The Potential Under Troubled Waters

 

With Israel’s discovery & exploitation of its natural gas fields, the country inherits a whole new set of problems & options it has never had to consider before.

By Aharon Lapidot

 

One morning in January 2009, the State of Israel awoke to the news that its eternal gripe against Moses for bringing us to the only corner of the Middle East that is bereft of oil suddenly — and surprisingly — was put to the test. While there still isn’t any black gold to be found on Israeli soil, there are quite large deposits of natural gas just off of our coast, with the potential for substantial profit quite real.

The numbers are mind-boggling. According to conservative estimates, the natural gas fields that have been discovered underneath the Mediterranean Sea and within the maritime borders of the State of Israel — in particular the Tamar and Leviathan projects, which are considered to be two of the largest deep-sea discoveries in the world in the last decade — could net somewhere around $200 billion in revenue.

As a result of the discovery, the production of electricity by way of natural gas will reach 60 percent within just two years, 90% in the years afterward. Potentially, there is 470 billion cubic meters in the larger field, Leviathan, and 250 billion cubic meters in Tamar. A lot of gas means a lot of money.

On the other hand, the expenses incurred in producing the gas are considerable. The cost of drilling alone is $100 million, and there is no guarantee that any drilling will yield results. A day’s work costs $1 million. Tamar’s rig alone cost billions to build. The sums of money that the investors, chief among them U.S.-based Noble Energy, poured into the Tamar drilling project before they could hope to see a single dollar as a return on their investment reached $3.25 billion.

“This is a business strictly for professionals,” said Yaron Zar, a senior analyst at Clal Finance who monitors the natural gas sector. The timing of the discoveries could not have come at a better time, since the demand for natural gas in Israel is likely to triple. In a year from now, the consumption of natural gas is estimated to reach 5 billion cubic meters. By 2017, natural gas consumption is due to hit 15 billion cubic meters.

Alongside the enticement inherent in this underground treasure, there arise the inevitable complications that are physical, legal, financial, and diplomatic in nature. There are international border conflicts, problems related to taxation and finances, environmental issues that need to be dealt with, and logistical challenges posed by the need to transport offshore gas through pipes that exceed 100 kilometers. There are other matters to consider, like weighing local consumption with export and storing the gas in land- and sea-based containers.

The most inescapable problem is that all of that gas — hundreds of billions of dollars worth — lies at sea, there for all to see, but still at sea.

Disputed borders

The Hebrew term “mayim kalkalim” (“economic waters”) is the Israeli interpretation of the international concept known as “exclusive economic zone.” According to this concept, an imaginary line stretches 23 kilometers out to sea from every point along the coast. This line demarcates what are known as “territorial waters,” which are subject to the same legal and political recognition as the terrestrial entity to which they belong. In other words, these areas are an inseparable part of the State of Israel. Israel’s territorial waters cover an area of 4,000 square kilometers.

In the region that extends beyond the territorial waters and reaches a distance of 200 kilometers offshore (or half the distance that separates two countries) lies the exclusive economic zone. As stipulated by the terms of international law, a state is permitted to exploit the natural resources that lie within this realm on condition that it doesn’t seal off the area or limit the movement of airplanes and sea vessels. The state is also obligated to put in place proper security arrangements, ensure that no harm is inflicted on the environment, make efforts to issue drilling licenses in a transparent manner, and prepare contingency plans in case of disaster. Israel’s exclusive economic zone stretches across 28,000 square kilometers, which exceeds the total size of the country’s land mass (22,000 square kilometers).

The delineation of the country’s exclusive economic zone is determined by international agreements. “In 2010 we signed an agreement with Cyprus that solved the issue of where the borders lay,” said Brig. Gen. Yaron Levy, chief of the Israel Navy’s staff. “We have a small dispute with Lebanon over a few degrees in the northeast corner. To avoid a situation like Sheba Farms (a swath of land along the northern border whose sovereignty has been a bone of contention between Israel and Lebanon) at sea, I would recommend refraining from establishing drilling points along the maritime frontier.”

A row may well erupt with Egypt over the status of the Samson and Gal drilling projects, which are near the maritime boundary that Israel shares with its neighbor to the southwest. To pre-empt possible friction, Israel recruited the Italian energy firm Edison, which is also heavily invested in Egypt, into the Gal project.

Tamar and us

Standing on the deck of the INS Dovra, which is taking us to the Tamar drilling site, Col. Ilan Lavi, who heads the navy’s planning and organization branch, rolls out a map marked with areas indicating the sources of the latest maritime threats with which Israel must deal, particularly in light of its increasingly active role in the exclusive economic zone.

“First of all, our area of operations has doubled and tripled in size,” he said. “Within that area, there are now some very attractive targets for hostile entities. We could face, among other things, bomb-rigged boats and ships as well as missiles of various types, some of which, like the (Russian-made) Yakhont, are very advanced and sophisticated. It is possible to inflict damage on a rig from beneath the surface of the water by using deep-sea bombs and explosive devices or divers. It could also be targeted from the air.”

Prime Minister Benjamin Netanyahu eloquently enunciated the need for bolstered defenses at sea. “There’s no doubt that this commodity is a strategic target which Israel’s enemies will look to harm,” he said. “As such, I have decided that the State of Israel will take part in safeguarding these assets.”

In its report, the Sheshinski Committee concluded that the state would be responsible for providing half of the funding toward security of the maritime installations. The task is therefore left to the Israel Navy.

“The maritime front has become quite complex,” said Brig. Gen. Levy. “In the north, as we saw during the Second Lebanon War [when the INS Hanit was hit], Hezbollah has acquired the most potent naval capability that Iran could provide. In Syria, we are seeing a significant investment in naval and maritime armaments, including land-to-sea missiles, particularly the Yakhont. Egypt is arming itself with Western vessels and German submarines that are built in the very same shipyards that produce our Dolphins. Even in Gaza, they’re not letting up. In March 2011, we intercepted a boat, the Victoria, which we found to be carrying land-to-sea 704-C missiles as well as radars. These were intended to be delivered to Gaza.”

The strategy that the navy chose to adopt is theatre-wide defense, which entails the combining of intelligence, reconnaissance, control, a physical presence, and, of course, a response to create a pocket of defense that would cover the entire area.

“The impact of a successful terrorist attack is dramatic,” Lavi said. “It not only entails the physical harm done to an installation, the economic ramifications of which reaches astronomical sums and which results in loss of work days. Such an attack would catapult insurance rates to heights which would call into question the very feasibility of undertaking the drilling project. It would also seriously dampen foreign companies’ motivation and willingness to do business here.”

The navy seeks to acquire four vessels that would serve as the backbone of its maritime defense strategy as it relates to the exclusive economic zone. “The navy is stretched thin and is doing all it can today,” according to Levy.

“The four new ships are known as ‘offshore patrol vessels,’ and the cost of purchasing them is $3 billion. Putting them into operation will take time. The building of such a ship takes over four years, but we would end up with an outstanding vessel that will be armed with our very own Iron Dome as well as Barak missiles, the Vulcan Phalanx CIWS, a helicopter, and other features. We can provide a real boost toward carrying out our mission.”

After 45 minutes at sea, the rigs, which look like spider-shaped structures from a distance, peer out from the horizon. The Yam Tethys field is smaller, while the Tamar complex is newer and bigger. Observers at the site could easily discern the Ashkelon and Gaza beachfronts, which appear to be at an equal distance from the site. This view encapsulates the problematic, complex nature of safeguarding installations that lie vulnerable in the exclusive economic zone.

These two rigs, which are separated by just 1.5 kilometers of sea, will be connected to a joint operating grid. “The Yam Tethys reservoir is empty,” Lavi said. “Tamar is a platform which we have connected to the longest gas pipeline in the world. It starts at the Tamar drilling site, which is an underwater site on the northern tip of the zone. The Tamar rig will receive the gas, filter it, decrease the pressure, and funnel it to land through Yam Tethys. The excess gas will be deposited in the empty Yam Tethys reservoir, creating another natural gas deposit.”

The entire system is due to begin operation next month.

“The Tamar project is ready to go from all aspects,” Zar said. “The business model is clear and precise, the risk is very low. This is the only project currently underway in the country that is assured of generating revenue in the long term.”

Natural gas superpower

Unlike the joke about “signs of oil” that would inevitably yield no deposits, natural gas is an entirely different story. This success story has an undisputed sponsor, Texas-based Noble Energy, one of the largest and most experienced companies in the field. The firm’s holdings, which include land- and sea-based drilling projects around the globe, are valued at $17 billion. It began operations in Israel in 1998.

Tamar natural gas well

The Yam Tethys reservoir (which encompasses the “Mari” and “Noah” drilling projects) was discovered in the early 2000s by a joint team of explorers from Noble and Delek, the Israeli energy conglomerate owned by billionaire businessman Yitzhak Tshuva. It is a relatively small reservoir (32 billion cubic meters), though since 2004 it has combined with the natural gas provided by Egypt to supply all of Israel’s modest gas needs (5 billion cubic meters of gas per year).

The partners in the Yam Tethys project smelled more riches beneath the sea. In 2006, they obtained permits to drill in the northern section of the exclusive economic zone. “At the time, whoever asked for a permit got one,” Zar said. “Noble and Delek received nearly the entire portion of the northern section. Today, the state is far stingier in handing out permits. To Noble’s credit, they did excellent work. They efficiently mapped out the entire area and as a result discovered Tamar, and then Leviathan.”

Noble introduced to Israel its first deep-sea drilling rig. Exploratory drilling began in 2008, months before Tamar was discovered in January 2009. This changed the entire picture. Not only did the enormous size of the reservoir change the energy calculus in the country, but the timing could not have been better. Israel’s traditional natural gas suppliers were winding down their operations. Egypt was in the throes of the Islamist revolution, while Yam Tethys had exhausted all of its potential.

“Two years ago, I predicted that we would no longer get gas from Egypt,” said Zar. “During the revolution, I monitored Egyptian media reports. I could detect within days when there would be another explosion at a natural gas supply pipeline to Israel. Beyond the political problems, however, there’s also a practical dilemma, and that is that Egypt just doesn’t have enough gas to export.”

In 2010, the Leviathan deposit was discovered. Even for an experienced, wealthy company like Noble, this was a seminal occurrence. On its Web site, it trumpeted the discovery as the largest reservoir in its history. Overnight, Israel became a natural gas superpower. The breakthrough compelled the finance minister, Yuval Steinitz, to take action. He formed a committee that was headed by Professor Eitan Sheshinski. Its task was to determine the royalties and commissions the state would exact as a result of the discovery of the natural resource.

Its primary recommendation was to institute oil and natural gas levies at a progressive rate that would only be collected after the entrepreneurs attained a full return on their investment plus an additional 50 percent gain and before they would have to pay corporate tax. The initial levy stood at 20%, and it would gradually rise to 50% in accordance with the resultant revenues.

“This is a real achievement for the State of Israel,” said Lavi. “From now until 2040, the state will benefit from royalties and taxes that will total $140 billion. That’s a 5% addition to GDP at no investment.”

Beware of disappointment

There are mixed opinions regarding the strategic significance that the natural gas deposits hold for Israel’s economy.

Uzi Landau, the minister of energy and water, told the February 2013 edition of Haaretz’s “Energy+” supplement: “The discoveries of Tamar and Leviathan and the potential for more discoveries augur an era of energy independence.” The transition to natural gas will impact the competition between private electricity producers in the market that are due to begin offering services by the end of 2015.

The discovery will also make its impact felt on the transport of gas, the lowering of energy prices on the market (although it is still uncertain as to whether these lowered rates will be felt by the consumer), industry’s transition to gas, and efforts to institute “cleaner” and “green” measures, despite the controversy over the proposed building of gas receptacles along the coast, something which environmentalists have adamantly opposed. Experts in the field say that Israel’s geopolitical standing will be enhanced by these discoveries. “Countries that export energy are more influential,” said one source.

Zar, however, preaches caution. “Natural gas significantly improves the state of the economy, but it doesn’t alter global agendas,” he said.

Even the most optimistic analysts rule out the possibility that the new natural gas findings will translate into a lifestyle led by Saudi oil sheikhs. They also warn that future drillings could yield disappointment. The Sara and Mira drilling projects, which were estimated to produce 180 billion cubic meters of natural gas, came up completely empty.

“The partnership with Petromed, which was established by the Land Development Company, invested $200 million in drilling which turned out to be worth nothing,” Zar said. “The geological structure of the ocean floor simply isn’t conducive to the production of gas reservoirs.”

Domestic consumption or export?

The most contentious issue surrounding the anticipated revenue from the natural gas findings is how much of the gas will be permitted for export. “If it weren’t for the Sheshinski committee, there wouldn’t be any export at all,” said Zar. “It was only because of the future profits that were guaranteed by the committee that people are even talking about this.”

A panel chaired by Shaul Zemach, the director-general of the Ministry of Energy and Water, has been assigned the task of determining how much of the gas that has been produced will be allocated for domestic consumption over the next 25 years and how much will be permitted for export. Why 25 years? That is because holding the gas in the domestic market for longer is liable to dampen the motivation of other entrepreneurs to find and develop more energy reservoirs, which would inevitably result in a significant loss of revenue for the state.

According to estimates, in the year 2016, the state economy will require investments that range between $10 and $20 billion. Allowing for natural gas exports is considered critical to luring another serious player in the energy market. The Leviathan partnership has also let it be known that if it is denied permission to export gas, it will not provide gas for domestic consumption since it would be cost-prohibitive given the scope of the investment.

“When the Antitrust Authority claims that it wants to break up the monopoly [in this case the one belonging to Noble Energy] in the natural gas market, it is, pardon me, talking nonsense,” Zar said angrily. “In Israel, like in the rest of the world, we need to get used to the fact that in the energy sector there are monopolies. In foreign countries, there are only a very small number of key players, and what the regulatory agencies need to do is just to make sure that prices don’t spin out of control. From a historical standpoint, we need to say ‘Thank you’ to Noble Energy for what it did for the country in this area. I don’t see any other alternatives banging on the door to get in.”

The Zemach committee has come up with three quite conservative estimates. First, there will be no more future discovering of significant gas findings. Secondly, despite assessments that the total volume of natural gas found in the fields could potentially reach 1.4 trillion cubic meters of natural gas, the committee based its conclusions on estimates that predicted a total output of just 950 billion cubic meters. Thirdly, in the next 25 years, the domestic market will consume 450 billion cubic meters that need to be preserved. In other words, there are at least 500 billion remaining for export.

The committee’s recommendations, which it handed down this past August, must be approved by the Israeli government. The delay in forming the next government has also put on hold final authorization. Charles Davidson, Noble’s CEO, was quoted as saying that until the Zemach committee report is approved, his company “cannot take any decisions regarding future large-scale projects in which it is involved in Israel.” In less diplomatic language, the most important player in Israel’s natural gas market has just issued a yellow card to our government.

Landau is prepared to accept the Zemach committee recommendations, but he, too, is waiting for the formation of the next coalition. “We will wait for the new government and we will outline an export policy,” the minister said. “After we set aside a sufficient amount of natural gas for domestic consumption, including the use of gas as part of a plan to create alternatives to petroleum, we will be able to export gas to our neighbors, the Jordanians and the Palestinians. There are talks being held between the Israel Electric Company and Cyprus that deal with planning for laying down a pipe along the ocean floor.”

People are also wondering what will be done with the money generated by the exports. On this issue, all of the experts are in agreement. If the money goes toward covering everyday expenses, paying back debts, or fulfilling coalition needs, then it’s a waste of time. This would be a disaster. If, on the other hand, a special fund is established that will be devoted to tending to the needs of future generations and other development projects, the State of Israel will emerge as the big winner.

We still haven’t even broached the issue of oil reservoirs that are believed to lie underneath the natural gas deposits that were discovered.

View original Israel Hayom publication at: http://www.israelhayom.com/site/newsletter_article.php?id=7833

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