Background 1 . The hydrocarbon sector plays a key role in Egypt. Egypt's balance of payments is heavily influenced by petroleum exports. Petroleum exports account for now about 40%of the total. As Egypt's oil production is declining from the mid-1990s, natural gas is increasing its importance substituting for domestic petroleum and maintaining exports of petroleum over a longer time. Use of natural gas in various sectors in Egypt would also improve environmental conditions. To this end, Petrogas, a public gas and LPG distribution company and a 100% subsidiary of Egyptian General Petroleum Corporation (EGPC) under the Government of Egypt (GOE) and the Ministry of Petroleum (MOP) is promoting gasification in various cities in Egypt, including the Greater Cairo Gas Distribution Component (GCGDC) under the Bank's Egypt Gas Investment Project (Loan NO. 3354-EGT). 2. GOE has recently embarked on an ambitious Economic Reform and Structural Adjustment Program (ERSAP) with a view of stimulating the economy. In this connection, GOE suggested to the MOP in January 1996, to accelerate privatization in such industries as oil, gas and LPG distribution. The Minister of MOP instructed Petrogas, as a test case, to implement the Port Said Gas distribution project on a basis of private sector business. The Port Said gas distribution project is included in the current Five Year Plan which is ending FY 2001/2002. According to Petrogas' plan, the project will promote gasification for: 100,000 residential consumers and replace LPG (100%); 600 commercial consumers for replacement of LPG (7 1 %), fuel oil (2 1 %), and other fuels (8%);
and 35 industrial consumers and replace of gas oil (67%), kerosene (27%), and other fuels (6%). The total investment cost is estimated at US$70 million and the construction is scheduled for 1997 and the last 12 months. 3. Bank's consultants, DONG (Denmark) completed the Gas Distribution Tariff Study in June 1994. The study addressed the urgent need for reform of gas and LPG tariffs so that they reflect economic costs. The recommendations have been under consideration of MOPIEGPC for 18 months. While prices of petroleum products are now close to international prices, the tariffs of natural gas and LPG are artificially suppressed. For example, the current LPG tariff is less than 40% of the kerosene price on an equivalent calorific term. As a result, the consumption of LPG is increasing at an annual growth rate of about 14%, forcing imports of about 100,000 tons at a cost of US$30 million. The LPG supply constraint is expected to continue unless the LPG tariff is reformed despite EGPC's commissioning in October 1995 of the Ameriya LPG plant with a capacity of 125,000 tons per Annum (TPA) and plans to produce additional 175,000 TPA of LPG at the second Trans Gulf LPG plant by the end of 1997. 4. Given relatively high costs for installation of gas distribution infrastructure for residential consumers, there is a concern about economic viability. Furthermore, the current low gas tariff would not support full recovery of the project cost. Although GOE has been promoting privatization in the industrial and power distribution subsectors, the GOE's message toward privatization is a sudden change in direction for EGPCPetrogas and they are in need of assistance. 0 bjectives 5. The proposed study aims at establishing a sound strategic framework for privatizing the natural gas distribution subsector while focusing on the Port Said gas distribution project. There are a number of issues which need to be solved before start of the privatization process even in the case of the small gas distribution project in the city of Port Said. Scope of Work 6. In line with the above objectives, the study encompasses the following scope of work: (a) review and assessment of economic and financial issues of the pilot project including cost recovery measures and achievement of an adequate rate of return on the investment; (b) identification of the full extent of changes necessary to operate effectively in a commercial manner as seen in the western countries; (c) establishing a reform strategy which aims at establishing commercially viable entities; and (d) recommendations on specific action programs to achieve improvements as circumstances permit. 7. More specifically, the study will cover the following eight discrete tasks: A Strategy i) review company objectives and establish short- to mid-term targets; ii) evaluate the balance between the interests of shareholders, management and employees and customers, and create a broad corporate strategy; and iii) identify appropriate steps toward reforming affiliated support industries for the gas distribution subsector. B . Management i) review board and shareholder responsibilities, accountability and reporting, and develop a governance process; and ii) recommend required changes in the organizational structure. C. Financial i) review roles, responsibilities and structure of a finance and accounting department, and suggest specific reform plans; ii) review Egyptian statutory reporting and suggest action steps toward international accounting principles and statements; iii) recommend procedures for budget preparation, control and monitoring; iv) recommend procedures for capital expenditures, project evaluation and finance, appraisal and control; and v) provide suggestions for treasury operations and balance sheet management. D. Corporate Planning i) review medium term projections of demand, supply, operating costs, personnel efficiency, operating and provide recommendations on profit improvement; and ii) assess pricing options and sensitivities using the DONG study and others; iii) review and evaluate capital expenditure program; and iv) provide recommendations on financing requirements and sources. E. Contracts and Purchasing i) assess existing contracts, identify bottlenecks and provide recommendations on reforming; ii) provide specific recommendations for contract enforcement for consumers and contractors; and iii) review procurement practices and provide recommendations for improvement. F . Technology i) assess present level of technological support and indicate options for upgrading; ii) provide comments for technology contracts and joint venture considerations; iii) identify required technological improvements in supporting the gas distribution subsector growth. G. Marketing i) assess customer profile and evaluate risks and potential; ii) recommend a customer service improvement program; and iii) assist in establishing commercial policies in the market economy. H . Operations i) review operating procedures and provide specific recommendations for reform; and ii) review and provide recommendations for reporting and information systems. Implementation 8. The study will be carried out jointly by the staff nominated by EGPCPetrogas and ESMAP staff members. To avoid overlapping, existing studies/information including DONG'S gas tariff study, the ESMAP study on Energy Assessment and others will be fully utilized as far as available. 9. It is envisaged that the Egyptian counter team will also provide various arrangements required for Bank's task force members to work in Egypt including the arrangement of visas, access to sites, local transportation, etc. Timetable 10. The proposed timetable for the study is as follows: Start of the Work: July 1996 Detailed Work Plan: August 1996 Interim Report: ; December 1996 .................................................................................................................................................................. Draft Final Report for Review: i March 1997 ................... ....... ... ............................................................... 2 ............................................................... Final Report I April 1997 Preliminary Budget 10. As shown in Annex 1, the preliminary budget requirement for this project is US$135,200. Annex 1 Preliminary Budget Egypt - Strategy for Private Sector Participation in the Gas Distribution Subsector Budget Line Description us$ ESMAP Supervision Consultant Fees Consultant Travel Administrative Support ESMAP Staff Travel Bank Staff Travel Local Costs Sub-contract Training Reporting Costs Sundries Unallocated Costs Sub-Total 135,200
