Recent resource discoveries aim to bridge Egypt's energy deficit

Egypt is one of Africa’s main oil and gas producers, but it is also the continent’s largest consumer of energy. Both oil and gas are found throughout the country in multiple onshore and offshore regions, including the Mediterranean Sea, which is emerging as a major new gas basin. Nevertheless, sourcing enough supply to meet demand is the sector’s central challenge, even as these discoveries are expected to contribute significantly to meeting demand within the next few years.

Supply & Demand

Egypt was a net energy exporter for decades. However, since the late 2000s when the cost of imports and exports were similar, production has lagged behind consumption, and a shortage of natural gas in the past several years has left industrial customers scrambling for solutions. Now an energy importer, Egypt’s bill is made larger still by a legacy subsidy regime which has contributed to the government’s cash shortage and its struggle to pay foreign energy producers for what they provide. Industry player David Chi, CEO of Apache, sees the benefit of reforming the subsidy programme. “One of the key challenges for the energy sector will be to reduce local consumption and manage demand through lower subsidies,” he told OBG. “This would allow a much greater percentage of production to be exported.”

The supply gap has set the tone for current policy in the energy sector, but created investment opportunities in the process. Terms for exploration and production have become more investor-friendly in recent years, in particular for gas. The government is also moving to relax control over downstream gas distribution, allowing third-party access to its pipeline network in order to encourage private investment in gas importing and sales. Furthermore, a feed-in tariff is being established to encourage the development of renewable energy-based options (see analysis). Egypt’s wind resources are particularly rich in an area on the Red Sea coast, near the Suez Canal and in relatively close proximity to Cairo, where the government hopes to build a group of special economic zones to be populated with industries reliant on a steady power supply.

Size & Scope

Egypt’s upstream and downstream energy sectors accounted for 18% of GDP in FY 2013/14. Since then, growth in upstream production has failed to keep up with downstream demand, with both oil and gas production falling below historical highs. Gas is considered the commodity with higher potential for the future, with the Zohr offshore field– the country’s biggest find yet – and BP’s West Nile Delta project set to boost output by about 50% in the next several years. Egypt is Africa’s third-largest producer of gas by output. Gas output dropped 13.1% in 2014, to 48.7bn cu metres. In 2013, by comparison, the figure was 56.1bn cu metres for the year.

Oil fields are more mature and new discoveries are smaller and more rare in comparison. Oil production averaged over 700,000 barrels per day (bpd) in 2014, and in October 2016 it stood at 492,000 bpd, down from a peak of more than 900,000 in the 1990s, but less of a decrease than natural gas production over the same period. Egypt is Africa’s fifth-largest oil producer behind Nigeria, Algeria, Angola and Libya.

In addition to being a major energy producer, Egypt serves as a transit platform for the global energy system thanks to two key pieces of infrastructure: the Suez Canal and the Suez-Mediterranean (SuMed) pipeline – the only alternative route in the region to move crude oil from the Indian Ocean to the Mediterranean Sea without going under Africa. Approximately 9% of waterborne crude passed through either the canal or the pipeline in 2014. Egypt’s energy infrastructure also includes around 7000 km of pipelines carrying oil, natural gas and fuels.

Egypt has the largest crude oil refining capacity in Africa, a continent which is chronically short in this area. Whilst estimates of total capacity vary, the figure is in line with current oil production, at just over 700,000 bpd. Capacity is falling, however, with a drop of 28% recorded from 2008 to 2013. In the last year of that period, average daily output was 445,000 bpd according to the Organisation of the Petroleum Exporting Countries’ Annual Statistical Bulletin 2016, suggesting a utilisation rate of 63%. It brought in 145,000 bpd of petroleum products in 2014, and exported around 60,000 bpd.

Gas processing capacity at plants across the country amounts to roughly 5bn cu metres per day. Pipelines are owned by the Egyptian General Petroleum Corporation (EGPC) or Egyptian Natural Gas Holding (EGAS), with the exception of the SuMed pipeline, which is owned by a consortium called Arab Petroleum Pipelines, of which EGPC holds 50%. Saudi Arabia’s Aramco, International Petroleum Investment of the UAE and three Kuwaiti companies each own a 15% share, and Qatar Petroleum has a 5% stake.

Sector Organisation

The primary laws governing the energy sector are Law 66 of 1953, called the Fuel Raw Materials Law; Law 86 of 1956 on mining and quarrying; Law 61 of 1958 on investment incentives; and Law 217 of 1980, which covers natural gas. Law 4 of 1994 covers environmental obligations and Law 91 of 2005, the Egyptian Income Tax Law, sets the tax rate for oil and gas production at 40.55%.

The Ministry of Electricity and Renewable Energy and the Ministry of Petroleum are the relevant government bodies in the sector, and EGPC serves as the national oil company although it does not operate any fields on its own. The EGPC instead acts as a joint venture (JV) partner to the foreign investors responsible for exploration and production.

EGAS was created in 2001 as the importance of natural gas was growing. EGPC and EGAS now share responsibility for upstream gas, with the former retaining control over older sites in the Red Sea and Western Desert areas and the latter overseeing the faster growing areas offshore in the Mediterranean Sea and in the Nile Delta region. Both companies hold regular bidding rounds. EGPC and EGAS are the exclusive buyers of output for the domestic market, responsible for downstream activities such as refining and transportation – EGPC owns the refineries, for example – as well as distribution and marketing.

The two companies also have regulatory responsibilities. Regulations are embedded in the exploration and production agreements signed with companies, which are adopted by the country’s parliament and become law. In the past these have been concessions, but in particular for gas, and in part as a response to what producers want, the government has switched to production-sharing contracts with flexible pricing structures for any profit gas to be sold to the state.

In the past that price was capped at $2.65 per million British thermal units (btu), but the state is now more flexible on what it is willing to pay for gas. For the Zohr field and the gas produced from BP’s West Nile Delta project, a price range was set as part of negotiations before production began, linked to a set internal rate of return. For the Zohr field, the government has committed to pay as much as $5.88 per million btu.

For EGPC’s acreage holders, agreements at the exploration phase cover drilling plans and, if a commercial discovery is made, a JV between the private investor and EGPC will be created along with a 25-year development plan. Ownership of these JVs is typically on a 50/50 basis. Profits typically are split on a 60/40 or 70/30 basis, according to EGPC.

One of the main challenges with Egypt’s legal structure is that because it is the primary buyer of any profit oil or gas, the state’s energy arms can sometimes build up arrears of payments to producers for the products they take. As of July 2016 foreign energy companies were owed a total of $3.4bn. “The terms are competitive in Egypt and the opportunities are what companies are looking for,’’ said Johannes Finborud, managing director of the Egyptian operations of Engie, the French energy company formerly known as GDF Suez. “But if payment for your production is delayed or doesn’t arrive, then the terms are less relevant.’’ Other important state bodies include Ganoub El Wadi Petroleum Holding Company, which is responsible for exploration and production in Upper Egypt, south of the 28th parallel. The Egyptian Mineral Resources Authority shares some regulatory responsibilities and also handles solid-mineral mining. The Egyptian Petrochemicals Holding Company was created in 2002 to manage and develop the petrochemicals industry. In the electricity segment, generation, transmission and distribution assets are owned by the Egyptian Electricity Holding Company, and regulation is handled by Egyptian Electric Utility and Consumer Protection Regulatory Agency (see analysis).

External Actors

The largest private sector producers are British Petroleum, Italy’s Eni, British Gas and Apache Corporation of the US. The first three focus on offshore properties whereas Apache’s acreage is located in the Western Desert.

Sovereign cooperation is also expanding the range of players in the energy sector. Since the 2011 Arab Spring demonstrations, Egypt has been the recipient of aid from Saudi Arabia and others, some of which has come in the form of petroleum products.

In January 2016, after President Xi Jinping visited Egypt, China announced that it was creating a $20bn fund along with the UAE and Qatar to invest in conventional energy in Egypt.

Reforms

The downstream legal environment is changing as well, thanks to the broad approach of subsidy reduction. A downstream gas law in the process of government approvals would create a new regulator to oversee the expected entry of more private sector participants into the business of importing and distributing gas, for example (see analysis). A recent new law in the electricity sector, adopted in November 2015, paves the way for liberalisation in that market, including the gradual phasing out of subsidies and allowing private generation and distribution for the national grid. Currently there is no formal independent power producer market for grid power, but off-grid production is allowed (see analysis).

Reserves

Oil reserve estimates vary in Egypt. According to the Oil & Gas Journal, in 2015 Egypt had 4.4bn barrels of proven oil reserves, whereas EGPC’s figure was 2.8bn plus 1.2bn in condensate. The 2015 BP Statistical Review of World Energy pegged the total at 3.5bn barrels which, at the current rate of production, would be depleted in 13.8 years from June 2015.

For gas, the Oil & Gas Journal estimated total reserves at 77trn cu feet. BP’s figure was 65.2trn cu feet, which at the current rate of production would mean another 37.9 years of extraction. Whilst crude reserves peaked in 1994 at 6.4bn barrels, gas reserves are at a record high and likely to climb higher given the recent pace of discoveries. Explorers report a regular flow of commercial discoveries, most of them small in keeping with the dispersed nature of Egypt’s reserves. EGPC reported 86 discoveries in 2013 and there were 23 new gas finds in FY 2014/15. As noted by officials, there were 75 rigs active as of May 2016.

The high degree of potential in Egypt is attributed to its maritime waters, which form a core part of the Eastern Mediterranean Basin, where the Zohr field is under development. The basin has a fairly short history of exploration. The US Geological Survey assessed an area within it, called the Levant Basin, in 2010 and estimated technically recoverable reserves of 122trn cu feet of gas and 1.7bn barrels of oil, with potential for as much as 227trn cu feet and 3.8bn barrels.

New Discoveries

There is ample potential for further discoveries in the area given recent finds nearby within the Israeli and Cypriot maritime borders. Israel is now producing from the 300bn cu metres Tamar field, which was discovered in 2009, and has also found a larger deposit called Leviathan. In Cyprus, the Aphrodite field, with 200bn cu metres, was found in 2011.

The highlight of 2015 was Eni’s Zohr discovery; a field containing up to 30trn cu feet, almost half of existing total reserves. In addition to being the biggest gas discovery in Egypt, it also set a record for Mediterranean offshore discoveries. Eni is now working to get the field into production as quickly as possible on request from the Egyptian government, which has been importing liquefied natural gas (LNG) and still has been unable to meet domestic demand. Eni successfully tested five wells by September 2016 to gauge the field’s potential. The government approved the development plans for Zohr in February 2016 and first gas was promised by the end of 2017 – a notably fast turnaround. “When you clear away the red tape you can move very fast in Egypt,’’ said Tarek Shalaby, commercial and business development manager for Edison International Egypt. The haul is more than enough to fill the demand gap – for now – but an assessment of long-term needs suggests that Egypt will require even more than its existing production and Zohr’s eventual contribution. The global energy consultancy Wood Mackenzie called the Zohr field transformational, but warned that the Egyptian government should not take its discovery as a signal to delay cuts in subsidies, which would begin lowering demand by encouraging efficient use of energy.

With a budget of $14bn, the plan calls for a first phase of 800m standard cu feet produced per day by the end of 2017, increasing to 2.6bn cu feet per day by 2019. Another 1.2bn cu feet per day is expected in 2017 from BP’s West Nile Delta project, in which BP owns 82.75% of two concessions. The fields hold 5trn cu feet of gas and 55m barrels of condensates.

Production at this scale comes with global implications. Thanks in large part to these two discoveries, Egypt might move from an importer of LNG to an exporter by 2020, possibly extending the duration of a global glut of LNG markets. Hussein El Ghazzawy, vice president and general manager at Schlumberger Oilfield Services Egypt, told OBG the opportunities do not stop there: “The gas discoveries in the Mediterranean are a big opportunity, but it is important not to ignore opportunities in other areas like the Western Dessert. Enhanced oil recovery techniques and the sourcing of local material offer interesting new possibilities for growth.”

Production

Egypt’s future is tied more to its gas than its oil, but at present it is the latter that provides consistent output. Oil production averaged 495,000 bpd in the first 10 months of 2016, according to the US Department of Energy, little changed from 513,000, the mean figure for 2015. This figure is slightly below 540,000 bpd, the average figure for the past 10 years. BP’s Global Energy Report 2016 quotes slightly differing figures – citing 723,000 bpd as the average 2015 figure, but the pattern of change is much the same. In terms of gas, meanwhile, output was at 48.7bn cu metres in 2014, 22.3% lower than peak output in 2009 of 62.7bn cu metres, according to BP’s figures. From 2000 to 2009 annual growth in production was 15% but from 2010 to 2013 the figure declined 3% on average each year. The country has been suffering from gas shortages since 2014 and has been using floating LNG terminals to make up some of the difference.

The most recent EGAS annual report for FY 2014/15 states that production for the period amounted to 1.46m tonnes of liquid petroleum gas, 602m tonnes of propane and 481m tonnes of ethane/propane. Government policy mandates that domestic gas is to be used within the country as much as possible, and that new discoveries should be earmarked wholly for local use. Gas exports had begun in 2003 to Jordan, Lebanon, Syria and Israel via the Arab Gas Pipeline at an average of 30% per year from 2010 to 2013, however exports to Israel were stopped in 2012 and in 2013 exports through the pipe had fallen to 42bn cu feet, from 193bn cu feet in 2010. EGAS reported a total of 8.7bn cu feet in FY 2014/15.

Egypt also has two LNG facilities, Damietta and Idku, with a combined capacity of 610bn cu feet per year through which exports are also processed. The plant at Damietta is a JV between EGAS, EGPC, Spain’s Gas Natural Fenosa and Eni. Its annual capacity of 264bn cu feet idled in 2012 due to Egypt maintaining gas for domestic consumption, as reported by Reuters in February 2013. The balance is at the Idku facility owned by EGPC, EGAS, British Gas, Petronas of Malaysia and Engie of France. Due to recent discoveries, the expectation is that LNG exports will ramp up again by 2020 according to a report from global consultancy McKinsey. For now, however, gas is piped to the country’s processing plants and then typically sent on to the state’s 49 gas-fired thermal plants, which together comprise the largest gas consumer in the market. Industrial clients are a secondary market that has been undersupplied since 2014.

Downstream

Total primary energy consumption reached 86.2m tonnes of oil or equivalent products in 2015, according to BP’s annual statistical review. The figure was up 0.8% from 2013, and up 45% from a decade earlier in 2004, largely due to Egypt’s fast-growing population. Natural gas and oil accounted for almost all consumption in 2013, at 53.8% and 42.6% of the product mix, respectively. “The downstream segment is strong, with agriculture and the demand for fuel and lubricants driving growth,” Hesham El Amroussy, chairman and managing director of fuels and lubricants, ExxonMobil Egypt, told OBG.

EGAS’ 2014/15 annual report showed local consumption of natural gas at 1.66trn cu feet, with imported LNG beginning in April 2015 to make up for a supply gap that began in 2014. Two floating storage and regasification units have been anchored off Ain Sokhna in the Red Sea since 2015 and are supplying a combined 1.1bn cu feet per day.

Another will arrive in 2017 to bring capacity to 1.95bn cu feet per day, according to Tarek El Molla, the minister of petroleum and mineral resources. Egypt began buying LNG in global markets in 2014, initially signing deals for about 70 deliveries by 2017, and adding another 46 by the end of 2016.

In 2015 the country also signed a deal with Gazprom to receive 35 cargoes over 5 years. What is clear, however, is that part of the financial-stability packages Egypt has received from nearby allies, such as Saudi Arabia, have included petroleum products. EGAS in its 2014/15 annual report reported 10 cargoes arriving with a total of 1.46bn cu metres. In April 2016 Saudi Aramco agreed to provide Egypt with 700,000 tonnes of refined oil products per month for five years, before Saudi announced it was ceasing shipments in October, in what was taken as a sign of lingering political tensions over the Syria conflict.

Gas imported by the state goes to the power sector and retail users before industrial demand is satisfied; in total, gas for electricity generation accounted for 1.04trn cu feet, or 63% of all consumption. EGAS in its annual report said there were 6.9m residential units connected to the system, 14,500 commercial customers and 2300 industrial customers as of June 2015. Gas is distributed by 16 public sector distributors, although with the new gas law private investment will be allowed for commercial deliveries (see analysis).

Prices Paid

Demand is rising in Egypt because of population growth, but also because prices for consumer fuels are subsidised, shielding price-conscious consumers from full exposure to the actual cost of what they consume. Egypt also subsidises electricity and food, and paying for these price controls accounts for about 30% of government spending, or 7% of GDP. In FY 2013/14 the government spent $18.2bn subsidising fuels and $1.8bn on power.

Subsidies have been cut significantly, from 2005-08 and again from 2012-14, but consumers still pay well below actual costs according to a study from the Egyptian Centre for Economic Studies, a Cairo-based think tank. The price of petrol in Egypt was the 13th lowest in the world as of June 2016, according to a study of 61 countries by Bloomberg data. Changes to the subsidies are fiercely opposed by Egyptians, the majority of whom are price-sensitive. Even at subsidised rates a gallon of petrol costs 28.4% of the daily average wage. That compares with 1.64% in the US, 5.28% in the UK and 16.86% in China.

“The subsidies are a political issue and the government is trying to educate the public on the plan to reduce subsidies,’’ said Akmal Zaghloul, director of business development for TAQA Arabia, the country’s largest privately-owned energy distributor. The government would like to reduce its exposure to subsidy regimes and already increased prices somewhat in recent years, though not enough to completely eliminate the subsidies. The state has introduced plans to phase them out gradually, so that prices would be regulated but sales would be cost-reflective. As part of a deal with the IMF, in November 2016 Egypt made significant cuts to subsidies. However, the deal also stipulated floating the currency, which meant that the effect of subsidy cuts was cancelled out, with subsidies actually increasing.

Outlook

With discoveries in 2016 and the expectation of future upstream findings, Egypt is well on its way to addressing the supply side of its energy provision problem. Managing demand increases through subsidy cuts is a longer-term proposition, and Egypt is working to become a net energy exporter again.

 

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The Report: Egypt 2017

Energy chapter from The Report: Egypt 2017