Price a hurdle for Egyptian gas exports

With estimates of Egypt's natural gas reserves rocketing to 25-35 tcf in the last few years, Egypt is now in a position where domestic demand can easily be satisfied for the foreseeable future and significant amounts of gas can be made available for exports.

The only sticking point before exports can go ahead seems to be the border price of Egyptian gas.

Current status

Currently, foreign companies operating in Egypt receive 85% of the BTU-adjusted price for Suez blend crude oil for natural gas purchased by state-owned Egyptian General Petroleum Corp. (EGPC).

Under production-sharing agreements (PSAs), EGPC buys part of the gas produced for investment/operating cost recovery and as profit share for the foreign contractors.

At an average oil price of $18/bbl in first half 1997, this purchase price works out to $2.64/MMBTU.

This price agreement created highly favorable conditions that led to an enthusiastic recent exploration effort, because it was formulated when oil prices collapsed at yearend 1986. However, the rosy outlook lasted only as long as Egypt's domestic demand for gas was strong. With more big finds coming almost weekly, the latter discoveries now will hardly find a domestic market until well into the next century, which, in turn, seriously threatens returns on the exploration investment made.

The PSAs allow the recovery of all capital investment related to the development of a field without "uplift," (without taking account of finance costs for the committed funds). Contractors are, therefore, eager to develop export outlets for the gas in order to recover costs and free up their capital as soon as possible.

Export prospects

Initial soundings have uncovered interest in Israel and Turkey to import Egyptian gas. Both countries are, however, unlikely to agree to a price for landed gas much above the European level of $2.50-3/MMBTU, which means the netback value at the Egyptian wellhead will be considerably below the oil equivalence price currently paid by EGPC. Exports to Turkey would involve a costly subsea pipeline or liquefied natural gas project on the Mediterranean coast as favored by Amoco Corp. and Agip SpA, two of the largest producers of Egyptian gas and leaders of the Nile Delta play. The netback value for Egyptian gas under this scenario might be only about $1/MMBTU.

Exports to Israel could use a pipeline through northern Sinai and the Gaza Strip. This could be more profitable, given Israel's other options for receiving gas, via subsea pipeline from Turkey or as LNG. That's especially true for the offshore wells north of the Sinai peninsula held by BG plc, which could net enough because they are closer to Israe* markets than to the big Egyptian centers. But political considerations make this an uncertain prospect.

Another potential hurdle for Egyptian gas exports is a campaign by Anadarko Corp. to find gas in Jordan (OGJ, July 14, 1997, p. 22) that would then compete with Egyptian supplies.

Dilemma for contractors

The Egyptian government, in recognizing the low-price prospects for exported gas, has made it clear that any exports would have to come out of the contractors' share of the gas produced.

This puts the foreign companies in a dilemma; they may have to wait for years before being able to sell gas to the Egyptians for the domestic market at the crude oil-equivalent price. On the other hand, if they develop export options, they will sell gas at a much lower wellhead price. This would certainly prompt the Egyptians to ask why they should pay more for the gas, if the contractors are happy with these lower prices.

Under existing PSAs, the contractors receive gas and associated condensate and natural gas liquids for cost recovery up to a maximum of 40% of production and 25% of the rest as profit share. The other 75% of production belongs to EGPC. No royalty is paid by the contractors. Taking into account the zero price for EGPC's profit share and the changing percentages being allocated for cost recovery, the contractors receive a long-run average price for gas of less than $1/MMBTU.

Compared with this average price, exports are likely to be profitable. From the Egyptian point of view, the picture is different: The profit share gas received by EGPC is upstream taxation and therefore legitimate revenue. Relinquishing part or all of it would be like lowering corporate tax-something the Egyptian parliament does not view favorably.

Fuel oil competition

By using gas, the Egyptians are substituting mainly for heavy fuel oil used in older power plants. The export value of this displaced fuel is the opportunity gain of using gas. At a price of $18/bbl for Suez blend crude oil, this fuel oil is priced at about $2/MMBTU. Higher thermal efficiency and environmental considerations of gas-fired power generation increase this opportunity price. Egypt has no incentive to give away its profit share gas below this price, and exports will not be feasible if this is the fob price, because the importing country makes the same comparison between gas and fuel oil only if it uses the cif price of gas. Transport costs would always make fuel oil the cheaper alternative.

Timing crucial

Egypt will, therefore, not agree to an export project unless the PSA partners can convince the EGPC negotiators that the time the contractors will have to wait before their discoveries are needed on the domestic market is more than what they bargained for.

The PSA gives EGPC 5 years after discovery to find a domestic market, after which the contractor "shall have the obligation to exert its reasonable efforts to find an export market for gas reserves."

EGPC then still has another 7 years to find a market for gas, and only after 12 years, the parties "shall consult each other on the disposition of the gas reserves."

That's not much of a club to wield in order to force the Egyptians into an export project if they do not like it.