State Wants Higher Royalties on Gas, Oil

The state is considering increasing royalties it takes from the productionn of oil and natural gas in Israel, now that discoveries of potentially commercially viable quantities of the fossil fuels have reawakened interest in the issue.

Finance Minister Yuval Steinitz announced yesterday that he was appointing a committee "to examine the fiscal policy on oil and gas resources in Israel."

The current taxes, royalties and fees on energy production were formulated in 1952, and have not been updated since then.

The committee will compare Israel's policies to those of western democracies with similar economic conditions, while taking into account Israel's unique geopolitical and economic conditions.

Energy companies have been pressuring Steinitz in an effort to stop him from appointing the committee. Treasury sources said yesterday that the royalties that companies paid for oil and natural gas drilling licenses in Israel and offshore were lower than those in many other countries.

Steinitz had announced recently that he would not give in to such pressures. Several MKs said they expect similar pressure from energy company lobbyists when the Knesset is presented with a bill on the matter.

Yesterday's announcement about the committee did not contain any information on important questions such as whether the changes in taxes and royalties would be retroactive - though government officials have said any changes would not apply to existing license owners.

Prof. Eytan Sheshinski of the Hebrew University will chair the committee. In the 1980s he headed a public commission on tax reform. The other members include Finance Ministry Budgets Director Udi Nissan; Israel Tax Authority head Yehuda Nasradishi; Prof. Eugene Kandel, the head of the National Economic Council in the Prime Minister's Office; and the director general of the National Infrastructures Ministry, Shmuel Tzemach.

The committee was instructed to propose an up-to-date policy for future gas and oil discoveries, and to study the implications of the present discoveries on the Israeli economy.

The committee will present its recommendations to Steinitz by mid-August.

The present law levies 12.5% royalties on gross revenues from the sale of extracted natural gas or oil. But the state also covers 15% of the production costs, so the royalties are actually only 10.6%.

In practice, the true level of royalty payments is even less, as there are other tax breaks such as depreciation as the field empties out. This translates into one of two possibilities: A 27.5% tax reduction on gross revenues, or taxing only 50% of the franchisee's total taxable income. This all comes in addition to the recognition of all drilling and production costs as tax-deductable expenses.

In 2002 the Finance Ministry tried to amend the Petroleum Law to increase royalties on gas production, but gas company lobbyists managed to stop them. Former infrastructures ministers also opposed such changes, as does current National Infrastructures Minister Uzi Landau.

Landau's bureau said yesterday: "The committee has been given a very serious responsibility, based on the fact that the oil and gas sector cannot tolerate uncertainty regarding such a significant parameter; and out of concern for the implications of halting investments and development in the current preliminary stages. The ministers will discuss the proper framework for the committee." The ministry said the recommendations should be only for future rights and not existing ones.

In 2002 the cabinet decided to levy additional taxes of 10% to 50% on profits from sales of natural gas and oil, on top of the 12.5% royalties.

The cabinet also voted to cancel a number of other benefits for the franchisees, including raising their tax rates to the same as that levied on industrial firms and canceling the franchisees' property rights on their license areas or pipelines.

At the same time the cabinet also decided to require tenders for issuing drilling licenses. But this entire move was halted completely in Novemebr 2002, when then infrastructures minister Effi Eitam objected and the Knesset Economic Affairs Committee voted down the proposals unanimously.

Energy companies also lobbied heavily against, and the U.S. ambassador to Israel at the time also strongly denounced the changes.