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Jan 7, 2013 | 11:15 GMT

Egypt: Few Options Out of a Natural Gas Dilemma

Egypt: Few Options Out of a Natural Gas Dilemma
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Summary

A rising demand for natural gas in Egypt is threatening the country's already delicate political and economic situation. Currently a net exporter of natural gas, Egypt may soon have to begin importing the commodity to offset its stagnating domestic production. It is not a matter of depleting resources; Egypt's natural gas reserves are not about to disappear imminently. But the country may not be able to produce what resources it has to adequately meet domestic demand and honor its export contracts. Whatever the government decides, meeting the public's growing energy demands will be essential, albeit difficult, given Egypt's economic woes, for ensuring economic and social stability. 

A recently passed constitutional referendum may help settle Egypt's political dilemma, but the country's economic problems remain. In 2012, Egypt had a trade deficit of an estimated $30 billion. Meanwhile, inflows of capital have fallen. Egypt's budget deficit alone is $31.5 billion, and a deal for an International Monetary Fund loan has been postponed.

Certainly, Egypt's becoming a net petroleum importer in 2008 contributed to the budget deficit. And now that the gap is narrowing between natural gas production and demand — domestically and from export contracts — Cairo is considering options for acquiring more natural gas. An obvious option available to the government is importing the commodity (though Egypt probably will not become a net importer of natural gas in the immediate future). The problem is that the additional cost of importing natural gas could hurt Egypt economically, but passing additional costs to the population as the government eases subsidies could lead to social instability.

Explaining the Imbalance

Egypt's natural gas sector is relatively young; production began in 1975, but Egypt did not export natural gas until 2003. In 2010, Egypt had an estimated 1.7 trillion cubic meters of proven reserves, but those estimates have changed after further exploration. As of 2012, there were roughly 2.2 trillion cubic meters of proven reserves. But in 2009, production actually decreased slightly before plateauing. To some extent, this was not unexpected. Production invariably declines at any natural gas production site, and the largest decline occurs within the first few years of a well's existence. To offset this decline, a new well must be drilled or old wells must be revitalized with new technology or techniques.

Natural gas production peaked in the late-2000s. Natural gas was on the rise, and Egypt started to encourage natural gas as an alternative to oil. From 2009 to 2011 alone, domestic consumption of natural gas grew from 44 billion cubic meters per year to 51 billion cubic meters per year. Natural gas was especially encouraged in the electricity sector, which consumes more than 50 percent of all natural gas production. Electricity production in Egypt has nearly doubled since 2001, and since 2007, the electrical grid has been undergoing upgrades for increased capacity, much of which is geared toward using natural gas as a fuel supply. There has been a steady increase in grid capacity since 1990, and there is an ongoing plan to add roughly 22,000 megawatts to electrical capacity by 2014. 

Subsidized natural gas and electricity have allowed for low prices and have encouraged consumption. But Egypt's population is also growing, and taken together, these factors have resulted in an ever-increasing demand for natural gas. The problem is that supply is not keeping pace with demand. As recently as Dec. 27, 2012, several power plants halted or reduced electricity generation because of a lack of fuel. Moreover, power outages due to a lack of fuel have been recorded in recent summers, and more outages are expected this summer. Cairo understands the discrepancy between consumption and production and that public stability at least partly hangs in the balance of its remedy.

Export and Foreign Investment

More than 80 percent of Egypt's total reserves are found in the Nile Delta and the Mediterranean Sea, so it should come as no surprise that the vast majority — about 70 percent — of all natural gas produced comes from these areas. Much of this production is done offshore. Efforts to expand or maintain current production levels will require Egypt to move to deeper waters, which are more difficult and more expensive to exploit. Exploiting these deeper waters would require additional foreign investment and technology.

Egypt: Few Options Out of a Natural Gas Dilemma

Egypt Natural Gas

Generally, Egypt is seen as receptive to foreign investment despite the fact that energy extraction projects still entail heavy state participation. Several international energy companies, including BP and BG Group, operate in the country. Upstream natural gas operations are required by law to sign onto mandatory joint ventures with Egyptian Natural Gas Holding Company, and an operating company must be established between the contractor and the state for exploration and production. But the policy allows room for negotiating in the terms of the production-sharing agreement. These conditions are considered relatively favorable conditions for foreign investment. 

Egyptian policy prioritizes the domestic market over the export market. Since exports are international firms' best opportunity to profit — natural gas often is sold at lower rates to the domestic market than to the international market — they often try to secure this additional volume for export.

As production has slowed, exports have also fallen. They fell from more than 18 billion cubic meters in 2009 to 10.5 billion cubic meters in 2011. If exports continue to decline, the Egyptian government may be forced to pay more for natural gas to maintain future foreign investment. In fact, when deep-water exploration waned from 2006 to 2010, Egypt paid more for natural gas produced in these areas. Were this to happen again, it would only add to the current subsidy burden.

Recent reports indicate that even Egypt's biggest liquid natural gas destination, Spain, has stopped receiving Egyptian natural gas. Moreover, regional political and security issues in the Sinai have limited Egypt's piped natural gas exports in recent years. The export contract to Israel was terminated in 2012, and while exports to Jordan have recently resumed, pipeline attacks over the past year have severely disrupted exports.

To some degree, continued foreign investment is contingent on Egypt's ability to export, recover costs and profit. But exploration for new wells may be slowing. There are fewer offshore rigs in Egyptian waters now than there were a few years go. Now there is a new round of bidding for natural gas exploration — the first since former President Hosni Mubarak's ouster — slated to conclude in early 2013, pushing back the deadline due to a reported lack of interest. It is unclear whether new and ongoing investment will be sufficient to compensate for production that has tapered off. While future projections indicate that Egyptian natural gas has the potential to increase, any new finds from current operations or new exploration projects will take years to develop.

An Expensive Alternative

Cairo already has long-term export contracts in place, but the government banned new long-term export contracts in 2008 to contend with increasing domestic consumption and to allay fears that natural gas was being overextended. Such policies may in part deter future development in the natural gas sector — current foreign involvement notwithstanding.

Given the dip in production and the surge in demand, the new Egyptian government has been considering importing natural gas to ease the strain on demand. On Nov. 22, 2012, Egyptian private equity firm Citadel Capital signed a joint venture led by Qatari investment bank QInvest. The project would entail building, owning and operating a floating liquid natural gas import terminal. Because the terminal would supply high-volume users, it would help address Egypt's chronic power shortages. Much of that natural gas reportedly will come from Algeria and Qatar. The terminal is slated to be completed by May 2013, but since construction has yet to begin and will take perhaps a year to complete, that date is probably unrealistic.

Importing liquefied natural gas will likely be more expensive than using domestically produced natural gas. Egypt may have to borrow money or trade political influence for a reduced price. Regardless of how the new imported natural gas is obtained, Egypt will still have to cope with an imbalanced supply and demand for at least 6 to 12 months before proposed changes can be implemented, if exports are to be maintained. Righting that imbalance will help stave off domestic instability. With investor confidence possibly waning alongside the unattractive option of borrowing money to fund a worsening trade deficit, attractive solutions appear scarce.

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