Israel Electric's fight to keep the lights on

TEL AVIV Wed Jul 18, 2012 3:31pm BST

Electricity pylons and power transmission lines are seen at night near Kibbutz Negba in southern Israel May 17, 2012. REUTERS/Amir Cohen

Electricity pylons and power transmission lines are seen at night near Kibbutz Negba in southern Israel May 17, 2012.

Credit: Reuters/Amir Cohen

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TEL AVIV (Reuters) - In a TV comedy sketch well-known among Israelis, a man sits in his living room bundled in a fur coat with four air conditioners on full blast. A shivering guest asks if he could turn just one of them off.

"Turn off an air conditioner?" retorts the man who, as an employee of Israel Electric Corp, would enjoy free electricity. "Why turn off an air conditioner when I can turn on an electric heater?"

Some viewers may have chuckled when the sketch first aired years ago. But for the majority of Israelis now, facing the prospect of rolling blackouts in sweltering heat, the electricity situation is no joke.

Israel Electric Corp (IEC), which is responsible for nearly every aspect of electricity from running power plants to connecting households, simply cannot keep up with growing demand.

The state-owned utility just lost natural gas supplies from neighbouring Egypt and fuel costs are soaring. Reserves are low and capacity insufficient and the government, under pressure from massive cost-of-living protests, has limited how much it can charge the public for electricity consumption.

IEC is also grappling with a huge debt load exacerbated by generous workforce benefits. Its nearly 13,000 staff enjoy salaries three times the national average - and that free electricity.

Reforms are needed, and fast. But the crackdown the government has been promising for more than a decade is being fiercely resisted by the union, and politicians have backed down from a sweeping plan to split IEC into two companies, one for power generation and one for distribution.

Unions saw the plan as a first step towards privatising the company and feared job cuts.

They are now in protracted negotiations over "mini reforms", while areas around the country's second most populous city Tel Aviv lost power for hours in the middle of the day last week.

YEARS OF NEGLECT

Since Israel's founding 64 years ago IEC has been the only player in the electricity sector, but has never received enough money to cover the expenses of a growing population's demands.

Rates for consumers were kept low by the government which limited cash injections to the company itself. IEC has now accrued a whopping $16 billion in debt and is being kept alive by repeated government-guaranteed bond offerings -- including 2.9 billion shekels ($734 million) raised earlier this month -- which help it pay for fuel but add to its problems.

One source at the company said IEC wanted to issue over $1.3 billion in bonds this month, but the government said it would only back just over half that amount.

With the debt burden a priority rather than infrastructure investment, grid capacity lags well behind demand. Energy Minister Uzi Landau said recently reserves could drop to two or three percent of total production this summer, a dangerously low level. Reserve margins typically stand above 20 percent in developed countries.

The government blames much of the IEC's problems on its workforce.

"The high salaries and free electricity have tarnished the company's image," acknowledged IEC chairman Yiftah Ron-Tal in a recent briefing with reporters.

But by European standards, household electricity bills remain low, and the government's own policies on tariffs have contributed to IEC's fragile financial situation.

According to Eurostat, the EU's statistics database, Israelis paid on average 9.3 cents per kilowatt hour at the end of 2011, well below most European countries. Prices have risen 8.3 percent since then, bringing the total increase to 23.3 percent since March 2011, and another 16 percent hike has been approved.

But that may be too little, too late to cover the country's soaring energy costs.

Israel lost 40 percent of its natural gas supplies last February when saboteurs in Egypt's Sinai peninsula, seizing on the chaos that followed the overthrow of President Hosni Mubarak, began blowing up the pipeline that carried gas to Israel. Gas did not flow for most of 2011 and Cairo officially terminated the 20-year export deal in April.

The remaining 60 percent of natural gas, which is Israel's main energy source, comes from a small offshore field that has subsequently been over-taxed and is nearly depleted.

IEC has had to turn to more expensive fuels like diesel and fuel oil, and at the start of the year said it may need an additional $2.5 billion for those costs alone.

Had all this happened a year from now the effect would have been minimal. Israel recently discovered huge offshore natural gas reserves, enough to secure its needs for decades. But production at the first field, called Tamar, is not due to begin until mid-2013.

IEC lost 785 million shekels in 2011, despite revenue jumping 24 percent to 24.5 billion shekels. With the halt in Egyptian gas IEC said its fuel expenses soared to 25 billion shekels a year from 10 billion.

Underscoring the urgency of the situation, Standard and Poor's put IEC's "BB+" foreign currency rating on "CreditWatch negative" in April, citing weak liquidity.

In late May, Moody's Investors Service's Israel affiliate Midroog lowered its outlook for two of IEC's bonds to "negative" from "stable", noting the utility would have trouble financing operations without government backing.

ODDS ON REFORM

Though the ratings agencies say the government will not let IEC default, Ron-Tal says the situation means it must focus on financial rehabilitation at the expense of developing the electricity grid.

Thus the talks about "mini reform" are focused on opening the country's power grids to competition and new investment. Officials from the finance and energy ministries, IEC management, the electricity regulator and union leaders are under pressure to agree a deal that can be put to cabinet for approval by the end of the year.

According to an official at the Finance Ministry who asked to remain unnamed because of the sensitivity of the talks, the current plan is leave IEC intact but to take power grid management out of its hands and create a different entity -- a dispatcher of sorts which could allocate resources from a central network to which private firms also contributed energy.

"This will facilitate the creation of fair play and competitive conditions for private electricity producers," said Amit Mor, chief executive of energy consulting firm Eco Energy and former Energy Ministry official and consultant to the World Bank.

The government began to introduce competition in the electricity sector very slowly in 2004 when it granted a tender to OPC, part of the Israel Corp (ILCO.TA) conglomerate, to build a private power plant. Since then private companies Dalia and Dorad have also won licences to build private power plants. The first will begin production in January.

By 2020 these plants could supply as much as 30 percent of the country's electricity, Mor said, serving both IEC and some of its current industrial clients and hastening the need for the former to restructure if it hopes to maintain market share.

However, the success or failure of the planned reforms hinges largely on whether the government can cut a deal with labour. IEC wants to offer early retirement to reduce its workforce by 2,000 and scrap perks like free electricity. Union leaders want to limit the cuts to 1,000.

Observers decline to lay odds on the chances of an agreement being reached.

"Much depends on the flexibility of the government, the company and employees. The parties are aware of the gravity of the situation," said Mor.

"I hope that an agreement can be reached by the end of the year. This is crucial for the company."

($1 = 3.95 shekels)

(Editing by Sophie Walker and Sonya Hepinstall)

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