Crunch Time for Egypt's Energy Mess?

Sisi is taking bold steps, including forging possible deals with Israel, to keep his country from going over a financial cliff.

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."

Mohamed el-Shahed - AFP - Getty


France Latest Country Seeking Alternative to Almighty Dollar

Smarting from a record fine on its largest bank, France wants the dollar dislodged as the global default currency.

Just days after watching its largest bank agree to pay the United States an eye-popping fine, France thinks China and Russia are on to something with their calls for doing deals in other currencies besides the dollar as a way of minimizing Washington's outsized influence on the rules of global finance.

Like Russian President Vladimir Putin when he found himself the target of U.S. sanctions over Ukraine, French Finance Minister Michel Sapin lashed out Sunday, July 6, about the dollar's status as the world's default currency. Sapin's call for rebellion against the ubiquity of the dollar comes after France's biggest bank, BNP Paribas, was socked with a record $9 billion fine last week for violating U.S. sanctions against Sudan, Iran, and Cuba.

For countries that want to avoid the long arm of U.S. law, it's an appealing idea. The dollar's dominance in international trade and finance allows the U.S. government to interfere in transactions that don't involve its citizens. A foreign bank routing money from someone in Japan to someone in Russia has to comply with U.S. laws, including sanctions, if it does so in dollars. Ergo, Putin, China, and now Sapin have a simple solution: avoid U.S. dollars -- avoid U.S. prosecutors. But it's not that easy.

Governments and markets rely on the U.S. dollar as the reserve currency not by mandate but by preference. Because the dollar is seen as stable and liquid, people choose to deal in dollars instead of local currencies. The greenback was on one side of 87 percent of foreign exchange transactions in 2013, according to the Bank for International Settlements.

Even in the case of BNP, choosing another currency probably wouldn't have gotten the bank out of trouble. BNP's U.S. operations, including investment-banking offices and 700 retail branches, hold it answerable to U.S. law regardless. Still, Sapin sees the bank's Justice Department-imposed penalty as proof that Europe needs to push for broader use of the euro.

"We [Europeans] are selling to ourselves in dollars, for instance, when we sell planes. Is that necessary? I don't think so," Sapin told the Financial Times. "I think a rebalancing is possible and necessary, not just regarding the euro but also for the big currencies of the emerging countries, which account for more and more of global trade."

But it's unclear how the French government, which is still struggling to right its own economy, could unseat the U.S. dollar.

"Not sure there is much the French (directly or through the EU) can do about that," Harvard Law School professor Hal Scott said in an email. "Short of requiring contracts of Europeans to be denominated in euros, hard to imagine them doing that."

Putin also tried to turn the Russian economy away from the dollar after the United States imposed sanctions as a cudgel to expel him from Ukraine's Crimean peninsula. Washington froze the assets of 45 people, including some of Putin's closest allies, and 19 banks and companies. When Visa and MasterCard stopped serving the blacklisted Russian banks, Putin called for a national system and threatened to eject the worldwide payment giants. But the effort to create a Russian replacement, which is expected to be long and expensive, quickly hit snags. The Kremlin has since softened its stance toward Visa and MasterCard in an effort to get the companies to join up with much less established local partners.

In May, Putin also inked a $400 billion deal to sell natural gas to China while visiting Shanghai. The long-awaited gas contract, as well as a separate agreement to use local currencies instead of the dollar, sparked concerns about a rising Moscow-Beijing economic alliance beyond the reach of Western influence -- and financial pressure.

"The problem is the lack of a compelling alternative," Marc Chandler, global head of currency strategy at Brown Brothers Harriman, wrote on his website.

"When the euro was first launched, many argued … that this was the first alternative to the dollar and business and investors would jump at the opportunity," Chandler continued. "They really haven't."

The use of greenbacks is actually on the rise. The percentage of transactions involving dollars on one side increased from 85 percent to 87 percent between 2010 and 2013, while the percentage of transactions involving euros fell from 39 percent to 33 percent. The use of the Chinese renminbi, which some have advocated as a replacement for the dollar, is up -- from 1 percent to 2 percent between 2010 and 2013.