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Egypt natural gas outlook | Sector developments reconfirm long-term deficit

Maintain expectation of a sustained long-term gas deficit. We cut our demand estimates by 4-7% over 2018-21, mainly due to the impact of global externalities (higher oil prices and capital outflows from EM economies), on economic growth and gas demand. We hold our supply and pricing forecasts roughly unchanged. We also maintain our view that Egypt will remain a gas deficit nation beyond 2020e, despite the drastic supply improvement – Egypt’s natural gas supply should grow at a 2017-20e CAGR of 17.2% – as growing demand needs absorb the majority of new supply. Over 2019-20e, we expect Egypt to barely reach self-sufficiency, with no scope for exports. A recent USD15bn deal was signed to import natural gas from Israel, which we expect to materialise only beyond 2020, when Egypt’s gas deficit resurfaces. Sector reforms should continue until the gas market is fully liberalised and most users receive gas at the import price parity of USD8-9/mmBtu. We see limited impact from higher gas prices on our industrial coverage universe, as the majority of players either operate on other fuel sources or should be able to pass higher gas prices to end consumers.   

Energy subsidy cuts in line; more major price jumps needed for full liberalisation.  Over Jun-Jul 2018, the government went through another round of energy subsidy cuts, raising the natural gas price for residential users by c50%, fuel prices by 45%, and power prices by 30-34%, on average. This comes in line with our expectation of a rising energy cost and price curve over 2017-20e, despite the improving supply. We estimate that another 127% increase in average residential natural gas price, 43% in average fuel prices, and 145% in average power prices are needed for the full liberalisation of energy prices in Egypt. The government spared industrial users from higher natural gas prices for this leg of the subsidy cut, but we believe that eventually, most users should be getting gas at the import price parity of USD8-9/mmBtu.

Shifting new power generation project awards to coal and alternatives. After Egypt’s USD6.6bn 14.4GW gas-fired power plants were awarded in Aug-15, new power generation project awards are mostly shifting towards coal and alternative fuels. USD11.7bn of non-gas fired power generation projects were awarded since 2015 to date vs. only USD2.1bn in total over 2000-2015. The government, in our view, is willing to alleviate the pressure facing the natural gas market in the long run by investing in power generation capacities that run on other fuel than natural gas. We expect this to change the fuel mix within Egypt’s power plants to 75% NG/HFO and 25% coal/alternatives in 2022e, compared to the current 91% NG/HFO and 9% alternatives.

Economic implications and key beneficiaries. We calculate the total natural gas production cost to the government to rise gradually to USD6.7bn in 2018 and USD8.3bn in 2019e, from USD5.3bn in 2017, since the local gas production from the new fields is costlier than old fields. This comes despite the improving local gas supply, pressuring the government to shift the burden to end consumers through continued energy price hikes over 2019-20e. A faster-than-expected pace of coal and alternative fuel usage in power plants can pose significant upside, and delay the pace of natural gas price increases. Within our coverage, we see Orascom Construction [Overweight |TP USD11.5 / EGP203] and Elsewedy Electric [Neutral | TP EGP165] best-positioned to capitalise on the new non-gas fired power generation project awards.