Don't write off Leviathan

Amiram Barkat

Predictions of the consequences for Israel of the Egyptian gas discovery have cut loose from the facts.

How will the huge gas discovery in Egypt affect the development of the Leviathan reservoir in Israel? Has the prospect of exports of Israeli gas suffered a mortal blow? Will an Egyptian gas supplier turn up here shortly to compete with the Israeli developers? Some of these questions were without clear answers even before the latest Egyptian discovery, and the only thing that has changed is that the uncertainty has grown. Anyone who claims otherwise is a charlatan or an amateur, and there is no shortage of those here.

It's always refreshing to discover how quickly self-styled gas experts produce eulogies for Leviathan, and how few minutes it takes politicians to formulate a forthright press release declaring how right they have been all along, at a time when the professionals are still trying to understand the significance of what has happened.

To realize how much public discourse in Israel is sometimes divorced from the most basic facts, it was enough to listen this morning to one of the leading radio current affairs programs and hear the presenter ask an Egyptian journalist in all seriousness whether the Egyptians had the capability of developing the new gas reserve, as though it was the first large gas field discovered on Egyptian territory. "We should wish you success with your gas regulation," the presenter concluded the discussion with his Egyptian counterpart gaily, alluding to bitter Israeli experience, "You're setting out on a hard path, until you reach agreement on the percentage for the drillers, the percentage for the state, what belongs to you and what belongs to the exploration companies."

So for the benefit of that veteran presenter and many of his colleagues who come out with categorical statements without knowing anything, here are a few basic facts about Egypt and gas.

In recent years, Egypt has been ranked 22nd in the world for the size of its natural gas reserves. It has proven reserves of 1,650 billion BCM (billion cubic meters), double those of Israel, including Leviathan. Israeli geologists will tell you that the gas discoveries off the Egyptian coast in the 1990s were the main motivation for renewing gas exploration in Israel, exploration that yielded the Yam Tethys, Tamar, and Leviathan discoveries.

The Egyptian gas industry thrived at the beginning of the 2000s, and the rate of production reached more than 60 BCM in 2008, ten times the rate of production in Israel in 2014. At the same time, gas consumption in the Egyptian economy shot up, with the encouragement of the government, which subsidized the price of gas. The Mubarak family doled out franchises to cronies for setting up gas guzzling industrial plants in Sinai that benefitted from gas at reduced cost, similar to the prices promised by Egyptian gas supplier EMG to Israel Electric Corporation (before it unilaterally raised the price by 40%).

Incompetent government policy, however, brought about a deep crisis in the Egyptian economy: international energy companies stopped investing in exploration because of the excessively low gas price, the transport and distribution infrastructure suffered from neglect, while demand for the subsidized gas soared by 6% annually.

In 2012, Egypt found itself with a severe shortage of gas, and the government ordered an almost complete halt to the export of gas to Europe, the Far East, Israel and Jordan. Absurdly enough, Egypt started to import natural gas, while the two installations for liquefying gas for export, constructed on the Egyptian coast at a huge investment, stood idle. Their owners, international giants like BG, Union Fenosa, and Eni, demanded massive compensation from the Egyptian government, amounting to $6 billion.

At about the same time, the initial connection was made between BG and Union Fenosa and the developers of Tamar and Leviathan. At that time, Delek Group and its partner Noble Energy were conducting negotiations with Australian company Woodside Petroleum, which wanted to become a partner in the Leviathan reservoir in order export the Israeli gas to the Far East by means of a floating liquefaction installation.

Delek Group controlling shareholder Yitzhak Tshuva was frustrated by the low price the Australians offered, and wanted to prove that there was an alternative to them. His efforts succeeded beyond his hopes: the Egyptian option suddenly emerged as the deal of the decade. Instead of the construction of liquefaction infrastructure at an investment of $10 billion, Israeli gas would flow to Egypt via a maritime pipeline directly to the existing liquefaction installations that were crying out for gas. Even Noble Energy, which saw the Australians as natural partners, in the end preferred Egypt to them given the much better internal rates of return from exporting gas via a pipeline as against the many risks involved in constructing a floating liquefaction installation.

In May 2014, letters of intent were exchanged between the Tamar developers and Union Fenosa, Eni's partner in the gas liquefaction installation at Damietta, for the export of gas to the tune of $20 billion. A month later, similar letters were exchanged between the Leviathan developers and BG, owner of the other plant, at Idku, with a view to a deal double that size.

Meanwhile, however, something happened in the land of the pyramids. The new regime of General el-Sisi brought with it stable government and a friendly approach to the energy companies, meeting them halfway. Egypt's state-owned gas company, E-Gas, sharply raised the price it was paying the gas producers, to $5.88 per MMbtu (slightly more, incidentally, than Israel Electric Corporation currently pays for gas from Tamar), exploration activity in Egypt resumed full pelt, and dozens of new agreements were signed between the government and a series of international companies operating in the country.

The great gas discovery in Egypt fell on Nobel Energy and Delek as a complete surprise. The guiding concept that had taken hold among all the decision makers in Israel was cracked, not to say shattered. Although people in Israel were aware of the deep change that had taken place in the Egytian gas industry, they tended to attribute to it only positive significance, as with the change for the better in relations with Israel itself. No-one foresaw a huge discovery that might substantially narrow the "window of commercialization" in Egypt's gas market.

The discovery, incidentally, is very close to Israel's Leviathan, and has similar geological characteristics. The reserve itself is not larger than Leviathan, because the published figure relates to the total quantity of gas it contains, and not to the quantity that can be produced from it. The discovery could indicate that there additional reserves close by, perhaps on the Israeli side too.

The race to discover gas has reopened. Nevertheless, it is still too soon to write off the gas deals, because it is not clear how much gas can be sold in the Egyptian economy and whether the Egyptian government will allow Eni to export in substantial quantities. After the trauma Egypt underwent in the past few years, it is doubtful whether even a huge reserve such as has now been discovered can allay the government's fear of a gas shortage. Nor is it clear whether Eni will decide to forego the fairly readily available gas from Tamar and wait another two-three years until the gas comes on stream from its new reserve. It may prefer to retain the agreement, with amendments, such as a much shorter supply period.

The chances of survival of the second agreement, with BG, on which development of the Leviathan reservoir is based, are much higher, because BG is a competitor of Eni. For that reason, it is certainly possible that the negotiations will yet come to a successful conclusion, despite the huge discovery.

Another likely scenario is that Union Fenosa and BG will wait until the picture becomes clear. In that event, the Leviathan developers will face a tough choice: whether to take the risk of further deferring development of the reservoir, or whether to make do with limited development, on the basis of other customers, chiefly the Jordanian power company.

The agreement with BG should assure Leviathan of annual gas sales of 7 BCM. Without BG, the developers believe that they can find customers for 6 BCM from Jordan, from Israel, and perhaps from Turkey.

Theoretically, the developers can change the development format for Leviathan and go for a limited, cheaper plan at an investment of $3.5 billion instead of $7-8 billion. That would involve a certain delay in the timetable and giving up some of the tax breaks they stand to obtain under the Sheshinski law.

The possibility of bringing Woodside back into the picture and exporting liquefied gas from a floating installation seems the least likely option at present. On the other hand, the twists and turns of the past few years have shown that anything is still possible and everything is still open.

What about the Israeli government's outline gas agreement? The claim that it has become irrelevant following the Egyptian gas discovery has yet to be proved. As far as the developers are concerned, the possibility of developing Leviathan was and remains a real proposition. Without the agreement, the parties will soon find themselves in court, with the developers now having no special incentive to reach a compromise.

And what about the chances of a new gas supplier turning up from Egypt? Without going into the dismal results of Israel's existing gas supply agreement with Egypt, it can be estimated that at the currently prevailing price levels in Egypt, it is very doubtful whether such a supplier would be able to offer a really competitive price.

Published by Globes [online], Israel business news - - on August 31, 2015

© Copyright of Globes Publisher Itonut (1983) Ltd. 2015

Twitter Facebook Linkedin RSS Newsletters גלובס Israel Business Conference 2018