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    Categories: Economy

Export dreams: Will Zohr gas production allow Egypt to light Europe and its own cities?

Production at the Zohr gas field was officially inaugurated by President Abdel Fattah al-Sisi on the last day of January, a little over a month after production began.

The Port Said ceremony that Sisi presided over was the highlight of celebrations marking the field’s discovery, which the government has hailed as the start of Egypt’s path to self sufficiency in electricity generation and manufacturing, both of which are pivotal to political and economic stability.

However, the production goals associated with this massive gas find have expanded into lofty hopes that Egypt will reclaim its role as a net exporter of gas, a highly beneficial scenario for European importers, who have long sought to decrease their dependence on Russia as their primary source of natural gas.

Since production began at the end of last year, European media analysts have revisited this decades old dream in a way that strongly resembles the beginning of the millennium, when consecutive gas findings were met with headlines claiming that Egypt’s gas would light all of Europe, opening the door for actual export deals with Israel and Jordan. However, by 2009, an acute energy crisis had beset Egypt, intensifying in the aftermath of the January 2011 revolution and leading to widespread power outages and a halt in production at factories.

The Zohr gas field is the largest ever natural gas find in the Mediterranean Sea. However, there may be a reprisal of events that played out in the 2000s, as new export hopes ignore Egypt’s growing and present needs for gas, needs that are expected to exceed current consumption levels, as well as the total quantity of Egypt’s gas reserves.

How much of Zohr’s gas does Egypt get?

Although Egyptian media outlets have reported the Zohr gas field’s reserves at 30 trillion cubic feet, this figure has not been confirmed, Sherif Wadood, an oil and gas expert who co-founded and managed several companies in the energy field in Egypt and abroad, tells Mada Masr.

Zohr potentially has 30 trillion cubic feet of original gas in place (OGIP), according to a statement published by the Italian petroleum company Eni, which discovered the gas field in the Mediterranean Sea north of Port Said in August 2015. OGIP is an estimation that designates the total volume of gas stored in a reservoir prior to production, but according to Wadood, reserves are usually calculated as a percentage of OGIP, depending on the technical and economic characteristics of a given reservoir.

Wadood notes that looking at similar gas reservoirs can be instructive in determining how much gas can be extracted from Zohr.  In the primary production stage for similar reserves, he says that 35 percent of OGIP can be extracted, and, in the secondary stage, the extraction figure can reach up to 65 percent or more.

If Wadood’s estimation is taken as a guiding point, the potential quantity of gas that may be extracted from Zohr is around 20 trillion cubic feet, not the reported 30 trillion cubic feet.

“However, even in this case, 20 trillion cubic feet is still a large amount of gas, equivalent to more than a third of Egypt’s reserves prior to the [Zohr] finding,” says Wadood.

Distributing gas shares in the Zohr deal

Egypt’s government aims to use the full production yield from the Zohr gas field, at least for the first five years of production, to cover its domestic needs. This production yield includes the  government’s share, which, according to the terms of the agreement, the government will not pay for. Also included within this yield is the share enjoined to international oil companies, for which the government will pay a price determined by a flexible formula that ranges from US$4 – $5.88 per MMBTU, depending on the quantity of gas produced.

The Zohr agreement, published as Law 2/2014, stipulates that 40 percent of production not used in petroleum operations will be allocated to Eni’s subsidiary the Italian Egyptian Oil Company (IEOC) for cost recovery. This allocation would remain in place until Eni has recouped the full extent of its investment, including exploration costs and field development costs. In addition, Eni would also recoup their operational costs from the beginning of commercial production and throughout the lifetime of the project.

The exploration and field development costs came in at $12 billion, excluding an additional $4 billion to ensure that maximum gas output would last throughout the lifetime of the project, Petroleum Minister Tarek al-Molla stated in a televised interview with Sky News Arabia in October 2017.

Production began at the end of December 2017, with 350 million cubic feet being pumped out of Zohr per day. This initial output level fell short of the original estimate of 500 million cubic feet per day that Prime Minister Sherif Ismail announced in September. The government currently estimates that production will increase to 1 billion cubic feet per day by mid-2018, before reaching its peak a year later in 2019 at 2.7 billion cubic feet per day.

Based on these figures, Mada Masr estimates that Eni would be entitled to the cost recovery share of 40 percent for almost 11 years, which constitutes half of the project’s estimated lifetime.

As for the remaining 60 percent of gas output, the Zohr agreement indicates that it will be distributed between Eni’s IEOC and the state-owned Egyptian Natural Gas Holding Company (EGAS), according to production levels.

This means that during the first decade of Zohr’s production, a period that spans half the lifetime of the project, the contract grants Eni 58.6 percent of the production yield, including both cost recovery and profit gas. This is the amount of gas that the Egyptian government would be buying at a rate of $4 to $5.88 per MMBTU. On the other hand, during this period, the Egyptian government would have access to 41.4 percent of the production yield through EGAS without payment.

During the second half of the project’s lifetime, the cost recovery ratio falls from 40 percent to 20 percent in order to compensate for the ongoing field development costs. The remaining 80 percent is then distributed between EGAS and IEOC in accordance with output levels. As such, Mada Masr estimates that in the second half of the project’s lifetime, Eni would keep a total of almost 45 percent of output, and EGAS would get the remaining 55 percent.

“The actual role of the foreign partner after the exploration phase becomes financing the investments needed for production, until all costs are recovered, in addition to a profit margin,” says Wadood.

Although the agreement stipulates that a 10 percent royalty fee is due to the government, whether in the form of cash or gas output, the contract also obligated EGAS to pay that fee rather than Eni.

What are Egypt’s gas needs?

To achieve self sufficiency, Egypt would need to be able to produce enough natural gas to cover domestic demand. While experts expect a large increase in production due to the Zohr field, some note that production is not likely to be sufficient to cover the real demand in the economy, which is estimated to be much higher than the current consumption levels.

Total gas output

Egypt’s gas production has already taken an upward turn in the recent period, not only due to the Zohr gas field but also to the new gas output coming from recent discoveries, including the North Alexandria field, Atoll and Noroos.

The Atoll gas field, found in the Mediterranean north of Damietta Governorate, began production at a rate of 300 million cubic feet per day at the end of 2017, a few months after output from the Noroos gas field, north of the Nile Delta, reached 1 billion cubic feet per day. Meanwhile, output from the North Alexandria field reached 700 million cubic feet per day in May, and is expected to increase further.

Collectively, the yields of the three gas fields contributed to raising Egypt’s total gas output to 5.1 billion cubic feet per day in 2017, compared to 4.4 billion cubic feet per day in 2016, according to Prime Minister Sherif Ismail.

“We have to realize that the petroleum sector is a dynamic industry where new discoveries lead to higher production, while, at the same time, production from other gas fields naturally diminish,” said Mohamed Shoeib, the former head of EGAS, in a televised interview on the privately owned television network CBC in December 2017.

For Wadood, however, when evaluating the recent increase in production, not only is it important to take into account the dynamic aspect of gas production, but also the technical risks and sustainability of producing at peak levels. Overproducing could damage a natural gas reservoir, he says, as happened with the Rashid gas field in the Nile Delta.

Gas demand and consumption

According to official figures, total domestic consumption of gas stands at around 6.2 billion cubic feet per day in the summer and 5.8 billion cubic feet per day in the winter. With this in mind, the government estimates that an increase in output would cover consumption and help Egypt reach self sufficiency. However, experts have noted that these statements confuse the current levels of consumption with the real demand in the economy, which is neither known nor published.

“We expect to see a notable ramp up in gas demand from new-build gas power plants in the country, as well as from residential connections to the domestic power grid,” Richard Taylor, an oil and gas analyst at Fitch Group-affiliate BMI Research told Mada Masr in December.

Generating electricity accounts for more than 60 percent of natural gas consumption in Egypt, while the manufacturing sector consumes 23 percent, according to the most recent report by EGAS for the fiscal year 2014/2015.

“While domestic gas output ramping up from next year will reduce the need for imported liquid natural gas [LNG] substantially, it is our view that seasonal demand dynamics will still necessitate the import of several LNG cargoes in the short term,” said Taylor.

Despite this, the petroleum minister announced on January 28 that Egypt intends to halt LNG imports by the end of June, six months earlier than originally expected, according to a Reuters report.

Wadeed emphasized that while consumption is limited by the amount of gas available, demand refers to all the gas needs in the economy, including demand which is unmet due to limited resources.

“I do not know the size of the real demand in Egypt, but what is certain is that it is higher than consumption levels one year ago, because currently there are factories that have halted operations and others that are not operating at their full capacity. There are also power generation stations that are fueling up on mazut. These factors indicate that Egypt’s consumption levels do not necessarily reflect that its natural gas needs are being met. This is due to the reduction in natural gas consumption throughout the past few years,” he says.

The use of mazut, a heavy, low-quality fuel oil used to generate electricity in power stations, has been criticized by Abdel Khalek Ayyad, the former head of the state-owned Egyptian General Petroleum Corporation, on his facebook page. According to Ayyad, mazut is simultaneously more costly and less efficient than natural gas. However, he pointed out that the use of mazut to generate electricity is a recent phenomenon directly linked to the acute energy shortage of the past few years.

Shoeib aired similar criticisms in his CBC interview, stating that diesel costs the government $12 to $13 per MMBTU, while mazut costs $10 per MMBTU, both of which come in at a higher cost than LNG imports which are estimated at around $9 per MMBTU. “Hence, in order to achieve savings, it is in Egypt’s interest to keep on importing LNG as a substitute for mazut and diesel, for both electricity generation and industry,” Shoeib said.

Achieving self sufficiency therefore is not only a question of cutting out LNG imports, but it also a question of cutting off mazut and diesel imports for the purpose of power generation, noted Ayyad. He added that the estimated amount of gas needed to achieve self sufficiency should take into account projections for population and economic growth.

A step toward exporting gas?

A few days following the start of experimental production at Zohr at the end of 2017, Molla announced that Egypt’s foreign partners would be allowed to export their shares of gas in five years. “The government added a clause to the new exploration agreements allowing companies to export part of their share of extracted gas if Egypt does not need it,” the petroleum minister is cited as saying in Reuters.

Ayyad and Wadood are skeptical, however, about whether estimated production levels will be able to turn Egypt into a gas exporter. According to Wadood, Molla’s statements ignore the timespan of production, because, unlike oil, extracted gas has to be immediately consumed through pipelines or liquefied and stored, which is a very costly process.

This indicates that a long term export agreement would be highly impractical, he says, as a gas surplus now does not necessarily mean that there will be a surplus in several years.

While Wadood believes that becoming a net exporter within five years would require more massive finds, Taylor told Mada Masr that BMI Research expects that “the majority of additional medium term gas output growth will come from subsequent development phases of the existing fields, with companies seeking to leverage existing infrastructure.”

The ways in which the gains of the Zohr gas field are being exaggerated recalls the early 2000s, when the Mubarak government overstated Egypt’s reserves in order to justify decisions further down the track, including commitments to long-term export deals, which culminated in blackouts that lasted for years and billions of dollars in fines for breaking the contracts.

Correction: An earlier version of this article incorrectly stated that during the first decade of Zohr’s production the Egyptian government would have access to 40.6 percent of the field’s production yield through EGAS without payment. It has been amended to reflect the correct figure.