Five years ago, significant deposits of natural gas were discovered off the coast of Israel, followed in 2011 by a minor natural gas discovery offshore of neighboring Cyprus. These discoveries have catalyzed explorations in the greater Eastern Mediterranean region generating expectations of enhanced regional energy security and economic and environmental payoffs, benefits Israel has already begun to reap with the Tamar gas field, which began operating in 2013. In the past year, Israel, with the help of the United States, and energy investors have made progress in negotiating initial agreements for gas supplies to Israel’s neighbors. These agreements could contribute to regional prosperity.

In December, however, an anti-trust challenge arose in Israel that may delay the development of the Leviathan gas field, the largest in the region; delay progress on proposed gas supply projects from Israel to its neighbors, including Jordan and Egypt; and threaten the security of Israel’s supply. This anti-trust challenge is ill-founded.

A policy solution that recognizes the inherent lack of competition in small gas markets and enables the Leviathan gas field project to move forward must be adopted. In energy policies, a variety of competing public goals are consistently at stake: public health, environmental sustainability, economic growth, foreign relations, and more. Competitive markets should be a tool and not a goal. In developing Israel’s natural gas sector, a solution should be found to balance various public interests and not put competition above the rest of these interests.

Israel’s Regulatory Framework

Recognizing the significance of the natural gas discoveries, Israeli Prime Minister Benjamin Netanyahu in October 2011 appointed an inter-ministerial committee to propose regulatory mechanisms that would govern the nascent natural gas sector, domestic utilization, and export strategies. Members of the Zemach Committee, which gets its informal name from its chairman, Shaul Zemach, Director-General of Israel’s Ministry of Energy and Water, came from a wide range of Israeli ministries, including Foreign Affairs, Finance, Environmental Protection, and authorities, including Israel’s Antitrust Authority. The Zemach Committee met over eleven months. It was preceded and followed by two smaller government inquiries, both headed by Prof. Eytan Sheshinski, which focused on natural resource tax and royalty policies. The Israeli government officially adopted the recommendations of the Zemach Committee in a slightly revised form, and the Israeli High Court of Justice in October 2013 rebuffed a challenge from non-governmental organizations and opposition politicians to the government’s authority (versus the parliament) to decide on natural gas policies.

Through the Zemach Committee, Israel’s policy process on the natural gas volumes was exceptional: the government established a guiding strategy and professional framework to take into consideration competing public and government agency interests, and to attempt to resolve conflicts between them during the policy formation process. Through the Zemach Committee process, Israel decided to adopt a government strategy for the management of its newfound natural resources. This was unique since most states upon discovering large natural gas resources have initiated energy export and only calculated the impact on the domestic market etc. a number of years after the fact, if at all. The Zemach Committee process also provided a clear vision of the regulatory framework that should govern the natural gas sector.

Netanyahu’s official appointment document for the Zemach Committee included three goals, one of which has proven problematic: “the establishment of a competitive market throughout all its segments.”  Netanyahu did not ask the committee to examine the role of competition in the emerging natural gas sector, rather he demanded that a competitive market be established. In order to meet this demand, the Zemach Committee recommended that companies investing in the natural gas fields market their gas to consumers separately (and not as one consortium or joint venture).

An additional regulatory factor affecting Israel’s emerging natural gas sector is its strong anti-trust legislation and institutions. Israel’s Antitrust Authority is an independent government authority that operates in accordance with the Restrictive Business Practices Law of 1988. The Authority makes policy recommendations and can recommend to the Attorney General criminal proceedings in anti-trust violations. All of these recommendations are subject to sanction or dismissal by Israeli courts.

Two companies, the US-based Noble Energy and Israel’s Delek Energy (and its subsidiaries), hold the main stakes in the licenses for exploration and production in both the Leviathan and Tamar fields. The additional gas fields discovered offshore of Israel so far are very small. In an attempt to establish a competitive natural gas market in Israel, Antitrust Authority Commissioner, Prof. David Gilo, in March 2014 recommended to Noble Energy and Delek Energy to sell their stakes in two very small fields (Tanin and Karish). He said he did not foresee any violation of anti-trust legislation if they acted on his recommendation. However, amid public scrutiny, it soon became clear that even if new investors could be found for the two small fields (they most likely were too small to be developed by a commercial entity) it would not represent meaningful competition in the Israeli gas sector. Thus, on December 23, 2014, Gilo revoked his previous recommendation and informed the investing companies that he sought a new arrangement, most likely limiting each company to meaningful ownership in either the Tamar or Leviathan fields, and urged their divestment. Gilo, who is currently conducting interviews and further study with the company representatives, has not released his final legal judgment.

Implications of the Anti-Trust Decision

If the current investing companies are forced to divest, the prospect of developing Leviathan within the next five years will become unattainable. Under current global market conditions, where expensive natural gas production projects are finding it difficult to be profitable, it is hard to envision new investors in the Leviathan project.

This delay could threaten Israel’s own security of supply of natural gas. From around 2021, Israel will begin to need supplies in addition to that currently provided by Tamar, which by 2020 will be the source of close to 70 percent of Israel’s power generation. A final investment decision (FID) sanctioning the development of Leviathan needs to be taken by late 2015 if those supplies are to reach the Israeli market on time. It should be noted that the anti-trust challenge is only one of many standing in the path of sanctioning development of the Leviathan field. No contracts for supplies have been concluded and all related agreements are non-binding letters of intent or memoranda of understanding.

Furthermore, Israel’s natural gas supply is vulnerable because almost all of it comes from a single field that uses one supply pipeline. The addition of supplies from Leviathan could reduce that vulnerability.

The Antitrust Commissioner’s decision is also particularly problematic for its timing. The intervention came late in the Israeli natural gas policy process, which has been under formation since 2011. The Antitrust Authority was represented in the Zemach Committee and had opportunities in the early stages of the policy formation to provide input and identify solutions to ensure a fair-price mechanism and legal structure for the marketing of Israel’s natural gas. To pull the reins so late in the policy process is especially damaging. Each delay adds to the cost of the project.

Israel will hold national elections in March. With a parliamentary government system, Israel cannot hope to have a new functioning government until late April. Thus, identification of a new policy solution that can address the competition concerns and enable the project to move forward probably will not take place until late spring/early summer of 2015.

Resolution and Moving Forward

Due to the independent status of the Antitrust Authority and the authority of the anti-trust courts to block any trade arrangement that is viewed as a violation of Israel’s competition laws, the Israel government does not have formal standing to intervene in these developments. However, the government, the investing companies, and the United States can promote a policy solution that will be satisfactory in terms of anti-trust legislation.

The first step in addressing the anti-trust challenge in Israel would require government authorities to be realistic regarding their goals in establishing a competitive gas market in Israel. Natural gas is different from almost any traded good. Only a few places in the world have functioning competitive gas markets. In these places — the United States, the United Kingdom, and the Netherlands — there are a large number of buyers and sellers in the market.

Israel’s situation is quite different: two significant suppliers (two gas fields) and only one meaningful buyer, the Israel Electric Corporation. This is not and cannot be a truly competitive market. In addition, even in places where there are successfully functioning gas markets, like in the UK, the market has failed to produce low prices or security of supply. Across the Israeli political spectrum — both on the left as well as the right — the main political forces embrace competition as the answer to most of Israel’s economic challenges. However, in certain sectors, like natural gas, that have a small number of players, a competitive market is not attainable. This fact should be recognized. Israeli law allows for exemptions from the anti-trust limitations when a sector is viewed to have a “natural monopoly” or other unavoidable structure. This decision is still the privy of the Antitrust Authority and cannot be made by the government, but if the exceptionalism of competitive gas markets was pointed out to the Antitrust Authority it could help the Authority seek a practical recommendation.

Once the current ownership structure of the gas fields is exempted, instead of attempting to break it up, a policy solution can be offered to address pricing and contracts to ensure that there is no unfair price consequence of the gas being supplied by a single supplier. A price mechanism for the natural gas supplies from Leviathan that would incentivize development of the field and could reflect changes in economic trends should be devised.  A useful mechanism is pegging the gas price to the prices of alternative sources of power generation, such as coal and/or renewables. It is much better to peg to the true competitors of market share, which are other fuel sources, than to other gas markets where the conditions are irrelevant to the supply options in Israel.

Over the past two years, the US State Department, and especially its Bureau of Energy Resources, has played a constructive role in facilitating initial agreements for supply from gas fields in Israel to its neighbors — Jordan, the Palestinian Authority, and Egypt — and should be commended. On the current anti-trust challenge, the US government should understand that the anti-trust issue is not an issue that can be solved by government intervention. The Antitrust Authority and the Israeli courts are completely independent of the government and this rule of law arrangement should be respected by outside governments. However, the US can be useful in helping the Antitrust Authority identify a technical arrangement that will suffice the legal demands while enabling the project to move forward. Attempting in any way to export the US model of a gas market will not attain this. The Henry Hub gas market has hundreds of players and so cannot be duplicated in Israel or any other region where there are a small number of players in the natural gas sector.

There are also lessons for US global energy policy efforts in the Israeli case. The US should be careful in its policy promotion of competitive gas markets abroad. In most small markets this is unattainable. Worse than a monopoly, is an illusion of competition.

Prof. Brenda Shaffer, an international energy specialist, is a visiting researcher at Georgetown University’s Center for Eurasian, Russian and East European Studies (CERES), on sabbatical from the University of Haifa. She was a participant in the Atlantic Council’s Energy & Economic Summit in Istanbul on November 20-21, 2014. She has served as an advisor to Israel’s Ministry of Energy and Water.

Related Experts: Brenda Shaffer