ISRAEL ELECTRIC
CORPORATION LIMITED
FILES INDEX – Part I
The financial reports, for the year ended December 31, 2010, are presented in a primary order.
Each chapter is numbered separately according to its internal sequence.
Part I
Chapter A - Description of Corporate Business.
Chapter B - Board of Directors' Report on the Status of the Corporation's Affairs.
Supplement - Additional report regarding the efficiency of the internal controls on the financial reporting
The Israel Electric Corporation Ltd.
Chapter A
Description of the Corporation's Business Affairs
For the Year Ended December 31, 2010 Prominent Disclaimer
This English translation of the “Description of the Corporation's Business Affairs” for the year ended December 31, 2010 ("English Translation") is provided for information purposes only.
In the event of any conflict or inconsistency between the terms of this English Translation and the original version prepared in Hebrew, the Hebrew version shall prevail and holders of the Notes should refer to the Hebrew version for any and all financial or other information relating to the Company.
The Company and its Directors make no representations as to the accuracy and reliability of the financial information in this English Translation, except that the Company and its Directors represent that reasonable care has been taken to correctly translate and reproduce such information, yet notwithstanding the above, the translation of any technical terms are, in the absence of generally agreed equivalent terms in English, approximations to convey the general sense intended in the Hebrew version.
The Company reserves the right to effect such amendments to this English Translation as may be necessary to remove such conflict or inconsistency.
2 Table of Contents Section A: Description of Corporate Business 1. Description of the economic development of Company business ...... 4 1.1 Company activity and description of business development ...... 4 1.2 Chart of the Company's Holding Structure...... 5 1.3 Areas of Activity ...... 5 1.4 Investments in Company capital and dealings in its shares ...... 6 1.5 Distribution of dividends ...... 6 1.6 Financial information regarding areas of Company activity (In millions of NIS adjusted to December 31, 2010) ...... 8 1.7 General environment and effect of external factors on Company activity ...... 9 1.8 Electricity rates...... 58 2. Matters Relating to Each Activity Segment Separately...... 79 2.1 The Generation Segment...... 79 2.2 The Transmission and Transformation Segment ...... 117 2.3 The distribution segment ...... 127 3. Description of the Company’s business - matters pertaining Company activity in general...... 140 3.1 Information on Business Initiative...... 140 3.2 Insurance and risk management...... 141 3.3 Customers - consumers of electricity ...... 142 3.4 Marketing and distribution ...... 144 3.5 Seasonality...... 144 3.6 Research and development ...... 145 3.7 Human resources (see Annexes E, F and G below) ...... 147 3.8 Fixed assets and facilities ...... 158 3.9 Working Capital ...... 160 3.10 Financing...... 160 3.11 Taxation...... 162 3.12 Restrictions and regulation of corporate activity ...... 162 3.13 Trade Restrictions Regulations ...... 172 3.14 Material agreements...... 174 3.15 Legal proceedings ...... 175 3.16 Strategy and objectives ...... 175 3.17 Discussion of risk factors ...... 177
3
1. Description of the economic development of Company business
1.1 Company activity and description of business development The Company was incorporated in Israel on March 29, 1923 with the main purpose of generating, transmitting, distributing, selling and supplying electricity to all consumers.
The Company was registered under the name The Palestine Electric Corporation Ltd., which in 1961 was changed to its current name, The Israel Electric Corporation Ltd.
Soon after its establishment, the British Mandatory Government in Palestine gave the Company a concession known as the Jordan Concession, and assigned to it a concession known as the Yarkon Concession (which was originally granted to Pinchas Rutenberg). By virtue of these concessions the exclusive right to generate, supply, distribute and sell electricity all over Mandatory Palestine, excluding Jerusalem and its surroundings was bestowed upon the Company.
These concessions were ratified by the Electricity Concessions Order, 1927 ("The Electricity Concessions Order"), that was published in chapter 52 of the Laws of Palestine (“the concession” or “the concessions”).
The validity of the concessions granted by the Electricity Concessions Order ended on March 4, 1996, and since March 5, 1996 the Company has been subject, among others, to the provisions of the Electricity Sector Law – 1996 ("the Electricity Sector Law") which has been amended several times, since its enactment. The Electricity Sector Law can be seen on the Internet site of the Public Services Authority - Electricity (“the Electricity Authority”), at www.pua.gov.il.
Regarding the structural change required by the provisions of the Electricity Sector Law and the Company’s preparations for its implementation, see section 1.7 below.
Regarding the organizational restructuring of the Company ("Matzpen Plan") see section 3.7.4 hereunder.
The Company is owned by the State of Israel, which holds about 99.85% of its shares, and therefore the Company and its activities are subject to the Government Companies Law – 1975 (“the Government Companies Law”). In the Companies Law – 1999 (“the Companies Law”), the definition of “public company” was changed and currently, pursuant to Amendment No. 3 to the Companies Law, the Company is defined as “a company whose shares are registered for trading on a stock exchange or were offered to the public in a prospectus within the meaning of the Securities Law, or offered to the public outside Israel, according to the public offering document, required by laws outside Israel and are held by the public.”
On February 7, 2005, following the Company’s request to the Government Companies Authority ("the Companies Authority") to clarify the issue of its status as a public or private company, the Company received an opinion from the legal advisor of the Companies Authority, indicating that in the opinion of the Companies Authority, the Company is a public company within the meaning of the Companies Law. According to the opinion, the fact that it was not possible to identify with certainty the origin of shares held by the public did not justify denying the protections granted by the Law to the public shareholders, and the burden of proof lay with the Company to show that all such shares actually originated from private issues.
4 In light of Amendment 3 to the Companies Law and the changed definition of “public company” in the Companies Law and in view of the opinion of the legal advisor of the Companies Authority, the Company is operating as a public company.
1.2 Chart of the Company's Holding Structure
Israel Electric Corporation Ltd.*
50% 99.98% 100%
Advanced Studies Fund Jordan Properties National Coal Supply of Israel Electric Company Ltd. Corporation Ltd. Corporation Ltd.,
* Other inactive subsidiaries and secondary subsidiaries of the Company are excluded from the chart. The Company also has minor and negligible holding (almost zero holding rate) in the following companies: Israel Chemicals Ltd., Binyaney Ha'Uma Ltd., and The Farmers Company in Israel Ltd., as well as the government company, Mekorot Water Company Ltd. Please note that the Company includes the National Coal Supply Corporation Ltd., in its consolidated financial statements.
1.3 Areas of Activity The Company operates as one coordinated and integrated system engaged in the provision of electricity, from the electricity generation stage through transmission, distribution, supply and trade. The Company is also engaged in construction of the infrastructures required for the aforementioned activities. The Company’s activity covers three main segments of activity1 :
1 Note that the sectors of activity according to the Electricity Sector Law also include system management, supply and trade in electricity.
5 1.3.1 Electricity generation, including all activities involved in the generation of electricity at the Company’s sites (see sections 2.1.1 and 2.1.15 in this report).
1.3.2 Electricity transmission and transformation, including transmitting electricity from generation sites along ultra high and high voltage cables to switching stations, and between switching stations and sub stations, over high and ultra high voltage lines using transformers (see sections 2.2.1 to 2.2.11 in this report).
1.3.3 Distribution of electricity, including sending electricity from sub stations to consumers over high voltage lines and low voltage lines, and supplying and selling electricity to consumers (see sections 2.3.1 to 2.3.12 in this report).
For financial information about the Company’s areas of activity, the principles and the results of allocation of statements of operations and balance sheets according to operating segment, see section 1.6 in this report and Notes 34 and 38 to the Company's Financial Statements as of December 31, 2010.
Although pursuant to the provisions of the Electricity Sector Law, the Electricity Authority defined separate rates for the Company for the different segments of activity, nevertheless most consumers of electricity pay one weighted rate for their electricity, which includes all segments of activity. Therefore, matters relating to Company customers, seasonality, human resources, research and development, working capital, financing, taxation, objectives, business strategy and risk factors are described with reference to the Company as a whole (see sections 3.1 to 3.17 in this report).
1.4 Investments in Company capital and dealings in its shares To the best of the Company’s knowledge, there were no material dealings in its shares in the last two years.
1.5 Distribution of dividends
a) The policy of the Companies Authority on payment of dividends 1) According to the provisions of section 33(c) of the Government Companies Law, a Board of Directors decision regarding the appropriation of earnings of a Government company, including distribution as defined in the Companies Law, must be approved by the Companies Authority; if the Companies Authority disagrees with the Board’s decision, then a company of the same type as the Company (so long as it is not undergoing privatization) shall act in accordance with the decision of the Companies Authority (as approved by the Government).
2) The current policy of the Companies Authority (which may change from time to time) with respect to the appropriation of earnings to payment of dividends, from 1995 onwards, divides the earnings from which dividends will be paid into two types:
(a) Dividends from current earnings will be paid in public service companies, equal to 60% of the annual net current income, before payment from earnings of bonuses to employees.
(b) Dividends from cumulative earnings will be determined for each company specifically, taking into account the instructions of the company's incorporation articles, the instructions of the law and a number of relevant facts, including investment requirements for the next few years, liquid resources, cash accumulated, cash flow,
6 financial leverage, working capital requirements and possible privatization of the company.
The provision for dividends was recorded in view of the directives of clause 3 of the Companies Authority circular no. c2-97/1 dated February 9, 1997, and the Companies Authority’s clarification that when recording dividends, attention must be paid to all elements of the net income before payment of bonuses to employees from earnings.
The Company’s Board of Directors believes that according to the tests in section 302 of the Companies Law, which in the view of the legal advisers takes precedence over the contents of the Government Companies Law and the Authority’s circulars, it is proper to determine the amount of dividends that should be distributed in accordance with the tests in the Companies Law only. Therefore, the aforementioned recorded appropriation does not detract from or affect the position of the Board of Directors regarding the distribution itself.
b) Dividends on account of earnings in 2008- 2009 The Company recorded a profit for 2008 and 2009, therefore the dividends calculated for 2008, before the restatement, according to the policy of the Companies Authority amounts to approximately NIS 351 million (after the restatement, the calculated sum would have amounted to approximately NIS 466 million) and the dividends calculated according to the same policy for 2009 amounts to approximately NIS 763 million. Distribution of dividends with respect to these two years is subject to the approval of the Board of Directors of the Company. The Government Companies Authority does not intend to request distribution of dividends for the years 2008-2009.
For details on dividends for the previous years, see the Statement on Changes in Shareholders’ Equity in the Financial Statements. c) Dividends on account of earnings in 2010 No provision for dividend was made with respect to 2010. d) Profits available for distribution The balance of profits available for distribution as of the date of this report is NIS 15,615 million.
7 1.6 Financial information regarding areas of Company activity (In millions of NIS adjusted to December 31, 2010)
For the year ended December 31, 2010
Income from Attributed Ordinary Revenues costs Operations Assets Generation 14,896 14,43 753 39,998 Transmission and transformation 1,733 1,196 537 16,279 Distribution 2,793 2,408 385 22,990 Total 19,422 17,747 1,675 79,267
For the year ended December 31, 2009
Income from Attributed Ordinary Revenues costs Operations Assets Generation 14,731 12,989 1,742 42,181 Transmission and transformation 1,741 1,180 561 16,979 Distribution 2,832 2,400 432 22,442 Total 19,304 16,569 2,735 81,602
For the year ended December 31, 2008
Income from Attributed Ordinary Revenues costs Operations Assets Generation 20,221 17,443 2,779 43,083 Transmission and transformation 1,784 1,205 579 17,341 Distribution 2,926 2,495 421 22,923 Total 24,921 21,142 3,779 83,347
Fuel costs of the Company are variable costs. All other costs are fixed short term costs.
For details of the rules and assumptions under which the division into operating segments was made, and other details, see Notes 34 and 38 to the Financial Statements as of December 31, 2010.
8 1.7 General environment and effect of external factors on Company activity 1.7.1 The Electricity Sector Law as Amended
Since March 5, 1996 the Company has been operating in accordance with the Electricity Sector Law and its regulations. In addition, the Company is subject to the provisions of the Government Companies Law and its regulations.
The Electricity Sector Law replaced the Electricity Concessions Order and pursuant to it the Company is continuing its regular activities and provision of services, all subject to its provisions. The first licenses for the Company’s activity in accordance with the Electricity Sector Law were received on September 4, 1997 (see this section following and section 1.7.3 of this report).
The purpose of the Electricity Sector Law is to regulate activity in the electricity sector for the public benefit, while ensuring reliability, availability, quality and efficiency, and creating the conditions for competition and minimizing costs.
As stated, the Electricity Sector Law has been amended several times, among other things in order to regulate structural changes in the electricity sector (including the future structure of the Company). The main points of the Electricity Sector Law given below refer to its format after the introduction of Amendment 9 of July 23, 2009.
1. The main provisions of the Electricity Sector Law regarding structural change The rules for granting licenses by the Electricity Authority, with the approval of the Minister of National Infrastructures ("the Minister"), pursuant to the Electricity Sector Law, include a number of restrictions, as detailed below.
Different activities in the electricity sector will be separated, and in general, it is prohibited for one entity to be granted a license for more than one activity (subject to exceptions described below) and ceilings are set for generation capacity covered by generation licenses held by a person, and for the extent of distribution covered by distribution licenses held by a person, and also imposes other restrictions on the licenses held by a cluster of companies, particularly the possession of licenses of different types and the generation capacity and of the distribution permitted to be held by the cluster of companies (see sub-sections e – h below).
At the date of this report, the Company has licenses for 100% of its transmission, distribution, supply and generation capacity. Pursuant to the Electricity Sector Order, Dates Postponement – 2010 ("Dates Postponement Order") licenses of the Company for all its operations were extended up to January 1, 2012.
The main rules for and restrictions on granting licenses according to the Electricity Sector Law and its amendments are as follows:
a) A license is granted for one activity, location or defined area, and different types of generation licenses may be granted for one power station (section 4(b) of the Electricity Sector Law).
b) The Electricity Authority, with the Minister’s approval, may grant a license for an activity (generation, transmission, system management, distribution, supply and trade in electricity), stipulate terms in it, and either limit or not limit its period of validity (section 4 of the Electricity Sector law).
9 c) An entity shall not be granted a license for more than one activity; however:
1) A generation license may be granted with a supply license, taking into account, inter alia, the development of competition in the electricity sector (section No. 4 (b1) (1)). A supply license cannot be granted to the holder of a transmission license . However, the transitional provisions specify that a holder of a distribution license that is a Government company or Government subsidiary may be given a supply license up to January 1, 2012, and the Minister of Finance and the Minister of National Infrastructures ("the Ministers") may, in consultation with the Companies Authority and the Electricity Authority, stipulate in an Order that such supply license may be granted up to January 1, 2013 (section 60 (d 10) of the Electricity Sector Law). A supply license may be provided to companies possessing distribution licenses which are not Government companies or Government subsidiaries until January 1, 2012. The Ministers, in consultation with the Electricity Authority, are permitted to issue orders stating that such a company may be provided a supply license until January 1 2013, and they are permitted, after proper consultation, if they determine that such an action is essential for the advancement of the goals of the Electricity Sector Law, to postpone - by legal order - the aforementioned date by a period of no greater than six months (section 60 (d 12) of the Electricity Sector Law).
2) Generation licenses may be given to the holder of a system management license or its subsidiary, if its license so provides and this is essential to ensure reliability of electricity supply, providing that such licenses shall not be granted for 5% or more of the generation capacity in the market, and if the Minister determines that there are special circumstances, for 10% or more of this capacity (section 4 (b1) (2) of the Electricity Sector Law). d) No generation license shall be granted to a person that, after receiving the license, shall control 30% or more of the generation capacity in the market, and no distribution license shall be granted to a person that, after receiving the license, shall control 25% or more of the distribution capacity in the market (section 6 (g) (3), 6 (h) (3) of the Electricity Sector Law). e) No generation or distribution license shall be granted to whoever controls the holder of a transmission license (section 6 (e) of the Electricity Sector Law). f) No transmission license shall be granted to whoever controls the holder of a generation or distribution license (section 6 (f) of the Electricity Sector Law). g) No generation license shall be granted to an entity that controls:
1. The holder of a distribution license for 10% or more of distribution capacity in the market (section 6 (g) (1) of the Electricity Sector Law); or
2. The holder of a distribution license if the controlling entity, after receiving the requested license, holds 10% or more of the generation capacity in the electricity sector (section 6 (g) (2) of the Electricity Sector Law). h) No distribution license shall be granted to an entity that controls:
1. The holder of a generation license for 10% or more of generation capacity in the market (section 6 (h) (1) of the Electricity Sector Law); or
10 2. The holder of a generation license if the controlling entity, after receiving the requested license, holds 10% or more of the distribution capacity in the electricity sector (section 6 (h) (2) of the Electricity Sector Law). i) System management operations are operations requiring a license in accordance with the Electricity Sector Law (the license is an essential service supplier's license) (section 2 of the Electricity Sector Law). j) No license shall be granted to a person, excluding the State, that after receiving such license will have a system management license, or will control the holder of such a license, or will be the holder of a distribution, generation or supply license, or will control the holder of such licenses, except as stated in paragraph c(2) above. Accordingly, the holder of a system management license shall be a separate corporation outside the corporate structure of the Company. Nevertheless, at this stage, the Company can continue its system management activity, and the licenses of the Company for all its operations, including system management activities, were extended up to January 1, 2012, with an option for additional extensions in future (see additional details of Amendment No. 8 below). k) The Ministers, in consultation with the Electricity Authority and with the Companies Authority, may determine different percentages from those stated in paragraphs (d), (g) and (h) above, which specify the limitations on the granting of generation and distribution licenses, if they believe that this is essential for promoting the aims of the Law (the different rates may involve either an increase or a decrease in the total generation and distribution capacity that one entity may hold or that a license holder may control through control of other license holders, as the case may be), and also determine additional restrictions to those specified above on the granting of licenses (section 6 (i) of the Electricity Sector Law). l) Licenses validity – it was decided that licenses granted to the Company pursuant to the Electricity Sector Law and that were in force before the end of the transitional period (March 3, 2006), will remain in force for all the activities they cover until July 1, 2009. As of the date of the report, the licenses of the Company have been extended by the "Dates Postponement Order" up to January 1, 2012 (section 60 (d4) (2) of the Electricity Sector Law). Licenses extended as aforementioned, will remain in force for the duration of the extension period, provided that the Company will comply with the provisions of these licenses, with the stipulations of the Electricity Sector Law and the stipulations of any other law (for extension of the validity of these licenses, see paragraph (q) below.) m) Granting substitute licenses - the Electricity Authority, with the Minister’s approval, may grant substitute licenses to the licenses of the Company, or to some of them, during this period. In the event that substitute licenses are granted, then licenses of the Company will apply only to the activities for which no substitute licenses were granted (section 60 (d4) (4) of the Electricity Sector Law). n) Receiving generation licenses for new facilities - the Electricity Authority, with the Minister’s approval, may grant additional generation licenses to the Company, so that the Company may be granted new licenses within the framework of its current operations for the power stations included in the development plan approved pursuant to section 19 of the Electricity Sector Law up to January 1, 2009, for the period for which the Company’s
11 licenses that were granted will be in force (section 60 (d5) of the Electricity Sector Law). o) The Electricity Authority, with the Minister’s approval, may grant generation and distribution licenses to a Government company or Government subsidiary, with respect to the electricity system operating in accordance with the licenses, as detailed in sections l, m, and n above, even if this contradicts provisions that no entity shall hold licenses for generation of 30% or more of the generation capacity in the electricity sector, and 25% or more of the distribution capacity in the case of distribution licenses, providing that all the following conditions are met (section 60 (d6) of the Electricity Sector Law):
1) Generation licenses will only be granted if after receiving the license, the license holder will have power stations operating on a mixture of different types of fuel, including diesel, natural gas and coal, but, relating to coal, it is possible that the license applicant does not itself produce electricity from coal but has rights to obtain electricity generated in a coal powered facility. A license holder according to this paragraph shall be deemed to concentrate a significant portion of generation in the electricity sector and shall be subject to the provisions of the Electricity Sector Law regarding the holder of an essential service provider’s license, unless the Minister determines otherwise. A decision by the Minister before January 1, 2015 requires the consent of the Minister of Finance.
2) Distribution licenses shall be granted so that the costs of the license holders for the electrical facilities used in their activity, at the time of granting the licenses, are as similar as possible; however, the Ministers may, in consultation with the Electricity Authority and the Companies Authority, determine otherwise if they believe this is necessary to promote the purposes of the Electricity Sector Law.
3) After obtaining the license, the license holder shall not control, through another corporation, 30% or more of generation capacity in the market, or 25% or more of the distribution capacity.
4) The validity of the license shall be conditional on the fact that, from July 1, 2013, no Government company or Government subsidiary, jointly or separately, shall hold more than 51% of the means of control of the holder of a distribution or generation license, granted pursuant to this section. This limitation will apply to the Company in the event that the Company will receive new generation and distribution licenses for its subsidiaries.
5) By January 1, 2011, the Ministers will determine, in consultation with the Electricity Authority and with the Companies Authority, by way of an order, if any Government company or Government subsidiary that owns the means of control of the holder of a generation or distribution license may also own the means of control of the holder of a transmission license (section 60 (d8) (1) of the Electricity Sector Law) was extended under the Dates Postponement Order for one year, up to January 1, 2012, the last date of the aforesaid ministers decision.
6) If the Ministers issue an order as per paragraph (1) above, stating that a Government company or Government subsidiary may not own the means of control of the holder of a transmission license, they will also determine the date and manner for implementing this
12 decision, providing that the date shall be no later than January 1, 2013 and the validity of the transmission license will be conditional on compliance with this order (section 60 (d8) (2) of the Electricity Sector Law).
7) If the Ministers issue an order as per paragraph (1) above, stating that a Government company or Government subsidiary may own the means of control of the holder of a transmission license, they may also, in the same order, stipulate the terms, restrictions and provisions that will apply to such holdings, in order to promote the purposes of the Electricity Sector Law, and the validity of the transmission license will be conditional on compliance with this order and the provisions of the law forbidding a Government Company or a Government subsidiary, starting from July 1, 2013, from holding more than 51% of the means of control of the distribution or generation license holder (section 60 (d8) (3) of the Electricity Sector Law). p) From January 1, 2009, a Government company or Government subsidiary which holds the means of control of a license holder pursuant to the provisions of section 60 of the Electricity Sector Law, may not engage in the field of engineering design of power stations, construction of power stations, logistics, information technology or the purchase of all types of fuel. In addition, from that date onwards, a Government company or Government subsidiary with a license as per the provisions of section 60 of the Electricity Sector Law, may not engage in such occupations for another corporation with a license pursuant to the Electricity Sector Law. However, if corporations have been established that may engage in such occupations, the Ministers shall stipulate in an order that the Company may continue to engage in these occupations until January 1, 2010, and also that notwithstanding the provisions of the Obligation for Tenders Law – 1992 (hereinafter: “the Tenders Law”), a Government company or Government subsidiary that holds a license pursuant to the provisions of section 60 of the Electricity Sector Law shall give preference to these corporations, all for the period and under the terms stipulated (section 60 (d9) of the Electricity Sector Law). As of the report date, the process of restructuring the Company was not implemented, therefore, the said service companies were not yet formed. Hence, the Company, as a license holder, may engage in the said occupations for itself and for other corporations that are not license holders according to the Electricity Sector Law. It should be clarified that parties interested in generating electricity receive a conditional license from the Electricity Authority, prior to building a power station. q) Extension of Dates and Licenses - The Ministers may, in consultation with the Electricity Authority and with the Companies Authority, if they believe that this is essential to promote the purposes of the Electricity Sector Law, may issue an order, upon approval of the Economic Affairs Committee of the Knesset to postpone the dates in: paragraph (c)1, (granting a supply license to a Government company or Government subsidiary that holds a distribution license until January 1, 2012, or by approval of the Ministers up to January 1, 2013); paragraph (l) (licenses validity – licenses of all the operations were extended by the Dates Postponement Order up to January 1, 2012); paragraph (m) (granting alternative licenses); paragraph (n) (granting additional generation licenses to power stations included in the development plan up to January 1, 2009) and paragraph (p) (the decision of the Ministers up to January 1, 2011, on the possibility that a Government company or a Government
13 subsidiary that holds control of a holder of a generation license or a distribution license will also hold the control means in a holder of a transmission license and implementation date thereof) above, for additional periods of no more than one year each time. Postponement of the dates regarding the permission to grant the Company generation licenses for new facilities, as detailed in paragraph (n) above, will be implemented only after the Ministers believe that there is no other reasonable alternative to the construction of a power station, with due consideration of the urgent needs of the energy sector (section 60 (d11) of the Electricity Sector Law). As at the report date, the licenses of the Company for all its operations were extended by the Dates Postponement Order up to January 1, 2012.
The Structure of the Company after implementing the structural change required by the Electricity Sector Law In the Company’s opinion, based inter alia on the policy document detailed in section 2 below, implementing the amendment to the Electricity Sector Law makes it possible to change to a corporate structure on a gradual timetable, whereby the Company, as a parent company, will hold subsidiaries as follows: at least four companies with generation licenses, operating with a similar mix of fuels (subject to the remark on generation using coal in section (o)(1) above), each of which will hold licenses for a maximum of 30% of generation capacity in the market; at least four companies with distribution licenses, each holding licenses for a maximum of 25% of the distribution capacity in the market, where the costs for the electricity facilities used by each company will be as similar as possible; a company with a transmission license, for which the Ministers will determine by January 1, 2012, whether it will remain in the framework of the Company concern; and one or more companies to provide services (see sub-section (p) above). Until July 2013, the parent company may hold a maximum of 51% of the means of control of the generation or distribution companies. The system management activities are activities that require a license in accordance with the Electricity Sector Law and will be conducted in a separate corporation, outside the corporate structure of the Company.
It is also clarified that the interpretation given above is not the only possible interpretation of the Electricity Sector Law, which may also be construed as stipulating a different structure of license holding in the electricity sector, including absolute corporate separation between the holders of licenses for the different segments of activity (subject to the aforesaid possibility of owning means of control, pursuant to the Law).
In March 2003 the Government decided, in the framework of its plan to privatize Government companies, to charge the Companies Authority with drawing up proposals regarding privatization of Government companies, including the Company, after ensuring implementation of the conclusions of the Committee for Reform in the Electricity Sector and the decision of the Socio-Economic Cabinet on this matter, but no more than 49% of the Company’s shares.
Previously, there was no real progress in the structural changes, due among other things to employee sanctions over the structural change issue (appeals of the Company to the Labor Courts on the structural change issues failed) and since negotiations with various government entities on the restructuring issue did not mature into agreements. Therefore, in the Company’s opinion, in light of the above, it was unable to proceed with the necessary
14 preparations for the structural changes.
It should be noted that at the beginning of May 2009 (following sanctions of the workers' organization over the plan for organizational change "Matzpen" (see section 3.7.4 below)), the Management and the workers' organization agreed to open a process of discussions on the restructuring of the electricity sector and structural change and efficiency in the Company and to open negotiations on resulting workers rights, scheduled to be completed by August 1, 2009, aiming to reach an agreement on the aforementioned changes.
On September 16, 2009, the Board of Directors unanimously agreed to enable effective negotiations between the Company, the State, the Histadrut and the employees organization, without time limits, to establish an agreed upon outline of an organizational change in the Company and restructuring of the Electricity Sector. Representatives of the State, the Histadrut, the employees organization and the Company Management agreed on March 18, 2010 to start an intensive and continued process of discussions on the subject of the structural change and employees rights thereto. These discussions, attended by all parties, were scheduled to take place on several days each week, aiming to reach an agreement on the aforementioned subjects. Following discussions on the structural change, the Management, the workers’ organization and State representatives agreed, in september, 2010, on the following outline of principles: The system management activity will be taken out of the Company and transferred to a separate Government company that will act as the system manager. In the generation segment: a. The whole Ramat Hovav site will be sold and transferred to full private or Government ownership. b. The activity of CCGT 4 of the Alon Tavor emergency plan will be sold and transferred to full private or Government ownership. The Company will plan and build the unit. c. Project D, the coal operated power station will be built as a separate company. The Company will plan and build it and a private partner will be introduced with a shareholding of 51%. d. The prohibition, in principle, that prevents the Company from building additional power stations will be lifted and the Company will build a nuclear power station, or power stations at an equivalent volume, that will be owned by the Company, starting from 2020, according to the needs of the development plan. e. The Company will be allowed to upgrade and replace power stations it owns according to its needs and at the obsolescence of the existing equipment. The Company will be allowed to plan and build power stations and also act in the fields of logistics, computerization and information, in Israel and abroad, and the current limitations on these fields of operation will be lifted. Except the aforementioned changes, activities of the Company will not be incorporated as subsidiaries, including the generation, transmission and distribution activities as well as the activities of the headquarters divisions that serve the Company. All these activities will remain in the Company as one united Company. The Company will operate through profit centers that will enable full transparency and costs attribution according to a model that will be determined in line with the nature of the Company's operations. All the consents to this outline are subject to the consent on all the components of the agreement (structural change, organizational change, efficiency, financial stability and employees' rights). Discussions are expected to be held in the near future between all the related parties on the need for negotiations and discussions on the said components for the purposes of reaching comprehensive agreements to begin its implementation. Implementation of the concluded agreements will only start after concluding all these subjects. If and when the negotiations will mature into an agreement, it will be expressed in a change of the normative condition.
15 See notes 1 c 5 and 1 i to the Financial Statements of December 31, 2010. On December 15, 2010, the Board of Directors of the Company decided to make progress during 2011 in the implementation of the structural change and a comprehensive efficiency plan in the Company. The Board of Directors called upon all the parties involved to cooperate closely and thus enter immediately into intensive discussions to proceed with the agreed upon process.
It should be noted that the final decision regarding the Company’s structural change pursuant to the provisions of the Electricity Sector Law rests with the State and is outside the Company’s control. It is possible that further regulatory approvals may be required.
The information on implementing the organizational change in the Company is forward looking in nature, as defined in the Securities Law. The said information is based on future data of an uncertain realization nature, which are not under the sole control of the Company but depend on decisions of the Government/Ministers/legislation amendments. Moreover, this information is materially based on subjective estimates of the Company as of the date of this report, regarding macro factors which affect the Company and the nature of the decisions it may make in light of these developments. The said estimates may not materialize or materialize partially or not as expected, due inter alia to changes in the positions of the Ministers and the Government or the applicable law, which are outside the Company's control.
2. The Policy Document On February 15, 2007 (just before Amendment 5 to the Electricity Sector Law), the Director General of the Ministry of National Infrastructures, the Budgets Commissioner of the Ministry of Finance and the Director General of the Government Companies Authority, issued a document (“the Policy Document”) containing their main recommendations for implementing the general structural changes in the Company. On the basis of the Government stated decision and the policy document, Amendment 5 of the Electricity Sector Law was passed on March 1, 2007 as detailed above and below, which has been amended a number of times since Amendment 5 and affect the organizational change, the last of which is Amendment 9.
The main points of the Policy Document:
a) Company structure The Company will become a Government owned holding company, from which there will be a gradual split off of subsidiaries in the areas of generation, delivery, distribution and services relating to design and construction of power stations, services and logistics, information technologies and fuel. In addition, on the basis of the existing activity in the Company, a separate fully Government-owned company will be established to manage the system, manage trade and long term planning, and gradually the existing activities of the Company in these areas will be transferred to the subsidiaries, according to the planned timetable. In the intermediate stage, Company Management and any areas of activity not incorporated separately will remain part of the holding company. One of the aims of this structural change is to make the Company more efficient by bringing more generation power into the economy at minimum cost for electricity consumers.
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1) System management
A fully owned Government company will be set up to manage the system, trade and long term planning. Each of these activities will operate as a controlled profit center. Operation of the management company will be regulated. Rates to finance its activity and its operational criteria will be determined by the Electricity Authority. The system management company will be obliged to provide services to all parties in the Electricity Sector, without discrimination.
2) Delivery system
A subsidiary of the Company will be set up to deal with the delivery system and to be responsible for electricity transmission through ultra high and high voltage and for transformation in switching stations and substations. Clear rules will be established for structural separation and independence between the Company and the delivery system company, to ensure the business independence of the delivery system company and the development of competition. The rights to control the delivery system company will be held by the State, to ensure independence and to prevent a conflict of interest between the companies in the group. The operations of the delivery system company will be regulated. The rates for the services provided by the company and its criteria will be determined by the Electricity Authority.
3) Distribution system
The distribution segment of the Company will be split into four or five district companies, creating territorial continuity. The companies will be as similar as possible in their cost structures and scope of activity and will be established and will operate as subsidiaries of the Company, in spheres of responsibility specified in the policy document, with clear rules for structural separation and independence between the Company and the distribution companies and among the distribution companies themselves, to ensure the business independence of the distribution companies and promote competition in the Electricity Sector. Operation of the distribution companies will be regulated. The rates for the services provided by the Company and its criteria will be determined by the Electricity Authority and the distribution companies will be obliged to provide services to all parties in the Electricity Sector, without discrimination.
4) Supply segment
Following the incorporation of the Company’s generation companies (as detailed below), there will be an initial assignment of all consumers in the sector to these companies according to principles determined by the restructuring implementation management and upon approval of the Ministers. The generation companies and additional independent parties, other than the distribution, delivery or system management companies, will supply electricity to consumers, according to supply licenses. The removal of price controls in the generation and supply segments, like consumer ability to choose, will be introduced gradually for groups of consumers, where regulation will be removed first from the largest consumers, and from domestic
17 consumers at the end. Rules to ensure consumers freedom of choice will be defined up to January 1, 2008.
5) Other services
The departments of design, construction and implementation of power stations, information technology, logistics and the fuel and coal segment will be established and operated as a separate company/ subsidiaries of the Company, with clear rules set regarding structural separation and independence between the subsidiaries and the Company and among the subsidiaries themselves in order to ensure the business independence of these companies and development of competition in this sector. After selling 49% of the Company’s holdings in the distribution and generation companies, the Company will be permitted to establish subsidiaries that will engage in other fields of operation. These activities will be subject to the provisions of section 6(d) of the Electricity Sector Law. b) Generation of electricity 1) The policy document presents two alternative structures for the generation companies:
Option 1: Generation activity in the Company’s existing generation units will be transferred to four to six subsidiaries (“the generation companies”). These companies will be as similar as possible in their structure, generation technologies and consumption of fuels used to operate the generation units, and with similar generation costs, except for the coal powered units. Each of the two existing coal sites will be maintained by two generation companies, through joint ownership, and they will not sell electricity directly to consumers.
Option 2: Existing generation activity will be transferred to four subsidiaries, which will be as similar as possible in their structure, generation technologies and consumption of fuel used to operate the generation units, excluding for the coal powered units. Each of the two existing coal sites will be owned by one of the generation companies, so that in addition to the other units, two of the generation companies will each have a coal powered station. The third and fourth generation companies will have agreements to purchase capacity and/or energy from the two companies that own coal powered units. The purpose is to create a similar mix in the supply of electricity.
2) Both aforementioned alternatives will include future coal powered stations (D and E) which will be set up and incorporated by subsidiaries of the Company, subject to the principles given in the policy document and to implement the structural change in the Company, in line with the development plans approved by the Minister of National Infrastructures and subject to any law.
3) The structure and the setting up of the generation companies will be determined in a way that avoids market failures or unfair exploitation of market power in the electricity market.
4) Clear rules will be specified for structural separation and independence between the holding company and the generation companies, and among themselves, to ensure their
18 business independence and to promote competition in the electricity sector.
5) After the sale of 49% of the holdings of the holding company in the generation company, the company will be permitted to engage in water desalination, subject to the provisions of section 6(d) of the Electricity Sector Law regarding the obligation of a essential service provider. c) Regulation and recognition of costs 1) The regulation existing before implementation of the structural change on all segments of the market will continue to apply, and will be removed gradually for the generation and supply segments, as the competitive conditions in the market make it possible. The criteria for this gradual reduction of regulation will be defined by September 1, 2007 by the administration (see section (e) below).
2) The recognized costs of the structural change will be expressed in future electricity rates.
3) The Electricity Authority regulation of rates of the subsidiaries and sister companies will take into account, until it is removed (in generation and supply), a fair return on capital.
4) At the time of the split, the Government will take steps to create the conditions required for financial strength and stability of companies in the Company’s holdings group and the system management company, assuming reasonable business conduct of the regulated companies. d) Transfer of assets and liabilities 1) The Company will transfer to the new companies the assets connected to the segments of activity that they will handle.
2) The Company will continue to be responsible for any loans it has taken out and they will not be transferred to the companies to be established.
3) Assets used by more than one company will be transferred to the company determined by the Ministers, and suitable contracts will be prepared to arrange the use of these assets by the other companies, on terms that will promote the objective of achieving competition as soon as possible.
4) The selling price will be determined according to the book value of the assets in the Company’s books.
5) Part of the price, equal to the balance of the Company’s loans just before the transfer, will be paid gradually by the companies receiving the assets, on dates that will enable the Company to pay its creditors the amounts guaranteed for the loans.
6) The balance of the proceeds will be paid to the Company immediately by the transferee companies. Money originating from the balance of the proceeds that the Company receives from its subsidiaries will be used by the Company immediately for investment in the share capital of the subsidiaries.
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7) The part of the proceeds that is not paid immediately will be repaid with interest to enable the Company to pay the interest that the it owes in accordance with the conditions of the loans taken out.
8) The assets will be sold to the new companies such that the assets and revenues remaining with the Company after the structural change, directly and indirectly – through its holdings in the new subsidiaries, will allow it to settle its debt balances to its creditors.
9) The administration that will deal with implementation of the structural change will be responsible for dealing with the Company’s creditors on matters relating to this change. e) Setting up an administration for the structural change An administration will be set up to prepare all the actions, agreements, documents and decisions necessary to implement all the principles in the policy document, in accordance with the timetable specified therein. By the publication date of this report the aforesaid administration had not been set up. The Director General of the Ministry of National Infrastructures, the Budgets Commissioner and the Director General of the Government Companies Authority will be the steering team of the administration. Each member of the steering team is entitled to appoint a representative(s) on his behalf, who will participate in the meetings in his place. Administration employees will be employed out of the budget of the Government Companies Authority, subject to an unanimous employment approval of the steering team.
An accompanying document to the policy document, dated February 15, 2007, published by the Director General of the Government Companies Authority, the Wages Commissioner in the Ministry of Finance, the Budgets Commissioner in the Ministry of Finance and the Director General of the Ministry of National Infrastructures also includes recommendations on the matter of negotiation with the employees about their rights following the structural change, as follows:
1) A team including Company and Government representatives will conduct accelerated negotiations with the employees’ representatives and the Histadrut in an attempt to reach agreement on the terms for transferring employees from the Electric Corporation to the subsidiaries/sister companies and their working conditions in these subsidiaries/sister companies (hereinafter: “the transfer agreements”), all in accordance with the principles specified in the policy document (hereinafter: “the structural change”).
2) The aforesaid collective agreements will include maintaining the legal continuity of the rights of transferred employees, including retaining their accumulated legal rights such as pension rights.
3) Compensation to employees for the structural change, as agreed in the transfer agreements, will be given by the relevant companies, subject to implementation of milestones in the process of the structural change.
4) Company employees who meet the criteria will be entitled to compensation for the decrease in the holdings of the holding company, either from the holding company or
20 the generation companies or distribution companies, or from the other service companies, as applicable, according to the procedures of the Companies Authority for compensating employees upon privatization. The employees may also compete to purchase further holdings in these companies, on equal terms.
For more details of negotiations with employees on the structural change see Note 24(c) to the Financial Statements as of December 31, 2010.
f) Timetables according to the policy document The policy document sets out detailed timetables for implementing the structural change. Some of them were also incorporated into Amendment 5 to the Electricity Sector Law. Significantly all of the set dates, as specified in the policy document, have passed and Amendment 8 to the Electricity Sector Law cancelled significantly all of the dates set by Amendment 5.
3. Letter from the Director General of the Companies Authority On February 28, 2007, the Director General of the Companies Authority sent a letter to the Company in which he reiterates that during implementation of the reform pursuant to the Electricity Sector Law, including its amendment (the letter referred to Amendment 5), there will be an examination inter alia of the implications of the structural change for the Company’s obligations, with the aim of not preventing repayment of loans taken by the Company (“letter of the Director General of the Companies Authority”).
4. Amendment 8 and 9 to the Electricity Sector Law On August 5, 2008 the Knesset passed Amendment 8 (applied retroactively from July 1, 2008) amending the Electricity Sector Law. See the main amendments to the Electricity Sector Law in section 1.7.1 (l-o) in this report and in addition:
a. Cancellation of the milestones defined in Amendment 5 as a condition to extending the licenses – section 60 (d7) of the Law was cancelled, which before the Amendment to the Law regulated the extension of licenses to the Company and by force of which the Electricity Sector Order (Dates Postponement) – 2007 and the Electricity Sector Order (Extension of Company Licenses Validity and Implementation of the Restructuring of the Electricity Sector) – 2007 (hereafter: "Implementation and Extension Orders") were issued. In effect, the mechanism of the Implementation and Extension Orders, the milestones and the schedules stipulated by law and by the orders to establish generation, distribution and transmission companies were cancelled.
b. Extension of dates and licenses – the Ministers upon consultation with the Electricity Authority and the Government Companies Authority, with approval of the Economic Affairs Committee of the Knesset, will be entitled to extend the aforementioned dates in sections 60(d4)(2) and (4), 60(d5), 60(d8) and 60(d10) of the Electricity Sector Law for additional periods that shall not exceed one year each time. Postponement of the dates regarding the permit to grant generation licenses for new installations to the Company, as indicated in section 60 (d5) of the Electricity Sector Law, will be allowed only after the Ministers are convinced that there is no other reasonable alternative to build a power station, with due consideration of the urgent needs of the Energy Sector (section 60 (d11) of the Electricity
21 Sector Law).
c. As a result of Amendment 8, a future extension of the licenses does not require the Knesset to amend the legislation but grants flexibility to the Ministers, upon approval of the Economic Affairs Committee of the Knesset and under the provisions of the law, to extend the aforementioned dates for additional periods that shall not exceed one year each time.
According to the Dates Postponement Order, the licenses for all the activities of the Company were extended up to January 1, 2012.
Section 17a, added to the Electricity Sector Law on July 23, 2009 under Amendment 9, grants the Electricity Authority the authority to cancel the validity of an essential service supplier's license (after warning that license owner), upon discovery that the holder of an essential service supplier license failed to pay all payments due from him (in accordance with the Electricity Sector Law or the conditions of the license) to another holder of an essential service supplier license. The Company was conscientious in making payments due in accordance with the law to other license holders regularly, on time and as required, except in exceptional cases or in circumstances outside the Company's control (e.g., a strike). In addition, the Company believes that even in the event of violating the obligation to make a payment due to another license holder according to the law, the likelihood of applying such a severe sanction with such far-reaching implications for the electricity sector is very low.
Amendment 9 to the Electricity Sector Law also expands the term "Rates" from payments paid by a transmission license holder to another license holder to include payments paid by an essential service supplier license holder to another license holder, except a payment determined by a tender that is published by the State and also payments paid by an essential service supplier to the consumer for electricity generation by the consumer and payments to the consumer under the demands management arrangements pursuant to the Electricity Sector Law.
Section 17 (c1) of the Electricity Sector Law was also amended accordingly, to regulate payments by every essential service supplier license holder (not limited to transmission license holders as prior to the amendment) to a license holder or a consumer (not limited to license holders as prior to this amendment), to adapt it to the aforementioned definition of "Rates".
5. The position of the Management and the Board of Directors regarding the structural change
Further to Amendment 5 to the Electricity Sector Law, and the decision of the Government on February 18, 2007, the Company’s Board of Directors decided on February 22, 2007 to set up an internal administration in the Company (“the HQ”) to implement the structural change according to the provisions of the Electricity Sector Law. According to this decision, the Company’s Management submitted a detailed plan for the HQ for implementation of structural change to the Regulatory Committee of the Board of Directors, which approved the plan. The HQ has not yet been set up and activated because of employee sanctions (for details see note 24(c) to the Financial Statements as of December 31, 2010).
Pursuant to Amendment 8 to the Electricity Sector Law, future extension of the licenses does not
22 require amendment of the legislation by the Knesset, but the Ministers have been enabled, under the terms provided by the Electricity Sector Law, to extend the said dates for additional periods that shall not exceed one year each time. Accordingly, On December 29, 2010, the Ministers extended the licenses of the Company up to January 1, 2012 by the Dates Postponement Order.
The Company's Management and Board of Directors is of the opinion that the Electricity Sector Law and its amendments do not deal with all of the issues raised by the expected structural change and do not arrange, in detail, the manner of execution of the structural change. In the opinion of the Company's management and Board of Directors, the Company's real restructuring is essential in order to be able to fulfill the duties imposed by the Electricity Sector Law and they intend to act to the best of their abilities to promote a real restructuring under a realistic outline and in agreement with the employees organization. It is stressed that a significant element of the structural change is beyond the control of the Company and rests in the hands of the State. Attention is drawn to the stipulations of the different decisions of the Government regarding the structural change, the policy document and the letter from the Director General of the Companies Authority (see section 1.7.1 1 n and 2 e above and Note 1e3 and 4 to the Financial Statements as of December 31, 2010). Therefore, the Company is doing all it can to work with the relevant elements in the Government, the employees’ organization and the Histadrut in order to reach an arrangement agreed upon, among others, with the Company’s employees. There has been no substantial progress in the past, in implementation of the structural change, due inter alia, to employee sanctions on issues of the structural change and since negotiations with various Government authorities did not yet reach the agreements stage. Therefore, in the Company’s view, this made it impossible to proceed with the necessary preparations for the structural change. During the recent months, following negotiations conducted between the management, the employees’ organization and State representatives, these parties agreed on an outline in principle, as detailed in Note 1i to the Financial Statements as of December 31, 2010. Agreement on this outline is subject to an agreement over the other components of the change, including an organizational change plan, an efficiency plan, financial strength of the Company and regulating employees rights. Discussions between all the parties involved are expected in the coming period to negotiate and discuss the said components for the purpose of reaching comprehensive agreements and for implementing these agreements.
The Company's Board of Directors and its management also believe that executing and implementing the structural change involves dealing with issues relating to the Company’s creditors, in view of agreements with them, to the extent that they are affected by the structural change, subject to the provisions of the Law. As of the date of this report, the Government and the Company had not yet completed dealing with these matters. On December 15, 2010, the Board of Directors of the Company decided to make progress during 2011 in the implementation of the structural change and a comprehensive efficiency plan in the Company. The Board of Directors called upon all the parties involved to cooperate closely and thus enter immediately into intensive discussions to proceed with the agreed upon process.
6. Additional significant provisions of the Electricity Sector Law a) A holder of a license for transmission, distribution or system management, and the holder of one or more generation licenses who were determined by the Minister to concentrate a
23 material portion of electricity generation, are defined as a holder of an essential service provider’s license. The Company was defined as an essential service supplier. b) The Electricity Sector Law stipulates that the holder of an essential service provider’s license:
1) Shall provide the service to the general public without discrimination, according to the Authority’s criteria efficiently and reliably, according to the terms of its license and any law;
2) Shall purchase electricity from a private electricity producer, and provide infrastructure and backup services, according to the terms of its license and any law;
3) Shall provide backup services to the holder of a self generation license, at its request, according to the terms of its license and any law;
4) Shall act to ensure provision of all its services throughout the license period, including services as per the development plan approved according to the Electricity Sector Law, while doing everything necessary to provide the aforesaid services.
The Minister, in consultation with the Electricity Authority, may demand that the holder of an essential service provider license submit for his approval a development plan, either complete or in parts, for the purpose of its activities pursuant to the license, and if it fails to submit such development plan, he may, in consultation with the Electricity Authority, determine a development plan for the license holder, and in this case the license holder must operate accordingly. The Minister may determine regulations regarding the responsibility of the holder of a transmission license for development of the electricity sector, pursuant to the aforesaid development plan, including planning the electricity network.
In addition, the Electricity Sector Law states that: the holder of an essential service provider’s license must prepare financial statements as defined by the Ministers, in consultation with the Minister of Justice regarding the level of detail in them, the accounting principles for their preparation, the declarations and the notes attached to them; the holder of an essential service license will collect payments pursuant to the rates set by the Electricity Authority; the holder of a transmission license will make payments to another license holder according to the rates set by the Electricity Authority; and the Electricity Authority shall determine the criteria by which the holder of an essential service provider’s license shall be entitled not to provide the service or not to make the purchases as required by this Law, to stop, postpone or limit them, if the license holder has not received payments for them according to any law or if the terms for providing the service or making the purchase are not met. c) Transfer, encumbrance and confiscation of the license or the assets:
1) A license or any part of it may not be transferred, encumbered or confiscated, directly or indirectly, except with the Minister’s approval. Also, the guarantees given by the license holder and/or money deriving from their realization may not be encumbered or confiscated.
2) The Minister may stipulate in the license that certain of the license holder’s assets, required in the Minister’s opinion to exercise the licensed activities, cannot be
24 transferred, encumbered or requisitioned, directly or indirectly, except with the Minister’s approval. d) A private electricity producer may sell electricity to the holder of an essential service provider’s license, or to another, according to the license terms. e) The Electricity Authority was set up to act pursuant to the purposes of the Electricity Sector Law and the policies of the Government, the Minister or the policies of the Ministers in accordance with their powers under any law in the electricity sector, and to supervise compliance with the provisions of the Law and the licenses, and to perform other duties as stipulated in the Electricity Sector Law and imposed by any other law. f) The duties of the Electricity Authority shall include:
1) Setting rates and ways of updating them (for further details on rate setting and the applicable legislation see section 1.8 in this report).
2) Setting criteria for the standard, nature and quality of the service provided by the holder of an essential service provider’s license, and setting criteria for cases where such a license holder is not obliged to provide a service or make a purchase, and subject to the development plan approved by the Minister, and supervising compliance with the aforesaid criteria.
3) The Electricity Authority has the authority to define provisions regarding payments by the holder of an essential service provider’s license to consumers for any breach of the aforesaid criteria, and to check and decide on any consumer complaints. In addition, it may give instructions regarding a specific deal with the holder of an essential service provider’s license, if the case is covered in the rules issued by the Minister.
4) Granting licenses and supervising compliance with their provisions.
On the matter of orders regarding rate setting, see section 1.8 in this report. g) The Electricity Sector Law states that the Electricity Authority may grant operating licenses, stipulate their terms, and limit or not limit their period of validity. Such licenses shall become valid after approval by the Minister. In addition, the Law states that the Minister may, if he considers it necessary to advance the purposes of the Law and the Government’s policies or the policies regarding the electricity sector, instruct the Electricity Authority to grant a license, change the terms of a license, add or remove conditions (for reasons to be recorded, after hearing the position of the Electricity Authority on the matter and after notifying the Government); if the Minister issues such an instruction, the Electricity Authority shall execute this instruction within the time specified; if 21 days have passed from the date when the Minister notified the Government and no written request to discuss the notice is received from the Government, the Minister’s instruction shall be deemed valid. In addition, the Law as amended states that the Electricity Authority has various duties of reporting to the Minister. Also, if the Minister deems that the Electricity Authority is not acting properly, and in accordance with the provisions of the Electricity Sector Law, he has the power to dissolve it, if within a reasonable time determined by him the Authority fails to perform its duties (in consultation with the Minister of Finance and with the Government’s approval). Within 30 days of dissolving the Electricity Authority as aforesaid, a new
25 Authority shall be appointed, and until then, the existing Electricity Authority will continue to operate.
h) No license for an essential service provider will be issued except to a company that undertakes to engage only in the activities according to the licenses granted to it under this Law and in associated activities. The holder of an essential service provider license may engage in other activities, after approval by the Ministers in consultation with the Electricity Authority, which will not affect its activities or the supervision of compliance with its obligations under the Electricity Sector Law.
i) The Electricity Sector Law states that in the event that a license granted under the Law is cancelled, suspended or altered for the reasons given in clause 8 of the Electricity Sector Law (the policy of the Government or the Minister regarding the electricity sector, the contribution to the level of services to the public, the benefit to consumers and competition), the Ministers may determine rules for granting compensation to the license holder, but according to the aforesaid rules, it is possible that the rate of compensation may be zero. As of the date of this report, the aforesaid rules have not yet been defined.
1.7.2 The Assets Arrangement a) Regarding certain rights and assets held by the Company before the replacement of the Electricity Concessions Order by the Electricity Sector Law (March 5, 1996), the Electricity Sector Law (section 62) makes the following provisions:
a) Notwithstanding the provisions of clause 46 in the Rider to the Electricity Concessions Order (“clause 46 of the Concession”), the obligations of the Electric Corporation and the rights and assets that it held when the concession expired and for which it is entitled to compensation from the State according to the aforesaid clause, will remain in the possession of the Electric Corporation, and no compensation will be paid for them ("assets subject to compensation") .
b) The rights and assets for which the Electric Corporation is not entitled to compensation (as stated in paragraph (1) above) and which are used or intended for use, whether directly or indirectly, for its operations pursuant to this Law, shall be acquired by the Company at their value on the day such assets and rights are purchased, in accordance with the arrangement to be signed between the State and the Electric Corporation; in this clause, “used” “intended for use” - as determined by the Ministers ("assets in use not subject to compensation").
c) Another group of assets, which are not subject to compensation and are not used and are not intended to be used by the Company in its operations, is defined in clause 46 of the concession, as not entitling the Company for compensation upon transfer to the State, while Section 62 does not regulate the treatment of these assets. However, since the assets are not used and not designated for any use by the Company, they are not part of the definition of “the enterprise”, in its meaning in the aforementioned clause 46 ("unused assets not subject to compensation").
The Law does not specify which assets will be included in paragraph a(1) above (“assets
26 subject to compensation”), and which under the provisions of the Electricity Sector Law remain in the possession of the Company, and it is not required to pay the State for them according to the Law; or in paragraph a(2) above (“assets not subject to compensation”), for which an assets arrangement should be made. Also, the Electricity Sector Law does not define the method for determining the value of these assets.
According to section 62 of the Electricity Sector Law, the Company will indemnify the State for any payment paid by the State arising from any obligation of the Company which was in force at the concession expiration date, resulting from the expiration or from applying the provisions of the Electricity Sector Law regarding the assets arrangement.
In the first year following the expiry of the concession, there were no negotiations, and in any case the parties did not reach an arrangement and the Ministers did not define which are the assets in use not subject to compensation (assets in use or intended for use by the Company) and/or provisions regarding the purchase of such rights and assets (hereinafter: “the assets arrangement”).
4) Until the arrangement is carried out (as stated in paragraph (2) above), the rights and assets for which the arrangement is to be made will remain in the possession of the Electric Corporation, as they were when the concession expired. If the parties fail to reach such an arrangement within one year from the expiry of the concession, the Ministers will stipulate the terms for the purchase of the aforesaid rights and assets.
The Position of the Company on the Subject of the Assets Arrangement The Company believes, based on the opinion of its legal advisers on the matter of the proper interpretation of the assets arrangement, taking into account the provisions mentioned above of the
27 Electricity Sector Law, the rider to the Electricity Concessions Order2, by which the majority of the assets that were held by the Company at the time the concession expired (both depreciable assets that were fully depreciated, and depreciable assets that were not fully depreciated at the time the concession expired, and excluding marginal assets) the assets are subject to compensation and therefore should not be included in the assets arrangement. In the current situation, where implementation of the assets arrangement was not intended to have and does not have a material effect on the Company or its financial position, although this matter is subject to examination by a Government team appointed to determine the method of implementing the structural change in the Company, and to the decision of the Ministers, and therefore there is no certainty that implementation of the assets arrangement will not have such an effect.
The Opinion of the State c. On February 15, 2000 the Company received a letter from the Deputy Commissioner of Budgets in the Ministry of Finance, in which he indicated that the Government team appointed to handle this subject, had formulated a State economic and legal opinion (which was attached to the letter to the Company) (hereinafter: “the State opinion”), the implementation of which could have a material effect on the Company.
According to the State opinion, with reference to the provisions of clause 44(c) and clause 46 of the concession, the Company is not entitled to compensation for investments that were returned to the Company through provisions for depreciation, Therefore, the State opinion included the following assets in the definition of assets not subject to compensation, included in the assets arrangement:
1. All Company assets that at the time when the concession expired had been fully depreciated, due to the fact that the investments in them were recognized in the rate by way of provisions for depreciation (power stations, transmission and distribution facilities, real estate assets and
2 Section 62 of the Electricity Sector Law refers to clause 46 of the concession. In its updated version, after the amendment to the concession in 1970, and under the heading “end of the concession”, clause 46 states as follows:
“At the end of the concession, the enterprise will be transferred free of charge, with all its fixtures and instruments and materials, to the ownership of the High Commissioner, on condition that the High Commissioner pays suitable compensation for the fuels, mechanisms, meters and instruments, whether located in the storeroom or are in transit to the Company or ordered by it and belonging to the Company that paid for them. If the Company has meanwhile set up any laboratory or other scientific institution or library and if the High Commissioner has received that institution or library into his possession, he will pay suitable compensation for them. However, the Company will be entitled to claim appropriate compensation for installations and enhancements under the terms stated in clause 44(c), as if the Government had purchased the enterprise at the time when the enterprise was transferred to the Government’s possession. The provisions of clause 44(f) of the Rider to the Electricity Concessions Order (“clause 44(f) of the concession”) will apply, mutatis mutandis, as if the Government had purchased the enterprise at the aforesaid time.”
28 other assets such as equipment, vehicles and various buildings).
2. Assets that were not fully depreciated, to the extent of what was depreciated less the liabilities, according to a specific rate depending on the source of their funding - mainly power stations, transmission and distribution facilities, certain real estate and other equipment.
3. Company assets that are not subject to depreciation - particularly intangible assets and shares of held companies, but not cash and inventory.
The State opinion sets out criteria for categorizing the assets as stated, as well as formulae for calculating the value of the purchase, based on the economic value of the assets and the liabilities. The State opinion contains no data regarding the economic value of the assets and the obligations or the method of determining it.
The cost as of March 31, 1996 of the assets that were fully depreciated as specified in paragraph 1) above, as shown in the Company’s Financial Statements as of that date, was about NIS 4.46 billion (about NIS 7 billion in the shekels of December 2010).
The net depreciated cost as of March 31, 1996 in the Company’s books of the assets specified in paragraphs 2) and 3) above is about NIS 4.5 billion (about NIS 7 billion in the shekels of December 2010). Note that the aforementioned data is data as of March 31, 1996, whereas the determining date is the concession expiration date, namely March 5, 1996.
In the State's opinion, the total sum of assets not subject to compensation, to be included in the assets arrangement is NIS 7 billion.
In the Company’s opinion, the amounts indicated above should not be used to draw conclusions about the economic value of the assets, according to which the amount that the Company may be asked to pay is supposed to be determined, even if the position expressed in the State opinion is accepted.
Letter of the Electricity Administration Manager
d) Soon after receiving the State opinion, the manager of the Electricity Administration in the Ministry of National Infrastructures (hereinafter: “the manager”) wrote to the Company, on the instructions of the Minister, instructing the Company not to respond to the letter from the Ministry of Finance concerning the assets arrangement before the subject had been discussed in an orderly fashion between the Ministers’ ministries, and between the Company and the Ministry of National Infrastructures.
The Opinion of the Company
e) The Company believes, based on the opinion of its legal advisors, that an interpretation of section 62 of the Electricity Sector Law in a way that obliges the Company to pay such amounts or any similar amount for the purchase of assets from the State, would be contrary to the purpose and declared aims of the Electricity Sector Law, contrary to the proper principles of interpretation, and would adversely affect the Company’s ownership rights because of the damage to its shareholders’ equity, the possible demand for early repayment of Company loans, doubt about its ability to settle its liabilities and continue to function as a going concern, while
29 the clear intention of the legislator was that the Company would exist and perform its functions and the tasks imposed on it by the Electricity Sector Law and in the licenses granted by virtue thereof.
In addition, accepting this interpretation, and assuming that the cost of purchase should be recognized in the electricity rate, would oblige electricity consumers to pay once again for assets whose purchase by the Company has already been funded by consumers through the electricity rates. f) It should be noted that over the years the Company created a number of floating liens on all its assets and rights. The assets arrangement could have implications for the application of the said floating liens on those assets that will be subject to the assets arrangement. g) The Company is of the opinion, based on the opinion of its legal advisors, that the cost to the Company, if and to the extent that there will be any with respect to the assets arrangement or in connection with an acquisition directive from the Ministers, needs to be recognized in the electricity rate base, although there is no certainty of this. h) Certain assets, which, prior to the replacement of the Electricity Concession Order by the Electricity Sector Law, were held and which are not used, and are not intended to be used, in the Company's operations according to the Electricity Sector Law and which, according to the Company's position, based on the opinion of its legal advisors, are not subject to the assets arrangement (unused assets that are not subject to compensation) and therefore should not be transferred to the State, probably will not remain in the Company's possession. The position presented in the Ministry of Finance's Opinion, assumed that these assets have been transferred to the State. The Company's policy was and is to purchase assets, which are designated to be used in the Company's operations to produce and transmit electricity. Therefore, in the Company's opinion, if the aforesaid assets were indeed held, their number is small and their depreciated cost in the Financial Statements is low. No notice was given on behalf of the Ministers regarding this matter as of the report date. i) On the basis of all of the above, the Company, based on the opinion it obtained, believes that the implementation of the assets arrangement was not meant to have and does not have a material effect on the Company or its financial position, although the matter is subject to the determination of the Ministers' team and, therefore, there is no certainty that the implementation of the assets arrangement will not have this effect.
The information on the effect of the assets arrangement on the Company or its financial condition is forward looking in nature, as defined in the Securities Law. The said information is based on future data of an uncertain realization nature, which are not under the sole control of the Company but depend on decisions of the Government/Ministers/legislation amendments. Moreover, this information is materially based on subjective estimates of the Company as of the date of this report, regarding macro factors which affect the Company and the nature of the decisions it may make in light of these developments. The said estimates may not materialize or materialize partially or not as expected, due inter alia to changes in the positions of the Ministers and the Government or the applicable law, which are outside the Company's control.
30 1.7.3 Licenses and regulations drawn up by virtue of the Electricity Sector Law
a) Licenses granted to the Company: 1) On September 2, 1997, the Electricity Sector Regulations (Terms and Procedures for Granting Licenses and the Duties of License Holders), 1997 were enacted, which inter alia stipulate the procedures and terms that a license applicant must comply with to qualify for a license, including terms relating to shareholders’ equity, financial resources and so forth. The regulations also stipulate that the Minister may make the grant of an essential service provider’s license conditional on the license applicant’s organizational and legal structure, or on receiving an undertaking to change the aforesaid structure, and may also order an organizational and legal structure change during the period that the license is in force.
2) The Company has a license for the transmission, distribution, supply and sale of electricity and for trading in it, called the "Gold License" as well as separate generating licenses, granted for the each generation unit separately (“generating licenses”)3. In 2007, a new field of operation was included in the Electricity Sector law, defined as "System Management". The Company performs the system management function under the Gold License, signed by the Minister of National Infrastructures on September 4, 1997, without being granted an additional license for system management. Since the Company has a transmission license, it is defined as an essential service provider pursuant to the Electricity Sector Law. Also, the Minister decided, on the basis of clause 18(b) of the Electricity Sector Law, that since the Company concentrates a significant share of generation and distribution of the electricity sector, it is subject to the provisions of the Electricity Sector Law that refer to an essential service provider. The Ministers extended the Company’s licenses up to January 1, 2012 by the Dates Postponement Order. Since the licenses are extended through orders which are subject to a legal limit as to the number of times the license may be extended, January 1, 2012 is the last time for this extension. The Company estimates that there is no certainty that, at the end of the maximum period for extending the licenses without making the outlined structural changes stated in the Electricity Sector Law, the Company will be granted licenses (in full or in part) or that there will be no change to the terms of those licenses compared to the existing licenses (all or part). On this matter see note 1(b) to the Financial Statements as of December 31, 2010, and also section 1.7 above regarding the structural change. On August 25, 2010, the Company addressed the Electricity Authority with a request for generation licenses for the following generation units: Ramat Hovav - units 6, 7, 8; Haifa power station - units 3 and 4; Hagit - unit 1; and Eshkol - unit 3 ("The Request"). As at the request filing date, all these generation units completed their initial synchronization and commenced operation (except Ramat Hovav 8, which was initially synchronized in November 2010 and Haifa 3 which is expected to commence operation next month). Representatives of the Company even met with representatives of the Electricity Authority on September 15, 2010 and submitted the request to the Electricity Authority together with the attached annexes. It was concluded that the Electricity Authority will speed up the processing of the request.
3 On April 29, 2007, the Minister of National Infrastructures signed six new generation licenses for the following units: Eshkol, Alon Tavor, Gezer 3, Gezer 4, Hagit 2 and Tsafit.
31 On March 23, 2011, the Electricity Authority issued its decision on granting six permanent licenses for generating electricity for a fixed period, according to the Electricity Sector Law and transferred it for the approval of the Minister of National Infrastructures. On March 24, 2011, Chairman of the Electricity Authority and the Minister of National Infrastructures signed generation licenses for six generation units that were synchronized to the grid: Ramat Hovav - Units 6, 7 and 8, Haifa - Unit 4, Hagit - Unit 1 and Eshkol - Unit 1. According to the Electricity Sector Law, the licenses are granted at present up to December 1, 2012. Moreover, under Amendment No. 9 to the Electricity Sector Law of July 23, 2009, section 17(a) was added to the Electricity Sector Law, granting the Electricity Authority the authority to revoke the license of an essential service supplier (after warning that license holder) if it finds that the holder of an essential service supplier license did not remit all payments due (according to the Electricity Law or the license terms) to another license holder. The Company was conscientious in remitting amounts due to other license holders according to any law regularly and on time, except exceptional cases, under circumstances outside of the control of the Company (e.g., a strike). In addition, the Company believes that even in the event of breaching the obligation of paying another license amounts due according to the law, the likelihood of exercising such a severe sanction with such far reaching implications for the electricity sector is very low.
b) Sanctions for operating electricity generating units without a license The Electricity Sector Law provides for sanctions against anyone who operates electricity generating units without a legal license, as follows:
1. Criminal sanctions - according to the provisions of the Electricity Sector Law, performance of any activity requiring a license under the Electricity Sector Law (including the field of electricity generation) without a license constitutes a criminal offense for which the company may be fined. The Law also states that an executive who does not supervise and do everything possible to prevent these offenses being committed by a corporation or any of its employees - may be sentenced to a year’s imprisonment and a fine.
2. Revoking licenses - the Electricity Sector Law states that “no person shall carry out activity except in accordance with a license pursuant to this Law”, and also that “if a license is granted, the license holder shall operate according to its terms”. According to the licenses held by the Company, the Company must follow the provisions of the Electricity Sector Law, including any Law that comes into force after the licenses are granted. A breach of the Law is a breach of the licenses, and the Electricity Authority may revoke the licenses if he finds that any of their terms have been breached (such as by a breach of the Law, as stated).
On May 16, 2007, the Electricity Authority decided on the need for the deposit of guarantees to secure compliance with the terms of permanent electricity licenses. According to this decision, the guarantee ceiling for a license holder shall not exceed 15 million dollars. According to this decision, the Company will be requested to deposit guarantees according to the progress of the Company's restructuring process, including granting of licenses for the activities of the Company. c) Provisions stipulated in the licenses granted to the Company The generation licenses and the Gold License that were granted to the Company stipulate,
32 among other things, that:
1. The Gold License and the majority of the generation licenses stipulate that each activity will be carried out as a separate profit center, and an activity may be carried out in more than one profit center. The profit centers are as ordered by the Minister, or the Electricity Authority, or the Manager, according to the specific formula of each license. Some of the licenses specify that the profit centers will be as ordered by the Minister as specified in the attachment to the license. It should be noted that there were no such attachments to those generating licenses regarding profit centers.
2. The license holder will submit annual financial statements audited by an external auditor separately for each district, each activity, each generating unit or power station and each profit center, as aforesaid in section 1 above and will also submit consolidated financial statements for its activities under each of the licenses it holds. If the holder of a generating license has one or more licenses for additional activities, such statements will also be submitted for those activities, as instructed by the Minister.
3. A license holder will submit a business plan to the manager or to the Electricity Authority or the Minister (as the case may be), including pro forma financial statements audited by the license holder’s external auditor for its activities under the license for each license period. The license holder will update the plan and submit the updated plan to the manager or to the Electricity Authority (as the case may be), each year. The reports will be prepared separately for each district, each activity, each generating unit or power station, and each profit center (for the generating licenses, as instructed by the manager or to the Electricity Authority (as the case may be).
4. The Company will carry out the actions and the services reliably, efficiently and without discrimination in a manner that will not affect possible fair competition.
5. The license holder may carry out the activities associated with the activities under the license, specified in the attachment to the license. Associated activities not included in the attachment must be approved in accordance with the instructions of the Electricity Sector Law.
6. The generating licenses stipulate that each generating unit will be available to generate electricity according to the operating and maintenance plan submitted by the Company and approved by the manager.
7. A development plan will be submitted to the Minister.
8. The Gold License states that infrastructure and support services will be provided to other license holders and the duty to purchase electricity from private producers applies (see clause 2.1.4 in this report).
9. It is forbidden to encumber, transfer or confiscate the assets specified in the licenses (which include most of the Company’s assets) except with the Minister’s approval. The Gold License also states that the Minister may add to or remove from the list of assets in the attachment, throughout the license period.
The inclusion of or reference to an asset, in the attachment, does not grant the license holder any right to such asset and derogate his obligations with respect to that asset, in
33 accordance with the provisions of the Electricity Sector Law regarding the assets arrangement (see Note 1(h) to the Financial Statements as of December 31, 2010). In the event that a third party had any rights in an asset of the assets used for the activities of the license holder on the license application date, the license holder will pledge to the best of its ability to prevent a situation where realization of rights in the asset may affect performance of his obligations according to the license.
10. There shall be no change to or reorganization of the license holder, including merger, split, compromise, arrangement or voluntary liquidation, without the Minister’s approval.
11. The Electricity Authority may at any time revoke all or part of the license, or suspend it or add to its terms, rules and duties or change them, if it finds that any of the license’s terms have been breached, or that any of the restrictions on obtaining it exist, or that the license holder no longer meets the qualifications demanded by the Electricity Sector Law and its regulations. The generating licenses also state that the Electricity Authority is also entitled to act as aforesaid for the reasons given in section 8 of the Electricity Sector Law (note that certain licenses grant the said authority to the Minister and not to the Electricity Authority. However, following Amendment 3 to the Electricity Sector Law in April 2005, in which the authority to grant licenses and supervise compliance with their terms was transferred to the Electricity Authority, the provisions of the licenses granted above should be read in light of the changes in authority stated in the amendment).
12. The holder of a generating license and a Gold License will pay the license fee set by the Ministers.
13. A license holder will not acquire and will not hold means of control over another license holder and will not control that holder in any other way, directly or indirectly, unless approved by the Minister of National Infrastructures. The generation licenses also state that control over a license holder will not be transferred, directly or indirectly, unless approved by the Minister of National Infrastructures.
14. If the State is obliged to make any payment for any action or omission of the generation license holder in connection with its activities under the license, the license holder shall compensate the State.
15. Pursuant to the terms of the licenses, the State received exemption from liability towards the license holder and third parties as follows:
a. No approval, permit or instruction given to the license holder for the purpose of this license or as part of it, whether given before or after the license is granted, will impose any responsibility by the State towards the license holder or any third party and will not provide grounds for any claim by the license holder or such third party against the State.
b. Nothing in the powers of approval or supervision given under this license, including the use of such powers, imposes on the State any responsibility that according to this license is imposed on the license holder, nor does it remove or reduce such liability.
16. The regulations specified in sub-section e) below include different provisions in additions to the provisions included in the licenses granted to the Company.
34 The Company does not submit audited financial statements for the profit centers as required by most of the licenses. Nevertheless, the licenses received for the new generating units repeat the requirement for audited reporting by profit centers. the Company is exposed to proceedings that may be initiated against it due to its failure to conform to these requirements. In addition, the Electricity Sector Law determines sanctions against any entity acting without a legal license. By the publication date of this report no steps had been taken in relation to this. In the Company’s estimation, its failure to fulfill this requirement will have no significant implications.
As of the date of this report, except for the aforesaid, the Company's Management estimates that it fulfills the conditions of the granted licenses. d) Provisions of the Electricity Sector Law regarding cancellation/suspension of license Section 8 of the Electricity Sector Law states that when the Electricity Authority is required to decide whether to grant a license or what terms to include in it, and when the Minister is required to give approval under sections 11-13 of the Electricity Sector Law, they should act in accordance with the Government or the Minister’s policies regarding the electricity sector, and consider among other things: the contribution of the license to the level of service to the public, the good of consumers and the contribution of the license to competition in the market.
Section 9 of the Electricity Sector Law states that the Electricity Authority may at any time revoke a license or suspend it, and with the approval of the Minister, may add terms, rules and obligations to it, or change them, if it decides that any of the license’s terms have been breached, that any of the restrictions on obtaining it exist, or that the license holder no longer meets the qualifications demanded by the Electricity Sector Law. The Authority, with the approval of the Minister, may act as aforesaid even without the above reasons, for the considerations specified in section 8 in the Electricity Sector Law. The Electricity Authority will give the license holder the opportunity to state its case. e) Regulations deriving from the Electricity Sector Law In December 2004, the Electricity Sector Regulations (Co-generation) – 2004, and the Electricity Sector Regulations (Terms and Procedures for Granting Licenses and Obligations of the License Holder) (Amendment) – 2004, were published, with the emphasis on a survey of risks and required insurance, and that same month four additional regulations were signed which were published on February 8, 2005, as follows:
1) The Electricity Sector Regulations (Co-generation) (Amendment), 2005, including an amendment to the Electricity Sector Regulations (Co-generation), 2004 published in December 2004.
2) The Electricity Sector Regulations (Terms and Procedures for Granting Licenses and Duties of License Holders) (Amendment 2) – 2005, including an amendment to the Electricity Sector Regulations (Terms and Procedures for Granting Licenses and Obligations of the License Holder) (Amendment) – 2004 published in December 2004 (that put the emphasis on a survey of risks and the required insurances).
3) Rules of the Electricity Sector (Transactions with an Essential Service Provider) (Amendment) – 2005, including an extension of the application of the Rules of the Electricity Sector (Transactions with an Essential Service Provider) – 2000 to cover an
35 entity that received approval from the Minister or a generating license before the Electricity Sector Regulations (Private Conventional Electricity Producer) – 2005 came into force, or received a generating license based on such approval, and also to a producer whose facility is operated with renewable energy. A further amendment to these regulations was published in the Official Gazette on February 17, 2005.
4) The Electricity Sector Regulations (Private Conventional Electricity Producer), 2005. An amendment to these regulations was published in the Official Gazette on February 17, 2005, according to which the provisions of the regulations also apply to a producer who received a license through a tender published before the said regulations were implemented. All the aforesaid regulations relate differently to producers with generating units using different technologies to those of the private producer: generating units using renewable energy - power generated from the sun, wind, water and waste. Generating units using technologies of cogeneration - units simultaneously generating electrical power and usable thermal power (steam), conventional technology including stored power. The regulations were intended to regulate transactions between a private producer and an essential service provider for the supply of electricity and the possibility of supplying electricity to end consumers while receiving infrastructure services, backup and associated services from the holder of a transmission or distribution license. The regulations stipulate various methods for transactions with an essential service provider, as follows: the method for the sale of energy and the method for the sale of available capacity and energy. For each of these methods a price was set according to the terms specified in the regulations. In addition, there are cases where the price is fixed by consent between the parties. The regulations will have implications for the Company only insofar as generating facilities are set up in accordance with the approvals in principle given and/or to be given to private electricity producers, and at this stage the Company cannot estimate the effect of these regulations. For additional information, see Note 2.1.4 to the report. As at the report date, the Company is complying with all the requirements specified in these regulations, except the requirement in the generating licenses to include the State as a beneficiary in some of the construction policies for projects that are nearly complete. In new construction policies that will be agreed by the Company, this requirement will be arranged in advance. All the aforementioned regulations were amended in August 2009, for the purpose of regulating the actions of the system manager as the party that communicates with the private producers. The Electricity Sector Regulations (Terms and Procedures for Granting a License and Obligations of the License Holder) – 1997, were also amended to reflect Amendment 3 of the Electricity Sector Law – 2005, on the manner of directing the application for a license to the Electricity Authority, in light of its authority to grant licenses, where the license becomes valid only upon the Minister's approval. 1.7.4 The Government Companies Law 1.7.4.1 According to the Government Companies Law, a Government company is defined as a company in which more than half of the voting power at its general meetings or the right to
36 appoint more than half its directors is held by the State or by the State together with a Government company or a Government subsidiary; since the State of Israel holds approximately 99.85% of the Company’s share capital, the Company is defined as a Government company under this Law.
1.7.4.2 The Government Companies Law states, among other things, that:
1) A decision by a Government company to sell shares that it holds in its Government subsidiary requires the approval of the Government and the Finance Committee of the Knesset.
2) Decisions by Government companies on the following matters require Government approval:
(a) Changing the company’s purposes.
(b) Increasing its registered share capital.
(c) Changing the rights linked to shares.
(d) Allocating company shares or agreement to transfer shares as required by the foundation documents - if this could lead to a material change in the balance of power between members of the company or grant a new member 10% or more of the face value of the share capital or voting rights in the company or right to appoint a director.
(e) Issue of redeemable preference shares.
(f) Issue of debentures convertible to shares, and conversion into shares of debentures issued without the right of conversion or of a loan received by the company.
(g) Changing the company from a company that is not private to a private company, or vice versa.
(h) Reorganization of the company, its voluntary liquidation, compromise, arrangement or merger with another company.
(i) Setting up a company, alone or with others, and acquiring shares in an existing company, excluding acquisition of shares on the stock exchange by a company for which such acquisition is part of its normal business. If the Government company believes that any action or transaction does not require approval under this paragraph and the Companies Authority disagrees, the said action or transaction will be submitted to the Government for approval.
(j) A right granted by a company or an obligation that a company assumes which could tend to restrict the Government, directly or indirectly, whether in its government duties or in its position as a shareholder in the company, including in connection with structural changes and privatization, promoting competition and regulating the industry in which the company operates; on this matter, “right or obligation” - including a right or obligation by which any action or omission of the Government, which is not under the company’s control, will grant a third party the right to remedies against the company.
(k) An offer of securities to the public according to a prospectus, if the Companies
37 Authority believes that the result of publishing the financial reports could be that the State, as the controlling owner of the company, would bear responsibility for any damage caused by any misleading detail in the prospectus, according to the Securities Law, and so informs the company.
(l) An action as a shareholder in a Government subsidiary on one of the matters described in paragraphs (a) to (j) above.
(m) An undertaking for one of the actions specified in paragraphs (a) to (k) above.
Such decisions by a Government subsidiary also require Government approval, and will be brought before the Ministers, by means of the parent company, to obtain such approval.
3) The Minister of Finance may, on the recommendation of the Companies Authority, determine rules for preparing the budgets and plans, for the annual budget of the company and implementation thereof, and use of resources available to the company, annual operational plans of the company and long term plans and company employees standard whether for all the Government companies or for different types.
4) A Government company will operate according to the same business considerations as usual in non Government companies, unless the Government, with the approval of the Finance Committee of the Knesset, has stipulated other considerations for its actions. No other considerations for its actions were stipulated to the Company as of the date of this report. As long as the Company is a Government Company, the Government, upon approval of the Finance Committee of the Knesset, is entitled to make other decisions for the actions of the Company and the Company would act according to the other considerations for its action , also after this report.
5) In addition, according to the provisions of any law, the Minister of Finance may, in consultation with the Minister of Justice, and with reference to a public company - in consultation with the Securities Authority, determine at the suggestion of the Companies Authority rules for preparation of financial statements by a Government company which has been defined as providing an essential service to the public, including the items to be included in them, the accounting principles for their preparation, and the declarations and notes to be attached to them. By force of this order, the Government Companies Regulations (Principles for Preparing Financial Statements of the Israel Electric Corporation Ltd.) (Temporary Order) – 2004, were enacted.
6) The decision of the Board of Directors on designation of Company's profits or distribution (as defined in the Companies Law) is subject to the approval of the Companies Authority. If the Companies Authority disputes this decision of the Board of Directors, the Company will act according to the decision of the Companies Authority, as approved by the Government. Moreover, the said regulations will not apply to a company when the Government, upon approval of the Finance Committee of the Knesset, decides that due to a public offering, it is obliged to not enforce this. See also section 1.5 in this report.
7) If the Companies Authority deems that the public interest so requires, it may instruct the Government company on how to present items in its financial statements or in any other report that the company is required to submit according to any law, providing that instructions on this matter are not stipulated in the rules, in law or in the generally accepted
38 accounting principles and in the accepted rules of reporting.
8) If the Companies Authority disagrees with the manner of presenting items in the financial statements or in any other report that the Government company is required to submit according to any law, it may, if it deems that the public interest so requires, instruct the company to disclose the position of the Companies Authority and describe the dispute in its reports, to the satisfaction of the Companies Authority. 1.7.4.3 Principles of the Government Companies Authority for preparing financial statements
According to the regulations of the Government Companies Authority (Principles for Preparing Financial Statements of the Israel Electric Corporation Ltd.) (Temporary Order) – 2004, additional disclosure obligations are applied to the Company originating from directives issued to the Company by the Government Companies Authority, as detailed below:
a) Directive issued on March 2, 2004 - disclosure should be provided in the Company's financial statements regarding the operating segments for the generation, transmission and distribution of electricity. The disclosure will include condensed balance sheets, statements of operations and the principal details that were used in the preparation of the areas of operation. Disclosure will also be made of the financial targets, including targets for achievement of the normative costs determined by the Electricity Authority, and the differences between them and the actual costs. b) Directive issued on September 14, 2004, as follows:
1) The Company's licenses, rates, activities, its regulation and the decisions by the State and its authorities relate to each activity of the Company separately. This is a complex company with an enormous scope of activities that provides a service to the public. In view of the short timetable for the execution of the numerous and complicated preparations required by the beginning of 2006, the date of the end of the licenses and of the current rate basis, disclosure is required as detailed in this directive.
The accounting estimates and the disclosure made in the Financial Statements concerning the Company's operations constitute an important phase for the purpose of proper disclosure and meeting the timetables. Providing this disclosure in the Financial Statements is essential to fulfilling the duties of transparency, proper disclosure and complying with the duties of reporting and accountability, while creating controls and reporting mechanisms that are essential to the Board of Directors, the Company's management, the shareholders and other users to the financial statements. 2) The disclosure will be provided based on the principles regarding the recording of the transactions concerning the various activities and will include, among others, comparative data, including, as stated below, Financial Statements of the various activities, details of the assumptions, the main details and the accounting principles applied in their preparation.
The calculation of the rates for the various activities will be in accordance with the principles that have been (or will be) prescribed by the Electricity Authority regarding this issue.
39 3) Disclosure regarding the activities will be provided for the operations detailed in section 5 below, and will be included in all of the Annual and Quarterly Financial Statements and the budgets (annual and multi-year), that will be filed on a current basis by the Company, in accordance with the principles and the details including in the provisions of the Authority's circulars and as detailed below.
4) Starting from the Financial Statements for the second quarter of 2005 and thereafter, the aforesaid disclosure will, in addition, include the following details:
a) Financial Statements of generation units to which section 6(g) to the Electricity Sector Law applies. b) Financial Statements of activities at the sites: Rutenberg and Orot Rabin c) Financial Statements of the transmission segment. d) Financial Statements of the distribution segment according to the details of section 5 below.
5) Below are details of the activities for which the Company was required to provide the aforementioned disclosure:
a) The distribution segments: the Northern district, Haifa district, Jerusalem district, Dan district and the Southern district - each separately. b) The generation segments: Rutenberg site, Orot Rabin site, Haifa site, Reading site, Eshkol site, Gezer site, Hagit site, Alon Tavor site, Ramat Hovav site, Tsafit site and the other sites as one additional generation site - each separately. c) The transmission segment.
As of the date of this report, the Company fulfills the aforesaid directives. However, the directives on the preparation of separate Financial Statements for each activity as detailed in section 4 and 5 above were postponed by the Government Companies Authority in a letter dated March 26, 2006, from the Director General of the Companies Authority, notifying the Company that the implementation of the preliminary milestones is deferred by at least one quarter and that the appropriate framework and timetable for implementing the directive will be defined by May 2006. Until the date of signing the Financial Statements, there have been no further developments in the matter.
It should be noted that implementing the aforementioned directives constitutes a condition of these Regulations for preparing adjusted Financial Statements.
c) Investment in the Company
For as long as the Company is a Government company, the Government will not invest in the Company except with the approval of the Finance Committee of the Knesset.
1.7.4.4 Application of the Government Companies Law to Government subsidiaries
The provisions of the Government Companies Law state that the Law will apply to a Government subsidiary, just as it applies to a Government company, with certain changes. In addition, the Government Companies Law stipulates additional provisions for a Government subsidiary, including:
The directors of Government subsidiaries on behalf of the parent company are appointed by the board of the parent company, with the approval of the Ministers, after consultation with the
40 Appointments Scrutiny Committee4.
The provisions of the Government Companies Law regarding conditions of fitness, unfitness, proper representation of both sexes, proper representation of the Arab population and special fitness for those with connections to Government ministers, also apply to these directors. If the Government sells shares that it held in the parent company, or if the parent company sells shares it held in the subsidiary, all or some of the directors appointed on behalf of the parent company will cease to hold office as directors in the Government subsidiary, if this is a necessary outcome of the sale, from the day that the Companies Authority or the parent company notifies the Government subsidiary of it. If the sale makes it necessary to terminate the office of only some of the aforesaid directors, the Ministers, after consultation with the Appointments Scrutiny Committee, will decide which directors will be dismissed.
A decision by a Government company to sell shares that it holds in its Government subsidiary must be approved by the Government and the Finance Committee of the Knesset (except for certain reservations concerning the sale of shares registered for trade on a stock exchange).
The Government Companies Law authorizes the board of directors of a Government company to demand from the CEO of the Company's subsidiary information on any matter that in the opinion of the board, concerns the affairs of the subsidiary, and the board is also authorized to ask the subsidiary’s external auditor and internal auditor for reports relating to it.
1.7.4.5 The Government Companies Authority
The Government Companies Law states that the Companies Authority will advise the Government, by means of the Minister of Finance, and will advise ministers on matters relating to the Government companies; will follow Government guidelines to deal with matters common to all the Government companies; will monitor compliance with the recommendations of the State Comptroller relating to Government companies and assist with such compliance; will advise and assist Government companies on managing their affairs; will continuously monitor the activity of each of the Government companies, including achieving their goals, the course of business, the financial situation and the compensation policies, and will report its findings to the Ministers; will examine the reports submitted to it from Government companies and the material on which the reports are based and will make comments on them to the company and to the Ministers; will handle and assist in any liquidation, merger, compromise, arrangement, reorganization and sale of shares of Government companies; will advise the Ministerial Committee on Privatization and will handle the implementation of decisions on privatization; will carry out any tasks imposed on it by the Government or the Ministers and any other task assigned to it by the Government Companies Law, in relation to any Government company.
The Companies Authority may send its own representative to any meeting of the board of directors of a Government company. The status of the Companies Authority representative in the said meeting will be that of a director, except that he will not be included in the count of those present necessary to constitute a legal quorum, and he will have no voting rights.
1.7.4.6 The Board of Directors
4 "The Appointments Scrutiny Committee" is a committee appointed by the Minister of Finance to check the fitness and suitability of candidates for positions as directors, chairman of the board or CEO in a Government company.
41 a) Chairman of the Board The board of directors of a Government company will elect one of its members as chairman of the board. His election must be approved by the Ministers after consultation with the Appointments Scrutiny Committee, but the Government may appoint the chairman from among the members of the board of directors, if it deems this necessary, after consulting the Appointments Scrutiny Committee. The Law regulates the conditions of fitness for the chairman of the board of directors. The chairman of the board must give the Ministers and the Companies Authority copies of the minutes of board meetings within two weeks from every meeting and, once every six months, and whenever required by the Ministers or the Companies Authority, must submit a written report of the company’s activities and the work of the board of directors. Also, the chairman of the board must submit to the Ministers and the Companies Authority the proposed annual budget, work plans and drafts of financial reports a month before they are due to be discussed, unless the Ministers, upon consulting with the Companies Authority set a shorter period. b) Tasks of the Board of Directors The Government Companies Law specifies the matters which the board of directors must handle, and powers that it may not delegate. Inter alia, the board must decide the general policies of the company in terms of its purposes, its financial activities, its budgets, work plans for each year and for the long term, number of employees required, approve pursuant to the recommendation of the Chief Executive Officer (“CEO”), appointments of senior officers, as they are defined in the Government Companies Law and their pay, discuss drafts of the financial statements and the comments of the auditors to these statements and approve the provision of loans and the deposit of amounts that exceed the normal course of company business. The board must ensure, every year, the preparation of balance sheets and profit and loss statements, including appropriation of profits, a report of resources and their uses and consolidated financial statements. In addition, the board must also determine, subject to the rules stipulated by the Minister of Finance, at the suggestion of the Companies Authority, the method of selecting executive officials in the company, and the conditions of fitness required of them. The board of directors must determine how other company employees will be selected and their conditions of fitness, subject to any rules that may be stipulated by the Minister of Finance at the suggestion of the Companies Authority. The board of directors may appoint from among its members permanent committees or committees for specific matters, whose decisions will constitute recommendations to the board. The board may adopt, amend or reject these recommendations and it may also delegate powers to the committee, except for the powers mentioned above that may not be delegated. Board meetings will take place as needed, and at least once every two months, unless the Ministers, after consultation with the Companies Authority, decide on other dates, according to the nature of the company’s business. The board will hold special meetings at the request of the Ministers, the Companies Authority, or one of the directors. The Minister of Finance may, on the recommendation of the Companies Authority, set
42 rules for the board’s method of working and its agenda, whether for all Government companies or by type. c) Directors on behalf of the State A directors on behalf of the State in a Government company (in this sub-section: “director on behalf of the State” or “director”) is appointed by the Ministers after consultation with the Appointments Scrutiny Committee. The letter of appointment will be delivered to the director by the Ministers after receiving the opinion of the Appointments Scrutiny Committee, with a copy to the company via the Companies Authority. The appointment is in force from the day the letter is delivered to the company, unless it states another date. According to the Government Companies Law, the Minister of Finance will appoint a committee to examine the fitness and suitability of candidates to serve as a director on behalf of the State, chairman of the board or CEO of a Government Company. According to the Government Companies Law, a director on behalf of the State in a government company must be a resident of Israel who is at least 25 years old and meets one of the following conditions:
(a) He holds an academic degree in one of the following subjects: economics, business management, law, accountancy, public administration, engineering or labor studies, or holds another academic degree or has completed other higher education studies, all in relation to the main area of business of the company; Nevertheless, a person is also qualified to act as a director in a Government company if he holds an M.A., or a Ph.D., academic degree even when he does not fulfill the aforementioned conditions, provided that the number of such directors in a Government company where the Government appoints no more than six directors, does not exceed one; and in a Government company where the Government appoints at least seven directors, two directors, where at least one of them holds a Ph.D. degree.
(b) He has at least five years experience in one of the following, or has cumulative experience of at least five years in two or more of the following:
1. In a senior business management position in a large corporation.
2. In a senior public office or a senior position in the public service dealing with economic, commercial, administrative or legal matters.
3. In a senior position in the main area of the company’s business. A director may not be a minister, a deputy minister, a member of the Knesset, an employee of the company or someone employed in its service, excluding the CEO and the elected employee representative of Company employees. On this matter, the chairman of the board of directors will not be deemed a company employee; the Director General and employees of the Companies Authority (unless the company is in the process of dissolution or liquidation of its business), a public representative whose other business may create a conflict of interest with his position as director of the company, anyone convicted of an offense that in the opinion of the Government’s legal adviser bears dishonor or prohibits such appointment, anyone who is unfit to serve as a director according to the Companies Order or any other law, and anyone who has an economic connection to the company or to a
43 corporation linked to the company, as defined in the Government Companies Law, or who has a personal connection to the company management or the management of a related corporation. The number of directors from among public employees will be no greater than two thirds of the total number of directors appointed as Government representatives. At least one director will be appointed to a Government company after the Appointments Scrutiny Committee finds that he is an expert in accounting and finance, in its meaning in the Companies Law. In addition, according to the Government Companies Law, directors are subject to provisions regarding their length of service, terms of service (including compensation and expenses paid to the director) and provisions regarding the expiry of their term of office and their suspension. The Government Companies Law also stipulates obligations regarding provision of information about the company to Ministers and to the Government Authority. If the Appointments Scrutiny Committee finds that a candidate for the position of director, chairman of the board or CEO has a personal, business or political connection to any of the Government Ministers, it will not recommend his candidacy, unless it finds that he has special qualifications in the company’s areas of activity, or that there are other special considerations of fitness in addition to the required conditions of fitness according to the Government Companies Law. If the Appointments Scrutiny Committee decides not to recommend the appointment of a candidate who meets the aforesaid conditions, the Minister may submit an objection to the decision, which will be discussed by the plenary Government. The Committee’s reasons will be put to the Government by the Government’s legal advisor or his representative. If the Government rejects the Minister’s objection, the candidate will not be appointed as director. In addition to the provisions of the Government Companies Law, the Government's legal adviser will publish, from time to time, opinions and guidelines on issues relating to the appointment or service of directors on behalf of the State in Government companies, such as issues of conflict of interests between the director’s business and the business of the company that could render him unfit or restrict his ability to serve as a director on behalf of the State; appointments of professional state employees as directors, the duty of trust of directors in Government companies, and the participation of such directors in discussions relating to the relationship between the State and a Government company. d) Payment of Directors 1. Payment to Directors from the Public According to the Government Companies Regulations (Rules for Compensation and Expenses for Directors from the Public in Government Companies) – 1994, a director of a Government company is entitled to compensation for serving as a director, to be paid by the company according to the number of board meetings or committee meetings in which he participates (according to the company rank as stated in the aforesaid regulations). The regulations stipulate other provisions on the date of payment and other conditions under which directors are paid, up to the ceiling stated in the regulations, while an annual fee may
44 be paid to the chairman of the board, up to the ceiling stated in the regulations. 2. Payment to External Directors Companies Regulations (Rules for Compensation and Expenses for an External Director) - 2000, were amended on March 6, 2008. Pursuant to the amendment, the Company cannot continue paying compensation to an external director that is relative to the compensation paid to directors who are not external directors (equal to such a director in practice), as the board of directors decided previously and has paid to external directors up to now. Therefore, the General Meeting of the Company approved on July 7, 2008 the decision of the board of directors of the Company and the decision of the Audit Committee of the Company, entitling External Directors of the Company, experts and non-experts to receive annual compensation and compensation for participating in meetings, at the minimum amounts specified in the second and third addendums to these regulations, as amended from time to time, in addition to personal accountability insurance for officers, as acceptable in the Company. e) Other provisions According to the Government Companies Law, a director on behalf of the State will be appointed for no more than three years from when his appointment takes effect. A director who ceases to serve can be appointed again. A director will cease to serve before the end of the period of his appointment for one of these causes: resignation by submitting a letter of resignation to the Ministers; absence from four consecutive meetings or six meetings within a year, unless the Ministers decide, after consultation with the Companies Authority, that there was a justifiable reason; inability to fulfill his function and the Ministers, after consultation with the Companies Authority, have so notified the company; conviction of an offense that in the opinion of the Government’s legal adviser bears dishonor or necessitates ending his service; existence of any of the circumstances that disqualify a person from being a director; the Companies Authority, or the Ministers, after consultation with the Companies Authority, deem that he is not performing his duties appropriately and dismissed him by a notice to the Company; the Companies Authority decides that the director does not act in a manner that promotes the implementation of the privatization decision, or acts actively or by omission in a way that affects the ability of the Company to implement a certain order or requirement related to the privatization, as detailed in the Government Companies Law; A director who was appointed as a state employee or the employee of another Government company who ceases to be so will cease to serve from the day the Companies Authority notifies the company of this, but the Ministers may, after consultation with the Companies Authority, authorize his re-appointment. A director on behalf of the State must, despite any other law, give, on demand, to the Ministers and the Companies Authority information about company matters and his activities in that respect. If a director on behalf of the State learns of company business that apparently involves an offense against the law or integrity, he must bring the matter to the knowledge of the chairman of the board, the Ministers, the Companies Authority and the State Comptroller without delay. The composition of the board will give proper representation to members of both sexes, and until this is achieved, Ministers will appoint, as far as possible in the specific circumstances, members of the sex that is not sufficiently represented on the board at that time.
45 In addition, the composition of the board will give proper representation to the Arab population, and until this is achieved, Ministers will appoint, as far as possible in the specific circumstances, members of the Arab population. In this context - “the Arab population” includes the Druze and Circassian populations. According to the guidelines of the Attorney General (Proper Representation of Certain Sectors), published in March 2003, in cases where the Appointments Scrutiny Committee finds that insufficient attention has been given to the matter of such proper representation, it may refuse to approve an appointment or withhold an appointment, even if the candidate has the necessary qualifications. In the absence of the required proper representation, the Committee will draw the attention of the Ministers to this fact and the meeting will be held after candidates from the population that is not properly represented are proposed or after the Ministers give the Committee satisfactory reasons in writing why no candidate as aforesaid was proposed, under the circumstances.
f) Directors from among the Employees
The Government Companies Regulations (Rules for Deciding the Elected Representative of the Company Employees as a Director) – 1977, stipulate the obligation to appoint a director from among the employees of a Government company or Government subsidiary that employs at least 100 people (and is not a bank) and the methods of choosing the employees’ representative and conditions for his fitness to serve.
The Ministers appoint the directors from among the six employees who received the greatest number of votes from the other employees. The selection method will be general, personal, secret and direct. This director is not subject to the normal fitness conditions applying to directors on behalf of the State. g) Independent Directors
Amendment No. 8 of the Companies Law, ("The Companies Law") defines arrangements aimed at reinforcing the independence of the Board of Directors of a public company, and states, inter alia, that a public company is entitled to include in its Articles a stipulation, whereby independent Directors, in the number defined by the company, will serve in its Board of Directors and the company is also entitled to set their percentage out of the serving members of the Board of Directors. The regulation recommends appointing a majority of independent Directors, and in a company with a control holder or a control holder of a concern, one third of the Directors being independent is sufficient. Since the authority to appoint Directors is granted to the Minister of Finance and the Minister of National Infrastructures in consultation with the Appointments Scrutiny Committee, the Company addressed the Government Companies Authority on February 8, 2009 and requested to receive its position and guidelines on adopting the independent Director's arrangement, their number and service period.
The position of the Government Companies Authority as received by the Company on February 24, 2009, is that including a binding stipulation in the articles of a public government company, that requires the appointment of a certain number of independent Directors, as defined in Amendment No. 8 to the Companies Law, may impose significant limitations on appointing Directors for that company, due to the strict requirements which an independent Director has to fulfill in his relations with the State and entities under its control.
46 On the other hand, it does not seem that such a binding stipulation will contribute to significantly improve the activity of the Board of Directors in the Company and reinforce its independent status, beyond the current defenses provided by the stipulations of the Government Companies Law and the principles of the Administrative Law.
Companies regulations published recently (Directives and Conditions on the Subject of the Approval Process of Financial Statements) – 2010, ("The Articles"), require that financial statements will be submitted to the Board of Directors for discussion and approval after the discussion in the Committee for Reviewing Financial Statements ("The Committee"). These regulations will be applied from the preparation date of the financial statements as of December 31, 2010. Regulation 3(a) states that the majority of committee members will be independent directors. Regulation 3(a)(6) states that the legal quorum for discussions and decisions making in the committee will be the majority of its members, provided that the majority of the members present are independent directors, of which one is an external director.
On March 7, 2011, Amendment No. 16 to the Companies Law, was passed. The amendment stipulates, inter alia, that the majority of the audit committee of the board of directors will be independent directors (section 115 (a) to the law and that the legal quorum for a meeting and decision making of the audit committee will be the majority of its members, provided that the majority of the directors present are independent directors, of whom one will be an external director. This amendment will come into force six months after its publication date in the official gazette.
The said amendment also specifies the definition of an "independent director", stating that an external director will also be regarded as an independent director. This amendment will come into force six months after its publication date in the official gazette. The Company believes that according to a reasonable interpretation of the Government Companies Law and Regulations, which equalizes in fact the qualification conditions of an independent director to that of an external director, the Company may regard an external director as an independent director even before that amendment comes into force, since implied qualification conditions required for an independent director are fulfilled for each external director. This interpretation is accepted by the Ministry of Justice and the Government Companies Authority. Therefore, the committee for reviewing the financial statements may be comprised of a majority of external directors and the Company is not obliged to classify directors as "independent".
h) The Chief Executive Officer
The CEO of a Government company is appointed by the board of directors with the approval of the Ministers, after consultation with the Appointments Scrutiny Committee. However, the Government may appoint the CEO if it deems this necessary. The Government Companies Law states that the terms of fitness for a CEO of a Government company are the same as those applying to directors on behalf of the State (see sub-section (c) above) but in exceptional cases and on the terms stated in the Law, a person who does not meet all these conditions may be appointed, subject to the provisions of the Government Companies Law.
The CEO is responsible for the day to day management of company affairs in the framework of
47 the company’s annual budget and the work plans, as decided by the board of directors, and in the framework of board decisions. The CEO will have the powers that can be granted to a business manager, in accordance with the Companies Law and the Articles of the Company except for those powers given to the board of directors and to another authority. The General Meeting may limit or add restrictions on the powers of the CEO, and the board may also do so.
The CEO must give the board of directors reports of the company’s day to day activities on the dates determined for this by the board.
In certain circumstances, as specified in the Government Companies Law, the Government or the board of directors may dismiss the CEO. The board may also suspend him, due to suspicion of a criminal offense that has harmed the company, while observing the obligation to suspend him if he is indicted for an offense that in the opinion of the Attorney General justifies his suspension.
The board may appoint an acting CEO in the event that a CEO’s term of office expires or is suspended, to serve until a permanent CEO is appointed. According to the instructions of the Companies Authority, of July 5, 2001, the appointment of an acting CEO will take place only under exceptional circumstances, for a limited period of time, upon approval of the Companies Authority, where a precondition for appointment of an acting CEO is confirmation by the head of the Companies Authority that special circumstances exist that justify this. The appointment of an acting CEO, upon approval of the Director General of the Companies Authority, will be for three months, and in exceptional cases for a further three months.
According to the guideline of the Companies Authority on this subject (on February 28, 2002), the appointment of an acting CEO must also be approved by the Appointments Scrutiny Committee, in accordance with the provisions of the Government Companies Law on qualifications for an appointment as a CEO. i) Holders of special office in a Government Company 1) External Auditor and Legal Adviser The decision of the General Meeting of a Government company on the appointment of an external auditor must be approved by the Companies Authority. Also the appointment of a legal adviser for the company requires the approval of the Companies Authority. In the Rules of Government Companies (Appointment and Pay of External Auditors) – 1994 and in the Rules of Government Companies (Appointment and Pay of Legal Advisers) – 1992, rules are set down on the manner of appointing and revoking appointments, conditions and fitness for the appointment, duration of the term in office and the pay of an external auditor or legal adviser who is not a company employee, as applicable. The external auditor of a Government company must, notwithstanding any other law, give the board of directors, the Ministers and the Companies Authority, on demand, information on company affairs, conduct a special audit of the company, and submit a report of the results to them.
2) Internal Auditor The Internal Audit Law – 1992 (hereinafter: “the Audit Law”) applies, inter alia, to an audited body within the meaning of section 9(5) of the State Comptroller Law – 1958. Other
48 provisions apply by virtue of the Companies Law. According to the Audit Law, every public body will have internal audits conducted by an internal auditor. According to the Government Companies Law, the board of directors of a Government Company must appoint an internal auditor, unless the Companies Authority confirms that the scope or nature of the company’s activity do not require the appointment of an internal auditor and the board will determine the tasks and authority of the internal auditor. The internal auditor will be subordinate to the chairman of the board of directors and the CEO, and will submit his reports and proposals to the board of directors, see section 3 d in the Board of Directors’ Report.
1.7.4.7 Ensuring the correctness of the Financial Statements and the Board of Directors’ Report
According to the provisions of the Government Company Regulations (Additional Report on Actions Taken and Representations Given to Ensure the Correctness of the Financial Reports and the Board of Directors’ Report) – 2005, a Government company and a Government subsidiary are required to attach to their annual financial statements and the interim financial statements an additional report in the format given in the Rider regarding actions taken and representations given to ensure the correctness of the aforesaid financial reports and the board of directors’ report, including separate signed declarations from all the office holders who have signed those reports.
If the Companies Authority considers that the public interest requires this, it may instruct the Government company on how to present items in the financial reports or in any other report that the company is required to submit under any law. If the Companies Authority disputes the presentation of items in the financial reports or any other report that the company is required to submit in accordance with any law, it may, if it considers that the public interest requires this, instruct the company to disclose the position of the Companies Authority and to describe the dispute in the reports to the satisfaction of the Companies Authority.
Government Companies Regulations (an Additional Report on Actions Taken and Representations Provided to Ensure Additional Reports on the Effectiveness of the Internal Audit of Financial Statements) – 2007, require Government Companies, including the Company, to attach to their annual and quarterly financial statements, starting with statements published as of December 31, 2009, an additional report on actions taken and representations provided, to ensure adequate disclosure and correctness in the financial statements and the report of the Board of Directors. For additional information , see paragraph 6 b) in the report of the Board of Directors.
1.7.4.8 Election of Senior Officers
Senior officers within the meaning of section 32(a)(4) of the Government Companies Law, in a Government company and a Government subsidiary, are appointed according to the provisions of the Government Company Regulations (Rules for the Election of Senior Officers) – 2005.
1.7.4.9 Rules on the Employment of Relatives
The Government Company Regulations (Rules on Employment of Relatives) – 2005 stipulate rules and procedures regarding the employment of relatives of employees of the Government
49 company and the Government subsidiary. The procedures for recruiting employees are subject to these regulations and to the company’s internal rules, which are adapted to the regulations and to the guidelines of the Company's Board of Directors. Employment of relatives in the Company is also subject to the regulations and the internal rules and to the guidelines of the Company's Board of Directors, which define restrictions on the employment of relatives in positions which involve a subordinate relationship between them, or where there is a fear of possible conflict of interest. The internal audit of all the activities of the Company also audits the subject of employing relatives and the Company acts according to the recommendations of its auditor. See also details of the State Comptroller's report on the subject in section 3.12.6 in this report. In 2010, the Company assimilated 521 new employees. 6.1% of these employees have relatives in the Company.
1.7.4.10 Obtaining Information from a Government Company
1) Information for the Companies Authority The Companies Authority may, for the purpose of performing its duties, ask the Government company and any director representing the State, plus the CEO of the company and through him, anybody working for the company or employed in its service, for any information and material on company affairs, and may study the company’s records and documents. According to the Government Companies Regulations (Rules on Qualification of Examiner by the Authority) – 2005, if the Government Companies Authority decides to carry out an examination as part of its duties, it may authorize an examiner to study the records and documents of the Company and require the Company or the aforementioned position holders to provide information and material on the affairs of the Company. The examiner will be a suitably qualified professional, as applicable, including a lawyer, accountant, surveyor or financial adviser, depending on the terms stipulated in these regulations.
2) Information to the General Public According to the Freedom of Information Law – 1998 (hereinafter: “Freedom of Information Law”), any Israeli citizen or resident is entitled to receive information from a public authority. Pursuant to Amendment 5 of the Freedom of Information Law of August 2, 2007, a public authority, according to the aforesaid Law, includes inter alia any Government company or Government subsidiary, excluding companies determined by the Minister of Justice, with the approval of the Constitution, Law and Justice Committee. The Amendment was applied from August 2, 2008. On November 12, 2008 Freedom of Information Directive (Government Company and Government Subsidiary which is not a public authority) – 2008, was published, excluding Government companies from the application of the Freedom of Information Law or the application of the Freedom of Information Law regarding certain fields of activity. The Company is not included in the companies that were excluded by the order, therefore, the provisions of the Freedom of Information Law apply to the Company from August 2, 2008. Pursuant to applying the Freedom of Information Law to the Company, it acted to implement and integrate the instructions of the law. The Company took the following steps: Appointed unit referents, published directions in its website on the process of applying for information, mapped types of environmental information it holds and appointed a steering committee to outline the freedom of information policy in the Company. According to the provisions of the Freedom of
50 Information Law, the CEO appointed an "Officer in Charge of the Freedom of Information" for the Company, who is responsible for implementing the provisions of the Freedom of Information Law in the Company. According to the provisions of the Freedom of Information Law, the Company may reject a request for information and not give any information where there is a fear that the said information could harm the country’s security, foreign relations or public safety, or the security or safety of any person, relating to any information as determined by the Minister of Defense in an injunction5, information whose publication constitutes an invasion of privacy (within the meaning of the Protection of Privacy Law – 1981) and also any information whose publication is forbidden by law. In addition, the Company may refuse to give information in certain cases, including information that could interfere with its proper functioning, information about policy in the stages of formation, or details of negotiations with an external entity or person, details of internal management of the Company that do not concern the public, information that is a commercial secret or a professional secret of information of an economical value, which if published, could materially affect its value, and the Company may also refuse to give information in other circumstances as defined in the Freedom of Information Law. 1.7.5 Decisions of the Government of Israel concerning the Electricity sector From 1995 (towards the end of the concessions granted to the Company) and in the subsequent years, the Government and the Socio-Economic Cabinet made various decisions concerning the electricity sector which were largely integrated in the Electricity Sector Law. A summary of the main decisions, as follows:
1.7.5.1 Government Decision on March 25, 2003 (No. 104)
Under the recovery plan for the Israeli economy the Government reached two decisions related to the Company on March 25, 2003, as follows:
a. Reform the Electricity Sector, including the amendment of the Electricity Sector Law, in accordance with the principles outlined in the decision.
b. Promote privatization of Government companies through a public offering, by requiring the Companies Authority to compile and submit proposals for privatizing Government companies, also relating to the Company, all after ensuring the implementation of the conclusions of the Electricity Sector Reform Committee and decisions of the Socio-Economic Cabinet on this subject, at a rate that will not exceed 49% of the Company's shares.
1.7.5.2 Government Decisions on September 23, 2007 (No. 2390)
Pursuant to a Government decision on September 23, 2007 and according to the policy on increasing the generation capacity and decreasing demands in the Electricity Sector, it was decided:
a. To charge the team set up by the Minister of Finance6 on September 6, 2007, with informing the
5 To the best of the Company's knowledge, at the date of signing this report, no injunctions had been issued concerning the Company on this matter. 6 The team members were representatives of the Comptroller General, Budgets Commissioner, the legal advisor of the Ministry of Finance, a representative of the Ministry of National Infrastructures, to be appointed by the Minister of National Infrastructures and a representative of the Electricity Authority.
51 Ministers of the status of negotiations with the OPC company, as of that date, regarding the tender for erecting the power station at the Mishor Rotem site. Based on the findings, the Ministers will decide on ways to increase the electricity generation capacity for the Israeli electricity sector in the coming years.
b. To charge the Comptroller General in the Ministry of Finance with appointing an inter- Ministerial tenders committee, to publish an international tender for the erection of two solar power stations in the Ashalim area.
c. To determine that Government objectives over the next few years to limit demand for electricity during shortages should also serve to limit the demand achieved now, and instruct the Electricity Authority to define its position on determining tools, by December 31, 2007, in the framework of its powers in law, to enable restriction of demand for electricity during shortages, noting Government policy.
d. To charge the Minister of National Infrastructures with utilizing his powers to promote the Government objectives of limiting demand, inter alia, using the tools available to it by virtue of the Electricity Sector Law – 1996, and the Energy Sources Law – 1989.
1.7.5.3 Government Decision on June 30, 2008 (No. 3704)
The Government decided on June 30, 2008, to adopt the decision of the Ministers Committee for Socio-Economic Affairs ("The Socio-Economic Cabinet") to establish, by August 1, 2008, two Government companies, owned by the State of Israel, to operate in the Electricity Sector, a System Management Company Ltd. and a New Electricity Generation Stations Company Ltd. company. To the best knowledge of the Company, two new Government companies were registered on October 26, 2008 in the Companies Register – Systems Management Company Ltd. and New Electricity Generation Stations Company Ltd.
It was also decided that the granting of new generation licenses to the Company will be limited only to stations approved under the development plan, up to January 1, 2009. Pursuant to this decision, the Electricity Sector Law was amended to enable the Electricity Authority, with approval of the Minister of National Infrastructures to approve construction of new power stations, under the emergency plan. See also details of the emergency plan in section 1.8.2 d herein.
The same decision of the Government also states that construction of additional power stations by the Company beyond the aforementioned will not be approved, unless there are special circumstances, if the Ministers, upon consultation with the Electricity Authority and the Government Companies Authority realize that there is no reasonable alternative to the urgent construction of a power station to ensure electricity supply to the Electricity Sector, in view of the immediate needs of the energy sector.
1.7.5.4 Government Decision on September 18, 2008 (No. 4095)
The Government decided on September 18, 2008, to take steps to achieve more efficient energy consumption and set a Government guideline target for reducing the expected electricity consumption by 20% of the forecast electricity consumption in 2020, based on actual electricity
52 consumption in 20067.
On January 29, 2009, the Government plenum approved the decision of the Socio-Economic Committee on setting a guiding objective and defining tools to promote renewable energies, especially in the Negev and Arava regions. The decision sets, inter alia, a guiding objective for generating electricity from renewable energy at a 10% rate of the national electrical energy requirements for 2020 (an interim objective - 5% by 2014). It was also decided to act to build power stations based on renewable energy sources, especially in the Negev and Arava regions, with an annual capacity of 250 megawatts at least, starting from 2010 and up to 2020. In addition, this decision charges the Planning Manger in the Ministry of Interior, in coordination with the Electricity Administration Manager in the Ministry of National Infrastructures, the Ministry of Environmental Protection, Israel Lands Administration and the Ministry of Defense to locate lands suitable for building power stations operated by renewable energies, especially in the Negev and Arava regions and the Electricity Authority was instructed to review the conformance of the criteria and rates to the implementation of these Government decisions.
7 The steps include energy saving in Government facilities, financing energy saving projects in local municipalities, assistance to energy services suppliers to obtain credit lines and preparing guidelines on the subject.
53
1.7.5.5 Government Decision on May 12, 2009 (No. 129)
On May 12, 2009, the Government reached a decision on the subject of increasing competition in the Electricity Sector. The primary principles of this decision are:
Promotion of independent electricity producers
a. Amend the Electricity Sector Law as follows:
1. To state in the law, that a condition to the validity of a essential service provider's license, that collects payments from electricity consumers ("Collecting Essential Service Provider"), is the paying of all payments required from the supplier to the system management license holder, with respect to system management services, or to any generation license holder, with respect to making available or generating electricity according to the stipulations of the purchase agreement between that Essential Service Provider and the generation license holder.
2. Amend the rates definition in the law to include all types of payments made by a Collecting Essential Service Provider to the generation license holder or to the consumer.
3. Perform the acts required to complete the regulation of independent electricity producers through the licenses method up to August 1, 2009.
b. To charge the Minister of Finance and the Minister of National Infrastructures to promote the actions of the Government Companies that were established by force of the Government decision on June 30, 2008, relating to the management of the electricity system, construction and operation of power stations in accordance with the objectives of the said companies, including recruitment of the required manpower, allocation of the capital these companies require to implement its goals, preparation of the companies to obtain the required licenses and promotion of their actions. To the best knowledge of the Company, directors were appointed in these companies, however, the Company does not have information on other actions in these companies.
c To charge the Comptroller General in the Ministry of Finance, through the Government Procurement Administration to publish a tender for purchasing electricity for all Government Ministries from private electricity producers. The Comptroller General will report to the Socio-Economic Committee on the progress in implementing this item up to June 1, 2009. To the best knowledge of the Company, no such tender was published as yet.
d. Outline acts to locate and promote sites for establishing power stations.
54 Increasing the Efficiency of the Supervision over the Company
a. Establish a team to increase coordination and efficiency of the supervision over the Company. The team is required to increase the coordination and transparency of the actions of the entities that supervise the Company, increase efficiency of the supervision and consulting budgets and recommendations on the method and scope of the supervision over the Company, including establishing of a permanent coordination procedure among team members. The team's actions will focus on material issues in the operation of the Company, including pension, wages, actions permitted by law, all according to the authorities of the supervising entities in Israel.
b. The Minister of Finance and the Minister of National Infrastructures will report the initial conclusions of the team up to August 1, 2009 to the Socio-Economic Committee.
Pursuant to this decision, paragraphs (1) and (2) above were included in Amendment 9 to the Electricity Sector Law and the Electricity Authority also made several decisions that regulate the operation of private electricity producers, including the update of chapters E and F of the Criteria Book on July 31, 2009, aiming to regulate the operation of the supplier as a mediator between private electricity producers and consumers under private transactions and to define the sphere of responsibility of the system manager. In addition, the Government approved on July 27, 2009, a new arrangement for private electricity producers that is another step in their integration.
1.7.5.6 Government Decision of July 15, 2010 (No. 2024) and Government Decision of March 6, 2011 (No. 2949)
On July 15, 2010, the Government published its decision on increasing the number of broadband infrastructure suppliers by means of the Company, through establishing a communication company that will use a fixed communication infrastructure over the electricity network and operate it to provide telecommunication services, as defined by the Communications Law (Telecommunications and Broadcasting) – 1982 ("Telecommunication Services"). Pursuant to the Government decision, the Government of Israel reached a decision on March 6, 2011, to allow the Company to establish, together with another party, a company that will use the fixed communication infrastructure over the electricity grid of the Company to provide telecommunications services, and hold shares and means of control subject to conditions specified in the decisions. The main conditions are:
The Company will not hold more than 49% of the shareholding in the communication company and will not control it.
Subject to the decision of the Government, a joint selection committee will be established, to select the control holder of the company that will be established. Half the members of this committee will be State representatives and half Company representatives. The only investments invested by the Company in the communication company will be related to granting usage rights of infrastructures
55 held by the Company. The communication company will enter an agreement with the Company to build and maintain a communication infrastructure and to obtain usage rights of infrastructures held by the Company and will be allowed to enter an agreement with the Company on receiving services of operating the fiber optic network it maintains (the Backbone network). The communication company will enter agreements with license holders only, on an equal and open basis to all license holders, for the purpose of supplying telecommunication services and will not enter into direct agreements with private consumers (except large-scale customers upon approval of the Minister).
1.7.5.7 Government Decision on November 18, 2010 (No. 2442)
On November 18, 2010 the Government of Israel published a decision on establishing a regulators team to increase coordination and efficiency of the supervision over the Company as detailed below:
1. Pursuant to Government decision No. 129 on May 12, 2009 on establishing a team to increase coordination and efficiency of the supervision over the Company, without impairing the authority of any regulating entity in its field, appoint the Director General of the Government Companies Authority as the team leader and add to team members specified in the Government decision the Supervisor of the Capital Markets or his representative and the Deputy Attorney General (Economic-Fiscal) or his representative ("The Regulators Team").
2. Instruct the regulators team to initiate an audit of the following issues on its behalf:
a) The refund of surplus amounts, if any, transferred by the Company to third parties (the Central Pension Fund or other accounts included in the Financial Statements of the Company, related to pension and non-pension pensions components.)
b) The manner of treatment of differences between the Company's obligation to the insured in the Financial Statements of the Company and obligation estimated by the Central Pension Fund.
c) Risk management and division of responsibility between the Company and the Central Pension Fund on all matters related to investment management of funds in the Fund.
d) Review of the factors that led to errors in pension items in the Financial Statements of the Company in previous reporting periods, corrected in the Financial Statements as of June 30, 2009.
e) Causes of the delays in publishing quarterly and annual Financial Statements of the Company.
f) Examination of aspects related to the reserve funds of the Company, deposited in a trust account for paying different liabilities of the Company with respect to salary components that are not included in the Central Pension Fund.
g) The Regulators Team will act on the aforementioned issues and especially the issues specified in sections d, e and f, insofar as the team will decide that it required cooperation between the regulators and the Company, through the Government Companies Authority, to
56 coordinate, inter alia, between work that will be performed by the Regulators Team and additional examinations and the conclusions drawing process that will be conducted by the Company's Board of Directors and its Committees to locate the parties responsible for the aforesaid issued.
The Team will submit an interim report to the Minister of Finance and to the Minister of National Infrastructures within 90 days. Submission date of the final report will be stated in the interim report.
1.7.5.8 Government Decision of January 16, 2011 (No. 2727)
On January 16, 2011, the Government of Israel approved the decision of the Ministers Committee on Economical Affairs of January 9, 2011 (SE/105) as follows:
To amend the Government decision No. 2561 (SE/97) of December 9, 2010 on funds raising in Israel by the Company, so as to increase the total funds raised to NIS 4 billion (instead of NIS 1 billion). NIS 3.5 billion out of the said amount will be used for financing during 2011, in accordance with the decision of the Board of Directors of the Company of December 26, 2010 and an amount of up to NIS 0.5 billion will be used for financing or for developing the transmission and distribution system, as will be approved by the Minister of National Infrastructures.
57 Electricity rates 1.7.1 General The Company operates as one integrated and coordinated system to supply electricity to consumers, from the stage of electricity generation at the generation sites, through its transmission and transformation to distribution and supply to the end point of the individual consumer. However, in accordance with the provisions of the Electricity Sector Law, the Electricity Authority defines separate rates for the Company’s various activity segments. Yet, most electricity consumers pay a single weighted rate for electricity, which covers all the segments of activity.
1. The main provisions of the Electricity Sector Law on the subject of rates are as follows:
a. The Electricity Authority will determine rates on the basis of cost, taking into account among other things the type and standard of services. The cost will also include a fair rate of return on capital, with due consideration of the rights and obligations of a license holder of a Essential Service Provider.
The law did not define a fair rate of return.
b. When setting rates, the Electricity Authority may ignore some or all of the costs that in its opinion are not necessary to enable the holder of an essential service provider license to fulfill its obligations.
c. Every rate will reflect the cost of the particular service with no reduction in one price at the cost of raising another price.
d. The rates will be updated according to the update formula determined by the Electricity Authority. The update formula will include recognized required costs, a fair rate of return on capital, and after consultation with the Ministers, may also include an improved efficiency factor.
2. On September 12, 2004, the Supreme Court of the High Court of Justice decided, in Case No. 7976/04 inter alia, in the matter of a petition by Company against the Electricity Authority, that the consideration regarding maintaining the Company’s financial strength, although it is relevant for setting the electricity rates, only reflects one aspect of the public good with which the Electricity Authority is charged pursuant to the Electricity Sector Law. When exercising its powers under the Law, the Electricity Authority must take account of a whole set of considerations designed to “regulate activity in the electricity sector for the public good, while ensuring availability, quality, efficiency, and all while creating the conditions for competition and minimizing costs”.
3. The functions of the Electricity Authority, which was established pursuant to the Electricity Sector Law, include setting and updating electricity rates. Decisions taken by the Electricity Authority from time to time have defined the general principles applying to all electricity rates, as well as special decisions for various types of rates recognized for the Company. The decisions applying to all rates are described below, while the decisions regarding particular rates will be described in the discussions of the relevant activity segments.
58 1.7.2 Decision regarding the basis for electricity rates a. The new electricity rate a) On February 1, 2010, the Electricity Authority reached a decision on updating the new rate base for the generation segment for the years 2010-2014, and on updating the rate structure book relating to the demand classification groups and the consumption distribution, as well as a compensation formula with respect to the delayed update, which will apply to all electricity chain segments. This decision and the rates derived from it became valid on February 15, 2010.Under this decision, the Electricity Authority updated the rate base for the generation segment for the years 2010 – 2014, which also updated rate components, including, inter alia, capital costs,, operating costs, fuels mixture and more. The recognized costs were determined after the Electricity Authority conducted a costs control of Company costs, as recorded in its records over the years.
The main points arising from this decision, are as follows:: 1. Fuels Costs The fuels mixture will be calculated every year as an average of fuel mixtures according to a forecast of load curves related to different climates. The fuels basket will be retroactively updated every year, according to the actual demand curve and updates arising from new relevant professional information. The difference will be refunded to the consumers or to the Company with interest and linkage. In addition, starting from the new rate base, the fuel mixture will be calculated and applied on a calendar basis for that year (January – December). The Electricity Authority defined in advance the majority of the parameters to be used to calculate the fuel mixture throughout the test period, including operation dates of generation units. The Gas Incentive provided by the new rate base is limited to the years 2009 - 2012 and applied to new gas agreements only made and entered after the current agreements (Yam Thetis agreement in 2002 and with the Egyptian gas supplier).
2. Capital Costs The recognized capital costs are comprised of the following main components: Depreciation Return on Capital: Return on equity and return on the foreign capital
a) Recognized Assets and Depreciation Assets recognized in the new rate base for the generation segment were determined according a future outline for 2010-2014 and will be updated every year. Recognized cost with respect to generation units was determined according to the development plan that includes the list of recognized units and their dates of operation (and not according to the increase in sales as implemented in the current rate). The generation units were divided into old and new units: "Old" units - generation units that commenced operation before December 31, 2002. "New" units - generation units that were operated and that will be operated after December 31, 2002. Recognition of the costs of the "old" units Is mainly based on costs thereof in the Company’s books. Crude operated units that were converted to gas, where life expectation estimate was changed - the recognized cost was determined according to the depreciation that would have accumulated if the changed estimation was made at the conversion to gas date. Conversion to gas investments will be recognized after the commencement of operation with gas under the annual updates following the commencing operation with gas date.
59 Recognition of the costs of the "new" units Costs of the "new units are recognized according to normative parameters, e.g., operation dates, building duration and normative interest. The "new" generation units were divided into two classes from aspects of rate recognition: CCGTs outside of the emergency plan (except Tsafit stage B (units 1-10)). CCGTs defined as "emergency" + Tsafit Stage B (units 11-21).
Recognized equipment costs The recognized equipment costs of the "new" units, where construction has already started (units 1-10) are based on costs of contracts entered into by the Company. Equipment costs of CCGTs defined as "emergency" projects and of Stage B (units 11- 21) were determined in a normative manner, using data from the Gas Turbine Handbook (GTH) (average costs in the global market) adjusted to the Company.
Other Costs Marine shipping costs, auxiliary equipment cost and expert services cost were determined as a percentage of the cost of the primary equipment. The percentage was based on these costs in current units.
Development and installation costs - all costs except equipment, interest incurred during the construction and exceptional costs. Development and installation costs were determined in a normative manner. The development and installation costs of the "new" units will be recognized in a normative manner, based on an average of historical costs of building a gas turbine, a steam addition and CCGTs, in accordance with costs audit, performed by the Electricity Authority. In the event that units under construction incur costs, that are excessive in the opinion of the Company, the Company may request the Electricity Authority to recognize these costs. . The normative development and installation costs were divided into two groups: a. Costs of Company employees are linked to changes in the average monthly salary of an Israeli employee do not include, at this stage, pension costs of generation A and generation B employees and pension costs with respect to free electricity, holiday gifts and bonuses for generation C employees, until a final decision is reached on the pension issue. b. Contractors costs, linked to the index of input in residential building. Financing costs during the construction period are based on normative construction duration and normative, recognized interest rates.
Fines on Failure to Meet Timetables In accordance with the decision of the Electricity Authority, if the Company fails to meet predetermined normative timetables for commencing operation of generation units, the recognized income of the Company will be decreased under a fines mechanism, calculated on a daily basis. A formula for calculating fines with respect to failure to meet normative operation dates of the following "new" units which have not yet commenced operation: Haifa 3 and 4, Alon Tavor "emergency", stage B of Eshkol "emergency", Hagit "emergency" and Ramat Hovav 8 "emergency" and stage B of Tsafit. The penalty for each unit will be calculated according to the number of delayed commercial operation days from the normative operation date. The fine mechanism as specified in the decision of the Electricity Authority on June 29, 2009, still applies to the three "emergency" gas turbines (Eshkol, Hagit and Ramat Hovav – unit 8). The penalty rate for a delay in construction of a steam unit of each of the generation units that are not emergency is 75% of the fine for a delay in construction of a gas turbine unit. Maximum fine for a gas turbine may amount up to 25% of the unit cost.
60 A delay that exceeds one year will be penalized by one of the following sanctions: Recognition of costs will stop until commercial operation begins,. Continued recognition in a normative operation date for the fuels mixture. Review of the recognition manner for all the costs related to the generation units and appropriate action modes, jointly with the Ministry of National Infrastructures. In response to its previous requests, the Company received on December 15, 2010, the approval of the Minister of National Infrastructures for the development plans of the electricity sector, which include approval to postpone dates of the development plan. Pursuant to the decision of the Minister of National Infrastructures, the Company requested that the Electricity Authority amend the normative operation dates it set for the generation units in its rates base for the generation segment. On March 24, 2011 the Electricity Authority decided to update the normative operation dates of generation units stated in its decision on the rate base for the generation segment, according to the approval of the Minister of National Infrastructures. See also Note 3a.3(b) to the financial statements as of December 31, 2010. b. Financing Costs Financing costs will continue to be recognized in a normative manner, based on the recognized operating assets and not on the basis of the actual obligations. The recognized leverage remains one third equity and two thirds foreign capital. The recognized return on foreign capital is derived from three components: The financing basket of the foreign capital will be divided into three components: The NIS financing basket component reflecting loans raised in the local market; a hedged financing basket component derived from a new hedging mechanism and NIS at higher interest rates financing basket component reflecting loans in foreign currency for which the Company is required to initiate hedging transactions. o The NIS financing basket - for which an average real NIS interest rate will be recognized. o The hedged financing basket - for which the following components will be recognized: an average, real NIS interest rate, the hedging obligation spreading rate for the Company or of the Company with respect to basket differences – index and with respect to interest differences between the average foreign currency interest rate and the average, real NIS interest rate. A decrease in the hedged financing basket was defined up to its cancellation within three years. The previous hedging mechanism was cancelled, the debt to consumers was packaged and will be returned to the consumers over five years. o NIS financing basket at higher interest for which an average, higher, real NIS interest rate will be recognized. Recognized yield rates on foreign capital linked to the CPI and to exchange rates were determined at the starting point according to the Financial Statements for 2007, while using the rolling formula for 2008 (and for the coming years at every subsequent annual update). Return on Equity The return on equity in the generation segment will be 7.8% after tax (9.5% before tax) compared to 7% in the current base. Total recognized financing costs will be the multiplication of the weighted recognized yield rate (equity and foreign capital) by the recognized assets basket, from which the reserve for deferred taxes will be deducted.
61 The Hedging Mechanism The new rate base book for the generation segment for the years 2010-2014 states that the hedging mechanism will be updated for all segments of the electricity chain. The main principles of the mechanism are as follows: The amount in the hedging fund will be updated at the annual update date according to the recognized assets and the decreasing outline as published by the Electricity Authority, until this mechanism is cancelled completely within three years. Differences between the interest on foreign currency and the real interest rate on the NIS will also constitute a part of the hedged amount and will be spread until the end of the hedging mechanism. The exchange rate of the determining basket and the interest on foreign currency will be linked to the US$ and to the Euro at 75% and 25% rates. Amounts accumulated to the credit or debit of the Company will be spread up to the end of the hedging mechanism in April 2013. However, it should be noted that in light of the expected structural changes, the Electricity Authority freezes its plan up to March 31, 2011, or up to the initiation date of the structural change process, according to the earliest. The efficiency mechanism is not applied to the hedging component.
3. Operating Costs Recognition of operating costs in the new rate base was determined based on past costs (2002-2006), adjusted for an increase in sales. A 2% amortization factor is applied to these costs. No final decision was made with respect to pension costs. Once the decision is reached, this component will be updated in the recognized operating costs. The rates book includes an adjustment of pension costs to the amendment as published by the Company on December 27, 2009. The following costs were reclassified in the rate as operating costs: Investments in operational power stations. Joint assets capital costs. Spare parts inventory capital costs. Adjustment for costs of free electricity (exceeding average household consumption). Fuels accompanying costs loaded to fuel prices. Coal ash treatment, crude bottoms depreciation, electricity consumption in Company facilities. Operational salary costs were linked to the salary of an Israeli employee position and not to the CPI, as proposed in the hearing, or to salaries of State employees, as requested by the Company. According to the Electricity Authority's decision, only half of the spare parts inventory capital costs will recognized as calculated by the Electricity Authority in the LC method in 2002-2006. This component is recognized under the recognized operational costs and will therefore increase each year according to the increase in sales, less a 2% amortization factor, determined by the Electricity Authority.
Updates for the Transmission and Distribution Segments Pursuant to setting a new rate base for the generation segment, the Electricity Authority also updated some of the components for the transmission and distribution segments. Return rates on foreign capital were updated for the high voltage and low voltage transmission and distribution segments, similar to the updates in the generation segment. In addition, a new hedging mechanism was applied to these segments. The effect of the new rate base on the Financial Statements of the Company: The Company works with the Electricity Authority in order to receive rate coverage for non-recognized costs. The Company has, so far, held meetings with the professional team of the Electricity Authority on the subject of cost controls over power stations construction and corresponded with the Electricity Authority. The
62 Company passed on to the Electricity Authority numerous data and explanations on the costs of the units. The Company wishes to present its main arguments against the decision of the Electricity Authority on the rate base for the generation segment a meeting of the plenum of the Electricity Authority. The Company also intends to submit a letter, specifying detailed comments on the determined rates base. See Note 3 a to the Financial Statements as of December 31, 2010, on the main implications of the new rate. b. The Previous Electricity Rate
The decision of the Authority on the "electricity rates and criteria for the years 2002-2005 and the methods of updating them" (“the rate document”) came into effect on July 5, 2002. That decision stated that if by December 31, 2005 no new rate bases for January 1, 2006 onwards had been decided, then the decisions of the Electricity Authority would be valid until such new rate bases were defined. As of the date of this report, the Electricity Authority did not set new rates, for the generation segment only.
The electricity rate was first divided into the following segments on that date:
1. Generation.
2. Transmission.
3. High voltage distribution segment.
4. Low voltage distribution segment.
5. Consumer costs.
The majority of the consumers pay one weighted rate for electricity, including all the operational segments, each consumer according to the connection voltage that reflects the parts of the system required to supply electricity to that consumer. The generation rate by itself is also used for transactions with private producers. The transmission rate is also used for transactions with producers for their own use. Private producers who sell electricity to the clients pay transmission and distribution rates according to the supply voltage to the consumer.
The rate document set the cost recognized to the Company for each of the aforementioned segments. The recognized cost is comprised of the following main components:
1. Fuel costs.
2. Equity costs.
3. Operational costs.
Recognized fuel costs consist about 47% of the current rate, capital costs about 27% and operational costs about 21%.
Details of each of the above components and additional issues related to the current rate base are presented below:
63 1) Fuels Costs
The fuels costs component in the rate is determined according to approved normative fuel quantities and approved fuel prices, based on actual fuels costs. The approved fuels quantities were determined by an estimated mixture of the use of the various power stations (that consume various types of fuel and that each have different utilization). The estimated fuel mixture is determined annually in advance based on various data, for example, the volume of demand for electricity forecast for that year, and the expected availability of each of the power stations. (Starting from the new rate base, the fuel mixture is calculated twice. First during the annual update according to the forecast demand curve. Secondly, during the following annual update according to the actual demand curve and according to events that were unknown. The fuel mixture is applied retroactively from January to December of the year for which it is calculated.)
2) Equity Costs
Recognized equity costs are comprised of the main components as follows:
Depreciation
The rate of return on equity: The annual rate of return on equity and return on foreign capital.
a) The Assets Base:
Equity costs were calculated on the basis of the recognized active assets of the company. Assets under construction were excluded from the equity cost calculations.
The assets basis for the generation segment was calculated based on data of the net active assets during 1995-1999 and for the other segments based on average assets in 2000.
b) Depreciation:
Recognized depreciation costs were based on depreciation costs recorded in the records of the Company. Recognized depreciation costs for the generation segment were determined on the basis of the years 1996 – 1999 and for the other segments on the basis of 2000.
c) Return on Equity:
A ratio between equity and foreign capital of one-third and two-thirds, respectively was determined for the purpose of calculating the recognized return on equity.
(1) Return on Equity:
The annual rate of return on equity was determined at 7% for the generation segment, 5.5% for the transmission segment and 6.2% for the low and high voltage distribution segment.
(2) Return on Foreign Capital: A recognized division of the foreign capital between foreign capital linked to a basket of currencies (representing loans raised abroad) and foreign capital linked to the CPI (representing CPI linked loans raised in Israel) was determined for calculating the recognized return on foreign capital. According to the course determined for this division over the years, the percentage of the foreign capital linked to the basket of currencies was reduced progressively on an annual basis, from 70% in 2002 to 54% in
64 2006. The percentage of the foreign capital linked to the basket of currencies continued to drop in 2007 and 2008 to 50.61% and 47.43% respectively. The rate for 2009 was also 47.43%.
The interest rates on foreign capital were determined on the basis of the prevailing market interest rates, on a weighted basis. The annual update for 2008, determined that interest rate on foreign capital linked to the basket of currencies will be 6.76% and the interest rate on foreign capital linked to the CPI will be 4.70%. The 2009 annual update has not been set for the interest rate on foreign equity. The Electricity Authority decided that interest rates will be updated when the new rates base for the generation segment will become effective, according to models determined in the new rates base.
3) Operating Costs The recognized operating costs are based on operating costs recorded in the Company's records. Recognized operating costs of the generation segment is based on the years 1996 - 1999. The other segments are based on the Financial Statements for 2000.
4) Other Subjects a) Amortization factors Amortization factors per kWh sold, representing the expected efficiency and intended to reflect economies of scale at cumulative annual rates. The annual rates as of the date of this report are: 1. 2.1% on inputs of the generation segment, excluding fuel; 2. 1.3%, on inputs of the transmission and transformation segment; 3. 2.5%, on inputs of the high-voltage distribution segment; 4. 3.7% on inputs of the low-voltage distribution segment 5. 2% on inputs of consumer costs segment.
b) Annual Update Each year, in April, the Electricity Authority is supposed to carry out an annual update of the various components of the recognized costs. The updated components, among others, include: return on foreign capital, the fuel mixture, costs of purchasing electricity from independent producers, conversion of power stations to CCGT, addition due to the cable laying component, compensation for delay in updates and gas incentive. On March 3, 2009, the update was carried out retroactively for 2008. The differences with respect to the delayed update were recorded as a regulatory asset. On May 3, 2009, the Electricity Authority published the annual update for 2009. The update included only a small part of the rate components list which should have been updated in the annual update. Update of the majority of the components e.g. interest on foreign capital, fuel mixture component, capital sum recognized for hedging purposes was carried out once the new rate base of the generation segment comes into force, in accordance with the updated models of the new base. On February 1, 2010, the Electricity Authority published its decision on the recognized fuels mix for 2009. This mix is expected to be retroactively updated as of April 1, 2009. The Electricity Authority also published its decision on updating the natural gas price retroactively from July 2009, pursuant to entering new gas contracts. The Electricity Authority stated in the new rate base that an incentive for new gas contracts in the years 2009-2012 will be granted. Nevertheless, the formulas determined by the Electricity Authority did not leave any incentive for the Company in 2009.
65 Partial decisions were published during October, November and December 2010 on the annual update for 2010. These decisions became effective on the publication date of the annual 2010 update, among them was a decision on the recognized fuels mixtures for 2010 (base mixture and incentive mixture). These mixtures are expected to apply retroactively from January 2010 and be updated according the actual usage demand curve and other changes during the annual update for 2011. According to published mixtures, the Company expects a minor negative gas incentive in 2010. In addition, recognized financing costs were published. The annual update of 2010 was published on March 14, 2011, updating the recognized costs to the company and also recognition of costs derived from buying electricity from private producers and arrangement applied to the Company. The updated rates according to this update became effective on March 22, 2011. c) Current Rate Update. Recognized fuel rates were linked to changes in fuel prices. Foreign capital costs were linked to their weights in the basket of currencies (as determined by the Bank of Israel on May 1, 2006) and other rate components are linked to the CPI. Therefore, electricity rates are calculated biweekly (upon the publication of the CPI and upon the publication of fuel prices). The foreign capital component, linked to the basket of currencies, is updated upon the publication of the CPI and on the annual update date. The input basket of each of the segments is recalculated at each of these dates ("Theoretical Update"). Electricity rates are actually updated when the earliest of the following events occur: (1). A change to the cost of the basket of total system inputs, minus a reduction factor, of 5.5% in relation to the updated rate. (2) A change to the cost of the basket of total system inputs, minus a reduction factor, of 3.5%, providing that three months have elapsed from the last update date. (3) When six months have elapsed from the last update date. (4) Differences created between the actual update and the theoretical update are recorded as a regulatory asset (liability) and included in the rate as of the annual update date. The Electricity Authority updated the rate in an annual update for 2010, which became effective on March 22, 2011 and updated the electricity rate at an average rate of 0.34% compared to rates in force from February 15, 2010. The updated costs with respect to this annual update, starting on April 2010, which were not expressed in the rates update, will be expressed in the compensation mechanism with respect to the delay in the update in 2011.
d) Special Additions to the Rate Additional advanced recognition of investments On August 8, 2007, the Authority decided to give the Company an additional 5% of the recognized cost to fund its development plans, for a number of investment projects in the different segments. Obtaining this addition is conditional on submitting reports of the physical and financial progress of those projects and supervision of them by a supervisor acting on behalf of the Electricity Authority. The addition ended in September 2008. The accumulated addition was deducted from the assets recognized in the rates basis in the manner determined by the Electricity Authority.
66 Addition for the Emergency Plan On August 27, 2008, the Minister of National Infrastructures approved an emergency plan for the electricity sector, that includes construction of three combined cycle gas turbines: at Ramat Hovav, Eshkol and Hagit (synchronization of the gas turbine in July 2010 and the steam addition in July 2012), in addition to two gas turbines at Ramat Hovav, that were synchronized in November 2009 and in January 2010. All in addition to the approved multi-year development plan. On December 28, 2008, the Minister of National Infrastructures approved the construction of a fourth CCGT at Alon Tavor (stage A up to the summer of 2011 and stage B, steam addition up to the summer of 2013). On October 30, 2008, the Electricity Authority reached a decision on financing stage A of the an emergency plan for the Electricity Sector, as approved by the Minister of National Infrastructures, Detailed in Note 3 f to the Financial Statements as of December 31, 2010. The main principles of the decision, as made by the Electricity Authority on October 30, 2008, are:
1) Pursuant to the accelerated development needs required by the Company and mainly the emergency plan for building generation units, as decided by the Minister of National Infrastructures, and in view of the financial condition of the Company and the uncertainty in the capital markets, the Electricity Authority sets a dedicated amount for development for the years 2009 - 2010, as follows: a) The Electricity Authority will recognize the costs for financing the development plant in the electricity rates at an accumulated amount of NIS 2 billion. This recognition will be spread over a period of two years, starting from January 2009 and ending on January 1, 2011, or up to the end of the collection, according to the earliest. b) The aforementioned amount in sub-section 1.a will be managed through a dedicated account, supervised by the Electricity Authority. Allocation of resources to the Company, for the emergency plan only, will be based on achievement of plan implementation milestones, upon approval of the Electricity Authority. c) The Electricity Authority will include its decision in calculations for defining the rates base for the generation segment and will verify that no surplus payment is created when defining the rates for the Company.
2) Recognition of this amount is subject to fulfilling the detailed conditions, including attainment of the timetables for operation of the project, as follows: a) The Company will meet the timetables for the development plan of the generation segment, including the emergency plan, as approved by the Minister for National Infrastructures and pursuant to the stipulations of the document for a hearing, published by the Electricity Authority. b) The CEO of the Company will report to the plenum of the Electricity Authority once every quarter on the implementation of the general development plan, including the development plan referred to in this decision, relating to meeting timetables, costs and a budget versus execution report, in a format approved by the Electricity Authority. c) The Company will not transfer funds to the CPY Pension Fund, exceeding the monthly current provision, until examinations are completed and decisions are made by committees appointed to this purpose in the Company, in the Government Companies Authority and the review conducted by the Electricity Authority, all subject to the law. d) The Company will act as soon as possible to execute efficiency steps which it announced to improve the financial condition of the Company.
On October 31, 2008, the Board of Directors of the Company approved Phase A of the emergency plan for the Electricity Sector. This approval is issued pursuant to the decision
67 of the Electricity Authority on the aforementioned principles for financing the emergency plan. The Board of Directors of the Company approved that the Management of the Company will enter an agreement with Siemens to purchase three gas turbines and peripheral equipment. This approval comes in addition to the purchase of two gas turbines from General Electric, purchased for the Ramat Hovav site. Total expected investment for this stage of the emergency plan amounts to approximately NIS 3.6 billion and was expected to be financed as follows: Approximately NIS 0.9 billion received as customer credit through Siemens and approximately NIS 2 billion will be collected through the electricity rate, in accordance with the decision of the Electricity Authority. The balance will be financed from internal sources of the Company. The Company records this rate addition, setting off from assets under construction items. As of the balance sheet date, the Company deducted the amount of NIS 2,095 million from the assets under construction item. So far, the Company has deposited in the dedicated account, which is supervised by the Electricity Authority, approximately NIS 2 billion. To date, the Electricity Authority approved the release of approximately NIS 1.35 billion for current use in projects, therefore, the current balance in the dedicated account is approximately NIS 0.65 billion. On March 7, 2011 the Electricity Authority published a decision on the subject of "Spreading the Debt of the Company to prevent electricity shortage". The decision also related to the balance in the dedicated bank account with respect to stage A of the emergency plan and stated that this balance will be used only for the development of the electricity sector, for projects listed in the budget book for the generation segment in 2011. The decision of the Electricity Authority of June 29, 2009, states that in the event that the Company fails to attain the timetables stipulated in the emergency plan for commercial operation of the aforementioned power stations included in it, the Company will be penalized, as follows: 1) Regarding each of the two power stations at Ramat Hovav, included in the emergency plan for the summer of 2009, which the Company undertook to operate up to and no later than July and August 2009: (a) For each month of delay in the commercial operation compared to the scheduled date in the emergency plan for the summer of 2009, the recognized cost will be decreased by an amount of NIS 5 million for each month of delay for the months July through December 2009 and by an amount of NIS 10 million for each month of delay for the months January through June 2010. (b) Moreover, and without derogating the aforementioned in paragraph (1), a sum amounting to one fifth of the total dedicated amount will be deducted in the event of an additional delay in the synchronization date of each of the two aforementioned power stations beyond June 30, 2010. In the event that such a deduction will result in a debt to the consumers, the Electricity Authority will determine the mechanism and period for repaying this debt. 2) Regarding each of the three power stations (gas turbines in Eshkol, Ramat Hovav and Hagit sites) included in the emergency plan for the summer of 2010, which the Company undertook to operate up to and no later than July 2010:
(a) For each month of delay in the commercial operation compared to the scheduled date in the emergency plan for the summer of 2010, the recognized cost will be decreased by an amount of NIS 10 million for each month of delay for the months July through December 2010 and by an amount of NIS 15 million for each month of delay for the months January through June 2011.
(b) Moreover, and without derogating the aforementioned in paragraph (1), a sum amounting to one fifth of the total dedicated amount will be deducted in the event of an additional delay in the synchronization date of each of the three aforementioned power stations beyond June 30, 2011. In the event that such a
68 deduction will result in a debt to the consumers, the Electricity Authority will determine the mechanism and period for repaying this debt.
3) The costs deducted by the Electricity Authority, as aforementioned in section 2 a above, will be presented as an expense in the statement of operation of the Company, with proper disclosure. The Company disputes the decision of the Electricity Authority and forwarded its response to the Electricity Authority. In response to its request in the past on December 15, 2010, the Company received the approval of the Minister of National Infrastructures for the development plans of the electricity sector, which include, inter alia, approval to postpone the dates of the Company's development plan. The approval also includes the delay in the gas turbine at Hagit to August 2010, and the emergency gas turbine at Ramat Hovav unit 8 to December 2010. Pursuant to the decision of the Minister of National Infrastructures, the Company addressed a request to the Electricity Authority on December 27, 2010 to change the normative operation dates it set for the generation units under the rates base for the generation segment. According to the decision of the Electricity Authority on March 14, 2011, the determining date for reducing recognized costs due to failure to meet the timetables of the regular development plan and the emergency development plan of power stations is the synchronization date of the unit and not its commercial operation date. On March 24, 2011, the Electricity Authority updated the normative operation dates of the generation units, including operation dates of the gas turbine in Hagit and Ramat Hovav unit 8, as approved by the Minister of National Infrastructures, See also Note 3a3b to the Financial Statements as of December 31, 2010. As of the statements of financial position date, Company records do not include any net regulatory liability with respect to reducing the aforementioned recognized costs. See also Note 3 f to the Financial Statements as of December 31, 2010. On March 7, 2011 the Electricity Authority published a decision on the subject of "Spreading the Debt of the Company to prevent electricity shortage", stating that the Company's debt to consumers, in the amount of NIS 2 billion will be spread up to the end of 2025, as the outline for financing stage B of the emergency plan. The Electricity Authority subjected the debt spreading to certain conditions, including the an efficiency plan for the Company. The Electricity Authority also determined updated synchronization date for the three aforementioned steam additions. These dates were also included in the decision of the Electricity Authority on March 24, 2011, on updating normative operation dates of generation units.
5) Revenues Development As aforesaid, costs recognized in the rate are based on the previous year: In the generation segment according to an average of the years 1996 – 1999 (depreciated and factored to the year 2000 according to the increase in sales), and the other segments are based on the year 2000. Since the average rate is determined as a cost per kWh, the Company’s revenue increases every year, according to the increase in sales. On the other hand, the revenues are amortized according to amortization coefficients.
1.7.3 Reduced Social Rates The Electricity Sector Law states that a consumer who reached retirement age and was eligible for income support would pay a reduced fee of 50% of the domestic rate for the first 400 kWh consumed each month for domestic purposes only.
On July 5, 2007, the Electricity Sector Regulations (Ways of Proving Eligibility for a Reduced
69 Payment) – 2007 came into force, which regulate the implementation of the provisions of section 31a(a) of the Electricity Sector Law regarding reduced payment for electricity by needy population groups. The regulations include provisions for the National Insurance Institute to prove eligibility, form of notification of eligibility and way of transferring the information to the essential service provider. To complete the arrangement, the Electricity Authority published a decision on July 18, 2007, in which it made changes in the criteria for implementing the provisions of section 31a of the Electricity Sector Law regarding eligibility for reduced payments. This decision regulates the manner of applying the reduced payment in the consumer’s electric bill, and the method by which the costs incurred by the essential service provider due to the aforesaid reduced payment will be recognized. On June 18, 2008, the Electricity Authority decided to include in this arrangements secondary users at the same registered consumption site, registered in the name of the registered consumer, who meet the conditions of entitlement to reduced rates, provided that a meter to measure their household electricity consumptions is installed in their home.
The Electricity Sector Law also stated that when setting rates for all consumers, the Authority would take into account the reduction in electricity rates paid by those eligible under the aforesaid regulations. As of December 31, 2010, the Company created a NIS 118 million regulatory asset (NIS 151 million for 2009) for providing reduced payments to needy populations which are yet to be received through the electricity rate.
1.7.4 Disputes between the Company and the Electricity Authority The Company disputes the Electricity Authority's decisions regarding the electricity rate over the years and claims that these decisions had a significant effect on its income (see details of the "open subjects" below).
To the best knowledge of the Company, without receiving any written notice the Electricity Authority undertook to review the decisions it made within its decision on the new rates base for the generation segment.
Nevertheless, and despite establishing a dedicated team for this purpose, the Electricity Authority did not relate to these subjects in its decision on the new rates base for the generation segment.
70 The "open subjects" are detailed below:
Estimated Subject Electricity Authority’s Decision Company’s Position Financial Volume
New rate base for the On February 1, 2010, the Electricity The Company disputes many decisions generation segment Authority published its decision on made in the rates base which were used the new rate base for the generation to determine the level of the recognized segment for the years 2010-2014. The costs in the examined year. The decision of the Electricity Authority Company claims that the determined and the subsequent rates book it rate will lead to highly significant loss published detail the determination of income to the Company. The main mode of the recognized costs for the subjects that affect the Company Company (fuels, capital, operation, include significant non-recognition of etc.) for the generation segment in the building costs of fixed assets, setting examined years. fines in considerable amounts which will apply if the Company will fail to meet normative timetables set by the Electricity Authority to operate the generation units, use of an incorrect sales forecast to calculate the recognized cost per kWh, determine lower yield rates on foreign capital raised by the Company than the actual yield, partial recognition of operation costs the Company is expected to incur and setting an ineffective incentive mechanism for using natural gas.
Amortization The Authority has placed Unreasonable efficiency coefficients, NIS 12,800 million Coefficients amortization coefficients starting applied to the Company for many for the years 1996- April 2004 at the following years, are unreasonable and 2009. (in September cumulative annual rates: 2.1% for significantly affect its revenues. 2010 prices) generation, 1.3% for transmission, The decrease applied by the Authority 2.5% in high voltage distribution and in April 2004 was too little and too 3.7% for low voltage distribution. A late. The Company's request is that a decision was made not to award 2% amortization coefficient should be retroactive compensation for previous applied to the operational component years in which amortization only and also to receive retroactive coefficients were not reduced. compensation for previous years, for which the amortization coefficients were not reduced.
71 Estimated Subject Electricity Authority’s Decision Company’s Position Financial Volume
Fuels basket - forced The Electricity Authority uses forced The Company believes that NIS 2,800 million unavailability values unavailability values and maintenance unavailability values and maintenance for the years 2003- days lower than those accepted days for the calculation of fuel 2007 (in current
worldwide, and in some cased even mixtures must be based upon long term prices) lower than the actual performance of normative parameters, which will allow
the Company to calculate fuel baskets the Company to enjoy the fruits of recognized in the electricity rate of efficiency in operating the system the Company.
Fuels basket - Gas The Authority set an incentive path The current format of the incentive Total saving for the Incentive for the Company in June 2002 for the prevents the Company from benefiting economy for the years 2003 - 2006 only. from the full potential of the incentive, years 2004-2009 is
due, inter alia, to delays in gas supply approximately NIS In 2007-2009, the Electricity to different sites for reasons outside the 23,500 million from Authority did not leave any gas Company's control. Moreover, the which the incentive incentive for the Company. Company believes that it has achieved paid to the Company In the new rate base for the significant savings thanks to its efforts is NIS 1,078 million generation segment, published in on the natural gas subject and therefore (in current prices). February 2010, the Electricity requests to receive a permanent 20%
Authority decided to grant a gas incentive out of the total savings incentive to new gas transactions only realized by use of natural gas, for the years 2009 to 2012. The continuing throughout the life span of formulas defined by the Authority did the units operated with natural gas and not provide any gas incentive to the also that the rate formula be calculated Company for 2009. The Company from the day of actual activation of the also expects a minor negative generation units because of the great incentive in 2010. uncertainty involved in the schedule of gas supply to the sites and the integration of the Egyptian supplier into the system.
72 Estimated Subject Electricity Authority’s Decision Company’s Position Financial Volume
Fuels Basket Mix for The recognized fuel mixture was The actual demand in 2007 NIS 690 million in the year of 2007 calculated annually according to an significantly the original 2007 demand 2007 (in current expected demand forecast. The prediction, used to calculate the fuels prices). Authority rejected the Company’s mixture. As a result the Company
request to recalculate the recognized incurred a considerable loss of income fuels mixture for 2007, to include the for which the Company requested to actual increased demand and reflect receive coverage by recalculation of the the correct fuels mixture consumed recognized fuel basket. by the Company. In the new rate base, the Authority decided to update the fuels mixture retroactively every year according to the actual demand curve. The Authority does not intend to apply the mechanism for the fuel mixture in 2007.
Fuels Basket - In the annual update for 2007, the Since the Gezer units started operating NIS 1,200 million postponement in Authority stated, as part of the basic with gas only during 2008 and operated for the years 2007 - converting power assumptions for the 2007 fuel mixture on diesel up to that time, the Company 2008 stations to natural gas calculation, that the Gezer A station incurred losses pursuant to this (in current prices) and using more will begin operating with natural gas decision. Since the operation of Gezer expensive fuel in mid October 2007. A CCGT with gas was delayed due to factors outside the Company's control, Gezer Combined In its annual update for 2008 the the Company requested the Authority Cycle A Electricity Authority did not change to recognize September 2008 in the this decision for setting the fuels mixture as the gas arrival date to recognized fuels mixture for 2008. Gezer A CCGT.
Fuels basket - The fuels mixture, recognized for the In 2005, the power station was actually NIS 280 million for postponed conversion 2005 fuel basket, was calculated powered by crude only, which is a 2005 of power stations to assuming that the Reading Station more expensive fuel, due to reasons (in current prices) natural gas and use of will be powered by natural gas and in beyond the Company’s control. more expensive fuel - May 2005. Consequently the Company incurred Reading Power additional costs that were not covered
Station by the electricity rate, for which the Company requests to receive rate coverage.
73 Estimated Subject Electricity Authority’s Decision Company’s Position Financial Volume
Fuels Basket - The Authority denied the application The station was closed from March to NIS 170 million for Reading Power of the Company to recognize the loss June 2006 by an order of the Ministry 2006 Station - Closed by of income caused to the Company as of Environmental Protection. From the (in current prices) order of the Ministry a result of implementing the order to closing date, the Company was forced of Environment close the station. to produce electricity at alternate stations using a more expensive fuel mixture, using among others, diesel operated power stations, to avoid any disruption in power supply to consumers. Consequently, the Company incurred loss of income. The Company requests to receive rate coverage for this loss of income.
Loss From Collection In 2002, the Authority set an income For reasons beyond the Company's NIS 1,300 million of the Average Rate which the Company is entitled to control, stemming mainly from changes for the years 2000- collect from the public for the purpose in electricity consumption habits of the 2009. of covering its expenses. public, influenced by the indication of (in current prices) the current rates, the Company failed to Despite requests of the Company, the collect the full income as defined by Electricity Authority did not amend the Authority and therefore, did not the rates structure for the related cover its expenses. The Company years. appealed to the Authority to amend the During the determination of the new rate structure, while compensating for rates base, rates were set according to years in which the Company did not distribution of the consumption in collect the full recognized income. 2006. According to the decision of the Electricity Authority, it intends to update the consumption distributions once a year, at the annual update date, following a data audit.
74 Estimated Subject Electricity Authority’s Decision Company’s Position Financial Volume
Exogenous Expenses In 1998, the Electricity Authority set The Company submitted reports to the NIS 1,005 million a mechanism for annual recognition Authority, on these expenses annually. for the years 2002- of exogenous expenses in the The Company requests to receive rate 2008. electricity rate. coverage for the full exogenous (in September 2010 expenses it incurred up to the In 2005, the Electricity Authority prices) mechanism cancellation date by the published a decision that canceled the Authority. mechanism established in 1998 for recognition of exogenous expenses The Company submitted in April 2006 and did not recognize the amounts a proposal to the Electricity Authority paid during the trial period (e.g., for an alternative recognition approximately NIS 150 million with mechanism in significant exogenous respect to 2004). expenses it will incur in future.
The Electricity Authority did not decide as yet on a new mechanism for recognizing future expenses (as proposed by the professional team acting on its behalf in April 2007).
Financing Costs In 2002, the Authority recognized in The Company raised (and is expected NIS 550 million for the electricity rates cost related to to raise in future) foreign capital at the years 2002-2009. funds raising costs in Israel, based on volumes amounting to billions NIS (in current prices) State bonds for 10 years with an each year. Fund raising costs in Israel added margin of 0.73% and on fund and abroad, was higher in recent years raising costs abroad, based on U.S.A., than costs recognized by the Authority State bonds for 10 years with an (margin of the last funds raising in
added margin of 2.4%. Israel was 4.35% and 6.84% abroad), causing loss of income to the Company. (This mechanism was in force up to The Company requests recognition of the decision of the Electricity all financing costs it actually incurred Authority in February 2010 regarding with respect to funds raised during the the rates base for the generation test period. segment).
75 Estimated Subject Electricity Authority’s Decision Company’s Position Financial Volume
Electric Consumption The Authority rejected the The current rate calculation method, NIS 210 million for in Company Facilities Company’s claim that power determined by the Electricity Authority, the years 2002-2009 consumption at the Company’s excludes electricity consumed by (in current prices) facilities is not included in the rate Company facilities used for the normal base. The Authority claims that cost operation of the Company from of electricity consumed in Company coverage in the Electricity rate, since facilities is part of its recognized the required income is divided by the operation costs and the Company total electricity consumption of the should budget these costs in the total Israeli market that includes the recognized operation costs. electricity consumption of Company facilities. Costs with respect to electricity consumption at Company facilities were partially recognized in the new rate base, only for costs of the generation segment.
76 In addition, the Electricity Authority did not yet reach a decision on several material subjects (see details below) that caused a significant damage to the Company's income over the years.
The subjects are:
Estimated Subject Electricity Authority’s Decision Company’s Position Financial Volume
The Order of Rate In its December 2005 decision the The Company believes that NIS 1,500 million Determination and Electricity Authority noted that it first determining the order of the segments for each of the years Delays in Updating intends to set a new rate for the for which the rates are updated is 2006 - 2008 the Rate Bases for generation system, followed by the important. It is necessary to begin with (in December 2007 Various Segments distribution system and only at the segments with an accumulated deficit prices) end for the transmission system. of costs coverage (distribution and
transmission). On July 30, 2008, the Authority published a document for a hearing The Company incurred a considerable on the new rate base for the loss of income due to the prolonged generation segment. The Authority delay of over four years in updating the reached a decision on a new rate base rates base for the generation segment for the generation segment only (in and, as of the present date, over five February 2010) but not for the other years in updating rates bases for the segments. The Authority did not transmission and distribution segments. compensate the Company for failure to update the rates base for the generation segments for the previous years.
77 Estimated Subject Electricity Authority’s Decision Company’s Position Financial Volume
Expenses Due to The Electricity Authority did not yet Due to significant changes in NIS 2,930, million Pension Liabilities reach a decision on the subject. calculation rules of actuarial liabilities as of December 31, beginning from 2003, as determined by 2007 The Electricity Authority established the Commissioner of the Capital a committee in 2004 to discuss this Market, Insurance and Savings of the issue. This committee suspended its Ministry of Finance, the Company was operations at a certain stage. In the obliged to record high expenses document for the hearing on the new amounts in its statements of operation rate base for the generation segment, that did not have a rate coverage since it indicated that its work to review these were not included in the rate pension costs of Company employees base. Then, upon adopting the was not completed as yet and that it principles of the International intends to complete the review during Accounting Standard 19 (IAS 19), the approaching period and submit it considerable amounts were charged as to a public hearing so that pension actuarial losses which were not yet costs will be reflected in the final amortized and which are not decision on the new rates bases of the recognized in the electricity rate as generation segment. well. The Company believes that rate In March 2009, as part of its coverage should be granted to the full deliberations on the subject, the debt, arising from spreading the Authority requested to receive from actuarial changes according to IAS 19. the Company all its correspondence with external entities over the years.
In its decision on the new rate base for the generation segment, the Authority noted that pursuant to this decision, it intends to publish principles and guidelines for recognizing pension costs of Company employees from June 1996 for a public hearing and issue a final decision on the subject during 2010. The Electricity Authority did not yet reach any decision on the subject.
78 2. Matters Relating to Each Activity Segment Separately
2.1 The Generation Segment 2.1.1 General information about the generation segment
As of December 31, 2010, the Company maintains and operates 17 power station sites (including five sites for steam driven power stations) with installed generating capacity of 12,769 megawatts. Each Company power station site has one or more separate units to generate electricity. On December 31, 2010 the Company had 64 generating units, of which 20 were steam powered and 44 gas turbines (of which 16 industrial gas turbines, 16 jet gas turbines, 8 combined cycle gas turbines and 4 industrial gas turbines for future operation in the combined cycle format).
The Company’s steam driven generating units produce electricity with steam turbines and include carbonic units powered by coal and/or fuel oil, steam units driven by fuel oil and/or natural gas, jet gas turbines driven by diesel only and industrial gas turbines driven by diesel and/or natural gas.
Power stations in the natural gas era retain the ability to use two fuels (except Reading power station), and can operate with both natural gas and liquid gasoline. This is to maintain their ability to generate electricity even when there is a shortage of natural gas or a problem with its supply.
In addition to the electricity generated at its power stations, the Company purchases small amounts of electricity (about 0.5% of the total supplied by the Company in 2009 and 2010) from private electricity producers, some of whom sell all their output to the Company, while others generate electricity for their own use and only sell to the Company their surplus production (see section 2.1.4.2 in this report).
2.1.1.1 Structure of the Operation Sector
As mentioned the Company's operation in this sector is generation of electricity, and as of the date of this report, the Company generated the major share of electricity in Israel, while the balance, in minor volumes is generated by private suppliers. See also section 2.1.4.2 below.
2.1.1.2 Legislative and Regulatory Limitations and Special Constraints applying to the Sector
The Company estimates that its operation in the generation segment, similar to its other operation segments is subject to regulatory limitations, e.g., regulations included in the provisions of the Electricity Sector Law and the Government Companies Law, to constraints arising from licensing issues and licenses and permits required by various authorities and Government ministries, e.g., The Electricity Authority, the Companies Authority, the Ministry of National Infrastructures and the Ministry of Environmental Protection and to structural changes and emergency and development plans in the Electricity Sector. The Company holds generation licenses granted separately to each generation unit. For details of these aspects in the Company's operation and the different limitations, see sections 1.7.1 and 1.7.3 above.
2.1.1.3 Trends and Changes in Scope of Operation and Profitability
The Company estimates that various factors my affect its operation scope and profitability in this sector, including changes in electricity consumption rates, changes in electricity rates, changes in the supply and/or prices of raw materials required to generate electricity and entry of competitors (including private suppliers) to the electricity generation sector. See also sections 1.7.1, 1.7.3 and 1.7.5 above.
79 Material changes in the scope of operations during 2010: Synchronization of gas turbine unit No. 7 at Ramat Hovav site, with a capacity of 118 megawatts. Transition to use of natural gas in the CCGT unit at Tsafit Stage A site, reducing the capacity by 13 megawatts. Synchronization of CCGT No. 4 Stage A at Haifa site, with a capacity of 234 megawatts. Synchronization of gas turbine unit No. 3 at Eshkol site, with a capacity of 260 megawatts. Transition to use of natural gas at units 1, 2, 3, 4, 6, 7 at Ramat Hovav site. Synchronization of gas turbine unit No. 1 at Hagit site, with a capacity of 256 megawatts. Synchronization of gas turbine unit No. 8 at Ramat Hovav site, with a capacity of 250 megawatts
Material changes in the scope of operation anticipated during 2011: Commencement of operation of a steam addition to CCGT 4 at Haifa site, with a capacity of 127 megawatts. Commencement of operation of CCGT unit 3 at Haifa site, with a capacity of 377 megawatts.
2.1.1.4 Developments in Markets of the Operating Sector or Changes in Consumer Characteristics
The Company operates as one integrated and coordinated system for supplying electricity to customers, namely all the consumers in the State of Israel, starting from the generation of electricity and its transmission, distribution and supply and trade of electricity. The Company also operates in the building of the infrastructures required for those operations.
2.1.1.5 Technological Changes which may have a Material Effect on the Operating Sector
The Company generates, transmits, distributes and sells electricity to all the consumers in the State of Israel. During 2011, the Company is expected to continue the use of natural gas. Thus, the installed capacity of gas operated units will amount to 55% of the installed capacity at the end of 2011.
Technological Changes – Transition to the use of natural gas at the sites (subject to completing construction of the gas transportation system by Natural Gas Lines Company):
Tsafit site From 05/2011
Haifa site From 06/2011
2.1.1.6 Critical Success Factors of and Changes to the Operating Sector
The Company estimates that the business success of the generation segment depends, inter alia, on the level of demand for electricity, gas availability from its suppliers, achievement of the timetables of the emergency plan, costs of raw materials required to generate electricity, recognition of the total costs required to generate electricity in the electricity rate and the ability of the generating entity to achieve efficiency both structurally and technologically. See also sections 2.1.3 and 2.1.4 to this report.
80 2.1.1.7 Changes in Suppliers and Raw Materials in the Operating Sector
The suppliers and raw materials for this operating sector are suppliers of coal, crude, natural gas and diesel oil, used to generate electricity. For details of changes in suppliers and raw materials see section 2.1.10 below.
2.1.1.8 Barriers to Entry into the Operating Sector and Relevant Changes
The Company estimates that organizations that operate in the electricity generation segment mainly need an initial investment of equity for building generation facilities, for concluding a bank financing agreement and the financial strength required for current maintenance. In addition, the complex regulation in this sector requires an organization that wishes to generate electricity to conform to strict quality requirements and standards. Professional knowledge, experience in electricity generation, positive goodwill in the sector, as well as availability of land to build electricity generation facilities are also important factors. Moreover, the uncertainty of the natural gas supply may also consist an barrier to entry regarding electricity generation that is based on natural gas.
2.1.1.9 Structure of Competition in this Sector and Changes to it
The electricity generation segment in Israel is currently characterized by an extremely low level of competition, the sole competitors of the Company at present are the private electricity producers, who, at this stage, produce an insignificant volume of electricity. In light of the structural changes required by the provisions of the Electricity Sector Law, including incorporation of generation units as separate subsidiaries and in light of the trend indicated by the Israeli Government and the Electricity Authority to encourage entry of private producers to the electricity sector, the Company is unable, at this stage, to estimate the implications of the aforementioned incorporation on future competition. See also sections 1.7.1 and 1.7.3 above. 2.1.2 Products and Services General
As explained above, the Company operates as one combined and coordinated system, to supply electricity to consumers, from the generation of electricity at production sites, through its transmission and transformation, to its distribution and supply to the end points of each consumer. The electricity generated in the generation sites is not sold to external parties, it is transmitted to end users through the transmission and transformation segments and supplied through the distribution segments.
The Company’s steam driven generating units which run on coal and natural gas, are designed to supply the basic levels of demand for electricity. At the date of this report and in accordance with the provisions of the current contracts, the cost of generating a kWh of electricity using natural gas at CCGT units is the lowest of all the alternatives available to the Company followed by generation using coal, lower efficiency gas operated units, while the most expensive means per kWh generated are operated by fuel oil and diesel oil. As the demand curve rises, the Company operates generating units according to the criterion of cost of fuels per kWh generated with due consideration of operational constraints.
Therefore, the Company first operates CCGT units using natural gas and the steam driven generators that run on coal, followed by steam generators converted to gas and then gas turbine units that run on
81 natural gas and if necessary (mainly in periods of peak demand) the generating units that run on diesel oil - industrial gas turbines and jet gas turbines, which can be started and stopped more quickly than steam powered units, but are more expensive to run.
Following the conversion of 4 units at the Eshkol site and their operation by burning natural gas, in 2006 the Company began to use natural gas in converted units at the Reading power station, and the project to reduce emissions and convert two units in the Haifa power station to gas was completed. In 2008, all generation units in the Gezer site commenced operation with natural gas (instead of fuel oil).
In 2009, all generation units at the Hagit site commenced operation fired by natural gas (instead of diesel).
In 2010, use of natural gas started at Tsafit site and Ramat Hovav site (instead of diesel).
The plan is to incorporate natural gas into the Haifa and Alon Tavor power stations in 2011. As of December 31, 2010, about 40% of the Company’s total installed generating capacity uses natural gas. a. Steam driven generating units On December 31, 2010 the Company had 5 power stations with 20 steam driven generating units, and a cumulative installed generating capacity of 6,462 megawatts. These electricity generating units included 10 dual purpose units (that can run on both fuel oil and coal, and currently run on coal) with a cumulative installed generating capacity of 4,840 megawatts, 4 units operating on fuel oil with a cumulative installed generating capacity of 432 megawatts, and 6 generating units currently operating on natural gas, of which 4 units are capable of operation with either natural gas or fuel oil, with a cumulative installed generating capacity of 1,340 megawatts. Dual purpose power stations, which currently run on coal, require large investment and take a long time to set up, but when they are running on coal, the cost per kWh produced by them is low. The generators running on fuel oil were used to generate electricity for basic loads until the energy crisis in the 1970s, following which it was decided to diversify fuel use by setting up the dual purpose power stations, which can also use coal. When larger quantities of natural gas become available, more of the fuel oil generators that were converted to run on natural gas will be operated (see section 2.1.1.3 in this report). Haifa B (2 x 72 MW) generating units were removed from the generation system since January 2009. Eshkol B (2 x 75 MW) and Haifa B (2 x 141 MW) generating units were declared systems under preservation since May 2009. b. Combined cycle generating units On December 31, 2010 the Company had 8 combined cycle gas turbine generating units, 1 at Ramat Hovav, 3 at Hagit, 2 at Gezer, 1 at Alon Tavor and 1 at Eshkol, one of which at this stage use diesel (natural gas in future), and seven burn natural gas (Eshkol, Gezer, Ramat Hovav and Hagit). The total installed generating capacity of the eight combined cycle units is 2,848 megawatts. In addition, four industrial gas turbines (Tsafit, Eshkol, Hagit and Haifa) which, in the future, will receive steam additions, will operate in the combined cycle format. The total installed generating capacity of these gas turbine is 998 megawatts. The combined cycle gas turbines (“CCGT”) improve burn utilization rates considerably. The combined cycle is a
82 combination of industrial gas turbines and steam turbines. This technology exploits the residual heat emitted from the industrial gas turbines to run an additional (steam) turbine, with no extra fuel. Instead of emitting the gases to the air, its heat is exploited for further re-use. This action contributes both to great savings in fuel and to better preservation of the environment. Gas turbines On December 31, 2010 the Company had 36 gas turbine generating units of which 27 units use diesel and 9 units use natural gas, with cumulative installed generating capacity of 3,309 megawatts. Of these 36 units, 30 are located in 11 separate sites designated as gas turbine power stations, and 6 units are installed on the sites of steam driven power station. Industrial gas turbines and jet gas turbines can be set up with a relatively low investment and in a short time. However, generating electricity with gas turbines that use diesel is more expensive than with steam driven units, and the operation of jet gas turbines is more expensive than industrial gas turbines. On the other hand, gas turbines can be started and stopped more quickly. Therefore, the Company uses its gas turbines in periods of peak demand. When natural gas is available at sites where gas turbines are located, the Company will run the industrial gas turbines with natural gas. Electricity generation volumes and timings are dictated by the electricity consumption of end consumers at any given moment. For seasonality of electricity consumption, see section 3.5 herein. Details of consumption development, recorded peak demands and electricity demand trends are presented in sections 2.1.5 and 2.1.6 below. Details of the Company's share in electricity generation in Israel, are presented in Section 2.1.5 below. 2.1.3 Segmentation of Revenues and Profitability
2.1.3.1 Generation Segment Rate On February 1, 2010, the Electricity Authority reached a decision on updating the new rate base for the generation segment for the years 2010-2014, and on updating the rate structure book relating to the demand classification groups and the consumption distribution and the compensation formula for the delay in rates update, to be applied to all electricity chain segments. This decision and rates deriving from it came into force on February 15, 2010. Under this decision, the Electricity Authority updated the rate base for the generation segment for the years 2010 – 2014, updating rate components, including capital costs operating costs, fuel mixture and more. The update does not include any reference to the pension costs of Company's employees. The recognized costs were determined after the Electricity Authority conducted a costs audit of Company costs, as recorded in its records over the years. For the main points arising from the Electricity Authority decision on the new rate base for the generation segment see section 1.8 in this report. The Company has many reservations related to the new rate base. The Company has already sent its main objections to the determined rate to the Electricity Authority.
83 The Company is working with the Electricity Authority for the purpose of receiving coverage for non-recognized costs. So far, this included meetings with the professional team of the Electricity Authority on the subject of control over construction costs of power stations, and correspondence with the Electricity Authority. The Company forwarded to the Electricity Authority comprehensive data and explanations on the costs of the units. The Company wishes to present its main arguments against the decision of the Electricity Authority on the subject of the rate base for the generation segment for discussion in front of its plenum. In addition, the Company intends to issue a letter specifying detailed comments on the determined rates base. For the main implications of the new rate base, see Note 3a(3) to the Financial Statements as of December 31, 2010.
2.1.3.2 Revenues Net income in the year 2010 from sales of electricity attributed to the generating segment (according to the assumptions described in Note 38 to the Financial Statements) amounted to about NIS 14,776 million for sales of 52,037 million kWh, compared to about NIS 14,627 million (adjusted) for sales of 48,947 million kWh in 2009, an increase of about NIS 149 million in income.
2.1.3.3 Profit from regular activities - generating segment Profit from regular activities of the generating segment for the year 2010 amounted to about NIS 753 million, compared to about NIS 1,742 million (adjusted) in 2009, a decrease of about NIS 989 million. 2.1.4 Competition 2.1.4.1 General
The Company currently generates, transmits, distributes and supplies nearly all the electricity consumed in Israel. Regarding the declaration of the Company as a monopoly and its implications, see section 3.13 of this report.
The licenses granted to the Company for its activity are valid until January 1, 2012 (subject to Decision No. 1 of the Public Services Authority - Electricity in its meeting number 318).
Regarding the provisions of the Electricity Sector Law that stipulate restrictions on holding licenses, see section 1.7.1 of this report.
In addition, in view of the structural changes required by the Electricity Sector Law, including the incorporation of generating units into separate subsidiaries (see sections 1.7.1 and 1.7.3 of this report), and also in light of the wishes of the Israeli Government and the Electricity Authority to encourage entry of private electricity producers to the electricity sector, the Company cannot estimate the future implications of such incorporation on competition, and on the Company’s activity, profitability and financial situation.
2.1.4.2 Private electricity producers a) In accordance with to the Electricity Sector Law, the Company, as an essential service supplier is obliged to purchase electricity generated by private electricity producers, although the Electricity Sector Law does not define a maximum quantity which the Company is obliged to purchase. In accordance with the provisions of the Law and the terms of its license, the Company is required to allow private electricity producers to use its transmission and supply
84 system to provide a backup supply source to customers of the private electricity producers (the Electricity Authority has not yet defined the backup rate). b) The integration of private producers in the electricity sector was stipulated by the policy of the Government of Israel and its decisions to open the electricity generating industry to private producers. Regarding Government decisions that set targets to increase the installed electricity generating capacity of private producers to 20% of the country’s installed generating capacity, see Note 1(e) to the Financial Statements as of December 31, 2010.
The Government reached during 2009 additional decisions on promoting private electricity producers (decision on May 12, 2009), as included in the proposed Arrangements Law 2009- 2010 "Perform the acts required to complete the regulation of independent electricity producers through the licenses method up to August 1, 2009". The Arrangements Law also proposes to state that a condition for the validity of the license of an essential service supplier that collects payments from electricity consumers, is the making of all payments required from the essential service supplier to another license holder. c) In October 2005 the Electricity Authority determined criteria for infrastructure arrangements by which producers can sell electricity to the Company and “supply” electricity to end consumers using the Company’s transmission grid. For transmitting the energy, the Company will charge a rate set by the Authority. So far, the implementation of these infrastructure arrangements are being tested in association with IPP Ashkelon. On July 27, 2009, the Electricity Authority published a decision that updates chapters E - F to the criteria book, that include extensions, additions and updates of the criteria published in October 2005. The updated criteria specify the relations and work procedures between the system manager and the suppliers and private producers.
In its decision of December 8, 2008, the Electricity Authority set a rate arrangement for a conventional private producer for a sale transaction of available capacity and energy to the system manager. This decision states that the producer will be able to choose to allocate part (or all) of the generation capacity of its facility to the system manager. The system manager will be obliged to a predetermined gas quantity in return for this allocation. The system manger will be obliged to the proportional share of the producer's gas transaction, even if the producer does not use it. d) On July 19, 2009, the Electricity Authority published an update to its decision on rate arrangements supporting financing to private electricity producers. The decision is intended to provide a safety net to private electricity producers and is another step in the Government's actions to create conditions for promoting private enterprise in the electricity sector. In this framework, the Electricity Authority determined that the Company will deposit a sum of money on behalf of every private producer in a dedicated account, managed by a trustee acting as a third party, equal to the value of payments for two months, for the electricity the producer is expected to sell to the Company. These funds will be used to secure payments to the producer. The decision states, that for an act or a default of an essential service provider, the gas delivery company of a third party, that will affect the generation ability of the private producer will be the responsibility of the essential service provider. The decision also establishes a rate arrangement applied between a private electricity producer and the essential service supplier in the event of force majeure, insurance event and a discriminating change in the law.
85 e) The installed generating capacity of private producers that sell electricity to the Company, at all voltage levels, at the time of signing this report, represents about 2.1% (278 MW) of the total installed capacity in Israel (12,769 MW). The private producers can be divided into five main categories:
1. Private electricity producers from alternative energy sources (wind, water, sun, co- generation) with whom agreements were signed for a total capacity of about 50 megawatts. These power stations operate without the possibility of planning or controlling the level of output (Must Run), and they are operated under District supervision.
2. Diesel power stations – Etgal, with a capacity of about 26 megawatts and Noga Paz, with a capacity of 16 megawatts The Electricity Authority determined the rate for these power stations on the basis of their actual generation costs.
3. A private electricity producer, IPP Ashkelon (with a capacity of 87 MW), started commercial operation in 2008 without signing an agreement with the Company. The producer is paid according to the co-generation rate, approved by the Electricity Authority.
4. A private electricity producer, Ashdod Refineries (with a capacity of 49 MW), started commercial operation in July 2009 without signing an agreement with the Company. The producer is paid according to the co-generation rate, approved by the Electricity Authority.
5. A private electricity producer Mashav Initiation & Development, (Nesher Ramla, with a capacity of 48.3 MW) completed acceptance tests in January 2010. An agreement for 2010 was entered with the producer on July 13, 2010, for selling their surplus electricity to the Company and an extended agreement was entered on January 1, 2011. The Electricity Authority is not a party in all matters related to this agreement, except for the setting of a ceiling price. Therefore, electricity purchases from this producer are not included in the rate in any way. f) For about a decade, the State tried to integrate private electricity producers into the electricity sector through the tenders method, so far with little success. As part of these attempts, the Ministry of National Infrastructures published (in June 2001) a public tender for a private producer for a combined cycle power station with a capacity of 440 megawatts at Mishor Rotem. O.P.C. Rotem Ltd. won the tender, but disagreements with the State over the conclusion of an agreement with the Company according to the terms of the tender delayed the execution of the agreement and the case reached the High Court. The disagreements between the parties were concluded and received the force of a court ruling on September 4, 2008 and the Board of Directors of the Company approved the signing of the agreement on November 27, 2008 providing that the Electricity Authority was prepared to recognize all the costs, expenses and damage that the Company could incur due to the agreement, for the purpose of setting the recognized rate, and that the Ministers authorized the Company to handle any surplus or deficit of natural gas of the producer according to the agreement, and subject to an examination of the monetary guarantees to be submitted by O.P.C. Rotem Ltd., which had to meet the Company’s needs. Upon receiving the required approvals, an electricity purchase agreement was entered between the parties on November 2, 2009.
During 2010, discussions were conducted between the producer and the tenders committee, which conducted the tender (representatives of the Accountant General and the Ministry of
86 National Infrastructures), representatives of the Electricity Authority and representatives of the Company to settle several issues on financing of the project. In January 2011, the parties concluded the changes in the agreement and the Electricity Authority, in a decision in meeting 323 of January 17, 2011, approved the changes and the coverage for additional costs on the Company arising from the changes. The producer notified the Company that 330 MW (out of the 440 MW total capacity of the facility) are intended for sale to private consumers.
g) The State replaced the tenders method with the licenses method and any entrepreneur who meets several basic conditions receives a conditional license that enables commencing processes for building a power station. The total capacity of valid conditional licenses as of December 31, 2010 is 4,430 MW consisting approximately 26% of the installed electricity generation capacity in Israel as of December 2010.
h) During the last three years, the Company received dozens of proposals for private power station projects at a total capacity of about 10,000 MW. The Company initiated a process to examine possible integration of the suggested projects in the electricity grid. The process, conducted as a feasibility study, was expanded and approved by the Electricity Authority in its decision 222, on July 9, 2008, In this framework, 30 projects were examined. Once the entrepreneurs start building power stations and producing and/or selling electricity in 2010 (with an overall capacity of about 6,400 MW), it may be expected that they will supply part of the increase in electricity consumption, although the Company is unable to estimate the scope, mainly in light of the uncertainty regarding the ability to implement consolidated arrangement conditions to be agreed, prices of natural gas to the entrepreneurs and their ability to find end consumers.
i) During the year ended December 31, 2010, the Company purchased about 290 million kWh from private producers. In the year ended on December 31, 2009, the Company purchased about 261 million kWh. The average price paid by the Company to private producers in 2010 was 90 agorot per kWh (44 agorot per kWh in 2009). The electricity purchased from these producers in 2010 and 2009 represented about 0.5% of the electricity supplied by the Company each year.
2.1.4.3 Renewable Energies 1) In March 2008 the State decided to publish a first tender for the construction of up to four solar power stations in the Negev, with a total capacity of about 250 MW in solar thermal technology and up to 30 MW in photovoltaic technology. The power stations will be constructed at the Ashalim site in the Negev, in an area of about 4,000 dunams. Announcement of the winners in the solar thermal technology tender is expected in the third quarter of 2011. As of the publication date of this report, there are no data on the expected end of the photovoltaic technology tender.
2) In June 2008, the Electricity Authority approved a rate for small solar photovoltaic facilities (up to 50 KW) with a total accumulated capacity of up to 50 MW. On July 26, 2010, the Electricity Authority updated its decision on the subject to allow an addition of 120 MW capacity to this arrangement.
3) The existence of small, business photo voltaic facilities with a capacity of 47 MW which were build or approved was detected during December 2009. This capacity exceeds the quota as specified in the decision of the Electricity Authority (35 MW out of the total quota of 50 MW, allocated to such facilities). Another decision of the Electricity Authority states that all the
87 facilities that received the required approvals by December 14, 2009 will benefit from the rate that was set for the initial arrangement. In addition, the Company also addressed the Electricity Authority on the subject of exceptional cases of consumers who are in different stages of the process with a total capacity of 12 MW. (Small scale producers, up to 50 MW are defined as consumers producing for self consumption who transfer surplus to the Electricity Authority, who do not need a generation license).
4) On September 7, 2009, the Electricity Authority published an arrangement for small wind turbines.
5) On December 28, 2009, the Electricity Authority publishes an arrangement for medium solar facilities (exceeding 50 kWh) connected to the distribution grid.
6) On February 7, 2010, a rate arrangement was published for generation units, using solar energy, holding generation licenses, that are connected to the transmission grid,
7) On October 6, 2010, a rate arrangement for electricity generation facilities from bio gas was published for a hearing.
8) As of the publication date of this report, the Company cannot estimate the total number of private producers using renewable energies and the installed capacity, which will be built and operated as a result of the tender and in accordance with the aforementioned decisions of the Electricity Authority. 2.1.5 Generating capacity The following table shows the Company’s installed generating capacity (including private producers included in the Company’s system of supervision and control of load), and peak demand in megawatts for the years 2010 and 2009: 2010 2009 Installed generating capacity (IEC + Etgal)………………………. 12,795 11,690 Peak demand of the economy …………………………………… 11,530 10,280 Of which: generated by the Company …………………………… (*)10,950 9,900 Available capacity during peak demand …………………………. 11,520 11,010 * This peak demand was measured on August 19, 2010.
The generation units Haifa B (2 X 72 MW) were removed from the generation system since January 2009.
In 2010, the Company’s installed generating capacity increased by about 1,105 megawatts, due to the following changes: Synchronization of gas turbine unit No. 7 at Ramat Hovav site, with a capacity of 118 megawatts. Transition to use of natural gas in the CCGT unit at Tsafit Stage A site, reducing the capacity by 13 megawatts. Synchronization of CCGT No. 4 Stage A at Haifa site, with a capacity of 234 megawatts. Synchronization of gas turbine unit No. 3 at Eshkol site, with a capacity of 260 megawatts. Synchronization of gas turbine unit No. 1 at Hagit site, with a capacity of 256 megawatts. Synchronization of gas turbine unit No. 8 at Ramat Hovav site, with a capacity of 250 megawatts
88 The following table specifies the various generating units, and their generating capacity in megawatts at December 31, 2010, including electricity purchased from a private producer (ETGAL ASHDOD Ltd.), included in the Company’s system of supervision and control of load: Type of unit Site No. of Installed units generating capacity (in MW) Steam driven power stations Dual purpose power stations Orot Rabin (Maor David A, B) 6 2,590 Rutenberg 4 2,250 Total dual purpose power stations (coal and fuel oil) 10 4,840 Dual purpose power stations (natural gas and fuel oil) Eshkol 4 912 Reading (*) 2 428 Total dual purpose power stations (natural gas and fuel oil) 6 1,340 Total dual purpose power stations 16 6,180 Power stations operating on fuel oil Haifa 2 282 Eshkol 2 150 Total power stations operating on fuel oil 4 432 Total steam driven power stations 20 6,612 Gas turbines Industrial gas turbines Ramat Hovav 5 686 Tsafit 2 220 Alon Tavor 2 220 Eilat 1 34 Atarot 2 68 Gezer 4 592 Total industrial gas turbines 16 1,820 Jet gas turbines Hartuv 1 40 Eitan 1 40 Ra’anana 1 11 Caesarea 3 130 Haifa 2 80 Kinnarot 2 80 Orot Rabin 1 15 Rutenberg 2 40 Eshkol 1 10 Eilat 2 58 Total jet gas turbines 16 504 Total gas turbines 32 2,324 Combined cycle gas turbines Ramat Hovav 1 335 Hagit 3 1,019 Eshkol 1 377 Gezer 3, 4 2 744 Alon Tavor 1 373
Gas turbines intended for future operation as Tsafit 1 235 combined cycle Hagit 1 256 Eshkol 1 260 Haifa 1 234 Total combined cycle gas turbines and gas turbines intended for future operation as combined cycle 12 3,833 Total generating units in the Company 64 12,769 Generating by private producers under Company supervision (Etgal 1 26 Ashdod)
89 Type of unit Site No. of Installed units generating capacity (in MW) Total including private producers under Company supervision 65 12,795
90 2.1.6 Developing the electricity sector - the generating segment
a) Method of determining the plan The main purpose of the development plan for the generating segment is to serve as a basis for reaching practical decisions on additional generating units required, their type, capacity, dates of commencement of operation and their location, while defining the optimal fuel mixture required for their operation. The plan contends mainly with uncertainty in all input aspects: demand for electricity, fuel prices, techno-economical data of candidates for developing the generation system and more. For these reasons, the planning is usually performed through different future scenarios, aimed at reviewing the scope of uncertainty in order to contend with future possible realizations of the planning parameters. In light of the above, there is a perpetual need for the development plans to be updated periodically.
Section 19(a) of the Electricity Sector Law states that the Minister, in consultation with the Electricity Authority may require an essential service license holder to submit for his approval, in the required format and time, a development plan, as a whole or in parts, needed to fulfill the obligations provided by the license; after the Minister, in consultation with the Electricity Authority approves the plan, the essential service license holder will act only according to the approved plan.
The aforesaid requirement is specified in section 28a of the generation license, stipulating, inter alia, that the license holder will submit a development plan regarding its operations according to the license to the Minister, every five years.
b) Main assumptions and constraints underlying the development plan and its implications on reserve level and reliability of the generation system: 1) Development in electricity consumption is affected by economical, climatic and demographical factors. The link between electricity consumption and the influential factors is expressed with the help of an econometric model, developed by Economical Models Ltd., ("Economical Models") jointly with the Company. It should be noted that energy efficiency in electricity consumption over the years was included in the calculations in the future demand forecasts and subsequently in planning the generation system.
Since the long term planning of the generation system is especially long and includes a high uncertainty rate about the future economic development of the State and climatic conditions, it is highly important to conduct an extensive risk analysis during the optimization of the generation system development, with due consideration of distributed demand forecasts.
Consequently, demand forecasts up to 2030 were prepared in three economic scenarios (describing three combinations of weighting a reasonable economic scenario with a basic and accelerated economic scenarios) and two climatic summer scenarios (difficult, extreme), which together create six possible scenarios. All these are performed with the purpose of enabling system planners to expand the risk analysis and thereby reduce the risk involved in decision making.
91 The global economic crisis that started in 2008, affects the demand for electricity forecast. The Company, jointly with Economical Models and the Ministry of National Infrastructures is in an on-going process of reviewing the changes in the demand for electricity, to adapt the demand forecasts to trends indicated by the local and global changes. Therefore, possible updates may still be required in the long term demand forecast.
2) Forecast of gaps between peak demand and generating capacity for the years 2012- 2015: The following table summarizes the expected available capacity of the Company’s generating units (including existing small private electricity producers) compared to the weighted summer peak demand forecast for 2012-2015 in megawatts (negative numbers in brackets).
It should be noted that the following forecast data are based on the most recent update of long term demand for electricity forecast, conducted in July 2009 and includes the estimated effects of the global economical crisis up to that date.
Year Forecast Installed Available capacity in summer Available Available Available reserve peak capacity considering stoppages for reserve in capacity in in summer, demand performing emission summer summer, assuming a fault reduction projects in existing assuming a fault in the largest unit coal power stations in the largest unit Megawatts 2012 11,358 13,500 12,744 1,386 12,169 811 2013 12,054 14,097 12,744 690 12,169 (115) 2014 12,662 14,097 12,744 82 12,169 (493) 2015 13,158 14,097 12,769 (389) 12,194 (964)
Assumptions used in preparing the table
(a) The Company’s forecast of weighted peak demand for electricity is based on the scenario that assumes reasonable economic development and extreme climate in summer.
(b) The forecast for installed capacity is based on the expected start of operation of new generating units according to the Company’s development plan, including the emergency plan for 2010 - 2013, scrapping of old generating units, and stoppage of current generation units in order to implement environmental projects.
(c) In the summer the available capacity is obtained after deducting reduced output of industrial gas turbines and CCGT units from the available capacity caused by the effect of the high ambient temperature.
(d) A fault in the largest unit - a fault in the largest carbonic unit would cause a reduction of about 575 megawatts, and therefore the available capacity is reduced by 575 megawatts each year.
92 (e) Available capacity does not include the entry of new private producers.
It should be noted that according to the data presented in the table above, the reserve of the generation system may be significantly lower than the values required by planning reliability criteria, from which a reserve of 20% of the generation capacity is derived.
3) Expected development of additional generating capacity According to the development plan, the Company is expected to complete the construction of a further 3 new combined cycle units with a total capacity of 1,112 MW by 2012, which have been approved by the Ministry of National Infrastructures for the sites at Tsafit and Haifa. These 3 units are at various stages of planning and construction. So far the construction of two gas turbines, one at Haifa site and the other at Tsafit was completed. Tsafit was connected to natural gas at the beginning of May 2010.
In addition, in light of the risks to reliability of electricity supply, the Minister of National Infrastructures approved the addition of generation units with a total capacity of 1,765 MW, under the framework of an emergency plan. Under the plan, two gas turbines with a total capacity of 240 MW are operated at Ramat Hovav and four combined cycle gas turbines with a total capacity of 1,525 MW will be operated:
In the first stage, gas turbines - during the summer of 2010, units were operated in Eshkol, Ramat Hovav and Hagit sites and during the summer of 2012 the unit in Alon Tavor site will be operated.
Second stage - Additional steam driven units will be built, enabling operation of the units in a combined cycle at Eshkol, Ramat Hovav and Hagit and Alon Tavor in the summer of 2013.
It should be noted that the capacities stated above are the capacities of the units when operating on natural gas, which assumes that natural gas will reach all the electricity generating sites during the period mentioned above.
In addition to these natural gas driven generation additions, the Company plans to operate a coal operated power station, Project D, to diversify the energy sources and prevent too high a dependency on natural gas, which may impair the reliability of the electricity supply. This station, already included in the development plan by the Minister of National Infrastructures in 2001, comprises two generation units of 630 megawatts each, at Rutenberg site in Ashkelon. The earliest possible operation date of this project is 2016 and 2017. As of the Financial Statements date the ratification of the power station construction is awaiting the Government's decision, while reviewing the effect of finding new gas fields along the shores of Israel on the project and considering its construction as a dual-fuel power station that can be operated using either coal or natural gas.
c. Forecast of Investments Required to Implement the Development Plan of the Generation Segments According to the financial planning for 2011-2015, published in 2010, there are two scenarios for the investments plan:
93 Assuming that project D and the full stage B of the emergency plan are constructed, the investments in generation will average approximately NIS 4.6 billion per year.
Investments in generation without the construction of project D and the full stage B of the emergency plan will average approximately NIS 2 billion per year.
d. Forward Looking Information
The detailed estimates of the Electricity Sector development plan – the generation segment is forward looking in nature, based on the aforementioned forecasts and assumptions. Upon completion of the updated investments plan or pursuant to instructions issued to the Company (as a essential service provider) on the development plan it must implement, the Company may require investments in different volumes than aforementioned. This information contains subjective forecasts, valuations, estimates and other plans of the Company for the report date, regarding work assumptions used to prepare the forecast and realization date of those assumptions. This information is based on future data, the realization of which is uncertain by nature and outside the sole control of the Company.
The main factors which may prevent this forward looking information from materializing or change the estimated implementation timetable of the development plan and the subsequent investments according to the aforementioned outline are, inter alia, changes in the expected increase in demand for electricity; implementation of the future restructuring of the Electricity Sector and the Company (see paragraph 1.7.1 in this report) and the effect of the restructuring on the implementation of the Company's development and investments plan; difficulties in receiving licenses and/or changes in the regulations relating to the environment and to licensing; lack of appropriate rate coverage (see Note 3(c) to the Financial Statements); the ability of the Company to raise the funds required to implement the development plan. 2.1.7 Fixed assets and facilities The details of fixed assets and facilities given below refer to property and assets held by the Company or used by it, ignoring disputes between the Company and the State regarding the Company’s rights to the aforesaid property and assets, which were in the Company’s possession when the concession expired. (As for the “assets arrangement” and its implications for the Company, see section 1.7.2 in this report.)
Site name Location Nature Area in sq.m. 1. Rutenberg power station Ashkelon Power station 1,442,600 2. Reading power station Tel Aviv Power station 227,861 3. Haifa power station Shemen Beach, Haifa Power station 355,964 4.* Hagit power station Near Elyakim Junction Power station 735,844 5. Gezer power station Near Nesher factory, Ramle Power station 451,200 6. Eshkol power station Ashdod Power station 470,055 7. Orot Rabin power station Hadera Power station 2,024,940 8. Ra’anana sub-station and Ra’anana industrial zone Gas turbine 27,631 gas turbine 9* Ramat Hovav gas turbine Ramat Hovav industrial zone Gas turbine/ 201,960 switching
94 10 Atarot sub-station and gas Atarot industrial zone Gas turbine 38,194 turbine 11 Kinnarot sub-station and North of Tiberias Gas turbine 29,870 gas turbine 12 Hartuv sub-station and gas Beit Shemesh industrial zone Gas turbine 28,470 turbine 13 Alon Tavor gas turbine Alon Tavor Gas turbine 142,660 14 Eitan sub-station and gas Moshav Eitan Gas turbine 41,704 turbine 15 Eilat sub-station and gas Eilat Gas turbine 67,600 turbine 16 Tsafit sub-station and gas Tsafit Gas turbine 232,970 turbine 17 Caesarea sub-station and Caesarea Gas turbine 228,500 gas turbine Total area: 6,748,023 * There is also a switching station in this power station
These assets are owned by the Company (but see Note 1.e to the Financial Statements on the assets arrangement) or held by it, in the framework of long term leases (mainly with the Israel Land Administration) or under rights that were granted to the Company by the owners of the assets (e.g., easement or permission to use free of charge which is not a lease, or possession right with a process of arranging it under a contract) or rights granted to the Company by Law. The aforesaid assets and rights are subject to floating liens created by the Company to secure part of its obligations (see Note 18.c to the Financial Statements) and also part of these assets (three electricity generation turbines purchased by the Company from Siemens, installed at Ramat Hovav, Eshkol and Hagit sites) are subject to permanent liens created by the Company to secure its obligations to different financing entities (see Note 3 a to the Financial Statements as of December 31, 2010). 2.1.8 Intangible Assets On the matter of the Company’s generating licenses and the provisions of the Electricity Sector Law on granting generating licenses, see section 1.7.1 of this report. 2.1.9 Human resources The generating segment has 2,312 permanent employees and 158 temporary employees as of December 31, 2010 (see also Appendix A below.) For details on terms of employment, training and other details, see section 3.7.2 of this report. 2.1.10 Raw materials and suppliers a) The following table shows the generation breakdown in percentages according to the fuel used in the generating segment to produce electricity in the years 2009 and 2010:
For the period January - December
95 2010 2009
Coal 61% 64.7%
Fuel oil 0.9% 1.2%
Natural gas 36.6% 32.6%
Diesel 1.5% 1.5%
Total 100% 100%
Fuel costs accounted for about ___% of the Company’s operating costs in 2010, and about 59.4% of its operating costs in 2009. b) The following table shows the total costs for fuel (including attributed labor costs) used to generate electricity in the generating segment in the years 2009 and 2010:
Year ended December 31 in millions of NIS (of December 2010 purchasing power)
2010 2009
Coal 4,725 5,274
Fuel oil 236 250
Natural gas 2,760 2,296
Diesel 1,201 1,202
Total cost of fuels 8,922 9,022
96 c. The following table presents the average cost of fuel used by the Company in the years 2009 to 2010:
Year ended December 31 in agorot (of December 2010 per kWh)
2010 2009
Power stations operating on coal 13.8 15
Power stations operating on natural gas 13.4 13
Power stations operating on fuel oil 47.9 39
Power stations operating on diesel 143 146.7
d) All types of fuel used by the Company at the time of signing this report are purchased directly or indirectly from sources outside Israel (excluding natural gas which at the date of this report is also purchased from a local supplier - the Yam Thetis Group). An additional gas contract with the Egyptian company EMG was signed in August 2005, and the gas started flowing in May 2008 (for additional information, see section 2.1.10 h below). As a result, the Company and the State of Israel have almost no control over the availability of fuels in general and any type of fuel in particular (regarding this risk factor see also section 3.17 herein). Any disruption of fuel supplies could affect the Company’s operating results. In order to reduce the negative effects of such disruptions, the Company keeps limited reserves of each type of fuel used to generate electricity (except natural gas).
The Company estimates that its reserves of coal, fuel oil and diesel will be sufficient for consumption of at least one and a half months.
Pursuant to the reports of the finding of gas in the "Tamar" field, located about 90 km west of Haifa shore, in January 2009, the Company opened negotiations with the partners on the purchase of gas from this field under the gas purchasing processes of the Company. The gas found in "Tamar" field ensures (after the Yam Thetis reservoir is depleted) that purchase of quantities of natural gas will continue to be available from a local supply source, that is not affected by political issues which affect gas supplied through pipelines originating abroad. It should be noted that the depth and distance from the shore of "Tamar" field will require considerable investments in the development of the field, including construction of a gas pipeline to the shores of Israel. This process is expected to take 3-5 years, consequently, gas supply from this field is not expected to start before 2013. Negotiations with Tamar partners on a gas purchasing agreement from this field were suspended for some time, in light of the uncertainty of the partners arising from the publication of the conclusions of Shishinski Committee, that studied the fiscal implications of gas and oil resources in Israel. The negotiations continue at the present.
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e. Coal 1) In each the years ending on December 31, 2010 and December 31, 2009 the Company consumed 12.3 million tons of coal. The Company purchases all the coal it requires through the National Coal Supply Corporation Ltd. (“the Coal Company”), which is a fully owned subsidiary of the Company. See Note 1h. to the Financial Statements as of December 31, 2010. As of the date of this report, the Coal Company does not depend on a single supplier.
On July 15, 2004, the Company and the Coal Company signed an agreement for purchase, supply and delivery of coal to the Company’s coal fired power stations - Orot Rabin in Hadera and Rutenberg in Ashkelon. The agreement was in force from December 31, 2003 and will be in force as long as the Company holds licenses for these power stations. The Company has the right to cancel this agreement by prior notice of one year. The price paid is calculated on the basis of cost plus agreed profit, and subject to the price of coal approved for the Company by the Electricity Authority. According to this agreement, ownership of coal stocks passes directly from the supplier to the Company, while the Coal Company will take care of transporting the coal to the power stations, taking out suitable insurance (in favor of the Company) in the event of any loss or damage to the coal.
In 2010 the adjusted average cost of a ton of coal was NIS 384 compared to 2009, when the adjusted average cost of a ton of coal was NIS 429.
2) The Coal Company purchases coal (usually in the framework of supply contracts for at least one year) from several sources. At the time of signing this report, the Coal Company’s main sources of coal are in Africa, South America, Asia and Australia. Company representatives participate in the negotiations that take place between the Coal Company and their suppliers, particularly on matters of quality, availability and price. Most of the Coal Company’s purchases of coal are on a FOB basis, but the price to the Company includes the additional costs for transporting the coal and unloading it at the production sites.
3) According to the directives of the outline plan that apply to "Orot Rabin" the Company is required to use low sulfur coal in this site. The Company purchases coal with various percentages of sulfur from the Coal Company and burns various types that ensure it meets these directives. On December 24, 2010, the Minister of the Environment signed a general lateral "personal order" applying to all the power stations of the Company. This order includes a directive on burning low sulfur coal in Rutenberg Site in Ashkelon. See section 2.1.13 of this report. f. Fuel Oil 1) In 2010 and 2009 the Company consumed about 119 and 152 thousand tons of fuel oil respectively. At December 31, 2010, the adjusted average cost of a ton of fuel oil was NIS 1,991 compared to the adjusted average cost of a ton of fuel oil in 2009, which amounted to NIS 1,641. When the Company began using natural gas (see section 2.1.10 h below), consumption of fuel oil was reduced.
98 2) Fuel oil supply was based in 2010 on deliveries from Haifa and Ashdod refineries that won the international tender published by the Company. The Company has an option to extend the contract for another year. The suppliers are responsible for delivering the fuel oil to the inlet of Haifa and Ashdod power stations or to the Company's marine connections at Orot Rabin and Rutenberg sites. The Company pays prices based on CIF LAVERA terms (trade prices in the Mediterranean Basin), plus a marketing margin. As of the date of this report, the Company is not dependent on a single supplier.
3) In accordance with the Environmental Protection Order published by the Minister for Environmental Protection in 1992, the Company uses low sulfur fuel oil with a maximum sulfur content of 0.5%. The Haifa power station uses fuel oil with a maximum sulfur content of 0.3%. g) Diesel 1) In 2010 and 2009 the Company consumed 219,000 and 208,000 tons of diesel respectively. In those years the Company purchased diesel on the local market from local fuel companies, usually in the framework of supply contracts for one year. At the beginning of 2007, the Company also began to import diesel from the Vitol company. The price of the diesel is based on CIF LAVERA terms (trade prices in the Mediterranean Basin), plus marketing margins, infrastructure costs and excise tax. From the beginning of the year the Company purchased diesel for heating containing 0.2% sulfur and in preparation for the new diesel standard that will become effective on January 2010, the Company purchased in June 2009 diesel for heating containing 0.1% sulfur only. In light of the inventory held by the Company and the fact that the refinery in Haifa is prepared to produce diesel according to the required standard, the Company is not dependent on VITOL.
The Company pays for diesel quantities ordered for delivery on a certain date according to the price for the month of that order.
2) The prices paid by the Company for diesel are linked to world market prices, with margins determined in competitive tenders between Company suppliers. In 2010 the average adjusted cost of a ton of diesel was about NIS 5,480 compared to 2009, when the cost to the Company was about NIS 5,772 per ton of diesel.
3) The diesel is brought to the Company’s gas turbine operated power stations mainly through the national pipeline, or by tanker trucks to sites that are not connected to the national pipeline.. h) Natural gas 1) In 2010 the Company consumed about 3,268,000 tons (about 4.82 billion cubic meters of natural gas) at an average cost of NIS 845 per ton, while in 2009 the Company consumed about 2,741,000 tons (about 4.04 billion cubic meters), at an average adjusted cost of NIS 838 per ton. Gas began flowing to the Tsafit site in June 2010 and to the Ramat Hovav site in July 2010. As Company sites are connected to the natural gas transportation system, consumption will gradually increase to 5-6 billion cubic meters annually.
99 2) The Company is engaged in converting industrial gas turbines operating on diesel to operate on natural gas as well and also in the construction of new turbines. As of December 31, 2010, five generating units at the Eshkol power station were running on natural gas, with installed generating capacity of 1,285 MW, four of which are steam driven power stations with installed generating capacity of 912 MW and one is of the combined cycle type with installed generating capacity of 373 MW. Also, two generating units at the Reading power station were operating on natural gas with installed generating capacity of 428 MW. As of July 2008, 2 combined cycle gas turbine units and 4 units of open cycle at the Gezer site have a total capacity of 1,064 MW. Gradual operation of generation units at the Hagit site with a total capacity of 1,019 MW in three combined cycles started since the end of May 2009. Operation of an open cycle unit at the Tsafit site, at a total capacity of 248 MW, started in June 2010, and the Ramat Hovav site was connected to the gas transportation system in July 2010, where a CCGT and 4 open cycle units are operated at a total capacity of about 800 MW. When the Company began using natural gas (in 2004), the quantities of fuel oil it consumed declined (see section 2.1.10 (f) below). The reduction in use of diesel took place during 2008 after connecting the Gezer site to the gas transportation system in July 2008. Connection of the Hagit site to the gas transportation system in May 2009 further reduced the annual diesel consumption of the Company. This information is forward looking information, based on the development plans of the Company. This information contains forecasts, subjective valuations, estimates and other plans of the Company as of the signing date of this report, regarding work assumptions it used to prepare the forecast and realization dates of these assumptions.
3) During 2010, about 56% of the natural gas was supplied by the Yam Thetis Group, which holds the Mari natural gas marine reservoir, located about 24 km west of Ashkelon. The agreement to supply natural gas was signed with the Yam Thetis Group in June 2002, as detailed below. 44% of the gas was supplied by the Egyptian company EMG through a marine pipeline from El-Arish to Ashkelon, enabling gas transportation from the Egyptian gas system according to the agreement signed in August 2005, as detailed below.
4) Agreements for Purchasing Natural Gas
1. Purchase of Natural Gas from the Yam Thetis Group
In June 2002 an agreement to supply natural gas was signed with the Yam Thetis Group, according to which the Group will supply the Company with natural gas for 11 years from the date it begins flowing, or until total consumption reaches 18 billion cubic meters (about half the amount of natural gas the Company needs for the coming decade), whichever is the earlier. The total value of the agreement with Yam Thetis is about USD 1.8 billion. The agreement includes an undertaking by the Company to pay for a minimum quantity of natural gas, whether or not the Company actually consumes it (“Take or Pay”). The quantity of gas paid for but not consumed in specific periods will be available to the Company in the following periods, subject to the terms of the agreement. Since February 2004 natural gas has been supplied according to the agreement.
100 In July 2009, the Company entered a second agreement with Yam Thetis Group for the purchase of additional quantities of natural gas in an annual amount of 1 billion cubic meters (BCM) for the next five years. The balance of the gas quantity to which the Company was entitled on June 30, 2009, under the gas agreements with Yam Thetis Group (the first agreement in June 2002 and the second agreement in July 2009), amounted to about 11.2 BCM, of which 6.2 BCM remained from the first agreement
2. Purchase of natural gas from the EMG company.
On July 21, 2005, the Board of Directors of the Company approved the agreement that the Company reached with EMG for supply of natural gas. According to the agreement, the quantities of gas to be purchased (about 25 BCM) will be at an average annual rate of 1.7 BCM for 15 years with an option for the Company to extend it for a further 5 years on the same terms and for the same annual quantities. To exercise the option, the Company must give notice of 36 months before the end of the basic period.
On July 31, 2005, the Government approved the aforementioned decision of the Board of Directors, in accordance with section 11(a)9(a) of the Government Companies Law.
The supply of the gas started in May 1, 2008, where at the end of the two month running- in period, the contractual gas supply period began (on July 1, 2008).
Since the beginning of the gas supply by EMG in May 2008 and the beginning of the contractual obligatory supply in July 2008, the supplier did not fulfill its contractual commitments. According to the supplier's statements, there is a general shortage of gas in Egypt due to delayed developments of new gas fields, which limits supply volumes; demand for gas that exceeds forecasts and failures in the supply system caused by the overload applied to gas supply and treatment systems. Pursuant to an amended gas sales agreement between the Egyptian Government, the Company and EMG, the parties have concluded in the summer of 2009, the terms for updating the original agreement, entered on 2005, while adapting it to the developments since then. The Audit Committee and the plenum of the Company's Board of Directors approved this update of the agreement. The main amendments to the agreement are: a) Change in the price of natural gas and defining a periodic price update mechanism. b) Reduction in quantities that the Company is committed to purchase under the agreement. c) Defining means to ensure reliable gas supply.
On February 15, 2011, an explosion occurred in a metering station, located along the natural gas pipeline carrying gas from Egypt to Jordan As a result of the fire there, the Egyptian gas company (EGAS) stopped the gas supply to the delivery system in the area, including the pipelines supplying natural gas to Israel. The explosion was caused by a terrorist act. EMG notified the Company about a force majeure event. The explosion required construction of a bypass to the damaged gas pipe and replacement of several valves. Gas supply was resumed on March 15, 2011.
The Company is prepared to supply short term electricity demand through increased burdening of the coal operated generation unit, increased gas supply from "Yam Thetis" group and use of alternative fuels, such as crude and diesel oil during peak demand. See also Section 6f2 of the Board of Directors’ Report.
101 5) Agreement Of Intention to Supply Natural Gas from the Tamar Field and Natural Gas Storage Services in Mari-B Field Under the gas procurement process, which started in 2007, the Company reached an understanding with the stake holding companies in Tamar Field, located about 90 km west of Haifa, on the principles of gas supply from this field, for a period of 15 years, starting on July 2013. The parties entered a letter of intent (non-obligatory) on December 13, 2009, that concluded the quantities and price formula. On December 24, 2009, the Company's Board of Directors approved the letter of intent as the basis for negotiations on a binding contract and the Company reported this to the Securities Authority on December 27, 2009. In addition, the Company concluded a letter of intent (non-obligatory) with Yam Thetis Group, that produces gas from Mari-B field, opposite Ashkelon shores, whereby the Group will provide natural gas storage services to the Company from this field. The starting date for providing the storage services will be concluded in a detailed contract that will allow the Company to store gas reserves in Mari-B field from the beginning of the regular gas supply from Tamar Field, to be used by the Company during disruptions in gas supply from current gas sources or during peak demands. Based on these two letters of intent, the parties intend to conclude detailed agreements within six months that will be submitted for the approval of the authorized committees. As aforementioned, negotiations between the Company and the Tamar partners was suspended for some time, in light of the uncertainty of the partners following the publication of the Shishinski Committee conclusions, that reviewed the fiscal implications of gas and oil resources in Israel. The negotiations continue at present.
6) Agreement to Transport Natural Gas In June 2006, the Company signed an agreement with Israel Natural Gas Lines Company Ltd. (hereinafter “the Gas Lines company”) to transport natural gas, under a formula published by the Natural Gas Authority, and which will apply to all consumers of natural gas who sign agreements with the Gas Lines company.
The agreement regulates the commercial, technical and legal rules for piping natural gas, for a period of 15 years. This agreement was signed for the Eshkol and Reading sites, as the Electric Corporation had reservations about a number of issues in the agreement. On May 31, 2007, the Gas Authority published a general formula for agreement on piping gas between the Gas Lines Company and consumers in the economy. In February 2008 the Board of Directors approved the wording of a permanent natural gas transport agreement between the Company and the Gas Lines Company, replacing the June 2006 agreement. The new agreement was signed in January 2009.
Under the agreement, the Electric Corporation was granted flexibility regarding orders for capacity by means of the right to shift up to 15% of the ordered capacity and by the right to order capacity for the short term (for a full month minimum). This agreement shall stay in force for 15 years, applying to all sites to be connected to the gas pipeline.
7) The project to set up a natural gas transportation system (hereinafter: “the Project”) 1. The Company was charged by the Israeli Government with funding, ordering and managing the work to set up part of the natural gas transportation system in Israel. For this purpose, an agreement signed in November 10, 2004 between the Israel National Gas Lines Company Ltd (hereinafter “INGL”), the Government of Israel and the Company. Four annexes consisting an integral part of this agreement were prepared
102 ("The Tripartite Agreement"). The Company engaged the services of experts who drew up the plans for the project. The plans were approved by the professional company (EON, engaged by INGL) and by the Gas Authority. The Company engaged executing contractors and supervisors, all of whom are experts in their fields. The agreements with the professional parties included responsibility of these parties in the scope that corresponded to the obligations of the Company in the tripartite agreement. 2. The construction was executed over five years, during which several segments of the gas transportation system were transferred to the State. The onshore segment from "Dor" station to the "Hagit" power station and the PRMS station at "Hagit" was the last segment transferred to the state in February 2009. 3. The Company filed a claim against the State and INGL relating to the national gas transportation project. The State and INGL filed counterclaims. These claims are heard in an arbitration process conducted by the Director of the Government Companies Authority. In May 2008, the Attorney General announced the appointment of Dr. Udi Nissan, Director General of the Government Companies Authority (at that time), as the arbitrator in the disputes between the Company on the one side and INGL and the State on the other side on the gas transportation project. In December 2008, the Company filed a position paper (statement of claim) on its behalf, requesting the State and INGL to incur a list of additional costs it incurred during the construction of the project, amounting to tens of millions of NIS. In January 2009, the State and INGL filed a position paper on their behalf requesting to oblige the Company to bear the unrecognized costs, including costs of repair and/or completion works, allegedly caused by negligent conduct and alleged violations by the Company of the tripartite agreement entered between the parties (the majority of the claims filed by the State and INGL were not quantified in exact amounts, but are likely to amount to tens of millions of NIS). During August 2009, the parties filed response papers on their behalf and denied each other's claims.
The causes of action of the parties to the arbitration and the remedies requested are as follows: The status of the Company in the Project and its Scope of Responsibility: The Company claims that according to the provisions of the tripartite agreement, the role of the Company is to finance the Project, manage it and order the work required and it may not be regarded as the primary contractor who is responsible for all the construction works of the project performed by subcontractors. The State and INGL claim that the Company should assume all the responsibility for all the works performed by sub-contractors. It should be noted that the decision on the role of the Company in the project and the scope of responsibility does not involve direct financial cost, but affects the decision on the other disputes between the parties.
a. Repair of damage to the north section of the gas pipeline. The parties disagree on the repair method of the pipe performed by the Company. While the Company upholds the mechanical repair method actually implemented and financed by the insurers of the project, the State and INGL claim that the repair should have been performed by the welding method, which is not covered by the insurers of the project. To avoid a delay in commissioning the pipe, the parties agreed, as an interim solution and until the arbitration will reach a decision, that in the event that the State will decide to perform another repair, the Company will incur half of the repair cost, up to a ceiling of $15 million (as an interim financing, where the final amount will be decided according to the decision of the arbitration). As of the present date, the State did not decide on performing another repair on the pipeline. b. Other Works. The Company claims recognition of costs arising from additional works it performed during the construction project (reconstruction of the crossing points of the gas pipe in the approximate sum of $ 22.5 million, conducting an ROV survey during the construction in the approximate sum of $5.3 million) and
103 works that the Company is required to perform in future (rock dumping in the amount of $ 10 million). These costs total approximately $ 37.8 million. The Company negotiated with the insurers of the project, who agreed to incur a final payment of approximately $ 24.7 million. The amount is paid with respect to the additional works already financed by the Company (supports) and other works, expected to be performed in future by INGL (rock dumping), less a deductible according to the policy in the amount of $ 2.5 million, less several deductions. c. Claims of the Cable Companies – a claim in the amount of NIS 29 million filed by the cable companies against the State, INGL and the Company. According to a compromise agreement that was entered with the cable companies, upon consent of the State and INGL, the Company paid NIS 16.5 million to the cable companies, to settle the claim. The insurers of the project incurred this cost of compromise, deducting $ 2 million with respect to deductible and damages attributed to impacts from marine vessels which are not covered by the insurance policy. Therefore, the amount of the claim in this case currently amounts to $ 2 million. d. Trawler Fishermen Claim – a claim in the amount of NIS 35 million, filed by fishermen and fishing companies against the State, INGL and the Company with respect to closing and narrowing fishing areas due to the project. The Company on the one hand and the State and INGL on the other hand claim that if the fishermen's claim is eventually accepted the other party should be required to assume all the responsibility and charges decreed. The parties reached an agreement, stating that the division of the responsibility among them will be discussed by the arbitration and not filed to the court. It should be noted that this claim, filed to the Tel Aviv district court is in its preliminary proceedings and evidence hearings in the claim are expected during June 2011. e. Rust and “Smart Pig” damages – INGL and the State request the arbiter to determine that the Company should incur costs of the "Smart Pig" test. The statement of claim does not indicate an amount, yet this is an obligation for $ 0.5 million, which expired in June 2010 and which in any case was conditional to finding negative results. The test was conducted and stated that there is no need for repairs. f. Pipeline depth underground issue - the State and INGL claim that the Company should incur the costs of laying the pipes underground to be determined by a professional technical expert and as required by the Ministry of Defense. The claim does not state the sums. g. Claims of INGL and the State regarding defects and other faults detected in the PRMS system at Ashdod (€ 205,000 + exceptional maintenance costs), replacement of sand bags in the under-water cages, additional supervision costs (BIPOL Ltd), leak repair costs in Hadera (NIS 2.4 million), delays and faults in the planning and building of the receiving station at Ashdod. The Company denies the claims of the State and INGL and claims that in any case, according to its role and position in the project as stipulated by the tripartite agreement, it cannot be charged with any responsibility for the said damages and costs. h. Timetable – INGL and the State claim that they incurred damages due to the alleged failure of the Company to meet the timetable specified by the tripartite agreement, such as loss of capacity fees, financing costs and more. The Company claims that according to the directives of the tripartite agreement and the timetable specified in it, no delay occurred in the execution of the project and in some segments, the Company was even ahead of the agreed upon delivery date. The amount of the claim was not yet concluded.
In addition to the aforementioned, the Company has two other causes of action against the State and INGL:
104 i. Financing expenses the Company incurred due to a delay in refunding VAT, at the amount of NIS 4.3 million. j. Recognition of connection rates – a notice of a dispute that may possibly be brought up for a decision of the arbitrator, regarding recognition of connection rates incurred by the Company of approximately $ 461 thousand, arising from the construction of a PRMS at "Reading" station, $ 1,185 thousand with respect to construction of PRMS Ashdod and $ 3,075 thousand related to the PRMS construction at "Hagit".
4. In addition to the aforementioned causes of action brought before arbitration, there are disputed issues between the Company and INGL, which have a financial implication, as follows: a. The Company insists on receiving payment of approximately $ 4 million in respect of the fourth annex to the tripartite agreement (funds held by INGL as a deposit). It should be noted that according to the fourth annex, another amount of approximately $ 4 million of the deposit will be transferred to the Company after receiving the approval of the competent body on the completion of the obligations of the Company, specified in Annex A of the fourth annex (including assuming the rock dumping performance costs and receiving completion certificates. b. Payment of management fees of approximately $ 10 million according to section 743 of the tripartite agreement. c. The request of the Company to INGL to complete the approval process for the project's costs in different segments. d. The demand of the Company to receive a refund for financing costs incurred by the Company before taking out the loan from OPIC. These costs amount to approximately $ 18 million. e. A demand of the Company to settle payments exceeding the loan from OPIC in the amount of approximately $ 10 million. f. A demand of INGL to receive a refund of expenses arising from the construction of the permanent receiving station at Ashdod, of approximately $ 2 million.
5. The Arbitration Process: As of the current date, one preliminary arbitration meeting was held with the arbitrator Dr. Udi Nissan (on August 27, 2008), in which dates were set for filing claims by all parties. The arbitration meetings were not resumed after the claims were filed, due, inter alia, to negotiations conducted with the insurers of the project, which had implications on the aforementioned claims of the parties and due to the fact that Dr. Nissan ended his term as the Director General of the Government Companies Authority. On August 30, 2010, a meeting was held, chaired by the Deputy Director General of the Government Companies Authority (Aharon Goldman, CPA), in the presence of the parties, on resuming the arbitration process and resolving the disputes between the parties. At present, the arbitration process between the parties is pending and waiting for the Director General of the Government Companies Authority to start the arbitration. Completion of the litigation between the parties cannot be estimated at present time. For additional information, see Note 13 g to the Financial Statements as of December 31,2010. 2.1.11 Working Capital The Company operates as one integrated and coordinated system, and therefore its working capital is examined in terms of the Company as a whole (see section 3.9 of this report). However, details are given below of the policy of holding stocks of fuel allocated to the generating segment:
105 a. Coal: the Company’s policy is to maintain a reserve suitable for average consumption of seven weeks (in each of the power stations), and avoids going below the stock needed for five weeks. In the event of a fault in the coal unloading system, the coal is moved from one site to another in accordance with the Company’s existing emergency procedures.
b. Fuel Oil: the Company’s policy is to maintain a reserve of 160-200 thousand tons at Orot Rabin and Ashkelon which are storage sites, although the current use of fuel oil in these sites is small. In the event of an emergency, fuel oil will be moved from these sites to the steam driven power stations.
c. Diesel: the Company’s policy is to maintain an emergency reserve of 165 thousand tons. The stock is stored in containers located at Company sites and the national storage terminals. 2.1.12 Restrictions and regulation of the generating segment activity The generating segment is subject to the provisions of the Electricity Sector Law, the regulations drawn up by virtue of it, and the provisions of the generating licenses granted to the Company (see sections 1.7.1 to 1.7.3 in this report).
In addition, the generating segment is subject to regulation and restrictions by virtue of the Planning and Construction Law 1965 and the Business Licensing Law 1968 as well as various environmental legislation, as specified in sections 2.1.3 and 3.12.11 of this report. 2.1.13 Environmental quality - generating segment a) The activities of the Company, including the generating segment, are subject to environmental laws and regulations regarding various matters such as pollution of air, soil, water sources, noise, magnetic fields, storage, transportation and disposal of hazardous materials and others. Many of these laws and regulations were introduced a long time ago, while others are at various stages of regulation and standardization.
These laws include among others: the Abatement of Nuisances Law - 1961, ("Abatement of Nuisances Law"), including personal orders issued by force of this law, the Planning and Building Law - 1965, the Licensing of Businesses Law - 1968, the Water Law – 1959 and its regulations, Water Rules (Treatment of Water Polluted by Fuel) – 2010, the Prevention of Sea Pollution from Land-Based Sources Law - 1988, the Hazardous Substances Law - 1993, the Protection of the Coastal Environment Law - 2004, Non-Ionizing Radiation Law - 2006 including Non-Ionizing Radiation Regulations - 2009, Clean Air Law - 2008, Freedom of Information Law - 1998 including Freedom of Information Regulations (making information on the environment available to the public) – 2009, The Pharmacists Regulations (Radioactive Elements and Their Products) – 1980, The Energy Sources Law - 1989 and other laws and regulations, either by force of the aforementioned laws or by force of other regulations and other by-laws (hereinafter: “environmental legislation”). Environmental legislation stipulates, inter alia, permitted levels for air pollution, noise, materials emitted in sewage and other waste from power stations and the Company’s other facilities, as well as mechanisms for handling hazardous materials, restrictions and procedures for erecting facilities and buildings (the Planning and Building Law) and so on.
To the best knowledge of the Company, the majority of its generation facilities comply with all the existing environmental laws and regulations as of the date of this report. The Company also
106 works with the regulators with requests to adapt certain requirements applied to some of its generation units to enable the Company to conform with the requirements. See also section b2 below.
Standards applying to the activities of the Company, the environmental quality supervision and enforcement of environmental regulations became stricter in recent years. The Company estimates that this trend will continue and even become stricter in the coming years, inter alia, similar to the accepted in western countries. The Company is studying the implications of the laws and regulations proposed on environmental subjects, acts to prevent or minimize the environmental hazards that may occur during its operation and has allocated funds in its operating budget in order to comply with existing and expected environmental laws and regulations applying to its activities. Nevertheless, there is no certainty that the costs and liabilities connected with existing and expected legislation will not be higher than the amounts allocated by the Company for this purpose. The Company believes, as of the date of these Financial Statements and based on the instructions of the Electricity Sector Law - 1996, that the significant costs it will be required to incur, arising from new regulatory requirements, will be covered under the electricity rate. A decision on costs recognition is subject to an audit by the Electricity Authority. This estimate is forward looking information.
As of the publication date of this report, several environmental bills are in different legislative stages and several regulations are pending. The following bills and regulations are proposed:
- A memorandum on land pollution prevention and rehabilitating contaminated lands law – 2011, intended in general to protect, rehabilitate and preserve the lands in Israel. As at the date of this report, this memorandum law, imposes, inter alia, various duties on the polluter, holder and owner of polluted land, including the duty to conduct land surveys, treatment of contaminated lands and more. In addition, the memorandum law defines, as at the date of this report, financing mechanisms and duty to register contaminated lands as such in the lands registry.
- A bill on preventing asbestos and harmful dust hazards – 2011, intended to prevent and reduce nuisances caused by asbestos and harmful dust. The bill imposes duties, inter alia, on owners of an industrial facility, including the duty to dismantle brittle asbestos within 10 years from the approval date of the law. This bill was approved for the second and third call on March 15, 2011.
- A bill of environmental protection (supervision and enforcement authorities), intended to expand all the enforcement authorities granted to the Ministry of the Environment, to effect improvement and efficiency of environmental enforcement.
This bill was approved for the second and third call on March 15, 2011.
- Hazardous materials regulations (classification and exemption) bill, proposed by the Ministry of the Environment as a reform of the current regulations. The proposed regulations define, inter alia, that coal ash will be subject to a poisons license. Such a category will require the Company to build a warehouse for coal ash.
- A bill on clean air regulations (air quality values), proposing to set maximum values to the presence of different pollutant in the air, specified in the first addendum to the law. Deterring values and environmental values.
107 These bills, if and insofar as approved could have significant economic implications for the Company. The Company is of the opinion that based on the stipulations of the Electricity Sector Law, that the significant costs it will be required to incur, arising from new regulatory requirements, will be covered under the electricity rate. A decision on costs recognition is subject to an audit by the Electricity Authority. This estimate is forward looking in nature. See description of the environmental risks and the Company's policy regarding environmental protection and environmental laws in section 6 f of the Board of Directors Report.
b. Atmospheric Emissions
1. Clean Air Law.
The clean air law came into force on January 1, 2011. The purpose of this law is to regulate air quality in Israel and prevent air pollution, by establishing a national monitoring system for measuring air pollution and defining air pollution standards. In addition, the law obliges the Government to prepare a national, multi-annual plan that will include targets for preventing air pollution. The law also requires publication of monitoring and sampling data provided by plants to the general public. The law regulation a regulation and supervision system on the subject and includes a considerable chapter that grants enforcement and punishment authorities, including the ability to exercise financial sanctions against plants due to violations of the law, authority to enter plants and issue orders to stop the use of the whole emission source or part thereof. Granting an emission license involve a public participation process.
According to the Clean Air Law, the Company is required to file requests for emission license for facilities that are required to have a license. The Company is required to file requests for emission licenses for the current power stations up to March 15, 2015. It should be noted that a new non-operational unit will also be regarded as an existing power station, if it is operated by natural gas and has an approved planning scheme with an environmental effect survey. New facilities that require a license will be required to obtain an emission license for operation at any time after January 1, 2011. The emission license will cancel the need to obtain some of the other licenses on air quality issues, currently applied to the Company's facilities, such as personal orders and air quality conditions in business licenses.
According to the Clean Air Regulations (Fees) – 2010, a fee will be charged for an emission license, billed on the request for an emission license filing date, for each emission source that is required to have a license, according to its operation type and volume. A fee was also defined with respect to a request to make a significant change in the emission source. The Company estimates that the maximum total amount of the fees it will be required to pay is immaterial.
According to the Clean Air Law, the Ministry of the Environment should define a charge on emitting pollutants to the air, to be required of any holder of an emission license. This charge was not defined as yet.
The Company studying the economic, legal and operational implications arising from the law and started preparations related to drawing the requests for emission licenses for existing power stations.
2. Personal Orders by Force to the Abatement of Nuisances Law
108 Atmospheric emissions from power stations include sulfur dioxide, nitrous oxide, carbon dioxide and particles. On December 26, 2010, the Minister of the Environment signed a general comprehensive "Personal order" according to the Abatement of Nuisances Law - 1961, applying to all existing power stations of the Company. The order defines, inter alia, the obligation to install devices for reducing emissions in the coal fired power stations of the Company, gradually up to the end of 2016; emission values from power stations; the continued monitoring and installation of monitoring devices obligation; obligations of tracking, recording and reporting limitations applied to the use of fuels and more. In its response to the Ministry of the Environment, the Company argued that the act of issuing an order on the eve of the expiration of the authority to issue the order according to the Abatement of Nuisances Law is unreasonable and does not enable the Company and the other regulators of the electricity sector to respond to the actual problems. The Company also argued that some of the instructions of the order are either unreasonable of impossible to fulfill. Thus the Company argues that it will not be able to fulfill the requirement on using coal with a 0.43% annual average sulfur contents in all the coal operated generation units (an instruction that came into force on March 26, 2011), due to the coal reserves in the global market; the Company will not be able to meet the dates required for installing continued monitoring instruments in the stack (an instructions that came into force on March 26, 2011); the Company will find it difficult to fulfill its obligation to supply electricity in exceptional cases requiring the use of backup fuel, since the instructions of the personal order do not include all the required situations and the order requires advance approval of the Ministry of the Environment; the Company doubts its ability to meet timetables set by the order for installing emission reduction facilities in the coal operated units. The Company addressed the Ministry of the Environment, requesting it to amend the "personal order" and so far, received negative or procedural responses to its requests. In addition, Haifa, Reading, Eshkol and Orot Rabin sites are subject to specific “personal orders” – provisions including directives as detailed below, which were not cancelled upon the issue of the lateral order. It should be noted that the lateral order states that its directives supersede directives of previous personal orders issued, unless it explicitly states otherwise, except on all matters related to specific sections in the personal order of October 12, 2009, issued for Orot Rabin power station in Hadera (see below) and unless explicitly stated otherwise.
The personal order for Eshkol site, Ashdod was first issued in 1985 and amended in 1995, 2000 and 2009. The main orders are: prevention of unreasonable air pollution, use of low sulfur crude, warning procedure for intermittent operation of monitoring systems, soot blowing restrictions, monitoring, metering, sampling, recording, reporting and limitations applied to the operation of units in "Eshkol B" power station.
The personal order for Reading site, Tel Aviv, was first issued in 1993 and amended in 1996, 2000, 2002, 2004 and 2006. The main orders are: prevention of unreasonable air pollution, use of low sulfur crude, warning procedure for intermittent operation of monitoring systems, soot blowing restrictions, monitoring, metering, sampling, recording, reporting, closure of Reading B power station and transition to use of natural gas only.
The personal order for Haifa site was recently amended on December 23, 2010 and cancelled the previous personal orders for Haifa. The main orders are: prevention of high and unreasonable air pollution, operation of all units with natural gas only at the end of 90 days from
109 the order issue date, obligation to install nitrogen oxides reduction devices up to December 31, 2015 in Haifa C, limiting the operation of Haifa C to 1,000 hours per year, soot blowing restrictions, limiting starting of operations and shut downs and maximum atmospheric emission values.
The personal order for Orot Rabin site, Hadera was issued in 2009. The main orders are: prevention of high and unreasonable air pollution, obligation to install emission reducing devices in units 5 and 6, with indicated milestones in the timetables of the devices installations, monitoring and sampling plan, instructions on failures in emission reduction devices, reporting obligation and more.
The Company's CEO was summoned on January 9, 2011, to a hearing at the Haifa District of the Ministry of Environmental Protection, with respect to a claimed failure to fulfill the instructions of the second milestone included in the personal order of Orot Rabin (the milestone relating to entering agreements with suppliers of emission gases cleaning devices), after receiving an extension for meeting the milestone. The Company presented the causes that prevented it from fulfilling the instructions of the milestone, arising from claims filed against the bidding process conducted by the Company for purchasing equipment for the nitrogen oxides treatment facility and its efforts to meet the timetables. The position of the Ministry of Environmental Protection regarding the opening of an investigation process of the failure to fulfill the said instructions of the order was not yet received.
The Company is continually implementing measures to reduce polluting emissions. These measures include using low sulfur fuel oil at the Haifa site until natural gas reaches this site (and closing the Haifa B generation units): Use of low sulfur coal in coal power stations. Installing means to reduce nitrous oxide during use of natural gas or diesel in many of the industrial gas turbines. The installations were done on the basis of European requirements for large combustion installations, which are stricter than the provisions and requirements on this matter in Israel.
In the large fuel oil power stations, Haifa C, Eshkol C and D, the Company installed preliminary means to reduce nitrous oxide in the years 2002-2006 at a total cost of about 96 million dollars.
The Company operates systems to monitor and control emissions from its facilities in the air, in the sea and on land. The data are submitted to the regulating authorities and other relevant agencies. c) Integrated Licensing
The Ministry of the Environment has recently published a draft document on adopting an integrated licensing policy in Israel for large scale plants which have complex effects on the environment and guidelines on providing information for such a licensing process.
Integrated licensing, as stated in the European Integrated Pollution Prevention and Control (IPPC) Directive wishes to examine in general the environmental effects of the plant on the environment from all aspects (effluents, air, soil, etc.) and determine individual conditions for each plant with due consideration to its unique conditions and the integration between its different environmental effects.
110 The published draft document includes a general outline of the information that will be required during the integrated licensing process. Filing plans to reduce emissions will be requires as well as information related to development plans of the plant.
The Ministry of the Environment did not decide as yet which plants will be required to comply with the integrated licensing proves and announced that the target population of this process will be defined during the coming year. The IPPC directive is applied to a list of categories, most of which are the same as those required for an emission license according to the Clean Air Law. The mechanism will require reorganization and addition of information and surveys submitted to the Ministry of the Environment for licensing Company sites. The economic, legal and operational implications that will arise from adopting the policy by the Ministry of the Environment cannot be estimated at this stage.
d) Pollutant Release & Transfer Register (PRTR) (Environmental Information System)
The PRTR is an environmental data base of all materials having a polluting potential, emitted to the air, water and soil or transferred to another site, inter alia by industrial sources. The system is in the building and review processes by the Ministry of the Environment, according to the corresponding European model, as part of Israel's joining process to the OECD. When the system will be fully operational, it will oblige each facility with a pollution potential to file an annual report on materials it emits to the air, water and soil. This information will be available to the public.
At this stage, the Ministry of the Environment conducts a "pilot" in some industrial plants. The Company participates in the pilot in one of its sites. The Ministry of the Environment intends to enforce the PRTR system through legislation in the next few years. The economic, legal and operational implications that will arise from adopting the policy by the Ministry of the Environment cannot be estimated at this stage. e) Natural Gas
In February 2004 the Company began using natural gas (see section 2.1.10(h) of this report), which gradually replaced liquid fuel in the large steam driven units and in some of the industrial gas turbines and CCGTs. Use of natural gas considerably reduces sulfur dioxide and particle emissions, and also reduces carbon dioxide emissions (greenhouse gas). At the time of signing this report, the Eshkol power station (except Unit 3), Reading power station, Gezer, Hagit (except Unit 1), Tsafit (unit 3) and Ramat Hovav (except Unit 8) operate on natural gas.
A natural gas delivery infrastructure is currently being built for Haifa and Alon Tavor sites. Natural gas supply to Hagit Unit 1, Ramat Hovav Unit 8 and Eshkol Unit 3 will begin within the next six months.
In spite of the change to natural gas as the fuel in power stations, and the plan for significant reduction in the use and storage of liquid fuels (fuel oil and diesel), issues of preventing land and water pollution are expected to occupy the Company for quite some time.
Although the change to natural gas is indeed expected to reduce operational leakage of fuel that contaminates the ground, as older fuel infrastructures (containers and pipes) are emptied, shut down and dismantled, it may be required to perform land rehabilitation works.
111 For example, dismantling of old fuel infrastructures processes in the Reading area include planning and examining options for orderly shut down and dismantling of these infrastructures with due consideration to their location in urban areas.
The Company estimates, as of the date of this report that shutting down fuel installations will involve considerable material expenditure of tens of millions of dollars for dealing with the environmental implications of shutting down the fuel installations. This estimate is based on future data.
In addition a requirement, recently introduced on fuel installations that the Company will continue to maintain and operate, states that existing unsealed catchments should be sealed, in accordance with draft conditions for renewing business licenses. The Company estimates as of the date of this report, that sealing catchments of fuel installations will involve expenditure of tens of millions of dollars.
The Ministry of Environmental Protection recently issued another requirement to seal transformer arrays (this requirement was issued following a transformers oil spill in the Kishon secondary station. This is a limited spill event treated by the Company in accordance with the requirements and in coordination with the Ministry for the Environment). The Company is studying the implications of the requirement to seal transformers arrays and its financial implications for the Company. f. Coal
About 61% of the electricity in Israel is generated by the large units operating on coal in the Orot Rabin and Rutenberg sites. Imports of coal have risen over the years and are expected to continue to rise in future if erection of the additional units of project D will be approved. Coal consumption produces coal ashes in a quantity of about 1.2 million tons per year. In the past surplus ashes that were not required were discharged into the sea, in accordance with legally granted permits, but after the Barcelona Treaty on protection of the Mediterranean was amended, disposal of ashes in the sea stopped in 1999. Since disposal of coal ashes into the sea stopped, the entire quantity of ashes produced by the Company is shipped for exploitation in the construction, infrastructures and agriculture industries. Usage in the construction industry (manufacture of cement and concrete) is most profitable, economically. In 2006-2010, over 90% of the produced ashes was sold to the construction industry and only a relatively small quantity, mainly bottom ashes, was delivered for use in infrastructures and agriculture.
Surplus seasonal ashes are stored at internal sites within the Orot Rabin and Rutenberg power stations until a use is found for them in industry or infrastructure. The quantity of coal ashes, stored in the power stations decreased significantly, following an increased demand for the ashes. At the same time, the Company wishes to improve its ability to store coal ashes, so as to market the ashes in an optimal manner and to be prepared for crisis conditions. On June 23, 2008, the Radiation Officer in the Ministry of Environmental Protection announced that he considers coal ash to be "Radioactive Waste”, however, despite this classification, the Radiation Officer announced that the radioactivity rate of coal ash is not high enough to require its burial in the dedicated site in Dimona.
The Company filed an objection to the decision on classifying coal as "radioactive waste", based on professional information on the effect of coal ash on radioactive radiation from building
112 materials in general and specifically from concrete and cement. The Company based its objection on guidelines of other countries that do not regard coal ash as a substance that requires supervision due to the low concentrations of radioactive elements it contains. According to the guidelines of the International Atomic Energy Agency (“IAEA”), coal ash, with the concentrations of radioactive elements in it, is exempt from directives related to reporting and supervision on subjects of protection against radiation (e.g. for international transportation).
On October 2, 2008, the Company received a letter from the Deputy CEO of the Ministry of the Environment, indicating that this Ministry is interests in optimal and maximal utilization of coal ash, all under supervision of the contents of radioactive materials in building materials containing coal ash.
The Company believes that in view of the fact that even the Ministry of the Environment is not interested in stopping productive uses of coal ash, the parties will find a solution to resolve this dispute. To date, the announcement of the Radiation Officer did not affect coal ash sales by the Company.
The standard IS 5098 "Contents of Natural Radioactive Elements in Building Materials", published in January, 2010, states that building materials, including those containing coal ash cannot be produced or marketed unless tested to ensure that the fulfill the requirements of the new standard. The Radiation Division Head in the Ministry of Environmental Protection expressed a reservation against the standard. Building material containing coal ash are tested in accordance with the standard requirements. g. Planning and Building
As required by planning and licensing processes, the Company conducts estimates of the environmental effect of its operations. The Company prepares environmental effect surveys and environmental opinions about its installations, in accordance with rules and guidelines issued by planning and environment authorities. These documents present the environmental estimate and steps proposed to treat detected problems. The environmental documents are presented to the approval of the related authorities.
According to the Tel Aviv Power Station Law (Cancellation), 1994, the National Council for Planning and Construction was authorized to set a timetable for ending the operation of Reading power stations and its facilities. In July 1996 the National Council ordered the preparation of an outline plan to regulate continued use of the site. In June 2007 the National Council for Planning and Construction decided to distribute the outline plan for comments of the districts committees and public reservations. The plan determines the continued operation of the power stations to the end of 2020 and decided, as authorized by the law which facilities will be eliminated, which will be relocated, environmental development and public designation of some of the cleared areas. This actions have a considerable financial cost of tens millions of dollars. Operation of the station beyond 2020 will require a change in the national outline plan. The Company filed a detailed objection to this national outline plan, which was heard and discussed by an investigator appointed by the National Council for Planning and Building. The recommendations of the investigator were not published as yet.
113 Pursuant to the decision of the Natural Gas Licensing Authority of Tel Aviv District and conclusions with the Municipality of Tel Aviv, the Company committed to and built a shore promenade, including a bridge over the station's cooling water pool area.
h) Industrial waste from the power stations is drained into storage facilities on each site. In coastal power stations the waste is treated in dedicated purification plants. If possible, the purified (liquid) waste is recycled for use by the station. Other liquid waste is discharged into the sea according to permits given to each power station site by the Interdepartmental Committee for Permits for Sea Discharge, which operates by virtue of the Prevention of Sea Pollution from Mainland Sources Law, 1988. Power stations close to municipal sewage systems send their sanitary waste to these systems. In power stations that are not close to such sewage systems, independent plants have been set up to treat the waste. Liquid treated waste is used to irrigate landscaped gardens on these sites, in accordance with the irrigation with liquid waste permits issued to each site by the Ministry of Health, by virtue of the Public Health Regulations, 1981 (Amendment 1990).
i) PCB
The Company has removed all transformers and cables containing Poy Chlorinated Biphenyls (PCB) (a fluid with high insulation and fire retarding properties, compared to mineral oil) from its power stations and other external facilities.
j) Other Conditions in Business Licenses
The Business Licensing Law, the regulations regulated and licenses issued by force of this law include different environmental conditions. The Company applied for business licenses for all its power stations. The majority of the power stations received business licenses and some are in advanced approval stages. Changes, which may be made in the policy of the Ministry of Environmental Protection, or which may occur in generation sites of the Company, may cause changes in or additions to the terms of the business licenses, including changes that may require adjustment of some facilities of the Company.
The terms of the Orot Rabin site business license were amended recently. This required the Company to prepare a "Gaps Survey" relating to operation of storage, offloading, loading and transportation of coal and coal ash throughout the world. The Company submitted this survey but did not yet receive the response of the Ministry of the Environment. Conditions were also added recently to the business license of Haifa on the subject of increasing the thickness of the catchment, according to the requirements of the Civil Defense Command. The Ministry of the Environment is currently forming framework conditions for CCGT units in the Ramat Hovav, Hagit, Alon Tavor and Gezer sites. The Company forwarded its comments to these framework conditions.
k) Investments of the Company in Environmental Quality – Generation Segment
2008 2009 2010
Approximate investment in environmental quality 79 122 188 installations in million NIS
114 Approximate current costs (excluding amortization) in 75 71 70 million NIS
In 2010, the Company made investments of about NIS 182 million in environmental matters at its generating facilities (and also approximately NIS 6 million in special projects). In addition to the investments, in 2010, as part of the costs of operating power stations and associated costs for fuel, the Company spent about NIS 70 million to meet environmental requirements.
The Company estimates that the major share of the total amount of environmental costs incurred by the Company in the reported period was invested in future prevention and reduction of damage to the environment. The balance was invested in repairing and rehabilitating the environment.
In order to comply with environmental legislation and terms, the Company allocates funds in its financial budgets. For 2011, in the Company’s budget for regular operations and development, it has allocated about NIS 817 million for compliance with environmental requirements (of which approximately NIS 87 million is within the operation and fuel budgets). This includes dealing with coal ash, handling kindlers, preservation activities, coastal cleaning and dealing with sewage, separate drainage for industrial waste, prevention of environmental nuisance, etc.
In the Company’s development budget it has allocated the sum of about NIS 7,700 million for reducing emissions (initial estimate only) without interest incurred during construction, in the years 2012-2017, as follows:
The plan includes:
(a) Installing “preliminary measures” to reduce nitrous oxide in eight existing carbonic generating units at Orot Rabin and Rutenberg (installed in Rutenberg B). These “preliminary measures” reduce the production of nitrous oxide in the combustion process, as distinct from secondary means that reduce nitrous oxide after the combustion process.
(b) Installation of devices to remove sulfur dioxide in eight coal operated generation at Orot Rabin site and at Rutenberg site (such devices operate already in Rutenberg B).
(c) Installation of catalytic devices to further reduce nitrogen oxides in ten coal driven generation units at Orot Rabin Rutenberg sites. Catalytic devices (SCR) are secondary means to reduce nitrogen oxide after the burning process.
The main execution costs in 2010 of developing environmental projects are as follows:
1) Installation of sulfur removers in units 5 and 6 at Orot Rabin power station and in units 1 and 2 at the Rutenberg power station at the approximate cost of NIS 77.6 million.
2) Reducing emissions through Preliminary Means (PM) in units 5, 6 at Orot Rabin power station at the approximate cost of NIS 46.2 million.
3) Conversion to gas project at Ramat Hovav at the approximate cost of NIS 23 million.
4) Reducing the magnetic fields in electrical installations (implementing the "Smart Avoidance " policy) at the approximate cost of NIS 5.7 million.
115 The financial data are based on past experience of the Company and on forecasts of the Company, based on the extent of the environmental effect caused by the current generation actions of the Company and current environmental protection orders.
The estimates of the Company on the expected scope of investments in environmental quality are forward looking in nature, based on the Company's budget and work plans. The said estimates may not materialize or materialize partially or not as expected, due inter alia to factors which are not under the sole control of the Company, including a change in regulatory requirements applied to the Company and other events, including events arising from materialization of risk factors of the Company.
l) Legal Proceedings
Various claims - criminal and civil - have been filed against the Company and its managers in connection with the activity of the generating segment, arguing breaches of environmental legislation. The criminal claims refer in principle to sea and air pollution, and those that have been investigated did not involve significant penalties for the Company or its managers. For more information, see Note 24(b)2 to the Financial Statements as of December 31, 2010. 2.1.14 Material Agreements The agreements described below are material agreements outside the Company’s normal course of business that are not described in other sections of this report.
a) Agreements involving the supply of natural gas The Company has a number of arrangements with the Government and with government companies for the supply of natural gas, including:
1) Agreement to build a natural gas piping system: the Company signed an agreement to set up part of the natural gas piping system with the Government and with the Gas Lines company (a company fully owned by the State) - see section 2.1.10 in this report. As of December 31, 2010 and December 31, 2009, the balance of the long term obligation for this project amounted to NIS 930 million and NIS 1,078 million respectively.
2) Indemnification for the State of Israel: the Company has submitted indemnification documents to the State (Ministry of Defense) in connection with damage that could be caused to the State due to the passage of a gas pipeline through land belonging to the State, for any damage, expense, payment or loss incurred by the Ministry in the event that the undersea pipeline is not laid according to the provisions of the coordination agreement signed in this context. For details see Note 13(h) to the Financial Statements as of December 31, 2010.
3) Agreement to Conduct Natural Gas, see section 2.1.10 in this report.
2.1.15 Legal proceedings a. Appeal of the Yerukim Party for Life and Environmental Quality in Israel
On October 26, 2008, the Yerukim Party and its leaders filed an appeal to the sub-committee for appeals of the National Planning and Construction Board, on the decision of the Coastal
116 Environment Protection Committee, of August 20, 2008, approving the construction of Project D. The appeal claimed that the plan was approved while the Coastal Environment Protection Committee did not have the full factual basis on the effect of coal power stations on the coastal environment, when the Company did not receive the legal building permits (required before the approval of the Coastal Environment Protection Committee), while alternatives to reduce the effect of the coastal environment were not reviews. The appeal also claims that implementation of the plan will cause severe damage to the coastal environment. On June 7, 2009, the sub- committee for appeals issued its decision, rejecting on the threshold the appeal of the Yerukim Party, since the appealers had no right to appeal the decision of the Coastal Environment Protection Committee.
b. Appeal to the High Court of Justice by Adam Teva Vedin, an Israeli Society for Protection of the Environment and by the Yerukim Party, for Life and Environmental Quality in Israel
On June 26 and 29, 2008, two appeals requesting an order nisi and an interim order were filed against the decision of the Committee for Building and Planning to approve the forwarding of the plan to build an additional coal power station in Ashkelon, Project D, to the comments of the district committees and comments of the public.
The appeal requests the respondents to provide reasons for the following: reason for not cancelling the decision of the Committee for Building and Planning to approve the forwarding of the plan which is the subject of the appeal until the full required information is presented to the committee, the reason of the Government of Israel for not reconsidering its position and for not holding the discussions on the alternatives for this project by the Government; the reason for not exercising their authority for allowing their objections to be heard and considered during the decision process of the Government; the reason for not forwarding the plan for discussion in the National Board by force of its being the entity that represents, through its members, all the parties related to a decision of the said type; the reason for not subjecting the continuation of the process in the Committee for Building and Planning to receiving the approval of the Coastal Environment Protection Committee, in accordance with the provisions of the Coastal Environment Protection Law, 2004 (already approved by the time of submitting the appeal).
The decision, issued on June 29, 2008, states that both appeals will be heard together and the response to both appeals will be issued together. The request of the applicants to issue an interim order to avoid and promotion of the plan and also avoid performance of any work at the site, arising from the plan was rejected.
On November 11, 2009, the High Court of Justice recommended that the applicants withdraw their appeal, on the grounds of being premature, and the applicants accepted this recommendation.
Regarding legal proceedings pending against the Company, including proceedings for the generating segment, see Note 24 b to the Financial Statements as of December 31, 2010.
2.2 The Transmission and Transformation Segment 2.2.1 General information about the transmission and transformation segment The transmission and transformation of electricity is undertaken in the framework of a license that
117 the Company received for the transmission, distribution, supply, sale of electricity and trade in it. This license, with all the activities it includes, was extended by amendment No. 8 to the Electricity Sector Law up to January 1, 2012.
It should be noted that the Company has not received a new, separate license for the transmission activity, and therefore this activity is carried out according to the format of the aforesaid combined license (which as stated referred to a number of activities).
The Company’s transmission grid covers the whole of the State of Israel and territories under the rule of the State of Israel since June 1967. The transmission grid consists of ultra high voltage lines (400 kwh) over which electricity is sent from the generating units to the main switching stations, which transform the electricity using linkage transformers and transmit the electricity through high voltage lines, to substations located all over the country. From the substations the electricity, after being transformed to high voltage, is sent to end users through the distribution system (see section 2.3 in this report).
For information on management of the system as determined in the different amendments of the Electricity Sector Law, see paragraph 1.1.7 sub-section 1 in this report. a. Structure of the Segment
As aforementioned, the Company's operation in this segment is transmission and transformation of electricity generated in the different generation units of the Company to switching and substations located throughout Israel. As of the report date, the Company transmits all the electricity in Israel, supplies part of it the high voltage consumers and transforms and transmits the remaining part to districts of the Company. b. Limitations of Laws, Standards and Specific Constraints Applied to this Segment
The Company estimates that its operations in the transmission and transformation segment, similar to its other fields of operation, are subject to legal limitations, such as limitations stipulated in the provisions of the Electricity Sector Law and the Government Companies Law and to constraints arising from licensing issues and licenses required by different Government authorities and ministries, e.g., the Electricity Authority, the Government Companies Authority, the Ministry of National Infrastructures and the Ministry of Environment, and to structural changes and emergency and development plans for the Electricity Sector.
118 c. Trends and Changes in the Field of Operation and its Profitability
The Company estimates that several factors may affect the volume of operation and profitability of this segment, such as entry of private producers, changes in electricity consumption and changes in electricity rates.
The main trends and changes are as follows:
a. The expected entry of private producers and increased reserve of generation capacity leads to the expected construction of additional switching stations and ultra-high and high voltage lines.
b. Increased demand for electricity may lead to building more substations,
c. The Company acts decisively to reduce construction costs of substations by building open substations in most cases, and reducing prices of all components of the stations. Nevertheless, due to stricter requirements of the authorities, the Company is expected to build a larger number of closed substations.
d. Construction of a higher number of private high and ultra high voltage substations (for private electricity producers and for consumers) will lead to a higher investment of work hours for commissioning, tests and maintenance.
e. Updates in the tenders law will encumber purchasing processes and prolong their duration..
f. Changes in criteria will require higher payments, as indemnification to electricity producers and to consumers connected to high and ultra high voltage grids.
d. Technological Changes that may have a Material Effect on the Field of Operation
The Company generates, transmits, distributes and sells electricity to all the consumers in the State of Israel. The technological changes that may have a material effect on this field of operation are as follows:.
Installation of transformers (75 MVA) with current limiters in the urban substations, to increase the capacity of current substations and introducing new technologies (e.g., ACSS wires and 2,000 Ampere cables) to increase the capacity of the current transmission lines. As of the date of this report, the Company acts to build substations while reducing the costs of all the station's components.
e. Critical Success Factors of Changes to the Field of Operation
The Company estimates that the business success of the transmission and transformation segment depends, inter alia on the demand for electricity level, the maintenance and operation costs of the transmission and transformation facilities, the recognition of the total costs required to transmit electricity in the electricity rate and in the ability of the transmission and transformation segment to be more efficient from both structural and technological aspects. See also sections 1.7 and 1.8 in the report. 2.2.2 Products and Services As explained above, the Company operates as one combined and coordinated system, to supply electricity to consumers, from the generation of electricity at production sites, through its transmission and transformation, to its distribution and supply to the end users. See section 3.3 in
119 this report. 2.2.3 Segmentation of Revenues and Profitability
a) Future Electricity rate - transmission and transformation segment In its document for a hearing, published in July 30, 2008, the Electricity Authority stated that this document, relating to the generation segment, is one stage for setting recognized costs for all the segments in the electricity chain (generation, transmission, distribution and delivery), scheduled to be performed during 2010.
The document also states that the Electricity Authority considers it is very important to have a correct and up to date definition of the transmission segment activity before its costs are determined, since this is a unique segment that provides essential services to the Company and to private entities operating in the electricity sector. In view of this, the Electricity Authority deems it is essential for the Company to act immediately and make administrative arrangements to enable this segment to operate as a distinct, consolidated segment in the framework of an essential service provider license. The costs involved in such preparations will be included in the recognized costs of the segment, insofar as such preparations are made. The transmission segment will include the following activities: Forecasting market demand and consumption, ultra planning, simulations of system stability from both the generation and consumption ends, integration and supervision and control actions over the whole electricity delivery in the system, including trade management mode.
The Electricity Authority did not yet set a new rate base for this segment.
b) Revenues The net revenues from electricity sales attributed to the transmission and transformation segment (see Note 38 to the Financial Statements) in 2010 amounted to some NIS 1,730 million, compared to about adjusted NIS 1,740 million in 2009, a decrease of NIS 10 million in revenues.
c) Profit from regular activities - transmission and transformation segment Profits from regular activities in the transmission and transformation segment in 2010 were about NIS 537 million, compared to adjusted NIS 561 million 2009, a decrease of some NIS 24 million.
120 2.4 Capacity of the transmission and transformation system
a) Transmission system (Voltage Lines):
December 31 400 kV lines 161 kV lines 115 kV lines 161 kV km circuit km circuit km circuit km circuit 2010 739.8 4,240 132 94 2009 738.6 4,141 132 94
On December 31, 2010, and December 31, 2009, the installed capacity of a 400/161 kV connection transformer was 10,000 megavolts.
Transmission of ultra high and high voltage electricity enables transfer of energy between the generating power stations and load centers, with low losses.
b) Transformation system 1) On December 31, 2010 the transformation system covered 199 substations (of which 40 were owned by consumers); compared to 197 substations (of which 40 were owned by consumers) on December 31, 2009.
2) On December 31, 2010, the installed transformation capacity was 17,159 MVA (including 2,524 MVA for substations owned by consumers) compared to an installed transformation capacity was 16,889 MVA (including 2,524 MVA for substations owned by consumers) on December 31, 2009 The following table shows the number of switching stations and substations, belonging to the Company and to consumers, by type, on December 31, 2010 and 2009:
Type of station: Switching Substations Private Total Year: stations stations 31/12/2010 10 149 40 199 31/12/2009 9 148 40 197
The material changes in the transformation system which occurred in 2010 are: building an external 400 kV arranger at Ein Tut (switching station) commissioning an external substation Maalot and additional transformers at Shprinzak, Cabri, Caesarea and Beit Shean. 2.2.5 Fixed Assets and Facilities The details of fixed assets and facilities given below refer to property and assets held by the Company and/or used by the Company for this field of operation, ignoring any disputes between the Company and the State regarding the Company’s rights to such property and assets which were held by the Company when the concession expired. (Regarding the assets arrangement and its implications for the Company, see note 1.e to the Financial Statements as of December 31, 2010.)
The transmission and transformation segment has switching stations at various locations as shown in the following table:
121 Site name Location Nature Area in sq.m. Caesarea switching station* Caesarea Switching station 228,500 Tsafit switching station* Near Kfar Menachem Switching station 232,970 Petach Tikva switching station Near Morasha Junction Switching station 65,073 Zevulun switching station Kfar Hassidim Switching station 272,045 Gan Shorek switching station Rishon Lezion Switching station 206,500 Even Sapir switching station S.W. of Moshav Even Sapir Switching station 104,000 Gezer* Near Ramle Switching station 201,960 Yavneh switching station Ashdod Junction Switching station 100,117 Yarkon switching station Tel Aviv, Ramat Ha'hayal Switching station 116,655 Total area: 1,066,350
* The area of the aforementioned switching stations in included in the area of the related power stations site, as detailed in section 2.1.7 in this report.
The transmission and transformation segment has 10 switching stations, 107 permanent substations, 18 temporary substations and 10 mobile substations in action all over the country, covering 1.9 million sq./m.
These assets are owned by the Company (but see Note 1.g to the Financial Statements as on December 31, 2010 on the assets arrangement) or held by it, in the framework of long term leases, or of rights that were granted to the Company by the owners of the assets (e.g., easement or permission to use free of charge which is not a lease, or possession right with a process of arranging it under a contract) or rights granted to the Company by law. The aforesaid assets and rights are subject to floating liens created by the Company to secure its obligations (see Note 18.e to the Financial Statements as of December 31, 2010).
2.2.6 Developing the Electricity sector - Transmission and Transformation Segment
a) Method of defining development plans for the transmission and transformation segment The development plan for the transmission and transformation system for the years 2011-2015, at a total investment of approximately NIS 4 billion, for the said period and approximately NIS 700-800 million per year. The plan includes construction of new projects and projects to enlarge and improve the existing system, in order to adapt it to the needs of the electricity sector, taking into account the availability of sites and the Company’s ability to realize the projects. This development plan was submitted to the Ministry of National Infrastructures for approval, after consultation with the Electricity Authority, as required by section 19(a) of the Electricity Sector Law, regulation 43(b) of the Electricity Sector Regulations (Conditions and Procedures for Granting a License and Obligations of the License Holder), 1997 and by section 34(a) of the transmission, distribution, delivery, sale of and trade in electricity. As of the date of this report, the Company did not receive the approval of the Minister of National Infrastructure, although it acts according to this plan .
122 The main projects in the transmission and transformation segment completed in 2010 are:
a. Erection of stationary substation – Maalot.
b. Additional transformation in existing substations – Beit Shean Cabri, and Caesarea.
c. Construction of 110.3 km overhead circuits.
d. Hundreds of relatively small projects and advanced multi-annual projects became operational in 2010.
b) Main Assumptions and Constraints Underlying the Development Plan The development plan is based on:
1) Geographical spread of load, matching the forecast of national demand.
2) Development plan for the generating system.
3) Planning criteria.
4) Implementation of advanced and proven technologies in the transmission and transformation system.
5) Analysis of chances of realizing the projects.
The purpose of the development plan is to adapt the transmission and transformation system to the needs of the national economy while reducing costs and minimizing land resources, according to the defined standard of reliability and quality of electricity. The plan was prepared taking account of uncertainty as well as planning, land, environmental and economic constraints and their implications for the ability to implement the plan.
The development plan meets the following needs:
(1) Ensuring optimal operating conditions for the generating system, taking account of the expected geographical breakdown of loads and according to various reasonable scenarios regarding the load on generating units.
(2) Ensuring system survivability.
(3) Ensuring proper reliability of supply to consumers in the event of faults in generating units, transmission circuits, substations, connection transformers and transformers in substations.
(4) Maintaining the quality of electrical energy supplied.
(5) Consideration of the ability to implement the projects.
The development plan for the transmission and transformation segment is the product of techno- economic optimization of various alternatives that meet these needs.
The projects described in the development plans are examined with respect to their chances of implementation, which depend on the availability of sites and the Company’s ability to realize them. Revised operation dates are set based on these assessments.
123 In accordance with the Government decision to generate electricity from renewable energy at a 10% rate by 2020, the Company is acting to implement this plan.
As part of these actions, the Company published numerous surveys on possible integration of the different initiatives (the surveys are conducted in accordance with the decisions of the Electricity Authority).
Regarding the subject of the Government tender for a solar power station in Ashalim, the Company is completing the plans related to the environmental document and a planning scheme for a 161 kV facility and a 161 kV line in the site. Regarding the private power station Ktura, the Company is completing the material for an environmental survey for the required 161 kV line.
At the same time, it should be noted that the Company will not be able to contain the initiatives for building a power station based on renewable energy of a material capacity without completing the new 161 kV line to Eilat, especially without running a section in Machtesh Ramon area. c) Development of the transmission system In the years 2011-2015 it is planned to add about 127 km of circuit to the ultra high voltage (400 kV) transmission system, conditional on the conclusion of statutory procedures for approval of the lines. This plan does not take into account the option of connecting 400 kV lines with neighboring countries: Egypt and Jordan. During 2010, a 400 kV gas turbine in Ramat Hovav (units 7, 8) and Hagit (unit 1) were synchronized to the system. In addition, multi- annual projects were advanced and commenced operation in 2010. As of the report date, the Company conforms to the timetable set in the development plan.
During the period 2011-2015 it is planned to add about 645 km of circuit to the high voltage (161 KWh) transmission system. In addition about 769 km. of circuit will be upgraded/ re- erected/ relocated. Addition of another 47 km. of underground cable circuits are also planned for 2011-2015. d) Development of the 400/161 kV transformation system The development plan includes the addition of a connection transformer with a capacity of 575 megavolts at the Zevulun switching station, setting up the Ayalon switching station with two connection transformers with a total capacity of 1,300 MVA, upgrading the transformers cooling system in Caesarea and relocation of a linking transformer from Tsafit to Petach Tikva and upgrading it to 650 MVA. In 2015 - conditional on the conclusion of statutory procedures for approval of the aforesaid sites. At the end of 2015 the Company expects to have 10 switching stations with a total capacity of 12,295 MVA. e) Development of 161 kV transformation capacity
The development of substations in the transmission and transformation segment is based on long term planning, taking account of the geographical dispersion of demand. This forecast is expressed by setting up new fixed substations, temporary and mobile substations, plus adding transformation in existing substations.
124 There are two types of substations: internal and external. The trend is to erect external substations wherever possible, for economic reasons.
In the years 2011-2015 the Company expects to add about 14 permanent substations with total transformation capacity of 1,600 MVA. By the end of 2014 there should be some 148 substations (stationary, temporary and mobile) with total transformation capacity of about 16,440 MVA. In addition a high voltage capacitors battery will be installed at Ayalon substation, at a capacity of 220 MVA. f) Forecast of investments required to implement the development plan for the transmission and transformation segment According to investment data from previous years, an average investment of about NIS 700-800 million is required for the transmission and transformation system each year over the years, from 2011 to 2015, to implement the development plan.
This information includes forecasts, subjective estimates and other plans of the Company as of the date of this report, regarding work assumptions used to prepare the forecasts and realization schedules of these assumptions. The information is based on future data of an uncertain realization nature, that are not fully controlled by the Company. The main factors that could affect the actual realization of this predictive information or that could cause changes in the estimated timetable for execution, as described above, include the following:
Changes in the expected rate of growth in demand for electricity, implementation of the future organizational change in the electricity sector and the Company (see section 1.7.1 of this report) and the implications of the structural change for realization of the Company’s development and investment plans; any development plan that may be defined by the Minister for National Infrastructures for the transmission and transformation segment; difficulties in obtaining licenses and/or changes in legislation affecting environmental issues and licensing; absence of suitable rate cover; the Company’s ability to raise the required funding for its development plan. 2.2.7 Intangible assets Regarding the Company’s transmission license and the provisions of the Electricity Sector Law regarding licenses, see section 1.7.3 of this report. 2.2.8 Human resources As of December 31, 2010, the transmission segment employs 401 permanent workers and 58 temporary workers (not including operating staff on transmission lines, which are organizationally attached to the distribution Districts - see section 2.3.9 in this report). (See also Annex B below.) For details of the terms of employment and other details see section 3.7 in this report. 2.2.9 Environmental quality - transmission and transformation segment For the environmental aspects in the transmission and transformation segments, see sections 2.1.13j and 3.12 of this report.
For the environmental effects of non ionizing radiation and electromagnetic radiation see section 2.3.10 of this report.
125 2.2.10 Restrictions and regulation of the transmission and transformation segment activity For licensing procedures according to the Planning and Construction Law, see section 3.12 of this report.
For the criteria for the infrastructure services that the Company is obliged to provide for private producers, including the criteria in October 2005, see section 2.1.4 of this report. 2.2.11 Legal proceedings For legal proceedings and indemnification documents given by the Company in accordance with section 197 of the Planning and Construction Law, see Note 24 b to the Financial Statements as of December 31, 2010.
126 2.3 The distribution segment 2.3.1 General information about the distribution segment
2.3.1.1 a) On December 31, 2009, the Company’s distribution system consisted of lines with voltages of 33 MVA, 22 MVA and 12.6 - 6.3 MVA (high voltage lines), low voltage lines and distribution transformers.
b) The Company supplies most consumer with low voltage electricity, and large consumers with high voltage electricity.
c) The distribution segment is divided into five districts, covering the whole country, through which the major part of the Company’s work connections and service to its customers takes place: at the time of signing this report they numbered 2.5 million.
1) The northern District covers all the northern Districts of Israel, from the Alexander River in the south, excluding Haifa and its environs. The District’s activity along the Lebanese, Syrian and Jordanian borders, and at the south eastern side along the seam line, is conducted in the framework of security restrictions. In 2010, this District served some 405,000 customers, compared to 398,000 in 2009. This District is characterized by a scattered population, with a large number of small towns and villages, and long distribution lines.
2) Dan District is bounded by Road 5, Glilot Junction in the north, Bar Ilan and Or Yehuda in the east and the town of Holon in the south. This is the most densely populated of all the Company’s Districts, because of its urban nature. Therefore, most of the distribution grid in the Dan District is underground. In 2010 this District served about 542,000 customers, compared to 538,000 in 2009.
3) The Jerusalem District covers Greater Jerusalem, Beit Shemesh, Har Tuv, Har Hevron and its south, Samaria including the town of Ariel, the Jordan Valley between Ein Gedi and Mechula. Because of its location, this District bears the main burden of the Company’s work in the Judea and Samaria areas on a daily basis. The activity is possible thanks to the removal of electricity supply from the dispute, and thanks to the cooperation with the East Jerusalem Electric Company. In 2010 this District served about 277,000 customers, compared to 273,000 in 2009. In addition to the number of registered consumers, the district ensures electricity supply to about 250,000 Palestinian consumers.
4) The Southern District is the largest of the Company’s Districts, stretching from Emek Hefer in the north to Eilat in the south, excluding the Dan District which includes greater Tel Aviv. In accordance with its size, this District serves about 40% of the Company’s customers. In 2010 the southern District served about 994,000 customers, compared to 978,000 in 2009. Activities of the district along the border with Gaza is subject to security limitations and sometimes under fire.
5) The Haifa District covers Haifa and its environs, from the South Acre Industrial Zone in the north, Shefaram and Mishmar Ha’emek in the east, Bat Shlomo in the south and the Carmel Beach settlements in the west. This District is largely a densely populated urban
127 area, and therefore about one half of the grid lines in it are under ground. In 2010 the Haifa District served about 268,000 customers, compared to 266,000 in 2009.
2.3.1.2 Structure of the Segment
As aforementioned, the Company's operation in this field is distribution of electricity from substations through high voltage and low voltage lines and delivery and sale of electricity to consumers. As of the report date, the Company distributes, delivers and sells all the electricity in Israel.
2.3.1.3 Limitations of Laws, Standards and Specific Constraints Applied to this Field
The Company estimates that its operations in the distribution segment, similar to its other fields of operation, are subject to legal limitations, such as limitations stipulated in the provisions of the Electricity Sector Law and the Government Companies Law and to constraints arising from licensing issues and licenses required by different Government authorities and ministries, e.g., the Electricity Authority, the Government Companies Authority, the Ministry of National Infrastructures and the Ministry of Environment, and to structural changes and emergency and development plans for the Electricity Sector. The electricity distribution activity is performed in accordance with the license granted to the Company, referring to "transmission, distribution, delivery, sale and trade in electricity." This license, as applied to all the activities specified in it, was extended to January 1, 2012. It should be noted that the Company did not receive a new and separate license for the distribution activity. Therefore, the activity is performed in accordance with the provisions of the aforementioned overall license (that referred to several activities). For details of these aspects of the Company's activity and the different limitations, see sections 1.7.3, 1.7.5 in this report.
2.3.1.4 Trends and Changes in the Field of Operation and its Profitability
The Company estimates that several factors may affect the volume of operation and profitability of this segment, such as changes in electricity consumption and changes in electricity rates.
2.3.1.5 Critical Success Factors of the Field of Operation and Changes thereto
The Company estimates that the business success of the distribution segment depends, inter alia on the level of demand for electricity, the maintenance and operation costs of the distribution facilities, the recognition of the total costs required to distribute electricity in the electricity rate and on the ability of the distribution segment to be more efficient from both structural and technological aspects. 2.3.2 Products and Services As explained above, the Company operates as one integrated, coordinated system, to supply electricity to consumers, from the stage of generation at production sites, through transmission and transformation, to the end points of distribution and supply in the premises of each consumer of electricity. The Company also connects customer premises to the grid and enlarges existing connections.
128 2.3.3 Segmentation of Revenues and Profitability
a. Future Electricity rate – the Distribution segment In its document for a hearing, published on July 30, 2008, the Electricity Authority stated that this document relating to the generation segment, is one stage for setting recognized costs for all the segments in the electricity chain (generation, transmission, distribution and delivery), scheduled to be performed during 2009.
In its decision of December 18, 2005 the Electricity Authority stated that in determining a new rate base for the distribution segment it will establish a costs outline that will limit the permitted annual investments level to maintain the standard of services to the consumer, including reliable supply and connection to the grid.
To define the quantitative models that will assist the Electricity Authority to determine the recognized costs for the distribution segment, the Electricity Authority appointed a consultant, to study the distribution system development models proposed by the Company and by the Electricity Authority and recommend the suitable models, in his opinion to the Electricity Authority. As of the date of this report, The Electricity Authority did not set a new rate base for this segment as yet.
b) Revenues The net revenues from electricity sales attributed to the distribution segment in 2010 (according to the assumptions specified in Note 38 to the Financial Statements), amounted to some NIS 2,705 million, compared to about adjusted NIS 2,689 million in 2009, an increase in revenues of NIS 8 million.
c) Profit from regular activities - distribution segment Profit from regular activities of the distribution segment in 2010 amounted to about NIS 384 million, compared to about adjusted NIS 432 in 2009, a decrease of about NIS 48 million. 2.3.4 Competition At the time of signing this report, the Company has no competitors in the distribution and supply segment, except in relation to distributers who receive bulk electricity and distribute the electricity to end consumers (see section 3.3 of this report). Regarding the provisions of the Electricity Sector Law on restrictions on holding licenses, see section 1.7.3 of this report.
Regarding the competition in the supply segment, the Company faces minor competition from private producers who sell electricity directly to end consumers. In addition, in view of the structural changes required by the Electricity Sector Law, including incorporation of the holders of distribution licenses as separate companies (see sections 1.7.1 and 1.7.3 of this report), the Company cannot estimate the implications of such incorporation for the future of the Company’s competition, activity, profitability and financial situation.
2.3.5 Distribution capacity On December 31, 2010 the distribution system included 25,254 km. of high voltage grid lines (compared to 24,818 km. on December 31, 2009 and 24,599 km in 2008), 45,488 distribution transformers with a total capacity of 21,954 MVA (compared to 44,957 distribution transformers at
129 December 31, 2009 with a total capacity of 21,526 MVA and 44,435 distribution transformers at 31 December 2008, with a total capacity of 21,241 MVA), and 19,615 km of low voltage grid lines (compared to 19,259 km. on December 31, 2009 and 19,065 km on December 31, 2008).
The following table shows the number of distribution transformers by type on December 31 in the years 2010 to 2008.
Number of transformers Type of transformer: 12.6-6.3 22 MVA 33 MVA Total Year: MVA 2010 2,684 38,699 4,105 45,488 2009 2,656 38,255 4,046 44,957 2008 2,614 37,839 3,982 44,435
2.3.6 Fixed assets and facilities Details of fixed assets and facilities described below refer to property and assets held by the Company and/or used by the Company, in this field of operation ignoring any disputes between the Company and the State regarding the Company’s rights to such property and assets which were held by the Company when the concession expired. (Regarding the assets arrangement and its implications for the Company, see section 1.7.2 in this report.)
The Company has about 30 regional and district offices, of which 25 are in separate sites and 5 are integrated within substation sites, covering about 150,000 sq.m.
There are some 12,500 transformation, switching and accumulator rooms deployed all over the country.
The Company owns these assets (see also section 1(e) in the Financial Statements as of December 31, 2010 on the assets arrangement), or holds the assets and part of the lands are under long term leasing agreements (mainly with the Israel Lands Administration) or under rights granted to the Company by property owners (e.g., easement or permission to use free of charge which is not a lease, or holding rights under a process to regulate it in a contract), or under rights granted to the Company by the law. The aforesaid assets and rights are subject to floating liens created by the Company to secure its obligations (see Note 18 e to the Financial Statements as of December 31, 2010).
The Company’s property also includes property, mainly grids and lines, located in Judea and Samaria and the Gaza area (including areas of the Palestinian Authority) (hereinafter: “the territories”). Company management estimate that the use of these facilities for the supply of electricity will continue, and the properties will remain in the Company’s possession, excluding rights to use land connected to this land in the Gaza and northern Samaria Districts, from which Israelis were evacuated in accordance with the Implementation of the Disengagement Plan Law, 2005. See also Note 11 (g) to the Financial Statements as of December 31, 2010.
130 2.3.7 Development of the electricity sector - distribution
a. Method of defining development plans for the distribution segment The development plan for the distribution system includes the three main components of the distribution grid: the high voltage grid, distribution transformers, and the low voltage grid. Each of these elements are referred to individually with respect to building and replacement. The distribution grid also includes the component of electricity meters and improvements in connections to homes. The development plan is intended to adapt the distribution system to the needs of the electricity sector in view of the introduction of new substations and development of existing substations, additional consumers, expected growth in load of existing consumers and aging of the current grid, in accordance with techno-economic planning criteria.
Section 19(a) of the Electricity Sector Law states that the Minister, in consultation with the Electricity Authority may require an essential service license holder to submit to his approval, in the required format and time, a development plan, as a whole or in parts, needed to fulfill the obligations provided by the license; after the Minister, in consultation with the Electricity Authority approves the plan, the essential service license holder will only act according to the approved plan.
The aforesaid requirement is specified in section 34a of the transmission, distribution, delivery, sale and trade in electricity license, stipulating, inter alia, that the license holder will submit a development plan in accordance with the law and the regulations, as instructed by the Minister in accordance with the operations of the license holder according to the license.
Regulation 43(b) of the Electricity Sector Regulations (Terms and Procedures for Granting a License and Obligations of the License Holder), 1997, also stipulates the a transmission or distribution license holder should submit a multi-annual development plan to the Minister.
b. Main Assumptions and Constraints Underlying the Development Plan The development plan for the distribution grid is based on the following data and assumptions:
1) Forecast number of domestic and small business connections, obtained from the department of statistics and market research.
2) Forecast number of large businesses connections bases on average performance in previous years (data is derived from the infrastructure system and the orders system).
3) Data on high voltage consumers, from the orders system.
4) Technical guidelines for planning the distribution grid.
5) Guidelines from the Ministry of National Infrastructures, local authorities, statutory authorities for planning and executing national infrastructures, such as instructions from the Ministry of National Infrastructures on construction of an underground grid in urban and industrial areas characterized by high population density.
c. Expected development of additional distribution capacity The expected development of additional distribution capacity is based on long term plans of the Customers Division for 2010, submitted to the Board of Directors as part of the financial planning of the Company.
131 1) High voltage During the period 2011-2015 some 3,451 km of high voltage above ground and underground lines are expected to be added. In addition, about 285 km of grid will be replaced. About 670 km over ground and underground high voltage lines are expected to be added in 2011.
At the end of this period, the total length of high voltage lines is expected to be about 28,705 km.
2) Low voltage During the period 2011-2015 some 3,409 km of low voltage over ground and underground lines are expected to be added. In addition, about 271 km of grid will be replaced. About 654 km above ground and underground low voltage lines will be added in 2011.
At the end of this period, the total length of low voltage lines is expected to be about 23,024 km.
3) Distribution transformers During the period 2011-2015 some 4,523 distribution transformers are expected to be added. In those years about 3,058 transformers are scheduled for replacement. About 884 new transformers are scheduled to be added in 2011 and about 623 transformers are scheduled for replacement
At the end of this period, the Company expects to have at its disposal about 50,039 distribution transformers. d. Forecast of investments required to implement the development plan for the distribution segment The annual average investment forecast for each of the years 2011 up to 2015 stands at some NIS 1.1-1.3 billion per year. This forecast also includes the investment in special projects, as specified below:
1. Implications of the radiation law: changes in the new and existing grid to adapt it to the requirements of the radiation law.
The annual investment forecast includes an estimate of the additional costs due to changes in planning and execution required by the radiation permits obtained. However, there are costs that cannot be estimated at present. Realistic estimates will only be possible when practical experience has been gained of at least one year following operation of the radiation law. Regarding existing facilities, to which the law will apply starting on July 1, 2008, the expert committee is supposed to set criteria. In the meantime, the Company is improving its existing facilities from aspects of reducing magnetic fields, at an approximate amount of $ 2 million per year.
2. Privatization of kibbutzim and the changeover from bulk supply to individual supply.
3. Burial of existing grids in populated areas: bringing forward investments in line with opportunities to excavate in city centers.
132 4. Moving pylons from roads.
5. Entry of private producers, for which the Company will have to built additional grid.
However, this estimate is predictive in nature, and when the updated investment forecast is prepared, the investments required by the Company may differ from the foregoing. This information includes forecasts, subjective estimates and other plans of the Company as of the date of this report, regarding work assumptions employed by the Company to prepare the forecast and its realization dates. The said estimates are based on future data that may not materialize or materialize partially or not as expected, which are outside the Company's control The main factors that could affect the realization of the predictions or lead to changes in the estimated timetable for implementation of the development plan as described above include:
1) Non realization of special projects.
2) Changes in the forecast rate of growth in the number of connections.
3) Implementation of changes in the future organizational structure of the electricity sector and of the Company (see section 1.7.1 of this report) and their implications for the Company’s development and investment plans; difficulties in obtaining licenses and/or changes in legislation in the area of environmental quality and licensing; absence of suitable rate cover (see Note 1(f) to the Financial Statements as of December 31, 2010); the Company’s ability to raise the finance required for the development plan.
The electrical vehicle project - The Company, as a essential service provider, is obliged to erect the charging posts in public areas - roads and sidewalks. The condition for performing the project is ensuring coverage of the essential service provider costs for the erection and maintenance of the charging system in public areas. Costs of the charging post and its connection to the grid and also its current operation and maintenance costs will be covered separately through the electricity rates, as a payment component that will apply to the electrical vehicles owners sector and not to the general public.
It is proposed to set a rate in two parts, comprised of a fixed payment for each charging (to cover costs of the charging posts installed by the Company and specific fixed costs) and a price per kWh (to cover actually consumed electricity costs).
e. Electricity Pylons Protection Project The Electricity Pylons Protection Project was completed at the beginning of 2011.
Some 130,000 electricity pylons were protected in this project. 2.3.8 Intangible Assets On the matter of the Company’s transmission license which includes the distribution license, and the provisions of the Electricity Sector Law on granting distribution licenses, see sections 1.7.1 and 1.7.3 of this report. 2.3.9 Human resources As on December 31, 2010, the distribution segment has 3,430 permanent employees and 909 temporary employees. As explained above, some of these employees who are organizationally
133 attached to the distribution segment are engaged, in addition to setting up and maintaining the distribution system, also in setting up and operating transmission grids (see section 2.2.8 of this report). (See Appendix C below.) For details on terms of employment, training and other details, see section 3.7 of this report. 2.3.10 Environmental quality
a. Background The modern lifestyle is characterized by huge consumption of electricity, which makes possible much convenient and safe usage. Electricity is the main source of energy in most households, industry and businesses.
The electricity current creates an electrical field and magnetic field around it. The level of these fields depends on the respective voltage or the current, the structure of the line, the arrangement of phases on it and the distance from it.
These fields influence other electrical loads around them. They change their direction with a frequency of 50 cycles per second (50Hz), a frequency that is considered extremely low.
The energy linked to this low frequency is very low and in practice negligible. Over the last 30 years, there has been thorough investigation worldwide of the question of whether there is a link between extended exposure to the magnetic fields found in residences that are close to main electricity facilities or domestic electric appliances and the incidence of certain diseases, in particular leukemia in children. The studies include dozens of health surveys and thousands of laboratory tests.
A brief summary of research to date shows that the findings of some health surveys indicated a link between magnetic fields and leukemia in children (these findings were attacked by other researchers, since they are based entirely on estimates and since the statistic link that was found is extremely weak and cannot indicate the existence of a causal, scientific link between magnetic fields and infantile leukemia), while other health surveys and laboratory tests found nothing to indicate any link whatsoever.
The World Health Organization (WHO) and the International Radiation Protection Association (IRPA) in 1990 published guidelines on exposure to electrical and magnetic fields. The purpose was to prevent the known effects of magnetic fields, that is, induction of currents in the body that can affect the function of muscles and the nervous system. According to these guidelines, the maximum value for a magnetic field exposed to humans is 1,000 milligauss, and the maximum value for an electrical field is 5kw per meter. These values are based on the known effects of magnetic fields - induction of the electrical currents in the body. The values were published again in 1998, by the International Committee for Non Ionizing Radiation Protection (ICNIRP) as environmental threshold values, intended to ensure that the limit set for current induction flow in a body is not exceeded. According to ICNIRP, environmental thresholds for an electrical or magnetic fields may be exceeded, as long as the limit of the induced current in a body is not exceeded. Updated guidelines of ICNIRP, published in November 2010, state that the maximum value of a magnetic field for a population is 2,000 milligauss and relates to known effects arising from the induction of an electrical field in a body.
With reference to epidemiological findings, that there could be other health effects of extended
134 exposure to magnetic fields at lower levels than the threshold stated above, the Committee said that there was insufficient information to set threshold values lower than the aforementioned, even in the updated document of November 2010..
The guidelines of the ICNIRP were adopted by the European Union and many western countries, as well as by Israel, through the Ministry for Environmental Protection and the Electric Corporation.
The International Association for Research into Cancer (IARC) in mid 2001 categorized magnetic fields as a “possible carcinogen”. According to the grading system of this Association, these fields are classified as a third degree risk (for comparison, this grade of risk also includes, for example, coffee). The ICNIRP mentioned above examined this definition and stated, at the end of 2001, that it did not affect the maximum value of 1,000 milligauss determined by it as aforesaid. This position reflects the current policy of the WHO.
As a response to the possibility that there are long term effects, the WHO and many institutions and countries worldwide support the “principle of caution”, which means that even in the absence of certainty regarding the existence of any risk, and its scope - if any, there is justification for adopting certain preventive measures - not too far-reaching - on all aspects of exposure to magnetic fields.
This policy was validated once again in a comprehensive policy document from the WHO in June 2007, which states that there should be no new threshold lower than 1,000 milligauss, that magnetic fields will continue to be defined as “possible carcinogens”, and with a recommendation to use precautions that are low cost or without cost. It also recommended further research on the subject.
As stated in the updated guidelines, published by the ICNIRP committee in November 2010 for low frequency magnetic and electrical fields, the threshold value for the populations was increased to 2,000 milligauss. The document also refers to the recommendations of WHO on all matters related to implementing the principle of caution to the , unproven, possible long term effects on the population. b. In February 2002, the Director General of the Ministry of Environmental Protection appointed an advisory expert committee to define an Israeli standard for the magnetic field from the electricity grid, with reference to the actions of other countries and international bodies. On March 17, 2005, the committee submitted its recommendations to the Director General of the Ministry, including setting an upper threshold for exposure of 1,000 milligauss, applied to short term effects, while also operating the principle of preventive precautions for the magnetic field from the electricity grid, a principle that means adopting the accepted technical measures at reasonable cost, to reduce the level of exposure, as far as possible. Regarding implementation of the precaution principle, the report of the expert committee stipulates planning measures to be adopted when planning new facilities, and also states that for existing facilities a public committee will be set up, to determine the order of actions and the manner of dealing with facilities in the framework of the defined budget of $2 million per year. The committee adopted the position of the WHO, that it should not define a threshold lower than the maximum value given above.
The Ministry of Environmental Protection published the report on its Internet site, and its
135 recommendations were incorporated in the Non Ionizing Radiation Law, in 2006, as the basis for decisions by the Radiation Officer on matters concerning the terms for permits covering the electrical grid, until regulations for the electrical grid are introduced. c. Although the Ministry of Environmental Protection retracted the recommendation to plan and operate electricity facilities in a way that will prevent exposure of the population to electromagnetic radiation that exceeds an average of 10 milligauss per day and cancelled this recommendation even before the experts committee published its report, the Company adopted a policy of “smart avoidance” as part of its environmental policy. In this framework, the Planning, Development and Technology (PDT) Division and the Consumers Implementation Division carry out engineering work on limiting magnetic fields in all kinds of electrical installations. For new installations, the principles of smart avoidance are implemented right from the design phase. In high voltage facilities, the principle is implemented as part of the Company’s development plan. For high voltage lines, phase lines and arrangements are defined that restrict the levels of magnetic fields in populated buildings as much as possible. For high voltage and low voltage facilities, planning is based on keeping conductors away from occupied rooms, and improving mutual setoff between phases. These principles are also gradually being implemented in existing facilities that create relatively high fields in adjacent buildings (on this matter see below, the section above on the report of the experts committee). At the same time research is taking place on the development of further reduction methods. The expenses recorded for the smart prevention project in 2010 is approximately NIS 6 million. d. On January 1, 2006, the Non Ionizing Radiation Law, 2006 was published in the Government records. The Law was also applied to electrical facilities used for generation, transmission, distribution and supply, as far as supply to homes. The Law stipulates that no radiation facility can be set up or operated without a permit from the Radiation Officer in the Ministry of Environmental Protection. It is also possible to obtain a permit to cover the erection and operation of several facilities of the same type. The Law gives the Radiation Officer in the Ministry of Environmental Protection wide powers. The Law came into force on January 1, 2007 with respect to new electrical facilities (those facilities for which no building permit or authorization was received by January 1, 2007), and is intended to come into force for existing facilities on July 15, 2008. This is a “framework” law, that is, it states that “preventive precautions” must be adopted but does not specify what they are or any binding threshold values. These matters must be included in the regulations to be promulgated by January 1, 2007. Up to the publication of the said regulations, the law adopted the aforementioned report of the experts committee, published on March 3, 2005. It should be noted that pursuant to the Non Ionizing Radiation Law, decisions that have an effect on the costs for the electricity sector and regulations that have a direct and material effect on these costs, must be approved by the Minister of National Infrastructures and the Minister of Finance.
In January 19, 2009 "Non-Ionizing Radiation Regulations – 2009" were published. The regulations require payment of fees for radiation permits to electricity facilities and for every new facility built by force of these permits. The fees amount was last raised in August 18, 2010.
According to an initial estimate, cost of the fees may amount to approximately NIS 2.7 million per year. e. The Company is studying the economic, legal, operational and technical implications of the
136 foregoing. The Company believes that based on the stipulations of the Electricity Sector Law, the material costs arising from the adaptations required to comply with the provisions of the Law and/or the regulations will be covered by the electricity rates. This estimate is predictive in nature. f. In order to implement the Law, the Company set up teams with representatives of the relevant divisions, and discussions began through the Ministry of National Infrastructures with the Ministry of Environmental Protection. g. The Company submitted applications for most of the new facilities on the grid and for all the existing facilities on the grid. So far, the majority of permits required to build new electricity facilities and continued operation of existing facilities were received. The Ministry of Environmental Protection refused to grant permits for some of the applications, yet solutions acceptable to the Ministry of Environmental Protection and the Company were found. The Company is in continual negotiations with the Ministry of Environmental Protection to find reasonable solutions in the event of problems. h. As stated, the Law does not set threshold values for lengthy exposure to electrical and magnetic fields with a frequency of 50Hz. However, and as stated in paragraph (a) above, back in 1990 and later on under the report of the experts committee of March 2005, the Ministry of Environmental Protection adopted the position of the WHO that recommended a threshold value of 1,000 milligauss for short exposure to magnetic fields.
According to the calculations and tests carried out by the Company itself, for various electricity lines and transformation facilities, the Company believes that in general it is complying with the ICNIRP guidelines. There are special cases where there may be a limited local deviation from the ICNIRP threshold for a magnetic field close to a few existing facilities, yet the Company estimates that there is no deviation from the ICNIRP limit regarding the direct effect on the body. The Company is working to plan new facilities so as to avoid deviations from the aforesaid threshold. i. The Ministry of Environmental Protection prepared an explanation for sending to anyone who inquired and also for incorporation in the survey reports of the Ministry and of private surveyors. According to this explanation, the threshold value of 1,000 milligauss is for a short time only, while extended exposure to levels above 2 milligauss is a possible carcinogen, and the average levels in residential rooms in Israel are no higher than 0.4 milligauss. Recently, while handling a customer complaint, it was found that the explanation sent by the Ministry to private surveyors or customers includes a recommendation that the average level for continuous 24 hour exposure should be 2 milligauss, for 12 hours continuous exposure - 3 milligauss, and for 8 hours continuous exposure - 4 milligauss. These statements aroused complaints and claims against the Company from the public and the authorities. Moreover, several planning authorities have incorporated into the building permits for electrical facilities a condition stating that it is forbidden for the level of the magnetic field from the facility to be greater than 2 milligauss. Such a condition was also included in the planning scheme for building a secondary station. The inclusion of this condition prevents the Company from connecting facilities to its electrical grid. The Company submitted an objection to this position to the Ministry of Environmental Protection and the Ministry of National Infrastructures, arguing that this explanation has been interpreted by the public and by some of the authorities as a binding
137 standard, which the Company cannot meet. In October 2010, the media reported that the Minister of the Environment requested the public experts committee on the subject of magnetic fields from the electricity grid to submit up to March 1, 2011, proposed threshold values and distances between electricity facilities and populated buildings. In a joint meeting of the Health and Environment Knesset committee, an employee of the Ministry of Health said that the Ministries of Health and Environment reached an agreement on new threshold values for a magnetic field from the electricity grid: a threshold of 10 milligauss for existing facilities and 4 milligauss for new facilities. The Company objects to the adoption of these thresholds, since they have a material and direct effect on the development and cost of the electricity sector and also in the availability and reliability of the electricity supply. The Company is studying the implications of setting these thresholds and is forming its response to these actions.
j. Many inquiries on this subject of the existing magnetic fields around electrical facilities are received from the public, some of an informative nature, and others framed as requests or demands for measurements and other actions to reduce the level of the magnetic fields deriving from these facilities. The Company responds to every inquiry.
k. To date, a number of complaints were filed in court against the Company in connection with the magnetic field, but were deleted or dismissed. A decision that dismissed the claims states, inter alia, that the valid standard in Israel is 1,000 milligauss. 10 claims against the Company are pending currently, which include complaints related to magnetic fields from the electricity grid.
2.3.11 Restrictions and regulation of Company activity
Criteria for supply reliability - rules for supplying electricity to consumers According to the Electricity Sector Law, one of the functions of the Electricity Authority is “setting criteria for the standard, nature and quality of the service provided by the holder of an essential service provider’s license”. The criteria include both rules for the agreement between consumers and the Company, and the rates charged for the various services provided by the Company.
The criteria are updated by the Electricity Authority from time to time, and currently replace most of the provisions of the arrangement that existed with rules for supply of electricity to consumers and rules for connections.
In addition, the Electricity Authority defined the standard of reliability that underlies the electricity rate, as follows:
a) The rate bases are intended to achieve an overall level of reliability for consumers of low voltage electricity equal to an average of 100 minutes of power cuts per consumer per year (hereinafter: “the target”).
b) (1) By February 2003, the Authority will define a binding plan to achieve the target (by the date of signing this report, no such plan had been defined). (2) The Authority will not recognize investments in the D.M.S. project (a Company project intended to improve the reliability of electricity) outside the framework of the aforesaid plan, to be approved by it.
138 c) On the basis of the existing operating setup, the Company is required to limit the difference between levels of reliability in the different administrative districts and the general average from 100% to 50%.
The Company estimates that the changes in the criteria as published in the rate document, compared to the rules of supply included in the previous arrangement, have no significant implications for the Company. It estimates that it is complying with these criteria, except as specified above and below on the matter of setting a standard for reliability of supply. With respect to the aforesaid standard of reliability, the Authority has not yet defined a binding plan for achieving the target.
The Company has acted in the past to persuade the Electricity Authority to accept its position that it will not be possible to implement the Authority’s decision, but it will be possible to achieve an overall standard of reliability for low voltage consumers of about 141 minutes of power cuts per consumer per year on average on completion of the whole D.M.S. project, including its options (which according to the current timetable is expected to be finished towards 2016). The Company achieved this target in 2009 and assumes that it will achieve this target in years when the weather is average. Following a heavy storm in the winter months of 2010, the Company did not meet this target. Regarding the variance between the regions, the Company succeeded in reducing the variance (standard deviation) between the criteria of non- supply minutes of the administrative regions to a national average of less than 50% in 2005. The Company cannot estimate whether its plan will be accepted by the Electricity Authority, or the implications for it of failing to meet the target set by the Authority as stated above, although it is possible that failure to meet the target on the dates stipulated by the Electricity Authority could result in non recognition of certain costs in the distribution segment. 2.3.12 Legal proceedings On the matter of legal proceedings related to this field of operation, see section 2.3.10 of this report and Note 24 b to the Financial Statements as of December 31, 2010.
139 3. Description of the Company’s business - matters pertaining Company activity in general
In addition to the aforementioned information, relating to each operation segment of the Company separately, the following is a description of matters relating to the operation of the Company as a whole. The information in this chapter, together with the aforementioned information, reflects the general description of the business of the Company on a consolidated basis.
3.1 Information on Business Initiative The business initiation and development unit, established in 1995, is responsible for business initiation and development within the Company's fields of operation, in Israel and abroad, with the purpose of expanding the operation fields of the Company and achieve optimal utilization of the professional knowledge, the skilled human resource, the by products, infrastructures and its other resources. The operation principles, activities and objectives of the unit are approved from time to time, as needed, through discussions of the Company's Board of Directors or its committees.
The Company acts in business initiation under the licenses of the Company, where some of the activities require approval of the Electricity Administration Manager and were approved continuously. At the date of this report, the unit acts in several primary fields:
a. Commercialization of by products produced during electricity generation. Forecast sales for 2011 totals to approximately NIS 27 million.
b. Use of Company infrastructures to sell services. Forecast sales for 2011 totals to approximately NIS 34 million
c. Sales of knowledge, consultation and engineering services in Israel and abroad. Forecast sales for 2011 totals to approximately NIS 55 million.
d. The field of energy efficiency is a new field in which the Company acts, inter alia, in the sale of energy efficiency solutions to firms, through the sale of professional services of the Company, in cooperation with other companies. Revenues from this activity in 2010 total approximately NIS 1 million. Forecast revenues for 2011, amount to NIS 3 million.
e. An additional field, to which the Company wishes to enter in the near future is the communication field.
The Company has a significant advantage, arising from the existence of a developed communication infrastructure, that may be used for selling services on a business basis. This infrastructure is comprised of an optical fibers network on the high and ultra high voltage lines. This infrastructure was built by the Company as part of the electricity generation and transmission control system. This system has surplus capacity arising from technological developments. In addition, the Company has thousands of pylons that may serve as a basis for rapid spreading of a fibers network and as a basis for wireless antennas system.
The Minister of National Infrastructures granted a license to the Company to conduct a test in the field of providing communication infrastructure services. The test was very successfully conducted in Kiryat Shmone at homes of 150 families. On July 15, 2010, the Government decided to enable provision of broadband infrastructure by IEC, by establishing a communication company that will use the stationary communication infrastructure over the
140 electricity grid and operate it, for the purpose of providing communication services as defined in the Communication Law (Bezeq and Services) – 1982 ("Bezeq Services"). Following that decision, the Government of Israel reached a decision on March 6, 2011, to allow the Company, to establish, together with another party, a company that will use the stationary communication infrastructure over the electricity grid to provide Bezeq services, hold shares and controlling stales, subject to conditions specified in the decisions. See also section 1.7.5.6 in this report.
f. Technological Greenhouse - see section 3.6 b in this report
On December 13, 2007, the Company's Board of Directors reached the following decisions regarding the founding of four subsidiaries for expanding the Company's business and entrepreneurial activities in new fields of activities. As of the date of this report, the decision of the Board of Directors was not implemented, pursuant to the decision to wait for the progress of the Company's restructuring process and the Company does not have any subsidiary designated to conduct business initiation actions. Nevertheless, the Company applied to the State, requesting to receive a specific approval for holding shares in a dedicated company that is interested in building a combined cycle power station in Cyprus
On February 3, 2009, the Restrictive Trade Authority sent a letter to the Company outlining rules related to arrangements in which the Company may have rights in the competing third parties or parties that may compete with the Company or grant an option for shares in such third parties, which oblige the Company to notify the Restrictive Trade Authority in advance about such arrangements.
3.2 Insurance and risk management a. Introduction
The Company has considerable properties and conducts extensive operations throughout Israel. The Company, as other organizations, is exposed to risks that may affect its ability to achieve goals and objectives set by the Company's management. These risks include, strategic, operational, capital market (financial), natural and war risks. To reduce the probability of these risks to the optimal minimum and to fulfill the requirements of the Electricity Sector Regulations, the Company performs risks management actions, through risks reviews and cost - benefit analyses in the organizational units of the Company, including preparation of annual work plans, timetables and required budgets and at the Enterprise Risk Management (ERM) level, by an external consultant, according to principles outlined in the circular published by the Government Companies Authority 2009-1. These actions assist the Company's management to scale the risks and define orders of priority for handling the risks and the work plan required to reduce these risks.
Based on the aforementioned, the Company decides which risks should be insured so that it buys insurance policies, such as insurance of property, liabilities, construction, position holders responsibility, vehicles and marine insurance, intended to provide proper coverage of damages that the Company, its employees and other third parties may incur. It should be noted that the policies usually exclude damages arising from terror and war actions. These damages are usually covered by a special fund, provided by the State of Israel for compensation of damages arising from terror and war actions. The fund is subject to the Property and Compensation Fund Law.
141 However, it is noted that a dispute between the Company and the property tax authorities on payment for direct war damages is currently in legal proceedings.
b. The Main Insured Risks.
The main insured risks are as follows:
1. Physical damage to property.
2. Loss of income and increased fuel expenses.
3. Natural hazards.
4. Liabilities to third parties and to employees.
3. Insurance
The Company buys insurance policies that cover appropriate insurance coverage as follows:
1. "All risks" insurance policy to cover damages to the property of the Company (except the electricity grid), including loss of income and increased fuel expenses cover. Cover limit of this policy is $ 1 billion.
2. Liability insurance policy that includes coverage of general third party liability, product liability, professional liability, accidental contamination damage, responsibility with respect to electromagnetic radiation and employer liability. Cover limit of this policy is $ 100 million.
3. Construction insurance policy of all risks to insure damages during the construction of power stations. Cover limit of this policy is the value of the project.
4. Position holders insurance policy that covers the liability of position holders in the Company. Cover limit of this policy is $ 300 million.
5. Marine third party liabilities insurance, covering the marine actions of the company (e.g., fuels loading/ offloading operations, tugging coal ships, etc.). Cover limit of this policy is $ 50 million.
6. Compulsory insurance and third party insurance of the vehicles fleet of the Company.
7. Insurance of cargo transported through marine, air and land transportation.
8. Insurance of Company's craft.
9. Additional insurance policies according to the needs of the Company.
3.3 Customers - consumers of electricity a) On December 31, 2010 the Company’s customers numbered about 2.5 million. In the period between December 31, 2009 and December 31, 2010, the number of customers increased by about 35,800. On December 31, 2009, the Company's customers numbered about 2.5 million. Consumption of electricity in 2010 was about 52,037 million kWh, an increase of 3,090 million kWh compared to 2009. From December 2009 to December 2010, electricity consumption increased by about 6.43%, from 48,947 million kWh to 52,037 million kWh. For details of peak demand see section 2.1.6 in this report.
142 b) The Company classifies its customers into households, industry, public buildings and commerce, bulk, water pumping and agriculture.
The following table shows consumption of electricity by type of customer in the years ending on December 31, 2010 and December 31, 2009 (see note 28 to the Financial Statements):
Year ended December 31, 2010 (in kWh millions and percentages)
12/2010 % 12/2009 %
Domestic 15,590 30 15,117 30.9
Industrial 10,647 20.5 10,329 21.1
Public, commercial 17,132 32.9 15,624 31.9
Palestinian Authority 4,025 7.7 3,783 7.7
Water pumping 3,029 5.8 2,404 4.9
Agriculture 1,614 3.1 1,690 3.5
Total 52,037 100.0 48,947 100.0
As of December 31, 2010, the Company served about 2.2 million households, representing nearly every household in the State of Israel similar December 31, 2009.
c) In the year ending on December 31, 2010, domestic consumption increased by about 3.1%, relative to the same period in the previous year. Revenues in current prices (gross) from the sale of electricity in the domestic sector in 2010 decreased by about 4.8%, relative to the previous year, due to rates decrease.
d) The public commercial sector includes electricity consumption by stores, shopping centers, various businesses and authorities in the public sector, such as local authorities, government ministries and schools. Electricity consumption in this sector increased in the period ended on December 31, 2010 by about 9.6%, relative to the previous year, leading to a decrease in (gross) revenues from the sale of electricity in this sector in 2010 of about 4.46%, relative to the previous year due to a rate decrease.
e) Electricity consumption in the industrial sector increased by about 3.1% in the year ended on December 31, 2010, relative to the previous year. (Gross) revenues in current prices from the sale of electricity in the industrial sector decreased in 2010 by about 9.8%, relative to the previous year, due to a decrease in the rate.
f) Water pumping is required to provide all parts of the country with water for drinking, irrigation and other purposes. Electricity consumption in this sector increased by 26% in the year ended December 31, 2010 compared to the previous year. In 2010, (gross) revenues in current prices
143 from the sale of electricity in the water pumping sector increased by about 13.4% relative to the previous year, due to increased consumption.
g) In the year ended on December 31, 2010, electricity consumption in the agricultural sector decreased by about 4.5%, relative to the previous year. Revenues decreased in 2010 by about 15% relative to the previous year due to decreased rates and electricity consumption.
h) Types of electricity rates: There are five types of electricity rates to the consumer: “domestic”, “agricultural”, “street lighting”, “general”, “bulk” (that is - one meter for a main customer who provides electricity to secondary customers) and rates based on load and time of consumption (hereinafter: “LTR”).
LTR rates were first introduced into Israel in 1982, and they now apply to very high voltage, high voltage and low voltage customers whose connection size is 3x200 amperes or more, or whose annual consumption is greater than 60,000 kWh. The rate is based on the marginal costs in the system and is intended to strengthen the link between the costs the consumer causes in the system according to the timing of consumption, and the amounts paid.
The total number of consumers on LTR at December 31, 2010 was 56,114 (compared to 53,678 at December 31, 2009), representing only 2.3% of consumers, but who account for 59.3% of total electricity consumption.
3.4 Marketing and distribution The Company initiates communicative advertising campaigns on subjects concerning electricity safety and intelligent consumption, which are current issues included in the agenda of the Company As of December 31, 2010, advertising costs of the Company totaled approximately NIS 9.9 million, compared to approximately NIS 8.9 million in 2009.
3.5 Seasonality Demand for electricity in Israel is seasonal. The highest levels of demand are in summer (due to the use of air conditioners) and in winter (due to the use of heaters) compared to transitional seasons. Not only is average demand higher in winter and summer, but the days of extreme heat or cold are also responsible for periods of peak demand.
144 Company income in the different seasons is also affected by changes in the rates for consumers who pay according to load and time (LTR), who represent about 59.3% of total consumption, since the LTR rates are higher on average in summer than in the transitional seasons and in winter. In this context, the four seasons are defined summer (July to September), winter (December to March), and the transitional seasons - spring (April to June) and fall (October to November).
Gross revenues from electricity in 2010 and 2009 Adjusted for the New Israeli Shekel of December 2010
In NIS millions
Quarter 1 Quarter 2 Quarter 3 Quarter 4 Total
2010 3,693 4,391 6,274 4,845 19,203
2009 5,475 4,635 6,497 3,473 19,080
3.6 Research and development a. General
The purpose of the R&D expense is to develop tools to utilize and derive the greatest advantage from new technologies, to deal with stricter requirements for environmental protection (in all areas) and to achieve supply reliability targets, while striving to minimize costs. The results of the investments in R&D are tested in advanced research projects, mainly on the following subjects:
New technologies to improve utilization in the electricity chain.
Improving the reliability and quality of electricity supply.
Load management (DSM).
Varying sources of energy and renewable energies
Environmental aspects relating to Company activity.
Optimal utilization of land reserves and other Company resources.
Improved and more efficient processes.
Smart grid
The Company is favorably disposed to research with a potential for implementation within a five year period. Projects are carried out either by Company employees or by external bodies (universities, research institutions organizations and so on). It should be noted that not every research project can promise success and implementation, however, the knowledge and tools acquired during the research process are an added value that the Company can utilize in the course of its regular engineering and operating work. Moreover, in every arrangement it makes concerning research, the Company includes a clause that secures its rights to the outcomes (at the cost of the research expenses and/or return on investment and/or royalties, as applicable).
145 In 2010 Company expenses for R&D projects were approximately NIS 7 million (excluding the Technological Ideas Promotion Center) (compared to NIS 5 million in 2009). The operating budget for 2011 indicates that the Company is expected to expend approximately NIS 15 million for research and development (excluding the Technological Ideas Promotion Center). b. Technological Greenhouse
The Company took steps to build a technological greenhouse. As part of these actions, the Company built a Technological Innovative Ideas Promotion Center designated for supporting entrepreneurs with and industrial development and implementation potential in the fields of electricity, related fields and environmental quality fields related to electricity..
Persons with ideas, enterprises and inventors who are accepted by the Technological Ideas Promotion Center will be granted financial support (by way of granting a convertible loan of up to NIS 3 million per project according to fulfillment of milestones and work plans), accompaniment of a professional team, use of Company infrastructures and connections in Israel and abroad. Up to 2010, agreements were entered with seven companies. An agreement was entered with one company up to the publication date of this report. Business negotiations are currently conducted with three additional companied, aiming to reach the agreements entering date in the second quarter of 2011.
The budget for 2011 includes a sum of approximately NIS 12 million required to grant loans to about 10 companied under the Technological Ideas Promotion Center and also for the regular operation of the Technological Ideas Promotion Center.
146 3.7 Human resources
See also Annexes E, F and G below.
3.7.1 Workforce by sphere of activity a. The workforce on December 31, 2010 consisted of 12,677 employees compared to 12,663 on December 31, 2009. About 40% of Company employees are engaged in development of the electricity sector in the various segments.
Workforce by main areas of activity
Area of activity No. of positions
1) Generation 2,470
2) Transmission and transforming (including system management) 459
3) Distribution (marketing and districts) *4,339
4) Headquarters (strategic resources, finance and economics, general 1,548 administration)
5) Service (organization, logistics, security and emergency situations, 1,788 supply and storage)
6) Engineering projects (planning and execution) **2,073
Total: 12,677
* Includes employees engaged in setting the distribution system and transmission lines. ** Engaged mainly in setting up power stations, sub stations and switching stations.
b. Changes in the Workforce In 2010 the workforce remained without material change compared to December 31, 2009.
c. Significant dependence on a particular employee The Electricity Corporation is not significantly dependent on any specific employee.
147 3.7.2 Instruction and Training in the Company a. Employee promotion and training course Employees are promoted on a professional basis, with reference to their contribution to the Company’s productivity and the application of values of striving for excellence and continual update of performance norms, in line with changes in the technological, organizational and business environment in which the Company operates, and using tools for measurement and assessment. Promotion to management grades involves strict appointment processes, which seek to comply with the CEO’s policy of promoting women to senior positions and strengthening managers at all levels, emphasizing excellence. Active employees promotion – grade promotion in accordance with section 103 of the labor law takes place once every year/ two years, unless grade promotion is prevented in coordination with the workers committee. Appointment to positions up to the level of a deputy division manager follows the procedure of the Company by a bi-partisan tenders committee, in which the human resources division manager has the decisive vote in the event of a dispute among the tenders committee members (in tenders up to a deputy department manager level and up) and the CEO (in tenders for department manager position and up). The Company provides both vocational and managerial promotion paths, which are integrated into the human resources development system which is based on internal training in the various areas of work, as well as programs for acquiring or completing formal education. This is all part of a continuous process of nurturing human resources and threshold requirements for professional/ managerial advancement in the transition between positions. The Company emphasized the need to expand occupation fields and specializations of employees and managers. Consequently, the Company promotes plans for internal mobility and professional retraining, including rotation of managers and holders of sensitive positions, aiming to utilize the potential of the existing human resources prior to initiating external recruiting and assimilation processes. b. The training arrangements in the Company include five schools and a national training headquarters:
School for electricity generation and transmission professions - This school mainly trains employees of power stations and transforming and switching stations, as well as employees of the national unit for load management. The school runs courses and supplementary training on integrating new technologies, such as electricity generation with natural gas and in combined cycles, operation and maintenance of transforming and switching stations, operating control systems in power stations using programmed controllers, and refreshing the knowledge of employees in the division. The school also leads the development plan of Company employees in Environmental studies, including M.A. study plans in this field.
School for marketing and grid professions - This school trains the district workers on matters of marketing and service, and areas of work on the grid. This includes training on service and marketing for staff at the Company’s call center on 103, strategic customer coordinators, workers in the commercial accounts and collection departments. The school also trains field staff to the level of experienced technician and practical engineers. In
148 addition, the school provides study programs for training electrical engineers in "strong current" to prepare them for registration in the engineers register in the field of "strong current". A study program that trained practical engineers as "strong current" electrical engineers was completed in 2010. The school, jointly with the academy, also prepares programs for a master's degree in electricity.
School for engineering projects - This school trains employees and managers in the engineering projects division, which includes the engineering planning department and the project execution department, plus the logistics and property department and the technology planning and development department. The school also functions as an authorization authority in different occupations, as required by the law and the regulations. The school leads, develops and trains employees in the fields of "Projects Management" and “Renewable Energies”. The school for computers and information technologies - The school trains all Company employees for all types of computer usage and assimilation of computer technologies, and also trains employees of the IT department on computer systems and telecommunications. The school also develops programs and training aids for remote studying and also study programs for the managers reserve, by completing academic studies (General B.A. and M.A. in Business Administration). The school for management and administration - This school trains and develops management staff in the Company at all levels and provides training for managers on matters of business, management and administration. This includes training employees for department and division management positions as well as head office administrative staff. The school also develops active managers through subject targeted courses on different administration fields. The Company’s training organization is intended to provide support for improving the performance of employees and raising the professional standard of the Company’s human resources. The system provides training in a whole range of trades covering the Company’s main areas of activity, plus the qualifications required by law and regulations for work in certain areas. The training staff develop study and training programs for employees and managers at different stages of their professional lives in the Company, and preparation for moving into different fields of work. Training also focuses on incorporating new technologies, with an emphasis on safe behavior at work. All courses are managed by training teams from the various schools and other Company employees who share their knowledge with course participants. The training system also handles formal study arrangements, for example for technicians and engineers, in subjects required by the Company, particularly in areas of new technologies, as well as studies for a bachelor's degree, general studies and a master’s degree in business administration subjects. The training organization operates continuously to maintain its status as an authorizing entity wherever Company employees require such authorization and the authorization is subject to participating in courses and fulfilling their requirements. The training organization also acts to expand the number of study syllabuses approved by the Ministry of Industry and Trade and also curriculum and study requirements recognized by the Ministry of Education, the Advanced Studies Pay Committee, Adults Education Department.
149 c. Costs with respect to training and studies on the Company Following are expenses arising from training and studies in the Company in 2010. There is no material change in these expenses compared to 2009:
1. School expenses in 2010 (lecturers, refreshments, equipment, travel for participants) totaled NIS 10.5 million.
2. Costs for IT supplementary training for employees and managers - NIS 8 million.
3. Payment for courses, seminars and conferences outside the Company - NIS 2.1 million.
4. This does not include direct and associated costs of studies for higher degrees and students for diplomas who are recorded on account of their salaries and are taxed.
150 3.7.3 Compensation funds for employees, benefits and employment agreements
a) Employment agreements 1) Labor relations in the Company are regulated by labor legislation, by work agreements and by collective agreements (the new labor constitution and Company procedures dealing with work conditions (hereinafter “the Employment Agreements”), which constitute a binding format in the Company for matters of starting or terminating employment, working conditions, labor relations and the rights and duties of the parties. The labor agreements apply to all employees in the Company (except those on personal contracts), with the reservations that they include. The labor agreements (and particularly the labor constitution and Company procedures) regulate most terms of employment in the Company, including: salary and terms of service, eligibility for an energy basket, hours of work and rest, overtime, shift work, paid absences (vacation, sickness and so on), retirement terms and more. The labor agreements also include various provisions concerning personnel management in the Company, including: procedures for receiving new employees and dismissing employees (including restrictions on the reasons for which an employee may be dismissed, the manner of carrying out the dismissal and the circumstances in which there is need to obtain the consent of the workers’ committee on this matter), restrictions on moving employees from one job to another, disciplinary arrangements and so on. The labor agreements are changed and updated every few years. Pay agreements are reached following negotiations between the Company management and the General Federation of Labor (the Histadrut) and the National Committee of IEC Employees, and require the approval of the Government Companies Authority, the Wages and Work Agreement Officer in the Ministry of Finance and the Company’s Board of Directors. In principle, Company employees can be divided into two groups - management grades and professional grades - engineers, academics, lawyers, practical engineers and technicians. The wages scale of these employees grades is similar. The Company maintains one pay table, where for each management grade there is an equivalent professional grade. Pay terms, pension and other employee rights relating to the termination of the employer employee relationship vary for the different groups to which the employees belong, as described in section 3 below.
2) The Company is subject to section 29 of the Budget Fundamentals Law, which in fact restricts its ability to operate independently in matters of employee pay and benefits, and places on it an obligation to obtain the approval of the Government Companies Authority and the Wages and Work Agreements Officer in the Ministry of Finance on such matters, in addition to the approval of the Government Companies Authority, as stipulated by the Government Companies Law.
On August 21, 2006, the Company received a letter from the Supervisor of Wages and Work Agreements in the Ministry of Finance ("The Supervisor"), announcing the decision regarding the salary terms of the Company's employees and pensioners/survivors specifying among others, several salary components that were paid to Company employees and pensioners/survivors, contrary to the Budget Basis Law – 1985, which he therefore decided to cancel and/or change. The Supervisor also instructed the Company to
151 require its employees and pensioners/survivors to refund these components. The Supervisor also decided that Company pensioners/survivors will be promoted to a higher rank every three years instead of every two years.
The Company, the employees representatives and the Supervisor conducted discussions over the years and on January 31, 2011, entered into a salary agreement, that includes settlement of salary deviations in the Company, against a 0.5% decrease from the total corresponding salary supplements determined in the salary agreement of the public sector and also another 0.3% reduction from the previous salary agreement of the Company. 3) On January 31, 2011, two collective agreements were signed between the Company, the employees’ organization and the Histadrut, with the approval of the authorized parties. The salary agreement (that also includes settlement of salary deviations) is based on the salary agreement of employees in the public sector, signed on January 12, 2011, and an agreement on the transition of the pension to linkage to the CPI. The main principles of the salary agreement for the period January 2009 up to June 30, 2012: a. Update of the combined salary table. A uniform addition to the salary in the combined salary table to be paid at the following rates on the following dates: From January 1, 2011, an addition of 2.25%. From January 1, 2012, a supplement up to 3.75% (*). From January 1, 2013, a supplement up to 5.75%.
* This rate includes a deduction of 0.5% from the corresponding salary addition of public sector employees (2%), as part of settling salary deviations in the Company (see details in section f below).
b. A one time only bonus to employees and pensioners/survivors: In the February 2011 salary, employees who conform to the following criteria and pensioners/survivors entitled to budgetary pension will receive a one time bonus as follows: An employee who worked in the Company on October 1, 2010 and was employed continuously as on January 31, 2011 will receive a one time bonus of NIS 2,000 gross. A pensioner/survivor entitled to a budgetary pension will receive a one time bonus of NIS 2,000 gross, multiplied by the pension rate, regardless of his/her retirement date. c. Update of child day-care rate: Starting on September 1, 2011, the child day-care supplement will be updated as follows: For a child under the age of 5 years: NIS 300 per month. For two children at least whose ages are under 5 years: NIS 500 per month. d. Cancelling the decrease of recreation pay for 2011: recreation pay for 2011 will be paid in full. e. Increased rate of provisions and deduction to pension fund: Increase in the rate of Company provision and deduction from the employee's salary to a pension fund, with respect to the insured salary for cumulative pension (for all types of temporary employees and Generation C employees) and to the pension fund of salaried employees (to employees entitled to it, and for salary components which are not expense refund), similar to the corresponding increase for public sector employees. Starting on January 1, 2011 the Company's provision rate will increase by 0.5% and the deduction rate from the employee's salary will also increase by 0.5%. Starting on January 1, 2013, the Company's provision rate will increase by an additional 0.5% and the deduction rate from the employee's salary will also increase by an additional 0.5%.
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f. Settling deviations from the salary: Entitlement for a star rank and 14 salary: An employee who started work in the Company before January 1, 2004 will be entitled to a star rank and a 14 salary upon reaching 20/25 years of work in the Company for a woman/man respectively. An employee who started work in the Company on or after January 1, 2004 will not be entitled to a star rank and a 14 salary at all. g. The agreement also defined entitlement to a rank upon retirement and the manner of acquiring the rights during unpaid leave. The approval of the agreement on linking the pensions by Supervisor of Wages and Work Agreements also reconfirmed the entitlement to budgetary pension from the Company of each employee and pensioner of generation B and their survivors (whoever commenced employment from April 1, 1975 and up to June 10, 1996 inclusive and became a permanent employee of the Company). The main principles of the Pension Agreement are as follows: 1. A change in the pension update mechanism for employees entitled to existing budgetary pension in the Company, similar to the agreement signed by the State, which links the pensions to the CPI, to maintain their real value. The change will apply from January 2012, subject to the completion of suitable legislative procedures, as required by the approval of this agreement by the Supervisor of Wages and Work Agreements in the Ministry of Finance. 2. A one time bonus payment to pensioners/survivors entitled to a budgetary pension who retired from the Company up to December 31, 2010 ("existing pensioners/survivors") in two parts: in February 2011 and in July 2011. 3. Payment of a percentage addition to the pension, at the rate of 8% and 12% to existing pensioners/survivors (according to their rank) from January 2012, subject to the completion of suitable legislative procedures, as required by the approval of this agreement by the Supervisor of Wages and Work Agreements in the Ministry of Finance. 4. From January 2012, a welfare fund will be established for pensioners entitled to budgetary pension, similar to the fund established for public sector employees, subject to the completion of suitable legislative procedures, as required by the approval of this agreement by the Supervisor of Wages and Work Agreements in the Ministry of Finance. For details on the employees reward plans, benefits and employment agreements, see Note 19a2 to the Financial Statements as of December 31, 2010.
4) Permanent Employees - 9,721 employees (as of the salary of December 31, 2010): An employee who has received tenure pursuant to Company procedures. These employees are divided into generations A and B (employees, who started work in the Company up to June 10, 1996 inclusive) who have a budgeted pension pursuant to the regulations of the Central Pension Provident Fund of the Electric Corporation Employees (managed from May 1, 2010 by Infinity, who replaced C.P.Y.), and generation C employees (who began work from June 11, 1996 onwards), who are insured in accumulator external pension funds. Employee on special contract 861 employees (as of the salary of December 31, 2010): an employee who is hired for a temporary position, to perform a defined task that lasts for a defined period, such as: setting up a power station or sub stations or working on long term projects in the Districts. These employees are entitled, under the collective agreement, to the rights specified in the labor constitution for permanent employees, excluding entitlement to the budget pension and to reduced rate energy basket. Severance pay paid to employees on special contract who are subject to a special collective agreement since 1996, upon dismissal is increased by 200% for each of the first two years of work, and by 300% for each subsequent year.
153 According to collective agreements on the subject, the maximum period of employment of employees on a special contract who began work in the Company from January 1, 2005 onwards is 5 years, and the maximum period of employment for those who began work up to December 31, 2004 inclusive is up to 10 years. Temporary employee 1,098 employees (as of the salary of December 31, 2010): An employee hired for a particular task but not on a special agreement. Temporary employees have the rights specified in the labor constitution, with the exceptions listed therein, and excluding the right to budgeted pension and energy basket. Severance pay paid to temporary employees is as required by law. Temporary employee on a special agreement 1,089 employees (as of the salary of December 31, 2010): a temporary employee who has worked for at least two years in the Company and signed a transition to temporary status special agreement. As per the collective agreement, this employee is entitled to the rights specified in the labor constitution for permanent employees, excluding the right to budgeted pension and an energy basket. Severance pay paid to temporary employees on a special agreement is as required by law. In accordance with the collective agreements on the subject, the maximum period of employment of temporary employees on a special agreement who began work in the Company from January 1, 2005 onwards is up to 5 years, and the maximum period of employment for those who began work up to December 31, 2004 inclusive, is 10 years, . Employee on personal contract 21 employees (as of the salary of December 31, 2010): an employee who signs a personal contract on being accepted for work in the Company, which stipulates his salary and other terms of work. b) Rewards for employees In general, the Company has no special reward programs for employees, except for the following:
1) The Board of Directors may decide on payment of a bonus to employees with the restrictions of the guidelines from the Government Companies Authority in this context, which stipulate among other things that the bonus may not be more than 10% of the Company’s net profit for the year. A bonus is intended to reward employees for outstanding performance and the Company’s success, and must be approved in advance by the Government Companies Authority.
2) CEO award for excellence to chosen employees for 2010. On February 16, 2010, the Government Companies Authority approved the allocation of a budget for this payment.
3) Permanent employees and pensions are entitled to an energy basket up to a consumption ceiling of 18,000 kWh per annum, for domestic consumption at their place of residence for their personal use.
4) Central Pension Fund
As of March 8, 2005, the Company deposits funds to cover pension liabilities for pension for employees of generations A and B in the Central Pensions Fund ("Pension Fund"). The Pension Fund acts by force of the Income Tax Regulations (Rules for Approving and Managing Pension Funds) - 1964. The fund is currently managed by the managing
154 company "Infinity". See also Note 19 a to the Financial Statements as of December 31, 2010. 3.7.4 Organizational Change – "Matzpen Plan" On May 14, 2008, the Board of Directors of the Company approved in principle the outline of the plan for structural change (Matzpen Plan), presented to the Board of Directors by the CEO of the Company. The plan is based, inter alia, on the retirement of about 2,000 - 2,500 employees and a process of reducing the number of Company employees to be spread over a period of three years, reorganizing Company units, including a change in the control of the Management, consolidation of functions benefiting from economics of scale, elimination of duplications and creation of supportive management mechanisms aimed at improving processes, management flexibility and optimal utilization of resources and manpower. Initial estimates made by the Management of the Company indicate that the total cost of the plan is an estimated NIS 2.3 - 4.0 billion. Conditions for recognition of the amounts expected with respect to the plan (except employee retirement) in accordance with the instructions of IAS No. 19 have not reached fruition, as yet. The Board of Directors instructed the CEO of the Company to commence an intensive consultation and negotiation process, on the subject of workers’ rights with the workers’ representatives, as required by law, as soon as possible. The workers’ organization announced that it objects to the implementation of the plan and prohibited the workers from cooperating on this subject. Several consultation meetings were held later on but did not lead to an understanding between the parties. The Management and the workers' organization, agreed at the beginning of May 2009, to open discussions (as detailed in section 1.7.1 in this report) on the restructuring of the electricity sector and structural change and efficiency process in the Company and open negotiations on resulting workers rights. Representatives of the State, the Histadrut, the employees organization and the Company's Management agreed on March 18, 2010 to start an intensive and continued process of discussions on the subject of the structural change and related employees rights. On August 8, 2010, the National Secretariat decided to approve an outline of a structural change in the Company, according to the proposal of the Company's Management. 3.7.5 Labor relations and Employment Termination Labor relations in the Company are based on the principles of the new labor constitution for Company employees, entered into on March 25, 2002 ("Labor Constitution"). The Labor Constitution and procedures derived from it are the main normative source for all matters related to engagement to work in the Company, employment termination, work conditions and labor relations. The labor constitution has a legal status of a bilateral collective agreement, valid until December 31, 2015.
Section 185 of the Labor Constitution states that according to Company needs the Company's Management, upon agreement with the workers committee, may move an employee to a different position or another work site, temporarily or permanently, without affecting the employees work conditions and without deducting from the salary.
Employment termination of Company employees subjected to the Labor Constitution is regulated in sections 200-201 of the Labor Constitution. The provisions of these sections enable the Company to dismiss an employee due to re-organization in the units of the Company or due to any other justified reason, where in every case of dismissal, except a temporary employee, the Company will first discuss the case with the workers committee and the employee will be dismissed in agreement with the workers committee.
In the absence of an agreement with the workers committee on dismissing a Company employee, the issue will be brought to negotiations between the Company's CEO and the Histadrut, according to
155 the instruction of section 223 of the Labor Constitution. The Labor Constitution does not provide a decision mechanism for the event of disagreement between the Company's CEO and the Histadrut.
The aforementioned provisions of the Labor Constitution indicate that the ability of the Company's management to initiate efficiency actions involving employment termination of Company employees is limited. Such steps require the consent of the workers committee and in the absence of such a consent, the issue may be escalated to negotiations with the Histadrut. When such negotiations fail the Labor Constitution does not provide a mechanism that will enable implementation of a re- organization process involving dismissal of employees without obtaining the consent to these processes.
On the matter of labor relations in the Company and the status of labor disputes at the time of signing this report, see Note 24(c) to the Financial Statements as of December 31, 2010.
3.7.6 Labor Disputes 1) A notice with respect to a strike was submitted on May 26, 2008, according to the Settlements of Labor Disputes Law. The disputed matters are:
The intention of the employer to implement a comprehensive organizational change and an efficiency plan, with significant and critical impact on the employees in all aspects, including, but not limited to work conditions, rights, pension rights, status, employment security. The employer intends to perform a massive efficiency plan within the framework of the organizational change and the efficiency plan, including, inter alia, early retirement of 2,000 up to 2,500 tenured employees, from all units of the Company, up to three years from the plan's commencing date, according to lists compiled by Management. The employer is not acting in good faith when it attempts to push the workers organization aside and present it with accomplished facts, by setting, inter alia, a nine months timetable for preparing and implementing the organizational change and the efficiency plan.
On January 1, 2009, the CEO and the Employees Committee reached understandings on the implementation of some of the steps of the Matzpen plan and conducting intensive negotiations about subsequent steps, up to February 15, 2009. Because the negotiations failed, the CEO announced on March 10, 2009, that implementation of the organizational restructuring component of the Matzpen plan will continue.
Following the decision of the CEO, the employees opened rolling sanctions on March 12, 2009.
The Company appealed to the Electricity Authority to receive rate coverage for damages caused by the sanctions.
In response to the Company's applications to the district labor court, the court issued the following decisions:
The decision issued on April 5, 2009 obliges the employees to repair every failure and cooperate with all actions required to prepare and submit the Financial Statements on time. The decision forbids the employees from opening any sanctions that will disrupt the Financial Statements preparation process. It also states that the Company will suspend actions to implement the "Matzpen" plan for 45 days and orders all the parties to open intensive
156 negotiations on reviewing ways to implement the "Matzpen" plan by mutual consent. The decision also states that until another decision is made, the Company will not deduct from the wages of the employees with respect to sanctions up to that date. The decision made on April 16, 2009, obliges the employees to refrain from disruptions that may disrupt regular supply of electricity, namely, enable routine operation of the electricity chain and repair all failures in any of the Company's generation units. This obligation excludes renovation actions in second and third shifts and connection of generation units to natural gas.
On April 26, 2009, after several hours of unsuccessful attempts to reach an agreed upon course of understanding between representatives of the State, the workers organization and the Company, another discussion was scheduled for May 3, 2009. On May 3, 2009, the Management and the workers organization reached understandings that will remain in force up to August 1, 2009, or up to a later date, as agreed upon by the parties, relating mainly to the suspension of the Matzpen plan and reverting the situation related to Matzpen plan to its status on the eve of February 15, 2009, removing all sanctions and returning immediately to full normal work routine.
A letter, delivered earlier, on April 30, 2009, from the Director General of the Ministry of National Infrastructures and the Director General of the Government Companies Authority, addressed to the CEO of the Company and to the Chairman of the workers organization, announces their intention to conduct discussions on the restructuring of the Company with the parties and negotiate the workers rights under the restructuring plan.
On July 8, 2009, representatives of the State, the Company and the employees organization reached an understanding on the subject of holding intensive discussions on the restructuring and efficiency plan and conducting negotiations on the subject of employees rights in the restructuring, aiming to reach agreed upon principles by September 18, 2009.
2) A notice of a strike was issued on November 12, 2009, according to the Settlements of Labor Disputes Law.
The main disputed issues: a. Attempts to damage the pension of the employees, reduce the actuarial debt and decrease the pension liability of the employer, including attempts to damage the Central Pension Provident Fund (CPY) and its financial strength. The employer ignores demands of the employees’ representatives to improve pension terms and prevent pension erosion and tries to go back on earlier agreements. b. Demands of the employees’ representatives regarding implications and impact on work conditions, salaries and status of employees of the Accounting and Economic Division, arising from imposing an exceptional work load on these employees.
3) On January 31, 2011 two special collective agreements were signed – a salary agreement and settling deviations from salary and an agreement on linking pensions to the CPI. The agreements specified, inter alia, that all causes for collective labor disputes at the national and local levels which were announced or notified and are related to the subjects resolved in the agreements are cancelled (see section 3.7.3 above).
157 3.8 Fixed assets and facilities a. General
The details of fixed assets and facilities given below refer to property and assets owned by the Company and/or used by it, ignoring disputes between the Company and the State regarding the Company’s rights to the assets and facilities that were held by the Company at the time the concessions expired. (For details of the “assets arrangement” and its implications for the Company, see section 1.7.2 in this report.)
At the Company’s initiative, over the last few years there has been a concentrated, focused and continuous effort to collect information on all the Company assets, that was dispersed in the different divisions and districts, including transformation stations, mobile/ temporary/ leased facilities etc., and to set up a proper “assets ledger”, for recording rights (including caveats, where relevant), management and supervision, including removing intruders from Company assets or settling the status of those using Company assets. The Company has a full “main assets ledger” (that is updated from time to time) and a “secondary assets ledger” (about 13,000 assets, mainly transformation stations). The Company is also working to register its rights to assets, both “main assets” and “secondary assets”.
b. Facilities serving all the operation segments
Below are details of fixed assets and facilities used in all segments of activity.
The Company’s head office building, with an area of 80,000 sq.m. is located at the southern entrance to Haifa. The Company has leasing rights to about 80 properties used for various purposes, such as offices, storerooms, monitoring stations, temporary and mobile sub stations, etc.
The Company also has 9 logistics sites used for storage, as follows:
Site name Location Type Area in sq.m. 1. Technical Center Workshop* Tel Aviv Logistical 1,380 2. Giborei Yisrael Warehouse Tel Aviv Logistical 8,508 3. Kiryat Shmone Warehouse Kiryat Shmone Logistical 3,000 4. Kiryat Gat Site ** Kiryat Gat Logistical 3,600 5. North Acre Logistics Center** Acre Logistical 121,572 6. Storage area for equipment carts Jerusalem Logistical 775 7. Beit Dagan Warehouse Beit Dagan Logistical 85,108 8. Leyland Logistical Center Ashdod Logistical 106,000 9. Orot Rabin Logistical Center Hadera Logistical 270,000 Total area: 599,943
* The asset is scheduled for sale during the coming year.
** At the time of signing this report, these properties are vacant and not used for storage.
These assets are owned by the Company (but see Note 1.g to the Financial Statements as of December 31, 2010, on the assets arrangement) or held by it, in the framework of long term
158 leases (mainly with the Israel Land Administration) or of rights that were granted to the Company by the owners of the assets (e.g., easement, lease or permission to use free of charge which is not a lease, or possession right with a process of arranging it under a contract) or rights granted to the Company by law. The aforesaid assets and rights are subject to floating liens created by the Company to secure its obligations (see note 18.e to the Financial Statements as of December 31, 2010). c. Fixed Assets
The fixed assets of the Company are divided into two main groups: Operated fixed assets and fixed assets under construction. The operated fixed assets is mostly comprised of power stations (including land, buildings and machines), switching and transformation stations, distribution grids, switching stations and ultra high 400 kWh voltage lines. Fixed assets under construction is mostly comprised of power stations and buildings.
The Company has assets (particularly distribution networks) in the Palestinian Authority areas. Company management estimates that if ownership of these assets is transferred from the Company, it will be compensated with an amount equal at least to the value of the assets as shown in its financial reports (see Note 11 g to the Financial Statements as of December 31, 2010). d. Intangible Assets
1. Software
The Company deals in characterizing, developing and implementing information systems and solutions that support business processes of the Company in the following segments: Customers service and billing, electricity chain, planning and erection of engineering projects, security and safety software and software for administration, business and logistics. The Company has acquired extensive experience and knowledge in planning, hosting and operating computerization infrastructures on all types of platforms, telecommunication and control and command infrastructures and services (optical fibers, microwave, wireless), specialized in various IT architecture and technologies, focusing mainly on data security and integration as well as the whole life cycle of high volume computerization and telecommunication projects.
2. Patents
As of December 31, 2010, the Company has one patent, in registration process on the subject of chemical indicators for identifying hot spots in transformers.
In addition, the Company handles patents of the Technological Ideas Promotion Unit. The unit conducts patents applicability tests of projects in which the Company is interested, budgeted in a separate budget, subject to the agreements procedure of the Company. The conditions of each agreement, including patents handling, as related to the project, are concluded in a negotiation between the Company and the initiators of the project, followed by entering an agreement (convertible loan) between the parties.
3. Concessions
159 Jordan Investments Co. Ltd., ("Jordan Investments"), holds a user license in 20 VHF frequencies which it purchased in 1999 from "Aeromid". The purchase of the frequencies was financed by the Company and in return, the Company received exclusive user rights for these frequencies. These frequencies are designated for use in the DMS project.
3.9 Working Capital
Credit policy a. Customer credit: the average range of credit to customers in the year ending on December 31, 2010 was 56.6 days compared to 61.6 days in 2009. The average extent of customer credit in the year ending on December 31, 2010 was approximately NIS 3,422 million compared to NIS 4,111 million in 2009.
b. Supplier credit: the average range of credit from suppliers in the year ending on December 31, 2010 was about 34 days compared to 39 days in 2009. The average extent of supplier credit in the year ending on December 31, 2010 was approximately NIS 1,239 million compared to NIS 1,465 in 2009.
3.10 Financing 3.10.1 The electricity rate is set on the basis of the Company’s costs as described in section __ of this report and in Note 1(f) to the Financial Statements. In view of the aforesaid rate principles, the Company’s revenues (excluding yield on capital less the dividends required according to the guidelines of the Companies Authority, as stated in section 1.8 of this report) do not constitute a main source for funding the development of the electricity sector, and the Company is therefore required to raise most of the funding necessary from external sources.
Nevertheless, in recent years, financing part of the development plans of the Company was raised through an increase of rates. Thus for example, starting from September 8, 2007, the Electricity Authority approved an recognized cost addition of 5% for a year or until a new rate base is determined for the generation segment, whichever is earlier, which is advance recognition of the cost of the investment. Moreover, in its decision of October 30, 2008, the Electricity Authority recognizes emergency plan financing costs in an accumulated amount of NIS 2 billion. See Note 3 (f) to the Financial Statements as of December 31, 2010.
The recognition will be spread over a period of two years, starting on January 2009 and up to November 1, 2011 or until collection is completed..
The Company generally raises capital by issuing public and private debentures in Israel and abroad and from local and overseas banks by means of credit lines and dedicated loans to fund imports and equipment. The Company conducts hedging transactions from time to time, to minimize the effect of fluctuations in the exchange rates of the currencies. 3.10.2 Average rate of interest on loans The Company funds its activities with bank credit and non-bank credit. Below are details of average rates of interest for the period ended on December 31, 2010 on loans that are not designated for special use by the Company, split into short term and long term credit from bank and non-bank sources.
160
Details Average interest rate Average interest rate (%) for (%) for short term credit long term credit Bank credit sources 3.37 4.45 Non bank credit sources 7.46 6.40
3.10.3 Restrictions applying to the Corporation on receiving credit The Company will require quite large amounts of external financing to fund its development plan. The Company’s ability to borrow from the Israeli banking system is limited due to the credit restrictions applying pursuant to the Bank of Israel’s instructions for proper bank management. According to these instructions, an Israeli bank may not grant a loan to a “single borrower” that is greater than 15% of its shareholders’ equity, after adjustments, and in addition an Israeli bank may not grant loans to a “group of borrowers” that amount to more than 30% of the bank’s shareholders’ equity, after adjustments. The term “group of borrowers” includes, inter alia, the borrower, the party that controls the borrower and any other party controlled by them. Regarding these restrictions, the State is not considered a borrower and is not included in a “group of borrowers”.
According to the Supervision of Financial Services Law (Provident Funds), 2005 and its regulations, a fund may hold securities, make deposits and grant loans to a company for a maximum of 15% of the estimated value of its assets. In addition, any fund may hold up to 15% (25% for groups of investors) of the total face value of negotiable debentures of the same series. In effect, the Company estimates that the provident funds are not exploiting the maximum rate allowed by the Law.
The theoretical potential of obtaining loans from the banking system and from the institutional market in Israel is, in the Company’s estimation, considerably lower than its needs, and in any case cannot constitute the only source of financing for its development plan. 3.10.4 Credit received from the date of this report to the date of signing it From December 31, 2010 to the date of signing this report, the Company raised the amount of some NIS 2,518 million in return for issuing debentures and obtaining loans, as detailed below:
Date of issue Fund Raising Amount in original Amount in currency Million NIS 18/01/11 Debentures series 2022 NIS 2,503.3 million 2,503.3 nominal value of 2,195,840.000 21/01/11 Loan from DZ Euro 3.0 million 14.7
3.10.5 Restrictions applying to the Corporation by force of Financing Agreements On the signing date of this report, the Company is not required to comply with any financial covenants whatsoever (e.g., service debt ratio or date cap. ratio) regarding credit received from banks or from others. Nevertheless, in part of the loan agreements, the Company is required to receive the approval of the lender to the transfer of assets that are the subject of the specific loan. For details on the main restrictions applied to the Company by force of its financial liabilities and the main grounds
161 for demands for immediate repayment included in the loan agreements and debentures of the Company, see Note 18(g) to the Financial Statements as of December 31, 2010. 3.10.6 Credit with variable interest At December 31, 2010 the Company had a total of NIS 4,390.40 million in variable interest credit, as detailed below:
Interest range in Balance at 31.12.10 Interest ranges 2010 (millions) Currency (in %) Original High Low High Low NIS currency US$ Libor 6m + 1.7 Libor 6m + 0.15 2.64 0.54 333.2 1,182.5 Euro Libor 6m + 1 Libor 6m + 0.325 2.11 1.27 622.8 2,950.8 Swiss franc Libor 6m + 0.5 Libor 6m+0.5 0.96 0.74 0.8 2.9 GB Pound Libor 6m + 0.5 Libor 6m + 0.5 1.53 1.28 0.8 4.2 Unlinked NIS Telbor 6m + 1.15 Telbor 6m + 1.15 2.91 2.39 250 250
3.10.7 Credit rating The overall ability of the Company to fulfill its financial obligations is rated by two local rating companies and two international rating companies. The credit rating of the Company in each of the rating companies is as follows:
In Israel 1. Maalot S&P: (ilAA-) with a stable outlook. 2. Midroog: Aa2 with a negative outlook. Overseas 1. Moody's: Baa2 with a stable outlook. 2. S&P: (BB+) with a stable outlook, while secured preference debentures of the Company are rated at (BB+) and included in the CreditWatch Negative list. See details of the rating of the overall ability of the Company to fulfill its financial obligations, see the Report of the Board of Directors, section 5 a in the Board of Directors Report as of December 31, 2010.
3.11 Taxation On this matter see Note 22 to the Financial Statements as of December 31, 2010.
3.12 Restrictions and regulation of corporate activity On this matter see sections 1.7.1 and 1.7.3 of this report.
162 3.12.1 Provisions of the Electricity Sector Law, its underlying regulations and decisions of the Electricity Authority On this matter see sections 1.7.1 to 1.7.3 of this report. 3.12.2 Government decisions On this matter see Note 1. c to the Financial Statements as of December 31, 2010. 3.12.3 The Budget Foundations Law, 1985 (“the Budget Foundations Law”) The Budget Foundations Law applies to any Government company, Government subsidiary and involved company.
In addition to the Company’s obligation to operate in accordance with the rules laid down by the Government and to obtain its approval when determining pay, social conditions, benefits, grants and other working conditions for its senior and other employees, as stated in section 32(a)(4) of the Government Companies Law, the Company is also subject to a number of the provisions of the Budget Foundations Law, which states that Government companies, Government subsidiaries and involved companies within the meaning of the Government Companies Law, are included in the definition of “budgeted entity”.
According to the provisions of section 29 of the Budget Foundations Law, the Company cannot agree to changes in pay, retirement terms or pensions, or any other monetary benefits relating to work, and cannot introduce any such changes or benefits, except in accordance with what is agreed or introduced with respect to all state employees or with the approval of the Minister of Finance.
Notwithstanding the contents of any law, any agreement or arrangement is null and void if it contradicts the aforesaid provisions. If any budgeted entity fails to comply with these provisions, the Minister of Finance may deduct an amount equal to the amount paid due to this breach from the amounts to be transferred to the budgeted entity from the state budget, and may stop or reduce any grant or participation that the budgeted entity would have otherwise received from the Government, for as long as the budgeted entity makes payments contrary to the provisions of the Budget Foundations Law.
A director who knowingly agrees to any changes or benefits contrary to the foregoing shall be deemed to be a director who is not properly fulfilling his duties, for the purposes of the ministers’ authority to dismiss directors, and consent by the CEO to such changes will be deemed sufficient cause for the Government to dismiss him.
A budgeted entity must give the Director General of the Ministry of Finance, on demand, any information he requires for the purpose of monitoring compliance with the Budget Foundations Law.
A budgeted entity shall give the Supervisor of Wages and Work Agreements in the Ministry of Finance, once a year, a detailed report on the terms of employment of every office holder, within the definition of section 33(a) (d) of the Budget Foundations Law, which it employs. The definition includes the chairman and members of the Board, the CEO and his deputy, the company secretary, internal comptroller, legal counsel and any other manager directly subordinate to the CEO.
The budgeted entity will also submit to the Commissioner for Pay on demand any arrangements, agreements and group or individual wage agreements. The Minister of Finance may withhold amounts due to an entity that fails to comply with the obligation of reporting.
163 The Supervisor of Wages and Work Agreements may, with respect to any wage agreement that includes a wage anomaly within the meaning of section 29 of the Budget Foundations Law, audit the matter, determine temporary arrangements for the audit period, inform the entity and its employees at the end of the audit that the agreement is cancelled, and of the obligation to cease any deviating payments, decide what to do with any wages paid under the anomalous agreement and decide what agreement or arrangement shall apply to the parties instead of the anomalous agreement. See section 3.7.3(a) in this report on the review of wages excesses by the Supervisor of Wages and Work Agreements. 3.12.4 Woman’s Equal Right Law, 1951 Pursuant to the provisions of this Law, a public body and the tenders and appointments committees of a public body shall give suitable expression, in the circumstances, to the representation of women in the various positions and grades of their employees, in management, the board of directors and the council, providing that if for the purpose of exercising this provision preference must be given to a woman, such preference shall be given if the candidates of both sexes have similar qualifications.
The definition of “public body” includes Government companies, unless the Ministry of Justice determines, with the approval of the Knesset Committee for the Promotion of Women’s Status, on the matter of its employees, that the aforesaid duty of representation shall not apply. 3.12.5 Resolving disputes between the Company and the State
Resolving disputes in civil matters between a Government Company and another Government entity.
According to the guidelines from the Government’s legal advisor, it is proper to avoid as far as possible any court proceedings to resolve legal disputes on civil matters between a Government Company and the State or a corporation incorporated according to the law or another Government Company.
Therefore, a Government Company should make all efforts to resolve a legal dispute between that company and the State, a public corporation or another Government Company by any means other than filing a claim to the court.
A Government Company that fails to resolve the dispute in any other way and wishes to file a claim will notify the Manager of the Government Companies Authority in advance.
The Manager of the Government Companies Authority who receives such a notice will take steps to resolve the dispute by way of negotiations, mediation, providing a legal opinion by a third party, agreed upon between the parties (including the Government’s legal advisor or whoever is appointed by him), a committee agreed upon between the parties, or in any other way, according to the case at hand.
If the dispute is not settled by an agreed upon arrangement between the parties within a reasonable time and the Government Company still insists on filing a claim, the Manager of the Government Companies Authority will refer the dispute to the Government’s legal advisor or whoever is appointed by him.
If the Government’s legal advisor deems it necessary, he will act to settle the dispute in whatever manner he sees fit, according to the circumstances. If he is unable to do so within a reasonable time,
164 he will give an opinion to the parties (in a Government Company, even to the Board of Directors of that company) on the question of what the next steps should be.
If the circumstances require urgent recourse to the Court, in a claim or a request, to avoid missing a date determined by law, or prevent the situation from changing or prevent other grave damages, an effort will be made to extend the date of prevent the damages, as the case may be. If all these are not possible, the company may apply to the Court, as required under the circumstances of the case and then take the aforesaid steps to resolve the dispute.
Resolving Disputes on Civil Matters between the State and Public Corporations or Government Companies The guidelines of the legal advisor outline the recommended course of action, according to which it is proper to avoid as far as possible any court proceedings to resolve legal disputes on civil matters between the State and a public corporation incorporated according to the law or Government companies.
Therefore, no civil claim shall be filed by the State against a public corporations and against a Government company, or by a Government company, except after obtaining approval from one of the following: the legal advisor, the State attorney, the deputy State attorney or the head of the civil department in the State attorney’s office.
A request for the aforementioned approval will be addressed to the District Attorney, according to the location or to the head of the civil department in the State attorney’s office, who will discuss the matter with the legal advisor of the public corporation or with the Government Company and will act to resolve the dispute by way of negotiations, mediation, providing a legal opinion by the legal advisor of the Government or whoever is appointed by him, or in another way, according to the circumstances.
If the dispute is not settled within a reasonable time, the Government's legal advisor will decide on the next steps.
Resolving Disputes between Government Companies on Infrastructure Issues According to section 59b of the Government Companies Law, one or more committees will be established for the purpose of settling disputes between infrastructure companies in the following matters:
1) Coordination on infrastructure works.
2) Scope of infrastructure works.
3) Timetables for performing infrastructure works.
4) Payment required for performing infrastructure works.
5) Coordination on the subject of passage through areas held by an infrastructure company.
6) Another dispute that delays or may delay infrastructure works.
The Committee for resolving disputes will decide on the dispute at hand in the shortest possible time under the circumstances and no later than the end of forty five days from receiving the application.
165 The Committee is entitled to extend the said period in light of special reasons, which will be recorded.
The Committee for resolving disputes will decide on the dispute in a manner that is deems efficient, fair and just under the circumstances, with due consideration of the applicable law and the public benefit. The decision of the Committee shall be issued in writing and include arguments and reasons. 3.12.6 The State Comptroller and the Commissioner for Public Complaints
a. The State Comptroller The State Comptroller Law, 1958 (Combined Version) (hereinafter: “the State Comptroller Law”) makes every audited body (as defined in the Law) subject to an audit by the State Comptroller (hereinafter: “the Comptroller”) and stipulates provisions regarding the duties of the audited body to provide the Comptroller with documents and information. The State Comptroller Law grants the Comptroller powers to carry out an audit of a company’s activity, assets, finance, liabilities and administration, as specified in the Law. At the suggestion of the Government or the Comptroller, the Knesset Audit Committee may determine, from time to time, with respect to a particular entity or item in its budget, special methods of audit or restrictions. An audited body must submit to the Comptroller, on the date determined by him, a report of its income and expenses during its financial year, and any other information, report, document or action plan required by the Comptroller. The company’s auditor must each year submit to the State Comptroller a report pursuant to the State Comptroller’s Notice (Guidelines for a Corporation’s Outside Auditor), -1976. On completing the audit of the audited body, the Comptroller submits a report of his findings to the Knesset’s Committee of State Comptroller Matters, to the Prime Minister, the relevant minister and the auditing body. In the last three years, the Comptroller issued four audit reports on the Company. Details of the reports and the material findings indicated by the Comptroller are as follows: 1. State Comptroller's report No. 58 b, of May 2008 "Agreements for Purchasing Services by the Logistics and Assets Division", relates to the agreements control procedures of the Company. 2. State Comptroller's report No. 59a, of March 2009 "Agreements of the Israel Electric Corporation with a Building Management Company, relates to several aspects of the Company's agreement with CPM Building Management Ltd., (CPM), mainly engaged to manage the completion of the main offices building in Haifa, and supervision over its work. 3. State Comptroller's report No. 59b, of May 2009 "Preparations for Contending with Shortage of Electricity", related to the preparations made by the parties in charge of developing the electricity sector, to prevent shortage of electricity. 4. State Comptroller's report No. 60b, of February 2010 "Purchasing Consultation Services", relates to consultation services engaged by the Company for the units of the CEO. The Company is in the process of correcting the faults indicated by the Comptroller.
b. The Commissioner for Public Complaints
166 According to the State Comptroller Law, 1988 (Combined Version), the Commissioner for Public Complaints may investigate complaints against the company as an “audited entity”, on account of any action or omission or delay in action that directly affects the complainer himself, or directly deprives him of some benefit. The Commissioner’s findings of his investigations and his recommendations for correcting any defects are sent to the audited body. 3.12.7 Purchasing procedure, Tenders The Obligation for Tenders Law, 1992 (hereinafter: “Obligation for Tenders Law”) imposes on the State and every Government corporation, as defined in the Law, the obligation to hold a public tender giving everyone an equal chance to participate. Holding such a tender is a precondition for entering into any agreement concerning a deal involving goods, land, services or execution of any work, with the exceptions stated in the Law and the Obligation for Tenders Regulations, 1993, based on the Law.
As well as the general provisions of the Tenders Regulations, which apply to all entities to which the Obligation for Tenders Law applies, chapter E of the regulations deals with agreements by Government companies and Government subsidies, and imposes special additional duties on them.
Company purchases are made by means of public tenders, or by contacting a number of authorized suppliers (“closed tender”), or by negotiations with suppliers (exemption from tender). The Company prefers to make purchasing arrangements through public tenders even when the tenders regulations allow the Company to enter a purchasing agreement through other agreements, unless it is it is justified and reasonable in the circumstances to enter the agreement through another method.
According to the tenders regulations, when that it is justified and reasonable in the circumstances, the Company may enter agreements to purchase goods with special and unusual features in a closed tender by contacting suppliers who meet the requirements and the criteria defined by the Company, and are on the list of authorized suppliers (provided that there is a limited number of potentially suitable suppliers for the specific need).
The Company has a unit for authorizing suppliers that works to locate and authorize suppliers who can meet the Company’s requirements for various goods. The unit’s list of authorized suppliers is published by the Company in the Company's website, and suppliers who wish to be included in it can go through the proper process. .
The Tenders Regulations also define cases where it is possible to enter purchase agreements without holding a tender, (exemption from tender) after studying the possibility of entering the agreement through a bid process, insofar as it is justified and reasonable under the circumstances to enter the purchase agreement in this method. On the basis of the provisions of sections 3 and 4 of the Tenders Law, regulations 3, 5, 5a and 34 were drawn up. Regulation 34 deals with exemptions from the obligation of Government companies to hold a tender. For example, in cases where the value of the transaction is up to NIS 600,000, or in the case of agreements required urgently to prevent actual damage (where the purchase agreement is required within two work days or less), agreements that are a continuation of previous agreements, and agreements where a tender could affect the Company’s profitability, its ability to compete with others, its business opportunity, its ability to perform the functions imposed on by law, or its ability to provide a service or commodity that is essential to the public.
167 Regulation 10 of the Tenders Regulations regulates the work procedures of the tender committee: decisions are taken by majority vote, with reasons, and recorded in a signed protocol. The Company has two levels of tender committees, one level for divisional, district or inter-divisional committees, consisting of employees at techno-administrative grades. In certain cases, according to Company procedures, these committees refer their decisions to the second committee, the supreme tenders committee of the Board of Directors, which consists of members of the Board. The supreme tender committee is authorized to review and supervise the decisions of the divisional and District tender committees.
Since January 1, 1996 the Company has operated, in addition to the Tenders Law and its associated regulations, also in accordance with the provisions of the Government Purchases Agreement. Wherever there is a discrepancy between the Tenders Regulations and the Government Purchases Agreement, the Israeli legislature has determined that the Purchases Agreement takes precedence.
According to the Government Purchases Agreement, it will apply to tenders to purchase goods (excluding cables, electro-mechanical meters, transformers, fuses and switches, electrical motors) and certain types of services listed in the Agreement, for an amount greater than about $554,155 (about $13.27 million for building services). Such tenders, subject to the Government Purchases Agreement, must also be published in the press in English and there must be equal treatment for all bidders, including bidders offering goods made in Israel and those offering goods made in countries that have signed the Government Purchases Agreement.
With respect to purchases that are subject to the Government Purchases Agreement, there is no obligation to prefer Israeli made products as there is in the Preference of Israeli Produce Regulations. For these purchases it is obligatory to have an international tender with fully equal opportunities for suppliers of goods from all countries in the Agreement. It should be noted that the Preference of Israeli Produce Regulations continue to apply to international tenders that are subject to the Government Purchases Agreement with respect to bidders with goods made in countries that have not signed the Agreement, and in these cases the Company gives preference to Israeli made goods.
3.12.8 Permits for Toxic Substances A permit for toxic substances is a license required pursuant to the Dangerous Substances Law, 1993, for anyone using dangerous substances, which are defined in the Law. The Dangerous Substances Regulations (Classification and Exemption) 1996 specify an exemption based on the concentration and quantity of each substance. The permit for toxic substances is subject to conditions for proper handling of dangerous substances specified by the permit, aimed at protecting the public and the environment. The Dangerous Substances Regulations (Criteria) 2003 define the validity of the permit according to the type of occupation and quantity of dangerous substances required.
The Ministry of the Environment is currently promoting an amendment to the Hazardous Materials Regulations (Classification and Exemption) which indicates that coal ash may be regarded as a material that requires a permit for toxic substance. This classification may have considerable financial implications under the implementation of the conditions in the permits for toxic substances, if such a permit will be required for coal ash.
168 The Company engages in a variety of activities involving a wide range of dangerous substances. The main usage, and in large quantities, is in the generating segment, and during storage in the main warehouses at coastal power station sites.
All power station sites (fuel oil, coal and gas turbines) have site specific toxic permits that cover the use of toxic substances at those sites, and associated activities: storage, workshops, and laboratories. The permits at power stations are renewed each year, and for gas turbines the permits are renewed once every three years.
There is also a toxins permit for the transmission and transforming division which is renewed every three years, and a toxins permit for transporting dangerous substances for the national transportation sector, in the logistics and assets division, which is renewed every two years.
As of the date of this report, the Company performs all the actions required to comply with the conditions of the permits for toxic substances.
3.12.9 Preparations for dangerous substance incidents - factory files A factory file is a binding document required by the Regulations on Licensing of Dangerous Businesses, 1993. This document describes the preparations for preventing and handling incidents involving dangerous substances that could arise as a result of an operating fault, accident, terror attack, earthquake or another force majeure. The structure and contents of factory files are outlined in the legislation. These factory files are submitted on demand to the local licensing authority, fire fighting service, home front command, Ministry of Environmental Protection, and the Urban Association for Environmental Quality.
All power plant sites have factory files that are updated as necessary, particularly following the changes in production units and the changeover to work with natural gas. In the framework of licensing for operation with natural gas, the factory files are also checked and approved by the Natural Gas Authority in the Ministry of Infrastructures.
In all power stations and substations in the transmission and transformation division, the emergency team carries out drills on responses to dangerous substance incidents, including involving the relevant authorities, the Ministry of Environmental Protection, the Urban Association for Environmental Quality, the fire service, the police and the home front command. 3.12.10 Quality assurance and control Standards - all Company units meet the requirements of Israeli standard ISO9001:2000. The Company’s quality management policy states that the Company is a leading business entity whose purpose is to develop the electricity sector in Israel and to provide regular supply of high quality, competitive electricity, with the emphasis on preserving the environment, maintaining occupational health and safety and a high level of service. Some units in the Company implement an integrated management system according to the requirements of ISO 9001, ISO 14001 and/or OHSAS18001 standards and based on the principles underlying the aforesaid policy.
Some laboratories in the Company are certified by ISO/IEC 17025 standard, in addition to the aforementioned certifications.
169 Quality control - the Company’s organization, quality and safety division has a quality control sector, whose functions are as follows: to control the quality of products purchased by the Company, from the stage of preparing the quality requirements in the product specifications attached to the purchase order, until the product is received by the Company; to give professional advice to Company units on quality control, at their request; to participate in handling any faults found in products made for the Company; to participate in handling complaints from Company units concerning defects discovered while using products. 3.12.11 Planning and building All Company facilities are set up in accordance with building permits issued pursuant to the provisions of the Planning and Building Law, 1965, excluding the erection of electricity grid facilities, as defined in the Planning and Building Regulations (Regulating Transmission, Distribution and Supply of Electricity) 1998, which is done in accordance with permissions granted by virtue of the Planning and Building Law and the aforesaid Regulations.
If the Company discovers that any work requiring such permits was not done according to the law, it works with relevant authorities to obtain the legally required permits.
Pursuant to the instructions of the National Council for Planning and Building, outline plans are required in order to erect 400 kV lines. The outline plans and the procedures for approving them comply with the provisions of the Planning and Building Law. Recently the Ministry of the Interior has adopted the position that the erection of 161 kV lines also requires preparation of a detailed outline plan (this position is expressed in an internal directive of the Ministry and in combining the said requirement in the different local and District outline plans). The Company opposes this position for the reason that it is not compatible with the provisions of the applicable law. This issue was discussed with the Deputy Legal Advisor to the Government, who accepted the Company’s position and stated that the authorization procedure stipulated in the law is suitable for approval of 161 kV lines subject to “improvement of the authorization procedure”. In the opinion of the Ministry of the Interior, the conclusion of the Deputy Legal Advisor of the Government is phrased in a manner that allows the planning committees to exercise their discretion on including instructions in the outline plan stipulating that the erection of 161 kV lines will be entered in the plan. Therefore, the Ministry of the Interior holds to its policy, stating that 161 kV lines will only be approved according to a detailed outline plan. Consequently, the Company filed a petition to the Supreme Court, sitting as High Court of Justice to declare the aforementioned internal directive of the Planning Administration and amendment to the outline plan of the Southern District null and void. The petition is pending.
In a preliminary reply to the petition, the state claims that the court has no reason to intervene, since there is no fault in combining a directive that requires an outline plan as an obligatory requirement for outline plans and also since in all matters related to the directive of the planning administration, this is an early petition. In the hearing for the petition on October 1, 2009, the court suggested that the parties should attempt to reach a compromise on the suitable planning outline for erecting 161 kW lines. The parties are holding talks in an attempt to reach such a compromise.
The owner of rights to land may submit a claim for compensation for a drop in the value of such land as a result of approving the plan, against the local committee to whose jurisdiction an outline plan applies. The Company has undertaken to indemnify the local committees within whose jurisdiction
170 these plans apply, with respect to certain plans, for the full amounts that the committees may be obliged to pay to the owners of land who are affected, all subject and according to the stated in the version of the indemnification letters (apart from one plan in which the burden of compensation will be divided between the institutions involved in the plan). In appeals submitted to related appeals committees against the local committees, on the subject of decreased value. According to the instructions of the indemnification letters, the Company was added to the appeals as a party that may be affected by receipt thereof (See also Note 24 b 8 to the Financial Statements as of December 31, 2010). The indemnification letters do not specify sums. The letters require indemnification of 100% of the value of the claim (appeal) filed against the local committee. The total sum of the claims is detailed in the Financial Statements and is updated from time to time.
The Company learned recently that the Ministry of the Interior, through a chosen planning team, promotes a national planning scheme No. TMA 40 dealing in utilizing the subterranean space, including a comprehensive instruction requiring electricity infrastructures to be installed underground. However, the planning institute will have the discretion to state that a specific infrastructure may be installed above ground. The Company submitted its initial position on the subject to the Ministry of the Interior and requested that the sub-committee of the national council on planning in principle will not hold discussions on the policy document until the Company will submit a professional document that analyzes the significance of installing electricity facilities underground. Accordingly, the Company is conducting headquarters work that will be completed in two weeks time, which examines the possible implications of the plan in principle, including economic, security and technical/ statutory implications.
3.12.12 Business licensing a. The Company acts to arrange business licenses for items requiring such licenses at its facilities, pursuant to the Business Licensing Law, 1968, and by virtue of an internal Company procedure on this matter, activity that involves making changes and adjustments to meet the requirements of competent bodies under any law. On the report date, the majority of the generation units in the generation segment hold business license that are extended or renewed from tine to time.
b. Business licenses have already been obtained for the majority of power stations and also for some of the items in logistical and administrative facilities. Regarding other items, a special team from the Company is occupied at the date of this report, in locating the remaining items that require licensing and submitting applications for the licenses. The Company recently received a draft of framework conditions for issuing a business license to power stations – gas turbines, written by the Ministry of Environmental Protection. The Company estimates that the current version of the draft (currently under discussion between the Company and the Ministry of Environmental Protection) may have material economic and other implications for the operation of several of the main Company sites/ facilities.
For environmental conditions in business licenses, see section 2.1.13 of this report.
On the obligation to prepare factory files pursuant to the Licensing Regulations for Dangerous Businesses, 1993, see section 3.12.9 above.
171 3.13 Trade Restrictions Regulations On January 5, 1999 the Commissioner for Trade Restrictions (“the Commissioner”) announced, by virtue of his authority pursuant to the Trade Restrictions Law, 1988 (“the Trade Restrictions Law”), that the Company has a monopoly in the area of supplying (generating and selling), transmitting and distributing electricity, and providing backup services to electricity consumers and producers. The announcement of the Commissioner is only declarative. This announcement in itself does not change the status of the Company as a monopoly holder.
3.13.1 The statutory tools stipulated in the Trade Restrictions Law grant the Commissioner, inter alia, the right to demand that the uniform contracts be submitted for his approval, and the right to intervene in any Company activities that could affect the public or competition, including referral to the Trade Restrictions Court (“the Court”) with a petition to split a monopoly into two or more separate business corporations.
3.13.2 On May 4, 1999 the Company submitted an appeal against this decision of the Commissioner in the announcement to the Court, following which, on March 19, 2001, the Company reached an agreement with the Commissioner, which was given the validity of a ruling, as follows:
a. The Company has a monopoly in the electricity sector, including the following components: supply - the generation and sale of electricity, transmission and distribution of electricity, provision of backup services to electricity consumers and producers.
b. The provisions of chapter D of the Trade Restrictions Law (on the subject of a monopoly) apply to the Company as a monopoly, both in the electricity sector in general and in each of its segments, as detailed in paragraph (a) above.
3.13.3 Up to the date of signing this report, the declaration that the Company is a monopoly had no material effect on its activity, profitability or financial situation. In view of the existing level of supervision of the Company, by the Electricity Authority and other authorities, and in view of the structural changes required by the provisions of the Electricity Sector Law, including the incorporation of generating units into separate subsidiaries (see section 1.7.1, 2a of this report), the Company cannot estimate the future implications of this declaration on its activity, profitability or financial situation, although it is possible that it will have significant implications.
The information on the implications of declaring the Company as a monopoly is forward looking in nature, as defined in the Securities Law. The said information is based past experience and current information and data available to the Company at the date of this report. on future data of an uncertain realization nature, which are not under the sole control of the Company and depend on decisions of the Government/ Ministers/ regulatory amendments. Nevertheless, the said declaration may be affected by external factors outside the Company's control, including materialization of any of the risk factors detailed in section 3.17 in this report.
3.13.4 In addition to the foregoing, the Company is subject to all the provisions of the Trade Restrictions Law, including on the subject of binding arrangements and mergers. It should be noted, that as a monopoly, a merger of the Company with any other company is subject to the provisions of the Trade Restrictions Law on the matter of mergers.
The Company implements an internal enforcement plan on trade restrictions.
172 3.13.5 The implications of the declaration of the Company as a monopoly on the purchase of electricity from private producers a. On August 5, 1997, the Company, on the instructions of the Ministry of National Infrastructures, published a tender to set up a private power station at Ramat Hovav with an available capacity of 370 MW. The terms of the tender include a stipulation that the winner shall undertake to sell to the Electric Corporation, exclusively, all the electricity generated at the power station for a period of twenty years.
Following a request from the Commissioner, arguing suspicion of a binding arrangement, the tender contained a provision that it would be cancelled if the Court failed to approve the aforesaid arrangement.
b. The Company asked the Commissioner for exemption for this binding arrangement. The Commissioner refused and would only agree to an exemption for the binding arrangement for a limited period until 2006. As a result, the Company petitioned the Court for approval of this binding arrangement.
c. Before the Court gave its verdict, and when the Company was declared a monopoly, the Commissioner informed the Company that he was considering issuing instructions to the Company, by virtue of his authority under the Trade Restrictions Law, regarding the conditions for holding the aforesaid tender.
d. On March 22, 1999, the Court gave a verdict in which it did not approve the binding arrangement stipulated in the tender, stating that this arrangement was damaging to competition and not compatible with the intention of the legislature in the Electricity Sector Law.
e. As for the Commissioner’s request that the Court instruct the Company to continue with the tender after removing the items on exclusivity for selling electricity to the Company, the Court expressed an opinion that it was doubtful this could be done, whether according to the laws of tenders, or in the absence of the Company’s consent so long as the Minister of National Infrastructures had not defined rules for deals concerning the purchase of electricity from private produces pursuant to section 20(b) of the Electricity Sector Law.
f. On September 10, 2000, the Minister of National Infrastructures published such rules (Rules for the Electricity Sector (Deals with an Essential Service Provider), 2000). Section 9 of these rules stipulates commencement of the rules on September 11, 2000 and they would also apply to deals where proceedings began before that date and were not yet completed.
g. As a result, the Company reached an agreement with the Trades Restrictions Authority regarding private electricity producers with whom the Company has agreements (see section 2.1.4 of this report), as follows:
1. The Company would inform the existing private electricity producers that the exclusivity agreements between these private producers and the Company were immediately terminated. 2. The private electricity producers could stop selling all or some of the electricity generated by them to the Company, with prior notice.
173 3. New agreements signed between the Company and private electricity producers and subject to the Rules for the Electricity Sector (Transactions with an Essential Service Provider), 2000, would not include exclusivity conditions. h. Following the Court’s ruling based on the rules published by the Minister, changes were made to the draft agreement with the private producer at Ramat Hovav in line with the aforesaid rules. See also section 2.1.4.2 f in this report.
Regarding the data demanded from the Company by the Trades Restrictions Authority on the Business Development Unit, see section 3.1 in this report.
3.14 Material agreements
The agreements described below are material agreements outside the normal course of Company business, and which are not described elsewhere in this report.
The desalination facility at the Orot Rabin site On September 7, 2004, the State and the Company signed an agreement that the Company would grant the State or an entrepreneur chosen by it (H2ID) the right to use land of about 71 denims within the grounds of the Hadera power station, to set up a sea water desalination plant. The right to use the land would start on a date determined by the Government (“the determining date”) and would be given for a period of 24 years and 11 months. On December 10, 2007 the State announced that this was the “determining date”.
In return for granting this right of use, the Company received a one time payment of approximately NIS 7.5 million to cover the costs of removing structures on the land to be handed over to the concession holder and moving them elsewhere on the power station grounds and also, a one time only amount of approximately NIS 762,000 for coordination, planning and supervision actions, starting from 30 days after the determining date (namely, starting on January 9, 2008). The Company receives NIS 1,200,000 each year in December 2009 prices (linked to the Consumer Price Index). In return for services provided by the Company to the operator, from the start of production of desalinated water at the plant, the Company would be entitled to a payment of 0.24 cents for each cubic meter of desalinated water sold by the operator to the State (the facility was intended to supply some 127 million cubic meters of water each year).
The facility commenced operation at the end of 2009.
174 3.15 Legal proceedings Several class actions and other significant claims have been filed against the Company. For details see Note 24 b to the Financial Statements as of December 31, 2010.
3.16 Strategy and objectives
3.16.1 Vision The Company strives to continue being the leading commercial Company in Israel in the electricity generation and supply sector and adapt itself to changing market conditions and to economic, social and technological changes in Israel and world wide, while adjusting the equipment procurement and actions of the Company to these changes and at the same time develop other business fields and penetrate new and international markets.
To achieve that,
The Company will develop and provide products and services that supply the needs of our customers, with respect, fairness, reliability and transparency in dealing with customers, employees, suppliers and shareholders;
The Company will provide optimal service, while ensuring availability, quality and safety;
The Company will strive for excellence, innovation and maximum managerial and technological efficiency;
The Company will acknowledge its employees as its main asset and support their promotion, striving to arouse feelings of pride and belonging and encourage their commitment and creativity.
The Company will do all that while upholding the law and the principles of correct management, striving for durable development and social and environmental responsibility.
3.16.2 Main Values The Company is customer oriented. Its employees are the most important asset. The Company acts through a business perspective, emphasizing quality and reliability of all its actions, with high awareness of the community and the environment.
3.16.3 Main objectives 1. Supply electricity at a good availability and reliability level
2. Attain higher service quality while adhering to the covenant between the Company and its customers, improve supply reliability, meet timetables, provide training and professional advice to customers and respond to public needs with the required flexibility.
3. Attain financial strength, adequate profitability and maintain a stable cash flow.
4. Expand business initiation actions, develop new markets and fields of activity in Israel and abroad and utilize existing platforms to increase the revenues of the Company.
5. Foster the human resource while enhancing the professional expertise of Company employees through raising their academic level, constant training and motivation. Enable employees
175 participation and encourage innovation and excellence. Cultivate and empower managers' positions.
6. Act responsibly on national and community issues, including preservation of the environment, contribution to community project, enhancement of public safety, support and encourage the local industry, realize technological progress and participate in outlining the energy policy in Israel and in the Middle East.
3.16.4 Means of achieving these objectives
3.16.4.1 Development a) Increase the generation capacity of the Company, subject to implementing criteria for optimal reliability so as to maintain balance between the cost of unsupplied energy and the cost of adding means of production.
b) Optimal integration of production means using natural gas to decrease the use of expensive fuels and reduce pollutants emission to the environment.
c) Planning and developing transmission and transformation systems at standards that ensure the transmission of generated energy to consumption centers at the required level of reliability and quality, and maintaining system survivability.
d) Developing the distribution system in response to the increased number of consumers, increased demand of existing consumers and attain the required reliability and quality of electricity while minimizing costs.
e) Plan and implement emission reduction projects in power stations and implement other investments in environmental protection.
f) Develop other fields of activity.
3.16.4.2 Operation a) Integrating a policy of environmental operation and development.
b) Optimal operation of means of production, while maintaining economic logic in allocating resources and ensuring a good level of availability and reliability.
c) Implementing a policy of optimal operation and maintenance, to ensure availability during peak demand, and renovations at the lowest possible cost, based on economic advisability considerations.
d) Using the optimal mix of fuels to operate the generation system.
3.16.4.3 Customers a) Developing new products and services for customers.
b) Providing service with reference to the needs of different market segments, with an emphasis on strategic customers.
c) Fostering links with Company customers as part of management policy.
d) Strengthening the Company’s links with the community through initiated activities, cooperation with educational, environmental bodies, etc.
176 3.16.4.4 Resource management
a) Maintaining, optimizing and fostering the human resource by developing tracks for advancement and professional and managerial training.
b) Pursuing a policy of intelligent purchases of fuels, as required by operations, with attention to fuel quality and cost, environmental issues, reliability of electricity supply and varying the sources of fuel.
c) Finding a comprehensive system solution to the rate structure, including improving the interface with the Electricity Authority.
d) Responsible financial management that facilitates attainment of adequate profitability, maintains a stable cash flow, raises private capital for funding development plans and upgrades the Company’s rating.
3.16.4.5 Reach agreement, initiate and implement all the required changes, including restructuring of the electricity sector, organizational changes and increased efficiency in the Company.
3.17 Financial Information related to geographical regions
The Company does not report according to geographical regions.
3.18 Discussion of risk factors The Company estimates that it is exposed to several primary risk factors, arising from the economic situation and the unique characteristics of the Company, specified below (the risk factors described below do not include risks in the Company’s main area of activity, such as the risk of a large-scale technical problem, or the effects of future technological changes, or the general risks applying to any large corporation, such as earthquakes, storms etc.).
177 The following table presents the risk factors of the Company, scaled according to estimates of the Company on the extent of the effect of this risk factor on Company activity: Effect Large Moderate Low Risk Group Risk Category Significant effect on Moderate effect on Minor effect on Company Objectives Company objectives Company objectives Setting the electricity rate X a. Compliance and Compliance with State laws X regulation Changing Regulation and New X Laws Security events X Geopolitical situation and X external political risks Risks to Reputation X Competition X b. Strategic Risks Natural disasters (earthquake/flooding) X Fires X Natural gas supply X Planning and implementing the X development plan Structural change X Legal X Credit risks X Liquidity Risks X Market Risks X c. Financial Risks Capital raising X Liabilities with respect to pension fund X Accounting and financial X statements Environment X Health and Safety X Human capital X Human errors X Labor relations X Technical failures X d. Operational Embezzlement and fraud X Risks Information Technology X Forecasts X Suppliers X Projects risks X Information security X Maintenance planning and X reserve management
See section 6 f to the Board of Directors Report as of December 31, 2010, for more information on risk factors of the Company.
Amos Lasker Dr. Ziv Reich Yiftah Ron-Tal Chief Executive Officer Chairman of the Committee for Chairman of the Board of Directors Reviewing the Financial Statements Report approved on: March 31, 2011
178
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The Israel Electric Corporation Ltd.
Chapter B
Board of Directors' Report on the Status of the Corporation's Affairs
For the Year Ended December 31, 2010
Prominent Disclaimer
This English translation of the "Company's Board of Directors' Report on the Status of the Corporation's Affairs" for the year ended December 31, 2010 ("English Translation") is provided for informational purposes only.
In the event of any conflict or inconsistency between the terms of this English Translation and the original version prepared in Hebrew, the Hebrew version shall prevail and holders of the Notes should refer to the Hebrew version for any and all financial or other information relating to the Company.
The Company and its Directors make no representations as to the accuracy and reliability of the financial information in this English Translation, save that the Company and its Directors represent that reasonable care has been taken to correctly translate and reproduce such information, yet notwithstanding the above, the translation of any technical terms are, in the absence of generally agreed equivalent terms in English, approximations to convey the general sense intended in the Hebrew version.
The Company reserves the right to effect such amendments to this English Translation as may be necessary to remove such conflict or inconsistency.
THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
The Board of Directors of the Israel Electric Corporation ("The Company") hereby presents the Directors’ Report on the status of the corporation's affairs for the period ending December 31, 2010, according to the provisions of circulars of the Government Companies Authority and the Securities Regulations (Periodic and Immediate Statements) - 1970. Explanations of the Board of Directors on different issues are presented hereunder.
1. Business Position of the Corporation A. Brief Description of the Company and its Business Environment. The Company acts as one combined and coordinated system that deals in supplying electricity to consumers, starting from the electricity generation stage through transmission, distribution and supply of and commerce in electricity. The Company also deals in the construction of the infrastructure required for these activities. Company operations include three main fields: Generation, transmission and transformation of electricity and its distribution. The Company provides electricity to most of the State’s consumers of electricity, and customer distribution is such that it is not dependent on any of them. The Company is owned by the State of Israel which holds about 99.85% of its share capital, therefore the Company and its operation are subject to the directives of the Government Companies Law – 1975 (“the Government Companies Law”). As of March 5, 1996, the Company has operated according to the Electricity Sector Law – 1996 (“the Electricity Sector Law”) and its regulations. The Electricity Sector Law replaced the Electricity Concessions Order and the Public Utilities Authority - Electricity ("The Electricity Authority") was founded according to this ordinance. The duties of the Electricity Authority are, among others, to set rates and define rate update processes, to award licenses and to supervise fulfillment of instructions specified in the licenses. For additional details on the Electricity Sector Law, see Note 1b to the Financial Statements. The Consolidated Financial Statements of the Company ("the Financial Statements") fulfill the directives of the Government Companies Regulations (Rules for Preparing Financial Statements of the Israel Electric Corporation Ltd.) (Temporary Order) – 2004 and their amendments ("Government Companies Regulations") and the directives of the Securities Regulations (Preparing Annual Financial Statements) – 2010. On December 29, 2010, the Minister of Finance and the Minister of National Infrastructures issued an order to extend the licenses of the Company, for one year, up to January 1, 2012. This date is the last date on which the Ministers can decide whether a Government company that holds a controlling stake in a generation or a distribution license holder can also hold a controlling stake in a distribution license holder. See information on generation licenses for other generation works in Note 1 b to the Financial Statements in Chapter C of this report.
3 3 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
1. Business Position of the Corporation (continued) B. Assessment of the Financial Impact of the Difference between Financial Reporting Principles as Applied in the Financial Statements of the Company and the Financial Reporting Standards as Applied in IFRS
Under the Government Companies Regulations the Company is required to assess and present the estimated impact of the implementation of the financial reporting rules in its Financial Statements as compared with International Financial Reporting Standards as follows:
December 31, December 31, December 2010 2009 31, 2008 NIS in millions Impact on shareholders’ equity – prepared under the Regulations Decrease in impact due to implementation of the standard for Regulated Companies (4,300) (3,800) (3,000) Increase in impact of the IFRS 5,900 4,600 1,400
Total increase (decrease) in shareholders’ 1,600 800 (1,600) equity
Impact on net income – prepared under the Regulations Increase (decrease) in impact due to implementation of the standard for Regulated 340 1,800 (400) Companies Increase in impact of the IFRS 920 1,900 1,500 Total increase in net income 1,360 3,700 1,100
It will be noted that the quantitative data presented above represent an assessment and estimate only, and it should be emphasized that any reference to this data should be made with particular caution, since the Company maintains its reporting systems according to the Government Companies Regulations.
4 4 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
1. Business Position of the Corporation (continued) C. Electricity Rate Mechanism
1) The Electricity Sector Law states that the Company’s rates shall be set from time to time by the Electricity Authority based on the cost principle. On February 1, 2010, the Electricity Authority published a decision on updating the new rate base for the generation segment for the years 2010-2014, and on updating the rate structure book relating to the demand classification groups and the consumption distribution and the compensation formula for the delay in rates update, to be applied to all electricity chain segments. This decision and rates deriving from it came into force on February 15, 2010. Under this decision, the Electricity Authority updated the rate base for the generation segment for the years 2010 – 2014, updating rate components, including capital costs, operating costs, fuel mixture and more. The update does not include any reference to the pension costs of Company's employees. The recognized costs were determined after the Electricity Authority conducted a costs control of Company costs, as recorded in its records over the years. This change in the rate has material effects on the Company, mainly due to non-recognition of the full costs of the Company (see Note 3a3(a) and due to cost reductions ("fines") with respect to failure to meet normative operation dates (see Note 3a3(b) in Chapter C of this report). The Company took and is taking active steps on several planes to change the aforementioned decision of the Electricity Authority. The Company reviews periodically the effect of the new rate base on its Financial Statements, estimated exposure and estimated provisions and updates them accordingly. For details of the main principles of the new rate base for the generation segment, update of some of the components of the transmission and distribution segments and their effect on the Financial Statements of the Company see Note 3 a to the Financial Statements in Chapter C of this report. On October 4, 2010, the Electricity Authority published its decision on updating three components of the Electricity rate: the recognized fuels mix for 2010, recognized financing costs and additional costs of installation of lines underground for the distribution segment (see Note 1f3(b) to the Financial Statements in Chapter C of this report). These decisions came into force on the annual update date for 2010, namely, March 22, 2011. On November 1, 2010, the Electricity Authority published a group of additional decisions that came into force on the said annual update for 2010. The decisions include amendments to the decision of the Electricity Authority of February 15, 2010 on the new rate base for the generation segment (mainly an addition of NIS 260 million to NIS 293 million, in November 2010 prices, to the assets recognized for recognition of capital costs for the years 2010 - 2014, compared to assets recognized in the decision of February 2010, decrease in the Company's debt to consumers with respect to the hedging mechanism of NIS 294 million, in November 2010 prices, amended energy loss factors in the grid and distribution of electricity consumption according to rate groups) and other decisions, including several items which are part of the annual update of the rate base. The rate recognizes purchases of electricity from private producers, pollution prevention premiums to producers of renewable energy, purchases of electricity from producers of photovoltaic electricity, rolling blackout arrangements through operation of own generators, frequency shedding agreements, voluntary shedding agreements by means of rolling peak and social rate. 2) The Company and the Electricity Authority have disagreements concerning a series of material issues involving highly significant sums. The Electricity Authority’s lack of recognition of costs incurred by the Company in the rate of these issues caused and will continue to cause a significant decrease in the Company's revenues and to the lack of recognition of some of its assets, which leads to losses and to substantial erosion in shareholders’ equity. On December 8, 2010, the Company submitted to the Electricity Authority an updated list of issues that were broached in the past and did not yet receive the adequate response in the form of a decision of the plenum of the Electricity Authority, which is the authorized entity to provide answers. 5 5 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
1. Business Position of the Corporation (continued) C. Electricity Rate Mechanism (continued) 3) Decisions of the Electricity Authority Disputed by the Company: Estimate and volume of the sums are before the effect of the restatement. This restatement has no material effect on the estimated financial amounts Subject Electricity Authority’s Decision Company’s Position Estimated Financial Volume The New Rate On February 1, 2010, the Electricity The Company disputes many decisions See Note 3 a 3 to the Base for the Authority published a decision on updating made in the rates base, which were Financial Statements Generation the new rate base for the generation used to determine the recognized rate in Chapter C of this Segment segment for the years 2010-2014, the of increase during the test years. The report. decision of the Authority and the rates book Company claims that the determined published accordingly present the manner of rate will cause a highly significant loss determining the recognized costs of the of income to the Company. The main Company (fuels, capital, operations, etc.) issues that affect the Company include, for the generation segment in the test years. significant non-recognition of construction costs of fixed assets, defining fines in considerable amounts to be applied to the Company should it fail to meet normative timetables determined by the Authority for commencing operation of the generation units, use of an erroneous sales forecast to calculate the recognized cost per one kW/h, setting lower rates of return on foreign currency than those incurred by the Company to actually raise debt, failure to recognize the full operation costs the Company is expected to incur and setting an ineffective incentive mechanism for using natural gas. Amortization The Authority has placed amortization Unreasonable efficiency coefficients, NIS 14,000 million Coefficients coefficients starting April 2004 at the applied to the Company for many for the years 1996- following cumulative annual rates: 2.1% for years, significantly affect its revenues. 2010. generation, 1.3% for transmission, 2.5% in Throughout the years, the Electricity (In December 2010 high voltage distribution and 3.7% for low Authority did not present any prices). voltage distribution. A decision was made explanation or justification to the not to award retroactive compensation for amortization coefficient it defined. previous years in which amortization The decrease applied by the Authority coefficients were not reduced. in April 2004 was too little and too late. The position of the Company, backed up by and based on consultants studies, is that a 2% amortization coefficient should be applied to the operational component only and also to receive retroactive compensation for previous years, for which the amortization coefficients were not reduced. Fuels basket - Uses forced unavailability values and The Company believes that NIS 2,800 million forced maintenance days lower than those accepted unavailability values and maintenance for the years 2003- unavailability worldwide, and in some cases even lower days for the calculation of fuel mixtures 2007 values than the actual performance of the must be based upon long term (in current prices) Company to calculate fuel baskets normative parameters, which will allow recognized in the electricity rate of the the Company to enjoy the fruits of Company. efficiency in operating the system
6 6 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
1. Business Position of the Corporation (continued) C. Electricity Rate Mechanism (continued) 3) Decisions of the Electricity Authority Disputed by the Company (continued)
Subject Electricity Authority’s Decision Company’s Position Estimated Financial Volume Fuels basket - The Authority set an incentive path for the The Company believes that it has Total saving for the Gas Incentive Company in June 2002 for the years 2003 - achieved significant savings thanks to economy for the rate of fuel 2006 only. The authority did not allow any its efforts on the natural gas subject and years 2004 – 2009 is costs savings gas incentive to the Company in the years therefore requested to receive a approximately NIS retained by the 2007 - 2009. permanent 20% incentive out of the 23,500 million of Company as a (In the new rate base for the generation total savings realized by use of natural which NIS 1,080 result of the use segment, published in February 2010, gas gas, continuing throughout the life span million were granted of natural gas incentive will be granted to new gas of the units operated with natural gas. to the Company as transactions for the years 2009 to 2012. The In addition, the Company requested to an incentive. formulas as set by the Electricity Authority, receive an incentive for 2007 and 2008 (in current prices) do not grant any incentive to the Company with respect to current gas agreements. for 2009.) Fuels Basket The Authority refused to recalculate the The Company claims that a significant NIS 690 million in Mix for the recognized fuels basket for this year. (The change occurred between the original 2007 year of 2007 Authority stated in the new rate base that 2007 demand prediction and the actual (in current prices) the fuels basket will be retroactively demand, and as a result the Company’s updated each year according to the actual fuel mixture changed materially (use of demand curve). The Authority does not expensive fuels - diesel and crude). The intend to apply the mechanism it Company has requested a recalculation determined for the new rate base for the fuel of the recognized fuel basket by the basket in 2007 as well. Authority, since the Company incurred a loss of income. Fuels Basket - In the annual update for 2007, the Authority Gezer Combined Cycle A station NIS 1.2 billion for postponement stated, as part of the basic assumptions for started operating with gas in July 2008. the years 2007 and in converting the 2007 fuel mixture calculation, that the The Company requests compensation 2008 power stations Gezer A station will begin operating with for operating the station with crude (a (in current prices) to natural gas natural gas in mid October 2007. more expensive fuel) during the period and using more In its decision from March 2009 on the October 2007 to July 2008. expensive fuel recognized fuels basket for 2008 (in the Gezer annual update for 2008), the Electricity Combined Authority used this assumption again. Cycle A Fuels basket - The fuels mix, recognized for the 2005 fuel In 2005, the power station was actually NIS 280 million for postponed basket, was calculated assuming that the powered by crude only, which is a 2005 conversion of Reading Station will be powered by natural more expensive fuel, due to reasons (in current prices) power stations gas and in May 2005. beyond the Company’s control. In to natural gas practice, the station started operation and use of with natural gas in the second half of more expensive 2006. Consequently the Company fuel - Reading incurred additional costs that were not Power Station covered by the electricity rate, for which the Company requests to receive rate coverage.
7 7 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
1. Business Position of the Corporation (continued) C. Electricity Rate Mechanism (continued) 3) Decisions of the Electricity Authority Disputed by the Company (continued)
Subject Electricity Authority’s Decision Company’s Position Estimated Financial Volume
Fuels Basket - The Authority denied the application of the The station was closed from March to NIS 170 million for Reading Power Company to recognize the loss of income June 2006 by an order of the Ministry 2006 Station - caused to the Company as a result of of the Environment. From the closing (in current prices) Closed by order implementing the order to close the station date, the Company was forced to of the Ministry from March to June 2006. produce electricity at alternate stations of Environment using a more expensive fuel mixture, using among others, diesel operated power stations, to avoid any disruption in power supply to consumers. Consequently, the Company incurred loss of income. The Company requests to receive rate coverage for this loss of income. Loss From In the rate base published in 2002, the For reasons beyond the Company's NIS 1,300 million Collection of Authority set income which the Company is control, resulting mainly from changes for the years 2000- the Average entitled to collect from the public for the in electricity consumption habits of the 2009. Rate purpose of covering its expenses. public, influenced by the indication of Despite requests of the Company, the the current rates, the Company failed to (in current prices) Authority has not corrected the makeup of collect the full income as defined by the rate. the Authority and therefore, did not cover its expenses. The Company appealed to the Authority to amend the rate structure, while compensating for years in which the Company did not collect the full recognized income. Exogenous In 1998, the Electricity Authority set a As required in the decision of the NIS 1,005 million Expenses mechanism for annual recognition of Electricity Authority of 1998, the for the years 2002- exogenous expenses in the electricity rate. Company submitted annual reports of 2008 (in September In 2005, the Electricity Authority published these expenses for 2000-2004. The 2010 prices) a decision that canceled the mechanism Company did not receive rate coverage established for recognition of these for these expenses, nor for exogenous expenses. expenses in the following years. The In April 2007, the Electricity Authority Company persists in its request to forwarded the position of its professional receive rate coverage for past and experts team that includes a new present exogenous expenses. The mechanism for recognizing future Company submitted in April 2006 a exogenous expenses. proposal to the Electricity Authority for an alternative recognition mechanism for significant exogenous expenses it will incur in future.
8 8 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
1. Business Position of the Corporation (continued) C. Electricity Rate Mechanism (continued) 3) Decisions of the Electricity Authority Disputed by the Company (continued)
Subject Electricity Authority’s Decision Company’s Position Estimated Financial Volume Financing In 2002, the Authority recognized costs The Company raised (and is expected NIS 550 million for Costs related to funds raising costs in Israel in the to raise in future) foreign capital at the years 2002-2009. electricity rates cost related to funds raising volumes amounting to billions NIS costs in Israel, based on State bonds for 10 each year, mainly for financing the (in current prices) years with an added margin of 0.73% and development plans of the Electricity on fund raising costs abroad, based on U.S. Sector, to which it is committed. Fund Government bonds for 10 years with an raising costs in Israel and abroad, were added margin of 2.4%. (This mechanism higher in recent years (and actually was valid up to the decision of the throughout the test period) than costs Electricity Authority in February 2010 on recognized by the Authority (margin of the rate base of the generation segment). the last funds raising in Israel was 4.35% and 6.84% abroad), causing loss of income to the Company. The Company requests recognition of all financing costs it actually incurred with respect to funds raised during the test period. Electric The Authority rejected the Company’s The Company receives rate recognition NIS 210 million for Consumption claim that power consumption at the in the electricity consumption of the years 2002-2009 in Company Company’s facilities was not included in Company facilities used for its routine (in current prices) Facilities the recognized income of the Company. operation. The Authority claimed that power As shown by audits of the previous rate consumption cost at Company's facilities is base for the generation segment, part of the Company's recognized operating conducted by the Company, the costs and the Company should budget these electricity consumed by Company cost under the total sum of its recognized facilities is excluded from the operational costs. recognized income of the Company, since the required income was divided by the total electricity consumption of the Israeli market that includes the electricity consumption of Company facilities. Alon Tavor The rate update for 2008, implemented in The Company disputes the decision of NIS 50 million CCGT March 2009, set the operation commencing the Electricity Authority, since the (in current prices) date of Alon Tavor CCGT with diesel as delay was caused by events on which September 2008. The Electricity Authority the Company had no control. did not recognize the delay in completing Therefore, the Electricity Authority had the steam addition, caused by employee to recognize the actual operation sanctions. commencing date of the CCGT, namely, December 2008.
9 9 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
1. Business Position of the Corporation (continued) C. Electricity Rate Mechanism (continued) 3) Decisions of the Electricity Authority Disputed by the Company (continued)
In addition, the Electricity Authority did not reach a decision on several material subjects (see details below) that caused a significant damage to the Company's income over the years. Subject Electricity Authority’s Position Company’s Position Estimated Financial Volume Expenses Due The Electricity Authority did not yet reach a Following significant changes in NIS 2.93 billion as to Pension decision on the subject. calculation rules of actuarial liabilities of December 31, Liabilities The Electricity Authority established an beginning from 2003, as determined by 2007. external committee in 2004 to discuss this the Commissioner of the Capital (in current prices) issue. This committee suspended its Market, Insurance and Savings See also Note 3 c to operations at a certain stage. In the Division of the Ministry of Finance, the the Financial document for the hearing on the new rate Company was obliged to record high Statements in base for the generation segment, it indicated expense amounts in its statements of Chapter C of this that its work to review pension costs of operations that did not have rate report. Company employees was not completed as coverage since these were not included yet and that it intends to complete the in the rate base. Then, upon adopting review during the approaching period and the principles of the International submit it to a public hearing so that pension Accounting Standard 19 (IAS 19), costs will be reflected in the final decision considerable amounts were charged as on the new rates bases of the generation actuarial losses which were not yet segment. amortized and which are not In its decision on the new rate base for the recognized in the electricity rate as generation segments, the Electricity well. The Company believes that rate Authority noted that after the publication of coverage should be granted to the full this decision, it intends to publish for a debt, arising from spreading the public hearing on principles and general actuarial changes according to IAS 19. guidelines for recognizing pension costs of See Note 35 to the Financial Statements generation A, B and C employees starting in for more information. June 1996 and issue its final decision in 2010. The Electricity Authority did not yet reach a decision on the subject. Delays in In its December 2005 decision the The Company believes that NIS 1,620 million updating rate Authority noted that it first intends to set a determining the order of the rates is for each of the years bases for the new rate for the generation system, important. Actually determining the 2006 - 2008. different followed by the distribution system and rate first for the generation segment (In September 2010 segments and only at the end for the transmission system. which is the most profitable and lastly prices) changes in the On July 30, 2008, the Authority published a for the transmission segment that loses order of setting decision on the new rate base for the the most is incorrect as it is necessary them generation segment only (in February to begin with segments with an 2010), but not yet for the other segments. accumulated deficit of costs coverage The Electricity Authority did not (distribution and transmission). In compensate the Company with respect to addition, the Company incurred a failure to update the rate base for the significant loss of income due to the generation segment in previous years. prolonged delay (nearly five years) in updating the rate base.
For additional details of the disputes between the Company and the Electricity Authority, see also Note 3, sections C-E to the Financial Statements.
10 10 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
1. Business Position of the Corporation (continued) C. Electricity Rate Mechanism (continued)
4) Emergency plan for the Electricity sector On August 27, 2008, the Minister of National Infrastructures approved an addition to the development plan that includes construction of three combined cycle gas turbines: at Ramat Hovav, Eshkol and Hagit (Gas turbine synchronization in July 2010 and the steam addition up to July 2012). For details of the emergency plan and the related decisions of the Electricity Authority, see Note 3 f to the Financial Statements in Chapter C of this report. On December 15, 2010, the Board of Directors approved an outline for financing the three steam turbine add-ons project of Stage B of the Emergency Plan at an estimated cost of NIS 3.5 billion. The financing will be based on the following components: Financing of approximately NIS 2 billion from the Electricity Authority as financing by electricity consumers for 15 years, dedicated credit of approximately NIS 1.1 billion received through purchase of equipment and the balance, as needed, will be financed by the Company. The execution starting date of the project is subject to the fulfillment of the following conditions: a) Approval of the Government to grant a floating charge that will enable the Company to raise funds in Israel and abroad. b) Positive decisions of the Electricity Authority on the following subjects: 1. Receive the balance of the funding concluded with the Electricity Authority of NIS 2 billion with respect to stage A of the emergency plan, without any conditions. 2. Recognition of the building costs of stage A in the rate. 3. Cancellation of the fines in the rate, required of the Company pursuant to the claim that the Company failed to meet timetables, including adjustment of the fuels basket to the actual activation date. 4. Receive financing for stage B, as stated in section 2.1 above, without any conditions. 5. Any mechanism for meeting timetables and budgets must be symmetrical and mutual, even for meeting lower budget and shorter timetables. 6. Recognize the full increase of the operation expenses caused by the plan in the rate.
On March 7, 2011, the Electricity Authority published a decision in which it spreads a debt of NIS 2 billion out of the Company's debt to consumers up to 2025, for building the three steam additions at Eshkol, Hagit and Ramat Hovav, included in stage B of the emergency plan. In its decision, on March 24, 2011 the Electricity Authority updated the normative operation dates of the generation units which were set at the base rate of the generation segment. steam additions in stage B of the emergency project. According to this decision, the synchronization dates correspond to or are later than the dates approved by the Minister of National Infrastructure in his approval on December 15, 2010. On March 17, 2011, the Board of Directors decided to approve actions of the Company's Management to build the three steam additions in the new power stations at Hagit, Eshkol and Ramat Hovav. The plan will be financed through spreading the Company's debt in the electricity rate in the amount of NIS 2 billion up to the end of 2025. The Company will provide the balance of the funds, in accordance with the aforementioned decision of the Electricity Authority on March 7, 2011. Consequently, the Board of Directors approved the increase of the Company's development budget for 2011 by NIS 343 million. See also Note 3 f to the Financial Statements in Chapter C of this report.
5) The Company filed two administrative pleas against the Electricity Authority during the third quarter of 2010 (see Note 3 g to the Financial Statements in Chapter C of this report).
11 11 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
1. Business Position of the Corporation (continued)
D. 1) Expected Effect of the Evolving Collective Agreement on Linking the Pension to the CPI The Company estimated that the agreement, when it is signed, will increase the actuarial obligation, on the date of signing, by about NIS 1 billion. The Company estimated that the expected effect of the agreement on the linkage of the pension to the CPI, will increase the actuarial obligations, once the legislative procedures is completed, up to January 1, 2012 by approximately NIS 2.5 billion (estimate correct as on March 10, 2011), of which approximately NIS 1.3 billion is with respect to the share of the pensioners and will be charged to pension expenses (approximately NIS 1 billion after the effect of tax). The balance, attributed to active employees, will be charged in part, NIS 0.5 billion, to salary costs with respect to employees who accumulated entitlement to the aforesaid and in part, NIS 0.7 billion, will be recorded to an asset that will be spread over the average period of the balance of the period up to the entitlement to the above. This asset will be presented by offsetting from the said obligation. The effect of the agreement includes the cancellation of the decision of the Supervisor of Wages and Work Agreements, of June 2009, in the amount of NIS 82 million with respect to pensioners, which will be charged to pension expenses and approximately NIS 30 million with respect to active employees in the salary costs. In light if signing the salary agreement and resolving the salary deviations and the letter of the Supervisor of Wages and Work Agreements, will result in cancelling the provision for refunding sums paid to employees of approximately NIS 150 million, which were entered as an asset in the statement of financial position of the Company, of which NIS 33 million were recorded in the reported period as a decrease of salary costs in the reported period, of which NIS 20 million for pension expenses and NIS 13 for salary costs. In the reported period, with respect to repaying amounts paid according to employees rights in force before the decision of the Supervisor of Wages, the effect of the 0.3% balance of the salary agreement will also be cancelled. See also Note 19 a 2 of Chapter C to this report.
D. 2) Provisions for Refunding The Company presented provisions in the amount of NIS 2,104 million for refunding with respect to the effect of the restatement of the Financial Statements. The provision was recorded with respect to the difference between previous calculations used to determine the rate and computations calculated following the restatement at that time, (performed in June 2009 report). (For the expected effect of the collective agreement in linking the pension to the CPI, which will increase the actuarial liability, see Note 19 a 2 to the Financial Statements in Chapter C of this report). The Company's Board of Directors believes that the Electricity Authority will not act reasonably if it only examines the rate implications related to the restated components of the Financial Statements and that the Electricity Authority should examine the rate coverage of the actuarial liability as a whole (in this respect the Company has many claims, stating that the current rate coverage is lower than that required to cover the Company's actuarial liability and even applied to the Electricity Authority to receive such coverage (see Note 3 to the Financial Statements in Chapter C of this report). Therefore, the Board of Directors believes that it is too early to estimate any final effects of this provision on the cash flow of the Company. This is future looking information, subject to realization of the aforementioned assumptions.
E. Financial Condition 1) Comparing the financial position at 31 December 2010 with 31 December 2009 a) Total current assets as of December 31, 2010 amounted to NIS 9.240 million compared to NIS 10,139 million as of December 31, 2009. A decrease in the amount of NIS 899 million. This decrease in the balance of current assets as of December 31, 2010 compared to December 31, 2009 derives mainly from a decrease in accounts receivable, cash and cash equivalent.
12 12 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
1. Business Position of the Corporation (continued) E. Financial Condition (continued) 1) Comparing the financial position at 31 December 2010 with 31 December 2009 (continued)
Details of the current assets are as follows: The total sum of the cash and cash equivalents balance as of December 31, 2010 is NIS 3,208 million compared to NIS 3,988 million as of December 31, 2009. A decrease in the amount of NIS 780 million. Total short-term investments as of December 31, 2010 is 528 million NIS. Sum total of trade receivables balances as of December 31, 2010 is NIS 3,143 million compared to NIS 3,304 million as of December 31, 2009. A decrease in the amount of NIS 161 million. Sum total of other current assets as of December 31, 2010 is NIS 296 million, compared to NIS 915 million as of December 31, 2009. A decrease in the amount of NIS 619 million. Sum total balance of fuels inventory as of December 31, 2010 is NIS 1,799 million compared to NIS 1,703 million as of December 31, 2009. An increase in the amount of NIS 96 million. Sum total balance of warehouses inventory as of December 31, 2010 is NIS 266 million compared to NIS 229 million as of December 31, 2009. An increase in the amount of NIS 37 million.
b) 1) The Company holds amounts in a trust account with respect to additional pension liabilities, the balance of which as of December 31, 2010 is approximately NIS 1,938 million compared to NIS 1,781 million as at the end of the same period last year (for additional details, see Note 19 (5) to the Financial Statements in Chapter C of this report). 2) The sum total of investments in fixed assets for the reporting period amounted to approximately NIS 4,080 million, net, after offsetting consumer participation amounting to approximately NIS 592 million, compared to approximately NIS 4,038 million for the same period last year, after offsetting consumers participation amounting to NIS 976 million, an increase of approximately NIS 42 million, a rate of approximately 1.04%. Cumulative investments in the period were as follows: In power stations, combined cycle gas turbines and buildings a total of approximately NIS 1,957 million, in sub-stations and high voltage lines a sum of approximately NIS 437 million, in grids (with receipts deducted) a sum of approximately NIS 788 million net, after consumers participation in construction of fixed assets in a sum of approximately NIS (592) million, investments in vehicles and mobile mechanical equipment of approximately NIS 153 million, in other investments a sum of approximately NIS 366 million as well as an increase in long term storage capacity in a total of approximately NIS 971 million.
c) The balance of current liabilities as of December 31, 2010 is NIS 11,416 million, compared to NIS 7,902 million as of December 31, 2009. An increase of approximately NIS 3,514 million. Details of the current liabilities are as follows: Total sum of credit from banks and other credit providers as of December 31, 2010 is NIS 4,893 million compared to NIS 1,773 million as of December 31, 2009. An increase, in the amount of NIS 3,120 million. Total sum of trade payables as of December 31, 2010 is NIS 1,232 million compared to NIS 1,496 million as of December 31, 2009. A decrease in the amount of NIS 264 million. Total sum of other current liabilities as of December 31, 2010 is NIS 1,306 million compared to NIS 1,289 million as of December 31, 2009. An increase in the amount of NIS 17 million. Total sum of regulatory liabilities, net as of December 31, 2010 is NIS 2,793 million compared to NIS 2,052 as of December 31, 2009. An increase in the amount of NIS 741 million.
13 13 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
1. Business Position of the Corporation (continued) E. Financial Condition (continued) 1) Comparing the financial position at 31 December 2010 with 31 December 2009 (continued)
Total sum of customer advances, net of work in progress as of December 31, 2010 is NIS 454 million compared to NIS 453 million as of December 31, 2009. An increase in the amount of NIS 1 million. Total provisions balance as of December 31, 2010 is NIS 738 million compared to NIS 839 million as of December 31, 2009. A decrease in the amount of NIS 101 million.
d) On December 31, 2010, the Company had non-current net liabilities equaling approximately NIS 50,184 million that include debentures, liabilities to banking corporations and others equaling approximately NIS 38,573 million (see also details in section 5 d below) as detailed below: NIS 19,066 million in foreign currency, NIS 17,071 million index linked, NIS 939 million unlinked and hedge agreements (foreign currency – swap and forward contracts) amounting to approximately NIS 497million. Of the Company’s foreign currency liabilities listed above: NIS 13,407 million in USD, NIS 2,416 million in Euros, NIS 3,242 million in Japanese Yen, NIS 1 million in Swiss Francs. The Company also has debentures owed to the State of Israel equaling approximately to NIS 2,392 million. The Electricity Authority decided to transfer the real exposure to the currencies basket, amounting to approximately NIS 8.5 billion, out of these liabilities of the Company, to the electricity consumers and to the creation of a regulatory liability with respect to the financing its liabilities. The Company is exposed to real changes in currency rates for its liabilities except when such exposure is transferred to the consumers as above and when they are used for construction with financial expenses being capitalized to fixed assets. So as to minimize this exposure, the Company has entered into the following hedge
transactions: 1) Currency Swap Transactions Purchase of: In Millions of NIS U.S. Dollar 5,771 Euro 923 Yen 3,218 Pounds Sterling 375 10,287
In Return for: Linked NIS 8,843 NIS 1,062 Euro 445 Pounds Sterling 541 U.S. Dollar 243 11,134
As a result, as of the balance sheet date, the Company had long term credit balances for these transactions, amounting to approximately NIS 847 million (before current maturities equaling NIS 435 million).
14 14 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
1. Business Position of the Corporation (continued) E. Financial Condition (continued) 1) Comparing the financial position at 31 December 2010 with 31 December 2009 (continued)
2) Forward contracts: USD – NIS contracts - a volume of NIS 2,758 million. Euro – NIS contracts - a volume of NIS 247 million. Sterling – NIS contracts - a volume of NIS 173 million. NIS – U.S. Dollar contracts - a volume of NIS 974 million. The Company does not have long term balances with respect to the aforementioned forward contracts. 3) Interest Swap contracts: The Company enters into interest swap contracts (IRS) in which it exchanges variable interest with fixed interest, as follows: Euro contracts in the amount of NIS 1,421 million. Dollar contracts in the amount of NIS 532 million.
e) The Company holds sums to cover its pension-related liabilities in a central provident fund for pension, the balance of which is approximately NIS 20,586 thousand as of December 31, 2010, compared to NIS 19,533 thousand in the corresponding period last year.
f) The balance of deferred taxes as of December 31, 2010 amounted to approximately NIS 4,054 million compared to NIS 4,065 million as of December 31, 2009. A decrease of NIS 11 million. g) The shareholders’ equity as of December 31, 2010 amounted to approximately NIS 17,667 million compared to NIS 17,666 million as of December 31, 2009. An increase of NIS 1 million.
h) Financial Condition by Electricity Chain Segments 1) Current assets for the generation segment as of December 31, 2010 amounted to approximately NIS 9,240 million, largely deriving from trade receivables due to the sale of electricity amounting to approximately NIS 3,143 million (this section is attributed to segments according to the ratio of revenues), fuel inventory (fully attributed to the generation segment) amounting to approximately NIS 1,799 million and from a balance of cash and cash equivalents of approximately NIS 3,208 million. For the transmission segment, current assets amounted to approximately NIS 1,307 million and for the distribution segment approximately NIS 1,822 million, deriving mainly from trade receivables due to electricity sales and from balances of cash and cash equivalents.
2) Net fixed assets as of December 31, 2010 amounted for the generation segment to approximately NIS 28,655 million, for the transmission segment approximately NIS 14,241 million and approximately NIS 18,018 million for the distribution segment. Direct assets were attributed to the appropriate segments; joint assets (some 3% of the Company’s assets) were divided according to a distribution key that the Company assesses to be a reasonable estimate for attributing these assets. During the period covered by the report, the Company invested a total of approximately NIS 1,957 million, approximately NIS 475 million and approximately NIS 844 million in direct assets in the generation, transmission and distribution elements, respectively. In addition, a sum of approximately NIS 804 million was invested in joint property.
15 15 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
1. Business Position of the Corporation (continued) E. Financial Condition (continued) 1) Comparing the financial position at 31 December 2010 with 31 December 2009 (continued)
3) (a) As of December 31, 2010, long term loans and debentures (debentures, liabilities to banking corporations and others, and others) for the generation segment totaled approximately NIS 21,056 million, for the transmission segment approximately NIS 8,429 million and for the distribution segment approximately NIS 10,480 million. Long term loans and debentures were mainly attributed to the segments according to the distribution ratio of fixed assets and according to the manner of financing the Company’s assets according to the rate principles. (b) Net liabilities deriving from severance pay were attributed to segments according to current salary ratios in operations and totaled approximately NIS 1,347 million for the generation segment, approximately NIS 183 million for the transmission segment and approximately NIS 1,017 million for the distribution segment. 4) The current ratio as of December 31, 2010 for the generation segment is 1.01, for the transmission segment 0.73 and 0.51 for the distribution segment. 5) The ratio of the sum of liabilities to shareholders’ equity as of December 31, 2010 is 3.96 for the generation segment, 2.98 for the transmission segment and 3.17 for the distribution segment. 6) Capital yield in annual terms (calculated according to capital at the end of the period) is negative at a rate of approximately 0.07% on capital in the generation segment, in the transmission segment yield of approximately 0.42% and in the distribution negative segment yield of approximately 0.57%.
2) Comparing the financial position at December 31, 2009 with December 31, 2008 a) Total current assets at December 31, 2009, amounted to NIS 10,139 million. compared to a total of NIS 11,571 million as of December 31, 2008. A decrease of NIS 1,432 million. The decrease in the balance of current assets derives mainly from the decrease in fuel stock The current assets are as follows: Total Cash and cash equivalents as of December 31, 2009, is NIS 3,988 million compared to NIS 3,768 millions as of December 31, 2008. An increase of NIS 220 million. Total sum of trade payables as of December 31, 2009, is NIS 3,304 million compared to NIS 3,580 millions as on December 31, 2008. A decrease of NIS 276 million. Total sum of trade payables as of December 31, 2009, is NIS 915 million, compared to NIS 975 million as of December 31, 2008. A decrease of NIS 60 million. Total fuel inventory balance at December 31, 2009, is NIS 1,703 million compared with NIS 2,975 million as of December 31, 2008. A decrease of NIS 1,272 million. Total warehouse inventory balance as at December 31, 2009, is NIS 229 million compared with NIS 240 million as at December 31, 2008. A decrease of NIS 11 million. Total regulatory assets as of December 31, 2008 is NIS 33 million.
b) 1) The Company holds amounts in a trust account with respect to additional pension liabilities, the balance of which as of December 31, 2009 is approximately NIS 1,781 million compared to NIS 1,633 million as at the end of the same period last year (for additional details, see Note 19 (5) to the Financial Statements in Chapter C of this report). 2) The sum total of investments in fixed assets for the reporting period amounted to approximately NIS 4,038 million, net, after offsetting consumer participation amounting to approximately NIS 977 million, compared to approximately NIS 2,931 million for the same period last year, after offsetting consumers participation amounting to NIS 745 million, an increase of approximately NIS 1,107 million, a rate of approximately 37.11%.
16 16 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
1. Business Position of the Corporation (continued) E. Financial Condition (continued) 2) Comparing the financial position at December 31, 2009 with December 31, 2008 (continued)
Cumulative investments in the period were as follows: In power stations, combined cycle gas turbines and buildings a total of approximately NIS 2,557 million, in sub-stations and high voltage lines a sum of approximately NIS 514 million, in grids (with receipts deducted) a sum of approximately NIS 704 million net, after consumers participation in construction of fixed assets in a sum of approximately NIS (977) million, investments in vehicles and mobile mechanical equipment of approximately NIS 136 million, in other investments a sum of approximately NIS 271 million as well as an increase in long term storage capacity in a total of approximately NIS 823 million. c) The balance of current liabilities as of December 31, 2009 is NIS 7,902 million, compared to NIS 11,184 million as of December 31, 2008. A decrease of approximately NIS 3,282 million. Details of the current liabilities are as follows: Total sum of credit from banks and other credit providers as of December 31, 2009 is NIS 1,773 million compared to NIS 6,884 million as of December 31, 2008. A decrease, in the amount of NIS 5,111 million. Total sum of trade payables as of December 31, 2009 is NIS 1,496 million compared to NIS 1,411 million as of December 31, 2008. An increase in the amount of NIS 85 million. Total sum of trade receivables as of December 31, 2009 is NIS 1,289 million compared to NIS 1,735 million as of December 31, 2008. An increase in the amount of NIS 85 million. Total sum of other current liabilities as of December 31, 2009 is NIS 1,306 million compared to NIS 1,289 million as of December 31, 2009. A decrease in the amount of NIS 446 million. Total sum of regulatory liabilities, net as of December 31, 2009 is NIS 2,052 million. Total sum of customer advances, net of work in progress as of December 31, 2009 is NIS 453 million compared to NIS 315 million as of December 31, 2008. An increase in the amount of NIS 138 million. Total provisions balance as of December 31, 2009 and as of December 31, 2008 is NIS 839 million.
d) On December 31, 2009, the Company had non-current net liabilities equaling approximately NIS 56,034 million that include debentures, liabilities to banking corporations and others equaling approximately NIS 38,573 million (see also details in section 5 d below) as detailed below: NIS 19,066 million in foreign currency, NIS 17,071 million index linked, NIS 939 million unlinked and hedge agreements (foreign currency – swap and forward contracts) amounting to approximately NIS 497million. Of the Company’s foreign currency liabilities listed above: NIS 13,407 million in USD, NIS 2,416 million in Euros, NIS 3,242 million in Japanese Yen, NIS 1 million in Swiss Francs. The Company also has debentures owed to the State of Israel equaling approximately to NIS 2,392 million. The Electricity Authority decided to transfer the real exposure to the currencies basket, amounting to approximately NIS 8.5 billion, out of these liabilities of the Company, to the electricity consumers and to the creation of a regulatory liability with respect to the financing its liabilities. The Company is exposed to real changes in currency rates for its liabilities except when such exposure is transferred to the consumers as above and when they are used for construction with financial expenses being capitalized to fixed assets. So as to minimize this exposure, the Company has entered into the following hedge
transactions:
17 17 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
1. Business Position of the Corporation (continued) E. Financial Condition (continued) 2) Comparing the financial position at December 31, 2009 with December 31, 2008 (continued)
1) Currency Swap Transactions Purchase of: In Millions of NIS U.S. Dollar 5,771 Euro 923 Yen 3,218 Pounds Sterling 375 10,287
In Return for: Linked NIS 8,843 NIS 1,062 Euro 445 Pounds Sterling 541 U.S. Dollar 243 11,134
As a result, as of the balance sheet date, the Company had long term credit balances for these transactions, amounting to approximately NIS 847 million (before current maturities equaling NIS 435 million).
2) Forward contracts: USD – NIS contracts - a volume of NIS 2,758 million. Euro – NIS contracts - a volume of NIS 247 million. Sterling – NIS contracts - a volume of NIS 173 million. NIS – U.S. Dollar contracts - a volume of NIS 974 million. The Company does not have long term balances with respect to the aforementioned forward contracts. 3) Interest Swap contracts: The Company enters into interest swap contracts (IRS) in which it exchanges variable interest with fixed interest, as follows: Euro contracts in the amount of NIS 1,421 million. Dollar contracts in the amount of NIS 532 million. e) The Company holds sums to cover its pension-related liabilities in a central provident fund for pension, the balance of which is approximately NIS 19,533 thousand as of December 31, 2010, compared to NIS 17,873 thousand in the corresponding period last year.
f) The balance of deferred taxes as of December 31, 2009 amounted to approximately NIS 4,065 million compared to NIS 5,191 million as of December 31, 2008. A decrease of NIS 1,126 million. g) The shareholders’ equity as of December 31, 2009 amounted to approximately NIS 17,666 million compared to NIS 16,273 million as of December 31, 2008. A decrease of NIS 1,393 million.
18 18 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
1. Business Position of the Corporation (continued) F. Operating Results (continued) 1) Comparison of Operating Results for the Year 2010 compared to the Year 2009
a) Net revenues from the sale of electricity for 2009 from the sale of 52,037 million kWh, totaled approximately NIS 19,203 million, compared to approximately NIS 19,080 million from the sale of 48,947 million kWh for the same period the previous year. This consists of an approximately NIS 123 million decrease in revenues, a decrease of approximately 0.64%. The peak of demand for electricity by the economy for the reporting period was in August 2010, reaching 11,530 megawatts (including 10,950 megawatts produced by the Company, about 380 megawatts produced by private producers and independent producers and about 200 megawatts through other arrangements), where the available standard capacity of the Company then was 11,520 megawatts (excluding private producers and other arrangements), compared to the peak of demand for electricity by the economy in July of the previous year of 10,280 megawatts (including 9,900 megawatts produced by the Company, about 330 megawatts produced by private producers and independent producers and about 50 megawatts though other arrangements), where the available standard capacity of the Company then was 11,010 megawatts (excluding private producers and other arrangements). The change in revenues noted above derives from two reasons, which are: - An decrease of approximately NIS 1,082 million as a result of a real decrease in average income per kWh (a decrease of approximately 5.67% compared to an increase of approximately 20.56% for the same period the previous year). - A decrease of approximately NIS 1,205 million as a result of a decrease in consumption (a decrease of approximately 3,090 million kWh, which constitutes a decrease of approximately 6.31% compared to an increase of approximately 2.42% for the same period the previous year).
b) (1) Depreciation and amortization expenses presented in the statement of operations for the period equaled approximately NIS 4,192 million compared to a total of approximately NIS 4,000 million for the same period the previous year, which constitutes an increase of approximately NIS 192 million. This increase derives from additional investments. (2) Provision for the establishment of non-recognition of costs of fixed assets totaling about NIS 933 million during the period, consisting of the affair as part of the electrical system running expenses of NIS 933 million.
c) The cost of fuel consumed (without the salary component) in 2009 amounted to a sum of approximately NIS 8,791 million, and a sum of approximately NIS 8,922 million (including the salary component) compared to approximately NIS 8,905 million (without the salary component) and a sum of approximately NIS 9,022 million (including the salary component) for the same period the previous year. A decrease of approximately NIS 114 million (without the salary component) and of approximately NIS 100 million (with the salary component), which constitutes a decrease of approximately 1.28% (without the salary component) and approximately 1.11% (with the salary component), is largely explained as follows: (1) A decrease in the cost of diesel fuel consumed due to a real price decrease amounting to approximately NIS 64 million, compared to a decrease in the cost of diesel fuel consumption of approximately NIS 63 million (a decrease of approximately 5.05% in the average cost per ton compared to the same period the previous year).
19 19 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
1. Business Position of the Corporation (continued) F. Operating Results (continued) 1) Comparison of Operating Results for the Year 2010 to the Year 2009 (continued)
(2) An increase in the quantity of natural gas consumed of approximately NIS 441 million, in addition to an increase in the cost of natural gas consumed, amounting to approximately NIS 23 million (an increase of approximately 0.82% in the average cost per ton compared to the same period the previous year). (3) A decrease in the cost of crude consumed amounting to approximately NIS 41 million (a decrease of approximately 21.32% in the average cost per ton compared to the same period the previous year) and a decrease in the quantity of crude consumption of approximately NIS 55 million. (4) A decrease in the cost of coal consumption due to a real price increase amounting to approximately NIS 559 million (a decrease of approximately 10.58% in the average cost per ton compared to the same period the previous year) compared to the decreased amount of coal consumed equaling NIS 10 million.
d) Operating costs amounted to approximately NIS 17,495 million (including depreciation and fuel and an offset of power purchased and expenses related to pensioner liabilities, hereunder “Inclusive”) and NIS 3,448 million (excluding depreciation and fuel, power purchases and expenses related to pensioner liabilities, hereunder “Non-inclusive”), compared to a total of approximately NIS 16,651 (Inclusive) and NIS 3,629 million (Non- inclusive) , a decrease of approximately NIS 844 million (Inclusive) and an increase of approximately NIS 181 million (Non-inclusive).
e) Profit from operating the electricity system for 2009 amounted to approximately NIS 3,086 million, compared to a sum of approximately NIS 4,122 million; a decrease of approximately NIS 1,036 million, which constitutes an approximate 25.13% increase.
f) Income deriving from liabilities to pensioners, net, amounted to approximately NIS 19 million, compared to expenses amounting to approximately NIS 221 million, a decrease of approximately NIS 202 million.
g) The Profit before taxes on income to approximately NIS 4 million, compared to a profit of approximately NIS 278 million, a change of approximately NIS 274 million.
h) Tax expenses amounted to approximately NIS 3 million income as opposed to an expense of approximately NIS 1,115 million for the same period the previous year, an approximate NIS 1,118 million change.
i) The Profit amounted to approximately NIS 1 million compared to a profit of approximately NIS 1,393 million for the same period the previous year, a change of approximately NIS 1,392 million.
20 20 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
1. Business Position of the Corporation (continued) F. Operating Results (continued) 1) Comparison of Operating Results for the Year 2009 to the Year 2008 (continued) j) Financing Expenses (continued) The decrease of financing expenses to financing income for the interim period compared to the same period in the previous year, are as follows:
For the Year Ending Difference Sum Analysis Difference 31/12/2010 31/12/2009 NIS in millions A. Erosion of Financial Liabilities Increase in financing income from the erosion of financial liabilities in foreign currency amounting to NIS 717 million net after deposits, deriving from an increase in the real revaluation at a rate of 4.19% for the same period in the previous year to a real revaluation rate of 7.86% for the reporting period (717) (1,862) (1,145)
No change in financial hedge contracts - 240 240 Total increase in financing income (717) (1,622) (905) Increase in financial income transferred to the regulatory liability in the reporting period according to the Electricity Authority’s decision with regard to the Company’s exposure to foreign currency due to the increase in real revaluation of the basket 441 943 502 Decrease in financial expenses, due to changes in the known CPI, net after deposits (45) 8 53 Increase in expenses, due to erosion of the working capital items, loans and receivables 9 185 176
Total increase in financial income to expense from erosion of financial liabilities (312) (486) (174)
B. Other Financial Expenses Decrease in interest expenses (386) 2,480 2,866 Financial expenses from interest swap transactions 11 11 - Expenses transferred to a regulatory asset with respect to interest differences (142) (142) - Loans and receivables (46) (35) 11 Total decrease in other financial expenses: (563) 2,314 2,877 Total decrease in financial expenses before capitalization (875) 1,828 2,703
C. Capitalization of construction projects Decrease in the capitalization of financial expenses (89) 157 246 Total decrease in financial expenses in the reporting period, compared to the same period in the previous year after the transfer to a regulatory asset and after capitalization of financial expenses (786) 1,671 2,457
Presented in the Financial Statements Other financing expenses, net 1,027 2,201 Transfer of financial income to a regulatory asset 801 502 Financial expense capitalization (157) (246) Total financial expenses 1,671 2,457
21 21 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
1. Business Position of the Corporation (continued) F. Operating Results (continued) 2) Comparison of Operating Results for the Year 2009 compared to the Year 2008
a) Net revenues from the sale of electricity for 2009 from the sale of 48,947 million kWh, totaled approximately NIS 19,080 million, compared to approximately NIS 24,775 million from the sale of 50,161 million kWh for the same period the previous year. This consists of an approximately NIS 5,695 million decrease in revenues, a decrease of approximately 22.99%. The change in revenues noted above derives from two reasons, which are: - An decrease of approximately NIS 5,095 million as a result of a real decrease in average income per kWh (a decrease of approximately 20.57% compared to an increase of approximately 14.10% for the same period the previous year). - A decrease of approximately NIS 600 million as a result of a decrease in consumption (a decrease of approximately 1,214 million kWh, which constitutes a decrease of approximately 1.70% compared to an increase of approximately 2.42% for the same period the previous year).
b) Depreciation and amortization expenses presented in the statement of operations for 2009 equaled approximately NIS 4,000 million compared to a total of approximately NIS 3,884 million for the same period the previous year, which constitutes an increase of approximately NIS 116 million. This increase derives from additional investments.
c) The cost of fuel consumed (without the salary component) in 2009 amounted to a sum of approximately NIS 8,905 million, and a sum of approximately NIS 9,022 million (including the salary component) compared to approximately NIS 13,165 million (without the salary component) and a sum of approximately NIS 13,296 million (including the salary component) for the same period the previous year. A decrease of approximately NIS 4,260 million (without the salary component) and of approximately NIS 4,274 million (with the salary component), which constitutes a decrease of approximately 32.36% (without the salary component) and approximately 32.15% (with the salary component), is largely explained as follows: (1) A decrease in the cost of diesel fuel consumed due to a real price decrease amounting to approximately NIS 32 million, compared to a decrease in the cost of diesel fuel consumption of approximately NIS 2,926 million a decrease of approximately 2.61% in the average cost per ton compared to the same period the previous year). (2) An increase in the quantity of natural gas consumed of approximately NIS 250 million, in addition to an increase in the cost of natural gas consumed, amounting to approximately NIS 371 million (an increase of approximately 19.30% in the average cost per ton compared to the same period the previous year). (3) A decrease in the cost of crude consumed amounting to approximately NIS 120 million (a decrease of approximately 32.51% in the average cost per ton compared to the same period the previous year) and a decrease in the quantity of crude consumption of approximately NIS 588 million. (4) A decrease in the cost of coal consumption due to a real price increase amounting to approximately NIS 1,027 million (a decrease of approximately 16.29% in the average cost per ton compared to the same period the previous year) compared to the decreased amount of coal consumed equaling NIS 202 million. d) Operating costs amounted to approximately NIS 16,651 million (including depreciation and fuel and an offset of power purchased and expenses related to pensioner liabilities, hereunder “Inclusive”) and NIS 3,629 million (excluding depreciation and fuel, power purchases and expenses related to pensioner liabilities, hereunder “Non-inclusive”), compared to a total of approximately NIS 20,683 (Inclusive) and NIS 3,503 million (Non- inclusive) , a decrease of approximately NIS 4,032 million (Inclusive) and an increase of approximately NIS 126 million (Non-inclusive). 22 22 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
Business Position of the Corporation (continued) F. Operating Results (continued) 2) Comparison of Operating Results for the Year 2009 to the Year 2008 (continued)
e) Profit from operating the electricity system for 2009 amounted to approximately NIS 4,122 million, compared to a sum of approximately NIS 5,571 million; a decrease of approximately NIS 1,449 million, which constitutes an approximate 26.01% increase.
f) Income deriving from liabilities to pensioners, net, amounted to approximately NIS 221 million, compared to expenses amounting to approximately NIS 300 million, a decrease of approximately NIS 521 million.
g) The Profit before taxes on income to approximately NIS 278 million, compared to a profit of approximately NIS 1,199 million, a change of approximately NIS 921 million.
h) Tax expenses amounted to approximately NIS 1,097 million income as opposed to an expense of approximately NIS 306 million for the same period the previous year, an approximate NIS 1,403 million change.
i) The Profit amounted to approximately NIS 1,375 million compared to a profit of approximately NIS 893 million for the same period the previous year, a change of approximately NIS 482 million.
j) Financial expenses See details on the next page:
23 23 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
1. Business Position of the Corporation (continued) F. Operating Results (continued) 2) Comparison of Operating Results for the Year 2009 to the Year 2008 (continued) (j) Financing Expenses Decrease in Financing expenses in corresponding periods 2008-2009, are as follows:
For the Year Ending Difference Sum Analysis Difference 31/12/2009 31/12/2008 NIS in millions A. Erosion of Financial Liabilities Increased financing income from the erosion of financial liabilities in foreign currency amounting to NIS 671 million net after deposits, deriving from a decrease in the real revaluation at a rate of 1.58% for the same period in the previous year to a real revaluation rate of 4.19% for the reporting period, consisting of:. (671) (1,145) (474) Decrease in net financial income after deposits from raising capital Transition from income to expenses in financing expenses from financial hedge agreements 697 240 (457) Total decrease in financing income 26 (905) (931) Decrease in financial income transferred to the regulatory liability in the reporting period according to the Electricity Authority’s decision with regard to the Company’s exposure to foreign currency due to the decrease in real revaluation of the basket to its real devaluation (489) 502 991 Decrease in financial expenses, due to changes in the known CPI, net after deposits (69) 53 122 Increase in financing expenses, due to erosion of the working capital items, loans and receivables 138 176 31
Total transition from financial expenses to financial income from erosion of financial liabilities (350) (174) 213
B. Other Financial Expenses Increase in interest expenses 94 2,866 2,772 Transitions from financial income to financial expenses – loans and receivables 113 11 (102)
Total increase in other financial expenses: 207 2,877 2,670 Total decrease in financial expenses before capitalization (180) 2,703 2,893 Decrease in capitalization of undesignated financial expenses (20) 246 266 Decrease in the capitalization of financial expenses Total decrease in financial expenses in the reporting period, compared to the same period in the previous year after the transfer to a regulatory asset and after capitalization of financial expenses (160) 2,457 2,617
Presented in the Financial Statements Other financial expenses (income) 2,201 1,892 Transfer of financial income to a regulatory asset 502 991 Financial expense capitalization (246) (266) Total financial expenses 2,457 2,617
24 24 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
1. Business Position of the Corporation (continued) F. Operating Results (continued) 3) Condensed Quarterly Statements of Operations for 2010 are as follows
Adjusted to NIS of December 2010, NIS in millions
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Total (Unaudited) (Audited)
Revenues...... 3,724 4,421 6,308 4,696 19,422
Cost of operating the electricity system ...... 3,655 3,815 4,658 4,208 16,336
Profit from operating the electricity system ...... 69 606 1,650 761 3,086
Sales and marketing expenses...... 191 192 188 202 773
Administrative and general expenses 155 142 158 202 657
Expenses (income) from liabilities to pensioners, net...... 3 (14) (24) (16) (19)
Income (loss) from current 280 286 1,328 341 1,675 operations
Financial expenses (income), net .... 580 767 58 382 1,671
Income (loss) from current operations before income tax ...... (860) 481 1,386 42 4 Expenses (income) from taxes on income...... (179) (102) 232 52 3
Income (loss) from current operations after taxes...... 681 (379) 1,154 93 1
The changes in operating results between quarters are due, inter alia, to: 1. a. Income - Changes in electricity rates during the reporting year – on February 15, 2010, the electricity rate decreased by approximately 11.64%, mainly due to the update of the rate base for the generation segment, which increased the rate, derived mainly from a decrease in the fuels basket. b. Seasonality affected by weather - during the winter and summer seasons the average electricity consumption is higher than that in the transitional seasons, and is often characterized by peak demand due to extreme cold or hot conditions. Electricity rates for consumers paying by load and time, which represent some 59.3% of consumed KWh, are higher on average in winter and summer than in the transitional seasons. c. Expenses (income) from liabilities to pensioners, net – the main reason for the change in the last quarter is added costs arising from recording the effect of the salary agreement signed in January 2011 with respect to pensioners. d. Operational cost of the electricity system – the changes between the quarters arise from seasonality – see section b above.
25 25 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
1. Business Position of the Corporation (continued) F. Operating Results (continued) 4) Results of Operations by Segments for the Reporting Period
According to Section 33.b of the Government Companies Act and according to the provisions of circulars of the Government Companies Authority the Company was required, starting from the December 31, 2004 Financial Statements, to provide disclosure in the form of notes containing statements of operations and a balance sheet, with regard to the fields of activity included in the three segments of the electricity chain and detailing the premises and details used for their preparation (see Note 34 to the Financial Statements). The following are explanations concerning the results of operational segments: generation, transmission and distribution of electricity for the cumulative period, as presented in Note 34 to the Financial Statements:
a. Revenues Net revenues from the sale of electricity for the accumulated period derives from the sale of 52,037 million kWh, compared to the sale of 48,947 kWh in the same period the previous year, and is divided according to the following breakdown: 1. Generation - net revenues from the sale of electricity in the generation segment for the cumulative period amounted to approximately NIS 14,776 million, compared to approximately NIS 14,627 million for the same period the previous year, an approximate NIS 149 million increase in income. The increase in revenues derives from two main factors: a decrease of approximately NIS 774 million due to a real decrease of the rate, partially set off by an increased consumption of approximately 3,090 million kWh at a rate of approximately 6.3%, which means an increase of approximately NIS 923 million. 2. Transmission - net revenues from the sale of electricity in the transmission segment for the cumulative period reached an amount of approximately NIS 1,730 million, compared to approximately NIS 1,740 million for the same period the previous year, an approximate NIS 10 million decrease in revenues. 3. Distribution - net revenues from the sale of electricity in the distribution segment for the period reached an amount of approximately NIS 2,697 million, compared to NIS 2,705 million for the same period the previous year. An approximate NIS 8 million decrease in revenues.
b. Depreciation and Amortization Expenses 1. Generation - depreciation and amortization expenses presented in the statement of operations for the generation segment for the cumulative period, amounted to approximately NIS 2,202 million, compared to NIS 2,036 million for the same period the previous year, an approximate NIS 166 million increase. In addition, the Company recorded a provision with respect to non-recognition of fixed assets construction costs in the generation segment of approximately NIS 933 million for the period.
2. Transmission - depreciation and amortization expenses presented in the statement of operations for the transmission segment for the cumulative period, amounted to NIS 858 million, compared to NIS 843 million for the same period the previous year, an approximate NIS 15 million increase.
3. Distribution - depreciation and amortization expenses presented in the statement of operations for the distribution segment for the cumulative period, amounted to approximately NIS 1,132 million, compared to approximately NIS 1,121 million for the same period the previous year, an approximate NIS 11 million increase.
26 26 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
1. Business Position of the Corporation (continued) F. Operating Results (continued) 4) Results of Operations by Segments for the Reporting Period (continued)
c. Fuel Fuel consumption costs (without the salary component) for the generation segment in the cumulative period amounted to approximately NIS 8,791 million, compared to approximately NIS 8,905 million for the same period the previous year, an approximate NIS 114 million decrease derived mainly from a decrease in the amount of fuel consumed and also decreased fuel prices worldwide. Fuel consumption costs are attributed in their entirety to the generation segment.
d. Operating Costs 1. Generation - operating costs (without depreciation, fuel and expenses for liabilities to pensioners, net) for the generation segment for the cumulative period amounted to approximately NIS 1,825 million, compared to approximately NIS 1,909 million for the same period the previous year, an approximate NIS 84 million decrease. 2. Transmission - operating costs (without depreciation, fuel and expenses for liabilities to pensioners, net) for the transmission segment for the cumulative period amounted to approximately NIS 339 million, compared to approximately NIS 352 million in the same period the previous year, an approximate NIS 13 million decrease. 3. Distribution - operating costs (without depreciation, fuel and expenses for liabilities to pensioners, net) for the distribution segment for the cumulative period amounted to approximately NIS 1,284 million, compared to approximately NIS 1,367 million for the same period the previous year, an approximate NIS 83 million decrease.
e. Net Income from Liabilities to Pensioners Net income from liabilities to pensioners for the entire Company, amounted to approximately NIS 19 million for the reporting period. Distributing pension expenses between the various segments is done by the current salary ratio in operating costs for the electricity chain existing in the report period: 52.89% in generation, 7.19% in transmission and 39.92% in distribution.
f. Net Financial Expenses Net financial expenses are divided between the various segments mainly according to the net ratio of active fixed assets. Financial expenses after capitalization, for the entire Company, amounts to approximately NIS 1,671 million for the reporting period compared to financial expenses of approximately NIS 2,457 million for the previous year, an approximate NIS 786 million decrease in net finance expenses. In the generation segment: an approximate NIS 394 million decrease. In the transmission segment: an approximate NIS 181 million decrease and in the distribution segment: an approximate NIS 211 million decrease.
5) Operating Results by Reporting Units for the Report Period According to Section 33.b of the Government Companies Act and according to the provisions of circulars of the Government Companies Authority the Company was required, starting from the December 31, 2004 financial statements, to provide disclosure in the form of notes containing statements of operations and a balance sheet, with regard to the fields of activity included in the three segments of the electricity chain and detailing the premises and details used for their preparation (see Note 38 to the Financial Statements in Chapter C to this report).
27 27 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
1. Business Position of the Corporation (continued) F. Operating Results (continued) 5) Results of Operations by Segments for the Reporting Period
Upon analysis of the results of the activities of the various units and regarding rates set by the Electricity Authority for the segments, one might recognize that all three segments did not attain the required returns, because of a lack of rate coverage for all normative costs, deriving mainly from: Failure to update the transmission and distribution rates. Insufficient update of the generation rate Continued implementation of high efficiency factor in the rate.
G. Liquidity for the Reporting Period
1) The cash surplus created from current activities, from taking long term loans and from other loans, was used largely to finance development activity required by the electricity sector, meaning investment in fixed assets amounting to approximately NIS 3,241 million and repayment of loans amounting to approximately NIS 1,469 million. The Company presented a cash surplus in the reporting period derived from current activities in the approximate amount of NIS 3,395 million, compared to approximately NIS 6,868 million for the same period the previous year, an approximate NIS 3,473 million decrease. The amount of cash used for investment activities in the period reached approximately NIS 3,564 million compared to NIS 3,909 million in the same period last year, a change of NIS 345 million. The amount of cash used for financing activities in the period amounted to approximately NIS 611 million, compared to approximately NIS 2,739 million used for financing activities in the same period last year, a change of approximately NIS 2,128 million.
2) Disclosure of the forecasted cash flows for financing repayment of corporate liabilities a) According to the guidelines of the Securities Authority (guideline in accordance with section 36 a(b) of the Securities Law – 1968), Disclosure of the Forecasted Cash Flows to Finance Repayment of Corporate Liabilities, of February 8, 2009 and paragraph 10 (b) (14) to the regulations, the Board of Directors of the Company reviewed the cash flows capability of the Company to fulfill present and expected liabilities for two years, starting from the reporting year or the report date, as the case may be ("The Cash Flow Period"), on their payment dates and found that there is no reasonable concern that the Company will not fulfill these obligations. b) The cash flow forecast reviewed by the Board of Directors is based on the new rate base for the generation segment, applied since February 15, 2010 (see Note 3 a to the Financial Statements in Chapter C of this report). The cash flow forecast is also based on the following assumptions: (1) Demand for electricity forecasts, made by the Company. (2) Implement the development plan of the Company with changes required for meeting the goal of the Board of Directors for debt raising in 2011, with the addition of executing stage B of the emergency plan in the financial volume and financing framework approved by the Electricity Authority in its decision on March 7, 2011. (3) On the subject of payments deposited in the Main Pension Fund of IEC Workers ("The Fund"): a. Spread the actuarial deficit ("Exceptional Deficit") of approximately NIS 0.78 billion over 10 years, with a monthly payment that will not be less than NIS 50 million, as long as the actuarial deficit exists, according to the amendment of the articles of the Fund, approved by the Commissioner of the Capital Market, Saving and Insurance Division in the Ministry of Finance.
28 28 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
1. Business Position of the Corporation (continued) G. Liquidity for the Reporting Period (continued)
b. Payments with respect to the "current deficit", arising from accrued current rights, will be deposited in three equal consecutive monthly payments. (4) Funds raising for debt recycling, as required, will be performed according to the decisions of the Board of Directors relating to this subject. The Company estimates that it will be able to raise the required sums. However, in the event of difficulties, it will apply to the State for assistance. From past experience, it is evident that agents of the Government assist in finding solutions to problems that the Company come up against based on the Company being an essential service provider and a Government company and due to its importance to the Israeli national economy. This is a future looking statement, subject to realization of the aforementioned assumptions.
2. Details Concerning Exposure to Market Risks and their Management a. The Company's Market Risk Manager The Company's person responsible for market risk management is the Senior Vice-President of Finance and Economics, Mr. Harel Zeev Blinde. The following are his details: 1) Entered Service: April 2008 2) I.D. no.: 024300634 3) Year of Birth: 1969 4) Citizenship: Israeli 5) Corporate Position: Senior Vice-President of Finance and Economics. 6) Position in Corporate Subsidiary or Interested Party: None. 7) He is not a family member of any other Company executive or interested party. 8) Education: B.A. in Economics and Mathematics and an MA in Economics and Business Administration. 9) Business Experience for the Past 6 Years: Vice President of Finance and Economics at the Company, in the years prior to the current position, served in different roles in the Ministry of Finance: Vice Commissioner of Budgets, Deputy Commissioner of Budgets.
b. The Financial Crisis 1) The most severe financial crisis ever experienced by the American capital market since the early 1930's, that broke out in full force in September 2008 upon the collapse of Lehmann Brothers Investments Bank created at the time, more severe conditions than in the past for raising funds in Israel and abroad. Moreover, there was a reduction in the supply of sources of bank financing due to stricter terms for obtaining credit from banks. Following steps taken by central banks and governments throughout the world to alleviate the credit crisis and encourage the positive momentum, a recovery is discernible in the global capital markets and, as a result of that, in the Company's capital raising ability in international capital markets. 2010 ended on a positive note, where financial markets are optimistic about growth in 2011, pursuant to expected improvement in the U.S.A. economy arising from an aggressive monetary and fiscal expansion policy. 2) Capital raising - a) Capital raising in Israel – in 2010, floatations in the business sector in Israel amounted to approximately NIS 23.3 billion, similar to floatations in 2009, that amounted to approximately NIS 25.9 billion (Source: The Bank of Israel). Recovery in credit availability and the Company's funds raising ability from the banking and non-banking systems in Israel occurred in 2010, mainly due to the fact that the Company avoided funds raising in Israel since February 2009 and from the general improvement of market conditions. This recovery was expressed in January 2011, when the Company raised approximately NIS 2.5 billion through a private placement of debentures in the Israeli capital market. The Company estimates that it can raise all the capital it requires in 2011, in the Israeli capital market. 29 29 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
2. Details about the exposure to market risks and their management (continued) b. The Financial Crisis (continued)
b) Capital raising abroad – The international capital markets recovered from the financial crisis and share prices returned to the levels of 2008, prior to the collapse of Lehman Brothers. The Company receives indications from leading international investment banks that despite the lowered international credit rating of the Company, announced in January 2011, the Company has access to international capital markets that enables the Company to raise funds according to its needs. c. Description of the Company’s Market Risks The Company sells its product, electricity, at a price set by an outside body - the Electricity Authority. The price is based on the cost principle. Notwithstanding the setting of the recognized costs, the Electricity Authority fixed the normative costs of the different components in the rate, which occasionally do not match the Company’s actual costs. As a result, regarding the bulk of its activities, the Company is not exposed to market risks, with the exception of the following:
1) Financing a) Exchange Rate Differentials The major part of the Company's revenues are nominally in NIS. At the same time, as of December 31, 2010, an amount of NIS 22,801 million is in foreign currency and constitutes 54% of the long term obligations of the Company, before entering into hedging transactions. Therefore, fluctuations in exchange rates cause changes in the financing expenses of the Company that may affect the financial results of the Company. The Company also incurs financial expenses arising from obligations linked to the CPI, however, these expenses are usually stable. The considerable volume of long term obligations in foreign currency affected the business results of the Company in the past, as fluctuations in the NIS – foreign currency exchange rates were expressed in profit or loss. The Electricity Authority included a financing component, at the rate of 27% of the foreign capital recognized as linked to the foreign currency ("hedged sum"), linked to a "determining basket" defined by the Electricity Authority as linked to the U.S.$ and the Euro at the rate of 75% and 25% respectively. The hedged sum is intended to reflect part of the financing expenses/income derived from the exposure of the Company to foreign currency and transfer it to electricity consumers. As a result of the decision of the Electricity Authority to decrease the rate of the hedged financing component in the rate, the Company will be required to increase the volume of hedging transactions in the capital market. However, market capacity may be limited and cause a deviation in the Company's exposure to foreign currency in relation to the desired exposure rate as defined in the Company's policy. As aforementioned, the hedged sum is a partial recognition of the long term obligations of the Company in foreign currency. The balance of the exposure affects the business results of the Company due to fluctuations in the exchange rates. Therefore, the Company took various steps, intended to reduce the effect of these fluctuations and decrease the balance of the exposure to foreign currency, by entering into hedging transactions.
b) Interest on All of the Company’s Loans The Company is exposed to the difference between the interest rate recognized (in foreign currency and NIS), in the basis of the rates which only change upon the yearly rate update, and the actual interest rate (in foreign currency and NIS) with respect to its loans. c) Capitalization of Loan costs Regarding capitalization of loan costs see Note 2 to the Financial Statements in Chapter C of this report 30 30 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
2. Details about the exposure to market risks and their management (continued) c. Description of the Company’s Market Risks (continued)
2) Input Price Change The input basket for the other rate components (except for fuel costs and part of the operating costs) was linked to changes in the CPI. Therefore, the Company is exposed to market risks deriving from a real increase in the prices of other inputs.
3) Capital Market Changes Affecting the Pension Funds and Pension Obligation The Company is obliged to maintain an appropriate financial fund in the Central Pension Fund (the “Fund”) that will enable pension payments to entitled pensioners and employees of Generation A and Generation B, according to the actuarial liability, calculated by the actuary of the Fund. The Fund calculates the actuarial liability of the Company for employees in the pension plan to determine the sum that the Company should deposit according to this liability. The Company will be responsible for making-up any deficit between the Fund and the actual liability. At the same time, there is a particular uncertainty regarding the volume of deposits that the fund will require. The deposits in the pension fund of the Company are based on a forecast of cash flows expected in the future, which are based on several actuarial assumptions. The actual pension liabilities of the Company are expected to differ from the forecasted liabilities, due to changed circumstances. Moreover, the actuarial model for calculating the deposits in the pension fund may change in the future according to changes in life expectancy, regulatory issues, economic climate and other issues. These changes may cause a surplus or a deficit in the Company's liabilities to the pension fund. The main risks to which the Company is exposed are: a. The investment policy of the Fund and its effect of the fund – The fund held by the Fund includes various assets, comprised mostly of Government debentures and CPI linked bank deposits. Therefore, the yield of the fund is affected by the fundamental risks of markets behavior and its effect on the composition and value of the assets in the fund b. Average duration risks – the changes in yields of Government debentures have the highest effect on the financial value of the liabilities (the reserve) compared to the financial value of the assets (the fund) caused by the longer average duration of the reserve compared to that of the fund.. Reduction of market risks requires therefore, diversification of investments in terms of the mix of held financial assets, the average duration, credit rating, etc. c. Credit risks – failure of a third party to meet its obligations to the Fund may decrease the value of Fund assets. d. The Company’s Policy for Managing Market Risks 1) The Company’s policy for Managing Market Risks of Exposure to Foreign Currency The policy of the Company is to manage market risks arising from economic exposure of the Company to foreign currency. So as to minimize the Company’s exposure to foreign currency fluctuations, the Board of Directors of the Company has reached the following decisions concerning the Company’s exposure:
a. The sum of real exposure due to liabilities linked and denominated in foreign currency passed on to electricity consumers- the Company will execute foreign currency hedge transactions (mainly swap and forward) to conform the expense structure to the recognized revenue structure according to the makeup of the determining basket, defined by the Electricity Authority. The swap transactions will be for a minimum of one year. As a rule, transactions shall be executed in order to cover at least 85% of the balance of exposure, so that the amount exposed in each currency will not surpass the cumulative value of 15% of the loan balance in the currency in question.
31 31 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
2. Details about the exposure to market risks and their management (continued) d. The Company’s Policy for Managing Market Risks (continued)
b) Concerning the balance of exposure of the Company's foreign currency liabilities (after implementing paragraph a above) - the Company shall enter into hedge transactions (mainly forward and swap), if market conditions justify it, so as to minimize exposure to foreign currency. Swap transactions shall be for a minimum of one year taking into account inflation in Israel and Western countries, along with capital market interest rates. c) The instruction of the Finance Division Manager permits a deviation in excess of 15% only if the amount of the exposure is no greater than $10 million or the equivalent of that sum in any other foreign currency, each foreign currency separately. d) The Company will consider possible hedging transactions to spread the exposure to interest and foreign currency (variable/fixed interest) for the purpose of reducing the exposure to rising interest rates, if market conditions will justify it.
2) Steps taken by the Company to Contend with Market Risk Affecting Pension Funds and Pension Liabilities The Company acts to supervise and control, as far as possible, the ability of the Fund to effect payments to entitled employees out of its assets, as follows: a) A dedicated department is charged with the task of controlling the financial activity of the Fund and supervising the conformance to all legal directives and the management services agreement between the companies and the management company of the Fund. b) The Company has a representative on the Fund's Board of Directors and in its committees (Company employees have an additional representative). These directors participate in defining the suitable policy for managing the funds, including providing a solution to the risk of average duration gaps between the assets and the liabilities by adjusting, as best as possible, the average duration of the assets to investments, with due consideration of the borrower's risks and investment volume and also investing the major share of Fund assets in NIS linked assets. c) Aiming to reduce the fluctuations in transfers to the Fund, mainly due to the change in the yields curve for capitalizing the actuarial liability, the Company acted to spread the "exceptional debt". On November 15, 2010, the change in the articles of the Main Pension
Fund was approved by the Supervisor of the Capital Market in the Ministry of Finance. 3) Division of Responsibility and the Scope of Authority in the Company’s Management, in Managing the Exposure to Foreign Currency As per the Company’s policy concerning the treatment of exposure deriving from market risks, as detailed above, the head of the Finance Department is authorized to approve transactions, with the exception of currency exchange transactions, interest swap transactions and additional transactions, e.g., options, etc., which require the approval of the Deputy CEO for Finance and Economics. In addition, the Board of Directors has determined that certain Company employees shall perform, on behalf of the Company, hedge transactions in accordance with its policy. A detailed report shall be delivered to the Board of Directors each quarter, as part of the deliberation of the Financial Statements, concerning the currency exposure at the end of each quarter and the hedge transactions carried out over the current quarter. e. Supervising and Realizing the Risk Management Policy
1) Actual Treatment by the Board of Directors As mentioned above, the Board of Directors receives a quarterly report on the subject of the Company’s risk management and exposure to market risks.
32 32 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
2. Details about the exposure to market risks and their management (continued) e. Supervising and Realizing the Risk Management Policy (continued)
2) Company Control Mechanisms The Company's Internal Audit occasionally tracks the performance of decisions made by the Board of Directors and its committees on the subject of exposure to foreign currency.
3) Gains Deriving From Market Risks due to Exposure to Foreign Currency Over the course of the reporting period the Company derived a gain of approximately NIS 123 million as a result of currency exchange transactions. In addition, the Company derived a gain from forward transactions amounting to approximately NIS 117 million. The purpose of hedge transactions is to hedge the Company’s exposure to foreign currency and their results are the reverse of the results of the exposure of the base asset - the Company’s foreign currency liabilities. Therefore, one must note that the aforementioned NIS 240 million gain was offset in part by a loss incurred from loan erosion, on account of which these swap and forward transactions were made. f. Further Details Concerning the Management of Financial Market Risks According to a Circular of the Government Companies Authority According to the January 2005 Government Companies Authority circular, the following details are required from Government companies: 1) The Company maintains a periodic system for the management of financial market risks, by carrying out monthly tracking of its financial liabilities and their hedges. 2) The Company has tracked its liabilities over the reporting period and has performed hedges based upon its needs and according to set policy, after consultation and independent opinions from outside experts. 3) The chances of loss from the various investments, and the Company’s debts as a result of the possibility that the opposing party in the transaction or the Company’s debts will fail to meet their obligations or in the absence of the possibility to legally enforce the existence of a debt, are equal to the balance of these assets in the Company’s balance sheets. 4) The Company has no market risk from off balance sheet positions, as the purpose of these transactions is purely defensive. As a rule, the Company acts in the matter of finances and investments according to law so as to minimize costs and achieve maximum returns, while spreading its investments throughout various banks. This activity, like all Company activities, is examined by the Company’s Internal Audit following accepted auditing standards and according to a work plan approved by the Audit Committee of the Board of Directors. g. Linkage Basis Report Regarding information concerning the linkage terms of the Company's monetary balances as of December 31, 2010, and the same period in the previous year, see the tables in Note 27 to the Financial Statements in Chapter C of this report. h. Sensitivity tests Information on sensitivity tests, see Note 27 to the Financial Statements in Chapter C of this report.
33 33 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
2. Details Concerning Exposure to Market Risks and their Management (continued) i. Derivative Positions According to Company policy detailed in paragraphs d above, the Company has engaged in currency exchange transactions constituting hedging transactions, the balances of which as of December 31, 2010 is a follows:
Currency swap transactions
- The purchase of $90 million in consideration of €90 million for a period of 7 years. The net fair value as of December 31, 2010 is an approximately NIS 105 million obligation.
- The purchase of $140 million in consideration of £95 million for a period of 5 years. The net fair value as of December 31, 2010 is an approximately NIS 24 million obligation.
- The purchase of $7,740 million in consideration of NIS 5,080 million for a period of up to 10 years. The net fair value as of December 31, 2010 is an approximately NIS 311 million obligation.
- The purchase of € 145 million in return for NIS 721 million for a period of up to 2 years. The net fair value as of December 31, 2010 is an approximately NIS 27 million obligation.
- The purchase of £66 million in consideration of NIS 435 million for a period of up to 2 years. The net fair value as of December 31, 2010 is an approximately NIS 108 million obligation.
- The purchase of ¥ 66,500 million in consideration of NIS 2,805 million for a period of up to 2 years. The net fair value as of December 31, 2010 is an approximately NIS 52 million obligation.
- The purchase of € 47 million in consideration of $ 60 million for a period of 7 years. The net fair value as of December 31, 2010 is an approximately NIS 7 million obligation.
- The purchase of $ 400 million in consideration of NIS 1,852.4 million for a period of 25 years. The net fair value as of December 31, 2010 is an approximately NIS 214 million obligation.
Interest Swap Transactions - The purchase of € 150 million, the balance of which on December 31, 2010 is a NIS 3 million obligation. - The purchase of $ 150 million, the balance of which on December 31, 2010 is a NIS 3 million obligation.
In addition, the Company makes use of forward transactions the balances of which as of December 31, 2010 is as follows:
- The purchase of $ 715 million in consideration of NIS 2,758 million for a period of up to one year. The net fair value as of December 31, 2010 is an approximately NIS 199 million obligation.
- The purchase of NIS 1,057 million in consideration of $ 275 million for a period of up to one year. The net fair value as of December 31, 2010 is an approximately NIS 77 million asset.
- The purchase of £ 30 million in consideration of NIS 172 million for a period of up to one year. The net fair value as of December 31, 2010 is an approximately NIS 7 million obligation.
- The purchase of € 50 million in return for NIS 247 million for a period of up to one year. The net fair value as of December 31, 2010 is an approximately NIS 9 million obligation
These financial instrument transactions are carried out with banking institutions and in the Company’s opinion, no losses deriving from credit risks are expected as a result. The balance of transactions as of the date of the balance sheet is the highest balance. The Company does not hold or sell financial instruments for trading.
34 34 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
3. Aspects of Corporate Governance a. Contributions
The Company is prevented from making contributions in light of Government Companies Authority directives. At the same time, the Board of Directors of the Company approved on March 25, 2010, the transfer of computers at the end of their usage period that were designated for scrap, to Ecommunity - Ecology for the Sheltered Community Ltd, which offers ecological end solutions to electronic waste and employs people with special needs to perform the work.
b. Directors Possessing Accounting and Financial Skills In accordance with the Securities Regulations (Periodic and Immediate Statements) - 1970, concerning the reporting on Directors with financial and accounting skills, the Board of Directors has decided that the appropriate minimal number of Directors possessing accounting and financial skills is three, this taking into account, among other things, the size of the Company, its type and character, the complexity of its activities and the number of members of the Board of Directors. In the opinion of the Board of Directors, this number will permit the Board of Directors to meet the obligations imposed upon it in the framework of the new directive, including obligations imposed upon it under law and the Company’s documents of incorporation, especially as it pertains to its responsibility in examining the Company’s financial condition and in issuing and approving Financial Statements.
These Directors have been integrated into committees of the Board of Directors dealing with financial and accounting matters, as follows: Planning and budgeting, finance, balance sheets and offerings, primary tender committee, auditing, properties and construction, organization, manpower and procedures, regulation, marketing communications and customer relations, investments and risk management. For this report, the Company has five Directors possessing accounting and financial skills. The following are their details, denoting the facts from which their Directorships derive, and detailing the committees of the Board of Directors of which they are members:
Ms. Shulamit Eshbol - a lawyer and a CPA. Partner in the Eshbol Borovsly & Co., law firm. B.A. in Accounting from the College of Management and L.L.B in Law from the Herzliya Interdisciplinary Center. Serves as the Chairperson of the Audit Committee at Haifa University for the last three years. Member in the following committees of the Board of Directors: Chairperson of the Environment Committee, Chairperson of the Corporate Governance and Ethical Code Committee, Chairperson of the committee to review the actuarial liability, member of the Strategy Committee, the Assets and Construction Committee, the Regulation Committee and the Finance, Balance Sheet and Issue Committee. Ms. Eshbol ended her term of service on February 10, 2011.
Dr. Ziv Reich, an external Director, CPA, B.A. in Business Management specializing in Accountancy from the College of Management, Tel Aviv, MBA in Administration and Internal Auditing, Bar Ilan University and Ph.D. in Business Management, Warnborough University, London and Dean of the Insurance School and Coordinator of the Accounting studies in Netanya Academic College. Academic lecturer on accountancy, taxation and finance. Author of numerous books on accountancy and taxation. Formerly, Deputy Chairman of the Advisory Committee for Supervision of Financial Institutions in the Ministry of Finance. Chairman of the National Training and Advanced Studies Committee of the Institute of Internal Auditors and CEO of The Ramle Foundation for Education, Culture and Development. Member of the following committees of the Board of Directors: Supreme Tenders Committee; Audit Committee; Finance, Balance Sheet and Issue Committee, Assets and Building Committee and the Environment Committee.
35 35 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
3. Aspects of Corporate Governance b. Directors Possessing Accounting and Financial Skills (continued)
Mr. Avraham Natan, B.A. in Economics and M.A. in Public Administration, Bar Ilan University. During 2004 – 2009, Mr. Avraham Natan served as the Chairman of the Audit Committee and chairman of the Statement of Financial Position Committee of Bank Mizrachi, in this capacity, he acquired experience and knowledge in reading, comprehending and analyzing financial statements. Also served as the Chairman of the Government Company for Medals and Coins, 2002 – 2008. Acts at present as a Director in Kamor Ltd., and Director in the Central Bottling Company Ltd. Member of the following committees: Supreme Tenders Committee, Audit Committee and the Corporate Governance Committee.
Ms. Iris Stark, Managing Partnert of Stark & Stark, Auditors. Holds a CPA title (B.A.) and an (M.A.) degree in economics. Acts as a senior lecturer to managers and directors in courses offered by institutes such as Lahav - The Faculty of Management, Tel Aviv University and in the MBA programs of Bar Ilan University on the subjects of training directors in public and government companies, in fields of corporate governance and internal audit. Member of the following committees: Assets and Building Committee, Audit Committee, Finance Committee and the Corporate Governance Committee.
Mr. Raiek Abu-Rish, CPA and lawyer. Serves as a Director since May 2010. Holds a B.A. in Economics and Accounting from the Hebrew University, Jerusalem. A self employed CPA since 2006, specializing mainly in taxation, audit and finance. Member of the following committees: Finance, Balance Sheet and Issue Committee, Manpower and Procedures Committee, Environment Committee, Marketing Communications Committee, Assets and Construction Committee, Actuarial Liabilities Committee and Strategy Committee.
c. Independent Directors Amendment No. 8 of the Companies Law ("The Companies Law"), defines arrangements aimed at reinforcing the independence of the Board of Directors of a public company, and states, inter alia, that a public company is entitled to include in its Articles a stipulation, whereby independent Directors, in the number defined by the company will serve in its Board of Directors and the company is also entitled to set their percentage out of the serving members of the Board of Directors. The regulation recommends appointing a majority of independent Directors, and in a company with a control holder or a control holder of a concern, one third of independent Directors is sufficient. Since the authority to appoint Directors is granted to the Minister of Finance and the Minister of National Infrastructures in consultation with the appointments review committee, on February 8, 2009 the Company addressed the Government Companies Authority and requested to receive its position and guidelines on adopting the independent Director's arrangement, their number and service period.
The position of the Government Companies Authority as received by the Company on February 24, 2009, is that including a binding stipulation in the articles of a government public company that requires the appointment of a certain number of independent Directors, as defined in Amendment No. 8 to the Companies Law may impose significant limitations on appointing Directors for that company, due to the strict requirements which an independent Director has to fulfill in his relations with the State and entities under its control. On the other hand, it does not seem that such a binding stipulation will contribute to significantly improve the activity of the Board of Directors in the Company and reinforce its independent status, above the current protections provided by the stipulations of the Government Companies Law and the principles of the administrative law.
36 36 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
3. Aspects of Corporate Governance (continued) c. Independent Directors (continued)
Companies regulations published recently (Instructions and Conditions for the Financial Statements approval process) - 2010 ("The Regulations") require that the financial statements will be submitted to the discussion and approval of the Board of Directors after a discussion in the committee for auditing financial statements ("The Committee"). These regulations will be implemented from the preparation date of the financial statements for December 31, 2010. Regulation 3(a) states that the majority of the committee members will be independent directors. Regulation 3(a)(6) states that the legal quorum for discussion and decision making in the committee is the majority of its members, provided that the independent directors make up the majority of those present, with one external director. On March 7, 2011, the Knesset passed Amendment No. 16 to the Government Companies Law, which stipulates inter alia, that the majority of the audit committee of the board of directors will be independent directors (section 115 (a) to the law) and that the legal quorum for a meeting and decision making of the audit committee will be the majority of its members, provided that the majority of the directors present are independent directors, of whom one will be an external director. This amendment will come into force six months after its publication date in the Official Gazette. The said amendment also specifies the definition of an "independent director", stating that an external director will also be regarded as an independent director. This amendment will come into force sixty days after its publication date in the Official Gazette. The Company believes that according to a reasonable interpretation of the Government Companies Law and Regulations, which equalizes in fact the qualification conditions of an independent director to that of an external director, the Company may regard an External Director as an Independent Director even before the said amendment comes into force, since all qualification conditions required for an independent director are fulfilled for each External Director. This interpretation is accepted by the Ministry of Justice and the Government Companies Authority. Therefore, the Committee for Reviewing the Financial Statements may be comprised of a majority of External Directors and the Company is not obliged to classify Directors as "independent".
d. The Company’s Internal Auditor
1) Details of the Internal Auditor a) The Internal Auditor is Mr. Shay Rosenstock, who began his service as the Internal Auditor on August 2, 2009. b) The Internal Auditor conforms to the conditions stipulated in section 146(b) of the Companies Law and to the directives of section 8 of the Internal Audit Law - 1992 ("Internal Audit law"). c) The Internal Auditor is an employee of the Company and does not act in any other capacity in the Company, in addition to the Internal Audit, except for the position of the ombudsman for public and employees' complaints. Fulfilling these additional roles does not affect his ability to perform his primary role. d) The Internal Auditor does not have any material business relations or other material relations with the Company and does not hold any position outside the Company which creates, or may create, a conflict of interests with his role as an Internal Auditor. e) The Internal Auditor was appointed, inter alia, in accordance with the Company procedure on the subject - "choice, approval and the appointment of senior employees" (determined in accordance with the provisions of Article 32 (a) (5) of the Government Companies Law). f) On March 17, 2011, the Company's Board of Directors decided to adopt the recommendation of the Audit Committee and appoint Mr. Igal Harel as the Acting Internal Auditor until a permanent Internal Auditor will be appointed. See details in Section 12 below. 37 37 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
3. Aspects of Corporate Governance (continued) d. The Company’s Internal Auditor (continued) 2) Appointment Process On April 23, 2009 the Audit Committee recommended to the Board of Directors that Mr. Shay Rosenstock should be chosen for the position of an internal auditor of the Company, according to recommendations received and in light of the added value he brings, of a different view of the system, the managing experience, professional knowledge and his personality. This recommendation of the Audit Committee was submitted to meeting No. 1273 of the Board of Directors on April 30, 2009, where it was decided that: "the Board of Directors chooses Mr. Shay Rosenstock, as the Internal Auditor of the Company and Mr. Yigal Harel as the qualified substitute. The appointment of the Internal Auditor is for a trial year. The permanent appointment will be submitted to the approval of the Board of Directors at the end of the trial year".
3) Identity of the Supervisor of the Internal Auditor a) The CEO and the Chairman of the Board of Directors of the Company supervise the Internal Auditor and Public Complaints Commissioner on behalf of the organization. b) The identity of the supervisors conforms to section 49 of the Government Companies Law. c) The obligations and the authorities of the Internal Auditor are set in the procedure “The Internal Audit and Public Complaints Commissioner” on the Company. The Internal Audit procedure is approved by the Audit Committee.
4) Work Plan a) Work plans of the Internal Audit previously included a multi-year schedule and an annual work plan. The annual work plan was based on results of a risk analysis - structure and process for five years (2008 - 2012), approved by the Audit Committee of the Board of Directors in December 2007. An update of the risk analysis was approved by the Audit Committee of the Board of Directors in December 2008. The temporary work plan of the internal audit for 2010 was approved by the Audit Committee of the Board of Directors on December 17, 2009 and by the Board of Directors on December 24, 2009. The plan is based mainly on results of the aforementioned risks analysis. In August 2009 the Internal Audit started a general processes risks review. The risks review served as the basis for outlining a new multi-year work plan for the Internal Audit for the years 2011 - 2013. The risks review was completed in March 2010 and presented to the Audit Committee in April and June 2010. The multi-year work plan (2011-2013) and the updated work plan for 2010 were submitted to and discussed by the Audit Committee in July 2010. The Audit Committee recommended that the Board of Directors will approve the plans. The multi-year work plan and the updated plan for 2010 were approved by the meeting of the Board of Directors in December 2010.
b) The Internal Auditor submits a proposed annual work plan, in coordination with the Chairman of the Board of Directors, the Chairman of the Audit Committee and the CEO. The annual work plan is discussed and approved by the Audit Committee and by the Board of Directors. The work plan for 2011, based on the risks review and the multi-year work plan were recommended by the Audit Committee and approved by the Board of Directors in December 2010.
c) Demands to perform audit tasks and sometimes audits with higher priority than other tasks during the work year are initiated by the Chairman of the Board of Directors, the Chairman of the Audit Committee, the CEO, members of the Board of Directors and the Internal Auditor. In addition, the Internal Audit conducts additional audits that are not planned in advance during the year, pursuant to audit reports of the State Comptroller and pursuant to direct and anonymous complaints received at the Company. All these are integrated in the work plan within the approved scope of the plan. 38 38 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
3. Aspects of Corporate Governance (continued) d. The Company’s Internal Auditor (continued)
The Internal Auditor prepares an annual report every year, summarizing the Internal Audit reports completed during that year. The semi-annual report and the annual report of the Internal Audit are submitted to the Chairman of the Board of Directors, the Chairman of the Audit Committee of the Board of Directors and the CEO d) The Internal Auditor submitted in 2010 an audit report on the subject of transactions that require special approvals – exceptional transactions with shareholders that took place up to December 2009. The material transactions in 2010 were not yet audited by the Internal Auditor. e) The Internal Audit submitted audit reports, including follow-up reports in the area of computerized information systems during the reporting period, January - December, 2010.
5) Audit of Held Companies a) Work plans of the Internal Audit include, from time to time, audit of the subsidiaries. b) An independent Internal Auditor was appointed for the National Coal Supply Corporation.
6) Scope of Employment a) The Internal Audit has 43 budgeted positions for employees who perform audits and handle public and employees complaints (including secretaries and administrators). The Internal Auditor clarifies complaints from the public, including employee complaints, assisted by employees of the Internal Audit. In addition, the Internal Auditor engages outsourced audit services. b) According to the multi-year work plan, as recommended for approval in July 2010, by the Audit Committee and approved by the Board of Directors in December 2010, the Internal Auditor estimates that the work scope of the Internal Audit enables audits of material issues in the Company about once every three years.
7) Performance of the Audit a) As stated by the Internal Auditor, audits are conducted according to accepted professional standards of Internal Auditing, in accordance with the applicable laws and in conformance to the Internal Audit Law and to the directives of the Government Companies Authority, furnished from time to time in circulars of the Government Companies Authority. b) The Board of Directors and the Audit Committee assess that the Internal Auditor conformed to the requirements specified in the professional standards.
8) Access to Information The Internal Auditor and his representatives are granted free, continuous and direct access to every hard copy or digital document, data, database, or information, including financial data, for performing their tasks. The Internal Auditor and his representatives are entitled to enter every asset and inspect it, in conformance with the contents of section 9 of the Internal Audit Law.
39 39 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
3. Aspects of Corporate Governance (continued) d. The Company’s Internal Auditor (continued)
9) Reports of the Internal Auditor a) Reports of the Internal Auditor are submitted in writing. The Internal Auditor submits a summarized report of the work of the Internal Audit and a follow-up report on implementation of decisions and recommendations. b) During the work year, the Internal Auditor submits final versions of audit reports to the Chairman of the Board of Directors, to the CEO and to the Chairman of the Audit Committee of the Board of Directors. Audit reports are submitted to the members of the Board of Directors, to members of Management and to the audited entities through the Secretary of the Board of Directors. The semi-annual reports submitted by the Chairman of the Board of Directors to the Finance and Infrastructures Ministers and to the Manager of the Companies Authority include a report on the performance of the Internal Audit in the Company. c) During January - December, 2010, the Internal Auditor presented 132 reports: 76 audit reports, 46 examination reports, 2 summaries, 7 risks review reports and a summarizing report on the data of the master processes risks survey. During this period, the Audit Committee of the Board of Directors held 10 discussions on the Internal Auditor’s findings and recommendations which took place on January 7, 2010, February 11, 2010, March 18, 2010, April 28, 2010, May 13, 2010, June 24, 2010, July 15, 2010 and August 19, 2010, October 7, 2010 and December 9, 2010.
10) Evaluation of the Board of Directors of the Internal Auditor’s Activities According to the new proposed multi-annual plan, the Internal Auditor estimates that the scope of the Internal Auditor’s activities allows the auditing of material subjects once every 3 years or so. This scope, the character and continuity of the Internal Auditor’s activities and his work plans are, in the Board of Director’s estimate, reasonable and are capable of realizing the Company’s Internal Auditing goals.
11) Wages The Internal Auditor is an employee of the Company, employed on an individual contract. The Board of Directors estimates that the wages do not affect the ability of the Internal Auditor to exercise his professional consideration.
12. Miscellaneous a. Mr. Shay Rosenstock was appointed as the internal auditor of the Company for 5 years, where the first year was defined as a trial year and the permanent appointment will be granted according to the results of that year. On July 29, 2010, at the end of the trial year, the Audit Committee of the Company decided to recommend that the Board of Directors should not approve the appointment of Mr. Rosenstock as the internal auditor of the Company for a fixed term. The Board of Directors of the Company decided to extend the trial period of Mr. Rosenstock beyond the trial year, to grant Mr. Rosenstock an opportunity to present his claims to the Board of Directors and enable the Board of Directors to reach a considered decision on the subject. On August 12, 2010, the Board of Directors received a letter from the Manager of the Ombudsman’s Office of the State Comptroller's office, of August 9, 2010, with an attached letter from the Internal Auditor of the Company. In his letter of August 4, 2010, Mr. Rosenstock requests that the Ombudsman’s Office exercise the authority vested in it by force of Article 45C of the State Comptroller Law – 1958 [integrated version] ("State Comptroller Law"), to give him a protection order to prevent the "dismissal process" initiated against him. In his appeal to the Ombudsman’s Office, the Internal Auditor complained that the purpose of the dismissal process it to prevent him from performing his duties in examining 40 40 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
3. Aspects of Corporate Governance (continued) d. The Company’s Internal Auditor (continued)
complaints he received on suspected failure of two directors in the Company (who are also members of the Audit Committee) to report the existence of a conflict of interests in their actions. The Manager of the Ombudsman’s Office informed that the State Comptroller expects that no actions which can change the legal or factual status of the internal auditor, relating to his status, position and authority will be taken during the investigation of the internal auditor's complaint. The Commissionaire will consider the need to exercise his authority according to Article 45C of the State Comptroller Law, namely, to issue a protective order as requested by the auditor, after receiving the Company's response. The Company acted accordingly. On February 6, 2011, the Company received the report of the Ombudsman’s Office. The main findings, as presented in the report’s conclusion, are as follows: "Ultimately, after a thorough examination of the investigation’s materials, we do not have a sufficient basis to determine that the employment termination process of the claimant was initiated in response to actions taken by the claimant to investigate the two anonymous complaints against the directors. As for the course of the process to terminate the employment of the plaintiff as the Internal Auditor, we found that the concept of the Company to regard the first year of his tenure as a trial period was erroneous and contrary to the law and the position of the Government Companies Authority. As a result of understanding the process as refusal to appoint to a permanent position and not as the termination of employment, several of the Audit Committee members assumed that relatively lesser arguments will be sufficient to terminate the employment of the plaintiff in the Company, compared to a process intended to terminate employment after a permanent position has been granted. This assumption, which was a decisive factor in understanding their considerations, was erroneous. As for the correct conduct of the process, we found fundamental faults that touch on the roots of the issue that violated the right of the auditor to a full and real hearing, as required by the law. The result is that the decision of the Audit Committee to recommend that the Board of Directors “shall not grant a permanent appointment” to the plaintiff in void. Upon receiving the Ombudsman’s report on the subject, the Internal Auditor addressed a request to the Chairman of the Board of Directors to end his position in the Company. The request of the Internal Auditor was granted and he signed an agreement for the termination of his employment. The employment termination agreement of Mr. Rosenstock is subject to the approval of the Board of Directors and also other approvals required by the law. The employment termination agreement of the Internal Auditor was approved on February 17, 2011. On March 3, 2011, Mr. Rosenstock ceased acting as the Internal Auditor of the Company. On March 3, 2011, the Audit Committee recommended to the Company's Board of Directors that the Acting and Deputy Internal Auditor, Mr. Igal Harel, will act as the Internal Auditor from the resignation date of the Internal Auditor, Mr. S. Rosenstock, according to his employment termination agreement, until the Board of Directors will appoint a permanent Internal Auditor, after the Audit Committee will propose a candidate, who will be chosen through a process according to the Circular of the Government Companies Authority on the subject of Appointing an Internal Auditor 2010-1, and according to any law applied to the appointment of an internal auditor. The recommendation of the Audit Committee was approved by the Board of Directors on March 17, 2011.
41 41 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
3. Aspects of Corporate Governance (continued) d. The Company’s Internal Auditor (continued)
b) Review of the audit quality, as required by the Government Companies Circular of December 12, 2010, will be performed during 2011. The review of the internal audit quality will be performed on two levels: The first level will relate to reviewing the internal audit system in the Company. This review will examine, inter alia, the interface between the Audit Committee and the internal auditor and other organs in the Company (Board of Directors, Management, etc.). The second level will audit the quality of the work of the internal auditor and his team. This level will examine whether the internal auditor functions as required to promote the Company's internal audit objectives.
e. Fees of the Outside Auditor Pursuant to section 36a(b) of the Securities Law - 1968, the total fees to which the outside auditor was entitled in respect with audit services and other services relating to the years 2009 – 2010 are detailed below:
For the year ended on December 31 2010 2009 Brightman Almagor Brightman Almagor Zohar & Co. Zohar& Co. firm firm Hours NIS'000 Hours NIS'000 a. Fees for audit services, for services related to audits and for tax services 14,000 3,080 11,550 1,740
b. Other fees - total fees for services provided by the outside auditor which are not included in paragraph 13,000 2,860 14,100 2,600 (a) above
Details of types of services included in the amounts in paragraph (b): 1. Accompanying the company in its preparations for implementing Government Company Regulations on the subject of the testing of effectiveness of the internal controls on financial reporting. 2. Performance of special examinations in accordance with directives of the Government Companies Authority. 3. Preparation of opinions, in accordance with the requirements of State authorities and/or on accounting and other subjects. 4. Accompanying the company in internal discussions with external parties. 5. Issuing various certifications. 6. Effects of the new rate base structure on the financial statements. 7. Prospectus for abroad.
42 42 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
3. Aspects of Corporate Governance (continued) f. Financial Report Approval Process
In accordance with Securities Authority directives dated July 23, 2007 and February 21, 2011, concerning financial report approval procedures for a reporting corporation (according to Section 36a(b) of the Securities Act 1968), the Company must provide information concerning the Financial Statement process and supervision, as follows:
1) The Committee for Reviewing the Financial Statements On January 27, 2011, the Board of Directors approved the establishment of the Committee for Reviewing the Financial Statements. The Committee for Reviewing the Financial Statements is not the Audit Committee of the Board of Directors.
2) Members of the Committee for Reviewing the Financial Statements a. Dr. Ziv Reich, CPA, an External Director, acts as the Chairman of the Committee, has accounting and financial expertise. Dr. Ziv Reich, CPA, B.A. in Business Management specializing in Accountancy from the College of Management, Tel Aviv, MBA in Administration and Internal Auditing, Bar Ilan University and Ph.D. in Business Management, Warnborough University, London. In the last five years, Dean of the Insurance School and Coordinator of the Accounting studies in Netanya Academic College. Academic lecturer on accountancy, taxation and finance. Acts as the Deputy Chairman of the Advisory Committee for Supervision of Financial Institutions in the Ministry of Finance. Chairman of the National Training and Advanced Studies Committee of the Institute of Internal Auditors, Member of the Professional Advisory Committee of the Securities Authority and CEO of The Ramle Foundation for Education, Culture and Development. Acts as a Director and Chairman of the Investments Committee in Tamir Fishman & Co and a Director in Pilat Ltd. Dr. Reich, CPA, signed a statement about his education and experience on March 1, 2011.
b. Ms. Iris Stark, CPA, Committee member, has accounting and financial expertise. Ms. Stark, CPA, holds a B.A. in Economics and Accounting and an M.A. in Economics from Bar Ilan University. In the last five years is a partner of Stark & Stark, Accountants. Acts as a lecturer on corporate governance on the subject of corporate law and non-profit institutes in academic institutes and Faculties of Management. Up to August 2007, acted as Chairperson of the Board of Directors of Ashdod Port Company Ltd. Acts as a Director and Chairperson of the Audit Committee in Bank Massad, of Beinleumi Group, Director and Member of the Audit Committee in the Compensation and Pension Fund of the Employees of the Jewish Agency Ltd., Member of the Management Board of Kibbutzim College of Education, Technology and the Arts, Chairperson of the Audit Committee of the Technology Teaching College, Jerusalem, Director in Shemesh Fund, founded by Rashi Fund and in Safra Foundation for encouragement of young entrepreneurs, Member of the CPA’s Council and Vice President of the Institute of CPA’s in Israel. Ms. Stark signed a statement about her education and experience on March 2, 2011.
c. Ms. Dorit Inbar, External Director, Committee member. Law graduate of Tel Aviv University and MBA in Business Management, Tel Aviv University. In the last five years acted as the Vice Chairperson of the Israel Broadcasting Authority, lectures in Tel Aviv University and the Academic College Tel Aviv-Yaffo and is the CEO of the New Israeli Foundation for Cinema and TV. Acts as a Director in the Management of the Israeli Opera and Member of the Management Board and of the Board of Trustees of Beit Berl College.
3) Financial Statements Approval Process in the Committee for Reviewing the Financial Statements The Committee for Reviewing the Financial Statements, in its authority according to the Government Companies Regulations (Directives and Conditions Related to the Approval of the Financial Statements) - 2010, reviews the material issues in the financial reporting and 43 43 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
3. Aspects of Corporate Governance (continued) f. Financial Report Approval Process (continued)
decides on a recommendation to the Company's Board of Directors, on several subjects, including the following: a) Valuations and estimates prepared for the Financial Statements. b) Internal controls related to the financial reporting. c) Complete and adequate disclosure in the Financial Statements. d) The adopted accounting policies and the accounting treatment applied to material affairs of the Company. e) Valuations, including the assumptions and estimates that served as the basis thereto, that is used as the basis for the data in the Financial Statements. The Committee also reviews various aspects of control and risk management, both aspects reflected in the Financial Statements and aspects that affect the reliability of the Financial Statements. The Company's Board of Directors is the organ that discusses and approves the Financial Statements, after the Members of the Board of Directors receive the draft of the Financial Statements and the recommendations of the Committee for Reviewing the Financial Statements at least three business days before the meeting, which is a reasonable time, in light of the volume and complexity of the recommendations. The meeting of the Board of Directors and of the Committee for Reviewing the Financial Statements, that discuss and approve the Financial Statements are attended by the external auditor of the Company as well as external consultants on various subjects, whose opinions are included and attached to the statements, or whose opinions were used as the basis for setting values included in the Financial Statements. These participants usually add clarifications, explanations, comments and elucidations about the Financial Statements and provide answers to questions and clarifications asked by Members of the Board of Directors and the Committee, prior to approval thereof. All the Members of the Committee for Reviewing the Financial Statements met on February 17, 2011, March 3, 2011, March 16, 2011, March 22, 2011, March 23, 2011, March 30, 2011 in order to decide on its recommendations to the Board of Directors. These meetings were also attended by Mr. Harel Zeev Blinde, VP Finance and Economics, Legal Advisor and the Company Secretary Mr. David Yahav, attorney, representatives of the external auditor and the acting Internal Auditor Mr. Igal Harel. Also attending for specific subjects - Mr. Yiftah Ron-Tal, Chairman of the Board of Directors, Mr. Amos Lasker, CEO, or Mr. Moshe Bachar, Deputy CEO. The meetings were also attended by Directors, and additional Company employees for some of the Meetings, depending on the subject.
4) The Nature of the Organs Responsible for the Approval Process of the Financial Statements The Company’s Board of Directors headed by Mr. Yiftah Ron-Tal, the Committee for Reviewing the Financial Statements headed by Dr. Ziv Reich, CPA, acting as the Chairman, Ms. Iris Stark, CPA, Ms. Dorit Inbar, as well as CEO Mr. Amos Lasker and Senior VP of Finance and Economics, Harel Zeev Blinde.
The following are the dates of meetings with respect to overall control, including the names and positions of participants:
44 44 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
3. Aspects of Corporate Governance (continued) f. Financial Report Approval Process (continued)
Meeting of the Committee for Reviewing the Financial Statements and Issuances on March 30, 2011: Dr. Ziv Reich Chairman of the Committee Ms. Dorit Inbar Committee Member Ms. Iris Stark Committee Member Representatives of the External Auditor Brightman Almagor Zohar & Co. firm Mr. Harel Zeev Blinde Senior Vice President, Finance and Economics Consultants representatives of Kesselman Finances accountants Mr. David Yahav, attorney Legal Advisor and Company Secretary Mr. Igal Harel Acting Internal Auditor
Meeting of the Board of Directors on March 31, 2011: Mr. Yiftah Ron-Tal Chairman of the Board of Directors Mr. Amos Lasker Chief Executive Officer Mr. Harel Zeev Blinde Senior Vice President, Finance and Economics Dr. Ziv Reich Board Member Mr. Raiek Abu-Rish Board Member Ms. Shulamit Eshbol Board Member Mr. Yossi Vadana Board Member Mr. Shimon Eckhaus Board Member Ms. Shlomit Barnea-Farago Board Member Ms. Rochelle Don-Yechiya Board Member Ms. Yaffa Vigodsky Board Member Ms. Dvorah Chen Board Member Mr. Avraham Natan Board Member Ms. Dorit Inbar Board Member Ms. Iris Stark Board Member Ms. Sarit Giladi-Dor Company's Spokeswoman Mr. David Yahav, attorney Legal Advisor and Company Secretary
5) Steps Taken by Persons Entrusted with Overall Control in the Company The Company acts in accordance with the directives of the Government Companies Authority published in the Regulations - Additional Report Concerning Actions Taken and Representations made to Ensure Correctness of the Financial Statements and the Directors’ Report-2005 (hereby: “the Regulations”), according to which Government companies, the Company among them, must attach to their Financial Statements, both yearly and quarterly, an additional report in which Company officers responsible for setting and enforcing controls and procedures in the Company declare, for the purpose of the disclosure required for the reports, that controls and procedures in question have been set, in order to ensure the correctness of the Financial Statements and the Directors’ Report. After the completion of the Financial Statements and their approval by the Senior Vice President, Finance and Economics and CEO of the Company, the reports are transferred to the office of the Board of Directors. The Financial Statements are brought before the Committee for Reviewing the Financial Statements and the plenum of the Board of Directors for discussion and approval (as part of the discussions of the Committee for Reviewing the Financial Statements and after a discussion in this Committee and its recommendation to approve the Financial Statements, the plenum of the Board of Directors discusses the approval of the Financial Statements. The salient points of data, findings and conclusions in the report drafts are presented and noted). The external auditor of the Company and its legal advisor also participate in the meeting as noted above.
45 45 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
3. Aspects of Corporate Governance (continued) f. Financial Report Approval Process (continued)
After the aforesaid discussion and answers to questions and comments from members of the Board of Directors that are prepared in advance or brought up during the meeting of the Board of Directors, the Financial Statements are approved in a voting process. The Company has formulated a “Workings of the Disclosure Committee on the Subject of Disclosure in the Financial Statements” procedure, which includes the formation of a Disclosure Committee for the purpose of, among other things, confirmation, implementation and execution of examinations of control effectiveness over the periodic Financial Statements, including verification that the information contained in the reports is complete, accurate and proper, as well as for confirming controls and procedures ensuring the disclosure of the aforementioned information and the assessment and reporting of their effectiveness, discussion of inherent weaknesses that require disclosure, reporting and tracking of the correction of these weaknesses, etc. The findings and recommendations of the committee are reported to the Senior Vice President - Finance and Economics. In addition, the Company has set a “Working Procedure for the Approval of Financial Statements, Changes in Critical Accounting Policies and Changes in Actuary Premises”, which sets in place, among other things, a discovery, treatment and reporting mechanism concerning events and information that may influence critical accounting policies and/or actuarial assumptions according to which the Company operates, including transferring reports and discussions to the appropriate Company persons, comprising the Senior Vice President - Finance and Economics, the Senior Vice President - Human Resources, the CEO, the Chairman of the Committee for Reviewing the Financial Statements, Members of the Committee for Reviewing the Financial Statements, the Chairman of the Board of Directors and members of the Board of Directors.
4. Instructions for Disclosure Related to the Financial Reporting of the Corporation A. Events that Occurred after the Statement of Financial Position Date
1) Directors Appointment and Retirement On January 22, 2011, Mr. Izhak Elyashive ended this term as a Director in the Company. On February 2, 2011, Mr. Philip Mandelker ended his term as a Director in the Company. On February 10, 2011, Ms. Shulamit Eshbol ended her term as a Director in the Company. 2) - On February 14, 2011, the Internal Auditor ended his term of employment. See Section 3 d herein for more details. On March 17, 2011, Mr. Igal Harel was appointed as the Internal Auditor until a permanent Internal Auditor will be appointed - On March 15, 2011, Ms. Shulamit Barnea-Fargo was reappointed as a Director in the Company. - On March 17, 2011, the Company's Board of Director decided to appoint Mr. Eli Glickman as the CEO of the Company. - On March 20, 2011, Mr. Amit Oberkovitch ended his term as a Director in the Company and was appointed asthe Deputy Manager for Human Resources Planning and Development in the Company at the Human Resources Division 3) On January 18, 2011, the Company completed a private issue of debentures. See Note 18 to the Financial Statements for details. For other events, see details in Note 36 to the Financial Statements in Chapter C of this report.
46 46 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
4. Instructions for Disclosure Related to the Financial Reporting of the Corporation
B. Critical Accounting Estimates 1) See Note 2 aa to the Financial Statements in Chapter C of this report for more details on the critical accounting estimates applied to the different subjects in the Financial Statements. 2) Actuarial changes in the reported year are as follows: Beginning with the actuarial estimate of the obligation as of September 30, 2010, the Company decided to adopt the recommendation of the Company's actuary, based on a research he conducted on the subject, and change the assumption of age differences between spouses. In previous estimates, the assumption was based on Table 10p in the "Circular of the Ministry of Finance", while the current assumption uses an adjusted table for a male employee/pensioner. The effect of the change amounts to an approximate decrease of NIS 75 million in the obligation. The Company also decided to implement the recommendation actuarial estimate of the obligation as of December 31, 2010, and change as follows: 1. Regarding the assumption of compensation in a special agreement - the wages increase rate and forecast departure rates of the relevant population was changed and its effect is approximately NIS 0.3 million. 2. The assumption of compensation upon departure was changed to zero, due to zero probability of employees leaving without pension. The effect of this assumption is approximately NIS 14 million increase of the obligation. 3. The Company based the early retirement assumption on its past experience in early retirement rates during 2002-2010, excluding retirements under special offer programs. The effect of the change of this assumption is a decreased liability of approximately NIS 62 million. These updates do not have an effect of the statement of financial position and the statement of operations of the Company as of the Financial Statements date, due to spreading mechanism of IAS 19, as implemented by the Company
3) Analysis of the sensitivity to change according to key factors and estimates as of December 31, 2010:
Actuarial Assumptions The Change Increase The Change Decrease Capitalized interest rate 0.1% 280 -0.1% 273 Salary increase rate 0.5% 545 - 0.5% 505 Pension increase rate 0.5% 700 - 0.5% 649
47 47 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
4. Instructions for Disclosure Related to the Financial Reporting of the Corporation (continued) C. Material and Highly Material Valuations
1) In accordance with Section 8b of Chapter 1 of the Securities Regulations (Periodic and Immediate Reports) – 1970 (The following regulations) and also according to the legal position No. 105-23 of the Securities Authority on the subject and the attached clarification: When a material valuation serves as the basis to determine the value of data in a periodic report, including determining that there is no need to change the value of the data, the report will disclose different parameters detailed in the regulations and in the event of a highly material valuation, it will be attached to the report. 1. The Securities Authority determined "quantitative" tests (statement of financial position test and results test) to examine the materiality of the valuations. Nevertheless, the Securities Authority stated that an alternative test may be defined, where a qualitative examination of the features of the corporation justify it. According to the results test, as determined by the Securities Authority, the effect of the change in value arising from the valuation related to the total net or comprehensive profit respectively, of the Company in the reporting period ("The Result Test of the Securities Authority"). The Company is of the opinion that the profit test (the Results Test) of the Security Authority, is not a reflective test of the Company, considering the unique features of the Company and its activities, as detailed below: a. The Company's profit is low in relation to the volume of operations of the Company and is highly affected by fluctuations of external parameters. b. The revenues of the Company are based on a rate determined by the Electricity Authority. c. The Company is subject to regulatory supervision. It has no control on its revenues, since the rate is predetermined and the quantity is affected by rigid demand. d. The Company believes that the profitability index is of secondary importance compared to criteria of financial soundness and the ability to repay obligations. e. The high differences in profit both in annual and quarterly results depend on factors outside of the Company's control. f. A considerable part of the Company's operations is in investment, which is not expressed in the net profit results. The Company concludes from this data that the Result Test of the Securities Authority is not the suitable tool for examining the materiality of a valuation in the Company. In light of the qualitative considerations specified in section a-f above, the Company concluded that the results test, as defined by the Securities Authority, is not a suitable tool for reviewing the valuation materiality of the Company. The Company will examine the materiality of the valuations according to a different quantity results test that reflects correctly the materiality subject in valuations in the Company's financial statements.
The Company will examine the materiality of the valuation according to the following tests: 1) Statement of financial position test – to examine the valuation in relation to the total assets of the Company, as presented in the Consolidated statement of financial position as of the last date of the reported period (identical to the statement of financial position test determined by the Securities Authority). 2) Result test – to examine the effect of the change in value as a result of the valuation on the normative profit of the Company, namely, the theoretical expected profit as determined by the regulator - the Electricity Authority (instead of the Result Test of the Securities Authority). A valuation that maintains a ratio of 10% or more will be considered highly material A valuation that maintains a ratio of 5% or more will be considered material. The materiality of the valuations will be examined separately for each stand alone asset/liability, provided that there is no dependence between certain assets to certain liabilities requiring an examination as one group. The subject was submitted to the Committee for Reviewing the Financial Statements and these tests were approved by the Board of Directors. 48 48 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
4. Instructions for Disclosure Related to the Financial Reporting of the Corporation (continued) C. Material and Highly Material Valuations
2. Company valuations, used as the basis for determining the value of data in the Financial Statements on the following subjects: a. Very High Materiality Valuations The Company has very high materiality valuations on the subjects: 1. Assets impairment in accordance with IAS 36. 2. Actuarial obligation with respect to benefits to employees according to IAS 19. These valuations are attached in annexes to the Financial Statements. In accordance with Regulation 8b(i) of the Securities presented below information regarding the very fundamental valuation of the company:
Identification of Valuation subject Assets impairment Actuarial obligation for employee An impairment examination of benefits in accordance with Company's assets when IAS 36 are IAS 19 implemented – assets of the three operation segments of the Company The timing of the evaluation: December 31, 2010 December 31, 2010 Evaluation subject value immediately before the valuation date had generally accepted accounting principles, including depreciation and amortization, not required the change in value according to the valuation; NIS 63,997 million NIS 17,857 million Determined in accordance with the Minimum useful value of NIS evaluation 64,128 million Identifying assessor and its Kesselman Finance Assessment was carried out by Ernst characteristics: Pricewaterhouse Coopers Ltd. & Young (Israel) Ltd. (Kesselman Finance) under the (hereinafter: Ernst & Young) direction of Mr. Tzur Fenigstein, by Emanuel Berzack and the CPA with an MBA with Actuarial department staff supervise Honors with a BA in d by him. Emanuel Accounting and Economics. Both Berzack B.Econ.Sc. (Actuarial Statis from Tel Aviv tics) University Witwaterstand, Sout University. Tzur is a partner h Africa, and is in Kesselman & authorized Actuary (full member of Kesselman PricewaterhouseCooper the Israel Association of Actuaries - s Accountants, Finance and FILAA, and the Institute Economics Practice Leader at of Actuaries in England - FIA). His Kesselman Finance professional experience - over the PricewaterhouseCoopers Finance L past 12 td. ("Kesselman Finance"). His years includes actuarial estimates of experience includes project employee benefits of similar types to management and that of the Company, research in strategic pension liabilities of pension funds, financial advice, preparation of insurance liabilities expert opinions, preparation of insurance companies, duties of an of economic work in public actuary or an examining policy and regulation, actuary examines or auditor. evaluation and assessment of companies business plans
49 49 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
4. Instructions for Disclosure Related to the Financial Reporting of the Corporation (continued) C. Material and Highly Material Valuations
Dependency in evaluation No On March 29, 2011 the new actuary orderer of the Company from Ernst & Young (Israel) Ltd., who provides actuarial services to the Company from the first quarter of 2010, received a letter of indemnification from the Company. For details, see Note19a.2)(e)Chapter C of this report. Evaluation model which the DCF DCF appraiser used Assumptions according to The discount rate (or WACC); 4.98% Weighted grossed up interest rate in which the in generation segment, 5.31% in the current value of the liability is appraiser performed the valua Network segments 2.88% Real update of salary during tion, depending on the Forecast of future cash flows, expected the work period model estimates: to derive from a cash generating unit Individual salary development model was based on current rate base structure of active employees and including and based on assumptions representing, salary increase between current inter alia, the economic conditions that salary agreement or general future will exist during the useful life of the salary agreements (offsetting assets of the units, most important of inflationary effect). Real update of which are: pension amounts after employment - The current rate base structure of the termination – individual pension generation segment, as determined in development model of pensioners February 2010, will end at the end of (offsetting inflationary effect). 2014, the new rate will be effective Pensioners and survivors mortality early 2015. including updating mortality rates – - The new rate base of the transmission according to the Ministry of Finance and distribution segments is expected circular of May 17, 2007. to take effect between August 2011 and For additional actuarial assumptions, February 2012. see the Actuary's Opinion Annex. - In examining cash generating units, the company has identified three segments of the company as one cash generating unit. - the new rate base of the three operations segments of the Company will provide full coverage for investment and operational costs of the Company, in accordance with the Electricity Sector Law. - Fuel costs which the company will incur will be covered in electricity rate throughout the forecast period. - The weighted cost of capital (WACC) for calculating the return on equity. Discount rates taken into account in calculating the recoverable amount are: 5.31% per the generation segment, 4.98% per network segments. Such values reflect the time value of money, and the specific risks as determined in the electricity rate for each operation segment.
50 50 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
4. Instructions for Disclosure Related to the Financial Reporting of the Corporation (continued) C. Material and Highly Material Valuations
a) These valuations are attached in the Annexes to the Financial Statements b) Disclosure of non – material valuations, which if classified according to the results test of the Authority would have presented a very high materiality.
According to tests adopted by the Company valuations of subjects which are immaterial, yet according to the result test of the Authority, these valuations are viewed as material. 1. Fund - Central Pension Fund The Company deposits funds to cover pension liabilities for pension for employees included in the pension plan in the Central Pensions Fund. Ss of May 1, 2010, Infinity - Administrating the Main Pension Fund Ltd., started managing the fund. Applying the Company's tests for examining the materiality of the valuation led to the conclusion that a valuation on this subject is non-material. See details in Note 19 to the Financial Statements in Chapter C in this report. 2. Hedging Transactions - the Company entered into foreign currency hedging transactions (mainly swap and forward transactions) in order to match the structure of expenses to the recognized structure of revenues (composition of the Bank of Israel's Basket of Currencies). For detailed types of expenses, see Note 27 in Chapter C of this report.
According to the guidelines of the Securities Authority, details of the results of quantitative tests, applied to these valuations, namely, the statement of financial position test, the results test (the normative profit test) and the results test of the Securities Authority are presented as follows:
Examining the effect of the change in value according to the results test of the Electricity Authority is based on the change in value after tax, while examining the effect of the change according to the normative profit change is based on the valuation before tax, since the normative profit is a profit before tax.
51 51 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
4. Instructions for Disclosure Related to the Financial Reporting of the Corporation (continued) C. Material and Highly Material Valuations
Subject Statement of financial Result Test of the Result of Normative position test Securities profit test Authority 1. Fund – non-negotiable assets Deposits in Mizrahi Tefahot 1.6%=1,298/79,267 3000%= 30/1 V.H 3.5%=40/1,159 Bank Non-material material Non-material Deposits in Bank Hapoalim 1.9%=1,526/79,267 3500%=35/1 4%=46/1,159 Non-material V.H material Non-material
DEUTSCHE BANK Bonds 0.1%=76/79,267 200%=2/1 0.3%=3/1,159 Non-material V.H material Non-material UBS VAR 28.07.18 Bonds 0.07%=58/79,267 140% =1.4/1 0.2%=2/1,159 Non-material V.H material Non - material Israel Corporation Ltd Bonds 0.06%=49/79,267 160%=1.6/1 0.2%=2/1,159 Non-material V.H material Non-material Mekorot Bonds 0.2%=189/79,267 300%=3/1 0.4%=4/1,159 Non-material V.H material Non-material Hayovel Lines Ltd Bonds 0.1%=85/79,267 200%=2/1 0.3%=3/1,159 Non-material V.H material Non-material Netivim Series A Bonds 0.06%=50/79,267 130% =1.3/1 0.2%=2/1,159 Non-material V.H material Non-material F.I.B.I. Investments Ltd Bonds 0.05%= 36/79,267 100%=1/1 0.09%=1/1,159 Non-material V.H material Non-material Delek Group Bonds 0.07%=55/79,267 100%=1/1 0.2%=2/1,159 Non-material V.H material Non-material Investment Fund - FIMI 0.01%=4/79,267 6%=0.06/1 =0 0/1,159 Capital Non-material V.H material Non-material Elad Group Bonds 0.01%=10/79,267 30%=0.3/1 =0 0/1,159 Non-material V.H material Non-material Investment Fund – Manof Fund 0.04%= 32/79,267 12%=0.12/1 =0 0/1,159 Non-material V.H material Non-material TELOS 2006-1X 0.01%=4/79,267 7%=0.07/1 =0 0/1,159 Financial Tools Non-material V.H material Non-material SIGNET GLOBAL FIXED 0.01%=9/79,267 26%=0.26/1 =0 0/1,159 Investment Fund Non-material V.H material Non-material Profimex Global Real Total Real 0.01%=10/79,267 13%=0.13/1 =0 0/1,159 Estate Fund Non-material V.H material Non-material PI SPC EMSP1 CLASS 0.02%=19/79,267 23%=0.23/1 =0 0/1,159 Investment Fund Non-material V.H material Non-material HIGHLAND CREDIT OPPO =0 3/79,267 5.2%=0.052/1 =0 0/1,159 Non-material V.H material Non-material Overseas structured instruments EDR REAL ESTATE FUND =0 3/79,267 10%=0.1/1 =0 0/1159 Investment Fund Non-material V.H material Non-material CROSSROADS PE FUND 0.02%=14/79,267 29%=0.29/1 =0 0/1,159 Investment Fund Non-material V.H material Non-material ARES ECO FOUND 0.01%=5/79,267 11%=0.11/1 =0 0/1,159 Overseas structured instruments Non-material V.H material Non-material Israel Natural Gas Lines Ltd. 0.02%=13/79,267 30%=0.3/1 =0 0/1,159 Bonds Non-material V.H material Non-material
52 52 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
4. Instructions for Disclosure Related to the Financial Reporting of the Corporation (continued) C. Material and Highly Material Valuations (continued) b) Disclosure of non – material valuations, which if classified according to the results test of the Authority would have presented as very high materiality
Statement of financial position Result test of the Authority Normative profit result test test Swap transaction 0%= 14/79267 non-material 562%= 6/1 V.H. material 0.6% = 7.5/1159 non-material Swap transaction 0%= 14/79267 non-material 563%= 6/1 V.H. material 0.6% = 7.5/1159 non-material Swap transaction 0%= 17/79267 non-material 829%-= 8/1 - V.H. material 1%- 11.1/1159 - non-material Swap transaction 0%= 16/79267 non-material 822%-= 8/1 - V.H. material 0.9%- =11/1159 - non-material Swap transaction 0%= 15/79267 non-material 560%= 6/1 V.H. material 0.6% = 7.5/1159 non-material Swap transaction 0%= 16/79267 non-material 643%= 6/1 V.H. material 0.7% = 8.6/1159 non-material Swap transaction 0%= 84/79267 non-material 1746%-= 17/1 - V.H. material 2%- =23.3/1159 -non-material Swap transaction No balance for year end 590%-= 6/1- V.H. material 0.7%- =7.9/1159- non-material Swap transaction No balance for year end 289%-= 3/1- V.H. material 0.3%- =3.9/1159- non-material Swap transaction No balance for year end 273%-= 3/1- V.H. material 0.3%- =3.6/1159- non-material Swap transaction No balance for year end 2082%-= 21/1- V.H. material 2.4%- =27.8/1159-non-material Swap transaction 0%= 134/79267 non-material 3836%= 38/1 V.H. material 4.4% =51.2/1159 non-material Swap transaction 0%= 80/79267 non-material 2302%= 23/1 V.H. material 2.6% =30.7/1159 non-material Swap transaction 0% 0 non-material 1071%-= 11/1 - V.H. material1.2%- =14.3/1159 - non-material Swap transaction 0% 0 non-material 1070%-= 11/1 - V.H. material1.2%- =14.3/1159 - non-material Swap transaction 0%= 9/79267- non-material 477%-= 5/1 - V.H. material 0.5%- =6.4/1159- non-material Swap transaction 0%= 21/79267 non-material 2042%-= 20/1 -V.H. material2.3%- = 27.2/1159 - non-material Swap transaction No balance for year end 905%-= 9/1-V.H. material 1%- =12.1/1159 - non-material Swap transaction 0%= 7/79267 non-material 2365%= 24/1V.H. material 2.7% =31.5/1159 non-material Swap transaction 0%= 69/79267 non-material 1192%= 12/1 V.H. material 1.4% =15.9/1159 non-material Swap transaction No balance for year end 2054%= 21/1 V.H. material 2.4% =27.4/1159 non-material Swap transaction No balance for year end 2311%= 23/1 V.H. material 2.7% =30.8/1159 non-material Swap transaction No balance for year end 343%-= 3/1- V.H. material 0.4%- =4.6/1159- non-material Swap transaction No balance for year end 480%-= 5/1- V.H. material 0.6%- = 6.4/1159 non-material * V.H. material – Very Highly material
53 53 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
4. Instructions for Disclosure Related to the Financial Reporting of the Corporation (continued) C. Material and Highly Material Valuations (continued) b) Disclosure of non – material valuations, which if classified according to the results test of the Authority would have presented as very high materiality
Statement of financial position Result test of the Authority Normative profit result test test Swap transaction No balance for year end 335%-= 3/1- V.H. material 0.4%- =4.5/1159- non-material Swap transaction No balance for year end 655%-= 7/1- V.H. material 0.8%- =8.7/1159-non-material Swap transaction No balance for year end 212%-= 2/1- V.H. material 0.2%- =2.8/1159- non-material Swap transaction No balance for year end 448%-= 4/1- V.H. material 0.5%- =6/1159- non-material Swap transaction No balance for year end 447%-= 4/1- V.H. material 0.5%- =6/1159- non-material Swap transaction No balance for year end 225%-= 2/1- V.H. material 0.3%- =3/1159- non-material Swap transaction No balance for year end 839%-= 8/1- V.H. material 1%- =11.2/1159- non-material Swap transaction No balance for year end 549%= 5/1 V.H. material 0.6% =7.3/1159 non-material Swap transaction No balance for year end 154%-= 2/1- V.H. material 0.2%- =2/1159- non-material Swap transaction No balance for year end 352%-= 4/1- V.H. material 0.4%- =4.7/1159-non-material Swap transaction 0%= 17/79267 non-material 457%-= 5/1 -V.H. material 0.5%- =6.1/1159 - non-material Swap transaction 0%= 17/79267non-material 441%-= 4/1 - V.H. material 0.5%- =5.9/1159 - non-material Swap transaction 0%= 44/79267 non-material 1127%= 11/1 V.H. material 1.3% =15/1159 non-material Swap transaction 0%= 45/79267 non-material 1127%= 11/1 V.H. material 1.3% =15/1159 non-material Swap transaction 0%= 43/79267 non-material 1121%= 11/1 V.H. material 1.3% =14.9/1159 non-material Swap transaction 0%= 43/79267 non-material 1119%= 11/1 V.H. material 1.3% =14.9/1159 non-material Swap transaction 0%= 7/79267 non-material 745%-= 7/1 - V.H. material 0.9%- =9.9/1159 - non-material Swap transaction 0%= 3/79267 non-material 684%-= 7/1 - V.H. material 0.8%- =9.1/1159 - non-material Swap transaction 0%= 10/79267 non-material 792%-= 8/1 - V.H. material 0.9%- =10.6/1159 - non-material Swap transaction 0%= 10/79267 non-material 733%-= 7/1 - V.H. material 0.8%- =9.8/1159 - non-material Swap transaction 0%= 11/79267 non-material 910%-= 9/1 - V.H. material 1%- =12.1/1159 - non-material Swap transaction 0%= 10/79267 non-material 851%-= 9/1 - V.H. material 1%- =11.3/1159 - non-material Swap transaction 0%= 32/79267 non-material 1427%= 14/1V.H. material 1.6% =19/1159 non-material Swap transaction 0%= 3/79267 non-material 269%= 3/1 V.H. material 0.3% = 3.6/1159 non-material Swap transaction 0%= 5/79267 non-material 533%= 5/1 V.H. material 0.6% = 7.1/1159 non-material
* V.H. material – Very Highly material
54 54 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
4. Instructions for Disclosure Related to the Financial Reporting of the Corporation (continued) C. Material and Highly Material Valuations (continued) b) Disclosure of non – material valuations, which if classified according to the results test of the Authority would have presented a very high materiality
Statement of financial Result test of the Authority Normative profit result test position test Swap transaction 0%= 3/79267non-material 256%= 3/1 V.H. material 0.3% = 3.4/1159 non-material Swap transaction 0%= 8/79267 non-material 416%-= 4/1 - V.H. material 0.5%- =5.5/1159 -non-material Swap transaction 0%= 7/79267 non-material 410%-= 4/1 - V.H. material 0.5%- = 5.5/1159non-material Swap transaction 0%= 7/79267- non-material 407%-= 4/1- V.H. material 0.5%- =5.4/1159-non-material Swap transaction 0%= 7/79267 non-material 362%= 4/1 V.H. material 0.4% = 4.8/1159non-material Swap transaction 0%= 9/79267non-material 611%= 6/1 V.H. material 0.7% = 8.2/1159non-material Swap transaction 0%= 5/79267 non-material 353%= 4/1 V.H. material 0.4% = 4.7/1159non-material Swap transaction 0%= 6/79267 non-material 392%= 4/1V.H. material 0.5% = 5.2/1159non-material Swap transaction 0%= 6/79267 non-material 390%= 4/1V.H. material 0.4% = 5.2/1159non-material Swap transaction 0%= 6/79267non-material 306%= 3/1V.H. material 0.4% = 4.1/1159non-material Swap transaction 0%= 5/79267 non-material 251%= 3/1V.H. material 0.3% = 3.3/1159non-material יSwap transaction 0%= 11/79267 non-material 576%= 6/1V.H. material 0.7% = 7.7/1159non-material Swap transaction 0%= 4/79267 non-material 223%= 2/1V.H. material 0.3% = 3/1159non-material Swap transaction 0%= 6/79267- non-material 428%-= 4/1 -V.H. material 0.5%- =5.7/1159 -non-material Swap transaction 0%= 6/79267- non-material 515%-= 5/1 -V.H. material 0.6%- =6.9/1159 -non-material Swap transaction 0%= 18/79267non-material 1072%-= 11/1 -V.H. material1.2%- =14.3/1159 - non-material Swap transaction 0%= 3/79267 non-material 335%= 3/1 V.H. material 0.4% = 4.5/1159 non-material Swap transaction 0%= 1/79267 non-material 14%-= 0/1 V.H. material 0% =0.2/1159 -non-material Swap transaction 0%= 7/79267 non-material 541%= 5/1 V.H. material 0.6% = 7.2/1159 non-material Swap transaction 0%= 7/79267 non-material 485%= 5/1 V.H. material 0.6% = 6.5/1159 non-material Swap transaction 0%= 2/79267 non-material 188%= 2/1 V.H. material 0.2% = 2.5/1159 non-material Swap transaction 0%= 5/79267 non-material 339%= 3/1 V.H. material 0.4% = 4.5/1159 non-material Swap transaction 0%= 5/79267 non-material 325%= 3/1 V.H. material 0.4% = 4.3/1159 non-material Swap transaction 0%= 12/79267 non-material 835%= 8/1 V.H. material 1% = 11.1/1159 non-material Swap transaction 0%= 13/79267 non-material 833%= 8/1 V.H. material 1% = 11.1/1159 non-material Swap transaction 0%= 4/79267 non-material 257%= 3/1 V.H. material 0.3% = 3.4/1159 non-material Swap transaction 0%= 4/79267 non-material 100%= 1/1 V.H. material 0.1% = 1.3/1159 non-material Swap transaction 0%= 1/79267- non-material 51%-= 1/1- V.H. material 0.1%- =0.7/1159- non-material Swap transaction 0%= 7/79267- non-material 496%-= 5/1- V.H. material 0.6%- =6.6/1159- non-material יSwap transaction 0%= 6/79267 non-material 512%= 5/1 V.H. material 0.6% = 6.8/1159 non-material יSwap transaction 0%= 3/79267 non-material 79%= 1/1 V.H. material 0.1% = 1.1/1159 non-material
* V.H. material – Very Highly material
55 55 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
5. Dedicated Disclosure to Debentures Holders A. Rating of the General Ability of the Company to Meet its Financial Obligations
(1) Main Developments in Rating in Israel Maalot S&P a) In November 2002, Maalot Israeli Securities Rating Company Ltd. (“Maalot”) announced that it awards the highest ranking (AAA) to the Company’s debentures. b) On November 22 2006, Maalot announced to the Company that it would be lowering the ranking of the Company’s outstanding debentures from (AAA) to (AA+/Negative). c) In January 2008, Maalot sold all its operations to the international rating company Standard & Poor's and changed its name to Standard & Poor’s Maalot (“Maalot S&P”). d) On December 30, 2008 Maalot S&P announced that it is including the rating of the Company's debentures in its CreditWatch Negative list. e) On March 24, 2009, Maalot S&P announced that it is lowering the Company debentures rating from (ilAA+) to (ilAA), while leaving the rating in its CreditWatch Negative list. On September 30, 2009, Maalot S&P announced that it is removing the Company from the CreditWatch Negative list. f) On October 6, 2010, Maalot S&P announced that it includes the Company debentures rating (ilAA/Negative) in the CreditWatch Negative list and stated that it will hold meetings with the Management of the Company, related Government parties and/or related authorities, such as the Public Utilities Authority - Electricity during the next quarter and than decide on the rating. g) On January 4, 2011, Maalot S&P announced that that it is lowering the Company’s rating from (ilAA) to (ilAA-), with a stable outlook, and removed the rating from its CreditWatch Negative list. Maalot S&P noted in its announcement that it estimates that the rating of the Company is limited by a weak financial profile, uncertainty regarding the regulation framework, repeated delays in implementing a reform in the electricity sector and weak corporate governance. Maalot explained that the stable rating outlook reflects its opinion that although the Company's own credit profile is not expected to improve in the short term, the "highly likely" probability that the State of Israel will grant exceptional support to the Company, stabilizes the credit profile of the Company. The Company notes in addition, that during discussions with the rating companies, the Company received a letter from the Minister of Finance and the Minister of National Infrastructures on December 27, 2010, stating inter alia, that for the purpose of enabling the Company to serve its international debt by floating new debentures, and insofar as needed, they will act to place a package of Government guarantees to new debentures that will be issued in 2011 and 2012. Maalot noted in this context that, in its opinion, the letter supports the liquidity of the Company versus the Company's own liquidity condition.
Midroog a) On June 30, 2010, the period of the agreement between the Company and Maalot S&P with regard to the rating of debentures ended, except for debentures issued by the Company up to June 30, 2010. Maalot will continue to rate the debentures ("The Existing Debt") issued by the Company up to and including June 30, 2010, until their redemption date. In the process of choosing a rating company to rate debentures issued from July 1, 2010, the Company conducted a competitive procedure, as instructed and required by the Mandatory Tender Regulations, to choose an Israeli rating company. Following the process and in accordance with its results, the Company engaged with the Israeli credit rating company – “Midroog Ltd.” ("Midroog"). Hence, all debentures to be issued by the Company after July 1, 2010 (the “new debt") will be rated by Midroog Ltd. b) On July 14, 2010, Midroog announced that it grants an issuer rating of (Aa2) with a negative forecast to the new debt of the Company, reflecting the general ability of the Company to meet its financial liabilities.
56 56 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
5. Dedicated Disclosure to Debentures Holders (continued) A. Rating of the General Ability of the Company to Meet its Financial Obligations (continued)
c) On October 7, 2010, Midroog announced that it grants a debentures raising framework to the Company of up to NIS 4 billion and the issuer rating of the Company remains at (Aa2) with a negative forecast. d) On December 2, 2010, Midroog announced that it decided to reconfirm the issuer rating of (Aa2) with a negative forecast.
(2) Main Development in Rating Abroad The Company's debentures in foreign currency were rated in 1996 by two international rating companies, Standard & Poor's (“S&P”) and Moody's, at (A-) and (A3) rating, respectively.
Moody's: a) In January 2003, Moody's rating company lowered the rating of Company's debentures in foreign currency by two levels from (A3) to (Baa2) with a negative forecast. b) In June 2005 Moody’s announced a change in methodology, which led to the Company’s rating remaining at (Baa2) but the negative forecast was improved to a stable forecast. c) Moody's reconfirms the Company's rating periodically. The last reconfirmation of the rating was announced in September 2010 in which Moody's indicated that the rating of the Company is (Baa2) with a stable forecast.
S&P: a) In February 2003, S&P rating company lowered the rating of the Company’s debentures in foreign currency from (A-) to (BBB+/Negative Outlook). b) On January 17, 2008, S&P acquired the operations of the Israeli rating company Maalot. This means that, as of this date, the ranking review and changes in the local ranking of the Company by Maalot and the ranking abroad by the international rating company S&P are almost completely correlated. c) On December 30, 2008, S&P announced that it includes the rating of the Company's debentures in foreign currency (BBB+/Negative Outlook) in its periodic CreditWatch Negative list. d) On March 24, 2009, S&P announced that it is lowering the rating of the Company's debentures in foreign currency from (BBB+/Negative Outlook) to (BBB/Negative Outlook), while leaving the rating in its CreditWatch Negative list. On September 30, 2009, S&P removed the Company from the CreditWatch Negative list. e) On October 5, 2010, S&P announced that it is lowering the rating of the Company's debentures in foreign currency from (BBB/Negative Outlook) to (BBB-/Negative Outlook) and that it includes the Company in the CreditWatch Negative list. S&P announced that it will hold meetings with the Management of the Company, related Government parties and/or related authorities, such as the Public Utilities Authority - Electricity during the next quarter and than decide on the rating. f) On January 4, 2011, S&P announced that it is lowering the rating of the Company's foreign currency from (BBB-) to (BB+) and removed the rating from its CreditWatch Negative list. S&P also announced the lowering the rating of the primary secured debentures in foreign currency of the Company from (BBB-) to (BB+) and kept it on the CreditWatch Negative list. S&P noted in its announcement that it estimates that the rating of the Company is limited by a weak financial profile, uncertainty regarding the regulation framework, repeated delays in implementing a reform in the electricity sector and weak corporate governance. S&P explained that the stable rating outlook reflects its opinion that, although the Company's own credit profile is not expected to improve in the short term, the "highly likely" probability that the State of Israel will grant exceptional support to the Company, stabilizes the credit profile of the Company. 57 57 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
5. Dedicated Disclosure to Debentures Holders (continued) A. Rating (continued)
The Company notes in addition, that during discussions with the rating companies, the Company received a letter from the Minister of Finance and the Minister of National Infrastructures on December 27, 2010, stating inter alia, that for the purpose of enabling the Company to serve its international debt by floating new debentures, and insofar as needed, they will act to place a package of Government guarantees to new debentures that will be issued in 2011 and 2012. S&P noted in this context that, in its opinion, the letter supports the liquidity of the Company versus the Company's own liquidity condition.
For more details on the rating of the Company, see the website of the Securities Authority www.magna.isa.gov.il.
58 58 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
5. Dedicated Disclosure to Debentures Holders (continued)
B. Details of Debentures of the Group Traded in Israel 1) Details of debentures series 22 as at December 31, 2010, as required in the 8th addition to the Securities Regulations are as follows:
a) Series Debentures (Series 22) Issue date (initial) May 29, 2002 Total nominal value on the issue date (initial) NIS 500,000,000 nominal value. Nominal value on December 31, 2010 NIS 6,000,000,000 nominal value Revaluated nominal value in accordance with NIS 7,123,131,466 linkage conditions for the report date (December 31, 2010) Accumulated interest (as of December 31, 2010) NIS 51,444,838 Its fair value included in the last Financial The fair value of the marketable series in the Statements stock exchange value, see below Stock exchange value of debenture series on December 31, 2010 NIS 8,118,000,000 Interest type (fixed or variable) Fixed Interest rate 6.5% Principal payment dates 1/12 of the principal every May 20, August 20, and November 20, of each of the years 2012 – 2014 and on February 20 of each of the years 2013-2015 from May 20, 2012 until the redemption date – February 20, 2015 Interest payment dates Interest is paid in quarterly rated on August 20, November 20, February 20 and May 20 of every year, starting from the initial issue date and up to the redemption date Linkage basis Linked to the CPI of April 2002 It was determined that the debentures can be No converted to another security The entity is entitled to early redemption or No enforced conversion of the debentures to other securities insofar that it exists and the conditions for exercising exist A warranty was issued for payment of the entity's No liability, in accordance with a trust deed Is this debentures series considered material Yes according to regulation S/B (13)
b) Details of trustee for the liabilities - debentures (series 22): Name of trustee company: Trust Company of Bank Leumi LeIsrael Ltd. Name of responsible person: Ms. Idit Twizer Address: 8, Rothschild Avenue, Tel Aviv 66881 Telephone: 03-5170777 Fax: 03-5170770
c) The debentures cannot be converted.
59 59 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
5. Dedicated Disclosure to Debentures Holders (continued) B. Details of Debentures of the Group Traded in Israel (continued) 1) Details of debentures Series 22 as of December 31, 2010, as required in the 8th addition to the Securities Regulations (continued)
d) Rating of Debentures Series 22 by a Rating Company: The rating company: Maalot S&P. The Company's debentures series 22 was not rated on the issue date. In November 2002, Maalot rated the Company's debentures at (AAA). On November 2006, the rating was lowered to (AA+/Negative). On December 30, 2008 Maalot S&P announced that it has included the rating of the Company's debentures in its CreditWatch Negative list. On March 24, 2009 the rating of Company debentures was lowered from (AA+) to (ilAA) with a negative outlook and the debentures of the Company remained in the CreditWatch Negative list. On September 30, 2009, Maalot S&P reconfirmed the rating of Company debentures (ilAA/Negative) and removed them from the CreditWatch Negative list. On October 6, 2010, Maalot S&P announced that it includes the Company debentures rating (ilAA/Negative) in the CreditWatch Negative list. On January 4, 2011, Maalot S&P announced that it is lowering the rating of the Company from (ilAA/Negative) to (ilAA-/Stable) and removed the rating from its CreditWatch Negative list. For rating of Company debentures, see paragraph 5 a 1 above.
e) Description of Assets Pledged to Secure The Liabilities of the Group with Respect to Debentures No pledged assets.
2) Details of Debentures Repaid During the Reported Year: 1) On October 31, 2010, negotiable debentures, series 21, issued by the Company on the Tel Aviv Stock Exchange were repaid in full in accordance with the original terms of the trust deed. 2) On December 29, 2010 non-negotiable debentures were paid off., in an approximate sum of Yen 6 billion, issued by the Company in the global funds raising abroad.
C. Long Term Capital Sources
Over the course of the reporting period, a total of approximately NIS 181 million was raised through loans in foreign currency.
D. Debentures and Liabilities to Banking and Other Corporations
The Company is a liability intensive entity with respect to loans and debentures. The balance of loans and long-term and extended term debentures as of December 31, 2010, without debentures to the State of Israel, is approximately NIS 37,573 million, detailed as follows:
60 60 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
5. Dedicated Disclosure to Debentures Holders (continued) D. Debentures and Liabilities to Banking and Other Corporations (continued)
Liabilities in Index-Linked NIS Millions of NIS Index-linked debentures to the public 14,177 Index-linked provident fund loans 1,489 Other index-linked loans (a) 764
Total Index Linked NIS 16,430
Non-linked NIS debentures in public offerings 657 Non-linked NIS loans 250 Total Non-Linked NIS 907 Dollar Linked Liabilities Money raised from a private offering for the sale of debentures in the US in US dollars 4,525 Loans in US dollars (b) 4,970 Money raised from a private offering for the sale of debentures in Europe in US dollars 603 Offering to institutional investors in Europe and the US, traded on the Singapore stock exchange, in US dollars 6,211 Total in Linked to US dollars 16,309 Money raised from a private offering for the sale of debentures in Japan in yen 3,444 Loans in euros 3,036 Loans in Swiss francs 8 Loans in pounds sterling 4 Total 40,138
Less discounts/premiums on debentures, current maturities, issuance expenses and hedge agreements, net. (2,916) Total debentures and liabilities to banks and others 37,222 Long term accounts payable 351 Total 37,573 (a) Including loans guaranteed by the State of Israel equaling NIS 476 million. (b) Including loans guaranteed by the State of Israel equaling NIS 795 million.
E. Long Term Credit Average as of December 31, 2010 – The credit was received from banks and others. The average credit for the reporting period was approximately NIS 45,054 million and consisted mainly of long term loans and debentures (including hedge, postponed, premium and discounting of debentures transactions). F. Short Term Credit Average as of December 31, 2010 – The credit was received from banks and others. The average credit for the reporting period was approximately NIS 4,363 million and consisted mainly of short term loans, overdrafts and current maturities of long-term loans. G. Average Suppliers’ Credit as of December 31, 2010 – The average credit period for suppliers is approximately 34 days. Average credit from suppliers for the reporting period amounted to approximately NIS 1,239 million. H. Average Customers’ Credit as of December 31, 2010 – The average credit period for customers is approximately 56.6 days. Average credit to customers for the reporting period amounted to approximately NIS 3,422 million.
61 61 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
6. Miscellaneous a. Indemnification Letter to Officers On December 24, 2009, the Company received an approval in principle from the State for issuing an indemnification letter to officers of the Company (Member of the Company's Board of Directors who served in this capacity on the date of the formal submission of the Financial Statements of the Company as of June 30, 2009 ("The Determining Date"), the CEO of the Company, the CFO of the Company and the Legal Consultant of the Company, provided that they served in the said positions on the determining date. In the indemnification letter, the Company undertakes to indemnify any officer for any liability or expense for which no indemnification was received from others: 1) With respect to any direct or indirect action related to the preparation, approval and publication of the Financial Statements of the Company as of June 30, 2009, unless the Company objects to the indemnification because the liability or expense is not related directly or indirectly to the correction of the error and the Director of the Government Companies Authority approves the position of the Company, after receiving the opinion of the Deputy Attorney General and the affirmation of the court. 2) With respect to implications of the correction of the error on the preparation, approval and/or publication of the Financial Statements and/or implications of the error correction on transactions related to or based on the Financial Statements of the Company preceding the determining date, all according to the terms specified in the indemnification letter. The indemnification will not apply in the following cases: Breach of obligation of trust, except breach of obligation of trust towards the Company, when the officer acted in good faith and had a reasonable basis to assume that the act will not affect the benefit of the Company. Intentional or reckless breach of the obligation of caution, except when it is a result of negligence only. An act taken with the intention of deriving unlawful personal gain. Indemnification with respect to paying a penalty or a fine imposed on an officer. The cumulative sum of indemnification that the Company may pay to all officers according to this indemnification letter and according to all other obligation and indemnification letter to position holders (as implied by the Companies Ordinance – 1999) and to Company employees, issued or as will be issued by the Company in the future, including, if and as far as the Company will grant indemnification regarding restructuring and/or privatization of the Company, will not exceed 25% of the Company's equity, as of June 30, 2009, linked to the CPI in Israel, starting from the July 2009 index ("Maximum Indemnification Sum"). The Company's indemnification obligation will not apply to any sum which the insurer of the officer’s insurance policy has recognized as its responsibility and placed at the disposal of the officer on a date that enables him to fulfill the obligation imposed on him. However, when the officer is charged with an indemnifiable event in an amount exceeding the sum paid by the insurer, the indemnification will apply to the difference between the financial liability imposed on the officer and/or legal expenses expended by the officer or that were imposed on him and the sum received from the insurer for the same event, provided that the indemnification sum that the Company will be charged with according to this obligation letter will not exceed the maximum indemnification sum. The Company will also indemnify the officer with respect to the deductible that he will be required to pay according to the insurance policy. The obligation of the Company according to this indemnification letter will be valid from the determining date, namely from the formal submission of the Financial Statements of the Company as of June 30, 2009. The obligation of the Company to indemnify a Director is a transaction with an interested party, by being an agreement between the Company and a Director in the Company regarding the terms of his position, therefore, approval of the Audit Committee, Board of Directors and the General Meeting is required according to the Companies Law.
62 62 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
6. Miscellaneous (continued) a Indemnification Letter to a Position Holder (continued)
The obligation to provide indemnification, in the version approved in principle by the State, was approved by the Audit Committee of the Board of Directors and the Board of Directors of the Company and the General Meeting of the Shareholders’ of the Company. On July 11, 2010, the Acting Chairman of the Board of Directors (at the time), Mr. Michael Lazer, applied to the Government Companies Authority on behalf of the members of the Company's Board of Directors, requesting to expand the indemnification letter granted to members of the Board of Directors in the extent that will provide solutions to risks described in the application letter, will not be limited to a certain event or subject to the implementation of the restructuring of the Company. On January 4, 2011, the Chairman of the Board of Directors, Mr. Yiftah Ron-Tall addressed another request to expand the aforementioned indemnification letter. The Company did not receive the response of the Government Companies Authority up to the date of this report.
b. Evaluations of the Effectiveness of Internal Controls and Disclosure Controls over the Financial Statement 1) In accordance with the directive of the Securities Authority, the Company was required in 2005 to prepare, in the spirit of the principles set in Section 404 of the U.S. Sarbanes-Oxley Act, reports concerning the Company’s controls with respect to actuarial commitments for the purpose of calculating pension liabilities, and fixed assets and fixed assets under construction. The control reports have been completed, presented to the Securities Authority and publicly published. These reports included mapping the manual controls and IT systems and the examination of their effectiveness, including their strengths and weaknesses, as well as including recommendations to improve flaws defined as non-material found in the inspections. All of the recommendations have been addressed by the Company. 2) According to Government Companies Authority Regulations (Additional Report on Actions Taken and Presentations Made to Assure Correctness of the Financial Statements and the Board of Directors' Report - 2005) Government companies, including the Company, are required to attach to their yearly and quarterly Financial Statements an additional report concerning the activities taken and the presentations given so as to ensure full disclosure in the Financial Statements and the Directors’ Report. So as to implement this directive, the Company set up a system the purpose of which is to confirm and assess disclosure controls, information gathering processes and information processing for the Financial Statements. This so as to permit functionaries signing the Financial Statements and the Directors’ Report to declare in the additional report, that the Financial Statements and the Directors’ Report do not contain incorrect presentations of material facts and that they properly reflect in all material aspects the Company’s financial condition, operating results, changes in shareholders’ equity and cash flows as of the dates and for the periods presented in the reports. The Company has set a procedure to confirm the lack of existence of weaknesses that may impact the report’s integrity, to implement all existing disclosure controls, among them implementing a systematic mechanism to manage and monitor information, to gather information from executives and statements of middle managers concerning the implementation of disclosure controls in their fields of responsibility, as well as applying appropriate controls to any changed work procedures. 3) According to Government Companies Authority Regulations (Additional Report on Actions Taken and Presentations Made to Assure Correctness of Additional Reports on the Subject of the Effectiveness of Internal Controls on Financial Reporting) – 2007, Government companies, among them the Company, are required to attach to their annual Financial Statements, starting with the report published as of December 31, 2009, an additional report concerning actions taken to ensure the correctness of the financial reporting, among them, establishing a system of internal controls, with the main purposes of: to examine the processes affecting the Company’s records which detail its transactions, to confirm the existence of controls and test their effectiveness and to ascertain with a reasonable level of certainty that Company receipts and expenditures are only made in accordance with the approval of properly authorized 63 63 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
6. Miscellaneous (continued) b. Evaluations of the Effectiveness of Internal Controls and Disclosure Controls over the Financial Statement (continued)
Company bodies. Therefore, the Company engaged the firm of Ernst & Young to act as an expert guide and ensure correct presentation of the financial reporting. The Company established administration, control and work units to implement the regulations. A steering committee, comprised of senior management functionaries and experienced consultants in the field was established and also a Control Committee and a work team. Roles of these committees and convening schedules were defined. The Company completed preparations required to implement regulations, all according to the accepted methodologies and standards, the COSO and the COBIT model (for information systems), with the assistance of the expert and in full cooperation of the auditor of the Company. A dedicated computerized system was integrated in the project to implement the regulations in the Company, to manage the project and perform current on-going maintenance of the control upon completion of the project. The system allows documentation of risks and controls in any process, documentation of the performed tests and results thereof. The system also provided the ability to monitor faults corrections and to generate various control and administration reports. In its additional report on the internal controls over the financial reporting in accordance with the Government Companies Regulations, attached for the first time to the financial statements for the year 2009, the Board of Directors and the Management of the Company announced that the internal controls in the Company over the financial reporting of the Company for the period ending on December 31, 2009 are ineffective, due to a material weakness of the internal controls over financial reporting, detailed below: The Company does not maintain sufficient control over the financial value of assets managed at the Pension Fund of Company employees. To remove this material weakness in this subject, the Company took various steps during 2010: The Company engaged the services of an expert for the purpose of receiving an evaluation of the Fund's assets in accordance with IFRS standards. The Company assimilated a dedicated system for calculating and managing the assets of the Fund. The Company believes that these corrective actions correct the material weakness of the internal controls over the aforementioned financial reporting. Brightman, Almagor, Zohar & Co., the external auditors of the Company, which audited the financial statements of the Company for the period ending on December 31, 2009, issued an opinion on the effectiveness of the internal controls over the financial reporting of the Company. In the opinion of the external auditor, there are other material weaknesses in the internal controls over the financial reporting in the Company, in addition to the aforementioned, as follows: The Company did not maintain effective controls to ensure that the rights and benefits, according to which payroll and pension payments are paid and actuarial obligations included, are authorized in conformity with the regulations of the law. The Company did not maintain effective controls over the appropriateness of the assumptions according to which the actuarial obligations are calculated. The company conducted corrective action in the work processes and controls to remove, in 2010, the control gap and material weaknesses that have been raised by the auditor. Regarding the rights and benefits, according to which the wage and pension payments are paid, and which include actuarial commitments. The Company has established procedures for determining and applying the future rights approved by the Board, and conducts discussions to clarify the implications of signing the agreement on the salary rights issue. The Company requested and received an opinion from its legal advisors clarifying the entitlements and benefits granted in the past, except for payments of board and lodgings. On the subject of correctness of the assumptions used to calculate the actuarial obligations, the 64 64 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
Company set work rules with the different actuaries – the Company's actuary, the reviewing actuary and the consulting actuary and defined a procedure for checking the actuarial assumptions and signs for analyzing changes in these assumptions. The procedure and the signs were approved by the Board of Directors. In the additional report on the internal controls over financial reporting in accordance with the Government Companies Regulations, attached to the Financial Statements for 2010, the Board of Directors and the Management of the Company announced that the internal controls over financial reporting of the Company for the period ending on December 31, 2010, is ineffective, due to a material weakness in the internal controls over financial reporting, detailed below: 1) The Company did not maintain effective controls over the appropriateness of recognition of salary and indirect costs in the Fixed Assets balances, appropriateness of the Fixed Assets counts, appropriateness of Fixed Assets valuations and recognition and measurement of decommissioning, restoration and similar liabilities as part of the cost of an item of property. 2) The Company did not maintain effective controls to ensure that the rights and benefits, according to which payroll and pension payments are paid and actuarial obligations included, are authorized in conformity with the regulations of the law. Correction of Material Weaknesses 1) The Company is in the process of strengthening controls to comply with the requirements for charging salary and indirect costs to fixed assets, presenting inventory of fixed assets and its value in the Financial Statements and inclusion of obligations with respect to decommissioning fixed assets and restoring sites and charging costs to fixed assets. 2) The Company presented a restatement for correcting errors of previous reporting periods in its Financial Statements for the period ending on December 31, 2010. The Company is also in the process of strengthening the aforementioned controls. The Company estimates that these corrective actions will correct the aforementioned material weaknesses in the internal controls over the financial reporting.
Brightman, Almagor, Zohar & Co., the external auditors of the Company, which audited the Financial Statements of the Company for the period ending on December 31, 2010, issued an opinion on the effectiveness of the internal controls over the financial reporting of the Company. In its opinion of the external auditor, refers to the aforementioned material weaknesses.
65 65 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
6. Miscellaneous (continued) b. Evaluations of the Effectiveness of Internal Controls and Disclosure Controls over the Financial Statement (continued)
4) On November 24, 2009, the Finance Committee of the Knesset approved an amendment to the Securities Regulations (Periodic and Immediate Reports) - 1970 ("The Amendment"). This amendment requires all reporting corporations that have securities registered for trade in the Tel Aviv Stock Exchange to declare the effectiveness of their internal controls over financial reporting and disclosure. On October 7, 2010, the Companies Authority published regulations (Additional Reporting on the Effectiveness of the Internal Controls over Financial Reporting) (Amendment) – 2010 and Regulations (Additional Report Regarding Actions Taken and Representations Made to Ensure the Accuracy of the Financial Statements and the Directors' Report) (Amendment) – 2010. Implementation of the aforementioned amendments in the regulations is intended to enable the Chairman of the Securities Authority to exercise his authority, according to section 9b(f) and 38c(f) to the Securities Regulations and determine that a Government Company that is also a reporting company according to the Securities Law – 1968, that implements the said regulations of the Companies Authority will report the effectiveness of the internal controls in the format stipulated in the Companies Authority Regulations. The Company appealed to the Chairman of the Securities Authority, requesting him to exercise his authority to determine that the Company, under its definition as a Government Company that complies with all Government Authority Regulations, including the aforementioned, will report the effectiveness of the internal controls in the format specified by the Companies Authority Regulations. In response to the request of the Company, the Chairman of the Securities Authority decided on January 4, 2011, to accept the Company's request to report the effectiveness of the internal controls in the format specified by the Companies Authority Regulations, as long as the Company fulfills these regulations. This arrangement is subject to the commitment of the Company to review the facts presented to the staff of the Security Authority in the request on every report date and report any change to them. This includes a review of changes in the regulations or in Government Companies Regulations, changes in the status of the Company which affect the laws applied to it, changes in the implementation mode of Government Companies Regulations in the Company and any other change relevant to this subject. As at the date of the report, the Company fulfilled the requirements of the stipulations and found that there was no change in the regulations or any other relevant change.
66 66 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
6. Miscellaneous (continued)
c. Events During the Reported Period
1. In preparing and auditing financial statements for 2010, a number of issues for which retroactive amendment is required in respect of previous years were raised. For more information, see Note in Chapter C in this report. 2. For the purpose of supervising and controlling Company funds transferred to the Workers’ Organization, the Company entered an agreement with an external auditors firm that controls Company funds transferred to the Workers Organization. The Company transfers between NIS 10-15 million per year to the Workers’ Organization to participate in the funding of its current activities. 3. On February 15, 2010, a new rate base for the generation segment was published. See section 1 c above for details. 4. On February 17, 2010, the Company received a loan from DZ in the amount of approximately Euro 24 million. The loan will be paid off in twenty four equal semi-annual payments from March 31, 2011 up to September 30, 2022. 5. On July 15, 2010, the Government published its decision to expand the number of suppliers of wide band infrastructures by the Company. See details in Notes 1 c 8 to the Financial Statements in Chapter C of this report. 6. On July 22, 2010, the Board of Directors of the Company decided, inter alia, to act as recommended by the World Bank (see Note 1 to the Financial Statements in Chapter C of this report). 7. Following negotiations conducted between the Management, the workers’ organization and State representatives, these parties agreed on August 8, 2010, on an outline in principle. See details in Note 1 h to the Financial Statements in Chapter C of this report. 8. On August 8, 2010, during a review of the development plan for the electricity sector in Israel for the years 2010-2016, the Prime Minister instructed to include the General Manager of the Prime Minister's office in the staff work initiated by the Ministry of Finance jointly with the Ministry of National Infrastructures, the Ministry of the Interior and the Ministry of the Environment and will submit recommendations on the comprehensive management of the Israeli electricity sector, within 90 days. See Note 1 c 9 to the Financial Statements in Chapter C of this report. 9. On August 12, 2010, the Company entered an agreement with Dorad Energy Ltd., ("Dorad") on purchasing available capacity and energy and providing infrastructure services. The generation capacity of Dorad will be about 800 MW. Dorad is scheduled to commence electricity generation at the beginning of 2013. 10. On September 16, 2010, the Board of Directors of the Company approved a special collective agreement on changing the pension update mechanism and settling payments previously defined as salary deviations. See Note 19 to the Financial Statements in Chapter C in this report for details. 11. On October 25, 2010, the Company signed an agreement with Shemen Industries Ltd., for 10 years with an option for extension on steam supply to Shemen Industries Ltd. For details, see the immediate report of October 26, 2010, No, 2010-01-658692 at the website of the Securities Authority, www.magna.isa.gov.il. 12. On December 15, 2010, the Minister of National Infrastructures, after consulting with the Electricity Authority, approved the development plans of the electricity sector, which included, inter alia, an approval to postpone the dates of the development plans of the Company. See more details in Note 3 to the Financial Statements in Chapter C of this report. 13. On December 26, 2010 the Minister of the Environment signed two personal orders for nuisance prevention from power stations of the Company according to section 8 of the Abatement of Nuisances Law – 1961. For details on the main orders, see report of December 27, 2010 No. 2010-01-733074 at the website of the Securities Authority.
67 67 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
14. The following are appointments and completion of service terms that occurred during the report period: - On January 6, 2010, Mr. Gideon Frank was appointed as a Director of the Company. - On January 6, 2010, Ms. Rochelle Don-Yechiya was appointed as a Director of the Company. -- On January 6, 2010, Mr. Shimon Eckhaus was appointed as a Director of the Company. - On January 14, 2010, Mr. Natan Avraham was appointed as a Director of the Company. - On February 17, 2010, Ms. Aura Sova-Gindin ended her term of service as a Director of the Company. - On February 17, 2010, Ms. Yaffa Vigodsky ended her term of service as a Director of the Company and was reappointed on February 21, 2010 for another term. - On February 20, 2010, Mr. Mordechai Friedman ended his term of service. - On April 25, 2010, Ms. Dvora Henn was appointed as a Director of the Company. - On April 25, 2010, Ms. Iris Shtark was appointed as a Director of the Company. - On May 3, 2010, Mr. Reik Abu-Rish was appointed as a Director of the Company. - On July 2, 2010, Ms. Blanche Kay ended her term of service as a Director of the Company. - On September 16, 2010, Mr. Yiftah Ron-Tal was appointed as the Chairman of the Board of Directors of the Company. - On December 16, 2010, the Chief Executive Officer of the Company, Mr. Amos Lasker announced his decision to end his role in March 2011. - On December 26, 2010, Mr. Michael Lazer ended his role. d. Appointing External Auditors 1. In accordance with the decision of the General Meeting No. 86 on May 31, 2010, the appointment of the Brightman Almagor Zohar & Co. auditing firm as the Company's external auditors was reconfirmed for the period starting January 1 2010 and up to December 31, 2010, subject to the approval of the Government Companies Authority. The Company requested the approval of the Government Companies Authority to the appointment, which was not received as yet. 2. As specified in the decision of the General Meeting, the Company's Board of Directors implemented all the directives included in the circulars of the Government Companies Authority (as published from time to time) on procedures of employing external auditors and setting their fees and on the Financial Statements (audited, reviewed, budget), reports of the Board of Directors and external and Internal Audit execution reports. e. The Link between Rewards to Senior Position Holders and Stakeholders in the Company and Their Contribution to the Company 1) Rewards to Position Holders The reward to position holders in the Company, as a Government Company, differs completely from rewards in other public companies. The salary terms of senior position holders who receive the highest rewards in the Company are determined according to collective agreements and arrangements applied to all Company employees, where salary terms of the Company's CEO are determined according to an individual employment agreement in a unified version, dictated by the Government Companies Authority and defined according to its circulars. The collective agreements do not include any mechanisms for changing the salary according to ability and performance of position holders. The Company's Board of Directors has limited discretion in determining the salary of the CEO, except the annual award and salary updates of the CEO, approved by the Board of Directors according to the guidelines of the Government Companies Authority. The Company's Board of Directors examined in its meeting on March 31, 2011 the reward terms of position holders detailed in Chapter D of this report. Based on the aforementioned information, the Board of Directors concluded that the rewards paid to the five senior position holders who receive that highest rewards in the Company, befit the complexity of their positions and are reasonable. The Company's Board of Directors determined that the salary 68 68 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
6. Miscellaneous (continued) e. The Link between Rewards to Senior Position Holders and Stakeholders in the Company and Their Contribution to the Company (continued)
terms are significantly lower in comparison to position holders in similar positions (or of a similar rank) in other public companies with a similar scope of activities to that of the Company. . 2) Reward to Stakeholders As specified in Chapter D of this report, the Company does not have stakeholders who receive rewards, who are not Directors and are not included in the aforementioned list, presented in Chapter D of this report. Directors’ fees are determined according to the law, as detailed in Chapter D, therefore, the Company's Board of Directors is not required to examine rewards paid to Directors.
69 69 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
6. Miscellaneous (continued)
f. Risks Management In accordance with the Government Companies Authority Circular from June 11, 2009, enclosed herewith a description of the significant risks of the Company.
Effect Large Moderate Low Risk Group Risk Category Significant effect Moderate effect Minor effect on on Company on Company Company Objectives objectives objectives 1. Setting of the electricity rate X a. Compliance 2. Compliance to State laws X and regulation 3. Changing Regulation and New X Laws 1. Security events X 2. Geopolitical situation and X external political risks 3. Risks to Reputation X 4. Competition X b. Strategic 5. Natural disasters Risks (earthquake/flooding) X 6. Fires X 7. Natural gas supply X 8. Planning and implementing the X development plan 9. Structural change 1. Legal X 2. Credit risks X 3. Liquidity Risks X 4. Market Risks X c. Financial 5. Capital raising X Risks 6. Liabilities with respect to pension fund X 7. Accounting and financial X statements 1. Environment X 2. Health and Safety X 3. Human capital X 4. Human errors 5. Labor relations X 6. Technical failures X d. Operational 7. Embezzlement and fraud X Risks 8. Information Technology X 9. Suppliers X 10. Projects risks X 11. Information security X 12. Maintenance planning and X reserve management
70 70 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
6. Miscellaneous (continued) f. Risk Management (continued) 1) Compliance and Regulatory Risks a) Setting the Electricity Rate High risk level, with a stable direction of change. The Company’s financial condition is affected, inter alia, by the level of electricity rates it charges its consumers. The rate is set by the Electricity Authority by force of the Electricity Sector Law - 1996 and therefore, the Electricity Authority has the sole authority to set rates and they are therefore beyond the Company’s control. The manner of rate setting affects directly and considerably Company’s income, cash flow, profitability and financial strength (see Notes 1 c and 3 to the Financial Statements in Chapter C of this report). The Electricity Sector Law establishes that the Electricity Authority should, from time to time, set the rates based on the cost principle, considering also the type and level of the services provided, and also considering an adequate rate of return on the capital, where the Electricity Authority is permitted to exclude in its setting of the rates, all or partial consideration of such expenses which it feels are unnecessary in Company’s pursuit of own obligations as an essential service provider. The rate should reflect the cost of the specific service, with the price of no specific service reduced at the expense of an increase to another service rate. The rate will be revised according to a formula as set by the Electricity Authority, where the revised formula may include parameters of efficiency (meaning, the rate at which the revision may be reduced, as established by the Electricity Authority in consultation with the ministers, to promote the efficiency of organizations holding essential service provider licenses). Based on the above, the Company’s exposure to risks may be characterized as mostly due to the exposure to expenses which are not or will not be recognized for rate purposes, from formula revision mechanisms which do not cover the Company’s full exposure to price changes, unbudgeted expenses and costs due to the efficiency requirements where and to the extent to which the Company fails to comply with such requirements. An important reason why the electricity rate is a risk factor is that recognition of the Company’s cost of investments is established based partly on past records and partly on various normative parameters with no guarantee that all of its future costs will be covered. Another risk factor originates in that there is still no sufficient information on the principles guiding the establishment of the rate base in the next evaluation period for the full electricity chain (the current rate base for all segments was due to expire in 2005). New rate bases for the transmission, transformation and distribution segments and for consumer costs have not yet been set. The new rate base for the generation segment was set in February 2010. Initial analysis of the rate indicates that it does not provide full coverage of the capital costs of the Company due to the expected non-recognition of part of the costs of Company assets that is in addition to the fines mechanism imposed on the Company due to the expectation of not meeting the normative timetable for the entering into operation of the generation units. Moreover, the rate may not cover the expected operational costs in the generation segment in the coming years. The Company studied in depth the full significance derived from the rate and addressed a request to the Electricity Authority to present to its plenum the main arguments against the decisions of the Electricity Authority on this subject. The Company indicates in its request that another discussion of the plenum of the Electricity Authority is essential to try and prevent the imminent severe damage to the Company, to the economy and to the consumers arising from the decisions made on this subject to date. Long term planning (an essential tool in the electricity economy today) requires information on the prevailing future electricity rates. Such information is also vital for the Company’s decision making with regard to projects and long term plans.
71 71 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
6. Miscellaneous (continued) f. Risk Management (continued) 1) Compliance and Regulatory Risks a) Setting the Electricity Rate (continued) In its Financial Statements, the Company follows international standards as required under the Government Companies Regulations, complete with all exclusions it provides for the Company. These regulations will remain in effect until the end of 2010. Should they not be extended, the Company will suffer exposure due to the difference between the rate coverage as calculated by the CPI adjusted data and the representation in the Financial Statements under international standard requirements (nominal data). Since the Company’s costs will not be covered by the rate, losses are expected to be created in its Financial Statements. As for several of the Electricity Authority's previous decisions relating to the rates, the Company is still pursuing intensive negotiations with the Electricity Authority on this matter, including such decisions as related to costs for which it requested rate coverage and to future application of the IFRS (see Note 3 to the Financial Statements in Chapter C of this report). Should these negotiations conclude with the Company’s position on this matter still overlooked, they may adversely affect the Company’s operations, business results or financial condition.
b) Compliance with State Laws Medium risk level, with a stable direction of change. The Company was granted licenses under the Electricity Sector Law for the transmission, supply, distribution and trading of power, as well as separate power generation licenses for the various units. These licenses regulate all of the Company’s operations, however they also impose additional limitations on them. For example, the Electricity Sector Law requires the Company, where so requested by the Minister (in consultation with the Electricity Authority), to submit for Minister’s authorization a full or partial development plan, and the Minister, in turn, is authorized to establish, in consultation with the Electricity Authority, a development plan for the Company on Company’s failure to submit own development plan at his request. Also, the licenses may be revoked or modified before termination as provided under the Electricity Sector Law instructions and license terms. Under Amendment 8, subsequent extension of the licenses does not required Knesset legislation but can rather be effected for 1 year periods at a time under authorization by the Minister of National Infrastructures and the Finance Minister, in consultation with the Electricity Authority and the Companies Authority, and subject to authorization by the Economic Affairs Committee of the Knesset. So far, the licenses were extended soon before they expired, and, on December 29, 2010, they were extended until January 1, 2012 under the Electricity Sector Order (Dates Postponement) - 2010, however there is no telling whether or not new licenses will be granted or existing licenses extended in future, and whether or not the terms of the new licenses will remain the same as the existing ones. Based on past experience, the Company estimates that the licenses will indeed be extended. In addition, there is no certainty that the existing control and licensing instructions of the electricity economy will not be changed in the future. Also, beyond the requirements of the Electricity Sector Law as related to the incorporation of operations under subsidiary organizations, the Company cannot predict what changes will be made with regard to licensing and other control provisions when the license extension periods as established under the Law for the licenses granted to the Company by force of the Electricity Sector Law are up. If the licenses are not extended or if the licenses or other control provisions are changed, the Company or its financial state may be adversely affected.
72 72 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
6. Miscellaneous (continued) f. Risk Management (continued) 1) Compliance and Regulatory Risks c) Changing Regulation and New Laws Medium risk level, with an upward direction of change. Beside the regulated electricity rates, the Israel electricity sector, as well as the Company’s operations, are subject to extensive control as required, inter alia, under the Electricity Sector Law. These regulatory instructions relate to licensing, competition, rates and environmental requirements, to name a few of the concerns. The regulatory environment within which the Company currently operates comprises the Ministry of National Infrastructures, the Government Companies Authority, the Public Services Authority – Electricity (establishing the electricity rates and criteria), the Securities Authority, the Ministry of Environment, the Ministry of the Interior, the Planning authorities and the Israel Antitrust Authority. The Company is not certain that the cost associated with the application of the stringent regulation as above and that the unique characteristics of the electricity authority and other factors as above will not adversely affect Company’s business results, operations and financial condition. The Company is also subject to extensive supervision under the Government Companies Law of 1975, the Securities Law of 1968 and the Antitrust Law of 1988. Failure of the Company to comply with laws and regulations (current and/or new) in its business/operating environment may cause the State to impose heavy fines on the Company, the issuance and implementation of in personam orders against senior managers of the Company and also damage the Company's image. All Company employees, from the senior management to the employees in the field are highly aware to the subject of compliance with State laws.
2) Strategic Risks a) Security Events Medium risk level, with an upward direction of change. Security events may affect the Company in each of its fields of operation, such as electricity generation and distribution facilities and/or damage to fuel delivery and storage systems. Since the Company is a monopoly that supplies almost all the electricity consumed in Israel, any damage to the Company will affect its generation capacity and cause it to fail to attain its main objective of providing continued, reliable and high quality electricity to all customers of the Company. War Risks As an essential service provider, the Company is obliged under decrees of the State of Israel to prepare for any war risk, in order to maintain its ability to supply electricity to the State of Israel in the case of an emergency. The Company’s CEO serves as Head of the Assigned Electricity Authority. As such, both he and the Company he heads are obligated under the Defense Ministry instructions (National Emergency Authority) to supply electricity to the State of Israel also in times of emergency. The Company is subject to the Civil Defense Law and must therefore follow Civil Defense and Israeli Police instructions and prepare for a war emergency. The Company’s control and preparations for war emergencies include analysis of a reference wartime scenario, running of drills, construction of equipment stocks and setting up of operational headquarters. Preparations are accomplished under instructions by the National Emergency Authority.
73 73 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
6. Miscellaneous (continued) f. Risk Management (continued) 2) Strategic Risks (continued) a) Security Events (continued)
Terrorism Under Israeli Government Decree in 84 Critical Infrastructures, and also under the Secured Organizations Defense Regulation act, the Company is obligated to secure all of own personnel and facilities against any disruption of its routine operations. By force of this act, Israel Police instructs the Company’s security officers to run all security operations using skilled personnel and advanced technologies in the prevention of various acts of terrorism which directly affect both the Company and the national security (mass killings, car bombs, demolition charges, heavy damages to essential national infrastructure targets, shooting, suicide bombers etc). The Company established a security procedure in Company facilities, that will enable the Company to supply electricity both in lull times and in emergencies, and to secure all of own personnel and visitors on its various sites. The insurance policies purchased by the Company normally exclude damages originating in terrorism or war. These damages should be covered under a special state fund allocated for terrorism and war damage compensations and subject to the Property Tax and Compensation Fund Act. It shall be noted, however, that the Company disagrees with the Property Tax Authorities on the payment of direct war damages, the issue is currently under legal consideration. b) Geopolitical Situation and External Political Risks Medium risk level, with an upward direction of change. Most Western countries have a backup for electricity supply systems in the event of a serious incident. The national and political environment of the State of Israel have far reaching implications in regards to the back up of the electricity grid in the event of disasters. The electricity grid in the State of Israel is a de facto isolated island in all matters related to electricity generation and supply to inhabitants with no option to purchase electricity and/or backup from other local or overseas suppliers. The various fuels used by the Company in the power generation process as well as a large proportion of the equipment required by the various Company facilities are purchased, either directly or indirectly, from foreign sources. A substantial amount of the fuel and equipment is purchased under time limited contracts. Since it is so largely dependent on foreign sources, the Company is exposed to numerous risks, such as delayed equipment or fuel supplies as may result from political instability, embargos, port strikes, security tensions and other such occurrences. Any disruption in the supply of the various fuels employed in the generation of power compromises both the financial state of the Company and its reputation. The Company acts in several ways to prevent extensive damage and disruptions of supply: variety of energy sources and assurance of stocks, variety of generation technologies, enabling the transition from one fuel type to another, research and development of advanced technologies, optimized operation while minimizing costs. On 25 January 2011 the Egyptian residents began a series of street demonstrations, protests and civil disobedience actions against the Mubarak government, which called for his dismissal. On 11 February 2011 President Mubarak announced that he has resigned and passed the control of Egypt to the military. On February 5, 2011, an explosion occurred in the gas pipeline in the El-Arish area, caused by a terrorist act. The explosion occurred in a metering station, located along the natural gas pipeline carrying gas from Egypt to Jordan and Syria, at a distance of about 30 km from the gas supply line to Israel. Following the explosion, gas supply to Israel was
74 74 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
6. Miscellaneous (continued) f. Risk Management (continued) 2) Strategic Risks (continued)
stopped for about five and a half weeks. Gas supply from Egypt was resumed on March 15, 2011. The Company is prepared to supply short term electricity demand through increased burdening of the coal operated generation units, increased gas supply from "Yam Thetis" group and use of alternative fuels, such as crude and diesel oil during peak demand. In the medium term, the Company is prepared, in accordance with the decision of the Minister of National Infrastructures, to import liquefied natural gas, which can be regasified on a ship opposite the shore of Hadera. This solution will fulfill the demand for gas from the time when gas supply from Mari B will diminish until gas will be supplied from "Tamar". In the long term of two years and more, the Company will rely on the "Tamar" gas reservoir and on gas supply from Egypt.
c) Risks to Reputation Medium risk level, with an upward direction of change. The Israel Electric Company Ltd., is a monopoly. This starting point has a material effect on its public image. The Company's image is affected by internal and external factors. Previous surveys indicate that the Company's image is rated as medium-low level. Public antagonism against the Company is reflected in the approach of all the parties that interact with it: decision makers, regulators, opinion shapers and the general public - Company customers of all kinds. Under these circumstances, the current image perception creates an “image deficiency” representing a gap between the actual qualities, professional capabilities and the level of service provided by the Company and the way the public views it. A company that suffers from a poor image will find it difficult to act in its spheres of operations and under such circumstances, it may enter a possible crisis from a negative starting point.
d) Competition Medium risk level, with an upward direction of change. As of the date of this report, the Company generates, transmits and supplies most of the power consumed within the State of Israel. Since it is a stated Government policy to allow competition in the electricity sector, the Government set the goal of increasing power generation by private electricity producers from 5% to 20% of the country’s power generation capacity. Although the Company feels this goal will be attained during the year of 2015 or not later than 2016 in view of the currently very small generating capacity of the private electricity producers and the long time it takes to set up the equipment required for power generation, there is no guarantee that Company’s estimations in this regard are true. Also, the Company believes that increased use of natural gas is an accelerating factor in the generation of power may accelerate competition in the electricity sector since natural gas fired generation units are considerably cheaper to construct than coal or liquid fuel fired ones. The instructions of the Electricity Sector Law are designed to promote the structural change of the Israeli electricity sector, including those which concern the construction and operation of subsidiaries sharing the same business lines with the Company so as to encourage competition in the electricity sector. Under the Electricity Sector Law and Orders, holders of transmission licenses are required, inter alia, (a) to purchase power from private electricity producers (with the purchase periods and amounts subject to the type of the relevant private electricity producer), (b) to allow private electricity producers 75 75 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
6. Miscellaneous (continued) f. Risk Management (continued) 2) Strategic Risks (continued) d) Competition (continued)
to sell power to their customers through the Company’s transmission network and supply mechanisms, and (c) to provide customers of the private electricity producers an alternative supply source. There is currently uncertainty with regard to the regulations set by the Minister of National Infrastructures and to the criteria set by the Electricity Authority with respect to preferences which may be given to private electricity producers over the Company. The growth potential of the competition poses a financial risk to the Company since it introduces an element of uncertainty with regard to the amount of electricity the Company will be required to produce in the future. Should the electricity projects of the private electricity producers as currently planned not be realized, the Company will still be required to supply the amount of electricity which would have been supplied by such projects. The Electricity Authority has made some decrees which were designed to encourage the penetration of private producers in the market while providing them a rather expansive safety net. In its decision of July 19, 2009, the Authority established that, for private electricity producers who fulfill certain terms, the Company should deposit in a designated account a sum of money which equals a bimonthly payment for the power expected to be sold to the Company by that producer. These sums, which would not be included on the list of Company’s pledged assets, shall serve to secure payments to the producer. As of this date, the said sums were not deposited. Also established were a rate agreement to apply between the private electricity producer and the vital service provider on occurrence of a force majeure, safety event or change to a discriminating law, and a rate agreement as derived from the division of the responsibility between the parties to the purchase transaction. This decision holds the essential service provider responsible for producer’s compensation by various payments on the occurrence of a force majeure incident which would delay or preclude the purchase transaction as well as for damages to the producer’s facility as may be due to an action of omission by the natural gas transportation company. This decision will apply to private generation license holders who will be subject to the following conditions: (a) license holders that operate electricity generation facilities with a normative value not less than NIS 50 million who have a legally binding agreement with an essential service provider to buy the energy and/or energy and availability from them, (b) license holders who have a senior debt at the date of a force majeure event, (c) the license holders completed a financial closure no later than June 1, 2012. The Israeli Government has taken various steps, within the context of the Electricity Sector Law, to encourage generation of electricity by private producers and to increase competition in the distribution segment. Additional conditional licenses were granted to private producers with a capacity of approximately 4,395 MW that, as of December 31, 2010, comprise approximately 30.5% of the Company’s total installed generating capacity. About half of this capacity is at an advanced stage of design. Nevertheless, the Company cannot predict how many projects will be completed during the coming decade. When these private producers begin generating and/or selling electricity, it is anticipated that they will supply the growth in demand for electricity consumption. In its decision dated July 27, 2009, the Electricity Authority set a rate agreement for a conventional private electricity producer in a transaction of selling available capacity and energy to the system manager. In such a transaction, the producers will have the right to make some (up to 90% of the facility's capacity) of the available generation capacity of their stations available to the system manager, for which the system manager will commit to a predefined amount of gas. The system manager will be liable for the relative share in producer’s gas transaction whether or not it will be used in effect. 76 76 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
6. Miscellaneous (continued) f. Risk Management (continued) 2) Strategic Risks (continued) d) Competition (continued)
In addition, the Electricity Authority published an update of Criteria Section E, which covers the infrastructure services provided by an essential service provider to suppliers and customers, and Section F, which covers producers’ dealings with the system manager in availability and energy purchase transactions. These criteria regulate essential service provider and system manager dealings with facilitators and private electricity producers. Under the proposed document, private transactions in the electricity economy will be accomplished through the facilitator whose central function would be that of a commercial organization mediating among the market players. These decisions will impose numerous costs on the Company, which will rise as private electricity producer operations expand and which the Company cannot quantify at this point in time. These costs will be taken into account in the framework of the rate setting process by the Electricity Authority, according to its decisions on September 13, 2010 and November 11, 2010. Under the assumption that the structural change will have the generation segment split among a number of companies, these companies may encounter competition by private electricity producers who will penetrate the market. The Company believes that if such change is indeed effected, the electricity producing companies formed out of the split will be able to make use of Company’s extensive experience as well as its human and physical capital to compete in an optimal manner. Yet, since there is no telling how such producing companies will operate, it remains to be seen whether they will compete with the private electricity producers on equal terms or be given a lesser preference compared with the private electricity producers. Nevertheless, since the Company operates in a regulated market, the introduction of private electricity producers in the market will not expose the Company to any risk of competition.
e) Natural Disasters Medium risk level, with an upward direction of change. Earthquake - Under the emergency plans of both the local and the world emergency authorities, power stations are defined as vital lifelines in the provision of immediate response and rectification of an incident. Report RR-355 "Preparations of the Company for an Earthquake Event" written by the Planning, Development and Technologies Division, includes recommendations for administrative and professional preparations of the Company to contend with earthquakes, relating to current and future facilities. The report includes both the design and the immediate and long term responses. Pursuant to findings and recommendations of a report that studied the preparedness of the Company for an earthquake event in both current and future facilities, the Company established committees that are dealing with providing solutions and responses to earthquakes. Other reports were also prepared, containing recommendations on treating the generation, transmission and storage facilities, the buildings, etc. As a result of the reports, work plans were prepared to implement these recommendations. Implementation of the recommendations is at different stages at the units of the Company. In addition, reports describing the anticipated damage of an earthquake to Company facilities were prepared for an operational assessment of the operation in the event of an earthquake. Based on these reports, earthquake drills were conducted to check the preparedness of the Company and raise the preparedness level. 77 77 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
6. Miscellaneous (continued) f. Risk Management (continued) 2) Strategic Risks (continued) e) Natural Disasters (continued)
The Company is performing multi-year projects to gradually anchor equipment items in its facilities and reinforce its buildings. New buildings and facilities are built in compliance with the requirements of Israeli Building Code 413, that defines resistance to earthquakes. A reference scenario drill was run in 2009, whereby an earthquake incident is outlined (location and intensity) along with its implications on Company facilities, electrical system, transportation infrastructures and personnel.
Flooding as a result of extreme weather conditions or a tsunami - Many Company sites have basements which could fill up with rainwater were it not for the draining systems installed to prevent this. These basements are common in power stations, substations and transformer stations. Under extreme conditions when the amount of rainwater exceeds the capacity of the drainage system or where the drainage system is clogged, a flooding risk arises. Flooding impairs plant operation and may induce direct and indirect property damages. To minimize the effect of such risk, draining systems design, construction and maintenance are inspected before the rainy season starts. Storms and extreme weather conditions which may cause damage to strategic transmission lines - The Company makes the necessary preparations to contend with extreme weather conditions by increased maintenance of strategic transmission lines defined as "Red" and "Orange" lines, by conducting annual drills of operating the emergency pylons, by having an emergency stock of pylons and grid accessories and by operation of a bypass system to provide alternate electricity supply in an emergency. The Company buys insurance policies to insure against damage caused by natural disasters, in the amount of $1 billion per event.
f) Fire Medium risk level, with a downward direction of change. Company facilities securing the electricity chain and other Company facilities such as office buildings, workshops, garages and warehouses are plagued with fire hazards originating in the flammable and toxic materials stored on the premises alongside with numerous sources of ignition. Since power stations feature the presence of fuels and operations involving flames, high temperatures and pressures, the fire hazards they entail are considerably greater than in other facilities. A fire breakout may stop the operation of a number of generation units and induce consequential damages due to operating a power station using higher cost fuels, all in addition to any direct damage as will result from the fire, including the costs of cleanup, repair, replacement of units and clearing of all waste and pollutants, etc. The greatest fire damage would be that which is caused by the fire reaching the boilers and turbine halls of two large and adjacent coal fired units. All direct and consequential fire damages are covered under Company’s purchased All Risks insurance. Major Company facilities are fitted with sophisticated fire detection and control systems designed and installed under strict Israeli and international standards. These systems are serviced by trained and qualified professionals, and they are activated at recommended intervals to check for normal operation. The Company employs professional firefighters and site emergency teams, all subject to training and drills to preserve their skills. 78 78 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
6. Miscellaneous (continued) f. Risk Management (continued) 2) Strategic Risks (continued) f) Fire (continued)
The Israel Fire Emergency Service runs periodic audits on Company sites where the existing fire detection and control systems are evaluated for design, construction and maintenance, unreasonable fire hazards and site personnel readiness for fire prevention and control. Joint drills are also run with the Emergency Services in order to evaluate the level of cooperation and to practice the operational capabilities required to extinguish large scale fires.
g) Natural Gas Supply High risk level, with an upward direction of change. The increasing dependence of the Company on natural gas to generate electricity creates risks for the Company due to the limited number of natural gas suppliers and limitations arising from the natural gas delivery system. Disruptions in gas supply, arising from breaches of purchase agreements with gas suppliers will force the operation of the generation system with more expensive alternate fuels in order to avoid prolonged disruptions of electricity supply to consumers. The Company estimates that the probability of disruptions in the gas delivery system that will require prolonged repair periods, is low. However, the expected financial damage caused by such events may be high if the Company does not have a sufficient generation capacity to supply the demand for electricity. Nevertheless, the Company intends to use the "Mari" reservoir after it is fully utilized to store an emergency supply of natural gas. The Company also anticipates that it will purchase additional quantities of natural gas after the commissioning of the new Tamar and Leviathan gas reservoirs in the longer term future. According to a government decision, a process is currently under way in which the government will choose a company that will build and operate a liquid natural gas (LNG) terminal, which will allow import and storage of natural gas. In preparation for bridging the gap that may occur from the exhaustion of the Mari B gas field until the "Tamar" gas field is developed, the Company is considering the import of LNG on regasifying ships. The State is responsible for resolving all the statutory issues. Israel Natural Gas Lines Ltd., will be responsible for building the buoy and connecting it to the national supply system, while the Company will be responsible for entering an agreement with the aforesaid ship and for purchasing the LNG. According to the master plan of the gas transportation system, the system will be upgraded by adding parallel lines around bottle necks as well as an eastern land line as a back-up for the marine line between Ashdod and Dor beach. The Company is considering ordering additional site connecting facilities (Pressure Reducing and Metering System “PRMS”) to avoid a situation in which a disruption in a PRMS facility will cause a breakdown in a generation site.
h) Planning and Execution of the Development Plans Medium risk level, with a downward direction of change. Under the Electricity Sector Law, the Company is not responsible for the development of the electrical system. However, in effect, it is indeed responsible for the supply of reliable and available electricity. This is why it must see to the development of the generation, transmission, transforming and distribution systems.
79 79 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
6. Miscellaneous (continued) f. Risk Management (continued) 2) Strategic Risks (continued) h) Planning and Execution of the Development Plans (continued)
Future development relies on a number of factors: future market demand forecasts, the geographical distribution of the predicted demand, development of production technologies and means, supply forecasts for the various fuel types, environmental limitations, development of existing and new sites, the current and predicted geopolitical situation, and forecasts of private electricity producers penetration in the electricity sector. The larger the number of the prediction parameters is, the greater the uncertainty and difficulty of prediction become. The Company relies on these demand forecasts when it makes monetary and resource investments, raises capital and sets up facilities. If the forecast is lower than the actual demands, under the same weather conditions chosen to plan at a higher growth rate than the annual growth rate, then the Company’s existing means may not cover the future demands. In the opposite situation, Company is exposed to losses of income due to low demand forecast. Control measures to minimize damage as a result of missing or forecasting an increase in demand include integrating and promoting projects, adding bridging projects and launching of emergency projects, postponement / cancellation of the purchase of equipment and flexibility while quantities engagements with vendors. Another factor affecting the planning and execution targets development program is scheduled receipt of permissions and approvals for establishing projects. In establishing a new facility, the company is required (Planning and Zoning Law and other laws) receive a series of certificates such as statutory construction permits and approvals (environmental and others). Various permits affect the scope of activities and meeting company objectives and are barriers to entry channels for such additional activities to increase production capacity. In order to deal with risks obtaining construction projects The company operates in several ways, including resource allocation for the project planning stage to remove obstacles facing the process of obtaining the relevant approvals and alternative action plans in cases of an unexpected delay in obtaining approvals. In addition to the above, the existing experience in the Company, development plans and policies the conservative short-and long- term funding of the Company also controls to minimize the damage.
i) Structural change As required by the Electricity Market Law, the Company is obliged to structural change. At the time of writing this report there is great uncertainty regarding the implementation of the law and how the Company, its operations, its right and duty to meet its demands. As a result, the implications of such a structural change in the Company are not clear at this point and despite the opinion of the Company that, if a final agreement is reached, the structural change will affect for the better, there is no certainty and it could also be cause a negative impact on the Company or on its financial condition. At the time of writing this report, the law states a gradual implementation of structural change in the Company, to operate several subsidiaries for generation and transmission. Following this process, different activities in the electricity sector will be separated, and in general, a single body will not get a license for more than one activity, subject to some exceptions. Structural changes in the Electricity Sector Law published have not yet been implemented. Electricity Sector Law fixes limits of the production capacity will be covered by production licenses held by entities, and the scope covered by the distribution licenses held by the entities. The Electricity Sector Law imposes further restrictions on the licenses held by a group of companies or under common control. Especially the possession of different types of licenses, production capacity and distribution areas included in these licenses. The Company is exempt from these restrictions unti the implementation of structural changes as set out in the Electricity Sector Law. By the law, a minimum of four production entities, four distribution 80 80 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010 entities, one transmission entity and one system management entity will be allowed. In August 2010 the Company reached agreement with representatives of the Government, employees’ organization and the Histadrut regarding the outline of the principles of restructuring, these are subject to understanding and agreement on other parts of the structural change, including structural and organizational changes, the Company's efficiency plan, measures to improve financial stability and employees compensation (especially for dismissal), managerial flexibility and finally will commit to the changing electricity market Discussions are held with all parties about the elements of structural change. To reach all-out agreements and to begin these discussions, the necessary changes according to Electricity Sector Law, may take a long time, and the final terms of agreements and legislation may differ from those predicted today. Depending on the extent and type of change, it may be necessary to obtain the consent of some of the company's creditors, which may take a long time. The agreement may be made under conditions that are not beneficial to the Company, or not accepted at all. On 15 December 2010, decided the Company's Board decided to promote the implementation of structural change, including the understandings mentioned above, and the Company's efficiency program (Matzpen). The Implementation of the program is expected to reduce costs and achieve greater operational efficiency. The Company conducts continuous and intensive process of discussions between representatives of the state, the Histadrut , the employees’ organization and the Management on the subject of structural and organizational changes and the rights of employees related to them. Since the electricity sector law conditions have not changed, and no final agreement was reached on the elements of the restructuring, the Company can not be sure that the structural change will take place. In the Company's opinion, if a final agreement is reached, the structural change will influence the Company for the better, but there is no certainty in this, so it is unclear what the impact will be on the company's business, operating results or financial conditions.
3) Financial Risks a) Legal Medium risk level, with a stable direction of change. As of this date, six applications are outstanding against the Company for claims to be recognized as class actions amounting to approximately NIS 19.9 billion, detailed in Note 27g to the Financial Statements. Based on the opinion of its own legal advisors, the Company has not made any provisions in its financial statements for these actions. The claims are managed by joint teams of the engineering units of the Company and the legal advisers
b) Credit Risks Medium risk level, with a stable direction of change. The risk arises from credit granted to customers of the Company where a financial loss risk exists, arising from bankruptcy or degraded credit rating of debtors or parties to a contract. In all matters of collection enforcement, the Company acts by using Red Lights information as obtained by the Company from business data banks regularly and passed on to the districts of the Company.
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6. Miscellaneous (continued) f. Risk Management (continued) 3) Financial Risks (continued) c) Liquidity Risks High risk level, with an upward direction of change. Some of Company’s existing financing agreements and bonds include clauses which permit the lenders to request immediate repayment on occurrence of an event which, in the lenders’ view, may have a considerable adverse effect on Company’s ability to pay the debt, and on occurrence of events as related to the sale of certain assets. See more in Note 27 g to the Financial Statements in Chapter C of this report. In this context, some financing agreements establish that the Company undertakes to submit to the lenders routine updates on all events that or may adversely affect the Company’s operations and/or financial strength, however the right to request immediate repayment rests, under certain circumstances, at the sole discretion of the lender. Should the lender decide to exercise its right to request immediate repayment, this may entitle other lenders to demand immediate payment of the balance of the unpaid principal and the accrued interest and thereby compromise Company’s operations, business results and financial condition. On December 31, 2010, these loans amounted to approximately NIS 19.1 billion.
d) Market Risks - Exposure to Changes in Exchange Rates on Foreign Currency on the Loans Balances Medium-high risk level, with difficulties in forecasting the direction of change and market trends. See detail under Market Risks in note 6 f2 above. e) Raising Capital High risk level, with an upward direction of change. Financing of the Company’s development plan, derived from the expected growing demand for electricity, as well as its need to recycle its outstanding debts, require, in the Company’s estimation, external financing sources in substantial volumes. The Company estimates the financing level it will require in the future is about 3 to 4 billion Shekels. The Company believes that some of the financing required for the longer term will be raised by loans from local and foreign banks and from local and overseas capital market bond issues. The Company’s power to raise long term financing in the future as well as the cost of such financing all depend on a variety of factors, including: the Company’s business results and financial condition; the Company’s bond rating; the economical conditions and the capital market; the interest rates; the availability of credit from banks and other lenders; investors’ confidence in the Company; the Company’s business success; the security, legal and political conditions in Israel; the government’s privatization policy; and the ability to raise credit from banks and other financial institutions in Israel; which, in turn, is affected by the Single Lender, Lender Group and Single Issuer limitations. In addition to this, the Company’s leverage level is already high, as was noted in the World Bank Reports, and may not support the additional borrowing needed to fully finance its investment program. On June 22, 2010, based upon the recommendations of the World Bank Reports, the Board of Directors of the Company resolved to reduce the Company’s financial leverage to 60% over a period of six years, which amounts to a debt reduction of NIS 9 billion. On December 26, 2010, the Company’s Board of Directors resolved to privately issue debt in Israel for an amount up to NIS 4 billion in 2011 with the proceeds to be used for debt repayment. The Company’s debt repayment for the years 2010 - 2011 is NIS 5.2 billion, and therefore, the Company intends to reduce its debt by NIS 1.2 billion in 2011 (in 2010 In 2010 not capital raising through bond issues has been conducted). In future years, the Company intends to raise less than its debt repayment until its financial leverage reaches 60%. The 82 82 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
6. Miscellaneous (continued) f. Risk Management (continued) 3) Financial Risks (continued) e) Raising Capital (continued) development budget for the year of 2010 was adjusted by the Company’s Board of Directors to reflect certain reductions in investments. Although the Company’s development plan requires significant capital expenditures, the Company’s Board of Directors has determined that the Company will not fund certain projects in order to avoid an increase in the Company’s liabilities and to encourage the Company and the Government to seek external financing sources. The Company is continuing to apply pressure on the Electricity Authority to increase the rate and is working with the Government Companies Authority, the Ministry of Finance, the Ministry of National Infrastructures, the workers’ organization and the Histadrut on the restructuring of the electricity sector to enable the Company to continue with its development plan. Furthermore, the Board of Directors of the Company continues to examine new potential financing solutions for the purpose of building such projects. Should the Government insist that the Company implement Emergency Plan phase B, this will require substantial additional funding and will require the financial support of the Government or of the Electricity Authority by increasing the rate. On 15 December 2010, National Infrastructure Minister approved the development plan for the electricity sector in particular performing Stage B of the emergency plan. On December 15, 2010, based on the recommendations of a team headed by the Director General of the Ministry of Finance that was charged with examining the needs of the electricity sector for 2013 and the findings of the World Bank reports, the Company’s Board of Directors approved an outline for financing and implementing the steam turbine add-ons project of Stage B of the Emergency Plan at an estimated cost of NIS 3.5 billion, based on the following components: (1) funding of NIS 2 billion from the Electricity Authority for the financing by the electricity consumers over 15 years. (2) dedicated credit in amount of NIS 1.1 billion which is expected to be obtained following the purchase of equipment. (3) the remaining amount, as required, will be financed by the company and all subject to certain Government of Israel and Electricity Authority approvals and agreements. On March 7, 2011, Electricity Authority decided to spread the company's consumer debt of NIS 2 billion up to the end of 2025 (15 years). On December 27, 2010, the Company received a letter from the Ministers in which the Ministers announced that, if needed, they will act to put in place Government of Israel guarantees over new debentures issued by the Company in the years 2011 and 2012 to service the Company’s international debt. However, the Company is currently of the view that such Government of Israel assistance is not required. Should the Company fail to raise capital as planned, then the pursuit of the development plan may suffer further delays and additional costs which may adversely affect Company’s operations, business results and financial condition.
f) Liabilities with Respect to Pension Fund Medium risk level, with a steady direction of change. See detail under Market Risks in section 2 above.
g) Accounting and Financial Reporting Medium risk level, with a downward direction of change. 1. The Company faces a risk due to failure to meet the deadline specified under the Law and under various agreements for the publication of its Financial Statements and also as due to the potential need to restate previously published Financial Statements.
83 83 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
6. Miscellaneous (continued) f. Risk Management (continued) 3) Financial Risks (continued) g) Accounting and Financial Reporting (continued) This risk originates mostly in the raising of profound accounting issues for the first time by changes to the accounting, legal and other environments close to the date when the statements were to be published. This may make it objectively difficult to establish accounting policies which will also be acceptable to the external auditor, and to implement them in the Financial Statements within the legally required schedule. If realized, this risk may have extensive implications, from the imposition of penalties and consideration of position holders as personally liable, to impact on the business environment within which the Company operates, including its capital raising capability, increased capital raising cost and potential adverse effect on Company’s business operations.
2. The Company also faces a risk associated with the correctness and inadequate disclosure of the information presented in its Financial Statements as may arise from lack of an effective internal controls system to handle the reports and disclosures provided in these Financial Statements. The Company acts to minimize the damage by implementing the Government Companies Regulations to review the effectiveness of the internal controls over the reporting and disclosure in the Financial Statements.
4) Operational Risks a) Environmental Protection Medium risk level, with an upward direction of change. The Company’s operations are subject to various environmental laws and regulations relating to air and water pollution, noise prevention, electromagnetic fields, storage, transportation, disposal of dangerous materials, and management of ground pollution. Some of these laws are in effect at the date of this report, while others are still in the making. In recent years there has been tightening standards applicable to the Company's operations, environmental monitoring and enforcing environmental standards. The Company estimates that this trend is expected to continue and even worsen in the coming years, in part, in accordance with the practice in Western countries. In the Company’s estimation, it fundamentally meets all legal and regulatory environmental requirements at the date of this report and also works with regulators to match certain requirements. The company is studying the implications of proposed laws and regulations in environmental protection, works to prevent or minimize the environmental risks that may occur during operation, and has allocated funds in the budgets for compliance with the provisions applicable environmental laws on those who are expected to apply to it. However, there is no guarantee that the costs and liabilities under existing laws and regulations and those expected will not exceed the amounts allocated by the Company for these purposes. The Company estimates that as of the date of this report, based on the directives of the Electricity Sector Law - 1996, the material costs it will be compelled to incur so as to comply with new regulatory requirements, will be recognized in the electricity tariff. The decision on recognizing the costs is subject to an audit by the Electricity Authority. Aforementioned company estimates are forward-looking information. As part of the Company's risk management, the Company acts to minimize the environmental impact of its operations in compliance with its governing laws and standards. These actions include the construction of pollutant emission reducing facilities and the transition to the use of natural gas, monitoring and sampling of the current environmental performance, control at fuel sites, reducing potable water use, adopting a cautious policy in relation to magnetic 84 84 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
fields from company facilities and others. For details on the company's operations and expansion of environmental issues, see Section 2.1.13 in Chapter A of this report. The company has developed mechanisms to control and monitor environmental aspects and is involved in parts of the legislative process which may have had an impact on IEC activities, studying the effects of environmental legislation in the making, preparing "environmental situation files" which concentrate the obligations originating from laws, regulations, permits, licenses and Company procedures that are used as the basis for conducting control over the fulfillment of the obligations and for taking steps required to implement them. b) Health and Safety Medium risk level, with a steady direction of change. The Company’s safety activities are subject to the following State Laws: (1) Labor Inspection (Organization) Law; (2) Work Safety Ordinance. Company operations are run under work procedures and safety instructions designed to protect health, welfare and safety of its employees against various risks and hazards associated with the work environment and the protective equipment required and the storage and protection of faulty equipment and hazardous materials. These instructions reflect the requirements of State laws and are even stricter. Also provided are the (legally required) personnel refresher training programs covering workplace hazards, and the various protection and control measures to be taken to minimize the damage induced by a safety event. Safety managers on the various Company sites run supervisions and surveys to identify and manage the hazards. The different safety committees meet at least eight times a year and act as a joint safety forum, attended by representatives of the management and employees. The distribution and transmission networks are maintained under the national network procedures which specify the scope and frequency of audits and also the technical parameters identifying the state of the facilities so as to allow early identification and rectification of safety faults. In addition to the above, in order to protect passers by from injury, Customers Division personnel are required to report all safety hazards as detected on Company premises, and to take every precaution required. The Company buys insurance policies to provide insurance coverage to equipment, employees and third parties. c) Human Capital Medium risk level, with an upward direction of change. The Company's human resources is managed through the aspiration to create a human resource mix with a high commitment to the organization, based on high quality and professional employees that contribute to labor productivity and to establishing and attaining efficiency norms, while upholding mutual respect, ethics and moral values, and compliance with the law. The Company’s operational profile spans a broad range of operations and skills, from engineering and planning through operation and maintenance of power generation and transmission systems, to bookkeeping and other varied pursuits and services. Failure to attract and retain skillful and suitable personnel threatens the Company’s operational and managerial capabilities. This threat is mostly prominent when it comes to: The demand for engineers with specific expertise in the electricity field, in view of the aging of the generation of the Company’s veteran engineers. In this respect, the threat became greater still due to a lack of specialized electricity study programs in the field of high current in the Israeli engineering schools. 85 85 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
The dropout of temporary employees leaves knowledge gaps and requires the training of other personnel. To mitigate this risk, the Company promotes coaching programs for young engineers and their accompaniment by experienced engineers, and also through training programs designed to eliminate the knowledge gaps. The Company contends with the human capital risk by taking the following actions: A training system responsible for preparing annual and multi-year training programs according to the work plans and unique needs of the units; manpower substitution performed according to approved manpower standards; encouraging internal migration and conversion processes; short, medium and long term planning of personnel; backing up of employees in critical key positions. d) Human Errors Medium risk level, with a steady direction of change. Human errors are inherent in any action, yet, in some instances, they may cause severe damages and injury. These are most likely to occur where the error is made in facilities and systems of the Company by system management supervisors, regional/area/power station command room supervisors or maintenance personnel. Many accidents originate from human errors, therefore, to reduce the probability of error and the severity of the damage, the Company invests in writing work procedures and instructions of operation, maintenance and safety and personnel training and certification, to improve awareness to possible error situations and to equip employees will tools to avoid such situations, including debriefing of incidents and implementation of lessons learned. e) Labor Relations High risk level, with an upward direction of change. The Company acts to maintain good labor relations and to communicate regularly with the labor organization and follow all of its own employment agreements – all to prevent any breakdown in the labor relations. Labor relations breakdowns may be manifested by labor disputes which may lead to employee sanctions and even general and prolonged strikes which, in turn, may disrupt the supply of electricity to the Company customers. Such a disruption may entail financial and safety damages to the State's residents, affect their quality of life, and also damage the Company’s image and financial situation (reduction in income). In the event of a breakdown in labor relations, the Company continues to negotiate with the workers’ organization yet also takes actions against groups disrupting the Company’s operations, including legal action as required against the workers’ organization so as to prevent disproportional damage to the customer and to the Company profits. The Company also negotiates with the General Labor Federation (Histadrut) and the Government Authorities.
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6. Miscellaneous (continued) f. Risk Management (continued) 4) Operational Risks (continued)
f) Technical Failures High-medium risk level, with an upward direction of change. The reliability of power station, substation and switching station equipment affects the reliability of the entire station. On any equipment failure, the station may suffer limited generation capacity and even removal from the generation and/or transmission circuit. Repair of large scale breakdowns entails extremely high direct and consequential costs as related to equipment, replacement parts, specialized labor, contractors and Company personnel, alternative fuel costs and additional costs as are due to transmission system losses.
To preserve equipment reliability, periodic maintenance works and tests are performed in evaluation of equipment status. Test results provide an indication of the need for equipment maintenance or replacement. The Company compares the failure data with data as collected by other electric companies worldwide, and has mostly found that own equipment reliability is often higher than the world accepted averages. Company’s All Risks insurance covers major equipment failures, although with a high deductible (10 million US Dollars as direct cost and 60 days for alternative fuels). Heavy equipment damages mostly entail time consuming insurance claims which often conclude in arbitration and/or settlement. Nevertheless, the Company managed to cover a considerable part of the insurance expenses in the past using payments made by the insurance company for “premature failure” claims in connection with power plant equipment. In recent years, Company’s fleet of generation units has increasingly relied on natural gas burning combined cycle stations. Although advantageous in numerous respects, the combined cycle stations feature higher and faster attrition as compared with the conventional units, all as a result of the higher operating temperatures and flow rates. The combined cycle units require frequent maintenance. They suffer a higher rate of major failures and their design life cycle is shorter. The Company invests in development and maintenance plans and acts to renovate generation units according multi-year work plans.
g) Embezzlements and Frauds Medium risk level, with a steady direction of change. Since the Company encompasses a broad spectrum of different business pursuits totaling billions of Shekels, it is exposed to a wide range of embezzlement and fraud risks some of which may incur financial losses and impair the Company's image. This category includes incidents of equipment theft from Company sites and illegal usage. 2010 was characterized by accelerated activity to reduce embezzlement and fraud risk, as mapped by an external consultant and members of a dedicated team. Pursuant to actions of the team and implementation of suitable control of different business processes, most of the risks were transferred at the end of 2010 to the status of current monitoring by the different units. As at the time of writing this report, a risk survey of tenders is being conducted. A work plan for managing the risks will be prepared on the basis of this survey.
h) Information Systems Medium risk level, with a stable direction of change. The Company’s business processes are supported by information systems in the following areas: 87 87 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
6. Miscellaneous (continued) f. Risk Management (continued) 4) Operational Risks (continued) h) Information Systems (continued) (1) Electricity chain – power generation and supply; (2) Business/financial – financing, financial statements, collection, supplier payments, planning; (3) Customer service – hotline 103, website. Failure of any of the information systems supporting these processes will disrupt the processes and damage the Company’s financial condition and reputation.
The Company’s array of computer systems is based on two reciprocally backed-up computer centers (in Tel Aviv and in Haifa). Physical backup of all data is provided on a remote site, with critical systems also backed up synchronously. A two way backup drill is run annually between the two computer centers. Preventive actions are also taken to prevent failures at the computer centers including: upgrading of the physical infrastructure and the electrical system, periodic testing of the supporting systems (UPS, generator, structure control system, flood detector and firefighting system). Failure scenarios are provided for all systems defined as critical. These scenarios are drilled and updated under an emergency drills program (covering earthquake, war and other emergencies) as implemented by the Company.
i) Suppliers Medium-low risk level, with a steady direction of change. The Company’s supply chain comprises of purchasing processes, contract management, equipment supplies and storage of stocks. To minimize the damage caused by the collapse of equipment suppliers and/or faulty management of agreements with suppliers, the Company checks the financial soundness of suppliers during the procurement processes and manages procurement contracts according to Company procedures and instructions of the professional parties in the Company. Suppliers who manufacture materials that are critical to the operation of power stations were mapped and various actions to prevent shortage of these materials were studied. To broaden its circle of manufacturers, suppliers and service providers, the Company located alternative suppliers whenever possible for production and supply of spare parts, encourages reengineering, local production and certifies potential manufacturers and suppliers. These actions contribute to the Country’s participation in the economical effort of the State.
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6. Miscellaneous (continued) f. Risk Management (continued) 4) Operational Risks (continued) j) Projects Risks Medium risk level, with a stable direction of change. A dedicated unit at the Company manages complex engineering projects for the construction and maintenance of components in the electricity chain. The success of the projects are measured by three main criteria: meeting the budget of the project, its time table and the quality of the project. The main risk is deviation from the timetables and the budget allocated to the project. The Company conducts a risks management process in projects, using different tools and methodologies. In addition, the Company contends with these risks by promoting alternative projects, bridging projects and recently even through emergency projects to close the gaps.
k) Information Security Low risk level with an upward change direction of the risk. System hacking may disrupt and damage the information systems as well as the normal operation of the systems supporting the Company’s business operations. Moreover, system penetration by a hostile code may damage the management network, and cause a leak of data to unauthorized functions and impair data integrity. Hostile codes may be entered and the network penetrated through various means, including: during web surfing, through incoming emails or through use of contaminated storage facilities. In the framework of increasing the level of information security in the Company, several actions have been taken: Implementation of an anti-virus protective system in the connections to the internet, the e-mail servers, other servers and end stations. Implementation of a security component to protect databases containing sensitive data and warnings of on any unauthorized access attempts. Implementation of a central logs gathering and analysis system. Reinforcement of the authorizations system through a central authorizations control and management system. Monitoring the current operations: unauthorized accesses, access to sensitive transactions in the information systems, access to information systems at unusual times. Conducting risks surveys of the information systems. The Company also acts to increase personnel awareness to data security through a dedicated data security campaign. Moreover, all Company employees will attend training on information security subjects during 2011, to increase their awareness to this issue. The management network is separated from the operational network. The data is transferred between the networks using a dedicated tool.
The Information Systems Division has been accredited to data Security Standard ISO- 27001, the accreditation of which serves as an additional control over the Division for compliance with the various requirements to reduce the Company’s data security risks. Company’s computer equipment is covered similarly to other operational assets of the Company under an All Risks insurance which includes profit losses/increased fuel expenses as may result from damage to the computer systems. The Company acts under regulation and supervision of the Prime Minister's Office on information security subjects.
89 89 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
6. Miscellaneous (continued) f. Risk Management (continued) 4) Operational Risks (continued)
l) Management of Maintenance and Reserve Medium risk level, with an upward direction of change. Since the electricity sector in the State of Israel is an isolated sector (see Geopolitical Situation and External Political Risks) and the reserve level of the Company is not high, there is a risk of failure to supply the demand for electricity in isolated situations of peak demand arising from unpredicted extreme weather conditions during renovation periods of Company units and a risk of failure to meet the renovation schedule, which may result in a breakdown of generation units. The Company acts to minimize damage that may arise from these risks through a dedicated procedure for shutting units down for renovation and defining an annual units renovation plan. In addition, the Company acts to prevent failure to supply the demand by an advertising campaign on saving electricity, to reduce electricity consumption and by implementing the "smart grid".
g. A strategic plan for sustainable development in the company In February 2011 a Strategic Plan for the sustainable development of the company was submitted according to the Government Companies Authority Circular dated 29 June 2009. In this framework, the Company reported about the actions taken based on this program. The following report is part of the Strategic Plan for Sustainable Development– Electricity sector development is a constant balancing between various considerations, including power quality, reliability of supply, costs to the economy and environmental considerations. Various aspects of electricity sector development are examined in the Company by the people involved in system development and the environment. During the generation, transmission and supply of the electricity required in the economy in Israel, naturally creates environmental hazards. Therefore, the Company sees itself as responsible for and makes a commitment to take measures to protect the environment and reduce environmental hazards along the power chain. The Company is working to integrate environmental considerations in all areas of operations including decision-making stages of initiating the project, determining the technology, design, implementation, operation and monitoring. The company is, for the life of the project, from planning to operation of the facilities, while maintaining a continuous reduction of environmental impacts taking into account the principles of sustainable development, and the adoption of proven technologies and the most economical. Air quality issue of greenhouse gases are the most relevant areas as component of air pollutants and emissions of greenhouse gases of power stations is a high weight in the economy in general in emission. The company has integrated at an accelerated rate since the beginning of 2004 the use of natural gas in a central role in production and at the same time improved the environmental quality of the types of fuels used to generate electricity (coal, fuel oil, diesel). These actions, along with increasing the efficiency of power plants introducing a modern combined cycle units led to the reduction of the characteristic emission of emissions of pollutants into the air. The Company’s environmental flagship project for the 2011-2020 decade, is installing facilities to reduce emissions from coal-fired generation units. Facilities include PM (primary measures) and - nitrogen oxides reduction SCR and FGD to reduce sulfur dioxide. The cost of anticipated investment moves around about NIS 8 billion + VAT. This is not a simple task to install at production facilities and operational units that must provide electricity to customers. The company is trying to implement environmental values into its corporate culture, environmental awareness and commitment of employees and integrating environmental issues in planning, implementation and operation of the electricity chain, including increased work with the community affected by its power stations. The company will continue in the future to lead in the environmental field as required by the significant environmental effects arising from the facilities.
90 90 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
6. Miscellaneous (continued) g. A strategic plan for sustainable development in the company (continued)
Substantive environmental issues relating to the Company's activities. The Company manufactures and supplies electricity in Israel while taking measures to protect the environment and reduce environmental hazards, along the power chain: generation, transmission, transformation and distribution. Electricity sector development is a constant balancing between various considerations, including power quality, reliability of supply, costs to the economy and environmental considerations. The various aspects of electricity sector development are examined in the Planning and Development Department, in which sector reaches the status of Deputy Director, whose job is handling the environmental aspects – legislation involved in society through integration with other sectors in the Department. This segment addresses, inter alia integrating environmental issues and implementation of laws. The environmental effects related to Company activities relate to air emissions of the products of fuel combustion (sulfur dioxide, nitrogen oxides, particulates, carbon monoxide and carbon dioxide - a greenhouse gas), seawater for cooling, discharged treated industrial wastewater under a permit to sea, land runoff, reclaimed water used to irrigate the garden by individual permits where possible, hazardous substances, radiation and electromagnetic fields, and noise. Coal ash and powder produced in the process of coal burning power stations at "Orot Rabin" and "Rutenberg" are for beneficial use in cement and concrete industry infrastructure and the quantity produced is used in full. A significant part of the company's production facilities is located along the Mediterranean coast and the company is preparing both fuel and marine pollution prevention and protecting its facilities from polluting the sea from an external source.
Major environmental policies of the company
a. Integration of environmental considerations in all areas of operations including decision- making. b. Planning and operating facilities while maintaining a continuous reduction of environmental impacts taking into account the principles of sustainable development, while adopting proven technologies and the most economical. c. Adoption of advanced environmental proven standards, even in the absence of laws and regulations. d. Rational use of raw materials and natural resources: land, air, water and fuel. 6. Miscellaneous (continued)
e. Reducing and recycling waste by-products. f. Combining landscape considerations, regional and environmental planning new facilities and maintenance of existing facilities. g. Maintaining dialogue - an open and transparent dialogue with the public regarding programs that have environmental impact. h. Reducing greenhouse gas emissions, in the spirit of international treaties partnered by the State of Israel by increasing the efficiency of power plants, expanded use of fuels and environmentally friendly energy sources and encouraging energy efficiency. i. Interaction with environmental bodies, national and international public, including participation in environmental research, advanced technologies and entrepreneurship development. j.. Implementation of environmental values in the corporate culture, environmental awareness and commitment of employees and integrating environmental issues in the community activities.
91 91 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
Over the years operated company internal work teams to formulate master plans in the section topics, as follows:
A master plan to implement "emission standards" in power generation facilities of the company A master plan for wastewater and effluent treatment subject to prevent ground, water source and sea water pollution A master plan to prevent sea water pollution from fuel Integrated planning of water resources at IEC facilities A master plan for solid waste treatment in IEC Implementation of policies for coal ash A master plan for the treatment of harmful asbestos dust at IEC sites Appearance and landscape master plan for IEC sites Energy saving at administrative facilities of the Company A master plan for electromagnetic fields from Company facilities and their implications A master plan on the subject of hazardous materials at IEC sites A master plan for noise at IEC sites Integrated - Environmental planning of sub-stations, switching station and transmission lines Operational work plan in internal information and training employees to increase environmental awareness A master plan for the Sea and Beaches CO2 emission reduction h. Environmental Concerns See Note 1 g to the Financial Statements in Chapter C in this report. i. Organizational Structure For a description of the organizational structure, the number of employees by field of activity in accordance with the organizational structure – see the Report of the Description of the Corporation’s Affairs as of December 31, 2010, Sections 2.1.9, 2.2.8, 2.3.9
92 92 THE ISRAEL ELECTRIC CORPORATION LIMITED BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE CORPORATION'S AFFAIRS FOR THE YEAR ENDED DECEMBER 31, 2010
6. Miscellaneous (continued) j. Dividend distributions See the Statement of Changes in Shareholders’ Equity. k Taxation See Note 22 to the Financial Statements in Chapter C of this report. l. Legal Procedures See Note 24 to the Financial Statements in Chapter C of this report. m. Assets – Land and Appendages See Note 11 to the Financial Statements in Chapter C of this report. n. Agreements See Note 24 to the Financial Statements in Chapter C of this report.
The Board of Directors and Management wish to express their appreciation to the Company’s employees and its managers.
Amos Lasker Dr. Ziv Reich Yiftah Ron-Tal CEO Chairman, Committee Chairman of the Board of for Reviewing the Directors Financial Statements Date of Approval: March 31, 2011
93 93
The Israel Electric Corporation Ltd.
Supplement
Additional Report Regarding the Effectiveness of the Internal Control Over Financial Reporting
For the Year Ended December 31, 2010
Prominent Disclaimer
This English translation of the “Additional Report Regarding the Effectiveness of the Internal Control Over Financial Reporting” for the year ended December 31, 2010 ("English Translation") is provided for information purposes only.
In the event of any conflict or inconsistency between the terms of this English Translation and the original version prepared in Hebrew, the Hebrew version shall prevail and holders of the Notes should refer to the Hebrew version for any and all financial information relating to the Company.
The Company, its Directors and its Auditors make no representations as to the accuracy and reliability of the financial information in this English Translation, save that the Company and its Directors represent that reasonable care has been taken to correctly translate and reproduce such information, yet notwithstanding the above, the translation of any technical terms are, in the absence of generally agreed equivalent terms in English, approximations to convey the general sense intended in the Hebrew version.
The Company reserves the right to effect such amendments to this English Translation as may be necessary to remove such conflict or inconsistency.
Auditors' Report to the Shareholders of the Israel Electric Corporation Limited.
On the Effectiveness of Internal Control over Financial Reporting
According to paragraph 3 of the Government Companies Regulations (Additional Reports on the Effectiveness of Internal Control Over Financial Reporting), 2007
We have audited the internal control over financial reporting of Israel Electric Corporation Limited (the "Company") as of December 31, 2010, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
The Company’s Board of Directors and Management are responsible for maintaining effective internal control over financial reporting and for their assessment of the effectiveness of internal control over financial reporting, included in the accompanying Board of Directors and Management's report on Internal Control over Financial Reporting, which is enclosed under the Government Companies Regulations (Additional Reports on the Effectiveness of Internal Control Over Financial Reporting), 2007. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (PCAOB) as was adopted by the Institute of Certified Public Accountants in Israel. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on that risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A Government-owned corporation's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with the financial reporting principles applying to the Company (such principles applying to the Company are explained in note 2a to the financial statements as of December 31, 2010). A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with the financial reporting principles applying to the Company (as explained in note 2a to the financial statements as of December 31, 2010), and that receipts and expenditures of the company are being made only in accordance with proper authorizations of directors and management of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
1
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis.
The following material weakness has been identified and included in the Report of the Board of Directors and Management on Internal Control over Financial Reporting:
1. The Company did not maintain effective controls over the appropriateness of recognition of salary and indirect costs in the Fixed Assets balances, appropriateness of the Fixed Assets counts, appropriateness of Fixed Assets valuations and recognition and measurement of decommissioning, restoration and similar liabilities as part of the cost of an item of property.
2. The Company did not maintain effective controls to ensure that the rights and benefits according to which payroll and pension payments are paid and actuarial obligations included, are authorized in conformity with requirements of the law.
The aforementioned material weaknesses were considered in determining the nature and extent of audit tests applied in our audit of the Company's consolidated financial statements as of and for the year ended December 31, 2010, and this report does not affect our report on such financial statements.
In our opinion, because of the effect of the material weaknesses identified above on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2010, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We have also audited, in accordance with Israeli generally accepted auditing standards, the consolidated financial statements of the Company as of and for each of the three years in the period ended December 31, 2010, and our report dated March 31, 2011 expressed an unqualified opinion on those financial statements and included explanatory paragraphs pertaining to a number of issues.
Brightman Almagor Zohar & Co. Certified Public Accountants A member firm of Deloitte Touche Tohmatsu
Tel Aviv, March 31, 2011
2
SECOND ADDENDUM (REGULATION 2)
A REPORT OF THE BOARD OF DIRECTORS AND THE MANAGEMENT ON THE INTERNAL CONTROLS OVER FINANCIAL REPORTING IN ACCORDANCE WITH GOVERNMENT COMPANIES REGULATIONS (ADDITIONAL REPORT REGARDING THE EFFECTIVENESS OF THE INTERNAL CONTROLS OVER FINANCIAL REPORTING), 2007
The Management, under supervision and upon approval of the Board of Directors of the Israel Electric Corporation Ltd., is responsible for establishing and maintaining adequate internal controls over financial reporting of the Company. The internal controls over financial reporting is a process designed to provide a reasonable measure of assurance regarding the reliability of the financial report and the preparation of the financial statements for external purposes, in accordance with generally acceptable accounting principles and the directives of the Government Companies Law. Due to its inherent limitations, the internal controls over financial reporting are not intended to provide an absolute assurance that a material misstatement will be prevented or discovered.
The Management and the Board of Directors conducted an assessment of effectiveness of the internal controls over financial reporting of the Company and its efficiency, based on criteria defined in a control model named "COSO Model".
Based on this evaluation, the Company's Management and Board of Directors concluded that the internal controls over financial reporting of the Company for the period ended on December 31, 2010, are not effective, due to material weaknesses of the internal controls over financial reporting, as detailed below:
1. The Company did not maintain effective controls over the appropriateness of recognition of salary and indirect costs in the Fixed Assets balances, appropriateness of the Fixed Assets counts, appropriateness of Fixed Assets valuations and recognition and measurement of decommissioning, restoration and similar liabilities as part of the cost of an item of property.
2. The Company did not maintain effective controls to ensure that the rights and benefits according to which payroll and pension payments are paid and actuarial obligations included, are authorized in conformity with requirements of the law.
Correction of the material weaknesses
1. The Company is in the process of strengthening controls to comply with the requirements for charging salary and indirect costs to fixed assets, presenting inventory of fixed assets and its value in the Financial Statements and inclusion of obligations with respect to decommissioning fixed assets and restoring sites and charging costs to fixed assets.
2. The Company presented a restatement for correcting errors of previous reporting periods in its Financial Statements for the period ending on December 31, 2010. The Company is also in the process of strengthening the aforementioned controls.
The Company estimates that these corrective actions will correct the aforementioned material weaknesses in the internal controls over the financial reporting.
The Opinion of the External Auditor The external auditor of the Company, Brightman Almagor Zohar & Co., who audited the financial statements of the Company for the period ended on December 31, 2010, issued an opinion on the effectiveness of the Company's internal control over financial reporting.
In its opinion, the external auditor referred to the material weakness specified above.
Mr. Harel Zeev Blinde Mr. Amos Lasker Dr. Ziv Reich Mr. Yiftah Ron-Tal Senior Vice-President of Chief Executive Officer Chairman, Committee Chairman, Board of Finances and Economics for Reviewing the Directors Financial Statements
March 31, 2011