The Final Nail in the Coffin of Israel's Natural Gas Framework

While Israelis were on vacation, the global price of natural gas dropped, and with it the basis for the revenues the government was counting on.

Ofer Vaknin

“Only a donkey doesn’t change his mind,” Moshe Dayan supposedly once said. It is clear to any thinking person that if the market conditions change, then you must rethink things. Now, with the High Holidays behind us, the government must return to the issue of natural gas and make a decision about the so-called framework agreement. The question is simple: Will Prime Minister Benjamin Netanyahu continue to insist on finding a way to approve the present natural gas framework, or will the government reexamine it in light of the major changes that have occurred in recent months?

What changes? First is the discovery of the enormous Zohr offshore gas field off the Egyptian coast, which is some 40% larger than Israel’s Leviathan field. Every week there is a new analysis of the implications of this find on the Mediterranean gas market.

The second major change, and the more important one, is the world price of natural gas. While we, in Israel, were on vacation, or busy arguing over the gas framework the global price of natural gas has continued to fall, and with it all the calculations of profits and revenues on which the framework was based.

True, energy prices are very volatile and extremely difficult to predict, but nonetheless we must still make decisions. And the only way to decide is based on expert opinions. And it turns out the experts forecast that demand and prices in liquefied natural gas markets are falling - and this is true for the medium term, at least until 2020.

Analysts from investment bank J.P. Morgan, for example, recently published a report that is quite challenging for world gas prices. The American investment bank estimates that very few long–term natural gas contracts will be signed in the coming years, and after a visit to Asia, where the major customers for LNG are, they identified 10 trends that reinforce their forecast of low natural gas prices.

These trends include a drop in demand for energy in general, the restarting of nuclear power plants in Japan, low prices for coal (lower than for gas), a lack of customers for new gas contracts, continued development and supply from new gas fields in Africa and Canada, competition in the European market, and low yields from new drilling in Australia. This is a list that drives the last nail into the coffin of the natural gas market, as JP Morgan analysts said.

The gas monopoly has already demonstrated its power

The government of Israel and the Israeli public both had many reasons to demand a different gas framework to regulate the natural gas market even a year or two ago, well before the Egyptian discoveries and the drop in world gas prices.

The proposed framework does not dismantle the gas producers’ monopoly, it does not control prices, and does not lower the price paid in the long–term contracts signed by the Israel Electric Corporation (which determine the price of electricity in Israel). It does not require the producers to build a second pipeline to bring the gas onshore and create a backup supply system, and it provides the companies with a hard–to–understand governmental promise of immunity from future changes — and developments over the last few months certainly prove that such changes will always occur.

In addition to the question of gas prices, the framework strengthens an extremely powerful monopoly — both economically and politically — and all this is in direct contradiction to what the politicians from all parties promised before the recent elections: To fight monopolies.

It is impossible to ignore the threat of the gas monopoly on Israeli democracy: Kobi Maimon, the owner of Isramco and one of the partners in the Tamar offshore gas field, has incapacitated his good friend, Finance Minister Moshe Kahlon, who is unable to fulfill his responsibilities.

Kahlon decided he will not deal with gas matters, but in reality the members of his party are acting to promote the framework, which is a great boon for the partners in Tamar. Yitzhak Tshuva, one of the owners of both Tamar and Leviathan, sometimes meets with Netanyahu; while Texas based Noble Energy, the senior partner in the offshore fields, has been putting great political and diplomatic pressure on Netanyahu from Republican donors connected to the oil and gas industry, as well as making threats to sue Israel in international courts.

Alongside all these other faults of the framework, there are now the new developments in the gas market. The fall in prices, for example, has trashed all the calculations for government revenues from gas in coming years. The public certainly remembers Netanyahu’s mantra while he was trying to sell us the framework: The gas will bring in hundreds of billions, and this money will “flow to health, education and welfare.” National Infrastructure, Energy and Water Minister Yuval Steinitz promised that some 70% of the revenues of the Leviathan field would “be returned to the public.” But if the experts are right in their assessments of future gas prices, then the government’s numbers are simply wrong.

Even before the holidays, it was revealed that the Finance Ministry and Tax Authority had already estimated that these revenues would be tens of percent lower than the figures Netanyahu and Steinitz had relied on, using estimates of historical prices from the Bank of Israel.

New, realistic estimates — that any accountant can calculate based on the company’s financial reports and the new taxes on natural resources — show that the state’s share of the Tamar field revenues will be no higher than 45% in terms of discounted cash flow.

The government won’t see a cent from Leviathan any time soon

The fate of the Leviathan field is very murky — given the present price level and supply, it is not at all certain that there will be any buyers for the gas. In any case, it is also clear that the state will not see a single cent from Leviathan any time soon, and even after that the government’s revenues will be very low, certainly compared to the rosy forecasts bandied about until now.

It is hard to believe that only a few months ago Steinitz tried to convince the public and the Knesset that the price of gas in Israel was low by presenting out of date figures that reflected the situation before prices crashed, while ignoring (innocently, or not) expert opinions about future prices.

In other words, the central claim of those who supported the gas framework was the “gas will return to the public,” but today that is in great doubt.

The Egyptian gas find also changes the rules of the game. The principle behind the gas framework, under the pressure from Noble, Delek and Isramco, was to receive permission to sell as much gas as possible — and immediately. This was a natural and logical demand for the companies to make. The minute they found gas and built the infrastructure, the marginal production costs were almost zero. The gas comes out of the ground all by itself. So it is in their interest to sell as much gas as possible, as quickly as possible to return their investment and start making a profit.

What the gas monopoly achieved in the framework was the government’s consent to allow them to sell 25% (at the very least, and this could grow to 30%) of Tamar's gas as exports. The plan was to lay a pipeline from the Tamar field (and later from Leviathan) to Egypt, where the gas would be liquefied, loaded on ships and sold in world markets.

But given the Egyptian gas discoveries, all these dreams of exports may be unrealistic. It depends on Egypt, its interests, and how much Cairo decides to export from the Zohr field.

Another idea of laying a pipeline all the way to Greece is completely impractical given today’s prices. The idea of building a liquefaction plant in Cyprus also seems to be marginal from an economic standpoint.

This in itself is not a disaster: If Leviathan has no customers, then maybe it would be better to save the gas for Israel’s future generations and to encourage large parts of the Israeli economy, such as buses and other public transportation, and power stations to make the transition to gas — over half of Israel’s electricity is still produced with coal today.

Times have changed, the numbers have changed, and so the framework needs to be rethought. Now is the time. Israeli politicians need to realize that they cannot rid themselves of the thorn in their backsides that is the natural gas framework. Why? Because this is the largest industry in Israel and the most important one. It affects the entire country’s energy independence, and it will be influenced by geopolitical factors which are constantly changing.