Monday, April 30, 2012

Mills - Power Play

Egypt may think it struck a blow against Israel by canceling a gas deal between the two countries. But all it really did was shoot itself in the foot.

Robin M. Mills..
Foreign Policy..
27 April '12..

It must be serious news to make Israel's ultra-hawkish foreign minister turn conciliatory. Yet Avigdor Lieberman described Egypt's April 22 cancellation of its deal to supply Israel with natural gas as "a trade dispute," minimizing the political repercussions of the end to the most significant economic tie between the two erstwhile adversaries. "To turn a business dispute into a diplomatic dispute would be a mistake," Lieberman counseled.

At first sight, the deal's cancellation is a blow to Israel. During normal times, 40 percent of its gas needs were met by Egypt. In the deal's absence, Israel's utility company has raised its rates by a third and has turned to burning expensive, dirty fuel oil. Even so, there are fears of blackouts this summer.

The formal cutoff was only the postscript to a long series of interruptions to the gas supply. The pipelines in the Sinai Peninsula have been bombed some 14 times since Egypt's revolution as law and order has broken down and Bedouin tribes have revenged their grievances against the government. Gas flowed to Israel for only 140 days last year, and 25 days in the first three months of this year.

Other Israeli politicians were not as sanguine as Lieberman. Finance Minister Yuval Steinitz worried that the cancellation was "a dangerous precedent which casts a shadow on the peace agreements and the peaceful atmosphere between Egypt and Israel."

Yet the cancellation is neither a challenge to the Camp David Accords nor a purely commercial matter. The decision is instead a product of Egypt's muddled domestic politics, which means short-term pain for Tel Aviv but a longer-term strategic defeat for Cairo. As for the law, it's at least debatable: The 1979 peace treaty obliges Egypt and Israel to maintain normal economic relations, but the gas deal is dealt with in a 2005 memorandum of understanding referencing the treaty. Such memoranda are generally considered nonbinding in international law.

The gas deal with Israel has long been deeply unpopular in Egypt. Quite apart from the unpopularity of trading with a regional pariah, the deal is seen as a giveaway. The price for the gas was initially as low as $1.25 per million British thermal units (MMBtu) and was reportedly increased to $4 in 2008 -- the same as Egyptian industries pay. In the absence of a regional benchmark at the time of the deal in 2005, the price might have been defensible, but it now seems very low compared with the $7 to $10 Egypt earns for exports to Southern Europe.

The Egyptian Natural Gas Holding Company (EGAS), the Egyptian company that canceled the deal, explained its decision by saying that the East Mediterranean Gas Company (EMG), the Egyptian-Israeli joint venture that runs the pipeline, had failed to pay for the gas. But EMG had already last October launched arbitration proceedings against EGAS, with total claims amounting to some $8 billion, due to the repeated interruptions in supply caused by pipeline bombings. So it seems likely that's not the whole story.

Still, the timing of the cutoff is strange, as the gas contract has in recent months not been high in the public's consciousness. It is also hard not to speculate how the tumultuous politics in Cairo played into this decision. If it was sanctioned by the ruling Supreme Council of the Armed Forces (SCAF), was the aim to take credit for a popular initiative ahead of the presidential election -- and if so, why has SCAF not claimed responsibility? Or was the intention to remove a potentially thorny issue from the agenda of the new president, or alternatively to deny him such a populist victory? Given the tumultuous and often opaque political scene in Cairo nowadays, observers can do little more than wonder.

Rather than being an orchestrated maneuver for political advantage, it is also possible that the termination is one more part of Egypt's chaotic, mismanaged transition. Former officials in Hosni Mubarak's regime who allegedly enriched themselves off the gas deal have increasingly been on the receiving end of public anger. Quintessential crony capitalist Hussein Salem, a Mubarak intimate, was convicted in absentia last October on corruption charges related to the deal, and his protégé, former Petroleum Minister Sameh Fahmy, was arrested on similar charges more than a year ago and is currently facing trial. Informed sources have suggested to me that Fahmy's successor, Abdullah Ghorab, was apparently not involved in the decision to annul the contract, which may have been made by senior EGAS personnel fearful of prosecution or public anger.

The cutoff may also be part of rather heavy-handed negotiation tactics to compel the Israeli side to pay a higher price. Compared with the alternative of burning fuel oil, a short-term price as high as $16 per MMBtu might still be competitive. Indeed, Egypt's minister of international cooperation, Fayza Abul Naga -- who is already seen on the world stage as decidedly uncooperative due to her central role in the prosecution of American NGO workers in Egypt -- said on April 23 that the country was ready to resume supplies, albeit at a higher price.

Whatever the reason for the decision, it has squandered one of the Egyptian energy industry's most precious resources. The one thing more important for gas customers than attractive prices is security. As Algeria discovered in the early 1980s and Russia and Ukraine in 2009, once a gas supplier gains a reputation for unreliability, it is very hard to shake off. With the pipeline bombings and now this contractual action, Egypt has squandered a lot of hard-won trust.

This incident marks the definitive end of a very successful period for Egypt's gas industry. Beginning in the early 1990s, Cairo liberalized its natural gas exploration policy, invited foreign investment, and developed new gas exports, including building liquefied natural gas (LNG) plants and pipelines to Israel and its Arab neighbors Jordan and Syria. Major new fields were found offshore in the Nile Delta, and in the two decades since 1990, gas reserves increased nearly sixfold and production almost eightfold.

But this policy had already run into trouble before the revolution. Low, fixed prices made new developments unviable, while encouraging demand to grow at 9 percent annually. Egypt's LNG plants are running below capacity, and its promising shale-gas potential and new offshore fields will not be exploited without price increases. Political paralysis in Cairo, however, makes it all but impossible to reform the subsidized domestic market.

The horizon of Egypt's gas sector is also steadily shrinking. Ambitious plans to expand the Arab Gas Pipeline as far as Turkey, to link it to the European market, have been relegated to the realm of dreams. It also remains to be seen whether prices to Jordan will be raised further or whether that deal too will be annulled. Hassan Younis, minister of electricity and energy, made it clear that the gas originally sent to Israel will now be diverted to the domestic market. But despite claims that Egypt could benefit from using the gas at home, the 2.1 billion cubic meters (BCM) shipped in 2010 is a small part of Egypt's total output of 61 BCM.

Israel will suffer some short-term pain for Egypt's decision. It has already begun contingency plans, however, stepping up output from its existing domestic fields and planning a fast-tracked LNG import terminal. It could be operational as early as the end of this year and would more than replace the lost Egyptian gas -- though at three times the price.

Additionally, while Egypt's gas future looks gloomy without major reforms, Israel's has been transformed by new discoveries in the deep waters of the eastern Mediterranean. The first big find, the Tamar gas field, is due to start production in April 2013. Egypt has thus given Israel a useful opportunity not only to escape from a deal that was about to become unnecessary, but also to claim damages and the moral high ground.

The timing is admittedly awkward for Israel, given that its electricity company has been negotiating gas purchase agreements with the companies developing Tamar at the same time as the Knesset passed a law imposing higher taxes and royalties on profits from the fields. Now -- with the energy companies aware that Israel needs their gas supplies more than ever before -- the electricity company's bargaining position has weakened significantly.

But in the longer term, the picture is bright. Even without Tamar, the Leviathan gas field alone -- found in 2010 and due to enter production in 2017 -- could supply increasing Israeli demand up to 2030 and still have a 20-year reserve remaining. With significant remaining exploration potential, Israel could therefore become a major exporter. Energy-poor Jordan is a likely market; the Hashemite Kingdom is already set to lose $2.1 billion this year due to the pipeline bombings. The other countries on the eastern shore of the Mediterranean, Syria and Lebanon, are obviously not possible customers for Israel, barring a seismic political realignment. Iraq should be the major supplier for these countries, but Baghdad is locked in a lengthy internal debate concerning gas requirements for domestic use.

In a remarkable role reversal, it is even conceivable that Israel could end up sending gas to Egypt. Or Israel may expand its share in the European market by becoming a significant LNG exporter in its own right, perhaps via Cyprus, which enjoyed a significant discovery of its own last October. Either way, Israel draws its neighbors closer into its economic orbit, while at the same time diminishing Egypt's role. This will also strengthen the determination of Lieberman and Prime Minister Benjamin Netanyahu to press ahead with offshore gas development despite territorial disputes with Lebanon and Turkey (via the conflict over the divided island of Cyprus).

The cancellation of the unloved gas deal should not be overplayed as a token of hostility from the new Egypt toward Israel. But it does remove one plank of their already shaky economic cooperation. And it demonstrates that, under its current leadership, Egypt's political and economic clout is further dwindling at the very moment that Tel Aviv has landed an unexpected windfall.


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