Analysis

The Costliest Mistake in Israel’s History

In a report this week, the State Comptroller puts the excess cost Israelis are paying 
for natural gas from the offshore Tamar field at as much as $2.3 billion over 17 years

Minister Yuval Steinitz, left, with Prime Minister Benjamin Netanyahu. Steinitz and the Energy Ministry people looked only at the development of the gas fields, and didn’t even think about how to convert Israel to gas.
Steinitz, left, with Netanyahu. Steinitz and the Energy Ministry looked only at development of the gas fields, and didn’t even think about how to convert Israel to gas. Emil Salman

Five years after the state-owned power monopoly Israel Electric Corporation signed a contract with the gas cartel, the state comptroller has finally put a price tag on how much the deeply faulty agreement will cost the Israeli public in needlessly high prices.

The answer is somewhere between $2 billion and $2.3 billion over the deal’s 17-year lifespan – and the amount could end up being double that, the comptroller said in his reported released on Tuesday.

The greatly flawed nature of the IEC contract has been known for some time; TheMarker itself played a big role in exposing it in a series of stories in 2010-13. But the comptroller has not attached an authoritative figure to what is certainly the costliest debacle in Israel’s history as half the natural gas consumed by Israel was contracted for at excessively high prices.

The reports recalls a difficult history over the three years that the IEC and the partners of the Tamar gas field – the U.S. company Noble Energy and the Israeli companies Delek Group and Isramco – negotiated the terms of the agreement.

Tamar
Albatross

The short history is that IEC was paying an average of $275 per million British thermal units (BTUs) for gas from Israel’s first gas field Yam Thetis in the years 2004-11. By the time it signed a contract to import Egyptian gas through the company EMG in 2008, the price had risen to $4.

When IEC and the Tamar partners signed a letter of intent a year later, the price was set at $5.04 and by the time they reached final terms in 2012 it was $5.40. The contract’s linkage terms will bring the average price this year to $5.91 per million BTUs.

The State Comptroller says the 2012 contract was based on an excessive price, a fault made worse by the fact it was linked to the U.S. consumer price index plus or minus 1%. In addition, IEC contracted for more gas than it needed and agreed to concessions that favored the gas companies.

Who’s to blame: The report points its finger mainly at IEC and less so at the gas companies, which as private sector bodies aren’t subject to direct criticism by the comptroller. Regulators failed to take action even though they knew as the negotiations were underway that there were problems and failed to provide clear policies.

“IEC is a government power company with experience in negotiating gas contracts, but its legal status, its business considerations and its incentive system are not necessarily compatible with the needs of the economy for natural gas,” the report says.

Part of the blame for the high cost of gas is the perfect storm that blew in as contract talks were underway, which explains why the terms contained in the 2009 letter of intent were better from IEC’s and consumers’ perspective than the final ones agreed on in 2012.

In the interim, production at the Yam Thetis field suddenly dropped and chaos in Egypt led to terror attacks on EMG’s pipeline and finally to Cairo’s cancelling the agreement altogether inn 2012. That created a severe gas shortage in Israel and left Tamar suddenly as a monopoly supplier.

Meanwhile, the government adopted the recommendations of the Sheshinski committee in 2011, which raised taxes imposed on gas production. The Tamar partners exploited the difficult situation, in part by effectively passing on the costs of Sheshinski to IEC and then to electricity users.

The state comptroller doesn’t try to make calculation about thwta the “correct” price of gas should have been. Rather it uses the 2009 price the two sides has agreed on as a benchmark. Not only was the price just $4 per million BTUs, linkage was based on mainly on global petroleum prices.

Because the final contract was based on the U.S. CPI, the price for Tamar gas was inevitably going to rise no matter what. If it had been linked to oil prices, the price would have plummeted, as it turns out. That’s why IEC is now paying $5.91 per million BTUs, as calculated by TheMarker, while private power companies that negotiated better contracts are paying just $4.70.

The comptroller estimates that the linkage portion alone will cost IEC and its customers between $370 million and $640 million over the life of the contract.

As praiseworthy as are the report’s findings, which were the result of 18 months of working including withstanding pressure from interested parties, it fails to take its investigation past the year 2014. As a result, the controversial gas framework agreement, which spelled out the final outstanding terms governing Israel’s gas industry, never get a mention, nor are the contracts that the gas cartel signed with other companies examined. Both play a role in the price of gas Israelis play.

In any event, the comptroller recommends two things to help mitigate the failures of the past. One is that the energy and finance ministries use the option contained in the agreement to negotiate lower prices during windows that open up in 2021 and 2024.

The other is two ensure that a second undersea pipeline is laid from Tamar to the Israeli coast.