Crunch Time for Egypt’s Energy Mess?

Egypt is so desperate to finally come to grips with its energy and fiscal nightmares that its new government is doing the once unthinkable: rolling back generous domestic fuel subsidies and opening the door to imported natural gas from Israel.

The moves are hitting ordinary Egyptians in the pocketbook and angering those who have grown up on a steady diet of anti-Israel propaganda. Over the weekend, Egypt abruptly hiked domestic prices for energy products such as gasoline and diesel by almost 80 percent, a step that has the potential to send food prices skyrocketing as well. Egyptian officials are also speaking more warmly about Israel than they have in years. Oil Minister Sherif Ismail told Egyptian media recently that deals with Israel are "no longer taboo," and that, given the economic crisis, importing gas from Israel is not cause for "embarrassment."

Taken together, the policy shifts underscore how the country has reached a breaking point in its efforts to overcome long-standing problems with its economy that, if left untreated, could end up blowing up the new government of former defense chief Abdel Fattah al-Sisi. But taking action is not without its own dangers: Raising energy prices risks sparking a public backlash, and closer ties with Israel have been especially politically sensitive in post-Mubarak Egypt.

Still, Sisi and his advisors don’t have much of a choice if they want to finally address the two-pronged problem plaguing the economies of Egypt and many others in the region. Egypt, to put it bluntly, has little money, in part because it pours about more than $10 billion a year, or roughly 10 percent of its GDP, into efforts to subsidize cheap fuel at home: Before the reforms, diesel cost about 70 cents a gallon in Egypt, versus about $4 in the United States. In the past, Egypt earned export revenues from shipping natural gas to Europe. But booming domestic demand across Egypt — spurred, in part, by those very subsidies — has outstripped production, meaning there’s not enough natural gas left to send overseas.

That has left gas export terminals sputtering, government revenues waning, and foreign energy firms fuming. That’s where importing gas from Israel could help — if the companies involved can reach a deal on price and if both governments sign off on the deal. Bringing Israeli gas to Egypt would enable the country to restart gas exports, but some portion of Israeli gas would also likely to have to be set aside to serve the domestic Egyptian market.

Increasing gas exports again would be good for Egyptian government coffers. But politically, with blackouts rampant and factories struggling to get the energy they need, shipping more gas overseas could cause trouble. Carving off a slice of that Israeli gas to feed the Egyptian market could soothe political worries at home — but may not sit too well with companies, such as BG Group PLC, that have already suffered plenty from a downturn in their gas export business from Egypt.

The prospect of importing gas from Israel illustrates just how dramatically the country’s energy position has deteriorated in recent years. In the late 1990s, Egypt started exporting liquefied natural gas (LNG) to customers in Europe, and in 2008 it began exporting natural gas to Israel. That trade was abruptly stopped in 2012, due both to falling Egyptian gas supplies and rising tensions between Israel and Egypt after the 2011 revolution that brought down former strongman Hosni Mubarak.

Both production and exports of Egyptian natural gas peaked in 2009; production has slipped steadily since, and soaring domestic demand has helped cut exports by more than half over the past five years. Egypt is so desperate for the very gas it recently exported that it hopes to build a floating terminal on the Red Sea to import expensive LNG itself. Israel, meanwhile, is busy tapping its vast offshore oil and gas fields in the hopes of becoming a big energy exporter in the region, with Egypt a natural — if wary — customer.

Last week, BG, a large British gas company, signed a letter of intent with the companies running Israel’s big Leviathan field to transport gas via an undersea pipeline to Egypt. The preliminary deal, which could be worth about $30 billion over 15 years, would help BG get much of the gas it needs to run its export terminal on the Egyptian coast, where gas is turned into LNG for export to Europe. It comes less than two months after the partners at another Israeli gas field, Tamar, announced a similar letter of intent to ship gas to another LNG facility in Egypt. (Noble Energy helps both Israeli operations actually extract the gas.)

Israeli gas exports to Egypt aren’t a done deal. Both governments have to sign off on any accord, and final pricing terms still need to be determined. But the Egyptian government seems to be increasingly comfortable with the idea of relying, in part, on Israeli energy to keep its economy afloat — as long as some of the gas is kept for domestic use. One Egyptian government oil official told the Wall Street Journal, "Things are different in Egypt now and we see no issue in this deal if it is beneficial for the country."

Laura El-Katiri, a specialist on the Middle East and a research fellow at the Oxford Institute for Energy Studies in London, said a deal with Israel makes sense for both countries. "There’s no cheaper way to get gas at the moment in Egypt," she said.

Importing Israeli gas, in any event, likely won’t materialize until the completion of the new pipelines later this decade. In the short term, tackling the energy subsidies will have the biggest immediate impact — and potentially the biggest risks.

The 80 percent spike in the prices of gasoline and diesel came just days after the Egyptian government began gradually raising the price of electricity. In real terms, even after the price hikes, energy prices are still artificially low in Egypt — diesel, for example, is still less than $1 a gallon even after the increase. But the government’s move has folks on the street grumbling about pricier public transport and fuel costs for small businesses. There are also concerns that higher energy costs will trickle down — through transport and agriculture — to raise the cost of food. Expensive bread was one of the sparks that lit the 2011 revolution. That the government is knowingly accepting those risks today highlights just how dire its +fiscal situation has become.

"Either Egypt had to hit the brakes themselves, or they’d hit the wall. Those were the options. And Sisi decided to hit the brakes," said Matthew Reed, vice president at Foreign Reports, a consultancy that specializes in Middle East oil issues.

He said that Sisi’s bold move contrasts with the caution of former president Mohamed Morsi, who, despite being a popularly elected Islamist politician, didn’t even dare to raise so-called "sin taxes" on cigarettes and alcohol. Sisi, who is known to drink with visiting American dignitaries, did so almost immediately after taking power.

"Sisi is unique now for having walked the walk," Reed said, and the nascent reforms could reopen the door for Egypt to receive a long-stalled, $4.8 billion loan from the International Monetary Fund that it desperately needs to close a looming budget gap. The IMF has insisted Egypt make fundamental economic reforms, including reining in runaway energy subsidies.

The full impact of rolling back energy subsidies will become clearer over the summer, right when Egyptian tempers are likely to be further frayed by ever-present electricity blackouts — caused in part by domestic shortages of natural gas — that cut power to the country’s air conditioners, televisions, and fans. Sisi’s resounding electoral victory could shield him from the worst of the public backlash, and may have made this the least bad time to start the painful but necessary reforms, El-Katiri said.

"He didn’t do this because he thinks it’s popular," she said. "It is five minutes to midnight there, in terms of timing."