Rising oil bill may erase Egypt's savings from gas milestone

CAIRO (Bloomberg) -- No sooner has Egypt achieved its milestone of regaining self-sufficiency in natural gas than another corner of the energy market threatens to deal a new blow to fragile government finances.

A six-fold increase in production at the giant offshore Zohr field means Egypt can now meet its own needs domestically. The government may now save some $2 billion a year after receiving what it said was the final shipment of expensive liquefied natural gas last week. But relief for the most populous Arab country -- a net importer of refined gasoline and diesel -- could be short-lived.

Egypt’s 2018-2019 budget assumes oil prices at $67/bbl but crude has already surged past $80, threatening plans to cut the deficit under an economic overhaul program backed by a $12-billion International Monetary Fund loan. It also poses a dilemma for the government, which had sought to phase out fuel subsidies by mid-2019; burden the population by lifting prices higher and faster than expected or abandon its deficit target altogether.

“It boils down to a political choice for the government: either raise prices sharply and face social discontent, or find other sources of funding such as raising taxes on the rich,” said Salma Hussein, a researcher with the Cairo-based Egyptian Initiative for Personal Rights. “The government will probably choose what it did in the past couple of years -- increase borrowing, in addition to cutting subsidies and wages.”

Egypt’s population of nearly 100 million has seen real incomes gutted since the pound was allowed to trade freely in 2016, propelling inflation to over 30% for much of last year. The nation has seen three rounds of cuts in fuel subsidies since then, and removing them altogether is certain to inflict more pain on households.

The North African nation already faces an uphill struggle to reach its goal of cutting the budget deficit to 8.4% of gross domestic product in the current fiscal year, which ends in the middle of 2019. Foreign investors are shunning local-currency treasuries and the government’s cost of borrowing has risen since the fiscal year started in July.

Every dollar above its budgeted oil price translates into 4 billion pounds ($222 million) in additional expenditure annually. The government plans to spend 89 billion pounds on fuel subsidies in the current year, a figure that may double if oil continues to rally. Under official estimates, the fiscal deficit will reach 439 billion pounds this year.

The nation’s trade balance will also suffer, potentially wiping out gains from ending LNG imports. Every extra $10 in oil prices add $1 billion to $1.2 billion to Egypt’s current-account deficit, according to estimates by Mohamed Abu Basha, head of macro analysis at Cairo-based EFG-Hermes investment bank.

Wary of such risks, Egypt had made an agreement with Citigroup Inc. and JP Morgan Chase & Co. to hedge against fluctuations in oil prices. The plan, however, hasn’t been implemented as a result of the surge in prices, Finance Minister Mohamed Maait said Sept. 19.

Although a revenue increase from Egypt’s own oil exports should partially mitigate some of the impact on the budget and the balance of payments from higher crude prices, the net effect will likely be negative, Abu Basha said.

Brent crude traded around a four-year high of $84.9/bbl on Wednesday as markets tighten ahead of U.S. sanctions on Iran and plummeting Venezuelan production.

OPEC’s largest producer, Saudi Arabia, said it had boosted production to near-record levels.

If oil stabilized above $80, the coming fuel price hike planned for the middle of next year will be “more costly from an inflation perspective,” according to EFG-Hermes. That, in turn, will mean interest rates -- which were slated to drop in the current fiscal year -- will likely remain elevated for a longer period of time, it said.

While the outlook for oil holds out little promise for Egypt, the country is fast emerging as a regional hub for gas re-exports to its neighbors. Two recent deals paved the way for Egypt to pipe in Israeli and Cypriot gas, likely for liquefaction and shipment to Europe.

Becoming self-sufficient not only allows Egypt to reduce imports by about $2 billion a year, “but will also increase direct investment in energy-related industries,” said Hany Farahat, senior economist at CI Capital in Cairo.