Natural Gas Self-Sufficiency, the Welfare of Factories, and the Dilemma in Between

Originally published in Business Monthly‘s March 2018 issue.

Egypt to stop natural gas imports by June.” The long-awaited announcement came from Tarek el Molla, minister of petroleum and mineral resources. Amid a celebration of the recovery of the once net exporter of natural gas, the issuance of executive regulations that allow private companies to begin importing and distributing natural gas made its way to the media — a move that had been in the works since 2015. At first glance, the two developments support an upward trajectory for the industry, yet unless market dynamics change the latter remains at risk.

Egypt’s energy mix has always been largely skewed toward natural gas, a factor that ignited an energy crisis that lasted from 2012 to 2016. The past few years, the state has invested billions to close the demand-supply gap, reaching an all-time high LNG import bill of $3.55 billion in fiscal year 2016, according to official figures. The crisis initially grew in response to the government’s decision to prioritize electricity demands over feedstock to factories, a fact that has been widely criticized due to the significant losses reported by steel factories at the time. One notable example was Ezz el Dekhila’s reported losses of EGP 116 million in the first quarter of 2015.

At the peak of the crisis, the government decided to liberalize the natural gas market. The state-owned Egyptian Natural Gas Holding Company (EGAS) announced in May 2015 the decision to allow private companies to use the national grid to import, transfer, and distribute natural gas, with energy-intensive factories as the core consumers. At this point, all natural gas imported into Egypt is the sole responsibility of EGAS, costing an average of $250 million per month, according to a statement by el Molla in January. The decision to open the market was made to ease the burden of mounting local demand from the government’s shoulders.

The process of turning the plan into reality, however, took years. After lengthy deliberations, Parliament passed a law establishing the Gas Regulatory Authority (GRA) in early July, shortly after President Abdel Fattah el Sisi issued a decree rendering the regulation act official. However, the executive regulations were not issued until mid-February, with el Molla announcing on the sidelines of the Egypt Petroleum Show (EGYPS 2018) conference that private companies were expected to begin operating soon.

Looking at the math of it, the once-lucrative concept of liberalizing the market is barely needed if the country is to reach self-sufficiency in just a few months. Simply put, the GRA was created to solve a crisis that no longer exists, which begs the question of whether the market will automatically absorb new entrants or will EGAS withdraw its supplies to make room for private company participation.

Answering this from the perspective of the government, Mohamed Khafagy, general manager for natural gas and economic affairs at EGAS, notes that “while the existing natural gas supply and demand gap is expected to end by the beginning of the second half of 2018, especially with the presence of the mega Zohr field, we have an obligation to open the market for the private sector, thus allowing the market to shift away from being a monopoly for EGAS.” Khafagy, who headed the team responsible for developing the calculations of the transportation tariffs and operational mechanisms, said the state is not only allowing the private importation and distribution of natural gas, it also will allow contractors (companies working on natural gas exploration and production activities) to sell part of their production directly to factories, instead of to the state for distribution.

“The important point here is that while yes we will become self-sufficient very soon, Zohr alone can’t keep the gap closed,” Khafagy continued “it can probably only do so for a couple of years, and sustain us well for about eight years. We need a backup for it, we need to discover another field that would secure us for a longer period of time, especially given that our consumption is growing at about 10 percent per year, and that is why we are about to offer more bid rounds aimed at natural gas.”

Zohr’s maximum production is about 2.7 billion cubic feet per day (bcf/d), which should be reached by the end of 2019, according to Eni, the Italian energy company that operates the field. Furthermore, many mature fields are expected to witness a decline in production during that timeframe. Other fields, such as Libra and Taurus in the West Nile Delta development, are expected to help extend the life of Zohr by lifting a small percentage of the pressure off of it. By the end of this year, Egypt’s total natural gas production is expected to be 6 to 6.2 bcf/d, while consumption currently stands at 5.2 bcf/d, of which around 1 bcf/d is imported, based on statements by el Molla to Reuters in July.

“The importance of opening up the market now is to ensure that we avoid the gap that may occur in the coming years. Whether by allowing contractors to distribute their share of production in the local market, allowing private companies to import and distribute to factories, or striking another field like Zohr, which could happen when we encourage more investors to have confidence in the resource potential of Egypt,” he explained.

Sharing a similar opinion, Khaled Abou Bakr, executive chairman of TAQA Arabia, noted that “the whole idea is to remove the burden off the shoulder of the government. The government can be responsible for supplying national projects and its [contractual] commitments to industries, while any factory seeking expansion or any new greenfield project should secure their own needs of natural gas.”

While expected to develop at a fast pace, the process for private companies entering the new market has been slow. According to figures announced by the former vice chairman of the GRA, seven companies have shown interest in applying for permits, of which only three have acquired an initial permit: TAQA Arabia, Fleet Energy, and BB Energy. According to Khafagy, these companies still need final approval from EGAS before continuing the process of obtaining a license from the GRA.

The remaining four companies, including Toyota, have been in talks for some time without taking any official steps to enter the market. In response to questions about the reasons behind what seems like hesitation, Tokuji Koyama, general manager for Egypt at Toyota Tsusho Corporation said: “We are interested in the situation and observing it, but that is all we can note on the matter.”

On the other hand, representing one of the first companies to obtain initial permits, Abou Bakr shared his optimistic view of the coming phase: “This is a very healthy process that will allow us to give our customer all the available gas they need. Globally, there are a lot of suppliers and there is plenty of LNG in the international market. The natural gas industry itself is so dynamic, that it allows us, as Taqa, to take advantage of this flexibility in favor of our local customer.”

He went on to deny any negative impact from reaching self-sufficiency on the potential of the new market. “The minister explained that self-sufficiency is to cover the actual obligation of the government. It is for the actual status, but looking at the ambitions of our government and with our expected economic growth another stream of supply is needed,” he explained. To illustrate his point, Abou Bakr provided an example highlighting the immediate need for the service his company is about to offer, “The contracts of some factories, for example, state 100,000 cubic meters of feedstock, yet the factories end up consuming 130,000 cubic meters. Previously when natural gas was available this need was met but now the government is going to be very strict, leaving the factories to purchase the additional 30,000 they need from the market.”

A key issue here is the welfare of an industrial sector that previously lost millions as natural gas supplies fluctuated. While, self-sufficiency should ensure that factories receive the stated amounts in their contracts with the government, which Khafagy confirmed should happen in coming months, they are the main customer of private sector suppliers.

Addressing the issue from the perspective of the industrial sector, a steel factory owner who requested anonymity noted that “the market is concerned with the final selling price for privately imported natural gas, suggesting it may not be competitive with the current $7/mBtu [million British thermal units] charged by the government to steel factories.” He expressed concern over whether the government plans to decrease its supplies, essentially forcing factories to buy from the private sector.

Sharing a similar notion, Mostafa el Gabaly, managing director at Abu Zaabal Fertilizer & Chemical Company, wonders if the government will limit its supply only to state-owned factories, leaving the private sector no other option but to deal with private importers regardless of price, thus skewing the competitive advantage towards state-owned companies that offer similar product lines.
Both industrial executives also had fears regarding whether the decision will be left to them to choose between continuing with EGAS or shifting to private suppliers.

Commenting on the concern, Khafagy believes private sector pricing will be competitive with the government. “It is a matter of packages. Which companies can supply a steady amount for extended durations? Which supplier can offer timely and consistent delivery? Who offers better contract terms? And so on,” he explained.

“Furthermore, based on infrastructure and cost of transfer, not all companies will offer the same prices throughout the country or even extend services to all cities. For example, some companies will have the ability to distribute in Upper Egypt, while others will focus on the Northern region of the country. Similar to fuel stations, they are all profitable and they all offer the same service at the same price, so it is a matter of service-packages and location,” says Khafagy. He further notes that the United Kingdom took 11 years to develop a competitive market in terms of natural gas distribution and today the country has 37 distributors, “all coexisting in a competitive market.”

Contractors also have concerns about price. “They are afraid that with the taxes imposed, they will not be able to compete with private companies that import natural gas. Which is not true at all. Contractors produce at a cost of $6/mBtu, and after taxes they should reach about $6.5-$7/mBtu. This makes locally produced natural gas competitive with import supplies. Depending on the source, imported natural gas should average the same selling price.”

Another element in the equation is the potential increase in demand from new factories, a point that Khafagy dismissed. “In the short-term, there is no expected increase in terms of demand from factories, as the government paused all supply approvals for some time now,” he says. “They are, however, expected to begin granting approvals to supply factories with feedstock very soon, probably right after the supply-demand gap is closed.”

It is, however, important to note that in terms of energy-intensive factories, currently only steel and fertilizer factories receive natural gas from EGAS; with the exception of one factory, the government has stopped supplying all cement companies, who now rely on biofuels.

General consumption, however, is a different matter. The electricity sector, for example, is expected to see a surge in feedstock demand, as the three new electricity plants built by Siemens begin to reach their capacity, says Khafagy. As for population growth and economic reform, CI Capital forecasts that energy consumption will increase 6.9 percent annually; furthermore, both residential and industrial natural gas demand is forecast to grow at an annual rate of 4.8 percent to reach 3.2 bcf/d by 2021.

Other than prices and freedom of choice, el Gabaly raised some questions regarding the nature of contracts with private companies: “Will they offer stable long term contracts and clear conditions? How competitive will their contracts be? How will the matter be regulated? I don’t know, and this is my concern.”

Both steel and fertilizer factory managers have more questions than answers, highlighting a lack of information flow from the government to the end user. As the anonymous steel factory owner puts it: “We need transparency in terms of prices charged, overall strategy followed, and the future stability of the resources offered. I am not buying an apartment in New Cairo, I am building factories and creating a long-term business.”

“In general, the market today offers unbelievable opportunities. Egypt can become an industrial country, but we mainly need competitiveness in terms of resources, and efficiency in terms of process and general market mechanism,” he added. “Factories, for example, should be divided not only by industry, but by exporters and suppliers of the local market […] Factories that export 90 percent of their production and ones that only supply the local market are affected differently by each decision made.”

Noting a similar point, el Gabaly believes that the government should differentiate between companies that use natural gas as feedstock and other that use it as raw material, creating from it different products. “The needs of each differs.”

El Gabaly believes the government should differentiate between companies that use natural gas as feedstock and those that use it as a raw material, creating different products.

As figures and experts agree that self-sufficiency probably will be short-lived, and unless the miracle of another Zohr knocks on Egypt’s doors soon, liberalizing the market is a necessary safety net.

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