On October 20, 2013, Israel's High Court of Justice will rule on the legality of an Israeli cabinet decision that was passed in June regarding natural gas exports. As described below, the cabinet's June decision limited rights guaranteed to the public by law, rights that were intended to maximize the nation's benefits from its fossil fuel resources. As such, the decision was the culmination of a systematic effort by government officials over the past three years to forfeit the public's rights in every area where those rights limited the potential profits of the gas field licensees. The government decision on exports will force the country to import alternative fuels over the coming decades at a net loss of 200 billion dollars or more.*
Licenses to explore and develop Israel's gas fields were issued for free, without public tenders. Excuses have subsequently been given for the free distribution, such as the claim that gas exploration was a high risk. In truth, the officials who issued the licenses, and those who received them, knew that that the probability of gas discovery was high and the relative costs of exploration almost trivial (with costs of tens of millions to confirm fields valued at tens to hundreds of billions). The true rationale for free distribution of licenses was that the framework for gas and oil development reserved for the state key rights of ownership.
Under a patchwork of laws regarding the production of natural gas resources, authority is given to the state to determine how quickly fields are to be developed, the quantity of gas that is to be produced, and the terms that are offered to licensees, including the price of gas. The legal framework ostensibly ensures that after the discovery of gas (or oil) it is the public, including local industrialists, that benefit from a cheap, reliable flow of fuel, while gas field licensees are prevented from setting market terms and conditions.
Key Points of Law
1. Development of a field must commence immediately after discover, unless the state determines that development can be delayed. On-site work must begin within 6 months and production within 3 years. (See paragraphs 24, 29c, 31, and 51 of the Oil Law 1952.)
2. The price of gas is set by the state. (Paragraphs 92 – 93 of the Gas Sector Law 2002, Paragraph 30.c.1 of the Anti-Trust Law 1988, Paragraph 12 of the Regulation of Prices of Goods and Services Law 1996.)
3. The state can set taxes on local sales of natural gas taxes. (Paragraph 2a of the Tariff Law 1958.)
4. The state can set how the local market is divided between local producers. (Paragraphs 92-93 of the Gas Sector Law, paragraph 30.c.5.)
5. The state can set the production level of a field. (Paragraphs 29d, 33, and 82 of the Oil Law.)
6. Local demand priority. The state can demand diversion of exports to meet local needs arising from a sudden supply loss or long term demand growth. (Paragraph 33 of the Oil Law.)
7. The state has the sole authority to set how and to where gas exports are to be delivered. (Paragraph 35 of the Gas Sector Law.)
8. Licensees who do not meet terms set by the state forfeit their licenses. (Paragraph 55 of the Oil Law.)
The Government Gas Export Decision – Circumvention of Key National Rights
The government decision was publicized as a decision to limit exports to 40% of projected national reserves. However, a thorough analysis of the decision indicates that it was designed specifically to forfeit key elements of the state's authority over gas production.
1. Export Quotas: Circumventing the local priority over exports.
The Government decision gave the energy minister authority to approve gas contracts that will be exempt from the requirement of local demand priority. After contracts are approved, the minister will not be able to subsequently divert exports to meet increases in local need, regardless of whether the local need stems from a sudden supply failure or from demand growth over time. The decision means that the country will not only have to import fuels once gas supplies have been depleted, but that the country will likely have to import alternative fuels in parallel with exporting under long term contracts. (A number of countries, including Denmark, England, and Malaysia, the world's second largest liquid natural gas exporter, already find themselves in this situation.)
2. Export Facilities: Forfeiting government authority to determine how and where to export.
The decision allows the owners of the license on the Leviathan gas field, Israel's largest field, to build their own export facilities, in direct contradiction to the stipulations of the Gas Sector Law (paragraph 35) which gives sole authority over the building of export facilities to the energy minister. Under the Gas Sector Law, ownership of gas export facilities is forbidden to gas producers and is to be allocated by tender or to the national gas lines company. Allowing gas producer ownership prevents government control and weakens the public's ability to negotiate with the licensees.
The government decision also instructed the energy minister to approve all export contracts as long as an export quota was not surpassed, without considering the economic return that the state could expect from any given project. Taxes on exports are likely to provide only 10 to 20% of the value of natural gas as a substitute for imported fuels. The 80 to 90% economic loss will amount to a total loss of at least 200 billion dollars under an optimistic scenario that global fuel costs in 20 to 30 years will be relatively the same as today (accounting for general inflation). By law, most of the export tax will be saved in a national fund for long-term use, but the bottom line is that when the gas reserves are depleted in 20 to 30 years, the fund will have only a fifth or a tenth, and perhaps even less, of the value that the gas would have if it had been saved for long-term domestic use. Licenses were not issued with any government commitment to allow exports, and there is no reason to commit to any project unless it can be shown to be profitable to the country.
3. Exports constraints that cannot be implemented under Israel's free trade agreements.
Government officials claim that exports will be limited to 40% of Israel's "probable" reserves. But the free trade agreements of the World Trade Organization, in which Israel is a member, forbid quantitative export constraints (GATT paragraph Article XI). If producers succeed in exporting the amount set by quota before all reserves are depleted, the 40% constraint will not be enforceable. In other words, the 40% limit is merely a ruse to allow export to be limited only by producers' calculations as to how to most effectively optimize their own profits.
4. Imposition of illegal, but discreet export tariff that minimizes public benefit
Export fuel tariffs are currently forbidden by paragraph 8 of the Fuel Tariff Law (though such taxes are the only legal means of limiting exports under the WTO agreements). Changing the law to permit export tariffs would be a reasonable step towards increasing the economic benefits of export. However, the government made the decision to impose a hidden tax that benefits not the public but the owners of the gas licenses other than Leviathan (though most have approximately the same ownership as Leviathan). The hidden tax comes in the form of export "rights" that the Leviathan field must buy from the other licensees. The export rights are to be distributed for free to the licensees. Obviously, the public would benefit more if the Leviathan licensees had to buy their export rights directly from the state.
The Government decision culminates a series of actions by public officials that forfeit the public's rights
1. Forfeiting authority to demand field development.
The Leviathan field, bigger than all of Israel's other fields combined, was discovered in November 2010. According to the law, field development should have begun in April 2011, and lack of progress should have led to cancellation of the license. Four other small fields have also been subsequently discovered, but the Ministry of Energy has thus far exempted all from the requirement of development under the excuse that the potential profitability of development is not clear. (The excuse includes an additional twist meant to distort the public's rights: because profitability is for some reason not clear, the Oil Commissioner claims that it is not clear if discoveries were actually made.) In other words, the public right to gas field development, even when only marginally profitable to the licensees, has been forfeited, and bargaining power has been given to the licensees. This bargaining power was one of the main excuses for the government decision, as Netanyahu himself stated that exports were necessary to "encourage" further gas field development.
In truth, the only encouragement that is needed is enforcement of the law. The local market could easily support further field development, just not the maximum level of development that licensees are planning in order to maximize their profits. Today, even with the Tamar field on-line and producing at full capacity, a portion of the country's electricity is produced from imported LNG. Local gas could replace that LNG for a sixth the cost (net taxes). Many of the nation's factories rely on imported fuels that could be replaced by local gas for a tenth the cost. While saving local customers hundreds of millions of dollars, the production of local gas from Leviathan would net the licensees a handsome profit. Excess gas produced from a first stage development of Leviathan could also be sold to Israel's neighbors, Jordan and Egypt, further enhancing their initial returns. (The licensees claim that the local market for the next few years would not justify their project costs, but they hide the fact that the field could be developed in stages corresponding to the growing local need.)
2. Forfeiting authority to set local prices.
In May, 2012, a joint pricing committee of the energy and finance ministries declared that it would not interfere in pricing despite stating that there was "concern that prices being set were not compatible with the need to ensure a balance between reasonable return to the investor and the public interest." Prices that were set between the now producing Tamar field and Israeli gas customers, with the government-owned Israeli Electric Company (IEC) being the largest customer, are four or five times the cost of production (including cost of capital). If producers are allowed to continue charging prices far above costs, the Israel public will pay over the next 20 to 25 years about 60 billion dollars more than they would with price regulation. Of that amount, about half will be returned as taxes to the government, meaning a net cost to the public of about 30 billion dollars.
3. Forfeiting authority to control market so as to encourage competition, production redundancy, and local market priority.
In June, 2012, Israel's Antitrust Commissioner approved long-term contracts that tied Israeli customers, including the IEC, into buying most of their gas from the Tamar gas field. The commissioner gave approval despite expressing the view that new field development depended on ensuring licensees of sufficient market demand. In other words, his approval limited the potential for competition, which is also necessary to ensure that the market has excess gas to meet demand when there are supply failures.
4. Violating the legal time limits set on licenses.
The Oil Law specifically forbids the Oil Commissioner from extending licenses beyond the permitted seven year limit, unless a discovery is made, at which point the license is converted to a 30-year lease. However, this stipulation of the law has been ignored when it does not suit the licensees. The Tamar license was extended to nine years before discovery was made in 2009. The Shimshon license was recently extended beyond seven years as well. In the Shimshon case, a discovery has been made, but it has not been recognized by the Oil Commissioner, thereby making the license extension illegal.
5. Ignoring data relevant to long-term planning.
The government claims that its new gas export regulations will encourage new exploration. But all of the territory in Israel's economic zone has been analyzed by seismic studies and the estimates released indicate that there are no signs of further giant fields such as Tamar and Leviathan. In other words, most of what Israel can expect to find has already been found. Israel needn't rush to find and develop the remaining small fields. Gradual development is considered responsible energy policy everywhere else in the world.
The government also claims that exports are necessary for providing extra tax revenue. As described above, the revenue will be only a fraction of the value of the gas. The government, for its part, has presented no explanation of how it has estimated potential revenue, given that no specific export projects were analyzed. The government did, however, state that it would pass new export tax legislation, but also gave no indication of what type of tax was being considered. A flat tariff tax would be most reasonable, forcing the licensees to consider only projects that could return the minimum demanded by the state. However, given the cost of producing LNG, no tariff could close the gap between the prospective tax revenue and the cost Israel must pay to import fuel alternatives.
The global price of natural gas over the next five to ten years may fall, due to several large projects coming on-line and expanded use of shale gas extraction. But at the same time, projects continue to get more expensive, as do oil and coal projects, and demand continues to rise. No experts expect the cost of fuel to be lower in twenty-five to thirty years, when Israel's gas reserves are likely to be depleted. Israel's government officials stand alone in the world in their view that energy resources should be depleted as quickly as possible and that long-term supplies needn't concern a nation. They see shale gas as a long-term solution or claim that alternative energy from the sun and wind will soon make fossil fuels irrelevant. To this extent, they join fringe theorists who see fossil fuel use as a conspiracy of the global oil and gas companies.
A nation should follow the safest course of action to ensure long-term survival. While we hope that the world's energy problems somehow will be solved, we need to recognize the risk that they will not be solved meaning that energy resources will be increasingly costly. Selling off Israel's gas supplies when there is a risk of higher future energy prices is the course of risking Israel future. In all likelihood, none of Israel's policy makers really believe energy prices will fall, but rather believe in the personal benefits of supporting the financial elite who took control of Israel's gas licenses. Sadly, their support for the licensees can be expected to cost their nation $200 billion or more.
*Calculation of export economic loss based on projected export of 360 BCM of gas. Value of gas based on current average cost of imported alternative fuels (such as LNG, crude oil, and mazut and diesel): $19/mmbtu. Tax revenue from exports estimated as $3/mmbtu. Difference of $16 x 36 million mmbtu/BCM x 360 = $200 billion.