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Current challenges facing gas development in Egypt - International Law Office

International Law Office

Energy & Natural Resources - Egypt

Current challenges facing gas development in Egypt

June 06 2011

Introduction
Shortage of supply
Hindrances to development
Challenges of increasing production
Future prospects


Introduction

Much attention in recent months has been on the political situation in Egypt. At the recent Intergas VI Conference and Exhibition, the focus turned to Egypt's oil and gas sector and in particular the development of Egypt's gas reserves.

In terms of current reserves, Egypt has proven reserves of 78.1 trillion cubic feet (tcf) and probable reserves estimated at 120 tcf. Therefore, the scope for future development remains significant. Since gas production began in 1975, Egypt has produced 29 tcf in total - current production is in the region of 2.3 tcf. Egypt has been highly successful in increasing both reserves and production over the last decade or so (even in the early 1990s proven reserves were only in the region of 12 tcf). Similarly, local utilisation of gas has increased greatly, in particular through the development of a national grid which is now more than 17,000 kilometres in length and includes the recently completed Upper Egypt Gas Pipeline. This runs almost the entire length of the country from Dashur to Aswan and will assist in job creation in Upper Egypt. Local distribution networks have been implemented in many urban centres, in some cases via concession arrangements with the private sector. The use of compressed natural gas has also been promoted, with more than 100,000 vehicles converted to date. Industry is now a significant consumer and gas has been utilised to develop a number of petrochemical plants, many under the auspices of Egyptian PetroChemicals Holding Company, the state sector holding company and sponsor for this sector. However, more than 50% of local consumption is in the power sector, which is arguably not the best use for this valuable resource when alternatives exist. Egypt's policy of energy diversification and focus on renewables should reduce this in the coming years, as well as an increased awareness of the need for energy efficiency.

With respect to exports, Egypt also has a successful track record. Around 35% of production is currently exported, principally through gas pipelines and liquefied natural gas (LNG) terminals, including:

  • the Arab Gas Pipeline, which currently exports gas to Jordan, Syria and Lebanon;
  • the East Mediterranean Gas Pipeline, a controversial project which exports gas to Israel;
  • Egyptian LNG, which consists of two trains with a total capacity of 7.2 million tons a year exporting to France, the United States and other countries; and
  • SEGAS LNG, which consists of a single train with a total capacity of 5.5 million tons a year, primarily exporting to Spain.

The government's stated policy is that export commitments should not exceed one-third of proven reserves; during 2010 there was an official moratorium on new export projects. This is likely to remain the case in the short term as these projects are under much internal scrutiny at the moment. However, they remain a key source of foreign revenue for the country and are one of the reasons that Egypt has attracted so much foreign investment due to the ability to access other markets.

Shortage of supply

Egypt is, in many ways, a success story and a model for other jurisdictions. It was noted at the conference that in terms of the number of concessions awarded over the last decade, Egypt is number one in the region and in terms of foreign investment is second, behind Qatar. However, Egypt is now a net importer of oil and also faces a supply crunch in the gas sector. The rate of gas discoveries has tailed off since the large deepwater finds of the 1990s and production has not matched the pace of utilisation. This was brought to the fore in Summer 2010 when Cairo experienced a number of power cuts, in part due to a lack of gas. This has also caused delays to the launch of the tender process for the proposed Darut IPP Project and a study into gas availability is underway.

Subsidies are another major issue for the sector; these are estimated to reach E£80 billion this financial year and may hit E£100 billion in the year to come. Oil (and its derivative products) is the largest contributor to this subsidy bill and diversification to gas should assist in reducing it, as the level of subsidies in the industrial sector has been reduced greatly in recent years. However, with a rapidly growing population, consumption is set to increase - significant investment in exploration and production will be required to meet forecasted demands.

Hindrances to development

Egypt has a long and successful track record of attracting foreign investment in this sector, but a number of issues currently act as a hindrance to development.

Pricing mechanisms
Most of the concessions currently in production have a cap and floor on the gas price paid by the government to the private sector. These thresholds have not been subject to any indexation and inevitably value has been eroded to the point where it may not be cost effective to make further investment. This is a particular problem with the deepwater concession areas, where drilling costs may run at $500,000 a day. This is an issue that has been addressed by the government in recent years and a number of concessions have been subject to amendments in some cases, with the cap being set as high as $4.10 for 1 million British thermal units. However, it remains the case that there is no provision for indexation and this may therefore become an issue again in the future. The latest model concession agreement provides merely that the price will be agreed by the parties upon commercial discovery which, while permitting flexibility on this issue, also leaves a lot of uncertainty for international oil companies. Similar pricing mechanisms are used in long-term gas sales agreements both for export projects and to industry. The purchasers under such contracts are currently facing the prospect of forced price renegotiations which, while arguably inevitable in light of the rate at which gas prices have increased over the last decade, is impacting on investor confidence, as well as the appetite of banks to lend in the future.

Military permits
Military permits are required at all stages of exploration and production prior to carrying out activities. There is no legislative framework governing these and the system of issuance is inconsistent and unpredictable. In some cases delays have extended for years. Again, this is an issue that the government is aware of and it plans to obtain pre-approval for concession areas in future bidding rounds. However, it remains a major concern for current concessions and causes significant delay and additional cost to the detriment of all parties. The government should seek to implement a written process for these permits, ideally with provision for deemed approval after expiry of a certain period without response.

Bureaucracy
The approval process in the exploration and production sector remains complicated and opaque. In particular, the processes for cost recovery expenditure and payments are subject to extensive delays which are hindering further investment. The government recently stated that it wishes to increase gas production by 8% within the next six months. In order to do so, it is imperative that a transparent streamlined approval process be implemented. It was notable that Egyptian General Petroleum Corporation acknowledged this issue at the conference and stated that it intends to reduce the level of bureaucracy in the near future. This was a positive statement and was welcomed by the delegates.

Challenges of increasing production

So how will Egypt meet the challenge of increasing gas production? As noted earlier, the sector has many strengths which should be built upon further. Among these is the model concession agreement which has been in place for more than 30 years. Despite deficiencies, all parties are generally comfortable with the agreement and it has provided a degree of stability to the sector, particularly in recent years. As such, wholesale changes are unlikely and probably impractical, but it remains the case that it should be subject to further development - in particular with respect to pricing, permits and approvals, but also in relation to matters such as training. The model already includes requirements for minimum expenditure on training, but in light of the rates of unemployment in Egypt, perhaps consideration should be given to utilising these funds in other ways - such as establishing a centre of excellence to provide training relevant to the sector which would act as a legacy project for the country.

With respect to legislation for the sector, the existing framework dates back to the 1950s and is now largely redundant. Egypt is unusual in that the primary piece of legislation governing exploration and production is the concession agreement itself. In these days of change, it would seem an opportune time to undertake a review of these laws and implement a new regime to incorporate modern practices and take account of new technology. This might include the establishment of an independent regulator for the sector. It is notable that the most recent form of the concession agreement includes provision for the private sector to undertake local sales of gas. As part of liberalisation of the sector, they could be given the ability to sell direct to business and industry, which would relieve the government of administrative, financing and subsidy burdens.

Future prospects

So what does the future hold for the gas sector? Proven reserves seem set to increase, but clearly the focus of future utilisation of these reserves should be in the development of the downstream sector. In particular, efforts should be made to implement projects making use of the full value-chain to assist in job creation - such as the GasCities project proposed by Dana Gas, which aims to develop industrial cities around gas resources.

With respect to exports, while there are unlikely to be additional projects in the short term, these projects will continue to remain a key source of foreign revenue and expansion should be considered as reserves increase. The Arab gas pipeline is currently an under-utilised asset which could give access to the lucrative EU markets in the future. Access could also be given to the private sector to sell their share of gas production, which would encourage further investment as well as generating additional revenues for the state through transportation tariffs.

With declining oil reserves, the time may have come to revisit gas to liquids (GTL) projects. GTL has been considered in the past, but was deemed too complicated and expensive. This technology is now tried and tested, and if oil prices remain high it may be another option to meet local fuel demand and reduce the subsidy burden. Additionally, Egypt has large shale reserves which it may now be economic to develop. However, the current model concession is unsuitable for this type of resource and this would need to be reviewed to encourage private sector investment.

The gas sector in Egypt remains one where the development potential is significant. Investor confidence remains strong, but it is important that this be maintained, particularly during this period of uncertainty, and efforts made to encourage additional investment in the future.

For further information on this topic please contact Tim Armsby or Arig Ali at Trowers & Hamlins by telephone (+202 73 57 332), fax (+202 73 57 314) or email (tarmsby@trowers.com or aali@trowers.com).


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