What’s new in exploration

	Vol. 230 No. 12
GORDON FELLER, CONTRIBUTING EDITOR

Reward and risk of exploring in Egypt

There was a great deal of anticipation in the air when, in March 2009, Egypt offered choice acreage in the deepwater Nile Delta region, which is gas prone. These were areas that seemed appealing to many, especially because they were situated close to some of the country’s largest gas fields. But the results were quite disappointing: a tepid response from just a few companies.

A good place to invest? Several criteria would seem to recommend Egypt as a favorable place to explore for oil and gas. The country was ranked the second-best destination for foreign direct investment (FDI) among 59 African countries for the 2009–2010 fiscal year in a recent report by FDI Intelligence, a unit of the Financial Times. The study considered numerous criteria including infrastructure, local strategies for encouraging FDI, human resources, living standards and market openness.

Furthermore, Egypt’s Minister of Petroleum, Sameh Fahmy, announced on Sept. 3 that the country’s oil and gas sectors were superior to others in terms of growth during FY 2008–2009. Real growth in the oil and gas sectors represented 17.5% of economic growth during the fiscal year, versus 8.3% in the previous fiscal year. Such dramatic growth in this one sector can be attributed to continued foreign investment, still flowing into Egypt despite the global financial crisis.

The country’s oil demand is expected to increase from roughly 671,000 bpd in FY 2008–2009 to 771,000 bpd by FY 2013–2014. Egypt will consequently represent 18.9% of Africa’s oil demand, while only providing about 6.03% of the supply.

Why, then, was there such a tepid response to the recent Nile Delta acreage offer? Egypt’s growing list of economic problems were factors, but exploration companies don’t seem to let such factors deter them from active investment in at least 40 other countries with sometimes more difficult economies. Rather, it seems that Egypt’s simmering political problems were “top of the mind” for foreign investors, and especially for those firms thinking about putting real money to work on longer-term exploration. Insurers charge companies an arm and a leg to provide coverage to protect against asset expropriation, among other scenarios. Even for companies that can afford the coverage, uncertainty—even with a body of laws in place—kills the enthusiasm to undertake risky exploration.

Structure of Egypt’s oil industry. The country’s oil history has had an impact on the current situation. Production started in 1910, and was dominated by Anglo-Egyptian fields, in the form of a 50/50 JV linking BP and Shell. In 1964, that company’s assets were nationalized. But Egypt managed to maintain a foreign presence in the industry through a series of JVs. In 1973, the national government abandoned JVs in favor of contractual arrangement based on the production-sharing model, and the government offered attractive fiscal terms.

Egypt’s recent years have been marked by moves to make more oil available for export. This goal has been made more difficult by the fields’ natural decline and an increase in domestic consumption. In 1985, there was a turn toward the development of the gas sector. During the past 10 years there have been some oil finds, but these have been rather small. Between 2001 and 2006, the government offered many exploration blocks.

The contracts and fiscal terms to be found today in Egypt are not the same as neighboring states will offer. The country essentially offers a hybrid concession/joint venture/PSA. Concessions are given exclusively to EGPC, which pays a royalty of 10%. When a commercial discovery is made, the exploration license is converted into a development lease. EGPC and a foreign contractor form a JV. The PSA features are reflected in cost oil and profit oil.

Risk calculation. Political violence is a real concern to foreign investors. Local extremists either affiliated or inspired by al-Qaeda have carried out a string of relatively small attacks in Egypt over the past several years: Taba and Ras Shaitan (October 2004), a small-scale attack in the Khan al-Khalili bazaar (April 2005), Sharm El-Sheikh (July 2005), and the attacks on the Red Sea Resort of Dahab (April 2006). The targets of the attacks have been tourist infrastructure, particularly in the Sinai Peninsula. There is a significant risk of further isolated terrorist attacks, because Egypt remains a likely terrorist target due to its pro-Western stance and well-developed tourist infrastructure.

The Mubarak government is under some pressure from its neighbors for the way it is perceived to have handled the war in Gaza in the winter of 2008–2009. Further, as Egypt has positioned itself as a key negotiator for peace between Israel and Gaza’s leaders, it may face more criticism depending on the long-term results. Sectarian violence in Egypt’s underdeveloped south also remains a problem; it tends to target minority groups and, in isolated cases, foreign tourists.

The government’s prime focus is on continued political stability. As such, change, whether political or economic, will be incremental. While the government’s economic reform policy will remain on track, the Muslim Brotherhood’s electoral success will push the government to continue its clampdown on political opposition forces. These tactics will provoke further voter apathy and social unrest, and will feed the growth of extremism, though not to a sufficient degree to threaten the regime.

Sectarian violence and political pressure from other Arab states will continue to adversely affect Egypt’s exploration, reserves, lease sales and discoveries in the same way they affect the larger flow of foreign investment: by impacting the risk calculations of companies looking to invest there.