing coincided with a series of attacks launched by militants. Pipeline attacks in the region are not uncommon, with more than a dozen occurring in the past two years.

Egypt’s Suez Canal is a particularly vital transportation route. According to Arora, “the biggest threat [to the oil and gas sector] could be the closure of the Suez Canal and the Sumed pipeline…which could disrupt oil flows and result in a spike of oil prices. [If] these important routes are closed, around 2.5 million b/d of crude and 1.4 million b/d of petroleum products transported via the Suez Canal would have to be redirect around Africa, which can add around 15 days of transit to shipments destined for Europe and eight to ten days for those destined for the US.” Such a closure would impact markets worldwide.

The closure of these routes would also have significant domestic impacts. Sanders explained the necessity in protecting the Suez Canal and pipelines as they “have a direct effect on production and exports, as well as provide utilization fees [that are] critical to the stability of the Egyptian economy and tax base.” Recognizing that security in these regions is imperative, the military declared a state of emergency in Sinai and Suez on July 5. Additional troops have been deployed to the canal as a precaution to ensure its security during this period of unrest 1.

Existing and Future Investment
“Traditionally, Egypt has provided a friendly foreign investment environment for oil and gas companies. If security, economic, and political uncertainties persist, it is likely that oil and gas companies will re-consider their investments in Egypt. This would have significant impacts on both production and export volumes,” said Dr. Bahgat.

According to Dr. Katz, the biggest threat to investment in Egypt’s oil and gas sector “is the possibility of prolonged, intensified civil conflict.” Porter expressed similar concerns over long-term unrest explaining, “some exploration companies may declare force majeure if the political environment continues to deteriorate and they feel as if they are no longer able to safely operate in the country.” The impact of companies declaring, “force majeure … will slow Egypt’s exploration activities and introduce a lag in new production,” Porter explained. Restoring security thus becomes key in maintaining the country’s oil and gas sector.

Another concern of investors is the recognition of existing contracts. According to Sanders, if existing contracts are not recognized or agreed upon terms are not maintained, “this might motivate international oil and gas companies to curtail their activities in Egypt due to unacceptable risk. This could also result from extensive changes to import or export regulations…having a significant negative impact on the supply chain management systems supporting the industry.” A similar threat to the investment climate would be the nationalization of the oil and gas sector. A DC based energy analysis that preferred to remain anonymous cautioned, “if nationalization is a prospect, that will start companies thinking about an exit strategy.”

In terms of future investors, “companies that are not already invested in Egypt’s hydrocarbons sector have the luxury of waiting to see how the political situation unfolds,” informed Porter. “Obviously, there is a gamble here, those that return first will have ‘first mover’ advantage and those that wait too long maybe frozen out of potential opportunities. The challenge for IOCs is to correctly time their re-entry…No oil company wants to rush into post-Morsi Egypt only to have Egypt descend into further chaos, but at the same time oil companies do not want to write off Egypt,” Porter added. 

Protection Strategies
The recent unrest has given rise to many challenges for Egypt’s oil and gas sector. Despite the risks, experts remain cautiously optimistic over the future of the sector as measures to mitigate such threats can be adopted. “Mutual understanding, cooperation and coordination” between IOCs and the transitional government are necessary in ensuring the protection of investments in the country, informed Sanders.

The transitional government must strive to instill confidence in investors. Porter suggested, “it [the government] should make it clear to foreign investors in the hydrocarbons sector that their contracts will be valid…the new government should make it absolutely clear that any revision to hydrocarbon legislation will be the result of an open and transparent debate in order to allow foreign investors the opportunity to share their views and make preparations if they choose to exit the country.” Arora similarly emphasized the need for strong incentives “through policies to encourage foreign investment in the oil and gas sector.”

In terms of security Cammett recommended the government consider “committing military resources to defend oil and gas operations against sabotage. Some foreign operators in Egypt are already lobbying the state for military protection in country. The use of military to secure private investor assets, thought controversial, in not unprecedented in the global oil industry give the sector’s strategic importance,” Cammett explained.

Egypt’s political, economic, and security instability following the ousting of Morsi rallied the country’s stock market while concerns grew internationally as the price of crude increased. The risk of closure of the Suez Canal represents the greatest threat, as the impact would affect markets worldwide. Domestically, IOCs have been able to adapt to the unrest by implementing evacuations and other short-term strategies. However, if security is not regained in the medium to long term, operational costs will begin to increase and some companies may declare force majeure. Thus it is imperative that security is restored. Additionally, the transitional and future government should strive to ensure the sanctity of existing contracts, as well as legislation that promotes international investment in Egypt’s oil and gas sector.

By Maya Moseley


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