December 31, 2015
Last month during a conference titled "Energy Forecasts 2016" held in Tel Aviv, Israel, a few officials from the ministries of Finance and Energy who lectured from the podium had a common complaint: Natural gas is not attractive anymore to Israeli industrial customers and introducing it to them and infusing it into the industry is getting harder because of the energy price environment.
The difficulties grew this year as the sharp drop in energy prices closed the gap between oil products' prices and the price of natural gas. In Israel natural gas prices are fixed in a contract, a de facto price control, while other energy products' prices are linked to global energy prices. As a result, the prices of diesel oil and fuel oil, used in industry, came down sharply this year. Though those prices are still higher than those of gas, the gap between gas and oil prices are now not attractive enough to convert factory systems from oil to natural gas, as the latter's advantage was reduced by tens of percent. On the other hand, the sharp drop in coal prices during 2015 caused the gap price between coal and gas to increase resulting in power generation from coal being 25% cheaper than production from natural gas. An official at Israel Electric Corp (IEC) estimated recently that, at the current energy price levels, only a sharp drop in the natural gas price, from $5.5 MMbtu to $4 MMbtu would equalise power generation costs.
Those problems, of decreasing price gaps between oil products and natural gas on the one hand and increasing price gaps between natural gas and coal on the other hand, are unique to the Israeli energy market: Their source and their only cause is the disconnect between the natural gas price in Israel from prices in the global energy markets. The reason for the disconnect is the contract signed between the natural gas monopoly and the IEC, its biggest customer, which set a basic price at about $5.5 MMbtu. One can describe it as a de facto price control, and as price control mechanisms always do, it distorts market forces and real prices. Therefore, when Israel's Energy Ministry this week ordered the increased use of natural gas in power generation, it also ordered in parallel an increase in electricity prices, in order to finance, or subsidise, the use of expensive gas, through the electricity bills.
As mentioned above, natural gas prices in Israel are not adapted to world energy prices but linked to the American Consumer Price Index (CPI), the American price index, plus 1% for the contract's first seven years; thereafter it turns to the CPI minus 1%. However by then the price is supposed to climb to $7.5 MMbtu.
Despite the high natural gas price, the government is interested in encouraging industry and transportation to transition to this energy material, which is needed in order to justify further development of Israel's natural gas assets. So what do governments do when they face a financial problem? What governments generally do under such circumstances: throw money at the issue and hope for the best.
As such, the Israeli government has decided to subsidise the conversion to natural gas for various sectors in the economy/ (It's important to note, no one has used the word "subsidise" or "subsidy"; better to use the word "grants", a much more modern and neutral term).
That became clear during the conference in Tel Aviv, when one government official presented the government plans for grants while another one presented the government plans for taxation. On the expenditure side, the treasury would grant NIS 750,000 ($193,300) for an average factory's conversion to gas, which costs NIS 2 million ($515,400). The government will also subsidise extensively the installation of natural gas refueling stations in order to encourage change from oil to natural gas in transportation. On the fiscal side the treasury plans to raise the taxes on diesel oil and fuel oil for transportation and industry and also to raise the tax on coal, which is used only for power generation. (The natural gas taxation might go up but one can be assured that it will be by less than coal.) At the end of the process, the gap between natural gas prices and oil prices and the gap between gas prices and coal prices would be restored to their previous levels as natural gas would become once more an attractive alternative.
However this ambitious program is not coming free. It will cost the public hundreds of millions of shekels that will be shown at the top line of the natural gas monopoly partners' financial reports.
The logical solution in the Israeli market was the imposition of price controls on natural gas that would reduce its price, rather than inflate it, as is the current situation, and by doing so saving the taxpayers hundreds of millions of dollars and encouraging the transition to gas-based industry and transportation in an efficient manner.
Ya'acov Zalel
SOURCE
