Block party: Further exploration is on the way following a new bidding round

That plans for Egypt’s upstream energy sector are proceeding, despite recent upheaval and political uncertainty, is testament to its importance to the national economy. Whereas many government departments declined to initiate new projects or make important decisions during the interregnum period, the Ministry of Petroleum (MoP) and corresponding government agencies have pushed forward with at least some of their plans.

“Upstream interest is continuing, both onshore and offshore. The potential in Egypt is massive, as evidenced by the increased investment by many international oil companies (IOCs),” Ibrahim Khidr, the chairman and managing director of Sino Tharwa Drilling Company, told OBG. During the first eight months of the fiscal year 2011/12, LE42.28bn ($7.08bn) in private investment had been pledged for new projects in the energy sector, according to data provided by the MoP.

EXPLORATION: Further investment was seen as likely to come from a new bidding round for oil and gas exploration blocks, both onshore and offshore, the first since 2009. Bids were due by March 20, 2012, but as of August 2012, the government had yet to announce any winners. Sector watchers were predicting more interest in oil blocks onshore than for gas blocks offshore because of disparities in the complexity of exploration and the fact that contract terms for gas are generally considered less lucrative.

“All of Egypt’s geographical neighbours have large oil reserves including Libya, Sudan and Saudi Arabia. There is no reason why Egypt should not have more petroleum reserves, and to fully exploit this potential the country needs to increase exploration,” Issa Hamed Eleish, the chairman and managing director of Maridive Group, told OBG.

The Egyptian General Petroleum Corporation (EGPC) has attracted bids from 25 explorers, despite the political uncertainty. One explanation for this is that the key IOCs operating in Egypt, such as Shell, Apache and BP, are familiar with not just the geology of Egypt but also the political terrain. The 100th anniversary of Shell’s arrival in the country came around in 2012, and the company has been present and pumping oil through multiple revolutions. In addition, the exploration blocks are located away from the major population centres, making them an unlikely target for violence.

As of mid-2012, risks from legislative changes or government actions seemed unlikely, too. One of the most politically sensitive issue in the sector was Egypt’s commitment to export natural gas to Israel, which is outside the realm of upstream activities.

AFTER THE AUCTION: For the winning bidders in the block auction, there may not be a need to spend money immediately – it could be seen as prudent to bid now but hold off on exploration until the political situation has stabilised. Typical contract terms in Egypt allow for a seven-year exploration period.

Several legislative reforms could be implemented in the coming years that upstream energy companies would find attractive. Those include a possible liberalisation to allow producers and commercial users to negotiate sales directly, exploration terms that could make deepwater gas drilling more attractive and a reassigning of responsibilities between the government agencies involved in the sector. “Companies are not bullish about entering the Egyptian market at the moment, but there are still many good opportunities,” Hany Abd El Halim, the chairman of oil services firm Petrographics, told OBG.

SHALE GAS: While some industry watchers focus on 2011-12 sales, over the longer term new opportunities may provide diversification within the energy sector, with shale gas a particularly attractive option. Egypt’s shale reserves have not been explored sufficiently for there to be a reliable figure for proven reserves, but EGPC and the MoP have been studying the resource and are hoping to soon have details that would lead to exploration and production.

CURRENT OFFER: There were 15 blocks on offer in the latest bidding round by EGPC. Seven were in the basins of the Western Desert and eight on the other side of the Nile, in the Gulf of Suez, Sinai and Eastern Desert basins. In purely geological terms, these onshore blocks are similar to those which have proved popular with operators already in Egypt.

The Western Desert, in particular, has been the site of frequent discoveries – of the 64 new deposits found in the fiscal year 2009/10, for example, 80% came from this area, according to EGPC data.

“The drilling cost in the Western Desert is very cheap if we compare it to the cost of drilling in the Mediterranean,” EGPC’s deputy CEO for agreements, Adel Said Kamel, told local media in early 2012. “Some of our blocks are in the Gulf of Suez, which is oil-prone, so the potential for oil there is more than the gas potential. Exploring for gas takes time and also a lot of investment.”

Though the list of bidders is not known, EGPC’s stated preference is to attract new companies as well as extending existing relationships. The names suggested are generally the national oil companies of other producing countries, as opposed to IOCs. EGPC’s deputy CEO for exploration, Abdel Fattah, cited Chinese upstream firms’ successes in Sudan as a reason for courting their presence in Egypt.

GAS BLOCKS: Egypt’s exploration plan in early 2012 was to announce details of a bidding round for gas blocks after the completion of the oil round. As of May 2012, expectations were for blocks covering around 57,000 sq km, and an overall mix of 13 offshore blocks and two onshore, according to Mostafa El Bahr, the vice-chairman for agreements and exploration for the Egyptian Natural Gas Holding Company (EGAS). As in the oil sector, Egypt is hoping to see newcomers to the upstream industry participate. By May 2012 it was seen as unlikely for bidding to happen before a new government is in place.

Attracting upstream partners is likely to be significantly harder for gas blocks than for oil ones. Although political stability is among the concerns, the primary issue is the price EGAS will pay producers for extracted gas – around $2.65 per million British thermal units (mmBtu), a rate that is negotiable depending on extraction costs. Under existing rules, negotiations on price were to take place before gas was found and explorers could determine the cost of extraction and delivery.

In one of the higher-profile setbacks of recent years, in early 2011 Shell relinquished the Northeast Mediterranean Deepwater block, which it reportedly spent around $1bn exploring over the past decade or so, due to doubts about whether it could profit from extraction. “Although Shell made two gas discoveries, we have decided not to pursue these further due to the challenging economics of the project,” said a company statement.

The block is expected to be on offer again during the upcoming bidding round, and the episode has fuelled concerns about divestiture and decreasing interest. In response to some of these concerns EGAS is offering a more flexible procedure, in which a gas price is left until later to be settled, instead of being negotiated upfront.

Delaying the bids until after the election could also help clear up some uncertainties and encourage bidding. Among the several major policy directions the sector is awaiting is one on downstream subsidies, which are widely recognised as too expensive for the government to be sustainable.

Reform is expected, but the pace and extent of it remain unclear. However, liberalising prices could result in less pressure on the government to buy gas for resale into the domestic market at the cheapest possible price, which could eventually lead to better terms for producers.

Another factor that could portend a successful sale of gas exploration blocks is some offshore finds near the north-east boundary of Egypt’s maritime boundaries, in Cyprus’ sovereign territory. A discovery believed to be as large as 8trn cu feet has been made, boosting expectations for exploration success on Egypt’s side of that maritime border.

NEW CONTRACT STRUCTURE: Egypt is also experimenting with a new contract structure for a project operated by BP, in partnership with RWE Dea of Germany. The project is called the West Nile Delta project and will be developed without the creation of a joint venture with the Egyptian government, as is the normal procedure.

The agreement disposes of the typical production-sharing contract and joint venture with cost recovery provisions. The contract allows for price renegotiation after four years and then after every five years. For Egypt, apart from trying out a different approach that may help it boost production from the country’s offshore gas fields, the benefit is that private-sector contractors assume the risk and costs. BP Egypt estimates that if successful, the $15bn project would boost domestic gas supply by 22%.