Israel’s gas sector caught between low investment appetite and regulatory hurdles

06 Feb 2015 – Sudden changes to Israel’s energy regulatory framework have prompted the development of the country’s offshore gas fields to grind to a halt.

Israel boasts gas reserves of around 35 tcf, mainly located in the Tamar and Leviathan gas fields. Their major stakeholders, Noble Energy and Delek Drilling were hit at the end of last year by a request from Israel’s anti-trust regulatory to break their perceived monopoly by selling their interests in one of these fields. The government is expected to decide within weeks whether to further intervene in its hydrocarbon industry, prompting concern from investors. Earlier this month, Energy Minister Silvan Shalom reportedly reiterated that the current offshore operators may have to sell some of their reserves.

In an earlier statement, Noble called the move disturbing. “We believe this is a harmful precedent for Israel to set and we will vigorously defend our rights relating to our assets,” the company stated.

Since Israel is a political island in the Middle East, aside from importing LNG the development of its gas reserves is its only option for security of supply, a person familiar with the government’s thinking said. Therefore the price of the product is likely to be less competitive due to Delek and Noble’s dominant position, he said. The straightforward solution is that the government should do everything to split the monopoly, but it understands that Noble Energy is important and a significant contributor to Israel’s gas industry, he added.

Some of the structural solutions being considered for Leviathan are that Delek will not be involved as an operator, he said. Noble would dilute its shares, or Noble would be a passive partner, he added. This would provide the government with some notion of competition and some moderate price regulation. A decision on how to proceed is expected in the next few weeks, he said.

The Tamar gas field in the Levant Basin, about 80km off the Israeli coast, is owned by Noble Energy (36%), Isramco Negev 2 (28.75%), Dor Gas Exploration (4%), and two of Delek Group’s subsidiaries; Delek Drilling (15.625%) and Avner Oil Exploration (15.625%). It holds an estimated 10 tcf of gas and first went into production in April 2013, but there was further exploration underway. It mainly supplies the domestic market, through contracts with firms including the Israel Electric Corporation and Dalia Power Energies.

Leviathan, a 22 tcf gas reserve, is owned by Delek Drilling (22.7%) and Avner Oil Exploration (22.7%), Noble Energy (40%), and Ratio Oil Exploration (15%). The project has a capex requirement of about USD 6.5bn. Its partners had hoped for it to be in production by 2017.

Israel is a difficult market to operate in. Potential suitors must comply with the requirement that about half of production should be sold to the domestic market at a discount to wholesale prices, capping potential profits.

To operate in Israel means abstaining from other Middle Eastern markets for political purposes; a big ask from energy firms, which typically favour the cheaper production the Gulf offers.

Australian firm Woodside Petroleum pulled out of a USD 2.7bn deal to buy a 25% stake of Leviathan in May. Its collapse was blamed on tax and export uncertainties.

Until recently, the future of Leviathan seemed straightforward. The partners of the Leviathan field signed a tentative deal in September 2014 to sell gas to Jordan’s National Electric Power Company.

They were also in negotiations with BG Group to use its dormant LNG facilities in Egypt, which would have allowed exports further afield. Then came the anti-trust commissioner’s decision in November.

“In this environment it is a poor market to invest in. There are relatively high costs associated with developing there, as it is offshore,” the sector banker said.

Israel may not necessarily want to be an attractive commercial prospect, a UAE-based banker and the two analysts said.

“The profits of the oil companies are of secondary concern. It is not looking to become a world-class hub,” the UAE-based banker said. “The assets are viewed in terms of Israel’s security and own economic priorities.”

Earlier this month Jordan broke talks with Noble Energy over a gas supply deal, which was worth up to USD 15bn.

Instead, Jordan has turned to BG Group to buy gas offshore the Gaza strip, at a rate of 150-to-180 mcm a day from 2017. This switch was attributed to Israel’s unstable regulations.

Elections for Israel’s next Knesset will be held on 17 March 2015; it is unlikely a solution will be brokered before then.

There will not be any big changes before the elections. After the elections, there is a danger that further price controls could be imposed, the second analyst said.

If Noble Energy and Delek are required to reduce ownership or exit one of the larger fields, they would likely favour the disposal of Tamar, as Leviathan has more commercial upside.

“Tamar is de-risked, and the upside is known. It would be more sensible to find a partner for Tamar, rather than Leviathan; it can be monetised. Noble could still be a financial partner in Tamar, rather than an operational one,” the first analyst said.

The Israeli government, however, seems in no rush to overcome its regulatory adversities.

“Demand for gas in Israel is increasing at a slower pace than expected. So if Leviathan is delayed by a few years it is not too dramatic,” the second analyst said.

While oil and gas prices are low on the wholesale market, Israel will take advantage of this as opposed to developing its own reserves, the UAE-based banker said.

“Timeline delays aren’t an issue. They can get cheaper prices for oil and gas on the open market. Israel views its gas fields as a strategic reserve,” the banker added. “The rainy day isn’t here yet.”

by Katie McQue in London and Lisa Damast in Tel Aviv