Home inFocus Europe: Past and Present Collide (Summer 2018) Natural Gas: What it Means for Israel and Europe

Natural Gas: What it Means for Israel and Europe

Norman A. Bailey Summer 2018
A Noble Energy drilling rig in the Tamar gas field off the coast of Israel. (Photo: Noble Energy)

Editors Note: Israel is not part of Europe, the theme of this issue of inFOCUS. But Israel’s trade, political and social relations to the continent are central to its thinking – and to that of Europe. As European countries – particularly Poland and Ukraine - worry about their reliance on Russian gas during frigid winters, Israel has forged an energy future that may challenge Russian leverage over European policy.

Amidst the almost unbroken gloom and doom (mostly well-justified) about just about everything in our fracturing world it is a pleasure, for a change, to write about a development that is almost entirely good news. Israel, for the first 50 years of its existence, was almost totally devoid of natural resources, with the exception of some potash exports from the Dead Sea area. This was the basis of the joke that God promised the Israelites that he would lead them to a land of milk and honey, but he neglected to mention that all the oil and gas would go to others.

Finally, in 1999, Noble Energy of the United States and the Delek Group of Israel began to plan and then carry out exploration and development of natural gas reserves off the coast of Israel.  Ten years later the Tamar commercially-viable gas field was discovered and development began.  Two years later the massive Leviathan field was also discovered and is now in the course of development.  Other large fields have in the meantime been identified in Cypriot, Lebanese and Egyptian waters.

Having no experience with natural resource development, both the legal and regulatory structure of Israel was unprepared for the discovery of a major resource off-shore.  This led to several delays while commissions were formed and prepared their reports, political considerations were dealt with and a concerted effort on the part of environmental groups in league with certain Israeli officials to stop the development of Leviathan was finally overcome.

Now that gas is flowing from Tamar and will soon be flowing from Leviathan, it is time to step back and assess what all of this means for Israel in particular and the Middle East in general, as well as the significance for natural gas producers and consumers outside the region.

The Internal Market     

The discovery and exploration of natural gas in the waters off the coast of Israel is an unmitigated bonanza for Israel itself.  Israel is as of now self-sufficient in natural gas and as a result correspondingly less dependent on outside energy sources. Seventy percent of Israel’s electricity is now produced using gas and that figure will soon be 100 percent. Israeli industry, commerce and agriculture are now powered primarily by gas. Unlike coal, the importation of which will be almost entirely eliminated, petroleum and its derivatives will still be required for the vehicle fleet, although commercial and public vehicles are being converted to gas and in future a larger percentage of private cars will be electric or hybrid.

It is estimated that over the life of the fields the state of Israel will receive about $20 billion in taxes and royalties, save $9 billion that would otherwise have been spent on more expensive fuels and $2.8 billion dollars in reduced pollution costs due to decreased air pollution because of the switch to less-polluting gas from coal and petroleum. In the five years since Tamar went on line, there has been a reduction in air pollution of 48 percent.  Partially as a result of the natural gas development Israel is now running a comfortable budget surplus.

The External Market

In 2014 and 2016 Israel signed gas supply agreements with Jordan involving export earnings of $10.5 billion and earlier this year a $15 billion deal to supply Egypt. To go with its budget surplus Israel now has an equally comfortable trade surplus. Jordan and Egypt, of course, are the two Arab countries which have diplomatic relations with Israel and the gas deals enhance the relationships with both countries. In addition, plans are in discussion to expand gas sales to other countries, such as Turkey and Greece, as well as to join with Cyprus (which has a large gas field called Aphrodite in its territorial waters) in selling gas farther west in Europe. This development, in addition to the new North American gas surplus, will be significant in substituting for Russian and Qatari supplies. To the extent that eastern Mediterranean gas can substitute for Russian gas, Russian leverage on the European gas-importing countries will be lessened accordingly.

Geopolitical Considerations

With the reduction of the prices of oil and gas in recent years, primarily due to technological developments (“fracking”) leading to massive increases in production in the United States and Canada as well as elsewhere, the export earnings of most of the OPEC states (Organization of Petroleum Exporting Countries) as well as Russia have decreased substantially. Saudi Arabia and the United Arab Emirates (UAE) are responding by attempting to liberalize their economies and diversify their sources of income. Russia, on the contrary, is moving in the opposite direction; that is, toward greater central control of the economy, and is not anxious to expose its political system to outside influences through economic or political liberalization.

Substantial additions to the international supply of natural gas and gas liquids from the eastern Mediterranean will add to all these pressures.  Whereas Saudi Arabia, the UAE, Bahrain and Egypt have formed a front against Iran and its Gulf ally Qatar, bringing them ever-closer to Israel politically and militarily, Russia is engaged in its own long-term strategy of turning the Black Sea into a Russian lake and penetrating the Middle East through Syria, by building naval and air bases on the Syrian coast and supporting the beleaguered Bashar al-Assad regime. All this along with continuous displays of military strength and in the case of Ukraine and Georgia actual armed conflict, all along its borders with eastern Europe and the Baltic Sea, are very expensive. The continuation of increasing production of oil and gas worldwide cannot be viewed by the Kremlin with anything other than concern.

Negative Factors

Unfortunately, few things in life are entirely positive, or at least, without possible risks.  Russian concern, as mentioned above, is one factor that in future may bring Israel and Russia into conflict, although to date, the Israeli government has handled the relationship with great skill.  In addition, there is always the possibility of an accident affect the drilling rigs, production facilities and pipelines off and on shore. Although every possible preventive measure has been taken, complete assurance of safety is never possible, whether a fire in an offshore facility, a sudden surge of gas flow leading to a pipeline rupture, a ship colliding with a drilling rig, or other eventuality. 

Finally, if Israel is forced into a war with Iran or with a terrorist organization such as Hezbollah, Hamas, Islamic Jihad, al-Qaida or ISIS, both offshore and onshore facilities are at risk, including all offshore platforms. This obvious risk has caused the Israeli government to devote much greater resources to the Israeli Defense Force’s navy, traditionally the poor cousin of the Israeli military branches.  It has also resulted in a decision to station future offshore facilities closer to shore so they can be more effectively defended, and that, in turn, has caused a new outbreak of concern and anti-gas agitation on the part of Israeli environmental organizations.

Sovereign Wealth

The Israeli government, in the face of the natural gas bonanza, has decided to create a sovereign wealth fund in which to place the surplus earnings it is now receiving and will be receiving in future. At this point the use of the fund is not clear. In other countries, these accounts have been regularly pillaged to cover current expenses, white elephant projects or simple corruption. In other cases, especially Norway, sovereign wealth funds have been efficiently and honestly administered and serve as a formidable barrier to economic downturns.

For many years, Chile had a sovereign wealth fund into which excess earnings from copper exports were placed and which served to partially fund the Chilean armed forces, relieving the pressure on the regular budget. Israel might do well to decide to dedicate some percentage of the gas fund to the Israel Defense Forces and Border Police, since defense and security expenditures are a very large portion of the state budget.

Another possible use of some portion of the gas fund might be the initial capital funding of community investment corporations or funds, established on a geographic basis (cities, regions, etc.) or on a social basis (minorities or other groups), thereby alleviating the growing  concentration of wealth which plagues almost all the Western world (and not only the West) currently and which has been the source of much angst and soul-searching on the part of economists and political activists, as well as governments and civil society.

Whatever the final decisions are with reference to the use of the gas revenues they will be central to the economic, social and political directions in which Israeli society will move in the future.  As with any sudden access of wealth, what is now an unmixed blessing can turn into a curse.  Excessive dependence on gas earnings, however, is very unlikely since Israel had many decades to turn itself into a scientific and technological powerhouse, leading to massive inward investment and equally impressive export growth having nothing to do with any natural resources.

A vigilant central bank and the sterilization of excess earnings in a sovereign wealth fund should lay to rest initial worries about any inflationary effects from the gas bonanza. In fact, since the gas began to flow, Israeli inflation has stayed very modest. Meanwhile, the country has also avoided the deflationary pressures until recently affecting many other countries following the economic crisis of 2008-2009.

Final Considerations

Once energy needs and immediate budgetary requirements are fully satisfied by existing and prospective earnings from natural gas, the country must make crucial decisions about covering defense and security needs as well as the most appropriate distribution of the new wealth of the commonwealth among its members. On this, as well as other factors, the future of the country depends. Can it rise to the challenge?  Without question. Will it? That remains to be seen.

Israel is a huge economic, financial, scientific and technological success, lifting itself up from its earliest days of deprivation, attacked by seemingly overwhelming forces and triumphing against all odds; surviving very serious foreign and domestic policy mistakes, and plagued by religious and ethnic conflicts.  This miraculous country is saddled with a dysfunctional political system that often makes bad decisions for equally bad reasons but seems somehow to end up on the right side of history. The future is the one thing we can know nothing about. What we do know is that if it is faced with courage and wisdom, tomorrow will be better than today.

Norman A. Bailey, Ph.D.,  teaches economic statecraft at The Institute of World Politics.