Egypt’s former minister of petroleum from 1999-2011, Sameh Fahmy, has just been sentenced to 15 years in prison for his part in the export of Egypt’s natural gas to Israel. So has the alleged “holder of the keys of corruption,” ex-spy businessman Hussein Salem who invested in the project and cashed out before the gas started flowing for a 500% profit; several other state petroleum officials received 10 years. The legal reasoning behind the conviction seems obscure, however, as the full text of the judgement has not yet been released. News summaries say the conviction is for selling gas below the international price, without following proper procedures, and thus “squandering national resources.” Taken alone, each of those steps doesn’t mean much, but together with the fourth factor that the buying party was Israel, they add up to political dynamite. I don’t know much about the detail of the legal procedures, but I doubt that this could be much more of a technicality, given that the old regime could tailor petroleum legislation to its needs with impunity. As Bradley Hope of The National points out, Egypt built a similar pipeline across the Gulf of Aqaba in 2006 to export its gas to Jordan at similar prices, but nobody will be convicted for that crime.
The issue of Egypt-Israeli relations aside, I did some reporting about the industry here from 2005-2006 and I have a few points to make about the nature of natural gas production that none of yesterday’s news stories made. The petroleum industry likes to keep its contract dealings opaque because, like the finance industry, the complex structures of these deals are the source of their huge profits. The free market is a myth, in particular for a commodity like natural gas with spacial restrictions on its use. We are conditioned to think of fossil fuel energy as a fungible commodity with a perfectly competitive global marketplace (although futures speculation and OPEC, to name a few, manipulate the price of oil). However, the concept of an “international price” for natural gas is somewhat misleading. Unlike liquid oil, it is not cost effective to export gas long distances, particularly overseas, because gas is not dense enough. Countries with surplus gas mostly export to directly adjacent countries through pipelines: for example, the United States, which imports the vast majority of its natural gas from Canada. This means internationally traded gas is more expensive in regions where demand outpaces supply, and cheaper where there is an abundance of gas — like the Middle East.
It was only Japan’s voracious appetite for gas in the 1970s, which it could not pipe in, that prompted oil companies to develop cryogenic tanker ships that carry liquid methane at -162 Celsius. This makes it 600 times as dense as gas at room temperature and thus profitable. This technology also helped small island nations like Trinidad and Tobago, with a large surplus, export it to mainland consumers. (Trinidad is America’s #2 import source). However, the process requires massive capital investment: each plant costs $1 billion, and the ships are $200-300 million each. As a result, most liquified natural gas (“LNG”) transactions are in multiple-year contracts between producers and consumers, mediated by the international oil companies. Very little LNG enters the open market like crude oil. So with the volatility in energy markets in the past five to seven years , the “international price of gas” has been much higher than the average amount paid almost anywhere in the world under fixed supply contracts.
Egypt has a lot of natural gas. But producing this gas requires economic operations of hugely inconvenient and political dimensions. By a twist of fate, international oil companies discovered much of it about 15 years ago under the continental shelf of up to 200 km off the northern shore of the Nile delta in water fifty to several hundred meters deep. Getting at these reserves requires technology and engineering techniques that the Egyptian government doesn’t have, so it has contracted the work out to BG (formerly British Gas), BP (formerly British Petroleum, a different company), Shell, EMI and Union Fenosa. When BG (to take the largest natural gas contractor in the country) makes a discovery, the Egyptian Petroleum Ministry’s state-owned marketing company, the Egyptian General Petroleum Corporation, forms a joint venture company with BG that produces and the sells the gas — either back to EGPC for the domestic market, or for export.
Therefore, there are three crucial points of negotiation in forming this production deal:
1) How much “profit gas” (after all expenses are paid) does each partner take? Onshore, this is usually in the range of 75% Egypt to 25% oil company, but in offshore production the oil companies have leverage and get 30% or more.
2) How much must the joint venture give to the Egyptian grid, and how much can it export? Before the late 1990s discoveries, this was a non-issue: there were no pipelines and no ships. But the magnitude of these discoveries, which was at the time much greater than domestic demand, allowed the oil companies to convince Egypt to build several of its own LNG terminals. In fact, they made it a condition of doing riskier, higher-investment offshore work. The enticement was there, because Egyptian industry couldn’t use the gas (for electricity, plastic, fertilizer, etc.) at the rate the companies could produce it, but they would get a 65% share of a high net-back price (after transportation fees) from France or America, bolstering Egypt’s foreign exchange reserves. When Egypt entered the contracts in the early 2000s, they committed somewhere around 2/3 of the new gas (in multiple contracts) for LNG export and 1/3 for the domestic market. This is a ratio which by 2006 they were already regretting because of increased domestic demand. Even though Egypt has a gas surplus it is a net energy importer, in the form of oil. At the same time it planned to export this gas, other sectors of the economy (electricity generation and compressed natural gas taxis, to name two) were switching over to use natural gas because it was much much cheaper for the country than subsidizing imported diesel or fuel oil. This price difference was both because international oil prices are high — but local natural gas prices are under state control (below).
3) The crucial point at hand — What price does the EGPC pay for the gas being produced? It took me weeks of research and talking to industry officials before I understood the signs and lingo that allowed me to approach this sensitive question. In 2000, after the gas had been discovered, the ministry decided to set a cap on all its contracts at $2.65 per million metric British thermal units (mmbtus),
which was within international norms at the time which was appropriate for the increased costs but kept local subsidies under control. The oil companies were happy to comply, because they were getting to export a large portion of the gas as LNG to France where they were getting maybe $3.50 after transportation costs.
This is around the time that Egypt and East Mediterranean Gas (Hussein Salem’s Israel pipeline concession) entered negotiations. Remember, none of these shady deals would have been possible had there not been an abundance of gas available to the domestic market. According to The National, the original price Egypt was going to sell to East Mediterranean Gas, was an implausibly low $0.75-$1.50 per mmbtu. I’m not sure when this price dates to, but I imagine it is based on the the cost of onshore gas before the $2.65 offshore contracts came online. By 2006, when the BG gas was finally flowing, the energy markets had gone haywire: the price of a liquid natural gas unit on the US open market peaked at $14 that winter. It is not clear to me why Egypt did not just end the deal with Israel at this point and try to export more as LNG, or save it for the domestic market, but the answer is probably a series of bribes between the officials concerned (allegedly — again, I saw no direct evidence of this in the judgement yesterday). Deals like this have inertia. Millions had already been spent on the infrastructure, so Egypt and Israel renegotiated the Egyptian price to $3 per mmbtu (for a 35 cent profit per mmbtu) and proceeded. In defense of this reasoning, a pipeline is much less of a commitment than an LNG plant, both in capital and its requirement for a constant flow. The Israel price was not as much as Egypt was getting from the US (where it became the #3 source of natural gas (!) from 2006-2010) for its free-market LNG, but it also required nowhere near the infrastructure to make that transaction. One can’t wish an LNG plant into existence overnight; it takes five years to build.
The defense for Sameh Fahmy argued that gas giant Qatar was also receiving $3 per mmbtu for the gas it was selling as LNG. The fact stands that Egypt was selling maybe 3% of its total production to Israel, but 10% or more to Jordan at similar prices to fuel 80% of its electricity generation. (These sales are now suspended, because of repeated Bedouin attacks on the segment between Port Said that feeds both pipelines, and Jordan is forced to use much more expensive fuel oil). Does getting $3 when LNG is at $6 mean that the Egyptian taxpayer is subsidizing this gas? As you can tell, that is a subjective call.
There is little doubt that Fahmy and the men in power manipulated the system for personal gain, but determining what they did was illegal is essentially a political act. I believe that the media should be more transparent about the fact that state monopoly control over certain resources means that all choices — prices, production levels, trade partners, etc. — produce rents that these economic actors will fight over. The $2.65 capped production price for new gas is probably long-gone. I don’t know the new contract prices, as they are well-kept secrets. If international gas prices remain as high as they have been in the past several years (excepting the recession slump), it will be difficult for Egypt to convince the oil companies to prospect in deep water unless they pay more or let them export most of it — two unpalatable options.