A 12-Billion-Dollar Promise
Originally published in Egypt Oil & Gas on May 2015.
“BP to Invest $12 Billion in Egypt,” this is the headline that has caused a media frenzy to blow like wind passing through every news agency in the region.
BP has claimed the title for the biggest foreign direct investment made in Egypt, and reactions are still flooding in weeks later at extreme ends of the spectrum. After all, besides the headline, little details of the agreement itself were shared publicly.
To better understand the potential impact of this deal on Egypt and its economy, we need to go back to 1992; when BP (then Amaco), acquired the area from the Spanish company, Repsol. Since the acquisition, BP has had a standard Production Sharing Agreement with the EGPC, in which the development of natural gas had no mention.
Negotiations for this agreement have been going on for about 20 years, before Egypt needed natural gas, used it, or had the facilities to export it. Marketing the discovered gas back then was difficult, time-consuming, and expensive. There was simply no interest in natural gas. As local and international markets grew, the Egyptian government recognized the need to develop and produce natural gas. The terms of the agreement have been changed several times over the years; however, negotiations allowing Egypt to acquire all the production of the West Nile Delta Development (WND), began in 2008.
Today the WND involves the development of two of Egypt’s most significant deep-water concessions, the North Alexandria Concession, and the West Mediterranean Concession. $1.82bn of the allotted $12bn had already been spent prior to the investment announcement made during the Egyptian Economic Development Conference (EEDC).
As the operator, BP holds 60% equity in the North Alexandria concession and 80% equity in the West Mediterranean concession; while DEA (formerly named RWE DEA) holds the remaining interest as the partner.
The deal is not only significant for its investment, but also for the estimated production rate of natural gas, which is expected to reach up to 1.2 bcf/d, equivalent to about 25% of Egypt’s current gas production levels. However, production is not expected to begin until 2017, peaking by 2019.
Reserves are estimated at 5tcf of natural gas and 55m barrels of condensates. Further phases of exploration activities are expected to boost reserves from the WND, yet not by a significant amount. Experts estimate that further exploration may result in an additional 0.5 to 1tcf.
Details of the Agreement:
The new agreement format significantly amends the commonly employed Production Sharing Agreement (PSA); while the amended commercial terms are somewhat similar to a service agreement, they are different on one key point. The terms of the WND agreement give BP and its partner DEA 100% of the profits, after costs and taxes, where the EGPC will purchase all production at $4.1/m Btu and pump it directly into the national grid.
When asked about the nature of the agreement, Nasser Wali, Deputy CEO Assistant for Agreements stated, “This is not a production sharing agreement and it is not a service agreement. The name that suits the agreement best is ‘Development, Production & Exploitation Agreement’. All parties have agreed that this is the most accurate name and by extension, the description that fits the different nature of the agreement.”
The new terms provide protection against price fluctuations via a compensation formula. “BP is expected to pay $9bn to produce the stated amount. Through a series of formulas we came to find that a $4.1/m Btu price is profitable for all parties involved; however, if the production of the same amount (5tcf of gas, 55m barrels of condensates) costs more than the agreed-upon price by a minimum of $1bn, the operator (BP) will have the right to ask for a price revision, pending the approval of the Egyptian government. The price would then increase accordingly with a ceiling of 15%. This increase comes to a maximum of about 60 cents. Similarly, if the cost to produce the same amount is less than the estimated $9bn by at least $1bn, then the price will be reviewed—pending the agreement of the operator—with a 15% decrease floor,” said Wali.
The price is revised every five years, which means that the price will be revised four times over the contract duration of 20 years. Every price revision uses the original price of $4.1/m Btu as the foundation for calculating the percentage of increase. Given the likely scenario where the price will increase in each of the four price revisions, the final cost will hit $6.2m Btu by 2030 (15 years from now).
The agreement includes a cutoff point to the commercial terms giving BP and DEA 100% ownership of production. According to the agreement, any additional discovered quantities of gas or condensates will be shared on a 50:50 basis between the EGPC and BP/DEA. The split is conditioned on the cost of development passing the $450m mark; otherwise, the discovered quantity will follow the original terms.
The terms of the agreement give priority of purchase to the EGPC, or local consumption generally speaking. In other words, even though BP and DEA own the marketing rights to the production of WND, according to the agreement, only if the EGPC or other local entity does not wish to buy WND production can BP market it internationally.
Economic Factors Influencing the Deal:
The Egyptian government has been open about its dire need for the amount of natural gas that can be produced from the WND. It is indeed no secret that the Egyptian government has been spending billions trying to close the gap between its energy consumption and production levels. This is a problem not only brought on by the exponential increase in local consumption but by the lowering of production rates as a response to the arrears owed by the government to foreign oil companies. These two factors constitute the reality that Egypt has been left in a weaker negotiation position than previous attempts in reaching this deal.
When asked about it, Tarek El-Molla, Chairman of the EGPC, repeatedly emphasized that the EGPC is attempting to show very concrete commitment to its partners by working on this issue. “We were able to successfully reduce the debts owed to foreign partners from $6.3 billion to $3.1, and we are working to reduce this further.”
The Egyptian government does not only owe money to foreign firms, but it also owes to itself. El-Molla was very frank about the problems facing the petroleum ministry and EGPC. “We are owed about EGP 70bn by the ministry of electricity, and nearly EGP 6bn by Egypt Air. All told, we are owed about EGP 140bn.”
A significant factor that further heightened Egypt’s need to reach a deal with BP is the remarkably high cost of importing natural gas and fuel oil to generate enough electricity to meet local demand. Accurate estimates of the total amount the Egyptian government has paid over the past years trying to bridge the gap between consumption and production is unknown; however, glimpses of the considerably escalated cost can be seen in the recently announced $3.55bn price tag of LNG imports for the current fiscal year of 2015-2016.
Egypt, however, has long been willing to offer generous terms to attract investors to explore in areas that are expensive to develop. With the usual production sharing agreement, an exploration and production (E&P) company would not recover any of its costs if potential reserves are not found; this translates into a catastrophic loss if it occurs in a deep-water concession.
“We are trying not to be rigid. We want this to be a win-win situation because at the end of the day, if you compare prices it will always be cheaper to produce locally than to import, especially for LNG,” El- Molla clarified.
BP, on the other hand faced some challenges shortly before closing the deal. BP worldwide reported a loss of $969m in the fourth quarter of 2014. The company reacted by cutting its capital and exploratory budget by nearly 20%, down to about $20b.
Despite originally announcing the agreement in mid-2010, due to several reasons the finalization of the deal was postponed to 2015. Speculations around the real reason for the delay vary, some deemed it to be an ongoing negotiation on the price of gas, others explain it as a calming response to the media criticism of the agreement during a time where any negative attraction was blown out of proportion, and the rest describe it as a normal reaction to the volatile situation in the country during the past years.
Answering this question, Wali said, “The main reason for postponing the agreement was a dispute over the land the onshore facilities were going to be built on. Right after the 2011 uprising, the people living near the planned site refused the project due to environmental concerns. Many high-level officials tried to convince the civilians of the importance of the plant but failed. The Egyptian government then resolved the situation by granting BP another land to build the plant on. While the new location was suitable, the geological nature of the soil required a significant cost to be able to build on. This is where the need to use BG’s facilities emerged.”
Role of BG:
“Any petroleum agreement between the Egyptian government and an operator has a clause permitting the Egyptian government to use the facilities, providing they do not affect the efficiency of the ongoing project. Through this clause negotiations between BP and BG took place, giving the WND access to Burullus & Rosetta facilities to transport production onshore,” explains Wali.
The Taurus and Libra fields will be connected to the existing Burullus Gas plant, which currently has enough of a gap in its capacity to host initial production. The Giza and Fayoum fields will be tied back to the Rosetta plant, which will be modified to accommodate additional production rates. The Raven field will be connected to a new onshore plant adjacent to the existing Rosetta plant.
Public Opinion of the Deal:
Commenting on the project, Hesham Mekawi, BP North Africa Regional President said, “This is a critical milestone in the Egyptian oil and gas history. It marks the start of a major national project to add significant production to the domestic market. BP expects to double its current gas supply to the Egyptian domestic market during this decade when the WND project reaches its peak production.”
Through press statements, BP has portrayed a very optimistic vision of the effect of the WND project on the Egyptian economy. It promises to employ thousands of employees during the construction phase of the project, transfer technological know-how, and significantly contribute to the growth of petroleum-related industries. While that may be true, some analysts see it differently.
Energy analyst Mika Minio-Paluello said: “If I was Egyptian, I would be absolutely freaked out about what it means to move away from product-sharing agreements. There is a difference in what is best for the Egyptian state and what is best for BP. The more control you give to BP in making decisions, the less the public’s interests get represented.”
“If Egypt had an alternative way of doing it, they could have done it,” said David Butter, a Middle East analyst and associate fellow at Chatham House. “The basic fact is it is going to cost whatever it is going to cost to produce the gas.”
When asked about the public’s opinion of and the media response to the WND deal, Wali admitted that the EGPC has been widely criticized for not picking an Egyptian company to strike the deal with. “Regardless of the ownership of the concessions, tapping into the gas reservoir of the WND requires drilling to very deep levels, using advanced tools that can sustain intensely elevated temperatures. This process is very costly and only exploration giants have the technology to perform it. If the Egyptian government did not make the development a profitable venture for BP, or any other contractor, they would be better off leaving their money in banks.”
Other public concerns raised revolve around the Egyptian government buying natural gas that belongs to Egypt in the first place. Wali contested this point by saying, “That is simply not true. Our usual agreement involves paying for the cost recovery of the operator, which extends throughout the entire period of production. The new agreement states that the operator will handle all costs and Egypt will pay to acquire the gas, paying just enough to make the project profitable.”
The possibility of mimicking the same type of agreement with other foreign operators in Egypt seems to be high, and when asked about it Wali confirmed this, stating that “If the agreement model is successful, why not repeat it with other companies? Provided they are developing a deep-water, expensive-to-produce-from concession, where the EGPC will acquire the entire production.”
Watching the government deal with the energy gap is like watching someone solve a Rubik’s cube. As it struggles to balance one side, other sides of the cube get scrambled. EGAS announced recently its decision to seize gas supplies meant for factories as it attempts to generate enough electricity for the public grid, a move that cost factory owners a significant loss and is expected to increase prices for final goods. Adding to the mix the significant LNG and fuel oil imports, as well as the soaring price of electricity, and we end up with the perfect puzzle.