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Israel Natural Gas Demand Forecast 2014-2040

January 26, 2014

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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 .

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Prepared by Dr. Yacov Sheinin and Chen Herzog

Chen

Chen

Table of Contents

1 METHODOLOGY 6 2 EXECUTIVE SUMMARY 12

2.1 GAS DEMAND FORECAST SUMMARY 13 2.2 NATURAL GAS DEMAND COMPETITIVE ENVIRONMENT 22 2.3 DEMAND FORECAST BY SECTOR 26

3 ELECTRICITY DEMAND FORECAST 43 3.1 INTRODUCTION 44 3.2 INTERNATIONAL COMPARISON 48 3.3 ELECTRICITY DEMAND FOR DESALINATION 58 3.4 DEMAND FOR ELECTRICITY IN THE PALESTINIAN ECONOMY 60 3.5 DEMAND SENSITIVITY ANALYSIS 61

4 ELECTRICITY SUPPLY FORECAST 64 4.1 INTRODUCTION 65 4.2 COAL TO GAS CONVERSION 66 4.3 PROJECT D 69 4.4 ELECTRICITY SUPPLY BY IPPS 70 4.5 ELECTRICITY SUPPLY BY COGENERATION 71 4.6 RENEWABLE ENERGY SUPPLY 72 4.7 FUTURE NUCLEAR ENERGY 75

5 ISRAEL NATURAL GAS DEMAND FOR ELECTRICITY FORECAST 77 5.1 INTRODUCTION 78 5.2 THE DEMAND FOR NATURAL GAS 80 5.3 DEMAND FOR GAS FOR COGENERATION 83

6 GAS DEMAND FOR CHEMICALS AND TRANSPORTATION 85 6.1 DEMAND FOR GAS FOR TRANSPORTATION 86 6.2 DEMAND FOR GAS FOR CHEMICAL INDUSTRY 89 6.3 GLOBAL DEMAND FOR AMMONIA 92 6.4 THE MARKET FOR AMMONIA IN ISRAEL 93 6.5 POTENTIAL PRODUCTION OF AMMONIA IN ISRAEL 94 6.6 THE GLOBAL METHANOL MARKET 96 6.7 METHANOL AS A TRANSPORTATION FUEL 98 6.8 THE POTENTIAL FOR METHANOL IN ISRAEL 99 6.9 PRODUCTION OF METHANOL-BASED OLEFINS (MTO) 101 6.10 GAS TO LIQUIDS (GTL) 102

7 GAS DEMAND FOR EXPORT 104 7.1 JORDANIAN NATURAL GAS DEMAND 105 7.2 ISRAEL'S LNG EXPORT ALTERNATIVES 109 7.3 LNG EXPORT THROUGH EGYPT'S EXISTING PROJECTS 112

8 COMPETITIVE ENVIRONMENT 115 8.1 ISRAEL GAS RESERVES 116 8.2 GAS SUPPLY AND DEMAND 118

9. FORECAST TABLES 122

5

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

1 Methodology

1. Methodology

7

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).

1. Methodology

8

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

2013 2015 2020 2030 2040 CAGR 2013-40

Gross domestic product (2012 NIS bills.)

1,026 1,074 1,300 1,906 2,782 3.8%

GDP per capita (2012 kNIS) 127.3 128.7 143.2 180.5 229.4 2.2%

Population (thousands) 8,056 8,348 9,076 10,560 12,125 1.5%

Households (thousands) 2,339 2,428 2,672 3,231 3,881 1.9%

Participation rate 63% 63% 63% 64% 64% 0.1%

Civilian labor force (thousands)

3,654 3,761 4,080 4,901 5,758 1.7%

Average annual growth rate Cumulative 2013-2015

2016-2020

2021-2025

2026-2030

2031-2035

2036-2040

2013-2040

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%

1. Methodology

9

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

1. Methodology

10

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

1. Methodology

11

Natural Gas Demand Model Methodology

2 Executive Summary

2 Executive Summary

13

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 2011-12 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.

2 Executive Summary

14

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

2 Executive Summary

15

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 2015.

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).

Electricity Consumption Indicators US "Sun

Belt" States, 2013

Israel,

2013

Israel, 2040 EML forecast

Cooling Degree Days (>22°C)

990 840

GDP / Capita (US $)

$50,000 $34,000 $55,000

Electricity per capita: kWH/ capita Relative to US "Sun Belt"

13,900 KwH

100%

6,800 KwH

51%

11,700 KwH

84%

2 Executive Summary

16

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 2020.

2 Executive Summary

17

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).

2 Executive Summary

18

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 2040. 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 2020.

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.

2 Executive Summary

19

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

2013 2015 2020 2030 2040 Total 2013-2040

Running Total

2013-2040

Electricity and Cogeneration 7.0 12.0 15.7 17.8 23.0 499

Transportation - CNG

- 0.1 0.4 0.8 1.1 17 516

Chemical Industry - - 1.3 1.9 2.9 46 562

Further Coal conversion to gas**

- 6.0 6.0 6.0 132 694

Palestinian self-generation

- - - 2.9 4.4 53 747

Jordan - 0.1 4.1 5.6 7.5 128 875

Narrow Path (Subtotal)

7.0 12.2 27.5 35.1 44.8 875

LNG - - 7.0 18.0 27.5 370 1,245 Total Broad Path 7.0 12.2 34.5 53.1 72.3 1,245 *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

2 Executive Summary

20

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 2011-12). 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.

2 Executive Summary

21

Natural Gas Demand Forecast, in BCM*

Narrow Path /1

Broad Path /2

Timeline 2010 5.4 5.4 2011 5.2 5.2 Temporary gas

shortage 2012 2.9 2.9 2013 7.0 7.0 Tamar gas Q2 2014 8.6 8.6 Full Tamar 2015 12.2 12.2 Rabin A

conversion to gas (1400MW) 2016 13.0 13.0

2017 15.3 15.3 Further coal conversion to gas (3400MW)

2018 21.5 28.5 2019 24.6 31.6 2020 27.5 34.5 2021 28.6 35.6 2022 29.6 36.6 2023 30.7 42.7

Palestinian** shift to self-supply 2024 31.9 43.9

2025 33.0 45.0 2026 34.2 46.2 2027 35.5 47.5 2028 36.8 48.8 2029 37.9 49.9 2030 35.1 53.1 2031 36.0 54.0 1st nuclear unit 2032 37.2 55.2 2033 38.4 56.4 2034 39.7 57.7 2035 40.8 66.8 2036 42.0 68.0 2037 43.2 69.2 2038 44.4 71.9 2039 45.7 73.2 2040 44.8 72.3 2nd nuclear unit Total

2013-40 875 1,245

% 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

2 Executive Summary

22

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 1400-1800BCM. 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

2 Executive Summary

23

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 2040. 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 2025-2030.

2 Executive Summary

24

Narrow Path Alternative Synthetic/1 Demand Forecast By Supplier, in BCM

Total Supplier Tamar

Market Share Demand Tamar* Leviathan** Others /

LNG import Reserves 282 535 200 2013 7.0 2014 8.6 8.6 0.0 100% 2015 12.2 12.0 0.2 99% 2016 13.0 12.0 1.0 93% 2017 15.3 12.0 1.5 1.8 78% 2018 21.5 12.0 9.5 0.0 56% 2019 24.6 12.0 12.0 0.6 49% 2020 27.5 12.0 11.7 3.8 44% 2021 28.6 12.0 12.0 4.6 42% 2022 29.6 11.6 13.1 4.9 39% 2023 30.7 11.4 14.1 5.3 37% 2024 31.9 11.7 14.7 5.5 37% 2025 33.0 11.9 15.3 5.7 36% 2026 34.2 10.6 17.2 6.4 31% 2027 35.5 9.8 18.7 7.0 28% 2028 36.8 10.2 19.3 7.2 28% 2029 37.9 10.5 20.0 7.5 28% 2030 35.1 9.7 18.4 6.9 28% 2031 36.0 10.0 18.9 7.1 28% 2032 37.2 10.3 19.6 7.3 28% 2033 38.4 10.7 20.2 7.6 28% 2034 39.7 11.0 20.9 7.8 28% 2035 40.8 11.3 21.4 8.0 28% 2036 42.0 11.6 22.1 8.3 28% 2037 43.2 12.0 22.7 8.5 28% 2038 44.4 8.0 23.4 13.1 18% 2039 45.7 0.0 24.0 21.7 0% 2040 44.8 0.0 23.6 21.2 0% Total 875 282 414 179 32%

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 2022. Conservatively assumed unrestricted after 2022.

2 Executive Summary

25

Broad Path Alternative Synthetic/1 Demand Forecast By Supplier, in BCM


Market Share Demand Tamar* Leviathan** Others / LNG

import Reserves 282 535 300-400 2013 7.0 2014 8.6 8.6 0.0 100% 2015 12.2 12.0 0.2 99% 2016 13.0 12.0 1.0 93% 2017 15.3 12.0 1.5 1.8 78% 2018 28.5 12.0 16.5 0.0 56% 2019 31.6 12.0 19.0 0.6 49% 2020 34.5 12.0 15.1 7.5 44% 2021 35.6 12.0 15.6 8.0 42% 2022 36.6 12.0 15.6 9.0 39% 2023 42.7 12.0 19.8 10.9 37% 2024 43.9 12.0 20.7 11.2 37% 2025 45.0 12.0 21.4 11.6 36% 2026 46.2 11.5 21.7 13.0 31% 2027 47.5 11.8 22.4 13.4 28% 2028 48.8 12.0 23.0 13.7 28% 2029 49.9 12.0 23.9 14.1 28% 2030 53.1 12.0 26.1 14.9 28% 2031 54.0 12.0 26.8 15.2 28% 2032 55.2 12.0 27.6 15.5 28% 2033 56.4 12.0 28.5 15.9 28% 2034 57.7 12.0 27.4 18.2 28% 2035 66.8 12.0 31.7 23.0 28% 2036 68.0 12.0 32.3 23.7 28% 2037 69.2 3.0 32.6 33.6 28% 2038 71.9 0.0 33.8 38.1 18% 2039 73.2 0.0 32.0 41.2 0% 2040 72.3 0.0 0.0 72.3 0% Total 1,245 282 535 428 23%

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 2022. Conservatively assumed unrestricted after 2022. Export capacity 8 BCM from 2017, unrestricted after 2022.

2 Executive Summary

26

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 2040. This growth rate represents about a 2.0% annual

increase in electricity consumption per capita. Due to the expected growth in

2 Executive Summary

27

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).

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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

Very Low

Low Base High

GDP/Employee Growth Rate

1.4% 1.6% 2.0% 2.5%

GDP/Capita Growth Rate

1.6% 1.8% 2.2% 2.7%

GDP growth rate 3.2% 3.4% 3.8% 4.3%

Electricity demand Growth Rate

3.3% 3.4% 3.6% 3.9%

Electricity Demand in 2040, Bil. KwH

131 134 142 154

Natural Gas Demand 2013-2040 in BCM

368 461 499 539

% change in gas demand vs. base case, 2040

-7.9% - 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.

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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 2020. This is despite the fact that

Israel's CO2 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 CO2 emissions without

the added cost associated with renewable energy.

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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

2040.

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.

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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

2015. 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.

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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 2018-2020, along with Leviathan

entrance to the market.

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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.

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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.

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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 2040.

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*

2013 2,350 1.1% 0.0% 0 0.0 2015 2,412 1.3% 2.0% 57 0.1 2020 2,667 2.4% 11.0% 345 0.4 2025 3,021 2.6% 15.5% 551 0.6 2030 3,429 2.5% 18.0% 726 0.8 2035 3,823 2.0% 19.6% 882 1.0 2040 4,172 1.7% 20.0% 982 1.1

*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

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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)

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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 methane-

based 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

2015 2017 2020 2030 2040 Total 2013-2040

Ammonia 0 0.5 0.5 0.7 1.0 15

Methanol 0 0.5 0.5 0.8 1.3 19

Others 0 0.3 0.3 0.5 0.7 11

Total Chemical Industry Potential

0 1.3 1.3 2.0 3.0 45

*Excluding existing ORL demand which is included in the general Industry Sector Demand

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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 1994.

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 2011. Gas supply was based on a contract with Egypt for annual

imports of about 3 BCM per year.

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Jordan – Electricity and Gas Demand Forecast 2010 2020 2030 2040 Population (millions)

6.4 8.1 9.4 10.5

GDP per capita $4,060 $4,700 $6,060 $7,800

Electricity Capacity

3,140 MW 5,900 MW 8,000 MW 10,000 MW

Electricity Consumption per Capita

2,100 kWh 3,000 kWh 3,600 kWh 4,600 kWh

Gas Demand (BCM)

2.7 4.1 5.6 7.5

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 (0.1 – 0.3

BCM) to the Jordanian Potash industry.

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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.

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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.

Egypt's LNG Plants Utilization Rate ELNG 1 ELNG 2 Damietta

(Segas LNG)

Total

Plant Capacity (mmtpa)

3.6 3.6 5.0 12.2

Number of Trains

1 1 1 3

Foreign Shareholder*

BG (36%) Petronas

(36%)

BG (38%) Petronas

(38%)

Eni (40%) Fenosa (40%)

Start-up 2005 2005 2005

Storage Capacity (m3)

140,000 140,000 300,000

Production in 2013

1.5-2 1.5-2 0 3-4

2013 utilization rate

50% 50% 0% 30%

Gas Shortage in 2013, BCM

1.2-1.5 1.2-1.5 3.7 6.1 – 6.7

*Egyptian government companies hold 20% - 24% shares in the liquefaction plants.

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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 2018. 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.

3 Electricity Demand Forecast


44

3.1 Introduction

Our forecast is based on a disaggregated long-term demand model for

electricity, which is based on our macroeconomic model for the Israeli economy.

The demand for electricity in various economic sectors is dependent on various

economic variables, such as income growth, penetration of electrical

appliances, the price of electricity, demographic variables, (i.e. population

composition, growth rate, household size, etc.), and on weather conditions.

The relatively high growth is a result of a 1.5% population growth rate, a 1.9%

growth rate in the number of households, and an increase in ownership of

household electrical appliances – especially air conditioners for heating/cooling.

High growth is also expected in the commercial and industrial sectors due to an

increase in the intensity of usage per production unit, increased desalination

and the electrification of Israel's railway network.

Electricity Supply and Demand Forecast by Gas Purchasing Sector In billions of kwh

2013 2017 2020 2030 2040 CAGR Electricity Production 55.5 58.8 68.3 105.5 134.5 3.3%

Palestinian 5.0 6.4 7.5 11.9 18.0 4.9%

Industry self-production 3.4 13.3 14.0 16.3 18.9 6.5%

Total Supply 63.9 78.5 89.8 133.7 171.4 3.7%

-losses (generation, T&D) 4.8 5.9 6.8 10.0 12.8

Total Demand 59.1 72.6 83.0 123.7 158.6 3.7%


45

Accelerated growth in electricity demand in Israel is expected to continue, as

Israel continues to increase its standard of living (see appendix for our macro-

economic forecast).

Assuming average weather, local demand for electricity will grow at an average

rate of 3.7% per annum, reaching some 159 million MWh by 2040. This growth

rate represents about a 2.2% annual increase in electricity consumption per

capita and 1.8% annual increase in electricity consumption per household. The

increase is mainly due to an expected increase in the standard of living,

increase in A/C penetration, increased water desalination and electrification of

the Israeli railway system.

The principal factors expected to affect growth are an increase in disposable

income, a decline in unemployment, an increase in real wages, continuing

growth in electrical appliance use, primarily air conditioners for heating and

cooling, and the continuing introduction of additional electrical appliances.


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Electricity Demand Forecast in Israel

kWh Billions, excluding losses*

2013 2015 2020 2025 2030 2035 2040

Total Electricity Demand 59.1 65.9 83.0 101.1 123.7 141.4 158.6

(-) Palestinian Electricity Demand 4.6 5.3 6.9 8.8 11.0 13.6 16.6

(=) Total Electricity Demand in Israel 54.5 60.6 76.1 92.3 112.7 127.8 141.9

(+) Palestinian Electricity Demand 4.6 5.3 6.9 8.8 11.0 13.6 16.6

(=) Total Demand from IEC 54.0 47.0 53.9 66.8 81.6 94.1 107.3

GDP Index (2013=100) 100.0 104.7 126.7 153.1 185.8 224.4 271.2

Electricity Demand Ratio to $1 of GDP 0.205 0.218 0.226 0.226 0.228 0.214 0.197

*demand before losses. Total generation is about 7.5% higher.

Average Annual Rate of Change

Percent

Base Case Scenario 2013 2013- 2015- 2020- 2025- 2031- 2035-

2015 2020 2025 2030 2035 2040

Total Electricity Demand -3.1% 5.6% 4.7% 4.0% 4.1% 2.7% 2.3%

Palestinian Electricity Demand

1.2% 7.0% 5.7% 5.0% 4.5% 4.2% 4.2%

Total Electricity Demand in Israel

-3.4% 5.4% 4.7% 3.9% 4.1% 2.6% 2.1%

GDP Index 3.3% 2.3% 3.9% 3.9% 3.9% 3.8% 3.9%

Electricity Demand Ratio to $1 of GDP

-6.5% 3.0% 0.7% 0.1% 0.1% -1.2% -1.7%

Source: IEC, CBS, Economic Models’ estimate


47

It should be noted, that the decline in electricity demand in 2013 was primarily

due to the effect of unusual weather conditions, both in 2012 and 2013.

The summer of 2012 in Israel was about 20% warmer than average. Our

analysis shows that in the short term, elasticity of demand to substantial

changes in climate is about 0.15. As a result, the demand for electricity in 2012

increased in an accelerated rate of about 7.7%, which includes growth of about

3% above the trend to the effect of the extreme weather conditions that year.

On the other hand, in 2013, the summer was less hot than average and the

winter less cold than average. Overall, the climate in 2013 was about 30%

more comfortable than on average. As a result, the demand for electricity in

2013 decreased by 3.5% (instead of increasing from 2012's high levels by 1%

as expected). Therefore, the electricity demand in 2013, represents a level that

is about 4% below the "normal" level which would be expected under normal

weather conditions. As a result, assuming average weather in 2014, demand is

expected to increase by about 7.5%, which includes organic growth, and the

effect of the return to normal weather conditions.


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3.2 International Comparison

By international comparison, per capita electricity consumption in Israel is

similar to developed countries. Per capita electricity consumption to Israel is

similar to that of Germany, 23% higher than that of the UK, 15% lower than that

of Japan and Switzerland. It is still substantially lower compared with the US,

constituting only 60% of the US electricity consumption per capita.

However, because of weather conditions in Israel, higher electricity

consumption is expected, and the comparison the countries which have little

use for air conditioning is irrelevant.

Electricity Consumption KWh per Capita, 2012

According to our forecast, per capita electricity consumption in Israel should rise

by some 2.5% in the coming decade and by some 2% in the next two decades

until 2030. These growth rates are higher than growth rates in various other


49

industrialized countries. In the U.S. for example, per capita electricity

consumption has grows at a rate of 1.2% per annum and the Department of

Energy forecasts growth of less than 1% in the coming decade. However, the

intensity level of electricity use in Israel is still substantially lower than

customary in western countries, due to a gap in per capita income and

consumption (in addition to climatic differences).

Electricity Consumption per Capita International Comparison, 2012

Average Temp. (degree C)

Electricity Demand per Capita

July January Commercial Public & other Industry Residential Total

4.2 3.1 4.4 11.7 USA

21.0 11.0 3.2 1.2 2.4 6.8 California

29.5 7.0 5.1 3.6 5.3 14.0 Texas

4.8 3.5 5.6 13.9 US "Sun Belt" Avg.

24.0 -4.1 3.9 3.2 3.5 10.6 Michigan

28.0 12.0 2.5 1.5 1.9 6.8 Israel 2013

4.2 2.3 4.1 11.7 Israel 2040

International comparison of electricity consumption per capita indicates that the

two main factors that determine electricity demand are income (gdp/capita) and

weather conditions. Electricity demand in the US "Sun-Belt" states such as

Texas, where weather conditions are similar to Israel, is more than twice as

high compared to Israel. This gap is a result of Israel's economy lower income

levels, which cause lower penetration levels and usage intensity of electricity

appliances like air conditioners, cloth dryers, dishwashers, etc.


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Comparison of the consumption in Texas to other US states with hot climate

(the "Sun Belt" States) clearly indicates that the usage level in Texas is

representative of other states with similar climate. All the hot climate US

continental states (except Nevada) have Air Conditioning penetration of above

90% and residential electricity consumption of 5,000 KwH or more. Nevada's

residential electricity consumption is 21% less than the average US states, but

Air Conditioning penetration there is also 25% lower.

Electricity Consumption in US "Sun Belt" States

Residential

KwH/Capita Total

KwH/Capita AirCon HH Penetration

Georgia 5,409 13,204 97%

Arkansas 6,073 15,889 98%

South Carolina 6,005 16,466 94%

Alabama 6,353 17,873 98%

Oklahoma 5,979 15,555 98%

Nevada 4,394 12,751 71%

Mississippi 6,028 16,211 98%

Louisiana 6,525 18,412 98%

Texas 5,273 14,024 96% Arizona 5,024 11,454 91%

Florida 5,804 11,423 96%

Total US "Sun Belt" States

5,604 13,905 94%

Israel clearly shows similar usage patterns to the US "Sun Belt" states, although

due to the currently lower standard of leaving, a saturation level has not been

reached yet. In 2013, air conditioning penetration in Israeli households was 81%

(compared to 76% in 2010). We forecast both penetration and usage levels to

increase to levels similar to the US hot states, along with the increase in


51

standard of living. Electricity consumption per capita in Israel in 2040 is forecast

to be 15% below the average consumption in US Sun Belt states.

Our analysis indicates that the main factors that affect electricity consumption

are standard of living and climate. In cold countries, electricity consumption

tends to be lower, because of low air-conditioner penetration and usage rates,

and usage of other energy sources (natural gas or fuels) for heating rather than

electricity.

The weather in Israel is similar to the weather in the US "Sun Belt" states.

Compared to Houston Texas, Tel Aviv has 15% less cooling degree days and

7% less heating degree days. When comparing to the US "Sun Belt" States we

have accounted for the effect of weather differences on cooling and heating

electricity demand, as well as for the effect of Israel's smaller houses but larger

households.

Based on these adjustment factors, electricity demand per capita in Israel in

2040 is expected to be 15% less than the average US "Sun-Belt" states today.


52

Similarity between the weather in Israel and Texas

Tel Aviv, Israel Houston, Texas Electricity Consumption per Capita

2040 forecast: 11,700 14,024

Cooling Degree Days (CDD >22OC) 841 990

Heating Degree Days (HDD <22OC) 1,156 1,245

Daily High and Low Temperature

The daily average low (blue) and high (red) temperature with percentile bands (inner band from 25th to 75th

percentile, outer band from 10th to 90th percentile).

Fraction of Time Spent in Various Temperature Bands

The average fraction of time spent in various temperature bands: cold (0°C to 10°C), cool (10°C to 18°C),

comfortable (18°C to 24°C), warm (24°C to 29°C), hot (29°C to 38°C)


53

Comparison of electricity demand per capita in Northeast USA and Western

European countries with similar weather clearly indicates that there is no

substantial "cultural gap" between the US and Europe in terms of electricity

consumption per capita.

Electricity Consumption per capita (kWh per capita per year) Western Europe vs. North Eastern USA

W. Europe, 2011 North Eastern US, 2012 Austria 8,356 New Jersey 8,482 Belgium 8,021 Massachusetts 8,323 Switzerland 7,928 New Hampshire 8,230 France 7,289 Connecticut 8,226 Germany 7,081 Rhode Island 7,339 Netherlands 7,036 New York 7,315 Average 7,619 Average 7,986

The table on the next page compares the weather conditions in Vienna and

Boston. It clearly illustrates that both cities have similar weather conditions, and

similar electricity consumption.

Therefore we believe that weather conditions, along with standard of living, are

the main factors that determine electricity consumption.

Therefore, the US "Sun Belt" states, which have weather conditions similar to

Israel, are the most relevant benchmark for Israel's long term electricity

demand potential for 2040, when Israel's standard of living is forecast to be

beyond the level in the US and Europe today.


54

Similarity between the weather in Austria and Massachusetts

Austria (Vienna) Massachusetts (Boston) Electricity Consumption per Capita

8,356 8,323 Cooling Degree Days (CDD >22OC)

144 212 Heating Degree Days (HDD <22OC)

4,298 4,055 Daily High and Low Temperature





comfortable (18°C to 24°C), warm (24°C to 29°C), hot (29°C to 38°C) http://weatherspark.com

http://weatherspark.com/


55

Although the average temperature in Queensland, Australia is similar to Israel,

analysis of the variance in weather conditions, indicates that the weather in

Queensland in considerably less hot than Israel (and the US Sun-Belt states).

Queensland has almost 50% less cooling degree days than Tel Aviv, and 8%

less heating degree days. As the chart below clearly shows, while in Israel on

August on average 29% of the hours are considered hot climate (29 C or

above) in Queensland's hottest month less than 3% of the hours are hot (29 C

or above).

As a result, despite the fact that the standard of living in Queensland is much

higher than Israel today, air conditioner penetration in households in

Queensland is about 10% lower.

Thus we believe that in order to use the electricity demand in Queensland

Australia as a benchmark for Israel's electricity demand potential, the demand

has to be adjusted to reflect the fact that Israel has more than twice as much

cooling degree days. The result would be similar to the demand in the US "Sun

Belt" States.

Electricity Demand Indicators US "Sun

Belt" States, 2013

Queensland Australia,

2013

Israel,

2013

Israel, 2040

forecast Cooling Degree Days (>22°C)

990 440 840

Air Conditioner Penetration in households,

95% 72% 81% 95%

GDP / Capita (US $)

$50,000 $65,000 $34,000 $55,000

Electricity Consumption per capita (kWH/ capita)

13,900 KwH 12,700 KwH 6,800 KwH 11,700 KwH


56

Queensland Australia has significantly less hot weather than Israel

Tel Aviv, Israel Queensland, Australia Electricity Consumption per Capita

2040 forecast: 11,700 12,700 Cooling Degree Days (CDD >22°C)

841 442 Heating Degree Days (HDD <22°C)

1,156 1,063 Daily High and Low Temperature





comfortable (18°C to 24°C), warm (24°C to 29°C), hot (29°C to 38°C)


57

According to our forecast, electricity consumption per capita in Israel is

expected to increase from 6.8 mWh in 2013 to 11.7 mWh in 2040, which

represent convergence to demand levels in the US "Sun Belt" States, adjusted

to Israeli household size and Israeli weather conditions. Based on our forecast,

GDP/capita in Israel is expected to reach $57,000 per capita in 2040 (in real

terms), 18% higher than the GDP/capita in the US today.

Electricity Consumption per Capita, Israel vs. USA

The rise of electricity intensity in Israel is due to lower GDP per capita, and is

characteristic of countries with lower income levels. As the economy grows,

electricity demand reaches saturation, and a further growth does not yield

proportional increase in electricity demand.


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3.3 Electricity Demand for Desalination

In recent years the water problem in Israel has intensified and at present all

water pumped from wells and natural sources is being fully (but not efficiently)

utilized. Demand for water is expected to increase in the coming decade, with

total supply of potable water remaining steady (1.4 billion m3), requiring further

increase in desalination capacity.

According to the Economic Models water demand model, a growing deficit will

develop in Israel between water demand and supply. In 2020, excess demand

(including the Palestinian demand) is expected to require 750 million m3 of

desalination capacity and 1,500m m3 by 2040.

This forecast is made under the assumption that Israel will agree to allot some

500m m3 potable water to the Palestinians as part of future arrangement.

Israel can obtain unlimited water supply, available at a marginal cost of some

$0.55 per m3, by desalinating seawater. Since residential consumers are

already paying a marginal price of around $2 to $3 per m3 (including distribution

costs within the municipal pipeline network), then there is no limitation to supply

all the residential demand (see table below).

The demand for electricity for seawater desalination is about 0.8 billion kWh in

2012, and is expected to increase to 5 billion kWh in 2040 (at 3.5kWh per m3 of

desalinated water, based on reverse osmosis technology). It is assumed that

private producers will produce all the electricity for desalination, except for the

140m3 desalination plant in Hadera which will purchase electricity (0.3 billion

kWh per year) from IEC.


59

Israel Water Demand and Supply In million m3

Demand* Supply Israeli

Residential demand

per capita

Natural Sources

Desalination

2013 1,704 1,334 410 92

2015 1,790 1,357 590 99

2020 2,018 1,357 740 115

2025 2,315 1,357 960 115 2030 2,665 1,357 1,305 115

2035 2,770 1,357 1,415 115

2040 2,882 1,357 1,522 115

*Israeli demand plus allocation of 50 million m3 to Jordan, and 50-500 m3 to the Palestinians

Electricity Demand for Seawater Desalination

Mil. Cubic Meters of

Desalination

Electricity for

Desalination ( Bil. KWh)*

Gas Demand for Desalination

(BCM)* 2010 288 0.54 0.1

2011 300 0.8 0.1

2012 300 0.8 0.2

2013 410 1.0 0.3

2015 590 1.7 0.3

2020 740 2.3 0.5

2025 960 3.1 0.7

2030 1,305 4.3 0.9

2040 1,520 5.0 1.0

*Excludes desalination in Hadera (300 mil kWh/year which is supplied by IEC).


60

3.4 Demand for Electricity in the Palestinian Economy

Electricity consumption by the Palestinian economy has risen in the past

decade at an annual rate of about 5%. The growth stemmed from a rising

standard of living and electrification of the Palestinian economy

In the longer term, assuming that the peace process between Israel and the

Palestinian Authority will continue and in the positive path the parties will reach

a partial agreement, accelerated economic development can be expected in the

Palestinian Authority.

In these circumstances continued accelerated growth is expected in electricity

demand in the coming two decades at annual rates of 6% to 5%. Per capita

electricity consumption in the Palestinian economy in will reach in 2030 only

20% of the consumption in the Israeli economy.

We estimate that with the utilization of natural gas in Israel, the Palestinian

economy will act to separate its electricity generation from that of Israel. Thus,

we assume that within 10 years, the Palestinian Authority may generate all its

electricity needs by means of natural gas from Gaza or Israel.


61

3.5 Demand Sensitivity Analysis

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

Very Low

Low Base High

GDP/Employee Growth Rate

1.4% 1.6% 2.0% 2.5%

GDP/Capita Growth Rate

1.6% 1.8% 2.2% 2.7%

GDP growth rate 3.2% 3.4% 3.8% 4.3%

Electricity demand Growth Rate

3.3% 3.4% 3.6% 3.9%


131 134 142 154


368 461 499 539


-7.9% - 5.5% 0% 8.0%

According to our analysis, the long run price elasticity of electricity is about 0.37

(each 10% increase in electricity prices decreased electricity demand by about

3.5%). The demand response to price changes is gradual, and we estimate it

takes about 4 years for a complete demand adjustment (see table below).


62

Therefore, if the price changes are only temporary, the effect on demand is

relatively small.

Electricity Price Elasticity Estimate Demand reduction in response to a permanent 10% increase in electricity prices

Cumulative Electricity demand change

Year 1 -0.8%

Year 2 -1.6%

Year 3 -2.3%

Year 4 onwards -3.7%

The following table illustrates the effect of a permanent 10% increase in

electricity prices in 2012 over the years. The longer the price increase is

maintained, the higher the effect on gas demand, due to gradual adjustment

period in the demand response on the one hand, and the increased share of

gas in the electricity generation on the other hand.


63

Gas Demand Sensitivity to

Electricity Prices Low

Prices Base High

Prices Increase in electricity prices

-10% 0% 10%

Average annual increase in electricity demand

3.7% 3.6% 3.5%


146 142 138

% change in electricity demand vs. base case, 2040

+3.0% 0% -2.8%


518 499 479


3.8% 0% -4.0%

In case of a permanent increase in electricity prices of 10% in real terms,

electricity demand is expected to decrease by 3%, causing the overall gas

demand to decrease by about 3%.

The gas demand sensitivity to increase in prices, is less sensitive than the

overall electricity demand sensitivity, because the demand for gas as a

replacement for coal is not sensitive to electricity price changes.

4 Electricity Supply Forecast


65

4.1 Introduction

Generation capacity forecast is based on existing policy, to maintain an excess

production capacity margin of 10%-20% (of gross generation capacity). On the

average, this excess capacity is not used, thus it is clear that it is economically

efficient to build this reserve capacity using a technology that is characterized

by low investment costs and fast startup time, without sensitivity to energy

costs. Reserve capacity will therefore be maintained using Open Cycle units

(typically older units which have even lower thermal efficiency).

Israel Electricity Generation Capacity Forecast by Fuel In MW

2013 2017 2020 2030 2040 CAGR Coal / dual gas-coal 4,840 4,840 4,840 6,100 6,100 0.8%

Gas 7,520 11,778 13,003 16,523 21,717 3.9% FO/Diesel 1,170 1,170 1,170 1,170 1,170 0.0% Renewables 250 514 1,381 5,541 7,608 Nuclear - - - 3,600 Total Capacity 13,788 18,302 20,411 29,334 40,200 4.0%

Our long term electricity generation capacity forecast is based on an

assumption of economic efficient optimal construction plan. This is a synthetic

assumption, based on yearly optimization of electricity generation capacity. In

practice, investments in generation capacity are done in discrete steps, and

may be postponed for technical, financial or administrative reasons.


66

Plant operating decisions are made based on variable costs, which are

dominated by fuel costs. Plants are generally dispatched (started and run) to

serve loads based on production costs in what is called merit order, i.e., lowest

production costs first. That way the least expensive plants run the most,

minimizing production costs and thus minimizing total electricity costs.

Our baseline assumption is that existing coal units (either fulled with coal, or

gas at coal replacement prices) are used as baseload units, and are dispatched

before any other gas-fuelled units.

4.2 Coal to gas conversion

The Minister of National Infrastructures announced on August 1st, 2011, his

decision to convert four of the six coal-driven turbines at the Orot Rabin Power

Station to natural gas turbines with coal as back-up.

The conversion of coal units to dual fired gas/coal has several advantages to

the Israeli economy:

x It allows Israel to utilize its local gas resources as an alternative to

imported coal.

x Backup coal generation capacity avoids the strategic risk of

reliance solely on gas for electricity generation

x It enables the reduction of emissions (SOX, NOX and CO2) at

reduced costs


67

Existing Coal Based Power Units

Location Stage Turbines MW NOX emission

level*

SOX emission

level*

Vintage

Orot Rabin A 4X360 1,440 1,350 1,000 1981-

1984

B 2X575 1,150 950 1,000 1995-

1996

Rotenberg A 2X575 1,150 900 1,380 1990-

1991

B 2X550 1,100 500 1,000 2000-

2001

Total 10 4,840

*In mg. The required emission level by 2016 is 200 mg for all units.

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 almost all electricity production to natural gas

(with coal as a backup fuel).

Conversion of the existing coal units to dual fuel (gas/coal) gas has significant

benefits to the gas providers and to the Israeli economy. Israel could become

one of the cleanest nation (CO2 and pollution-wise) among the OECD

countries. The reduction in greenhouse gas emissions, SOX, NOX and particles

pollution provides substantial external benefits.


68

Potential Electricity Generation CO2 Emission Reduction Through coal to gas conversion

Millions of tons Existing Full Coal to Gas Conversion

Reduction

Coal Units 30.2 17.3 -43%

Gas Units 6.6 6.6 -

Other units 3.4 3.4 -

Total 40.2 27.3 -32%

Potential Electricity Generation SOX Emission Reduction Through coal to gas conversion

Millions of tons Existing Full Coal to Gas Conversion

Reduction

Coal Units 85.8 0.7 -99%

Gas Units 0.3 0.3 -

Other units 2.6 2.6 -

Total 88.7 3.6 -95%

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.


69

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, we assume that the conversion

of Israel's 10 coal units to gas in 2018-2020, along with Leviathan entrance to

the market.

4.3 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.

Our assumption is that project D will be built by 2022 fueled in normal times by

natural gas, under a competitive price for gas for this unit, with coal used as a

backup fuel only.


70

4.4 Electricity Supply by IPPs

Despite numerous attempts over the years by the Israeli government to

introduce new producers into the electricity market, IEC has maintained its

status as the sole producer.

In recent years the government has introduced a new policy to allow additional

private producers to enter the market.

There are currently 4 main IPP projects under way, the Dorad Group (800 MW)

the Ofer Group (400 MW) and the Dalia Group (800 MW) and the Beer Tuvia

Group (400MW).

The demand for gas for electricity production is not sensitive to policy changes

regarding competition in the electricity market or to the extent of the IPPs

existence. Even if IEC's market share will be reduced, gas demand will not be

affected since private producers will increase demand accordingly. 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.


71

4.5 Electricity Supply by Cogeneration

Cogeneration plants are becoming fairly widespread in Israel. These

cogeneration plants were initially built for self-production of electricity and

steam.

Total cogeneration natural gas demand (including desalination) is forecast to

increase from 0.5 BCM in 2010 to 3.2 BCM in 2015, and 4.5 BCM by 2030.

Gas Demand forecast by Major Industrial Gas Consumers, 2015

Gas Demand Estimate,

2015 ICL 0.75

ORL Haifa 1.0

AIPM 0.2

Paz Refinery 0.2

Ed Tech (Ramat Negev, Ashdod Energy) 0.3

Haifa Chemicals 0.1

Alon Tavor, Ramat Gabriel 0.3

Nesher 0.2

Agan, Makhteshim 0.15

Total 3.2

Source: Delek, Economic Models’ forecast


72

4.6 Renewable Energy Supply

The Israeli government decided to encourage renewable energy sources, and

adopted a target of 10% renewable energy of the electricity generation capacity

by 2020.

In order to support this goal, the government subsidized solar energy

producers.

Solar generation costs 5 to 10 times more than conventional technologies, and

therefore requires large subsidies to be built.

In February 2011, the finance ministry decided to withhold the solar energy

subsidy policy, due to the high subsidy costs of renewable energy.

Our forecast is based on the assumption 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.

In comparison, the EU has set a target of 20% renewables by 2020, but is

already producing about 13% of its electricity with hydro-electric units. Israel

has no potential for hydro-electric power, therefore our assumption is based on

a comparable usage of non-hydro electric renewables.

It should be notes that Israel's CO2 emissions today (per capita) are 20% below

the OECD average. Therefore, there is no reason that Israel will have to adopt

higher renewable targets.


73

Share of Renewable Energy Generation in OECD Countries % of total electricity generation

Hydroelectric Wind Non-Hydroelectric Renewables

Total Renewables

Iceland 74% 0% 26% 100% Norway 96% 1% 1% 97% Austria 61% 4% 12% 74% New Zealand

57% 3% 15% 73%

Canada 60% 1% 2% 62% Sweden 50% 2% 11% 60% Switzerland 55% 0% 4% 59% Portugal 17% 15% 21% 39% Finland 19% 0% 13% 32% Denmark 0% 19% 30% 30% Spain 9% 13% 16% 26% Italy 17% 2% 7% 25% Turkey 19% 1% 2% 21% Slovakia 18% 0% 2% 20% Germany 3% 6% 14% 18% Ireland 3% 11% 12% 15% Mexico 11% 0% 3% 14% France 11% 1% 3% 14% Greece 9% 4% 4% 13% Netherlands 0% 4% 11% 11% Luxembourg 4% 2% 7% 11% United States

7% 2% 4% 11%

Japan 8% 0% 2% 10% Hungary 1% 1% 8% 8% Australia 5% 2% 2% 7% United Kingdom

2% 2% 6% 7%

Belgium 0% 1% 7% 7% Poland 2% 1% 4% 6% Czech Republic

3% 0% 3% 6%

Korea, South

1% 0% 1% 1%

OECD Average

13% 2% 5% 18%

Source: DOE


74

Per Capita Carbon Dioxide Emissions from the Consumption of Energy in OECD

Country Ton CO2 /Capita Turkey 3.3 Chile 3.8 Mexico 4.0 Hungary 5.0 Portugal 5.3 Sweden 5.6 Switzerland 6.0 France 6.3 Slovakia 6.5 Italy 7.0 Spain 7.1 Poland 7.4 Israel 8.1 United Kingdom 8.4 Puerto Rico 8.4 Austria 8.4 Norway 8.5 Japan 8.6 Ireland 8.8 Denmark 9.0 New Zealand 9.3 Germany 9.3 Czech Republic 9.3 Greece 9.3 Guam 9.6 Finland 9.9 OECD Average 10.4 Korea, South 10.9 Iceland 11.1 Belgium 13.2 Netherlands 14.9 Canada 16.2 United States 17.7 Australia 19.6 Luxembourg 21.5

Source: DOE, CBS (Israel)


75

4.7 Future Nuclear Energy

Israel's long term electricity sector development plan 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.

Nuclear Energy Generation Capacity in OECD Counties In thousands of MW, 2010

Nuclear Capacity

(kMW)

% of Total Generation Capacity

France 63.260 54% Belgium 5.825 35% Slovakia 2.200 30% Sweden 8.938 26% Hungary 1.940 22% Korea, South 17.716 22% Czech Republic

3.760 21%

Japan* 47.935 17% Switzerland 3.220 17% Finland 2.671 16% Germany 20.486 15% United Kingdom

10.979 13%

OECD Total 312.270 12% Canada 13.345 10% United States 100.755 10% Spain 7.365 8% Mexico 1.365 2% Netherlands 0.510 2%

*Japan, before the Fokushima accident


76

Only half of OECD countries have nuclear energy generation. Notable counties

without any nuclear energy plants include Australia, Italy, Greece, Ireland,

Norway, Denmark and Turkey.

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.

The recent crisis at the Fukushima power plants in Japan also raised concerns

regarding nuclear energy safety. This is despite the fact the Japanese incident

showed that even a severe hit in (30 year old) reactors did not cause major

casualties. In contrast to Japan, in Israel, weather does not constitute a major

concern. However, there is a potential threat of terror and missile attacks, which

may prevent any nuclear power unit being built until the security issues are

solved.

Therefore, we assume that the possibility of a nuclear power plant in Israel

exists as a long term (20+ years from today) possibility.

Accordingly, our forecast is based on the assumption that the first two 1,200

MW nuclear power plants in Israel will not be completed before 2031, with

additional capacity built in 2040.

5 Israel Natural Gas Demand for Electricity Forecast

5 Israel Natural Gas Demand Forecast

78

5.1 Introduction

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.

In 2012, Israel's national gas pipeline grid has finally reached all the major

industrial areas, which enabled Israel's electricity sector to complete the shift of

its last oil based power units from diesel and fuel-oil to natural gas (In practice,

due to the gas shortage, some units had to temporarily switch back to oil).

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 2015.

Israel's electricity demand per capita is very low compared to western states

when accounting for weather conditions (the demand in Israel is 55% less than

the US "Sun Belt" states, which has comparable weather). As Israel's standard

of living increases, demand for electricity is expected to increase (see below).

We estimate that all the increase in Israel's electricity demand throughout 2040

will be supplied by natural gas (except from renewable energies that may reach

10% of Israel's electricity supply, and nuclear power stations that could be built

in 2031 and beyond).

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 a

competitive price for gas).

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


79

(1400MW). We believe that conversion of the other coal units to gas (3400MW)

is likely to occur along with Leviathan's entry to the market (although no formal

decision has been made yet).

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 major parts of it are planned to be electrified by

2017.

Israel's transportation sector can also benefit from the availability of local supply

of natural gas. In our view, unique economic potential exists for establishing

methanol production plant in Israel, which can produce methanol as a major

substitute for gasoline in the local market (M85 for new cars, M15 for existing

vehicles). Methanol is clean, safe and its usage as a vehicle fuel is economic

due to the home-advantage without requiring subsidy. We expect electric cars

and CNG vehicles are expected to remain small niche applications throughout

2040 due to driving range and cost limitations.

Experience worldwide shows that countries with a 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. Therefore, we

see potential for development of additional applications for natural gas based

chemical industries in Israel (See analysis in Chapter 6 below).


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5.2 The Demand for Natural Gas

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 2040. 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 2020.

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).


81

We define all these markets (Israel, Palestinians and Jordan) as the "Narrow Path" alternative.

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

2013 2015 2020 2030 2040 Total 2013-2040

Running Total

2013-2040

Electricity and Cogeneration 7.0 12.0 15.7 17.8 23.0 499

Transportation - CNG

- 0.1 0.4 0.8 1.1 17 516

Chemical Industry - - 1.3 1.9 2.9 46 562

Further Coal conversion to gas**

- 6.0 6.0 6.0 132 694

Palestinian self-generation

- - - 2.9 4.4 53 747

Jordan - 0.1 4.1 5.6 7.5 128 875

Narrow Path (Subtotal)

7.0 12.2 27.5 35.1 44.8 875

LNG - - 7.0 18.0 27.5 370 1,245 Total Broad Path 7.0 12.2 34.5 53.1 72.3 1,245 *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


82

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

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 2011-12). 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).


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5.3 Demand for Gas for Cogeneration

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.

Therefore, the potential gas demand by the Israeli industry in 2013, assuming

full conversion to natural gas is 2.8 BCM.

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 industry is expected to

reach 3.4 BCM by 2015.

Israel Fuel Demand by the Industry Sector in 2013

Fuel m. tons of fuel

Gas equivalent

BCM Fuel Oil 0.4 0.5

Diesel 0.02 0.02

Natural Gas 1.5

LPG (ex. Petrochemicals) 0.3 0.4

ORL Self-Use (Fuel Oil) 0.3 0.4

Total 1.0 2.8

The conversion from fuel oil and diesel to gas will create incremental gas

demand beyond the demand for gas for electricity.


84

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

about 1/4 of the price of fuel oil or diesel.

Gas Demand forecast by Major Industrial Gas Consumers, 2015

Gas Demand Estimate,

2015 ICL 0.75

ORL Haifa 1.0

AIPM 0.2

Paz Refinery 0.2

Ed Tech (Ramat Negev, Ashdod Energy) 0.3

Haifa Chemicals 0.1

Alon Tavor, Ramat Gabriel 0.3

Nesher 0.2

Agan, Makhteshim 0.15

Total 3.2

Source: Delek, Economic Models’ forecast

6 Gas Demand for Chemicals and Transportation


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6.1 Demand for Gas 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



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 2040.

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

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.


87

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*

2012 2,328 2.2% 0.0% 0 0.0 2013 2,352 1.1% 0.0% 0 0.0 2014 2,381 1.2% 0.0% 0 0.0 2015 2,412 1.3% 2.0% 57 0.1 2016 2,444 1.3% 4.0% 115 0.1 2017 2,490 1.9% 6.0% 176 0.2 2018 2,546 2.2% 8.0% 240 0.3 2019 2,604 2.3% 10.0% 307 0.3 2020 2,667 2.4% 11.0% 345 0.4 2021 2,732 2.4% 12.0% 386 0.4 2022 2,800 2.5% 13.0% 428 0.5 2023 2,872 2.6% 14.0% 473 0.5 2024 2,945 2.6% 15.0% 520 0.6 2025 3,021 2.6% 15.5% 551 0.6 2026 3,099 2.6% 16.0% 584 0.6 2027 3,181 2.6% 16.5% 618 0.7 2028 3,262 2.6% 17.0% 653 0.7 2029 3,345 2.5% 17.5% 689 0.7 2030 3,429 2.5% 18.0% 726 0.8 2031 3,511 2.4% 18.3% 756 0.8 2032 3,592 2.3% 18.6% 786 0.9 2033 3,671 2.2% 19.0% 821 0.9 2034 3,748 2.1% 19.3% 851 0.9 2035 3,823 2.0% 19.6% 882 1.0 2036 3,896 1.9% 19.7% 903 1.0 2037 3,966 1.8% 19.8% 924 1.0 2038 4,033 1.7% 19.9% 945 1.0 2039 4,102 1.7% 20.0% 963 1.0 2040 4,172 1.7% 20.0% 982 1.1

*Excluding Palestinian diesel demand for transportation


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1. Energy independence - ending the dependence on oil imports.

2. Exploiting the economic potential inherent in Israel's gas reserves.





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).

However, our forecast conservatively, does not include the potential demand for

M85 fuels.


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6.2 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 develops, 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 methane-

based chemical products.

The natural gas (methane) could be a basis for producing a range of traditional

chemical products (ammonia, methanol), for producing synthetic fuels (GTL), for

producing fuel substitutes (methanol and DME), and for producing olefins on the

basis of innovative technologies (MTO – methanol to olefins).

From a technological-engineering perspective a wide range of alternatives exist,

but the economic feasibility of producing the various products is dependent on

the natural gas prices, the oil products, and the petrochemical products, and the

availability of local or nearby target markets.


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Alternatives for the Petrochemical Industry Based on Natural Gas (Methane)

In countries with a surplus of natural gas (such as the Persian Gulf states, and

even Egypt) a large petrochemical industry has developed in recent years

based on the use of available natural gas.

As opposed to the gas in the Persian Gulf, the gas in Israel does not contain

ethane, which means that it is not suitable for the ethylene industry. An

examination should be undertaken, in our view, of the feasibility of establishing

an industry based on methane derivatives:

1. Production of ammonia, the major raw material for the fertilizer industry.

2. Production of methanol (a chemical and a fuel substitute).

3. Production of olefins from methanol (MTO).

4. Extraction of liquid distillates from methane (GTL technology).


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Chemical Industry Natural Gas Demand Forecast

In BCM

2015 2017 2020 2030 2040 Total 2013-2040

Ammonia 0 0.5 0.5 0.7 1.0 15

Methanol 0 0.5 0.5 0.8 1.3 19

Others 0 0.3 0.3 0.5 0.7 11

Total Chemical Industry Potential

0 1.3 1.3 2.0 3.0 45

*Excluding existing ORL demand which is included in the general Industry Sector Demand (see chapter 5).


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6.3 Global demand for ammonia

Global demand for ammonia was around 160 million tons in 2013, about 80% of

which was used in the fertilizer industry. Nitrogen (N), phosphorus (P), and

potassium (K) are the three major materials whose absence inhibits the growth

of plants. For this reason, they are the main components of fertilizers. Most

fertilizers worldwide are a mixture of phosphorus (whose major source is rock

phosphates), potassium and ammonia. Additional uses of ammonia are

manufacture of synthetic fibers (acrylic fibers and nylon), the manufacture of

explosives, and for cooling.

Forecast of Global Demand for Ammonia

The largest producers of ammonia are China (30% of the world market), and

the United States, India, and Russia (around 8% of the world production each).

Ammonia production is currently based mainly on natural gas. Production plants

using naphtha, which existed in the past in Europe (and in Israel) have closed


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due to a lack of profitability. Ammonia production in China is based mainly on

coal feed.

In recent years production plants have closed in the United States and Europe,

while at the same time plants have been established in countries with a surplus

of natural gas for export. Technological developments and the exploitation of

economies of scale have led to the establishment of advanced plants with a

production capacity of 1 to 1.5 million tons of ammonia a year.

6.4 The market for Ammonia in Israel

The demand for ammonia in Israel is around 120,000 tons a year, around $60

million in current market prices of ammonia of around $500 per ton. The major

consumer of ammonia is Haifa Chemicals, which produces fertilizers on the

basis of potash and phosphates (from Israel Chemicals), and imported

ammonia, and consumes around 80,000 tons of ammonia a year.

In Israel there is no longer any domestic production of ammonia, and all

domestic consumption is based on imports. The ammonia-manufacturing plant

in the Deshanim (fertilizers) factory was closed more than 15 years ago

because of the lack of profitability of operating a plant based on naphtha feed.

Haifa Chemicals established an import terminal for ammonia at Haifa as a

replacement for the production plant that closed, and is today the sole importer

of ammonia for the local market. About 120,000 tons of ammonia are imported

annually through the chemicals terminal in Haifa port, by means of refrigerated

ships with a capacity of 12,000 tons. The ammonia (pressurized and at a

temperature of minus 33 degrees) is offloaded to a 12,000-ton storage

container at the Kishon terminal, and from there it is piped to the Haifa

Chemicals plant and the Deshanim plant.

Haifa Chemicals (in its factories in the north and the south) consumes around

80,000 tons a year. The company's major product is potassium nitrate,


94

produced from nitric acid (extracted from ammonia), together with potash from

the Dead Sea.

Deshanim consumes around 40,000 tons of ammonia a year for its own

production, and marketing (in road tankers) to its customers, which include

dairies (milk cooling systems), food plants (for producing yeast and for cooling

systems), the military and security industry, the Electricity Corporation, the

pharmaceutical industry, ORL, and the Mekorot company.

6.5 Potential production of ammonia in Israel

The scale of domestic demand for ammonia is around 120,000 tons per year.

Ammonia exists in a gaseous state at room temperature, and is considered a

poisonous gas when inhaled. The storage and delivery systems of ammonia,

therefore, constitute a significant hazard in the event of a terror attack, fault, or

earthquake.

Today imported ammonia is stored at a 12,000-ton storage container at the

Kishon terminal near Haifa. This is considered a major risk factor, and triggered

the government decision in April 2013 to authorize a new Ammonia production

plant in the south of Israel, that will be operational by 2017, and will enable the

evacuation of the Ammonia storage near Haifa.

Several companies (including Dor Chemicals) have expressed interest in the

construction of an ammonia-producing plant on a scale of about 1 million tons

year for exporting Ammonia and for the supply the needs of the domestic

market.

The consumption of natural gas for producing ammonia is around 33.5 MMBTU

per ton of ammonia, which is around 1 BCM a year for the production of a

million tons of ammonia.


95

Characteristics of a Modern Ammonia-Producing Plant

Production capacity (thousand tons of

ammonia a year

1,000

Investment cost ($ millions) $M 900

Annual income ($ millions) $M500

Natural gas consumption a year (BCM) 0.95

Our gas demand forecast assumes the plant will be constructed in stages. The

first stage, in 2017, will produce 500,000 tons of ammonia a year, and further

expansion is expected from 2022 onwards at an average rate of 3% per year.


96

6.6 The global methanol market

Methanol is the alcohol with the simplest chemical structure, and is produced

worldwide almost exclusively from natural gas (in China coal is also used) in a

thermo-chemical process.

The Process of Producing Methanol from Natural Gas (Methane)

The current major use of methanol is as a base material for the production of

additional chemicals, but its major future potential is as a substitute for

transportation fuels. Today around 40% of methanol production worldwide is

used for extracting formaldehyde from which plastic materials, paint, explosives,

and textiles are produced. Some countries (especially in the Third World) still

use MTBE produced from methanol as an additive for enriching octanes in

Gasoline. Furthermore, it is possible to produce dimethyl ether from methanol,

as a substitute for diesel fuel.


97

Global Demand Forecast for Methanol

Source: Chemical Market Associates Inc. (CMAI) World Methanol Analysis, October 2010 (excluding MTO)

Global demand for methanol in 2013 was around 50 million tons, and is

expected to grow at a rate of more than 7% a year, mainly because of the

increasing use of methanol as a fuel substitute. China is the world's largest

consumer, consuming around 18 million tons a year (about a third of global

consumption), about half of which is for China's chemical industry, and half as

an additive for fuel and fuel substitutes. About half of China's methanol

consumption is imported and half is produced domestically (mainly from coal).

Because the major raw material for the production of methanol is methane from

natural gas, methanol producing plants are located only in proximity to sources

of natural gas. In Egypt, a plant for extracting methanol was completed in 2011

with a production volume of 1.3 million tons and an investment of $1 billion, in

cooperation with the Methanex company (which holds 60% of the project) as

part of Mubarak Gas and Petrochemicals at Damietta.


98

In our view, the economic logic for investing in the production of methanol in

Israel is derived from the combination of a local supply of natural gas, and the

possibility of developing a market for domestic consumption of methanol, as a

substitute for fuels. The home advantage for the production of methanol is at

least twice that of producing Gasoline, because of the fact that methanol

occupies double the volume of Gasoline (in other words, the transportation cost

is double per energy unit), and because of the small size of the market, which

necessitates transportation in smaller ships, thereby increasing costs per unit of

energy.

6.7 Methanol as a transportation fuel

Methanol can be used as fuel for internal combustion engines, and its use

requires only slight changes in the vehicle (flex fuel). Every new vehicle

manufactured today, can, with a relatively small addition (around $100 to $200)

be manufactured as a vehicle enabling the use of methanol (M85) or Gasoline

(flex fuel). The vehicle can also be adapted for the sole use of methanol, which

will improve the vehicle's effective efficiency by around 20%.

Methanol is cleaner and safer for use than Gasoline, but it causes corrosion,

and slight adaptations are therefore required to the vehicle for a mix that

includes more than 15% of methanol. The most usual mix is 85% methanol and

15% Gasoline (which is added to methanol, because in the event of burning, the

methanol flame is clean and invisible). This mix of M85 is a similar product to

E85 (85% ethanol and 15% Gasoline), which is sold in the United States and

Europe. Assessments are that the production of methanol from natural gas is

cheaper than the production of ethanol (which is produced from corn or soya),

and that the more extensive use of ethanol worldwide is a result of political and

not economic motives, and because of the fact that methanol produced from


99

natural gas does not fall into the category of "alternative fuels" or "renewable

energy".

In our view the major economic factor that has prevented the development of

methanol as an alternative fuel is the fact that the countries exporting natural

gas (and therefore with the potential to be large-scale exporters of methanol)

are also the large exporters of crude oil. These countries have no economic

interest in encouraging the development of alternative fuels that would lead to a

fall in oil prices.

The only country with a significant production capacity of methanol and that is

not a large exporter of crude oil, is China (in which methanol production is

based on coal), where there is a clear policy of introducing methanol as

transportation fuel as a substitute for Gasoline.

6.8 The potential for methanol in Israel

The Israeli government decided to invest more than 2 billion shekels in the

coming decade to increase Israel's energy independence and reduce the air



The discovery of natural gas reserves in Israel creates the potential to move to

flex-fuel vehicles powered by 85% methanol and 15% Gasoline.



1. Achieving energy independence and ending the dependence on oil

imports.

2. Fully exploiting the economic potential inherent in Israel's natural gas

reserves.


100





5. The improbability of domestic production of ethanol, because of a lack of

land and water.

With an investment of around $1.8 billion it will be possible to establish

methanol plants producing around 2.5 million tons a year, which will supply the

total current Gasoline consumption for transportation in Israel.

Dor Chemicals has recently announced its intentions to build a methanol

production plant in Israel with a capacity of up to 1 million ton methanol a year,

which requires gas supply of about 1 BCM a year.

Our gas demand forecast assumes the plant will be constructed in 2 stages.

The first stage, in 2017, will produce 500,000 tons of methanol a year, and

further expansions at an average rate of 5% a year from 2022 onwards.


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6.9 Production of methanol-based olefins (MTO)

The combination of local production of methanol, and Israel's existing olefins

industry, creates potential for expansion into petrochemicals with technologies

that produce olefins from methanol.

Innovative processes recently developed enable the production of olefins

(ethylene, propylene) from methanol. This process, called MTO (methanol to

olefins), enables the development of a petrochemical industry based on natural

gas (methane) or coal.

China in recent years is developing an MTO industry based on large reserves of

coal. The feasibility should be examined of developing MTO plants on the basis

of Israel's natural gas reserves.

This is an industry that offers a clear relative advantage to the petrochemicals

industry in Israel, but it is based on new technologies, and its feasibility might

well be conditional on finding an international partner with experience in this

area.

The production of olefins from methanol is at the initial penetration stage, but

assessments in the industry are that within 5 years the scale of consumption of

methanol for the production of olefins will reach around 13 million tons a year,

about 17% of global demand for methanol.

Forecast of Global Demand for Methanol to Produce Olefins (MTO)

2010 2014

Demand for methanol to produce olefins 1.1 12.6

Demand for methanol for fuels and chemistry

45 60

Total 46.1 72.6

Percentage of demand for olefins 0.5% 17%

Source: Methanex


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A typical plant for producing olefins produces about 800,000 tons of ethylene

and propylene from around 2.4 million tons of methanol. The consumption of

natural gas required to produce the methanol is around 2.3 BCM a year.

6.10 Gas to Liquids (GTL)

GTL processes enable the production of light distillates (Gasoline, naphtha, and

diesel) from natural gas, and these constitute a complete alternative to oil

products.

The major technological technique for extracting fuels from natural gas (similar

to liquefaction of coal) is a chemical process Fischer-Tropsch (FT) developed in

Germany in the 1920s, and was used by Germany to produce fuels from coal

during the Second World War.

A typical process creates about 70% diesel, about 25% naphtha, and about 5%

oils. This is a very energy-intensive process; about 43% of the energy contained

in the natural gas is consumed in creating the fuels (energetic efficiency of

57%). This implies that on the assumption of an alternative natural gas price of

$3 per MMBTU, the cost of the energy component alone (excluding capital and

operation) in the GTL process is around $32 a barrel.

Several GTL plants operate worldwide, most relatively small. The GTL project of

Royal Dutch Shell is the world's largest project for producing fuels from gas.

The project is expected to extract 16.5 BCM of natural gas a year (1.6 bcfd.),

and to produce from it 320,000 equivalent barrels of oil a day, from which

140,000 barrels a day of distillates will be extracted (around 7 million tons a

year), and 120,000 barrels a day of ethane.

This is a vertical project, established with an overall investment of $20 billion,

and includes extracting the natural gas, separating the ethane, and refining

methane into distillates.


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The high capital costs and the dependence on high energy prices (or very low

gas prices) to justify the economic viability, are the reason for the absence of

investment on a large scale in plants for producing fuels from gas, except for

investments supported by government policy (for example, the Qatar

government that provided gas at no cost to the Pear GTL project), in return for

partnership in profits (if there are any).

It is possible that for strategic reasons the Israeli government could provide

guarantees for establishing a small plant that would function as a pilot project

for experimentation and for studying the technology. However, for conservative

reasons we did not include this possibility in our gas demand forecast.

7 Gas Demand for Export

7. Gas Demand for Export

105

7.1 Natural Gas Demand from Jordan

Jordan, Israel's neighboring country on the east, is Israel's most close and

immediate export market. 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 Jordan and

north to Syria was the principal source of Jordanian natural gas imports until

2011. Gas supply was based on a contract with Egypt for annual imports of

about 3 BCM per year.

Jordan – Economic Forecast 2010 2020 2030 2040 Population (millions)

6.4 8.1 9.4 10.5

GDP per capita $4,060 $4,700 $6,060 $7,800

Electricity Capacity

3,140 MW 5,900 MW 8,000 MW 10,000 MW

Electricity Consumption per Capita

2,100 kWh 3,000 kWh 3,600 kWh 4,600 kWh

Gas Demand (BCM)

2.7 4.1 5.6 7.5


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.


106

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. 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 only about 10 km. The Tamar partners

and the Jordanian Potash Corp. are now discussing the supply of gas (0.1 – 0.3

BCM) to the Jordanian Potash industry.

Jordan Gas Pipeline


107

Although the supply quantities to the Jordanian Poash Corp. are small, they are

of strategic importance since they can server as a starting point for future gas

sales to Jordan. We estimate that a supply of 3.7 BCM starting 2017 increasing

to 7.5 BCM by 2040 has strong economic incentives for both sided.

Israel's peace agreement with Jordan was signed in 1991, but informal relations

existed even before that. Both governments have strong political incentive to

strengthen the strategic relationship. In economic terms, Israel may be Jordan's

most cost effective gas source, as purchasing LNG at Aquaba port is expected

to be a much more costly alternative, and building gas pipelines from Iraq or

Saudia Arabia is not economical due to the long distances and relatively small

supply volumes.


108

Jordan Gas Import Forecast Gas

Import BCM

Population (millions)

GDP/Capita (real $K)

Gas Import per $ GDP (BCM/ GDP)

2010 2.7 6.4 4.0 105.0 2013 7.3 3.9 2014 7.5 3.9 2015 0.125 7.7 4.0 2016 0.3 7.8 4.1 2017 0.5 7.9 4.2 110.5 2018 3.8 8.0 4.4 108.7 2019 4 8.0 4.6 109.6 2020 4.1 8.1 4.7 107.8 2021 4.3 8.2 4.8 108.4 2022 4.4 8.3 5.0 106.4 2023 4.5 8.5 5.1 104.5 2024 4.7 8.6 5.2 104.8 2025 4.8 8.7 5.3 102.8 2026 4.9 8.9 5.5 100.8 2027 5.1 9.0 5.6 100.8 2028 5.3 9.1 5.8 100.7 2029 5.4 9.2 5.9 98.7 2030 5.6 9.4 6.1 98.4 2031 5.7 9.5 6.2 96.4 2032 5.9 9.6 6.4 96.1 2033 6.1 9.7 6.6 95.6 2034 6.3 9.8 6.7 95.1 2035 6.5 10.0 6.9 94.5 2036 6.7 10.1 7.1 93.9 2037 6.9 10.2 7.3 93.2 2038 7.1 10.3 7.4 92.5 2039 7.3 10.4 7.6 91.8 2040 7.5 10.5 7.8 91.0



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7.2 Israel's LNG Export Alternatives

Current regulation, as approved by the Israeli Parliament allocated about 40%

of the discovered natural gas resources for export, including 50% of Leviathan's

resources, about 20% of Tamar's resources and 75%-100% of the smaller fields

resources.

Tamar/Leviathan Export Alternatives

Source: Noble Energy

Although currently there is no approved location for a liquefaction plant, as the

map above illustrates, several options exist for export out of Israel:

x existing underutilized LNG plants in Egypt,

x Floating LNG or an offshore liquefaction platform,

x liquefaction plant in Israel

x liquefaction plant in Cyprus,

x Export pipeline to Turkey.


110

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 a stationary offshore

liquefaction platform.

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.

Global LNG Demand and Supply Forecast

Source: Global LNG Update Sep. 2013, BG Group interpretation of Wood Mackenzie data (Q3 2013) * Trade: various research house views; Wood Mackenzie, PFC Energy acquired by IHS, IHS CERA, Poten & Partners, PIRA, FACTS Global Energy, Gas Strategies


111

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.

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.


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7.3 LNG export through Egypt's existing projects

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.

Egypt's Mobarak government had a policy which favored gas exports at the

expense of limited supply to the local market. Today, after the revolutions

against Mubarak and Morsi, any Egyptian government is expected to be more

sensitive to the needs of the local market and continue to limit gas export

quantities.

Egypt's Gas Supply and Demand

As a result of Egypt's new policy to prioritize local consumption of gas over

export, Egypt's LNG liquefaction plants are now operating at partial utilization

rates (less than 30% on average).


113

Egypt's LNG Plants Utilization Rate ELNG 1 ELNG 2 Damietta

(Segas LNG)

Total

Plant Capacity (mmtpa)

3.6 3.6 5.0 12.2

Number of Trains

1 1 1 3

Foreign Shareholder*

BG (36%) Petronas

(36%)

BG (38%) Petronas

(38%)

Eni (40%) Fenosa (40%)

Start-up 2005 2005 2005

Storage Capacity (m3)

140,000 140,000 300,000

Production in 2013

1.5-2 1.5-2 0 3-4

2013 utilization rate

50% 50% 0% 30%

Gas Shortage in 2013, BCM

1.2-1.5 1.2-1.5 3.7 6.1 – 6.7

*Egyptian government companies hold 20% - 24% shares in the liquefaction plants.

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 both 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


114

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).

In the longer term, building a dedicated sub-marine pipeline between the Yam

Tethys platform and the Egyptian LNG terminals at the Nile Delta, 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 through Egypt

of 2.5 BCM, increasing to 7 BCM in 2018, assuming an export pipeline will be

built by 2018.

Egyptian LNG Liquefaction Plants

8 Competitive Environment

8. Competitive Environment

116

8.1 Israel Gas Reserves

Israel's proven gas reserves are currently estimated at 883 BCM. According to

the US Geological Survey, the potential undiscovered gas resources in Israel

may reach additional 1400-1800BCM. 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 mean prospective reserves of additional fields which are actively being

explored is estimated at additional 175 BCM, bringing the total proven and

probable Israeli gas supply in the next decade to about 1,050 BCM.

Israel Gas Resources Estimate Gas Resources

(BCM) Category

Tamar 282 2P

Leviathan 535 2C

Karish 36 2C

Dalit 8 2C

Tanin 22 2C




117

Map of Israel's Gas and Petroleum Rights

Source: Ministry of Energy and Water Resources, Barclays Research

Shareholders in Israel's Gas and Petroleum Rights


118

8.2 Gas Supply and Demand

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 1400-1800BCM. 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



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


119

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 2040. 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 resources 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 2025-2030.


120







121

Broad Path Alternative Synthetic/1 Demand Forecast By Supplier, in BCM





9. Forecast Tables

9 Forecast Tables

123

Natural Gas Demand Forecast, in BCM*

Narrow Path /1

Broad Path /2

Timeline 2010 5.4 5.4 2011 5.2 5.2 Temporary gas

shortage 2012 2.9 2.9 2013 7.0 7.0 Tamar gas Q2 2014 8.6 8.6 Full Tamar 2015 12.2 12.2 Rabin A

conversion to gas (1400MW) 2016 13.0 13.0

2017 15.3 15.3 Further coal conversion to gas (3400MW)

2018 21.5 28.5 2019 24.6 31.6 2020 27.5 34.5 2021 28.6 35.6 2022 29.6 36.6 2023 30.7 42.7

Palestinian** shift to self-supply 2024 31.9 43.9

2025 33.0 45.0 2026 34.2 46.2 2027 35.5 47.5 2028 36.8 48.8 2029 37.9 49.9 2030 35.1 53.1 2031 36.0 54.0 1st nuclear unit 2032 37.2 55.2 2033 38.4 56.4 2034 39.7 57.7 2035 40.8 66.8 2036 42.0 68.0 2037 43.2 69.2 2038 44.4 71.9 2039 45.7 73.2 2040 44.8 72.3 2nd nuclear unit Total

2013-40 875 1,245

% 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

9 Forecast Tables

124

Narrow Path Natural Gas Demand By Sector, in BCM*

Israel Electricity

/1

Cogen / desalinati

on & Industry

CNG and

Chemical

Industry

IEC Coal to Gas /2

Palest. Self –

supply of electricit

y

Jordan (export)

Total Narrow

Path

2010 5.0 0.4 0.0 0.0 0.0 0.0 5.4 2011 4.4 0.8 0.0 0.0 0.0 0.0 5.2 2012 2.1 0.8 0.0 0.0 0.0 0.0 2.9 2013 5.5 1.5 0.0 0.0 0.0 0.0 7.0 2014 6.7 1.9 0.0 0.0 0.0 0.0 8.6 2015 8.6 3.3 0.1 0.0 0.0 0.1 12.2 2016 8.4 4.2 0.1 0.0 0.0 0.3 13.0 2017 9.1 4.2 1.5 0.0 0.0 0.5 15.3 2018 9.8 4.3 1.6 2.0 0.0 3.8 21.5 2019 10.6 4.4 1.7 4.0 0.0 4.0 24.6 2020 11.2 4.5 1.7 6.0 0.0 4.1 27.5 2021 11.9 4.6 1.8 6.0 0.0 4.3 28.6 2022 12.7 4.6 1.9 6.0 0.0 4.4 29.6 2023 13.0 4.7 2.0 6.0 0.5 4.5 30.7 2024 13.2 4.8 2.1 6.0 1.1 4.7 31.9 2025 13.3 4.9 2.2 6.0 1.7 4.8 33.0 2026 13.6 5.0 2.3 6.0 2.4 4.9 34.2 2027 14.4 5.1 2.4 6.0 2.6 5.1 35.5 2028 15.1 5.2 2.5 6.0 2.7 5.3 36.8 2029 15.9 5.3 2.6 6.0 2.8 5.4 37.9 2030 12.4 5.4 2.7 6.0 2.9 5.6 35.1 2031 12.9 5.5 2.8 6.0 3.0 5.7 36.0 2032 13.6 5.6 2.9 6.0 3.2 5.9 37.2 2033 14.3 5.7 3.1 6.0 3.3 6.1 38.4 2034 14.9 5.8 3.2 6.0 3.4 6.3 39.7 2035 15.4 5.9 3.3 6.0 3.6 6.5 40.8 2036 16.1 6.1 3.4 6.0 3.7 6.7 42.0 2037 16.7 6.2 3.6 6.0 3.9 6.9 43.2 2038 17.3 6.3 3.7 6.0 4.0 7.1 44.4 2039 17.9 6.4 3.8 6.0 4.2 7.3 45.7 2040 16.4 6.6 3.9 6.0 4.4 7.5 44.8 Total 2013-

40 361 138 63 132 53 128 875

*Assuming no supply side constraints from 2013 onwards. 1) Without any coal to gas conversion beyond Rabin A for which a government decision has been made. 2) Full coal to gas conversion. See section H below 3) Palestinians currently purchase electricity from Israel. Assuming they do not shift to self-generation until 2040 or continue to buy gas from Israel.

9 Forecast Tables

125

Broad Path Natural Gas Demand By Sector, in BCM*

Israel Electricity

/1

Cogen / desalinati

on & Industry

CNG and

Chemical

Industry

IEC Coal to Gas /2

Palest. Self –

supply of electricity

Jordan (export)

LNG Export

Total Broad Path

2010 5.0 0.4 0.0 0.0 0.0 0.0 0.0 5.4 2011 4.4 0.8 0.0 0.0 0.0 0.0 0.0 5.2 2012 2.1 0.8 0.0 0.0 0.0 0.0 0.0 2.9 2013 5.5 1.5 0.0 0.0 0.0 0.0 0.0 7.0 2014 6.7 1.9 0.0 0.0 0.0 0.0 0.0 8.6 2015 8.6 3.3 0.1 0.0 0.0 0.1 0.0 12.2 2016 8.4 4.2 0.1 0.0 0.0 0.3 0.0 13.0 2017 9.1 4.2 1.5 0.0 0.0 0.5 0.0 15.3 2018 9.8 4.3 1.6 2.0 0.0 3.8 7.0 28.5 2019 10.6 4.4 1.7 4.0 0.0 4.0 7.0 31.6 2020 11.2 4.5 1.7 6.0 0.0 4.1 7.0 34.5 2021 11.9 4.6 1.8 6.0 0.0 4.3 7.0 35.6 2022 12.7 4.6 1.9 6.0 0.0 4.4 7.0 36.6 2023 13.0 4.7 2.0 6.0 0.5 4.5 12.0 42.7 2024 13.2 4.8 2.1 6.0 1.1 4.7 12.0 43.9 2025 13.3 4.9 2.2 6.0 1.7 4.8 12.0 45.0 2026 13.6 5.0 2.3 6.0 2.4 4.9 12.0 46.2 2027 14.4 5.1 2.4 6.0 2.6 5.1 12.0 47.5 2028 15.1 5.2 2.5 6.0 2.7 5.3 12.0 48.8 2029 15.9 5.3 2.6 6.0 2.8 5.4 12.0 49.9 2030 12.4 5.4 2.7 6.0 2.9 5.6 18.0 53.1 2031 12.9 5.5 2.8 6.0 3.0 5.7 18.0 54.0 2032 13.6 5.6 2.9 6.0 3.2 5.9 18.0 55.2 2033 14.3 5.7 3.1 6.0 3.3 6.1 18.0 56.4 2034 14.9 5.8 3.2 6.0 3.4 6.3 18.0 57.7 2035 15.4 5.9 3.3 6.0 3.6 6.5 26.0 66.8 2036 16.1 6.1 3.4 6.0 3.7 6.7 26.0 68.0 2037 16.7 6.2 3.6 6.0 3.9 6.9 26.0 69.2 2038 17.3 6.3 3.7 6.0 4.0 7.1 27.5 71.9 2039 17.9 6.4 3.8 6.0 4.2 7.3 27.5 73.2 2040 16.4 6.6 3.9 6.0 4.4 7.5 27.5 72.3 Total 2013-

40 361 138 63 132 53 128 370 1,245

*Assuming no supply side constraints from 2013 onwards. 1) Without any coal to gas conversion beyond Rabin A for which a government decision has been made. 2) Full coal to gas conversion. See section H below 3) Palestinians currently purchase electricity from Israel. Assuming they do not shift to self-generation until 2040 or continue to buy gas from Israel.

9 Forecast Tables

126






9 Forecast Tables

127

Broad Path Alternative

Synthetic/1 Demand Forecast By Supplier, in BCM



