E&P Incentives Boosted As Threat Of Increased Imports Looms


BMI View: Due to the recent political instability in Egypt, the country's oil and gas sector has lost out on investment leading to a significant fall in gas output, which has now been met by strong demand growth. However, new incentives introduced by the Egyptian government are working to boost confidence in the oil and gas sector, supporting a return to growth in gas production over the coming years. These moves will be critical to reducing the costly impact of growing liquids imports and potentially return Egypt to a natural gas exporter over the longer term.

Egypt's oil and gas sector has suffered significantly due to the political disruption experienced in the country over the last few years. While oil and gas projects have not been particularly impacted, major investment in new developments has been held back. This is largely due to the political climate not providing a sufficiently stable environment to mitigate the risk to the billion-dollar investments needed to promote new oil and gas production. Underinvestment in the Egyptian oil and gas sector is increasingly impacting supply, with gas output seeing particularly strong falls in 2012 and 2013. Egypt has therefore been unable to provide sufficient gas to meet both strongly growing domestic demand and export quotas, resulting in gas destined for BG's Idku liquefied natural gas (LNG) export terminal being redirected to the domestic market. Due to this development BG has put a hold on further investment into the country until its debts are repaid and greater assurances over its operations can be made. Egypt reportedly owes oil and gas companies almost US$5bn.

Exports Snuffed Out
Egypt Natural Gas Production, Consumption & Net Exports (bcm)

Signs Of Change

However, while the large scale gas projects have been overlooked and are likely to stay that way until there is significant indication that political stability can be sustained, the lack of physical disruption to the oil and gas sector has seen the continuation of a large amount of exploration and production work. Over the last few years a chain of significant discoveries have been made; Apache being particularly successful in the Western Desert. A number of other smaller independents such as PetroCeltic, Dana Gas and RWE Dea have stepped up their operations in the country. As such we expect a small increase in gas production is likely in 2014, following a considerable fall last year.

That said, we see production and consumption of gas remaining tight over the coming years, as it will take some time for the exploration projects to translate into production. If demand continues to rise at the same rate, this could mean Egypt will have to increase imports of liquids products to replace lost gas supplies. Increase imports of refined products will add to the growing cost of the country's fuel import bill. The immediate situation has therefore pushed the current government into much needed action to promote new oil and gas developments.

Government Efforts To Promote E&P

In order to mitigate the growing cost of imports and subsidies, new incentives are being introduced by Cairo in an effort to keep oil and gas companies from exiting the country. The changes will be crucial given falling gas output and strong domestic gas demand driven by high subsidies. With the situation in Egypt still delicate following three years of political instability, the government is unlikely to change the current format of the subsidy system for the time being. While we believe this will continue to push gas consumption upward, we note Egypt's considerable below-ground potential should be sufficient enough to more than cover domestic demand provided there is an increase in investment.

The first step the government is taking to return interest to the country is to reimburse some of the significant levels of debt it has with oil and gas companies. In February, Oil Minister Sherif Ismail said around US$3.5bn will be paid back to companies by 2016. This will be an important step to regaining the confidence of larger companies, though in BG's case it could take a while with the firm reportedly owed US$1.2bn and taking a hit from lost LNG revenues.

Further improving the investment environment, the government has opened up the opportunity to discuss gas pricing structures in new developments. Currently, producers receive a maximum of around US$2.77 per million British thermal units (/mnBTU), or US$77 per 1,000 cubic metres. In many cases, particularly offshore, this barely covers the cost of development and offers little incentive to companies to take on the risk developing a project. The new approach allows producers greater leeway with regard to cost of development, taking into account aspects such as reservoir depth and distance from shore. This has already helped attract new companies to Egypt, albeit smaller independents, and should help incentivise further investment for large companies operating in the country's offshore.

A critical change in contracts allows gas produced from new concessions to be sold in deals made directly with commercial producers. This enables companies to avoid selling gas directly to the government, which would likely demand lower prices than private power plants or industrial facilities able to offer better returns.

Finally, it appears the Egyptian government is improving the bureaucratic process which has at times restrained progress. According to Sea Dragon Energy CEO Paul Welch, as cited by Reuters, the Egyptian Ministry of Petroleum has streamlined its approval process, leading to more rapid sanctioning of projects and major contracts.

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Related sectors of this article: Oil & Gas, Upstream, Exploration, LNG, Deepwater, Energy Policy
Geography: Egypt

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