Thoughts on Israel’s Natural Gas Policies

The Israeli government’s energy policy serves to transfer national wealth into private hands. By avoiding price regulation of the gas sector, the government allows gas licensees more than a billion dollars per year in excess profits at the public’s expense. Moreover, if the government moves forward with plans to approve gas exports, national wealth worth a hundred billion dollars or more may be sacrificed for the sake of enhancing the private profits of the gas licensees

Government/industry reps such as Shaul Meridor and Eytan Sheshinski claim that the public interest is served by the Law on Oil Profits Taxation (the “Sheshinski Law”), and by the sovereign wealth fund proposed in the law. In truth, given the legal framework under which the gas licensees were issued, the Sheshinski law was superfluous. The legal framework, which allowed the licenses to be distributed for free, reserved for the government the right to set production schedules, production rates, export rates, and pricing. The licensees had no legal reason to expect that government officials, as representatives of the public interest, would allow them to make unreasonable profits or to control other aspects of gas production.

The Sheshinski Law ignored (but did not invalidate) the government’s option of limiting profits under the Price Regulation Law of 1998. The Sheshinski Law set a profit tax at 46 %, regardless of the price charged, and applies the tax only after the licensees have accumulated significant profits, which, under a reasonable pricing regime, would be achieved only towards the end of the project lifetime. The public benefit would be more than twice as much if the government imposed fair profit limits on the licensees and then set variable tariffs (blu taxes) to achieve reasonable market prices. The tariff revenue, rather than the Sheshinski tax revenue, could be set aside for the sovereign wealth fund. (The Price Regulation Law specifically permits regulation of profits, which is more appropriate than regulation of prices in an industry in which each project has a different cost structure.)

If the gas licensees are allowed to continue earning profits at the current rate, assuming local sales reach 20 BCM by the year 2040, the wealth fund will accumulate between 1 and 2 billion dollars per year from the local sales, starting in 2020. But this means that the public will lose some $30 billion to monopoly profits over this period. To put these figures in perspective, the national debt is about $200 billion, and the annual interest on that debt now runs at about $11 billion. The country currently imports about $12 billion per year of oil. More comments on the sovereign fund are added below.

In addition to assuming that monopolistic pricing will be allowed, the Sheshinski Law also hid within its convoluted syntax a limit on export profits tax. Theoretically, internal taxation and export taxation should have no connection. The internal tax should balance policy goals related to revenue generation, economic growth, and fuel choice. External taxation should simply maximize revenue.

The government is planning to introduce a revision to the Sheshinski law to modify the export tax provisions, but without changing the current framework of the law by which 1) the tax only applies after the licensees have recovered all the profits that they would make over the entire lifetime of a project, if the public were protected by price regulation; and 2) the tax is capped at the same 46% as the local tax, as if the licensees were co-owners of the public resource.

Theoretically, the decision to export or not should be an economic decision–that is, the decision should be based on whether the revenue from export is greater than the present value of the resource held for future use.

Such a question requires that each potential export project be evaluated separately, as the revenue for each will be different. However, given that Israel’s alternatives to gas cost in the range of $20/mmbtu today, and global prices most likely will continue to rise in coming decades, it is unlikely that any export project will come close to being economically viable. (See list of alternative fuel prices below.)

The Tsemach Committee which evaluated gas exports did not bother to analyze the possible economic benefit, but instead claimed without analysis that the fastest possible development of Israel’s gas, combining both export and local sales, was in Israel’s interest. The committee further claimed that without exports, the development of Leviathan could not proceed, because the local market was not large enough. Furthermore, although the local market was supposedly not large enough to justify the necessary investment, the expected local shortage without immediate Leviathan development was so great that avoiding the shortage justified any possible economic loss from exports.

In truth, the projected “shortage” was based on plans to close coal-powered plants, which obviously do not need to be closed if the country does not have sufficient gas. Furthermore, the claim that the gas needed by Israel will not be enough to justify development of Leviathan ignores a number of facts. First, the need in Israel will continue to grow, especially given the large price differential between gas and imported oil. Second, in initial years Israel could export to neighbors, without having to be locked into long-term contracts. Long term contracts are only necessary when customers or suppliers must make significant infrastructure investments. Such investments are not needed for sales to Egypt or Jordan. Finally, given the outrageous profits currently enjoyed by Tamar, some of Tamar’s closed contracts could be shifted to Leviathan to ensure sufficient revenue in initial years to support the Leviathan project. Much is made of the value in having Leviathan as a backup to Tamar, though this view generally ignores the military costs of having to protect Leviathan in parallel with Tamar. In any case, the bottom line is that long-term export contracts are definitely not needed, and development should begin when it is in the country’s best interest, given the multiple factors of security and economics.

In summary, two fundamental questions are addressed when a state develops its resources: first, how should the development be structured to minimize costs and maximize reliability; and second, how much should be exported to increase foreign cash reserves, rather than being saved for current and future generations. Israel issued gas licenses for free under a legal framework that should have guaranteed the implementation of policies that would maximize the public’s benefit. However, subsequent policies are leading to a de facto privatization of the resource, so as to maximize the benefit to the licensees, despite the costs that this imposes on the public.

A few additional facts are worth noting. First, although the Sheshinski Committee supposedly hurt the interests of the gas partnerships by imposing a new tax, committee member Udi Nissan was appointed two years later to be Chairman of the Board of Delek Israel, also part of the Delek Holding Group that is a part owner of the Tamar and Leviathan licenses.

The government decision on exports specified that exports would be allowed as long as a reserve of gas is maintained that is expected to serve the local market until the year 2041. However, the quantity of gas in Israel’s reserves is not known with precision. Statistically, the quantity is estimated to be between 680 and 1100 BCM. If the lower quantity turns out to be more accurate and large scale exports are allowed, production at the Tamar field will begin to decline within 15 years, and the Leviathan field will only be able to make up for the decline if all exports at that point are diverted to the local market.

Relevant to this final point is the Gas Sector Law of 2002, which requires that export facilities be built only by government tender, rather than by gas field licensees, and only from the national gas network. The law thereby imposes the requirement that the export facilities be built in a manner that allows the government to divert exports to the local market if needed. This supports paragraph 33 of the Oil Law of 1952, which specifies that the government has the power to demand such diversion as the need arises.

Further comments on the gas sector monopoly:
One of the excuses for delaying price regulation has been the claim that various policy measures will lead to competition in the sector. However, none of the officials who call for “competition” expect that they will actually achieve a situation in which gas will be sold at a price close to its production cost. This would only be possible if the market had excess capacity and if no producers had sufficient market power to affect prices by withholding supply. It should also be recognized that Israel cannot expect to have more significant gas discoveries. Almost if not all of the country’s economic waters have been surveyed, and if there were significant finds still to be discovered, licensees would have publicized their potential.

Further comments on the sovereign fund:
Proponents of the fund emphasize that the money will be dedicated to the public, not the government, as if the government is a special interest that competes with the public good. They also claim that the fund will limit the “Dutch disease”, that is, the strengthening of the local currency. However, the time lag between the start of gas production and the time the tax is imposed prevents the fund from having any positive effect on stabilizing the exchange rate. Even if the timing were not offset, the impact on the exchange rate would be trivial given that: 1) the licensee owners will spend much of their revenue outside of Israel; 2) the value of production is relatively small compared with Israel’s overall foreign trade; and 3) the Bank of Israel already maintains cash reserves of $80 billion to stabilize the exchange rate. In principle, a sovereign fund makes sense if a government does not have debt or if the government sees value in managing an investment fund. In general, if the government has a significant debt, it is more economical to use excess revenue to pay down the debt. Let the pension funds that invest in government debt find appropriate investments for themselves.

Background facts:
Israel’s total energy consumption in 2014:
1 billion mmbtu. In other equivalent energy terms:
190 million barrels of oil
28 billion cubic meters (BCM) of gas (1/36)
40 million tons of coal. Or 44

Ratio of fuels consumed
1/2 imported oil,
1/4 (or a little less) coal
1/4 (or al little more) Tamar gas field.

Energy prices
IEC pays $5/mmbtu for Tamar gas
Imported crude oil costs about $110/bbl, about $20/mmbtu.
Imported LNG also about $20/mmbtu.
Coal costs about $80/tonne on global spot markets, which is $3/mmbtu.
Israeli consumers pay about 12 NIS/kg for propane (“cooking gas”), which is about $65/mmbtu.
At 8 NIS/liter, gasoline also costs the consumer about $65/mmbtu

One mmbtu of fuel generates about 120 kWh of electricity.
At $5/mmbtu, gas costs the IEC about 0.14 NIS/kWh.
The IEC charges 0.54 NIS/kWh: the fuel cost is about a quarter of the total.
( 1 kWh of electricity provides 0.004 mmbtu: electricity costs consumers about $38/mmbtu)

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