Plenty more efficiency: Deregulation among the likely developments in the downstream segment

In the summer of 2012 the pressure on Egypt’s downstream oil sector was increasing, due to short-term concerns linked to the country’s political instability. Some types of fuel were in short supply, and sector reform was widely considered one of the most pressing priorities for the government.

DUAL ROLE: The private sector has been allowed to participate in the marketing and distribution of oil-based products since 1990. As of mid-2012 there were 12 companies in the sector – four state agencies and eight privately owned ones. Most have taken on the dual role of licensed marketer of refined products, which means purchasing from the Egyptian General Petroleum Corporation (EGPC) and then reselling in a middleman role, as well as acting as retailers that sell to end-users.

EGPC and the Egyptian Natural Gas Holding Company (EGAS) are the sole sources in the country, and get their refined products or processed gas from domestic production as well as imports. Most gas customers are industrial concerns and distribution companies for residential use. Oil-based products are the main focus for downstream firms in Egypt.

The most popular and controversial products sold are the fuels, led by petrol and diesel. The subsidy system means basic fuels in Egypt are among the cheapest worldwide, starting at LE1.75 ($0.29) for a litre of 90-octane gasoline. The price rises to LE1.85 ($0.31) for 92-octane and LE2.75 ($0.46) for 95-octane. Liquefied petroleum gas, which is used for cooking, sells for LE2.50 ($0.42) per canister, according to figures from the Ministry of Petroleum – less than 10% of the actual cost of the fuel.

MARGINAL DECISIONS: Margins are thin for retailers, at approximately 5%. They make their money on lubricants – motor oils, for example – which are unregulated, and for which margins can rise to as high as 40%. Profit margins on petrol are LE0.12 ($0.02) per litre, according to Hassan Darwish, the logistics manager for ExxonMobil Egypt. Specialty products typically account for 20% of sales by volume, but as much as 80% of sales by value.

Subsidies on cooking gas and other fuels are also a major part of the system. Energy subsidies comprised 32% of government spending in the budget for 2011-12, according to a report by the American Chamber of Commerce in Egypt. Expressed as a percentage of GDP, subsidy spending has been between 8% and 12% of the total since 2005-06, Ministry of Finance data shows. At the current rate of spending, this is no longer affordable.

SHORTAGES: Proof of the unsustainable nature of the system came in 2012, with EGPC widely perceived to be unable to import sufficient fuel to meet demand. The year featured shortages, causing queues and accusations of hoarding. “It is very common now to see long lines of trucks and buses outside the filling stations,’’ said Mohamed Nafea, the managing director for the marketing division of Taqa Arabia, a downstream distributor. “But nobody can import because of the regulated price.” EGPC officials and politicians attributed this to distribution problems, rather than a supply shortage. However, in the private sector the company’s ability to import is widely considered the real reason for the shortages.

As of July 2012, with another round of shortages being felt, the supply of diesel fuel was estimated to be 35% short of demand. The system can more than likely muddle along in the short term, as it indirectly ensures that demand will not suddenly increase to the point of instability, as a finite supply of diesel inherently implies a cap on economic growth. New ventures that are particularly diesel-dependent are unlikely until supply is secure.

For fuel marketers and retailers, margins are too thin on these basic products, at around 5%, to allow for expansion or any other sort of capital expenditure. “All companies have been working for the last 10 years from hand to mouth,’’ Nafea said. “The margins are too low to support investment, so everybody is relying on deregulation in the future.’’ That would mean allowing companies to import on their own. If that happened, the IOCs with downstream ventures in Egypt would stand to benefit the most, as they can take advantage of their global supply chains.

GOVERNMENT HELP: Talk of smaller measures is scant, but some changes short of deregulation could provide a degree of relief, at least from the perspective of retailers. “What would be helpful is if the government would review the fuel price at least every six months or make adjustments for inflation,’’ said Andy Wells, the chairman and managing director of fuels marketing for ExxonMobil’s Egyptian operations. “They can make a change in price, which will facilitate the investments that are necessary for the infrastructure to be continued.’’ Wells said that profit margins for fuels have not changed since 2007.

In early 2012 Egypt was reportedly looking to secure enough supply to last through the summer, a job that was made more difficult by the cash flow situation at EGPC. “The EGPC debt issues have put financial strain on smaller oil companies. This is affecting their ability to invest; fortunately we are prepared to maintain our high level of investment here, in the belief that the situation will resolve itself in the medium term,” Nick Dancer, the country manager at Dana Petroleum, told OBG.

In late June 2012 Reuters reported that the country had bought $1.25bn worth of diesel and petrol, but at premium rates based on the perceived risk by oil traders of Egypt not paying for the shipments, or paying late. That is in part because of EGPC’s basic business model of buying at a high price and selling at a low one, but also because Egypt’s foreign currency reserves have fallen since the revolution.

EGPC reported details of 48 shipments over the summer months, with suppliers including trading firms such as Vitol and Glencore, the world’s top two independent oil-trading operations. According to reported details of Egypt’s purchases, the value at market price as of late June 2012 was around $920m for the 36 diesel shipments and about $330m for the 12 petrol deliveries.

DEREGULATION: Given these challenges, it is no surprise that most in the sector eagerly await deregulation, which is likely to happen in 2013. The basic principle behind it is expected to be EGPC and EGAS losing their status as monopoly suppliers, but also some of the burden of selling at prices well below market rates. Consumers could not handle suddenly paying market rates, however, and one idea floated to compensate has been to issue rebate coupons based on income levels, but at a declining rate.

The future is also likely to include a shakeup among the major companies in the downstream sector. Chevron said in March 2012 that it may sell its downstream assets in Egypt, which include 65 filling stations under the Caltex brand, a lubricants blending plant with a capacity of 23,000 tonnes a year and storage facilities in multiple locations.

That potential sale is in line with the worldwide trend. IOCs have been looking to sell their downstream operations in order to focus on exploration and production. Chevron also announced in March that it may divest from downstream in Pakistan and Australia, and competitors such as Shell, ExxonMobil and others are doing the same.

In some cases IOCs are choosing to retain downstream operations in countries where they are also active in the upstream sector, and ExxonMobil in Egypt is an example – the company has looked to divest its downstream assets everywhere in Africa apart from Nigeria and Egypt, both of which are important for the firm’s exploration and production arm. The potential for asset sales is likely to act as a disincentive to investment in new facilities. Building them is a challenge, with land acquisition and bureaucratic issues meaning constructing a filling station can take years. “To build a network and leverage a brand takes a long time,’’ said Nafea. “We do not think there will be new entrants to the market.”