The Dutch Disease

After several decades in which Israel’s ‘energy sector’ comprised a bunch of half-baked local companies (legally structured as partnerships, but let’s skip the niceties) in the “oil exploration sector”, Israel is on the way to becoming an energy producer and an energy exporter. The process began in 1999, when deposits of natural gas were discovered offshore by the ‘Yam Thetis’ group: those fields have now been developed and will soon be exhausted. They were thus not big enough to be a game-changer at the macro level. In January 2009, however, an Israeli syndicate headed by companies owned by Yitzchak Teshuva and partnered with the veteran American exploration company Noble Energy, made a major discovery in the Mediterranean, off Haifa. The Tamar field was, even on initial estimates, a major find – apparently the third-biggest in the world last year and potentially enough to supply Israel’s needs for 15-20 years. Its immediate impact was to save the Teshuva group from being dragged down to Davy Jones’ locker by the deadweight of debts used to finance his global real-estate empire. But that is a side-issue (unless you happen to be a shareholder or bondowner in the Teshuva group).

 Tamar and the wells being drilled in its general area have spurred a massive speculative boom in the local oil exploration sector, and the relevant companies have become the darlings of the local stock exchange, with every item of information and misinformation about them scrutinized as if it was holy writ. That is also nice, but also a side-issue, unless you are a speculator on the Tel Aviv Stock Exchange. What really matters is that there is no longer any doubt that the Israeli energy sector – mostly natural gas, but maybe some oil too; mostly offshore, but maybe some onshore, too – has become a big deal.

The myopic and bean-counting response of some Israeli government officials has been to propose changing the rules governing taxation and royalties of oil and gas discoveries. If this is done retroactively, as some of the stupider and more intensely obtuse proposals suggest, then the golden goose will be slaughtered whilst still a chick (or whatever baby geese are called). If it is done sensibly, in a graduated manner and with future effect, there should be enough profit for everyone, including the taxpayer. But even that is not the point.

The prospect of Israel generating most, or all, of its energy requirements from its own resources is truly a game-changer, with massive implications for the entire economy and, even more critically, for the country’s geo-strategic position. These implications will be realised gradually, as he process of bringing  ‘onstream’ the fields that have been, are being and probably will be discovered will take several years and cost many billions of dollars. Changing the energy infrastructure of the country from being based on oil or coal to natural gas – starting with the Israel Electric Corporation, where the process is already well underway —  will also take years, but will be ultimately be highly worthwhile economically and ecologically.

 The primary macro-economic impact of this change will be in Israel’s trade. Energy imports are by far the largest single factor influencing the country’s balance of trade and, by extension, its balance of payments. In late 2008, when oil prices collapsed, the  chronic trade deficit evaporated and, for months, Israel ran a trade surplus. Ideally, the new vista is of a permanent trade surplus and an even bigger surplus on the balance of payments than we have been running in recent years.

 But there is another side to the impending energy bonanza. The dark side of the force, in the context of natural resources riches, is called ‘the Dutch disease’. In the late 1960s, Holland – the epitome of a hard-working, Protestant-ethic, sober and no-nonsense industrialized European economy – made major offshore discoveries of natural gas. The result was that Holland ‘struck it rich’, the Dutch currency soared in value, Dutch labour and Dutch products became uncompetitive – a fatal development for a small trading economy such as Holland — and the country’s economic and social fabric suffered serious damage. A decade later, the process repeated itself in the UK, when North Sea oil began to flow and sterling became a ‘petro-currency’ during the second oil shock of 1979-80

 In Israel’s case, the shekel is already overvalued and the decline of the euro is rapidly exacerbating this problem. The dreaded Dutch disease is a real threat in the medium-term, when the investments have been made and the gas comes ashore. Thus whilst large-scale discoveries of energy sources are a tremendous boon, it is important to remember that they are a mixed blessing.

 At the macro-economic level, the government needs to start thinking very seriously not just abut how much revenue it can rake in – which is the remit of the recently-appointed committee headed by Professor Eitan Sheshinki – but about the very varied and diverse impacts that Tamar, Leviathan and our other offshore assets will have across the board. Ironically, this might prove easier to do after this week’s events, in which Israel made another important offshore discovery – that if you make waves out at sea, they can come ashore as a tsunami.