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Egypt: Operating challenges to persist despite optimism over Zohr gas discovery

2015-10-16 Protection Group International Ltd Egypt: Operating challenges to persist despite optimism over Zohr gas discovery

Successful development of Italian oil giant Eni’s Zohr discovery could help to ease chronic energy shortages in Egypt from 2017. The discovery, made in August, comes amid a number of other investments announced by international oil companies (IOCs) in recent months and signals increasing optimism over the prospects for the sector after the political and regulatory turbulence that followed the 2011 revolution. Despite evidence of an improving climate for investors, gas pricing and the absence of major economic reforms will likely remain key concerns for IOCs, especially in a climate of weak global oil prices. Furthermore, an increase in attacks on foreign interests and infrastructure over 2015, including Islamic State (IS) affiliate Sinai Province’s execution of a foreign oil worker in August, highlight security challenges that could deter investment in Egypt.

With estimated reserves of 840 bn cubic meters (bcm), the Zohr discovery could significantly alter the outlook for Egypt’s oil and gas sector from as early as 2017, if proposals by Eni to fast track production from the field proceed. The field is the largest ever found in the Mediterranean and potentially the 20th largest in the world. The discovery will strengthen a wider recovery in interest and investment that Egypt’s oil and gas sector has benefitted from over 2015. Political and economic upheaval after the 2011 revolution had a significant negative impact on the oil and gas sector. Both investment and production declined, and rapid growth in consumption led the government to divert gas intended for export to the domestic market, forcing foreign companies such as BG Group to declare force majeure.

However perceptions of improved political stability under Egyptian President Abdel Fatah al-Sisi, who won the country’s June 2014 election, have coincided with reforms long-sought by IOCs, including plans to phase out costly energy subsides altogether by 2019. Improved contract terms and the government’s ongoing efforts to pay down USD 3.5 bn in debts to IOCs that stem from 2011 have led to a gradual recovery in interest from investors. BP’s sanctioning of the USD 12 bn West Nile Delta development, a project that will boost domestic production by 25 percent, was among a total USD 17 bn in investments pledged by IOCs at a development conference in the Egyptian resort city of Sharm el Sheikh in March.

Security

Despite positive momentum in the oil and gas sector, more frequent attacks outside of the Sinai have demonstrated an increased threat to personnel and infrastructure from Islamist militant groups in Egypt. The escalation of attacks on foreign interests, businesses, and critical infrastructure over 2015 underscores a widening of the militant threat beyond frequently targeted security personnel that could damage investor confidence, something PGI previously assessed in July following the Sharm el Sheikh investor conference.

The Islamic State’s Egyptian affiliate, Sinai Province, claimed responsibility for the execution of a kidnapped Croatian employee of French geophysical services company CGG in July. Gunmen reportedly stopped the oil worker’s car on a desert road around 50 km from Cairo and, after releasing his driver, fled with the victim to an unknown location. While it was unclear if the victim was abducted initially by militants or by criminals and then sold, the operation highlighted the vulnerability of travel in country. Foreign nationals in Egypt have typically not been targeted in militant attacks and further targeting - Sinai Province also claimed responsibility for the August 2014 killing of a US oil worker in unclear circumstances near the country's border with Libya and unsuccessfully tried to attack the Karnak temple in Luxor in June this year- would mark a significant shift in tactics by militants, commensurate to the tactics of IS and its affiliates elsewhere in the region. Tens of attacks on gas pipelines in the Sinai since 2011, some of which have been claimed by Sinai Province, also demonstrate a threat to energy infrastructure in Egypt. Attacks on oil workers, fields and energy infrastructure by IS affiliates in Libya, Iraq and Syria illustrate the precedent for IS and its affiliates to target the energy sector.

 

 

Regulatory challenges

IOCs in Egypt will also continue to face other above ground risks as a result of the wider political and regulatory environment. In October, before the Zohr discovery was announced, Egyptian officials announced that only four out of the 12 offshore blocks available as part of the 2015 licensing round were awarded. Despite the fact that additional blocks were added to the licensing round and the deadline for bids was extended by two months, only a handful of IOCs participated in the round. Although the weaker than expected interest may reflect the impact of the poor outlook for oil and gas prices globally, it also suggests continued caution among investors in Egypt despite recent reforms.

Stronger interest is anticipated in a new offshore round planned for early 2016 but the government has announced repeated extensions of the deadline for full repayment of debts IOCs which could again weaken investor appetite. The most recent delay came in August when officials delayed the deadline for full repayment by a year to end-2016. A moratorium on gas exports, expected to remain until at least 2020, could limit the potential returns from projects given the government continues to artificially set prices for gas purchased from IOCs. The government has, on a contract by contract basis, negotiated higher gas prices and while rates have risen from previously uneconomic levels of typically not higher than USD 2.65 per million British thermal units, there are no plans to fully liberalise prices and link them to global markets.

Egypt has already been forced to begin imports of gas from global markets to ease immediate supply shortfalls, and the decision to purchase gas from Zohr and BP’s West Nile Delta at higher rates will weigh on already high trade and budget deficits. An uncertain financial outlook, as well as the potential for a reduction in financing form Egypt’s oil exporting Gulf allies, could undermine Cairo’s ability to meet financial commitments to IOCs.

Notwithstanding the positive impact of reforms targeting the oil and gas sector, Egypt has largely failed to address the underlying structural challenges that have seen the country ranked poorly at 119 out of 144 economies on the World Economic Forum’s 2015 Global Competitiveness Index. A complex and pervasive bureaucracy has resulted in oversized public sector, with parastatal organisations dominant in key sectors, including oil and gas, refining and electricity. The reversal of the democratisation process observed under Sisi has also ensured entrenched interests of the military, which controls a significant but unknown share of the economy through a vast industrial complex, have been consolidated, weakening genuine economic competitiveness within several sectors. In the absence of more systemic reforms, high-levels of corruption will persist and the economy will continue to underperform, threatening Egypt’s long-term prospects for stability.

 

 

 

Protection Group International Ltd

Egypt: Operating challenges to persist despite optimism over Zohr gas discovery - Protection Group International Ltd
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