Obstacles to Israeli natural gas development - CHAPTER 8: GLOBAL ENERGY DEBATES AND THE EASTERN MEDITERRANEAN

Joint Publication by: PRIO Cyprus Centre, Friedrich Ebert Stiftung, Atlantic Council
Elai Rettig

Introduction 

In 2009 and 2010 two major offshore gas fields were discovered in Israel’s exclusive economic zone (EEZ); the Tamar field, with estimated reserves of 282 billion cubic metres (bcm), and the Leviathan field, with estimated reserves of 500 bcm.1 Both fields were discovered by a private Israeli-American partnership consisting mainly of two companies – the Israeli Delek Group and the Texas-based Noble Energy Inc. These discoveries were later supplemented by two smaller fields named Tanin (discovered in 2012) and Karish (discovered in 2013) which were together estimated to hold 30 bcm.2 The discoveries initially sparked a sense of euphoria among Israeli decision-makers and the public. The gas fields were viewed not only as an economic blessing, but also a major security asset that could give the resource-poor State of Israel a much-sought-after level of energy independence it never had, and even the potential to reap political benefits by becoming an exporter of gas. 

Despite the initial glee, the five years that followed were characterized by internal political feuds and growing public discord that has left the Leviathan field still undeveloped and the export of gas a still unrealized goal. This paper will give a brief overview of the three main points of contention that have so far delayed Israel’s gas export potential: (1) disagreements over the amount of revenues to be taken from the fields, (2) the question of whether Israel should export its gas, and (3) the lack of competition in the Israeli gas market. The paper will then provide some insight into the public discourse in Israel to better explain how the third issue, the lack of competition, has so far proven to be the biggest hurdle to the development of Leviathan. Finally, the paper will discuss the impact of the Zohr field in Egypt and the role of additional players – Russia, Iran and Turkey – in the future outlook for Israel’s gas developments. 

Obstacles to Development 

Shortly following the discovery of Tamar in January 2009, a number of conflicts arose that touched upon deep political and economic divides within the Israeli society. The first was the question of how much revenue should the Israeli government demand for the development of the fields. The existing 1952 law stated that 12.5% of the value of gas upon production will be taken as revenue, yet many considered this amount to be too low.3 In April 2010 a special committee was established to examine the fiscal policy on oil and gas resources in Israel, headed by Prof. Eytan Sheshinski (The Sheshinski Committee).4 The committee deliberated for eight months, during which a fierce public debate ensued between civil organizations and opposition members of parliament who supported an increase of the tax, on the one side, and supporters and lobbyists of the gas companies, including shareholders, who advocated against the move, on the other.5 The Sheshinski committee concluded on January 2011, insti - tuting a progressive levy that would gradually amount to 50% of the gas companies’ excess profits, in addition to the 12.5% in direct revenue. This was considered a fair compromise by some, and not enough by others. 

The discovery of Leviathan in June 2010 sparked a second round of conflict as it now gave Israel the option to export some of its gas for profit. On October 2011 Prime Minister Netanyahu established a special inter-ministerial committee to examine the government’s policy regarding natural gas in Israel, headed by the director general of the Ministry of Energy, Mr. Shaul Zemach (The Zemach Committee).6 The committee had to strike a delicate balance between Israel’s desire to secure its energy independence for as long as possible while also encouraging further exploration and revenues by allowing for export. The committee sub - mitted its recommendations eleven months later on September 2012 under much public scrutiny. After several revisions, the government decided that 60% of the discovered gas would be reserved for domestic consumption, thus securing Israel’s market for approximately 30 years.7 Opponents saw this amount as insufficient for Israel’s continued independence, and demanded the release of the committee’s full protocols.8 Even without such protests, the imposition of direct export quotas is rare among gas-exporting OECD members. The ratio of 60-40 in favour of the domestic market seems to faithfully represent how energy inde pend - ence is still viewed by Israeli decision-makers as more important than the prospect of becoming an energy exporter. The collective trauma of being subjected to decades of oil embargos by Arab states was only enhanced in early 2012 when Egypt unilaterally cut-off gas exports to Israel following a series of explosions in the pipeline between them, forcing the Israeli Electricity Company to quickly switch to more expensive and polluting fuels in order to avoid blackouts.9 This was a stark reminder for both the committee members and the public of the importance of securing local gas for the domestic market. 

On paper, the Zemach and Sheshinski committees were meant to address the conflicts surrounding the gas fields and allow for their development. Tamar was quickly developed and gas started flowing to Israel’s shore on March 2013, providing the domestic market with 7.5 bcm of gas in 2014.10 The gas companies also reached initial understandings with Jordan and Egypt to export gas from both Tamar and Leviathan, the highlight of which was a deal with BG International Ltd. to export gas to the Idku LNG terminal in Egypt and from there to Europe.11 Despite this progress, a third issue suddenly rose that essentially froze the development of Leviathan. 

On November 2012, the Israeli Antitrust Authority led by Prof. David Gilo announced that the private partnership that discovered Israel’s gas fields constituted a monopoly, and there - fore could not develop the fields together.12 Though the antitrust previously allowed the com panies to develop the fields, it was now concerned that with the demise of the Egyptian gas pipeline Israel has become wholly dependent on a single supplier that controls all of its gas and its price. The companies therefore had to sell some of their fields to an outside competitor. While the authority’s decision was hailed by civil groups as an important step to combat centralism in the Israeli market, it also presented substantial difficulties for the government. State officials now had to negotiate with the gas companies over a framework that would both break their monopoly over the gas fields and also give them enough economic incentives to continue their development of Leviathan. Since Israel is a relatively small market for gas, with 85% consumed by only one source – the Israel Electric Company – it was hard to see how competition can emerge over the remaining 15%, and by whom. 

Providing a working framework proved to be a much more difficult task than initially assumed due to the public outcry that ensued. The monopoly status of the gas companies evoked strong emotions among the Israeli public, as it touched upon deep economic griev - ances voiced in previous years. The high cost of living in Israel, of which the price of houses and food products is most emblematic, had unprecedentedly brought hundreds of thousands of protestors to the streets of Tel-Aviv in the summer of 2011. It also gave rise to young politicians who used the rallying call for social justice and equality to be elected into parliament. For many of the protestors, the main culprit for the high prices in Israel was the deeply centralized market which was seen as dominated by a few monopolies and ‘tycoons’ that prevented competition from forming. Once the antitrust authority announced that the gas companies are creating a monopoly over the newly discovered gas, the idea of ‘breaking the monopoly’ immediately struck an emotional chord among many. The gas framework became a flag issue for young activists and civil NGOs in Israel as they were joined by leaders of the opposition parties in parliament, and with time became more and more uncompro - mising. The public’s involvement also gave a strong sense of backing to the antitrust com - missioner’s resolve to block development until the conditions he set forth were met. This had made the government’s task of reaching a workable framework extremely difficult, and one that became mired with bad blood and personal feuds, as well as strong party politics. 

After a series of undisclosed deliberations headed by the chairman of the Israeli National Economic Council, Prof. Eugene Kandel, a framework was announced in July 2015. It stated that the gas companies will have to sell their two smaller gas fields (Karish and Tanin) to a new devel - oper, and dilute their holdings of the Tamar field. In return, they will receive more favourable conditions that will allow them to develop Leviathan and export gas more quickly. Upon announcement, the new framework ran into strong opposition and was portrayed as being too favourable towards the gas companies. Karish and Tanin were argued to be too small to enable competition by a third party, and Delek and Noble still held an indirect dominant presence in both Tamar and Leviathan. In addition, a decision to allow the export of gas from Tamar and Leviathan before Leviathan is connected to the Israeli shore by pipeline was seen as an unnecessary risk to Israel’s energy security. Opponents also viewed the price ceiling set for domestic gas sales as too high. The antitrust commissioner thus refused to sign-off on the framework, claiming it did not properly address the issue of competition or break the monopoly. The issue quickly became political, with opposition members rallying public support against the government through weekly demonstrations calling to stop the gas theft’. 

On May 2015 the antitrust commissioner announced his resignation in response to the government’s refusal to revise the framework. This essentially meant that Prime Minister Netanyahu either had to reopen negotiations with the gas companies, or alternatively, evoke a special clause in the antitrust law (article 52) that allows him to circumvent the antitrust's directives for reasons of national security. In order to justify the unprecedented use of article 52, the government claimed that there is a security necessity to expedite the export of gas to Israel’s neighbours, mainly to Egypt and Jordan. The government relied on official documents submitted by the Ministry of Foreign Affairs and the National Security Council arguing that a lack of sufficient gas supplies would soon cause severe electricity and water shortages in Egypt and Jordan, and that this would lead to instability and mass protests.13 Such instability might spill over to Israel’s borders and jeopardize its security. A second argument was that if Israel would not soon provide Jordan and Egypt with the gas they needed, Iran would do so once sanctions are lifted. This would help Iran gain influence in those countries and threaten Israel’s security. A third argument was that Israel would benefit politically if it expedited export of gas to Europe, and especially to Cyprus and Greece. This was argued not only to help strength - en economic ties with these states, but also prevent the EU from possibly passing anti-Israeli resolutions, as it would need the consensus of both Cyprus and Greece to do so.14 Israel thus had a keen interest in quickly cementing its relations with these countries through gas.15 

Taking these considerations into account, Prime Minister Netanyahu invoked article 52 on December 2015. This was despite weekly protests, the public resignation of his Minister of Economics who refused to sign the article, and a special parliamentary commission advising against it. Though the framework was officially passed, it still did not guarantee a quick development of Leviathan. Shortly following the approval, a number of petitions were sub - mitted to Israel's High Court of Justice demanding the overturn of article 52 and the return to the negotiating table.16 Regardless of the result of such legal deliberations, a number of regional developments that occurred during this time have further complicated the devel - opment of Leviathan and undermined the logic behind the framework. First among them is the discovery of the Zohr field in Egypt.

The Effect of the Zohr field 

On August 2015 Italian energy company Eni announced what seems to be the largest deepsea gas discovery in the Mediterranean Sea, with estimates far surpassing those of Leviathan. The discovery caught the Israeli government by surprise, since the impending gas shortage in Egypt was repeatedly used as a central justification to circumvent the antitrust authority through article 52. With Egyptian gas reserves now estimated to double, the Israeli gov - ernment could no longer claim that Egypt’s stability depends on Israeli gas supply.17 The Zohr discovery thus gave wind to opposition groups in Israel attempting to stop the framework from being approved by petitioning the Supreme Court.

The Zohr field presents additional complications for Israeli gas development even assuming the framework is eventually is approved. Depending on the actual size of the field and the prospect of additional gas discoveries in the near future, Egypt may be able not only to provide gas for its own market, but also resume the export of LNG through its underused terminals.18 Such a scenario would prove problematic to Leviathan developers, as the initial under - standing to export gas to the Idku LNG terminal in Egypt was designed as an ‘anchor deal’ that will secure the necessary capital to develop Leviathan in the first place. If a competition ensues between Egyptian and Israeli gas over LNG capacity in the terminal, Egypt will most likely have the upper hand, leaving Israeli developers to look elsewhere for the initial investment needed. On the other hand, if Egypt decides to use the Zohr field for domestic consumption only, this frees up more Israeli gas to be exported by LNG once Leviathan is developed. It will also encourage further exploration in the region by foreign companies. As more fields are discovered in Egypt, however, the chances that Egypt’s LNG facilities will still be available for Israeli gas exports lessens, and so Israel indeed has an economic motivation to hurry and lock-in its exports from Leviathan to Idku, but it no longer has the justification of national security to do so.19 

Other players in the region: Russia, Iran, Turkey 

The involvement of additional players in the regional gas market will also have an effect on the development of Israel’s gas fields as the framework moves forward. Russia’s Gazprom has repeatedly shown interest in the Israeli fields, and was reportedly close to buying a major stake in Leviathan in 2012.20 Though the deal fell through, Russia continued to show interest in smaller fields, including some that were questionable in terms of economic viability (such as the small Gaza Marine field offshore Gaza). Its reasons for doing so are mainly political.21 Other than gaining influence in Israel’s economy, Russia seeks additional access to the Mediterranean Sea for its naval forces, yet has so far failed to achieve this goal. The new framework approved by the Israeli government and the expected fall of global gas prices may allow Gazprom another opportunity to gain a foothold in the region. As Delek and Noble are now forced to sell the smaller Tanin and Karish fields to a new competitor, a question is raised as to who would purchase these small deep-sea fields (which are earmarked for Israeli con - sump tion) only to compete over a small market share against much larger fields. Lower gas prices also make additional exploration in Israel's EEZ less lucrative to private companies. This will leave Gazprom (including closely affiliated companies, such as Edison) more leeway to enter the region. The potential entrance of Gazprom into the regional gas market could cause concern among European states, since one of the main justifications for purchasing expensive LNG from the Eastern-Mediterranean Sea is to diversify away from Russian gas. Israel should thus be wary of Russian involvement if it wishes to target the EU as a future consumer of its gas. 

As opposed to Russia, the involvement of Iran is a surprisingly positive factor for Israeli gas development. The Israeli government has consistently viewed the possibility of Iranian gas exports reaching Jordan and Egypt as a direct threat to its security.22 The concern that Iran will gain influence in the region by flooding the market with gas has encouraged Israel to expedite development of its own fields and push for exports to counter Iran. This argument was repeatedly sounded by the Israeli government during deliberations over the use of article 52. In this regard, Iran ironically serves as a de facto catalyst for cooperation over gas fields in the region. In reality, however, Iran is years away from being able to export gas to Israel’s neighbours, and will most likely offer gas that is considerably more expensive than that of Israel or Egypt.23

Israeli-Turkish relations also play an important factor moving forward. Since the 1990s, good relations with Turkey have been, and will most likely remain, a top priority for Israeli foreign policy in the region. Turkey is not only a leading market for Israeli goods,24 it is also seen as a significant regional military power and, more importantly, a Muslim ally in a region that is scarce with friends for Israel. If political conditions allow for it, Israel would likely prefer to strengthen its economic and security ties with Turkey over other regional players through a gas deal. During parliamentary deliberations over the use of article 52, Prime Minister Netanyahu has been vocal about the use of gas trade with Turkey as a potential catalyst for rapprochement between the states.25 However, gas pipeline agreements entail long-term commitments, and currently there is little trust that Turkish President Erdoğan will not use a future pipeline as leverage against Israel. Israel will thus be cautious about signing binding gas deals with Turkey in the near future. 

Final words 

Israeli gas developments hold many benefits for the region. They have the potential to strengthen economic and political ties, alleviate common security concerns, and address the problem of pollution in a region that still uses oil as the main fuel for its electricity generation.26 Rather than seek faraway markets, the potential for local regional growth in gas consumption is substantial and should be the main focus of Israeli gas exports. 

Footnotes

1. Assessments on the volume of gas vary from source to source. The data presented in this paper relies on official estimates by the Ministry of Energy in Israel, as published on their website: http://energy.gov.il/subjects/oilsearch/documents/israeli%20gas%20opportunitties.pdf 
2. This does not include a small undeveloped gas field offshore the Gaza Strip named Gaza Marine which was discovered in 1999 by British Gas and is estimated to hold 30 bcm. The field was handed over de facto to the Palestinian Authority during peace negotiations between Ehud Barak and Yasser Arafat. 
3. The low tax was originally intended to provide foreign energy companies with enough incentives to explore for oil and gas in Israel despite the threat of an Arab boycott against them, if they do so. 
4. A full report of the Sheshinski committee’s conclusions is available in English here: http://www.financeisrael.mof.gov.il/financeisrael/pages/en/publications/mof.aspx
5. Perhaps the most vicious attacks were directed at the Minister of Finance, Prof. Yuval Steinitz, as lobby groups financed by the gas companies staged demonstrations and published negative campaign ads personally attacking his character. In 2015, Prof. Steinitz became the Minister of Energy and Infrastructure, directly in charge of negotiating the terms of development with the gas companies. 
6. An executive summary of the Zemach committee’s recommendations is available in English here: http://energy.gov.il/English/Subjects/Natural%20Gas/Documents/pa3161ed-BREV%20main%20recommendations%20Tzemach%20report.pdf 
7. The initial recommendation did not mention 40% as a goal, but instead gave an exact number to be earmarked for domestic consumption (450 bcm). Future revisions by the government changed these calculations after it became clearer how much gas is actually available in the fields. 
8. The protocols were eventually released on June 2013, after censorship. They are available in Hebrew at the Ministry of Energy’s website: http://energy.gov.il/Subjects/NG/Pages/GxmsMniNGCommiteeTranscription.aspx 
9. See for example: Egypt Cancels Natural Gas Deal with Israel. (2012, April 22). Haaretz.; and Israel Electric to Sell More Bonds as Cash Crisis Deepens. (2012, November 7). Reuters. 
10. Delek Group. (2015, March 30). Delek Group 2014 Annual Financial Statement [Press release]. Retrieved from: http://ir.delek-group.com/phoenix.zhtml?c=160695&p=irol-newsArticle&ID=2030573 
11. Delek Group. (2014, June 29). Engagement in a Non-Binding LOI between Leviathan Partners and BG International Ltd. for the Export of Natural Gas [Press release]. Retrieved from: http://ir.delek-group.com/phoenix.zhtml?c=160695&p=irolnewsArticle&ID=1943456 
12. The Antitrust Authority. (2012, November 13). The General Director of Restrictive Trade Practices Declares the Partners in the Natural Gas Reservoir ‘Tamar’ to have a Monopoly on Israel’s Natural Gas Supply [Press Release]. Retrieved from: http://www.antitrust.gov.il/subject/182/item/32858.aspx 
13. Documents available in Hebrew by the Ministry of Energy: The Ministry of Foreign Affairs. (2015, July 1). National and Strategic aspects to the Development of the Gas Fields. Retrieved from: http://energy.gov.il/abouttheoffice/newsandupdates/documents/shimua/ngmfa.pdf; The National Security Council (MALAL). (2015, July 1). Natural Gas Sector in Israel – National Security Aspects and Repercussions from delays in the expansion and export of natural gas. Retrieved from: http://energy.gov.il/abouttheoffice/newsandupdates/documents/shimua/ngmalal.pdf 
14. This argument took special hold following the EU’s decision on November 2015 to label products originating from Israeli settlements. See for instance a policy report by former Israeli ambassador to the EU: Oded, E. (2015, December 6). Active Israeli Policy in the Mediterranean Basin. INSS Insight. No. 775. Retrieved from: http://www.inss.org.il/index.aspx?id=4538&articleid=11045 
15. A former senior member of the National Security Council, Dr. Eran Lerman, went even further to suggest that a friendly Cyprus may also act as an emergency airport for Israel in case the Ben-Gurion airport in Lod is shut down during war, as had briefly occurred in the 2014 operation in Gaza. 
16. At the moment of writing this paper, the petitions were still being examined by the High Court. 
17. This new reality may also spread beyond Egypt if it decides to fully resume gas exports to Jordan, Lebanon and Syria through the Arab Gas Pipeline. 
18. It should be noted that the discovery of Zohr comes in parallel to declining production from other gas wells in Egypt, and so Egypt may very well still need Israeli gas in the short term, depending on how quickly Leviathan and Zohr are developed.
19. Since the initial agreement made between Leviathan developers and Egypt was for the LNG facilities, and not for domestic Egyptian consumption, it could be argued that security considerations were only used as an excuse to justify the use of article 52, and that the economic incentive was always the goal for expediting the development of Leviathan. 
20. Barkat, A. (2012, October 16). Gazprom Bids Highest for Leviathan Partnership. Globes. Retrieved from: http://www.globes.co.il/en/article-1000790600. 
21. For more on Russia’s gas interests in Israel and the region, see Idan, A. (2013, July). Russia as Possible Partner in Developing Israeli Gas Discoveries. In Russia and Israel in the Changing Middle East: Conference Proceedings, INSS Memorandum 129; as well as his interview: The Russian Gas Giant that Haunts Europe and Israel. (2012, August 1). Haaretz. Retrieved from: http://www.haaretz.com/israel-news/business/the-russian-gas-giant-that-haunts-europe-and-israel-1.455117. 
22. Eli, A. B. (2015, July 6). Foreign Ministry: Iranian Threat a Key Reason to Clinch Israeli Gas Deal. Haaretz. Retrieved from: http://www.haaretz.com/israel-news/business/.premium-1.664561. 
23. For a thorough analysis of Iran’s actual natural gas export potential, see: Hassanzadeh, E. (2014). Iran’s Natural Gas Industry in the Post-Revolutionary Period: Optimism, Skepticism, and Potential. Oxford University Press Catalogue. 
24. In 2014, Israeli-Turkish trade reached an estimated record of $5.2 billion, making Turkey Israel’s 6th largest export destination according to the Israeli Ministry of Economy. Despite popular perceptions, trade between Turkey and Israel has significantly increased since the flotilla incident in 2010. 
25. Cohen, H. (2015, December 8). Netanyahu: Securing gas supply vital to Israel’s existence. Globes. Retrieved from: http://www.globes.co.il/en/article-netanyahu-securing-gas-supply-vital-to-israels-existence-1001086999. 
26. For more on the regional potential of Israeli gas exports, see Shaffer, B. (2011). Israel - New natural gas producer in the Mediterranean. Energy Policy. 39.9: 5379-5387; Shaffer, B. (2014). Can New Energy Supplies Bring Peace? German Marshall Fund of the United States.