Delek, Noble sue the gov’t for $15m. over gas royalties

Subsidiaries of Israel’s Delek Group and the Houston-based Noble Energy are suing the state for some $15 million, claiming the government has collected more royalties than permissible on natural gas sales.

Accusing the National Infrastructures, Energy and Water Ministry of calculating royalty revenues based on the higher Tamar reservoir gas prices while the companies were still selling gas according to lower-priced contracts, the firms submitted a complaint to the Jerusalem District Court on Thursday, according to reports filed on Sunday with the Tel Aviv Stock Exchange.

The complaint specifically targets a demand made by the ministry in November 2014 that required the companies to pay the difference between royalties derived from Tamar market values, and those derived from gas drawn from the Yam Tethys field and sold at older contractual prices starting in May 2013.

The nearly depleted Yam Tethys reservoir, about 25 km. west of Ashkelon, provided roughly 23 billion cubic meters of gas to the Israel Electric Corporation from February 2004 to December 2013; it still supplies a small amount of gas to other private customers. The much larger, 282-b.cu.m. Tamar reservoir, located 80 km. west of Haifa, began providing the country with gas in March 2013.

Noble Energy owns 36 percent of the Tamar reservoir, while Delek Group subsidiaries Delek Drilling and Avner Oil Exploration each own 15.625%.

Isramco controls 28.75% and Dor Gas has 4%. At Yam Tethys, Noble Energy holds 47.059% of the basin, while Delek Drilling owns 25%, Avner 23%, and the larger Delek Group 4.441%.

The Yam Tethys partners had longstanding supply contracts with the Electric Corporation and other clients, allocating quantities of gas for specific periods of time at average prices of $3-4 per mmBtu (1 million British thermal units). Once the more expensive Tamar basin was developed in 2013, additional gas contracts were negotiated at higher rates of $5-6 per mmBtu.

Production at Yam Tethys was unexpectedly expedited, however, after the Egyptian East Mediterranean Gas Company pipeline ceased supplying gas to Israel in April 2012, following 14 months of attacks by saboteurs in the Sinai. As a result of the ensuing natural gas shortage, the government requested that the companies draw more and more from Yam Tethys – not only from the quickly depleting Mari-B field, but also through quick development of the adjacent Noa and Pinnacles fields.

Due to Israel’s increased need for natural gas, the Yam Tethys basin drained much more quickly than projected, before original contracts with customers were fulfilled, industry sources told The Jerusalem Post on Sunday. The contracts promised certain amounts of gas within given time frames, regardless of the source, so the companies were left with no choice but to supply customers with gas from the much more expensive Tamar reservoir, although at lower prices.

They paid the government the required 12.5% royalty based on these prices – even though much of the gas was coming from Tamar.

While the largest of the old contracts, that of the Electric Corporation, expired in December 2013, several other contracts – based on the lower, Yam Tethys pricing – endured, with the longest one due to expire only in 2022, industry sources explained. The lawsuit applies to the period of about May 2013 through today, which includes many months in which gas was being supplied to the IEC from the Tamar reservoir although at the lower contractual price.

Despite the fact that a small quantity of gas remains in the Yam Tethys basin, the reservoir’s partners cannot utilize it, industry sources said. This is because it must remain in place to maintain pressure levels so the reservoir can serve as a storage facility for excess Tamar gas if necessary.

As long as the partners were still supplying gas according to the old contracts, they continued to pay royalties to the ministry according to the lower prices, no matter where the gas originated, the sources emphasized.

One such existing contract is that of IPP Delek Ashkelon Ltd., a private power producer that generates electricity for the Ashkelon desalination facility.

Last November 19, however, the ministry demanded that the partners pay the NIS 45 million ($11m.) difference between the royalties based on actual sale prices and those based on the much higher market value of Tamar gas. The $15m. requested by the companies accounts for interest accumulating with each passing month, the sources explained.

In addition to the funds, the partners are asking the court to issue a declaratory relief – a court determination of a party’s rights – regarding “the rate of royalties that the plaintiffs will pay in the future based on this income,” the TASE report said.

“The defendant is collecting from the plaintiff royalties based on amounts that exceed those the plaintiffs are receiving from their customers, based on the sale of natural gas, and which constitute, according to the plaintiff, the market price of such gas,” the report concluded.

In response to the lawsuit, the National Infrastructures, Energy and Water Ministry said it was in the process of reviewing the complaint and would deliver its formal answer in court. A press release issued by the ministry in November, at the time of the NIS 45m. payment, indicated the ministry’s position that the royalties paid until that point “did not reflect the value of Tamar gas.”

Dr. Amit Mor, CEO of the Eco Energy Financial and Strategic Consulting firm and an expert in energy policy and geopolitics at the Interdisciplinary Center Herzliya, attributed the situation at least partly to the “very well known problem” of transfer pricing – the pricing of goods when transferred between affiliates within a larger entity, as occurred in this case between affiliate partners in the Tamar and Yam Tethys reservoirs.

“In this case, it is also a transfer- of-supply obligation from one field to another,” Mor said.

“There is already a developed methodology in the US, Europe and other places in the world, regarding oil and gas transfer pricing,” he continued. “Since it is a rather complicated issue to determine the normative price, from time to time we see such disputes between the oil and gas companies and governments.”

As a result of Israel’s relative lack of experience in the natural gas arena, the methodology and practice will likely be refined with time, Mor explained. He stressed, however, that he had not been involved in the financial intricacies of the case and his statements on the subject were only general in nature.

He also faulted the government for its “mismanagement” of the Yam Tethys basin fields following the cessation of the Egyptian gas supply.

Due to the shortage, the Environmental Protection Ministry at the time pressured the government to require expedited gas extraction from the Mari-B field despite professional warnings from geologists “that pumping more gas than geologically optimal would ‘kill’ the reservoir,” he added.

“A quicker than geologically optimal extraction causes seawater to penetrate the reservoir, thus shortening the available extractable reserve,” he explained.

The companies adhered to the government’s request and not only sped up extraction from Mari-B, but expedited the development of smaller adjacent fields, all to their economic disadvantage, according to Mor.

“In principle, Noble and Delek should not be punished for their accountability in developing the tiny fields, which are marginally economically viable, in order to postpone the utilization of costly and polluting heavy fuel oil and diesel in power generation,” he said.