The appearance of a new drilling rig on the Mediterranean horizon was good news for Beirut last summer. It was proof that long-time political foes Israel and Lebanon could agree on one thing: the potential of possible gas discoveries under the sea.
After some lengthy US-mediated negotiations over territorial boundaries, an energy consortium including Total Energies, Eni and Qatar Energy began drilling in an area known as Block 9 in August.
This was a rare piece of good news for the country’s embattled economy. Four years into one of the worst economic crises in its history, Lebanon’s energy sector is hanging by a thread. The discovery of new gas fields would be a strong lure to attract foreign capital back into the country.
“If we can deliver an energy success story, proving that Electricité du Liban is able to honour its payments under the power purchase agreements, then we will see more investors come,” Carol Ayat, head of large corporates and specialized lending at Bank Audi tells Euromoney.
Indeed, exploration started on the back of what some economists had already described as an upturn in the Lebanese economy following a summer of high tourist numbers.
“Barring any major security and/or political malfunction, GDP growth should be positive in 2023, at around 1% or more, driven by tourism and pent-up demand,” said Ali Bolbol, chief economist and head of research at Blominvest Bank, speaking to Euromoney in September.
That major security and/or political malfunction happened on October 7.
When the Gaza-based group Hamas launched an assault on Israeli soil, it thrust the region into a renewed state of violence and geopolitical instability. The Hamas-Israel war is now spilling over into Lebanon as violence escalates at the border between Israeli armed forces, the Iran-backed militant group Hezbollah, and Palestinian jihadist groups.
As tensions escalate in the region, Lebanon’s lifelines – seasonal tourism revenues and energy projects– have suddenly been thrown into doubt.
A key sector
Energy is at the core of both the economic crisis in Lebanon and its potential recovery. The country ranks at the bottom of Euromonitor’s Global Energy Vulnerability Index 2023, just above Belarus.
Basic energy supply is a key issue. The country signed a gas-import agreement with Egypt and Syria in July 2022, which has yet to be implemented, and an electricity-import agreement signed with Jordan in early 2022 is also on hold.
Enthusiasm for the prospective capital returns from gas resources in the Mediterranean were short-lived.
According to Reuters, the energy consortium informed the Lebanese energy ministry and the Lebanese Petroleum Administration that no commercial gas was found in the first well in Block 9.
Total Energies Liban and the LPA did not respond to Euromoney’s request for confirmation.
For the political class, it is a reminder that sustainable economic recovery cannot depend on sporadic investments into a handful of eye-catching projects.
“Any activity in the energy space is a good opportunity for Lebanon because it encourages investors to come in, but we should not bet our life on discovering a lot of oil and gas,” said Saadeh Al Shami, deputy prime minister of Lebanon, speaking to Euromoney before the news emerged that exploration of the first well might not have been fruitful.
What remains is cheap and abundantly available solar power, but to capitalise on this resource, Lebanon needs to restore its failing public electricity provider.
With a cost of electricity exceeding 36 cents per KWh, you cannot grow a competitive economy
One of the only policy areas that Lebanon’s caretaker government has been able to agree on has been the restructuring of the public energy company EdL. Creating an electricity regulatory authority and auditing the public company are part of the deal for a $3 billion loan from the IMF.
“The financial rebalancing of the EdL is critical because the company is not cash-flow positive and cannot cover its costs or provide an adequate service,” one energy expert tells Euromoney.
There are a lot of questions about the quality of the reform plans, however.
“Although a cost-recovery tariff is a good first step for reform,” says Ayat, "it is not sufficient without tackling losses and inefficiencies in generation and transmission. This is the only way to be able to provide an efficient cost of electricity which supports economic growth."
EdL is struggling to deal with technical and non-technical losses and high costs due to inefficient electricity generation that relies on highly polluting and expensive fuel and an ageing infrastructure.
This compounded inefficiency is at the core of Lebanon’s stagnant rentier economy.
In the past, public electricity bills used to be very low, while private generators were very expensive. EdL's bill exchange rate is set at the Sayrafa rate – the official exchange rate set by Banque du Liban – with a 20% margin. That is an additional cost per kilowatt hour, and there is a fixed fee linked to infrastructure.
“You end up with an EdL bill that is more expensive than your private generator bill,” Ayat adds. "With a cost of electricity exceeding 36 cents per KWh, you cannot grow a competitive economy. This is a big issue for the private sector and residents in Lebanon, whose electricity bill represents a very high portion of their income and weighs heavily on energy security and sustainability."
Solar focus
This inefficiency is what is driving investment and production of renewable power in the country.
“We’ve seen the largest surge in distributed solar energy in Lebanon in the last two years as a response to the cost and availability of electricity/diesel, but this is still a largely unregulated space,” says Ayat.
Together with international development banks and advisers, Bank Audi helped negotiate the first power purchase agreement (PPA) with the ministry of energy and water and EdL for a wind project in 2018, to be used as a model for future renewable energy projects done in partnership between the private and public sectors.
“Before the crisis, we were very involved in working on arranging the financing of utility-scale renewable energy,” Ayat adds.
For customers who can afford them, solar panels are a good alternative to expensive grid-supplied electricity and private diesel generators. While estimates vary, the average price of solar power in Lebanon hovers around 5.7 cents/KWh.
This could play out in the Lebanese government’s favour, which has committed to sourcing 30% of the country’s energy from renewables by 2030, reaffirming the target at COP27 last year.
But instability has made conditions unfavourable even for household lending activities.
“For a while we were able to issue small [local-currency] loans to low-risk clients for solar, but not anymore,” one commercial banker tells Euromoney. “Restarting lending is important, but so is the other side of the balance sheet. Right now, our liabilities exceed our liquidity. A portion of deposits are there, and this the liquidity that we want to relend to generate income”.
Devaluation of the Lebanese pound means that most clients are looking for dollar loans, which are too risky for the banks to take on.
Dollarizing Lebanon’s public electricity bill
Lebanon’s public electricity company, Electricité du Liban (EdL), is in a tough position. While the Lebanese economy continues to dollarize in response to the catastrophic local-currency devaluation, its revenues are still in Lebanese pounds. The company is required by law to collect payments in Lebanese pounds at the official Sayfara exchange rate set by Banque du Liban, leading to considerable losses.
It cannot collect payments from customers in dollars without legislative reform.
The company is now liaising with the energy consortium made up of Total Energies, Eni and Qatar Energy over a power purchase agreement (PPA) to supplement its grid with a mix of renewable power and any future gas finds in the Block 9 area of the Mediterranean.
With regards to the bankability of the PPA in the current crisis, investors are trying to integrate new clauses into the contract to allow the tariffs to be paid in freely transferrable money.
"The problem is that EdL will have an issue if its revenues are exclusively Lebanese pound-based without a mechanism to convert them to dollars,” says Carol Ayat, head of large corporates and specialized lending at Bank Audi.
Discussions are continuing with the government to dollarize EdL’s collections.
“Obliging consumers to settle the invoices in US dollars requires a law, however, and right now parliament is not in a position to enact any legislation,” Ayat explains.
“The law doesn’t protect the bank,” the banker adds. "If you lend in dollars, the client is allowed to pay you back in Lebanese pounds at the Sayrafa rate, or with a bank cheque. This creates an additional risk of loss for us."
In the absence of a functioning banking sector able to lend, and the collapse of the average household’s purchasing power, any investment in solar generation can only be done through private-equity and private-debt vehicles backed by development finance institutions.
“We want to create a new financial ecosystem in the country, and one way to do that is by supporting impact funds,” says Danny Maalouly, head of investments at USAid in Lebanon.
The agency launched a $20 million solar and renewable energy fund back in March through its trade and investment facilitation activity.
USAid is one of the few international financiers willing to invest in Lebanon, but it cannot pay for everything itself.
“We have a budget, and we’re trying to create alternative financing solutions,” Maalouly adds. "For the solar fund, we are talking with the European DFIs and large international groups to get them to commit some capital to the fund."
With USAid providing the catalytic grant to get these funds started, investment managers are more likely to attract foreign investors. USAid works with Lebanese fund managers that are set up to run the funds in Lebanon, even if the money itself is elsewhere.
“We cannot only rely on the rebirth of the banking sector,” says Maalouly, adding that USAid has been working with advisory firms to draft a Lebanese diaspora strategy to drive private wealth investments back into the country.
Policy failures
Renewable energy remains a largely unregulated industry in Lebanon because its weak and corrupt public institutions have not been able to catch up with the rapid scaleup of decentralized solar.
“We have seen a huge surge in solar contractors, and many are not adequately qualified,” says Ayat. "This has led to some faulty installations and health and safety issues on certain sites."
To mitigate this, the Lebanese Center for Energy Conservation (LCEC) works with the energy ministry to introduce preventative measures.
It has published a list of certified and vetted solar photo-voltaic companies in Lebanon, while the government has introduced quality-control checks at the border.
But problems remain on the infrastructure side.
“For Lebanon to be able to increase renewable-energy penetration and reach its targets, you need to have a stable grid with good base-load power,” says Ayat. "Otherwise, excess electricity production from distributed renewable energy will go to waste and we will have technical issues rolling out large scale installations."
This is why renewable energy production initiatives cannot be looked at individually without addressing deeper financial-sector reforms.
“If we don’t deal with the structural issues now, the losses will accumulate” says Al Shami. "Depositors will go to their banks, withdrawing their deposits at a very low rate out of desperate necessity and they will be the ones suffering the most the longer reforms are delayed.
“It’s good that there is some movement in the private sector,” he adds, "but we need to reform the public sector and the financial sector to boost economic growth."
The delays are also preventing Lebanon from receiving that $3 billion from the IMF, which could provide some financial relief. According to the draft 2023 budget, the government is running a deficit of 24% of GDP – $500million.
There have been big cuts in public spending in the last two years to reduce this as much as possible, to the detriment of public services.
Given global antipathy to holding Lebanese debt, the state is not in a position to issue any more paper. Nor can it rely on the central bank for cash. In September, acting governor Wassim Mansouri announced that Banque du Liban would not print more money to cover the public deficit.
We need to reform the public sector and the financial sector to boost economic growth
The IMF loan could reassure foreign creditors that improvements have been made.
“The short-run implications should be good,” points out Bolbol at Blominvest, "but the medium-to-long-term implications on growth, employment, productivity and governance – which are the real implications – depend on how well the agreement is implemented and how far politics can be separated from economics."
In Lebanon, that won’t be easy. The political gridlock in which the caretaker government finds itself is preventing any legislation from going through parliament.
“Lebanon’s inability to agree on a reform path has been true for many years, way before the 2019 crisis,” says Adnan Mazarei, senior fellow at the Peterson Institute for International Economics and former Middle East deputy director for the IMF. "The problem is that reforms need to be undertaken by an elite which is the beneficiary of the status quo, and that is still the case today.
“But the banks also need to recapitalise,” he adds. "They are a significant player in the Lebanese political scene, and they have been hindering movement on the reforms."
Today, no one has any visibility on what will happen if conflict with Israel escalates at the border. What is certain, however, is that a new war would be catastrophic for the Lebanese people.
Not only will political instability discourage tourism, but it will also discourage private investment in the energy space and extinguish any flicker of economic recovery for Lebanon.
A tale of two exchange rates
“This is Riad Salameh magic,” Ahmad, a foreign-currency exchange dealer tells Euromoney as he pulls wads of fresh L£100,000 bills out of his pocket. He didn't want to give his full name.
We meet in one of the narrow streets in the Beirut neighbourhood of Geitawi, near one of Banque Libano-Française’s open but eerily quiet offices.
Locals don’t have much use for these local bank branches anymore – most cash withdrawals are done through money-transfer companies.
In this dollarized cash economy, remittances are an important lifeline. In 2022, the World Bank estimated that remittance flows to Lebanon were worth $6.4 billion. As fresh dollars get pumped into the real economy, they are exchanged on the market at a parallel rate that hovers around L£90,000 to the dollar.
But whenever the diaspora sends money back to Lebanon, there is an extra 2% cash-handling fee in addition to Western Union's standard service fee. And like most Lebanese people, Ahmad wants to know where this money ends up.
Western Union declined to comment.
Little trust in system
Ahmad runs an exchange shop with his cousin in Beirut. The shop is affiliated with Online Money Transfer (OMT), an accredited affiliate of Western Union. Although other services such as Remitly and MoneyGram are available, OMT dominates the money-transfer market in Lebanon. The company counts over 1,400 OMT branches across the country and is responsible for over 80% of all transfers.
These days in Lebanon, anyone can be a foreign-exchange trader. People sit on the side of highways on white plastic chairs waving wads of bills in the air, signalling to drivers who may want to exchange their dollars for Lebanese pounds.
“It used to feel like a drug market, but now everyone does it, and there is plenty of dollars to go around now that the tourism season has just ended,” Ahmad says.
Scrolling through a crowded WhatsApp group chat with what he says are vetted dealers, Ahmad shows Euromoney who has $50,000 to sell here and there, and at what rate.
He claims that this is how the dollars in the local economy are filtered back to the central bank: “The dollars then all get bought back by the Banque du Liban broker, that’s how they are building back their FX reserves.”
Banque du Liban declined to return calls on the topic.
There is little trust left in the system since the former central bank governor Riad Salameh – whose term ended in July this year – was charged with fraud, embezzlement and money laundering, both in Lebanon and abroad.
During his 30-year stint at the central bank, Salameh was nicknamed ‘The magician’ for seemingly having kept the Lebanese economy going despite post-war political instability.
“Lebanon ran a Ponzi scheme, whereby money kept rolling in to pay yesterday’s creditors and to keep rolling this over,” says Adnan Mazarei, senior fellow at the Peterson Institute for International Economics and former Middle East deputy director for the IMF. "The banks have been the major beneficiaries of this Ponzi scheme for years."
The World Bank estimates that Lebanon’s financial sector accumulated more than $72 billion in losses in what it considers to be one of the worst financial and liquidity crises in history.
Right now, Lebanese depositors are bearing the brunt of these losses.
How much is it, really?
One of the key questions that keeps coming up in Euromoney’s conversations with Lebanese bankers is to do with the exchange rate, and how Banque du Liban has managed to stabilise it.
“The amount of liquidity in the system is very low, so money in circulation has been reduced considerably,” a source close to the government tells Euromoney. "But the government is now collecting more revenues changing the value of the dollar applied to customs."
The Sayfara rate is the official exchange rate set by Banque du Liban. It was fixed at L£1,500 to the dollar from the 1990s until February 2023, when it went up to L£15,000.
Meanwhile the Lollar – a term coined to describe the dollars in Lebanese banks – is the rate at which banks are issuing dollar withdrawals in Lebanese pounds. That was fixed at a rate of L£8,000 to the dollar until February, when it too was readjusted to L£15,000 and monthly withdrawals capped at $1,600.
That is still well below the parallel market rate, which at time of writing stood at L£89,700
Lebanese banks have been making profits on the back of this gap for years, and by applying commissions on withdrawals.
A single figure
Unifying the rate is one of the core demands of the IMF agreement signed in April 2022.
In September, interim central bank governor Wassim Mansouri announced his plans to replace the Sayrafa platform with one run through Bloomberg’s trading system, a decision that was approved by the Cabinet.
Banks are eager to see if it will actually work.
“The platform should end the informality and chaos in the FX market,” says Ali Bolbol, chief economist and head of research at Blominvest Bank. "But in actual terms, we can’t really tell, until we know how the platform will operate and what are the rules and procedures that will be governing it.
“The platform will make the exchange rate presumably 'market'-determined,” he adds, "but it is not clear whether Banque du Liban will follow a flexible, managed float, or even an adjustable fixed regime."
As with most economic reform in Lebanon, this is also a politically sensitive issue.
“The platform is a transparent and cashless tool for interbank activity to take place, but it’s not going to have an impact on the exchange rate per se,” deputy prime minister of Lebanon Saadeh Al Shami tells Euromoney, adding that what will really affect the exchange rate are underlying economic, fiscal and financial policies.
“If you let the exchange rate float, reduce cash transactions and there is a transparent platform that the market can rely on, the currency exchangers will not be able to deviate too much from that rate,” he says.
There is a lot of cynicism around the announcement and whether it will amount to anything concrete.
“We must ask ourselves who is benefitting from the system,” says Karim Daher, international business lawyer and president of the Beirut Bar Association commission for the protection of depositors’ rights. "If you unify the currency exchange rate, the banks will no longer be able to make profits on the back of the devaluation and through commissions."
Daher and the BBA had been petitioning the government to put an end to this practice. In October, Banque du Liban issued a circular limiting fees that commercial banks can impose on Lollar accounts and prohibiting banks from applying commissions that did not exist before October 2019.
