Faults in the process of formulating an agreement between Israel Electric Corporation (IEC) (TASE: ELEC.B22) and the Tamar natural gas reservoir partners caused $820 million-1.5 billion in excess costs that could have been foreseen. This was the main conclusion of the State Comptroller's report on the process of signing the agreement. It now appears that the damage is actually $2-2.3 billion. The audit was conducted in September 2015-March 2016, following which supplementary checks were made by the Ministry of Finance and the Ministry of National Infrastructure, Energy, and Water Resources Israel Natural Gas Authority.
Following the discovery of the Tamar reservoir in January 2009, the Tamar partners and IEC began negotiations, leading to the signing of a letter of intent in December 2009. The letter contained a price formula linked to a basket of fuels and the US Producer Price Index (PPI), excluding food and energy, as is the prevailing practice at IEC. The formula included a floor price of $4 per heating unit for the purchase of 2.7 BCM a year for 15 years. IEC forecasts in early 2012 predicted that the price of gas would vary in the $5.20-6.60 per heating unit range over the period of the agreement.
The letter of intent constitutes one of the main targets of the critique, because according to the State Comptroller, the excellent formula in it was replaced later by linkage to the US Consumer Price Index (CPI). As of 2012, this change added $1.5 billion to the cost of the gas deal, and constitutes one of the defects that electricity consumers will have to pay for, which the State Comptroller's report states "is liable to affect pubic welfare." The State Comptroller's report later states that beyond a renewed discussion of the price eight years after the beginning of the agreement, "no measures ensuring the return of the additional cost were taken."
The initial draft agreement between the parties was drawn up in 2010, one month before the appointment of the Sheshinski Committee to Examine Fiscal Policy on Oil and Gas Resources in Israel. The agreement contained a clause protecting against taxation by giving the Tamar partners the right to raise the price. This clause was removed from the agreement following the publication of the Sheshinski Committee's recommendations in January 2011 and clarification of the royalties situation. A month later, the negotiations between the parties were speeded up, and discussions by the IEC board of directors steering committee dealing with the agreement show that on this point, the Tamar partners demanded a high price to compensate them for the increase in the government take.
"While the negotiations were taking place in 2011, the supply of gas from Egypt was disrupted, and stopped completely in April 2012," the State Comptroller's report states. "In addition, changes in the route of the gas pipeline to Israel's shores made the pipeline longer, and added to the costs. As a result, the ninth draft agreement in August 2011 contained the new formula, and the 11th draft, formulated in October, stated that 1% would be added to the linkage each year until 2019, and 1% would be subtracted from the linkage starting in 2020.
IEC told the State Comptroller that the Tamar partners had demanded 2% a year be added on top of the increase in the US CPI, and that in exchange for a compromise on the price, the company had managed to ensure itself an adequate supply. IEC added that the agreement, which was finally signed in March 2012, was that best that could have been achieved, given the shortage of Egyptian gas and the depletion of the Yam Tethys reservoir, which "strengthened the monopoly power of the Tamar partners… the only possible and practical solution for ending the energy crisis and renewing the supply of natural gas to the Israeli economy was rapid development of the Tamar reservoir."
According to the State Comptroller, because of the fall in energy prices in recent years, the damage caused by the change in the gas price formula was $2-2.3 billion, more than could have been foreseen. "The alternative formula of linkage to the US CPI reflects a high probability of a continued increase in gas prices, independently of developments in the energy market," the Comptroller wrote, "since the US CPI has risen by a relatively stable rate of 2.3% a year for the past two decades."
The Tamar partners attributed the price increase to several factors: a rise in the price of oil between the time the letter of intent was signed and the signing of the final agreement; the striking down of the National Outline Plan for building a facility for receiving gas on the Dor shore, which increased costs; the Sheshinski tax, which is projected to lower revenue from the reservoir by NIS 40 billion; the decisions by the Antitrust Authority director general, which restricted the partners; and the 50% ceiling on exports of gas from the reservoir.
The State Comptroller stated that the 2009 letter of intent reflected relatively competitive negotiations, and the formula in it "can therefore be a criterion for assessing the natural gas price when there is more than one supplier." On the other hand, the protection against taxation clause indicates "the intention of making the public pay all or part of the costs of the fees set by the Sheshinski Committee." Although the State Comptroller accepted part of IEC's arguments about the effect of factors beyond its control, he noted that these "do not justify raising the price of gas in the deal, in comparison with the letter of intent."
The Public Utilities Authority (electricity) explained that the linkage to the US index was a hedge against a rise in fuel prices. The State Comptroller commented that although hedging is an acceptable tool for reducing risk, "the hedging mechanism included in the deal imposes the increase in costs on the consumers, instead of on the Tamar partners." These opinions were backed by an opinion obtained by the Public Utilities Authority (electricity) from two experts, who wrote at the time that the method was an unacceptable and unreasonable one that "saddles the gas consumers with the risks, and leaves almost no risks to the gas producers." The State Comptroller adds that the mechanism in the letter had a hedge against a steep rise in energy prices.
Concerning the addition and subtraction from the change in the US index, the State Comptroller wrote that according to a calculation by his office, "A 1% drop in the CPI in the second half of the period of the agreement does not offset the 1% rise in the first half of the period of the agreement. The calculation shows that according to the known figures when the agreement was signed, this mechanism makes the Tamar deal $370-640 million more expensive in current values." The State Comptroller notes that this mechanism is not customary in gas agreements, and should be changed.
Published by Globes [online], Israel Business News - www.globes-online.com - on May 17, 2017
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