Natural Gas Bonanza, Blessing or Bane?

Israel may learn, as other countries have, that the sudden discovery of natural resources often has negative as well as positive effects

By ZIV HELLMAN
August 15, 2010 13:15
LIQUID GAS: If there is sufficient gas in Israel’s Leviathan field for export, it will need to be co

gas tanker311. (photo credit: Courtesy)

CAN THERE REALLY BE TOO much of a good thing? Will a whale of a natural gas discovery off the coast of Israel, which by all indications will make the country an international energy exporter for the first time in its history, be a boon – or a curse? Back in February 2009, an announcement that early signs indicating the Tamar 1 gas field, located in the Mediterranean Sea 90 kilometers (56 miles) off the coast of Haifa, contained 3.1 trillion cubic feet (TCF) of gas set off jubilation in the markets. At the time, Zvi Greenfeld, president and CEO of the Delek Group, a major stakeholder in the consortium conducting the gas drilling, told The Jerusalem Report that previous gas discoveries one-third as large had been described by him as historic, with the Tamar field simply leaving him speechless.

And that was before estimates of the Tamar reserves were bumped up to 5 TCF. The Tamar gas field was declared to be the largest gas find ever discovered in the eastern Mediterranean Sea, and the largest find in the world in 2009.

But that was then. In June of this year, the consortium – which includes the Houston-based oil operator Noble Energy Inc. (36 percent), Delek (31.25 percent through subsidiaries Avner Oil Exploration and Delek Drilling, controlled by Israeli real estate tycoon Yitzhak Tshuva), Isramco (28.75 percent) and Dor Gas Exploration (4 percent) – admitted its initial estimates had been wrong. The field, it reported, contained reserves of not 5 TCF of gas, but an immense 8.7 TCF.

Analysts estimated a gas field that size would suffice to provide Israel’s energy needs for over 35 years. The state-run Israel Electric Corporation has said it plans to buy at least $10 billion worth of gas from Tamar over 15 years.

The total value of the field may be $40 billion.

Israeli energy production to date has depended on oil and coal imports from as far away as Mexico and Norway.

Sounds good? Hold on to your hat. Going out to sea even farther, at a drilling site named Leviathan 130 kilometers (81 miles) from the Haifa coast, the consortium announced in early June that its seismic tests indicated gas reserves of a staggering 16 TCF, making the aptly named Leviathan field twice as large as Tamar.

That is a game changer.

“Israel is currently ranked fourth in Europe (excluding Russia) in proven natural gas reserves, after Norway, the Netherlands and the United Kingdom,” says Amit Mor, CEO of Eco Energy Ltd., an energy and environmental financial consultancy and investment firm. “If Leviathan does contain the amount of natural gas that is indicated by the early tests, it will move ahead of the UK and the Netherlands. This will provide significant geopolitical benefits to the nation as a long-term reliable source of energy.”

Operational plans are already being drawn up in which the gas extracted from the seabed will be processed on shore in Israel, where it will be converted into liquid natural gas (LNG), loaded onto ships and exported around the world.

Since energy imports are the single largest factor influencing Israel’s balance of trade and, by extension, its balance of payments, moving from energy importer to exporter can have significant macroeconomic consequences. For example, in late 2008, when world oil prices collapsed, the country’s trade deficit evaporated and for several months Israel ran a trade surplus.

THE SUMS OF MONEY POTENTIALLY involved, for those directly involved in the industry, their suppliers, and all Israelis via income to the state by way of royalties, are very large. But it is precisely for that reason that some have voiced cautious warnings. It may seem at first that extracting resources from the ground (or the sea) and selling them should be an unmitigated gift for a country, but the historical record often indicates otherwise. An over-emphasis on resource exports can crowd out other exports and distort exchange rates, and over-reliance on selling commodities abroad means being at the mercy of often volatile commodity price swings.

Perhaps more insidiously, windfalls from the export of resources have in many countries been a catalyst of income inequalities and an incentive for corruption.

There are many challenges as well as opportunities ahead as the pumping of gas from under the seabed becomes a reality.

Asource at Delek, who requests anonymity because she is not authorized to speak to the press, tells The Report that the consortium plans to construct another exploratory drilling rig over the Leviathan field by the end of this year to conduct a more detailed analysis of the prospects of producing gas there. Until the results of that drilling are finalized, consortium spokespeople are duty-bound to stress that the 16 TCF estimate is based solely on early seismic tests, and that there is still a significant probability that the reserves there are smaller.

There are even extremely early indications that there may be oil to be tapped in the vicinity of Leviathan, but the findings are so preliminary that the consortium has to date buried news of them deep in its public reports, with little fanfare.

But there is sufficient confidence in the seismic indications of natural gas for plans to export the gas in the Leviathan field to be progressing rapidly.

“Leviathan is still defined as a prospectus with 50 percent likelihood,” says Mor. “This is an extremely high estimate in the industry.

Most companies initiate drills when prospects are above 10 to 20 percent. But we should still keep in mind that there is a chance that there is only a small amount of gas at the Leviathan site.”

If there is sufficient gas in the Leviathan field for export, it will need to be converted into liquid natural gas before it can be shipped overseas.

“The technology for liquefying natural gas for ship transport is well developed, and would be appropriate for selling Israeli natural gas in markets around the world,” says a source in Delek. “Japan is the world’s largest consumer of LNG, and is therefore a natural candidate for being a major customer, but the European market may emerge as particularly attractive.”

Liquefaction of natural gas, however, is not an easy process.

“Export of natural gas by pipeline to Europe via Turkey is not economically and geopolitically viable,” notes Mor. “But liquefaction plants are very expensive to construct. They need to cool the gas down to -165 degrees Celsius (-265 Fahrenheit) to get the gas into liquid form. It then needs to be loaded onto special tankers maintaining the liquid state of the gas, which costs $300 million to $500 million per tanker.”

Mor also warns that, despite all the natural gas reserves on which Israel is sitting, there may be a temporary squeeze of resources. The Yam Thetis field off Ashkelon, on which the country has been relying for most of its current natural gas needs, is expected to be depleted by 2013. There is also a small supply of natural gas bought from Egypt.

“Tamar will be commissioned for operation only in 2014 or 2015,” says Mor. “This means there will be a two- to three-year gap between 2013 to 2015 in gas supply, and some IEC power stations will need to switch to diesel, and perhaps some more gas will temporarily be bought from Egypt.”

As can be expected, the announcement of such significant energy reserves in Israeli territorial waters was a trigger for rejoicing on the Tel Aviv Stock Exchange. Share prices of the Israeli companies in the consortium leapt by about 13 percent within a short time after the press release on the find.

BUT THE GAS DISCOVERY WAS also the spark for several controversies.

Among them is a claim raised by Lebanese Energy Minister Gebran Bassil that part of the Leviathan field lies in Lebanese territorial waters. Bassil warned that his country “will not allow Israel or any company working for Israeli interests to take any amount of our gas that is in our zone.” In response, the Minister of National Infrastructures Uzi Landau rejected Lebanon’s claim outright and retorted that “we will not hesitate to use our force and strength to protect not only the rule of law but the international maritime law.”

By the United Nations Convention on the Law of the Sea, a state abutting a body of water is entitled to all natural resources located within its maritime economic zone, which extends up to 200 nautical miles (370 km) out to sea. If the distance across the water between two countries is less than 400 nautical miles, the halfway point denotes the boundary. Haifa is about 148 nautical miles from Cyprus, and Leviathan is about 70 nautical miles from Haifa, indicating that Israel ostensibly has sole rights. The Ministry of National Infrastructures has so far only stated that it is “in touch” with Cyprus on the matter of formally delineating the two countries’ maritime borders.

Another matter of contention is the location of a future onshore site for receiving and processing the gas extracted from Tamar and Leviathan. The government’s initial suggestion that the Dor beach area, south of Haifa, be the main receiving site had environmental groups up in arms. As a result of the outcry, a national planning board charged with choosing the site ruled out Dor as a potential location in early July, while leaving the final determination of a site for a later date.

Yael Adlis, spokeswoman for the environmental advocacy group Adam Teva Vadin, tells The Report that although switching to natural gas as the main source of energy generation in Israel in place of less environmentally friendly gas and oil is to be welcomed, the location of a processing plant may pose sufficiently harmful environmental damage that it is not a decision to be rushed into. Adam Teva Vadin, in fact, is calling for serious consideration to be given to constructing such a gas processing plant on an offshore rig, where it can cause minimal damage to the onshore environment.

Delek sources say the company will construct its gas processing plant wherever the national planning board determines. They say it is perfectly capable of placing such a plant on an offshore rig, if need be. Israelis can at least rest assured that an accident on a natural gas drilling rig cannot cause anything like the major environmental damage recently inflicted on the Gulf of Mexico by the Deep Horizon oil spill; natural gas escaping from an underwater well can at worst bubble to the surface.

“There is no offshore gas liquefaction plant in the world, although some companies have recently announced that they are developing plans for the construction of such plants,” says Mor. “On the other hand, it will be a challenge to find the land needed for such a project in Israel. It is feasible but will require major planning and resource devotion to complete. Projects of that scale typically take 15 years to complete.”

ANOTHER CONTROVERSY GARNERING headlines has focused on the royalty fees the state will be able to collect from the natural gas fields. Israel’s terms for oil and gas exploration licenses were set over 50 years ago.

In principle, all natural resources located within Israeli territory are the property of the state, but licenses granted to oil and gas explorers typically give them ownership over the resources they discover. “In return, they are required to pay the state royalties based on “wellhead” value, meaning the value of the resources at the time they are extracted, which is usually lower than what would be charged to consumers and would translate into 12.5 percent of the company’s profits.”

By international standards, this is a relatively low government royalty rate, and is intended to serve as an incentive for explorers to take the financial risk of drilling at test sites. Taking into account expected royalties, value-added taxes and corporate taxes, the total income to the state from natural gas sale revenues will be about 35 percent. In many other countries, that figure can be as high as 80 percent, but no one in Israel paid the matter much attention over the decades when oil and gas discoveries in the country were scant to non-existent.

Now that a bonanza has been found, and with every uptick in the percentages translating into billions, Finance Minister Yuval Steinitz has stated that he intends to review the state’s policies on natural resource royalties and taxes. The Finance Ministry’s intentions have infuriated the members of the consortium that struck gas at Tamar and Leviathan, who charge that it’s unfair and illegal for the government to change the terms at such a late stage in the game, after the consortium has undertaken risks on the assumption that the royalty would be 12.5 percent.

The consortium also claims it has been experiencing difficulty obtaining credit on the markets due to the uncertainties surrounding the government’s policy. Tshuva, the controlling shareholder of Delek, has even asked US Congresswoman Shelley Berkley to speak on his behalf to the Israeli Embassy in Washington; Berkley’s congressional district covers Las Vegas, where Tshuva is developing a large hotel project.

Partly in response to the criticisms raised, the government appointed a commission to study and recommend the optimal fiscal policies to be applied to natural resource finds. The panel is headed by Eytan Sheshinski of the Hebrew University, an internationally recognized expert in public finance and taxation. It also announced that any policy changes would not be applied retroactively to the Tamar field or to any other natural gas discoveries preceding the Tamar finding.

This, however, still leaves open the possibility of new rules applying to the truly big prize, Leviathan. Sheshinski declined a request by The Jerusalem Report to be interviewed on the subject. Sources at Delek say that the government is now trying to raise the royalties it will receive from natural resource discoveries from 12.5 percent to between 16 and 18 percent, arguing that it can do so with respect to Leviathan because the 12.5 percent rate applied to “existing discoveries.” Since Leviathan is currently based solely on seismic indications and is not yet considered a full-fledged “discovery,” the government’s argument goes, the previous rates do not apply, leaving open the possibility of a rate hike. Delek intends to fight any hike.

THE CONTROVERSY OVER ROYALTY rights is perhaps an early indication that Israel may discover, as other countries have, that the sudden discovery of natural resources often has negative as well as positive effects. The lure of large sums has often served as an incentive for corruption. Income inequalities have become exacerbated in many resource-rich countries.

In economic theory, a term called “the Dutch disease” has developed to explain a possible relationship between the increase in exploitation of natural resources and declines in manufacturing sectors. The name comes from the experience of the manufacturing sector in the Netherlands after the discovery of a large natural gas field in 1959.

Initially hailed as a lucky find for the Netherlands, it led the Dutch currency to soar in value, making Dutch labor and products become less competitive, a very negative consequence for a small economy dependent on international trade. Similar effects were noted in the United Kingdom when North Sea oil began to flow and the pound sterling temporarily became a “petro currency.”

Under the Dutch model, a booming sector based on the extraction of oil or natural gas crowds out “lagging sectors” in manufacturing or agriculture. The resource boom shifts labor away from lagging sectors. At the same time, the extra revenue brought in from the booming sector leads to changes in wages, prices and exchange rates – with the latter harming the competitiveness of manufactured exports. Volatility in the price of natural resources, and thus the real exchange rate, increase uncertainty in the economy. The Bank of Israel has been fighting an over-appreciation of the shekel for the past year and a half; the development of an energy export sector will make life all the more difficult for the central bank in this respect.

Omer Moav, professor of economics at the Hebrew University, tells The Report that there are indeed reasons for concern about the large-scale export of natural gas.

“Exporting energy will have a negative effect on other Israeli exports,” says Moav.

“The economic mechanism [causing the negative effects] is the effect that exports will have on the exchange rate, as resource exports will raise the shekel’s exchange rate. The economy will benefit as the government will have more tax revenues, and perhaps we will all enjoy a cheaper source of energy, but at the same time some people are going to be very rich while many others might lose their jobs.”

Mor is less concerned about the danger of Dutch disease.

“It is important to put the flow of income to the state from natural gas revenues in perspective,” he says. “The Israeli economy generates about $120 billion per annum, with a national budget of some $60 billion. If natural gas exports generate another $2 billion to $3 billion in state revenues, it poses no real danger of Dutch disease.”

There are many examples of countries that have suffered negative effects from the export of resources, but when experts are asked to point to a country that has benefited handsomely from bountiful natural resources, the example almost always mentioned is Norway.

Norway, rich with oil fields, established the Petroleum Fund 20 years ago to invest most of the surplus money generated by the country’s oil sector. The fund, managed by professionals like a pension fund, has a total value of more than $400 billion (in a country with fewer than five million citizens), and is the single largest holder of stocks in Europe. It has been so successful at keeping money from being frittered away and spent in a manner that distorts the national economy that Norwegians are now asking whether they went too far in investing profits from their oil bonanza in savings for the future at the expense of more immediate needs.

Whether the Norwegian example should be followed, or another model for making use of natural gas profits can and should be drawn up, is a decision that Israel’s leadership will need to take in the near future. Given what is involved, wise leadership will certainly be needed to ensure that the blessing of resources in the nation’s territorial waters remains just that.


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