The Tamar partners will have to reopen their gas supply contract with Israel Electric Corporation (IEC) (TASE: ELEC.B22) so as not to pass onto consumers unnecessary expenses, the Public Utilities Authority (Electricity) ruled yesterday. The Authority is demanding that the Tamar partners change the linkage mechanism for the price of gas, which will reportedly reduce their expected revenue from the IEC contract by NIS 500 million. The Authority is also demanding the inclusion of several amendments to the contracts the partners signed with private power producers and manufacturers.
The Public Utilities Authority's decision partly reopens Israel's largest ever energy contract. Tamar partner Noble Energy Inc. (NYSE: NBL) estimates the current value of the IEC contract at $18-23 billion over 15 years. The Tamar partners - Noble Energy, Delek Group Ltd. (TASE: DLEKG), Isramco Ltd. (Nasdaq: ISRL; TASE: ISRA.L), and Alon Natural Gas Exploration Ltd. (TASE: ALGS) - are disappointed with the decision, but have declined to comment on it. Noble Energy, in its official statement about the IEC contract back in March had said that it expected that the Israeli government would approve the contract without material changes.
The Public Utilities Authority initiated its review of the IEC contract the day after IEC's board approved it on February 19. The review was based on the Authority's decision from June 6, 2011, that it would not allow the changes in Israel's gas supply market, caused by the cessation of gas deliveries from Egypt, which leaves Tamar, when it comes on line, as the sole supplier, to affect electricity rates.
In the review of the IEC contract, the Public Utilities Authority found "surplus costs differentials", which contravene the "interest rate, plus minus" mechanism, which was added to the gas price linkage formula. In contrast to prevailing gas supply contracts, the Tamar-IEC contract, for the first time, linked the price of gas to the American Consumer Price Index (CPI); the price will rise by the change in the CPI plus 1% through 2019, after which the price will rise by the change the CPI minus 1% until the contract expires. The logic behind the linkage formula was the new tax law following the Sheshinski Committee, which is based on a fixed annual rise in the price of gas.
The Public Utilities Authority ruled that deleting the "interest rate, plus minus" mechanism from the IEC contract was a condition for it to reconsider recognizing the price of gas set in the contract. Deleting the mechanism will reportedly reduce the Tamar partner's expected revenue from the contract by NIS 500 million. Another condition for recognizing the gas price is the option to increase contractual gas deliveries from 75.6 billion cubic meters (BCM) to 98 BCM.
However, the Public Utilities Authority said that this "was an extraordinary mechanism in gas contracts, which does not reflect the clear methodology for reducing gas prices over time to reflect market prices." Nonetheless, the Authority flattered IEC for the "operational and commercial advantages" it obtained, given the difficult conditions under which the negotiations were held.
Most of the Public Utilities Authority's criticism was leveled at the Tamar partners' contracts with private power producers and small customers. The review of these contracts led it to conclude that the basic price of gas "reflects cost differentials" compared with the prices set out in the letters of intent signed before gas deliveries from Egypt were disrupted. The Authority also pointed to "the absence of a mechanism for updating prices in the event that future gas suppliers enter the market", and too high quantity commitments (the take or pay clauses), which are liable to create entry barriers to consumers and suppliers due to the limited capacity of the gas pipeline from the Tamar production well.
The Public Utilities Authority's solution is to allow Tamar customers to choose among three alternatives: shorten the contract periods to seven years, or until 2020, whichever comes earlier; reduce the take or pay clauses to less than half of the contractual amounts (the prevailing proportion is 70-80%), or to revert to the original contractual agreements.
The share prices of the Tamar partners fell today. Delek Group share price fell 1.6% to NIS 681.80, its gas exploration units Avner Oil and Gas LP (TASE: AVNR.L) and Delek Drilling LP (TASE: DEDR.L) fell 0.3% to NIS 2.35 and 0.7% to NIS 12.81, respectively, and Isramco share price fell 1.5% to NIS 0.51. Alon Gas's share price fell 1.4% to NIS 43.38.
Published by Globes [online], Israel business news - www.globes-online.com - on May 22, 2012
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