Israel's Natural Gas Framework Was Not Born in Sin

Gas deal was the product of compromise, so it doesn’t fulfill the critics’ highest expectations and has created needless hysteria. But it’s still better than any other alternative we have.

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Bank of Israel governor Karnit Flug discussing Israel's natural gas plan with the Knesset's Economic Affairs Committee.
Bank of Israel governor Karnit Flug discussing Israel's natural gas plan with the Knesset's Economic Affairs Committee, Dec. 1, 2015.Credit: Emil Salman

Unintentionally, the Bank of Israel deceived the public last week. It came during the appearance of central bank governor Karnit Flug before the Knesset Economic Affairs Committee to speak about the natural gas framework. Flug presented the committee with the Bank of Israel’s updated forecasts for the revenues the state will receive from the sales of natural gas over coming decades. These estimates have shrunk by about 40% from those presented by the central bank two years ago. In addition, Flug presented the central bank’s forecasts for the government’s share of natural gas sales: between 47% to 53% of revenues from the Tamar offshore gas field.

This was the first time the Bank of Israel presented its own calculations involving the gas framework, and they caused quite a stir. The media interpreted the central bank’s figures as refuting the government’s position, which is that the state’s share of the gas companies’ profits will reach 60%.

But the thing is, that’s not really what Flug was saying. The Bank of Israel did not intend to refute the government position. In fact, it’s the opposite: The central bank only strengthens the government’s case. In its detailed position paper last week, the Bank of Israel noted that the government’s share of the gas companies’ profits are expected to reach 52% to 64% on average – exactly the same as the official government position. The 47% to 53% figure is the tax on the Tamar field (50% to 55% in the case of the Leviathan offshore field), but it relates to the state’s share in the revenues from the gas, not in the profits it yields.

For some economic reason, the Bank of Israel chose to carry out the detailed calculation on revenues, and in doing so deviated from those of the Sheshinski committee, which studied the taxation of Israel’s natural resources, and are based on the tax on the profits. When we translate the share of revenues into the share of profits, we reach the average of 60%. At full revenues, the government’s share of the profits (the marginal percentage) will be even higher – but the central bank did not provide this number.

Compromise has a price

This small mix-up proves in a nutshell the complexity of the taxation of natural gas and the regulation of the industry. This complexity, which is very difficult to explain in detail, seems to be one of the reasons the public debate over the gas framework has spilled over in recent weeks into hysteria. In Israel today the public has a feeling that the gas framework is corrupt, born in sin, and our children’s future was sold out to the tycoons for a mess of pottage.

This simply is not true. None of these statements is true, and in order to explain, it is worth ignoring the complex details for a moment, and looking at the overall picture.

“It is important to recognize that in the way of arrangements reached through negotiations, the final framework is the result of compromise – and because of that it does not bring to the two sides the maximum achievement possible as far as they are concerned,” said Flug to the committee. “But from the viewpoint of the state and the public, it leads to a better result than the existing alternatives as to the exploitation of the [gas] fields, moving up the reaching of redundancy in supply, and for prices too.”

This comment seems to have been Flug’s most important point about the framework: It is an agreement reached through compromise with the gas companies, after negotiations. It is not a framework that is a unilateral decision by the regulator and the state. The government intentionally chose not to act unilaterally, but through mutual agreement. And this choice has a price, the price of compromise, because we need to reach an agreement with the gas companies. But this choice also has an enormous advantage, because it also makes the gas companies committed to the agreement, and their incentive to act according to the framework is many times greater. In any case, they lose their legal claims against the government if in the future they do not meet their side of the pact.

The decision to act with mutual consent, and not through enforcement, is not by chance. It is worth mentioning that everyone who dealt with regulating the gas industry acted in consent. First of all, the previous antitrust commissioner, David Gilo, who for almost two years conducted negotiations with the gas companies, reached a draft of a “consent order” with them, and a year later changed his mind and announced the order’s cancellation. All told, Gilo tried for three years to reach an agreement with the gas companies.

In reality, after his backtracking from the proposed regulatory order, Gilo continued to support reaching a consensual agreement with the gas companies. After all, the former antitrust commissioner was a partner on the team that worked on the gas framework, which was established hastily after Gilo ended the negotiations over a regulatory order; and this team too tried to reach an agreed upon framework with the gas companies. In the end, they succeeded in reaching such a deal, but regrettably without Gilo. He resigned in anger from the negotiating table after reaching the conclusion that the government had given in too much to the gas tycoons in the negotiations.

The Bank of Israel tends to agree with Gilo on this. The central bank writes in its position paper that the regulatory order did not include the leniencies and commitments the government later agreed to, but this was the price the state had to pay for reaching an accord with the gas companies at a point in time when natural gas prices are falling, there are few options for exporting gas form the Leviathan field, and there is only one large company in Israel that uses the natural gas fields.

In addition, writes the central bank, the regulatory order did not include a commitment from the government to refrain from changing the business environment for 10 years, as does the present framework. This commitment is the “price” the state is paying for the uncertainty created, which contributed to the crisis between the government and the gas companies, states the Bank of Israel.

One can understand from the position paper that Gilo’s regulatory framework was a preferable compromise to the present one. From this perspective, Gilo’s retreat from that framework seems to have caused quite a bit of damage. Nonetheless, the Bank of Israel expresses its understanding for the gas framework that the government agreed to instead in the negotiations, which took place after three years of barren talks between the government and the gas companies.

This seems to be the complex message of the gas framework: It is one of compromise that was reached under uncomfortable circumstances for the state. That is why the framework is far from being optimal, but the Bank of Israel thinks – as does every other senior official in Israel involved in the details of the framework, with the exception of Gilo – that it is the preferable alternative to the other one available to us today: a unilateral act, without the agreement of the gas companies, which risks long, drawn-out legal battles with the companies. Delaying development of Leviathan would also be costly, and even a legal victory in the end would most likely be a Pyrrhic one. Of course there remains the threat to nationalize the gas fields, but in any case the government would need outside companies to develop and operate them, and this would make such a threat useless.

In cruder terms, the Bank of Israel also thinks that Israel needs Noble Energy in order to develop Leviathan, and as soon as possible. Exactly for this reason the government has contracted with Noble Energy in the gas framework, and exactly for this reason the government has agreed to the compromises in the framework. This is not a brilliant compromise, and it is no problem to prepare a long list of additional items that the state could have achieved in the framework, and which were not achieved.

But this is the nature of compromise - you don’t achieve everything in them – and the determined and unambiguous position of the Bank of Israel is that in the present situation this compromise is preferable to any other available alternative.

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