Woodside Balks at Leviathan Natural Gas Partnership as Tax Issues Scupper Launch

Australian company’s actions, causing postponement of official ceremony, takes partners in offshore development by surprise.

Offshore Leviathan natural gas drilling site.
Albatross

A ceremony to mark the entry of Woodside Petroleum as a partner in the Leviathan offshore natural gas field was delayed late Thursday after the Australian energy company protested the Israeli government’s planned tax policy toward the project.

Woodside has agreed in principle to invest $2.7 billion in the giant gas field off Israel’s coast in exchange for a 25% stake in the project, but the company has been at odds with the Israel Tax Authority over how to treat profits earned against the company’s investment in the field. Woodside is demanding that they be treated as shareholders loans – making the profits covering the company’s outlay tax-free – while Israeli officials apparently insist on treating it as a capital investment subject to tax.

Woodside is also demanding accelerated depreciation rights, even though it did not invest in Leviathan’s exploration or initial development.

Woodside’s decision to hold up the signing of the final documents surprised the current partners in the gas field – the Delek group and Ratio Oil Exploration partnership of Israel, and Texas-based Noble Energy. Delek owns 45% of Leviathan through its Avner and Delek Drilling units, while Noble Energy controls 40% and Ratio 15%. The gas field is by far the largest ever found in Israel’s economic waters, providing the country with an energy source and tax-revenue source that was beyond the imagination just a few years ago. 

Earlier Thursday, the government published the final components of the regulatory framework to govern Leviathan, details that Woodside was waiting to see prior to signing the partnership agreement. The state granted the partnership a 30-year production license to develop the field.

Officials from the current partners to Leviathan, along with representatives of Woodside, convened a meeting Thursday at Jerusalem’s King David Hotel to review the regulatory details in advance of the signing of the final documentation on Woodside’s entry into the partnership, which was expected later the same day.

When the Australians expressed displeasure at the final regulatory details, the signing ceremony – scheduled for that evening – was scrapped, with the explanation that Woodside remained dissatisfied with the Tax Authority’s stance.

The following day, Friday, executives from Woodside and Noble left Israel, although professional staff representing them remained in an effort to press for tax concessions.

The prospect of Woodside’s entry into the partnership was first announced in December 2012, but the sides held off on finalizing it until Israeli regulations on exports and taxation became clear.

While Woodside has said it would not proceed unless the arrangement made commercial sense, analysts said the latest delay was not necessarily a bad sign for the joint venture partners after trying to seal a deal over the past 16 months.

The understanding worked out between Woodside and the current Leviathan partners calls for the Australian firm to transfer $850 million to the partnership upon the closing of the transaction, in addition to a payment of another $160 million in the payment of super royalties. The balance of Woodside’s contribution, however, is due to be paid in the coming years as the development of the gas field progresses.

The complex transaction involved a number of regulatory agencies, including the Energy and Water Resources Ministry, which had three primary concerns: The extent to which a commitment would be made to invest in the project for the benefit of the local market rather than for export; limitations on the export of the gas; and the size of the guarantee that would be provided to assure development work would proceed.

On the guarantee issue, it was agreed that the partnership would provide an immediate $50 million guarantee, but only have to bring it up to $100 million in 2020. In addition, it would get back a guarantee on a Leviathan drilling site that was abandoned.

On the infrastructure issue, the ministry proposed that the partnership build gas pipelines and other infrastructure that purportedly exceeded what had been envisaged previously. This was done to provide excess capacity for smaller exploration sites that might be developed in the future, and to provide backup infrastructure in the event of technical problems at another offshore exploration site, Tamar, which is already producing natural gas.

The Leviathan partnership, however, countered that such a requirement would add a billion dollars to the cost of its project, boosting it to $5 billion.

Ultimately, the ministry agreed to condition the development of additional infrastructure on its economic feasibility, but another major stumbling block involved the ministry’s demand that, under certain circumstances, gas destined for export would be diverted for domestic use.

The partnership countered that it would be impossible to finance development of the site for export if the ministry could arbitrarily divert production for local use.

On this score, the partnership scored an achievement of sorts, with the ministry agreeing that a diversion of gas would only be allowed if there is a shortage in Israel, and that gas for export would only be diverted for domestic use to the extent that there is no contract for its sale abroad. In return, however, the partnership would have to maintain an emergency reserve for domestic use. Last June, the government decided that 40% of the country’s total reserves could be exported.

There has been a lot of speculation about how Leviathan will be developed and where the gas could be sold. The Israeli partners have said that 16 billion cubic meters of gas a year will be produced in the first stage, starting in 2017 or 2018. About half of this will be sent by pipeline to Israel, Jordan and the Palestinian Authority. The rest will be sold through a separate pipeline, perhaps to Turkey or Egypt. At the same time, there are more complex plans for liquid natural gas exports with an eye to Asian markets. LNG exports would be processed onshore at a facility in Cyprus or, more likely, at sea on a floating LNG vessel.

With reporting from Reuters.