FT REPORT – EGYPT 2007: Cairo toes pragmatic line with the IOCs

By James Drummond, Financial Times
Published: Dec 10, 2007

Butagaz! Butagaz!” the man on the donkey-drawn cart calls. As he does so he bangs the side of the canister with the main tool of his trade – his spanner. It is a familiar sound in Cairo still, despite widespread piping of gas to wealthier neighbourhoods of the Egyptian capital and lower Egypt. It may not be for much longer.

Egypt has long been known more for the potential of its gas than its oil. It is home to two big liquefied natural gas plants, one controlled by BG and partners at Idku, and the other by SEGAS, a consortium headed by Union Fenosa, the Spanish utility, and ENI of Italy, at Damietta. Both are on the Mediterranean coast.

Egypt is the second largest gas producer in Africa after Algeria and among the top 20 producers worldwide, according to the BP statistical review of world energy

Oil reserves are less abundant at 3.7bn barrels, according to BP. In June the ministry of petroleum said crude reserves were 3.97bn barrels. Production was 678,000 b/d in 2006, according to the same source.

“In Egypt you have a complete diversity – from the super majors like BP through the ENIs and then the Apaches down to Aim-listed companies. That reflects the fact that you have a whole host of plays from the Western Desert to offshore Mediterranean,” says Craig McMahon of Wood Mackenzie, the Edinburgh-based consultants.

In July it was revealed that BP had negotiated an agreement with the oil ministry, raising the base price paid by the Egyptian side for gas from BP’s North Alexandria block from $2.65 per million btu (British thermal units) to $4.70.

The BP agreement was portrayed as a concession by the Egyptian side, and in some ways it was. Historically, the Egyptian government, which has substantial commitments to the public in the form of heavilysubsidised gas, petrol and electricity, had paid far less.

But Zainul Rahim, chairman of Shell in Egypt, says that it is the international oil companies (IOCs) that have historically bent over backwards to accommodate the government – acknowledging the commitment to heavy subsidies.

He says the gas contracts have, for the most part, been linked to oil prices from Gulf of Suez concessions – which should mean that the floor price is much higher.

“It sounds like the government has been generous with BP and the IOCs. It is really the other way round,” says Mr Zainul Rahim.

“You’ll find that the minister of petroleum will report how he has saved x billion dollars or Egyptian pounds. What he means is that he has managed to persuade us to agree to a lower price than that stipulated in the contract,” he says.

What made the BP deal so significant was that it means positions very expensive to develop – such as Shell’s ultra deep-water Nemed bloc in the Mediterranean, an area the size of Belgium, and BP’s Raven – now become economic.

Mr McMahon says the oil companies are now moving beyond the shallower, easier areas into deeper and more difficult terrain that might be miocene.

“The problem is miocene formations tend to be high-temperature and highpressure and they take six months to drill,” he explains.

“That gets you back to cost. They cost a fortune. It’s very expensive and the IOCs were left to bare brunt of rising costs. The Egyptians have taken a very pragmatic response to caps and costs,” Mr McMahon says.

Cairo needs to be pragmatic. Egypt’s demand for energy is growing exponentially as rapid industrialisation and population growth suck in oil and gas. Demand is skewed by heavy subsidies on a range of products from petrol through to domestic gas.

The pattern of energy shortfall in what are perceived as hydrocarbon-rich countries is not confined to Egypt. Other, richer, states in the Gulf are having to cope with gas shortages caused in large part by subsidies and profligate use of resources.

Industry officials say an official policy of conserving some hydrocarbon reserves is being severely stretched. According to the constitution, one-third of any find is supposed to be exported, one-third for local consumption and one-third used for future generations – either left in the ground or the funds reinvested.

But now industry observers worry about a gas shortage. Rachid Mohamed Rachid, minister of trade and industry, says he and his colleagues are not projecting a gas shortage and the government has moved to curb energy demand by raising prices for industrial purchasers or off-takers. But he concedes demand is growing very fast.

“We are not expecting gas shortages in the short term. We have laid out the energy policy and the pricing strategy for the next 15 years. The reality is that we are growing much faster than we expected. The increase in energy consumption is growing at double-digits,” Mr Rachid says.

Last month Cairo announced, with US approval, that Russia had agreed to provide technology and advice on building nuclear power stations. The programme was frozen after the Chernobyl disaster.

It is not just subsidies that are a sensitive issue.

Industry experts question the wisdom of selling gas to neighbouring countries – first Jordan and then Syria – at what are now very low prices.

Israel is also in the frame to receive Egyptian gas – a sensitive topic given fraught relations with the Jewish state.

This is compounded by the fact that, back home in Egypt, it is only now that a pipeline is being built to the south. The Upper Egypt gas pipeline is projected to reach Aswan only in 2009.

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