Will Leviathan cut energy prices, increase competition?

Leviathan gas reservoir / Photo: Albatros

Gas is about to begin flowing from the huge offshore Israeli gas field, on time and within budget. But will it benefit Israeli consumers?

The Leviathan natural gas field is set to begin streaming gas to the Israeli coast tomorrow, an event that the government and the reservoir's developers are calling historic. Almost six years since the Tamar field was connected, Leviathan will become the second major gas field connected to the Israeli coast. Nine years have passed since the discovery of the gas and the beginning of the supply, compared with only three years for the Tamar field.

Most of the gas that will begin flowing tomorrow is for exports to the Jordan Electric Power Company, and in another month also to private customers in Egypt. Commencing in another week, gas will also flow to the Israel Electric Corporation (IEC). The fact that residents near the coastal terminal will be exposed to potential health damage caused by gas, most of which is for export, is arousing criticism from residents in the Hadera region. However, the flow of gas to Jordan and Egypt has been portrayed by the Netanyahu government as an important geopolitical and political interest. In the name of this interest, Prime Minister Benjamin Netanyahu bypassed the authority of the Israel Antitrust Authority director general at the time, and signed in his place, as Minister of the Economy and Industry (after Aryeh Deri, the previous minister, resigned) an exemption for an agreement in restraint of trade for Noble Energy and Delek Group, for the deal to buy the rights to area where the Leviathan reservoir is located.

Netanyahu's signature on the exemption was part of the general arrangement for the gas production sector, referred to as the gas plan. The plan aroused strong opposition at the time, involving the assertion that the state was perpetuating the monopoly of Delek Group and Noble Energy in the Israeli gas market, and forcing electricity consumers to continue paying the excessive gas price that IEC agreed to pay for the gas it was buying from the Tamar reservoir. Netanyahu stood firm against the protest with unqualified support for the plan devised by the professional staff in his government. In an extraordinary step, Netanyahu appeared before the Knesset Economic Committee and the Supreme Court justices to defend the gas plan. They were not impressed by his appearance, and struck down the all-encompassing stability clause in the original plan.

Completion of Leviathan's development is an appropriate time to assess what the gas plan achieved since it went into effect, and where it has failed.

Timetable: The targets were achieved

Development of the Leviathan field was the announced target for which the gas plan was devised, promoted and approved by the government four years ago. Netanyahu warned that without the plan, the gas would remain in the ground, or its supply would be delayed for years. The declared target of the plan will be achieved tomorrow when gas begins flowing from the offshore reservoir 130 kilometers off Israel's coast. As part of the celebrations, statements, and speeches, it can be assumed that Noble Energy and its Israeli partner, Delek Group, will not miss the opportunity to emphasize that connecting the reservoir to the coast was completed on time and within the $3.5 billion budget, in contrast to many large infrastructure projects taking place on land, such as the high-speed train to Jerusalem, also completed this week after a two-year delay. Delek Group and Noble Energy have also met the timetables forced on them in the gas plan for selling the small Tanin and Karish reservoirs. The deal for selling them to Energean was completed within 12 months from the date on which the gas plan was approved. Two years from now, another undertaking by Delek Group will be put to the test: completion of the sale of its holdings in Tamar by December 2021.

Competition: Still partial

In order to answer this question, a preliminary question must be answered about what it means. The expectations that the gas plan would generate competition were very moderate. The Ministry of Finance also admitted that the model for generating competition presented in the gas plan was partial and far from perfect. The entire issue of the gas plan arose because of competition, as a result of Israel Antitrust Authority director general Prof. David Gilo's declaration that the Leviathan partnership was an agreement in restraint of trade. The goal set by Gilo at the beginning was an ambitious one: creating absolute separation between ownership of Israel's two main gas reservoirs: Tamar and Leviathan. Delek Group and Noble Energy controlled 67% of Tamar and 85% of Leviathan at the time. Gilo believed that only the end of cross ownership between the reservoirs would allow real competition between them.

In the framework of the gas plan, under heavy pressure from the Ministry of Finance, Yitzhak Tshuva agreed to sell all of Delek Group's 31.25% holding in Tamar within six years of the date on which the gas plan was approved, i.e. by December 2021. In the case of Noble Energy, the company that operates the reservoir, it was decided only to reduce its holding in Tamar to 25%, to a large extent because of pressure from the Ministry of National Infrastructure, Energy, and Water Resources, whose staff feared that banishing Noble Energy from Tamar would result in no one being responsible for the reservoir.

In addition to ownership changes in Tamar, a clause was inserted into the gas plan requiring Delek Group and Noble Energy to sell Tanin and Karish, the two small gas reservoirs that they discovered, to a third party. The expectations that the purchaser of the small reservoirs would be able to compete against the huge Tamar and Leviathan were very low. Gilo himself thought that Tanin and Karish were not enough to create minimum conditions for competition, and proposed that the buyer should also be able to receive a share of Leviathan (a proposal that eventually did not go through, because Gilo withdrew it). Many expected that whoever bought the Tanin and Karish would try to extort regulatory concessions from the government with the help of its bargaining chip.

In retrospect, however, it turned out that Greek company Energean, which bought Tanin and Karish in late 2016, did not come to play games or wait for crumbs left over from the large reservoirs. Within a short time, Energean managed to sell all of the gas in Tanin and Karish by stealing fat contracts from its competitors. One year after entering the market, Energean astounded the analysts by signing a gas supply agreement with Israel Corporation at a price 37% lower than the price paid by IEC at the time in its 2012 agreement with the Tamar reservoir.

The final and no less surprising stage in the development of competition in the gas production market began this year, after Leviathan overcame Tamar in competition for an agreement to sell gas to the IEC for $800 million. The partners of Delek Group and Noble Energy in Tamar refused to accept the result, and made a more attractive offer to IEC, which did not go through because of opposition from Delek Group and Noble Energy. The partners argued that Delek Group and Noble Energy were damaging Tamar because they had larger financial interests in Leviathan, and demanded intervention by Israel Competition Authority director general Michal Halperin. Even if the Tamar offer does not go through, it is obvious that for the first time, conditions have emerged for competition between Israeli's two large reservoirs. In the bottom line, the internal rivalry in Tamar and the surplus supply of gas in the market support the development of real competition in the gas sector. On the other hand, now that Energean has sold almost all of the gas in Tanin and Karish, the future of competition also depends on the development of additional gas reservoirs.

Prices: The consumer is not yet benefiting

The decision that aroused the most criticism of the gas plan concerned prices, given the call to open the gas agreement signed between IEC and Tamar in 2012. The criticism focused on the mechanism for linking the prices in the agreement to the US Consumer Price Index (plus 1% interest). As a result, the price of gas in Israel rose at a time when gas prices in the spot market were plunging. It was also argued that the price, which was around $6 per BTU, gave the developers excessive profits, because their production cost was lower than $1. A senior IEC officeholder recently admitted that the price of gas would have been around $4.50 per BTU, were it not for the changes made in the agreement following the Sheshinski Committee. In a report, the State Comptroller estimated that the agreement represented a premium or excess cost for the public amounting to a cumulative NIS 8 billion.

The team that formulated the gas agreement, however, feared that opening the agreement would driver foreign investors away from Israel and lead to the filing of international arbitration claims against Israel by Noble Energy. Another important proposal, to institute gas price controls, was also rejected, after the government price control committee, which discussed the matter for years, was unable to take a clear stance.

The gas plan has yet to bring about a decrease in prices, but the good news is that prices are due to begin falling soon. Next month, IEC will begin buying gas from Leviathan at a reduced rate of $4.79 per BTU. Another price cut is likely if Tamar is allowed to submit a bid in competition with that of Leviathan. The price of gas is set to fall more substantially in 2021, when the price of gas in the Tamar agreement is revised from $6.30 to $4.90 per BTU, and after gas begins flowing from Karish and Tanin.

State revenues: What happened to the sovereign wealth fund?

Then-Minister of National Infrastructure, Energy, and Water Resources Dr. Yuval Steinitz recent argued that state revenues from the Tamar reservoir amount to NIS 10 billion. This number is apparently composed of NIS 4 billion in royalties that the state has thus far received, while the rest, assuming that Steinitz is correct, are revenues from corporate taxes and income taxes paid by the gas partnerships (figures that are not disclosed). The revenue instrument most conspicuous by its absence is the Israeli Citizens' Fund, the sovereign wealth fund into which revenues from excess profits tax (the Sheshinski tax) imposed on the gas producers as a result of implementation of the Sheshinski Committee's recommendations are supposed to be paid. The sovereign wealth fund for accumulating this tax will begin operating only in 2021, three years later than the original date, because revenues from the tax have so far been smaller than expected. The reasons for the delays are not directly linked to the gas plan, but the decision not to interfere in the price of gas or in the Sheshinski Committee taxation model was based to a large extent on the state's expectations that it would receive a substantial share of the developers' profits - the state's share is supposed be 50%. It can actually be argued that the fact that the state regards itself, as a result of the Sheshinki recommendations, as an important partner in the developers' profits affected its policy in all the arrangements with the developers, starting with the gas plan. In the bottom line, the Tamar developers have made an estimated $6 billion to date without paying one shekel in excess profits tax. Payment of the tax will begin this July, according to a revised forecast by the Israel Tax Authority.

International players in no rush to do business in Israel

On March 26, 2016, the High Court of Justice struck down the gas plan because of the all-encompassing reach of the stability clause as a took in agreements with investors. The justices ruled that the state's undertaking to prevent enactment of legislation changing the legal situation in three main areas "was made with a lack of authority, and should be struck down." Following the ruling, the state revised the stability clause and put the commitment to act against Knesset legislation into effect.

The state's insistence on the stability clause was derived from the argument that foreign investors would not enter the Israeli oil and gas exploration market (or the economy in general) because of too frequent changes in the rules of the game. In retrospect, however, even after the precedent of this clause was enacted (in its revised form), there has been no rush by large international companies to invest in Israel. The first round of tenders held by the Ministry of National Infrastructure, Energy, and Water Resources in December 2017 failed. A second round held this year scored a modest success: two small-to-medium-sized UK companies joined Israeli company Ratio Oil Exploration in a consortium that won exploration licenses in Israel. Large companies like Exxon Mobile of the US and Petrobras of Brazil sent representatives to Israel, bought the tender documents for $50,000, but eventually stayed out.

Connecting enterprises: Bureaucratic difficulties

80 enterprises around Israel have been connected to the natural gas distribution network, out of a target of 370 enterprises. Even enterprises that signed agreements in 2013-2014 for being connected to the gas network, however, are still waiting for gas, and some have received it only recently, Manufacturers Association of Israel Economics Division head Natanel Haiman warned in a talk with "Globes." "Consumers are losing confidence in the system, and many of them are already no longer pressing to be connected. They realize that the processes take a long time, and despite the government decision in August 2015 to speed up connecting enterprises to the natural gas network, nothing is happening."

The Manufacturers Association says that dozens more enterprises are currently waiting to be connected to the gas network, which will given them cheaper and cleaner energy for their production processes, while saving money on energy in the long term, reducing emissions and air pollution, improving the competitive capability of industry, lowering the cost of living, and reducing dependence on imported energy sources.

A report published by the State Comptroller in 2017 on the natural gas network and connection of consumers to the gas distribution network found that the gas network was not systematically addressing the connecting of consumers to the natural gas distribution network and was not supervising progress in deploying the network, as dictated by the distribution companies, which were having to cope with bureaucratic difficulties in their activity.

The State Comptroller also found that potential consumers who examined the economic feasibility of being connected to the gas distribution network were frequently encountering bureaucratic obstacles, uncertainty about the regulation that would apply to them, and were subject to new demands and unexpected delays in implementing the plan.

In some cases, efforts to place distribution lines in the jurisdiction of local authorities were being met with determined opposition by the local authorities, even when future consumers of natural gas were supposed to operate in their jurisdiction. In other cases, distribution companies were required to pay infrastructure companies for the use of land belonging to them in order to place a natural gas line on it.

Manufacturers Association sources said that even now, the obstacles mentioned in the State Comptroller's report were still delaying the connecting of industry to the natural gas network.

Next step: The sale of Delek Group's holdings in Tamar

The principal milestone still remaining in implementation of the gas plan is competing the sale of Delek Group's holdings in Tamar, which it discovered it 2009. Delek Drilling sold 9.25% of its shares in Tamar to Tamar Petroleum in July 2017, and reported a $500 million capital gain on the sale. In March 2018, Noble Energy followed suit, selling 7.5% of the rights to Tamar Petroleum for $560 million. Since then, Delek Group continues to hold 22% of the rights in the reservoir (not including indirect holdings through Delek Petroleum), which is must sell by the end of 2021. Tshuva tried to sell the shares to investment institutions at a high price, but as the deadline for selling approaches, the pressure on him is mounting. The market believes that if he does not find a buyer at a suitable price, he may eventually have to transfer the shares to a trusteeship.

Published by Globes, Israel business news - en.globes.co.il - on December 23, 2019

© Copyright of Globes Publisher Itonut (1983) Ltd. 2019

Leviathan gas reservoir / Photo: Albatros
Leviathan gas reservoir / Photo: Albatros
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