Israel Natural Gas Demand Forecast

Transcription

1 Israel Natural Gas Demand Forecast January 26, 2014

2 Legal Notice This report is provided for information purposes only, and does not constitute any recommendation or advice for any purpose. This report relies on publicly available information and other sources of information, including information provided by Noble Energy Inc, Delek Drilling LP ( Delek Drilling ), Avner Oil Exploration LP ( Avner Oil, and together with Delek Drilling and each of their respective affiliates, the Delek Parties ) and/or Isramco and/or Dor (collectively, the Project Co-Sponsors ), and which Economic Models Ltd. believes is reliable, without any independent verification of said reliability, unless specifically noted otherwise. The information provided in this report does not purport to include all elements that a prospective investor may desire and thus does not replace the need for a full analysis of all the facts and details appearing herein. With regard to any use or reliance on this document by any party, Economic Models Ltd., nor any persons acting on our behalf: (a) makes any warranty, expressed or implied, with respect to the use of any information or methods disclosed in this report; or (b) assumes any liability with respect to any information or methods disclosed in this report, except to the extent resulting from any fraud or willful misconduct of Economic Models Ltd. or any persons acting on its behalf. Any recipient of this document, by acceptance or use of this document, releases Economic Model Ltd. and anyone acting on its behalf from any and all liability for damage and/or loss that may be caused by use of this report, if any, and Economic Models Ltd. similarly disclaim any and all guarantee of, or liability for, the reliability of the information contained herein, except in all cases, to the extent resulting from any fraud or willful misconduct of Economic Models Ltd. or any persons acting on its behalf. In no event will Economic Models Ltd s directors, officers or employees be liable to the recipients hereof for any liability, damages, expenses and losses of any nature caused by or resulting from the services of Economic Modesl Ltd. or the report. The Delek Parties have indemnified Economic Models Ltd. for certain claims regarding this report. The economic forecast herein represents our understanding only and includes our forecasts of the Israeli economy and electricity and gas markets therein. Different methods of estimating and different assumptions are liable to lead to different results. The information contained herein is subject to change and may be rendered irrelevant at any time. Capital Market Models Ltd., an investment management company under the control of the shareholders of Economic Models Ltd., is a portfolio manager and as such may hold, or currently holds, or may purchase, publicly traded securities issued by the Project Co-Sponsors and/or parent companies for various clients and/or mutual funds managed by it. Prepared by Dr. Yacov Sheinin and Chen Herzog

3 Table of Contents 1 METHODOLOGY 6 2 EXECUTIVE SUMMARY GAS DEMAND FORECAST SUMMARY NATURAL GAS DEMAND COMPETITIVE ENVIRONMENT DEMAND FORECAST BY SECTOR 26 3 ELECTRICITY DEMAND FORECAST INTRODUCTION INTERNATIONAL COMPARISON ELECTRICITY DEMAND FOR DESALINATION DEMAND FOR ELECTRICITY IN THE PALESTINIAN ECONOMY DEMAND SENSITIVITY ANALYSIS 61 4 ELECTRICITY SUPPLY FORECAST INTRODUCTION COAL TO GAS CONVERSION PROJECT D ELECTRICITY SUPPLY BY IPPS ELECTRICITY SUPPLY BY COGENERATION RENEWABLE ENERGY SUPPLY FUTURE NUCLEAR ENERGY 75 5 ISRAEL NATURAL GAS DEMAND FOR ELECTRICITY FORECAST INTRODUCTION THE DEMAND FOR NATURAL GAS DEMAND FOR GAS FOR COGENERATION 83 6 GAS DEMAND FOR CHEMICALS AND TRANSPORTATION DEMAND FOR GAS FOR TRANSPORTATION DEMAND FOR GAS FOR CHEMICAL INDUSTRY GLOBAL DEMAND FOR AMMONIA THE MARKET FOR AMMONIA IN ISRAEL POTENTIAL PRODUCTION OF AMMONIA IN ISRAEL THE GLOBAL METHANOL MARKET METHANOL AS A TRANSPORTATION FUEL THE POTENTIAL FOR METHANOL IN ISRAEL PRODUCTION OF METHANOL-BASED OLEFINS (MTO) GAS TO LIQUIDS (GTL) GAS DEMAND FOR EXPORT JORDANIAN NATURAL GAS DEMAND ISRAEL'S LNG EXPORT ALTERNATIVES LNG EXPORT THROUGH EGYPT'S EXISTING PROJECTS COMPETITIVE ENVIRONMENT ISRAEL GAS RESERVES GAS SUPPLY AND DEMAND FORECAST TABLES 122

4 Abbreviations used throughout this document: IEC Israel Electric Corp. IPP Independent Power Producers LDC Low pressure gas distribution companies (distribution to small commercial and industrial gas customers) Cogen Cogeneration Desal Desalination PUA Public Utility Authority FO Fuel Oil 5

5 1 Methodology

6 1. Methodology Economic Models is a leading Israel macroeconomic research and economic consulting firm. It is best known for its exclusive macroeconomic model and its forecasts of fundamental economic indicators such as: GDP, employment, foreign trade, investment and inflation. The firm develops and maintains comprehensive models for various Israeli industries, and provides detailed demand forecasts such as: energy, electricity, communication services, cargo shipping, housing, and cement. Projects include: 1. Over 20 years of providing long-term electricity demand model. 2. Long-term demand for fuels. 3. Economic analysis of IPP projects. 4. Analysis of desalination projects, and demand for desalination. This analysis is based on Economic Models' long-term macroeconomic model of the Israeli economy. In preparing this analysis we have incorporated only official data and plans which were publicly published by IEC, the PUA and the Ministry of Energy and Water Resources and the Central Bureau of Statistics (CBS). 7

7 1. Methodology Our detailed macro-economic forecast assumption is presented in a separate presentation document. The following tables summarized the main characteristics of our forecast. Macro-Economic Forecast Summary CAGR ,026 1,074 1,300 1,906 2, % Gross domestic product (2012 NIS bills.) GDP per capita (2012 knis) % Population (thousands) 8,056 8,348 9,076 10,560 12, % Households (thousands) 2,339 2,428 2,672 3,231 3, % Participation rate 63% 63% 63% 64% 64% 0.1% Civilian labor force (thousands) 3,654 3,761 4,080 4,901 5, % Average annual growth rate Cumulative Gross domestic product 2.3% 3.9% 3.9% 3.9% 3.8% 3.9% 171.2% Government consumption** 2.9% 3.4% 3.5% 3.9% 3.8% 3.8% 161.0% Private consumption 3.0% 3.9% 4.0% 4.1% 4.0% 4.0% 181.0% Fixed investment 3.4% 6.1% 3.6% 3.5% 3.3% 3.2% 180.4% GDP per capita 0.5% 2.2% 2.3% 2.4% 2.4% 2.4% 80.2% 8

8 1. Methodology The charts below illustrate our methodology. Our demand model is based on the bottom-up approach, including several main demand components: a) Residential demand for electricity (private consumption), based on demand models for main appliances, factoring penetration rates, usage intensity and energy efficiency. b) Demand by the government sectors, commerce and services, based on our Israel macro-economic model. c) Demand by the industry, based on our macro-economic model, factoring in the relative energy intensity of various industries. d) Demand for desalination and water pumping based on our macroeconomic forecast and demand for water forecast e) Palestinian demand currently included within Israel demand. We assume that the Palestinians will shift to self-generation of electricity in 10 years (assuming normalization of the defense situation). Our electricity demand model is based on a bottom-up approach, which includes the effect of energy efficiency improvement, along with the effect of increased penetration rates and usage of household appliance. The results indicate convergence to demand levels in regions with comparable weather such as the US "Sun Belt" States (see detail in chapter 3). For natural gas demand estimate purpose, in this study we see the electricity generation sector (IEC and IPP's) as a single demand source. Assuming similar generation technologies, the demand for gas is not sensitive to the potential market share of new entrants to the electricity generation sector (see chapter 4 below). The explicit assumption is that all the increase in Israel's electricity supply throughout 2040 will be generated by natural gas (except from renewable 9

9 1. Methodology energies that may reach 10% of Israel's electricity supply, and nuclear power stations that could be built in 2031 and beyond). The main assumptions are outlined in the corresponding chapters through our report. Electricity Demand Model Methodology 10

10 1. Methodology Natural Gas Demand Model Methodology 11

11 2 Executive Summary

12 2 Executive Summary 2.1 Gas Demand Forecast Summary A. Background The discovery of the Tamar and Leviathan natural gas fields provides Israel with a unique opportunity to increase the use of natural gas as a relatively inexpensive and ecologically sound energy source, while increasing Israel's energy independence. Israel's first gas discovery, Yam Tethys, started producing gas in 2004 and initiated, together with gas that was imported by pipeline from Egypt, the transformation of the Israeli electric sector from coal and oil to coal and natural gas. However, until the Tamar and Leviathan discoveries, Israel's gas supplies were limited and Israel was dependent on gas import from Egypt for about 40% of its supply. Since the Egyptian revolution in January 2011, Egypt has practically stopped supplying gas to Israel. In April 2012, Egypt has announced the cancellation of its gas export contracts to Israel. Consequently, in Israel was in a temporary situation of gas shortage which forced some of the electricity power units to move back to oil as a backup fuel, at considerable cost. In April 2013, as the Tamar field began operation, Israel shifted all its electricity oil production back to gas. The further discovery of Leviathan along with Tamar provide the Israeli market with surplus gas supply from local sources, without dependence on import. The increased supply of natural gas worldwide, through the discovery of unconventional shale gas reserves is expected to accelerate the development of additional applications for natural gas, and Israel is well positioned to take part in this revolution. 13

13 2 Executive Summary Hence, according to our analysis, while the Tamar and Leviathan discoveries increase the gas supply to the Israeli market, they also facilitate and promote increased gas demand in Israel for applications that require a long and secure horizon of gas supply. Up to now, Israel's gas consumption was limited to fuel-oil and diesel replacement in electricity generation and cogeneration facilities. As our analysis shows, the availability of natural gas is expected to promote further demand for Israeli gas, which includes: 1. Conversion of the coal based power units to use gas in normal time 2. Electrification of Israel's railway system 3. Increased water desalination by 1 billion cubic meters 4. Gas usage for transportation (CNG and methanol) 5. Development of methane based chemical and petrochemical industries 14

14 2 Executive Summary B. Key Natural Gas Demand Drivers We estimate that Israel's energy sector transformation to natural gas is still in its first phase. Therefore, current demand quantities do not represent Israel's full demand potential at the current level of GDP. In 2012, Israel's national gas pipeline grid has finally reached all the major industrial areas, which enabled Israel Electric Corp. (IEC) to complete the shift of its last oil based power units from diesel and fuel-oil to natural gas. Israel's largest manufacturers are currently in the process of converting and upgrading their cogeneration facilities from oil to gas. This process was delayed due to delays in pipeline connection and the lack of natural gas. Most large industrial manufacturers are expected to complete the switch to gas by Israel's electricity demand per capita is very low compared to developed countries when accounting for weather conditions (the demand in Israel is 50% less than the U.S. "Sun Belt" states, which have comparable weather). As Israel's standard of living increases, demand for electricity is expected to increase (see below Economic Models Ltd, - EML forecast). Cooling Degree Days (>22 C) GDP / Capita (US $) Electricity per capita: kwh/ capita Relative to US "Sun Belt" Electricity Consumption Indicators US "Sun Belt" States, 2013 Israel, Israel, 2040 EML forecast $50,000 $34,000 $55,000 13,900 KwH 100% 6,800 KwH 51% 11,700 KwH 84% 15

15 2 Executive Summary We predict that all the increase in Israel's electricity demand throughout 2040 will be supplied by natural gas, except from renewable energies that may reach 8% of Israel's electricity supply, and nuclear power stations that could be built in 2031 and beyond. The new planned coal unit ("Project D" of 1,400 MW) that is planned to be built by 2022 will be a dual-fuel (coal/gas) unit and is expected be fueled by natural gas with coal used as a backup fuel only. Furthermore, we believe that there are strong economic and environmental incentives to convert all Israel's coal based power units to dual-fuel units that will be run on gas as a primary fuel, with coal as a backup fuel only, assuming long term gas contracts ensuring a competitive gas prices for these units relative to coal, based on the relative costs. Full conversion of Israel's coal units to gas (beyond Rabin A) will increase the gas demand by 6 BCM per year. Based on a decision of the Minister of Infrastructure, starting 2015 gas will be used as a replacement for coal in 4 of the Orot Rabin coal units units (1,400MW). We believe that conversion of the other coal units to gas (3,400MW), based on coal competitive price of gas for these units, makes economic sense from a macro-economic viewpoint. Practically, it can follow the same logic and occur along with Leviathan's entry to the market. The availability of natural gas is expected to enable increased gas usage for transportation applications in Israel. Israel's railway system in currently running on expensive diesel fuel and most parts of it are planned to be electrified from 2017 (an increase of about 0.5 BCM of natural gas demand per year). Israel's transportation sector can also benefit from the availability of local supply of natural gas. CNG is expected to replace about 10% of Israel's diesel based fleet by 2020, corresponding to 0.4 BCM of natural gas demand in

16 2 Executive Summary Experience worldwide shows that countries with natural gas surplus usually develop, parallel to an industry of LNG export, also a large and profitable petrochemical industry exploiting the availability of local methane gas sources. Unlike most other gas producing countries, which also have local supply of oil, coal, hydroelectric power and/or nuclear energy, Israel is a unique position in which its only local source of energy is natural gas. Therefore, from an economic point of view, it is expected that Israel will have higher usage of gas compared to other sources of energy, to utilize its relative advantage. Therefore, we see potential for development of additional applications for natural gas based industries in Israel (such as ammonia, methanol, olefin production, etc.), which can increase gas demand by at least 10% (1.3 BCM in 2020). 17

17 2 Executive Summary C. Natural Gas Demand Forecast Summary Economic Models natural gas demand forecast for Israel is based on a proprietary multi-factor macro-economic model, electricity demand and supply models, and an economic dispatch model based on a forecasted load-duration curve. Economic Models has been providing its customers with the long-term electricity demand model for over 20 years. Based on the assumptions detailed in this report and under average weather conditions, we forecast that the demand for natural gas in Israel, without any further coal to gas conversion, will increase from 7 BCM in 2013 to 17.4 BCM in 2020 and 27 BCM in This forecast includes the demand for natural gas by IEC, IPPs, cogeneration, transportation, chemical industry, low pressure industries (LDC) and desalination. Further conversion of existing coal units to gas (beyond Orot Rabin A) may increase annual gas demand by additional 6 BCM in Aggregate gas demand in the Israel until 2040 is expected to reach 562 BCM without further coal to gas conversion, 694 BCM with full coal conversion to gas. Additional regional captive markets include the Palestinian (which currently purchase electricity from Israel) and Jordan. Since Egypt has gas supply constraints, it is unlikely that these markets will be able to purchase gas from Egypt. It is also unlikely that the Gaza Marine Field (30 BCM offshore Gaza) will be developed in the coming years. Total regional potential demand throughout 2040 is estimated at 875 BCM, which includes Israeli and Palestinian demand of 747 BCM (85% of the regional demand) and export to Jordan of additional 128 BCM (15% of demand). We define all these markets (Israel, Palestinians and Jordan) as the "Narrow Path" alternative. 18

18 2 Executive Summary Beyond that, the current regulation allows export of about 40% of Israel's gas resources. Accordingly, in additional to the Narrow Path demand, further export out of Israel of up to 370BCM is expected, provided adequate resources are discovered. We define this alternative at the "Broad Path" alterative and believe that it has significantly more than 50% probability of materializing. Natural Gas Demand Forecast^ Summary by Sector In BCM Total Running Total Electricity and Cogeneration Transportation CNG Chemical Industry Further Coal conversion to gas** Palestinian selfgeneration Jordan Narrow Path (Subtotal) LNG ,245 Total Broad Path ,245 *IEC and IPP's, excluding potential gas demand for coal units for which a decision to convert to gas has not been made yet. **Beyond Orot Rabin A, for which no decision has been made. See section H: Advantages of Coal to gas conversion in Israel. ^Potential demand assuming no supply side constraints Although currently, there is no approved location for a liquefaction plant, several options exist for LNG export, including the existing underutilized LNG plants in Egypt, Floating LNG, an offshore liquefaction platform, liquefaction plant in Israel, or a liquefaction plant in Cyprus. LNG is a commodity and Israel is a 19

19 2 Executive Summary small player in the global LNG market. The Israeli Parliament approved to export 40% of total gas discoveries. Hence, we believe that there will be more incentives to explore gas and that the entire limited export quota will be sold in the global markets. Our demand forecasts in both paths do not take into account long term supply side constraints and capacity limitations. But in case of short term supply constraints, Israel may either import LNG, reduce export, and/or use more oil products (as was the case in ). The underlying assumption in the Broad Path forecast is that additional gas resources are discovered, to meet the 40% export allowance (see discussion in Section D competitive environment below). We believe that the Broad Path forecast is the likely path the Israeli Market is expected to follow in the coming decades. It should be emphasized the due to Israel's oil and gas tax reform (the Sheshinksy I Committee), the Israeli government is effectively the "senior partner" in Israel's gas fields, since the government receives 60% of the profits of the gas operators. Therefore, we believe that even though there are still uncertainties as to the location of Israel's export facilities, it is unreasonable to assume that the government will adopt a policy that will not enable the gas producers to reach the export quantities which were approved by the Israeli parliament (40% of reserves). Hence we believe that the Broad Path forecast is a highly likely path, and that the Narrow Path represents a conservative alternative. 20

20 2 Executive Summary Natural Gas Demand Forecast, in BCM* Narrow Path /1 Broad Path / 2 Timeline Temporary gas shortage Tamar gas Q Full Tamar Rabin A conversion to gas (1400MW) Further coal conversion to gas (3400MW) Palestinian** shift to self-supply st nuclear unit nd nuclear unit Total ,245 % export 15% 40% *Assuming no supply side constraints from 2013 onwards. /1 Israel, Palestinians and export to Jordan /2 Narrow Path with additional LNG export 21

21 2 Executive Summary 2.2 Natural Gas Demand Competitive Environment Proved and prospective gas resources in Israel are currently estimated at about 1,050 BCM. According to the US Geological Survey, the potential undiscovered gas resources in Israel may reach additional BCM. Realization of this further gas potential is very important for Israel for both economic and strategic reasons. However, gas exploration projects must face attractive gas marketability options in order to continue exploration at an acceptable rate. The current government policy limits export of gas to about 40% of production. Local demand throughout 2040 can reach about 70% the existing gas discoveries. Therefore, large scale investment in the development of further large gas production capacity beyond the current discoveries is not likely unless further export is viable and approved by the government. Israel Gas Resources Estimate (BCM) Category Tamar 282 2P Leviathan 535 2C Karish 36 2C Dalit 8 2C Tanin 22 2C Total Discovered 883 Ruth / Alon / Others* 175 Prospective Total Prospective (mean) 175 Total Resources 1,058 Our gas demand analysis shows the Tamar and Leviathan fields are expected to face significant gas demand from the local and regional markets. The local demand will allow a wide range of flexibility (subject to government regulation 22

22 2 Executive Summary and technical limitations) to allocate gas sales either to local or export markets, based on the relative netback in each market. The smaller gas producers, if proven economic, are expected to compete in the local market, since their alternative is to keep the gas in the ground for a long period. We expect that the pipelines and landing facilities for the small gas fields will be developed jointly, as a national infrastructure with government backing. Hence, we assume that all gas fields will have access to the local market, regardless of their size. Analysis of the existing discoveries and potential regional demand, show that the entire local demand can be supplied using the existing proven and prospective resources at least until The following tables illustrate a synthetic allocation of the demand among the suppliers. We assume that any further large scale gas discovery will only be developed if it has an identified potential export market (such as an LNG export facility and/or pipeline to Turkey) and additional export quotas are allocated by the Israeli government. Accordingly, our Narrow Path alternative (15% export) is based on current proved and prospective discoveries only. The Broad Path alternative (40% export) is analyzed under the assumption that additional 200 BCM of new reserves are gradually discovered by other suppliers to facilitate the additional export. The experience in Israel from the Tamar and Leviathan projects show that it takes at least 10 years from the decision to start the exploration drilling to active production. Tamar was developed in record time, which was facilitated because it was developed in a period of shortage of gas supply to the local market. Therefore, it is unlikely that further large scale gas fields will be explored and developed before

23 2 Executive Summary Narrow Path Alternative Synthetic /1 Demand Forecast By Supplier, in BCM Total Supplier Tamar Demand Tamar* Leviathan** Market Others / Share LNG import Reserves % % % % % % % % % % % % % % % % % % % % % % % % % % % Total % 1/ Assuming Market share proportional to reserves beyond Tamar's existing contracts and no supply side constraints * Tamar's current pipeline capacity limitations is 12 BCM per year ** Leviathan's capacity constraint to the regional market assumed at 12 BCM (6 BCM stage I capacity plus 6 BCM expansion for the coal to gas conversion contract) until Conservatively assumed unrestricted after

24 2 Executive Summary Broad Path Alternative Synthetic /1 Demand Forecast By Supplier, in BCM Total Supplier Tamar Demand Tamar* Leviathan** Market Others / LNG Share import Reserves % % % % % % % % % % % % % % % % % % % % % % % % % % % Total 1, % 1/ Assuming Market share proportional to reserves beyond Tamar's existing contracts and no supply side constraints * Tamar's current pipeline capacity limitations is 12 BCM per year ** Leviathan's capacity constraint to the regional market assumed at 12 BCM (6 BCM stage I capacity plus 6 BCM expansion for the coal to gas conversion contract) until Conservatively assumed unrestricted after Export capacity 8 BCM from 2017, unrestricted after

25 2 Executive Summary 2.3 Demand Forecast by Sector A. Demand for Gas for Electricity As opposed to most high income OECD countries, which have reached a saturation level in terms of electricity demand per capita, the demand for electricity in Israel continues to grow along with the growth in income and Israel's electricity consumption per capita is about 50% less than developed countries with comparable weather (see discussion in chapter 3 below) such as the US "Sun Belt" States. Our forecast that is based on the assumption that by 2040, electricity demand per capita in Israel will converge to a level about 15% less than the demand in the US "Sun Belt" States today. As we have shown in section 3.2 below, there is no significant "cultural gap" in terms of electricity consumption between high income countries with similar weather conditions. The electricity consumption per capita in the North Eastern USA is similar to European countries with similar weather conditions Queensland Australia's 10% lower electricity consumption per capita relative to the US "Sun Belt" States, is primarily due to climate differences. Queensland has 50% less cooling degree days than the US "Sun Belt" States and Israel, which leads to both lower air-conditioning penetration rates (70% in Queensland vs. 95% in the US "Sun Belt" States) and significantly lower air-conditioning usage intensity. Therefore, our forecast is also consistent with the Queensland Australia benchmark, when appropriate adjustments are applied for Australia's weather as compared to Israel's. According to our forecast, assuming average weather, local demand for electricity will grow at an average rate of 3.6% per annum, reaching some 159 million MWh by This growth rate represents about a 2.0% annual increase in electricity consumption per capita. Due to the expected growth in 26

26 2 Executive Summary labor participation rate, and the decrease in household size, these growth rate represent 1.8% annual increase in electricity consumption per household and per employee. The increase is mainly due to an expected increase in the standard of living, increase in air-conditioner penetration and usage, increased water desalination and electrification of the Israeli railway system. Electricity demand constitutes the major local market for natural gas, as we expect that all the increase in Israel's electricity demand throughout 2040 will be supplied by natural gas, except a limited supply of renewable energy (see below), potential nuclear power after 2013 (see below). 27

27 2 Executive Summary B. Sensitivity of Gas Demand for Electricity Production Electricity demand sensitivity to changes in GDP growth indicate that a 0.6% points permanent decrease (or increase) in GDP growth rate, results in 0.4% decrease (or increase) in average electricity demand growth rate, as illustrated in the table below. Electricity Natural Gas Demand Sensitivity to GDP Growth GDP/Employee Growth Rate GDP/Capita Growth Rate Very Low Base High Low 1.4% 1.6% 2.0% 2.5% 1.6% 1.8% 2.2% 2.7% GDP growth rate 3.2% 3.4% 3.8% 4.3% Electricity demand Growth Rate Electricity Demand in 2040, Bil. KwH Natural Gas Demand in BCM % change in gas demand vs. base case, % 3.4% 3.6% 3.9% % - 5.5% 0% 8.0% The demand for gas for electricity production is not sensitive to policy changes and to the extent the current electricity market reform proposal would be adopted. If IEC's market share will be reduced, gas demand will not be affected since private producers will increase demand accordingly (assuming similar generation technologies). The same is true if IPPs will have difficulties to compete in the market. From the natural gas demand viewpoint, it is irrelevant if the additional demand will come from IPPs or from IEC. 28

28 2 Executive Summary Furthermore, the goal of the proposed electricity market reform is to promote competition in the generation sector in order to reduce electricity prices. If the reform is successful, the reduction in electricity prices is expected to result in an increase electricity of and natural gas demand. Demand elasticity sensitivity to changes in electricity rates is estimated at 0.3, so that a permanent 10% increase (or decrease) in electricity prices, results a 3% decrease (or increase) in the electricity demand levels. C. Renewable Energy The Israeli government decided to encourage renewable energy sources, and declared a target of 10% renewable energy by This is despite the fact that Israel's CO 2 emissions today (per capita) are 20% below the OECD average. In order to support this goal, the government subsidizes solar energy producers. Our forecast for renewable energy production in Israel is based according to the EU renewable generation target for 2020, without hydro-electric power. Our forecast is made under the assumption that the Israeli policy will follow the pattern of the EU policy, so that by 2030, 20% of the generation capacity in Israel will be based on renewable (solar and wind) energy, accounting for about 8% of electricity production. However, we believe that our forecast is based on a conservative assumption, and due to the high cost of subsidizing solar energy, in practice it is likely less than 5% of the electricity production will be produced by renewable energy. In our view, full conversion of Israel's coal units to natural gas (with coal as a backup fuel) can achieve the same goal of reduction of CO 2 emissions without the added cost associated with renewable energy. 29

29 2 Executive Summary D. Nuclear Energy Israel's long term electricity sector development plans includes a nuclear power plant, and IEC has declared that it wishes to start the long term planning process for a future nuclear power station. Israel's Prime Minister Netanyahu also adopted the vision of a nuclear power plant, as a viable alternative to increase Israel's energy independence and flexibility. There are several obstacles to building a nuclear power plant in Israel, including the small size of the country which increases the risk in case of emergency, and the fact that Israel did not sign the Nuclear Non-Proliferation Treaty. Our forecast is based on the assumption that the first two 1,200 MW nuclear power plants in Israel will be completed in 2031, with an additional unit built in Each year of delay in the operation of Israel's nuclear plants is expected to increase gas demand by 4 BCM. Therefore, a 10 year delay (from 2031 to 2040), in the operation of Israel's first nuclear units will result in an increase of 40BCM in natural gas demand. 30

30 2 Executive Summary E. Advantages of Coal to gas conversion in Israel The current and potential future natural gas discoveries provide a unique opportunity to revolutionize Israel s energy strategy, and to dramatically decrease Israel s dependence on foreign energy sources for electricity, industry, and public transportation. With sufficient proven reserves of natural gas, and multiple points of entry connecting the gas field the national pipeline grid, there is significant advantage to the Israeli economy to shift electricity production from coal to natural gas, with coal used as a backup fuel for emergency periods. Based on this economic logic, the Ministry of Energy and Water Resources has decided to convert 4 Orot Rabin A units (1400MW) from coal to gas, starting Coal will only be used as a backup fuel. Further conversion of the existing coal units to dual fuel (gas/coal) gas has significant benefits to the gas providers and to the Israeli economy, assuming long term gas contracts ensuring a competitive gas prices for these units relative to coal, based on the relative costs. Israel could become one of the cleanest nations (CO2 and pollution-wise) among the OECD countries. The reduction in greenhouse gas emissions, SOX, NOX and particles pollution provides substantial external benefits. Our analysis shows that Israel has a very significant advantage to convert all its baseload coal electricity units from coal, an imported and polluting raw material to domestic, clean natural gas. In this way Israel will have a capacity of 4,800 MW dual fuel units that will regularly use natural gas, with coal used only as a backup fuel in emergency periods. 31

31 2 Executive Summary There has been a formal decision to convert 4 coal units with a total capacity of 1,400 MW from coal to gas. Although no formal decision has yet been made for the conversion of the other 6 coal units (3,400 MW) to gas, we are fully convinced that this a must! The strong economic incentives to all the relevant parties to make the conversion from coal to gas will force the parties (and especially the government) to find a "saddle point" gas price within the range so that each side will be better off. We estimate the full government's direct profit from coal to gas conversion is above $ 3 per MMBTU. It is easy to show that conversion of all the existing coal units to dual fuel (gas/coal) gas has significant benefits to the gas providers and to the Israeli economy. But the most important part of this conversion is the benefit of the government that receives (as direct taxes) 60% of the profit from the additional gas sales and 0% revenues from import of coal. Because Israel has excess gas supply we are fully convinced that long term gas contracts, for all the coal units, ensuring a competitive gas prices relative to coal will be reached. Therefore, due to these economic advantages, our forecast is based on the conversion of Israel's 10 coal units to gas in , along with Leviathan entrance to the market. 32

32 2 Executive Summary F. Project D Israel, as an isolated and small economy which faces security threats, has made a strategic decision to prevent dependence on a single source of energy for electricity production. Therefore, despite the government's efforts to restrict Israel Electric's capacity expansion, the government reform plan includes authorization for Israel Electric to build its next dual fuel coal/gas unit "Project D" (under the condition of 51% investor in the unit). Project D is planned for 2022 as a dual fuel coal/gas unit that will be fueled on gas, with coal as a backup fuel for emergency periods. Project D's strategic importance is that it will allow Israel to continue to have coal backup capacity for its entire baseload electricity demand. Based on government decisions, the new planned coal unit that is expected to be built by 2022 ("project D") will be built as a dual-fuel (coal/gas) unit, which will be fueled on natural gas, with coal for backup based on economic criteria. According to the decision, the unit's operating regime will be determined in cooperation with the finance ministry. Our assumption is that project D will be fueled by natural gas, under a competitive price of gas for the conversion project. According to the proposed electricity market reform, project D is planned to be built by IEC jointly with a strategic investor which will hold 51% share in the project. Any delay in building project D is expected to reduce gas demand after 2022 by 0.4 BCM per year as a result of substituting combined cycle gas units which have 20% higher thermal efficiency. 33

33 2 Executive Summary G. Demand for Gas for Cogeneration Our forecast shows an increase in demand for gas by cogeneration and industry from 1.5 BCM in 2013 to 3.4 BCM in 2015 This increase is primarily due to conversion from fuel oil and diesel of existing large industrial plants, due to mandatory regulation and economic profitability. In 2013, the Israeli industry consumed about 1.0 million tons of fuels (primarily fuel oil) for industrial uses (mainly steam production), which are about 1.3 BCM of natural gas in equivalent gas units. In addition, the industry used about 1.5 BCM of gas by units which were already converted from fuel to gas. By 2015, fuel demand by the industry in gas equivalent terms is expected to reach about 3.2 BCM. We estimate that all the existing heavy industry fuel, and about 25% of the light industry (low pressure consumers) will complete the transition from fuels to gas in the next 2 years. Accordingly, gas demand by the heavy industry (cogeneration and desalination) is expected to reach 3.2 BCM by 2015, with additional 0.2 BCM of gas by low pressure light industry (LDC). The conversion from fuel oil and diesel to gas will create incremental gas demand beyond the demand for gas for electricity. Some of the units are converted to gas due to regulatory requirement (like ORL in Haifa), and therefore the conversion is mandatory. For the others, there is a clear economic incentive to invest in the conversion, since the price of gas is currently about 1/4 of the price of fuel oil or diesel. 34

34 2 Executive Summary H. Gas demand for transportation The Israeli government recently decided to invest more than 2 billion shekels in the coming decade to increase Israel's energy independence and reduce air pollution. From Israel's perspective, the transition to energy independence is of strategic importance beyond the environmental implications. CNG based vehicles provide potential for natural gas based transportation, for specialty niche applications, such as urban transportation fleet including buses, taxis, delivery trucks etc. CNG provides a good solution to fleet vehicles which visit every day a central hub that can provide CNG refueling services, without a need to develop a costly network of refueling stations. We believe that CNG may replace about 10% of Israel's diesel based fleet fuel consumption by 2020, corresponding to 0.4 BCM of natural gas demand in 2020, gradually reaching a 20% market share by Demand Forecast of CNG for Transportation Total Israel Transportation Diesel* Demand (m. tons) Diesel Demand Growth Rate CNG Penetration in Diesel Fleet CNG demand in m. tons equivalent** CNG demand in BCM* , % 0.0% , % 2.0% , % 11.0% , % 15.5% , % 18.0% , % 19.6% , % 20.0% *Excluding Palestinian diesel demand for transportation In addition to CNG demand, based on our analysis Israel has an exceptional opportunity to create a methanol production industry that will enable it to 35

35 2 Executive Summary gradually move all its passenger cars to flex-fuel vehicles powered by 85% methanol and 15% Gasoline (M85). Our analysis indicates that due to the home-advantage methanol for local consumption can be produced at competitive prices relative to the price of Gasoline without any subsidy for the methanol. However, our forecast conservatively, does not include the potential demand for M85 fuels. In our view, Israel is a unique case in which the transition to methanol-powered vehicles is strategically beneficial for the national economy: 1. Energy independence - ending the dependence on oil imports. 2. Exploiting the economic potential inherent in Israel's gas reserves. 3. A small market, which facilitates the dispersion of a national infrastructure for refueling the methanol vehicles. 4. An isolated market, facilitating the transition to vehicles matched to methanol, and exploiting the advantage of the energetic efficiency. 5. No alternative local production of ethanol, due to lack of land and water. 6. A market with surplus natural gas and no oil reserves (no oil cannibalization problem). 7. Safeguard from an Arab boycott of Israel (as was in 1974) 36

36 2 Executive Summary I. Demand for Gas for Chemical Industry Experience worldwide shows that in most countries that have a surplus of natural gas, a large chemical and petrochemical industry are developed, which enables the economic potential inherent in the availability of energy sources to be realized. We believe that the discovery of large natural-gas fields along Israel's shores constitutes significant potential for the development of a chemical and petrochemical industry in Israel, and to enter new fields of producing methanebased chemical products. Our forecast assumes natural gas for chemical industry uses (beyond ORL's existing demand) will increase local gas demand by about 10%. This forecast is based on existing development plans for ammonia and methanol plants, with growth rates of 3%-5%, based on global growth rates for these products. Chemical Industry Natural Gas Demand Forecast In BCM Total Ammonia Methanol Others Total Chemical Industry Potential *Excluding existing ORL demand which is included in the general Industry Sector Demand 37

37 2 Executive Summary We believe there is considerable potential beyond this forecast for additional growth in these sectors, which is dependent on higher adoption rates of methanol fuel and development in GTL production technologies. J. Demand for gas from Jordan The discovery of Leviathan is expected to transform Israel from a gas importing country to a gas exporter. Due to the high costs of liquefactions, we believe that in the long-term, export of gas to Israel's neighboring countries is expected to be more profitable than other export markets. In addition, export to Jordan has strategic importance to Israel, as it strengthens the ties between the two countries which signed a peace agreement in The recent agreement of gas sales from Leviathan to the Palestinians is of strategic significance, since it provides full political legitimacy for other neighboring Arab countries such as Jordan and Egypt to purchase gas from Israel. Jordan, unlike its immediate neighbors, does not have significant energy resources. As a result, Jordan relies heavily on imports of crude oil, petroleum products, and natural gas to meet domestic energy demand. The Arab Gas Pipeline (AGP) which runs from Egypt through the Sinai desert to Jordan and north to Syria was the principal source of Jordanian natural gas imports until Gas supply was based on a contract with Egypt for annual imports of about 3 BCM per year. 38

38 2 Executive Summary Jordan Electricity and Gas Demand Forecast Population (millions) GDP per capita $4,060 $4,700 $6,060 $7,800 Electricity 3,140 MW 5,900 MW 8,000 MW 10,000 MW Capacity Electricity 2,100 kwh 3,000 kwh 3,600 kwh 4,600 kwh Consumption per Capita Gas Demand (BCM) Source: Economic Model estimates Like Israel, however, Jordan saw its gas supply cut off by sabotage starting in February 2011, which created long supply disruptions. As a result, Jordan, like Israel, was forced to burn more expensive fuels at its power stations. Since Egypt is facing gas shortage in the local market, gas exports from Egypt are unlikely to resume on a substantial ongoing basis. Jordan is now considering alternative gas supply sources. We believe that supply of gas from Israel has economic and strategic benefits for both Israel and Jordan. Israel's gas pipeline already reaches the Dead Sea at Sdom. Possible extension of the Israeli gas pipeline to reach the Jordanian Potash Industries requires an extension of the pipeline by about 10 km. The Tamar partners and the Jordanian Potash Corp. are now discussing the supply of gas ( BCM) to the Jordanian Potash industry. 39

39 2 Executive Summary K. LNG Export The global LNG trade is estimated at 320 BCM (236 mpta) in 2012 and is expected according to Wood Mackenzie's forecasts to reach 730 BCM (514 mpta) by 2030, representing a 4.4% growth rate. According to this forecast, on average, each year 3 more 4.5 mmpta LNG trains will need to be built worldwide. Israel is expected to be a small producer in the global LNG market. Export quantities have been administratively limited by the Israeli government's regulation, and we believe that in a commodity market a small player can export its entire quantities, since it has more flexibility to lower prices if needed, than the large players in the market. Although currently there is no approved location for a liquefaction plant, several options exist for LNG export out of Israel, including the existing underutilized LNG plants in Egypt, Floating LNG, an offshore liquefaction platform, or a liquefaction plant in Israel. Israel's crowded coastal shore has limited available locations for liquefaction plants. Therefore, we believe that if a liquefaction plant is built in Israel, it will most likely be off-shore, either as floating LNG project, or s stationary offshore liquefaction platform. From an economic point of view, the existing LNG plants in Egypt provides an economically attractive immediate outlet for Israel's gas export, taking advantage of underutilized existing liquefaction capacity. 40

40 2 Executive Summary Egypt's population is 10 times as large as Israel, while Egypt's gas reserves are only twice as large as Israel. Therefore, in the long term, Egypt needs its gas for self-consumption, and is not expected to have surplus gas for export. As a result of Egypt's new policy to prioritize local consumption of gas over export, the LNG liquefaction plants in Egypt are now operating at partial utilization rates (less than 30% on average). These plant are co-owned by international oil majors (BG, Petronas and Eni), and although there is strong economic interest to utilize them fully, Egypt does not have natural gas supply for it. Plant Capacity (mmtpa) Egypt's LNG Plants Utilization Rate ELNG 1 ELNG 2 Damietta (Segas LNG) Total Number of Trains Foreign Shareholder* BG (36%) Petronas (36%) BG (38%) Petronas (38%) Eni (40%) Fenosa (40%) Start-up Storage Capacity (m3) Production in utilization rate 140, , , % 50% 0% 30% Gas Shortage in 2013, BCM *Egyptian government companies hold 20% - 24% shares in the liquefaction plants. 41

41 2 Executive Summary In contrast to the situation in Egypt, Israel has today surplus gas authorized by the government for export (according to the Tzemach committee recommendation and the government's decision) without any existing LNG export facilities. From an economic point, in a situation where Egypt has 3 LNG trains which lack gas supply, selling gas to these LNG facilities has many economic benefits to all parties. There already exists a gas pipeline connection between Israel and Egypt (the EMG pipeline) which could be used to export Israeli gas to Egypt's liquefaction plants. However, past experience shows that the gas pipeline between Egypt and Israel is prone to terrorist attacks which have seriously disrupted supply in the past. Although gas sale to Egypt may be somewhat less politically sensitive than selling Egyptian gas to Israel, we cannot rule out the possibility that gas Israeli gas export will be similarly disrupted. Additionally, according to the information we received from the Tamar partners, capacity limitations in the existing gas pipelines limits Israel export ability to Egypt at about 2.5 BCM (mostly at off peak hours). Thus in any case, in the longer term, building a dedicated sub-marine pipeline between the Yam Tethys platform and the Egyptian LNG terminals at the Nile Delta will be required. This pipeline can both substantially reduce the political risk of terrorist attacks, and facilitate exports at the full quantities demanded by the LNG plants. Our forecast is based on the assumption of LNG export potential of 2.5 BCM, increasing to 7 BCM in 2018, based on the assumption that an export pipeline to Egypt or an offshore liquefaction plant will be built by Provided that additional gas resources are developed in Israel, export can increase to 18 BCM in 2030 and 26 BCM in 2035, while still meeting the 40% export quota. 42