This Selected Issues paper on the Arab Republic of Egypt examines the dynamic relationship between the nominal exchange rate and prices during Egypt’s exit from a managed exchange rate regime. The exit from the peg went through several phases, including a series of step devaluations between 2000 and 2002, a first attempt at a float in January 2003, and the successful transition to a unified, flexible exchange rate system in late-2004. From 2000 to 2004, the Egyptian pound experienced a cumulative depreciation of 68 percent against the U.S. dollar.

Abstract

This Selected Issues paper on the Arab Republic of Egypt examines the dynamic relationship between the nominal exchange rate and prices during Egypt’s exit from a managed exchange rate regime. The exit from the peg went through several phases, including a series of step devaluations between 2000 and 2002, a first attempt at a float in January 2003, and the successful transition to a unified, flexible exchange rate system in late-2004. From 2000 to 2004, the Egyptian pound experienced a cumulative depreciation of 68 percent against the U.S. dollar.

IV. The Oil and Gas Sector in the Balance of Payments27

A. Introduction

49. The oil and gas sector plays a more prominent role in the Egyptian economy than what is depicted at present in balance of payments data. The two main reasons are:

  • Crude oil exports are not recorded accurately. As a result, the oil trade balance consistently appears weaker than it should be. The official balance of payments misleadingly portrayed Egypt as a net importer of oil from 1998/99–2001/02.

  • Foreign direct investment in the oil and gas sector is also not recorded accurately; some foreign–financed investments in the hydrocarbon sector are not included in the balance of payments, making the financial account consistently weaker than what it should be.

50. While oil production has been on a declining trend over the past decade, gas output has doubled in the past five years and is expected to almost double again in the coming five. The expansion of gas production will turn Egypt into a major gas exporter over the medium term. Financial flows related to the gas sector will therefore become increasingly important for Egypt’s balance of payments.

51. Accurate and comprehensive recording of balance of payments flows related to the operations of the oil and gas sector will increase the information content of the balance of payments. This chapter will review current recording practices focusing on the data of recent years, outline how a more accurate and comprehensive recording of oil and gas flows would have affected the main balance of payments aggregates, and present medium–term projections of the balance of payments flows related to the oil and gas sector.

B. Basic Trends in Egypt’s Oil and Gas Sector

52. Oil production has been on a declining path since the mid–1990s, when output exceeded 900,000 barrels per day (bpd) (Figure 1).28 In combination with the gradual increase in domestic consumption, the net quantity of oil available for exports has been shrinking rapidly. EGPC’s annual report for 2002/03 indicates that Egypt’s production of crude oil, condensate, and LPG in the reporting year averaged 719,000 bpd. Consumption of petroleum products (including LPG) averaged 461,000 bpd, leaving 258,000 bpd for net exports. These estimates would have made Egypt about the 20th largest oil exporting country in the world in 2003. Egypt’s proven oil reserves amounted to 3.6 billion barrels in mid–2003. Ongoing exploration activities are expected to add to these reserves. On this basis, oil production is expected to be maintained near current levels (590,000 bpd of crude oil, 70,000 bpd of condensate, and 40,000 bpd of LPG) through 2020.

Figure 1.
Figure 1.

Egypt: Production and Consumption of Oil, 1994/95–2003/04

(In thousands of barrels per day)

Citation: IMF Staff Country Reports 2005, 179; 10.5089/9781451811858.002.A004

Source: Egypt General Petroleum Company.

53. Egypt is developing rapidly its large gas reserves. Gas production was approximating 30 billion cubic meters in 2002/03, about double what was produced five years earlier (Figure 2). Until recently, domestic consumption moved in tandem with production, leaving no room for exports. However, five major gas projects, currently at varying stages of development, are expected to raise annualgas production to 50 billion cubic meters by 2008 (Appendix IV.1). In most cases, contracts have already been signed to sell abroad the additional output of the new projects. Full execution of these contracts could place Egypt among the 10 largest net exporters of natural gas (in terms of 2003 levels) in the world (Table 1). Natural gas reserves were officially estimated at 66 trillion cubic feet (tcf) as of end–2004.29 Additional probable reserves have been estimated at 100 tcf. The proven gas reserves would be sufficient to last some 40 years based on projected output in 2008, the year that all currently contracted production is forecast to come on–stream.

Figure 2:
Figure 2:

Egypt: Production of Gas, 1994/95–2002/03

(In billions of cubic meters)

Citation: IMF Staff Country Reports 2005, 179; 10.5089/9781451811858.002.A004

Source: Egypt General Petroleum Company.
Table 1.

Ten Largest Net Gas exporters in 2003

(in billions of cubic meters)

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Sources: IEA, BP, Egyptian authorities.

C. Oil and Gas in the Balance of Payments

54. Foreign companies play a key role in the production of oil and gas in Egypt. Virtually all stages of the production process involve balance of payments flows.

  • Exploration activities in Egypt are mostly conducted by foreign companies. According to best practices, all expenses incurred by foreign companies for exploration purposes should be classified as inflows of foreign direct investment in the financial account of the balance of payments, even when no oil or gas is found (see IMF (2003), p. 50). To the extent that the exploration activities involve the use of (capital) goods and services sourced from abroad, these expenses should be recorded as outflows in the current account of the balance of payments.

  • Foreign companies also take the lead in developing the fields and setting up the related infrastructure after oil or gas has been found. The financing of all spending on rigs, drilling equipment, pipelines, etc., also should be classified as foreign direct investment in the financial account of the balance of payments. To the extent that the production activities make use of inputs, such as goods and services sourced from abroad, these should be recorded as outflows in the current account of the balance of payments.

  • The oil and gas that is sold outside the producing country (Egypt) ought to be recorded as exports in the current account of the balance of payments.

  • Remittances of foreign oil and gas companies’ profits to their headquarters should be recorded as outflows in the services account of the current account of the balance of payments. Reinvested earnings are to be recorded in both the current account (as an outflow) and the financial account (as an inflow).

The involvement of foreign companies in the exploration, production, and export of oil and gas therefore gives rise to four important categories of balance of payments flows: two inflows (foreign direct investment to finance the capital costs of exploration and production, and revenues generated by the sale of oil and gas on the international market) and two outflows (foreign exchange used to pay for (capital) goods and services sourced from abroad and profit remittances by foreign oil and gas companies).

D. Oil and Gas in Egypt’s Balance of Payments

55. The Egypt General Petroleum Corporation (EGPC), a state–owned entity, is a partner in all oil and gas projects in Egypt, either through its stake in joint–venture companies (JVCs) set up to operate individual projects, or through production sharing agreements. EGPC may finance investments in downstream operations (e.g., the domestic refineries and pipelines to and from the refineries), but it does not provide financing for upstream projects. Consequently, all other things equal, foreign direct investment (FDI) in Egypt’s oil and gas sector is probably higher than what it would have been if the EGPC were allowed to invest in the upstream oil and gas sector. Conversely, the foreign oil and gas companies participating in Egypt’s JVCs receive a larger share of the oil and gas produced to offset their investment costs than would otherwise be the case.

56. The recording of flows related to the oil and gas sector in Egypt’s balance of payments does not adhere to the best practices outlined in Section C. A key source of data used in the compilation of Egypt’s balance of payments is the international transactions reporting system (ITRS). Under this reporting system, resident commercial banks and authorized dealers in foreign exchange submit detailed statements on the foreign exchange transactions of their customers to the Central Bank of Egypt (CBE). The CBE then uses the ITRS to produce estimates of profit remittances by joint venture partners and operators of the production sharing agreements in the oil and gas sector (US$559 million and US$686 million in 2002/03 and 2003/04, respectively).30 A cross–check with alternative data sources and a comparison with best practices in balance of payments recording suggest four major shortcomings:

  • First, Egypt’s balance of payments underestimates inflows of FDI, particularly in the oil and gas sector. Table 2 presents the official (CBE) estimates of FDI net inflows and staff estimates of FDI in the oil and gas sector from 1999/2000 to 2003/04, derived from data compiled and published by the General Authority for Investment (GAFI). As the table shows, the difference between these two estimates may have been of the order of US$2–3 billion (2.5–3.7 percent of GDP) in the last two fiscal years.

  • Second, sales of crude oil and petroleum products abroad by foreign companies are not recorded in official export figures. The CBE uses EGPC estimates of exports and imports of crude oil and petroleum products. This data does include (as imports) the purchases of crude oil by the EGPC from foreign companies for the domestic refineries, but does not include crude oil sold abroad by foreign companies. As a result, Egypt’s export data has underestimated net exports of crude oil and petroleum products by approximately US$1 billion per annum in the past two years (Box 1).

  • Third, some financial transactions between the EGPC and its foreign partners are incorrectly recorded in the balance of payments. Egypt’s service and income account contains the item “invisible receipts of the EGPC”, which record inflows of about US$1.1 billion in the last two years. According to CBE officials, this item reflects foreign exchange obtained by the EGPC from foreign oil companies to pay domestic workers, suppliers, as well as taxes. If this is indeed the case, the transaction should not be included in the balance of payments as it represents a transfer of foreign exchange between partners that does not involve a cross–border transaction.

  • Fourth, exports of gas are not yet separately identified in the official balance of payments. EGPC data indicate that gas export revenues amounted to US$57 million in 2003/04, but it is not clear whether those gas exports were included in the CBE’s export figures.

Table 2.

Egypt: Estimates of Foreign Direct Investment

(In millions of U.S. dollars)

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Sources: Central Bank of Egypt; GAFI, Ministry of Finance; and IMF staff estimates.

Assumes implementation rate of 90 percent of commitments recorded with GAFI.

Assumes implementation rate of 80 percent of commitments recorded with GAFI.

Egypt: The Net Oil Trade Balance in 2002/03

The balance of payments published by the Central Bank of Egypt shows a net oil trade balance of US$850 million in 2002/03.

Net Oil Trade Balance

(In U.S.$ billions)

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Volume data provided by the EGPC implies a net oil trade surplus of about US$1.9 billion in 2002/03. According to these data, the volume of net exports of crude oil and petroleum products in that year was at least 9.34 million metric tons (MT). This estimate was obtained as follows:

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Using the average WEO oil price for 2002/03 (U$27.87 per barrel), this would imply a net oil trade balance of roughly US$1.9 billion.2

1 It is assumed that all bunker and aviation fuel is sold to domestic shipping companies and airlines.2 Using a conversion factor of 7.331 barrels per metric ton.

E. Revisions to Oil and Gas–Related Flows: An Illustration

57. The possible impact of revising Egypt’s official balance of payments estimates using alternative data sources for oil and gas–related flows and standard methodologies for balance of payments recording was investigated. The revisions take into account the deficiencies in the recording of FDI inflows, exports of crude oil and gas, and the “invisible receipts of the EGPC” identified in the previous section. Table 3 compares CBE estimates of the balance of payments for 2000/01–2003/04 with the revisions undertaken by staff.31 The exercise yields three key results:

  • Egypt’s trade balance and oil trade balance seem to be considerably stronger than suggested by the CBE data (by about US$1.4 billion in 2003/04).

  • Egypt’s service balance appears to be weaker than what is reported in the CBE data (by about US$1 billion in 2003/04), due mainly to the elimination of the “invisible receipts of the EGPC” item.32

  • Net FDI inflows would appear to be significantly higher than recorded in the CBE balance of payments, owing to the omission of FDI of oil and gas companies (between US$1.5 billion (2000/01) and US$3.2 billion (2003/04)).

58. The sizable revisions to key balance of payments aggregates resulting from this exercise raise questions about the quality of the non–oil current account data. For example, the illustrative estimates for FDI and the oil trade balance would imply, all other things equal, very large unrecorded balance of payments outflows (negative errors and omissions) of US$5.3 billion, or almost 7 percent of GDP in 2003/04. Alternatively, the non–oil current account balance would have to be weaker than what is implied by the CBE estimates.

59. The medium–term projections presented in Table 3 suggest that Egypt’s net oil and gas trade balance will post surpluses of around US$5 billion per annum until the end of this decade. This is a major improvement compared to the annual average net oil and gas trade balance of US$400 million implied by the official balance of payments data for the period 2000/01-2003/04. The emerging gas export sector accounts for half of this increase. Other factors contributing to this improvement include a more comprehensive recording of oil exports, higher oil prices projections in the medium term, and increased scope for crude oil exports following Egypt’s move towards gas–fired power plants.

60. The gas sector is expected to have a strong positive net impact on Egypt’s balance of payments over the medium term. Very preliminary projections suggest that gas exports, net of cost recovery by the foreign gas companies, will strengthen Egypt’s current account by close to US$1.5 billion per annum by the end of the decade (Appendix IV.2).

Table 3.

Egypt: Balance of Payments—Current Estimates and Oil and Gas–related Revisions

(In billions of U.S. dollars, revisions are shaded)

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Sources: Central Bank of Egypt; and IMF staff estimates and projections.

From of the Staff Report for the 2005 Article IV Consultation.

Includes profit repatriation from oil and gas.

F. Conclusions

61. This chapter has reviewed current recording practices of oil and gas–related flows in Egypt’s balance of payments. Due to deficiencies in the recording of oil and gas exports, export revenues appear to have been underestimated by more than US$1 billion per annum in recent years. Weaknesses in the recording of FDI inflows in the oil and gas sector have also led to under–recording, possibly by as much as US$3 billion per annum.

62. A more accurate and comprehensive recording of oil and gas flows could lead to important revisions in key aggregates of Egypt’s balance of payments. Revisions to the oil and gas–related flows are likely to expose weaknesses in the recording of other items in the balance of payments, including non–oil merchandise trade.

63. The imminent expansion of gas exports will have a strong positive impact on Egypt’s balance of payments, and underscores the need to address weaknesses in the recording of oil and gas–related flows.

APPENDIX IV. 1

Current and Prospective Gas Exports

Five major gas projects, currently at varying stages of implementation, are expected to raise Egypt’s gas exports to approximately 21 billion cubic meters per annum by 2008. At current prices (US$126 per thousand cubic meters), this would result in gross annual inflows of about US$2.7 billion (3.1 percent of GDP).

  • (i) Gas exports to Jordan via an undersea pipeline started in mid–2003. This first phase of the Arab Gas Pipeline project feeds a power station in Aqaba. Gas exports amounted to US$60 million in 2003/04 and are projected at US$80 million in 2004/05. A 30–year agreement envisages export volumes rising from the current level of 1.1 billion cubic meters per year (bcmy) to 2.3 bcmy by 2010/11. Construction of the next phase, an extension of the pipeline to Lebanon and Syria, is scheduled to begin in 2005. The pipeline should eventually reach Cyprus and Turkey, after which it could be connected to the European gas grid.

  • (ii) An agreement to sell gas to Israel via an off–shore pipeline was approved in principle in May 2004. The government of Israel endorsed the Memorandum of Understanding (MoU) in February 2005. Under the MoU, the state–owned Israel Electric Corporation would buy 1.2 bcmy of Egyptian gas from July 2006, rising to 1.7 bcmy one year later under a 15–year contract, with an option to extend the agreement for a further five years.

  • (iii) Exports from an LNG plant at Damietta, on the Mediterranean coast, started in January 2005. Union Fenosa of Spain and ENI of Italy built the plant at a cost of US$1.3 billion. The plant is owned by Spanish Egyptian Gas (SEGAS), a consortium in which Union Fenosa has an 80 percent share. The EGPC and the Egyptian Holding Company for Natural Gas (EGAS) each own a 10 percent share. Union Fenosa has a 25–year contract to buy the equivalent of 4.4 bcmy of natural gas from the Damietta plant. British Gas is taking a further 1 bcmy and discussions are advanced with a buyer for the plant’s remaining output of LNG (equivalent to 2.2 bcmy of natural gas).

  • (iv) Production at another LNG plant, at Idku, east of Alexandria, is scheduled to begin in the third quarter of 2005. British Gas and Petronas of Malaysia built the $1.1 billion plant and Gaz de France has committed to buy its output (equivalent to 5 bcmy of natural gas) under a 20–year contract. Gaz de France, British Gas, and Petronas form the bulk of Egyptian LNG, the consortium that owns the Idku facility. EGPC and EGAS have a combined stake of 24 percent.

  • (v) A second production train under construction at Idku is due to come on stream in mid–2006. Up to six LNG trains (independent production units for gas liquefaction) can be accommodated at Idku, compared with two at Damietta. The second train is the same size as the first train and will cost around US$900 million to construct. British Gas has signed on to purchase the output of this train.

APPENDIX IV.2

Medium–term projections of oil and gas–related flows

The medium–term projections in Table 3 incorporate the trend decline in oil production and a steady rise in domestic demand for petroleum products in line with the projected growth of the Egyptian economy. Accordingly, the projections for net exports of oil assume a 4 percent annual increase in the volume of oil imports and a 2 percent annual decline in oil exports. The assumptions which underlie the medium–term projections of balance of payments flows related to the new gas projects are summarized below.

Egypt: Projections of Current Account Flows Related to the New Gas Projects, 2004/05–10

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Sources: Ministry of Petroleum; and IMF staff estimates and projections.

References

  • British Petroleum, 2004, Statistical Review of World Energy (available from http://www.bp.com)

  • International Energy Agency, 2004, Key World Energy Statistics, 2004 available from (http://www.iea.com).

  • International Monetary Fund, 2003, “Foreign Direct Investment Statistics: How Countries Measure FDI 2001, (Washington: International Monetary Fund).

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27

Prepared by Geert Almekinders. The author would like to thank officials from the Ministry of Petroleum for helpful discussions during the staff visits.

28

The Egyptian authorities do not publish regularly time series data on oil production, and the annual report of the state–owned Egypt General Petroleum Corporation (EGPC) has limited circulation. Staff received data for the period 1995/96-2003/04, as well as the 2002/03 Annual Report of the EGPC from the Ministry of Petroleum. Data published by the International Energy Agency and in British Petroleum’s Statistical Review of World Energy differ considerably from the EGPC data, possibly reflecting different treatments of condensate and Liquefied Petroleum Gas (LPG).

29

A trillion cubic feet is equivalent to approximately 1,848 billion cubic meters.

30

While these estimates and their recording appear methodologically sound, the CBE has no alternative data sources against which to compare the estimates it obtains from this methodology.

31

The CBE estimates record the difference between a headcount-based estimate of tourism-related inflows (US$5.5 billion in 2003/04) and the estimates obtained from the ITRS (US$2.3 billion in 2003/04) as an outflow in the capital account. The estimates in Table 3 record only the flows based on direct estimates of tourist arrivals with the errors and omissions line offsetting any upward bias implicit in these estimates. The balance of payments in Table 7 of the staff report for the 2005 Article IV consultation follows the same methodology.

32

The reclassification of profit remittances from the “Other” category to the Investment Income category under service payments leaves the total for service payments unchanged.

Arab Republic of Egypt: Selected Issues
Author: International Monetary Fund