A political embarrassment of riches

The recent resignation of Israel’s antitrust commissioner has spotlighted the strange mixture of commercial vista, diplomatic sway and regulatory angst created by Israel’s unexpected gas bounty.

Israel's natural gas (photo credit: MINISTRY OF NATIONAL INFRASTRUCTURES)
Israel's natural gas
IT TOOK several millennia, but Moses’s blessing to the tribe of Asher, “may he dip his foot in oil,” has finally come true.
With an offshore drilling rig’s eternal flame braving Mediterranean winds 100 kilometers west of Haifa as the Tamar field’s gas flows to Israel for the third year, the mineral poverty that once was a hallmark of the Israeli economy is a thing of the past.
What began in 1999 with the discovery of a small gas field opposite Ashkelon was followed a decade later by vast findings in the waters further north. However, the world’s largest gas discovery in more than a decade posed for Israel unfamiliar regulatory, economic and strategic dilemmas.
Underscored by Antitrust Authority director- general David Gilo’s abrupt resignation in May, the regulatory tussle has been about competition, and before that about fiscal digestion and industrial royalties.
The digestion problem concerned the so-called “Dutch disease,” whereby an economy overwhelmed by a commodity’s fast returns soon sees its currency appreciate, consumer spending soar and import prices plunge while labor costs climb and unemployment expands, all of which ultimately generate recession, stagnation and decline.
Israel’s findings, believed to equal its entire gross domestic product, are so extensive that they can feed the country’s energy needs for 150 years, and for several generations add some $2 billion annually to its GDP. The prospect of fiscal indigestion, then, was very real.
This threat was addressed relatively quickly, when then-Bank of Israel governor Stanley Fischer inspired the passage of legislation that created a sovereign fund to absorb the gas royalties and invest them abroad, while dripping only their yields into the budget.
The royalties themselves, however, were more complex, since no one foresaw a bonanza like that which Israel now faced back when they were formulated, in 1952.
Challenged by a multi-partisan, high-tax lobby that stretched from Arab legislators to the Judea and Samaria Council, the government appointed an expert committee to explore the issue. All agreed that the 1952 Petroleum Law’s formula, whereby the value of one in eight pumped oil barrels would go to the Treasury, was anachronistic. The question was how to change it.
Headed by Hebrew University economist Eitan Sheshinski, the experts decided to add to the existing royalty formula a 20-50 percent tax on profits that would rise progressively, from the first shekel earned after a company pumped gas worth 1.5 times its original investments.
The principle, then, was to increase the citizens’ benefit from what the high-tax campaign was successfully describing as “the public’s treasure,” and to protect citizens from what the campaign derided as greedy tycoons’ abuse. At the same time, the government understood that private investors must not be overtaxed, lest they be chased away.
Judging by the industry’s subsequent behavior, the formula is working. Gas, revenue and tax returns are all flowing, to everyone’s gain. The new zeitgeist of social awareness, which by chance coincided with the gas findings, proved reconcilable with capitalism.
Yet, with thousands marching in the streets of Tel Aviv and Jerusalem demanding cheaper housing, tuition and food, the regulatory dilemma was not only about the taxes Big Business should pay, but also about the bills small households should foot. If Israel has so much gas, why not cut Mr. and Mrs. Israeli’s electricity bills? It was in this public atmosphere that Gilo, a Tel Aviv University law professor and an authority on business regulation, took up, in 2011, the position of antitrust commissioner.
Helped by the zeitgeist’s backwind, Gilo embarked on a pro-competition crusade the likes of which none of his predecessors had launched, blocking coordination of kindergarten tuitions and price-fixing of high-school textbooks; forcing cement monopoly Nesher to spin off one of its plants; and preventing Israel Chemicals from placing a bid for the Eilat port.
Having vowed not to proceed from his regulatory position to a job in the corporate world, as is common among senior officials in the Treasury, Bank of Israel and the Economy Ministry – Gilo saw no difference between gas production and kindergarten tuition. The gas market, he believed, should be subject to competition for the benefit of the small-time customers who live beyond its wells, refineries and pipelines.
The monopoly at stake is a partnership between Houston-based Noble Energy and Israel’s Delek, headed by real-estate magnate Yitzhak Tshuva. In some of the fields, the two companies have been joined by other partners, most notably Isramco in the Tamar field and Avner in nearby Tanin.
In Gilo’s vision, Israel’s offshore gas fields would be auctioned among competing franchises.
Moreover, some of the existing monopoly’s holdings would be sold. The day Gilo’s intention to break the monopoly was announced last December, Delek’s shares plunged 16.5 percent, in a clear indication that the markets assumed, based on Gilo’s track record, that what he plans is what will be. They were wrong.
The new government devised an alternative plan whereby the monopoly’s grip on the largest field, Leviathan, would be upheld, while Delek will sell and Noble will dilute their respective stakes in Tamar, in addition to shedding their holdings in Karish and Tanin.
The government’s motivation in this semi-withdrawal is, of course, a matter of interpretation.
The simplistic explanation for the quest to partly preserve the gas monopoly is politics. Tshuva is a lifelong Likud supporter. Netanyahu, according to this theory, had to find a way to reconcile his free-market faith with his political needs.
Then there is the social side. Tshuva and Finance Minister Moshe Kahlon hail from similar backgrounds, having been raised with many siblings in poor neighborhoods by immigrants who came from Libya. So did Kobi Maimon, owner of the prospecting company Isramco, Tshuva’s partner in Tamar. This aspect of the saga was, in fact, made formal by Kahlon himself when he announced his self-removal from the entire gas-industry regulation process due to his “friendship” with Maimon.
Kahlon, whose main electoral pitch was his record as a monopoly breaker, says he remains committed to that ideal, but on the issue of the gas monopoly he would hand over authority to the prime minister, who in any event shares his views.
Yet, there are less partisan explanations for the partial retreat from Gilo’s antitrust orthodoxy.
First of all, the monopoly will, after all, be weakened.
Second, Gilo-the-jurist’s axiom that only maximum competition will yield minimum prices is disputed by senior economists. Most notable among these is the same Sheshinski who devised the formula that multiplied the gas producers’ taxation.
Gas prices in Israel, he noted, are not higher than their levels abroad, despite the monopoly. Breaking it up, at the same time, would merely produce a duopoly, which, in turn, would not lower prices. Sheshinki’s recommendation, therefore, is to lower prices by indexing Israeli prices to those in the international market.
Sheshinki’s original appointment to probe the gas industry’s taxation was made in 2010 by then-finance minister Yuval Steinitz. In a typically Israeli déjà vu, the latter is now back on this scene, this time as the new Minister of Infrastructure, while the former returns as the latter’s adviser on deregulation of the gas industry.
Considering this, and judging by the general dynamics before and after the recent election, it seems the gas industry is headed toward partial deregulation, whereby competition will be imposed and the monopoly will be dented, while its owners are allowed to continue to thrive. The reason for this compromise may have less to do with politics, sociology and macroeconomics, and more to do with foreign affairs.
The gas fields’ value as diplomatic fuel was apparent from the outset.
To begin with, it was clear that foreign demand and Israeli quantities were such that exports would be both feasible and imperative.
The question was how much, as here, too, the same social activism that sought higher royalties now pressured for lower exports, arguing that excessive exports would come at the expense of cheaper gas for Israelis.
Netanyahu, therefore, appointed a separate committee, headed by then Energy Ministry director-general Shaul Tzemach, which emerged with a compromise much like those reached on the royalty and monopoly fronts – in this case, an export target figure of 53 percent of all gas reserves. This way, the Tzemach panel calculated, supplies for the Israeli economy would be ensured for at least 25 years.
This ratio is enough to open lucrative commercial opportunities and vast diplomatic vistas.
The potential for export deals became clear early, when South Korean conglomerate Daewoo explored, with Delek, prospects for liquefying Tamar’s gas and shipping it to Korea and Russian energy giant Gazprom.
However, the Israeli gas fields’ more natural customers are closer to home, and their significance exceeds the narrow limits of commerce.
The day after the recent election, and obviously regardless of the regulatory brouhaha before and after, the Tamar field’s developers announced a deal with Egypt’s Dolphinus Holdings to sell it an estimated $1.2 billion of gas over a seven-year period.
It was a link in a long and meandering chain of a resource diplomacy that harked back to the 1979 peace accords, after which Israel regularly bought oil from Egypt for more than 20 years. Last decade, as Egyptian oil reserves dwindled, Israel began purchasing gas from Egypt, until supply was disrupted by this decade’s intra-Egyptian terror.
Now, gas will be traveling in the opposite direction, flowing through the same pipe system that previously led Egyptian gas to Israel.
The deal with Egypt’s Dolphinus followed last year’s pact between Tamar’s developers and two Jordanian companies, Arab Potash and Jordan Bromine, for the sale of $500 million of gas over 15 years.
A month earlier, the Leviathan field’s developers signed a $1.2 billion deal with the Palestine Power Generation Company for the fueling of a future power station in Jenin. The Palestinians have since said they would cancel the agreement, but the gas fields’ regional significance has already been established and, in fact, transcends Israel’s Arab surroundings.
Cyprus, whose Aphrodite field stretches to Leviathan’s west, wants to create with Israel and Greece a pipeline into Europe. The common motivation of the three, apart from geography and commerce, is the joint adversary they see in Turkey under its current leadership.
This context became evident in summer 2010, when Netanyahu offered a gas deal to then-Greek premier George Papandreou, weeks after Turkish-Israeli relations plunged into an abyss following the violent IDF confrontation with the Turkish vessel Mavi Marmara on its way to Gaza. Then again, Turkey itself is thirsting for gas and, in recent years, has sent hints that gas contracts would help a rapprochement with Jerusalem ‒ a prospect Israel would surely welcome.
This, then, is the deeper context in which the burgeoning gas industry’s improvised regulation is steadily coalescing. Gas, an eternal morbidity in Jewish memory, now emerges as a potential harmonizer between the Jewish state and its neighbors.
All relevant players understand that what has been found undersea is now on its way to the conflicted world that sprawls above. Statesmen, investors, regulators, treasuries, and central banks are all configuring the new reality, as are terrorists and the generals and admirals who face them, which is why Israel is now building an integrated, multi-million dollar naval-aerial defense operation for its maritime rigs, highlighted by four custom- tailored frigates ordered in Germany for NIS 1.85 billion.
Seen this way, Netanyahu’s motivation in keeping the gas fields semi-monopolized while dominated by a developer he trusts might be more strategic than opportunistic. That may be what Gilo meant when he said, in explaining his resignation, that the gas industry’s regulation is fraught with issues beyond his pale, “such as foreign and security affairs.”