A worsening gas supply crunch in Egypt has prompted BG Group to issue force majeure notices under its LNG agreements in the country because of continuing diversions of gas to the domestic market and away from LNG production at its Egyptian LNG plant.
The announcement on the 27th January – accompanied by more bad news from the United States related to lower-than-expected gas prices – led to a 14% fall in the company’s share price, little more than a year after BG’s previous crisis in the autumn of 2012, which also had a devastating effect on the company’s value. Just 11 days before the announcement, on 16th January, BG’s shares had been trading at 1,351p. By the 28th they were trading at 1,053p, a 22% fall on that recent peak.
Growing gas crisis: The force majeure decision, shocking as it was, did not come as a complete surprise, given the impact that Egypt’s growing gas crisis has had on exports of both pipeline gas and LNG. Both of Egypt’s LNG projects have been hard hit. The single-train Segas plant at Damietta lies quiet – having last produced LNG in December 2012 – while the two-train Egyptian LNG plant at Idku spent much of 2012 running at around a third of its capacity. In 2012 Egyptian LNG production was just 4.7 million tonnes (mt). For 2013 it will struggle to exceed 3 mt.
As well as issuing force majeure notices, BG also gave an update on the outlook for 2014, ahead of the publication of preliminary 2013 fourth quarter and full year results on 4th February.
“Very disappointing” Commenting on the update, CEO Chris Finlayson said: “Despite the good progress we have made in 2013 we face short-term issues which are reflected in our revised 2014 guidance. This is very disappointing.
“We have elected to issue force majeure notices in Egypt reflecting the ongoing diversions of gas volumes to the domestic market. Year-on-year decline in Egypt and the US are the drivers of volume decline from 2013 to 2014, with the rest of the base portfolio broadly flat overall.
“The contribution from our key growth projects in Brazil and Australia, which remain on budget and schedule, is increasing, but the growing asset base and higher royalties, combined with the decline in production, are leading to higher unit operating costs in 2014. However, our long-term strategy remains unchanged, our capital expenditure level will decline and we continue to expect to be free cash flow positive in 2015.”
For 2013, BG expects to report production volumes of 633,000 barrels of oil equivalent (boe) and total operating profit for the LNG shipping and marketing business of $2.6 billion – both of which are “in line with guidance”. However, there will be non-cash, post-tax impairments totalling $2.4 billion, of which $1.3 billion is associated with Egypt and $1.1 billion with the United States.
LNG hopes: A decade ago Egypt looked set to become a major-league LNG producer. Construction work was in full swing on two liquefaction projects and both had ambitious plans for expansion. The Segas plant at Damietta was constructing its single 5.5 mtpa train and the partners in the project had their eyes set on building a second. The Egyptian LNG (ELNG) project at Idku was constructing two 3.6 mtpa trains on a site that the partners said had room for up to six such trains. If all these trains had been constructed, Egypt would today have had LNG capacity of close to 32 mtpa.
The first train at Damietta – the world’s largest at the time it started up – began operating in December 2004 and delivered its first cargo at the start of 2005. The proposed second train was never built. Both the ELNG trains came on stream in 2005 but, again, no more have been built.
Export exuberance: Egypt’s export exuberance of the early 2000s was largely the result of a string of impressive exploration successes during the 1990s and a crude-linked gas pricing structure that encouraged prompt development of the fields that had been found. By the turn of the millennium Egypt was facing oversupply and the government – keen to maximise revenue from gas development – revised the pricing structure, effectively ending oil linkage and capping payments at $2.65/MMBtu, and set in motion its various export projects.
The first real sign that Egypt was facing supply problems came as long ago as 2008, when the government imposed a moratorium on new exports. The moratorium was to be lifted in 2010 but by then it was becoming clear that Egypt was sooner or later going to have to import gas.
Even before the revolution that saw the downfall of former president Hosni Mubarak in 2011, Egypt’s LNG production had been on a downward trend for several years. Having peaked at 10.6 mt in 2006, total production fell to 10.0 mt in 2008 and to just 4.7 mt in 2012.
The commercial structure of the ELNG project at Idku is illustrated in the chart above. BG Group and Malaysia’s Petronas are the largest shareholders in both trains. EGPC and EGAS each hold 12% in both trains, while GDF Suez has a small stake in train 1, from which it is the sole off-taker, under a 20-year sales and purchase agreement (SPA). BG is the sole off-taker from train 2, again under a 20-year contract.
What now for Egypt? It is easier to state the problems that Egypt faces in addressing its energy crisis than to come up with easy solutions. What has become increasingly clear is that short-term palliatives will not stop the situation from worsening.
Most informed observers see the country’s massive subsidies bill as a major issue, because of the effect it has on demand growth and because the government simply cannot afford it. Reforms have begun but it remains to be seen whether they will be carried through and how effective they will be.
Somehow the government needs to find the money to meet its commitments to foreign companies, if they are not to pull out, which would leave Egypt in a worse situation than it is now. BG is not the only company that has been keeping its investments in Egypt under “continuous review”.
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