With the gas sector crisis looming in the background, Minister of National Infrastructures, Energy, and Water Resources Yuval Steinitz met yesterday with Delek Group Ltd. (TASE: DLEKG) controlling shareholder Yitzhak Tshuva and representatives of US company Noble Energy to reach a final settlement for the natural gas sector in Israel.
At the seven-hour meeting, the parties discussed unsolved issues. After the meeting Steinitz said, "I won't allow demagogic arguments to prevent development of the Leviathan gas reservoir. I initiated the establishment of the Sheshinski Committee, which doubled the taxes paid by the gas companies, so no one can lecture me about the public interest."
What issues were discussed at the meeting, is a solution close at hand, on what is the state willing to compromise that the gas companies are not willing to concede, and how do the US and Iran fit into the picture?
The public interest - cheap electricity for the consumer
If you had to put the matter in a nutshell, you could say that the interest is cheap electricity for consumers, cheap energy for industry, and especially ensuring that the situation will continue in the future, or at least in the coming decades. Today, 60% of the electricity produced in Israel comes from natural gas produced from the Tamar reservoir.
Cheap gas enabled Israel Electric Corporation (IEC) (TASE: ELEC.B22) to slash its cost of production to a fraction of what it was. While the company spent NIS 20 billion on fuel in 2012, it spent only NIS 6.1 billion in 2014, a 70% reduction. When IEC's cost of production falls, the power rates for consumers also fall.
Ensuring a continuous supply of gas
As of now, all the gas consumed in the Israeli economy comes from one reservoir - Tamar - through a single pipeline connected to the shore. If there is a malfunction in that pipeline or hostile terrorist activity against the gas facilities in the water, the Israeli economy will be paralyzed. In order to ensure a continuous stream of gas, an additional pipeline must be built from the Tamar reservoir to the shore, and development of the major Leviathan gas reservoir, which by itself can supply the Israeli economy's gas needs for decades, must be ensured.
No economic justification for developing Leviathan without export contracts
The reason is that the Israeli economy's gas consumption does not justify investing the billions of dollars needed to develop the Leviathan reservoir, or even building another pipeline from the Tamar reservoir. For that, giant export contracts are necessary. Indeed, over the past year, the partners in the reservoirs signed letters of intent to export gas to Egypt, Jordan, and the Palestinian Authority. It is estimated that the revenue from gas exports will add some $70 billion to the state treasury over the coming decades.
Six months ago, however, Antitrust Authority director general Prof. David Gilo decided that the structure of the Israeli gas sector must be changed. He argued that Delek Group and Noble Energy illegally bought 85% of the Leviathan reservoir from Ratio Oil Exploration (1992) LP (TASE:RATI.L), which then owned all of it), thereby contracting an agreement in restraint of trade. Since that declaration, the gas export negotiations have come to a standstill - Egypt and Jordan, which need cheap gas so badly, are looking for alternative sources.
Egypt, for example, has begun negotiating with Cyprus to import gas from the Aphrodite reservoir, and has even raised the price of gas for the local economy in order to attract foreign companies. For its part, Jordan has begun negotiations to buy gas from the Gaza Marine reservoir in Palestinian waters.
Six months of discussions
Ever since Gilo's declaration, the Antitrust Authority has tried to reach agreement with the gas companies in order to avoid a court case. Prime Minister Benjamin Netanyahu has appointed National Economic Council chairman Eugene Kandel to head a team for devising a compromise plan that will both be acceptable to the gas companies and serve the "public interest." For the first time, a team was assembled that included all the regulators involved, including the Ministries of National Infrastructure, Energy, and Water; Finance; and Justice; as well as the Antitrust Authority.
Last February, the regulators presented a plan they had all agreed on, but that the gas companies had not. Noble Energy insisted on being involved in the gas contracts for the local economy, and the gas companies did not agree to compete with each other in marketing gas from the Leviathan reservoir. The regulators also realized that separate marketing, as demanded by Gilo, could not be implemented in a small economy like Israel's with undeveloped infrastructure.
This realization led the regulators to devise a second compromise solution, and this time, the companies accepted it. The main point of the outline is a change in the ownership structure of the Tamar reservoir involving the sale of all of Delek Group's holdings and the dilution of Noble Energy's holdings from 36% at present to 25%. It was also agreed that Delek Group and Noble Energy would sell their holdings in the smaller Karish and Tanin reservoirs.
A new problem has now emerged: Gilo did not accept the new formula, arguing that it would not lead to real competition in the gas sector. After realizing that the other regulators were determined to go ahead with the agreement, however, he resigned.
What will happen when Iran returns to the market?
The last hurdle, it seems, is much more difficult than the state and the gas companies previously though and hoped. The gas sector in general, and the gas contracts in particular, are a complicated matter, including questions like gas prices, a basket of linkages, taxes on exports, and much else. Since the new compromise was presented last month, the Kandel team has been holding marathon meetings with the gas companies in order to reach final agreements.
One still unsolved dispute is the gas prices for the local economy. The gas companies are willing to undertake that the price of gas in future contracts will remain at its current low level of $5.70 per mmbtu, and this is also acceptable to the Ministry of National Infrastructure, Energy, and Water. The Ministry of Finance, on the other hand, is seeking to lower the price to $5.30. The difference may not sound like much, but it can amount to hundreds of millions of dollars within 15 years (the average life span of a gas contract).
Another as yet unsolved issue is the timetable for selling Karish and Tanin. While the gas companies are willing to undertake to sell these reservoirs within six years, the Ministry of Finance wants a relatively quick sale within 18 months. The price of gas to the local economy and the timetable for selling the small reservoirs will be relatively easy to reach agreement on, but the same is not true for all matters pertaining to gas exports. Here, the numbers play a much less significant role; their place is taken by geopolitics and Israel's relations with the neighboring countries.
"The US has an interest in the growth of the Israeli economy, and also an interest in the success of a US company (Noble Energy, H.C.) that has made large-scale investments. In addition, the US has an interest in the security and economic relations that the gas can make possible," US Ambassador to Israel Dan Shapiro said today in an Galei Zahal (Army Radio) interview, referring to the letter of intent signed by the Leviathan partners with the Jordanian Electric Power Company for the supply of 45 BCM of gas over 15 years.
Commenting on the geopolitical situation, Steinitz warned, "Iran has gas reserves with 40 times as much gas as Israel. They couldn't invest there for five years because of the sanctions, but the minute the sanctions are removed and Iran returns to the market, there's a risk we could be left high and dry. Israel should look at the whole geopolitical map, and not think merely about narrow considerations. As soon as Iran is free of the sanctions, the international companies and banks will hurry to go there, and we'll be stuck."
Panic does its work
So what is happening with gas exports? Egypt and Jordan are not waiting for Israel to solve its internal disputes; they are looking for other ways to buy cheap gas. This fact is arousing panic in the gas companies, but also in the Israeli government.
The panic is having an effect. In order to help gas exports to Egypt move ahead, the government will probably approve the export of gas from the Tamar reservoir to Spanish company Union Fenosa, even though it barred any significant exports of gas from Tamar before the Leviathan reservoir is connected to the shore. The gas companies are also asking the state to recognized construction costs for the pipeline they are due to build for exports to Egypt, meaning a delay in the payment of tax under the Sheshinski law. At the moment, it appears that the Ministry of Finance is opposing this demand.
Another unsolved question relating to gas exports concerns the gas export quotas. The gas companies are seeking to increase the quotas designated for export, so that the Israeli economy keeps 450 BCM for itself, not 540 BCM, as determined by the government. The government is refusing this demand, but is willing to consider to leave 45 BCM of gas for Jordan out of this export quota.
Another important unsolved issue is the model for determining taxes on gas exports. Last November, a team headed by former Minister of Finance director general Yael Andorn recommended legally establishing the Netback model for determining taxation on exports. Under this method, the state will determine the developers' expected taxable profit according to the price in the deal, minus an acceptable rate of making back the investment for deals of this type, plus the acceptable rate of return.
In order to ensure that the gas reservoirs partners do not sell the gas at excessively low prices, the committee recommended a mechanism for ensuring that the gas price in export deals is not lower than what is acceptable in Israel. The taxation law was not accepted, however, and the fall in global energy prices has also affected the gas companies' demands.
Published by Globes [online], Israel business news - www.globes-online.com - on June 17, 2015
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