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Israel Infrastructure and Natural Gas Industry - Recent Highlights

APRIL 2011

Bergman Naveh, Rona, PARTNER

Background

The Israeli gas industry has undergone tremendous developments in the past decade, due to the discovery of significant natural gas fields in Israeli territorial waters, the largest of which are the Tamar field, estimated at 247 billion cubic meters (“BCM”), and the Leviathan field containing 453 BCM. Currently, the “Mary B” field (20-16 BCM) is the only operative field and it provides, as of 2004, natural gas to the Israeli Electric Company (“IEC”). The recent discoveries produced a fast-growing energy market, such that in 2010, 45% of IEC electricity production was based on natural gas, compared to o% in 2003, and the overall consumption of natural gas increased by 275% between 2004-2009.

These developments, in turn, triggered a public and governmental review of certain matters relating to the exploration and production (“E&P”), taxation, marketing, distribution and transportation of natural gas and an extensive regulatory process, including the establishment of Israel Natural Gas Lines Ltd. (“INGL”), introduction of certain regulations relating to the E&P activity, marketing and distribution of natural gas and more. The most significant developments now pending with the Israeli authorities and legislators pertain to the matters of taxation, establishment of a liquidfied natural gas (“LNG”) terminal and to initiation of new legislation in order to increase competition in this field as detailed below.

Increasing the Government’s take - Sheshinski Committee

The Israeli parliament (“Knesset”) approved, on March 30, 2011, the Petroleum Profits Taxation Law (“Petroleum Taxation Law”), which constitutes the adoption of the Sheshinski Committee’s recommendations relating to the increase of total government take (“GT”) in E&P activities with a few amendments lobbied by the Gas rights owners.

The Petroleum Taxation Law presents a new tax regime for oil and natural gas exploitation that aims to assure the continuation of natural gas development, along with the receipt of suitable consideration for the public, while providing fair incentives to operators in this business sector. Key elements are:

• Under the new tax regime, the present 12.5% royalty imposed on oil revenues shall remain unchanged; • The depletion allowance is abolished and cannot be deducted from profits;

• A levy at an initial rate of 20% will be imposed on profits from oil and gas and will gradually rise to 50%, depending on the levy coefficient (the R-Factor). The R-Factor refers to the percentage of the amount invested in the exploration, the development and the establishment of the project, so that the 20% rate will be imposed only after a recovery of 150% of the amount invested (R-Factor of 1.5) and will range linearly up to 50% after a recovery of 230% of the amount invested (R-Factor of 2.3). The levy rate may be reduced if the corporate tax which is expected to gradually be reduced to 18% in 2016 will end up being higher than such rate, so that total stake of the State of Israel from the oil and natural gas project shall not increase above the State’s stake which was suggested in the Sheshinski Committee’s recommendations. For purposes of the levy rate calculation, the minimal gas sale price which will be accepted by the State is the bi-annual average local price. The assessing officer may, at his discretion, accept a lower price if it is proven by the project that there was no demand for the gas in Israel for such lower price;

•The oil rights holder may elect in advance with respect to any deductable asset, whether the deduction from the original price of the asset will be at a fixed rate of no more than 10%, or at a variable rate, so that for any tax year the total amount of deduction for all deductable assets (for which a deduction at a variable rate was elected), shall be as the total amount of the oil rights holder’s taxable income before deductions at the variable rate and after deductions at the fixed rate, as long as the deduction attributed to each assets will not exceed 10% of its original price;

•A partner’s share in the oil partnership shall be calculated according to the partner’s share in the oil partnership’s taxable income or its losses according to the Israeli Income Tax Ordinance [new version] 5721 - 1961, so that the deductions and losses will initially be made at the partnership level and only then attributed to each of the partners for determining the partner’s taxable income. The general partner shall be subject to the partnership’s reporting liabilities and shall file its annual tax return. Tax installments may also be payable on the account of the tax to which each of the partners shall be subject;

• The Petroleum Taxation Law provides transitional provisions to enable a gradual adaption to the new fiscal system.

Government’s Usage of Natural Gas proceeds

A public debate is currently taking place with respect to the utilization of such increased GT, where some support the establishment of an investment fund to serve Israel in national emergencies (such as earthquakes) and others support the usage of such monies to reduce Israeli national debt.

Competition Considerations

Meanwhile, the Israeli government is investigating ways to increase competition in the natural gas industry (currently dominated by two main players - Delek Group and Noble Energy), and announced the establishment of a number of teams and inter-ministerial committees to address the macro-aspects of the industry, including variation of supply sources, governmental involvement in enforcing competition, and strategy for gas importation, as well as the review of options for increase of consumption of natural gas, for example in industry and transportation. Other than the general concerns regarding monopoly implications, the concern is that new competitors will be dependent upon Delek and Noble’s offshore infrastructure to be established for Leviathan and Tamar fields. Therefore, the teams would also be tasked with resolving ways to enable competing companies to develop gas reserves yet to be discovered, by requiring Delek and Noble to offer open access to their pipelines, while regulating the fees they can charge. It was estimated that if such limitations will be imposed on Delek and Noble, they may be compensated by means of eased restrictions on exports, a step which may also encourage competition in the local industry. However such steps do not necessarily correspond to the Ministry of National Infrastructure stated policy requiring a reserve of natural gas supply adequate for at least 50 years before permitting export.

LNG Tenders

The transportation of LNG from offshore fields is currently contemplated through the establishment of a buoy which will be connected to the Israeli offshore gas pipeline near Hadera’s port, by the beginning of 2013. The LNG will be regasified by special ships to be leased by IEC in a separate procedure, for a period of one year which may be extended for an additional year. Accordingly, IEC and INGL recently published Request for Information (R.F.I.) for both parts of the above project.

Last Minute Development – The Privatization of the Port Of Eilat

On April 4, 2011 the Israeli Government Companies Authority published the Prequalification (PQ) documents for a tender, expected to be held by the end of the year 2011, including the scheme of the tender, for the privatization of the Port Company Ltd. (“Eilat Port”). This step, is in the framework of a resolution adopted by the Ministerial Committee for Privatization dated December 6, 2010 which determined that the Eilat Port, wholly owned and held by the State of Israel, will be privatized by way of private sale, as one block, of all of the State of Israel’s holdings in the Company.

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