Fueling Egypt’s Economy

The short-term woes of Egypt’s oil and gas industry will continue until underlying structural issues are addressed, regardless of changes in broader political instability.

Problems associated with a lack of fuel in Egypt continued through the end of 2013, but the sudden end to the shortages that plagued Mohammed Morsi’s presidency in June suggested that Egypt was not facing a real energy crisis rather a politicization of its oil and gas sector. It has since become clear that fuel shortages in Egypt are more directly the result of structural issues than of short-term political instability. Rising domestic demand as part of economic growth prior to 2011 far outstripped available fuel supplies, while inefficiencies associated with Egypt’s state-owned service provider, the Egyptian General Petroleum Corporation (EGPC), increased the likelihood of periodic fuel shortages. Following 2011, a weakening currency and an erosion of Egypt’s foreign reserves worsened the challenges confronting the EGPC and Egypt’s oil and gas sector more broadly.

In the uncertain months prior to the end of Morsi’s presidency, Egypt’s oil and gas sector was in limbo. On the streets of central Cairo, queues outside gas stations choked the city’s already strained commercial arteries and paralyzed local businesses. In the governorates, amid vexing shortages of fertilizers and diesel, farmers struggled to irrigate fields, harvest crops, and move their produce to market. Then, on the morning of July 1, 2013, lines outside gas stations all but disappeared, for the moment intimating that the politicization of the oil and gas sector was more responsible for the shortages than any longer term pressures.

Prior to the uprisings of January 25, 2011, Egypt’s oil and gas industry was an important asset in the country’s expanding economy. Although its annual output of approximately 710,000 barrels of oil per day (b/d) paled in comparison to that of the world’s largest producers—Saudi Arabia, for example, produced 9.4 million b/d in 2011—its oil exports were a stable earner of foreign currency and by 2009, Egypt had become the largest refiner of crude oil on the African continent—behind only South Africa. Its production of natural gas, too, had increased five-fold since the mid-1990s, to 2.2 trillion cubic feet (Tcf) in 2011; estimates of its proven natural gas reserves of 77 Tcf were the third highest in Africa as of 2013.

Egypt’s energy sector was growing. Foreign oil companies were investing unprecedented capital in exploration and development: nearly 70 percent of Egypt’s approximately $7 billionworth of foreign direct investment (FDI) in 2009-2010 flowed to Egypt’s oil and gas sector, dwarfing FDI in tourism, telecommunications, and real estate combined. Oil and gas revenues were roughly 16 percent of Egypt’s GDP in 2011, a figure poised to increase through the Egyptian government’s continued agreements with foreign oil firms and Egypt’s potential to become a key exporter of natural gas to Europe. And while total FDI slumped by more than two-thirds following the uprisings in January 2011, crude production remained constant and foreign oil companies did not evacuate Egypt en masse.

On one hand, constant crude production suggests that the oil and gas sector in Egypt is more robust than many commentators have argued. It’s reasonable to speculate that investment levels will remain high, particularly as the government has not interfered heavily in the sector since June 30—with the exception of several highly publicized contract breaches, most notably with the BG Group. On the other hand, drastic government actions could affect investor confidence in the oil and gas market in the future—if the government begins nationalizing oil fields, for example, or continues to divert crude supplies from export terminals to the domestic market at larger quantities. This remains to be seen.

Yet despite stable oil production following January 25, 2011, stresses to the street-level economy appeared in a series of gasoline, cooking fuel, and power shortages at the beginning of 2012. At the time, Fayza Abul Naga, the Mubarak-era Minister of Planning and International Co-operation, blamed smuggling and a growing black market for diesel—when the real issue lay in the underlying mismatch between growing demand and dwindling supplies, which the government struggled to reconcile and, as a result, could no longer ensure smooth deliveries of fuel to the market.

The Morsi government inherited these problems when it took office in June 2012 but failed to find a solution. As the government elsewhere avoided securing a desperately-needed $4.8 billion IMF loan and proved incapable of stemming the loss of Egypt’s foreign currency reserves, its response to the fuel shortages was conspiratorial. Rumors abounded that the military was interfering in the sector, that it was forcibly preventing foreign firms from working concessions or moving oil to market. In turn, government critics saw Egypt’s fuel shortages as a convenient way for the Morsi administration to preempt street protests and demobilize the opposition. The disturbances to the street-level economy and fears of prolonged shortages underlined popular perceptions of the Muslim Brotherhood’s mismanagement of the economy. Alongside political grievances, they were major factors behind the mass protests that materialized at the end of last June. Outbreaks of violence worsened these tensions as foreign oil companies periodically closed their country offices and evacuated international staff, as BP did in the days following June 30, 2013.

These issues were more political than economic and they do not explain the industry’s underlying challenges. Egypt’s previous disruptions to its fuel supply, such as the shortages and blackouts that emerged in 2007-2008, were largely explained by a market mismatch: Egypt’s economy was growing between 5 and 6 percent, and domestic demand for oil and gas far outpaced supply. After Egypt’s overall economic slowdown following 2011, the mismatch should have eased, but energy consumption continued to rise. This was somewhat paradoxical, but rising energy consumption could be explained by Egypt’s growing population, outdated infrastructure, and according to industry experts a higher rate of GDP growth—between 3 and 4 percent—than most current estimates.

In addition to the overall market imbalance, the domestic fuel supply is also complicated by the role of Egypt’s state-owned service provider, the EGPC, and how it operates with a weakening currency. Although private firms are mostly responsible for exploration and production, the EGPC is tasked with much of the downstream business—the marketing, distribution, and sale of oil products—in the country. As such, it is charged with ensuring the availability of subsidized fuel, which it does by buying oil from foreign companies in Egypt at below-market prices and then reselling it at a further discount to Egyptian consumers. Prior to 2011, when Egypt’s public finances were healthy, it could afford to pay oil companies in foreign currency. But as investors pulled money out of Egypt and unloaded the Egyptian pound on the foreign exchange market following January 25, 2011, honoring contracts denominated in foreign currency became exceedingly expensive for the Egyptian government. With fewer financial resources and a grossly disadvantageous macroeconomic climate, the EGPC could no longer ensure steady supplies of fuel at below-market prices.

Political tensions have compounded these structural issues, but there are compelling reasons to be optimistic. Despite several highly publicized contract disputes, international oil companies have by and large continued to deploy unprecedented capital in Egypt and have expanded their exploration and drilling operations. There continue to be major new discoveries in the country, such as the majority BP-owned Salamat well, drilled in September 2013 as the deepest well opened to date in the Nile Delta. Moreover, it would be misleading to see the short-term woes of Egypt’s oil and gas industry as a barometer of broader political instability. Where longstanding market players have sold interests in their oil business in the country, others, such as France’s Total, have expanded their downstream operations, purchasing all of Chevron’s retail gas outlets in Egypt at the end of last August. Even for the Houston-based Apache Corporation, which sold a 33 percent stake in its Egyptian interests to the China Petrochemical Corporation (Sinopec), it still plans to invest $1.4 billion in Egypt for the coming year. The relatively new presence of Chinese firms—as in Iraqi Kurdistan—is perhaps more a sign that the opportunities outweigh the risks of investing in Egypt’s energy sector.

Shortages will likely continue in the near term and will only be solved as part of a comprehensive resolution of Egypt’s primary economic challenges: stabilizing its currency, strengthening its foreign reserves, and reforming its subsidy program. In the case of the latter, there are creative options for the government to phase out the costliest subsidies in a way that is socially equitable. As difficult as it might be to concede, given the ongoing political transgressions and violations of civil liberties, a Sisi-led government might have the political capital to carry out overdue subsidy reform if it so chooses. Whatever the political climate, any Egyptian government—even a Sisi one—should ensure that the country’s oil and gas sector remains an asset for Egypt moving forward. The future of Egypt’s economy depends on it.

This article is reprinted with permission from Sada.  It can be accessed online at: http://carnegieendowment.org/sada/2014/03/27/fueling-egypt-s-economy/h5yp

Max Reibman is a Gates Scholar and PhD candidate in Modern Middle East History at Pembroke College, Cambridge.