A short guide to weed through the grains of truth, neo-Bolshevism and mountains of disinformation.
By Yoram Gabison

“It is unconscionable that the Israeli public be left with just the crumbs from gas profits,” Labor MK Shelly Yachimovich stated last week during a radio interview.

Battling interests: Shelly Yachimovitch and the Forum versus Yitzhak Tshuva and the oil producers.

Yachimovich, considered the definitive spokesperson of the crusade to raise royalties from natural gas producers to the state, has lately been enjoying reams of publicity without spending a dime. Basically from the time it began early this year, the campaign she is leading has mobilized both the media and public support.

Finance Minister Yuval Steinitz sized up the public’s mood and hastily fell in line. On April 13, he appointed a committee under Eytan Sheshinski to examine taxation policy on oil and gas resources. Just two days earlier, answering a query submitted by Yachimovich, Steinitz had written the following: “The 12.5% rate for royalties was set in the Oil Law. This rate for royalties is common in democratic countries where oil exploration is carried out through licenses and concessions, and is considered even a bit high for deepwater exploration, where development and production are difficult.”

Despite this response, Steinitz recently said that the gas companies’ claim that raising the royalty rate would amount to retroactive taxation is an insult to the intelligence. The finance minister didn’t clarify if he meant the intelligence he demonstrated on April 13, or two days earlier.

The argument in favor of increasing the royalty rate in a nutshell: Gas discoveries are an asset of the nation, not the companies that it licensed; since this is an asset of great value – estimated at $44 billion – it is unreasonable that the government allow a group of “tycoons” to exclusively benefit; and it is within the government’s purview to change the royalty fees on natural gas, just as nobody objects to the state altering tax rates.

These arguments are based on the notion that the extent of the national resource “pie” is finite and known, and that the tycoons who hold a substantial portion of these national assets acquired them through means which may or may not be legitimate.

Like other popular political theories, this neo-Bolshevik approach, championed adamantly by Yachimovich, prefers to ignore facts that don’t fit. One significant inaccuracy: presenting the royalty rate issue as a conflict between the general public and the tycoons who seek to plunder its assets.

Yitzhak Tshuva, owner of the Delek group, holds the following shares in drilling rights: 15.8% in the Leviathan gas field (Ratio Yam license ), 10.8% in both the Tamar and the Dalit gas fields, and 19.6% in the Tethys Sea wells.

The Delek group, which held shares of 50.35% in Avner Oil Exploration and 52.33% in Delek Drilling in November 2003, just before Tethys Sea began supplying natural gas to the Israel Electric Company, has since increased those holdings to 60% and 57.7% respectively. These two limited partnerships also hold direct shares in the Ratio Yam license.

The remaining participation shares in the Leviathan, Tamar and Dalit licenses are held by Noble Energy (39.7%, 36% and 36%, respectively ) and the public (44.5%, 53.2% and 53.2%, respectively ).

So while talk on raising gas consortiums’ royalty fees aims to tax the companies and tycoons standing behind them, it’s actually the employees – whose provident fund managers chose this lucrative investment for their members – who’ll get hit first. Only after them comes Tshuva.

Golden egg eaters

Presenting Yitzhak Tshuva as the sole beneficiary of the goose’s golden egg is another deception. “It is unconscionable that the Israeli public be left with just the crumbs from gas profits,” in the words of Yachimovich.

The switch to gas actually saved the economy approximately NIS 23.5 billion between 2004 and 2009, according to IEC estimates. Of this, NIS 1.1 billion was a direct “incentive” to the electric company, which is held by the throat by its humble workers – who Yachimovich fiercely defended on another occasion. (More on this later. )

Over the same period, Tethys Sea profited NIS 4.4 billion (before depletion allowance deductions and financing costs ) and paid royalties totaling NIS 649 million.

The government decided not to gamble taxpayers’ money on oil and gas exploration, drilling and production. But this wasn’t its only option. It could have split the risk by entering into production sharing contracts with the private sector, or hired contractors to perform the exploration and development on its behalf, without involving any risk or stake to itself.

Without even spending a shekel (the tax benefits it has bestowed is a separate issue ) the government ended up with a windfall savings of NIS 23.5 billion, from an investment financed by speculative funds put up by Noble Energy, the investing public – and Tshuva.

This savings works out to an average of NIS 3.9 billion per year over the six years in which Tethys Sea provided gas to the IEC – approximately 0.5% of the annual gross domestic product. This, in the eyes of Yachimovich, is the lousy deal that leaves the Israeli public with merely “crumbs.”

Which begs the question – what would Yachimovich consider an excellent deal? In an interview with TheMarker, the Labor MK explained why she never speaks out against the powerful unions, where nepotism and hidden unemployment run rampant: “I’m in favor of strong employees. I want them to make plenty of money, without any shame.”

Workers at the electric company are, in fact, shameless – this cannot be denied them. Their average pay, almost fourfold the country’s average, totaled NIS 23 billion between 2004 and 2009 – the very period that Tethys Sea supplied the company with natural gas and saved the economy NIS 23.5 billion.

Yachimovich, along with MK Carmel Shama-Hacohen (Likud ), recently presented a bill that would raise the royalty fees from 12.5% to 20%. Had this rate been applied to Tethys Sea from 2004 to 2009, it would have produced an additional NIS 457 million for the state’s coffers.

If, on the other hand, IEC workers had taken a 15% pay cut during that same period, a net total of NIS 2.5 billion would have been saved – 5.4 times the amount the government would have gained under the bill proposed by Yachimovich and Shama-Hacohen.

These numbers don’t prevent Yachimovich from working tirelessly to raise the royalty fees, from completely avoiding taking any action on the issue of IEC workers’ wages, or from presenting herself as the defender of the interests of the middle class.

A shallow debate

The debate on royalties is based on the assumption that the drilling at Tamar, Dalit and Leviathan are all assets readily convertible to cash, and all that remains is arguing over who will share the loot. But that’s not exactly the case, as even those who advocate higher royalties well know.

Tamar 1 is 1,680 meters below sea level, but the gas lies at a total depth of 4,900 meters (yes, almost five kilometers below sea level ). Tamar 2 is 1,700 meters deep; the total depth to the fossil fuel is 5,145 meters. The Dalit 1 drill is 1,400 meters deep and will reach a total depth of 3,700 meters. Leviathan 1 also lies 1,600 meters below sea level and the main target, the gas field, is 5,100 meters deep.

The Mary and Noa fields, from which the Tethys Sea extracts gas that it sells to the Israel Electric Corporation, are 236 meters deep.

Deep-sea production costs far more than that done in shallow water, at three levels: drilling, producing and transporting. A deep-sea oil rig (300 to 1,500 meters ) and ultra-deep sea rig (more than 1,500 meters ) run between $375,000 to $450,000 a day. Noble Energy is paying $530,000 a day to use the Sedco Express rig, which arrived in Israeli waters last week to drill at Leviathan.

The exploration, which is scheduled to last five months, has a $150 million budget, including the cost of moving the rig. But if the target layer proves even deeper than thought, or in the event of secondary discoveries, the explorers will have to lease the Pride North America rig at a cost of $402,000 a day. Deep-sea rigs are semi-submersible. Drilling in shallow water, as Tethys Sea is doing, can be done with jack-up fixed rigs that cost $82,000 a day. Also, working in shallow water enables more drills to be done from the jack-up rig, and eliminates the need to bring another to the site at enormous investment.

The total investment in Tethys Sea, including laying a pipeline to shore and linking it to a terminal in Ashdod, came to $400 million over the project’s 10-year lifetime.

The cost of exploration alone at Tamar and Dalit has reached $350 million so far. The cost of developing Tamar alone, including laying submarine pipelines to a shoreline terminal, is estimated at $2.9 billion. The total cost for Tamar, therefore, will apparently come to about $3.5 billion – nine times what Tethys Sea has cost in 10 years.

Export or nationalize

The Leviathan (Ratio Yam ) project is even more complex. As Israel’s gas needs are met in full with production from Tethys Sea, Tamar and Egypt (through the company EMG ), the question then becomes what to do with the gas to be produced at Leviathan.

Israel consumed 4.5 billion cubic meters of gas in 2009. The National Infrastructure Ministry estimates consumption of 10 BCM in 2020.

Tamar is estimated to have 8.7 trillion cubic feet of gas, which works out to 247 BCM. Dalit is estimated to have 14.2 TCF, which is about 403 BCM ). And Leviathan may have as much as 16 TCF, or 453 BCM, without factoring in possible future finds.

Considering that today 35% of Israel’s gas comes from Egypt, at present consumption rates there is more than enough gas in Israeli territorial waters, at Tamar, Dalit and Leviathan. Assuming the government doesn’t ban the drillers from exporting the gas – which would be tantamount to nationalizing the industry – markets need to be found for the Leviathan gas, assuming its current “50% probability” becomes actual fact.

One solution is to build a liquefaction terminal onshore, which converts the gas into liquid (LNG ) so it can be transported by tanker to destinations in Europe and Asia. Building such a terminal would cost about $5 billion.

Alternatively, Israel could use the LNG terminal in Egypt for a fee. Or another option: an undersea pipeline could be laid to Greece, to reach destinations in Europe that want to reduce dependence on Russian gas.

The cost of Leviathan, including paying for submarine systems and constructing an LNG terminal, could reach $8 billion, making it the biggest infrastructure project in Israeli history. Its uniqueness lies in the fact that the entire investment would be necessary before even a single cubic millimeter of gas is produced. Therefore, the companies need assurance of fiscal stability – in other words, certainty about the tax and royalties policy that will be implemented by the government that licensed them, so they can evaluate their returns and raise the tremendous amounts of money they’ll need to invest.

Greater incentives around the world

Deep-sea drilling is enormously riskier than shallow-water drilling. Acknowledging the need to incentivize the companies, in January Britain ruled on an 800 million pound tax relief for each deep-sea gas or oil field west of the Shetland Islands. For them, deep-sea means 600 meters – not 1,700 like Tamar and Leviathan, and 1,300 at Dalit.

Alistair Darling, the outgoing British exchequer, explained that the government recognized the importance of the gas and oil industry to Britain’s economy and energy security. Tax breaks aren’t lost income to the state, another UK treasury official said: it’s tax the state couldn’t collect if it hadn’t granted the incentives.

Cairo changed its policy in July to motivate the British company BP and the German company BWE to drill at the West Mediterranean and North Alexandria deep-sea sites. The Egyptian government waived royalties and committed to buying all the gas from both sides in exchange for a commitment by the companies to invest $9 billion.

U.S. authorities, evidently unaware of Rabbi Michael Melchior’s insights into the energy business, estimated in 1995 that to advance investment in discovering and producing crude oil and gas in deep water, a new law would be needed and passed the Outer Continental Shelf Deep Water Royalty Relief Act. It exempts the companies from royalties if they produce a minimum amount. Critics howled. The exemption expired in 2005.

Despite technological advances in drilling achieved over the last decade, and the rising price of oil, in 2005 the United States enacted the Energy Policy Act, exempting companies from royalties if they produce no less than 5 million barrels of oil, or an equivalent value of gas, at depths of 400 to 800 meters. It also provides gradual exemptions on up to 12 million barrels of oil from depths of 1,600 to 2,000 meters.

Such exemptions are enacted because of the benefit to the national economy that large-scale fossil-fuel projects bring. Sometimes the public understands it, as seen with the Australians, ousting their popular prime minister, Kevin Rudd, in 2010 following his proposal to slap 40% tax on exploitation of natural resources.

The Arab embargo

In 2006, Yitzhak Tshuva and his partners in Tamar and Dalit gave Noble Energy 33% of the participation rights in the licenses for free, after British Gas stepped out. In January 2008, Delek Drilling, Avner and Ratio gave Noble 35% of the rights – again for free – in the Ratio Yam, Rachel, Amit and other sites. In return, Noble agreed to serve as project operator.

Yachimovich and her colleagues usually describe Tshuva as a tycoon whose greed overshadows his social conscience. So how did this miracle come about that twice he gave away a third of his rights? It’s all very simple – just send Rabbi Melchior out in a rowboat to bring home the billions of dollars floating on the sea, right?

So why did Tshuva do it? Because producing gas from deep-sea fields involves investment of billions of dollars, along with know-how that no Israeli company possesses. According to the new licensing terms, any group seeking a marine project must have an experienced operator. Giants like Chevron and Exxon aren’t lining up to participate in high-risk explorations in Israeli territorial waters (up to 320 km from the shoreline ). In contrast to the claims of Yachimovich et al, the Arab embargo is alive, kicking and effective.

The U.S. Geological Survey estimates the gas potential in the Mediterranean Basin at $540 billion. Some is in Israel’s waters. Yet the giants left the stage for the relatively smaller Noble.

Note that BG decided to forgo 35% of the rights to Ratio Yam, which has a 50% probability of producing 16 TCF of gas. Could BG – a company worth $27 billion, or double Noble’s value – have stupidly missed an opportunity? Or did it forgo doing business with Israel because it thought the price might be too high?

Limited demand for LNG

The presence of giant companies in the project has another crucial aspect to it. Israel’s rights to these discoveries is being challenged, as are the boundaries of its territorial waters. Alliance with a major American or British oil company would have improved Israel’s ability to fight its case. The chance of a big company joining diminishes if the Israeli government retroactively raises royalties.

Yachimovich, Melchior and their ilk, however, claim that raising royalties won’t decrease the chances that the discoveries will be developed. They assume that demand for LNG is infinite and that there’s no real competition in the LNG markets, and so the time it takes to develop the fields and build terminals doesn’t matter.

But that probably isn’t so. In fact, there are signs that a glut could be created in LNG, leading to fierce competition over prices. The losers will be the latecomers, and legal challenges to policy changes will only cause delays.

In Australia, two projects are underway at an investment of $55 billion. The country also has other projects in the pipeline, at an investment of $80 billion. Those, along with projects in Qatar, will be ready before Leviathan. Russia and Norway are also looking to building LNG terminals.

In early 2010, the Australian bank JBWere, of the Goldman Sachs group, wrote that surplus supply is a significant risk for LNG projects. The companies Reliance of India and CNOOC of China are investing $2.2 billion in U.S. projects that will give them the technology to produce gas trapped in rock. Such technology would allow China to exploit reserves of 26 TCF of gas in rock formations, affecting the price of LNG and the feasibility of developing fields.

Given the level of investment around the world, the latest technology and the signs of competition arising, the Sheshinski committee would do well to decide that its real mandate is to attract foreign investors, not to cause massive legal battles. Otherwise the gas is likely to remain lying there in the deep blue sea, and Israel’s unique opportunity will drown in the sea of Yachimovich’s demagoguery.

All that potential could be lost. But at least we’d have a bigger share of that zero.