It seems that nobody has bothered studying the state of the international gas market. Nor have they put any thought into how processes in that market affect the economic feasibility of Leviathan.
By Doron Tsur

I hate to be a joy-killer. But when elation runs riot, somebody has to ask the tough questions. It’s a thankless job, but somebody has to do it. If the answers are favorable, then by all means party on. But if there are no answers to be found that satisfy the test of logic, then perhaps the corks should stay in the champagne.

I’m talking about Leviathan. Last week, test results confirmed that the deep-sea field contained 16 trillion cubic feet of gas, worth tens of billions of dollars.

Jubilation among investors at news of the sort is understandable. The media also went wild, predicting that Israel would become a “gas superpower.” Soon, we are told, Israel will be able to export all that lovely gas, in gaseous form via pipeline and/or in liquefied form by tanker to gas-starved Europe.

It is a lovely vision. But in the heat of the moment, one forgets that old adage – Beware of what you wish for: you might get it.

It never ceases to surprise me how not only investors, but the entire financial press, get caught up in the moment and forget to do their homework. In this case, it seems that nobody seems has bothered studying the state of the international gas market. Nor have they put any thought into how processes in that market affect the economic feasibility of Leviathan. They’re just all caught up in the emotionally supercharged battle between the gas companies (backed by their shareholders ) that oppose any increase in taxes on the gas exploration companies, on the one hand, and Professor Eytan Sheshinski, Shelly Yachimovich and certain other parliamentarians, on the other, who argue that Israel’s natural resources belong to the people, and the state should get a bigger cut than it does.

So I shall endeavor here to present actual economic questions, the answers to which will affect the economic feasibility of the projects, completely irrespective of taxes. Calculation therefore is pre-tax, and from this point on, I won’t mention Sheshinski again. He’s become a household name, but I will be discussing other terms and names that most newspaper readers probably haven’t yet encountered.

But what emerges from their stories will greatly affect the merit of investing in the “gas shares.”

Marcellus and Ras Laffan

Have you ever heard of Marcellus? How about Ras Laffan, out there in Qatari territory? What about “Gas OPEC”? These are probably less familiar names to the average Israeli than “Leviathan” and “Tamar,” but they’re worth knowing.

Let’s start with Marcellus, and no, I don’t mean the swarthy gangster Marsellus Wallace from Quentin Tarantino’s “Pulp Fiction.” I mean the Marcellus shale configuration, a gigantic on-shore structure containing natural gas. It’s estimated to contain between 160 and 500 trillion cubic feet of gas, which is at least 10 times more than Leviathan. It’s directly below the states of New York and Pennsylvania in the American Northeast. You might say the location is ideal, considering its proximity to a population that needs the fuel.

Marcellus is far from being the only natural gas field in the continental United States, but its story is representative of the industry in recent years. Advanced drilling and production techniques, such as horizontal drilling, and “fracking” (short for hydraulic fracturing – a method of extracting hydrocarbons from shale sites inaccessible by conventional drilling, in which vast quantities of water and chemicals are pumped into the well ) have enabled the exploitation of sites previously considered unusable. One result has been a sharp fall in the price of natural gas.

Let’s put it simply: Technology created a glut.

Natural gas is measured in millions of BTU – British thermal units. Today, the price in North America is about $4 per million BTU. In 2008, when commodities were at a high, the price was about $12 per million BTU. It could be argued that all commodity prices have fallen since then, and that’s true. Oil prices have also retreated. But not all commodity prices have fallen to a fraction of their peak. Oil, for instance, traded at $140 per barrel and was trading yesterday at $89-$90. That’s a drop of 35%. Gas fell by 75% and hasn’t recovered since.

For years, analysts built models to compare the prices per unit of energy that could be derived from gas and oil. These models showed that the ratio between the price of a barrel of oil and a million BTU should be 1:6 to 1:10. That means that when oil is trading at $50 per barrel, gas should cost $5 to $8 per million BTU.

Two years ago, that ratio began to rise to around 12-14 in favor of oil. Quite a number of speculative investors then adopted a long-short strategy – long on natural gas and short on oil. They figured the ratio would return to its old level at some point and lost their pants.

Wouldn’t you know it: Instead of converging on a ratio below 10, if anything, the ratio kept going up and up to about 22 today in favor of oil.

Why did that historic ratio change so drastically? It’s hard to say, but the gigantic amounts of gas found at Marcellus and other fields, and the advances in extraction technology, most likely played a role.

How does all this affect Israeli investors?

Just ask people who got into Chesapeake (CHK ), one of the biggest natural gas producers in the United States and owner of a number of licenses in Marcellus. It currently trades at about $26 a share, roughly where it was in 1996. That’s 60% below its peak in June 2008.

No different in the Middle East

So much for North America. Let’s return our attention to our home turf, the Middle East, where the name “Ras Laffan” sounds a lot more familiar than “Marcellus.” It is, in fact, the name of a Qatari city that has a gigantic gas liquefaction terminal, which turns gas into liquid by intense cooling. The liquefied gas can then be transported by tanker all over the world, as nearby as Turkey and as far away as South America, India and China.

By the way, there’s a connection between Marcellus and Ras Laffan. Qatar has been building liquefaction facilities since 1997 and recently reached its target of producing 77 million tons of liquefied natural gas a year. Originally, it had planned to export the gas to the United States, a huge consumer of the stuff. But then enough was found in continental North America to spoil that plan, so Qatar exports it to wherever it finds buyers.

Qatar has become the world’s third-biggest exporter of LNG, after Russia and Iran. It has a huge advantage in already having all the infrastructure in place and working. In short, anybody thinking of elbowing into the global market for gas will find it pretty crowded and glutted.

The gas field that pumps to Ras Laffan is gargantuan. It’s estimated to have 900 trillion cubic feet of gas, which is – do the math – 56 times more than Leviathan. Near that field is another, called the South Pars field that belongs to Iran. It is estimated to contain 280 TCF.

Another point worth mentioning about the northern Qatari field: Qatar nationalized it in the late 1970s, expropriating it from Royal Dutch Shell. Despite that move, Royal Dutch Shell agreed to stay and operate the site, though its profit from doing so is a fraction of what it would have been had it remained the owner. Qatar has become very rich indeed since then, to the great benefit of its people.

Moving on: what is “Gas OPEC”? Unlike the case in the oil industry, the gas exporters are not a cartel. That may be part of the reason gas prices fell so much. But in recent years, there have been moves to form a cartel, a sort of OPEC for gas, to institutionalize and regulate prices. Or, in plain English, to pump them up and keep them artificially inflated.

Ostensibly, a cartel of this sort would benefit gas producers the world over. Prices would rise and stay high. But the candidates to be part of such a cartel are Iran, Russia, Qatar, Venezuela and Algiers – most of them not rabid fans of Israel.

A cartel of this sort would serve them and their gas companies well, but it would be horrible for exporters of Israeli gas, because it could issue the following diktat: We will not sell to anybody buying Israeli gas. And I don’t think pleas by “minority shareholders,” in this case begging the governments of Europe to buy Israeli gas after all, would have much of an effect.

I would like to qualify all the above by noting that more is unknown than known when it comes to this market. It’s impossible to know how events will play out or how the gas market will look five or six years down the road, when serious production from Leviathan should start. But there are a lot of question marks out there, and the issue of how much tax Delek Group and the other gas companies should pay is the least of them.

All these uncertainties need to be taken into account when investing in Israeli gas shares. I can’t help but feel, though, that nobody has given them a second thought.

The author is the CEO of the Psagot Compass.