"Only an international energy giant can develop Israel's gas reserves"

A research paper by consulting firm TASC concludes that Israel cannot go it alone in exploiting its natural gas discoveries, but attracting the right player won't be simple.

Israel cannot by itself realize the potential of its natural gas discoveries. Only an international energy giant will be able to provide the finance, the experience, and the know-how required to do so. That is the main conclusion arising from a position paper drafted by consultancy firm TASC. The document, the findings of which are published here for the first time, examines the development potential of the Israeli energy economy over the next decade. It estimates that, alongside relative stagnation in the traditional energy companies, there exists huge growth potential in natural gas, and to a lesser extent in private independent power production and solar energy. Realizing this potential will enable Israel to triple its economic activity in energy by the end of the decade, from NIS 16 billion to NIS 50 billion. However, in order to get there, Israel will have to overcome some difficult obstacles: it will have to allow natural gas exports in sufficient quantities; it will have to zone sites for constructing huge liquefaction installations; and it will have to persuade one of the ten global energy players to invest its know-how, experience, and tens of billions of dollars in the Israeli economy.

The traditional players - painful blows

TASC's position paper describes an energy economy in a period of the most significant change in its history. For 70 years, this economy has been dominated by three traditional sectors: Israel Electric Corporation (IEC); the fuel companies; and the oil refineries. In recent years, however, these traditional players have suffered a series of painful blows.

IEC was in trouble even before it was left without Egyptian gas. Its financial results for 2010 and 2011 indicate a gap of nearly NIS 3.5 billion between the profit figure derived from normative return-on-capital targets, according to which electricity rates are set, and the company's actual profit. Its debt mountain has continued to rise, and is rapidly approaching NIS 70 billion. Its credit rating has fallen three levels in recent years.

The fuel companies sustained a severe blow in the shape of the cut in their sales margin on gasoline by the state. The margin fell from NIS 0.80 per liter to NIS 0.65. The continuing erosion of profitability, which began even before this cut, can clearly be seen in the market caps of companies like Delek Israel Fuel Corporation Ltd. (TASE: DLKIS) and Granite Hacarmel Investments Ltd. (TASE: GRNT) (which controls Sonol), which have fallen by more than 50% since 2008.

IEC and the fuel companies can blame the state for their misfortunes. The oil refineries do not have that privilege. Responsibility for their plight lies with a global erosion of profit margins. Refining overcapacity on the one hand, and a fall in demand for refined products (such as gasoline, diesel fuel, and jet fuel) on the other, have cut the refining margin from $6-9 per barrel in 2007-2008 to $1-3 per barrel since early 2009.

Will the decline of the traditional players continue? TASC's scenario actually assumes stability, and even growth, in the revenue of the traditional energy companies. But even on this optimistic scenario, the traditional players will lag a long way behind the new ones. If this scenario materializes, the share of the energy market taken by IEC and the oil refineries will drop by more than 50%, and that taken by the fuel companies by more than two-thirds.

The new players - investment of $50 billion

What is happening in the energy economy can already be seen in the capex figures. Some $10 billion were invested in the sector in the period 2007-2011. 42% of this amount was invested in natural gas projects, private power plants, and renewable energy.

Independent power producers (IPP) arose as a result of a government decision in 1996 to start privatizing IEC. The first private power plants will start operating only in 2013, but there are already 16 private power ventures active in Israel, and in the past four years some $700 million have been invested in the industry, chiefly in power plant construction. Power production from renewable energy sources did not exist in 2007. Today, there are more than 90 companies in this market, almost all of them in solar energy using PV (photo-voltaic) technology. $300 million have already been invested in solar systems, and that is just the beginning. TASC estimates that these two sectors will require additional investment of $10 billion by 2020. This investment will enable private and renewable power production to take a 10% slice of the energy economy and reach an aggregate annual gross profit of some NIS 5 billion. Where will the finance come from? In TASC's view, the Israeli economy is capable of raising a considerable part of the required sums by itself.

The big story of the energy economy in the next decade, however, will not be in power production, but in natural gas. The industry came into being with the first gas discoveries in Israeli waters at the beginning of the millennium. In 2007, there were already 28 companies active in the upstream industry (gas exploration and production), although the industry is dominated by Delek Group Ltd. (TASE: DLEKG) and US company Noble Energy, which together hold most of the development rights in the maritime gas reserves. TASC assumes that by 2020 there will be three main gas suppliers in the economy, at least two of them export orientated. The Ministry of Finance would be happy to sign up for such a scenario.

TASC estimates that the natural gas sector has the potential to reach an annual gross profit of over NIS 25 billion by the end of the decade. But serious obstacles stand in the way of the realization of this forecast. The first, prior condition is that Israel should allow exports of gas without unnecessary constraints and limitations. The opponents of exports contend that the state needs to keep as much gas as possible for local consumption. According to TASC's approach, gas exports are vital because the local market is almost completely taken: the Tamar developers recently signed 15-year gas supply agreements with IEC and the private power producers. Despite the changes introduced into the agreements at the behest of the regulator, TASC believes that there is limited potential left in the Israeli economy for additional gas suppliers.

Israel's gas reserves, headed by the Leviathan gas field, enable it to export gas in significant quantities within a few years, on condition that infrastructures for producing liquefied natural gas (LNG) are constructed here. TASC assumes the construction of five liquefaction trains with a total output of 20 million tonnes of liquefied gas, equivalent to 28 BCM, that will start to operate in two stages in 2018 and 2020. Construction of this infrastructure depends on three main elements: suitable sites; experience and know-how; and, chiefly, money. A great deal of money.

It is up to the government to provide the sites. The possibilities are very limited: the Ashdod, Eilat, and Ashkelon areas. Fierce opposition can be expected from environmental organizations and nearby residents. The know-how, the experience, and the money, are things Israel will have to bring in from outside. "The Israeli economy has barely managed to raise its share of the $3 billion invested up to now in developing the natural gas economy," TASC says. "It has no ability to furnish the additional $40 billion required for future development." In this area too, the choices are very limited. There are ten players in the world with the appropriate experience, capability, and capital for constructing the LNG installations. Among them are Exxon Mobil, Shell, Total, ConocoPhillips, Chevron, BP, GDF Suez, and BG.

Some of these players will never enter the Israeli market, for fear of endangering their extensive activities in the Arab world. "The number of suitable companies prepared to look at the Israeli market can be counted on the fingers of one hand," says TASC. "It is necessary to start today to create the conditions that will attract these companies to Israel rather than to competing projects around the world."

"No chance of new players entering the Israeli market"

The Tamar developers are convinced that the way regulation is conducted in Israel, and the difficulties piled on them in developing the Tamar reserve, have scared off all the foreign investors that might have considered entering the Israeli market. "There is no chance that in the semi-chaos that prevails here new players will enter the Israeli market," said Isramco CEO Avi Gefen this week at a public meeting held by the government committee for examining policy for the natural gas economy in Israel. "We have had a tsunami of regulators who wanted to reopen the agreements. Where were you when they were signed?"

Delek Drilling CEOI Yossi Abu added: "Foreign investors won’t come here because of the regulatory uncertainty. We have to change diskette. It's not the government versus the developers, but the government and the developers versus our competitors in the rest of the world."

Yael Cohen-Paran, executive director of the Israel Energy Forum, represented the opponents of gas exports, saying that a 25-year view was "short term". "The interests of the developers are the opposite of those of the public, which wants gas for the long term," she said. "The government must choose sides: the public, or the developers."

Israel Land Development Company Energy Ltd. (TASE: IE) CEO Ohad Marani said, "Without exports, there will be no expansion of supply to the local economy. The next step should be development of an export infrastructure. If all the contracts are taken by a consortium of Noble and Delek, and new players will have no possibility of selling gas, the new companies will find it hard to raise money."

TASC's position paper - an independent research document

TASC Strategic Consulting, one of Israel's leading consultancy firms, prepared the position paper as part of general research carried out at the firm periodically. The work is not connected to any particular client.

TASC gained its understanding of the energy sector through advising most of Israel's large energy companies on various matters in the areas of conventional power production, natural gas, renewable energies, fuels, water , and the environment. TASC has also advised several large international energy companies on important projects around the world.

The energy team at TASC is led by Salco Kleerekoper, who is chairman of the firm he founded in 1993, and projects manager Roee Zass, who specializes in strategic and economic consulting in the areas of natural gas, power production, and the environment.

Energy and infrastructure is one TASC's five main areas of activity, alongside telecommunications and media, transport and logistics, financial services, and consumer products. The firm's work in these areas focuses on assisting senior management in reaching strategic decisions, marketing strategy, penetrating new markets, raising finance, and organizational matters.

Published by Globes [online], Israel business news - www.globes-online.com - on July 11, 2012

© Copyright of Globes Publisher Itonut (1983) Ltd. 2012

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