311_offshore oil well.
(photo credit: Associated Press)
Although Israel is in an oil-rich region of the world, the topic of mineral
royalties has until recently been mostly theoretical. The Heletz field in the
Negev has been producing a small quantity of oil since the 1950s, and the Yam
Thetis consortium found meaningful amounts of natural gas offshore a few years
ago. Overall, the amount of mineral wealth developed by private companies has
been small. But recent large offshore gas finds by a consortium including major
foreign investors have ignited a broad public discussion and dispute over the
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Israeli law prescribes a comparatively low level of
royalties on mineral finds. It was under this relatively generous regime
that the private companies invested huge sums in far-from-guaranteed hopes of
finding gas or oil. Now the country is considering raising the level of
royalties demanded, and the topic is being discussed by the Sheshinski
The proposal has generated strong, and strongly moralistic,
sentiments on both sides. Some are outraged by the prospect of using state power
to force conditions on foreign investors, while others are outraged by the
comparative pittance for which the government is selling the country’s mineral
wealth to wealthy investors.
Likud MK Carmel Shama expressed the dilemma
in picturesque language: “Some would define us as a banana republic or a
third-world country if we alter the royalties. But there is already third-world
conduct in the clearance sale [prices given] to foreign investors.”
are the economic and ethical considerations in this dilemma? There are really
two distinct questions.
First we have to ask what is the fair and
appropriate policy for managing Israel’s mineral wealth. And to the extent the
current policy differs from the ideal, we have to ask if it is fair to change
the policy after investments have already been made.
The answer to the
first question is that the country should seek the maximum return on its assets,
just as a private investor would. It is true that the government gets income tax
from the profits of the companies, but that income would accrue even if the gas
were privately owned. The appropriate level of royalties depends on many
factors, including the probability originally given for finding gas and the
expense involved in searching and drilling. The greater the risk and expense,
the greater the return deserved by the investors.
Without a detailed
understanding of the geological realities, it is obviously impossible to give a
firm opinion, but the current statutory royalty rate of 12.5 percent of profits
does sound rather low to me. If you had an oil gusher in your backyard, would
you let someone develop it in return for such a small amount?
But for better or
worse, that is the regulatory environment that was in place when the investment
was made. Is it right to change it now? For this question we may distinguish
three levels of commitment.
Making a retroactive charge should be
considered out of the question. Government policy creates an agreement between
the government and citizens; there is no place for retroactive changes except in
the cases of the most egregious oversights. New taxes now on extractions that
already took place would definitely be inappropriate.
The following level
is contractual obligation. Using state power to unilaterally abrogate contracts
is both unfair and also unwise, since it will make investors extremely reluctant
to take risks in the future. What about breaking contracts “contractually,” that
is, incurring whatever fines or penalties the contract itself imposes?
not as serious a problem, because to some extent these penalties are themselves
part of the contract. But even this is generally justified only when there was
some development unforeseen in the original contract. When the State of
Israel gave licenses to the companies looking for gas, it obviously was taking
into account the possibility that large amounts of gas would be found, so
tampering with the contracts would also seem ill-advised.
The final level
is the overall regulatory regime in which business activity takes place. There
is certainly importance to having stable regulations and tax rates to encourage
investment in human and physical capital that will bear fruit in the distant
future. But every country makes changes in tax rates and regulations according
to changing circumstances, and if the changes are not extreme, policy changes
cannot be viewed as “changing the rules of the game.” One of the rules is that a
sovereign state will mold its tax code to suit its changing
Labor MK Shelly Yacimovich, who supports raising the
royalties, said: “The government engages all the time in steps that have
retroactive impacts: It raises and lowers taxes, it cuts child support payments
after people already bore children... It can raise the corporate tax rate, and
then someone who already built a factory may come to object.”
words, an explicitly retroactive policy is against the rules of the game, but
making a forward-looking policy change that has retroactive effects is part of
So it seems to me that making changes in the royalty policy in
a way that is not retroactive, does not go against explicit contracts or
treaties, and is not designed specifically to exploit the recent finds, is
legitimate and quite possibly called for.
Israel will have to adjust to
being a country with mineral wealth. This will obviously require some change in
the regulatory environment, and some of these changes will have retroactive
impacts. Of course, it will be necessary to take into account the desire to have
the image and reality of stable policies, but making a change in the royalty
policy that fulfills these conditions does not make Israel a banana
Asher Meir is research director at the
Business Ethics Center of Jerusalem, an independent institute in the Jerusalem
College of Technology (Machon Lev).