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INDUSTRIES TO KICK ENERGY SUBSIDY HABIT
BY GEOFFREY CRAIG
Energy-intensive industries will face rising power
bills under the government’s new plan to phase out energy
subsidies over a three-year period. The Ministry of Trade &
Industry (MTI) announced last month that it had reached a deal with
the ministries of petroleum and electricity to establish a new pricing
policy for energy to alleviate the burden on the national budget
and reduce operating inefficiencies. “The government will
save LE 15 billion over the next three years by reducing these subsidies,”
Minister of Trade and Industry Rachid Mohamed Rachid said.
Under the new schedule, approved by the Supreme Energy Council,
natural gas prices for heavy industrial users will increase from
$1.25 per million Btu to $2.65 per million Btu, with an average
increase of $0.45 per annum. Electricity prices for heavy users
will rise by approximately 60 percent over the coming three years.
Final price levels, ranging between LE 0.178 and LE 0.295 per kilowatt
hour, will depend on the voltage of the electricity consumed by
the end user, with higher-voltage users paying less per unit.
Beyond 2010, the price of natural gas and electricity for these
users will be set according to a formula linking cost and world
market prices. However, prices will not be allowed to rise more
than 15 percent per year, Rachid stated, adding that energy subsidies
for other industries would be phased out over the coming six years.
The revised energy pricing strategy targets 40 companies that are
the country’s largest consumers of energy, primarily cement,
steel, fertilizer and aluminum producers. Together these companies
account for 20 percent of Egypt’s industrial production and
70 percent of the LE 4 billion in energy subsidies allocated to
industry last year.
Cheap feedstock has given these heavy consumers a significant, albeit
artificial, advantage over their international competitors and created
export markets for their products, analysts point out. The subsidy
revision aims at reducing inefficiencies in the market and helping
to shrink the budget deficit, estimated at 7 percent of GDP in FY
2006-07. “The government is trying to reduce the cost of subsidies,”
said Simon Kitchen, an economist at investment bank EFG-Hermes.
“It wants to target subsidies to the poorest members of societies,
so industrial users were obvious candidates for cuts.”
While higher energy costs will lower margins in the short term,
most analysts believe these industries will be able to absorb the
costs in the long term without a serious blow to profits. “The
costs of energy are still less than international prices. Cement
companies are making lots of profits – outstanding profits,”
affirmed Mohamed Kamel, general manager of the Chamber of Building
Materials. “We have to be realistic and comply with international
markets. Cutting subsidies is normal and long overdue.”
In fact, many industrialists would seem to welcome the long-awaited
policy announcement, as it gives potential investors greater clarity
regarding energy prices. “When foreign investors are doing
an estimate of costs for the lifetime of a project, they like as
much certainty as possible. They knew that the subsidy was costing
the government money and that it would eventually come to an end.
Now, they know what the prices will be over the next three years
and can determine their cost of production, and afterwards it will
be linked to global prices,” Kitchen explained.
Hassan Rateb, chairman of Sinai Cement, points out that low energy
costs helped turn Egypt from a net importer of cement to one of
the world’s largest exporters in less than a decade. The country
produced 38 million tons of cement in FY 2006-07, of which nearly
9 million tons were exported.
While energy subsidies were critical to the local cement industry’s
development, he believes the sector is now strong enough to survive
independently, provided the subsidies are removed gradually. “We
all know that there is a great portion of the product that is exported,
and it is not logical to subsidize the industry for [consumers abroad],
he says. “On the other hand, the low price of energy was an
advantage to the market, but now the feasibility of establishing
new plants should be reconsidered. Definitely, some investors will
change their mind and refrain from being involved in such kind of
investment considering the number of plants that are being constructed
in the Arab region.”
Analysts expect the pricing changes to have only a nominal effect
on the iron and steel industry. A steel executive told Business
Monthly that energy costs in steel production were considered minor,
only about 5 percent of total costs. The source said the new policy
was anticipated, and would therefore have no impact on his company’s
mix of local sales and exports.
But Mohamed Hanafy, general manager of the Chamber of Metallurgical
Industries, points out that domestic steel prices have risen in
line with higher raw material costs and stiffening local demand
to a level nearly at par with international prices. If local producers
pass on higher energy costs to consumers, even a small price hike
would push domestic prices above international prices, and lead
some consumers to buy imports. “Steel producers in Egypt can’t
raise prices because traders will then import cheaper rebars at
lower costs,” he says.
Meanwhile, the higher energy costs are expected to have negligible
impact on fertilizer exporters, as international market prices for
urea fertilizers remain high, ranging between $250 and $270 per
ton, says Sherif El Gabaly, president of the Egyptian Fertilizer
Trader Association. “The new gas price is totally reasonable
compared to the international prices that they are selling at,”
he said. But he argues that if the international price falls below
$200 per ton, then a new formula should be devised to lower gas
prices for fertilizer producers.
By contrast, the higher energy costs could squeeze profits of fertilizer
companies that sell on the local market, which are required to sell
their products at much lower prices, about $100 to $120 per ton,
El Gabaly said. He believes the government should increase the price
band in order for companies to absorb the higher energy costs, though
it is not clear which, if any, of these companies are among the
40 listed.
For the most part, economists say the companies targeted by the
energy pricing changes are not in a position to complain, as they
would never have reached their current capacity without subsidized
gas and electricity. While higher energy costs may dampen profits
in the short term, analysts stress that local and international
demand for their products is still strong, mitigating any long-term
impact.
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