THE ISRAEL ELECTRIC CORPORATION LIMITED 7.250% Notes Due 2019

FINAL PRICING SUPPLEMENT (To Offering Circular dated April 23, 2008)

U.S.$1,000,000,000 THE ISRAEL ELECTRIC CORPORATION LIMITED 7.250% Notes due 2019

The Israel Electric Corporation Limited (the ‘‘Company’’ or ‘‘IEC’’), a company organized under the laws of the State of Israel and 99.85% owned by the State of Israel, proposes to issue U.S.$1,000,000,000 aggregate principal amount of 7.250% Notes due 2019 (the ‘‘Notes’’). The Notes will bear interest at the rate of 7.250% per year. Interest on the Notes is payable on January 15 and July 15 of each year, beginning on July 15, 2008. The Notes will mature on January 15, 2019, and will be repaid at their principal amount. The Notes are redeemable prior to maturity, in whole or in part, at the Company’s option at a redemption price set forth under ‘‘Description of the Notes’’ in the Offering Circular or upon the occurrence of certain changes in Israeli tax law requiring the payment of additional amounts as described herein. In addition, in the event of a change of control or other specified events, holders of Notes (‘‘Noteholders’’, and each a ‘‘Noteholder’’) may require the Company to redeem their Notes at redemption prices set forth under ‘‘Description of the Notes’’ in the Offering Circular. The Notes will be general obligations of the Company and will be secured by a valid and enforceable perfected floating charge (the ‘‘Note Floating Charge’’) on the present and future assets of the Company that are charged under any other floating charge created by the Company, whether now existing or hereafter created. For a description of the floating charge, see ‘‘Description of the Notes—Note Floating Charge’’ in the Offering Circular. The Notes are not obligations of, or guaranteed by, the State of Israel. If any other entity engages in or undertakes all or substantially all of the Company’s transmission business, such other entity will be substituted for the Company as the issuer of the Notes and the Company shall provide an unconditional guarantee of the Notes. Approval in-principle has been obtained from the Singapore Exchange Securities Trading Limited (the ‘‘SGX-ST’’) for the Program to be listed on the Official List of the SGX-ST. An application has been made for the approval in-principle for the Notes to be listed and quoted on the Official List of the SGX-ST. The SGX-ST assumes no responsibility for the correctness of any of the statements made or opinions expressed or reports contained herein. Admission of the Notes to the Official List of the SGX-ST and the above approval in-principle of the SGX-ST is not to be taken as an indication of the merits of the Company or any of its subsidiaries or the Notes. The Notes will be listed and quoted on the Official List of SGX-ST and will be traded on the SGX-ST in a minimum board lot size of U.S.$200,000 for so long as any of the Notes are so listed.

Investing in the Notes involves risks. See ‘‘Risk Factors’’ beginning on page 21 of the Offering Circular. The Notes have not been and will not be registered under the United States Securities Act of 1933, as amended (the ‘‘Securities Act’’). Subject to certain exceptions, Notes may not be offered, sold or delivered within the United States or to U.S. persons (as defined in Regulation S under the Securities Act (‘‘Regulation S’’)). The Notes may be offered for sale (i) to qualified institutional buyers (as defined in Rule 144A under the Securities Act (‘‘Rule 144A’’)) (‘‘QIBs’’) in the United States in reliance on Rule 144A or (ii) outside the United States, in reliance on Regulation S. See ‘‘Plan of Distribution.’’ The Notes are subject to restrictions on transfer. See ‘‘Transfer Restrictions’’ in the Offering Circular. Offering Price: 99.831% of principal plus accrued interest if any from May 7, 2008 The managers referenced below expect to deliver the Notes on or about May 7, 2008, in book entry form only through the facilities of DTC for the accounts of its participants, including Clearstream Banking, société anonyme and Euroclear Bank S.A./N.V., as operator of the Euroclear System. Joint Book-Running Managers Citi Lehman Brothers Co-Managers JPMorgan Merrill Lynch & Co. Morgan Stanley May 1, 2008

SUMMARY OF TERMS

The following is a summary of the principal terms of the Notes to be issued by the Company pursuant to its U.S.$2,000,000,000 Global Medium-Term Note Program. This summary supplements the description of, and incorporates by reference the terms of, the Notes contained in the Offering Circular dated April 23, 2008 and should be read in connection therewith. Capitalized terms used herein and not otherwise deﬁned have the meaning ascribed to such terms in the Offering Circular.

Issuer: The Israel Electric Corporation Limited

Issue: U.S.$1,000,000,000 of 7.250% Notes due 2019

Issue Date: May 7, 2008

Maturity Date: January 15, 2019

Rate of Interest: 7.250% per annum. Interest will be computed on the basis of a 360-day year of twelve 30-day months.

Interest Payment Dates: January 15 and July 15 in each year, commencing July 15, 2008

Issue Price: 99.831% of principal amount

Early Redemption Amount: The Notes will be redeemable upon the occurrence of certain changes in Israeli tax law requiring the payment by the Company of additional amounts in respect of the Notes as described in the Offering Circular and upon an Event of Default, in each case at 100% of the principal amount of the Notes, together with interest accrued to the date of redemption. See ‘‘Description of the Notes—Redemption —Early Redemption Amounts’’ in the Offering Circular.

Redemption at the Option The Notes will be subject to redemption at the option of of the Noteholders: holders of the Notes following the occurrence of certain events, including; • if at the Relevant Time (as defined) the State of Israel is rated Investment Grade (as defined), the Notes are rated below Investment Grade and the Company has not used its best endeavors to obtain an Investment Grade rating of the Notes (taking into account the requirements of the Rating Agencies for the purposes of obtaining such rating and the timeframe required to obtain such rating); • upon the Company’s failure to comply with the Substitution (as defined below) provisions; • the Company ceases at or after the Relevant Time to engage lawfully in the Transmission Business (as defined) or the main business of the Company ceases to be the Transmission Business;

S-2 • a Change of Control (as defined); or • upon the occurrence of an event or circumstance which could reasonably be expected to have a Material Adverse Effect (as defined), each a ‘‘Put Event’’. If at any time while any Note remains outstanding, a Put Event occurs then, holders will have the option to require the Company to redeem the relevant Notes at the principal amount outstanding of the Notes plus, in certain circumstances, Foregone Margin (as defined), together in any case with accrued interest to the put date. See ‘‘Description of the Notes—Redemption’’ in the Offering Circular for definitions and additional detail.

Redemption at the Option The Notes will be redeemable, in whole at any time or in part of the Company: from time to time, at the Company’s option at a redemption price equal to the greater of: (i) 100% of the principal amount of the Notes to be redeemed on that redemption date; and (ii) as determined by the Quotation Agent, the sum of the present values of the remaining scheduled payments of principal and interest on the Notes being redeemed on that redemption date (not including any portion of such payments of interest accrued as of the date of redemption), discounted to the date of redemption on a semi-annual basis (assuming a 360-day year consisting of twelve 30-day months) at the Treasury Rate (as deﬁned below), plus 50 basis points, plus, in each case, accrued and unpaid interest thereon to the date of redemption. Notwithstanding the foregoing, installments of interest on Notes that are due and payable on interest payment dates falling on or prior to a redemption date will be payable on the interest payment date to the registered holders as of the close of business on the relevant record date according to the Notes and the Fiscal Agency Agreement. ‘‘Comparable Treasury Issue’’ means the United States Treasury security selected by the Quotation Agent as having a maturity comparable to the remaining term (as measured from the date of redemption) of the Notes to be redeemed that would be utilized, at the time of selection and in accordance with customary ﬁnancial practice, in pricing new issues of corporate debt securities of comparable maturity to the remaining term of such Notes. ‘‘Comparable Treasury Price’’ means, with respect to any redemption date, (i) the average of four Reference Treasury Dealer Quotations for such redemption date, after excluding the highest and lowest such Reference Treasury Dealer Quotations, or (ii) if the Quotation Agent obtains fewer than four such Reference Treasury Dealer Quotations, the average of all such quotations, or (iii) if only one Reference Treasury Dealer Quotation is received, such quotation.

S-3 ‘‘Quotation Agent’’ means any Reference Treasury Dealer appointed by the Company. ‘‘Reference Treasury Dealer’’ means (i) each of Citigroup Global Markets Inc. and Lehman Brothers Inc. (or their respective afﬁliates that are Primary Treasury Dealers) and their respective successors; provided, however, that if any of the foregoing shall cease to be a primary U.S. Government securities dealer in New York City (a ‘‘Primary Treasury Dealer’’), the Company will substitute therefor another Primary Treasury Dealer, and (ii) any other Primary Treasury Dealer selected by the Company. ‘‘Reference Treasury Dealer Quotations’’ means, with respect to each Reference Treasury Dealer and any redemption date, the average, as determined by the Company, of the bid and asked prices for the Comparable Treasury Issue (expressed in each case as a percentage of its principal amount) quoted in writing to the Quotation Agent by such Reference Treasury Dealer at 5:00 p.m., New York City time, on the third business day preceding such redemption date. ‘‘Treasury Rate’’ means, with respect to any redemption date, the rate per annum equal to the semi-annual equivalent yield to maturity of the Comparable Treasury Issue, assuming a price for the Comparable Treasury Issue (expressed as a percentage of its principal amount) equal to the Comparable Treasury Price for such redemption date. Notice of any redemption will be mailed at least 30 days but not more than 60 days before the redemption date to each registered holder of the Notes to be redeemed by the Company or by the Fiscal Agent on the Company’s behalf; provided that notice of redemption may be mailed more than 60 days prior to a redemption date if the notice is issued in connection with a defeasance of the Notes or a satisfaction and discharge of the Notes. Once notice of redemption is mailed, the Notes called for redemption will become due and payable on the redemption date and at the applicable redemption price, plus accrued and unpaid interest to, but excluding, the redemption date. Unless the Company defaults in payment of the redemption price, on and after the redemption date, interest will cease to accrue on the Notes or portions thereof called for redemption. On or before the redemption date, the Company will deposit with a paying agent (or the Fiscal Agent) money sufﬁcient to pay the redemption price of and accrued interest on the Notes to be redeemed on that date. If less than all of the Notes are to be redeemed, the Notes to be redeemed shall be selected by lot by DTC, in the case of Notes represented by a global security, or by the Fiscal Agent by a method the Fiscal Agent deems to be fair and appropriate, in the case of Notes that are not represented by a global security.

S-4 Restrictive Covenants: The Notes will contain covenants applicable to the Company, including covenants that limit the ability to incur liens and take actions that could impair the Note Floating Charge and covenants that require the Company to provide periodic reports, maintain public ratings and conduct its business in a lawful manner consistent with good industry practice. See ‘‘Description of the Notes—Certain Covenants’’ in the Offering Circular.

Substitution: The Company shall substitute for itself (a ‘‘Substitution’’) any other entity that at any time engages or undertakes or will engage in or undertake, all or substantially all of the Transmission Business (the ‘‘Substitute Obligor’’) as issuer of all of the Notes. Upon the occurrence of a Substitution, the Company will unconditionally and irrevocably guarantee the due and punctual payment of all sums payable by the Substitute Obligor in respect of the Notes (the ‘‘IEC Guarantee’’). The IEC Guarantee will constitute direct, general and unconditional obligations of the Company that will be secured by the Note Floating Charge. The assets subject to the Note Floating Charge will not include the Transmission Business assets or any other assets of the Substitute Obligor. The Note Floating Charge, will, however, attach to any shares of, or other equity interests in, the Company’s subsidiaries or other entities, if any. See ‘‘Description of the Notes—Note Floating Charge’’, ‘‘Description of the Notes—Substitution and ‘‘Taxation—Valid Status Tax Considerations—Substitution of Obligor ‘‘ in the Offering Circular.

Form of Notes: The Notes will be represented by Registered Global Notes that will be settled and cleared though DTC.

Denominations: U.S.$200,000 and integral multiples of U.S.$1,000 in excess thereof.

Stabilizing Agents: Citigroup Global Markets Inc. and Lehman Brothers Inc.

Series: Series 1

ISIN: US46507MAA09 (Restricted Global Note) US46507NAA81 (Regulation S Global Registered Note)

CUSIP: 46507MAA0 (Restricted Global Note) 46507NAA8 (Regulation S Global Registered Note)

Listing: Singapore Exchange Securities Trading Limited

S-5 CAPITALIZATION

The following table sets forth the consolidated capitalization, cash equivalents and short-term debt of the Company as of December 31, 2007 on an actual basis and as adjusted to reﬂect the issuance of the Notes. For further information, see the Financial Statements.

As of 31 December, 2007 Actual Adjusted (1) (in millions (in (in millions (in of adjusted millions of adjusted millions December 2007 of U.S. December 2007 of U.S. Shekels) Dollars) (5) Shekels) Dollars) (5) Cash and cash equivalents ...... NIS 456U.S.$ 119 NIS 4,284 U.S.$ 1,114 Short-term debt (current maturities of long-term debt) . . . 1,679 437 1,679 437

Long-term debt, net and extended-term debt, net (2)..... Notes, net (3) ...... 3,846 1,000 Debentures, net ...... 25,897 6,733 25,897 6,733 Loans from banks...... 11,354 2,952 11,354 2,952 Other loans ...... 2,009 522 2,009 522 Total long-term debt, net ...... 39,260 10,207 43,106 11,207 Extended-term debt, net...... 473 123 473 123 Perpetual debentures ...... 2,156 561 2,156 561 Total Long-term debt, net and extended-term debt, net...... 41,889 10,891 45,735 11,891 Shareholders’ Equity ...... Paid up share capital...... 972 253 972 253 Capital reserves...... 880 229 880 229 Dividend Provided ...... 2,358 613 2,358 613 Retained earnings ...... 9,636 2,505 9,636 2,505 Total shareholders’ equity ...... 13,846 3,600 13,846 3,600 Total capitalization (4) ...... NIS 55,735 U.S.$14,491 NIS 59,581 U.S.$15,491

(1) As adjusted to give effect to the issuance of U.S.$1,000 million aggregate principal amount (U.S.$994,810,000 net of discounts) of Notes offered hereby (translated to NIS 3,846,000,000 and NIS 3,826,039,260, respectively, based on the Shekel/Dollar exchange rate of 3.846:1.000 as at December 31, 2007).

(2) On January 17, 2008, the Company issued $250 million aggregate principal amount of debentures. In March 2008, the Company issued CPI-linked non-marketable debentures of the ‘‘2014 Linked Electric’’ series with an overall par value of approximately NIS 170 million in consideration of approximately NIS 181 million for a period of six years under standard interests for the Company’s capital raising rounds.

(3) The principal amount of the Notes is presented net of discounts, which will be amortized over the respective terms of the Notes. See Note 2.v.4 to the Company’s Financial Statements included in the Offering Circular.

(4) On January 17, 2008, the Company issued U.S.$250 million aggregate principal amount of debentures. In March 2008, the Company issued CPI-linked non-marketable debentures of the ‘‘2014 Linked Electric’’ series with an overall par value of approximately NIS 170 million in consideration of approximately NIS 181 million for a period of six years under standard interest for the Company’s capital raising rounds.

(5) U.S. Dollar amounts have been translated at NIS 3.846 to U.S.$1.00, the representative rate of exchange published by the Bank of Israel, for December 31, 2007.

S-6 PLAN OF DISTRIBUTION

Under the terms and subject to the conditions contained in a Terms/Syndication Agreement, dated May 1, 2008, the dealers named below (the ‘‘Dealers’’) have severally agreed to purchase from the Company, and the Company has agreed to sell to the Dealers, severally, the respective principal amount of Notes set forth opposite their respective names below: Dealer Principal Amount of Notes Citigroup Global Markets Inc...... U.S.$ 490,000,000 Lehman Brothers Inc...... 490,000,000 J.P. Morgan Securities Ltd...... 6,667,000 Merrill Lynch, Pierce, Fenner & Smith Incorporated ...... 6,667,000 Morgan Stanley & Co. Incorporated...... 6,666,000 Total ...... U.S.$1,000,000,000

The Company has been advised that the Dealers propose to offer the Notes directly at the offering price set forth on the cover page of this Pricing Supplement and may offer the Notes to certain dealers (who may include the Dealers) at such offering price less a discount not in excess of 0.20% of the principal amount of the Notes. The selected dealers may reallow a concession not in excess of 0.10% of the principal amount of the Notes to certain other brokers and dealers. After the offering, the offering price, the concession to selected dealers and the reallowance may be changed by the Dealers.

S-7 OFFERING CIRCULAR

THE ISRAEL ELECTRIC CORPORATION LIMITED U.S.$2,000,000,000 Global Medium-Term Note Program The Israel Electric Corporation Limited (the ‘‘Company’’ or ‘‘IEC’’), a company organized under the laws of the State of Israel and 99.85% owned by the State of Israel, may from time to time issue medium-term notes (the ‘‘Notes’’) denominated in any currency agreed by the Company and the relevant Dealer or Dealers (as defined below) pursuant to the Global Medium-Term Note Program described herein (the ‘‘Program’’). The Notes will have maturities as may be agreed between the Company and the relevant Dealer or Dealers and as indicated in the applicable Pricing Supplement (as defined below), subject to such minimum or maximum maturities as may be allowed or required from time to time by any applicable law. The maximum principal amount of all Notes from time to time outstanding will not exceed U.S.$2,000,000,000 (or the equivalent, calculated as described herein, in other, currencies), subject to the right of the Company to increase such amount upon satisfaction of certain conditions. The Notes will be general obligations of the Company and will be secured by a valid and enforceable perfected floating charge (the ‘‘Note Floating Charge’’) on the present and future assets of the Company that are charged under any other floating charge created by the Company, whether now existing or hereafter created. For a description of the floating charge, see ‘‘Description of the Notes—Note Floating Charge.’’ The Notes are not obligations of, or guaranteed by, the State of Israel. If any other entity engages in or undertakes all or substantially all of the Company’s transmission business, such other entity will be substituted for the Company as the issuer of the Notes and the Company shall provide an unconditional guarantee of the Notes. In addition, in the event of a change of control or other specified events, holders of Notes (‘‘Noteholders’’, and each a ‘‘Noteholder’’) may require the Company to redeem their Notes at redemption prices set forth under ‘‘Description of the Notes.’’ The Notes may be offered from time to time through one or more of the Euro Dealers and U.S. Agents listed below and any other dealer appointed from time to time by the Company (each a ‘‘Dealer’’). Notes may also be sold to a Dealer or Dealers as principal at negotiated discounts or otherwise, and Notes may be sold to or through syndicates of financial institutions for which a Dealer or Dealers will act as a lead manager or lead managers. Approval in-principle has been obtained from the Singapore Exchange Securities Trading Limited (the ‘‘SGX-ST’’) for the Program to be listed on the Official List of the SGX-ST. The SGX-ST assumes no responsibility for the correctness of any of the statements made or opinions expressed or reports contained herein. Admission of the Program to the Official List of the SGX-ST and the above approval in-principle of the SGX-ST is not to be taken as an indication of the merits of the Company or any of its subsidiaries, the Progam or the Notes. Any Notes issued under the Program that are listed and quoted on the Official List of SGX-ST will be traded on the SGX-ST in a minimum board lot size of U.S.$200,000 for so long as any of the Notes are so listed. The Program provides that individual Series (as defined below) of Notes may be listed on such other stock exchanges as may be agreed between the Company and the relevant Dealer or Dealers. The Company may also issue Series of Notes that are unlisted. Notice of the aggregate nominal amount of interest payable in respect of, issue price of, and any other terms and conditions not contained herein which are applicable to, each Tranche (as defined below) of Notes will be set forth in a pricing supplement (the ‘‘Pricing Supplement’’) which, with respect to any Notes to be listed on the SGX-ST will be delivered to the SGX-ST on or before the date of issue of the Notes of such Tranche. SEE ‘‘RISK FACTORS’’ STARTING ON PAGE 21 FOR CERTAIN CONSIDERATIONS RELATING TO AN INVESTMENT IN THE NOTES. The Notes have not been and will not be registered under the United States Securities Act of 1933, as amended (the ‘‘Securities Act’’). Subject to certain exceptions, Notes may not be offered, sold or delivered within the United States or to U.S. persons (as defined in Regulation S under the Securities Act (‘‘Regulation S’’)). The Notes may be offered for sale (i) to qualified institutional buyers (as defined in Rule 144A under the Securities Act (‘‘Rule 144A’’)) (‘‘QIBs’’) in the United States in reliance on Rule 144A, (ii) to a limited number of institutional investors that qualify as accredited investors (as defined in Rule 501(a)(1), (2), (3) and (7) under the Securities Act (‘‘Institutional Accredited Investors’’)) or (iii) outside the United States, in reliance on Regulation S. See ‘‘Plan of Distribution.’’ The Notes are subject to restrictions on transfer. See ‘‘Transfer Restrictions.’’ Co-Arrangers Citi Lehman Brothers

Euro Dealers Citi Lehman Brothers Credit Suisse DEXIA Capital Markets JPMorgan Merrill Lynch International Morgan Stanley UBS Investment Bank

U.S. Dealers Citi Lehman Brothers JPMorgan Merrill Lynch & Co. Morgan Stanley April 23, 2008 The Company accepts responsibility for the information contained in this Offering Circular. The Company, having made all reasonable inquiries, confirms that this Offering Circular contains all information with respect to the Company, the Company and its Subsidiaries (as defined below) taken as a whole (the ‘‘Group’’) and the Notes that is material in the context of the issue and offering of the Notes, the statements contained herein relating to the Company and the Group are in every material respect true and accurate and not misleading, the opinions and intentions expressed in this Offering Circular with regard to the Company and the Group are honestly held, have been reached after considering all relevant circumstances and are based on reasonable assumptions, there are no other facts with respect to the Company, the Group or the Notes, the omission of which would, in the context of the issue and offering of the Notes, make any statement in this Offering Circular misleading in any material respect, and all reasonable inquiries have been made by the Company to ascertain such facts and to verify the accuracy of all such information and statements. This Offering Circular is confidential. The Offering Circular has been prepared by the Company solely for use in connection with the proposed offering of the securities in this Offering Circular. This Offering Circular is personal to each offeree and does not constitute an offer to any other persons or to the public generally to subscribe for or otherwise acquire securities. Prospective investors are authorized to use this Offering Circular solely for the purpose of considering the purchase of the Notes. Distribution of this Offering Circular to any other person other than the prospective investor and any person retained to advise such prospective investor with respect to its purchase is unauthorized, and any disclosure of any of its contents, without the Company’s prior written consent, is prohibited. Each prospective investor, by accepting delivery of this Offering Circular, agrees to the foregoing and to make no photocopies of this Offering Circular or any documents referred to in this Offering Circular. In making an investment decision, prospective investors must rely on their own examination of the Company and the terms of the offering, including the merits and risks involved. Prospective investors should not construe anything in this Offering Circular as legal, business or tax advice. Each prospective investor should consult its own advisors as needed to make its investment decision and to determine whether it is legally permitted to purchase the securities under applicable legal investment or similar laws or regulations. No person has been authorized in connection with any offering made hereby to give any information or to make any representation that is not contained in or consistent with this Offering Circular or any other information supplied in connection with the Notes and, if given or made, such information or representation may not be relied upon as having been authorized by the Company, the Co-Arrangers (as defined below), the Dealers or any affiliate of any of the foregoing. Neither the Co-Arrangers nor any of the Dealers has separately verified the information contained in this Offering Circular. Accordingly, no representation, warranty or undertaking, express or implied, is made and no responsibility is accepted by the Co-Arrangers or the Dealers as to the accuracy or completeness of this Offering Circular or any further information supplied in connection with the Notes. The Co-Arrangers and the Dealers accept no liability in relation to this Offering Circular or any other information provided by the Company in connection with the Notes. This Offering Circular is to be read in conjunction with all documents which are deemed to be incorporated herein by reference. See ‘‘Documents Incorporated by Reference.’’ This Offering Circular shall be read and construed on the basis that such documents are so incorporated and form part of this Offering Circular. Neither the delivery of this Offering Circular or any amendment or supplement thereto nor the offer, sale or delivery of any Note shall under any circumstances create any implication that the information contained herein is correct at any time after the date hereof or the date upon which this Offering Circular has been most recently amended or supplemented or that there has been no change in the business, properties, financial condition, results of operations or prospects of the Company since the date hereof or of such amendment or supplement or that any other information supplied in connection with the Program is correct as of any time subsequent to the date on which it is supplied or, if different, the date indicated in the document containing the same. The Co-Arrangers and the Dealers expressly do not undertake to review such matters during the term of the Program.

2 Neither this Offering Circular or any amendment or supplement thereto nor any other information supplied in connection with the Notes constitutes an offer or invitation by or on behalf of any of the Company, the Co-Arrangers, the Dealers or any afﬁliate of any of the foregoing to any person to subscribe for or to purchase any of the Notes. This Offering Circular and any amendment or supplement thereto are not intended to provide the basis of any credit or other evaluation and should not be considered as a recommendation by the Company or any of the Dealers that any recipient of this Offering Circular or any amendment or supplement thereto should purchase Notes. Each investor contemplating purchasing Notes should make its own independent appraisal of the creditworthiness of the Company. Neither the Co-Arrangers nor any of the Dealers undertakes to review the ﬁnancial condition or affairs of the Company during the term of the arrangements contemplated by this Offering Circular nor to advise any investor or potential investor in the Notes of any information coming to the attention of the Co-Arrangers or any of the other Dealers.

The distribution of this Offering Circular and any amendment or supplement thereto and the offer, sale and delivery of Notes in certain jurisdictions may be restricted by law. Persons into whose possession this Offering Circular or any amendment or supplement thereto comes are required to inform themselves about and to observe any such restrictions. For a description of certain restrictions on offers, sales and deliveries of Notes and on distribution of this Offering Circular and other offering material, see ‘‘Plan of Distribution.’’ Certain other restrictions may apply as described in the applicable Pricing Supplement. This Offering Circular may not be used in connection with an offer to sell or the solicitation of an offer to buy the Notes in any jurisdiction in which such offer or solicitation is unlawful.

To permit compliance with Rule 144A in connection with resales of the Notes, the Company will furnish upon the request of a holder of a Note and a prospective purchaser designated by such holder the information required to be delivered under Rule 144A(d)(4) under the Securities Act if, at the time of such request, the Company is neither a reporting company under Section 13 or Section 15(d) of the U.S. Securities Exchange Act of 1934, as amended (the ‘‘Exchange Act’’), nor exempt from reporting pursuant to Rule 12g3-2(b) thereunder.

None of the stock exchanges on which the Notes may be listed under the Program assumes any responsibility for the correctness of any of the statements made or opinions or reports expressed or contained in this Offering Circular. Admission of the Notes to listing and quotation on any such exchange is not to be taken as an indication of the merits of the Company, its Subsidiaries or the Notes.

This Offering Circular has not been and will not be registered as a prospectus with the Monetary Authority of Singapore (the ‘‘MAS’’) and the Notes are offered by the Company pursuant to exemptions invoked under Sections 274 and 275 of the Securities and Futures Act (Chapter 289) of Singapore (the ‘‘SFA’’). Accordingly, the Company has not offered or sold the Notes or caused the Notes to be made the subject of an invitation for subscription or purchase, nor will it offer or sell the Notes or cause the Notes to be made the subject of an invitation for subscription or purchase, nor has it circulated or distributed nor will it circulate or distribute this Offering Circular or any other document or material in connection with the offer or sale, or invitation for subscription or purchase, of the Notes, whether directly or indirectly to persons in Singapore other than (i) to an institutional investor under Section 274 of the SFA, (ii) to a relevant person, or any person pursuant to Section 275(1A) of the SFA, and in accordance with the conditions speciﬁed in Section 275 of the SFA or (iii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA.

Where Notes are subscribed or purchased under Section 275 of the SFA by a relevant person which is:

(a) a corporation (which is not an accredited investor (as deﬁned in Section 4A of the SFA)) the sole business of which is to hold investments and the entire share capital of which is owned by one or more individuals, each of whom is an accredited investor; or

3 (b) a trust (where the trustee is not an accredited investor) whose sole purpose is to hold investments and each beneﬁciary of the trust is an individual who is an accredited investor, shares, debentures and units of shares and debentures of that corporation or the beneﬁciaries’ rights and interest (howsoever described) in that trust shall not be transferred within six months after that corporation or that trust has acquired the Notes pursuant to an offer made under Section 275 of the SFA except:

(i) to an institutional investor under Section 274 of the SFA or to a relevant person (as deﬁned in Section 275(2) of the SFA) and in accordance with the conditions speciﬁed in Section 275 of the SFA; or

(ii) (in the case of a corporation) where the transfer arises from an offer referred to in Section 275(1A) of the SFA, or (in the case of a trust) where the transfer arises from an offer that is made on terms that such rights or interests are acquired at a consideration of not less than S$200,000 (or its equivalent in a foreign currency) for each transaction, whether such amount is to be paid for in cash or by exchange of securities or other assets; or

(iii) where no consideration is given for the transfer; or

(iv) by operation of law.

4 TABLE OF CONTENTS

SERVICE OF PROCESS AND ENFORCEMENT OF CIVIL LIABILITIES...... 6 PRESENTATION OF FINANCIAL AND OPERATING DATA...... 7 DOCUMENTS INCORPORATED BY REFERENCE...... 8 FORWARD-LOOKING STATEMENTS...... 8 SUMMARY...... 9 RISK FACTORS ...... 21 RELATIONSHIP WITH THE STATE OF ISRAEL ...... 29 USE OF PROCEEDS ...... 31 EXCHANGE RATES ...... 31 CAPITALIZATION...... 32 SELECTED FINANCIAL DATA ...... 33 MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITIONS ...... 34 BUSINESS ...... 45 GLOSSARY ...... 76 MANAGEMENT ...... 78 TRANSACTIONS WITH RELATED PARTIES ...... 85 DESCRIPTION OF THE NOTES ...... 86 TAXATION...... 130 PLAN OF DISTRIBUTION ...... 139 TRANSFER RESTRICTIONS ...... 143 INDEPENDENT AUDITORS ...... 145 LEGAL MATTERS...... 145 INDEX TO FINANCIAL STATEMENTS ...... F-1 ANNEX A—CONDITIONS IN ISRAEL...... A-1 ANNEX B—FORM OF PRICING SUPPLEMENT...... B-1

5 SERVICE OF PROCESS AND ENFORCEMENT OF CIVIL LIABILITIES The Company is organized under the laws of the State of Israel. All of its directors and officers and the independent accountants named herein reside outside the United States (principally in Israel). All or a substantial portion of the assets of these persons and of the Company are located outside the United States. As a result, it may not be possible for investors to effect service of process within the United States upon such persons or the Company or to enforce against them judgments obtained in United States courts predicated upon the civil liability provisions of the federal securities laws of the United States. The Company has been informed by its legal counsel in Israel, Herzog, Fox & Neeman, that it may be difficult to assert U.S. federal securities laws claims in original actions instituted in Israel. Israeli courts may refuse to hear a claim based on a violation of U.S. securities laws because Israel is not the most appropriate forum to bring such a claim. In addition, even if an Israeli court agrees to hear such a claim, under exceptional circumstances it may determine that Israeli law and not U.S. law is applicable to the claim. However, subject to certain time limitations, Israeli courts are empowered to enforce foreign (including United States) final executory judgments for liquidated amounts in civil matters, obtained after completion of process before a court of competent jurisdiction (according to the rules of that court’s country and of private international law currently prevailing in Israel) which recognizes similar Israeli judgments. The foregoing is conditioned upon (a) adequate service of process being effected and the defendant having a reasonable opportunity to be heard, (b) such judgments or the enforcement thereof not being contrary to Israeli law, public policy, security or the sovereignty of the State of Israel, (c) such judgments not being in conflict with any other valid judgment in the same matter between the same parties, (d) such judgments not having been obtained by fraudulent means and (e) an action between the same parties in the same matter not being pending in any Israeli court at the time the lawsuit is instituted in the foreign court. The Company has appointed Corporation Service Company, 1133 Avenue of the Americas, Suite 3100, New York, New York 10036 as agent for service of process in any action in any federal or state court sitting in the City of New York arising out of the offering or any purchase or sale of the Notes or with respect to the Company’s obligations under the Notes and the Fiscal Agency Agreement (as defined below). Consent has not been given by the Company for such agent to accept service of process in connection with any other action. In an action in Israel to recover an amount in a non-Israeli currency, the Israeli court may render judgment for the equivalent amount in Israeli currency at the rate of exchange in force on the date thereof. Israeli courts may also render judgments in foreign currencies. Pending collection, the amount of the judgment of an Israeli court stated in Israeli currency ordinarily will be linked to the Consumer Price Index in Israel (the ‘‘CPI’’) plus interest at the annual rate (set by Israeli regulations) prevailing at such time. The regulations also set the rate of interest to be paid on judgments of Israeli courts in foreign currencies. All judgment creditors must bear the risk of unfavorable exchange rates. For information concerning the CPI, see Notes 2.d and e to the Company’s financial statements included in this Offering Circular (the ‘‘Financial Statements’’).

NOTICE TO PROSPECTIVE INVESTORS IN THE UNITED STATES Neither the U.S. Securities and Exchange Commission (‘‘SEC’’) nor any state securities commission has approved or disapproved of these securities or determined if this Offering Circular is truthful or complete. Any representation to the contrary is a criminal offense. The Notes are subject to restrictions on transferability and resale and may not be transferred or resold except as permitted under the Securities Act and the applicable state securities laws pursuant to registration or exemption therefrom. Prospective investors should be aware that they may be required to bear the ﬁnancial risks of this investment for an indeﬁnite period of time. Please refer to the sections in the Offering Circular entitled ‘‘Plan of Distribution’’ and ‘‘Transfer Restrictions.’’

NOTICE TO NEW HAMPSHIRE RESIDENTS NEITHER THE FACT THAT A REGISTRATION STATEMENT OR AN APPLICATION FOR A LICENSE HAS BEEN FILED UNDER CHAPTER 421-B OF THE NEW HAMPSHIRE REVISED STATUTES WITH THE STATE OF NEW HAMPSHIRE NOR THE FACT THAT A SECURITY IS

6 EFFECTIVELY REGISTERED OR A PERSON IS LICENSED IN THE STATE OF NEW HAMPSHIRE CONSTITUTES A FINDING BY THE SECRETARY OF STATE THAT ANY DOCUMENT FILED UNDER RSA 421-B IS TRUE, COMPLETE AND NOT MISLEADING. NEITHER, ANY SUCH FACT NOR THE FACT THAT AN EXEMPTION OR EXCEPTION IS AVAILABLE FOR A SECURITY OR A TRANSACTION MEANS THAT THE SECRETARY OF STATE HAS PASSED IN ANY WAY UPON THE MERITS OR QUALIFICATIONS OF, OR RECOMMENDED OR GIVEN APPROVAL TO, ANY PERSON, SECURITY OR TRANSACTION. IT IS UNLAWFUL TO MAKE, OR CAUSE TO BE MADE, TO ANY PROSPECTIVE PURCHASER, CUSTOMER OR CLIENT, ANY REPRESENTATION INCONSISTENT WITH THE PROVISIONS OF THIS PARAGRAPH.

PRESENTATION OF FINANCIAL AND OPERATING DATA In this Offering Circular, references to ‘‘U.S. Dollars’’, ‘‘U.S.$’’, or ‘‘$’’ are to the currency of the United States of America and references to ‘‘NIS,’’ ‘‘Shekels,’’ or ‘‘Agorot’’ are to the currency of Israel. One Shekel equals 100 Agorot. Unless otherwise specified or the context otherwise requires, references to ‘‘Australian Dollars’’ are to the currency of Australia, references to ‘‘Canadian Dollars’’ or ‘‘CDN’’ are to the currency of Canada, references to ‘‘Danish Kroner’’ are to the currency of Denmark, references to the ‘‘euro’’ are to the single currency introduced at the start of the third stage of the European Economic and Monetary Union pursuant to the treaty establishing the European Union (as amended from time to time), references to ‘‘Hong Kong Dollars’’ are to the currency of Hong Kong, references to ‘‘Y,’’ ‘‘Yen’’ or ‘‘Japanese Yen’’ are to the currency of Japan, references to ‘‘New Zealand Dollars’’ are to the currency of New Zealand, references to ‘‘Swiss Francs’’ are to the currency of Switzerland, references to ‘‘S$’’ or ‘‘Singapore Dollars’’ are to the currency of Singapore, and references to ‘‘Sterling’’ or ‘‘£’’ are to the currency of the United Kingdom of Great Britain and Northern Ireland. The Company maintains its financial books and records in Shekels and presents its financial statements in conformity with generally accepted accounting principles in Israel (‘‘Israeli GAAP’’). See Note 2 of the Financial Statements. The financial statements as at and for the period ended December 31, 2007 have been reconciled to International Financial Reporting Standards (‘‘IFRS’’). Israeli GAAP differs from generally accepted accounting principles in the United States (‘‘U.S. GAAP’’) in certain significant respects. See Note 32 to the Financial Statements for a reconciliation of the Company’s 2007 financial results to IFRS. In accordance with Israeli GAAP, the Company presents its financial statements in Shekels that have been adjusted to reflect changes in purchasing power of the Shekel due to inflation. Unless otherwise indicated, all financial data relating to the Company as at and for each of the years ended December 31, 2005, December 31, 2006 and December 31, 2007 are presented in Shekels adjusted to December 31, 2007 purchasing power (‘‘adjusted December 2007 Shekels’’). The annual financial statements as of and for the year ended December 31, 2005, have been audited by Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global, the annual financial statements for the year ended December 31, 2006 have been audited jointly by Kost Forer Gabbay & Kasierer and Brightman Almagor & Co., a member of Deloitte International, and the annual financial statements for the year ended December 31, 2007 have been audited by Brightman Almagor & Co. The annual financial statements for the years ended December 31, 2005, 2006 and 2007 have been prepared in adjusted December 2007 Shekels. See ‘‘Management’s Discussion and Analysis of Results of Operations and Financial Condition.’’ This Offering Circular contains translations of certain Shekel amounts into U.S. Dollars at specified rates solely for the convenience of the reader. These translations should not be construed as representations that the Shekel amounts actually represent such U.S. Dollar amounts. Unless otherwise indicated, for the years ended December 31, 2005, 2006 and 2007 such U.S. Dollar amounts have been translated at NIS 3.846 to U.S.$1.00, the representative rate of exchange published by the Bank of Israel, the Israeli central bank (the ‘‘Bank of Israel’’), for December 31, 2007. No representation is made that any amount in Shekels or U.S. Dollars referred to in this Offering Circular has been, could have been or could be

7 converted into U.S. Dollars or Shekels, as the case may be, at any particular rate or at all. See ‘‘Exchange Rates’’ for information regarding the rate of exchange between the Shekel and the U.S. Dollar for the periods speciﬁed therein.

DOCUMENTS INCORPORATED BY REFERENCE

All supplements to this Offering Circular circulated by the Company from time to time and the most recently published English translations of future annual and interim financial statements of the Company shall be deemed to be incorporated in, and to form part of, this Offering Circular, except that any statement contained herein or in a document which is or is deemed to be incorporated by reference herein shall be deemed to be modified or superseded for the purpose of this Offering Circular to the extent that a statement contained in any such subsequent document which is or is deemed to be incorporated by reference herein modified or supersedes such earlier statement (whether expressly, by implication or otherwise). Such documents will be available for inspection at the principal offices in London, England of the Bank of New York, the fiscal, principal paying and transfer agent for the Notes (the ‘‘Fiscal Agent’’), and for collection without charge from The Israel Electric Corporation Limited, 1 Netiv Ha’Or, P.O. Box 10, Haifa 31000, Israel. In addition, such documents will be available free of charge, for so long as any Note is outstanding, at the specified office of the Paying Agent (as defined below) in London.

If at any time prior to the completion of the distribution of any Tranche of Notes, any event occurs as a result of which the Offering Circular would include any untrue statement of a material fact or omit to state any material fact necessary to make the statements therein, in light of the circumstances under which they were made, not misleading, or if it shall be necessary to amend or supplement the Offering Circular to comply with applicable law, the Company will promptly prepare and provide to the Dealers (and ﬁle with the SGX-ST and any securities exchange on which any Notes are listed, if necessary) an amendment which will correct such statement or omission or effect such compliance.

FORWARD-LOOKING STATEMENTS

This Offering Circular includes forward-looking statements, including statements regarding the Company’s expectations and projections for future operating performance and business prospects. The words ‘‘believe’’, ‘‘expect’’, ‘‘anticipate’’, ‘‘estimate’’, ‘‘project’’, ‘‘plan’’, ‘‘intend’’ and ‘‘may’’ and similar words or expressions identify forward-looking statements. In addition, all statements other than statements of historical facts included in this Offering Circular are forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause actual results or performance of the Company to differ materially from those expressed or implied by such forward-looking statements. Such forward-looking statements are based on numerous assumptions regarding the Company’s present and future business strategies and the environment in which the Company will operate in the future. Accordingly, we caution you against relying on these forward-looking statements. The Company expressly disclaims any obligation or undertaking to release any updates or revisions to any forward-looking statement contained herein to reﬂect any change in the Company’s expectations with regard thereto or any change of events, conditions or circumstances on which any such statement was based. This Offering Circular discloses, under the caption ‘‘Risk Factors’’ and elsewhere, important factors that could cause actual results to differ materially from the Company’s expectations. All subsequent written and oral forward-looking statements attributable to the Company or persons acting on behalf of the Company are expressly qualiﬁed in their entirety by such cautionary statements.

8 SUMMARY The following summary should be read in conjunction with, and is qualified in its entirety by, the more detailed information and the Company’s financial statements and notes thereto appearing elsewhere in this Offering Circular. The following summary does not purport to be complete and is qualified in its entirety by the full text of this Offering Circular and, in relation to the terms and conditions of any particular Tranche of Notes, the applicable Pricing Supplement. A glossary of certain of the technical terms used in this summary and used throughout the Offering Circular is set forth under the heading ‘‘Glossary.’’ This Offering Circular contains forward looking statements that involve risks and uncertainties. Such statements are based on management’s current expectations and are subject to a number of factors and uncertainties which could cause the Company’s performance and the other matters discussed in the forward looking statements to differ significantly from that discussed in such forward looking statements. Factors that could cause such differences include, but are not limited to, those discussed in ‘‘Risk Factors’’ and elsewhere in this Offering Circular. The Company assumes no obligation to update its forward looking statements or to advise of changes in the assumptions and factors on which they are based. The Company The Company is the sole integrated electric utility in the State of Israel and generates, transmits, distributes and supplies substantially all the electricity used in the State of Israel. The State of Israel owns approximately 99.85% of the Company. The Company is one of the largest industrial companies in Israel. For the year ended December 31, 2007, the Company had total revenues of NIS19,264 million (U.S.$5,009 million) and recorded a net loss of NIS101 million (U.S.$26 million) and, at December 31, 2007, the Company had total assets of NIS68,974 million (U.S.$ 17,934 million), in each case in adjusted December 2007 Shekels. As of December 31, 2007, the Company owned and operated 17 power stations (including five major thermal power stations) with an aggregate installed generating capacity of 11,297 MW. In 2006 and 2007, the Company sold 46,175 Gwh and 49,323 Gwh of electricity, respectively. In the ten years from 1997 through to 2007, the aggregate demand for electricity in the State of Israel grew at an average annual rate of 4.8% exceeding the average annual rate of growth of the State of Israel’s gross domestic product (‘‘GDP’’) during the same period which was 3.8%. To meet increased electricity demand, the Company has constructed significant new generation facilities and expanded and improved its transmission and distribution system. The Company currently expects electricity demand in the State of Israel to increase by an average annual rate of approximately 3.4% for the next five years, while the expected average annual rate of growth of GDP for the next five years is 3.9%. To meet the projected electricity demand, the Company currently plans to add approximately 1,847 MW of installed capacity by 2011. See ‘‘Business—Development Strategy and Capital Investment Program.’’ The Company’s business is currently regulated pursuant to the Electricity Sector Law 5756-1996 (the ‘‘Electricity Sector Law’’), which became effective on March 4, 1996. The Electricity Sector Law provides for the issuance by the Minister of National Infrastructures of the State of Israel (the ‘‘Minister of Infrastructures’’) of licenses for various activities, including licenses for the generation, transmission, distribution and supply of electricity. On September 4, 1997, the Minister of Infrastructures issued a transmission, distribution and supply license to the Company, which grants the Company the right to transmit, distribute and supply electricity in the State of Israel. The Minister of Infrastructures also issued a generation license to the Company for each generation unit operated by the Company. The Company’s generation and transmission licenses were initially set to expire on March 3, 2006, but have been extended by the Minister of Infrastructures until July 1, 2008. The Company’s distribution and supply licenses, which were also set to expire on March 3, 2006, have been extended until July 1, 2009. Licenses have historically been extended shortly before their expiration, however, the Company cannot be certain that at the end of the maximum period for extending the licenses without making the outlined structural changes stated in the law, the Company will be granted licenses (in full or in part) or that there will be no changes to the terms of those licenses

9 compared with the existing licenses. Based on past experience, the Company expects that its licenses will be extended. See ‘‘Risk Factors—The Company’s operations are subject to extensive regulation’’, and ‘‘Business—Regulation—Licensing Requirements.’’ The Electricity Sector Law establishes a five-member Public Utilities Authority—Electricity (the ‘‘Electricity Authority’’), the members of which are nominated by the Minister of Infrastructures and the Minister of Finance of the State of Israel and appointed by the Israeli Government. The Electricity Sector Law requires the Electricity Authority to set electricity tariffs, or rates, on the basis of recognized cost (as determined by the Electricity Authority), taking into account the categories and level of services, and to include a ‘‘fair rate of return’’ on capital to be decided upon by the Electricity Authority and, if the Electricity Authority so determines, an efficiency factor to promote increased productivity and economies of scale in the generation, transmission and distribution of electricity. See ‘‘Risk Factors—The Company’s profitability is affected, among other things, by the level of the electricity tariff it charges’’ and ‘‘Business—Regulation—Tariffs.’’ The Electricity Sector Law has been amended several times, most recently in March 2008, to regulate structural changes in Israel’s electricity sector, including the Company’s future structure, and to impose limitations on the ability of a single entity to hold more than a certain share of any activity (e.g. generation and distribution) in the electricity sector. The amendments to the Electricity Sector Law establish the gradual process through which the Company will be restructured to operate several generation subsidiaries, distribution subsidiaries and a transmission subsidiary. Different activities in the electricity sector will be separated, and in general one entity will not be granted a license for more than one activity, subject to certain exceptions. The Electricity Sector Law sets ceilings for generation capacity covered by generation licenses held by an entity, and for the extent of distribution covered by distribution licenses held by an entity, 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 scope of distribution embodied in those licenses. As drafted, the law effectively would provide for a minimum of four more generation licenses, four distribution licenses, one transmission license and one system management license. The Company believes the restructuring cannot be executed and implemented in accordance with the Electricity Sector Law without reaching an agreement with the Company’s employees and the holders of its debentures as well, as with the Company’s remaining creditors, in a manner that will insure that the Company will be able to meet all its existing obligations towards them by law and the agreements entered into by the Company. The Company also believes that it is the State of Israel’s responsibility to act to implement the Electricity Sector Law in a manner that will guarantee that the Company will be able to meet its obligations, including to its creditors. See ‘‘Risk Factors—The Company’s operations are subject to extensive regulation’’ and ‘‘Business—Regulation—Restructuring.’’ One of the stated goals of the Electricity Sector Law is the encouragement of competition in the electricity sector, and the Israeli Government has set a target of increasing the generation of electricity by independent private producers of electricity (‘‘IPPs’’) from 0.6% of the State of Israel’s installed generating capacity at present to 20%. The Israeli Government has reaffirmed and expanded its policy to encourage competition, both with respect to the electricity sector generally and with respect to generation of electricity and distribution of electricity specifically. On July 12, 1999, the Electricity Authority resolved to allow IPPs to sell electricity directly to end-users using the Company’s transmission and distribution network. In 2007, IPPs sold approximately 200 million Kwh of electricity using the Company’s transmission and distribution network. The Electricity Authority will set tariffs to be charged by the Company for use of its network. The Israeli Government subsequently has taken various steps, within the context of the Electricity Sector Law, to facilitate increased generation of electricity by IPPs and to increase competition in the distribution of electricity. The Company believes that current conditional licenses have been granted to a number of private producers for a combined capacity of about 20% of Israel’s installed generating capacity. The majority of these projects are at the feasibility stage, however, the Company cannot be certain that they will be completed during the coming decade. When these private producers begin generating and/or selling electricity it is anticipated that they will supply some of the growth in demand for electricity consumption. The Company cannot, at present, estimate the future

10 implications of such increased competition on its business, results of operations or ﬁnancial condition. See the discussion in Note 1(a) to the Financial Statements and ‘‘Risk Factors—The Company will be subject to increased competition’’ and ‘‘Business—Competition.’’

History and Development

The Company was incorporated on March 29, 1923 with its principal object being the production, distribution, supply and sale of electricity to consumers. The Company was initially registered under the name ‘‘The Palestine Electric Corporation Limited’’ but this was changed in 1961 to its present name ‘‘The Israel Electric Corporation Limited.’’

Soon after its establishment, the British Mandatory Government of Palestine granted the Company the concession known as the Jordan Concession and also transferred to it the concession known as the Yarkon Concession (together, the ‘‘Concessions’’). The Concessions were conﬁrmed by the Electricity Concessions Order—1927 and gave the Company the exclusive right to generate, supply, distribute and sell electricity throughout Mandatory Palestine, excluding Jerusalem and its surroundings areas, for a period of 70 years from March 5, 1926 to March 4, 1996. Upon the termination of the Concessions in 1996, the Government enacted the Electricity Sector Law which provided that each activity in the electricity sector was to be governed by licenses which in the past were granted by the Minister of Infrastructures and currently, following an amendment to the Electricity Sector Law, are granted by the Electricity Authority with the approval of the Minister.

11 THE PROGRAM

Issuer: The Israel Electric Corporation Limited

Co-Arrangers: Citigroup Global Markets Inc. Lehman Brothers Inc.

Euro Dealers: Citigroup Global Markets Limited Lehman Brothers International (Europe) Credit Suisse (Europe) Limited Dexia Banque Internationale a` Luxembourg, socie´te´ anonyme, acting under the name of DEXIA Capital Markets J.P. Morgan Securities Ltd. Merrill Lynch International Morgan Stanley & Co. International PLC UBS Limited

U.S. Dealers: Citigroup Global Markets Inc. Lehman Brothers Inc. J.P. Morgan Securities Inc. Merrill Lynch, Pierce, Fenner & Smith Incorporated Morgan Stanley & Co. Incorporated

Fiscal Agent, Calculation Agent, Paying Agent and Transfer Agent: The Bank of New York, London branch

Registrar: The Bank of New York, New York branch

Charge Agent: The Bank of New York, London branch

Amount: Up to U.S.$2,000,000,000 (or its equivalent, as of the respective dates of issue, in other currencies or composite currencies) in aggregate principal amount of Notes outstanding at any one time, subject to the right of the Company to increase such limit in accordance with the terms of the Program Agreement.

Currencies: Such currencies or composite currencies as may be agreed between the Company and the relevant Dealer or Dealers and speciﬁed in the applicable Pricing Supplement. Each issue of Notes denominated in a currency in respect of which particular laws, guidelines, regulations and restrictions or reporting requirements apply will be issued in compliance with such laws, guidelines, regulations and restrictions or reporting requirements as in effect from time to time. See ‘‘Plan of Distribution.’’

Method of Issue: Notes will be issued in one or more series (each a ‘‘Series’’). The Notes comprising each Series will be denominated in the same currency, have the same maturity date and will bear interest (if any) on the same basis and at the same rate and will have terms which, apart from the issue date, the interest

12 commencement date and the issue price, are otherwise identical. The Notes of each Series are intended to be interchangeable with all other Notes of that Series. The Notes of any Series with the same issue date, issue price and interest commencement date will comprise a tranche (a ‘‘Tranche’’). A Pricing Supplement will be prepared in respect of each Tranche.

Form of Notes: Notes offered hereby may be issued in registered form (‘‘Registered Notes’’), as specified in the applicable Pricing Supplement. Notes initially sold to QIBs and Institutional Accredited Investors will, unless otherwise specified in the applicable Pricing Supplement, be available only in book- entry form, and will be represented by a global Registered Note (a ‘‘Restricted Global Note’’), which shall be deposited on or prior to the issue date of such Notes with the Registrar as custodian for The Depository Trust Company (‘‘DTC’’) and will be registered in the name of a nominee of DTC. Registered Notes sold outside the United States in reliance on Regulation S will, unless otherwise specified in the applicable Pricing Supplement, be available only in book entry form and will be represented by a global Registered Note deposited on or prior to the issue date of such Notes with the Registrar as custodian for (and registered in the name of a nominee of) DTC (a ‘‘Regulation S Global Note’’ and, together with Restricted Global Notes, ‘‘DTC Global Registered Notes’’) or, if so specified in the applicable Pricing Supplement, deposited with (and registered in the name of a nominee of) a common depositary (the ‘‘Common Depositary’’) for the account of Euroclear Bank S.A./N.V., as operator of the Euroclear System (‘‘Euroclear’’), and Clearstream, Banking, société anonyme (‘‘Clearstream’’) (a ‘‘Euroclear/Clearstream Global Registered Note’’). Until the expiration of the period which is 40 days after the completion of the distribution of each Tranche of Notes, as certified by the relevant Dealer in the case of a non- syndicated issue, or the lead manager in the case of a syndicated issue, beneficial interests in a Regulation S Global Note may not be offered or sold to, or for the account or benefit of, a U.S. person and may not be held otherwise than through Euroclear or Clearstream. See ‘‘Description of the Notes.’’

Ranking: The Notes will be general obligations of the Company and will be secured by a valid and enforceable perfected floating charge (the ‘‘Note Floating Charge’’) on the present and future assets of the Company that are charged under any other floating charge created by the Company, whether now existing or hereafter created. At December 31, 2007, the aggregate principal amount of indebtedness of the Company secured by floating charges on such assets was approximately NIS 24,353 million. On January 17, 2008 the Company issued

13 U.S.$250,000,000 floating rate notes that are also secured by a floating charge on such assets. The Notes will be effectively subordinated with respect to certain limited assets encumbered by fixed charges. At December 31, 2007, the amount of indebtedness secured by fixed charges was approximately NIS 92. The Notes and the related charge documents will restrict the ability of the Company and its Subsidiaries (as defined below) to secure future indebtedness with fixed charges but will not restrict the ability of the Company and its subsidiaries to secure future indebtedness with floating charges ranking pari passu with or subordinate to the floating charge securing the Notes. Moreover, the Noteholders would be structurally subordinated in right of payment to the rights of any creditors of the Company’s existing or future subsidiaries other than a Substituted Obligor.

Substitution: The Company shall substitute for itself (a ‘‘Substitution’’) any other entity that at any time engages or undertakes or will engage in or undertake, all or substantially all of the Transmission Business (as deﬁned in the ‘‘Description of the Notes’’) (the ‘‘Substitute Obligor’’) as issuer of all of the Notes. Upon the occurrence of a Substitution, the Company will unconditionally and irrevocably guarantee the due and punctual payment of all sums payable by the Substitute Obligor in respect of the Notes (the ‘‘IEC Guarantee’’). The IEC Guarantee will constitute direct, general and unconditional obligations of the Company that will be secured by the Note Floating Charge. The assets subject to the Note Floating Charge will not include the Transmission Business assets or any other assets of the Substitute Obligor. The Note Floating Charge, will, however, attach to any shares of, or other equity interests in, the Company’s subsidiaries or other entities, if any. See ‘‘Description of the Notes—Note Floating Charge’’, ‘‘Description of the Notes Substitution and ‘‘Taxation—Valid Status Tax Considerations—Substitution of Obligor.’’

Issue Price: Notes may be issued at their principal amount, at a premium or discount to their principal amount or on a partly paid basis, as speciﬁed in the applicable Pricing Supplement.

Maturities: Notes of each Series shall have such maturities as may be agreed between the Company and the relevant Dealer or Dealers and indicated in the applicable Pricing Supplement, subject to such minimum or maximum maturities as may be allowed or required from time to time by the relevant central bank (or equivalent body) or any laws or regulations applicable to the Company or the relevant currency.

14 Redemption at the Option of Holders: Unless otherwise indicated in a Pricing Supplement, the Notes will be subject to redemption at the option of holders of the notes following the occurrence of certain events, including; • if at the Relevant Time (as defined) the State of Israel is rated Investment Grade (as defined), the Notes are rated below Investment Grade and the Company has not used its best endeavors to obtain an Investment Grade rating of the Notes (taking into account the requirements of the Rating Agencies for the purposes of obtaining such rating and the timeframe required to obtain such rating); • upon the Company’s failure to comply with the Substitution provisions; • the Company ceases at or after the Relevant Time to engage lawfully in the Transmission Business or the main business of the Company ceases to be the Transmission Business; • a Change of Control (as defined); or • upon the occurrence of an event or circumstance which could reasonably be expected to have a Material Adverse Effect (as defined), each a ‘‘Put Event’’. If at any time while any Note remains outstanding, a Put Event (as defined) occurs then, holders will have the option to require the Company to redeem the relevant Notes at the principal amount outstanding of the Notes plus, in certain circumstances, Foregone Margin (as defined), together in any case with accrued interest to the put date. See ‘‘Description of the Notes—Redemption’’ for definitions and additional detail.

Redemption at the Option of the The applicable Pricing Supplement will indicate whether, Company: under what circumstances, and the terms on which Notes of a particular Series may be redeemed prior to their stated maturity. The Notes may also be redeemed at the option of the Company for taxation reasons as described under ‘‘Description of the Notes—Redemption.’’

Denominations of Notes: Such denominations as may be agreed between the Company and the relevant Dealer or Dealers and as indicated in the applicable Pricing Supplement, subject to the restrictions imposed by any applicable law or regulation applicable to the relevant currency and/or the Company. Notes initially sold to QIBs in the United States will be in minimum denominations of U.S.$200,000 and in integral multiples of U.S.$1,000 in excess thereof. Notes having a maturity of less than one year will, if the proceeds of the issue are accepted in the United Kingdom,

15 constitute deposits for the purposes of the prohibition on accepting deposits contained in section 19 of the Financial Services and Markets Act 2000 (the FSMA) unless they are issued to a limited class of professional investors and have a denomination of at least £100,000 or its equivalent.

Fixed Rate Notes: Fixed Rate Notes will bear interest at a fixed rate which will be payable in arrears on a specified date or dates in each year (as indicated in the applicable Pricing Supplement) and on redemption. Unless otherwise indicated in the applicable Pricing Supplement, in the case of U.S. Dollar-denominated Notes, interest will be calculated on the basis of a 360-day year consisting of 12 months of 30 days each, and in the case of euro-denominated Notes, interest will be calculated either on the same basis or on the basis of Actual/Actual (ICMA), as defined under ‘‘Description of the Notes—Fixed Rate Note.’’

Floating Rate Notes: Floating Rate Notes will bear interest calculated on the basis of a reference rate appearing on the agreed screen page of a commercial quotation service or on such other basis as may be agreed between the Company and the relevant Dealer or Dealers (as indicated in the applicable Pricing Supplement). The Spread and Spread Multiplier (if any) (as deﬁned) related to such Floating Rate Notes will be agreed between the Company and the relevant Dealer or Dealers for each issue of Floating Rate Notes. Floating Rate Notes may also have a maximum interest rate, a minimum interest rate or both. See ‘‘Description of the Notes—Floating Rate Note.’’

Indexed Notes: Amounts due on Indexed Notes in respect of principal, premium and interest, if any, and in the case of Original Issue Discount Notes (as deﬁned herein), the Amortized Face Amount (as deﬁned herein) or other amount payable in respect thereof, may be determined by reference to: (a) a currency exchange rate or rates, (b) a securities or commodities exchange index, (c) the value of a particular security or commodity, (d) any other index or indices or (e) formula or formulae. The applicable Pricing Supplement will specify the method by and terms on which such amounts will be determined and other information relating to such Indexed Notes.

Dual Currency Notes: All payments of principal, premium, if any, and interest in respect of Dual Currency Notes (which payments would otherwise be made in the Specified Currency, as defined) will be made in the optional payment currency specified in the applicable Pricing Supplement. The applicable Pricing Supplement will specify, among other things, the Specified Currency, the optional payment currency, the optional election dates and the interest payment dates for such Dual Currency Notes. See ‘‘Description of the Notes—Dual Currency Notes.’’

16 Zero Coupon Notes: Zero Coupon Notes will not bear interest; provided, that as from the Maturity Date or any other due date for repayment of such Note, any overdue amount payable on such Note shall bear interest at a rate per annum (expressed as a percentage) equal to the Accrual Yield (as defined) specified in the applicable Pricing Supplement (computed on the basis of a 360 day year of twelve 30-day months, unless otherwise specified in the applicable Pricing Supplement) until all amounts due in respect of such Notes have been paid. See ‘‘Description of the Notes—Zero Coupon Notes and Original Issue Discount Notes’’

Withholding Taxes: The Company is not required to withhold or deduct any amount from payments to the Noteholders on account of Israeli taxes pursuant to an exemption granted by the Ministry of Finance. In the event of a change that would require the Company to withhold or deduct for any such taxes in the future the Company will, subject to certain exceptions, pay such additional amounts as will result, after withholding or deduction for such taxes, in the payment of the amounts that would have been payable in respect of the Notes had no such withholding or deduction been required.

Restrictive Covenants: The Notes will contain covenants applicable to the Company, including covenants that limit the ability to incur liens and take actions that could impair the Note Floating Charge and covenants that require the Company to provide periodic reports, maintain public ratings and conduct its business in a lawful manner consistent with good industry practice. See ‘‘Description of the Notes—Certain Covenants.’’ Events of Default/Acceleration Events: The terms of the Notes will contain a cross-default provision relating to the non-payment (subject to certain grace periods) or acceleration of any Indebtedness (as hereinafter defined) of the Company which exceeds U.S.$25 million. The Notes will also contain other provisions that allow for holders to accelerate the maturity of the Notes in the case of certain events. See ‘‘Description of the Notes—Events of Default.’’ Listing: Approval in-principle has been obtained from the SGX-ST for the Program to be listed on the Official List of the SGX-ST. Notes may also be listed on one or more additional stock exchanges. Unlisted Notes may also be issued. The applicable Pricing Supplement will state whether or not the Notes are to be listed, and, if so, on which stock exchange or exchanges. Selling and Transfer Restrictions: There are restrictions on the sale and transfer of Notes (and beneficial interests therein) and the distribution of offering material in the United States, Israel, the United Kingdom, the European Economic Area, Japan and other restrictions may be required in connection with the offering and sale of a particular Tranche of Note in these and other countries. See ‘‘Transfer Restrictions’’ and ‘‘Plan of Distribution’’ below.

17 Governing Law: The Notes will be governed by, and construed in accordance with, the laws of the State of New York. The Note Floating Charge will be governed by the laws of the State of Israel.

Risk Factors: Prospective investors should carefully consider the information set forth under ‘‘Risk Factors.’’

18 Summary Financial and Operating Data

The following table presents certain financial and operating data of the Company for the periods and as of the dates indicated. The Company presents its financial statements in New Israeli Shekels (‘‘Shekels’’ or ‘‘NIS’’) that have been adjusted in accordance with Israeli GAAP to reflect changes in purchasing power of the Shekel due to inflation. The income statement and balance sheet data were derived from the Company’s audited annual financial statements as of and for the years ended December 31, 2005 through December 31, 2007.

The Company’s annual financial statements for the years ended December 31, 2005 through December 31, 2007 and the notes thereto have been prepared in accordance with Israeli GAAP, which differs from IFRS in certain significant respects. See Note 32 to the Financial Statements for a reconciliation of the Company’s 2007 financial results to IFRS. The Company’s financial statements for the year ended December 31, 2008 will be prepared in accordance with IFRS, unless the Minister of Finance exempts the Company from implementing IFRS, in whole or in part.

The summary ﬁnancial and operating data should be read in conjunction with the Management’s Discussion and Analysis of Results of Operations and Financial Condition, as well as the Financial Statements.

Year Ended December 31 2005 2005(6) 2006 2006(6) 2007 2007(6) (in millions of adjusted December 2007 Shekels and millions of U.S. Dollars, except ratios and operating and other data) Israeli GAAP: INCOME STATEMENT DATA: Revenues...... NIS17,317 U.S.$4,503 NIS18,188 U.S.$4,729 NIS19,264 U.S.$5,009 Cost of operating the electricity system ...... 13,192 3,430 13,904 3,615 15,526 4,037 Profit from operating the electricity system ...... 4,125 1,073 4,284 1,114 3,738 972 Other operating expenses (1) ...... 1,514 394 1,699 442 1,738 452 Income from current operations ..... 2,611 679 2,585 672 2,000 520 Financial expenses...... 2,132 554 1,760 458 908 236 Capitalization of financial expenses . . . (246) (64) (180) (47) (27) (7) Transfer of financial income to a regulatory asset liability ...... 91 24 668 174 1,202 313 Financial expenses, net ...... 1,977 514 2,248 585 2,083 542 Other expenses (income), net ...... 8 2 (7) (2) 64 17 Income (loss) from current operations before income taxes ...... 626 163 344 89 (147) (38) Netincome(loss)(2)...... 1,328 345 262 68 (101) (26) Interest coverage ratio (3) ...... 1.25 1.13 0.94 Earnings to fixed charges rate (4) .... 1.17 1.07 0.92 OPERATING AND OTHER DATA: Aggregate capacity (MW) ...... 10,480 10,899 11,323 Electricity sold (GWh)...... 44,309 46,175 49,323 Average rate (Agorot/Cents per KWh) (5) ...... 42.71 11.10 40.41 10.51 39.00 10.14

19 Year Ended December 31 2005 2005(6) 2006 2006(6) 2007 2007(6) (in millions of adjusted December 2007 Shekels and millions of U.S. Dollars, except ratios and operating and other data) BALANCE SHEET DATA (at end of year): Fixed assets, net ...... 59,811 15,551 59,101 15,367 58,245 15,144 Total assets...... 70,678 18,377 69,899 18,174 68,974 17,934 Current liabilities ...... 7,338 1,908 7,286 1,894 8,060 2,096 Long-term and extended-term liabilities, net...... 49,657 12,911 48,666 12,654 47,068 12,238 Shareholders’equity...... 13,683 3,558 13,947 3,626 13,846 3,600 Total liabilities and shareholders’ equity...... NIS70,678 U.S.$18,377 NIS69,899 U.S.$18,174 NIS68,974 U.S.$17,934

(1) Other operating expenses consist of Sales and marketing expenses, Administrative and general expenses and Expenses resulting from liabilities to pensioners, net.

(2) On July 25, 2005, the Knesset (Israeli Parliament) passed the Law for the Amendment of the Income Tax Ordinance (No. 147), 2005 which prescribes a gradual decrease until the year 2010 in the corporate tax rate in Israel. The decrease in deferred tax liabilities affected by the change in the tax rate caused a signiﬁcant increase in net income for the year 2005.

(3) Interest coverage ratio is determined by dividing the sum of income (loss) from current operations before income taxes and other financial expenses by other financial expenses. Other financial expenses were NIS 2,492 million and NIS 2,551 million and NIS 2,496 million, for the years ended 2005, 2006 and 2007 respectively. Other financial expenses exclude the effects of erosion related to loans and debentures and of transfer of financial income to a regulatory asset/liability and of capitalization of financial expenses which are included in the financial expenses, net line item above. See Note 28 to the Financial Statements. The ratios have been calculated as follows: Periods Ended December 31 2005 2006 2007 Income (loss) from current operations before income taxes. . 626 344 (147) Otherfinancialexpenses...... 2,492 2,551 2,496 Total...... 3,118 2,895 2,349 Otherfinancialexpenses...... 2,492 2,551 2,496 Ratio...... 1.25 1.13 0.94

(4) Earnings to fixed charges ratio is determined by dividing the sum of income (loss) before income taxes and financial expenses, net by financial expenses and transfer of financial income to a regulatory asset/liability. See ‘‘Management’s Discussion and Analysis of Results of Operations and Financial Condition—Financial Expenses (Income), Net’’ and Note 28 to the Financial Statements. For 2007, earnings were insufficient to cover fixed charges by NIS 174 million. The ratios have been calculated as follows: Periods Ended December 31 2005 2006 2007 Income (loss) from current operations before income taxes. . 626 344 (147) Financial expense, net...... 1,977 2,248 2,083 Total...... 2,603 2,592 1,936 Financial expenses ...... 2,132 1,760 908 Transfer of financial income to a regulatory liability...... 91 668 1,202 Total...... 2,223 2,428 2,110 Ratio...... 1.17 1.07 0.92

(5) The average rate represents the Company’s total revenues from electricity sales (gross) divided by the Company’s total electricity sales (in GWh). For the years ended December 31, 2005, 2006 and 2007, respectively, the Company’s total revenues from electricity sales (gross) include NIS 1,687 million, NIS 581 million and NIS 103 million, respectively, which represent amounts collected from customers as part of the rate structure in respect of the regulatory asset/liability and of pension component in the year 2005 and of consumers’ participation in ﬁxed assets in the year 2007. Accordingly, these amounts are included in the calculation of the average rate. However, these amounts are not included in the Company’s reported revenues. See ‘‘Management’s Discussion and Analysis of Results of Operations and Financial Condition—Results of Operations— Revenues.’’

(6) U.S. Dollar amounts have been translated at NIS 3.846 to U.S.$1.00, the representative rate of exchange published by the Bank of Israel, the Israeli central bank, for December 31, 2007.

20 RISK FACTORS Prior to investing in any Notes, potential investors should carefully consider, together with all other information contained in this Offering Circular, the risks described below. Any of these risks could materially and adversely affect the Company and an investment in the Notes. The risks described below are not exhaustive and other considerations, including some which may not be presently known to the Company or which the Company currently deems immaterial, may impact on any investment in the Notes. Words and expressions defined in the Terms and Conditions of the Notes below or elsewhere in this Offering Circular have the same meanings in this section. The Company’s profitability is affected, among other things, by the level of the electricity tariff it charges The Company’s profitability is affected by, among other things, the level of electricity tariff that it charges its consumers, which is set by the Electricity Authority and is therefore outside the control of the Company, and by the Company’s compliance with the expense limits set by the tariffs. The Electricity Sector Law sets out the following factors which the Electricity Authority needs to take into account when setting the tariff: • The Electricity Authority will determine the tariff on the principle of recognized cost, taking into account among other things the type and standard of services, and including a fair rate of return on capital, including, but not limited to, capital costs that may differ from the recognized costs made by the Electricity Authority; • When setting the tariff, the Electricity Authority may ignore some or all of the costs that in its opinion are not necessary to enable the Company as an essential service provider to fulfill its obligations; • The tariff will reflect the cost of the particular service price with no reduction in the price for one service price at the cost of raising the price for another; and • The tariff will be updated according to the formula set by the Electricity Authority. The updating formula may take into account efficiency factors. For this purpose ‘‘efficiency factors’’ means the rate by which the updating shall be reduced, as decided by the Electricity Authority in consultation with the Ministers, in order to promote greater efficiency of holders of essential service supplier license. In a petition to the Supreme Court, the Company requested that the Electricity Authority be required to approve a rate that would maintain the Company’s financial strength and stability and to increase the tariffs in accordance with its financial statements in order to maintain the real CPI-adjusted value of its equity. On September 12, 2004, the Supreme Court rejected the Company’s petition and stated in its judgment that it is satisfied that the Electricity Authority has examined the Company’s requests and its decisions were within its authority and reason and consequently the court would not intervene in the Electricity Authority’s considerations. Additionally, in its judgment the court remarked that any consideration of the maintenance of the Company’s financial strength, although relevant for setting the electricity tariffs, only reflects one aspect of the public good with which the Electricity Authority is charged according to the Electricity Sector Law. When exercising its powers according to 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.’’ The Company is, accordingly, exposed to risks where its costs and expenses are not recognized in full for the purpose of setting the tariff or where the updating formula does not accurately reflect its exposure to price fluctuations and exceptional expenses and to costs that deviate from the requirements for greater efficiency if the Company is unable to meet them. For example, in March 2008 the Electricity Authority dismissed the Company’s claims to update the fuel basket to reflect the actual fuel risk. See Note 3.a.7(c) to the Financial Statements.

21 In July 2006, the Israel Accounting Standards Board published Accounting Standard No. 29, ‘‘Adoption of International Financial Reporting Standards (‘‘IFRS’’). Under IFRS, the Company will be required to calculate and present all financial derivatives at fair value rather than at their contractual/ liability value. If the tariff is not adjusted to cover the costs reflected by IFRS, the result may be a material adverse effect on the Company’s profitability and financial position. For further information regarding differences between IFRS and Israeli GAAP and the Company’s implementation of the IFRS see Note 32 to the Financial Statements, particularly (i) Note 32.e regarding the possibility that the Company would have to restate (in IFRS financial statements) the amounts of CPI-linked financial assets and liabilities if a different method for measuring the effective interest rate will be required for such assets and liabilities, and (ii) Note 32.e (4)(b) regarding the possibility that the Company would have to restate (in IFRS financial statements) its pension obligation by using a discount rate compatible with market yields on high quality corporate bonds, instead of market yields on government bonds. See ‘‘Management’s Discussion and Analysis of Results of Operations and Financial Condition—Adoption of IFRS.’’ With respect to certain decisions of the Electricity Authority related to tariffs, the Company continues to engage in a substantial number of discussions with the Electricity Authority, including in respect of a wide range of cost determinations and the future application of IFRS. For further information, see Note 3.c to the Financial Statements. If these discussions are not resolved in the Company’s favor, they could have an adverse effect on the Company’s business, results or operations or financial condition. Other factors affecting the Company’s profitability include, among other things, the Company’s ability to meet its development obligations and efficiency targets. The Company’s operations are subject to extensive regulation The electricity sector in the State of Israel and the Company’s business are subject to extensive regulation, including pursuant to the Electricity Sector Law. Such regulation relates to, among other matters, licensing, competition, rates and environmental practices. See ‘‘Business—Regulation.’’ There is no certainty that the costs of complying with such extensive regulation and the unique characteristics of the electricity sector in the State of Israel will not have an adverse effect on the Company’s business, results of operations or financial condition. The Company has been granted licenses pursuant to the Electricity Sector Law for transmission, distribution and supply of electricity and trading in electricity, as well as separate generating licenses for the various production units (the ‘‘Licenses’’). The Licenses regulate the Company’s management of its operations but also impose additional obligations on the Company. For example, the Minister of Infrastructure has the right, in consultation with the Electricity Authority, to require the Company to submit for his approval development plans relating to the operation of the Licenses. If the Company fails to submit such development plans for approval, the Minister may, in consultation with the Electricity Authority, impose a development plan which the Company would then be obliged to implement. Also, the Licenses may be terminated or amended before their expiration, pursuant to the Electricity Sector Law and the terms of the Licenses. The Company’s generation and transmission licenses were initially set to expire on March 3, 2006, but have been extended by the Minister of Infrastructures until July 1, 2008. It should be noted that the Company has not yet received a new, separate license for the transmission activity, and therefore this activity is carried out its combined license, which refers to a number of activities. The Company’s distribution and supply licenses, which were also set to expire on March 3, 2006, have been extended until July 1, 2009. Licenses have historically been extended shortly before their expiration, however the Company cannot be certain that at the end of the maximum period for extending the licenses without making the outlined structural changes stated in the law, the Company will be granted licenses (in full or in part) or that there will be no changes to the terms of those licenses compared with the existing licenses. Based on past experience, the Company expects that its licenses will be extended. See ‘‘Business—Regulation—Licensing Requirements.’’ There can also be no assurance that the Government’s policy or the current regulations with respect to the electricity sector will not change in the future. The Company cannot predict what changes, if any, will be made with respect to licensing and other regulatory matters when the Licenses expire or otherwise. Any failure to obtain an extension or renewal of the Licenses or changes in licensing or other regulatory matters could have an adverse effect on Company’s business, results or operations or financial condition.

22 The Company is subject to structural reform The Company is subject to structural reform as set forth in the Electricity Sector Law (see ‘‘Business—Regulation—Restructuring’’). At the date of this Offering Circular, there is considerable uncertainty relating to the implementation of the Electricity Sector Law and the manner in which the Company, its operations, assets and liabilities are to be restructured in order to comply with the Electricity Sector Law. As a result, the implications of such structural reform on the Company are uncertain at this point and might have an adverse effect on the Company or its financial condition. Furthermore, the Policy Document issued by Government officials dated February 15, 2007 (the ‘‘Policy Document’’) sets forth, among other things, that (i) the Company will sell its assets related to the various segments of operation to new entities, which could be a subsidiary or a third party; (ii) the Company’s debt will remain with the Company and will not be transferred to the new entities; and (iii) the asset sale to the new entities will be undertaken in a manner enabling the Company to repay its outstanding debts to its creditors. An implementation of the Policy Document, that does not make adequate provision for outstanding debts to the Company’s creditors could have an adverse impact on the rights of Noteholders after such restructuring. The Electricity Sector Law and its amendments set out a timetable for the structural reform in the electricity sector in Israel (see ‘‘Business—Regulation—Restructuring’’). The Company is currently subject to certain employee sanctions which are preventing it from implementing the changes required to satisfy the provisions of the Electricity Sector Law. See Note 21.c of the Financial Statements. The Company therefore believes that it will not be able to meet the timetable for implementation of such changes. It is currently unclear what effect any such delay would have on the Company and no assurance can be given that any such delay would not have an adverse effect on the Company’s business, results of operations or financial condition; including as a result of non-extension of the Licenses if it occurs. The Company requires additional financing to fund its capital investment program The Company will require substantial additional financing to fund its current capital investment program (see ‘‘Business—Development Strategy and Capital Investment Program’’). Moreover, in view of further expected increase in demand for electricity the Company might be required to undertake additional capital investments. The Company cannot predict the level of such funding but believes that a portion of it will be raised from foreign currency loans and in the capital markets outside of Israel. The Company’s ability to obtain such external financing and the cost of such financing are dependent on numerous factors including general economic and capital market conditions, interest rates, credit availability from banks or other lenders, investor confidence in the Company, the success of the Company’s business, the economic, security, legal and political conditions in Israel and the privatization policy of the Government of Israel. If the Company is not able to raise capital as planned (in Israel or abroad), then the implementation of the capital investment plan will be susceptible to delays and additional costs, either of which may have an adverse effect on the Company’s business, results of operations or financial condition. The Company may be obliged to compensate the Government for certain assets The Electricity Sector Law provides, among other things, that certain assets held by the Company on the date on which the Concessions ended are to be acquired by the Company from the Government for their value (the ‘‘Asset Acquisition’’). The Electricity Sector Law does not specify which particular assets are to be so acquired or the method by which value was to be determined. Consequently, the assets to be so acquired may or may not constitute a significant portion of the Company’s assets, and the cost to the Company, if any, may or may not be significant. Pursuant to the Electricity Sector Law, since no agreement was reached by March 4, 1997 between the Minister of Infrastructures, the Minister of Finance and the Company, the terms of the acquisition are to be determined by the two Ministers. No such determination has been reached and consequently the rights and the assets remain with the Company as they were at the time of the expiration of the Concessions. The Company believes that the implementation of the Asset Acquisition will not have a material adverse effect on the Company’s business, results of operations or its financial condition, although there can be no assurance that this will be the case. For further details on the issue and relevant positions in respect thereto. See Note 1.a.6 of the Financial Statements.

23 The Company is subject to environmental laws The Company’s operations are subject to various environmental laws and regulations relating to air, electromagnetic ﬁeld, water and noise pollution and the storage, transportation and disposal of toxic, volatile or otherwise hazardous materials (see ‘‘Business—Environment’’). A substantial portion of these laws and regulations are well established while others are in various stages of development. The Company anticipates that current environmental laws and regulations may become more stringent and that additional laws will be adopted. The Company believes that it is in substantial compliance with the requirements of the existing environmental laws and regulations, and is studying the implications of proposed environmental laws and regulations. The Company believes that any expenditure that the Company needed to incur in order to comply with such proposed environmental legislation would be recognized by the Electricity Authority in the Tariffs. There can be no assurance, however, that the Company’s costs of compliance and liabilities under existing and new laws and regulations will not be substantial.

The Company is currently owned by the State of Israel The State of Israel currently owns approximately 99.85% of the outstanding shares of the Company. So long as it continues to own more than 50% of the outstanding shares, it will have the power to appoint all the directors of the Company and, consequently, will have effective control over the Company. The Government Companies Law 5735-1975 (the ‘‘Government Companies Law’’) requires that the Company (as a ‘‘Government Company’’) act in accordance with the business considerations by which a non-Government Company is normally guided, unless the Government, with the consent of the Finance Committee of the Knesset (the Israeli Parliament), directs that it acts otherwise. The Company has always acted in accordance with business considerations and the Government, in exercising its control over the Company, has never directed the Company to act otherwise, although there can be no assurance that the Government will not do so in the future. As a Government Company, the Company is required to seek approval of the Government before assuming any liability that may directly or indirectly restrict the ability of the Government to effect a privatization of the Company or other structural changes. There are also certain restrictions on the Company’s ability to effect changes in wages or other beneﬁts with its employees, and certain commercial or business acts require the consent of the government in order to become effective. The State of Israel is not obligated to maintain its ownership of the Company. The Company has existing ﬁnancing which includes, among other things, mandatory prepayment provisions where there is a change of control. In March 2003 the Government decided, in the framework of its plan for privatization of Government Companies, to require the Government Companies Authority (a statutory body established under the Government Companies Law) (the ‘‘GCA’’) to draft proposals for privatizing the Company by selling no more than 49% of its shares. Furthermore, in accordance with Amendment No. 5, after July 1, 2013 a Government Company or a government subsidiary will not hold, jointly or severally, more than 51% of the share capital of a generation or distribution license holder. See Note 1.d of the Financial Statements.

The Company will be subject to increased competition The Company presently generates, transmits and distributes substantially all of the electricity used in the State of Israel. The Government of Israel’s stated policy is to enable competition in the electricity sector and it has set a target of increasing the generation of electricity by IPPs from 0.65% to 20% of the State of Israel’s installed generating capacity. Although the Company does not believe that this target will be reached for a considerable period of time, particularly due to the very low current generating capacity of IPPs and the long lead time required for the construction of power generation equipment, there can be no assurance that this will be the case or that the target will not be achieved. In addition, the Company believes that the increased use of natural gas in electricity generation is likely to strengthen the long term competition in the electricity sector since natural gas electricity production units are signiﬁcantly cheaper to erect than those which run on coal or fuel oil.

24 The Electricity Sector Law provides for the restructuring of the electricity sector in Israel including the incorporation and operation of subsidiaries engaged in the lines of business in which the Company is currently engaged, in order to encourage competition in the sector. Pursuant to the Electricity Sector Law and its regulations, the holder of the transmission license is required to:

• purchase electricity from IPPs (the period for such purchase and the quantum of electricity are different according to the type of IPPs);

• allow IPPs to sell electricity to their customers using the Company’s transmission and distribution network; and

• provide a back-up source of supply to customers of IPPs.

There is currently uncertainty deriving from regulations prescribed by the Ministry of National Infrastructures and from criteria prescribed by the Electricity Authority regarding any preference that may be given to IPPs over the Company. The potential increase in competition has ﬁnancial risks for the Company since it produces uncertainty as to the level of electricity that it will be required to produce in the future. If the power projects currently being proposed by IPPs do not reach completion, the Company would still be required to supply the amount of electricity that was intended to have been produced by such projects.

The Company is exposed to currency ﬂuctuations and ﬂuctuations in the consumer price index

All of the Company’s revenues are denominated in Shekels. As at December 31, 2007, however, approximately 55% of the Company’s long-term and extended-term debt (including the current portion thereof) was denominated in or linked to currencies other than Shekels. As a result, fluctuations in foreign currency exchange rates, to the extent not offset by changes in the consumer price index (CPI), cause the Company’s financial expenses to increase or decrease, which affects the Company’s financial performance. Because of the considerable amount of long-term and extended-term debt denominated in foreign currencies, the Company’s results of operations have historically reflected substantial gains and losses attributable to fluctuations in rates of exchange between the Shekel and such foreign currencies.

The Electricity Authority includes in the basket of costs used to determine the Tariff an additional financing component (the ‘‘Financing Component’’) which is designed to reflect a portion of the Company’s financial expenses (or income) resulting from the Company’s foreign currency exposure. The effect of the Financing Component is to transfer a substantial portion of the Company’s exposure to exchange rate fluctuations to its customers.

Although the use of the Financing Component decreases the Company’s exposure to exchange rate fluctuations, the Financing Component only reflects a portion of the Company’s long-term and extended-term debt and does not apply to other material obligations of the Company. With respect to these other amounts, the Company’s results of operations are affected by fluctuations in rates of exchange between the Shekel and such foreign currencies. Therefore, the Company has taken a number of steps designed to mitigate the effects of such fluctuations, including seeking to limit its foreign currency exposure through hedging transactions. There can be no assurance, however, that the Company’s business, results of operations or financial condition will not be adversely affected in the future as a result of exchange rate fluctuations, notwithstanding the effect of the Financing Component and other actions taken by the Company to mitigate such fluctuations.

With the transition to IFRS, the Company will not be able to record supervised assets/liabilities in its ﬁnancial reports and, thus, the tariff cover given to protect some of the Company’s obligations in foreign currency cannot be shown in its ﬁnancial reports, thus creating exposure to changes in the differences between the rate of change in CPI compared with the rate of change of the basket of currencies. For more information regarding the effect of changes in the CPI with the transition to IFRS, see Note 3.b.10 of the Financial Statements.

25 The Company’s outstanding loans and notes are subject to mandatory prepayment and cross-default provisions Certain of the Company’s existing loan agreements and notes contain provisions which allow the lenders to demand immediate repayment where an event occurs which, in the lender’s opinion, could materially adversely affect the Company’s ability to repay the loan, and upon certain asset sales. See Note 18.f of the Financial Statements. While the Company is obligated to inform certain lenders of all events that it believes adversely affect or are liable to adversely affect it or its financial position, but the right to demand repayment is, in certain cases, in the sole discretion of the lenders. As at December 31, 2007, the total amount outstanding of such loans and notes was NIS 12.3 billion. If the lenders were to exercise this right it would entitle other lenders to demand immediate repayment of their outstanding loans which would have an adverse effect on the Company’s business, results of operations and financial position. The Company has obligations in respect of pension contributions The Company’s employees are entitled to receive a pension based on their final salary. The Company makes pension contributions in order to fund its future pension liabilities but there is considerable uncertainty as to the level at which such pension contributions should be made. In order to evaluate its pension liabilities, the Company uses actuarial calculations prepared by an independent actuary. The Company’s pension contributions are based on a forecast of future anticipated cash flows based on a number of actuarial assumptions. The Company’s pension commitments are likely to be different from those forecasted due to changes in circumstances. Also the actuarial model for calculating such pension contributions is liable to change in the future depending on changes in life expectancy, regulatory issues, economic climate and other matters. Such changes will influence whether the Company will face a surplus or shortfall in respect of its pension commitments. From March 8, 2005, the Company has been obliged to transfer cash which until that date was invested in a trust account and which was designated for covering liability for employee pensions under the Company’s pension plan, to the Central Provident Fund for Pension Pay (the ‘‘fund’’). See Note 17.a.(2) of the Financial Statements. The fund calculates the Company’s actuarial liability for employees in the pension plan in order to determine the amount that must be deposited by the Company in accordance with this liability. The Company will be responsible for any shortfall between proceeds realized from the fund and actual pension obligations. See Note 17.a of the Financial Statements. The actuarial assumptions according to which the fund calculates the amount of the Company’s actuarial liability are principally similar to the Company’s actuarial assumptions. However, should the fund modify its actuarial assumptions in the future there may be an inconsistency between the liability presented in the Company’s accounts and the amount the Company is required to deposit in the fund. The Company’s pension contributions are based on the assumption that employees will retire according to generally accepted actuarial estimates. In the event that all employees (or a large portion thereof) were dismissed all at once, the amount of the liability to these employees would be significantly greater than the amount of the liability that is presented in the financial statements. The increase derives from the fact that an employee who has worked for at least 10 years, who has reached the age of 40 or more and who is dismissed is entitled to a pension from the date of his dismissal (and in accordance with the rights accrued up to such day). In the assessment of the Company’s management such a situation is not expected although cannot be discounted due to the current uncertainty relating to the proposed structural reforms of the electricity sector in the State of Israel. The Company is dependent on foreign sources of fuel All the fuel used by the Company (other than a portion of natural gas) is purchased directly or indirectly from sources outside of Israel. In addition, a significant portion of such fuel is purchased under contracts of limited duration. Although the Company maintains limited reserves of all types of fuel used in the generation of electricity, supply disruptions could have an adverse effect on the Company’s business, results of operations or financial condition. The Company’s exposure to this risk is compounded by the fact that it is unable to purchase electricity from other providers inside or outside of Israel. For further information, see ‘‘Business—Fuel.’’

26 The activities of the Company are directly impacted by the economic, political and security situation in the State of Israel All of the Company’s assets are located in the State of Israel. Consequently, the Company’s operations are directly affected by economic, political and military conditions in Israel. The Company could be materially adversely affected if major hostilities break out in the Middle East, or if trade between Israel and its present significant trading partners is curtailed. Since the establishment of the State of Israel in 1948, a state of hostility has existed between Israel and the Arab countries in the region. Since October 2000, there has been a significant increase in violence between Israel and the Palestinians, primarily in the West Bank and Gaza Strip areas. Over the years, there have been a number of terrorist attacks in Israel, targeting both military and civilian facilities. The Company maintains extensive security over its facilities and is guided by authorized bodies such as the Israel Defence Forces Home Front Command. In the field of generation, the Company has conducted a situation assessment concerning the current threat and is taking suitable protective measures for those working at its plants. To date, it has not experienced any material damage to its facilities due to terrorist attacks, however, there can be no assurance that future attacks will not damage the Company’s facilities in a material way. Despite a current law that requires the Government to compensate the Company for any damage to the Company’s property caused by terrorist attack or any enemy hostility, no assurance can be given that any significant damage caused to the Company or its facilities would not have an adverse effect on the Company’s business, results of operations or financial condition. See ‘‘Annex A Conditions in Israel.’’ The Company is subject to a number of class actions A number of actions have been filed against the Company, which the plaintiffs have requested to be recognized as class actions. (See Note 21.b, particularly Note 21.b, 2 and 5, of the Financial Statements.) The claims total in aggregate approximately NIS 12.1 billion and the Company has made no provision for this in its accounts. If the claims were to be successful, they could have an adverse effect on the Company’s business, results of operations or financial condition. The Company may sell or transfer a significant amount of the collateral securing the Notes to subsidiaries or to third parties that are not subject to the Note Floating Charge and are not required to comply with restrictive covenants in the Notes The Notes are secured by a floating charge on the present and future assets of the Company that are charged under any other floating charge created by the Company, whether now existing or hereafter created. The Company is permitted under the terms of the Notes and the Note Floating Charge to transfer collateral to existing or new subsidiaries or to third parties in the ordinary course of business and in connection with the implementation of the Company’s restructuring contemplated by the Electricity Sector Law. Moreover, the ability of such subsidiaries and third party transferees, other than a Substituted Obligor, to use, pledge, sell or otherwise transfer such assets is not limited by the terms of the Notes. Because the Note Floating Charge relates only to assets of the Company and not to assets of the Company’s subsidiaries or to third party transferees, collateral that the Company transfers to its subsidiaries or third parties, including Transmission Business assets transferred to a Substituted Obligor, will thereafter cease to be collateral securing the Company’s obligations under the Notes. Any consideration received by the Company in exchange for such transferred assets will constitute collateral securing the Notes. While the Policy Document indicates that the Company will be adequately compensated for any assets transferred pursuant to the Electricity Sector Law, there can be no assurance as to what form such compensation will take or that such compensation, when taken together with the other collateral securing the Notes, will be sufficient to fully satisfy any claims the holders of the Notes may have against the Company. See ‘‘Description of the Notes’’ and Note 1.a to the Financial Statements. For a discussion of the U.S tax consequences that may arise on a Substitution see ‘‘Taxation—Valid Status Tax Considerations—Substitution of Obligor.’’ The Company must offer to repurchase the Notes upon a Put Event The terms of the Notes will require that, upon the occurrence of a Put Event, as such term is defined in the Description of Notes, the Company make an offer to redeem the Notes, or at the option of the Company, purchase (or procure the purchase of) the Notes at the principal amount outstanding of such

27 Notes plus under certain circumstances a premium, together with accrued interest to the date of redemption or repurchase. Any such redemption or repurchase obligation will be satisﬁed by the Company with either cash on hand or cash from new debt or equity ﬁnancings.

28 RELATIONSHIP WITH THE STATE OF ISRAEL The State of Israel owns approximately 99.85% of the Company’s capital stock and various individuals and corporate entities own the remaining interests. As a result of the State of Israel’s majority interest in the Company, the Company is subject to the Government Companies Law, and is a Government Company thereunder. The Government Companies Law requires that a Government Company act in accordance with the business considerations by which a non-Government Company is normally guided unless the Government, with the consent of the Finance Committee of the Knesset, otherwise directs. The Company has always acted in accordance with business considerations and the Government has never directed it to act otherwise. As a Government Company, certain actions of the Company require the approval of the Government or the Government Companies Authority (a statutory body established under the Government Companies Law) or the Minister of Infrastructures and the Minister of Finance or the Government. The actions requiring one or more of these approvals include changing the Company’s objects, increasing its authorized share capital, a reorganization of the Company, the granting of any right that could, directly or indirectly, restricting the Government (including in connection with carrying out structural changes, privatization or promoting competition), the allocation of profits of the Company, and the determination of wages, benefits and other aspects of employment of certain officers and other employees of the Company. Moreover, the Minister of Infrastructures and the Minister of Finance, after consultation with the Appointments Review Committee (a body established under the Government Companies Law), jointly appoint all Directors of the Company, and approve the Board of Director’s appointments of the Chairman of the Board and the Chief Executive Officer of the Company. Although the Board of Directors of the Company generally selects the Chairman of the Board, the Government may appoint the Chairman if the Government deems such action necessary. As a Government Company, the Company is also subject to certain Government regulations with respect to contracts it enters into. For example, the Company is subject to regulations that relate to giving priority to certain locally produced products over imports for so long as the price of such locally produced products meet certain criteria specified by the Government. In addition, in certain cases, the Company is required to obtain commitments from foreign suppliers to make offset purchases or investments in Israel, in an amount equal to a specified percentage of the value of their contracts with the Company, or to take other actions. To date, compliance with such regulations has not adversely affected the Company’s operations. Government policy provides that each Government Company will distribute 60% of its annual net profits (before payment of any bonus to employees from profits) as a dividend. As noted above, under the Government Companies Law, any decision by the Company’s Board of Directors concerning allocation of profits is subject to approval by the Government Companies Authority. In case of disagreement regarding a distribution between the Government Companies Authority and the Company’s Board of Directors, the Company is obliged to act in accordance with the Government Companies Authority’s decision, as approved by the Government. See Note 1.e to the Financial Statements. The Company plays an important role in the implementation of the Government’s national energy policy, including with respect to energy supply, market liberalization, environmental protection, safety, technological development and energy conservation. The Company’s primary regulators are the Minister of Infrastructures and the Electricity Authority. The Electricity Authority is empowered under the Electricity Sector Law to issue licenses for all activities in the electricity sector. In order to take effect, licenses must be approved by the Minister of Infrastructures. The Electricity Authority also sets the electricity rates or Tariffs. The members of the Electricity Authority are appointed by the Government after nomination by the Minister of Infrastructures and the Minister of Finance. The Electricity Sector Law provides that certain assets held by the Company in March 1996, the date on which the Concessions expired, are to be acquired by the Company from the Government for their value (the ‘‘Asset Acquisition’’). The Electricity Sector Law does not specify which particular assets are to be so acquired or the method by which value was to be determined. Consequently, the assets to be so acquired may or may not constitute a significant portion of the Company’s assets, and the cost to the Company, if any, may or may not be significant. Pursuant to the Electricity Sector Law, since no agreement

29 was reached by March 4, 1997 among the Minister of Infrastructures, the Minister of Finance and the Company, the terms of the Assets Acquisition are to be determined by the two Ministers. No such determination has been reached and consequently the rights and the assets remain with the Company as they were at the time of the expiration of the Concessions. The Company believes that the implementation of the Asset Acquisition will not have a material adverse effect on the Company’s business, results of operations or its ﬁnancial condition, although there can be no assurance that this will be the case. See Note 1.a(6) to the Financial Statements.

In addition to the Electricity Sector Law, the Goods and Services Supervision Act, 5756 – 1996 (the ‘‘Supervision Act’’) applies to the setting of electricity rates. The Supervision Act authorizes the Minister of Infrastructures and the Minister of Finance to determine the prices (including the rate of increase) of goods and services in accordance with the criteria set forth in the Supervision Act. The Electricity Authority believes that it is the only entity authorized to determine the electricity rates in Israel. The Company believes, however, based on the expert opinion of its legal consultants, that notwithstanding any act of determining electricity rates taken by the Electricity Authority, it is possible for the Minister of Infrastructures and the Minister of Finance to intervene in the rate setting process, by force of the Supervision Act, in extreme market conditions, such as high rates of inﬂation or the risk of such an inﬂation occurring.

The Company has borrowed directly from the State of Israel and has received the State of Israel’s guarantee for approximately NIS 6.8 billion of its borrowings. For information regarding the direct loans from and the guarantees by the State of Israel, see Transactions with Related Parties—Government of Israel—Other Transactions with the State of Israel and Other Government Owned Entities.’’ The Company’s obligations under the Notes will not be guaranteed or otherwise supported, directly or indirectly, by the Government. See Note 18.g to the Financial Statements.

The electricity sector in Israel is currently almost entirely constituted by the activities of the Company, which acts (and was declared by the Antitrust Commissioner) as a virtual monopoly in all sections of the sector (including electricity supply, electricity generation and the sale, transmission and distribution of electricity and provision of back-up services for electricity consumers and manufacturers). The Government, however, is under no obligation to maintain any portion of its current holdings in the Company. In March 2003, the Government decided to require the Government Companies Authority to draft proposals for privatization of the Company by selling up to 49% of its shares in the capital markets. Pursuant to such decision, the privatization will be carried out only after the Government is satisﬁed that the structural changes, and the decisions of the social-economic cabinet regarding it, will be implemented. On March 1, 2007, a signiﬁcant amendment the Electricity Sector Law was approved (‘‘Amendment No. 5’’). Amendment No. 5 was enacted to regulate structural changes in the electricity sector, including the Company’s future structure. Subsequently, on November 1, 2007, new implementation orders relative to the structural changes came into force (‘‘Implementation Orders’’). The Implementation Orders extended the Company’s licenses, postponed certain milestones and timetables for the implementation of the Company’s structural reform, and added interim milestones for the Company’s structural reform. See ‘‘Business—Regulation—Restructuring’’ and Note 1(a) to the Financial Statements.

30 USE OF PROCEEDS

Unless otherwise speciﬁed, the Company intends to use the net proceeds from the sale of Notes to ﬁnance the Company’s capital investment program and for other general corporate purposes as the Company may determine. For additional information with respect to the Company’s capital investment program and the anticipated funding for such program, see ‘‘Management’s Discussion and Analysis of Results of Operations and Financial Condition—Liquidity and Capital Resources’’ and ‘‘Business— Development Strategy and Capital Investment Program.’’ Pending use of the net proceeds for the purposes described above, the Company may invest such proceeds primarily in short-term, high-quality, interest-bearing investments, with interest and principal linked to the U.S. Dollar, hedged to the U.S. Dollar or linked to the CPI, or to deposit such proceeds in U.S. Dollar, U.S. Dollar-linked or U.S. Dollar-hedged bank accounts.

EXCHANGE RATES

The following table sets forth the representative rate of exchange published by the Bank of Israel based on U.S. Dollar-Shekel transactions for the periods and dates indicated. Rate End Year Ended December 31 Average High Low Period (Shekels per U.S.$1.00) 2003 ...... 4.54 4.92 4.28 4.38 2004 ...... 4.48 4.63 4.31 4.31 2005 ...... 4.49 4.74 4.30 4.60 2006 ...... 4.45 4.73 4.18 4.23 2007 ...... 4.11 4.34 3.83 3.85 2008 (through March 31, 2008)...... 3.63 3.86 3.38 3.55

For a discussion of the impact of exchange rate movements on the Company’s ﬁnancial condition and results of operations, see ‘‘Management’s Discussion and Analysis of Results of Operations and Financial Condition’’.

31 CAPITALIZATION

The following table sets forth the consolidated cash and cash equivalents, short-term debt and capitalization of the Company as of December 31, 2007 on an actual basis. For further see the Financial Statements.

in millions of adjusted in million of December 2007 Shekels U.S. Dollars(2) As of December 31, 2007 Cash and cash equivalent ...... NIS 456 U.S.$ 119 Short-term debt (current maturities of long-term debt) ...... 1,679 437 Long-term debt, net and extended-term debt, net Debentures, net ...... 25,897 6,733 Loans from banks...... 11,354 2,952 Other loans ...... 2,009 522 Total long-term debt, net ...... 39,260 10,207 Extended-term debt, net ...... 473 123 Perpetual debentures ...... 2,156 561 Total long-term debt, net and extended-term debt, net...... 41,889 10,891 Shareholders’ equity Paid up share capital ...... 972 253 Capital reserves ...... 880 229 Dividend Provided ...... 2,358 613 Retained earnings...... 9,636 2,505 Total shareholders’ equity...... 13,846 3,600 Total capitalization (1)...... NIS 55,735 U.S.$14,491

(1) On January 17, 2008, the Company issued $250 million aggregate principal amount of debentures. In March 2008, the Company issued CPI-linked non-marketable debentures of the ‘‘2014 Linked Electric’’ series with an overall par value of approximately NIS 170 million in consideration of approximately NIS 181 million for a period of six years under standard interests for the Company’s capital raising rounds.

(2) U.S. Dollar amounts have been translated at NIS 3.846 to U.S.$1.00, the representative rate of exchange published by the Bank of Israel, for December 31, 2007.

32 SELECTED FINANCIAL DATA

The following table presents certain financial data of the Company for the periods and as of the dates indicated. The Company presents its financial statements in Shekels that have been adjusted to reflect changes in purchasing power of the Shekel due to inflation. The income statement and balance sheet data were derived from the Company’s annual financial statements as of and for the years ended December 31, 2005 through 2007.

The Company’s annual financial statements for the years ended December 31, 2005 through 2007 and the notes thereto have been prepared in accordance with Israeli GAAP, which differs from U.S. GAAP and IFRS in certain significant respects. See Note 32 to the Financial Statements for a reconciliation of the Company’s 2007 financial results to IFRS. The Company’s financial statements for the year ended December 31, 2008 will be prepared in accordance with IFRS, unless the Minister of Finance exempts the Company from implementing IFRS, in whole or in part.

The summary ﬁnancial and operating data should be read in conjunction with the Management’s Discussion and Analysis of Results of Operations and Financial Conditions, as well as the Financial Statements.

Year Ended December 31 2005 2005(2) 2006 2006(2) 2007 2007(2) (in millions of adjusted December 2007 Shekels and millions of U.S. Dollars, except ratios and operating and other data) Israeli GAAP: INCOME STATEMENT DATA: Revenues...... NIS17,317 U.S.$4,503 NIS18,188 U.S.$4,729 NIS19,264 U.S.$5,009 Cost of operating the electricity system ...... 13,192 3,430 13,904 3,615 15,526 4,037 Profit from operating the electricity system ...... 4,125 1,073 4,284 1,114 3,738 972 Sales and marketing expenses .... 744 193 789 205 798 207 Administrative and general expenses ...... 660 172 789 205 710 185 Expenses (income) from liabilities to pensioners, net ...... 110 29 121 32 230 60 Income from current operations. . . 2,611 679 2,585 672 2,000 520 Financial expenses (income) ..... 2,132 554 1,760 458 908 236 Capitalization of financial (expenses) income...... (246) (64) (180) (47) (27) (7) Transfer of financial (expenses) income to a regulatory liability . . 91 24 668 174 1,202 313 Financial expenses (income), net . . 1,977 514 2,248 585 2,083 542 Other expenses (income), net .... 8 2 (7) (2) 64 17 Income (loss) from current operations before income taxes. . 626 163 344 89 (147) (38) Netincome(loss)(1)...... 1,328 345 262 68 (101) (26) BALANCE SHEET DATA (at end of year): Current assets ...... 7,509 1,952 6,521 1,695 6,755 1,757 Non-current assets ...... 2,941 765 3,442 895 3,185 828 Fixed assets, net...... 59,811 15,551 59,101 15,367 58,245 15,144 Other assets, net ...... 418 109 835 217 789 205 Total assets ...... 70,678 18,377 69,899 18,174 68,974 17,934 Current liabilities ...... 7,338 1,908 7,286 1,894 8,060 2,096 Long-term and extended-term liabilities, net ...... 49,657 12,911 48,666 12,654 47,068 12,238 Shareholders’equity...... 13,683 3,558 13,947 3,626 13,846 3,600 Total liabilities and shareholders’ equity...... NIS70,678 U.S.$18,377 NIS69,899 U.S.$18,174 NIS68,974 U.S.$17,934

(1) On July 25, 2005, the Knesset (Israeli Parliament) passed the Law for the Amendment of the Income Tax Ordinance (No> 147), 2005 which prescribes a gradual decrease until the year 2010 in the corporate tax rate in Israel. The decrease in deferred tax liabilities affected by the change in the tax rate caused a signiﬁcant increase in net income for the year 2005. (2) U.S. Dollar amounts have been translated at NIS 3.846 to U.S.$1.00, the representative rate of exchange published by the Bank of Israel, for December 31, 2007.

33 MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITIONS This Offering Circular contains forward-looking statements that involve risks and uncertainties. Such statements are based on management’s current expectations and are subject to a number of factors and uncertainties which could cause the Company’s performance and the other matters discussed in the forward-looking statements to differ signiﬁcantly from that discussed in the forward-looking statements. Factors that could cause such differences include, but are not limited to, those discussed in ‘‘Risk Factors’’ and elsewhere in this Offering Circular. The Company assumes no obligation to update its forward- looking statements or to advise of changes in the assumptions and factors on which they are based.

Introduction The following discussion of the years ended December 31, 2006 and 2007 is based on and should be read in conjunction with the Company’s annual financial statements and the notes thereto, included elsewhere in this Offering Circular. The Company’s annual financial statements have been prepared in accordance with Israeli GAAP, which differs from U.S. GAAP and IFRS in certain significant respects. See Note 32 to the Financial Statements for a reconciliation of the Company’s 2007 financial results to IFRS. In 2006, there was low deflation in Israel (-0.1%), which was below the lower limit of the target range of price stability and in 2007 Israel’s rate of inflation was 3.4%, which was over the high limit of the target range of price stability published by the Bank of Israel. In accordance with Israeli GAAP, all year-end financial data presented herein (unless otherwise indicated) has been stated in adjusted December 2007 Shekels. See ‘‘Presentation of Financial and Operating Data’’ and Notes 2.D and E to the Financial Statements. The Company’s results of operations are seasonal. The Company’s revenues are substantially higher during the cold winter months and the warm summer months than during other months. These seasonal increases are partially offset by an increase in fuel costs during those periods.

Overview The Company’s revenues are dependent upon the tariffs which it is permitted to charge its customers by the Electricity Authority. According to the Electricity Sector Law, the tariffs are determined on the basis of various factors, including recognized costs, a fair rate of return on capital and an efficiency factor. See the discussion below under ‘‘Business—Tariffs.’’ Consequently, although the Company’s net cash generated from its operating activities is sufficient to meet its working capital requirements and debt service, it does not constitute a sufficient source of funding for its entire capital investment program. The Company has historically raised, and will in the future seek to raise, financing to fund its capital investment program from external sources, primarily from loans from Israeli and foreign financial institutions, public and private offerings of debt in Israel and also abroad. In order to fund the Company’s development program for the years 2008 to 2012, the Company estimates that it will require substantial additional external sources of funding, including proceeds from the sale of the Notes.

Dividend Policy The Government Companies Law provides that any decision by the Board of Directors regarding the designation of the Company’s earnings, including in respect of any distribution (as deﬁned in the Companies Law), requires the approval of the GCA. In case of disagreement regarding a distribution between the GCA and the Company’s Board of Directors, the Company is obliged to act in accordance with the GCA’s decision, as approved by the government.

34 The current policy of the GCA (which could change from time to time) in respect of the payment of dividends provides that: • public utilities companies are required to distribute a dividend from current profits in an amount of 60% of the annual net current profit (before payment of any bonus to employees from profits); • a dividend from accumulated profits will be determined for each company individually, taking account of several relevant factors. Notwithstanding the current policy of the GCA described above, the Company’s Board of Directors has decided not to recommend the payment of a dividend in an amount of 60% of annual net current profits in each of the last three financial years. In each case, the Company has informed the GCA of the reasons for its decision. On March 26, 2008, the Director of the Companies Authority rendered his response regarding the examination of the designation of profits for the years ended December 31, 2005 and December 31, 2006, stating that, in 2008, the Companies Authority does not intend to require a dividend distribution in respect of 2005 and 2006. No response has been received by the Company with respect to 2007. If the GCA decides in the future that dividends have to be paid, then the Company’s internal resources would be reduced accordingly. For further information see Note 1.e to the Financial Statements.

Results of Operations

Revenues The Company receives virtually all of its revenues from electricity sales. The following tables set forth, by type of customer, the revenues of the Company (in millions of adjusted December 2007 Shekels and as a percentage of total revenues), electricity sales of the Company (in GWh and as a percentage of total sales) and average rates (in Agorot/KWh), in each case for the years 2006 and 2007.

2006 2007 Revenues (in millions of adjusted December 2007 Shekels, except %) Residential ...... NIS 6,434 34.5% NIS 6,583 34.2% Public, commercial and bulk ...... 6,985 37.4% 7,291 37.9% Agricultural...... 660 3.5% 666 3.5% Industrial...... 3,708 19.9% 3,803 19.8% Water pumping...... 871 4.7% 894 4.6% Total electricity sales (gross) ...... 18,658 100.0% 19,237 100% Adjustments: Collection in respect of regulatory asset/liability ...... (581) 190 Consumers’ participation in ﬁxed assets ...... — (293) Other income ...... 111 130 Revenues...... NIS18,188 NIS 19,264 Under the terms of the Electricity Sector Law, the electricity rates charged to the Company’s customers are regulated by the Electricity Authority. The rates are based on a formula established by the Electricity Authority, which the Electricity Authority has periodically revised. On July 5, 2002, the bases of the electricity rates and criteria for 2002-2005 and the manner for their updating came into force. Because new electricity rate bases have not been determined the Electricity Authority’s decisions remain in force. See Note 3.a to the Financial Statements. The electricity rates are examined by the Electricity Authority biweekly (with the publication of the CPI and with the publication of fuel prices), but the rates will effectively be updated in the event the inputs basket net of the efﬁciency factors changes by at least 3.5%, or with the elapse of half a year from the last update, whichever is earlier. The differences that arise between the biweekly update (as stated

35 above) and the effective update of the rate to the consumers are included in the rate beginning with the date of the upcoming annual update in which the Electricity Authority updates the rate base. As the result of the foregoing, the Company generates a regulatory asset or liability with relation to the dates for the updating of the rates. In the reported period, the Company generated a liability that reduced the Company’s revenues by an amount of approximately NIS 79 million, the balance of which as of the balance sheet date amounts to NIS 151 million. The Electricity Authority has, as it did in the past, once again decided that the Company’s accounting exposure for part of its loans and debentures denominated in or linked to foreign currency, which finance fixed assets in use exclusively, will be passed on to the electricity consumers through the electricity rate. In its decision, it stipulated that the amount of the exposure will be determined according to the recognized percentage of foreign capital linked to the basket of currencies, where it is linked to the rate of the change in the exchange rate for the basket and to the change in the annual amount of manufactured electricity. As the result of the decision, the Company generates a regulatory asset for the financial expenses. The decision determines that the differences between the changes in the basket of currencies, as calculated by the Company and the Electricity Authority, and the changes in the CPI for the amount stated above will be passed on to the electricity consumers. The rates formula also includes efficiency factors for a sold kWh, which is meant to result in efficiency for the Company and to reflect advantages of size at cumulative annual rates that are gradually accumulated. The annual rates are 2.1% on inputs of the generation segment, excluding fuel, 1.3% on inputs of the transmission and transformer segment; -2.5% on inputs of the high-voltage distribution segment, and 3.7% on inputs of the low-voltage distribution segment. Year Ended December 31, Electricity Sales The Company receives virtually all of its revenues from electricity sales. The following table sets forth, by type of customer, revenues (in millions of adjusted December 2007 Shekels and as a percentage of total sales the electricity sales of the Company (in GWh and as a percentage of total sales) and average rates (in Agorot/KWh), in each case for the years 2006 and 2007.

2006 2007 2006 2007 Average Rates (in (in GWh, except percentages) Agorot/KWh) Residential...... 14,313 31.0% 15,049 30.5% 44.95 43.74 Public, commercial and bulk ...... 16,881 36.6% 18,223 36.9% 41.38 40.01 Agricultural ...... 1,755 3.8% 1,852 3.8% 37.61 35.96 Industrial ...... 10,387 22.5% 11,178 22.7% 35.70 34.02 Water pumping ...... 2,838 6.1% 3,021 6.1% 30.69 29.59 Total ...... 46,174 100.0% 49,323 100.0% Average rate (1) ...... 40.41 39.00 Average rate (net) (2) ...... 39.15 38.79

(1) The average rate represents the Company’s total revenues from electricity sales (gross) divided by the Company’s total electricity sales (in GWh). The average rate includes amounts collected from customers as part of the rate structure in respect of the regulatory asset/liability which is not included in the Company’s reported revenues. See Note 24 to the Financial Statements. (2) The average rate (net) represents the Company’s reported revenues divided by total electricity sales (in GWh). Revenues for 2007 were NIS 19,264 million, representing an increase of 5.9% from 2006, primarily reﬂecting a 6.8%increase in electricity sales which was partially offset by a 0.91% decrease in the average electricity rate, net. The increase in electricity sales in 2007 was primarily due to the addition of new customers and increased consumption.

36 The decrease in average electricity rates in 2007 was primarily due to the impact of the efﬁciency factors on the electricity rate as compared with 2006 and the impact of the decrease of a basket of foreign currencies, the composition of which is determined by the Bank of Israel (the ‘‘Basket of Currencies’’), on the electricity rate. This decrease was partially offset by an increase in CPI as well as an increase in fuel prices.

Cost of Operating the Electricity System Cost of operating the electricity system consists of variable costs (including fuel costs and purchases of electricity) and ﬁxed costs (including the costs of operation of power stations and depreciation of generating assets). The following table sets forth information with respect to the components of the cost of operating the electricity system for 2006 and 2007:

Cost of Operating the Electricity System

Year Ended December 31 Change 2006 2007 2007 (in millions of adjusted December 2007 Shekels) % Variable costs Fuel costs (including wages) ...... NIS 8,495 NIS 10,006 18% Purchases of electricity...... 86 113 31% Total variable costs ...... 8,581 10,119 18% Fixed costs Operation of power stations (including wages) ..... 2,336 2,301 (1%) Depreciation of generating assets...... 2,987 3,106 4% Total ﬁxed costs...... 5,323 5,407 2% Total cost of operating the electricity system...... NIS 13,904 NIS 15,526 12% Cost of operating the electricity system for 2007 was NIS 15,526 million, representing an increase of NIS 1,622 million (12%) from 2006. This increase was primarily due to an increase in the cost of fuel of NIS 1,511 million (18%) and the depreciation of generating assets of NIS 119 million (4.0%). The increase in fuel costs was due to an increase in fuel prices, a change in the types and mix of fuels used in the Company’s operations and an increase in fuel consumption due to increased sales of electricity. The increase in depreciation of generating assets resulted primarily from an increase in investments in power stations, gas turbine and other investments in the year 2007. On November 12, 2007, the Company issued an immediate announcement warning of losses in the report period deriving from an actual increase in electricity demand beyond that predicted throughout the summer. As a result of this surge in demand, the Company had to use a more expensive fuel mixture, which included diesel fuel and crude oil, for which the Company has yet to receive compensation in its rates. On November 18, 2007, the Company approached the Electricity Authority with a request to update its fuel basket due to the growth in demand above and beyond the demand upon which the fuel basket was based. Yearly income due to this increase is estimated by the Company at NIS 690 million. On March 19, 2008, the Electricity Authority informed the Company that it was dismissing the Company’s claims regarding the absence of rate coverage in the fuel basket. The Electricity authority argued that the fuel basket recognition mechanism presupposes that there might be changes between the forecasted demand curve and the actual demand curve. The Electricity Authority’s examination revealed that the Company’s losses resulting from the change in the demand curve in 2007 approximate the Company’s proﬁts for 2005-2006. Furthermore, the Electricity Authority indicated that it intends to determine a defense mechanism during the next trial period against errors in forecasting the demand curve. The Company is evaluating all of the implications of the rate update and will consider its steps accordingly.

37 Sales and Marketing Expenses Sales and marketing expenses consist of the cost of operating and maintaining the transmission and distribution system and related depreciation. The following table sets forth information with respect to sales and marketing expenses for 2006 and 2007:

Sales and Marketing Expenses

Year Ended December 31 Change 2006 2007 2007 (in millions of adjusted December 2007 Shekels) (%) Operation of transmission and distribution system ..... NIS662 NIS675 2 Depreciation of transmission and distribution system . . 127 123 (3.1) Total sales and marketing expenses ...... NIS789 NIS798 1.1 Sales and marketing expenses for 2007 were NIS 798 million, representing an increase of NIS 9 million (1.1%) from 2006. This increase was due to an increase of NIS 13 million (2%) related to the operation of the transmission and distribution system resulting from an increase in maintenance expenses associated with the Company’s increased commercial activities and a decrease of NIS 4 million (3.1%) in depreciation of the transmission and distribution system as a result of a decrease in electricity meters investments in the year 2007.

Administrative and General Expenses Administrative and general expenses consist of wages, provisions for doubtful debts, depreciation and amortization of assets used in the management of the Company and certain other expenses. The following table sets forth information with respect to administrative and general expenses for 2006 and 2007:

Administrative and General Expenses

Year Ended December 31 Change 2006 2007 (in millions of adjusted December 2007 Shekels) (%) Wages and other expenses...... NIS653 NIS581 (11%) Depreciation and amortization of assets used in the management of the Company ...... 136 129 (5%) Total management and general expenses ...... NIS789 NIS710 (10%) Administrative and general expenses were NIS 710 million in 2007, representing a decrease of NIS 79 million (10%) from 2006. The decrease was primarily due to expenses in 2006 of NIS 57 million and NIS 25 million relating to an allowance in respect of the gas pipeline project and war damages, respectively. This decrease was partially offset by an increase in wages.

Expenses (income) from Liabilities to Pensioners, net Expenses (income) from liabilities to pensioners, net were NIS 230 million in 2007, representing an increase of NIS 109 million, net, compared with 2006. This increase was primarily due to an increase of depreciation of actuarial losses, which were greater in 2007 than 2006 because of a decrease in the average interest rate used to discount the cash ﬂow of the Company’s pension liability. See ‘‘Business— Employees’’ and Note 17 to the Financial Statements.

Financial Expenses (Income), Net Financial expenses (income), net, consist of: (a) loss (gain) from the erosion of liabilities, net, (i.e., resulting from exchange rate gains or losses associated with monetary assets and liabilities denominated in or linked to foreign currencies, net of the effect of changes in the CPI on the value of such assets and

38 liabilities), (b) other financial expenses (primarily interest expenses), (c) capitalization of financial (expenses) income related to loans and debentures which are intended to finance the investments under construction, and (d) transfer of financial expenses (income) to a regulatory asset/liability. The following table sets forth information with respect to financial expenses (income), net, for 2006 and 2007:

Financial Expenses (Income) Net Year Ended December 31 Change 2006 2007 (in millions of adjusted December 2007 Shekels) Loss (gain) from the erosion of liabilities, net . . . NIS (791) NIS (1,587) NIS (796) Other financial expenses (primarily interest expenses)...... 2,551 2,495 (56) Financial expenses...... 1,760 908 (852) Capitalization of financial (expenses) income.... (180) (27) 153 Transfer of financial expenses (income) to a regulatory asset/liability ...... 668 1,202 534 Financial expenses (income) net...... NIS 2,248 2,083 (165) Financial expenses (income), net, for 2007 were NIS 2,083 million, representing a decrease of NIS 165 million from 2006, primarily due to a decrease in financial expenses of NIS 852 million in 2007. This decrease was primarily due to a gain from erosion related to loans, debentures and swap transactions of NIS 796 million, resulting primarily from the difference between the rate of inflation during this period (3.4%) and the rate of decrease in the exchange rate of the Shekel against the Basket of Currencies in 2007 (6%) as compared with 2006. This represents a difference of 9.4%, compared with a difference of 5.1% in 2006. This decrease in financial expenses was also from a reduction in other financial expenses, primarily interest expenses, which decreased in 2007 by NIS 56 million because the average outstanding balances of long-term liabilities in 2007 was lower than in 2006. The decrease in financial expenses (income), net was partially offset by a decrease in capitalization of financial (expenses) income of NIS 153 million, and an increase in transfer of financial income to a regulatory asset/liability of NIS 534 million resulting from a loss from erosion related to a portion of the Company’s loans and debentures in foreign currency due to the gap between inflation and revaluation of the Shekel against the Basket of Currencies as explained above. See Notes 3.a.2 and 28 to the Financial Statements.

Income Taxes: Deferred Income taxes deferred for 2007 were NIS (36) million compared with NIS 91 million for 2006. The statutory tax rate was 29% in 2007 and 31% in 2006 as a result of changes in the corporate tax rate. The decrease in deferred income taxes in 2007 was primarily the result of a decrease in pre-tax proﬁt in 2007. The Company did not pay income taxes in 2007 or 2006 due to accumulated losses for tax purposes as a result of tax beneﬁts derived from accelerated depreciation.

Net Income (loss) Net income (loss) decreased in 2007 by NIS 363 million as compared with 2006. The decrease in net income (loss) was primarily due to decrease in income from current operations. Income from current operations decreased in 2007 by (23%) from 2006.

Liquidity and Capital Resources The Company traditionally has met its working capital and other capital requirements primarily from net cash generated by operating activities, loans from Israeli ﬁnancial institutions (including loans guaranteed by the State of Israel), loans from foreign ﬁnancial institutions (including loans guaranteed by

39 export credit agencies and, in certain cases, by the State of Israel), public and private offerings of debt in Israel and abroad and loans from provident funds. In 2006 and 2007, the Company raised approximately NIS 2.0 billion in each year in private debt offerings in Israel. Funds generated from operations in 2006 and 2007 were NIS 4.3 billion and NIS 3.6 billion, respectively. The following table provides information on the sources of long-term ﬁnancing, net, other than operating activities, for 2006 and 2007:

Year ended December 31 2006 2007 (in millions of adjusted December 2007 Shekels) Loans from foreign ﬁnancial institutions (1) ...... NIS 1,265 NIS 152 Private debt offerings in Israel ...... 2,031 2,000 Total ...... NIS 3,296 NIS 2,152

(1) Includes loans guaranteed by export credit agencies and, in certain cases, by the State of Israel. The Company has raised long-term financing, net, of NIS 3.3 billion and NIS 2.2 billion in 2006 and 2007, respectively. Funds generated from operations and long-term financing have been used primarily for the purchase of fixed assets. In 2006 and 2007, the Company’s cash investments for purchase of fixed assets were NIS 3.7 billion and NIS 3.0 billion, respectively. The Company’s total long-term and extended-term liabilities, net, were NIS 41.3 billion and NIS 39.7 billion at December 31, 2006 and 2007, respectively. Total long-term and extended-term liabilities decreased by 3.7% in 2007. The Company expects its working capital and other capital expenditures to continue to increase as it implements its capital investment program. The capital investment program contemplates the construction of a large number of new generating units and a significant expansion of the Company’s transmission and distribution systems in response to projected continuing increases in demand for electric power and in order to continue to improve the Company’s capacity reserve margins. The Company anticipates that capital expenditures will be the most significant use of funds over the next few years. The Company’s capital investment program for the period from 2008 through 2012 contemplates total capital expenditures of approximately NIS 28.6 billion. See ‘‘Business—Development Strategy and Capital Investment Program.’’ The Company expects that its capital expenditures from 2008 through to 2012 to fund its capital investment program will be approximately NIS 28.6 billion in aggregate and approximately NIS 5.7 billion annually. In view of the average size of annual investments made in the past on developing the generating segment (about NIS 1.9 billion each year from 2003 through 2006), and referring to the development plan described above, the Company estimates that the annual investment required to implement the development plan will be about NIS 2.6 billion. This estimate is predictive in nature and based on the latest investment forecast, which may change because of instructions given to the Company (as an essential service provider) regarding the development plans it must implement. Moreover, the actual type, number and capacity of generating units and transmission and distribution facilities constructed by the Company and the timing of such construction will depend upon a variety of factors. 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 and its associated investment include changes in the growth rate of demand for electricity, implementation of the structural changes in the electricity sector and in the Company and the implementations of changes in organizational structure for realization of the Company’s development and investment plans, difficulties obtaining licenses and/or changes in legislation dealing with the environment and licensing, the absence of suitable tariff cover (see Note 3.b of the Financial Statements), and the Company’s ability to raise the funding required for the development plan. See Risk Factors—The Company requires additional financing to fund its capital investment program.’’

40 In addition to the Company’s funding requirements relating to its capital investment program, the Company has signiﬁcant principal and interest payment obligations over the short and long term. The scheduled maturities of the Company’s outstanding long-term and extended-term debt (including balances of currency swap transactions) in the years 2008 to 2013 and thereafter are set forth in the table below:

Year Ended December 31 2013 and 2008 2009 2010 2011 2012 thereafter (in millions of adjusted December 2007 Shekels) Loans from Israeli and foreign financial institutions and from the State of Israel ...... NIS 1,288.8 NIS 1,169.0 NIS 1,154.9 NIS 1,025.3 NIS 956.0 NIS 7,810.1 Public and private debt offerings in Israel and abroad. . NIS 39.8 NIS 4,270.4 NIS 245.9 NIS 2,829.6 NIS 2,436.7 NIS 15,783.0 Supplier’s credit ..... 55.7 47.3 35.9 23.9 6.9 17.7 Swap and forward transactions...... 228.8 148.0 — 420.2 198.8 528.2 Total...... NIS 1,613.1 NIS 5,634.7 NIS 1,436.7 NIS 4,299.0 NIS 3,598.4 NIS 24,139.0 In 2006 and 2007, the Company did not pay dividends on its ordinary shares. In order to meet its future working capital and other capital requirements, the Company intends to continue to rely primarily upon net cash generated by operating activities, as well as, with respect to capital investment, public and private offerings of debt securities in the Israeli and foreign capital markets, loans from foreign financial institutions (most of which the Company expects to be guaranteed by export credit agencies) and loans from Israeli financial institutions, provident funds and the State of Israel. The Company believes that such funding sources in the aggregate will provide it with sufficient funds to meet its working capital and other capital requirements for the next 12 months. The Company anticipates that its long-term financing will increase in future years, requiring approximately NIS 20.1 billion of financing (based on December 2007 prices) in the five-year period ending December 31, 2012, and it is anticipated that a substantial portion of such liabilities will be obtained by public and private offerings of debt in Israel and abroad. Between NIS 2.7 billion and NIS 5.6 billion is expected to be raised in each year during such period. The Company’s ability to obtain long-term financing in the future is subject to a variety of factors including, among other things, the Company’s operating results and financial condition, general economic and political conditions in Israel, implementation of the structural changes, the availability of financing from banks and other financial institutions in Israel (subject to applicable lending limitations), including loans guaranteed by the State of Israel, and, with respect to foreign currency borrowings, the Government’s tax and currency control policies, and general economic and market conditions in the international capital markets. The availability of bank financing in Israel is subject to certain Israeli regulations limiting the amount a bank can lend to a particular borrower. An Israeli bank may not lend in excess of 15% of its equity to any one borrower. Based on the Company’s current bank borrowings, the equity position of Israeli banks and the opinion of the expert which had been provided to the GCA, the Company estimates that, consistent with such regulations, at December 31, 2007, the Company could have borrowed approximately NIS 5.0 billion of additional funds from the major Israeli banks. Three international banks: Citibank, Hong Kong Shanghai Banking Corporation (‘‘HSBC’’) and Deutsche Bank, have opened branches in Israel. Since these banks hold licenses from the Supervisor of Banks at the Bank of Israel to operate as Israeli banks, their presence in Israel increases the number of Israeli banks from which the Company can borrow under the single borrower regulations of the Bank of Israel. However, there can be no assurance as to the amounts, if any, that such banks would elect to lend to the Company. The Company currently

41 intends to limit further large borrowings from Israeli banks for ordinary purposes in order to ensure that it will be able to borrow from such banks in the event that the Company has unanticipated or special borrowing needs. The Company believes that the Israeli capital markets, including provident funds, will continue to be a dependable source of funds for a portion of the Company’s funding requirements. In connection with the issuance of a substantial portion of its debt, the Company has granted floating charges on substantially all of its assets to holders of such debt. The outstanding principal balance of the debt secured by such floating charges as of December 31, 2006 and 2007 was NIS 27,888 million and NIS 24,353 million, respectively. See ‘‘Description of the Notes—Note Floating Charge.’’ On January 17, 2008 the Company issued U.S.$250,000,000 floating rate notes that are also secured by a floating charge on substantially all of the Company’s assets. On March 18, 2008, the Company also issued NIS170 million of unsecured ‘‘2014 Linked Electric’’ series notes. Pursuant to an arrangement with the Ministry of Finance, during the period from 1983 through 1985, the Company issued perpetual debentures to the State of Israel for an aggregate consideration of NIS 15 million. Certain of these perpetual debentures bear interest at a rate of 5% per annum and the others bear interest at a rate of 5.75% per annum, in each case with the interest linked to the CPI. The principal of the perpetual debentures is not linked to the CPI. Except with respect to a nominal fixed charge in the aggregate amount of NIS 92, the perpetual debentures do not have priority over other debt of the Company. As a result of their terms, the perpetual debentures were treated until December 31, 2005 as equity under Israeli GAAP. Following the implementation of the Israeli Accounting Standard 22 (based on IAS-32), commencing January 1, 2006 the perpetual debentures are treated as a extended-term liability (NIS 2,156 million as of December 31, 2007). The loss of NIS 101 million for 2007 reduced the Company’s total shareholders’ equity from NIS 13.9 billion in 2006 to NIS 13.8 billion in 2007.

Impact of Inflation and Price-Level Adjustment Under Israeli GAAP, the Company is required to adjust non-monetary assets and liabilities, equity and income and expense accounts to reflect the effect of variations in the purchasing power of the Shekel. During inflationary periods, monetary items generate a gain or loss in purchasing power depending upon the currency in which they are denominated. See ‘‘Results of Operations—Financial Expenses (Income), Net.’’ Non-monetary assets and liabilities are adjusted to offset the effect of inflation and remain constant in real terms from period to period. Non-monetary assets and liabilities generally are adjusted using the CPI published by the Israeli Central Bureau of Statistics. Monetary assets and liabilities, other than items linked to the CPI, are not adjusted because their amounts are fixed by contract or otherwise in terms of currency, regardless of changes in specific prices or in the general price level. Holders of monetary assets and liabilities lose or gain general purchasing power during periods of inflation. Monetary liabilities in foreign currency are stated at closing exchange rates and are affected by the relationship between the CPI and the exchange rate of the Shekel. In each of 2006 and 2007, the Shekel’s revaluation against certain currencies represented in the Basket of Currencies was higher than the increase in the CPI (which decreased by 0.1% in 2006 and increased by 3.4% in 2007), with a resulting gain in price-level adjustment, because such liabilities were adjusted upward by a lower percentage than most of the non-monetary assets.

Foreign Currency Risk Exposure Substantially all of the Company’s revenues are denominated in Shekels and, as of December 31, 2007, approximately 54.6% of the Company’s long-term and extended-term liabilities (excluding loans financing fixed assets under constructions and foreign hedging transactions), were denominated in or linked to currencies other than the Shekel. The Electricity Authority includes a financing component (the ‘‘Financing Component’’) in its calculation of rates to reflect a portion of the Company’s financial expenses (or income) resulting from the Company’s foreign currency exposure, effectively transferring a substantial portion of the Company’s exposure to exchange rate fluctuations to its customers. In addition, to hedge its foreign currency exposure fully with respect to a portion of its foreign currency denominated

42 obligations (which is not covered by the Financing Component), the Company has entered into currency swap and forward transactions by swapping such obligations into Shekel-denominated obligations and expects to continue to do so in the future. The Company also seeks to limit its exposure to U.S. Dollar-denominated obligations by swapping some of its U.S. Dollar obligations into the Basket of Currencies, thereby reducing the exposure to the U.S. Dollar. See Note 23 to the Financial Statements. In 2006 and 2007, the Company recorded losses of NIS 1,252 million and NIS 886 million, respectively, on its hedging transactions. The inclusion of the Financing Component in the calculation of the electricity rates has mitigated, but not eliminated, the effect of exchange rate fluctuations on the Company’s results of operations. Currently, the foreign exchange exposure (calculated on the basis of changes in the representative rate in the Basket of Currencies, net of differences in the CPI) in respect of up to NIS 15.48 billion of foreign currency loans is reflected in the level of the tariffs. In order to reduce the Company’s exposure to exchange rate fluctuations, the Board of Directors has adopted a policy of carrying out foreign currency hedging transactions (primarily swaps and forwards) to adjust its financial expenses so that they are recognized for the purposes of the tariff setting mechanism. Any such transactions are executed for periods of at least two years taking into account the differences in the interest rates applicable to the various currencies, with permitted exposure of up to 15% of the loans balance in the particular currency. In addition, any balance of foreign currency exposure is generally exchanged for indexed linked obligations through foreign currency/index hedging transactions (primarily swaps and forwards) and, where markets conditions justify it, foreign currency/NIS transactions to reduce foreign currency exposure further. Generally, swaps and forwards are executed to cover at least 85% of the Company’s foreign currency exposure balance in order to ensure that the exposure for each currency does not exceed the cumulative value of 15% of the loan balances in the particular currency. For further information, see in particular Note 23 and Note 28 to the Company’s Financial Statements and ‘‘Risk Factors.’’ Adoption of IFRS In July 2006, the Israel Accounting Standards Board published Accounting Standard No. 29, ‘‘Adoption of International Financial Reporting Standards (‘‘IFRS’’) the Company intends to adopt IFRS. If the tariff is not adjusted to cover the costs reflected by IFRS, the result may be a material adverse effect on the Company’s profitability and financial position. On March 9, 2008, the Company applied to the Electricity Authority with a request to adjust the electricity rate in respect of IFRS and also announced that the transition to IFRS would lead to a reduction in shareholders’ equity of approximately NIS 2.5 billion as of December 31, 2007 and beyond that would lead to a significant decline in the Company’s profits every year. Compared with the financial statements adjusted to the CPI as until December 2007, the Company’s financial expenses will increase by approximately NIS 390 million (before the tax effect), also causing an erosion of approximately NIS 130 million in shareholders’ equity, as a result of every inflation percentage. In addition, the Company will be exposed in its financial statement to a real devaluation/revaluation in the basket of currencies in respect of the amount hedged in the electricity rate, so that each real percentage of change in the basket of currencies will be expressed in the financial statements (and not neutralized by a mechanism for creating regulatory assets/liabilities) thereby leading to an increase/a decrease in financial expenses of approximately NIS 140 million. This erosion in profits arising from the transition to IFRS might harm the credit rating of the Company’s debt, lead to an increase in cost of capital and make it difficult to continue raising capital for executing the development plan. The Company has requested that the electricity rate be calculated utilizing IFRS financial statements. On March 26, 2008, the Electricity Authority announced that the adoption of IFRS is expected to be a complex procedure that will be executed and studied over several years. In view of the Company’s demand for a significant electricity consumption rate increase due to the changes involving IFRS in its

43 accounting reporting, the Electricity Authority’s professional team indicated its view that the time is not right for determining the regulatory rate position regarding these changes. Until this subject is studied in full, the Electricity Authority will continue preparing the rate bases as practiced to date.

The Electricity Authority further clariﬁed that ‘‘a basic principle in the regulator’s work consists of the latter not being limited in his judgment to automatically recognize the Company’s costs as they appear in the books on its behalf or in its accounting records. In attempting to decide this issue, as in any other issue, the Electricity Authority will weigh all the relevant considerations in this respect (see the High Court of Justice’s ruling regarding the Electricity Authority’s decision in the matter of applying Accounting Standard No. 12 on the Company, No. 7976/04) and will reach an educated decision in this case at the appropriate time’’. The Company intends to continue negotiating with all the relevant factors in order to address the implications arising from the Electricity Authority’s announcement.

On March 9, 2008, the Company applied to the Minister of Finance requesting a further equity investment of approximately NIS 2.5 billion in order to prevent any injury to the Company’s capital raising ability, such as the erosion of capital arising from the transition to IFRS, to prevent any damage to the Company’s ﬁnancial stability and allow the continued development of the electricity sector. On March 31, 2008, the GCA replied to the Company. While rejecting the Company’s request for a further equity investment, the GCA indicated that it believes that there are several appropriate accounting solutions to the matter which should be co-ordinated between the Company and the GCA. The GCA’s response also implies that one of these solutions could be the enactment of special regulations exempting the Company from implementing IFRS, in whole or in part. Similar regulations were enacted in 2004 with respect the implementation of a new rule under Israeli GAAP.

For further information regarding differences between IFRS and Israeli GAAP and the Company’s implementation of the IFRS see Note 32 to the Financial Statements, particularly (i) Note 32.e regarding the possibility that the Company would have to restate (in IFRS financial statements) the amounts of CPI-linked financial assets and liabilities if a different method for measuring the effective interest rate will be required for such assets and liabilities, and (ii) Note 32.e (4)(b) regarding the possibility that the Company would have to restate (in IFRS financial statements) its pension obligation by using a discount rate compatible with market yields on high quality corporate bonds, instead of market yields on government bonds.

44 BUSINESS Overview The Company is the sole integrated electricity generation, transmission and distribution company in the State of Israel. The State of Israel currently owns approximately 99.85% of the Company, and the Company is therefore a Government Company subject to the provisions of the Governmental Companies Law. In addition, the Company operates as a ‘‘public company’’ in accordance with the provisions of Israeli law. (See ‘‘Relationship with the State of Israel’’ and ‘‘Regulation’’). The Company is one of the largest industrial companies in Israel. For the year ended December 31, 2007, the Company had total revenues of NIS 19,264 million, net income of NIS (101) million and total assets of NIS 68,974 million. As at December 31, 2007, the Company had an aggregate installed generating capacity of 11,323 MW. Currently the Company owns and operates 17 power station sites including 5 major thermal power stations. Total sales of electricity by the Company in 2007 were 49,323 million KWh. In the ten years from 1997 through to 2007, the aggregate demand for electricity in the State of Israel grew at an average annual rate of 4.8% exceeding the average annual rate of growth of the State of Israel’s gross domestic product (‘‘GDP’’) rate during the same period which was 3.8%. The primary factors affecting the Company’s operating performance are (i) the level of demand for electricity in the State of Israel, (ii) the tariffs that the Company is permitted to charge for electricity which are governed by regulation and (iii) the level of its operating costs. To meet increased electricity demand, the Company has made substantial investment in the construction of new generation facilities and in the expansion of and improvements to its transmission and distribution system. To meet projected future electricity demand, the Company’s capital investment program provides for the addition of 1,847 MW of installed capacity by the end of 2011. See ‘‘Development Strategy and Capital Investment Program.’’ The Company is subject to extensive regulation and supervision by various governmental authorities. In particular, the Electricity Sector Law established the Electricity Authority as the regulatory authority and sets out amongst other things the basis and timetable for the restructuring of the electricity sector in Israel including the Company in order to encourage competition in the sector. For further information, see Note 1.a to the Financial Statements and ‘‘Risk Factors.’’ Business operations Introduction The Company is a vertically integrated electricity company which generates, transmits, distributes and supplies electricity to consumers in the State of Israel. The Company’s activities are composed of three principal segments: a. Generation—activities of the power plants producing electricity, b. Transmission—the transmission and transformation system for high-voltage electricity and over long distances. c. Distribution—the electricity grid and the transformer stations system that brings electricity to the end consumer. Based on section 33.b of the Government Companies Law, and in accordance with the provisions of the Companies Authority circular dated March 2, 2004 (see Note 1.c above), the Company is required to provide disclosure in the form of a Note to the primary ﬁnancial statements. It will include statements of income, condensed balance sheets related to the various activities segments and details of assumptions and the principal details that were used in their preparation. The principles that the Electricity Authority used for determining the rate for the aforesaid activities segments, have been implemented in these statements.

45 The statements of income as they are presented in this Note do not necessarily reﬂect the results of operations of the various segments if they had been managed as separate economic entities, as implied in generally accepted accounting principles. The table below contains principle information regarding the attribution of the statement of operations and balance sheet according to activity segments: generation, transmission and distribution for the year ended December 31,2007:

Distribution Transmission Generation Total Total Balance sheet...... 17,557 14,614 36,803 68,974 Total revenues ...... 2,579 1,552 15,133 19,264 Income from current operations...... 228 477 1,295 2,000 Net income (loss) ...... (305) (22) 226 (101) For more information see Note 35 to the Financial Statements.

Generation

Production The Company maintains and operates 17 power station sites (including five major thermal power stations) with an aggregate installed generating capacity of 11,297 MW. Each power station site contains one or more individual units to generate electricity. The Company operates 60 generating units comprised of 22 thermal units, 29 gas turbine units, 6 combined cycle gas turbines and 3 gas turbine units which will be converted into combined cycle units. The Company seeks to maintain its thermal unit production capacity at a load that is sufficient to cover basic load demand levels. Coal currently is the cheapest fuel per KWh of electricity produced by the Company and therefore the Company seeks to maximize the use of coal for its base-load generation needs. As demand for electricity rises, the Company operates its generating units according to the criteria of marginal costs of fuels per KWh generated. At times of peak demand, the Company relies first on its thermal units before using the internal combustion units which can be started up and shut down more rapidly but operates at a higher cost. In addition to the electricity generated by the units, the Company purchases small amounts (about 0.4% of the total supplied by the Company in 2007 and 0.3% in 2006) from private electricity producers, some of which sell their entire output to the Company. Others sell their excess capacity to the Company. During 2007, no IPPs were added.

Thermal Units The Company operates coal, fuel oil and natural gas firing units. Some of these units are dual-purpose units that can be fired by either coal (main fuel) or fuel oil and some are dual purpose units firing natural gas (main fuel) or diesel/fuel oil. The Company operates 22 thermal units with an aggregate installed generating capacity of 6,756 MW. These units are comprised of: • 10 dual purpose units capable of operation on either fuel oil or coal with an aggregate installed generating capacity of 4,840 MW; • 6 units operating on fuel oil with an aggregate installed generating capacity of 576 MW; and • 6 units capable of operation on either natural gas or fuel oil with an aggregate installed generating capacity of 1,340 MW. The thermal units are designed to supply basic loads of demand for electricity. The dual purpose units are expensive to construct but the cost per KWh produced by them is the lowest. The generators which run on fuel oil were used to generate electricity for basic loads until the energy crisis in the 1970s, after which it was decided to diversify fuel use by setting up the dual purpose power stations, which can also use coal. As larger quantities of natural gas become available, more of the fuel oil generators that have been converted to run both on natural gas and on the conventional fuels will be operated on natural gas.

46 Gas Turbines The Company has three industrial gas turbines with an aggregate installed generating capacity of 694 MW which will be converted into combined cycle generating units. The Company operates 29 generating units of the gas turbine type that use diesel oil, with an aggregate installed generating capacity of 1,845 MW. Of these 29 units, 23 are located at 11 separate sites designated as gas turbine power stations, and 6 units are installed on the sites of thermal driven power stations. Setting up industrial gas turbines and jet gas turbines involves fairly low investment and relatively short time-frames. However, generating electricity with gas turbines is more expensive than with thermal units, and the operation of jet gas turbines is more expensive than the operation of industrial gas turbines. However, gas turbines can be started and stopped more quickly. Therefore, the Company uses its gas turbines in periods of peak demand. When natural gas becomes available at sites where gas turbines are located, the Company intends to operate the industrial gas turbines with natural gas.

Combined cycle generating units Combined cycle generating units produce electricity using a combination of industrial gas turbines and thermal turbines. This technology exploits the residual heat emitted from the industrial gas turbines to run an additional (thermal) turbine with no extra fuel. This contributes to savings in fuel and to better preservation of the environment. The Company operates six combined cycle gas turbine generating units with an aggregate installed generating capacity of 2,002 MW.

Economic Life of Units The useful life of thermal units without substantial renovation is at least 30 years. The useful life of internal combustion units without substantial renovation is at least 25 years for industrial gas turbines and at least 15 years for jet engines. Substantial renovations like those undertaken by the Company can extend the useful life of thermal units by 15 to 20 years and of gas turbine units by 10 to 15 years. The current physical condition of the units is good, with over 70% of current units having been commissioned in the last 15 years. Based upon industry sector information available to it, the Company, the Company believes that the outage rates applicable to its units are favorable compared with those of comparable electricity producers.

Installed Generation Capacity The Company’s installed generation capacity has increased from 10,899 MW in 2006 to 11,323 in 2007, representing an annual growth rate of 3.9%. This growth in generation capacity has been achieved through the expansion of existing power plants, construction of new power plants and by making improvements to operational performance of existing power plants.

47 The following table specifies the various generating units, and their generating capacity in MW as of December 31, 2007, including electricity purchased from private producers and distributed by the Company: Installed generating No. of capacity Type of unit Site units (in MW) Thermal driven power stations Dual purpose power stations (coal and fuel oil) Orot Rabin (Maor David A, B) 6 2,590 Rutenberg 4 2,250 10 4,840 Dual purpose power stations (natural gas and fuel oil) Eshkol 4 912 Reading 2 428 1,340 Total dual purpose power stations 16 6,180 Power stations operating on fuel oil Haifa 4 426 Eshkol 2 150 Total operating on fuel oil 6 576 Total thermal driven power stations 22 6,756 Gas turbines Industrial gas turbines Ramat Hovav 2 200 Tsafit 2 220 Alon Tavor 2 220 Eilat 1 34 Atarot 2 68 Gezer 4 592 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 65 Total gas turbines 29 1,845 Combined cycle gas turbines Ramat Hovav 1 335 Hagit 3 971 Eshkol 1 377 Gezer 3 1 319 Gas turbines intended for future operation as combined cycle Tsafit 1 248 Alon Tavor 1 240 Gezer 4 1 206* Total combined cycle gas turbines and gas turbines intended for future operation as combined cycle 9 2,696 Total Company generating units 60 11,297 Generating by private producers under Company dispatch (Etgal Ashdod) 1 26 Total including private producers under Company dispatch 61 11,323

* Operates by gas only due to management decision.

48 Peak Demand Peak demand is driven by a combination of population and economic growth. The following table sets out the peak demand, installed generating capacity (including electricity purchased from private producers but distributed by the Company) and available capacity during peak demand for the years 2006 and 2007. Year ending December 31 (MW) 2006 2007 Installed generating capacity ...... 10,899 11,323 Peak demand1...... 9,450 10,070 Available capacity during peak demand (installed generating capacity less the capacity of the units which were undergoing maintenance or in forced outage) ...... 9,813 10,514

1 On January 30, 2008, a peak demand of 10,200 MW was measured and, at that time, the available capacity was 10,729 MW. Currently peak demand for electricity is growing at a faster rate than installed generating capacity. Peak load typically builds up during the summer months because of increased usage of air conditioners. The Company’s installed capacity exceeded peak demand in each of the periods indicated. However, in the event demand exceeds peak capacity in the future, Israel, unlike many other countries, is currently unable to purchase electricity from neighboring countries to cover such excess demand. The Company has a shortage management policy. A shortage management situation is implemented when the Company knows in advance that it will not be able to supply the energy required at a specific time and, in order to balance the power grid, it is forced to initiate short power interruptions (of up to approximately one hour) distributed through various parts of the State of Israel. Electricity Generated and Capacity Factors For 2007, the Company generated a total of 53,613 millions of KWh of electricity representing a load factor of 60.8%, compared with 50,372 millions of KWh and 60.8%, respectively, for the year ending December 31, 2006. A load factor represents total generation of electricity in MWh, divided by the product of peak demand and the total number of hours in any given period. The average Availability of the Company’s plants is between 85% to 90%, which is equivalent to the best plants worldwide. However, due to wide fluctuations in seasonal demand, there are certain parts of the year when the plants do not have to achieve such high load factors in order to meet demand. Transmission All electricity produced by the Company is transmitted through the Company’s high voltage transmission grid which covers the whole of the State of Israel and those territories under the rule of the State of Israel since June 1967. The grid consists of high voltage lines which transfer the electricity generated by the units to the main switching stations. The main switching stations transform and distribute the electricity to sub-stations all over the State of Israel. From the sub-stations the electricity is sent to end users via the distribution system. The following table sets out the high voltage lines owned by the Company in the period 2006 to 2007: 161 KV 400 KV lines 161 KV lines 115 KV upper lines underground lines Date km circuit km circuit km circuit km circuit 12/31/2006 ...... 748 4,268 132 111 12/31/2007 ...... 748 4,331 132 107 Transmission of electricity at higher voltage levels is more efficient than at lower voltage levels because it reduces losses in transmission. As a result, the Company intends to expand its 400KV transmission grid.

49 The following table sets out the number of switching stations and sub-stations (belonging to the Company and to consumers) and installed transformation capacity in the period 2006 to 2007: Installed Switching Private Transformation Date stations Sub-stations stations Total Capacity (MW) 12/31/2006 ...... 9 145 39 193 15,819 12/31/2007 ...... 9 147 39 195 16,204 The material changes in the transmission system which occurred in 2007 are the construction of the Beitar external sub-station, Kenyonim internal sub-station and Canot external sub-station, and the creation of the Carmiel 3 mobile unit, and additional transformers at Beer Sheba North, Eitan, Taasia Edomim, Nyar Hadera and Iron.

Distribution The Company’s distribution system is comprised of sub-stations, which connect the transmission grid to the distribution system at reduced voltage levels from 161KV to 33KV, 22KV and 12.6KV (such voltages are referred to as ‘‘Medium Voltage’’). From the sub-stations, electricity is transmitted through the Company’s High Voltage power lines to transformers, which decrease the voltage to 400V (such voltages are referred as ‘‘Low Voltage’’), the levels at which electricity is distributed to the Company’s customers. From the transformers, electricity is distributed through the Company’s Low Voltage lines to the Company’s customers. The Company also distributes directly to certain medium-voltage customers through Medium Voltage lines. The Company’s distribution system supplies electricity to approximately 2.4 million customers and covers the following ﬁve geographical regions: Northern Region: This region covers the northern part of Israel excluding Haifa and its environs. As of December 31, 2007 this region served 384,490 customers, compared with 378,811 as of December 31, 2006. Dan Region: This region is bounded by the Kfar Hayarok 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 regions and therefore most of the distribution grid in the Dan region is underground. As of December 31, 2007 this region served 527,497 customers, compared with 522,861 as of December 31, 2006. Jerusalem region: This region covers Greater Jerusalem, Beit Shemesh, Har Tuv, Har Hevron and its south, Samaria including the town of Ariel and the Jordan Valley between Ein Gedi and Mechula. As of December 31, 2007 this region served 265,451 customers, compared with 261,718 as of December 31, 2006. Southern Region: This region is the largest of the Company’s regions, stretching from Emek Hefer in the north to Eilat in the south, excluding the Dan region. In accordance with its size, this region serves 40% of the Company’s customers. As of December 31, 2007, the southern region served 944,932 customers, compared with 930,846 as of December 31, 2006. Haifa region: This region 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 region is a relatively densely populated urban area, and therefore about two thirds of the grid lines are underground. As of December 31, 2007, the Haifa region served about 261,597 customers, compared with 259,499 as of December 31, 2006.

51 The following table sets out the High Voltage and Low Voltage lines owned by the Company in the period 2006 to 2007:

High Voltage Low Voltage Date (km) (km) 12/31/2006 ...... 23,662 17,948 12/31/2007 ...... 23,963 19,070 The following table sets out the number of transformers owned by the Company and their total transformation capacity at December 31, 2006 and 2007:

Date 6.3 – 12.6 KV 22 KV 33 KV Total Capacity (MVA) 12/31/2006 ...... 2,600 37,653 3,846 44,099 20,722 12/31/2007 ...... 2,613 38,355 3,907 44,875 20,927 Customer Base The Company serves approximately 2.4 million customers throughout the State of Israel. The Company classiﬁes its customers into households, industry, public and commercial structures, the Palestinian Authority, water pumping and agriculture. The number of the Company’s customers grew by approximately 30,232 in 2007. During that same period, electricity consumption rose by approximately 6.8%, from 46,174 millions of KWh to 49,323 millions of KWh. The table below sets out electricity consumption by type of customer for the years ended December 31, 2006 and 2007: (in millions of KWh, except for percentages) 2006 % 2007 % Residential...... 14,313 31.0 15,049 30.5 Industrial ...... 10,387 22.5 11,178 22.7 Public Commercial ...... 13,785 29.9 14,766 29.9 Palestinian Authority...... 3,096 6.7 3,457 7 Water pumping ...... 2,838 6.1 3,021 6.1 Agriculture ...... 1,755 3.8 1,852 3.8 Total ...... 46,174 100 49,323 100

Residential The Company serves approximately 2.1 million households, representing almost all households within the State of Israel. For the years ended December 31, 2007 and 2006, the residential sector accounted for approximately 31% of the total electricity consumption by the Company’s customers. Gross revenues from this sector amounted to NIS 6,583 million for the year ended December 31, 2007 compared with NIS 6,434 million for the year ended December 31, 2006, an increase of approximately NIS 149 million. In 2007, residential consumption grew by approximately 5.1%. Industrial Sector For the year ended December 31, 2007, the industrial sector accounted for approximately 22.7% of the total electricity consumption by the Company’s customers compared with 22.5% for the year ended December 31, 2006. Gross revenues from this sector amounted to NIS 3,803 million for the year ended December 31, 2007 compared with NIS 3,708 million for the year ended December 31, 2006. Electricity consumption within the industrial sector grew in 2007, by approximately 7.6%. Public Commercial Sector The public commercial sector includes electricity consumption by department stores, shopping centers, various businesses and authorities of the public sector, such as local authorities, government

52 ofﬁces and schools. As at December 31, 2007 and December 31, 2006, the public commercial sector accounted for approximately 30% of the total electricity consumption by the Company’s customers. Gross revenues from this sector amounted to NIS 7,291 million for the year ended December 31, 2007, compared with NIS 6,985 million for the year ended December 31, 2006, an increase of NIS 306 million. Electricity consumption in this sector grew in 2007 by approximately 7.1%.

Palestinian Authority For the year ended December 31, 2007, the Palestinian Authority and east Jerusalem accounted for approximately 7% of the total electricity consumption by the Company’s customers compared with 6.7% for the year ended December 31, 2006. The electricity consumption in this sector grew by approximately 11.7% and 8.1% during the years 2007 and 2006, respectively. This sector has a higher growth rate of consumption than the other sectors due to the higher rate of increase in its population and in its increase in purchase of electrical appliances. Electricity is sold in bulk directly to the Palestinian Authority rather than to individual customers.

Water Pumping Water pumping is required in order to provide all parts of the State of Israel with drinking water and water for irrigation and for other purposes. As at December 31, 2007 and 2006, the water pumping sector constituted approximately 6.1% of the total electricity consumption by the Company’s customers. Gross revenues from this sector amounted to NIS 894 million for the year ended December 31, 2007 compared with NIS 871 million for the year ended December 31, 2006. Electricity consumption in the water pumping sector grew in 2007 by approximately 6.4%.

Agriculture As at December 31, 2007 and 2006, the agriculture sector accounted for approximately 3.8% of the total electricity consumption by the Company’s customers. Gross revenues from this sector amounted to NIS 666 million for the year ended December 31, 2007 compared with NIS 660 million for the year ended December 31, 2006. In 2007, electricity consumption in the agriculture sector grew by approximately 5.5%.

Seasonality The demand for electricity in the State of Israel is seasonal. The demands are greater in the summer season (because of the use of air conditioners) and in the winter season (because of the use of heating devices) compared with the transitional seasons. In the winter and summer seasons the average electricity consumption is greater than that in the transitional seasons and is also characterized by days of high demand due to extreme conditions of cold or heat. In addition, the Company’s revenues in the different seasons is affected by the change in tariffs for consumers paying by load and time of use (‘‘TOU’’) and that represent approximately 58.7% of the electricity consumption, because the TOU tariffs are higher on average in the summer season compared with the TOU tariffs in the transitional and winter seasons. The seasons of the year in this respect are deﬁned as the summer season (the months July – September), the winter season (the months December – March) and the transitional seasons—spring (the months April – June) and the autumn (the months October – November). TOU tariffs apply to upper voltage, high voltage and low voltage consumers whose connection size is 3X200 ampere and greater or whose annual consumption is greater than 60,000 KWh per annum. The total number of consumers on TOU tariffs as at December 31, 2007 was 46,182—in other words, only 1.9% of consumers represent approximately 58.7% of total electricity consumption.

53 Research and Development The Company historically has invested between approximately NIS 10 million and NIS 20 million each year in research and development. The Company’s research and development program seeks to create and implement new and advanced production technologies to: • provide the Company with sufficient capacity for energy production in times of scarce or shifting sources of fuel supply; • reduce the Company’s cost of energy production; • increase the Company’s overall efficiency; and • develop alternative sources of energy. In addition, the Company’s research and development program seeks to develop and enhance the safety and reliability of its operations. In 2007, the Company incurred aggregate research and development costs of approximately NIS 7 million compared with NIS 11 million for 2006. Competition The Company presently generates, transmits and distributes substantially all of the electricity used in the State of Israel and has been declared to be a monopoly in the Electricity Sector by the Antitrust Commissioner. Pursuant to the Electricity Sector Law and its regulations, the Company is required to: • purchase electricity from IPPs; • allow IPPs to use its transmission and distribution network; and • provide a back-up source of supply to customers of IPPs. During the year ended December 31, 2007 the Company purchased about 200 million KWh from private producers (compared with 150 million KWh in 2006). The average price paid by the Company to private producers in 2006 and 2007 was 53 Agorot per KWh. The purchased electricity represented about 0.4% of the electricity supplied by the Company in 2007, compared with 0.3% in 2006. As at December 31, 2007, the cumulative installed generating capacity of private producers in Israel was 71 MW (the same in 2006), constituting 0.6% (the same in 2006) of the installed generating capacity in Israel. The Government of Israel’s stated policy is to enable competition in the electricity sector and it has set a target of increasing the generation of electricity by IPPs from 0.6% to 20% of the State of Israel’s installed generating capacity. As far as the Company is aware, conditional licenses have been granted to a number of private producers for a combined capacity of 2,300.15 MW representing about 20% of Israel’s installed generating capacity as at the date of this Offering Circular. The majority of these projects are at the feasibility stage; however, the Company cannot predict how many of them will be completed during the coming decade. When these private producers begin generating and/or selling electricity it is anticipated that they will supply some of the growth in demand for electricity consumption. The Company cannot at present estimate the future implications of such increased competition on its business, results of operations or financial condition. For further information, see also ‘‘Risk Factors.’’ The Company is also subject to competition from alternative power sources, such as natural gas, solar energy and fuel oil, for space and water heating. However, currently there is no practical substitute for electricity for industrial machinery, lighting, office equipment, air conditioning and many household appliances. The Electricity Sector Law provides for the restructuring of the electricity sector in Israel including the incorporation and operation of subsidiaries of the Company engaged in the lines of business in which the Company is currently engaged, in order to encourage competition in the sector. Fuel Introduction The Company’s primary source of fuel for electricity generation is coal.

54 In accordance with its capital investment program, the Company expects to increase gradually its proportion of production from natural gas in the future as certain sites are connected to the natural gas grid and some industrial gas turbines and thermal driven units that use fuel oil are converted to operate on natural gas. The following table sets out the breakdown in percentages of the raw materials used in the generating segment to produce electricity in 2006 and 2007:

For the year ended December 31 2006 2007 Coal ...... 70.9% 69.6% Fuel oil...... 5.5% 3.2% Natural gas ...... 18.1% 19.8% Diesel oil ...... 5.5% 7.4% Total ...... 100% 100%

Fuel costs constitute the Company’s largest single operating expense, accounting for approximately 64.4% of the Company’s operating costs for the year ended December 31, 2007 compared with approximately 60.1% for the year ended December 31, 2006. The following table sets out the total costs for fuel (including attributed labor costs) used to generate electricity in the electricity segment in 2006 and 2007:

NIS millions For the year ending December 31 2006 2007 Coal ...... 3,739 4,227 Fuel oil...... 1,159 696 Natural gas ...... 1,103 1,235 Diesel oil ...... 2,494 3,848 Total expenditure on fuels ...... 8,495 10,006

The following table sets out the average cost of fuel used by the Company in 2006 and 2007:

In Agorot per KWh Year ending December 31 2006 2007 Power stations operating on coal...... 10 11 Power stations operating on natural gas...... 12 12 Power stations operating on fuel oil ...... 41 40 Power stations operating on diesel oil ...... 91 97 Other than in respect of natural gas, the Company purchases all of its fuel directly or indirectly from sources outside Israel. 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. 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 oil will be sufﬁcient for at least one and a half months’ consumption. The Company also has access to strategic reserves of crude oil in the event of a serious disruption of fuel supplies. The Company purchases natural gas from a local supplier, the Yam Thetis Group. In addition, in August 2005, the Company entered into an agreement with the East Mediterranean Gas Company (‘‘EMG’’), an Egyptian company, for the supply of gas and the gas is currently expected to start ﬂowing to the Company during April 2008. In addition, the Company has entered into an agreement with the Yam Thetis Group for the purchase of additional quantities of spot natural gas at peak periods for the Eshkol and Reading sites until the end of March 2008. The Company has extended this agreement until EMG commences its supply of gas to the Company in April 2008.

55 Coal In 2007, the Company consumed 13.3 million tons of coal each year (compared with 12.5 million tons in 2006). The Company purchases all the coal it requires through its wholly owned subsidiary, the National Coal Supply Company Ltd. (the ‘‘Coal Company’’). For further information, see Note 9 and Note 13.a of the Financial Statements. For the year ended December 31, 2007, the adjusted average cost of a ton of coal was NIS 315.8 compared with NIS 291.9 in 2006. The Coal Company purchases coal (usually in the framework of supply contracts for at least one year) from several sources, in particular, from South Africa, Columbia, Russia, Indonesia and Australia. Coal Company representatives negotiate with their suppliers, particularly on matters of quality, availability and price. In order to ensure that sulphur dioxide emissions from its coal ﬁred power stations are no higher than the level stipulated in the environmental regulations in Israel, the Company is required to use low sulphur coal.

Coal reserves The Company’s policy is to maintain a reserve at each power station suitable for average consumption of seven weeks, and to avoid going below the stock needed for ﬁve weeks.

Fuel Oil In 2007, the Company consumed approximately 0.4 million tons of fuel oil, compared with 0.7 million tons in 2006, at an adjusted average cost of a ton of fuel oil was NIS 1,700.7, compared with NIS 1,743.4 in 2006. Since 2004, when the Company began using natural gas, its consumption of fuel oil has been diminishing and the Company expects this trend to continue as natural gas replaces fuel oil in additional generating units. The Company purchases fuel oil overseas for its power stations on a CIF (cost, insurance, freight) basis, where the supplier is responsible for shipping the fuel oil directly to the Company’s sites in Israel or to the supplier’s storage containers in Ashkelon. The Company relies exclusively on one supplier for its supply of fuel oil. The current fuel oil supply agreement dates from 2008 following a public tender process. The prices paid by the Company under the contract are determined on the basis of CIF Lavera prices (trade prices in the Mediterranean basin), plus a marketing margin. Under the terms of the agreement, the supplier supplies the Company with all the heavy fuel oil (with a maximum sulphur content of 0.5%) required during the contract term. In order to comply with the environmental quality order published by the Minister for the Environment in 1992, the Company uses low sulphur fuel oil with a maximum sulphur content of 0.5%

Fuel oil reserves The Company’s policy is to maintain a fuel oil reserve of two months of average consumption.

Diesel oil In 2007, the Company consumed 884 thousands of tons of diesel oil, compared with about 628 thousands of tons in 2006. Until 2006 the Company purchased diesel oil on the local market from local fuel companies, usually in the framework of supply contracts for one year. Since 2007, however, the Company has been importing diesel oil from Vitol, a Swiss company. The price of the diesel oil it purchases is based on prices of heating diesel oil (Diesel oil 0.2%)inthe Mediterranean basin as published by the Fuel Administration in the Ministry of National Infrastructures at the beginning of each month plus marketing margins, infrastructure costs and excise tax. The quantities of diesel oil ordered by the Company for shipment on a particular date are paid for at the prices of the month of order.

56 The Company expects to reduce its consumption of diesel oil fuel in 2008 when the gas pipeline is currently planned to be connected to the gas turbine sites in Gezer and Hagit. The prices paid by the Company for diesel oil are linked to world market prices, with margins determined in competitive tenders for suppliers. In 2007, the average adjusted cost of a ton of diesel oil was about NIS 4,358.8, compared with NIS 3,970.6 in 2006. Diesel oil is mainly supplied through the national pipeline to the Company’s power stations that run on gas turbines, except for small amounts which are brought to backup sites by tanker trucks.

Diesel oil reserves The Company’s policy is to maintain a reserve of no less than 165,000 tons (as an emergency reserve) or stock that can meet the needs of 100 hours of operation (whichever is the larger). Apart from this stock, the Company has operating stock in its gas turbine sites and at storage terminals. In order to improve its cash ﬂow, the Company recently decided to decrease its inventories of heavy oil and diesel oil. However, the Company regularly monitors its level of fuel oil and diesel oil reserves and will consider whether to increase them in the future.

Natural Gas The Company began using natural gas in February 2004 at the Eshkol power station and in July 2006 at the Reading power station. In 2007, the Company consumed 1,835 thousand of tons (about 2.695 billion cubic meters) at an average cost of NIS 676.3 per ton, and in 2006 the Company consumed 1,534 thousand of tons (about 2.264 billion cubic meters) at an average adjusted cost of NIS 720.9 per ton. As most of the Company’s sites are expected to be connected to the natural gas grid over the next three years, in accordance with the Company’s capital investment program (see ‘‘Strategy and Capital Investment Program’’), the Company anticipates that consumption will gradually increase to 4-5 billion cubic meters annually. The Company is converting industrial gas turbines and some of the thermal driven units that use fuel oil to operate on natural gas as well. Five generating units at the Eshkol power station run on natural gas, with an installed generating capacity of 1,285 MW, four of which are thermal driven power stations with a total installed generating capacity of 912 MW and one of which is a combined cycle unit with an installed generating capacity of 373 MW. In addition, two generating units at Reading power station operate using natural gas with an installed generating capacity of 428 MW. In addition, 3 combined cycle gas turbine units (at the Hagit and Gezer sites) are in the ﬁnal stages of preparation for commencement of operation.

Yam Thetis Group Natural gas is supplied to the Company by the Yam Thetis Group, which holds the rights to the Marie natural gas marine reservoir, located about 24 km west of Ashkelon. The Company and the Yam Thetis Group entered into an agreement to supply natural gas in June 2002 pursuant to which Yam Thetis has agreed to supply the Company with natural gas until 2014, or until consumption of a total quantity of 18 billion cubic meters, whichever is the earlier. The Company currently estimates that 18 billion cubic meters, is approximately half the amount of natural gas that the Company needs for the coming decade. The total value of the agreement with Yam Thetis is about U.S.$1.8 billion. The agreement includes a ‘‘take or pay’’ undertaking by the Company to pay for a minimum quantity of natural gas, whether or not the Company actually consumes it. Under the agreement, gas which has been paid for but not consumed in speciﬁc periods is required to be made available to the Company in subsequent periods, subject to the terms of the agreement. In August 2006, an agreement was signed between the Company and the Yam Thetis Group to regulate increased hourly consumption of gas at peak demand periods, above the quantity in the basic agreement. Gas supplied under this agreement is charged at a different rate from the basic agreement. The agreement rate is higher than the price in the basic agreement but lower than the price of fuel oil.

57 Purchase of Natural Gas from the EMG In August 2005, the Company signed an agreement with the EMG for the supply of natural gas from Egypt. The supply of Egyptian gas is currently expected to start during April 2008. Under the terms of this the agreement, approximately 25 billion cubic meters of gas are to be purchased at an average annual rate of 1.7 billion cubic meters over 15 years. The estimated value of amounts to be paid under this agreement is approximately U.S.$2.5 billion over a period of 15 years. The agreement is 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 is required to give notice of 36 months before the end of the initial period.

Israel Natural Gas Lines In 2003, Israel Natural Gas Lines Ltd. (‘‘INGL’’) was established by the Government to build and operate the system of transporting gas within the State of Israel and granted a license to transport natural gas. In June 2006, the Company signed an agreement with the INGL to transport natural gas to the Ashdod and Reading Power Stations. The agreement establishes the commercial, technical and legal provisions which apply to the transportation of natural gas for a period of 15 years (the ‘‘Transportation Agreement’’). On May 31, 2007, the Gas Authority published a general form of agreement on transporting gas between INGL and customers which will apply to all shippers of natural gas. The Company was granted ﬂexibility regarding capacity booking by the right to divert up to 15% of the booked capacity and by the right to book capacity for the short term (at a special tariff). The Company is supposed to sign this version of the agreement for 15 years, to apply to all sites to be connected to the gas transportation system.

Environment

Introduction The process of generation, transmission and supply of electricity has various environmental impacts. These include the following: Air Quality: Pollutants are released into the atmosphere during electricity generation as by- products of fuel combustion. The primary pollutants are sulphur dioxide, nitrogen oxide and carbon dioxide. The Company is currently implementing the following measures regarding these pollutants: • Sulphur dioxide and nitrogen oxide—Over the course of the next decade, if adopted, the Company will be required by the Ministry of Environmental Protection (by means of pending regulations currently being deliberated by the Knesset Committee of Interior and Environmental Quality) and by the planning authorities (through the national zoning plan), to install Flue Gas Desulphurization (‘‘FGD’’) and primary measures (‘‘PM’’) in eight coal fired generating units as well as Selective Catalytic Reduction (‘‘SCR’’) in the ten existing coal fired units. PM and FGD were pre-installed in the two units which entered into operation in 2000 to 2001. New coal fired units will be built with PM, FGD and SCR. • Carbon dioxide—There was no change in the proportion of natural gas used by the Company relative to other fuels between 2006 and 2007, and therefore there was no difference in the specific emissions from the generation system in 2007 compared with 2006 emissions. Operation of combined cycle generation units and introduction of natural gas in other sites will further reduce specific emissions. According to the Kyoto Protocol to the United Nations Climate Change Convention, Israel is considered a Non-Annex I (developing) country and is required only to report carbon dioxide emission levels. By-products: Coal ash and gypsum are physical by-product produced at coal-fired plants. All coal ash and gypsum are used to provide construction raw materials including cement and concrete production and filling materials for infrastructure projects.

58 Water Quality: The electricity generation process may have an impact on water quality and the Company is currently implementing the following measures: • Industrial wastewater—Industrial wastewater is collected and treated locally and disposed of at authorized sites and/or discharged into the sea subject to various permits. • Sanitary wastewater—Sanitary wastewater is either self-treated by the Company for irrigation purposes pursuant to special permits or directed to regional collection systems. In small sites, sanitary wastewater is directed to authorized sewage treatment plants. The Company may be required to connect its self-treatment sites to regional sewage collection systems, which will entail payment of fees and taxes. • Soil and ground water contamination—Leak detection and warning technology exists in fuel installations (fuel tanks and piping) and ground assessments are performed in order to detect and treat any historic leaks. Signiﬁcant ground contamination had been detected at the Reading plant in recent years. An the Company inter-departmental team was established in order to address the matter in accordance with the instructions of the Ministry of Environmental Protection. Land Use and Sensitive Areas: Israel’s coastal strip is protected by law and a national zoning plan. Power plants occupy about 4.32 kilometers of the Mediterranean coast which is 200 kilometers long. A public right of way is to be constructed between the Reading power plant and cooling water pond. It is planned that part of the 400 KV and 161 KV transmission lines will pass through highly sensitive environmental and public areas, which may result in opposition by environmental groups to these transmission lines. Electromagnetic Fields: The Non-ionizing Radiation Law (the ‘‘Radiation Law’’) was enacted in 2006. The Radiation Law provides that permits must be obtained for construction and operation of sources of radiation. Until the promulgation of regulations under the Radiation Law, World Health Organization policy had been adopted in Israel.

Future Legislation Certain additional environmental legislation is contemplated in Israel in the near future. The proposed laws and regulations could require significant additional expenses; however, the Company believes that the Electricity Authority would recognize in the tariffs any reasonable expenditure that the Company needs to incur in order to comply with such new environmental legislation. The proposed legislation includes the following: Clean Air to Israel Bill, 2005: This bill is designed to add to and consolidate existing Israeli environmental law. If enacted, the legislation would require the Company to apply for permits with respect to its emissions, which could impose significant additional economic and procedural obligations on the Company. The Company is in discussions with the Ministry of Environmental Protection and the Israel Union for Environmental Defence with regards to these matters. Proposed Regulations for the Prevention of Nuisances (Prevention of Air Pollution from Electricity Generation), 2007: The proposed regulations are based on the Nuisance Prevention Law and have been presented to the Knesset Committee of Interior and Environmental Quality for its approval. The regulations would set a specific and graded timetable for the implementation of new emissions limits for each of the Company’s sites. By the end of 2016 all of the Company’s generation plants are expected to operate according to the provisions set out in these regulations. In addition, all new plants would be constructed according to these regulations. The Company estimates that the total cost of implementing these regulations would amount to approximately U.S.$1.5-2 billion. The Company may have to request the phase-in period for the implementation of these regulations be extended in order to comply with their requirements. Contaminated Ground Remediation Bill, 2007: The bill would impose obligations on the Company to perform soil surveys and take action to remedy any historic ground contamination. It will also require soil surveys where there is an ongoing use of hazardous materials. Renewal of business permits and

59 issuance of building permits would be conditional upon compliance. In addition, the bill would impose on companies the requirement to contribute to a ground remediation government fund. Participation in such fund would be required by all companies handling hazardous materials and/or operating in the fuel sector. The proposed bill envisions a liability regime by which lenders may also become responsible for ground contamination cleanup under certain circumstances. Proposed Non-ionizing Radiation Regulations, 2007: The proposed regulations would be enacted under the Non-ionizing Radiation Law 2006 and require permits when constructing and operating sources of radiation—such a requirement already exists in the Non-ionizing Radiation Law. Evaluation based on a previous draft of the regulation indicated a cost to the Company of up to NIS 18 million per year. A recent draft includes some changes that will require clarification as to the intention of the regulator. Therefore, it is impossible at this stage to provide a decent evaluation of the anticipated cost of the regulation. Although the substantial requirements of the regulations are currently proposed to apply only to cellular operators, such legislation may set a precedent for electricity plants in the future. Protection on Environment (Polluters Pays) (Punishment Means) (Legislation Amendments) Bill, 2007: This bill would amend a number of laws which currently apply to the Company. The bill provides that the level of fines that would be imposed on a company for causing environmental harm would be determined based on the damage caused or from the profit gained as a result of such environmental damage. The proposed bill may significantly increase the scope of fines for environmental offences. Greenhouse Gas Emission Reduction Bill, 2008: The bill defines goals for the reduction of greenhouse gas emission levels in Israel, including a reduction of at least 25% of overall emissions by 2020 from a 2000 baseline, and a 50% reduction by 2050 from a 2000 baseline. Should regulations be promulgated to this effect, the Company may be subject to significant limits on its greenhouse gas emission levels and may be required to take measures and install technologies to reduce such emissions. Environmental Management The Company implements the following environmental risk management policies as part of its day to day operations: Management Units: The Company has in place several dedicated managerial units for environment management issues. The units deal with environmental planning and licensing, prevention of environmental hazards, and monitoring and control of environmental operations. The Company’s management and board approved an environmental policy which was first prepared in 1995 and has been updated several times since. New projects: During the preparation of the development plan for a new project, any environmental issues specific to that project (such as emissions of pollutants) are taken into consideration. Environmental guidelines on design, procurement, construction and operation are prepared for each project and, in addition, a significant portion of new projects are subject to environmental impact assessment requirements. Environmental monitoring: The Company constantly monitors air pollutants at source, ambient air pollution, marine environment, ground contamination, groundwater, noise and electromagnetic fields. Air monitoring data is transmitted to the supervising agencies in real time and summarized in the form of daily, monthly and annual reports. An intermittent control system is operated in respect of each coal fired power plant in order to enable the plant operator to switch to low sulphur coal during severe meteorological conditions which would affect the dispersion of pollutants. Environmental monitoring instruments used by the Company are generally approved by the U.S. Environmental Protection Agency and measurements are made using either American or European standards or methods. The results of the monitoring are compared with Israeli and/or American and European standards. Surveillance of environmental commitments: The Company has prepared environmental commitment files for all power station and partially covered sub-stations. The files contain all the environmental commitments imposed by law or as a result of internal decisions on each of the Company’s power stations (and on part of the Company’s sub-stations). The Company conducts ongoing surveillance of its environmental commitments. Procedures and quality standards: The Company has in place both company-wide environmental procedures as well as detailed internal procedures in respect of each power plant. All generating units are

60 ISO 9001:2000 certified. The environmental departments dealing with air pollutant monitoring at the source, soil monitoring at source and ambient air pollutant monitoring are either certified according to laboratory standard ISO 17025 or are in the process of being so certified. The Jerusalem district was certified according to environmental standard ISO 14001. Preparedness and response: The Company has in place a number of preparedness and reaction plans for marine pollution incidents that may affect the cooling water pools of coastal power plants. In addition, preparedness and reaction plans are being drafted for open sea pollution and pollution incidents from the Company’s sources, such as marine fuel connectors. The Company carries out periodic internal response simulations in relation to the discharge of hazardous materials. As required by the Hazardous Materials Law and its regulations, plant guideline books have been prepared for each power plant. There is also in place an emergency operating plan for the natural gas system in the power stations. In addition, the Company has established a cooperation plan with the Ramat Hovav local and industrial council (located in close proximity to the site of the switching station and gas turbines at Ramat Hovav) in the event of poisonous gas release from the industrial area.

Insurance and Risk Management For further information relating to insurance and risk management, see in particular Note 23 of the Financial Statements.

Introduction The Company maintains property, casualty, construction, directors’ and officers’ liability and third party liability insurance against damages/losses to its business to the extent the Company considers appropriate. The main policies as hereinafter described are, subject to various customary limitations and deductibles. The State of Israel has established a State compensation fund to compensate individuals and companies for damages resulting from hostilities including acts of war and acts of terror, subject to the Tax Asset and Compensation Fund Law. Notwithstanding the foregoing, under certain circumstances in areas designated as confrontation zones, we may be able to file claims with the State of Israel for indirect losses. As required by the Electricity Sector Regulations, the Company is implementing a risk management program. Accordingly, it is the responsibility of every the Company division manager to prepare an annual program comprised of detailed activities together with an explicit timetable and necessary budget which needs to be approved in advance by the CFO and VP for Generation and Transmission. This annual program is reviewed semi-annually and adjusted if required. The risk management program includes the identification, assessment, ranking and implementing activities aimed at minimizing risks.

Major Insurable Exposures The following exposures are insured: • Physical damage to property. • Business interruption and additional fuel expenditures. • Natural perils. • Legal liabilities.

Steps taken to prevent damage or losses The Company undertakes and maintains the following policies in order to minimize the risks to which it is exposed: • There is in place an operational and maintenance policy relating to the loading and shutting down of the units. • All generation, transmission and distribution functions are carried out by experienced workers who have the necessary qualiﬁcations for their jobs.

61 • Planning is undertaken in accordance with international or local standards. • Maintenance operations are based on preventative measures aimed at minimizing breakdown maintenance and are carried out at periods of low demand to ensure there is no interruption to supply. • Purchases are regulated by Israeli legislation and the Company’s internal guidelines aiming at achieving the best value under high quality controls of both purchases and sellers. • Periodic inspections of equipment and accessories are carried out in order to assess their technical condition for ongoing proper operation and maintenance in accordance with all applicable manufacturer instructions and applicable laws and regulations. • Emergency exercises are carried out. • Sufficient inventories of spare parts are maintained. • Adequate insurance policies are maintained: • All Risks policy covering the Company’s properties (excluding the grid) and generation assets together with business interruption and additional fuel expenditures. The sum insured is U.S.$1 billion. • General Liability policy covering the Company’s general liability to third parties including products, professional, employers and accidental pollution liabilities. The sum insured is U.S.$100 million • All Risks policy covering the construction of Power Projects. The sum insured is the full value of the projects. • D&O policy covering the legal liability of the Company’s Directors and Officers. The sum insured is U.S.$300 million. • Company’s vehicle fleet insurance policies and other policies as required.

Properties For further information relating to the Company’s properties including Asset Acquisition, see in particular Notes 1(a)6, 11, 13 and 21(b)(4) of the Financial Statements and ‘‘Risk Factors.’’ In addition to its generating plants, the Company occupies properties throughout the State of Israel, including sub-stations, transmission, distribution, storage and port facilities, ofﬁce buildings and warehouses. Except as discussed below, these properties are owned by the Company or occupied by the Company under long-term lease agreements (primarily with two governmental authorities and certain private property owners), under short term lease agreement or under rights of possession granted to the Company by the owners of the properties. Most of the facilities owned and used by the Company in its transmission and distribution system are situated on land owned by parties other than the Company in accordance with relevant laws. The Company receives rights of use and access from the owners of the land on which the facilities are situated, either pursuant to contract or following a procedure prescribed by law. Certain real property used by the Company is leased from governmental agencies and authorities pursuant to lease agreements that expired at the end of the Concessions. These lease agreements will be subject to discussions with the governmental agencies and authorities. With regard to the Company’s Reading power station, one part of the land on which the power station is situated is owned by the Company and another part is the subject of a lease from a governmental authority, which expired upon the expiration of the Concessions or any extension or renewal thereof. The remaining part of the land is owned by a governmental authority and possessed by the Company, but the Company has no formal registered ownership or leasehold therein. In addition, pursuant to the Tel Aviv Power Station (Repeal) Law 1994, the National Planning Commission (which has authority for national planning and zoning matters) is entitled to determine a timetable for the ultimate closing of the Reading power station. Notwithstanding the foregoing, in July 1996, the National Planning Commission issued instructions for the preparation of a town plan intended to permit the continuing operation of the power station.

62 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 the right to use certain land within the grounds of the Hadera power station to establish a sea water desalination plant from December 10, 2007 for a period of 24 years and 11 months. In return for granting this right of use, the Company would be entitled to a one time payment of NIS 7.5 million, to cover the costs of removing structures on the land and moving them elsewhere on the power station grounds, and NIS 1,140,000 per annum (linked to the consumer price index). 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 100 million cubic meters of water each year). The Company would also be entitled to payment for other services provided by it to the operator. In 2007, the Company was entitled to a one off payment of NIS 762,000 for coordination, planning and supervision activities. A substantial portion of the real estate in which the Company has rights is not registered in the Israeli Land Registry and the status of such properties has not been settled for various technical reasons, such as the absence of parcelization in a portion of those areas, the requirements of planning authorities to assemble master plans, and disputes with the various authorities, including the tax authorities, which prevent the procurement of the receipt of authorizations for registration in the Land Registry. Due to the complexity of the matter, it is not possible to estimate the period of time required to conclude the registration of the land, but, in the Company’s opinion, the cost of registering the land, as aforesaid, is not liable to be substantial. All of the power stations and properties owned by the Company are subject to floating charges in favor of various debt holders and will be subject to a floating charge in favor of the Charge Agent on behalf of the Noteholders upon the issuance of the Notes. See ‘‘Description of the Notes—Ranking.’’ At December 31, 2007, the aggregate amount of the Company’s fixed assets, net was NIS 58,245 million and the aggregate amount of indebtedness secured by floating charges on the assets of the Company was NIS 24,353 million.

Relationship with the State and Regulators For a detailed discussion of this matter, see in particular Notes 1 and 3 of the Financial Statements. Pursuant to the Electricity Sector Law, the Minister has overall responsibility for the electricity sector of Israel, including responsibility for and overall supervision of the Company. In addition, under the provisions of the Government Companies Law, the Minister is responsible for the affairs of the Company, acting together with the Minister of Finance. The Ministers, after consultation with the Appointments Review Committee (a body established under the Government Companies Law), jointly appoint the Directors of the Company, and approve the appointments of the Chairman of the Board and the Chief Executive Ofﬁcer of the Company. The Electricity Authority is empowered under the Electricity Sector Law to issue licenses for all activities in the electricity sector. In order to take effect, licenses must be approved by the Minister. The Government’s power to supervise and control the Company is derived primarily from (a) the Electricity Sector Law, (b) the Government Companies Law, and (c) its power as the owner of approximately 99.85% of the shares of the Company. In addition, the Company is subject to all other laws of the State of Israel. For further information see ‘‘Regulation.’’

Development Strategy and Capital Investment Program

Introduction The Company’s long-term power development strategy seeks to achieve optimum stability and economic efﬁciency in electricity supply. The main objectives are to signiﬁcantly increase the current installed generating capacity by adding dual-purpose power units to all existing thermal power plants and adding further industrial gas turbine units. The Company is in the process of building additional gas turbines and has plans to build two additional thermal power stations of 1260 MW (project D), which will consume coal. The Company’s power development strategy further provides for expansion and improvements to the distribution and transmission system.

63 The Company’s capital investment program is based on the Company’s assumptions of 4.2% average annual growth in electric power demand and, therefore, is subject to change depending on actual growth of demand and other factors. In light of the projected increase in demand for electricity, the capital investment program contemplates considerable expansion of the Company’s generating capacity. The following information includes forward-looking statements that reflect the Company’s expectations and projections. See ‘‘Forward-Looking Statements’’. The main assumptions and constraints underlying the development plan are the following: Forecast demand for electricity for the years 2007-2012 indicates an average annual growth rate of 3.4% in generating, and 4.2% for peak demand in the base scenario, and about 4.5% in generating and 5.2% for peak demand in the economic accelerated scenario. The demand forecast is based on the long term forecast for electricity consumption prepared by the Company after extensive work with external consultants. Changes in consumption are influenced by three main factors: economy, demography and climate (the ‘‘influential factors’’). The link between electricity consumption and the influential factors is expressed with the help of econometric models. The Company tracks the development of demand and amends its forecast according to circumstances. However, the long-term forecast of demand is only amended in the case of a significant, continuing change in one of the influential factors mentioned above, and not on the basis of short term data. Forecast of gaps between peak demand and generating capacity for the years 2008-2010 (median scenario). The following table summarizes the available capacity of the Company’s generating units compared with the peak demand forecast for these years in MW(negative numbers in brackets).

Available Available capacity in reserve in summer, summer, Forecast Available Available assuming a assuming a peak Installed capacity in reserve in fault in a fault in a Year demand capacity summer summer large unit large unit 2008 ...... 10,300 11,364 10,877 577 10,302 2 2009 ...... 10,800 11,733 11,022 222 10,447 (353) 2010 ...... 11,300 12,348 11,001 (299) 10,426 (874)

Assumptions used in preparing the table The Company’s forecast of demand for electricity was prepared on the following assumptions: • Annual average growth of 2.3% in GDP per head compared with 2005 for the years 2007-2030. • The forecast for installed capacity is based on the expected start of operation of new generating units according to the Company’s development plan, closure of old generating units, and improvement of units in order to implement environmental projects. • Available capacity equals installed capacity less generating units that are not operating because of planned maintenance or renovations or capacity restrictions or various legal restrictions and limitations in the transmission grid. • Expected development of additional generating capacity.

64 The table below sets out the additional generation units that the Company plans to construct in the years 2008 to 2011.

Additional Installed capacity Number of Estimated Year (in MW) Type of units units Sites of Completion 135 Add-on Combined cycle 1 Alonn Tavor 2008 136 Add-on Combined cycle 1 Gezer B 2008 238 Combined cycle (GT) 1 Haifa 4 2009 377 Combined cycle 1 Haifa 3 2010 123 Add-on Combined cycle 1 Zafit 2011 139 Add-on Combined cycle 1 Haifa 4 2011 According to the development plan, the Company will complete the construction of new combined cycle units with a total capacity of 1,847 MW by 2011, which have been approved by the Ministry of National Infrastructures for the sites at Gezer, Zafit, Alon Tavor and two units in Haifa. These units are in various stages of planning and erection, and so far the gas turbines are ready at Alon Tavor, Gezer and Tsafit. Therefore 699MW out of the planned 1,847MW of combined cycle units are already installed. These units are in addition to the combined cycle units already operating in Eshkol, Hagit and Gezer. It should be noted that the capacities stated above are the capacities of the units when operating on natural gas, assuming that natural gas reaches all the electricity generating sites during the period mentioned above. The Company has warned the Ministry of National Infrastructures of the projected risk of power shortages during peak demand periods in the summer of 2009 and the certainty of a shortage in the summer of 2010. For that purpose the Company has prepared an emergency generation plan so as to allow a 240 megawatt increase in the Company’s generation capabilities by Summer 2009. Two open cycle gas turbines at the Ramat Hovav site (2x120 MW) were recently approved by the Minister of National Infrastructures for erection by the Company to commence operation during Summer 2009. The addition of this investment in light of the Company’s severe cash flow difficulties demands an additional influx of capital which may be burdensome to the Company. Therefore, the Company approached the Electricity Authority on March 9, 2008 requesting approval of the full coverage of the high costs involved in this project by a special tariff increase. These high costs may lead to risks which the Company may have been able to avoid if the project had not been designated an ‘emergency’ project in accordance with the outline set by the Minister of National Infrastructure. However, the Company is of the opinion that it has done all it could given its legal responsibilities and authority and according to its outlined development plans. The Company has also directed the attention of the proper authorities to the electricity shortage predicted for 2008 to 2010. Under these circumstances, the Company is of the opinion that neither it nor its directors and officers have significant exposure from the possibility of the future electric shortages. In addition, the Company has launched a media campaign to encourage the rational use of electricity. See also Note 1(d)8 of the Financial Statements regarding the Government decision concerning its policy of increasing generation capacity and reducing demand in the electricity market. In the years 2008 to 2012 the Company plans to add approximately 320 km of transmission circuit to the ultra high voltage (400 kw) 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 kw lines with those in neighboring countries, Egypt and Jordan. During the period 2008 to 2012 the Company is planning to add about 732 km of circuit to the high voltage (161 kw) transmission system. In addition, about 601 km of circuit will be upgraded/re-erected/ relocated. Another 30 km of underground cable circuits are also planned for these years. Employees Introduction As at December 31, 2007, the Company had 12,212 employees (including 9,841 permanent employees and 2,371 temporary employees) all of whom were employed within the State of Israel. Of the total

65 number of the Company’s permanent employees, 24% were administrative staff, 30% were engineers and technicians, 44% were field workers and 2% were senior staff. For further information see Note 21(c) to the Financial Statements. Reduction in Employee Numbers During 2007 the Company reduced the number of its employees by 464 (3.7%) compared with December 2006. The majority of these job reductions have centered on the project and development section. Such reductions in the number of the Company’s employees were achieved by natural retirement, non-renewal of temporary employment contracts and a recruitment freeze. In addition, during 2008 the Company will carry out an early retirement program for 300 permanent employees. Employment Agreements In addition to Israeli employment law, the Company’s relations with its employees are governed by certain general employment agreements and collective bargaining arrangements (the ‘‘Employment Agreements’’). The Employment Agreements regulate the following matters: • Wage and service conditions; • Entitlement to free electricity up to a certain amount / quantity; • Rest and employment hours including overtime and shifts; • Paid Absences; • Disciplinary and Dismissal Procedures; • Retirement Conditions. Changes and updates to the Employment Agreements are executed periodically, within the framework of a wage agreement and following negotiations between the Company’s management, the General Federation of Labor and the National Secretariat of the Company’s employees. Any renegotiation also requires the approval of the GCA and the Company’s Board of Directors. The current wage Agreement expired on December 31, 2005 and there is currently a dispute between the Company’s management, the General Federation of Labor, and the National Secretariat of the Corporation’s employees with regard to the terms of the new agreement. Furthermore, 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. Employee Relations The Company’s labor union, has recently been involved in a number of disputes with the Company principally concerning wage levels and the implementation of the structural reforms required by the Electricity Sector Law. As at the date of this Offering Circular, the union has undertaken certain industrial actions short of a strike (referred to as ‘‘Sanctions’’) against the Company including: • non-cooperation with the requirement under the Electricity Sector Law to prepare separate financial statements for each business activity of the Company; • non-cooperation with the implementation and operations of certain computer systems including those designed to allow the Company to prepare its financial statements in accordance with IFRS. Recently the National Labor Court rejected the Company’s appeal requiring the employees to cooperate in this regard; and • commencement of legal actions, declaration of disputes and notice of intention to strike all undertaken by the employees in accordance with the Settlement of Labor Disputes Law. • hold-up in construction designed to enable natural gas flow to the Gezer and Hagit power plants. For further information see 21 (c) of the Financial Statements.

66 On August 5, 2007, the managing director of the Ministry of National Infrastructures approached the Company with a request to team up employees into a composition of seven different work teams which are to deal with the subject of the restructuring so that the teams’ deliberations will be concluded by September 10, 2007. The workers’ association has instructed the Company’s employees not to cooperate on this issue. In view of employee sanctions taken to date, there has been no substantial progress in effecting the restructuring and the Company’s applications to the Regional and National Labor courts regarding various restructuring issues were unsuccessful. Accordingly, the Company is currently unable to move forward in the required preparations for the restructuring. For more information see Note 21.c of the Financial Statements. On October 7, 2007, a notice of a strike in accordance with the Labor Dispute Settlement Act was delivered. The Company believes that even in the event that these labor disputes are not resolved and strikes commence, the Company’s ﬁnancial position will not be adversely affected.

Training The Company has established numerous training programs designed to enhance the skills of its employees. Each employee spends on average 4% of their working days each year in training.

Regulation The electricity sector in Israel almost entirely consists of the activities of the Company which acts as a virtual monopoly in all sections of the sector (including electricity supply, electricity generation and the sale, transmission and distribution of electricity and provision of back-up services for electricity consumers and manufacturers). The Company is therefore subject to extensive regulation and license requirements. The Government’s power to supervise and control the Company is derived primarily from (a) the Electricity Sector Law, (b) the Government Companies Law, and (c) its power as owner of approximately 99.85% of the shares of the Company. In addition, the Company is subject to all other laws of the State of Israel.

Licensing Requirements The Company is subject to the Electricity Sector Law. The purpose of the Electricity Sector Law is to regulate activity in the electricity sector for the beneﬁt of the public, while ensuring reliability, availability, quality and efﬁciency and facilitating competition and reducing costs. The latest substantial amendment to the Electricity Sector Law was published on March 1, 2007 (‘‘Amendment No. 5’’). Amendment No. 5 was introduced to regulate structural changes in the Electricity sector, including the Company’s future structure. For a further discussion of the Electricity Sector Law and the potential impact on the Company’s structure as a result of the implementation of the Electricity Sector Law and Amendment No. 5, see Note 1(a) to the Financial Statements. Under the Electricity Sector Law, the Minister has overall responsibility for the electricity sector of Israel, including responsibility for and overall supervision of the Company. The Electricity Authority is responsible under the Electricity Sector Law for granting licenses in respect of activities within the electricity Sector and the supervision thereof, setting the tariffs which the Company can charge and determining standards of service. In order to become effective, such licenses must be approved by the Minister. The Electricity Sector Law provides for a system of several types of licenses to be granted by the Electricity Authority, including, (i) a generation license, (ii) a transmission license, (iii) a supply license or distribution license, (iv) a supplier’s license for an ‘‘essential service’’, (v) a self-production license, (vi) a system management license, and (vii) ‘‘other license.’’ The Company has licenses for transmission, distribution and supply of electricity and trade in electricity, as well as separate generating licenses for the various production units. The Company is also subject to the provisions of the Electricity Sector Law that refer to an ‘‘essential service provider.’’

67 On November 1, 2007, new implementation orders came into force (‘‘Implementation Orders’’). The Implementation Orders extended the Company’s licenses, postponed certain milestones and timetables for the implementation of the Company’s structural reform and added interim milestones for the Company’s structural reform as follows: The Company’s generation license has been extended until July 1, 2008, by which time a number of subsidiaries are to be established to engage in the generation activities and the operation of the Company’s power stations. The effective date for the operations of the generation corporations has been postponed until July 1, 2009. The Company’s transmission license has been extended until July 1, 2008. By January 1, 2010, a transmission subsidiary is required to be incorporated to engage in the establishment and operation of the transmission system and will have a transmission license. The effective date for the operation of this transmission corporation remains December 31, 2010. The extension of the validity of the transmission license beyond July 1, 2008 is as follows: • From July 1, 2008 until September 1, 2008—if a corporation was established by the Implementation Orders, in a way that enables, starting from September 1, 2008, granting a system management license to that corporation in accordance with the Electricity Sector Law. • From September 2, 2008 until December 31, 2009—if a system management license was granted in accordance with the Electricity Sector Law. • From January 1, 2010 until December 31, 2010—if a corporation was established by the implementation order, in a way that enables, starting from December 31, 2010, granting a transmission license to that corporation in accordance with the Electricity Sector Law. The Implementation Orders stipulate that by July 1, 2008, a corporation responsible for the system management is required to be incorporated, which will be engaged in the activities required of the holder of the system management license. The effective date for the operation of the system management corporation has been postponed until March 1, 2009. The system management company will not be a subsidiary of the company, but shall be a Government Company outside to the Company’s corporate structure. The Company’s distribution license has been extended until July 1, 2009, by which time a number of distribution subsidiaries are required to be incorporated and will be engaged in distribution activities and operation of the Company’s distribution areas. The effective date for the operation of the distribution corporations remains January 1, 2010. The validity of the Company’s supply license has been extended until July 1, 2009, by which time all arrangements required for the grant of a supply license on the effective date is required to be completed. The Electricity Sector Law provides, among other things, that: • unless approved by the Minister, a license or part of it can not be transferred, pledged or attached directly or indirectly. • the Minister is allowed to determine in the license that certain assets, which belong to the license holder and are necessary in the opinion of the Minister to operate in accordance with the license, may not be transferred, pledged or attached, directly or indirectly unless approved by the Minister. The foregoing could have an adverse effect on the effectiveness of the protections available to the Noteholders. For further information including, milestones for implementation, see Note 1(a) to the Financial Statements and ‘‘Risk Factors.’’ Tariffs For further information relating to the tariffs, including details of fuel purchases and consumption as they affect the tariffs, see in particular Note 3 of the Financial Statements and ‘‘Risk Factors.’’

68 Since March 4, 1996, the Company has operated in accordance with the Electricity Sector Law, which replaced the Electricity Concession Ordinance. The Company operates as one combined and coordinated system to supply electricity to consumers, from the stage of electricity generation at the production sites, through its transmission and transforming, to distribution and supply to each consumer. In accordance with the provisions of the Electricity Sector Law, the Company has separate tariffs set by the Electricity Authority for the various activity segments and in addition the Electricity Authority sets the tariffs paid by the Company for electricity produced by IPPs. Most electricity consumers, however, pay a single weighted tariff for electricity that is relevant to the group of consumers to which he belongs, which covers all the segments of activity set by the Electricity Authority. The main provisions of the Electricity Sector Law on the subject of tariffs are as follows: • The Electricity Authority determines tariffs on the basis of recognized cost, taking into account among other things the type and standard of services, and including a fair rate of return on capital. • When setting tariffs, the Electricity Authority may ignore some or all of the costs that in its opinion are not necessary to enable the Company as an essential service provider to fulfill its obligations. • Every tariff will reflect the cost of the particular service price with no cross subsidizing, meaning no reduction in one service price at the cost of raising another service price. • The tariffs will be updated according to the formula set by the Electricity Authority. The updating formula will include necessary, recognized costs, a fair rate of return on capital and may also consider an efficiency factor. In the opinion of the Company, based on the opinion of its legal advisers, although as a rule the work of setting electricity rates will be done by the Electricity Authority, extreme situations are possible (such as during high inflation or when there is a fear it may break out) where the Ministers may intervene in setting rates, by virtue of the Supervision of Consumer Goods and Services Law, 1996. In a petition to the Supreme Court, the Company requested that the Electricity Authority be required to approve a rate that would maintain the Company’s financial strength and stability and to increase the tariffs in accordance with its financial statements in order to maintain the real CPI-adjusted value of its equity. On September 12, 2004, the Supreme Court rejected the Company’s petition and stated in its judgment that it is satisfied that the Electricity Authority has examined the Company’s requests and its decisions were within its authority and reason and consequently the court would not intervene in the Electricity Authority’s considerations. Additionally, in its judgment the court remarked that any consideration of the maintenance of the Company’s financial strength, although relevant for setting the electricity Tariffs, only reflects one aspect of the public good with which the Electricity Authority is charged according to the Electricity Sector Law. When exercising its powers according to 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.’’ On July 5, 2002, the electricity tariffs and criteria for the years 2002 through 2005 and the methods of updating these tariffs came into effect (the ‘‘tariff document’’). That decision stated that if by December 31, 2005 no new tariff bases for January 1 onwards have been decided, then the decisions of the Electricity Authority will be valid until such new tariff bases are defined. As at the date hereof, the Electricity Authority has not made any decision with respect to any new tariff bases. In its decision of August 8, 2007, the Electricity Authority indicated that it would publish its proposal for setting a tariff basis for the generating segment no later than January 1, 2008. In the notes to that decision, it added that it intended to determine tariff bases for the various segments during 2008 and/or even later in a graduated way. In its decision of December 26, 2007 the Electricity Authority postponed the publishing of this proposal to April 1, 2008. For further information, see Notes 3.a(6), 3.a(7) and 3.c to the Financial Statements.

69 Government Companies Law Since the State of Israel holds approximately 99.85% of the shares of the Company, the Company is a ‘‘Government Company’’ for the purposes of the Government Companies Law. The Government Companies Law provides that a Government Company is required to operate using the same business considerations as a non-Government Company unless the Government, with the approval of the Finance Committee of the Knesset, provides otherwise. Currently, the Company has not been required to operate on the basis of any considerations other than those which a non-Government Company would be subject to. As a Government Company, the Company is required to seek the approval of the Government in connection with various matters, including, changing the Company’s objects, increasing its authorized share capital, a reorganization of the Company, the granting of any right that could, directly or indirectly, restrict the Government (including in connection with carrying out structural changes, privatization or promoting competition). In addition, the Directors of the Company are appointed by Minister of Finance and the Minister of Infrastructures, and the Company’s Chief Executive Officer is appointed by the Board of Directors subject to the Minister of Infrastructures’ approval. For further information, see ‘‘Management —Board of Directors’’ and Note 1(c) to the Financial Statements. The Government Companies Law empowers the Government, with the approval of the Finance Committee of the Knesset, to exempt a Government company from all or some of the provisions of the Law for reasons of national security, foreign relations or international trade contacts. Environmental laws See ‘‘Environment’’ above for a further discussion on the environmental legislation with which the Company is required to comply. Declaration of the Company as a Monopoly by the Commissioner of Restrictive Trade Practices The Antitrust Commissioner has declared the Company to be the holder of a ‘‘monopoly’’ in the Electricity Sector, among other things, in the fields of supply (including electricity generation and its sale), transmission and distribution of electricity, and the provision of backup services to consumers and producers of electricity. The Restrictive Trade Practices Law grants the Commissioner of Restrictive Trade Practices, among other things, the right to review new standard-form contracts of a monopoly, to intervene regarding matters which are liable to injure the public, and to apply to the Restrictive Trade Practices Court, a body established under the Restrictive Trade Practices Law, for an order that the monopoly be dissolved by division into two or more separate business entities. In light of the existing degree of supervision by the Electricity Authority and other authorities to which the Company is subject and in view of the structural changes required pursuant to the provisions of the Electricity Sector Law, including the incorporation of the generation units in the framework of separate subsidiaries, the Company is unable to assess what would be the future implications of the aforesaid declaration on the Company’s operations, profitability and financial position, although it is possible that there will be material implications. Restructuring For a detailed discussion of the Electricity Sector Law and the changes planned both for the Company, in particular, and the electricity sector, in general, see in particular Note 1 of the Company’s Financial Statements. Since March 5, 1996, the electricity sector of the State of Israel has been regulated under the Electricity Sector Law. The purpose of the Electricity Sector Law is to regulate the activity of the electricity sector for the benefit of the public, while assuring reliability, availability, quality, efficiency, and creating the conditions for competition and minimizing costs. Under the Electricity Sector Law, the Electricity Authority grants licenses for all activities within the sector with the Minister’s approval. Pursuant to the amendments to the Electricity Sector Law, the Company should be divided into groups of subsidiaries, for generation, transmission, distribution and services. For the current validity of the Licenses see ‘‘Licensing Requirements’’ above.

70 On February 15, 2007, government officials issued the Policy Document, which contained their main recommendations for the implementation of the Company’s restructuring (for further information see Note 1(a) to the Financial Statements). Amendment no. 5, which is based among other things on the Policy Document and imposes limitations on the ability of a single entity to hold more than a certain share of any activity (generation and distribution), states that the system management activity (formerly an integral part of the Company’s structure) requires a license according to the Electricity Sector Law (the license will be for the supplier of an essential service as defined by the Electricity Sector Law). It also states that, subject to certain exceptions, no license is required to be granted under the Electricity Sector Law if after receiving such license the entity, excluding the State, will hold a license for system management or the means of control of the holder of the license for system management and will also hold a license for distribution, generation or supply, or will hold the means of control of the holder of such a license. Accordingly, the holder of the license for system management will be a separate company outside the Company’s corporate structure. Nevertheless, at this stage, the Company may continue its system management activity, and a license for the new corporation that will manage the system will be granted by March 1, 2009. If the Ministers realize that this is essential to further the aims of the Electricity Sector Law, the Ministers may, in consultation with the Electricity Authority and the GCA, issue an order to postpone certain of the dates set forth in the Electricity Sector Law, for a period of no more than six months. In the Implementation Orders the Ministers exercised such authority with respect to certain of such dates. For further information see ‘‘Licensing Requirements’’ above. In the Company’s opinion, implementation of the amendment to the Electricity Sector Law enables a transition according to a gradual timetable to a corporate structure in which the Company, as the parent, is a holding company which itself will have no licenses and will have the following subsidiaries: at least four companies with generating licenses, operating with a similar mix of fuels, each of which will have a license for 30% of the generating capacity in the economy, at most; at least four companies with distribution licenses, each of which will have a license for 25% of the distribution capacity in the economy, at most, and where the costs of the electrical facilities used by each of the companies will be as similar as possible; a company with the transmission license which in accordance with the Ministers decision by 2011 may remain within the Company; service company/companies. Under the Electricity Sector Law, after July 1, 2013, the parent company cannot hold more than 51% of the means of control of the generating or distribution companies. Until January 2012 with the approval of the Electricity Authority, and until January 2013 with the approval of the Ministers and subject to consultation with the GCA and Electricity Authority, supply can be undertaken either by generation companies or distribution companies. Thereafter, a supply license may only be granted to the holder of generation license. Pursuant to Amendment No. 7 to the Electricity Sector Law, a non-Government Company, or a subsidiary of such company, which holds a distribution license, can be granted a supply license until January 1, 2012. The Ministers, subject to consultation with the Electricity Authority, may issue an order granting a supply license until January 1, 2013. The Ministers, if satisfied that it is necessary for the promotion of the purposes of the Electricity Sector Law, and after consultation with the Electricity Authority, may also issue an order postponing the abovementioned date in a period not longer than six months. From January 1, 2009, a Government Company or subsidiary holding the means of control over a license holder will not be permitted to engage in constructing power stations, logistics, information technology or purchasing any type of fuel. Furthermore, in accordance with the Electricity Sector Law a Government Company or subsidiary holding a license will not engage in such activities on behalf of another company that holds a license. However, if companies that are permitted to engage in these activities have been established, the Ministers may determine that the Company can continue to engage in these activities until January 1, 2010. On February 22, 2007, the Company resolved to set up an internal administration for the Company (‘‘the headquarters’’) in order to implement the restructuring. According to that decision, the Company has submitted a detailed plan for setting up the headquarters for implementing the restructuring to the Board’s Regulatory Committee and the plan was approved. The headquarters have not yet been established or operated due to employee sanctions. See Note 21.c of the Financial Statements.

71 The Company believes that the time schedules stipulated in the Electricity Sector Law and in the Decrees are too tight and there is doubt as to the Company’s ability to perform all the changes required under the schedules established in the Law as amended. The Company is negotiating to the extent possible with the relevant entities in the State, the workers’ association and the New General Workers Union (‘‘Histadrut’’) in order to reach an agreement, inter alia, with the Company’s employees. For progress on the implementation of the restructuring of the electricity sector and for the opinion of the Company regarding this matter and the consequences thereof, see Note 1.a.4 of the Financial Statements.

Information Technology The Company relies on a variety of information technology systems in its operations and its success is largely dependent on the accuracy and proper use of these systems. In connection with managing its growth, the Company continually evaluates the adequacy of its systems and procedures, and anticipates that it will regularly need to make capital expenditures to update and modify its management information systems, including software and hardware, as the Company grows and the needs of its business change. The Company recently migrated a portion of its system into the SAP system. The Company may encounter issues with data integrity that could impact its ability to process orders, procure product and properly record transactions. The occurrence of a signiﬁcant system failure, electrical or telecommunications outages or the failure to expand or successfully implement or integrate new systems, could have a material adverse effect on the Company’s results of operations.

Legal Proceedings For further information relating to legal proceedings pending against the Company, see Note 21, particularly Note 21(b)1, 2 and 5, of the Financial Statements. The Company is involved in various legal proceedings and is subject to various pending claims in the ordinary course of its business including those described below. The Company is of the opinion, based on the opinion of its legal and professional advisors with respect to these claims, that ultimately, such claims and proceedings will not materially affect the ﬁnancial position of the Company.

Interest on Delinquent Bills On June 4, 2003, a claim was filed against the Company in connection with the Company’s demand for payment of interest in respect of delinquent electricity bills. A request has been made that the claim should be recognized as a class action (i.e. a claim under which every individual affected by the subject matter of the claim may apply to receive compensation thereunder). The amount of the ‘‘group’’ claim was estimated by the claimants to be approximately NIS 150 million. The Company is of the opinion, based on the opinion of its attorneys, that the chances to repulse the request for approval as a class action and the claim are reasonable. On November 21, 2007, the court gave its decision that the attorneys for the plaintiff had to submit an affidavit in which they revealed with due propriety, all the material details relating to the plaintiff’s request to withdraw the claim as required by the Class Actions Law, 5766—2006 (‘‘Class Actions Law’’). As the above affidavit was not submitted as stated above, on the December 2, 2007, the court decided that the attorneys for the plaintiff had to urgently notify the court how he was acting in light of the court’s earlier decision. On March 3, 2008, the court rendered its decision in the case of striking the motion in view of the plaintiffs’ failure to meet the requirements of the Class Actions Law pertaining to the terms required for their withdrawal from the lawsuit at this hearing stage, thereby bringing the proceedings in this case to a close.

Surcharge to the Electricity Rate A claim has been ﬁled against the Company in connection with the collection by the Company of a special surcharge to the electricity rate. The claimant claims, amongst other things, that the special

72 pension surcharge is a ‘‘hidden tax’’ that is being unlawfully collected, and that the Company must return it, together with interest and linkage, in the amount of approximately NIS 2,847 million in values of the date on which the claim was ﬁled, pursuant to the statement of claim and in the event the claim is recognized as a class action. The Company had collected a total of NIS 8,831 million in respect of the special surcharge. The claimant has sought to have the claim recognized as a class action. The Company is of the opinion, based on the advice of its legal counsel, that it has good arguments against the claim being approved as a class action. However, the Class Actions Law is a relatively new law that has not yet received interpretation, in this context, by the courts and, accordingly, the likelihood that the class action application will be approved cannot be assessed at this stage, in whole or in part. The Company’s legal advisors are therefore unable to estimate the impact of said claim on the proceedings discussed above or the Company’s chances to prevail during the hearing on the class action. On December 10, 2007, the Company received another new claim accompanied by a request to acknowledge the class action. This relates to a claim brought against a number of electronic companies and the Company to the effect that the electronic companies operated as a cartel in the sale of equipment used for the production of electricity—at prices which were 20% higher than a competitive price and by imposing a burden on the Company’s customers in circumstances in which the Company was aware of the existence of the cartel and cooperated with the cartel. The amount of the personal claim is NIS 1,403. The amount of the class action is NIS 3,156,750,000.

Claims for Payment of Municipal Taxes from the Municipality of Yavne The municipality of Yavne has made several claims demanding the payment of general property tax for 2000 for a total amount of NIS 32 million in respect of land which is located under high voltage and major power lines and is alleged to be occupied by the Company as a result. In 2001 and 2002, the municipality of Yavne sent several further demands for an additional amount of approximately NIS 74 million in relation to the same claim. The Company disputes these demands. The dispute is, in principle, signiﬁcant, and likely to impact on the manner in which the Company is charged general property tax by all local authorities, since the line infrastructure for transmitting electricity is located all across the State of Israel, should the claim succeed. On October 12, 2003, the position of the Attorney General, which supports the position of the Company, was furnished to the Company, according to which the electric lines, land beneath them and around them are exempt from the payment of general property tax. The Company is of the opinion, based on an opinion of its legal advisors and based on the position of the Attorney General, that its claims are grounded from a legal and factual perspective and that its chances for succeeding in the claim are reasonable.

Kishon River In May 2004, in the framework of a claim against Haifa Chemicals Ltd., Oil Refineries Ltd., the Association of Municipalities (Haifa region—Sewage) and the municipality of Haifa that was filed by soldiers of the IDF or their estates (95 claimants) regarding cancer and other diseases caused to them, they alleged, as a result of exposure to the water of the Kishon river, Haifa port, Shemen coast and the surrounding waters during their military service, a third party notice was filed against the Company. It is alleged that the Company’s power station in Haifa contributed to the pollution of the Kishon’s waters. The claimants allege that they have contracted cancer and other diseases and some of them have now died. The claimants have produced certain scientific evidence as to the pollution contained in the Kishon waters. The claim was filed against four defendants: one of the claimants, Haifa Chemicals Ltd., sent a third party notice against numerous additional defendants (22 third parties, including the Company, Frutarom Ltd., Gadot Petrochemical Industries Ltd., Gadot Biochemical Industries Ltd., Gadot Chemical Containers and Reservoirs Ltd., Fertilizers and Chemical Materials Ltd., Carmel Olefins Ltd. and others), and part of them have sent additional fourth party notices. The list is still not final since each party receiving a notice is entitled to file notices to additional parties on his behalf and, thereby, to increase the number of defendants. About a third of all of the claimants are estates and/or dependents of soldiers who

73 have died from different diseases that are alleged to have been caused by the hazardous materials in the Kishon river’s waters. It should be noted that in light of a recent ruling of the Supreme Court, an estate is eligible for compensation for the loss of earnings for the lost years. There is still not a uniform ruling that implements this law; however, it appears that it is already possible to estimate that the amounts of the compensation for each estate are liable to increase by tens of millions and perhaps hundreds of millions of shekels, each matter speciﬁcally and according to its circumstances. It is not possible to estimate at this initial stage the damage caused to each claimant. In the assessment of the Company’s attorneys, the aggregate amount for the claim is in the range of between NIS 650 million and NIS 800 million, including legal fees and court expenses. The Company’s attorneys point out in their opinion that the reference is only to a general estimate, based on the assumptions that they assume in the absence of data at this stage, that are liable to turn out to be erroneous when the real data are obtained. The Company rejects the above claims and, based on the opinion of its attorneys, it believes that the Company’s claims present it with a good defence against such claims, although this view may change as the case progresses.

Other Contingent Claims The Company has held discussions with the Israel Lands Administration (commencing in July 2000) with respect to potential lease fees for certain real estate properties at the Reading power plant site which it uses. To date, no request has been received by the Company for fees in respect of the use of these properties. The Company has not paid any fees in respect of the use of these properties for at least 20 years. The Company is unable to estimate if it will be required to pay user’s fees in respect of its past use of the land, and in case it is so requested, it cannot estimate what the amount will be. In addition, the Company is unable to estimate the amount which may be payable as lease fees for the future use of the land, and if, payable, whether they will be paid as capitalized lease fees or as current lease fees. The Company has not recorded any provisions in the ﬁnancial statements with respect to the claims described above.

Claims for Payment of Municipal Taxes The Company has received demands for property tax for periods prior to December 31, 2006 in amounts exceeding by about NIS 909 million the provision that was recorded for them in the annual ﬁnancial statements. These additional demands derive from the changes in classiﬁcation and the increase in the areas being billed. In the Company’s assessment, it will not ultimately be required to pay these amounts.

Claims under the Planning and Building Law The Planning and Building Law prescribes that the holders of rights in land who were adversely affected by a zoning plan, are entitled to indemnification from the local planning committees in whose boundaries this zoning plan applies. In order to set up 400 KW lines, zoning plans are required. Lately, the Ministry of the Interior has adopted a position whereby in order to erect 161 KW lines a detailed outline plan must be prepared. The Company opposes this position because it is not compatible with the provisions of the applicable law. This issue was brought up for discussion with the Assistant Attorney General, who accepted the Company’s position and determined that the authorization process provided for in the law is the process suitable for approving 161 KW lines subject to ‘‘improvement of the authorization process.’’ The Company undertook to indemnify the local committees in whose boundaries these zoning plans apply for the full amounts that the committees will be obliged to pay to the landowners who will be adversely affected, as stated above (aside from one plan, regarding which the indemnification burden shall be divided among the institutional bodies that are involved in the plan). These undertakings to indemnify were delivered after it was made clear to the Company that not delivering them will result in the non-approval of the plans or their suspension. Claims are pending against several local committees in an amount of about NIS522 million in excess of the provisions that were recorded in the Company’s financial statements. In the Company’s opinion, based on the opinion of its attorneys, which takes into consideration the opinion of the real estate actuary advising the Company with regard to the above claims,

74 if all of its arguments shall be rejected and the Company shall be forced to pay cash in respect to these claims, then the Company’s exposure with respect to these claims shall not exceed the provision that was recorded in the ﬁnancial statements. The Company is of the opinion that, if any amounts are payable by the Company, they will be attributable to the cost of erecting the relevant transmission lines. Should the Company be liable to pay any such amounts, it intends to apply to the Electricity Authority to recognize the payment of such amounts in setting the tariffs.

75 GLOSSARY Agorot. 1/100 of one NIS. Availability. Availability represents the amount of time electricity was able to be generated at full capacity, expressed as a percentage of the entire period indicated. Available capacity. Available capacity represents the combined peak output level that was actually available in any given period. Available reserve. Available reserve represents the surplus (or deﬁcit) of available capacity at the time of peak demand over peak demand during any given period. Capacity. Capacity represents the maximum rate at which a power plant can generate electric energy. Capacity typically is measured in either watts (W), kilowatts (KW), megawatts (MW) or gigawatts (GW). Capacity factor. Capacity factor represents the total number of KWh of electricity generated during a period, expressed as a percentage of the total number of KWh that would have been generated assuming continuous operation at installed capacity. Distribution. Distribution refers to the system that delivers electricity from a sub-station to customer premises at voltages of 33 KV or less. Diesel oil. Diesel oil means Petroleum Distillate No. 2. Generation. Electricity is produced in generating stations where a propulsion unit (e.g., a thermal or internal combustion unit) turns a large electric generator that produces electricity. A generating station may consist of several independent generating units. GCA. Government Companies Authority. GW. GW represents gigawatts, a unit for measuring the capacity to produce electricity. One gigawatt equals one billion watts. GWh. GWh represents gigawatt hours, a unit for measuring the generation of electricity. Installed capacity. Installed capacity represents the level of output that may be sustained continuously without signiﬁcant risk of damage to plant and equipment. Installed reserve factor. Installed reserve factor represents the total installed capacity at the time of peak demand divided by peak demand during any given period. Internal use. Internal use represents electricity consumed by generating units in the course of generation. KV. KV represents kilovolts, a unit for measuring voltage or electrical tension. One kilovolt equals 1,000 volts. KW. KW represents kilowatts, a unit for measuring the capacity to produce electricity. One kilowatt equals 1,000 watts. KWh. KWh represents kilowatt hours, a unit for measuring the generation of electricity. Load factor. Load factor represents total generation of electricity in MWh divided by the product of peak demand and the total number of hours in any given period. Ministers. Minister of National Infrastructures and Minister of Finance. MVA. MVA represents megavolt amperes, a unit for measuring the capacity to transmit electricity. MW. MW represents megawatts, a unit for measuring the capacity to produce electricity. One megawatt equals one million watts. MWh. MWh represents megawatt hours, a unit for measuring the generation of electricity. Peak demand. Peak demand represents the highest level of demand for electricity in any given period.

76 Power station. A particular building or complex of buildings containing one or more power generating units.

Sub-station. A sub-station is an assembly of equipment through which electricity is passed in order to convert it to a lower voltage that is generally suitable for use by end-users.

Transmission. Transmission refers to the part of the electric power system that carries electricity from power stations to distribution networks at voltages between 380 KV and 44 KV.

Unit. Each of the independent generating units at a power station.

77 MANAGEMENT

Board of Directors In accordance with the Company’s Articles of Association, the Board of Directors consists of not fewer than seven and not more than 21 members (currently, there are 16 members). Directors are appointed for three-year terms by the Minister of Infrastructures and the Minister of Finance after consultation with the Appointments Review Committee, the members of which are appointed by the Minister of Finance. Directors may be reappointed. The Company is also required by law to appoint two external directors. External directors are nominated by the Ministers after consultation with the Appointments Review Committee and appointed for three-year terms by the General Assembly. The references below to the date on which a director of the Company began to serve are to the month and year of the ﬁrst term for which the director was appointed. Breaks in service often occur between the completion of one term and the date of reappointment. The Board of Directors currently consists of the following persons:

Name Age Mordechai Friedman (Chairman) ...... 56 Michael Lazer ...... 63 Shlomit Barnea Farago ...... 50 Pnina Dvorin ...... 62 Dov Oren ...... 60 Yaffa Vigodsky ...... 62 Aura Sova-Gindin...... 56 Asaad Joubran ...... 30 Yossi Vadana ...... 52 Blanche Kay ...... 72 Raphael Edery ...... 71 Amit Lang ...... 48 Philip Mandelker ...... 61 Izhak Elyashive ...... 63 Shulamit Eshbol ...... 44 Stella Handler1 ...... 47

1 On December 6, 2007, Ms. Stella Handler was nominated as the Company’s director by the State of Israel. Her nomination is currently under review; consideration is being given to whether her appointment to the Board of Directors will inﬂuence the objectivity of the Company’s external auditors. Ms. Handler has not yet participated in any meetings of the Company’s Board of Directors or any committees of the Board of Directors and will not participate in any such meetings until the review process has been completed. On January 7, 2007, Dr. Orna Deutsch ended her term of ofﬁce as an external director of the Company. On November 22, 2007, Mr. Gavis announced his retirement from the position of external director. Following his departure, no external directors were serving in the Company. The Ministers have not yet proposed two external directors, in spite of the Company’s inquiries to the Minister and the Government Companies Authority. Until such external directors are appointed, the Audit Committee is prevented from approving transactions with interested parties. Mordechai Friedman has been the Chairman of the Board of Directors since February 2007. Mr. Friedman holds the following degrees: a B.A. in Economics & Accounting from Tel Aviv University

78 (1974-1977) Certified Public Accounting, Institute of CPA in Israel (1979); Certified Systems Analyst, Division of Continuing Education & Extended Studies, Technion—Israel Institute of Technology (1981-1982); Computerized Systems Auditor, National Institute of Labor Productivity (1983). Mr. Friedman was the Deputy Chairman and CEO (2005-2007), Partner and Manager (2003-2005) of Deloitte, Brightman, Almagor, Consulting & Advisory Services Group; Head of Audit and Accounting Practice, Deloitte, Brightman, Almagor (2001-2003); Head of Audit and Accounting Practice, Brightman, Bar-Levav, Friedman, Deloitte Member Firm in Israel (1997-1998); Founder and Managing Partner, Accounting Offices of Friedman, Shapira, Goldstein and Co. (1979-1997). Mr. Friedman was also a member of the Board of the Israeli Securities Authority (1983-1995), a former member of the Antitrust Tribunal and an Observer in the Accounting Standards Institute (as of 1997). Mr. Friedman is a Major in the Reserves. Mr. Friedman is also a member of every committee of the Company’s Board of Directors, except for the Audit Committee, and he currently serves as Chairman of the Environmental Protection Committee, the Planning, Budgeting and IT Committee and the Regulatory Committee. Michael Lazer has been a director of the Company since December 2001. Mr. Lazar was reappointed on 2004 and reappointed again on December 26, 2007. Mr. Lazar graduated from the Hebrew University’s Tel-Aviv Branch (accounting). Mr. Lazar engaged in the practice of accounting since 1972, principally in the areas of taxation, and is consulting to entrepreneurs in Israel and abroad. He serves on the board of directors of Granite Hacarmel Investments Ltd., Sonol Ltd., Supergas Ltd., and Modgal Ltd. Mr. Lazer is a member of the following committees of the Company’s Board of Directors: Properties and Construction Committee; Supreme Tender Committee; Insurance, Auditors and Legal Counsel Committee; Organization, Human Resources and Procedure Committee; Audit Committee; and Corporate Governance and Ethical Code Committee. He also serves as Chairman of the Board of Directors’ Finance, Balance Sheet and Investment & Risk Management Committee. Shlomit Barnea Farago has been a director of the Company since May 2002 and was reappointed on April 14, 2005 and again on April 14, 2008. Mrs. Barnea Farago has practiced law for 19 years. During the first 13 years she practiced law in the private sector and dealt mainly with commercial law and real estate. During the past five years Mrs. Barnea Farago held the position as legal counsel to the Israeli Prime Minister’s office. In addition, Mrs. Barnea Farago lectures in various topics of the labor law and administrative law, and published several articles on these topics. Ms. Barnea Farago is a member of the following committees of the Company’s Board of Directors: Supreme Tender Committee; Planning, Budgeting and IT Committee; Regulatory Committee; Organisation, Human Resources and Procedure Committee; Finance, Balance Sheet and Investment & Risk Management Committee; Committee for Promotion of Women within the Corporation; and Corporate Governance and Ethical Code Committee. She also serves as Chairwoman of the Board of Directors’ Audit Committee. Pnina Dvorin was appointed a director of the Company in January 2006. Ms. Dvorin holds LLM in Law and practiced law in her own independent firm. Ms. Dvorin has 20 years of experience in the Tel Aviv District Attorney’s office. Today, she serves on the board of directors of the following entities: Bank Hapoalim B.M., Wizcom Technologies Ltd., Saniv paper industry Ltd., Edmond De Rothschild—Trust Funds Management Ltd., Aspen Properties (1990) Ltd. Ms. Dvorin is a member of the following committees of the Company’s Board of Directors: Marketing Communications and Customer Relations Committee; Planning, Budgeting and IT Committee; Audit Committee; Investment and Risk Management Committee; Supreme Tender Committee; Properties and Construction Committee. She also serves as Chairwomen of the Board of Directors’ Organisation, Human Resources and Procedure Committee and Insurance, Auditors and Legal Counsel Committee. Dov Oren is an employee of the Company. Mr. Oren was appointed as director of the Company on behalf of the Company’s employees; he has served as a director since August 2006. He holds a B.A and M.A. degrees in Public Administration. His current position with the Company is Assistant Manager of Maintenance department network at the southern district.

79 Mr. Oren is a member of the following committees of the Company’s Board of Directors: Organisation, Human Resources and Procedure Committee; Planning, Budgeting and IT Committee; Properties and Construction Committee; Committee for Arab Sector Issues; Regulatory Committee; Finance, Balance Sheet and Investment & Risk Management Committee; Issues Environmental Protection Committee; Balance Sheet and Investment & Risk Management Committee; Insurance, Auditors and Legal Counsel Committee; and Regulatory Committee. Yaffa Vigodsky has been a director of the Company since February 2007. Mrs. Vigodsky holds an M.A. in educational management. From 1985 to 1995, she was vice-general manager in the administration institute. Between 1995 and 2003, Ms. Vigodsky served as the head of Scientific & Technical Administration in the Ministry of Education, leading the national computerizing program. Since 2003, Mrs. Vigodsky is the director general of the Israeli Educational Television. Mrs. Vigodsky is a Member of The National Technology Committee. Mrs. Vigodsky serves also as a director in the following boards: AMAL, network of science and technology school, Bet Tzvi, the school of acting, children and youth theatre, ILA—Israeli Association for science and technology. Ms. Vigodsky serves on the following committees of the Company’s Board of Directors: Supreme Tender Committee; Marketing Communications and Customer Relations Committee; Audit Committee; and Planning, Budgeting and IT Committee. Aura Sova-Gindin has been a director since January 2004 and was reappointed in February 2007. She has been in Government service since 1976. From 1988 to 1997, Ms. Sova-Gindin has been in charge of the Government’s contracts and project management, and served in the Government’s Ministry of Housing & Construction. Since 1997, she has been Senior Deputy Director General for Administration & Manpower with the Ministry of National Infrastructures. Since 2003, Ms. Sova-Gindin has served as a Member of the Government’s Civil Service Discipline Court. Ms. Sova-Gindin serves on the following committees of the Company’s Board of Directors: Organisation, Human Resources and Procedure Committee; Marketing Communications and Customer Relations Committee; Environmental Protection Committee; Committee for Arab Sector Issues; and Committee for Promotion of Women within the Corporation. Asaad Joubran has been a director since March 2004 and was reappointed in March 2007. Mr. Joubran practices law in E.S. Shimron, I. Molho, Persky & Co. Law Offices in Tel Aviv. Mr. Jourbran is a member of the following committees of the Company’s Board of Directors: Environmental Protection Committee; Insurance, Auditors and Legal Counsel Committee; Organisation, Human Resources and Procedure Committee; Audit Committee; and Regulatory Committee. He also serves as Chairman of the Supreme Tender Committee and the Committee for Arab Sector Issues. Yossi Vadana has been a director of the Company since August 2006. Mr. Vadana is a marketing communications expert and specializes in strategy consulting and marketing research. Mr. Vadana holds a B.A. in statistics and he is the general manager of Shavakim—Panorama since 1984. Mr. Vadana is Chairman of Marketing Communications and Customer Relations Committee of the Company’s Board of Directors and is also a member of the Board of Directors’ Planning, Budgeting and IT Committee, Regulatory Committee and Audit Committee. Blanche Kay has been a director of the Company since July 2007. She is a retired judge of the Magistrate’s Court in Tel-Aviv. Ms. Kay was the founder and first president of the Israel—Jordan Chamber of Commerce. Ms. Kay was a member of the board of Bezeq (2000-2007) and has been a member of the board of directors for Optima from the Hachsharat Hayishuv Group since 2002. Ms. Kay served as the head of an Appeal Tribunal in the District Court of Tel-Aviv and was a member of the Governmental Committee for the Allocation of Endowments to the State of Israel. Ms. Kay is a member of the following committees of the Company’s Board of Directors: Supreme Tender Committee; Properties and Construction Committee; Insurance, Auditors and Legal Counsel Committee; Organisation, Human Resources and Procedure Committee; Finance, Balance Sheet and Investment & Risk Management Committee; Regulatory Committee; Corporate Governance and Ethical Code Committee; and Audit Committee.

80 Raphael Edery has been a director of the Company since July 2007. He is the former Director- General and Chairman of the Workers Housing Corporation & ‘‘Shikoun Ovdim’’ Housing & building Company (since 1977). From 1981-1999, Mr. Edery held different positions at the Israeli Parliament—The Knesset as a: Member of Economic Affairs Committee; Chairman of the Alignment Party, Party Whip Chairman of the Coalition—Minister without Portfolio; Minister of the Environment, Member of Finance Committee; Economic Affairs Committee, Deputy Speaker. Currently, he is the Chairman of the board of R.E.G.L. Investments and Development Company since 1999. Mr. Edery is a member of the Balance Sheet and Investment & Risk Management Committee of the Company’s Board of Directors. Amit Lang has been a director of the company since December 2007. Mr. Lang holds the following degrees: B.A. in Economics and Management from the Academic College of Tel-Aviv (1996-1999), M.B.A. in finance and accounting from the College of Management (2002-2004) and M.A. in Public Policy from the Tel-Aviv University (2002-2004). Mr. Lang currently holds the position of Deputy for The Director of Budgets in the Ministry of Finance, in charge of transportation, local government, tourism and environmental issues. Mr. Lang is a member of the Planning, Budgeting and IT Committee of the Company’s Board of Directors. Philip Mandelker has been a director of the company since February 2008. Mr. Mandelker is Executive Vice President, Secretary and a Director of Zion Oil & Gas, Inc. an oil and gas exploration company listed on the American Stock Exchange. From 2003-2007, Mr. Mandelker was Of Counsel to Adam Law Offices and, from 2000-2003, Of Counsel to I. Amihud Ben-Porath, Hamou Law Offices, both in Tel Aviv. Between 1997 and 2000, Mr. Mandelker was Chief Legal Adviser of United Mizrahi Bank Ltd. (now Mizrahi-Tefahot Bank). Between 1971 to 1974 and 1981 to 1993, Mr. Mandelker practiced law in New York, where he specialized in antitrust, energy and international transactional and litigation law. Between 1974 and 1980 and 1993and 1996, Mr. Mandelker practiced law in Jerusalem and Tel Aviv in both private practice and government service (Ministry of Finance and Military Government). Mr Mandelker holds a J.D. degree (1971, cum laude) from Columbia University School of Law and a B.A. (English and Comparative Literature, 1968, cum Laude) from Columbia College. He is a member of the Israeli Chamber of Advocates, where he currently serves as Deputy Chairman of the Committee on the Environment, and the Bar of the State of New York. Mr. Mandelker is a member of the following committees of the Company’s Board of Directors: Corporate Governance and Ethical Code Committee; Regulatory Committee; Environmental Protection Committee; and Finance, Balance Sheet and Investment & Risk Management Committee. Izhak Elyashive has been a director of the Company since January 2008. Mr. Elyashive holds a B.A. in political science and labor relations from Tel Aviv University. In 1973, he was elected to be the mayor of Azor, a position he held for 15 years. In 1975, Mr. Elyashiv became a member of the management of the Organisation of the local authorities in Israel, in which capacity he acted as the vice chairman of the Organisation. From 1989 to 1992, he served as the chairman of the board of the Israel Postal Authority. From 1992 to 2007, Mr. Elyashiv has been the general manager of the K.K.L. (Jewish National Fund). In 1995, he was appointed to be the chairman of the board of the Israel Building Center. Mr. Elyashive is a member of the Properties and Construction Committee of the Company’s Board of Directors. Shulamit Eshbol has been a director of the company since February 2008. Ms. Eshbol worked in public accounting as a sole practitioner from 1994 to 1998. Ms. Eshbol also practiced law at the firm of Eshbol & Yakuel since 2000. As part of her legal practice, she is engaged in commercial and financial fields. Ms. Eshbol is a director of the industrial Development Bank of Israel Ltd and she is also Chairman of the Audit Committee of Haifa University. Ms. Eshbol served as a director in Zim Lines Ltd (2003-2003). Ms. Eshbol is a member of the following committees of the Company’s Board of Directors: Finance, Balance Sheet and Investment & Risk Management Committee and Environmental Protection Committee.

81 Committees of the Board of Directors The committees of the Company’s Board of Directors consist of the following: The Supreme Tenders Committee is responsible for approving agreements with suppliers and consultants above a certain amount, and agreements with suppliers whose offers are not the cheapest. The Supreme Tenders Committee is also responsible for handling any agreement procedure submitted to it by the Chief Executive Officer. The Audit Committee, which operates by virtue of the law, is responsible for discussing the audit reports, recommending approval of the internal comptroller’s work plan, discussing and monitoring handling of employee complaints and public complaints, and discussing any anomalous event as required by the chairman of the Board of Directors, the chairman of the Audit Committee, the CEO or the internal comptroller. The Planning, Budgeting and IT Committee is responsible, among other things, for approving the budget and monitoring its implementation and updating, defining ways of measuring improved efficiency, preparing long term plans and forecasts as the basis for work plans, and for various projects, lasting one or more years, in the fields of generation, transmission, transforming and delivery. The Finance, Balance Sheet and Issues Committee is responsible, among other things, for discussing the Company’s financial reports, loans and cash flows and issues in Israel and overseas. The Properties and Construction Committee is responsible, among other things, for the policy of purchasing and selling property, investments in property in the framework of the Company’s budgets and specific projects concerning Company properties. The Organisation, Human Resources and Procedures Committee is responsible for discussing the perception of principles in the organization of the Company, definition of its main functions, etc. This Committee also recommends approving the appointment of senior employees, discusses the Company’s wage policy, examines Company procedures and adapts them to the policy determined by the Board of Directors, and discusses various human resources matters. The Insurance, Auditors and Legal Counsel Committee is responsible for monitoring insurance cover of Company property, examining and approving insurance agreements (as the Supreme Tenders Committee for this subject) and handling the appointment of auditing accountants and external legal counsel for the Company. The Marketing Communications and Customer Relations Committee deals with the structure of customer rates, relations with customers, community projects and the whole subject of private electricity producers. The Environmental Protection Committee is responsible for handling the public aspects of operating the generating units from the environmental quality aspect, standards and licensing, actions to be taken to prevent air pollution from Company facilities, and monitoring compliance with environmental quality standards. The Regulatory Committee is responsible for relations between the Company and the various regulatory bodies that govern it, including the Electricity Committee and various planning and construction entities. The Investment and Risk Management Committee is responsible for handling and reviewing risks and Company exposure, supervising Company investments in business ventures or financial investments. The Committee also operates as a Supreme Tenders committee to approve the appointment and employment of consultants to the Company for its areas of activity. The Committee for the Promotion of Women within the Corporation is responsible for preparing an orderly plan to promote women in the organization. The Committee for Arab Sector Issues is responsible for promoting the employment of minorities in the Company and promoting the affairs of the Arab sector. The Corporate Governance and Ethical Code Committee is responsible for implementing the Corporate Governance and Ethical Codes.

82 Executive Ofﬁcers The following persons are currently executive ofﬁcers of the Company:

Name Age Office Amos Lasker...... 58 Chief Executive Officer Moshe Bachar ...... 58 Senior Vice-President, Generation and Transmission Harel Zeev Blinde ..... 38 Senior Vice-President and Chief Financial Officer Dr. Adrian Bianu ...... 60 Senior Vice-President, Strategic Resources Yakov Hain ...... 53 Senior Vice-President, Engineering Projects Asher Dahan...... 63 Senior Vice-President, Organisation, Logistics, Security and Emergency Igal Ben-Arie ...... 62 Senior Vice-President, Customers Yigal Harel ...... 53 Acting Internal Auditor Adv. David Yahav ..... 58 General Counsel and Secretary Amos Lasker was appointed to the position of Chief Executive Officer of the Company as of December 2007. He holds a B.A. in Economics and an MBA in Business & Quantity Research from Tel-Aviv University. Mr. Lasker has come to the Company with over 25 years’ ‎managerial experience in Israeli and international companies in the areas of industry, infrastructure, communication and venture capital. Moshe Bachar has been the Senior Vice-President of Generation and Transmission since September 2004. Mr. Bachar had served as the Chief Executive Officer of the Company from August 2007 until December 2007. Mr. Bachar was also the Head of the Generation and Transmission Division of the Company (1996-2004). Harel Zeev Blinde was appointed as the Vice-President and Chief Financial Officer of the Company in February 2008. Mr. Blinde holds a B.A. in Economics and Mathematics from Tel Aviv University. In addition, Mr. Blinde is currently studying for his M.A. in Economics and Business Administration in the Hebrew University of Jerusalem. Mr. Blinde served in the Ministry of Finance as Deputy to the State Budget Director and In charge of the Security Department in the State Budget Directory for four years. Dr. Adrian Bianu has been Senior Vice-President of Strategic Resources of the Company since April 2003. Dr. Adrian Bianu was Head of the Planning, Development & Technology Division of the Company (1996-2003). Yakov Hain was appointed as the Senior Vice-President of Engineering Projects of the Company in January 2007. Prior to this position Mr. Hain was General Manager of the Generation Division and Vice President of the Company (2004-2007), Superintendent of Gas Turbine Power Stations (2002-2004), and Deputy Vice President and Head of Electricity, Control and IT Group in the Generation Division (1996-2002). Mr. Hain has published many internationally recognized papers in the field of electricity, power control and the management of power systems. Mr. Hain holds Masters degrees in Electrical Engineering and Business Administration. Asher Dahan was appointed as the Senior Vice-President of Organisation, Logistics, Security, and Emergency in June 2006. Mr. Dahan has a Bachelor’s degree in Business Management. He was the Manager of the Southern District (2001-2006), the Manager of the Quality and Organisation Branch (1996-2001), the Company’s assistant-manager, and director of personnel for the Construction Branch (1989-1996) and addition Manager of Ashkelon Area (1987-1989). Yigal Ben-Arie was appointed as the Senior Vice-President of Marketing and Customer Relations in June 2006. Prior to this position, Mr. Ben-Arie was in charge of the Social Welfare Department of the Jerusalem District (1980-1985), head of the Social Welfare & Service Department of the Jerusalem District (1985-1987), administrative Assistant to the Head of the Jerusalem District (1987-1988), deputy Head of Jerusalem District, Administration & Human Resources (1988-1996), substitute Head of the Jerusalem District (1994-1996) vice-president and head of the Jerusalem District (1996-2006). He holds a B.S.W, Social Work from Hebrew University, Jerusalem. Yigal Harel has been the Acting Internal Auditor since December 2007.

83 Adv. David Yahav was appointed as the General Counsel and Secretary of Israel Electric since August 1996. Adv. Yahav holds L.L.B. and L.L.M. degrees.

Compensation of Directors and Ofﬁcers

For the year ended December 31, 2007, the aggregate amount of compensation paid to the directors and executive ofﬁcers of the Company, as a group, was approximately NIS 5.6 million.

The business address of the members of the Company’s Board of Directors is the registered ofﬁce of the Company at 1 Netiv Ha’Or, P.O.Box 10, Haifa 31000.

84 TRANSACTIONS WITH RELATED PARTIES The Company enters into transactions with the State of Israel and other entities controlled by the State (including Government Companies and Government authorities and other companies in which the State of Israel has a shareholding) which constitute related and interested parties of the Company. Leasing of Properties The Company leases part of its lands from governmental agencies. The Company believes that all such leases are on an arm’s-length basis. Power Sales The Company sells electricity to the Government of the State of Israel and to various governmental agencies and instrumentalities, as well as companies owned or controlled by the State of Israel. All such transactions are in accordance with the applicable tariffs. Other Transactions with the State of Israel and Other Government-Owned Entities The Company has outstanding loans from partially state-owned banks in Israel, all of which borrowings the Company believes are on an arm’s-length basis. In addition, the Company has borrowed directly from the State of Israel and has received the State of Israel’s guarantee for certain of its borrowings. Natural Gas Tripartite Agreement In accordance with the agreement dated November 10, 2004 between the State of Israel, Israel National Gas Lines Ltd. (‘‘INGL’’) and the Company (the ‘‘Tripartite Agreement’’), the Company undertook to finance and manage the project for establishing part of the natural gas transmission system in Israel (the ‘‘Project’’). Under the Tripartite Agreement, the Company is entitled to reimbursement for all approved costs, expended for the Project, by the ‘‘Authorised Body’’ as defined in the Tripartite Agreement. The Company indemnified the State of Israel (the Ministry of Defense) against losses incurred by the State in connection with the passage of the gas transmission line through security areas that belong to the State. The indemnification period has now expired and the Company is not aware of any event that might create responsibility and/or liability in accordance with such indemnification. The Company filed (in October 2007) an application with the competent court for the appointment of an arbitrator (see Note 13.g to the Financial Statements), regarding the following disputes: • The Authorised Body has rejected several requests made by the Company to increase the Project’s budget in connection with additional works carried out and to be carried out, as required by the Government of the State of Israel, amounting to about U.S.$20 million (disbursed by the Company for remedial works on the pipeline) and U.S.$10 million (committed to be paid for rock dumping). • Claims have been made by the Company against the State of Israel with regard to the method of repair to marine pipeline which was damaged. If the Company is required in the future to undertake repairs using a different method, the estimated expense will be about U.S.$30 million. • Claims have been made against the Company by the Ministry of Defence, the Ministry of Infrastructures, the Authorised Body and third parties with regard to the burial of the marine pipeline at a certain depth. • Claims have been made against the Company by third parties with regard to alleged damage to communication cables by the marine pipeline in the amount of approximately U.S.$6 million. • A claim has been filed against the Company by trawlers for damage allegedly caused by the marine pipeline in the amount of NIS 30 million. The Project is nearing conclusion and the last segment is due to be handed over to the State of Israel during the middle of 2008. For further information on transactions with related and interested parties, see Note 13 of the Financial Statements.

85 DESCRIPTION OF THE NOTES The Notes will be issued under the Company’s Global Medium-Term Note Program (the ‘‘Program’’) pursuant to a fiscal agency agreement, dated as of April 23, 2008 (together with any amendments or supplements thereto, the ‘‘Fiscal Agency Agreement’’) and made by and among the Company, The Bank of New York, London branch (the ‘‘Bank’’), in its capacity as fiscal agent (together with any successor to or substitute for the Bank in such capacity, the ‘‘Fiscal Agent’’), as calculation agent (together with any successor to or substitute for the Bank in such capacity and any additional calculation agents appointed in accordance with the Fiscal Agency Agreement, a ‘‘Calculation Agent’’), as principal paying agent (together with any successor to or substitute for the Bank in such capacity and any additional paying agents appointed in accordance with the Fiscal Agency Agreement, a ‘‘Paying Agent,’’), and as transfer agent (together with any successor to or substitute for the Bank in such capacity and any additional transfer agents appointed in accordance with the Fiscal Agency Agreement, a ‘‘Transfer Agent’’), The Bank of New York, New York branch (the ‘‘New York Bank’’), as registrar (together with any successor to or substitute for the New York Bank in such capacity, the ‘‘Registrar,’’) and a Transfer Agent. The Notes will be issued with the benefit of the Note Floating Charge (as defined below under ‘‘General’’) and the related Collateral Trust Agreement (as defined below under ‘‘General’’). Certain capitalized terms used and not otherwise defined herein have the meanings set forth below under ‘‘Certain Definitions.’’ The term ‘‘Company’’ includes any Substituted Obligor following a Substitution (as such terms are defined below under ‘‘Substitution’’) and ‘‘IEC’’ means The Israel Electric Corporation Limited. Copies of the Fiscal Agency Agreement, the Note Floating Charge and the Collateral Trust Agreement are available upon request at the specified offices of the Fiscal Agent, the Registrar and each other Paying Agent. The following summaries of certain provisions of the Notes, the Fiscal Agency Agreement and the Charge Documents do not purport to be complete and are subject to, and are qualified in their entirety by reference to, all the terms and conditions of the Fiscal Agency Agreement, including the definitions therein contained, the Notes of each Series and the pricing supplements related to the Notes of such Series (each, a ‘‘Pricing Supplement’’), and the Charge Documents. References herein to the ‘‘Terms and Conditions’’ of the Notes are to the terms and conditions set forth in Exhibit A to the Fiscal Agency Agreement as supplemented, replaced and/or modified by the Pricing Supplement applicable to the relevant Series or Tranche of Notes.

General The aggregate principal amount of Notes at any time outstanding under the Program will not exceed U.S.$2,000,000,000 (or the equivalent thereof in other currencies or composite currencies as determined on the Business Day (as defined below under ‘‘Interest Rates, Calculation of Interest, Business Day) preceding their respective issue dates), subject to the right of the Company to increase such amount upon the satisfaction of certain conditions set forth in the program agreement, dated April 23, 2008, and made by and among the Company and the several Dealers named therein (the ‘‘Program Agreement’’). For the purpose of calculating the U.S. Dollar equivalent of the aggregate nominal amount of Notes issued under the Program from time to time: (a) the U.S. Dollar equivalent of any Notes denominated in a Specified Currency (as defined below) other than U.S. Dollars shall be determined as of the Business Day prior to the day such Notes are issued on the basis of (i) the noon buying rate in New York City for cable transfers in such currency as certified for customs purposes by the Federal Reserve Bank of New York, or (ii) in the event the Federal Reserve Bank of New York does not certify a noon buying rate for such currency, on the basis of the rate quoted or published by the relevant central bank as the rate for buying such currency in U.S. Dollars or (iii) if no such rate is quoted or published, the rate determined by the Fiscal Agent based on a quotation or an average of quotations given to the Fiscal Agent by commercial banks that conduct foreign exchange operations or based on such other method as the Fiscal Agent may reasonably determine to calculate a market exchange rate, unless otherwise specified in the applicable Pricing Supplement (the rate determined in accordance with clause (i), (ii) or (iii) above being the ‘‘Market Exchange Rate’’ for such currency) on the Business Day prior to the day such Notes are issued (or if such Market Exchange Rate is not then available, the Market Exchange Rate most recently available prior thereto);

86 (b) the U.S. Dollar equivalent of Dual Currency Notes, Indexed Notes and Partly-Paid Notes (each as defined below under ‘‘Dual Currency Notes,’’ ‘‘Indexed Notes’’ and ‘‘Partly-Paid Notes,’’ respectively) shall be calculated in the manner specified above by reference to the original nominal amount of such Notes (in the case of Partly-Paid Notes regardless of the subscription price paid or the amount paid up on such Notes); and (c) the nominal amount of Zero Coupon Notes (as defined below under ‘‘Zero Coupon Notes and Original Issue Discount Notes’’) and other Notes issued at a discount or a premium shall be calculated in the manner specified above by reference to the net proceeds received by the Company for the relevant issue. The Notes will be issued in one or more series (each, a ‘‘Series’’), which, as used herein, means each original issue of Notes together with any further issues expressed to form a single Series with the original issue issued by the Company and which are denominated in the same Specified Currency, have the same date on which the principal is due and payable (the ‘‘Maturity Date’’), bear interest (if any) on the same basis and at the same rate and the terms of which, other than the date on which such notes are issued (the ‘‘Issue Date’’), the date from which such Notes bear interest (the ‘‘Interest Commencement Date’’) and/or the price (expressed as a percentage of the aggregate principal amount) at which such Notes are issued (the ‘‘Issue Price’’), are otherwise identical (including whether or not the Notes are listed). As used herein, ‘‘Tranche’’ means all Notes of the same Series with the same Issue Date, Issue Price and Interest Commencement Date. The Notes of each Series will be denominated in the currency or composite currency (the ‘‘Specified Currency’’), subject to any laws or regulations applicable to such currency or composite currency, as may be agreed upon between the Company and the relevant Dealer or Dealers and specified in the applicable Pricing Supplement, and payments in respect of each Note will be made in the Specified Currency for such Note. The Notes of each Series will have such maturities as may be agreed between the Company and the relevant Dealer or Dealers and indicated in the applicable Pricing Supplement, subject to such minimum or maximum maturities as may be allowed or required from time to time by the relevant central bank (or equivalent body) or any laws or regulations applicable to the Company or the Specified Currency. Notes having a maturity of less than one year will, if the proceeds of the issue are accepted in the United Kingdom, constitute deposits for the purposes of the prohibition on accepting deposits contained in section 19 of the Financial Services and Markets Act 2000 (the ‘‘FSMA’’) unless they are issued to a limited class of professional investors and have a denomination of at least £100,000 or its equivalent. The Notes will bear interest, if at all, at a fixed rate (‘‘Fixed Rate Notes’’) or floating rate (‘‘Floating Rate Notes’’) or by reference to an index or formula, in each case as specified in the applicable Pricing Supplement. The Notes will be general obligations of the Company and will be secured by a valid and enforceable perfected floating charge (the ‘‘Note Floating Charge’’) on the present and future assets of the Company that are charged under any other floating charge created by the Company, whether now existing or hereafter created (the ‘‘Collateral’’), in favor of the Charge Agent for the benefit of the Holders of the Notes, as provided in the Charge Documents. The Note Floating Charge will be granted to the New York Bank, as charge agent (together with any successors to or substitute for the New York Bank in such capacity, the ‘‘Charge Agent’’) for the benefit of the Noteholders, and the New York Bank will serve as Charge Agent thereunder pursuant to the collateral trust agreement, dated as of April 23, 2008, by and between IEC and the Charge Agent (the ‘‘Collateral Trust Agreement’’). As a result of the Note Floating Charge, the Notes will effectively rank (a) senior to all existing and future unsecured indebtedness of IEC, other than indebtedness receiving priority in right of payment by operation of law (e.g., certain claims for taxes, wages and rent), (b) pari passu with all existing and future Indebtedness of IEC secured by Floating Charges on the assets of IEC (unless such charges by their terms are subordinate to the Note Floating Charge) and (c) subordinate to all existing and future Indebtedness of IEC to the extent secured (whether by law or contract) by Fixed Charges on the assets of IEC (unless such charges by their terms are pari passu or subordinated to the

87 Note Floating Charge). For an explanation of the operation of the Note Floating Charge, see ‘‘Note Floating Charge’’ below. As of December 31, 2007, the Company had an aggregate of NIS 24,353 million of Indebtedness secured by pari passu Floating Charges and NIS 92 of Indebtedness secured by Fixed Charges ranking prior to the Note Floating Charge. On January 17, 2008, the Company issued U.S.$250,000,000 floating rate notes that are secured by a floating charge on substantially all of the Company’s assets. The Pricing Supplement relating to any Series of Notes (the form of which is set out in Annex B to this Offering Circular) will be prepared by or on behalf of, the Company and attached to, endorsed on or incorporated by reference into the Notes of such Series. Each Pricing Supplement will supplement the terms and conditions of the Notes and may specify other terms and conditions which will, to the extent so specified or to the extent inconsistent with the terms and conditions attached to, endorsed on or incorporated by reference into the related Series of Notes, for the purposes of such specific Series of Notes only, replace or modify such terms and conditions. The Pricing Supplement relating to any Series of Notes which is to be listed on a stock exchange will be delivered to such exchange, and a copy of each such Pricing Supplement will be available at the specified offices of the Fiscal Agent, the other Paying and Transfer Agents and the Registrar.

Form, Issuance, Delivery and Transfer The Company and the relevant Dealer or Dealers will agree on the form of Notes to be issued in respect of any issue of Notes. Notes of any Series will be issued in registered form (‘‘Registered Notes’’) both outside the United States in reliance on the exemption from registration provided by Regulation S and within the United States in reliance on Rule 144A or Section 4(2) of the Securities Act. Notwithstanding the foregoing and the provisions set forth below, Notes of any Series may be issued in such other form or forms as may be established by the Company for a Series and permitted by applicable law. Notes of any Series may also have such additional provisions, omissions, variations or substitutions as are not inconsistent with the provisions of the Fiscal Agency Agreement or of the applicable Pricing Supplement for such Series or applicable law and as are enforceable under such law, and may have such letters, numbers or other marks of identiﬁcation and such legends or endorsements placed thereon as are required by the forms thereof attached to the Fiscal Agency Agreement and as may be required to comply with any applicable law or rules thereunder or to comply with the rules of any securities exchange or governmental agency or as may, in accordance with the Fiscal Agency Agreement, be determined by an Authorized Representative of the Company, as conclusively evidenced by the execution of such Notes. All Notes of any particular Series will be serially numbered and otherwise substantially identical except as to denomination and except as provided in the Fiscal Agency Agreement or in the Pricing Supplement for such Series.

Registered Notes—General Notes in registered form may initially be issued in the form of one or more permanent global registered notes in an aggregate principal amount equal to the principal amount of the Notes of such Series (‘‘Global Registered Notes’’). which will only be exchangeable in the limited circumstances described below for Notes in the form of definitive registered notes (‘‘Definitive Registered Notes’’). If Registered Notes are issued upon the transfer, exchange or replacement of other Registered Notes not bearing the restrictive legends required by the respective applicable forms of Note attached to the Fiscal Agency Agreement (collectively, a ‘‘Restrictive Legend’’), the Notes so issued will not bear a Restrictive Legend. If Registered Notes are issued upon the transfer, exchange or replacement of other Registered Notes bearing a Restrictive Legend, or if a request is made to remove a Restrictive Legend of a Registered Note, the Registered Notes so issued will bear a Restrictive Legend as set forth on the applicable form of Note attached to the Fiscal Agency Agreement, or the Restrictive Legend will not be removed, as the case may be, unless (a) the conditions set forth under ‘‘Transfer Restrictions’’ in this Offering Circular have been satisfied or (b) the Company and the Registrar receive such satisfactory evidence, which may include an opinion of counsel as may reasonably be required by the Company (at the expense of the holder of such Note) that such Notes comply with the transfer restrictions described

88 under ‘‘Transfer Restrictions’’ in this Offering Circular and that neither the Restrictive Legend nor the restrictions on transfer set forth therein are required to ensure that transfers thereof comply, as the case may be, with the provisions of Rule 144A, Rule 144 or Regulation S under the Securities Act or that such Notes are not ‘‘restricted securities’’ within the meaning of Rule 144 under the Securities Act. Upon satisfaction of either clause (a) or (b), the Registrar, at the direction of the Company, will authenticate or cause to be authenticated and deliver or cause to be delivered a Note that does not bear the Restrictive Legend. If the Restrictive Legend is removed from the face of a Definitive Registered Note and such Note is subsequently held by the Company or an affiliate (as defined in Rule 144 under the Securities Act) of the Company and the Registrar obtains actual knowledge that such Note is so held, or if such Note is transferred to an Institutional Accredited Investor in a private placement or to a QIB pursuant to Rule 144A, the Restrictive Legend will be reinstated. The Company will, upon obtaining actual knowledge that any such Note is held by the Company or an affiliate, notify the Registrar in writing. The Registrar or its duly appointed agent will maintain with respect to Global Registered Notes and Definitive Registered Notes of each Series the definitive record (the ‘‘Note Register’’) in which will be recorded the names and addresses of the holders (the ‘‘registered Holders’’) of Registered Notes, the aggregate principal amount held by each of them, the Note numbers and other details with respect to the issuance, transfer and exchange of Registered Notes. Transfer, registration and/or exchange of any Note or Notes will be permitted and effected as described below without any charge to the Holder (as defined below under ‘‘Title; Treatment of ‘‘Holder’’ as Owner’’) of any such Note or Notes, other than any taxes or governmental charges payable in connection therewith or any expenses of delivery (other than delivery by regular mail) including, without limitation, insurance, postage and transportation. Global Registered Notes DTC Global Registered Notes. Unless otherwise set forth in the applicable Pricing Supplement, Global Registered Notes of a Series that are initially offered and sold in offshore transactions in reliance on Regulation S as provided in the Program Agreement will be represented by one or more, permanent global Notes in fully registered form which will be deposited, on or prior to the Issue Date of such Notes, with the Registrar, at its New York City branch, as custodian for The Depository Trust Company (‘‘DTC’’) and registered in the name of a nominee of DTC (each such Note, a ‘‘Regulation S Global Registered Note’’) duly executed and authenticated as provided in the Fiscal Agency Agreement for credit on the Issue Date to the accounts of the relevant Dealer or Dealers (or to such other accounts as they may direct) at Euroclear or Clearstream. Until the expiration of 40 days after the completion of the distribution of all Notes of the Tranche of which such Notes are a part as determined by the Company (based on information provided by the relevant Dealer or Dealers) and notified by the Company to the Fiscal Agent and each of Euroclear, Clearstream or DTC, beneficial interests in the Regulation S Global Registered Note may be held only through agent members of Euroclear or Clearstream, unless delivery is made in the form of a beneficial interest in a Restricted Global Note (as defined below) of the same Series in accordance with the certification requirements described below. Unless otherwise set forth in the applicable Pricing Supplement, Global Registered Notes of a Series that are initially offered and sold in the United States in reliance on Rule 144A or Section 4(2) of the Securities Act as provided in the Program Agreement will be represented by one or more permanent global Notes in fully registered form (a ‘‘Restricted Global Note’’ and, together with the Regulation S Global Registered Notes, the ‘‘DTC Global Registered Notes’’), which will be deposited, on or prior to the Issue Date of such Notes, on behalf of the subscribers for the Notes represented thereby, with the Registrar as custodian for DTC and registered in the name of a nominee of DTC, duly executed and authenticated as provided in the Fiscal Agency Agreement for credit on the Issue Date to the accounts of the relevant Dealer or Dealers (or to such other accounts as they may direct) at DTC. Only QIBs or purchasers of Notes pursuant to Regulation S may hold interests in Global Registered Notes through the facilities of DTC. The Restricted Global Note (and any Notes issued in exchange therefor) will be subject to certain restrictions on transfer set forth therein and in the Fiscal Agency Agreement and will bear the legend regarding such restrictions substantially in the form set forth under ‘‘Transfer Restrictions’’ in this Offering Circular.

89 A beneficial interest in the Regulation S Global Registered Note of a Series may be exchanged for, or transferred to, a person who takes delivery in the form of an interest in the Restricted Global Note of the same Series, provided that if such exchange or transfer takes place before the expiry of the period which is 40 days after the completion of the distribution of the Tranche of which such Note forms a part such exchange or transfer will be effected only upon receipt by the Registrar of a written certification from the transferor (in the applicable form provided in the Fiscal Agency Agreement) to the effect that such transfer is being made to a person whom the transferor reasonably believes is a QIB within the meaning of Rule 144A in a transaction meeting the requirements of Rule 144A and in accordance with any applicable securities laws of any state of the United States or any other jurisdiction. Beneficial interests in the Restricted Global Note of a Series may be exchanged for, or transferred to a person who takes delivery in the form of, an interest in the Regulation S Global Registered Note of the same Series only upon receipt by the Registrar of (i) instructions given in accordance with DTC’s procedures from an agent member directing the Registrar to credit or cause to be credited a beneficial interest in the Restricted Global Note, (ii) an order given by the holder of such beneficial interest in accordance with DTC’s procedures containing information regarding the participant account of DTC to be credited with such increase; provided that during the Restricted Period such information shall designate the Euroclear or Clearstream account to be credited with such increase and the name of such account and (iii) for exchanges made (1) during the Restricted Period, a certificate (in the applicable form provided in the Fiscal Agency Agreement) given by the holder of such beneficial interest stating that the exchange or transfer of such interest has been made in compliance with the transfer restrictions applicable to the Notes and pursuant to, and in accordance with, Regulation S and that such interest shall be held immediately thereafter only through Euroclear or Clearstream and (2) after the expiration of the Restricted Period, a written certification from the transferor (in the applicable form provided in the Fiscal Agency Agreement) to the effect that such transfer is being made in compliance with the transfer restrictions applicable to the Notes and that (A) such transfer or exchange has been made pursuant to, and in accordance with, Regulation S or (B) the Note being exchanged or transferred is not a ‘‘restricted security’’ (as defined in Rule 144 under the Securities Act). Any beneficial interest in a DTC Global Registered Note of a Series that is exchanged for, or transferred to a person who takes delivery in the form of, an interest in the other DTC Global Registered Note of the same Series will, upon transfer, cease to be an interest in such DTC Global Registered Note and become an interest in the other DTC Global Registered Note and, accordingly, will thereafter be subject to all transfer restrictions and other procedures applicable to beneficial interests in such other DTC Global Registered Note for as long as it remains such an interest. Transfers to a holder of an interest in a DTC Global Registered Note who wishes to take delivery of such interest through the same DTC Global Registered Note may be made at any time without certification, subject to applicable transfer restrictions. Except in the limited circumstances described below under ‘‘Book-Entry Provisions Applicable to DTC Global Registered Notes; Exchange for Definitive Registered Notes,’’ owners of beneficial interests in DTC Restricted Global Notes will not be entitled to receive physical delivery of Definitive Registered Notes. Euroclear/Clearstream Global Registered Notes. If the applicable Pricing Supplement so specifies, Global Registered Notes of a Series that are initially offered and sold only in offshore transactions in reliance on Regulation S as provided in the Program Agreement will be represented by one or more Regulation S Global Registered Notes, which will be deposited on or prior to the Issue Date for such Notes on behalf of the subscribers for the Notes represented thereby, with the Registrar at its London branch in its capacity as common depositary for Euroclear and Clearstream and registered in the name of the common depositary or its nominee, duly executed and authenticated as provided herein, for credit on the Issue Date to the accounts of the relevant Dealer or Dealers (or to such other accounts as they may direct) at Euroclear or Clearstream. Except in the limited circumstances described below under ‘‘Book Entry Provisions Applicable to Euroclear/Clearstream Global Registered Notes; Exchange of Euroclear/Clearstream Global Registered

90 Notes for Definitive Registered Notes,’’ owners of beneficial interests in Euroclear/Clearstream Global Registered Notes will not be entitled to receive physical delivery of Definitive Registered Notes.

Book-Entry Provisions Applicable to DTC Global Registered Notes; Exchange for Definitive Registered Notes. Upon the issuance of the DTC Global Registered Notes, DTC or its custodian will credit, on its internal book-entry system, the respective principal amounts of the individual beneficial interests represented by such DTC Global Registered Notes to the accounts of persons who have accounts with DTC. Such accounts initially will be designated by or on behalf of the Dealers. Ownership of beneficial interests in a DTC Global Registered Note will be limited to persons who have accounts with DTC (‘‘DTC Participants’’) or persons who hold interests through DTC Participants, including the respective depositaries of Euroclear and Clearstream. Ownership of beneficial interests in a DTC Global Registered Note will be shown on, and the transfer of such ownership will be effected only through, records maintained by DTC or its nominee (with respect to the interests of DTC Participants) and the records of DTC Participants (with respect to interests of persons who hold interests through DTC Participants).

So long as DTC or its nominee is the registered owner or holder of a DTC Global Registered Note, DTC or such nominee, as the case may be, will, except as otherwise provided in the Notes, be considered the sole owner or holder of the Notes represented by such DTC Global Registered Note for all purposes under the Fiscal Agency Agreement and such Notes. Unless (i) DTC notifies the Company that it is unwilling or unable to continue as depositary for a DTC Global Registered Note or if at any time DTC ceases to be a ‘‘clearing agency’’ registered under the Exchange Act and a successor depositary so registered is not appointed by the Company within 90 days of such notice or (ii) an Event of Default or Acceleration Event (each as defined below under ‘‘Events of Default and Acceleration Events’’) has occurred and is continuing with respect to the Notes represented by such DTC Global Registered Note, owners of beneficial interests in a DTC Global Registered Note will not be entitled to have any portion of such DTC Global Registered Note registered in their names, will not receive or be entitled to receive physical delivery of Definitive Registered Notes in exchange for their interests in a DTC Global Registered Note and, except as otherwise provided in the Notes, will not be considered to be the owners or holders of any Notes under the Fiscal Agency Agreement or the Notes. In addition, no beneficial owner of an interest in a DTC Global Registered Note will be able to transfer such interest except in accordance with DTC’s applicable procedures (in addition to those under the Fiscal Agency Agreement referred to herein and, if applicable, those of Euroclear and Clearstream). If the foregoing conditions are met and interests in a DTC Global Registered Note are exchangeable for Definitive Registered Notes, such Definitive Registered Notes issued upon transfer or exchange will be issued subject to the legending requirements described under ‘‘Registered Notes—General’’ above.

Interests in the Regulation S Global Registered Note may be held directly through Euroclear or Clearstream by participants in such systems, or indirectly through organizations that are participants in such systems. Upon expiry of the period which is 40 days after the completion of the distribution of the Tranche of which the applicable Notes form a part interests in the Regulation S Global Registered Note may also be held directly through DTC by DTC Participants, or indirectly through organizations other than Euroclear or Clearstream or participants in such systems that are DTC Participants.

Euroclear and Clearstream will hold interests in the Regulation S Global Registered Note on behalf of their participants through their respective depositaries, which in turn will hold such interests in the Regulation S Global Registered Note in customers’ securities accounts in the depositaries’ names on the books of DTC. Interests in the Restricted Global Note may be held directly through DTC by DTC Participants, or indirectly through organizations that are DTC Participants.

Payments of the principal, interest and Additional Amounts (as defined below under ‘‘Additional Payment Amounts’’), if any, on DTC Global Registered Notes will be made to DTC or its nominee, as the registered owner thereof. None of the Company, the Fiscal Agent, the Registrar or any Paying Agent will have any responsibility or liability for any aspect of the records relating to or payments made on account of beneficial ownership interests in the DTC Global Registered Notes or for maintaining, supervising or reviewing any records relating to such beneficial ownership interests.

91 The Company expects that DTC or its nominee, upon receipt of any payment of principal, interest or Additional Amounts, if any, in respect of a DTC Global Registered Note representing any Notes held by it or its nominee, will credit DTC Participants’ accounts with payments in amounts proportionate to their respective beneficial interests in the principal amount of such DTC Global Registered Note as shown on the records of DTC or its nominee. The Company also expects that payments by DTC Participants to owners of beneficial interests in such global Note held through such DTC Participants will be governed by standing instructions and customary practices. Such payments will be the responsibility of such DTC Participants. Transfers between DTC Participants will be effected in the ordinary way in accordance with DTC rules and will be settled in same-day funds. The laws of some jurisdictions require that certain persons take physical delivery of securities in definitive form. Consequently, the ability to transfer beneficial interests in a DTC Global Registered Note to such persons may be limited. Because DTC can only act on behalf of DTC Participants, who in turn act on behalf of indirect participants and certain banks, the ability of a person having a beneficial interest in a DTC Global Registered Note to pledge such interest to persons or entities that do not participate in the DTC system, or otherwise take actions in respect of such interest, may be affected by lack of a physical certificate of such interest. Transfers between participants in Euroclear and Clearstream will be affected in the ordinary way in accordance with their respective rules and operating procedures. Subject to compliance with the transfer restrictions applicable to the Notes described above and under ‘‘Transfer Restrictions’’ in this Offering Circular, cross-market transfers between DTC, on the one hand, and directly or indirectly, through Euroclear or Clearstream participants, on the other, will be effected through DTC in accordance with DTC rules on behalf of Euroclear or Clearstream, as the case may be, by its respective depositary which is a DTC Participant; however, such cross-market transactions will require delivery of instructions to Euroclear or Clearstream, as the case may be, by the counterparty in such system in accordance with its rules and procedures and within its established deadlines (Brussels time). Euroclear or Clearstream, as the case may be, will, if the transaction meets its settlement requirements, deliver instructions to its respective depositary to take action to effect final settlement on its behalf by delivering or receiving interests in the Regulation S Global Registered Note in DTC, and making or receiving payment in accordance with normal procedures for same-day funds settlement applicable to DTC. Euroclear participants and Clearstream participants may not deliver instructions directly to the depositaries for Euroclear or Clearstream. Because of time zone differences, the securities account of a Euroclear or Clearstream participant purchasing an interest in a DTC Global Registered Note from a DTC Participant will be credited during the securities settlement processing day (which must be a Business Day for Euroclear or Clearstream, as the case may be) immediately following the DTC settlement date, and such credit of any transactions in interests in a DTC Global Registered Note settled during such processing day will be reported to the relevant Euroclear or Clearstream participant on such day. Cash received in Euroclear or Clearstream as a result of sales of interests in a DTC Global Registered Note by or through a Euroclear or Clearstream participant to a DTC Participant will be received for value on the DTC settlement date, but will be available in the relevant Euroclear or Clearstream cash account only as of the Business Day following settlement in DTC. DTC has advised the Company that it will take any action permitted to be taken by a holder of Notes (including the presentation of Notes for exchange as described below) only at the direction of one or more DTC Participants to whose account with DTC interests in the DTC Global Registered Notes are credited, and only in respect of such portion of the aggregate principal amount of the Notes as to which such DTC Participant or Participants has or have given such direction. However, if there is an Event of Default or Acceleration Event under the Notes, DTC will exchange the DTC Global Registered Notes for Definitive Registered Notes, which it will distribute to its Participants in accordance with their proportionate entitlements and which, if representing interests in the Restricted Global Note, will be legended as set forth under ‘‘Transfer Restrictions’’ in this Offering Circular. DTC has advised the Company as follows: DTC is a limited-purpose trust company organized under the New York Banking Law, a ‘‘banking organization’’ within the meaning of the New York Banking Law,

92 a member of the Federal Reserve System, a ‘‘clearing corporation’’ within the meaning of the New York Uniform Commercial Code, and a ‘‘clearing agency’’ registered pursuant to the provisions of Section 17A of the Securities Exchange Act of 1934. DTC holds and provides asset servicing for issues of U.S. and non-U.S. equity securities that DTC Participants deposit with DTC. DTC also facilitates the post-trade settlement among Direct Participants of sales and other securities transactions in deposited securities, through electronic computerized book-entry transfers and pledges between Direct Participants’ accounts. This eliminates the need for physical movement of securities certificates. Direct Participants include both U.S. and non-U.S. securities brokers and dealers, banks, trust companies, clearing corporations, and certain other organizations. Access to the DTC system is also available to others, such as both U.S. and non-U.S. securities brokers and dealers, banks, trust companies, and clearing corporations that clear through or maintain a custodial relationship with a Direct Participant, either directly or indirectly (‘‘indirect participants’’). Although DTC, Euroclear and Clearstream have agreed to the foregoing procedures in order to facilitate transfers of interests in DTC Global Registered Notes among participants and accountholders of DTC, Euroclear and Clearstream, they are under no obligation to perform or continue to perform such procedures, and such procedures may be discontinued at any time. Neither the Company nor the Fiscal Agent will have any responsibility for the performance or nonperformance by DTC, Euroclear or Clearstream or their respective direct or indirect participants or accountholders of their respective obligations under the rules and procedures governing their operations. Book-Entry Provisions Applicable to Euroclear/Clearstream Global Registered Notes; Exchange of Euroclear/Clearstream Global Registered Notes for Definitive Registered Notes. So long as the Common Depositary or its nominee is the registered holder of a Euroclear/Clearstream Global Registered Note, the Common Depositary or such nominee, as the case may be, will be considered the sole owner or holder of the Notes represented by such Euroclear/Clearstream Global Registered Note for all purposes under the Fiscal Agency Agreement and such Notes. Unless (i) both Euroclear and Clearstream are closed for business for a continuous period of 14 days (other than by reason of holidays, statutory or otherwise) or both Euroclear and Clearstream announce intentions permanently to cease business or do in fact do so and (ii) an Event of Default or Acceleration Event has occurred and is continuing with respect to the Notes represented by such Euroclear/Clearstream Global Registered Note, owners of beneficial interests in a Euroclear/Clearstream Global Registered Note will not be entitled to have any portion of such Euroclear/Clearstream Global Registered Note registered in their names, will not receive or be entitled to receive physical delivery of Definitive Registered Notes in exchange for their interests in a Euroclear/Clearstream Global Registered Note and will not be considered to be the owners or holders of any Notes under the Fiscal Agency Agreement or the Notes. In addition, transfers between participants in Euroclear and Clearstream will be effected in the ordinary way in accordance with their respective rules and operating procedures. Definitive Registered Notes Definitive Registered Notes may be issued (i) if the applicable Pricing Supplement so provides, upon initial issuance outside the United States in reliance on Regulation S or within the United States in reliance on Rule 144A or Section 4(2) or (ii) in the circumstances set forth above under ‘‘Book-Entry Provisions Applicable to DTC Global Registered Notes; Exchange for Definitive Registered Notes’’ and ‘‘Book-Entry Provisions Applicable to Euroclear/Clearstream Global Registered Notes; Exchange of Euroclear/Clearstream Global Registered Notes for Definitive Registered Notes.’’ The Registrar or its duly authorized agent will deliver each Definitive Registered Note, executed and authenticated as provided in the Fiscal Agency Agreement, to the applicable Dealer or its designee, or, in the case of a sale pursuant to an agreement with a syndicate of Dealers, to the lead manager thereof or its designee, for the benefit of the purchaser of such Note against delivery by such Dealer of a receipt therefor or, if so instructed and, upon confirmation from the Company that proper payment by the purchaser has been made, deliver the Notes directly to the Company or its designee for the benefit of the purchaser of such Notes against delivery of a receipt therefor. Notwithstanding the foregoing, if the Registrar is so instructed otherwise by the Company, delivery of the Notes may be made before actual receipt of payment (‘‘delivery free’’) in accordance with the custom prevailing in the market. Upon the

93 issuance of any Deﬁnitive Registered Note, the Registrar will record the person who is designated by the Dealer, the lead manager or the Company, as the case may be, as the registered Holder of such Deﬁnitive Registered Note.

If any depositary at any time notifies the Company that it is unwilling or unable to continue as a depositary for the reasons set forth under ‘‘Book-Entry Provisions Applicable to DTC Global Registered Notes; Exchange for Definitive Registered Notes’’ or ‘‘Book-Entry Provisions Applicable to Euroclear/ Clearstream Global Registered Notes; Exchange of Euroclear/Clearstream Global Registered Notes for Definitive Registered Notes’’ or if at any time any depositary shall no longer be eligible to act as such because it ceases to be a clearing agency registered under the Exchange Act and in either case a successor depositary is not appointed by the Company within 90 days after the Company receives notice or becomes aware of such ineligibility, the Company will issue Definitive Registered Notes in exchange for the Global Registered Notes. Upon the occurrence of any of the events set forth in the preceding sentence, the Company shall execute, and, upon receipt of instructions from an Authorized Representative of the Company, the Registrar shall complete and authenticate or cause to be completed and authenticated Definitive Registered Notes in authorized denominations in an aggregate principal amount of the Global Notes in exchange for such Global Notes. In the case of certificates for Definitive Registered Notes issued in exchange for Restricted Global Notes, such certificates will bear, and be subject to, the legend referred to under ‘‘Transfer Restrictions’’ in this Offering Circular. Upon the transfer, exchange or replacement of such Definitive Registered Notes bearing the Restrictive Legend, or upon specific request for removal of the Restrictive Legend on a Definitive Registered Note, the Company will deliver only Definitive Registered Notes that bear such legend, or will refuse to remove such legend, as the case may be, unless there is delivered to the Company and the Registrar such satisfactory evidence, which may include an opinion of counsel as may reasonably be required by the Company (at the expense of the holder of such Note) that neither the Restrictive Legend nor the restrictions on transfer set forth therein are required to ensure that transfers thereof comply, as the case may be, with the provisions of Rule 144A, Rule 144 or Regulation S under the Securities Act.

Subject to the restrictions set forth under ‘‘Transfer Restrictions’’ in this Offering Circular and such reasonable and customary regulations as the Company may from time to time prescribe and the requirements of minimum denomination set forth in the Fiscal Agency Agreement or in any applicable Pricing Supplement, transfers of any Definitive Registered Note in whole or in part must be made at the office of the Registrar or its duly authorized agent or at the office of any Transfer Agent by delivery of such Definitive Registered Note with the form of transfer thereon duly endorsed by, or accompanied by a written instrument of transfer in form satisfactory to, the Company and the Registrar or its duly authorized agent or such Transfer Agent, as the case may be, duly executed by the registered Holder thereof or such registered Holder’s attorney-in-fact duly authorized in writing. In exchange for any Definitive Registered Note properly presented for transfer, the Fiscal Agent will promptly authenticate or cause to be authenticated and deliver or cause to be delivered at the office of the Registrar or its duly authorized agent or at the office of such Transfer Agent, as the case may be, to the transferee or send by mail (at the risk of the transferee) to such address as the transferee may request, a Definitive Registered Note or Notes registered in the name of such transferee, for the same aggregate principal amount as was transferred. Notwithstanding the foregoing, unless otherwise set forth in the applicable Pricing Supplement, a person who acquires a Definitive Registered Note in a transaction exempt from registration under the Securities Act in reliance on Rule 144A or Regulation S may take delivery thereof in the form of an interest in a Restricted Global Note or Regulation S Global Registered Note, as the case may be, representing Notes of the same Series. In exchange for any such Definitive Registered Note properly presented for transfer, the Registrar or its duly authorized agent or any other Transfer Agent, as the case may be, will record such transfer on its records and instruct DTC or its nominee or custodian, as the case may be, concurrently with such transfer, to increase or reflect on its records an increase in the principal amount of the applicable DTC Global Registered Note by the aggregate principal amount of the Definitive Registered Note to be so transferred, and to credit or cause to be credited to the account of the person specified in the accompanying transfer instructions, as provided in the Fiscal Agency Agreement, a beneficial interest in such DTC Global Registered Note equal to the aggregate principal amount of the

94 Definitive Registered Notes so transferred. Except as specified in this paragraph, Definitive Registered Notes will not be exchangeable for interests in a Global Registered Note. Subject to the requirements of minimum denomination set forth in the Fiscal Agency Agreement and any applicable Pricing Supplement, in the case of the transfer of any Definitive Registered Note in part, the Fiscal Agent will also promptly authenticate or cause to be authenticated and deliver or cause to be delivered at the office of the Registrar or its duly authorized agent or at the office of any Transfer Agent, as the case may be, to the transferor or send by mail (at the risk of the transferor) to such address as the transferor may request, a Definitive Registered Note or Notes, registered in the name of the transferor, for the aggregate principal amount that was not transferred. Definitive Registered Notes may also be exchanged for other Definitive Registered Notes of the same Series in any authorized denominations and of equal aggregate principal amount of the Notes of such Series, subject to the requirements of minimum denomination set forth in the Fiscal Agency Agreement and in any applicable Pricing Supplement. No transfer of any Definitive Registered Note will be made unless the request for such transfer is made by the registered Holder or by a duly authorized attorney-in-fact at the office of the Registrar or its duly authorized agent or at the office of any Transfer Agent. Neither the Registrar nor any Transfer Agent will register the transfer of or exchange of a Definitive Registered Note for a period of 15 days preceding the due date for any payment of interest on such Note, or during the period of 30 days preceding the due date for any payment of principal on such Note, or register the transfer of or exchange any Notes previously called for redemption. Further Issues of the Same Series The Company may from time to time, without the consent of any holder of a Note, create and issue further Notes having the same terms (other than the Issue Date, the Interest Commencement Date and the Issue Price, if any, specified in the applicable Pricing Supplement) as the Notes of an existing Series (including whether or not such Notes are listed), which are expressed to form a single series with the outstanding Notes of such Series. Denomination, Maturity, Title Denomination Subject to the provisions set forth in the Fiscal Agency Agreement and in the applicable Pricing Supplement and the restrictions imposed by any applicable law or regulation relating to any currency or composite currency, Notes of a Series issued outside the United States will have such denomination as may be agreed between the Company and the relevant Dealer or Dealers as specified in the applicable Pricing Supplement. Notes initially sold in the United States to QIBs and Institutional Accredited Investors will be in minimum denominations of U.S.$200,000 and integral multiples of U.S.$1,000 in excess thereof (or the equivalent thereof in the applicable Specified Currency). Unless otherwise set forth in the applicable Pricing Supplement, Notes having a maturity of less than one year will, if the proceeds of the issue are accepted in the United Kingdom, constitute deposits for the purposes of the prohibition on accepting deposits contained in section 19 of the FSMA unless they are issued to a limited class of professional investors and have a denomination of at least £100,000 or its equivalent. Maturity Notes of each Series will have such maturities as may be agreed between the Company and the relevant Dealer or Dealers and indicated in the applicable Pricing Supplement, subject to such minimum or maximum maturities as may be allowed or required from time to time by the relevant central bank (or equivalent body) or any laws or regulations applicable to the Company or the Specified Currency. Title; Treatment of ‘‘Holder’’ as Owner Subject to the provisions of the Fiscal Agency Agreement, title to Registered Notes will pass upon the registration of transfers in respect thereof in accordance with the Fiscal Agency Agreement. Prior to satisfaction of the applicable requirements for registration of transfer set forth in the Fiscal Agency Agreement, the Company, the Fiscal Agent, the Registrar, the Charge Agent and any Paying Agent or Transfer Agent may deem and treat the registered Holder of any Registered Note (a ‘‘Holder’’) as the

95 absolute owner, in each case for the purpose of receiving payment of the principal of (including premium or redemption amounts, if any, and, in the case of Original Issue Discount Notes, the Amortized Face Amount or other amount payable in respect thereof) and interest, if any, and Additional Amounts, if any, on such Note and for all other purposes whatsoever; provided, that each person who is for the time being shown in the records of Clearstream and/or Euroclear, as the case may be, as the owner of a particular nominal amount of Registered Notes represented by a Euroclear/Clearstream Global Registered Note, as the case may be (in which regard any certiﬁcate or other document issued by Clearstream and/or Euroclear, as the case may be, as to the nominal amount of such Notes standing to the account of any person will be conclusive and binding for all purposes), will be treated by the Company, the Fiscal Agent, the Registrar, the Charge Agent and any Paying Agent or Transfer Agent as a holder of such nominal amount of Registered Notes represented by a Euroclear/Clearstream Global Registered Note, as the case may be, for all purposes other than with respect to the payment of principal (including premium or redemption amounts, if any, and, if a Note is an Original Issue Discount Note, the Amortized Face Amount or other amount payable in respect thereof) or interest, if any, and Additional Amounts, if any, and any other amounts payable on such Registered Notes represented by a Euroclear/ Clearstream Global Registered Note, the right to which will be vested, as against the Company, the Fiscal Agent, the Registrar, the Charge Agent and any Paying Agent or Transfer Agent, solely in the Common Depositary or its nominee as the registered Holder of the Euroclear/Clearstream Global Registered Note, in accordance with and subject to its terms and the Fiscal Agency Agreement (and the term ‘‘Holders’’ will be construed accordingly), and none of the Company, the Fiscal Agent, the Registrar, the Charge Agent or any Paying Agent or Transfer Agent will be affected by notice to the contrary.

Currency of Notes Notes may be denominated in any Speciﬁed Currency as speciﬁed in the applicable Pricing Supplement, or such other currency or currencies as may be agreed between the Company and the relevant Dealers, subject to compliance with all applicable legal or regulatory requirements.

Payments

Payments—General Any interest (other than interest payable at maturity or upon redemption) and any Additional Amounts (as defined below) on Registered Notes of a Series will be payable to the Holders in whose name the Note is registered in the relevant Note Register maintained pursuant to the Fiscal Agency Agreement at the close of business on the 15th calendar day (whether or not a Business Day) next preceding the date such interest is due, unless otherwise specified in the applicable Pricing Supplement (the ‘‘Record Date’’), and principal (including premium or redemption amounts, if any, and, if a Note is an Original Issue Discount Note, the Amortized Face Amount or other amounts payable in respect thereof) and interest, if any, and Additional Amounts, if any, payable at maturity or upon redemption of such Note will be payable, upon surrender of such Note at the designated office or agency of a Transfer Agent, to the registered Holder of such Note, (x) in the case of DTC Global Registered Notes or Definitive Registered Notes, by check mailed to the registered address of the registered Holder, which, in the case of DTC Global Registered Notes, will be DTC or its nominee or upon application of any registered Holder of at least U.S.$1,000,000 principal amount of Notes (or its equivalent in other currencies or composite currencies), by wire transfer to such office or agency of any Transfer Agent or such account as the registered Holder may from time to time designate not later than 15 Business Days prior to such payment date (any such designation to remain in effect until changed upon 15 Business Days’ notice) or additionally or alternatively in such other manner as may be set forth in the applicable Pricing Supplement and (y) in the case of Euroclear/ Clearstream Global Registered Notes, to the Common Depositary or its nominee, who will be the registered Holder for Euroclear/Clearstream Global Registered Notes, which will allocate such payment to Euroclear or Clearstream for the portion of the Euroclear/Clearstream Global Registered Note held for its account by the Common Depositary. Each of Euroclear and Clearstream, as applicable, will undertake in such circumstances to credit any such amounts received by it to the respective accounts of the persons who are the owners of such interests on

96 the date on which such amounts are paid. Payments on a Euroclear/Clearstream Global Registered Note to participants in Euroclear or Clearstream will be effected in accordance with the customary procedures of Euroclear and Clearstream. Unless otherwise specified in an applicable Pricing Supplement, the first payment of interest on any Note originally issued between a Record Date and an Interest Payment Date (as defined below under ‘‘Fixed Rate Notes’’ and ‘‘Floating Rate Notes,’’ as applicable) will be made on the next succeeding Interest Payment Date. Any payment made to DTC or its nominee or to the Common Depositary or its nominee will discharge the relevant payment obligation of the Company, the Fiscal Agent and any Paying Agent. None of the Company, the Fiscal Agent or any Paying Agent will have any responsibility or liability for any aspect of the records relating to or payments made on account of beneficial ownership interests in the Global Registered Notes or for maintaining, supervising or reviewing any records relating to such beneficial ownership interests. Unless otherwise specified in the applicable Pricing Supplement, a Holder of an interest in a DTC Global Registered Note denominated or repayable in a Specified Currency other than U.S. Dollars electing to receive payments of principal (including premium or redemption amounts, if any, and, if such Note is an Original Issue Discount Note, the Amortized Face Amount or other amounts payable in respect thereof) or interest, if any, in a currency other than U.S. Dollars must notify the DTC Participant through which its interest is held on or prior to the applicable Record Date, in the case of a payment of interest, and on or prior to the twelfth day prior to the payment of principal, in the case of principal (including premium or redemption amounts, if any, and, if such Note is an Original Issue Discount Note, the Amortized Face Amount or other amounts payable in respect thereof), of such beneficial owner’s election to receive all or a portion of such payment in a Specified Currency other than U.S. Dollars, together with wire transfer payment instructions to an account in the Specified Currency. Any such election in respect of a payment of principal or interest will be irrevocable. In the case of a payment of interest, such DTC Participant must notify DTC of such election on or prior to the third Business Day after such Record Date. DTC will notify the Fiscal Agent of such election on or prior to the fifth Business Day after such Record Date. In the case of a payment of principal (including premium or redemption amounts, if any, and, if such Note is an Original Issue Discount Note, the Amortized Face Amount or other amounts payable in respect thereof), such DTC Participant must notify DTC of such election on or prior to the twelfth day prior to the payment of principal. DTC will notify the Fiscal Agent of such election on or prior to the tenth day prior to the payment of principal. If complete instructions are received by the DTC Participant and forwarded by the DTC Participant to DTC, and by DTC to the Fiscal Agent, on or prior to such dates, the beneficial owner will receive payments of principal and/or interest in the Specified Currency; otherwise only U.S. Dollar payments will be made by the Fiscal Agent through DTC. If any Holder of Notes does not elect to receive principal or interest payments in the Specified Currency in accordance with the rules and procedures of DTC, then such payments will be made in U.S. Dollars. Conversion of the Specified Currency into U.S. Dollars will be made by the Calculation Agent. In particular, the Calculation Agent has the right to deduct from payments made in U.S. Dollars all costs of converting amounts in the Specified Currency to U.S. Dollars.

Payment Business Day If the date for payment of any amount in respect of any Note is not a Payment Business Day, the holder thereof will not be entitled to payment of the amount due until the next following Payment Business Day in the relevant place and will not be entitled to any interest or other payment in respect of such delay. For these purposes, unless otherwise speciﬁed in the applicable Pricing Supplement, ‘‘Payment Business Day’’ means any day which is both: (a) a day in which commercial banks and foreign exchange markets settle payments in the relevant place of presentation; and (b) a Business Day.

The Fiscal Agent, Paying Agents, Transfer Agents and the Registrar The Company will initially appoint for each Note the Paying Agent(s) and/or Transfer Agent(s) listed at the foot of such Note and in the applicable Pricing Supplement. The Company reserves the right at any time to vary or terminate the appointment of a Fiscal Agent, any Paying Agent, Transfer Agent, or the

97 Registrar and to appoint additional or other Paying Agents, Transfer Agents, or another Fiscal Agent or Registrar; provided, that until each Note has been delivered to the Fiscal Agent for cancellation, or moneys sufficient to pay the principal (including premium or redemption amount, if any, and, if a Note is an Original Issue Discount Note, the Amortized Face Amount or other amounts payable in respect thereof) and, interest, if any, on such Note have been made available for payment and either paid or returned to the Company as provided herein, the Company covenants that it will at all times maintain a Paying Agent and Transfer Agent in the case of Notes issued in the United States or registered in the name of a U.S. person, in New York City, and if and for so long as the Notes are listed on any stock exchange or admitted to listing by any other relevant authority, there will at all times be a Paying Agent with a specified office in such places as the rules of the relevant stock exchange require (which, if the relevant stock exchange is the SGX-ST, shall be Singapore).

Prescription Claims against the Company (if any) for payment in respect of the Notes will be prescribed and become void unless made within ten years (in the case of principal) or ﬁve years (in the case of interest) from the appropriate Relevant Date (as deﬁned below under ‘‘Redemption—Early Redemption Amount’’) in respect thereof. All moneys held by the Fiscal Agent or any Paying Agent in respect of Notes of a Series which remain unclaimed shall be returned to the Company upon request on the earlier of (a) the obligation to make the principal payment in respect of such Notes becoming void or ceasing in accordance with the Terms and Conditions of such Notes and (b) the expiration of two years following the date on which the relevant payment in respect of such Notes shall have become due and payable. Upon the return of such funds, a Holder of Notes of such Series thereafter may look only to the Company for payment.

Interest Rates, Calculation of Interest, Business Day The rate of interest (‘‘Rate of Interest’’) on each Note will be equal to: (a) in the case of a Fixed Rate Note, the fixed rate specified in the applicable Pricing Supplement (which will be zero in the case of Zero Coupon Notes); or (b) in the case of a Floating Rate Note, the interest rate determined by reference to the Interest Rate Basis as specified in the applicable Pricing Supplement, either (i) plus or minus the Spread, if any, or (ii) multiplied by the Spread Multiplier, if any. The ‘‘Spread’’ is the number of basis points (one one-hundredth of a percentage point) specified in the applicable Pricing Supplement to be added to or subtracted from the Interest Rate Basis of such Floating Rate Note, and the ‘‘Spread Multiplier’’ is the percentage specified in the applicable Pricing Supplement to be applied to the Interest Rate Basis for such Floating Rate Note. The ‘‘Interest Rate Basis’’ is the rate specified, or determined according to a formula specified, in the applicable Pricing Supplement.

Fixed Rate Note If a Note is a Fixed Rate Note (other than a Zero Coupon Note) interest (in the case of a U.S. dollar-denominated Note, computed on the basis of a 360-day year of twelve 30-day months (‘‘30/360’’), in the case of a euro-denominated Note, computed on the basis of 30/360, Actual/Actual (ICMA) (as defined below) or as otherwise specified, in each case, in the applicable Pricing Supplement) will accrue from its Interest Commencement Date (or from the most recent date to which interest has been paid or made available for payment) on the unpaid principal amount (and, to the extent lawful, on overdue principal (including premium or redemption amount, if any, and, if a Note is an Original Issue Discount Note, the Amortized Face Amount or other amounts payable in respect thereof) and interest, if any, at the Rate of Interest per annum specified in the applicable Pricing Supplement, and will be payable in arrears on such dates in each year as are specified in the applicable Pricing Supplement (each an ‘‘Interest Payment Date’’), commencing, unless otherwise specified in the applicable Pricing Supplement, with the first such Interest Payment Date falling at least fifteen days after the Issue Date of such Note specified on the face of such Note, and at the Maturity Date or any redemption or repayment date, until

98 the principal thereof will be paid or made available for payment. Unless otherwise specified in the applicable Pricing Supplement, the interest payable on any Interest Payment Date will be the unpaid interest accrued from and including the Issue Date for the Notes or from and including the most recent date in respect of which interest has been paid or made available for payment to, but excluding, such Interest Payment Date and interest payable on the Maturity Date or upon redemption or repayment will include accrued interest from the Issue Date for the Notes or from and including the most recent date in respect of which interest has been paid or made available for payment to, but excluding, the Maturity Date or redemption or repayment date (in each case, an ‘‘Interest Period’’). ‘‘Actual/Actual (ICMA)’’ means (a) in the case of Notes where the number of days in the relevant period from (and including) the most recent Interest Payment Date (or, if none, the Interest Commencement Date) to (but excluding) the relevant payment date (the ‘‘Accrual Period’’) is equal to or shorter than the Interest Period during which the Accrual Period ends, the number of days in such Accrual Period divided by the product of (1) the number of days in such Interest Period and (2) the number of Interest Payment Dates (as specified in the applicable Pricing Supplement) that would occur in one calendar year; or (b) in the case of Notes where the Accrual Period is longer than the Interest Period during which the Accrual Period ends, the sum of: (1) the number of days in such Accrual Period falling in the Interest Period in which the Accrual Period begins divided by the product of (x) the number of days in such Interest Period and (y) the number of Interest Determination Dates (as specified in the applicable Pricing Supplement) that would occur in one calendar year; and (2) the number of days in such Accrual Period falling in the next Interest Period divided by the product of (x) the number of days in such Interest Period and (y) the number of Interest Determination Dates that would occur in one calendar year. Floating Rate Note If a Note is a Floating Rate Note, interest will accrue on such Note from the Interest Commencement Date specified in the applicable Pricing Supplement (or from the most recent date to which interest has been paid or made available for payment) on the unpaid principal amount (and, to the extent lawful, on overdue principal (including premium or redemption amount, if any, and, if a Note is an Original Issue Discount Note, the Amortized Face Amount or other amounts payable in respect thereof) and interest, if any) at a rate per annum equal to the Rate of Interest specified in the applicable Pricing Supplement until the first Reset Date (as defined below) specified in the applicable Pricing Supplement, or if none is specified, until the first Interest Payment Date following the Issue Date and thereafter at a rate determined in accordance with the applicable provisions set forth below or in the applicable Pricing Supplement, as specified in the applicable Pricing Supplement, and will be payable by the Company monthly, quarterly, semi-annually, annually or at such other intervals specified in the applicable Pricing Supplement under ‘‘Interest Periods’’ and on the dates specified in the applicable Pricing Supplement under ‘‘Interest Payment Dates’’ and at maturity or upon earlier redemption or repayment, until the entire principal amount thereof is paid or made available for payment. Any Floating Rate Note may provide that the Notes bear interest at a fixed rate for certain interest periods and a floating rate for certain interest periods and may also have either or both of the following, each as may be set forth in the applicable Pricing Supplement: (i) a maximum interest rate limitation, or ceiling, on the rate at which interest may accrue during any interest period (‘‘Maximum Interest Rate’’) and/or (ii) a minimum interest rate limitation, or floor, on the rate at which interest may accrue during any interest period (‘‘Minimum Interest Rate’’). In addition, the applicable Pricing Supplement will define or particularize for each Floating Rate Note the following terms, if applicable: the period to maturity of the instrument or obligation on which the interest rate formula is based (the ‘‘Index Maturity’’), the Rate of Interest, the Interest Commencement Date, the Interest Payment Date or Dates and the Reset Dates with respect to such Note. Unless otherwise specified in the applicable Pricing Supplement, the interest payable on a Floating Rate Note on any Interest Payment Date will be the unpaid interest accrued from and including its Issue

99 Date or from and including the most recent date in respect of which interest has been paid or made available for payment to, but excluding, such Interest Payment Date and interest payable on the Maturity Date or upon redemption or repayment will include accrued interest from the Issue Date or from and including the most recent date in respect of which interest has been paid or made available for payment to, but excluding, the Maturity Date or redemption or repayment date. Unless otherwise specified in the applicable Pricing Supplement, accrued interest will be calculated by multiplying the principal amount of the Note by an accrued interest factor. Such accrued interest factor will be computed, unless otherwise specified in the applicable Pricing Supplement, by adding the interest factor calculated for each day from the Issue Date or from the most recent date to which interest has been paid or made available for payment, as the case may be, to the date for which accrued interest is being calculated. Unless otherwise specified in the applicable Pricing Supplement, the interest factor for each such day (expressed as a decimal rounded, if necessary, as described below) will be computed by dividing the interest rate (expressed as a decimal rounded, if necessary, as described below) applicable to such day by 360 or, in the case of Treasury Rate Notes and Notes denominated or payable in Sterling or Canadian Dollars, by the actual number of days in the year. All percentages resulting from any calculation with respect to such Note will be rounded, unless otherwise specified in the applicable Pricing Supplement, to the nearest one-hundred thousandth of a percentage point, with five or more one-millionths of a percentage point being rounded upwards to the next higher one-hundred thousandth of a percentage point (e.g., 9.876545% (or .09876545) being rounded to 9.87655% (or .0987655)), and all currency or composite currency amounts used in or resulting from such calculations will be rounded to the nearest one-hundredth of a unit (with .005% of a unit being rounded upwards).

Unless otherwise specified in the applicable Pricing Supplement, the rate of interest on a Floating Rate Note will be calculated with reference to the Interest Rate Basis specified in the applicable Pricing Supplement and reset daily, weekly, monthly, quarterly, semi-annually or annually, or at such other intervals (each an ‘‘Interest Reset Period’’), in each case as specified in the applicable Pricing Supplement, and such interest rate will be reset on the Reset Dates specified in the applicable Pricing Supplement (each date upon which interest is so reset, a ‘‘Reset Date’’); provided, however, that (i) the interest rate in effect for the period ending on the first Reset Date, or if none is specified, on the first Interest Payment Date, will be the Rate of Interest specified in the applicable Pricing Supplement, (ii) the interest rate in effect for the ten calendar days immediately prior to the Maturity Date will be that in effect on the tenth calendar day preceding such Maturity Date and (iii) if a Floating Rate Note is designated as a Fixed Rate/Floating Rate Note in the applicable Pricing Supplement, the interest rate commencing on and including the fixed rate commencement date through to the fixed rate termination date, the maturity date, redemption date or optional redemption date, as the case may be, will be the fixed interest rate specified therein. Notwithstanding the foregoing, the interest rate on a Floating Rate Note will not be greater than the Maximum Interest Rate, if any, or less than the Minimum Interest Rate, if any, and in no event will be higher than the maximum rate permitted by New York law, as the same may be modified by United States law of general application. Except as provided in the next succeeding sentence or in the applicable Pricing Supplement, the Reset Date with respect to each Floating Rate Note will be: if the Interest Reset Period specified in such Note is daily, each Business Day; if the Interest Reset Period specified in such Note is weekly (unless the Interest Rate Basis specified in such Note is the Treasury Rate), the Wednesday of each week; if the Interest Reset Period specified in such Note is weekly and the Interest Rate Basis specified in such Note is the Treasury Rate, the Tuesday of each week; if the Interest Reset Period is monthly, the third Wednesday of each month; if the Interest Reset Period is quarterly, the third Wednesday of each March, June, September and December; if the Interest Reset Period is semiannually, the third Wednesday of two months in each year specified in the applicable Pricing Supplement; and if the Interest Reset Period is annually, the third Wednesday of the one month in each year specified in the applicable Pricing Supplement. If, pursuant to the preceding sentence, any Reset Date would otherwise be a day that is not a Market Day (as defined below) with respect to such Note, the Reset Date will be the next succeeding day that is a Market Day with respect to such Note, except that if the Interest Rate Basis is LIBOR and the next succeeding such Market Day falls in the next succeeding calendar month, such Reset Date will be the immediately preceding Market Day. Subject to applicable provisions of law

100 and except as may be provided in the applicable Pricing Supplement for a Floating Rate Note, on each Reset Date the rate of interest on such Note will be the rate determined in accordance with the provisions of the applicable heading below. ‘‘Market Day’’ means, unless otherwise specified in the applicable Pricing Supplement, with respect to any Note other than a LIBOR or EURIBOR (as defined below under ‘‘Determination of EURIBOR’’) Note, any Business Day, with respect to a LIBOR Note, any Business Day which is also London Business Day and, with respect to a EURIBOR Note, any TARGET Business Day (as defined below under ‘‘Determination of EURIBOR’’). ‘‘London Business Day’’ means any day on which dealings in deposits in the Specified Currency are transacted in the London interbank market. Subject to applicable provisions of law and except as provided herein and in the applicable Pricing Supplement, on each Reset Date the Rate of Interest on each Note shall be the rate determined in accordance with provisions of the applicable Pricing Supplement and set out as below, as applicable. The interest rate in effect on each day will be (a) if such day is a Reset Date, the interest rate with respect to the date on which the Rate of Interest is to be determined (as ‘‘Interest Determination Date’’) specified under the applicable heading below, or as otherwise specified in the applicable Pricing Supplement pertaining to such Reset Date, or (b) if such day is not a Reset Date, the interest rate with respect to the Interest Determination Date pertaining to the immediately preceding Reset Date, subject in either case to any Maximum or Minimum Interest Rate referred to above, to any adjustment by a Spread or a Spread Multiplier referred to above and to the provisions of the applicable Pricing Supplement. Determination of LIBOR If the Interest Rate Basis of a Note provides for payment of interest at a rate to be determined by reference to LIBOR, the Interest Determination Date pertaining to a Reset Date for such Note (the ‘‘LIBOR Determination Date’’) will be the second London Business Day (except in the case of Notes denominated in Sterling, for which the LIBOR Determination Date will be the first day of the relevant Interest Reset Period) preceding such Reset Date, and such Note will bear interest in accordance with the following provisions: (a) With respect to any LIBOR Determination Date, LIBOR will be ‘‘LIBOR Reuters’’, the arithmetic mean (rounded, if necessary, to the fourth decimal place, with 0.00005 being rounded upwards) of the offered rates (unless the specified designated LIBOR Page (as defined below) by its terms provides only for a single rate, in which case such single rate will be used) for deposits in the Specified Currency having the Index Maturity designated in the Note and/or the applicable Pricing Supplement, commencing on the second London Business Day immediately following the LIBOR Determination Date (or, in the case of Notes denominated in Sterling, on such LIBOR Determination Date), which appear on the Designated LIBOR Page specified in the Note and/or the applicable Pricing Supplement as of 11:00 a.m., London time, on that LIBOR Determination Date, if at least two such offered rates appear (unless, as aforesaid, only a single rate is required) on such Designated LIBOR Page. Notwithstanding the foregoing, if no rate appears, LIBOR in respect of the related LIBOR Determination Date will be determined as if the parties had specified the rate described in clause (b) below; and (b) With respect to any LIBOR Determination Date on which fewer than two offered rates appear, or if no rate appears, as the case may be, on the Designated LIBOR Page as specified above, the Calculation Agent will request the principal London office of each of four major reference banks in the London interbank market, selected by the Calculation Agent, to provide the Calculation Agent with its offered rate quotation for deposits in the Specified Currency having the Index Maturity designated in the Note and/or the applicable Pricing Supplement, commencing on the second London Business Day immediately following such LIBOR Determination Date (or, in the case of Notes denominated in Sterling, on such LIBOR Determination Date), to prime banks in the London interbank market as of approximately 11:00 a.m., London time, on such LIBOR Determination Date and in a principal amount that is representative for a single transaction in such Specified Currency in such market at such time. If at least two such quotations are provided, LIBOR determined on such LIBOR Determination Date will be the arithmetic mean (rounded, if necessary, to the fourth decimal place, with 0.00005 being rounded

101 upwards) of such quotations. If fewer than two quotations are provided, LIBOR determined on such LIBOR Determination Date will be the arithmetic mean (rounded, if necessary, to the fourth decimal place, with 0.00005 being rounded upwards) of the rates quoted as of approximately 11:00 a.m. (or such other time specified in the applicable Pricing Supplement) in the applicable Principal Financial Center (as defined below) for the Specified Currency on such LIBOR Determination Date by three major banks in such Principal Financial Center, selected by the Calculation Agent, for loans in the Specified Currency to leading European banks, having the Index Maturity designated in the Note and/or the applicable Pricing Supplement and in a principal amount that is representative for a single transaction in such Specified Currency in such market at such time; provided, however, that if the banks so selected by the Calculation Agent are not quoting as mentioned in this sentence, LIBOR determined on such LIBOR Determination Date will remain LIBOR then in effect on such LIBOR Determination Date. ‘‘Designated LIBOR Page’’ means the display on the Reuters Monitor Money Rates Service for the purpose of displaying the London interbank rates of major banks for the applicable Specified Currency. ‘‘Principal Financial Center’’ means, as with respect to any LIBOR Note, unless otherwise specified in the Note and the applicable Pricing Supplement, the capital city of the country that issues as its legal tender the Specified Currency of such Note, except that with respect to U.S. Dollars, the Principal Financial Center will be The City of New York and, with respect to euro, the Principal Financial Center will be Brussels.

Determination of EURIBOR If the Interest Rate Basis of a Note provides for payment of interest at a rate to be determined by reference to the Euro-zone (as defined below) interbank offered rate (‘‘EURIBOR’’), the Interest Determination Date pertaining to a Reset Date for such Note (the ‘‘EURIBOR Determination Date’’) will be the second TARGET Business Day (as defined below) preceding such Reset Date, and such Note will bear interest in accordance with the following provisions: (a) With respect to any EURIBOR Determination Date, EURIBOR will be the rate for deposits in euro having the Index Maturity designated in the Note and/or the applicable Pricing Supplement, commencing on the second TARGET Business Day immediately following such EURIBOR Determination Date which appears on the Designated EURIBOR Page (as defined below) specified in the Note and/or the applicable Pricing Supplement as of 11:00 a.m., Brussels time, on that EURIBOR Determination Date. Notwithstanding the foregoing, if no rate appears, EURIBOR in respect of the related EURIBOR Determination Date will be determined as if the parties had specified the rate described in clause (b) below; and (b) With respect to any EURIBOR Determination Date on which no rate appears on the Designated EURIBOR Page as specified above, the Calculation Agent will request the principal Brussels office of each of four major reference banks in the Euro-zone interbank market, selected by the Calculation Agent, to provide the Calculation Agent with its offered rate quotation for deposits in euro having the Index Maturity designated in the Note and/or the applicable Pricing Supplement, commencing on the second TARGET Business Day immediately following such EURIBOR Determination Date to prime banks in the Euro-zone interbank market as of approximately 11:00 a.m., Brussels time, on such EURIBOR Determination Date and in a principal amount that is representative for a single transaction in euro in such market at such time. If at least two such quotations are provided, EURIBOR determined on such EURIBOR Determination Date will be the arithmetic mean (rounded, if necessary, to the nearest unit (as defined below), with halves being rounded upwards) of such quotations. If fewer than two quotations are provided, EURIBOR determined on such EURIBOR Determination Date will be the arithmetic mean (rounded, if necessary, to the nearest unit (as defined below), with halves being rounded upwards) of the rates quoted as of approximately 11:00 a.m. (or such other time specified in the applicable Pricing Supplement) Brussels for euro on such EURIBOR Determination Date by leading banks in Brussels, selected by the Calculation Agent, for loans in euro to leading European banks, having the Index Maturity designated in the Note and/or the applicable Pricing Supplement and in a principal amount that is representative for a single transaction in euro in such market at such time; provided, however, that if the banks so selected by the Calculation Agent are not quoting as mentioned in this

102 sentence, EURIBOR determined on such EURIBOR Determination Date will remain EURIBOR then in effect on such EURIBOR Determination Date. ‘‘Designated EURIBOR Page’’ means the display on page 248 of the Dow Jones Telerate Service for the purpose of displaying the Euro-zone interbank rates of major banks for euro. ‘‘Euro-zone’’ means the region comprised of Member States of the European Union that adopt the single currency in accordance with the Treaty establishing the European Communities, as amended by the Treaty on European Union. ‘‘TARGET’’ means the Trans-European Automated Real-Time Gross Settlement Express Transfer System. ‘‘TARGET Business Day’’ means a day on which TARGET is operating. ‘‘Unit’’ means 0.01 euro. Determination of ISDA Rate If the Interest Rate Basis of a Note provides for the payment of interest at a rate determined by reference to the ISDA Rate, interest will be determined on the same basis as the floating rate under a notional interest rate swap transaction in the relevant Specified Currency governed by an agreement incorporating the 2006 ISDA Definitions, as amended and updated as at the Issue Date of the first Tranche of Notes (the ‘‘ISDA Definitions’’), as published by the International Swaps and Derivatives Association Inc. (‘‘ISDA’’). The ISDA Rate for any ISDA Rate Determination Date (as defined below) will be determined by the Calculation Agent in accordance with the following provisions: (a) On the second Market Day or such other day which is the convention for a Specified Currency prior to the Issue Date (an ‘‘ISDA Rate Determination Date’’), the Calculation Agent will determine the ISDA Rate by reference to the Floating Rate (as defined in the ISDA Definitions) in accordance with clause (b) below, adjusted by the addition or subtraction of the Spread, if any, specified in such Note and/or by multiplication by the Spread Multiplier, if any, specified in such Note; and (b) The ISDA Rate will be equal to the Floating Rate determined (regardless of any event of default, termination event or taxation event) by the Calculation Agent as if the Company had entered into an interest rate swap transaction governed by an agreement in the form of the ISDA Master Agreement (Multi-Currency-Cross Boarder) (an ‘‘ISDA Agreement’’) published by ISDA and evidenced by a Confirmation (as defined in the ISDA Agreement) incorporating the ISDA Definitions with the holder of the relevant Note under which: (1) the Floating Rate Option was as specified in the applicable Pricing Supplement; (2) the Company was the Floating Rate Payer; (3) the Fiscal Agent was the Calculation Agent or as otherwise specified in the applicable Pricing Supplement; (4) the Interest Commencement Date was the Effective Date; (5) the aggregate nominal amount of the Notes of the Series of which such Note is a part was the Notional Amount; (6) the applicable Interest Payment Period for such Note was the Designated Maturity; (7) the Interest Payment Dates for such Note were the Payment Dates for the Floating Rate Payer; and (8) all other items were as specified in the applicable Pricing Supplement. For purposes of this subsection, ‘‘Floating Rate Option’’, ‘‘Floating Rate Payer,’’ ‘‘Calculation Agent,’’ ‘‘Effective Date,’’ ‘‘Notional Amount,’’ ‘‘Designated Maturity’’ and ‘‘Payment Dates’’ have the meanings given to those terms in the ISDA Definitions. Determination of CD Rate If the Interest Rate Basis of a Note provides for payment of interest at a rate to be determined by reference to the CD Rate, the interest rate with respect to such Note for any Reset Date will equal (a)

103 the rate on the second Market Day with respect to such Note immediately preceding such Reset Date (the ‘‘CD Rate Determination Date’’) for negotiable certificates of deposit having the Index Maturity designated in the applicable Pricing Supplement (i) as published by the Board of Governors of the United States Federal Reserve System in the weekly statistical release entitled ‘‘Statistical Release H.15(519), Selected Interest Rates,’’ or any successor publication published (‘‘H.15(519)’’), under the heading ‘‘CDs (Secondary Market)’’ or (ii) if such rate is not so published by 9:00 a.m., New York City time, on the Calculation Date pertaining to such CD Rate Determination Date, then as published in the daily statistical release entitled ‘‘Composite 3:30 p.m. quotations for U.S. Government Securities’’ (‘‘Composite Quotations’’) under the heading ‘‘Certificates of Deposit’’ or (b) if such rate is not published in either H.15(519) or Composite Quotations by 3:00 p.m., New York City time, on such Calculation Date, the arithmetic mean (rounded, if necessary, to the fourth decimal place, with 0.00005 being rounded upwards), as calculated by the Calculation Agent on such Calculation Date, of the secondary market offered rates as of approximately 10:00 a.m., New York City time, on such CD Rate Determination Date, of three leading non-bank dealers in negotiable U.S. Dollar certificates of deposit in The City of New York (which may include the Dealers) selected by the Calculation Agent, for negotiable certificates of deposit of major United States money market banks with a remaining maturity closest to the Index Maturity designated in the applicable Pricing Supplement in denominations of U.S.$5,000,000, in each of the above cases adjusted by the addition or subtraction of the Spread, if any, specified in the applicable Pricing Supplement or by multiplication by the Spread Multiplier, if any, specified in the applicable Pricing Supplement; provided, however, that if the dealers selected as aforesaid by the Calculation Agent are not quoting as mentioned in this sentence, the CD Rate will remain the CD Rate then in effect on such CD Rate Determination Date.

Determination of Commercial Paper Rate If the Interest Rate Basis of a Note provides for the payment of interest at a rate to be determined by reference to the Commercial Paper Rate, the interest rate with respect to such Note for any Reset Date will equal (a) the Money Market Yield (calculated as described below) on such date of the rate on the second Market Day with respect to such Note immediately preceding such Reset Date (the ‘‘Commercial Paper Rate Determination Date’’) for commercial paper having the Index Maturity designated in the applicable Pricing Supplement (i) as published in H.15(519) under the caption ‘‘Commercial Paper- nonfinancial’’ or (ii) if such rate is not published by 9:00 a.m., New York City time, on the Calculation Date pertaining to such Commercial Paper Rate Determination Date, then as published in Composite Quotations under the heading ‘‘Commercial Paper-nonfinancial’’ or (b) if such yield is not published in either H.15(519) or Composite Quotations by 3:00 p.m., New York City time, on such Calculation Date, the Money Market Yield of the arithmetic mean (rounded, if necessary, to the fourth decimal place, with 0.00005 being rounded upwards), as calculated by the Calculation Agent on such Calculation Date, of the offered per annum rates (quoted on a bank discount basis), as of approximately 11:00 a.m., New York City time, on such Commercial Paper Rate Determination Date, of three leading dealers in commercial paper in The City of New York, selected by the Calculation Agent, for commercial paper having the Index Maturity designated in the applicable Pricing Supplement placed for an industrial issuer whose bond rating is ‘‘AA,’’ or the equivalent, from a nationally recognized statistical rating agency, in each of the above cases adjusted by the addition or subtraction of the Spread, if any, specified in the applicable Pricing Supplement or by multiplication by the Spread Multiplier, if any, specified in the applicable Pricing Supplement; provided, however, that if fewer than three dealers selected as aforesaid by the Calculation Agent are quoting as mentioned in this sentence, the Commercial Paper Rate with respect to such Commercial Paper Rate Determination Date will remain the Commercial Paper Rate then in effect on such Commercial Paper Rate Determination Date. ‘‘Money Market Yield’’ means a yield (expressed as a percentage rounded to the nearest one hundred-thousandth of a percentage point) calculated in accordance with the following formula:

Money Market Yield = D x 360 x 100 360-(D x M)

104 where ‘‘D’’ refers to the per annum rate for commercial paper, quoted on a bank discount basis and expressed as a decimal; and ‘‘M’’ refers to the actual number of days in the period for which interest is being calculated.

Determination of Prime Rate If the Interest Rate Basis of a Note provides for the payment of interest at a rate to be determined by reference to the Prime Rate, the interest rate with respect to such Note for any Reset Date will equal (a) the rate on the second Market Day with respect to such Note immediately preceding such Reset Date (the ‘‘Prime Rate Determination Date’’) as published in H.15(519) under the heading ‘‘Bank Prime Loan’’ or (b) if such rate is not so published by 9:00 a.m., New York City time, on the Calculation Date pertaining to such Prime Rate Determination Date, the arithmetic mean (rounded, if necessary, to the fourth decimal place, with 0.00005 being rounded upwards) of the rates of interest publicly announced by each bank named on the Reuters Screen USPRIME1 (as defined herein) as such bank’s prime rate or base lending rate as in effect on such Prime Rate Determination Date or (c) if fewer than four such rates appear on the Reuters Screen USPRIME1 for such Prime Rate Determination Date, the arithmetic mean (rounded, if necessary, to the fourth decimal place, with 0.00005 being rounded upwards) of the prime rates or base lending rates (quoted on the basis of the actual number of days in the year divided by 360) as of the close of business on such Prime Rate Determination Date publicly announced by three major banks in The City of New York, selected by the Calculation Agent, as each of their prime rates or base lending rates, in each of the above cases adjusted by the addition or subtraction of the Spread, if any, specified in the applicable Pricing Supplement or by multiplication by the Spread Multiplier, if any, specified in the applicable Pricing Supplement; provided, however, that if the Prime Rate is not published in H.15(519) or fewer than three banks selected as aforesaid by the Calculation Agent are quoting as mentioned in this sentence, the Prime Rate with respect to such Prime Rate Determination Date will remain the Prime Rate then in effect on such Prime Rate Determination Date. ‘‘Reuters Screen USPRIME1’’ means the display designated as page ‘‘USPRIME1’’ on the Reuters Monitor Money Rates Service (or such other page as may replace the USPRIME1 page on that service for the purpose of displaying prime rates or base lending rates of major United States banks).

Determination of Federal Funds Rate If the Interest Rate Basis of a Note provides for the payment of interest at a rate to be determined by reference to the Federal Funds Rate, the interest rate with respect to such Note for any Reset Date will equal (a) the rate on the second Market Day with respect to such Note immediately preceding such Reset Date (the ‘‘Federal Funds Rate Determination Date’’) for Federal Funds (i) as published in H.15(519) under the heading ‘‘Federal Funds (Effective)’’ or (ii) if such rate is not so published by 9:00 a.m., New York City time, on the Calculation Date pertaining to such Federal Funds Rate Determination Date, then as published in Composite Quotations under the heading ‘‘Federal Funds/ Effective Rate’’ or (b) if such rate is not published by 3:00 p.m., New York City time, on the Calculation Date pertaining to such Federal Funds Rate Determination Date, the arithmetic mean (rounded, if necessary, to the fourth decimal place, with 0.00005 being rounded upwards), as calculated by the Calculation Agent on such Calculation Date, of the rates for the last transaction in overnight Federal Funds arranged by three leading brokers of Federal Funds transactions in The City of New York, selected by the Calculation Agent, as of 9:00 a.m., New York City time, on such Federal Funds Rate Determination Date, in each of the above cases adjusted by the addition or subtraction of the Spread, if any, speciﬁed in the applicable Pricing Supplement or by multiplication by the Spread Multiplier, if any, speciﬁed in the applicable Pricing Supplement; provided, however, that if fewer than three brokers selected as aforesaid by the Calculation Agent are quoting as mentioned in this sentence, the Federal Funds Rate with respect to such Federal Funds Rate Determination Date will remain the Federal Funds Rate then in effect on such Federal Funds Rate Determination Date.

Determination of Treasury Rate If the Interest Rate Basis of a Note provides for the payment of interest at a rate to be determined by reference to the Treasury Rate, the interest rate with respect to such Note for any Reset Date will

105 equal (a) the rate for the auction on the relevant Treasury Rate Determination Date (as defined below) of direct obligations of the United States (‘‘Treasury Bills’’) having the Index Maturity specified on the Note and in the applicable Pricing Supplement as such rate is published in H.15(519) under the heading ‘‘U.S. Government Securities/Treasury Bills/Auction Average (Investment)’’ or (b) if such rate is not so published by 3:00 p.m., New York City time, on the Calculation Date pertaining to such Treasury Rate Determination Date, the auction average rate (expressed as a bond equivalent on the basis of a year of 365 or 366 days, as applicable, and applied on a daily basis) as otherwise announced by the United States Department of the Treasury or (c) in the event that the results of the auction of Treasury Bills having the specified Index Maturity are not published or reported as provided in (a) or (b) above, by 3:00 p.m., New York City time, on such Calculation Date, or if no such auction is held during such week, then the rate as published in H.15(519) under the heading ‘‘U.S. Government Securities/Treasury Bills/Secondary Market’’ on the Treasury Rate Determination Date for the Index Maturity specified on the Note and in the applicable Pricing Supplement or (d) in the event no such rate is published as provided in (c) above, by 3:00 p.m., New York City time, on such Calculation Date, the yield to maturity (expressed as a bond equivalent on the basis of a year of 365 or 366 days, as applicable, and applied on a daily basis) of the arithmetic mean (rounded, if necessary, to the fourth decimal place, with 0.00005 being rounded upwards) of the secondary market bid rates, as of approximately 3:30 p.m., New York City time, on such Treasury Rate Determination Date, of three leading primary United States government securities dealers in The City of New York, selected by the Calculation Agent, for the issue of Treasury Bills with a remaining maturity closest to the applicable Index Maturity, in each of the above cases adjusted by the addition or subtraction of the Spread, if any, specified in the applicable Pricing Supplement or by multiplication by the Spread Multiplier, if any, specified in the applicable Pricing Supplement; provided, however, that if fewer than three dealers selected as aforesaid by the Calculation Agent are quoting as mentioned in this sentence, the Treasury Rate with respect to such Treasury Rate Determination Date will remain the Treasury Rate then in effect on such Treasury Rate Determination Date. The ‘‘Treasury Rate Determination Date’’ pertaining to a Reset Date will be the day of the week in which such Reset Date falls on which Treasury Bills would normally be auctioned. Treasury Bills are usually sold at auction on Monday of each week, unless that day is a legal holiday, in which case the auction is usually held on the following Tuesday, except that such auction may be held on the preceding Friday. If, as a result of a legal holiday, an auction is so held on the preceding Friday, such Friday will be the Treasury Rate Determination Date pertaining to the Reset Date occurring in the next succeeding week. If an auction date will fall on any Reset Date, then such Reset Date will instead be the first Market Day immediately following such auction date. Determination of Eleventh District Cost of Funds Rate If the Interest Rate Basis of a Note provides for the payment of interest at a rate to be determined by reference to the Eleventh District Cost of Funds Rate, the interest rate with respect to such Note for any Reset Date will equal the rate calculated by (a) obtaining the monthly Eleventh District Cost of Funds Index (the ‘‘Index’’) published by the Federal Home Loan Bank (‘‘FHLB’’) of San Francisco during the month immediately preceding the second Market Day (the ‘‘Eleventh District Cost of Funds Rate Determination Date’’) with respect to the Note immediately preceding such Reset Date or (b) if the FHLB of San Francisco fails in any month to publish the Index, then the Eleventh District Cost of Funds Rate for the first Eleventh District Cost of Funds Rate Determination Date after such failure will be calculated on the basis of the Index most recently published prior to such Eleventh District Cost of Funds Rate Determination Date. If such failure occurs in the month immediately following a month in which a prior such failure occurred, then the Eleventh District Cost of Funds Rate Determination Date immediately following the second such failure will be calculated on the basis of the Index most recently published prior to such Eleventh District Cost of Funds Rate Determination Date and, thereafter, the Eleventh District Cost of Funds Rate for each succeeding Eleventh District Cost of Funds Rate Determination Date until the maturity or redemption of such Eleventh District Cost of Funds Rate Notes will be LIBOR, determined as if such Notes were LIBOR Notes, in each of the above cases adjusted by the addition or subtraction of the Spread, if any, specified in the applicable Pricing Supplement (which may be an Alternate Spread if the interest rate on such Note is determined as if it were a LIBOR Note in accordance with the foregoing procedures), or by multiplication by the Spread Multiplier, if any,

106 speciﬁed in the applicable Pricing Supplement (which may be an Alternate Spread Multiplier if the interest rate on such Note is determined as if it were a LIBOR Note in accordance with the foregoing procedures). Unless otherwise speciﬁed in the applicable Pricing Supplement, the ‘‘Calculation Date,’’ if applicable, pertaining to any Interest Determination Date will be the earlier of (i) the tenth calendar day after such Interest Determination Date or, if such day is not a Business Day, the next succeeding Business Day, or (ii) the Business Day preceding the applicable Interest Payment Date or Maturity Date, as the case may be. At the request of the Holder hereof, the Calculation Agent will provide to the Holder the interest rate then in effect on such Note and, if determined, the interest rate which will become effective as of the next Reset Date.

Calculation Agent Unless otherwise specified in the applicable Pricing Supplement, the Fiscal Agent or other duly authorized calculation agent, will act as Calculation Agent for all purposes under the Notes, and, by way of amplification but not limitation, for each LIBOR Determination Date, CD Rate Determination Date, Commercial Paper Rate Determination Date, Prime Rate Determination Date, Federal Funds Rate Determination Date, Treasury Rate Determination Date or Eleventh District Costs of Funds Rate Determination Date, as the case may be, in the case of Floating Rate Notes, or Interest Payment Date in the case of Fixed Rate Notes, will determine the interest rate as described above or in the applicable Pricing Supplement, and if applicable will determine the Redemption Amount if provided for in the applicable Pricing Supplement, and will notify Holders in accordance with the provisions of the Fiscal Agency Agreement. The Calculation Agent’s determination, or the determination of any other calculation agent or redemption calculation agent specified in the applicable Pricing Supplement, of any interest rate or redemption or other amounts will be, in the absence of manifest error, conclusive for all purposes and binding on all Holders of Notes.

Notification of Rate of Interest and Interest Amount The Calculation Agent will cause the Rate of Interest and the amount of interest payable (the ‘‘Interest Amount’’) for each Interest Period and the relevant Interest Payment Date to be notified to the Company, and the Fiscal Agent, the Paying Agents, the Registrar and any stock exchange on which the relevant Floating Rate Notes are for the time being listed, and to be notified in accordance with ‘‘Notices by the Company’’ below as soon as possible after their determination but in no event later than the fourth London Business Day thereafter. Each Interest Amount and Interest Payment Date so notified may subsequently be amended (or appropriate alternative arrangements made by way of adjustment) without notice in the event of an extension or shortening of the Interest Period. Any such amendment will be promptly notified to each stock exchange on which the relevant Floating Rate Notes are for the time being listed. For the purposes of this paragraph, the expression ‘‘London Business Day’’ means a day (other than Saturday or Sunday) on which banks and foreign exchange markets are open for business in London.

Certiﬁcates to be Final All certiﬁcates, communications, opinions, determinations, calculations, quotations and decisions given, expressed, made or obtained for the purposes of determinations of interest rates by the Calculation Agent will (in the absence of negligence, willful misconduct, bad faith or manifest error) be binding on the Company, the Fiscal Agent, the other Paying Agents and all Holders of Notes, and (in the absence as aforesaid) no liability to the Company or the Holders of Notes will attach to such agent in connection with the exercise or non-exercise by it of its powers, duties and discretions.

107 Business Day If any Interest Payment Date (or other date) which is specified in the applicable Pricing Supplement to be subject to adjustment in accordance with a Business Day convention would otherwise fall on a day which is not a Business Day, then, if the Business Day convention specified is: (a) the ‘‘Floating Rate Convention,’’ such Interest Payment Date (or other date) will be postponed to the next day which is a Business Day unless it would thereby fall into the next calendar month, in which event (1) such Interest Payment Date (or other date) will be brought forward to the immediately preceding Business Day and (2) after the foregoing (1) will have applied, each subsequent Interest Payment Date (or other date) will be the last Business Day of the last month of each subsequent Interest Period; or (b) the ‘‘Following Business Day Convention,’’ such Interest Payment Date (or other date) will be postponed to the next day which is a Business Day; or (c) the ‘‘Modified Following Business Day Convention,’’ such Interest Payment Date (or other date) will be postponed to the next day which is a Business Day unless it would thereby fall into the next calendar month, in which event such Interest Payment Date (or other date) will be brought forward to the immediately preceding Business Day; or (d) the ‘‘Preceding Business Day Convention,’’ such Interest Payment Date (or other date) will be brought forward to the immediately preceding Business Day. ‘‘Business Day’’ means (unless otherwise stated in the applicable Pricing Supplement) a day which is both: (a) a day (other than a Saturday or Sunday) on which commercial banks and foreign exchange markets settle payments in New York and Tel Aviv, it being understood that commercial banks and foreign exchange markets in Tel Aviv generally settle payments on those Fridays that are not holidays; and (b) either (1) in relation to interest payable in a Specified Currency other than euro, a day on which commercial banks and foreign exchange markets settle payments in the principal financial center of the country of the relevant Specified Currency (if other than New York or Tel Aviv) or (2) in relation to interest payable in euro, a TARGET Business Day on which commercial banks and foreign exchange markets are open for business in the place of presentation and are open for business and carrying out transactions in euro in the jurisdiction in which the euro account specified by the payee is located. Zero Coupon Notes and Original Issue Discount Notes If the Rate of Interest specified in the applicable Pricing Supplement is ‘‘zero,’’ such Note is a ‘‘Zero Coupon Note’’ and will not bear interest; provided, that from the Maturity Date or any other due date for repayment of such Note, any overdue amount payable on such Note will bear interest at a rate per annum (expressed as a percentage) equal to the Accrual Yield (as defined below) specified in the applicable Pricing Supplement (computed on the basis of a 360-day year of twelve 30-day months, unless otherwise specified in the applicable Pricing Supplement) until all amounts due in respect of such Note have been paid. The applicable Pricing Supplement will specify whether a Note is an Original Issue Discount Note. An Original Issue Discount Note is a Note (including any Zero Coupon Note) that is treated as having been issued with Original Issue Discount for United States federal income tax purposes (an ‘‘Original Issue Discount Note’’) and, in the event of acceleration of maturity of such Note, the amount payable thereon in lieu of the principal amount due at the Maturity Date thereof will be the amount (the ‘‘Amortized Face Amount’’) equal to (a) the Issue Price (as defined below) plus (b) that portion of the difference between the Issue Price and the principal amount that has accrued at the Accrual Yield (calculated in accordance with the method set forth in the applicable Pricing Supplement) at the date as of which the Amortized Face Amount is calculated, but in no event will the Amortized Face Amount exceed the principal amount of such Note due at the Maturity Date thereof. As used herein, (x) ‘‘Issue Price’’ means (a) the principal amount of a Note less (b) the Original Issue Discount thereof, (y) ‘‘Accrual Yield’’ means the yield-to-maturity stated in the applicable Pricing Supplement for the period from the Issue Date stated in the Pricing Supplement to the Maturity Date on the basis of the Issue Price and principal amount and (z) ‘‘Original Issue Discount’’ means the Original Issue Discount stated in the

108 Pricing Supplement multiplied by a fraction, the numerator of which is the principal amount of a Note and the denominator of which is the initial principal amount stated in the applicable Pricing Supplement.

Indexed Notes If the amount of principal, premium and interest, if any, and in the case of Original Issue Discount Notes, the Amortized Face Amount or other amount payable on the Notes of a Series of which such Note is a part is to be determined by reference to (a) a currency exchange rate or rates, (b) a securities or commodities exchange index, (c) the value of a particular security or commodity, (d) any other index or indices or (e) formula or formulae, then such Note is an Indexed Note and the applicable Pricing Supplement will specify the method by and terms on which the amount of principal (whether at or prior to the Maturity Date thereof), premium and interest, if any, and in the case of Original Issue Discount Notes, the Amortized Face Amount or other amount payable in respect of such Note will be determined and other information relating to the Tranche of which such Note is a part. An investment in Indexed Notes entails significant risks that are not associated with similar investments in a conventional fixed-rate debt security. If the interest rate of such a Note is so indexed, it may result in an interest rate that is less than that payable on a conventional fixed-rate debt security issued at the same time, including the possibility that no interest will be paid, and if the principal amount of such a Note is so indexed the principal amount payable at maturity may be less than the original purchase price of such Note if allowed pursuant to the terms of such Note, including the possibility that no principal will be paid. The secondary market for such Notes will be affected by a number of factors, independent of the creditworthiness of the Company and the value of the applicable currency, commodity or securities exchange index, including the volatility of the applicable currency, commodity or securities exchange index, the time remaining to the maturity of such Notes, the amount outstanding of such Notes and market interest rates. The value of the applicable currency, commodity or securities exchange index depends on a number of interrelated factors, including economic, financial and political events, over which the Company has no control. Additionally, if the formula used to determine the principal amount or interest payable with respect to such a Note contains a multiple or leverage factor, the effect of any change in the applicable currency, commodity or interest rate index will be increased. The historical experience of the relevant currencies, commodities or securities exchange indices should not be taken as an indication of future performance of such currencies, commodities or securities exchange indices during the term of any Note. Accordingly, prospective investors should consult their own financial and legal advisors as to the risks entailed by an investment in such Notes and the suitability of such Notes in light of their particular circumstances.

Dual Currency Notes The Company may from time to time offer Notes of a Series (‘‘Dual Currency Notes’’) as to which the Company has a one-time option, exercisable on any one of the dates specified in the applicable Pricing Supplement, of thereafter making all payments of principal, premium, if any, and interest (which payments would otherwise be made in the Specified Currency of such Notes) in the optional currency specified in the applicable Pricing Supplement. The applicable Pricing Supplement will specify, among other things, the Specified Currency, the optional payment currency, the designated exchange rate, the option election dates and the Interest Payment Dates for the Notes of the Series of which such Dual Currency Note is a part. The amounts payable and the method for calculating such amounts (whether in respect of principal, premium, if any, or interest and whether at maturity or otherwise) in respect of the Notes of the Series of which such Dual Currency Note is a part and any additional terms and conditions of such Series of Notes will be specified in the applicable Pricing Supplement.

Amortizing Notes The Company may from time to time offer Notes of a Series which are Notes that pay a level amount in respect of both interest and principal amortized over the life of such Notes (‘‘Amortizing Notes’’). Such Amortizing Notes will be redeemable in installments in the installment amounts (each an ‘‘Installment Amount’’) and on the installment dates (each an ‘‘Installment Date’’) speciﬁed in the applicable Pricing Supplement. Payments with respect to the Notes of the Series of which such Amortizing Note is a part will

109 be applied ﬁrst to interest due and payable thereon and then to the reduction of the unpaid principal amount thereof. Further information concerning additional terms and conditions and a table or formula setting forth repayment information in respect of any Amortizing Note will be included in the Pricing Supplement applicable to such Notes.

Accrual of Interest; Interest on Overdue Amounts; Limitation on Interest Rate Each Note (or in the case of the redemption of only part of a Note, that part only) will cease to bear interest (if any) from the due date or date of its redemption unless, upon due presentation thereof, payment of principal is improperly withheld or refused. If all or a portion of the principal amount of any Note (other than a Zero Coupon Note) is not paid when due, upon redemption or acceleration or otherwise, such overdue principal amount will continue to bear interest at the Rate of Interest speciﬁed in the applicable Pricing Supplement until payment thereof has been made or duly provided for in full. In the case of Zero Coupon Notes, any overdue amount payable on such Notes will bear interest as set forth above under ‘‘Zero Coupon Notes and Original Issue Discount Notes.’’

Redemption Notes of a Series will not be subject to redemption prior to maturity at the option of the Company or at the option of the Holder of any Note of such Series except as set forth in the applicable Pricing Supplement and as set forth below. Notice of redemption will be provided as set forth below under ‘‘Notices by the Company’’ or ‘‘Notice by Holders’’, as applicable. At Maturity. Unless otherwise set forth in the applicable Pricing Supplement and unless previously redeemed, or purchased and canceled, each Note will be redeemed by the Company at its Final Redemption Amount set forth in the applicable Pricing Supplement in the relevant Payment Currency on the maturity date (the ‘‘Maturity Date’’) set forth in the applicable Pricing Supplement. Early Redemption for Taxation Reasons. Subject to the conditions described below, the Notes of any Series may be redeemed, as a whole but not in part, at the option of the Company, at any time, upon not more than 60 days’ nor less than 30 days’ prior notice (given in accordance with the provisions governing the giving of notices set forth below) to the Holders thereof at a redemption price equal to the applicable Early Redemption Amount, together with interest accrued (but unpaid), if any, to but excluding the date fixed for redemption (which date, in the case of Floating Rate Notes, must be an Interest Payment Date), if the Company determines that on the next succeeding Interest Payment Date, as a result of any change in or amendment to the laws or treaties, or any regulations or rulings promulgated thereunder, of Israel, or any political subdivision thereof or any taxing authority therein, or any proposed change in such laws, treaties, regulations or rulings, or any change in the official application, enforcement or interpretation of such laws, treaties, regulations or rulings (including a holding by a court of competent jurisdiction in Israel), which change or amendment becomes effective or is proposed on or after the Issue Date of the first Tranche of Notes of such Series, in the case of Israeli taxes, the Company has or will become obligated to pay Additional Amounts (or, if Additional Amounts are payable by the Company as of the Issue Date, the Company has or will become obligated to pay Additional Amounts in excess of any Additional Amounts which are payable by the Company as of the Issue Date) on any Note and such obligation cannot be avoided by the Company by the taking of measures which (in the good faith opinion of the Company) are reasonable under the circumstances. Prior to the distribution of any notice of redemption pursuant to this paragraph, the Company will deliver to the Fiscal Agent a certificate stating that the Company is entitled to effect such redemption and setting forth a statement of facts showing that the conditions precedent to the right of the Company so to redeem have occurred. Notwithstanding the foregoing, the Company will have no right to redeem the Notes unless and until it has used its best efforts to obtain an exemption from any deduction or withholding obligation and its request has been denied by the relevant authorities. Redemption at the Option of the Company. If so set forth in the applicable Pricing Supplement, the Company may, having given not more than 60 days’ nor less than 30 days’ prior notice to the Holders of Notes of a Series (given as provided herein), redeem all or any part of the Notes of such Series then

110 outstanding on the dates and at the amounts specified or determined in the manner set forth in the applicable Pricing Supplement together with interest accrued, if any, to but excluding the date fixed for redemption (which date, in the case of Floating Rate Notes, must be an Interest Payment Date). In the event of a partial redemption of a Series of Notes, such redemption must be of a principal amount of such Series of Notes equal to or higher than the Minimum Redemption Amount and less than or equal to the Maximum Redemption Amount, both as set forth in the applicable Pricing Supplement. In the case of a partial redemption of Definitive Registered Notes, such Notes will be selected individually by lot not more than 60 days prior to the date fixed for redemption and a list of the Notes called for redemption will be notified in accordance with the provisions governing the giving of notices set forth under ‘‘Notices by the Company’’ below not less than 30 days prior to such date. In the case of a partial redemption of Global Registered Notes, such Notes will be selected in accordance with the rules of the relevant clearing system or systems, as the case may be.

Redemption at the Option of the Noteholders. Subject to the prior delivery of a Put Event Confirmation (as defined below) by the Fiscal Agent in accordance with the terms of the Fiscal Agency Agreement, each Noteholder will have the option upon the giving of a Put Notice (as defined below) (the ‘‘Put Option’’) to require the Company to redeem or, at the option of the Company, purchase (or procure the purchase of) each Note of which it is the holder on the Put Date (as defined below) at the principal amount outstanding of such Note plus (in the case of a Put Event described in any of clauses (b) to (d) inclusive below) Foregone Margin in respect of such Note, together in any case with accrued interest to the Put Date if: (a) at the Relevant Time (1) the State of Israel is rated Investment Grade, (2) the Notes are rated below Investment Grade and (3) the Company does not use best endeavors to obtain an Investment Grade rating of the Notes (taking into account the requirements of the Rating Agencies for the purposes of obtaining an Investment Grade rating and the timeframe required to obtain such rating); (b) the Company does not comply with the provisions set forth below under ‘‘Substitution;’’ (c) the Company ceases to engage lawfully in the Transmission Business or at or after the Relevant Time the main business of the Company ceases to be a Transmission Business; (d) a Change of Control occurs; or (e) an event or circumstance occurs which could reasonably be expected to have a Material Adverse Effect, (each such event, if so deemed by the Fiscal Agent as set forth below, a ‘‘Put Event’’). The terms ‘‘best endeavors’’ and ‘‘material adverse effect’’ are used in determining whether or not a Put Event has occurred. Although there is a limited body of case law interpreting the terms ‘‘best endeavors’’ or ‘‘best efforts’’ and ‘‘material adverse effect,’’ there is no precise established definition of the terms under applicable law. Accordingly, in certain circumstances there may be a degree of uncertainty as to whether a particular transaction would involve the ‘‘best endeavors’’, ‘‘best efforts’’ or a ‘‘material adverse effect.’’ As a result, it may be unclear as to whether a Put Event has occurred and whether a Noteholder will have the option to require the Company to redeem or, at the option of the Company, purchase (or procure the purchase of) each Note of which it is the holder on the Put Date as described above. Promptly upon the Company or holders representing at least 10% of the aggregate principal amount of the relevant Series of Notes becoming aware that an event has occurred or is subsisting which could, subject to the voting of the holders of the relevant Series of Notes, constitute a Put Event, the Company shall, or any such holders may, give written notice to the Fiscal Agent. The Fiscal Agent shall give notice (a ‘‘Put Event Notice’’) to the holders of the relevant Series in respect of all of the Notes. If the holders of more than 25% in aggregate principal amount of the relevant Series of Notes vote that there has been a Put Event, the Fiscal Agent shall give notice (a ‘‘Put Event Confirmation’’) to the Noteholders of such relevant Series of Notes in accordance with the Fiscal Agency Agreement specifying the nature of the Put Event and the procedure (set forth below) for exercising the option contained in this section.

111 The Fiscal Agent shall not be responsible for ascertaining or monitoring whether or not a Put Event has occurred and, unless and until it has actual knowledge to the contrary in writing, shall be entitled to assume that no such event has occurred.

To exercise the option of redemption of a Note above, the Noteholder must deliver a duly signed and completed notice of exercise in the form obtainable from the specified office of any Fiscal Agent (a ‘‘Put Notice’’) in which the Noteholder may specify an account to which payment is to be made (together with any certificate evidencing ownership of the Notes) to the specified office of any Fiscal Agent on any business day falling within the period (the ‘‘Put Period’’) of 45 days after a Put Event Confirmation is given. The Paying Agent will issue to each Noteholder that has delivered a Put Notice a non-transferable receipt in respect of the Notes subject to the Put Notice (the ‘‘Put Option Notes’’). Payment in respect of the Put Option Notes will be made, if the Noteholder duly specified a bank account in the Put Notice to which payment is to be made, on the date falling seven Business Days following the expiry of the Put Period (the ‘‘Put Date’’) by transfer to that bank account and, in every other case, on or after the Put Date in the manner provided for in the Fiscal Agency Agreement against presentation and surrender (or, in the case of part payment, endorsement) of such receipt at the specified office of any Paying Agent. A Put Notice, once given, shall be irrevocable. For the purposes of the Terms and Conditions and the Collateral Trust Agreement, receipts issued pursuant to this section shall be treated as if they evidenced ownership of Notes. The Company shall redeem the relevant Notes on the Put Date unless previously redeemed or purchased.

In addition, if so set forth in the applicable Pricing Supplement, the Company will, at the option of the Holder of any Note who has given to the Company not more than 60 days’ nor less than 30 days’ notice in accordance with the provisions governing the giving of notices set forth under ‘‘Notices by the Holders’’ below (unless otherwise specified in the applicable Pricing Supplement), which notice will be irrevocable, redeem such Note, subject to, and in accordance with, the terms specified in the applicable Pricing Supplement on the date or dates set forth in the applicable Pricing Supplement and at the amount set forth or determined in the manner specified in the applicable Pricing Supplement, together with interest accrued, if any, to but excluding the date fixed for redemption (which date, in the case of Floating Rate Notes, must be an Interest Payment Date).

Notwithstanding any other provision of the Fiscal Agency Agreement, each holder of a relevant Series of Notes shall independently exercise its right to deliver a Put Notice.

Presentation of Notes. If notice of redemption has been given in the manner set forth in the Fiscal Agency Agreement, the Notes so to be redeemed will become due and payable on the date fixed for redemption specified in such notice and, upon presentation and surrender of the Notes at the place or places specified in such notice maturing subsequent to the redemption date, the Notes will be paid and redeemed by the Company, at the places and in the manner and currency therein specified and at the redemption price therein specified together with accrued interest, if any, to the redemption date.

If the due date for redemption of any Note is not a due date for payment of interest, interest accrued from the preceding due date for payment of interest or the Issue Date, unless there is a different Interest Commencement Date, as the case may be, will only be payable against presentation (and surrender if appropriate) of the relevant Note. Interest accrued on a Note which bears interest after its Maturity Date will be payable on redemption of such Note against presentation thereof. From and after the redemption date, if moneys for the redemption of Notes called for redemption will have been made available at the corporate trust ofﬁce of the Fiscal Agent for redemption on the redemption date, the Notes called for redemption will cease to bear interest (and in the case of Original Issue Discount Notes, the Amortized Face Amount or other amounts payable in respect thereof will cease to increase), and the only right of the Holders of such Notes will be to receive payment of the redemption price together with accrued interest, if any, to the redemption date as aforesaid. If moneys for the redemption of the Notes are not made available for payment until after the redemption date, the Notes called for redemption will not cease to bear interest (and in the case of Original Issue Discount Notes, the Amortized Face Amount or other amount payable in respect thereof will not cease to increase) until such moneys have been so made available.

112 Early Redemption Amounts. For the purposes of ‘‘Early Redemption for Taxation Reasons’’ above and ‘‘Events of Default and Acceleration Events’’ below, Notes which are redeemed prior to their maturity date will be redeemed at a redemption price (each an ‘‘Early Redemption Amount’’) computed as follows, unless otherwise set forth in the applicable Pricing Supplement: (a) in the case of Notes (other than Indexed Notes or Notes issued on a partly paid basis (‘‘Partly Paid Notes’’)) issued at an Issue Price of 100% of their principal amount, at their principal amount in the relevant Specified Currency, together with, in the case of Fixed Rate Notes, interest accrued to the date fixed for redemption; (b) in the case of Notes (other than Original Issue Discount Notes, Indexed Notes or Partly Paid Notes), issued with an Issue Price greater or less than 100% of their principal amount, at the amount set forth in the applicable Pricing Supplement; (c) in the case of Original Issue Discount Notes (other than Indexed Notes or Partly Paid Notes), at an amount (the ‘‘Amortized Face Amount’’) equal to: (1) the sum of (x) the Reference Price set forth in the applicable Pricing Supplement and (y) the product of the Accrual Yield set forth in the applicable Pricing Supplement (compounded annually) being applied to the Reference Price from (and including) the Issue Date to (but excluding) the date fixed for redemption pursuant to the provisions described under ‘‘Early Redemption for Taxation Reasons’’ above or (as the case may be) the date upon which such Note becomes due and repayable as provided under ‘‘Events of Default and Acceleration Events’’ below; or (2) if the amount payable in respect of any Original Issue Discount Note upon redemption of such Note pursuant to the provisions described under ‘‘Early Redemption for Taxation Reasons’’ above or upon its becoming due and repayable as provided under ‘‘Events of Default and Acceleration Events’’ below is not paid when due, the amount due and repayable in respect of such Note will be the Amortized Face Amount of such Note computed as provided above, except that sub-paragraph (A) will have effect as though the references in sub-paragraph (A) to the date fixed for redemption or the date upon which the Original Issue Discount Note becomes due and repayable were replaced by references to the date (the ‘‘Relevant Date’’) that is the earlier of: (A) the day on which all sums due in respect of such Note up to that day are received by or on behalf of the Holder of such Note; and (B) the date on which the full amount of the moneys repayable has been received by the Fiscal Agent and notice to that effect has been given in accordance with the terms of the Fiscal Agency Agreement. The computation of the Amortized Face Amount in accordance with sub-paragraph (2) will continue to be made, to the extent permitted by applicable law after as well as before judgment, until the Relevant Date unless the Relevant Date falls on or after the Maturity Date, in which case the amount due and repayable will be the principal amount of such Note together with interest at a rate per annum equal to the Accrual Yield and computed as set forth above under ‘‘Zero Coupon Notes.’’ (d) in the case of Indexed Notes, the Early Redemption Amount will be determined in accordance with the index and/or the formula set forth in the applicable Pricing Supplement, and each such Indexed Note will be redeemed at the Early Redemption Amount; or (e) in the case of Partly Paid Notes, the Early Redemption Amount will be as set forth in the applicable Pricing Supplement. Amortizing Notes. If the Notes are ‘‘Amortizing Notes’’, they will be redeemed in the amounts (‘‘Installment Amounts’’) and on the dates (‘‘Installment Dates’’) specified in the applicable Pricing Supplement. Partly Paid Notes. If the Notes are Partly Paid Notes, they will be redeemed, whether at maturity, early redemption or otherwise in accordance with the provisions of the Terms and Conditions as amended by the applicable Pricing Supplement.

113 Repurchase The Company may at any time purchase Notes in any manner and at any price. Notes purchased by the Company may be held or surrendered to any Transfer Agent for cancellation. Any purchase by tender will be made available to the Holders of all Notes of a Series alike. The Notes so purchased, while held by or on behalf of the Company, will not entitle the Holder to vote at any meetings of the Noteholders and will not be deemed to be outstanding for the purposes of calculating quorums at meetings of Noteholders. Additional Payment Amounts All payments of principal of, and interest and premium (if any) on, the Notes by the Company will be made without deduction or withholding for or on account of any present or future taxes, duties, assessments or governmental charges of whatever nature imposed or levied by or on behalf of the State of Israel or by or within any political subdivision thereof or any authority therein having power to tax (‘‘Israeli Tax’’), unless deduction or withholding of such Israeli Tax is required by law. In that event, the Company will pay such additional amounts (‘‘Additional Amounts’’) as will result in the payment to holders of the Notes of the amounts which would otherwise have been receivable in respect of principal, and interest and premium (if any), except that no such Additional Amounts will be payable in respect of any Note: (a) to or on behalf of a Holder who is subject to such Israeli Tax by reason of his being or having been connected with the State of Israel, otherwise than merely by holding such Note or receiving principal or interest in respect thereof; or (b) to or on behalf of a Holder who would not be liable for or subject to such deduction or withholding by making a declaration of non-residence or other similar claim for exemption to the relevant tax authority if, after having been requested to make such a declaration or claim, such holder fails to do so; or (c) presented for payment by or on behalf of a holder who would have been able to avoid such deduction or withholding by presenting the relevant Note to another Paying Agent in a Member State of the European Union. The obligation to pay Additional Amounts in respect of taxes, duties, assessments and governmental charges will not apply to (a) any estate, inheritance, gift, sales, transfer, personal property or any similar tax, assessment or other governmental charge or (b) any tax, assessment or other governmental charge which is payable otherwise than by deduction or withholding from payments of principal or interest on the Notes; provided that, except as otherwise set forth in the Notes, the Company will pay all stamp and other duties, if any, which may be imposed by the State of Israel, the United States or any respective political subdivision thereof or any taxing authority of or in the foregoing, with respect to the Fiscal Agency Agreement or the Charge Documents or as a consequence of the issuance of the Notes. Any reference herein to principal and/or interest in respect of Notes of a Series will also be deemed to refer to any Additional Amounts which may be payable hereunder. Ranking The Notes will be general obligations of the Company and will be secured by the Note Floating Charge on the present and future assets of the Company that are charged under any other floating charge created by the Company, whether now existing or hereafter created (the ‘‘Collateral’’), in favor of the Charge Agent for the benefit of the Holders of the Notes, as provided in the Charge Documents. See ‘‘Note Floating Charge.’’ The Note Floating Charge has been granted to the Charge Agent for the benefit of the Noteholders. As a result of the Note Floating Charge, the Notes effectively will rank (a) senior to all existing and future unsecured indebtedness of IEC other than certain indebtedness receiving priority in right of payment by operation of law (e.g., certain claims for taxes, wages and rent); (b) pari passu with all existing and future Indebtedness of IEC secured by Floating Charges on the assets of IEC (unless such charges by their terms are subordinate to the Note Floating Charge); and (c) subordinate to all existing and future Indebtedness of IEC to the extent secured (whether by law or contract) by Fixed Charges on the assets of IEC (unless such charges by their terms are pari passu or subordinated to the Note Floating Charge).

114 Moreover, the Noteholders would be structurally subordinated in right of payment to the rights of any creditors of the Company’s existing or future subsidiaries other than a Substituted Obligor. As of December 31, 2007, there were 67 Floating Charges outstanding with respect to IEC, all of which rank pari passu with the Note Floating Charge and cover substantially all the assets of IEC. The total Indebtedness secured by the Floating Charges as of December 31, 2007 was NIS 24,353 million. On January 17, 2008, IEC issued U.S.$250,000,000 of notes secured by Floating Charge. The holders of Indebtedness secured by these Floating Charges (and any other Indebtedness secured by Floating Charges created in the future) have the right, upon liquidation, to be repaid in full prior to any other Indebtedness, other than Indebtedness to the extent secured by Fixed Charges and certain obligations which have preference by law (e.g., certain taxes, payments to or on behalf of employees and lease obligations). The total Indebtedness secured by Fixed Charges as of December 31, 2007 was NIS 92. The Notes will restrict the ability of the Company to secure future Indebtedness with Fixed Charges, but will not restrict the ability of the Company to secure future Indebtedness with Floating Charges ranking pari passu with or subordinated to the Note Floating Charge. The Charge Agent may, in its sole discretion and without the consent of the Noteholders, but subject to the Charge Documents, take all actions it deems necessary or appropriate in order to (a) enforce or effect the Charge Documents and (b) collect and receive any and all amounts payable in respect of the obligations of the Company under the Notes, to the extent realized pursuant to the Note Floating Charge. Subject to the provisions of the Charge Documents, the Charge Agent will have the power to institute and to maintain such suits and proceedings as it may deem expedient to prevent any impairment of the assets of the Company by any acts which may be unlawful or in violation of the Charge Documents or the Fiscal Agency Agreement and to preserve or protect its interest and the interest of the Noteholders in the assets of the Company. The Charge Agent is authorized to receive any funds for the benefit of Noteholders distributed under the Charge Documents and to make further distributions of such funds to the Noteholders (through the Fiscal Agent) according to the provisions of the Notes and the Fiscal Agency Agreement. Each Noteholder, by its acceptance of a Note, consents and agrees to the terms of the Charge Documents, appoints the Charge Agent to hold the security created by the Charge Documents on its behalf and authorizes and directs the Charge Agent to enter into the Charge Documents and to perform its obligations and exercise its rights thereunder in accordance therewith. Note Floating Charge In Israel, companies generally secure obligations by granting Fixed Charges or Floating Charges (each as defined hereinafter) on their assets. The Notes when issued will be secured by the Note Floating Charge, which is a valid and enforceable perfected floating charge on the present and future assets of IEC that are charged under any other floating charge created by IEC, whether now existing or hereafter created. A Fixed Charge is similar to a security interest or mortgage in the United States where the charge attaches to the assets covered by the Fixed Charge when the charge documentation is executed and filed with the appropriate authorities in Israel. The assets subject to a Fixed Charge must be held by the grantor of the charge as security for the secured indebtedness and, generally, may not be sold, transferred or otherwise disposed of without the consent of the secured party. A Floating Charge, although effective when the charge documentation is executed and filed with the appropriate authorities in Israel, floats over the subject assets until certain events occur which cause it to attach to the assets existing at such time. A Floating Charge attaches or ‘‘crystallizes’’ either (a) automatically upon a company entering into liquidation, whether voluntarily by way of resolution of the shareholders or involuntarily upon a liquidation order being entered by a court or (b) upon appointment of a receiver over some or all of the assets of a company upon application to the court by a creditor following an event of default on indebtedness or other obligations. Until the occurrence of a crystallization event, a company that has granted a Floating Charge over its assets generally may continue to use, sell, transfer or otherwise dispose of the charged assets in the ordinary course of its business (as interpreted under Israeli law) or as otherwise provided by the

115 applicable charge documents and use the proceeds from the sale, transfer or other disposition of such assets for any purpose, including making payments in respect of any indebtedness or other obligations. Upon the occurrence of a crystallization event, the Floating Charge converts to a Fixed Charge, and thereafter a company may only act with respect to the assets subject to a charge in accordance with the directions of a receiver or liquidator, acting pursuant to court orders. In such capacity, a receiver or liquidator has broad powers to act with respect to the charged assets, and typically is granted the authority: (a) to operate the company’s business so as to maximize the proceeds of the sale of the company’s assets, (b) to incur and to collect obligations on behalf of the company or (c) to sell or otherwise dispose of assets of the company and distribute the proceeds therefrom according to the preferences provided by applicable law. Unlike under U.S. law (outside of a bankruptcy proceeding), a secured creditor under Israeli law generally does not have the right to foreclose directly upon the assets securing its obligations and must instead rely on the actions of a court-appointed receiver or liquidator. Certain Covenants Except to the extent modified, removed or supplemented in a Pricing Supplement, the Notes will contain various covenants, including those set forth below. Negative Pledge. The Notes will provide that, other than Permitted Security Interests, the Company will not incur or suffer to exist any Security Interest upon any of its revenues, property or assets whether now owned or hereafter acquired as security for any Indebtedness, except that the Company may grant one or more Floating Charges unless at the same time or prior thereto provision is made to secure the Indebtedness due under the Notes equally and rateably with the Indebtedness secured by such Floating Charge for so long as such Indebtedness is so secured. Impairment of Floating Charge. The Notes will provide that IEC will not take or omit to take any action which could adversely affect the validity or enforceability of, or the effectiveness or ranking of, the Note Floating Charge. Taxes. The Notes will provide that the Company will pay, prior to delinquency, all taxes, assessments and governmental levies, except as the same are being contested in good faith and by appropriate proceedings or where the failure to pay would not have a material adverse effect on the Company and its Subsidiaries (as defined below) taken as a whole. Conduct of Business. The Notes will provide that the Company will finance, operate, maintain and conduct its business in a safe and proper manner having regard to its cash flow obligations from time to time and, amongst other things, the terms of the Licenses and its regulatory environment; and, in each case in accordance with, or as required by: (a) Applicable Law; (b) its constitutive documents; (c) Environmental Permits; and (d) Good Industry Practice. The Notes will also provide that the Company will perform its obligations under and comply with the terms of each of the Program Documents to which it is a party. Public Rating. The Notes will provide that unless otherwise agreed by the Fiscal Agent acting in accordance with the Fiscal Agency Agreement, for so long as Notes with a par value of at least U.S.$25,000,000 remain outstanding, the Company will procure, at its own cost and expense, that a public long term corporate rating of the Company is obtained from each Rating Agency and will take all action that may be required of it, at its own cost and expense, to maintain a rating. Reports and Notifications. The Notes will provide that the Company will furnish within the periods specified below (and within seven Business Days thereafter in English, if the original information was provided in Hebrew) to the Fiscal Agent and to the Paying Agent: (a) as soon as practicable and not later than five Business Days after so becoming aware, details of any event or circumstances that could, with the passage of time, giving of notice, the making of any determination or any combination thereof, give rise to a Put Event, Event of Default or an Acceleration Event;

116 (b) as soon as practicable and not later than five Business Days after so becoming aware, written notice of a material acquisition, disposition, merger (including in respect of any material Electricity Assets), restructuring, senior management change at the Company or change in its auditors; and (c) simultaneously with such reporting, any matter notified by or on behalf of the Company to an Israeli or other stock exchange or securities regulatory authority in Israel or elsewhere. All notices referred to above will be available for inspection at the respective offices of the Paying Agents. Any Holder may request that a copy of any such report be mailed to such Holder, at the expense of the Company, by written request to any Paying Agent. The Program Agreement will also provide that at any time when the Company is neither subject to Section 13 or 15(d) of the Exchange Act nor exempt from reporting pursuant to Rule 12g3-2(b) thereunder, upon request of a Noteholder, the Company will promptly furnish or cause to be furnished Rule 144A Information to such Noteholder or to a prospective purchaser of such Note designated by such Noteholder, as the case may be, in order to permit compliance by such Noteholder with Rule 144A under the Securities Act in connection with the resale of such Note by such Noteholder. ‘‘Rule 144A Information’’ will be such information as is specified pursuant to Rule 144A(d)(4) under the Securities Act (or any successor provision thereto). Substitution The Company will procure that if at any time any entity other than the Company engages in or undertakes, or will engage in or undertake, all or substantially all of the Transmission Business (hereinafter called the ‘‘Substituted Obligor’’), the Company will substitute for itself the Substituted Obligor as issuer of all of the Notes. The Company will procure that such substitution is effected in accordance with the following conditions: (a) the Substituted Obligor will, by means of a supplement to the Program Documents, which supplement will be enforceable and effective upon execution by IEC and the Substituted Obligor without regard to execution by any other counterparty thereto, including the Fiscal Agent (1) succeed to, and be substituted for, and may exercise every right and power of the Company under the Program Documents, excluding the Charge Documents, with the same effect as if the Substituted Obligor had been named as the Company herein and therein, and (2) agree to indemnify each Noteholder against any tax, duty, assessment or governmental charge which is imposed on it by (or by any authority in or of) the State of Israel and which would not have been so imposed had the substitution not been made, as well as against any tax, duty, assessment or governmental charge, and any cost or expense, relating to the substitution; (b) the Substituted Obligor will have become party to the Program Documents, excluding the Charge Documents, which will be enforceable and effective upon execution of the Program Documents by the Substituted Obligor without regard to execution by any other counterparty thereto, including the Fiscal Agent, as if it had been an original party to them; (c) all actions, conditions and things required to be taken, fulfilled and done (including the obtaining of necessary consents) to ensure that the supplements to the Program Documents represent valid, legally binding and enforceable obligations of the Substituted Obligor are so taken, fulfilled or done; (d) IEC enters into the IEC Guarantee and all actions, conditions and things required to be taken, fulfilled and done (including the obtaining of necessary consents) to ensure that the IEC Guarantee and Charge Documents represent valid, legally binding and enforceable obligations of IEC are so taken, fulfilled or done; (e) the Substitution (as defined below) will comply with Applicable Law and the Licenses and all necessary consents, permits, licenses and other regulatory approvals will have been obtained by IEC and the Substituted Obligor for the continued operation of the Transmission Business by the Substituted Obligor; (f) legal opinions will have been addressed and delivered to the Company and the Fiscal Agent from lawyers of recognized standing in each of the State of Israel and in the United States as to the fulfillment of the requirements of the provisions set for under this ‘‘Substitution’’ covenant and the other

117 matters specified in the Program Documents and that (1) the Notes are legal, valid, binding and enforceable obligations of the Substituted Obligor and (2) the IEC Guarantee, will remain the legal, valid and binding obligations of IEC; and (g) the Substituted Obligor has appointed a process agent as its agent in the United States to receive service of process on its behalf in relation to any legal proceedings arising out of or in connection with the Notes, (such actions being, collectively, referred to in the aggregate as a ‘‘Substitution’’). Following a Substitution, the Fiscal Agent will, without the consent of the Noteholders, treat the Substituted Obligor as the principal debtor under the Fiscal Agency Agreement in accordance with the provisions described above. Upon the execution of the supplements to the Program Documents and the delivery of the legal opinions, and assumptions of the obligations of the Company by the Substituted Obligor, the Substituted Obligor shall succeed to, and be substituted for, and may exercise every right and power of, the Company under the Program Documents and the Notes, with the exception of the Charge Documents, with the same effect as of the Substituted Obligor had been named the original obligor therein, and the IEC shall be released from its obligations in its capacity as an obligor under the Program Documents and the Notes (without prejudice to IEC’s other obligations including in its capacity as guarantor under the IEC Guarantee and under the Note Floating Charge). For a discussion of the U.S tax consequences that may arise on a Substitution see ‘‘Taxation—Valid Status Tax Considerations—Substitution of Obligor.’’ Certain Definitions Except to the extent modified, removed or supplemented in a Pricing Supplement or expressly defined otherwise in the context of a particular provision described in this ‘‘Description of the Notes,’’ the following terms have the meanings set forth below: ‘‘Affiliate’’ of any specified Person means (a) any other Person which, directly or indirectly, is in control of, is controlled by or is under common control with such specified Person, (b) any other Person which beneficially owns or holds 10% or more of any class of the voting stock of such specified Person, (c) any other Person of which 10% or more of the voting stock is beneficially owned or held by such specified Person or a Subsidiary of such specified Person or (d) any other Person who is a director or officer (i) of such specified Person, (ii) of any Subsidiary of such specified Person or (iii) of any Person described in clause (a) above. For purposes of this definition, (x) ‘‘control’’ of a Person means the power, direct or indirect, to direct or cause the direction of the management and policies of such Person whether by contract or otherwise and (y) ‘‘voting stock’’ means equity interests of a company entitled to vote in the election of directors of such company. ‘‘Applicable Law’’ means all laws (including Environmental Law), rules and regulations applicable to the Company, including without limitation the Israeli Companies Law—1999, the Electricity Sector Law, the Israeli Government Companies Law—1975, Israeli Anti-trust Law and the Budgetary Principles law, the Licenses, all regulations, binding resolutions of competent authorities and orders promulgated under any of the foregoing and any replacements to or amendments of any of the foregoing. ‘‘Authorization’’ means an authorization, consent, approval, resolution, license, exemption, filing, notarization or registration. ‘‘Authorized Representative’’ means such officers authorized to provide the Fiscal Agent and the Registrar with instructions for completing and issuing Notes and having the requisite authority to execute Notes on behalf of the Company, as certified to the Fiscal Agent in accordance with the Fiscal Agency Agreement. ‘‘Capital Stock’’ means any and all shares, interests, rights to purchase, warrants, options, participations or other equivalents of or interests in (however designated) corporate stock, including any preferred stock. ‘‘Change of Control’’ means the Company ceases to be directly or indirectly Controlled by the government of the State of Israel.

118 ‘‘Charge Documents’’ means each document, agreement or instrument evidencing, perfecting or assuring the Note Floating Charge, including the Collateral Trust Agreement, as each may be amended or supplemented from time to time in accordance with the terms of the Collateral Trust Agreement. ‘‘Company’’ means IEC or, following the occurrence of a substitution, the Substituted Obligor in accordance with the provisions of ‘‘Substitution’’ set forth above. ‘‘Comparable Treasury Issue’’ means the United States Treasury security selected by an Independent Investment Banker as having a maturity comparable to the remaining term of the Notes to be purchased that would be utilized, at the time of selection and in accordance with customary financial practice, in pricing new issues of corporate debt securities of comparable maturities to the remaining term of the Notes. ‘‘Comparable Treasury Price’’ means, with respect to any repurchase date, (i) the average of the bid and asked prices for the Comparable Treasury Issue (expressed in each case as a percentage of its principal amount) on the third Business Day preceding such repurchase date, as set forth in the daily statistical release (or any successor release) published by the Federal Reserve Bank of New York and designated ‘‘Composite 3:00 p.m. Quotations for U.S. Governmental Securities’’ or (ii) if such release (or any successor release) is not published or does not contain such prices on such Business Day, the Reference Treasury Dealer Quotation for such repurchase date. ‘‘Control’’ means the ability to direct the business of a corporation and the holding of more than 50% of the voting rights of such corporation and ‘‘Controlled’’ shall be construed accordingly. ‘‘Dealer’’ means each of Citigroup Global Markets Inc., Citigroup Global Markets Limited, Lehman Brothers International (Europe), Lehman Brothers Inc., Credit Suisse Securities (Europe) Limited, Dexia Banque Internationale a` Luxembourg, socie´te´ anonyme, acting under the name of DEXIA Capital Markets, J.P. Morgan Securities Inc, J.P. Morgan Securities Ltd., Merrill Lynch International, Merrill Lynch, Pierce, Fenner & Smith Incorporated, Morgan Stanley, Morgan Stanley & Co. Incorporated, UBS Limited and any other entity which the Company may appoint as a Dealer under the Program Agreement in accordance with the terms thereof and notice of whose appointment is given to the Fiscal Agent, and ‘‘Dealers’’ shall be construed accordingly and references to the ‘‘relevant Dealer or Dealers’’ shall be to the Dealers appointed to act as such in respect of a particular Series of Notes. ‘‘Default’’ means any event which is, or after notice or passage of time or both would be, an Event of Default. ‘‘Electricity Assets’’ any assets relating to the generation, transmission, distribution, supply and trading of electricity and for administration of the electricity system in the State of Israel and for the carrying on of all other activities related to electricity in the State of Israel, and any and all Licenses with respect thereto. ‘‘Electricity Sector Law’’ means the Israeli Electricity Sector Law—1996 and all amendments thereto and replacements thereof and all regulations and/or orders promulgated thereunder. ‘‘Environmental Law’’ means any applicable law, regulation, covenants, conditions, restrictions or agreements which directly or indirectly relates to: (a) the pollution, contamination or protection of the environment or the release or discharge of any toxic or hazardous substance; (b) harm to or the protection of human health; (c) the conditions of the workplace; or (d) any emission or substance capable of causing harm to any living organism or the environment. ‘‘Environmental Permits’’ means any permit and other Authorization and the filing of any notification, report or assessment required under any Environmental Law for the operation of the business of the Company conducted on or from the properties owned or used by any of them. ‘‘Exchange Act’’ means the U.S. Securities Exchange Act of 1934, as amended. ‘‘Exchange Rate Protection Agreement’’ means any currency future, hedge agreement, exchange rate swap agreement or other arrangement designed to protect the Company or any Subsidiary against fluctuations in foreign exchange rates. ‘‘Fixed Charge’’ means a charge created under Israeli law that attaches to the assets covered thereby when the charge documentation is executed and filed with the appropriate authorities in Israel (Shiabud Kavua).

119 ‘‘Floating Charge’’ means a floating charge created under Israeli law that attaches to the assets covered thereby when the charge documentation is executed and filed with the appropriate authorities in Israel (Shiabud Tzaf). ‘‘Foregone Margin’’ means the present value of the Spread calculated at the Put Date in respect of all remaining scheduled Interest Payment Dates up to and including the Final Interest Payment Date computed using a discount rate equal to the Treasury Rate plus 30 basis points as determined by the Fiscal Agent. ‘‘Good Industry Practice’’ means the standards, practices, methods and procedures as practiced in Israel conforming to all Applicable Laws and that degree of skill, diligence, prudence and foresight which would reasonably be expected from a skilled and experienced person undertaking all or part of the electricity business under the same or similar circumstances. ‘‘IEC Guarantee’’ means the guarantee entered into by IEC in accordance with the ‘‘Substitution’’ section in respect of the Substituted Obligor’s obligations under the Notes which are the subject of a Substitution. ‘‘Indebtedness’’ means any indebtedness of any Person for money borrowed or raised including (without limitation) any indebtedness for or in respect of: (a) moneys borrowed and debit balance at banks or other financial institutions; (b) amounts raised by acceptance under any acceptance credit facility; (c) amounts raised under any note purchase facility or the issue of bonds, notes, debentures, loan stock, certificates or any similar instrument; (d) the amount of any liability in respect of leases or hire purchase contracts which would, in accordance with applicable law and generally accepted accounting principles, be treated as finance or capital leases; (e) any counter indemnity obligation in respect of a guarantee, bond, standby or documentary letter of credit or any other instrument issued by a bank or a financial institution; (f) any amount raised by the issue or redeemable shares which are redeemable (other than at the option of the issuer) before the final Interest Payment Date or are otherwise classified as borrowings under the accounting principles as applicable to the Company; (g) the amount of any undisputed liability in respect of any purchase price for assets or services the payment of which is deferred for a period in excess of 180 days; (h) amounts raised under any other transaction (including, without limitation, any forward sale or purchase agreement) having the commercial effect of a borrowing; and (i) the amount of any liability in respect of any guarantee for any of the items referred to in paragraphs (a) to (h) above. ‘‘Independent Investment Banker’’ means Citigroup Global Markets Inc. and Lehman Brothers Inc., or if such firms are unwilling or unable to select the Comparable Treasury Issue, an independent investment banking institution of national standing appointed by the Company and acceptable to the Fiscal Agent. ‘‘Institutional Accredited Investor’’ means an institutional ‘‘accredited investor’’ as defined in Rule 501(a)(1), (2), (3) or (7) under the Securities Act that is also not a QIB. ‘‘Investment Grade’’ means a rating of BBB− or above from S&P and Baa3 or above from Moody’s or such other ratings as S&P or Moody’s may specify as investment grade from time to time. ‘‘Licenses’’ means the licenses held or required to be held by the Company for the purposes of electricity businesses including, without limitation licenses necessary for the generation, transmission, distribution, supply and trading of electricity and for administration of the electricity system in Israel and for the carrying on of all other activities related to electricity in Israel.

120 ‘‘Material Adverse Effect’’ means a material adverse effect on: (a) the business, operations, property, condition (financial or otherwise) or prospects of the Company; or (b) the ability of the Company to perform its obligations under the Notes or the Program Documents; or (c) the validity or enforceability of, or the effectiveness or ranking of the Note Floating Charge or the rights or remedies of the Charge Agent or the Noteholders under any of the Program Documents; or (d) the Company in respect of any relevant change of law, regulation, license, permit, approval, or other regulatory matter that could affect the ability to perform its financial obligations under the Notes, the Program Documents, in each case as determined by the Fiscal Agent (acting on the directions of the holders of the relevant Series of Notes acting reasonably). ‘‘Moody’s’’ means Moody’s Investors Service, Inc. ‘‘Note Floating Charge’’ has the meaning set forth in ‘‘Note Floating Charge.’’ ‘‘Permitted Security Interests’’ means: (a) Security Interests created by the Charge Documents; (b) Security Interests in existence as of the Issue Date and set forth in Schedules 1 and 2 to the Collateral Trust Agreement (whether or not registered on such date); (c) Fixed Charges over bank accounts of the Company in Israel created in the ordinary course of business or otherwise in accordance with Applicable Law and in an aggregate not exceeding U.S.$25 million (or its then equivalent in an applicable foreign currency) at any time; (d) deposits made in good faith in connection with bids, tenders, contracts (other than for the payment of Indebtedness) or leases to which the Company is a party, or deposits to secure public or statutory obligations of the Company, or deposits of cash to secure surety or appeal bonds to which the Company is a party, or deposits as security for contested taxes or for the payment of rent; (e) survey exceptions, easements or reservations of, or rights of others for, rights-of-way, sewers, electric lines, telegraph and telephone lines and other similar purposes, or zoning or other restrictions as to the use of real property, existing on date hereof or arising in future in the ordinary course of business or otherwise in accordance with Applicable Law; (f) Security Interests imposed by law, such as carriers’, warehousemen’s and mechanics’ liens, or other Security Interests arising out of judgments or awards against the Company with respect to which the Company shall then be prosecuting an appeal or other proceeding for review; (g) Security Interests for taxes, assessments, or government charges or claims that are not yet delinquent or that are being contested in good faith and by appropriate proceedings; and (h) Security Interests securing Purchase Money Debt, provided such Security Interests cover only the assets acquired with such Purchase Money Debt. ‘‘Person’’ means any individual, company, corporation, partnership, joint venture, association, joint stock company, trust, unincorporated organization or government or any agency or political subdivision thereof. ‘‘Principal Purchase Agreement’’ means any separate agreement between a Dealer and the Company whereby a Dealer may agree with the Company to purchase Notes as principal. ‘‘Program Agreement’’ means the program agreement, dated as of April 23, 2008 between the Company and the dealers party thereto. ‘‘Program Documents’’ means the Program Agreement, the Fiscal Agency Agreement and the Charge Documents and any Terms/Syndication Agreement. ‘‘Purchase Money Debt’’ of any Person means all obligations of such Person (a) consisting of the deferred purchase price of property, conditional sale obligations, obligations under any title retention agreement (but excluding trade accounts payable) and other purchase money obligations, in each case where the maturity of such obligation does not exceed the anticipated useful life of the asset being financed and (b) incurred to finance the acquisition of such asset.

121 ‘‘QIB’’ means a ‘‘qualified institutional buyer’’ as defined in Rule 144A under the Securities Act. ‘‘Rating Agency’’ means S&P or Moody’s and its successors or any rating agency substituted for either of them (or any permitted substitute of them) by the Company from time to time with the prior written approval of the Fiscal Agent. ‘‘Reference Treasury Dealer’’ means Citigroup Global Markets Inc. and Lehman Brothers Inc. and their respective successors; provided, however, that if either of them shall cease to be a primary U.S. Government securities dealer in New York City (a ‘‘Primary Treasury Dealer’’), the Company shall substitute therefor another Primary Treasury Dealer. ‘‘Reference Treasury Dealer Quotation’’ means, with respect to the Reference Treasury Dealer and any repurchase date, the average, as determined by the Fiscal Agent, of the bid and asked prices for the Comparable Treasury Issue (expressed in each case as a percentage of its principal amount) quoted in writing to the Fiscal Agent by such Reference Treasury Dealer at 5:00 p.m. on the third Business Day preceding the repurchase date. ‘‘Relevant Time’’ means either (a) unless a Substitution has occurred, when owning or deploying, and operating the Transmission Assets in the State of Israel becomes the predominant part of the business of IEC or (b) when a Substitution occurs. ‘‘Securities Act’’ means the U.S. Securities Act of 1933, as amended, and the rules and regulations promulgated thereunder. ‘‘Security Interest’’ means any mortgage, charge, pledge, lien or other security interest securing any obligation of any person or any other agreement or arrangement having a similar effect. ‘‘S&P’’ means Standard & Poor’s Ratings Services, a division of The McGraw-Hill Companies, Inc. and its successors. ‘‘Spread’’ shall have the meaning given to it in subsection (b) of the Section ‘‘Interest Rates, Calculation of Interest, Business Day’’ above. ‘‘Subsidiary’’ means any corporation or other entity of which Capital Stock or other ownership interests having ordinary voting power to elect a majority of the board of directors or other persons performing similar functions are at the time directly or indirectly owned by the Company. ‘‘Substitution’’ means a substitution of the obligations of the Company under the Notes in accordance with the provisions described above under ‘‘Substitution’’. ‘‘Syndicated Offering’’ means an offering whereby the Company issues Notes on a syndicated basis to two or more Dealers and/or two or more other underwriters. ‘‘Terms/Syndication Agreement’’ means the Principal Purchase Agreement for a Syndicated Offering. ‘‘Transmission’’ shall have the meaning given to it in the Electricity Sector Law. ‘‘Transmission Assets’’ means any essential assets which are deployed in Transmission in Israel by the Company and any and all Transmission Licenses. ‘‘Transmission Business’’ means the business of owning or deploying, and operating the Transmission Assets in the State of Israel (including the receipt of all tariff payments for transmission services under the Transmission Licenses). ‘‘Transmission License’’ means each License held or required to be held by the Company for the purposes of the Transmission Business. ‘‘Treasury Rate’’ means the yield to maturity at the time of computation of United States Treasury securities with a weighted average life (as compiled and published in the most recent Federal Reserve Statistical Release H.15 (519) which has become publicly available at least two Business Days (but not more than five Business Days) prior to the relevant date of payment (or, if such Statistical Release is not so published or available, any publicly available source of similar market data selected by the Fiscal Agent in good faith)) most nearly equal to the weighted average life of the Notes for period from the relevant date of payment to the final Interest Payment Date in each case as selected and determined by the Fiscal Agent.

122 Events of Default and Acceleration Events

Events of Default Each of the following constitutes an ‘‘Event of Default’’ with respect to the Notes: (a) Non-Payment of Interest: the Company defaults in any payment of interest on the Notes when the same becomes due and payable, and such default continues for a period of three Business Days; (b) Non-Payment of Principal: the Company defaults in the payment of the principal of the Notes when the same becomes due and payable at maturity, upon acceleration, redemption or otherwise, and such default with respect to any principal payment other than the final payment continues for a period of three Business Days; (c) Insolvency or Bankruptcy: (i) the Company is unable or admits inability to pay its debts as they fall due or is deemed to or declared to be unable to pay its debts under Applicable Law, suspends or threatens to suspend making payments on any of its debts, or, by reason of actual or anticipated financial difficulties, commences negotiations with one or more of its creditors with a view to rescheduling any of its indebtedness; or (ii) a moratorium is declared in respect of any indebtedness of the Company provided that the ending of the moratorium shall not remedy any Event of Default caused by that moratorium; or (iii) the Company (A) adopts a resolution for winding-up, entry into receivership or administration, or (B) an order of liquidation is issued in respect of the Company; or the Company enters into receivership. (d) Insolvency Proceedings: (i) Any corporate action, legal proceedings or other procedure or step is taken in relation to: (A) the suspension of payments, a moratorium of any indebtedness, winding-up, dissolution (whether temporary or permanent), administration or reorganization (by way of voluntary arrangement, scheme of arrangement or otherwise) of the Company; (B) a composition, compromise, assignment or arrangement with any creditor of the Company, other than any such arrangement entered into for the purpose of a solvent restructure or merger which (i) does not require the consent of any creditor or (ii) if the consent of a creditor is required, where such consent has been given by the relevant creditor, including, in each case, a solvent restructure or merger pursuant to Section 350 and/or Section 351 of the Israeli Companies Law—1999; (C) the appointment of a liquidator, receiver, administrative receiver, administrator, compulsory manager, custodian, trustee or other similar officer (each such appointment, whether temporary or permanent) in respect of the Company; (D) crystallization or enforcement of any security over a substantial part of the assets of the Company which is not discharged, stayed or dismissed within 14 days of commencement provided that the aggregate amount secured by any such security interests so enforced exceeds US$25,000,000 (or its equivalent in any other currency or currencies); or (E) any analogous procedure or step is taken in any jurisdiction. (ii) Paragraph (i) shall not apply to any winding-up petition which is frivolous or vexatious and is discharged, stayed or dismissed within 14 days of commencement or, if earlier, the date on which it is advertised. If any Event of Default occurs, then the Fiscal Agent (subject to being indemnified and/or secured to its satisfaction), upon the request of Holders of at least 25% in aggregate principal amount of the relevant Series of Notes shall, or the Holders of at least 25% in aggregate principal amount of the relevant Series of Notes may, give written notice to the Company declaring the relevant Series of Notes to be immediately due and payable, whereupon they shall become immediately due and payable at their principal amount outstanding together with accrued interest without further action or formality. No delay by the Fiscal Agent or Holders to give or cause to be given a notice to the Company declaring the relevant Series of Notes to be immediately due and payable upon any occurrence of an event that actually or potentially constitutes an Event of Default shall constitute a waiver by the Holders of such Series of Notes of their rights under the Fiscal Agency Agreement or in any other way prejudice their ability to enforce their rights and remedies under the Notes, the Program Documents and the Charge Documents.

123 Acceleration Events Each of the following constitutes an ‘‘Acceleration Event’’ with respect to the Notes: (a) Breach of Covenants: the Company does not comply with the covenants described above under the captions ‘‘Description of the Notes—Certain Covenants—Negative Pledges’’, ‘‘Description of the Notes— Certain Covenants—Reports and Notifications’’, ‘‘Description of the Notes— Redemption— Redemption at the Option of the Noteholders’’ and ‘‘Description of the Notes—Payment of Additional Amounts’’, and (other than in the case of ‘‘Description of the Notes—Redemption—Redemption at the Option of the Noteholders’’) such event or circumstance (i) is, in the opinion of the Fiscal Agent (acting on directions of the holders of more than 25% in aggregate principal amount of the relevant Series of Notes), incapable of remedy or (ii) is an event or circumstance which is, in the opinion of the Fiscal Agent (acting on the directions of the holders of more than 25% in aggregate principal amount of the relevant Series of Notes), capable of remedy, but remains unremedied for five days after the Fiscal Agent has given written notice of such event or circumstances has given written notice of such event or circumstances. (b) Breach of other Obligations: the Company does not comply with any provisions (other than those referred to in paragraph (a) above) or agreements in the Notes or the Charge Documents and (unless otherwise giving rise to a Put Event or an Event of Default), such event or circumstance (i) is, in the opinion of the Fiscal Agent (acting on the directions of the holders of more than 25% in aggregate principal amount of the relevant Series of Notes), incapable of remedy or (ii) is an event or circumstance which is, in the opinion of the Fiscal Agent (acting on the directions of the holders of more than 25% in aggregate principal amount of the relevant Series of Notes), capable of remedy, but remains unremedied for 30 days after the Fiscal Agent has given written notice of such event or circumstance. (c) Unlawfulness and invalidity: (i) it is or becomes unlawful for the Company to perform any of its obligations (A) under the Program Documents which is material in the context of the Notes or (B) under the Note Floating Charge; or (ii) any obligation or obligations of the Company under the Program Documents are not or cease to be legal, valid, binding or enforceable and the cessation individually or cumulatively materially and adversely affects the interests of the Noteholders; or the Note Floating Charge ceases to be legal, valid, binding, enforceable or effective or is alleged by the Company or IEC to be ineffective. (d) Cross Default: (i) any Indebtedness of the Company is not paid within 15 days after the expiration of any applicable grace period or within 30 days after final maturity; or (ii) any Indebtedness of the Company is declared to be or otherwise becomes due and payable prior to its specified maturity as a result of an event of default or an acceleration event (however described); provided that no Acceleration Event shall occur under this paragraph (d) if the aggregate amount of Indebtedness or commitment for Indebtedness falling within sub-paragraphs (i) to (ii) above is less than US$25,000,000 (or its equivalent in any other currency or currencies). (e) Creditors’ process: any expropriation, attachment, sequestration, distress or execution or any analogous process in any jurisdiction affects any asset or assets of the Company provided that the aggregate amount of the affected asset or assets exceeds US$25,000,000 (or its equivalent in any other currency or currencies). If any Acceleration Event occurs, then the Fiscal Agent (subject to being indemnified and/or secured to its satisfaction), upon the request of Holders of at least 25% in aggregate principal amount of the relevant Series of Notes shall, or the Holders of at least 25% in aggregate principal amount of the relevant Series of Notes may, give written notice to the Company declaring the relevant Series of Notes to be immediately due and payable, whereupon they shall become immediately due and payable at their principal amount outstanding together with accrued interest without further action or formality. No delay by the Fiscal Agent or Holders to give or cause to be given a notice to the Company declaring the relevant Series of Notes to be immediately due and payable upon any occurrence of an event that actually or potentially constitutes an Acceleration Event shall constitute a waiver by the Holders of such

124 Series of Notes of their rights under the Fiscal Agency Agreement or in any way prejudice their ability to enforce their rights and remedies under the Notes, the Program Documents and the Charge Documents.

Meetings of Holders The Fiscal Agency Agreement contains provisions, which are binding on the Company and the Holders of Notes, for convening meetings of the Holders of Notes of any Series to consider matters affecting their interests, including to modify, amend or supplement the terms of the Notes of such Series, the Fiscal Agency Agreement or the Charge Documents or to waive future compliance with or past default under, such Notes. A meeting of Holders of Notes of a Series may be called by the Company, the Fiscal Agent, the Charge Agent or the Holders of at least 10% in aggregate principal amount of the outstanding Notes of such Series. To be entitled to vote at any meeting of Holders of Notes of a Series, a Person must be a Holder of outstanding Notes of such Series or a Person appointed by an instrument in writing as proxy for a Holder or Holders of outstanding Notes of such Series by such Holder or Holders, which proxy need not be a Holder of Notes. The Persons entitled to vote a majority in aggregate principal amount of the outstanding Notes which may be affected by the action to be taken at such meeting, except as hereinafter provided, will constitute a quorum for the transaction of all business specified above. At the reconvening of any meeting adjourned for a lack of a quorum the Person or Persons entitled to vote 25% in aggregate principal amount of the outstanding Notes which may be affected by the action to be taken at such meeting will constitute a quorum for the taking of any action set forth in the notice of the original meeting. The Fiscal Agent may make such reasonable and customary regulations as it will deem advisable for any meeting of Holders of Notes of any Series with respect to the proof of the holding of Notes of such Series, the adjournment and chairmanship of such meeting, the appointment and duties of inspectors of votes, certificates and other evidence of the right to vote, and such other matters concerning the conduct of the meeting as it will deem appropriate, subject to the terms of the Fiscal Agency Agreement. Except as otherwise provided below, any modifications, amendments, supplements or waivers to the Fiscal Agency Agreement or the Terms and Conditions of the Notes of a Series will require the written consent or approval of the Company, the Fiscal Agent and (a) the written consent of Holders of a majority in aggregate principal amount of the outstanding Notes of such Series or (b) the approval of a majority of the aggregate principal amount of such Notes represented at a meeting of the Holders of Notes of such Series (each such majority in the foregoing clauses (a) and (b) being referred to herein as a ‘‘Requisite Majority’’); provided, however, that any such modification, amendment, supplement or waiver which affects the outstanding Notes of more than one Series (as determined by the Company) will require (i) the written consent of Holders of a majority in aggregate principal amount of the outstanding Notes affected thereby or (ii) the approval of a majority of the aggregate principal amount of such Notes represented at such meeting of the Holders of Notes. Any modifications, amendments, supplements or waivers to the Charge Documents will require the consent of the Company, the Charge Agent and the Requisite Majority of each Series of Notes secured thereby voting separately. Except as otherwise provided below, any such modification, amendment, supplement or waiver with respect to the Notes, the Fiscal Agency Agreement and the Charge Documents will be conclusive and binding on all Holders of Notes affected thereby, whether or not they have given such consent or were present at such meeting and whether or not notation of such modification, amendment, supplement or waiver is made upon the Notes, and on all future Holders of Notes. Any instrument given by or on behalf of any Holder of a Note in connection with any consent to any such modification, amendment, supplement or waiver will be irrevocable once given and will be conclusive and binding on all subsequent Holders of such Note. Notwithstanding anything herein to the contrary, the approval of any release of the Note Floating Charge with respect to such Series or any modification, amendment, supplement or waiver to such Series or to the Charge Documents with respect to such Series, in each case in connection with such approval, requires the approval of the Requisite Majority of such Series of Notes voting separately. In addition, any instructions provided by the Noteholders secured by the Note Floating Charge with respect to the Note

125 Floating Charge or the Collateral Trust Agreement require the approval of the Holders of a majority in aggregate principal amount of the outstanding Notes so secured voting together. Notwithstanding anything herein to the contrary, no action at any meeting of Holders of Notes, and no modification, amendment, supplement or waiver to the Notes, the Fiscal Agency Agreement or the Charge Documents, may, unless approved by an Extraordinary Resolution (i) change the maturity of the principal (including premium or redemption amounts, if any, and, in the case of Original Issue Discount Notes, the Amortized Face Amount or other amounts payable in respect thereof) or interest, if any, in respect of any Note of such Series, or reduce the principal amount (including premium or redemption amounts, if any, and, in the case of Original Issue Discount Notes, the Amortized Face Amount or other amounts payable in respect thereof) thereof, or reduce the rate or extend the time of payment of any installment of interest thereon, (ii) change the place or currency of payment of principal of, or interest on, any Notes of such Series, (iii) change the Company’s obligation to pay Additional Amounts, (iv) impair or affect the right of any Noteholder to institute suit for the enforcement of any such payment on or after the due date therefor (or in the case of redemption, on or after the redemption date), (v) permit the creation of any Charge (other than Permitted Security Interests) or release the Note Floating Charge (other than as provided in the preceding paragraph) or deprive the Holders of the Notes of the security afforded by the Note Floating Charge (other than as provided in the preceding paragraph), (vi) waive an Event of Default in the payment of principal of, or interest on, the Notes of such Series, (vii) reduce the proportion of the principal amount of Notes of such Series the consent of the Holders of which is necessary to modify or amend the Fiscal Agency Agreement, the Terms and Conditions of the Notes of such Series or the Charge Documents or to make, take or give consent, waiver or other action provided hereby or thereby to be made, taken or given or (viii) reduce the percentage of aggregate principal amount of Notes outstanding required for the adoption of a resolution or the quorum required at any meeting of Holders of Notes at which a resolution is adopted, in each case, unless such action or modification, amendment or supplement is approved by an extraordinary resolution (an ‘‘Extraordinary Resolution’’) which may only be passed by the affirmative vote of the Registered Holder of each Note of such Series then outstanding. The Company and the Fiscal Agent may agree, without the vote or consent of any Holder of Notes, but subject to the consent of the Charge Agent, to any modifications, amendments, supplements or waivers to the Fiscal Agency Agreement or the Notes and the Company and the Charge Agent may agree, without the vote or consent of any Holder of Notes to any modifications, amendments, supplements or waivers to the Charge Documents, in each case subject to the preceding paragraph and solely for the purpose of (a) providing for the issuance of Notes in bearer form, (b) adding to the covenants of the Company for the benefit of the Noteholders, (c) surrendering any right or power conferred upon the Company, (d) correcting or supplementing any defective provision or manifest error contained in the Fiscal Agency Agreement, the Notes or the Charge Documents in a manner which does not adversely affect the interests of any Holders of the Notes in any respect, (e) amending the certification requirements set forth in the Fiscal Agency Agreement in order to allow the Company to comply with the certification requirements with respect to nationality or status as required by applicable laws or (f) making any modification, or granting any waiver or authorization of any breach or proposed breach of, any of the Terms and Conditions of the Notes or any other provisions of the Fiscal Agency Agreement or the Charge Documents in any manner which the Company and the Fiscal Agent or the Charge Agent, as the case may be, may determine, provided that such modification, waiver or authorization does not adversely affect the interests of any Holders of Notes in any material respect. For purposes of the provisions of the Fiscal Agency Agreement and the Terms and Conditions of the Notes, any Note authenticated and delivered pursuant to the Fiscal Agency Agreement will, as of any date of determination, be deemed to be ‘‘outstanding,’’ except: (a) Notes theretofore canceled by the Fiscal Agent or the Registrar or delivered to or to the order of the Fiscal Agent or the Registrar for cancellation or held by the Fiscal Agent or the Registrar for reissuance but not reissued; (b) Notes which have been called for redemption in accordance with their terms or which have become due and payable at maturity or otherwise and with respect to which moneys sufficient to pay the

126 principal thereof (including premium and redemption, if any, and in the case of Original Issue Discount Notes, the Amortized Face Amount or other amounts payable in respect thereof) and interest, if any, in respect thereof will have been made available to the Fiscal Agent; or (c) Notes in lieu of or in substitution for which other Notes will have been authenticated and delivered pursuant to the Fiscal Agency Agreement; provided, however, that in determining whether the Holders of the requisite principal amount of outstanding Notes of a Series are present at a meeting of Holders of Notes of such Series for quorum purposes or have consented to or voted in favor of any request, demand, authorization, direction, notice, consent, waiver, amendment, modiﬁcation or supplement hereunder, Notes of such Series owned directly or indirectly by the Company or any Afﬁliate of the Company will be disregarded and deemed not to be outstanding. The Holder of a Note may, at any meeting of Holders of a Series of Notes at which such Holder is entitled to vote, cast one vote for each currency unit in principal amount of the Notes held by such Holder in which such Notes are denominated. Notwithstanding the foregoing, at any meeting of Holders of more than one Series of Notes, a Holder of a Note which does not specify regular payments of interest, including, without limitation, Original Issue Discount Notes, will be entitled to one vote at any such meeting for each such currency unit of the redemption value of such Note calculated as of the date of such meeting. Where Notes are denominated in one or more currencies other than U.S. Dollars, the U.S. Dollar equivalent of such Notes will be calculated at the Market Exchange Rates on the date of such meeting or, in the case of written consents or notices, on such date as Holders will designate for such purpose and each Holder of such a Note will have one vote for every U.S. Dollar of Notes (converted as aforesaid) which it holds.

Notices by the Company All notices to redeem Registered Notes and all other communications to Holders of Registered Notes will (except to the extent otherwise expressly provided in the applicable Pricing Supplement) be in writing and sent, ﬁrst class postage pre-paid, and will be addressed to such Holders at their respective addresses appearing in the Note Register maintained pursuant to the Fiscal Agency Agreement. In the case of DTC Global Registered Notes, such notices will be sent to DTC or its nominee, as the Registered Holder, and DTC will communicate such notices to its participants in accordance with its standard procedures. In the case of the Euroclear/Clearstream Global Registered Notes, such notices will be sent to the Common Depositary or its nominee, as the Registered Holder, who will in turn forward such notices to Euroclear and Clearstream for communication with their participants in accordance with their standard procedures. Neither the failure to give notice nor any defect in any notice given to any particular Holder of a Note will affect the sufﬁciency of any notice with respect to other Notes.

Notices by the Holders Notices to be given by any Holder of a Note will be in writing and given by lodging the same, together with the relevant Note or Notes, to the Fiscal Agent or any Paying Agent or, in the case of Registered Notes, the Registrar or any Transfer Agent. So long as any of the Notes are represented by a Global Note, such notice may be given by any Holder of a Note to the Fiscal Agent via DTC, Euroclear and/or Clearstream, as the case may be, in such manner as the Fiscal Agent and DTC, Euroclear and/or Clearstream, as the case may be, may approve for this purpose.

Replacement of Notes The Registrar is authorized from time to time in accordance with the provisions of the Fiscal Agency Agreement to authenticate or cause to be authenticated and deliver or cause to be delivered (i) Notes of a Series in exchange for or in lieu of Notes of such Series of like tenor and of like form which become mutilated, destroyed, defaced, stolen or lost upon payment by the claimant of the expenses incurred in connection therewith and on such terms as to evidence and indemnity as the Company and the Registrar,

127 as the case may be, may reasonably require, and mutilated or defaced Notes must be surrendered before replacements will be issued; (ii) Notes of a Series in any authorized denominations and of equal aggregate principal amount of Notes of such Series, subject to the requirements as to minimum denomination; and (iii) if specifically so provided by the applicable Pricing Supplement, Notes of such Series in exchange for Notes of another Series. Each Note surrendered for exchange will be dated the date of its original issuance. Each Note executed, authenticated and delivered upon any transfer or exchange for or in lieu of the whole or any part of any Note will carry all rights, if any, to the principal amount (including premium or redemption amounts, if any, and, in the case of Original Issue Discount Notes, the Amortized Face Amount or other amount payable in respect thereof) and to interest, if any, accrued and unpaid and to accrue which were carried by the whole or such part of such Note. No such exchanges, however, will be made by the Fiscal Agent or the Registrar, and no Holder of any Note may require such an exchange, during the period of 30 days preceding the due date for any payment of principal (including premium or redemption amounts, if any, and, in the case of Original Issue Discount Notes, the Amortized Face Amount or other amount payable in respect thereof) on such Note. Governing Law; Service of Process; Jurisdiction The Fiscal Agency Agreement, the Notes and the Collateral Trust Agreement will be governed by, and construed in accordance with, the laws of the State of New York and the Note Floating Charge will be governed by, and construed in accordance with, the laws of the State of Israel, in each case without regard to that state’s principles of conflicts of laws. Each party to the Fiscal Agency Agreement and the Collateral Trust Agreement has irrevocably submitted to the jurisdiction of any United States Federal or New York State court sitting in New York City, the Borough of Manhattan, and further submits to the jurisdiction of any competent court in the place of its corporate domicile for the purpose of any suit, action or proceeding arising out of or related to the Fiscal Agency Agreement, the Collateral Trust Agreement, any Note (‘‘Proceedings’’). The Collateral Trust Agreement also states that nothing contained in the Collateral Trust Agreement prevents the Charge Agent or any of the Noteholders from taking Proceedings in any other courts with jurisdiction and that, to the extent allowed by law, the Charge Agent or any of the Noteholders may take concurrent Proceedings in any number of jurisdictions, and in such event the Company (or IEC) may take counter proceedings in such jurisdictions, and in such event the Company (or IEC) may take counter proceedings in such jurisdictions. Each such party will waive, to the fullest extent permitted by law, any objection which it may have to the laying of the venue of any such Proceedings brought in such a court and any claim that any such Proceedings have been brought in an inconvenient forum. Each such party will agree that a final judgment in any Proceedings brought in such a court will be conclusive and binding upon it and may be enforced in any court to the jurisdiction of which it is subject by a suit upon such judgment; provided, that in the case of the Company, service of process is effected on it in accordance with the provisions set forth below or as otherwise permitted by law. With respect to the Note Floating Charge, the District Court of Israel sitting in Haifa will have exclusive jurisdiction to which all parties will submit. As long as any Note remains outstanding, the Company will at all times have an authorized agent in New York City, the Borough of Manhattan upon whom process may be served in connection with any Proceedings. Service of process upon such agent and written notice of such service delivered to the Company will, to the fullest extent permitted by applicable law, be deemed in every respect effective service of process upon the Company in any Proceedings. The Company has appointed Corporation Service Company, 1133 Avenue of the Americas, Suite 3100, New York, NY 10036 as its agent for such purposes, and covenants and agrees that (i) service of process in any Proceedings may be made upon it at such office of such agent (or such other address in New York City, the Borough of Manhattan or at the office of any other authorized agents as the Company may designate by written notice to the Fiscal Agent) and (ii) prior to such termination of such agency for any reason, the Company will so appoint a successor thereto as agent. The Company will consent in respect of any Proceedings to the giving of any relief or the issue of any process in connection with such Proceedings including, without limitation, the making, enforcement or execution against any property whatsoever (irrespective of its use or intended use) of any order or

128 judgment which may be made or given in such Proceedings. To the extent that the Company may in any jurisdiction claim for itself or its assets immunity from suit, execution, attachment (whether in aid of execution, before judgment, or otherwise) or other legal process and to the extent that in any such jurisdiction there may be attributed to itself or its assets such immunity (whether or not claimed), the Company will irrevocably agree not to claim and will irrevocably waive such immunity to the full extent permitted by the laws of such jurisdiction and will agree that the waivers set forth in this paragraph will have the fullest extent permitted under the United States Foreign Sovereign Immunities Act of 1976 and are intended to be irrevocable for purposes of such act.

Service of process personally delivered upon the agent speciﬁed above and written notice of such service delivered to the Company will be deemed in every respect effective service of process upon the Company; provided, however, that no notice by mail on the Company or any of its agents will be deemed effective service of process.

Notwithstanding anything to the contrary above, the Note Floating Charge shall be governed by, and construed in accordance with the laws of the State of Israel and any Proceedings and matters related thereto shall be submitted to the exclusive jurisdiction of the district court of Haifa.

Judgment Currency Indemnity

The Company agrees that, if a judgment or order given or made by any court for the payment of any amount in respect of any Note is expressed in a currency (the ‘‘judgment currency’’) other than the currency (the ‘‘denomination currency’’) in which such Note is denominated or in which such amount is payable, it will indemnify the relevant Holder against any deﬁciency arising or resulting from any variation in rates of exchange between the date as of which the amount in the denomination currency is notionally converted into the amount in the judgment currency for the purposes of such judgment or order and the date of actual payment thereof. This indemnity will constitute a separate and independent obligation from the other obligations contained in the Terms and Conditions, will give rise to a separate and independent cause of action, will apply irrespective of any indulgence granted from time to time and will continue in full force and effect notwithstanding any judgment or order for a liquidated sum or sums in respect of amounts due in respect of the relevant Note or under any such judgment or order.

Fiscal Agent; Other Agents

The Fiscal Agency Agreement and the Charge Documents contain provisions for the indemniﬁcation of the Fiscal Agent, the Registrar, the Calculation Agent, the Paying Agents, the Transfer Agents and the Charge Agent for their relief from responsibility. The Fiscal Agent, the Calculation Agent, the Registrar, any Paying Agents or Transfer Agents and the Charge Agent are entitled to enter into business transactions with the Company without accounting for any proﬁt resulting therefrom. The Fiscal Agent may, with the consent of the Company, appoint one or more agents to act on its behalf for the purpose of authenticating and delivering Notes and registering transfers of Notes.

129 TAXATION The following is a general description of certain tax considerations relating to the Notes. It does not purport to be a complete analysis of all tax considerations relating to the Notes. Prospective purchasers of Notes should consult their own tax advisers as to the consequences under the tax laws of the country of which they are resident for tax purposes and the tax laws of the State of Israel of acquiring, holding and disposing of Notes and receiving payments of interest, principal and/or other amounts under the Notes. This summary is based upon the law as in effect on the date of this Offering Circular and is subject to any change in law that may take effect after such date. Investors should also note that the appointment by an investor in Notes, or any person through which an investor holds Notes, of a custodian, collection agent or similar person in relation to such Notes in any jurisdiction may have tax implications. Investors should consult their own tax advisers with respect to the tax consequences for them of any such appointment. Israeli Tax Considerations The following is a summary of the main Israeli tax issues applicable to foreign holders of the Notes, based on the applicable legislation as of April 1, 2008. The following is not intended, and should not be construed, as legal or professional tax advice and is not exhaustive of all possible tax considerations. It should be noted that in recent years Israel has adopted a number of tax reforms, which have led to extensive changes to Israel’s tax laws. As a result of these reforms, new regulations and pronouncements of the Israeli Tax Authority have been published from time to time, although no accepted practice or conclusive rulings have been issued that can assist in interpreting the new legislation in any certain manner. Prospective purchasers of the Notes should obtain professional tax advice suitable to their specific circumstances and country of residence. Capital gain on the sale of the Notes by Foreign Residents The Company anticipates receiving a ruling from the Israeli Tax Authority pursuant to which, following the listing of the Notes on a non-Israeli stock exchange, and for so long as the Notes are so listed, foreign residents will be exempt of Israeli tax on capital gain from the sale of the Notes to the extent that: (i) the Notes were purchased by the foreign resident after the date in which the Notes became registered in a foreign stock exchange; (ii) the Notes were sold in the foreign stock exchange; (iii) the capital gain is not allocated to a permanent establishment that the foreign resident has in Israel; and (iv) the seller is not subject to Section 101 and 130A of the Israeli Income Tax Ordinance and the Israeli Inflationary Adjustment Law. Payments of Interest and Original Issue Discount The Company anticipates receiving a ruling from the Israeli Tax Authority pursuant to which, following the listing of the Notes on a non-Israeli stock exchange and for so long as the Notes are so listed, foreign residents will be tax exempt from Israeli tax on interest income and Original Issue Discount from the Notes and the Company has no withholding obligation with respect to the payment of such interest and Original issue Discount. Pursuant to the terms of the Notes, in the event that the Company is required to withhold or deduct on account of Israeli taxes in the future, the Company undertakes to make all payments of interest and principal on the Notes free and clear of, and exempt from, and without deduction for or on account of, any tax, levy, deduction, charge or withholding imposed by the State of Israel or by any political subdivision thereof or any authority therein having power to tax (collectively, ‘‘Taxes’’). Included in this undertaking is the obligation of the Company, subject to certain exemptions, to pay to the holders of the Notes such additional amounts as may be necessary in order that the net payments received by the holders of the Notes after deduction or withholding for or on account of any such Taxes, shall be equal to the amount otherwise due and payable by the Company if such amount had not been subject to such withholding or deduction (the ‘‘Gross-Up Payments’’). Under the present laws of Israel, there is no law, regulation, device or order which prohibits the Company from fulfilling its aforementioned undertakings and making all payments under the Notes in

130 amounts which will be sufﬁcient to ensure that the payments will be received by the holders of the Notes free and clear of all Taxes. The Company is permitted to pay the applicable tax directly to the State of Israel in addition to the sums being paid to the holders of the Notes.

United States Tax Considerations

U.S. Treasury Circular 230 Notice The tax discussion contained in this Offering Circular was not intended or written to be used, and cannot be used, for the purpose of avoiding United States federal tax penalties. This discussion was written to support the promotion or marketing of the transactions or matters addressed in this Offering Circular. Noteholders should seek advice based on their particular circumstances from an independent tax advisor.

General The following is a summary of certain U.S. federal income tax consequences to U.S. Noteholders (as defined below) that acquire, own and dispose of any of the Notes and who or that is an initial purchaser of the Notes and will hold the Notes as capital assets. The discussion does not cover all aspects of U.S. federal income taxation that may be relevant to particular investors, and does not address state, local, non-U.S. or other tax laws. In particular, this summary does not address tax considerations applicable to U.S. Noteholders that own or will own (directly or indirectly) 10% or more of the Company’s voting stock, nor does this summary discuss all of the tax considerations that may be relevant to certain types of holders subject to special treatment under the U.S. federal income tax laws (such as dealers or traders in securities, financial institutions, insurance companies, regulated investment companies, real estate investment trusts, investors liable for the alternative minimum tax, tax-exempt organizations, persons that will hold the Notes as part of a straddle, hedging or conversion transaction for U.S. federal income tax purposes, partnerships or other entities classified as partnerships for U.S. federal income tax purposes, persons holding the Notes through partnerships or other pass-through entities, and holders whose functional currency is not the U.S. dollar). Except as specifically set forth below, this summary does not address any tax considerations applicable to persons who or that are not U.S. Noteholders. This summary is based on the Internal Revenue Code of 1986 (the ‘‘Code’’), as amended, its legislative history, final, temporary and proposed regulations thereunder, published rulings and court decisions, all as are currently in effect. All of these laws and authorities are subject to change at any time, possibly with retroactive effect. No assurances can be given that any changes in these laws or authorities will not affect the accuracy of the discussions set forth in this summary. Each Series of the Notes may be issued with a variety of different terms, the specifics of many of which will not be determined until the issuance of a Pricing Supplement for such Series. Accordingly, certain of the U.S. federal income tax matters relevant to the acquisition, ownership or disposition of a particular Series of the Notes may not be ascertainable until the Pricing Supplement for such Series is issued. The following discussion sets forth certain general tax matters which may be described without the requirement of referring to the specific terms of any particular Series of the Notes. It does not generally address the treatment of Indexed Notes, Dual Currency Notes or Notes subject to a Put Option. Any special U.S. federal income tax considerations relevant to a particular issue of the Notes will be provided in the applicable Pricing Supplement. The discussion below assumes that the Notes will be treated as debt for U.S. federal income tax purposes. The Company has not sought any opinion of counsel or ruling from the U.S. Internal Revenue Service (the ‘‘IRS’’) with respect to the statements made and the conclusions reached in this summary, and there can be no assurance that the IRS will agree with such statements and conclusions.

U.S. Noteholders

Deﬁnition As used herein, the term ‘‘U.S. Noteholder’’ means a beneﬁcial owner of the Notes that is for U.S. federal income tax purposes (i) an individual citizen or resident of the United States, (ii) a corporation

131 (or any other entity treated as a corporation for U.S. federal income tax purposes) created or organized under the laws of the United States or any state thereof or the District of Columbia, (iii) an estate, the income of which is subject to U.S. federal income tax without regard to its source, or (iv) a trust (a) as to which one or more U.S. persons (as deﬁned for U.S. federal tax purposes) have the authority to control all substantial decisions and over which a court within the United States is able to exercise primary supervision, or (b) that was in existence on August 20, 1996, was considered a U.S. trust as of that date, and has in effect an election to continue to be so treated.

If a partnership (including for this purpose any entity treated as a partnership for U.S. federal income tax purposes) is a beneﬁcial owner of the Notes, the treatment of a partner in the partnership will generally depend upon the status of the partner and upon the activities of the partnership.

Payments or Accrual of Interest

Except as set forth below, payments of interest, including additional amounts, if any, on the Notes generally will be taxable to the U.S. Noteholders as ordinary interest income at the time such amounts are received or accrued, in accordance with the U.S. Noteholder’s regular method of tax accounting. If the U.S. Noteholder generally reports taxable income using the accrual method, payments of interest must be included in income as they accrue. If the Noteholder generally reports taxable income using the cash method, payments of interest must be included in income as they are received.

For purposes of the foreign tax credit provisions of the Code, interest paid or accrued on the Notes generally will constitute foreign source income and will be classiﬁed as ‘‘passive category income’’ (or, in certain cases, as ‘‘general category income’’).

Original Issue Discount

U.S. Noteholders of Original Issue Discount (OID) Notes (other than Short-Term Notes, discussed below under ‘‘Short-Term Notes’’) will be subject to special tax accounting rules, as described herein. Additional rules applicable to OID Notes which are denominated in or whose payments are determined by reference to a Foreign Currency are described under ‘‘Foreign Currency Notes’’ below.

For federal income tax purposes, and subject to the de minimis rule described below, when a debt instrument is issued at discount, the amount of such discount (OID) is treated as ordinary interest income. The U.S. Noteholder must include in gross income amounts of OID on OID Notes as ordinary interest income on an accrual basis under a ‘‘constant yield to maturity’’ method described below (whether the U.S. Noteholder is a cash or accrual basis taxpayer). Generally, OID must be included in income in advance of the receipt of cash representing such income.

The total amount of OID on OID Notes will equal the excess of the Notes ‘‘stated redemption price at maturity’’ over their ‘‘issue price.’’ The stated redemption price at maturity equals the sum of all payments due under the OID Notes, other than any payments of qualiﬁed stated interest. The issue price will generally equal the initial public offering price at which a substantial number of Notes are issued in a given offering if the amount is more than a statutory de minimis amount described below.

The amount of OID on OID Notes that the U.S. Noteholder must include in income during a taxable year is the sum of the ‘‘daily portions’’ of OID for those Notes. The daily portions are determined by allocating to each day in an ‘‘accrual period’’ (generally the period between compounding dates) a pro rata portion of the OID attributable to that accrual period. The amount of OID attributable to an accrual period is the product of the ‘‘adjusted issue price’’ of the Notes at the beginning of the accrual period and its yield to maturity. The adjusted issue price of the Notes is generally equal to the sum of their issue price and all prior accruals of OID. Cash payments on OID Notes are allocated ﬁrst to any stated interest then due, then to previously accrued OID (in the order of accrual) to which cash payments have not yet been allocated, and then to principal.

132 The term ‘‘qualified stated interest’’ means stated interest that is unconditionally payable in cash or in property, other than debt instruments of the Company, and the interest to be paid meets all of the following conditions: • it is payable at least once per year; • it is payable over the entire term of the Notes; and • it is payable at a fixed rate or, subject to certain conditions, based on one or more indices. The Company will provide notice in the applicable Pricing Supplement or Supplements when it determines that a particular Note will bear interest that is not or may not be qualified stated interest. U.S. Noteholders generally may make an irrevocable election to include in their income the entire return on OID Notes (including payments of qualified stated interest) under the constant yield method applicable to OID. For purposes of the foreign tax credit provisions of the Code, any OID accrued on the Notes and included in the U.S. Noteholder’s income will constitute foreign source income and will be classified as ‘‘passive category income’’ (or, in certain cases, as ‘‘general category income’’). Certain of the Notes may be redeemed prior to their maturity date at the option of the Company and/or at the option of the U.S. Noteholder, or may provide for certain payments which are treated as ‘‘contingent’’ payments under the OID rules. Notes containing such features may be subject to rules that differ from the general OID rules discussed herein. In the case of a Note that is a Floating Rate Note, the OID calculations are generally made as though the Note will bear interest in all periods at a fixed rate generally equal to the rate that would be applicable to interest payments on the Note on its date of issue or, in the case of certain Floating Rate Notes, the rate that reflects the yield to maturity that is reasonably expected for the Note. Actual interest payments in excess of this assumed rate are generally treated as additional qualified stated interest when made. Additional rules may apply if interest on a Floating Rate Note is based on more than one interest index, or such Note is treated as providing for one or more contingent payments. The U.S. federal income tax, including OID, consequences to a U.S. Noteholder of an Indexed Note will depend on factors including the specific index or indices used to determine indexed payments on the Note and the amount and timing of any noncontingent payments of principal and interest. Certain instruments that provide for wholly or substantially contingent principal payments may not constitute debt for U.S. federal income tax purposes.

Short-Term Notes In the case of Notes having an original maturity of one year or less from the date of issuance (‘‘Short-Term Notes’’), U.S. Noteholders that report income for U.S. federal income tax purposes on the accrual method, certain other U.S. Noteholders (for example, banks, regulated investment companies, and dealers in securities) and electing cash method U.S. Noteholders are required to accrue the ‘‘discount’’ on such Short-Term Notes as ordinary income on a straight-line basis over the remaining life of such Notes (unless an irrevocable election is made for such Notes to accrue such discount according to a constant yield method based on daily compounding). The discount on a Short-Term Note for this purpose equals the excess of the total payments (including all stated interest) to be made on such Note over the issue price of (or, if an election is made, the U.S. Noteholder’s basis in) the Short-Term Note. Discount recognized under this provision is generally in lieu of, and not in addition to, stated interest on the Notes. In general, individuals and certain other cash method U.S. Noteholders of a Short-Term Note are not required to include accrued discount on such Note in their income currently unless they elect to do so (but may be required to include any stated interest in income as the interest is received). In the case of a U.S. Noteholder that is not required, and does not elect, to include discount in income currently, any gain realized on the sale, exchange or retirement of a Short-Term Note will generally be ordinary income to the extent of the discount accrued through the date of sale, exchange or retirement. In addition, a U.S.

133 Noteholder that is not required, and does not elect, to include accrued discount in income currently may be required to defer deductions for a portion of the U.S. Noteholder’s interest expense with respect to any indebtedness incurred or continued to purchase or carry Short-Term Notes. The above-described elections available to be made with respect to Short-Term Notes generally apply for the taxable year for which they are made and all subsequent taxable years and may not be revoked without the consent of the IRS. Treatment of Premium If the U.S. Noteholder purchases an OID Note for an amount that is greater than its adjusted issue price but equal to or less than the sum of all amounts payable on the Note after the purchase date, other than payments of qualified stated interest, the U.S. Noteholder will be considered to have purchased that Note at an ‘‘acquisition premium’’. Under the acquisition premium rules, the amount of OID that the U.S. Noteholder must include in his gross income with respect to the Note for any taxable year will be reduced by the portion of the acquisition premium properly allocable to that year. If the U.S. Noteholder purchases a Note (including an OID) Note for an amount in excess of the sum of all the amounts payable on the Note after the purchase date, other than qualified stated interest, the U.S. Noteholder will be considered to have purchased the Note at a ‘‘premium’’ and, if it is an OID Note, the U.S. Noteholder will not be required to include any OID income. The U.S. Noteholder generally may elect to amortize this premium over the remaining term of the Notes. If the U.S. Noteholder makes this election, the amount of interest income that must be reported for U.S. federal income tax purposes with respect to any interest payment date will be reduced by the amount of premium allocated to the period from the previous interest payment date to that interest payment date. The amount of premium allocated to any such period is calculated by taking the difference between (i) the stated interest payable on the interest payment date on which that period ends and (ii) the product of (a) the Notes overall yield to maturity and (b) the U.S. Noteholder’s purchase price for the Notes (reduced by amounts of premium allocated to previous periods). In the case of instruments that provide for alternative payment schedules, the amount of premium is calculated by assuming that (a) the U.S. Noteholder will exercise or not exercise options in a manner that maximizes his yield and (b) the Company will exercise or not exercise options in a manner that minimizes the U.S. Noteholder’s yield (except the Company will be assumed to exercise call options in a manner that maximizes the U.S. Noteholder’s yield). If the U.S. Noteholder makes the election to amortize premium, it must be applied to the Notes and to all debt instruments acquired at a premium that the U.S. Noteholder holds at the beginning of the taxable year in which the election is made and all debt instruments subsequently purchased at a premium, unless the U.S. Noteholder obtains the IRS’s consent to a change. If the U.S. Noteholder does not make the election to amortize premium on the Notes and holds the Notes to maturity, the U.S. Noteholder will have a capital loss for U.S. federal income tax purposes, equal to the amount of the premium, when the Notes mature. If the U.S. Noteholder does not make the election to amortize premium and sells or otherwise dispose of the Notes before maturity, the premium will be included in the ‘‘tax basis’’ in the Notes as defined below, and therefore will decrease the gain, or increase the loss, that the U.S. Noteholder otherwise would realize on the sale or other disposition of the Notes. Treatment of Pre-issuance Interest If the Notes are issued with pre-issuance accrued interest, the U.S. Noteholder may treat the Notes, for U.S. federal income tax purposes, as having been issued for an amount that excludes the pre-issuance accrued interest. In that event, a portion of the first stated interest payment equal to the excluded pre-issuance accrued interest will be treated as a return of such pre-issuance accrued interest and will not be taxable to the U.S. Noteholder or otherwise treated as an amount payable on the Notes. Market Discount If the U.S. Noteholder acquires Notes from an original holder at a ‘‘market discount’’, his income may be affected by the market discount provisions of the Code. Debt instruments such as the Notes are

134 considered to have been purchased at market discount if, subsequent to their original issuance, they are purchased at a price below their stated redemption price at maturity or, in the case of an OID Note, its adjusted issue price. Under the market discount rules, if the U.S. Noteholder purchases the Notes at a market discount in excess of a statutory deﬁned de minimis amount and thereafter recognizes gain upon a disposition or retirement of (or receive partial principal payment on) the Notes, then the lesser of the gain so recognized (or the amount of such principal payment) and the portion of the market discount that accrued while the U.S. Noteholder held the Notes generally will be treated as ordinary income at such time. Moreover, any such market discount on the Notes may be taxable to the U.S. Noteholder at the time of certain otherwise non-taxable transactions. In addition, the U.S. Noteholder may be required to defer a portion of any interest expense that otherwise may be deductible on any indebtedness incurred or maintained to purchase or carry such Notes in an amount not exceeding the deferred income until such income is realized. The amount of market discount treated as having accrued will be determined by (i) on a ratable basis by multiplying the market discount times a fraction, the numerator of which is the number of days the U.S. Noteholder held the Notes and the denominator of which is the total number of days after the date the U.S. Noteholder acquired the Notes up to and including the date of its maturity or (ii) if the U.S. Noteholder elects, on a constant interest rate method. The U.S. Noteholder may make that election with respect to any Notes, but such election is irrevocable. Neither the rule treating accrued market discount as ordinary income on disposition nor the rule deferring interest deductions applies if the U.S. Noteholder elects to include the accrued market discount income currently. This election, once made, applies to all market discount obligations acquired during or after the ﬁrst taxable year to which the election applies and may not be revoked without the consent of the IRS. If the election is made to include market discount in income currently, the basis of the Notes in the U.S. Noteholder’s hands will be increased by the market discount thereon as it is included in income.

Sale or Disposition of Notes If the U.S. Noteholder sells or otherwise disposes of any Notes, he will generally be required to report a capital gain or loss equal to the difference between the ‘‘amount realized’’ and his ‘‘tax basis’’ in such Notes. The U.S. Noteholder’s ‘‘amount realized’’ will be the value of what was received for selling or otherwise disposing of the Notes, other than amounts that represent interest that is due to the U.S. Noteholder but that has not yet been paid (which will be taxed to the U.S. Noteholder as interest). The U.S. Noteholder’s ‘‘tax basis’’ in the Notes will equal the amount paid for the Notes, decreased (but not below zero) by any amortized premium (as described above) and by any cash payments of principal that the U.S. Noteholder has received with respect to the Notes, and increased by any OID previously included in income. Gain or loss from the sale or other disposition of any Notes generally will be long-term capital gain or loss if, at the time the U.S. Noteholder sells or disposes of the Notes, the U.S. Noteholder has held the Notes for more than one year. The gain or loss will be short-term capital gain or loss if the U.S. Noteholder held the Notes for one year or less. If the U.S. Noteholder is not a corporation, he will generally pay less U.S. federal income tax on long-term capital gain than on short-term capital gain. Limitations may apply to the U.S. Noteholder’s ability to deduct a capital loss. Any capital gains or losses that arise when the U.S. Noteholder sells or disposes of the Notes generally will be treated as U.S. source income, or loss allocable to U.S. source income, for purposes of the foreign tax credit provisions of the Code.

Foreign Currency Notes The following discussion applies to Foreign Currency Notes if such Notes are not denominated in or indexed to a currency that is considered a hyperinﬂationary currency. A U.S. Noteholder who purchases a Note with a Foreign Currency will generally recognize ordinary income or loss (‘‘foreign exchange gain or loss’’) in an amount equal to the difference, if any, between the U.S. Noteholder’s U.S. Dollar tax basis

135 in the Foreign Currency used to purchase such Note and the U.S. Dollar fair market value at the ‘‘spot rate’’ on the date of purchase of such currency. Additional foreign exchange gain or loss may be required to be recognized by a U.S. Noteholder with respect to interest or other amounts which the U.S. Noteholder is entitled to receive with respect to a Note where such amounts are denominated in terms of or are determined by reference to a single Foreign Currency (a ‘‘Foreign Currency Note’’). A U.S. Noteholder who uses the cash method of accounting for U.S. federal income tax purposes for reporting interest income on a Foreign Currency Note and who receives an interest payment on such Note which is denominated in or determined by reference to a Foreign Currency will be required to include in income the U.S. Dollar value of the amount of interest income received (determined by translating the amount of Foreign Currency interest paid at the ‘‘spot rate’’ for such Foreign Currency on the date such payment is received), regardless of whether the payment is received in U.S. Dollars or is in fact converted into U.S. Dollars. No exchange gain or loss is recognized with respect to the receipt of such payment, although exchange gain or loss may be required to be recognized on a subsequent disposition of any Foreign Currency so received. The U.S. Noteholder’s basis in such Foreign Currency will equal the amount included in such income with respect to such interest payment. A U.S. Noteholder that is required to accrue interest income (including OID, interest on certain Short-Term Notes and market discount in the case where a U.S. Noteholder has elected to accrue market discount currently) on a Foreign Currency Note prior to the receipt of such interest will be required to include in income for each accrual period the U.S. Dollar value of such interest denominated in or determined by reference to the Foreign Currency that has accrued during such accrual period, determined by translating such interest at the average rate of exchange for the interest accrual period during which such interest accrued (or, in the case of a short period resulting from an interest accrual period that straddles two taxable years of the U.S. Noteholder, such short period). For this purpose, the average rate is the simple average of spot rates of exchange for each business day of such period or other average exchange rate for the period reasonably derived and consistently applied by the U.S. Noteholder. Upon receipt of the interest payment to which such accrual relates, the U.S. Noteholder will recognize foreign exchange gain or loss in an amount equal to the difference between the U.S. Dollar value of the payment received (determined by translating the Foreign Currency amounts at the ‘‘spot rate’’ for such Foreign Currency on the date of receipt) and the amount of such prior accrual. The foreign currency gain or loss will generally be treated as U.S. source ordinary income or loss. In applying this rule, all receipts on a Note will be viewed first as the receipt of any stated interest payments called for under the terms of the Note, second as receipts of previously accrued and unpaid OID (to the extent thereof, with payments considered made for the earliest accrual periods first, and thereafter as the receipt of principal. OID on a Foreign Currency Note is determined in the foreign currency at the time of acquisition of the Note. U.S. Noteholders required to accrue interest income on a Foreign Currency Note pursuant to the foregoing may elect, in lieu of the above-stated average-rate method, to translate the accrued Foreign Currency interest to U.S. Dollars based upon the spot rate in effect on the last day of the accrual period (or the last day of its taxable year in the case of an accrual period that straddles the U.S. Noteholder’s taxable year), or on the date the interest payment is received if such date is within five business days of the end of the accrual period (in which case no foreign exchange gain or loss will be required to be recognized). Any such election must be applied consistently to all debt instruments held by the U.S. Noteholder at the beginning of the first taxable year to which such election applies or thereafter acquired and cannot be changed without the consent of the IRS. The amount of market discount on a Foreign Currency for which a current accrual election is not made (See ‘‘Market Discount’’ above) includible in income by the U.S. Noteholder of such Note will generally be determined by translating the accrued market discount on such Note (determined in the Foreign Currency) into U.S. Dollars at the spot rate on the date market discount is required to be recognized (i.e., the date such Note is retired or otherwise disposed of). No foreign exchange gain or loss with respect to such market discount is required to be recognized. Note premium on a Foreign Currency Note will be computed in units of the applicable Foreign Currency. With respect to a U.S. Noteholder that elects to amortize the premium, the amortizable note premium will reduce interest income denominated in or determined by reference to the applicable

136 Foreign Currency in units of Foreign Currency. At the time note premium offsets interest income, foreign exchange gain or loss (which is generally ordinary income or loss) will be realized based on the difference between the spot rates at such time and at the time of acquisition of the Foreign Currency Note. A U.S. Noteholder that does not elect to amortize note premium will translate the note premium, computed in the applicable Foreign Currency, into U.S. Dollars at the spot rate on the maturity date and such note premium will constitute a capital loss which may be offset or eliminated by exchange gain. A U.S. Noteholder’s tax basis in a Foreign Currency Note will be the U.S. Dollar value of the Foreign Currency amount paid for such Note determined at the time of such purchase. For purposes of determining the amount of any gain or loss recognized by a U.S. Noteholder on the sale, exchange or retirement of a Foreign Currency Note, the amount realized upon such sale, exchange or retirement will be the U.S. Dollar value of the amount realized in Foreign Currency (other than amounts attributable to accrued but unpaid interest not previously included in the U.S. Noteholder’s income), determined at the time of the sale, exchange or retirement. A U.S. Noteholder will recognize foreign exchange gain or loss attributable to the movement in exchange rates between the time of purchase and the time of disposition (including the sale, exchange or retirement) of a Foreign Currency Note. The realization of such gain or loss will be limited to the amount of overall gain or loss realized on the disposition of a Foreign Currency Note. A U.S. Noteholder will have a tax basis in any Foreign Currency received as interest or on the sale, exchange or retirement of a Foreign Currency Note equal to the U.S. Dollar value of such Foreign Currency, determined at the time the interest is received or at the time of the sale, exchange or retirement. Any gain or loss realized by a U.S. Noteholder on a sale or other disposition of Foreign Currency (including its exchange for U.S. Dollars or its use to purchase Notes) will be ordinary income or loss.Non-U.S. Noteholders This section applies to holders of the Notes that are ‘‘Non-U.S. Noteholder’’, meaning beneficial owners of the Notes that are not U.S. Noteholders as defined above. A Non-U.S. Noteholder will not be subject to U.S. federal income tax on interest received on the Notes unless engaged in a trade or business in the United States and the interest on the Notes is treated for tax purposes as ‘‘effectively connected’’ to that trade or business. If a Non-U.S. Noteholder is engaged in a U.S. trade or business and the interest income is deemed to be effectively connected to that trade or business, the Non-U.S. Noteholder will generally be subject to U.S. federal income tax on that interest in the same manner as a U.S. Noteholder. In addition, if the Non-U.S. Noteholder is a foreign corporation, interest income subject to tax in that manner may increase the Non-U.S. Noteholder’s liability under the U.S. branch profits tax. Subject to the backup withholding discussion below, the Non-U.S. Noteholder will not be subject to U.S. federal income tax or withholding tax for any capital gain realized when selling the Notes if: (a) that gain is not effectively connected for tax purposes to any U.S. trade or business the Non-U.S. Noteholder is engaged in; and (b) the Non-U.S. Noteholder is an individual, and (A) is not in the United States for 183 days or more in the taxable year in which the Notes are sold or (B) does not have a tax home (as defined in the Code) in the United States in the taxable year in which the Notes are sold and the gain is not attributable to any office or other fixed place of business maintained in the United States by the Non-U.S. Noteholder.

Substitution of Obligor Unless an exception applies, upon a Substitution with respect to a Note the Noteholder will be treated for U.S. tax purposes as having sold the Note (at the moment at which the Company ceases to be the primary obligor thereon) in a taxable transaction in exchange for an otherwise identical Note on which the transferee is the obligor. The consequences of that notional exchange are generally the same as those described under ‘‘—U.S. Noteholders — Sale or Disposition of Notes’’ and ‘‘—Non-U.S. Noteholders’’ in connection with an actual sale or other taxable disposition of a Note and the consequences of the acquisition, ownership and disposition of the ‘‘new’’ Notes received in the deemed exchange will generally be the same as described above with respect to Notes actually purchased.

137 Backup Withholding and Information Reporting

In general, if the Non-U.S. Noteholder is not a corporation or otherwise exempt, information reporting requirements will apply to payments of principal and interest to the Non-U.S. Noteholder if such payments are made within the United States or by or through a custodian or nominee that is a ‘‘U.S. Controlled Person,’’ as deﬁned below.

‘‘Backup withholding’’ will apply to such payments of principal and interest if the Non-U.S. Noteholder fails to provide an accurate taxpayer identiﬁcation number, fails to certify not being subject to backup withholding, fails to report all interest and dividend income required to be shown on his U.S. federal income tax returns or if fails to demonstrate his eligibility for an exemption.

Non-U.S. Noteholders are generally exempt from these withholding and reporting requirements (assuming that the gain or income is otherwise exempt from U.S. federal income tax), but they may be required to comply with certification and identification procedures in order to prove their exemptions. If a Non-U.S. Noteholder holds Notes through a foreign partnership, these certification procedures would generally be applied to the Non-U.S. Noteholder as a partner. If the Non-U.S. Noteholder is paid the proceeds of a sale or redemption of a Note effected at the U.S. office of a broker, he will generally be subject to the information reporting and backup withholding rules described above. In addition, the information reporting rules will apply to payments of proceeds of a sale or redemption effected at a foreign office of a broker that is a ‘‘U.S. Controlled Person,’’ as defined below, unless the broker has documentary evidence that the holder or beneficial owner is not a U.S. Noteholder or the holder or beneficial owner otherwise establishes an exemption.

A U.S. Controlled Person is:

(a) a U.S. Person;

(b) a controlled foreign corporation for U.S. federal tax purposes;

(c) a foreign person 50% or more of whose gross income is effectively connected with a U.S. trade or business for tax purposes for a speciﬁed three-year period; or

(d) a foreign partnership in which U.S. Persons hold more than 50% of the income or capital interests or which is engaged in a U.S. trade or business.

Backup withholding is not an additional tax. Any amounts withheld under the backup withholding rules will generally be allowed as a refund or a credit against U.S. federal income tax liability as long as the required information is provided to the IRS.

138 PLAN OF DISTRIBUTION Subject to the terms and conditions of the Program Agreement, Notes may be offered by the Company from time to time through Dealers, which have agreed to use all reasonable efforts to solicit offers to purchase Notes. The Company will pay the relevant Dealer a commission for sales made through it as Dealer (unless otherwise agreed). The Company will have the sole right to accept offers to purchase Notes and may reject any offer to purchase Notes in whole or in part. A Dealer will have the right to reject any offer to purchase Notes solicited by it in whole or in part. The Company may also sell Notes to a Dealer as principal for its own account at a discount or commission to be agreed upon at the time of sale. In addition, the Notes may be sold from time to time through a syndicate of financial institutions, for which a Dealer (or Dealers) shall act as a lead manager (or lead managers) (each a ‘‘Lead Manager’’). Such Notes may be resold to investors at prevailing market prices, or prices related thereto at the time of such resale or at a fixed offering price or otherwise, as determined by the relevant Dealer or Dealers. In addition, the Dealers may offer any Notes purchased as principal to other dealers. The Dealers may sell Notes to any dealer at a discount. The Company has agreed to indemnify the Dealers against certain liabilities and to reimburse the Dealers for certain expenses relating to the Program. In connection with the issue of any Tranche of Notes, the relevant Dealer or Dealers (if any) named as the Stabilizing Agent(s) (or persons acting on behalf of any Stabilizing Agent(s)) in the applicable Pricing Supplement) may over-allot Notes or effect transactions with a view to supporting the market price of the Notes at a level higher than that which might otherwise prevail. However, there is no assurance that the Stabilizing Agent(s) (or persons acting on behalf of a Stabilizing Agent) will undertake stabilization action. Any stabilization action may begin on or after the date on which adequate public disclosure of the terms of the offer of the relevant Tranche of Notes is made and, if begun, may be ended at any time, but it must end no later than the earlier of 30 days after the issue date of the relevant Tranche of Notes and 60 days after the date of the allotment of the relevant Tranche of Notes. Any stabilization action or overallotment must be conducted by the relevant Stabilizing Agent(s) (or persons acting on behalf of any Stabilizing Agent(s)) in accordance with all applicable laws and rules. The Company has been advised by the Dealers that the Dealers may make a market in the Notes; however, the Company cannot provide any assurance that a secondary market for the Notes will develop. In the ordinary course of their respective businesses, certain of the Dealers and/or their affiliates have in the past engaged, and may in the future engage, in the investment banking and commercial banking transactions with or involving the Company and its affiliates for which they may have received, and may in the future receive, customary compensation. United States The Notes have not been, and will not be, registered under the Securities Act and may not be offered or sold within the United States or to, or for the account or benefit of, U.S. persons except in accordance with Regulation S or pursuant to an exemption from the registration requirements of the Securities Act. Each Dealer has agreed, and each additional Dealer appointed under the Program will be required to agree, that it has not offered, sold or delivered, and will not offer, sell or deliver, Notes of any Tranche in reliance upon Regulation S (i) as part of their distribution at any time and (ii) otherwise until 40 days after the completion of the distribution of all Notes of such Tranche, as determined and certified to the Fiscal Agent by such Dealer (or, in the case of a sale of a Series of Notes through a syndicate of financial institutions, by the Lead Manager(s)), within the United States or to, or for the account or benefit of, a U.S. person and that it will have sent to each Dealer to which it sells Notes during the 40-day distribution compliance period a confirmation or other notice setting forth the restrictions on offers and sales of the Notes within the United States or to, or for the account or benefit of, U.S. persons. Terms used in the preceding two paragraphs have the meanings ascribed to them by Regulation S under the Securities Act. In addition, until 40 days after the completion of the distribution of any Tranche of Notes, an offer or sale of Notes of such Tranche within the United States by any Dealer (whether or not participating in

139 the offering) may violate the registration requirements of the Securities Act if such offer or sale is made otherwise than in accordance with an applicable exemption from registration under the Securities Act. Dealers may resell Registered Notes in the United States to QIBs pursuant to Rule 144A, and each such purchaser of Notes is hereby notified that Dealers may be relying on the exemption from the registration requirements of the Securities Act provided by Rule 144A. Registered Notes may also be offered and sold in the United States to Institutional Accredited Investors in reliance upon the exemption from registration provided by Section 4(2) thereof, which exempts transactions by an issuer not involving any public offering. The minimum aggregate principal amount of Notes which may be purchased by a QIB pursuant to Rule 144A must be at least U.S.$1,000 (or the equivalent thereof in the applicable Specified Currency). The minimum aggregate principal amount of Notes that may be purchased by or on behalf of any Institutional Accredited Investor is U.S.$200,000 (or the equivalent thereof in the applicable Specified Currency). To the extent that the Company is not subject to or does not comply with the reporting requirements of Section 13 or 15(d) of the Exchange Act or the information furnishing requirements of Rule 12g3-2(b) thereunder, the Company has agreed to furnish to Holders of the Notes and to prospective purchasers designated by such Holders, upon request thereby, such information as may be required by Rule 144A. Any purchaser of Notes must have sufficient knowledge and experience in business matters to be capable of evaluating the merits and risks of investing in and holding the Notes and be able to bear the economic risk of the investment for an indefinite period of time because the Notes have not been registered under the Securities Act. The Company has not undertaken to register the Notes thereafter, and the Notes cannot be reoffered, resold, pledged or otherwise transferred within the United States or to, or for the account or benefit of, a U.S. person unless they are subsequently registered or an exemption from such registration is available. There can be no assurance that the Notes will be sold or that there will be a secondary market for the Notes. See ‘‘Risk Factors-Limited Liquidity of the Notes.’’ Each Series of Notes will also be subject to such additional U.S. selling restrictions as the Company and the relevant Dealer or Dealers may agree and as set forth in the applicable Pricing Supplement. Each of the Dealers has agreed or will agree that it will offer, sell or deliver such Notes only in compliance with such additional selling restrictions.

Israel Each Dealer has agreed and each additional Dealer appointed under the Program Agreement will be required to agree that, unless otherwise provided in the applicable Pricing Supplement, it will not offer, sell or transfer the Notes in Israel in the initial distribution of any Notes and it will not offer, sell or transfer the Notes at any time to any Israeli ﬁnancial institutions (including their foreign branches or subsidiaries) in or outside of Israel.

European Economic Area In relation to each member state of the European Economic Area that has implemented the Prospectus Directive (each, a relevant member state), each Dealer has represented and agreed, and each additional dealer appointed under the Program Agreement will be required to represent, warrant and agree that, with effect from and including the date on which the Prospectus Directive is implemented in that relevant member state (the relevant implementation date), an offer of securities described in this Offering Circular may not be made to the public in that relevant member state other than: • to any legal entity that is authorized or regulated to operate in the financial markets or, if not so authorized or regulated, whose corporate purpose is solely to invest in securities; • to any legal entity that has two or more of (1) an average of at least 250 employees during the last financial year; (2) a total balance sheet of more than u43,000,000 and (3) an annual net turnover of more than u50,000,000, as shown in its last annual or consolidated accounts; • to fewer than 100 natural or legal persons (other than qualified investors as defined in the Prospectus Directive) subject to obtaining the prior consent of the Dealers; or

140 • in any other circumstances that do not require the publication of a prospectus pursuant to Article 3 of the Prospectus Directive, provided that no such offer of securities shall require the Company or any Dealer to publish a prospectus pursuant to Article 3 of the Prospectus Directive. For purposes of this provision, the expression an ‘‘offer of securities to the public’’ in any relevant member state means the communication in any form and by any means of sufficient information on the terms of the offer and the securities to be offered so as to enable an investor to decide to purchase or subscribe the securities, as the expression may be varied in that member state by any measure implementing the Prospectus Directive in that member state, and the expression ‘‘Prospectus Directive’’ means Directive 2003/71/EC and includes any relevant implementing measure in each relevant member state. The Company has not authorized and does not authorize the making of any offer of securities through any financial intermediary on their behalf, other than offers made by the Dealers with a view to the final placement of the securities as contemplated in this Offering Circular. Accordingly, no purchaser of the securities, other than the Dealers, is authorized to make any further offer of the securities on behalf of the Company or the Dealers.

Selling Restrictions Addressing Additional Countries’ Securities Laws

United Kingdom Each Dealer severally represents, warrants and agrees, and each additional dealer appointed under the Program Agreement will be required to represent, warrant and agree, that: (i) it has only communicated or caused to be communicated and will only communicate or cause to be communicated an invitation or inducement to engage in investment activity (within the meaning of Section 21 of the FSMA) received by it in connection with the issue or sale of any Notes in circumstances in which Section 21(1) of the FSMA does not apply to the Company; and (ii) it has complied and will comply with all applicable provisions of the FSMA with respect to anything done by it in relation to any Notes in, from or otherwise involving the United Kingdom.

Singapore This Offering Circular has not been and will not be registered as a prospectus with the Monetary Authority of Singapore (the ‘‘MAS’’) and the Notes are offered by the Company pursuant to exemptions invoked under Sections 274 and 275 of the Securities and Futures Act (Chapter 289) of Singapore (the ‘‘SFA’’). Accordingly, the Company has not offered or sold the Notes or caused the Notes to be made the subject of an invitation for subscription or purchase, nor will it offer or sell the Notes or cause the Notes to be made the subject of an invitation for subscription or purchase, nor has it circulated or distributed nor will it circulate or distribute this Offering Circular or any other document or material in connection with the offer or sale, or invitation for subscription or purchase, of the Notes, whether directly or indirectly to persons in Singapore other than (i) to an institutional investor under Section 274 of the SFA, (ii) to a relevant person, or any person pursuant to Section 275(1A) of the SFA, and in accordance with the conditions specified in Section 275 of the SFA or (iii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA. Where Notes are subscribed or purchased under Section 275 of the SFA by a relevant person which is: (a) a corporation (which is not an accredited investor (as defined in Section 4A of the SFA)) the sole business of which is to hold investments and the entire share capital of which is owned by one or more individuals, each of whom is an accredited investor; or (b) a trust (where the trustee is not an accredited investor) whose sole purpose is to hold investments and each beneficiary of the trust is an individual who is an accredited investor,

141 shares, debentures and units of shares and debentures of that corporation or the beneﬁciaries’ rights and interest (howsoever described) in that trust shall not be transferred within six months after that corporation or that trust has acquired the Notes pursuant to an offer made under Section 275 of the SFA except:

(iii) where no consideration is given for the transfer; or

(iv) by operation of law.

Other Restrictions

Each Dealer has agreed, and each additional Dealer appointed under the Program Agreement will be required to agree, that it will observe in all material respects all applicable securities laws and regulations in any country or jurisdiction in which it may offer, sell or deliver Notes (other than the United States, except to the extent provided above) and that it will not, directly or indirectly, offer, sell, resell or deliver Notes or distribute any offering material in relation to the Notes except under circumstances that will result in compliance in all material respects with any applicable securities laws and regulations. In addition, each Dealer has agreed, and each additional Dealer appointed under the Program Agreement will be required to agree, that it will comply with such other additional restrictions as the Company and such Dealer or Dealers shall agree, in which event such additional restrictions will be set forth in the applicable Pricing Supplement.

Neither the Fiscal Agent nor any of the Dealers represents that Notes may at any time lawfully be sold in compliance with any applicable registration or other requirements in any jurisdiction, or pursuant to any exemption available thereunder, or assumes any responsibility for facilitating such sale.

142 TRANSFER RESTRICTIONS Because of the following restrictions, purchasers of Notes in the United States are advised to consult legal counsel prior to making, any offer, sale, resale, pledge or transfer of such Notes. Each prospective purchaser of Notes, by accepting delivery of this Offering Circular, will be deemed to have represented and agreed as follows: (1) Such offeree acknowledges that this Offering Circular is personal to such offeree and does not constitute an offer to any other person or to the public generally to subscribe for or otherwise acquire the Notes other than pursuant to Rule 144A or Section 4(2) of the Securities Act or in offshore transactions in accordance with Regulation S. Distribution of this Offering Circular, or disclosure of any of its contents to any person other than such offeree and those persons, if any, retained to advise such offeree with respect thereto is unauthorized, and any such distribution or disclosure, without the prior written consent of the Company, is prohibited. (2) Such offeree agrees to make no photocopies of this Offering Circular or any documents referred to herein. Each purchaser of Notes will be deemed to have represented and agreed as follows (terms used in this paragraph that are defined in Rule 144A or in Regulation S are used herein as defined therein): (1) It certifies that (A) it is a ‘‘qualified institutional buyer’’ and, at the time of purchase of the Notes, it (or one or more qualified institutional buyers for whose account it is acting) will be the beneficial owner of such Notes or it is a broker-dealer acting for the account of its customer, its customer has confirmed to it that such person is a qualified institutional buyer, (B) it is located outside the United States and is not a U.S. person or (C) it is an institutional investor that qualifies as an ‘‘accredited investor’’ (as defined in Rule 501(a)(1), (2), (3) and (7) under the Securities Act) (an ‘‘Institutional Accredited Investors’’). (2) It acknowledges (or if it is acting for the account of another person, such person has confirmed to it that such person acknowledges) that the Notes have not been and will not be registered under the Securities Act. (3) It agrees (if it is acting for the account of another person, such person has confirmed to it that such person agrees) that it (or such person) will not offer, sell, pledge or otherwise transfer the Notes except (A) to a person whom it reasonably believes (or it and anyone acting on its behalf reasonably believes) is a qualified institutional buyer in a transaction meeting the requirements of Rule 144A, (B) in accordance with Regulation S under the Securities Act, (C) in accordance with Rule 144 under the Securities Act (if available), or (D) in a transaction otherwise exempt from the registration requirements of the Securities Act, in each case in accordance with any applicable securities laws of any state of the United States or any other jurisdiction. (4) The purchaser understands that Notes offered in reliance on Rule 144A may initially be represented by a Restricted Global Note and that Notes of the same Tranche offered in reliance on Regulation S may initially be represented by a Regulation S Global Registered Note. Before any interest in a Restricted Global Note may be offered, sold, pledged or otherwise transferred to a person who takes delivery in the form of an interest in a Regulation S Global Registered Note, the transferor will be required to provide the Registrar a written certification (in the applicable form provided in the Fiscal Agency Agreement) to the effect that such transfer is being made in compliance with Regulation S under the Securities Act or, if so available, Rule 144 under the Securities Act. Before any interest in a Regulation S Global Registered Note may be offered, sold, pledged or otherwise transferred to a person who takes delivery in the form of an interest in a Restricted Global Note, the transferor will be required to provide to the Registrar ,a written certification, (in the applicable form provided in the Fiscal Agency Agreement) to the effect that such transfer is being made to a person whom the transferor reasonably believes is a ‘‘qualified institutional buyer’’ within the meaning of Rule 144A in a transaction meeting the requirements of Rule 144A and in accordance with any applicable securities laws of any state of the United States or any other jurisdiction.

143 (5) It understands that each Global Note will bear a legend to the following effect unless the Company determines otherwise in compliance with applicable law: ‘‘THIS NOTE HAS NOT BEEN AND WILL NOT BE REGISTERED UNDER THE U.S. SECURITIES ACT OF 1933, AS AMENDED (THE ‘‘SECURITIES ACT’’), AND MAY NOT BE OFFERED, SOLD, PLEDGED OR OTHERWISE TRANSFERRED EXCEPT (1) TO A PERSON WHO THE SELLER REASONABLY BELIEVES IS A QUALIFIED INSTITUTIONAL BUYER, WITHIN THE MEANING OF RULE 144A UNDER THE SECURITIES ACT IN A TRANSACTION MEETING THE REQUIREMENTS OF RULE 144A, (2) IN ACCORDANCE WITH REGULATION S UNDER THE SECURITIES ACT, (3) IN ACCORDANCE WITH RULE 144 UNDER THE SECURITIES ACT (IF AVAILABLE), OR (4) IN A TRANSACTION OTHERWISE EXEMPT FROM THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT AND IN ACCORDANCE WITH ANY APPLICABLE SECURITIES LAWS OF ANY STATE OF THE UNITED STATES OR ANY OTHER JURISDICTION.’’ (6) It understands that the legend set forth in clause (5) above will be removed from each Regulation S Global Note, Euroclear/Clearstream Global Registered Note relating to any Tranche of Notes after 40 days following the completion of the distribution of all Notes of such Tranche. (7) It understands that each Definitive Registered Note will bear a legend to the following effect unless the Company determines otherwise in compliance with applicable law: ‘‘THIS NOTE HAS NOT BEEN AND WILL NOT BE REGISTERED UNDER THE U.S. SECURITIES ACT OF 1933, AS AMENDED (THE ‘‘SECURITIES ACT’’), AND MAY NOT BE OFFERED, SOLD, PLEDGED OR OTHERWISE TRANSFERRED EXCEPT (1) TO A PERSON WHO THE SELLER REASONABLY BELIEVES IS A QUALIFIED INSTITUTIONAL BUYER WITHIN THE MEANING OF RULE 144A IN A TRANSACTION MEETING THE REQUIREMENTS OF RULE 144A, (2) IN ACCORDANCE WITH REGULATION S UNDER THE SECURITIES ACT OR (3) IN ACCORDANCE WITH RULE 144 UNDER THE SECURITIES ACT (IF AVAILABLE). THE HOLDER OF THIS NOTE WILL BE REQUIRED TO FURNISH TO THE COMPANY AND THE REGISTRAR SUCH CERTIFICATIONS, LEGAL OPINIONS OR OTHER INFORMATION, IF ANY, AS THEY MAY REASONABLY REQUIRE TO CONFIRM THAT THE PROPOSED TRANSFER IS BEING MADE PURSUANT TO AN EXEMPTION FROM, OR IN A TRANSACTION NOT SUBJECT TO, THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT.’’ (8) Each Institutional Accredited Investor that is an initial purchaser of the Notes will be required to sign a representation letter as to compliance with the Securities Act in the form attached to the Fiscal Agency Agreement. Prior to any proposed transfer of an interest in the Notes represented by a Registered Note, the transferor must check the appropriate box on the Registered Note relating to the manner of such transfer in compliance with the Securities Act. Such transferor will be required to furnish to the Company and the Registrar such certifications, legal opinions or other information, if any, as they may reasonably require to confirm that the proposed transfer is being made pursuant to an exemption from, or in a transaction not subject to, the registration requirements of the Securities Act. (9) Each transferor of an interest in the Notes agrees to deliver to each person to whom it transfers such interest notice of any applicable restrictions on transfer. (10) It acknowledges that the Company, the Registrar, the Dealers and others will rely upon the truth and accuracy of the foregoing acknowledgments, representations and agreements. If it is acquiring any Notes as a fiduciary or agent for one or more accounts, it represents that it has sole investment, discretion with respect to each such account and that it has full power to make the foregoing acknowledgments, representations and agreements on behalf of each such account. (11) Unless otherwise agreed in writing in advance by the Company or provided in the applicable Pricing Supplement, Notes may not be transferred to or held by any Israeli financial institutions, including their foreign branches or subsidiaries. Any purported transfer in violation of the foregoing shall be null and void.

144 INDEPENDENT AUDITORS

The annual financial statements of the Company for the year ended December 31, 2007 have been audited by Brightman Almagor & Co., a member of Deloitte International. The annual financial statements of the Company as of and for the year ended December 31, 2006 have been audited jointly by Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global, and Brightman Almagor & Co. The annual financial statements of the Company as of and for the year ended December 31, 2005 have been audited by Kost Forer Gabbay & Kasierer.

LEGAL MATTERS

Certain legal matters in connection with this offering will be passed upon for the Company by Arnold & Porter LLP in connection with United States Federal and New York law and by Herzog Fox & Neeman Law Ofﬁces as to matters of Israeli law. Weil, Gotshal & Manges LLP New York, New York represented the Dealers as to matters of United States Federal and New York law and Meitar Liquornik Geva & Leshem Brandwein represented the Dealers in connection with Israeli law.

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[THIS PAGE LEFT INTENTIONALLY BLANK] INDEX TO FINANCIAL STATEMENTS Auditor’s Report to Shareholders ...... F-2 Directors’ Statements...... F-4 Balance Sheet as of December 31, 2006 and 2007 ...... F-8 Statements of Operations – Years ended December 31, 2005, 2006 and 2007...... F-10 Statements of Changes in Shareholders’ Equity – Years ended December 31, 2005, 2006 and 2007 ...... F-11 Statements of Cash Flow – Years ended December 31, 2005, 2006 and 2007 ...... F-12 Notes to the Financial Statements ...... F-15

EXHIBITS Auditor’s Report for the year ended December 31, 2006 ...... Exhibit 1 Auditor’s Report for the year ended December 31, 2005 ...... Exhibit 2

F-1 Brightman Almagor 1 Azrieli Center Tel Aviv 67021 P.O.B. 16593, Tel Aviv 61164 Israel

Tel: +972 (3) 608 5555 Fax: +972 (3) 609 4022 [email protected] www.deloitte.co.il AUDITORS’ REPORT To the Shareholders of the Israel Electric Corporation Limited We have audited the accompanying balance sheet of the Israel Electric Corporation Limited (‘‘the Company’’) as of December 31, 2007, and the related statements of operations, changes in shareholders’ equity and cash flows for the year then ended. These financial statements are the responsibility of the Company’s Board of Directors and its management. Our responsibility is to express an opinion on these financial statements based on our audit. The financial statements as of December 31, 2006 and for the year then ended were audited jointly by us and by other auditors and the joint auditors’ report dated March 29, 2007 expressed an unqualified opinion on those statements. The financial statements for the year ended December 31, 2005 were audited by other auditors, whose report dated March 29, 2007 expressed an unqualified opinion on those statements. We conducted our audit in accordance with generally accepted auditing standards in Israel including those prescribed by the Israeli Auditors’ Regulations (Auditor’s Mode of Performance)—1973. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the Company’s Board of Directors and its management, as well as evaluating the overall financial statements presentation. We believe that our audit provides a reasonable basis for our opinion. As described in Note 2.a.(3), the Minister of Finance has prescribed principles for the preparation of the Company’s financial statements, in regulations issued in accordance with his authority under section 33.a of the Government Companies Law. Pursuant to these principles, the Company shall continue reporting in values adjusted for the changes in the purchasing power of Israeli currency through December 31, 2007, in accordance with the provisions of Accounting Opinion No. 36 (including the provisions prescribed in Accounting Opinions Nos. 40, 50 and 56) of the Institute of Certified Public Accountants in Israel. In our opinion, the financial statements referred to above present fairly, in conformity with generally accepted accounting principles in Israel and in accordance with that stated in the preceding paragraph, in all material respects, the financial position of the Company as of December 31, 2007 and the results of its operations, the changes in its shareholders’ equity and its cash flows for the year then ended. Furthermore, in our opinion, the financial statements referred to above are prepared in accordance with the Securities Regulations (Preparation of Annual Financial Statements)—1993.

F-2 Without qualifying our above opinion, we draw attention to the following matters:

1. Note 1.a.6 regarding the ‘‘Asset Arrangement’’ and regarding material amounts that the Company may be obligated to pay under that arrangement.

2. Note 21.b (subsections 1, 2 and 5) regarding class action lawsuits and other material claims that were ﬁled against the Company.

3. Note 32.e.3 (e) regarding the possibility that the Company would have to restate (in IFRS ﬁnancial statements) the amounts of CPI-linked ﬁnancial assets and liabilities if a different method for measuring the effective interest rate will be required for such assets and liabilities.

4. Note 32.e.4.b regarding the possibility that the Company would have to restate (in IFRS ﬁnancial statements) its pension obligation by using a discount rate compatible with market yields on high quality corporate bonds, instead of market yields on government bonds.

Notes 34 and 35 include additional information that is required pursuant to instructions of the Government Companies Authority (by virtue of section 33.b to the Government Companies Law), excluding information regarding land rights as discussed in Note 34.e.

Brightman Almagor & Co. Certiﬁed Public Accountants

March 31, 2008

F-3 ADDENDUM (REGULATION 2)

IN ACCORDANCE WITH GOVERNMENT COMPANIES REGULATIONS (ADDITIONAL REPORT REGARDING ACTIONS TAKEN AND REPRESENTATIONS MADE TO SECURE THE ACCURACY OF THE FINANCIAL STATEMENTS AND DIRECTORS’ REPORT), 2005

I, Moshe Bachman, certify that:

1. I have reviewed the annual ﬁnancial statements and directors’ report of The Israel Electric Corporation Limited (‘‘the Company’’) for 2007 (collectively—‘‘the reports’’).

2. To the best of my knowledge and after reviewing the reports, they do not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by the reports.

3. To the best of my knowledge and after reviewing the reports, the financial statements and other financial information included in the directors’ report fairly present, in all material respects, the financial condition, results of operations, changes in shareholders’ equity and cash flows of the Company as of, and for, the periods presented in the reports.

4. The Company’s other certifying ofﬁcers and I are responsible for establishing and maintaining disclosure controls and procedures for the Company. Accordingly, we have designed such disclosure controls and procedures, or had established under our charge such disclosure controls and procedures, designed to ensure that material information relating to the Company is made known to us by others in the Company particularly during the period in which the reports were prepared.

5. The Company’s other certifying ofﬁcers and I have disclosed to the Company’s auditors and the Company’s board of directors, based on our most recent evaluation:

a. All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the Company’s ability to record, process, summarize and report financial information.

b. Any fraud, whether or not material, that involves management or other employees who have a signiﬁcant role in the Company’s internal controls over ﬁnancial reporting.

There is nothing in the aforesaid to derogate from my responsibility or the responsibility of anyone else, pursuant to any law.

Moshe Bachman March 31, 2008 Acting Vice-President of Finances and Economics

F-4 ADDENDUM (REGULATION 2)

I, Amos Lasker, certify that:

1. I have reviewed the annual ﬁnancial statements and directors’ report of The Israel Electric Corporation Limited (‘‘the Company’’) for 2007 (collectively—‘‘the reports’’).

5. The Company’s other certifying ofﬁcers and I have disclosed to the Company’s auditors and the Company’s board of directors, based on our most recent evaluation:

b. Any fraud, whether or not material, that involves management or other employees who have a signiﬁcant role in the Company’s internal controls over ﬁnancial reporting.

There is nothing in the aforesaid to derogate from my responsibility or the responsibility of anyone else, pursuant to any law.

Amos Lasker March 31, 2008 Chief Executive Ofﬁcer

F-5 ADDENDUM (REGULATION 2)

I, Michael Lazer, certify that:

1. I have reviewed the annual ﬁnancial statements and directors’ report of The Israel Electric Corporation Limited (‘‘the Company’’) for 2007 (collectively—‘‘the reports’’).

5. The Company’s other certifying ofﬁcers and I have disclosed to the Company’s auditors and the Company’s board of directors, based on our most recent evaluation:

b. Any fraud, whether or not material, that involves management or other employees who have a signiﬁcant role in the Company’s internal controls over ﬁnancial reporting.

There is nothing in the aforesaid to derogate from my responsibility or the responsibility of anyone else, pursuant to any law.

Michael Lazer March 31, 2008 Director

F-6 ADDENDUM (REGULATION 2)

I, Mordechai Friedman, certify that:

1. I have reviewed the annual ﬁnancial statements and directors’ report of The Israel Electric Corporation Limited (‘‘the Company’’) for 2007 (collectively—‘‘the reports’’).

5. The Company’s other certifying ofﬁcers and I have disclosed to the Company’s auditors and the Company’s board of directors, based on our most recent evaluation:

b. Any fraud, whether or not material, that involves management or other employees who have a signiﬁcant role in the Company’s internal controls over ﬁnancial reporting.

There is nothing in the aforesaid to derogate from my responsibility or the responsibility of anyone else, pursuant to any law.

Mordechai Friedman March 31, 2008 Chairman of the Board of Directors

F-7 THE ISRAEL ELECTRIC CORPORATION LIMITED BALANCE SHEETS (Adjusted NIS in December 31, 2007 purchasing power)

December 31, 2007 2006 Note NIS in millions CURRENT ASSETS Cash and cash equivalents ...... 456 746 Short-term investments ...... 4 — 218 Trade receivables for sales of electricity ...... 5 3,062 2,969 Other accounts receivable ...... 6 772 700 Inventory – fuel ...... 7 2,249 1,675 Inventory – stores ...... 216 213 6,755 6,521 NON-CURRENT ASSETS LONG-TERM DEBTS...... 8 1,985 2,517 INVESTMENTS IN INVESTEES ...... 9 64 59 INVESTMENTS IN DEBENTURES ...... 10 1,136 866 Fixed assets in operation, net ...... 53,097 51,906 Fixed assets under construction...... 5,148 7,195 Fixed assets, net ...... 11 58,245 59,101 INTANGIBLE ASSETS, NET ...... 12 789 835 68,974 69,899

The accompanying notes are an integral part of the ﬁnancial statements.

Mr. Moshe Bachman Mr. Amos Lasker Mr. Michael Lazer Mr. Mordechai Friedman Acting Vice-President of Chief Executive Director Chairman of the Finances and Economics Ofﬁcer Board of Directors

March 31, 2008 Date of approval of the ﬁnancial statements

F-8 THE ISRAEL ELECTRIC CORPORATION LIMITED BALANCE SHEETS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

December 31, 2007 2006 Note NIS in millions CURRENT LIABILITIES Credit from banks and other credit providers ...... 14 1,683 2,896 Liabilities to suppliers and providers ...... 2,504 1,530 Customer advances, net of work in progress ...... 15 247 279 Other current liabilities...... 16 3,626 2,581 8,060 7,286 LONG-TERM AND EXTENDED-TERM LIABILITIES, NET Obligations due to employee-employer relationships, net ...... 17 746 737 DEBENTURES AND LIABILITIES TO BANKS Long-term debentures, net ...... 25,897 25,614 Liabilities to banks...... 11,354 12,842 Other long-term liabilities ...... 2,009 2,281 Extended-term debentures, net ...... 473 539 18 39,733 41,276 DEFERRED TAXES, NET ...... 19 4,433 4,484 PERPETUAL DEBENTURES ...... 20 2,156 2,169 COMMITMENTS AND CONTINGENT LIABILITIES ...... 21 SHAREHOLDERS’ EQUITY ...... 31.a 13,846 13,947 68,974 69,899

The accompanying notes are an integral part of the ﬁnancial statements.

F-9 THE ISRAEL ELECTRIC CORPORATION LIMITED STATEMENTS OF OPERATIONS (Adjusted NIS in December 31, 2007 purchasing power)

Year Ended December 31, 2007 2006 2005 Note NIS in millions Revenues...... 24 19,264 18,188 17,317 Cost of operating the Electricity System: Wages...... 1,653 1,573 1,377 Fuel ...... 9,861 8,357 8,099 Purchases of electricity ...... 113 86 75 Operation of the generation system ...... 534 599 573 Operation of the transmission and distribution system...... 259 302 248 Depreciation...... 3,106 2,987 2,820 15,526 13,904 13,192 Profit from operating the Electricity System ...... 3,738 4,284 4,125 Sales and marketing expenses ...... 25 798 789 744 Administrative and general expenses...... 26 710 789 660 Expenses resulting from liabilities to pensioners, net ...... 230 121 110 1,738 1,699 1,514 Income from current operations ...... 2,000 2,585 2,611 Financial expenses, net: Financial expenses...... 908 1,760 2,132 Capitalization of financial expenses ...... (27) (180) (246) Transfer of financial income to a regulatory liability ...... 1,202 668 91 Financial expenses, net ...... 28 2,083 2,248 1,977 Other expenses (income), net ...... 29 64 (7) 8 Income (loss) from current operations before income taxes ... (147) 344 626 Income tax expenses (benefit): Deferred taxes ...... (36) 91 170 Effect of change in tax rate on deferred taxes ...... — — (865) Total income tax expenses (benefit)...... 19 (36) 91 (695) Income (loss) from current operations after provision for income taxes...... (111) 253 1,321 Equity in earnings of affiliated company, net ...... 10 9 7 Net income (loss)...... (101) 262 1,328

The accompanying notes are an integral part of the ﬁnancial statements.

F-10 THE ISRAEL ELECTRIC CORPORATION LIMITED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Adjusted NIS in December 31, 2007 purchasing power)

Paid-up Perpetual Capital share debentures reserves Provision for Retained capital (Note 20) (Note 22) dividend earnings Total NIS in millions Balance as of January 1, 2005 ...... 972 2,169 880 1,546 9,044 14,611 Changes during 2005 Net income...... — — — — 1,328 1,328 Interest on perpetual debentures (net of NIS (28 million from tax savings) (1)...... — — — — (85) (85) Erosion of dividend payable for 2004 (2)...... — — — (36) 36 — Dividend provided for 2005 (2) ..... — — — 761 (761) — Balance as of December 31, 2005 ..... 972 2,169 880 2,271 9,562 15,854 Changes during 2006 Net income...... — — — — 262 262 Reclassiﬁcation ...... — (2,169) — — (2,169) Erosion of dividend provided for previous years (2) ...... — — — 2 (2) — Dividends provided for 2006 (2) .... — — — 165 (165) — Balance as of December 31, 2006 ..... 972 — 880 2,438 9,657 13,947 Changes during 2007 Net loss...... — — — — (101) (101) Erosion of dividend from previous years (2) ...... — — — (80) 80 — Balance as of December 31, 2007 ..... 972 — 880 2,358 9,636 13,846

(1) Net of erosion of interest payable as of the beginning of the period. (2) a. As stated in Note 1.e, the policy of the Government Companies Authority (‘‘the Companies Authority’’) is to distribute dividends at a rate of 60% of annual current net income, before profit-based bonus payment to employees. b. The amount of dividends for 2004 is about NIS 1,546 million, for 2005 is about NIS 761 million and for 2006, about NIS 165 million. c. The Company’s Board of Directors decided to recommend to the General Meeting the distribution of dividends in the amount of NIS 118 million from the earnings for 2004, which is because in its opinion, dividends should not be distributed out of the earnings derived from a change in accounting policy and from an amount resulting from a decrease in the tax rate (see also Note 1.e below). d. The Company applied to the Director of the Companies Authority to receive his approval of the above recommendation for 2004 and as of the date of signing these financial statements, has not yet received his reply. e. For the time being, the Board of Directors has not recommended the distribution of dividends for 2005 and 2006. f. On March 26, 2008, the Director of the Companies Authority rendered his response regarding the examination of the designation of profits for 2006 – 2005 stating that in 2008, the Companies Authority does not intend to require a dividend distribution in respect of 2006 – 2005. The accompanying notes are an integral part of the financial statements.

F-11 THE ISRAEL ELECTRIC CORPORATION LIMITED STATEMENTS OF CASH FLOWS (Adjusted NIS in December 31, 2007 purchasing power)

Year Ended December 31, 2007 2006 2005 NIS in millions Cash flows from operating activities: Net income (loss) according to the statements of operations...... (101) 262 1,328 Adjustments required to reconcile net income (loss) to net cash provided by operating activities – Annex A ...... 3,654 4,043 2,788 Net cash provided by operating activities ...... 3,553 4,305 4,116 Cash flows from investing activities: Purchase of fixed assets...... (2,874) (3,466) *)(4,650) Deposit in excess of funding over provision fore pension ...... — (647) (67) Sale (purchase) of in intangible assets ...... (202) (220) *)16 Purchase of marketable securities and other long-term investments. . . (261) (172) (671) Proceeds from sale of fixed assets ...... 62 39 29 Sale (purchase) of short-term marketable securities and investments, net...... — 426 (415) Repayment (grant) of long-term loans ...... 6 (131) (368) Collection of long-term debts...... 50 38 57 Repayment (placement) of bank deposits ...... 218 (218) — Net cash used in investing activities ...... (3,001) (4,351) (6,069) Cash flows from financing activities: Dividends paid ...... — — (113) Repayment of short-term debentures ...... — — (303) Interest on perpetual debentures...... — — (113) Issuance of long-term debentures, net ...... 2,000 2,031 5,129 Other long-term loans received, net ...... 152 1,265 318 Repayment of long-term debentures ...... (1,043) (1,650) (1,478) Repayment of other long-term loans ...... (173) (226) (212) Other long-term loans repaid...... (1,268) (1,361) (1,191) Placement (repayment) of swap transactions, net ...... (510) (509) 176 Short-term credit from banks, net ...... — (19) (1) Net cash provided by (used in) financing activities ...... (842) (469) 2,212 Increase (decrease) in cash and cash equivalents ...... (290) (515) 259 Balance of cash and cash equivalents at the beginning of the year ..... 746 1,261 1,002 Balance of cash and cash equivalents at the end of the year ...... 456 746 1,261

* Reclassiﬁed.

The accompanying notes are an integral part of the ﬁnancial statements.

F-12 THE ISRAEL ELECTRIC CORPORATION LIMITED STATEMENTS OF CASH FLOWS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

ANNEX A—ADJUSTMENTS REQUIRED TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES

Year Ended December 31, 2007 2006 2005 NIS in millions Income and expenses not affecting cash flows: Equity in earnings of investees, net of dividend received ...... (15) (4) (5) Depreciation and amortization ...... 3,417 3,309 3,256 Deferred taxes, net...... (36) 91 (695) Increase in obligations due to employee-employer relationships, net. . 307 30 10 Erosion of loans and debentures, net (including swap transactions). . . (1,567) (595) (270) Decrease in regulatory asset due to financial expenses, net ...... 1,093 725 222 Decrease (increase) in other regulatory assets ...... (5) 486 374 Erosion (excess) of collectible debts ...... 30 27 (3) Capital loss on sale of fixed assets ...... 86 1 41 Increase in value of marketable securities, net ...... (9) (33) (2) 3,301 4,037 2,928 Changes in assets and liabilities: Decrease (increase) in trade receivables for sales of electricity...... 84 (29) (74) Decrease (increase) in other current assets ...... (49) (80) 42 Decrease (increase) in inventory – stores ...... (3) (42) 12 Decrease (increase) in inventory – fuel ...... (574) 38 (304) Increase (decrease) in customer advances, net of work in progress . . . (32) 114 64 Increase (decrease) in liabilities to suppliers and service providers . . . 974 (57) (218) Increase (decrease) in other current liabilities ...... (47) 62 338 353 6 (140) 3,654 4,043 2,788

The accompanying notes are an integral part of the ﬁnancial statements.

F-13 THE ISRAEL ELECTRIC CORPORATION LIMITED STATEMENTS OF CASH FLOWS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

ANNEX B—ACTIVITIES NOT REFLECTED IN THE STATEMENTS OF CASH FLOWS

Year Ended December 31, 2007 2006 2005 NIS in millions Proceeds received from Government insurance company related to linkage to differences on indexed debentures against an identical payment to the holders of the debentures...... 1 12 6

The accompanying notes are an integral part of the ﬁnancial statements.

F-14 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT The Company is engaged in the generation, transmission, distribution of and commerce in electricity, and the construction of the infrastructures required for these activities.

a. The Electricity Sector Law and its amendments Since March 5, 1996, the Company has been subject, inter alia, to provisions of the Electricity Sector Law—1996 (‘‘the Electricity Sector Law’’), which has been amended several times, the latest of which was approved in March 2008 (Amendments No. 5, 6 and 7). Further, the Company is subject to the provisions of the Government Companies Law, 1975 (‘‘the Government Companies Law’’). As for the operating licenses for the Company’s activities pursuant to the Electricity Sector Law, see Note 1b below. The purpose of the Electricity Sector Law is to regulate the activities in the Electricity Sector for the benefit of the public, while ensuring reliability, availability, quality and efficiency, all while creating and facilitating competition and reducing costs. As stated above, the Electricity Sector Law has been amended several times, the latest of which in March 2008 and this, among others, in order to regulate structural changes in the electricity sector, including the Company’s future structure. The latest significant amendment to the Electricity Sector Law is Amendment No. 5 of March 1, 2007 (‘‘Amendment No. 5’’), that prescribed provisions in connection with the Electricity Sector’s future structure. The principal provisions of the Law as described below are pursuant to the Law as it is formulated after Amendment No. 6 came into effect.

1. The main provisions of the Electricity Sector Law are as follows: The main principles for granting licenses by the Public Utilities Authority— Electricity (‘‘the Electricity Authority’’) as approved by the Minister of National Infrastructures (‘‘the Minister’’) as prescribed by Electricity Sector Law, include several restrictions as speciﬁed below. The various activities in the electricity sector will be segregated, in general forbidding the granting of a license to more than one activity to a person (subject to the exceptions that will be listed below), and prescribes caps for the scope of generation capability inherent in the generation licenses held by a person, and the scope of distribution inherent in the distribution licenses held by a person. In addition, it imposes a series of restrictions on the holding of licenses in a cluster of companies, the principal element of which is the imposing of restrictions on holding of licenses of various types and the scope of generation capacity and distribution that it is possible to hold in a cluster of companies (see subsections e-h below). According to the Electricity Sector Decree (the Extension of the Period of the Validity of the Company’s Licenses and Implementation of the Restructuring in the Electricity Sector), 2007 and the Electricity Sector Decree (Deferral of Dates), 2007 (‘‘the Decrees’’) published on November 1, 2007, the Company’s licenses covering the overall scope of its activities were extended effective November 1, 2007 as follows: the generation and transmission licenses were extended until July 1, 2008 and the distribution and supply licenses were extended until July 1, 2009.

F-15 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) a. The Electricity Sector Law and its amendments (continued) In addition, interim provisions were determined in the Electricity Sector Law for the gradual implementation of these restrictions in 2007-2013. Below are the principal rules and restrictions for granting licenses prescribed in the Electricity Sector Law, as amended: a) A license will be granted for one activity, place or deﬁned area, and it is possible that different generation licenses will be granted in proportion to one power station. b) The Electricity Authority, as approved by the Minister, is entitled to grant a license for activities (generation, transmission, system management, distribution, supply and commercial activities in electricity), to prescribe terms therein, as well as to limit or not to limit the period it is in force. c) No person will be granted a license for more than one activity, except for: – A generation license may be granted together with a supply license provided that attention is given, among others, to the developments in the competition in the electricity sector. It should be noted that Amendment No. 5 eliminated the possibility of granting a supply license to a holder of a distribution license. Nevertheless, Amendment No. 5 prescribes a transition provision whereby the holder of a distribution license that is a Government company or Government subsidiary may be granted a supply license until January 1, 2012 and the Ministers, in consultation with the Companies Authority and the Electricity Authority, are entitled to determine in a decree that a supply license will be granted as above until January 1, 2013; – Amendment No. 7 to the Electricity Sector Law prescribes that a supply license may also be granted until January 1, 2012 to a company that owns a distribution license and is not a government company or subsidiary. The ministers, in consultation with the Electricity Authority, may determine by decree that such company will be granted a supply license through January 1, 2013 and may, under the same consultation, and if they see it as vital for promoting the purposes of this Law, defer said date by decree for a period not exceeding six months. – Amendment No. 5 eliminates the option of granting a limited volume generation license (up to 10% of the sector’s total generation capacity) to the holder of a transmission license but it prescribes that the holder of a license for managing the system or its subsidiary if it is so determined in the license and it is essential for the reliability of the power supply, may also be granted generation licenses provided that these licenses are not granted with respect to 5% or more of the generation capacity of the electricity sector and if the Minister considers that there are special circumstances, 10% or more of said capacity.

F-16 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) a. The Electricity Sector Law and its amendments (continued) d) A generation license shall not be granted to a person that, following receipt of the requested license, will hold 30% or more of the volume of generation capability in the electricity sector, and a distribution license shall not be granted to a person that, following receipt of the requested license, shall hold 25% or more (prior to Amendment No. 5, the quantity referred to 20%) of the volume of distribution in the electricity sector. e) Generation or distribution licenses shall not be granted to someone holding means of control in the holder of a transmission license. f) A transmission license shall not be granted to someone holding means of control in the holder of a generation license or the holder of a distribution license. g) A generation license shall not be granted to someone holding means of control in: – The holder of a distribution license for a volume of 10% or more of the distribution capacity in the electricity sector, or; – The holder of a distribution license if, following the receipt of the requested license, it shall hold by the means of control 10% or more of the volume of generation capability in the electricity sector. h) A distribution license shall not be granted to the holder of means of control in: – The holder of a generation license, who holds 10% or more of the volume of generation capability in the electricity sector, or; – The holder of a generation license if, following the receipt of the requested license, it shall hold by means of control 10% or more of the volume of distribution in the electricity sector. i) Amendment No. 5 stipulates that a license shall not be granted if after receiving the license, there will be an person other than the State holding a license for management of the system or holding the means of control in said licensee and will also hold a distribution, generation or supply license or will hold the means of control in said licensee, other than as stated in 1.b below. j) The Ministers of National Infrastructures and of Finance (‘‘the Ministers’’), in consultation with the Electricity Authority and with the Companies Authority, are entitled to determine rates which are different from the rates prescribed in sections d, g and h above, that detail the restrictions on granting generation and distribution licenses, as stated above, if they are convinced that the matter is essential to advancing the objectives of the Law (different rates could include both an increase and a decrease in the volume of generation and distribution capability that any person whomsoever could hold or that the license holder could hold through the holding of the means of control in other license holders, as applicable), as well as to determine additional restrictions to the restrictions described above for granting licenses.

F-17 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) a. The Electricity Sector Law and its amendments (continued) Amendment No. 5 modiﬁes the transition periods prescribed by the Electricity Sector Law and determines new transition provisions, schedules and milestones for the Company’s restructuring as follows: a) Despite the provisions of the Electricity Sector Law and the provisions of the licenses granted to the Company pursuant to the Electricity Sector Law, that were in effect on the eve of the end of the transition period (March 3, 2006), the licenses will remain in effect for all the activities previously carried out according to the licenses until July 1, 2007 (as for the extension of the decrees beyond said date, see section d) below). b) Amendment No. 5 regulates the activities of the Company’s power stations with respect to which a license could not be obtained prior to the amendment and prescribes that the Electricity Authority, with the Minister’s approval, is entitled to grant generation licenses despite the restrictions stipulated in the Electricity Sector Law on the power stations included in the development plan approved by the Electricity Sector Law whose establishment commenced prior to March 4, 2007 for a period during which the licenses mentioned in a) above and granted prior to the end of the transition period are in effect. As for the elaboration on this matter, see b)2) below. Accordingly, on April 29, 2007, the Minister granted his approval for the licenses granted to the Company by the Electricity Authority for said power stations. c) Amendment No. 5 stipulates that the system management activity requires a license according to the Electricity sector Law (an essential service provider license). It further stipulates that a license will not be granted according to the Electricity Sector Law if after receiving such license, a person, other than the State, will own a license to manage a system or will hold the means of control over the system management license owner and will also own a distribution, generation or supply license or will hold the means of control over such a license owner other than as speciﬁed in b) above. Accordingly, a system management license owner must be part of a separate corporation outside of the Company’s corporate structure. Despite the above, at this stage, the Company will be able to continue the system management activity and the license to the new corporation that will manage the system will be granted by September 1, 2008. (As for the extension of the dates and the decrees, see d) below). The Electricity Authority, under the Minister’s approval, is entitled to grant generation and distribution licenses to a Government company or Government subsidiary for the electric system operated in accordance with the above licenses as stated in a) and b) above even if the provisions according to which a person shall not hold 30% or more of the electricity sector’s generation capacity after receiving the generation license and 25% or more of the electricity sector’s distribution volume after receiving the distribution license are not met, provided that all of the following stipulations are met:

F-18 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) a. The Electricity Sector Law and its amendments (continued) 1) The generation licenses shall only be granted if after receiving the license the license holder will hold power stations operating on the basis of a mixture of various types of fuels such as diesel oil, natural gas and coal. As for the matter of coal, the license applicant is not obligated to produce the coal operated electricity by itself but rather may own rights to receive electricity produced in a coal operated power station. The license holder according to this section shall be viewed as concentrating a substantial portion of the electricity sector generation capacity and will be subject to the provisions of the Electricity Sector Law regarding an essential service provider licensee as long as the Minister does not determine otherwise. The Minister’s determination prior to January 1, 2015 requires the consent of the Minister of Finance. 2) Distribution licenses will be granted in such a manner that the costs of the license holders regarding the electricity facilities they use for operations upon granting the licenses will be as similar as possible; however, the Ministers, in consultation with the Electricity Authority and the Companies Authority, are entitled to determine otherwise if they consider that it is for the advancement of the objectives of the Electricity Sector Law. 3) After receiving the license, the license holder will not hold, through another corporation, 30% or more of the electricity sector’s generation capacity or 25% or more of the distribution volume in the electricity sector. 4) The license will be in effect provided that as of July 1, 2013, a Government company or Government subsidiary will not hold, jointly or severally, more than 51% of the means of control in the holder of a distribution or generation license, as provided by this section. d) On November 1, 2007, the Decrees came into effect. The Decrees include the extension of the Company’s licenses, the deferral of part of the Company’s restructuring schedules and the addition of interim milestones for the transition of the Company to a corporate structure as follows: The generation licenses will be extended until July 1, 2008. Until that date, several corporations will be established as subsidiaries of the Company to engage in the generation activities and to activate the power stations operated by the Company. The determining date for operating the generation corporations has been deferred by six months from January 1, 2009 until July 1, 2009. In addition, two additional milestones were determined for the course of said period, from the establishment of the generation companies until their operation as follows: By November 1, 2008—the arrangements required for the capital structure, including the assets and liabilities and all other arrangements required for the corporation’s activity, will be completed.

F-19 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) a. The Electricity Sector Law and its amendments (continued) By January 1, 2009—the economic and operational arrangements between the generation corporation and the other corporations to be established pursuant to the Decrees will be completed. The transmission license was extended until July 1, 2008. The Decrees also stipulate directives for the establishment and operation of the transmission corporations that determine that by January 1, 2010, the transmission corporation will be established as a subsidiary of the Company and engage in setting up and operating the transmission license owner’s electricity network. The determining date for activating the transmission corporation remains December 31, 2010. Furthermore, two additional milestones were determined for the above period from the establishment of the transmission corporation until its operation as follows: By May 1, 2010—the arrangements required for the capital structure, including the assets and liabilities and all other arrangements required for the corporation’s activity will be completed. By July 1, 2010—the economic and operational arrangements between the transmission corporation and the other corporations to be established pursuant to the Decrees will be completed. The extension of a transmission license beyond July 1, 2008, as speciﬁed below: – As of July 1, 2008 through September 1, 2008—if a corporation has been established pursuant to the implementation decree in a manner that will enable granting a system management license commencing from the determining date (September 1, 2008), granting a system management license for that corporation pursuant to the provisions of the Electricity Sector Law. – As of September 2, 2008 through December 31, 2009—if a system management license has been granted pursuant to the provisions of the Electricity Sector Law. – As of January 1, 2010 through December 31, 2010—if a corporation has been established pursuant to the implementation decree in a manner that will enable granting a transmission license for that corporation, beginning from the determining date of the transmission license (December 31, 2010) pursuant to the provisions of the Electricity Sector Law. The decree states that by July 1, 2008, a corporation will be established for managing the system to engage in the activities required from the owner of a system management license. The determining date for activating the system management corporation was deferred by six months from September 1, 2008 to March 1, 2009. The system management corporation will not be a subsidiary of the Company but rather a government company outside the Company’s corporate structure.

F-20 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) a. The Electricity Sector Law and its amendments (continued) In addition, two additional milestones were determined for the course of said period, from establishment until operation as follows: By November 1, 2008—the arrangements required for the capital structure, including the assets and liabilities and all other arrangements required for the corporation’s activity will be completed. By January 1, 2009—the economic and operational arrangements between the system management corporation and the other corporations to be established pursuant to the Decrees will be completed. The distribution license was extended until July 1, 2009. Until that date, several distribution corporations will be established as subsidiaries of the Company to engage in the distribution activity and operate the Company’s distribution segments. The determining date for activating the distribution corporations remains January 1, 2010. In addition, two additional milestones were determined as follows: By March 1, 2009—the arrangements required for the capital structure, including the assets and liabilities and all other arrangements required for the corporation’s activity will be completed. By May 1, 2009—the economic and operational arrangements between the distribution corporations and the other corporations to be established pursuant to the Decrees will be completed. The supply license was extended until July 1, 2009. Until that date, the arrangements required for the supply activity will be ﬁnalized to allow granting a supply license on the determining date. e) The Electricity Sector Law prescribes that the licenses extended pursuant to section d) above will be in effect for the duration of the extension period provided that the Company will comply with their provisions, the provisions of the Electricity Sector Law and any other law. The Law also prescribes that the provisions of the implementation decrees will be viewed as one of the conditions among the conditions for the activities that are the subject of the extended licenses. f) 1) The Ministers will determine in a decree, in consultation with the Electricity Authority and the Companies Authority, by January 1, 2011, if a Government company or Government subsidiary holding the means of control in a holder of a generation or distribution license will also be able to hold the means of control in a holder of a transmission license. 2) If the Ministers determine by decree pursuant to section (1) above that a Government company or subsidiary is not allowed to hold the means of control over a transmission license holder, they will also determine the date and manner of the implementation of their stipulation provided that the date is not later than January 1, 2013 and the transmission license will be in effect conditional upon fulﬁlling the provisions of the decree.

F-21 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) a. The Electricity Sector Law and its amendments (continued) 3) If the Ministers determine by decree pursuant to section (1) above that a Government company or Government subsidiary is allowed to hold the means of control over a transmission license holder, they may also determine by the same decree any conditions, restrictions and provisions to apply to said holdings for the purpose of advancing the objectives of the Electricity Sector Law. The transmission license will be in effect conditional upon fulﬁlling the provisions of the decree and the stipulations of section c) above. g) As of January 1, 2009, a Government company or Government subsidiary holding the means of control over a license holder as provided above will not engage in the engineering planning of power stations, in erecting power stations, in logistics, information technology and purchasing any type of fuel. Furthermore, as of said date, a Government company or Government subsidiary holding a license as provided above will not engage in the abovementioned activities on behalf of another corporation that holds a license according to the Electricity Sector Law; however, if corporations that are permitted to engage in said activities have been established, the Ministers will determine by decree that the Company will be able to continue engaging in said activities until January 1, 2010 and the Ministers are also entitled to determine by decree that despite the provisions pursuant to the Mandatory Tenders Law, 1992, a Government company or Government subsidiary holding a license as provided above will grant priority to these corporations all for the period and under the conditions to be determined. h) Despite the abovementioned in section c) above, a supply license may be granted to a Government company or Government subsidiary holding a distribution license pursuant to the Electricity Sector Law until January 1, 2012 and the Ministers, in consultation with the Electricity Authority and the Companies Authority, are entitled to determine by decree that such company may be granted a supply license until January 1, 2013. Amendment No. 5 eliminates the possibility of granting a supply license to a holder of a distribution license subject to the abovementioned exceptions. As stated above, Amendment No. 7 enacts similar provisions with respect to a company that is not a government company or subsidiary. i) The Ministers, in consultation with the Electricity Authority and the Companies Authority, having learned that it is vital for advancing the objectives of the Electricity Sector Law, are entitled to delay by decree the dates stated in section d) above, all or some, other than the date stated in d) above, for a period not exceeding six months. As stated above, certain of the dates for implementing the restructuring in the Company have been deferred by the Ministers by way of the Decrees. The Company believes that the adoption of the amendment to the Law allows it to restructure itself into a corporate structure under a gradual time frame

F-22 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) a. The Electricity Sector Law and its amendments (continued) where the Company, as the parent company, will hold subsidiaries as follows: at least four companies holding a generation license and operating on the basis of a similar fuel mixture (subject to the matter of generation using coal as stated in c) above), each holding licenses covering 30% of the electricity sector’s generation capacity at the most; at least four companies holding a distribution license, each holding licenses covering 25% of the sector’s distribution capacity at the most, with the costs relating to the electricity facilities used by each of these companies will be as similar as possible; a company holding a transmission license as to which the Ministers will determine, by January 1, 2011, if it shall remain in the corporate structure; and a subsidiary or subsidiaries for providing services. Commencing from January 1, 2009, and the Company as well under certain conditions—as of January 1, 2010, the company or subsidiaries that will receive the license under the Law will not be able to provide services to others but only amongst themselves and will grant priority to receiving services from the company (or companies) despite the provisions of the Mandatory Tenders Law. At this stage, the Company will be able to continue activities of managing the system and the license to the new corporation that will manage the system will be granted by March 1, 2009. Until July 2013, the parent company will be able to hold 51% at the most of the means of control over the generation or distribution companies (see also (4) above). On August 5, 2007, the managing director of the Ministry of National Infrastructures approached the Company with a request to team up employees into a composition of seven different work teams which are to deal with the subject of the restructuring so that the teams’ deliberations will be concluded by September 10, 2007. The workers’ association has instructed the Company’s employees not to cooperate on this issue. In view of employee sanctions taken to date (see Note 21.c below), there has been no substantial progress in effecting the restructuring and the Company’s applications to the Regional and National Labor Courts regarding various restructuring issues were unsuccessful. Accordingly, the Company is currently unable to move forward in the required preparations for the restructuring. 2. The policy document On February 15, 2007 (near the date of publication of Amendment No. 5 to the Electricity Sector Law), the managing director of the Ministry of National Infrastructures, the Supervisor the Ministry of Finance and the Director of the Companies Authority issued a document (‘‘the policy document’’) that contains their recommended outline for the restructuring of the Company. Based on the Government’s decision as above and the policy document, the Electricity Sector Law was amended on March 1, 2007 (Amendment No. 5). The principal points of the policy document are as follows: a) Company structure The Electric Corporation (‘‘the Company’’) will be a holding company owned by the Government, from which in stages, subsidiaries will be split

F-23 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) a. The Electricity Sector Law and its amendments (continued) off to engaged in generation, delivery and distribution, as well as companies to provide services to implement and construct power stations, plan power stations, services and logistics, information technology and fuels. In addition, based on the Company’s existing activities, a separate company will be formed, wholly owned by the Government, to manage the system, the commerce and long-term planning, and to which the current operations in these areas will be transferred, according to a pre-determined schedule. In the intermediate stage, the Company’s management and any area of activity that will not be separately incorporated will remain a part of the holding company. One of the objectives of this restructuring is to streamline the Company’s operations in a manner that will add generation power to the economy while imposing minimum costs on the consumers of electricity. 1) System management A wholly owned Government company will be established and activated to manage the system, the commerce and the long-term planning. The system management company will operate under supervision. 2) The transmission system A subsidiary of the Company will be established to engage with the transmission system and be in charge of electricity transmission, transformation and switching. Clear rules establishing a structural distinction and independence between the Company and the transmission system company will be prescribed in order to assure its business independence and to ensure the development of competition. The control rights over the transmission company will be held by the State, all in order to secure independence and to prevent conﬂicts of interests within the Company. 3) The distribution system The distribution segment will be split into four or ﬁve regional distribution companies with territorial continuity that will be structurally similar in terms of costs and scopes of activities, as far as possible. These companies will be established and act as subsidiaries of the Company, and clear rules of structural segregation and independence between the Company and the distribution companies will be established. The distribution companies will operate under supervision. 4) Additional services The activities of planning and construction of power stations, information technology, logistics and fuels will be established and operated by subsidiaries of the Company and clear rules of structural segregation and independence between the Company and the distribution companies will be established.

F-24 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) a. The Electricity Sector Law and its amendments (continued) b) Electricity generation 1) Future coal operated power stations (‘‘D’’ and ‘‘E’’) will be established and incorporated by subsidiaries of the Company, subject to the principles speciﬁed in the policy document and the implementation of the restructuring of the Company according to the development plans approved by the Minister and subject to all laws. 2) Determining the structure and establishment of the generation companies will be in such a manner so as to prevent market failures or unjust exploitation of the electricity power in the electricity sector. 3) Clear rules of structural segregation and independence between the holding companies and the generation companies, and between all of the generation companies will be established in order to assure the business independence of the generation companies and to assure the development of competition in the electricity sector. 4) Following the sale of 49% of the interests of the holding companies in the generation company, the latter will be permitted to engage in water desalination. 5) The supply segment will be attributed to the generation companies so that with the incorporation of the generation companies of the Company, all the electricity sector consumers will be initially attributed to these companies and by January 1, 2008, rules to guarantee freedom of choice for the consumers will be instituted. The removal of price control in the distribution and supply segments, as the consumer’s ability to choose, will be gradually instituted according to consumer groups, with control over the largest consumers being removed at the beginning of the process and over to the household consumers at the end of the process. c) Regulation and cost recognition 1) The control in effect on the eve of the restructuring over all the sector’s segments will continue to apply and will be removed gradually from of the generation and supply segments as permitted by the competitive conditions in the sector. The criteria for the gradual removal of said control will be determined by September 1, 2007 by the Administration (see section e) below). 2) The recognized costs of the restructuring will be manifested in the future electricity rates. 3) The Electricity Authority’s control over the rates of the subsidiaries and sister companies will take into consideration a fair return on the capital until it is removed (for generation and supply).

F-25 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) a. The Electricity Sector Law and its amendments (continued) 4) Upon the split, the Government will act to create the conditions required for the ﬁnancial strength and stability of the companies in the Company’s holding group and the system management company, given the reasonable business conduct of the supervised companies. d) Assignment of debts and assets – The Company will sell the assets pertaining to the operating segments that will be assigned to the new companies to these companies. – Loans taken out by the Company will remain its responsibility and will not be assigned to the companies established. – Assets used by more than one company will be assigned to a company determined by the Ministers and proper contracts arranging the use of the assets by the other companies will be prepared under terms that will allow achievement of the goal of competition as soon as possible. – The sale consideration will be determined according to the book value of the assets in the Company’s books. – A portion of the consideration, in an amount equal to the Company’s outstanding loans near the date of the transfer, will be gradually repaid by the companies to which the assets were transferred on dates that will allow the Company to pay the secured amounts of the loans to its creditors. – The remaining consideration will be immediately paid to the Company by the transferee companies. Funds from source of which the remaining consideration is received by the Company from the subsidiaries will serve the Company to immediately invest in the share capital of the subsidiaries. – The portion of the consideration that is not immediately disbursed will bear interest to allow the repayment of the interest on the loans taken out by the Company according to their terms. – The sale of the assets to the new companies will be executed in a manner in which the Company’s assets and revenues subsequent to the restructuring, directly and indirectly, through its holdings in the subsidiaries to be established, will allow the repayment of the Company’s outstanding debts to the creditors. – The Administration that will implement the restructuring will be in charge of handling the contact with the Company’s creditors in the aspects relating to the restructuring. e) Setting up an Administration for carrying out the restructuring An Administration will be set up whose duties will consist of preparing all of the steps, agreements, documents and decisions required for

F-26 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) a. The Electricity Sector Law and its amendments (continued) executing the principles determined in the document of the managing directors based on the schedule that it stipulates, by the time that the ﬁnancial statements are signed, prior to the establishment of the Administration.

3. The letter of the Director of the Companies Authority On February 28, 2007, the Director of the Companies Authority addressed the Company in a letter which reiterated that the implementation of the reform in the Company pursuant to the Electricity Sector Law, as amended (Amendment No. 5) will be carried out, among other things, while examining the implications of the restructuring on the Company’s liabilities and this, inter alia, so as to not obstruct the Company from meeting its loan obligations (‘‘the letter of the Director of the Companies Authority’’).

4. The position of the Company’s management and Board of Directors regarding the structural change Following Amendment No. 5 to the Electricity Sector Law and the Government’s decision of February 18, 2007, on February 22, 2007, the Company’s Board of Directors resolved to set up an internal administration for the Company (‘‘the headquarters’’) in order to implement the structural change according to Amendment No. 5 as above. According to said decision, the Company’s management has submitted a detailed plan for setting up the headquarters for implementing the structural change to the Board’s Regulatory Committee and the plan was approved. The headquarters have not yet been established or operated due to employee sanctions (see more details in Note 21.c below). The Company’s management and Board of Directors believe that the schedules stipulated in Amendment No. 5 to the Electricity Sector Law and in the Decrees are too tight and there is doubt as to the Company’s ability to perform the whole of the changes required under the schedules established in the Law as amended. Moreover, Amendment No. 5 and the Decrees do not deal with the variety of issues raised by the expected restructuring in the Company and do not arrange in detail the manner of executing the restructuring. In the opinion of the Company’s management and Board of Directors, the Company’s restructuring is essential in order to be able to fulﬁll the duties prescribed by the Electricity Sector Law and they intend to act to the best of their abilities to promote restructuring under a realistic outline and in agreement with the employees. It should be emphasized that a substantial part of the restructuring is not in the hands of the Company but in the hands of the State. Attention is hereby directed towards the matters stated in the various government decisions regarding the restructuring, see 1.d below, in the policy document and in the letter of the Director of the Companies Authority in sections 2) and 3) above. For that purpose, the Company is negotiating to the extent possible with the relevant entities in the State, the workers’ association and the New General Workers Union (‘‘Histadrut’’) in order to reach an agreement, inter alia, with the Company’s employees.

F-27 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) a. The Electricity Sector Law and its amendments (continued) Furthermore, in the opinion of the Company’s management and Board of Directors, the execution and implementation of the restructuring will involve issues regarding the Company’s creditors, in view of agreements signed with them, as far as they are affected by the restructuring, all subject to provisions of the law. Until the date of the approval of the financial statements, the State and the Company have not yet settled the treatment of said issues. 5. Below are additional provisions included in the Electricity Sector Law a) The holder of a transmission, distribution or system management license as well as the holder of a generation license or licenses as to which the Minister has determined that it concentrates a substantial part of the electricity sector’s generation capacity, are defined as holders of an essential service provider license. The Electricity Sector Law determines that the holder of an essential service provider license shall: 1) Provide nondiscriminatory service to the general public based on the standards established by the Electricity Authority in a reliable and efficient manner, all as stipulated in the license and in any law. 2) Purchase electricity from a private power manufacturer and render infrastructure and backup services, all as stipulated in the license and in any law. 3) Render backup services to the holder of a self-generation license, at its request, all as stipulated in the license and in any law. 4) Act to guarantee that its services are rendered in full for the duration of the license period, including rendering services according to the development plan approved by the Electricity Sector Law, while taking all the steps needed to render such services. The Minister, in consultation with the Electricity Authority, may demand that a holder of such license submit a development plan, integral or segmented, for his approval, for the purpose of its activities as provided by the license and if such a development plan is not submitted to the Minister’s approval, such a plan will be designated for the licensee in consultation with the Electricity Authority and the licensee will have to abide by it. The Minister is entitled to enact regulations concerning the holder of a transmission license’s responsibility for developing the electricity sector, pursuant to the above development plan, including planning the electricity network. Furthermore, the Electricity Sector Law stipulates that the holder of an essential service provider license will prepare financial statements as determined by the Ministers, in consultation with the Minister of Justice, in the matter of the level of their specifications, the accounting principles underlying their preparation and the assertions and notes accompanying them. The holder of an essential service provider license will charge fees at rates determined by the Authority.

F-28 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) a. The Electricity Sector Law and its amendments (continued) The holder of a transmission license will pay the holder of another license fees at rates determined by the Authority and the Authority will also determine standards according to which the holder of an essential service provider license is entitled not to provide the service or make the purchase prescribed by the Electricity Sector Law, and may discontinue them, delay them or restrict them if it has not received fees for them according to any law or if the terms for providing the service or making the purchase as required by law have not been met. b) The transfer, pledge and seizure of the license or assets: 1) A license or any part thereof cannot be transferred, pledged or seized, directly or indirectly, unless with the Minister’s consent. Moreover, a guarantee provided by the license holder and/or the funds arising from its redemption cannot be pledge or seized. 2) The Minister may determine in the license that certain assets of the license holder that he believes are necessary for performing the activities prescribed by the license cannot be transferred, pledged or seized, directly or indirectly, unless with the Minister’s consent. c) A private electricity manufacturer may sell electricity to the holder of an essential service provider license or another, according to the terms of the license. d) The Electricity Authority was established to act pursuant to the objectives of the Electricity Sector Law and in accordance with Government policy, the Minister’s policy or the policy of the ministers based on their authorities according to any law for the electricity sector and to supervise that the provisions of the Electricity Sector Law and the licenses are met as well as fulfill the duties assigned to it by the Electricity Sector Law and imposed on it by any other law. The Electricity Authority’s duties, among others, are as follows: 1) Fixing rates and rate updating policies. 2) Setting standards regarding level, nature and quality of the service provided by the essential service provider and setting standards for instances where the essential service provider licensee is not obligated to render a service or make an acquisition and subject to the development plan approved by the Minister, supervision of fulfillment of duties, according to said standards. 3) The Electricity Authority has the power to establish directives in the matter of amounts to be paid by the essential service provider licensee to consumers due to breach of the standards set and to examine and decide on customer complaints. In addition, it shall be entitled to provide instructions as to a specific transaction with an essential service provider license holder, if a relevant directive for same has been stipulated by the Minister. 4) Granting licenses and supervising the compliance with the provisions stipulated by the licenses.

F-29 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) a. The Electricity Sector Law and its amendments (continued) As for the decisions of the Electricity Authority resulting from the above, see Note 3 below. e) The principal directives in the matter of fixing rates are as follows: 1) The Electricity Authority will fix rates based on the cost principle taking into consideration, among others, the type and level of services and will include a fair rate of return on capital. 2) The Law did not define a fair rate of return. 3) In fixing rates, the Electricity Authority may choose not to take into consideration all or some of the expenses which it believes are irrelevant to fulfilling the duties of the essential service provider licensee. 4) Every rate will reflect the cost of a certain service without subtracting from one price at the expense of raising another price. 5) The rates will be updated according to an update formula determined by the Electricity Authority. The update formula will include recognized allowable required costs, a fair rate of return on capital and, after consulting with the ministers, might bring an efficiency coefficient into account. On September 12, 2004, in the framework of the Company’s appeal against the Electricity Authority, the Supreme Court determined, among others, that the consideration regarding maintaining the Company’s financial solvency, although it constitutes a relevant consideration in determining the electricity rates, expresses only one aspect of the public interest over which the Electricity Authority is charged with pursuant to the Electricity Sector Law. In exercising its authority pursuant to the law, the Electricity Authority must include in the quorum of its considerations, an entire composite of considerations that were intended to result in ‘‘the arrangement of the activities in the Electricity Sector for the public interest, while assuring availability, quality, efficiency, all of which while creating conditions for competition and minimization of costs’’. f) The Electricity Sector Law determines that the Electricity Authority is entitled to grant a license for an activity, determine terms thereof and limit or not limit the period of the license. Such a license will become effective after the Minister’s approval. In addition, the Electricity Sector Law determines that the Minister is entitled, if he contends that the matter is necessary in order to advance the objectives of the Law and the Government’s policy or its policy in the Electricity Sector, to instruct the Electricity Authority to grant a license, to change the terms of a license, to add to or detract from the terms of a license (for reasons that will be recorded, after he has heard the Electricity Authority’s position on the matter, and after he has given notice to the Government of that). Should the Minister instruct, as aforesaid, the Electricity Authority will carry out

F-30 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) a. The Electricity Sector Law and its amendments (continued) his directive within the period of time he determined. If 21 days have elapsed from the date on which the Minister gave his notice to the Government and no written demand was made by a member of the Government to discuss the notice, the Minister’s instruction will be viewed as being in force. In addition the Law, as amended, has prescribed that various obligations to report to the Minister are imposed on the Electricity Authority.

Further, if the Minister shall see that the Electricity Authority is not acting properly in accordance with the provisions of the Electricity Sector Law, he is authorized to disband it, if within a reasonable period of time that will be determined it did not fulﬁll what was imposed on it (in consultation with the Minister of Finance and as approved by the Government). Within 30 days of the disbanding of the Electricity Authority, a new Authority will be appointed, and until then the Authority will continue operating in its previous composition.

g) An essential service provider license will not be granted except to a company that will undertake that it will only engage in activities pursuant to the licenses that were granted to it pursuant to this law and in related activities. The holder of an essential service provider license is entitled to engage in other activities, which were approved for it by the Ministers in consultation with the Electricity Authority, where there is nothing in being engaged in them that would impair its activities or the regulation of his fulﬁlling his obligations pursuant to the Electricity Sector Law.

h) The Electricity Sector Law stipulates that if a license granted by law has been cancelled, made conditional or amended for reasons stated in section 8 to the Electricity Sector Law (Government Policy Regarding the Electricity Sector, the Contribution to the Level of Services to the Public, the Good of the Consumers and Competition), the Ministers may determine criteria for granting compensation to the license holder but it is possible that based on the above criteria, the compensation rate will be zero.

The Company’s management estimates that in view of the fact that both the Company’s development activities and the pledges on the Company’s assets created to secure its liabilities have been approved by the Minister, then if damage is caused to the Company as a result of the above, it shall be compensated according to accepted economic principles, pursuant to established rules, although no notice in this matter has been delivered by the Government.

i) According to the Electricity Sector Law, the Electricity Authority is qualiﬁed to determine and update electricity rates. However, the Control of Prices of Goods and Services Law, 1996 (‘‘the Control Law’’) also applies to the electricity rates. The Company believes, based on the opinion of its legal advisors, that in spite of the fact that as a rule the

F-31 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) a. The Electricity Sector Law and its amendments (continued) determination of electricity rates will generally be carried out by the Electricity Authority, intervention by the Ministers is likely in setting rates, by force of the Control Law, in the event that the Israeli market faces extreme situations (such as high inﬂation or the fear of its outbreak).

It should be noted that in the opinion of the Electricity Authority, it is the only party authorized to determine electricity rates.

6. The assets arrangement

a) With respect to certain rights and assets, which were held by the Company on the eve of the replacement of the Electricity Concession Ordinance by the Electricity Sector Law, the following provisions were determined in the Electricity Sector Law (section 62):

1) In spite of the provisions of section 46 to the amendment to the Electricity Concession Ordinance (‘‘section 46 to the concession’’), the liabilities of the Electric Corporation, as well as the rights and assets which it held at the time that the Concession expired, and for which it is entitled to compensation from the State pursuant to the aforesaid section, will remain with the Electric Corporation and no compensation will be paid for them.

2) The rights and assets for which the Electric Corporation is not entitled to compensation, as stated above in section 1, and which are used or were designated to be used, whether directly or indirectly, for its operations pursuant to this law, will be purchased by the Company according to their value on the date the rights and assets were acquired, in accordance with an arrangement to be signed by the State and the Electric Corporation; in this section ‘‘are used’’ or ‘‘were designated to be used’’, as will be determined by the ministers.

3) Until the arrangement referred to above in section 2 is carried out, the assets and rights, as to which the arrangement is being prepared, will remain with the Electric Corporation, as they were at the time that the Concession expired. If the parties do not arrive at the aforesaid arrangement within one year from the date that the Concession expires, the ministers will determine provisions as to the acquisition of the aforesaid rights and assets.

b) In the ﬁrst year following the date on which the Concession expired, no negotiations were held and, in any case, the parties did not reach a arrangement and, as of the date on which the ﬁnancial statements were signed, the ministers had not determined the assets that are used or are intended to be used by the Company and/or any provisions with respect to the acquisition of the aforesaid rights and assets (‘‘the assets arrangement’’).

F-32 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) a. The Electricity Sector Law and its amendments (continued) c) The law does not detail which assets will be included under section a.1 above (‘‘the compensable assets’’) which, according to the provisions of the Electricity Sector Law, remain with the Company, and, in accordance with the Electricity Sector Law, it is not required to pay the State for them; or, under section a.2 above (‘‘the non-compensable assets’’) for which, as stated, the assets arrangement is to be prepared. In addition, the Electricity Sector Law does not define the method pursuant to which the value of these assets will be determined. d) Section 62 to the Electricity Sector Law refers to section 46 to the Concession. Section 46 to the Concession in its updated version, following the amendment of the Concession in 1970, which was titled ‘‘Expiration of Concession’’ determines as follows: ‘‘At the expiration of the Concession the plant together with all fittings accessories and stores shall pass into the ownership of the High Commissioner free of charge subject to the payment by the High Commissioner of adequate compensation for any supplies of fuel materials apparatus meters and instruments in stock or in transport or on order belonging to the Company which had paid for them. Should the Company in the meantime have set up any laboratory or other scientific establishment or a library and should the High Commissioner take over such establishment and/or library, he shall pay adequate compensation therefore. However, the Company shall be entitled to claim adequate compensation for installations and repairs in the conditions determined in section 44(c), as if the Government acquired the plant on the date on which the plant passed into the Government’s ownership. The provisions of section 44(f) to the appendix to the Electricity Concession Ordinance (hereinafter: ‘‘section 44(f) of the Concession’’) will apply, with the required changes as applicable, as if the Government had acquired the undertaking on the aforesaid date.’’ e) Section 44(c) of the appendix to the Electricity Concession Ordinance (hereinafter: ‘‘Section 44(c) of the Concession’’) in its updated version prescribes:’’ The Government shall also pay to the Company adequate compensation for each one of the installations put into place and the repairs made, other than repairs required by ordinary wear and tear, prior to the date of the purchase, all of which if all of these were met and, in the event they were met: The installation or the repair was not written-off pursuant to the provisions of the second amendment to the Concession. The payment for the installation and the repair was not from a debt deriving from a debenture or from the principal of a loan that were not yet paid, and that the Government will be obligated to repay them pursuant to the provision of subsection (c).

F-33 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) a. The Electricity Sector Law and its amendments (continued) The payment for the installation or repair was not made from share capital or by someone with an interest in the connection, as implied by the concession amendment deed.’’

f) Section 44(f) of the Concession prescribes the following:

‘‘If at the date of such purchase, any debenture or other loan principal of the Company authorized under Clause 38 hereof shall be outstanding, the High Commissioner shall take over all of the liabilities of the Company derived therefrom, but shall be entitled to the beneﬁt of any funds earmarked for the amortization of these liabilities’’.

g) The Company believes, based on the opinion of its legal advisors regarding the matter of the appropriate interpretation of the assets arrangement, and taking into consideration the provisions mentioned above with respect to the amendment to the Electricity Concession Ordinance, pursuant to which, the majority of the assets held by the Company when the Concession expired (both fully depreciated depreciable assets and depreciable assets which were not fully depreciated at the time the Concession expired, and excluding assets in a marginal amount), are compensable assets and, therefore, they are not supposed to be included in the assets arrangement, and also, to the implementation of the assets arrangement there was not supposed to be, there is not and will not be a material effect on the Company or its ﬁnancial position, although the matter is to be studied and determined by the ministers’ team that was appointed in order to determine the implementation of the Company’s restructuring, and, therefore, there is no certainty that the implementation of the assets arrangement will not have such an effect.

h) On February 15, 2000, the Company received a letter from the Deputy Commissioner of Budgets at the Ministry of Finance wherein he indicates that as part of the activities of the Governmental team that was appointed to deal with the issue, an economic, accounting and legal State opinion was prepared (and was attached to the letter to the Company), (‘‘the State’s Opinion’’) the implementation which might have a material effect on the Company.

According to the State’s Opinion and in reference to the provisions of section 46 to the Concession, the Company was entitled to compensation for items of inventory that were ordered by it and for which it paid, for certain assets, subject to the conditions detailed in the provisions of section 44(c) to the Concession:

1) The assets were not fully depreciated—in the State’s Opinion it was claimed that this condition is not only applicable to the fully depreciated assets, but that it also restricts the Company’s right to compensation for assets which were only partially depreciated, which is, in view of the double stipulation, required at the

F-34 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) a. The Electricity Sector Law and its amendments (continued) beginning of section 44(c) to the Concession: ‘‘if all of these were met and in the event they will be met...’’, the Company was entitled to compensation primarily because of the depreciable assets which were not fully depreciated, for the balance which was not yet written off. 2) Those assets whose acquisition was financed by liabilities which the Government will be obligated to repay—in the State’s Opinion, it was stated that, in this connection, it is prepared to accept the position presented in the Opinion obtained by the Company, pursuant to which this condition is irrelevant in view of the fact that under the provisions of the Electricity Sector Law (section 62(a)), the liabilities which were supposed to be transferred to the State at the end of the Concession remained with the Company. 3) The payment for the assets was not financed by share capital or payments which the Company received for any connection to the electricity grid—in the State’s Opinion, the argument which is detailed in the Opinion obtained by the Company, is rejected pursuant to which, this condition is irrelevant, where the rationale and economic logic for this, in their opinion, is that compensation will not be made to the shareholders for the assets which were not financed from owners’ sources, and this in spite of the almost absolute equality which currently exists between the ‘‘shareholders’’ and the ‘‘sovereign’’. Therefore, the State’s Opinion included in its definition of the assets for which no compensation is due and to which the assets arrangement is supposed to apply, the following assets: 1) All of the Company’s assets which at the time the Concession expired were fully depreciated, and this because of the fact that the investments in them were recognized in the electricity rate through the provisions for depreciation (power plants, transmission and distribution facilities, real estate properties and various assets such as equipment, machinery and various buildings). 2) Assets which were not fully depreciated, in the amount of what was depreciated net of liabilities, according to a certain percentage which depends on their financing sources—primarily power plants, transmission and distribution facilities, certain real estate and additional equipment. 3) The Company’s non-depreciable assets—primarily intangible assets and shares of investee companies, but not cash and inventory. In the State’s Opinion, criteria were determined for classifying the assets, as aforesaid and, in addition, formulae were determined for

F-35 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) a. The Electricity Sector Law and its amendments (continued) calculating acquisition value on the basis of the economic value of the assets and the liabilities. There are no data in the economic Opinion with respect to the economic value or the method for determining it.

The cost, as of March 31, 1996, of the assets which were fully depreciated, as detailed in section 1 above, as it appears in the Company’s ﬁnancial statements at of that date, is approximately NIS 4.46 billion (approximately NIS 6 billion in NIS of December 2007). The net depreciated cost, as of March 31, 1996, in the Company’s books, of the assets detailed in sections 2 and 3 above, is approximately NIS 4.5 billion (approximately NIS 6 billion in NIS of December 2007).

In the Company’s opinion, one should not infer the economic value of the assets from the amounts indicated above where pursuant to this economic value, the amount which the Company is liable to be requested to pay will be determined, even if the position presented in the State’s Opinion is accepted.

i) Just after the State’s Opinion was received, the Director of the Electricity Authority in the Ministry of National Infrastructures (‘‘the Director’’) wrote a letter to the Company, as instructed by the Minister. In the letter, he instructed the Company not to respond to the Ministry of Finance’s communication with regard to the matter of the assets arrangement, as long as the matter had not been discussed in an orderly manner between the ofﬁces of the ministers and between the Company and the Ministry of National Infrastructures.

j) The Company is of the opinion, based on the opinion of its legal advisors, that the interpretation of section 62 to the Electricity Sector Law in a manner which will obligate the Company for the payment of the above amounts or any similar amount, in order to purchase the assets from the State, will be contrary to the declared purposes and objectives of the Electricity Sector Law, contrary to the principles of the appropriate interpretation and will constitute an impairment of the proprietary rights of the Company, due to the impairment which will arise to the Company’s shareholders’ equity, the possibility of acceleration of the Company’s loans, the doubt as to its ability to repay its liabilities and to continue operating as a going concern, while the explicit intention of the legislator was that the Company will exist and fulﬁll the functions it was assigned and the tasks imposed upon it in the Electricity Sector Law and the licenses granted to it by virtue thereof.

In addition, the acceptance of the aforesaid interpretation, and assuming that the acquisition cost must be recognized in the electricity rate (see section k. below) will obligate the electricity consumers to pay for the assets once again, after the acquisition by the Company was already paid for in the past by the consumers by means of the electricity rate.

F-36 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) a. The Electricity Sector Law and its amendments (continued) k) The Company is of the opinion, based on the opinion of its legal advisors, that the cost for the Company, if and to the extent that there will be any with respect to the assets arrangement or in connection with the acquisition directives of the ministers, needs to be recognized in the electricity rate base, although there is no certainty of this. l) Certain assets, which, on the eve of the replacement of the Electricity Concession Ordinance by the Electricity Sector Law, were held and which are not used in, 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, probably they will not continue to remain in the Company’s possession. The position presented in the Ministry of Finance’s Opinion, assumed that these assets were 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 by the Ministers regarding this matter. m) 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, does not have and will not have a material effect on the Company or its financial position, although the matter is subject to the examination and determination of the ministers’ team and, therefore, there is no certainty that the implementation of the assets arrangement will not have this effect. 7. If the State is required to make any payment with respect to any one of the Company’s liabilities which were in effect when the Concession expired, due to its expiration or what was mentioned in section 3 above, the Company will indemnify it for any such payment. b. Licenses and Regulations Pursuant To The Electricity Sector Law 1) On September 2, 1997, regulations under the Electricity Sector Law were adopted (Conditions and Procedures for the Granting of a License and the Obligations of the Licensee), 1997, which determine, among other things, the procedures and conditions that the party requesting a license must comply with in order to be eligible to receive a license, including conditions regarding shareholders’ equity, internal sources of financing and related matters. The regulations also provide that the Minister may condition the granting of a license as a supplier of an essential service upon the organizational and legal structure of the party requesting a license or upon such party providing a commitment to change the aforementioned structure. In addition, the Minister may direct that a change in the organizational and legal structure be carried out during the term of the license. The Minister may not, however, do so during the period in which the initial transmission license is valid.

F-37 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) b. Licenses and Regulations Pursuant To The Electricity Sector Law (continued) 2) The Company has a license for the transmission, supply of and commerce in electricity, as well as separate generation licenses for the various generation units (‘‘the generation licenses’’). Since the Company holds a transmission license, it is defined as an essential service provider pursuant to the Electricity Sector Law. The validity of the existing licenses held by the Company has been extended according to the implementation decrees (as stated in a.1)d) above). The Minister also determined, pursuant to the Electricity Sector Law, that since the Company holds a substantial portion of the electricity generation capacity in the electricity sector, it is subject to the provisions of the Electricity Sector Law referring to an essential service provider. On November 1, 2007, the Ministers signed the decrees for extending the validity of the Company’s licenses (see also a.1)d) above). The Company believes that there is no certainty that at the end of the maximum period for extending the licenses and without carrying out the restructuring plan prescribed by the law, it will be granted licenses (in whole or in part) or that there will be no change in the terms of the licenses compared to the existing licenses (in whole or in part). See also Note 1 a.1) above for information about the restructuring. 3) The generation and transmission licenses which have been granted provide, among other things, that: – All of the Company’s activities will be carried out as separate profit centers and certain activities may be carried out in more than one profit center. The profit centers are set forth in an appendix to the license. This appendix was not attached to the generation licenses. – The license holder will submit separate audited annual financial statements for each area, activity, generation unit or power plant and for each profit center (regarding generation licenses, as the Director will direct, and regarding the transmission license, as the Minister will direct from time to time), and will also submit consolidated financial statements regarding its activities based on all the licenses it holds. If the holder of a generation license is holding another license or other licenses for additional activities, financial statements will be submitted as described above also for those activities, as the Minister may direct. – The license holder will submit a business plan to the Director, including pro forma financial statements audited by the auditors of the license holder, regarding its activities pursuant to the license for the entire period of the license. The license holder will update the plan each year and will present the updated plan to the Director. The financial statements will be prepared separately for each area, activity, generation unit or power plant and profit center (regarding generation licenses, as the Director will direct, and regarding the transmission license, as the Minister will direct from time to time). – The Company, while ensuring reliability and efficiency and without discrimination, will carry out the activities and services.

F-38 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) b. Licenses and Regulations Pursuant To The Electricity Sector Law (continued) – A license holder may carry out the activities which are ancillary to those activities performed pursuant to the license, as described in the appendix to the license. Ancillary activities not included in the appendix must be approved by the Minister. – The generation licenses provide that a generation unit must be available for the generation of electricity in accordance with the operation and maintenance program to be filed by the Company and approved by the Director. – A development program (see section a.5 above) as well as a business plan shall be submitted to the Minister. – The transmission license requires providing infrastructure and backup services to other license holders, and an obligation to purchase electricity from independent power producers (see section a.5 above). – Pledging, transferring or seizing the assets specified in the licenses (which include substantially all of the Company’s assets) is prohibited, except as permitted by the Minister (see section a.5 above). In addition, the transmission license prescribes that the Minister is entitled to add to or remove from the list of assets in the appendix to the license, during the term of the license. – The direct or indirect inclusion of or reference to an asset in the licenses or their appendices will not be deemed to grant the license holder any rights in the asset with respect to the assets agreement (see section a.6 above). – There shall be no change or reorganization in the owner of the license, including by merger, split, compromise, arrangement or voluntary liquidation, without the Minister’s authorization. – The Minister may at any time cancel a license, in its entirety or partially, or suspend a license or add or change general conditions, rules and obligations thereunder if he discovers one of the conditions of the license was breached or that one of the restrictions on its approval exists or that the holder of the license is no longer qualified to hold the license as required by the Electricity Sector Law and its regulations. The generation licenses further provide that the Minister may act as aforesaid for the reasons specified in Section 8 of the Electricity Sector Law. (It should be pointed out that subsequent to Amendment No. 3 to the Electricity Sector Law dated April 2005 that transferred the authority of granting licenses and supervising compliance with their terms to the Electricity Authority, the provisions of the licenses as above should be construed in view of the change in authorities, as stated in the Amendment). – A generation license fee shall be paid by the holder at a rate to be determined by the Ministers. – If the State is required to make any payment with respect to an action or omission of the license holder in connection with its activities pursuant to

F-39 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) b. Licenses and Regulations Pursuant To The Electricity Sector Law (continued) the license, the license holder will indemnify the State. Also pursuant to the license for the transmission, distribution, supply, sale of and commerce in electricity of September 4, 1997, the State was granted an exemption from any liability towards a license holder or a third party under the terms specified in the license. The Company’s management believes that, except for what is stated below, the Company is in compliance with the terms of the licenses that were granted. The Company does not file audited financial statements for the profit centers, as required in the licenses. The Company intended to make arrangements for the preparation of financial statements per area of activity, as required by the provisions of the Companies Authority since the Company believes that such implementation will meet the requirements of the licenses. Due to sanctions initiated by the Company’s employees in that respect, the Company did not file the above financial statements and received an extension from the Companies Authority for at least a one quarter (see 1.c and 3.c). Nevertheless, the licenses received in respect of the new generation units (generation units whose establishment began prior to March 4, 2007—Eshkol, Alon Tavor, Gezer (2 units), Hagit and Zafit) reiterate the demand for reporting according to audited profit centers. In view of the above, the Company notified the Minister that the current phrasing of these licenses implies that the Company is exposed to legal proceedings, which might be initiated against it for not complying with the above requirements, in addition to further ramifications in areas which cannot be estimated by the Company at present. 4. The Electricity Sector Law imposes sanctions on anyone who operates units for generating electricity without a license as specified below: – Criminal sanctions—Pursuant to section 52 (a) of the Electricity Sector Law, carrying out activities in the electricity generation sector (or any other activities in the electricity sector that requires licensing) without a license constitutes a criminal offense the law for which, regarding the Company, there are penalties. In addition, the law prescribes that an executive who does not monitor and do everything possible to prevent violations of the law by the company or one of its employees—the sentence is one-year imprisonment and a fine. – Cancellation of licenses—Section 3 of the Electricity Sector Law prescribes that: ‘‘No one will perform activities (including the generation of electricity) except pursuant to a license from the Minister pursuant to this law’’, and that ‘‘if a license is granted, the holder of the license will act in accordance with the terms of his license.’’ According to the licenses held by the Company, the Company must act in accordance with the provisions of the law, including any law that came into force subsequent to the granting of the licenses. Violation of the law constitutes a breach of the licenses, and the Minister is entitled to cancel the licenses if he finds that any of their conditions were violated (such as the violation of the law, as stated above).

F-40 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) b. Licenses and Regulations Pursuant To The Electricity Sector Law (continued) 5. On May 16, 2007, the Electricity Authority resolved that guarantees should be deposited for complying with ﬁxed electricity licenses that will be granted subsequent to the date of this resolution. The ceiling of guarantee for the license holders will not exceed $ 15 million.

c. The Government Companies Law 1) Pursuant to the Government Companies Law, a Government company is deﬁned as a company where in excess of half of the voting rights at general meetings or the right to appoint more than half of its directors are held by the State, or are held by the State together with a Government company or a Government subsidiary. Since the State of Israel holds 99.85% of the Company’s share capital, pursuant to this law the Company is deﬁned as a Government company. 2) The Government Companies Law prescribes, among others, as follows: a) The decision by a Government company to sell shares that it holds in its Government subsidiary requires Government approval and the approval of the Knesset’s Finance Committee. b) Decisions by a Government company in these matters require Government approval: (1) Changes in the company’s objectives. (2) Increase in the authorized share capital. (3) Changes in the rights attached to the shares. (4) Allocation of the company’s shares or the agreement to transfer shares when called for according to the incorporation documents —if this involves something that can result in a material change in the balance of power between the members of the company or that can provide a new member with 10% or more of the par value of the share capital or the voting rights in the company or the right to appoint a director. (5) Issuance of redeemable preferred shares. (6) Issuance of convertible debentures, and the conversion into shares of debentures issued without the right of conversion or a loan received by the company. (7) Changing the company from a company that is not private to a private company or from a private company to one that is not private. (8) The reorganization of the company, its voluntary dissolution, compromise, arrangement or merger with another company. (9) The establishment of a company, alone or with others, and the purchase of shares in an existing company, other than the purchase of shares on the stock exchange held by a company that is

F-41 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) c. The Government Companies Law (continued) regularly engaged in this type of acquisitions. If the Government company believes that a certain action or transaction does not require approval according to this paragraph and the Companies Authority disagrees with this belief, the action or transaction will be brought to the approval of the Government. (10) A right granted by a company or a commitment which a company assumed where it is possible that it could, directly or indirectly, restrict the Government, whether in its governing function or in its position as a shareholder in the company, including in connection with carrying out structural changes and privatization, promoting competition and regulating the sector in which the Company operates. In this respect, ‘‘right or commitment’’—including a right or commitment, pursuant to which an act or omission on the part of the Government, not under the Company’s control, will provide a third party with relief and remedies against the Company. (11) A public offering of securities pursuant to a prospectus, if the Companies Authority assumes that as a result of the publication of a prospectus, the State, being the controlling shareholder in the Company, might be responsible for any damage that will be caused by a misleading detail in the prospectus, pursuant to the Securities Law, 1968 (‘‘the Securities Law’’), and so informed the Company. (12) An act as a shareholder in a Government subsidiary in one of the matters stated above in sections (1) through (10). (13) A commitment to one of the acts stated above in sections (1) through (11). Such decisions made by a Government subsidiary also require the approval of the Government and will be brought before the Ministers by the parent company to obtain such approval. c) The Minister of Finance is entitled, pursuant to the recommendation of the Companies Authority, to determine regulations for the preparation of the budgets and programs, whether for all Government companies or for certain categories. d) A Government company will operate according to the business considerations by which a non-Government company operates, except if the Government has determined, with the approval of the Knesset’s Finance Committee, other options for carrying out its operations. The Company has always acted in this manner and the State of Israel has never instructed the Company to utilize other options. However, the Government has the power to instruct the Company to take certain actions, including such that will cause the sale of some of its assets, subject to obtaining the proper approvals. e) In addition to the provisions of any law, the Minister of Finance, in consultation with the Minister of Justice, and with respect to a public company—in consultation with the Securities Authority, is entitled to

F-42 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) c. The Government Companies Law (continued) determine according to the recommendation of the Companies Authority, rules for the preparation of a Government company’s financial statements as to which, he has determined is supplying the public with an essential service, including with respect to the details that they will comprise, the accounting principles to be applied in their preparation, and the declarations and notes that they will include. f) Should the Companies Authority feel that the public interest so requires, it is entitled to instruct a Government company as to the manner in which to present details in its financial statements, or in any other report that the company is required to file pursuant to any law, provided that the instructions in this regard were not determined in the rules, law or generally accepted accounting principles and by generally accepted reporting principles (in this matter, see Note 34 below). g) If the Companies Authority disputes the manner in which details are presented in the financial statements or any other report that the Government company is required to file pursuant to all laws, it is entitled, if it feels that the public interest so requires, to instruct the company to disclose the position of the Companies Authority and to describe the dispute in the financial statements to the satisfaction of the Companies Authority. 3. As to the aforesaid in sections 2.e through 2.g, the Companies Authority approached the Company with various requests for the disclosure of additional information in the financial statements, as detailed below (see also Note 34.b.(3).): a) In March 2004, the Companies Authority instructed the Company that, pursuant to section 33.b of the Government Companies Law, 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 operating segments. 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) On September 14, 2004, a directive was issued to the Company (‘‘the directive’’) by the Companies Authority, in accordance with its authority under section 33.b of the Government Companies Law, 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. What is involved 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 until the beginning of 2006, the date of the end of the licenses and current rate basis, disclosure is required as detailed in this directive. The accounting preparations and the disclosure made in the financial

F-43 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) c. The Government Companies Law (continued) 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 of 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 used 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). 3) Disclosure 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) In the financial statements for the second quarter of 2005 and thereafter, the aforesaid disclosure will, in addition, include the following details in a note: 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: 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, Zafit site and the other sites as one additional generation site—each separately. c) The transmission segment.

F-44 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) c. The Government Companies Law (continued) d) In January 2005, the Company decided to become organized in order to enable the preparation of separate financial statements for each activity as required by the directives of the Companies Authority in section 4 above in the directive (‘‘separate financial statements’’), where the work plan includes, among others, preparation of methodology, work procedures, internal controls procedures, as well as a computerized solution. Performing the work in accordance with this decision was postponed due to the sanctions taken by the employees that prevented the implementation of the decision. On March 26, 2006, the Company received a letter from the Director of the Companies Authority with notification that the implementation of the preliminary milestones that were set to be completed by March 26, 2006 is deferred by at least one more quarter. Until the date of signing the financial statements, there have been no further developments in the matter. As stated in Note 2.a.(3), implementing the directives of the Companies Authority for disclosure of the Company’s operations constitutes a condition of the Government Companies Regulations (Principles for the Preparation of Financial Statements of the Israel Electric Corporation Ltd.) (Temporary Order), 2004 (‘‘the Regulations’’) enacted by the Minister of Finance for preparing adjusted financial statements beginning as of January 1, 2004 through December 31, 2007. In addition to this, exclusion of information required pursuant to the law from the financial statements is liable to result in an impairment of the Company’s ability to publish financial statements.

d. Government Decisions regarding the Electricity Sector Law Over the years, the Governments of Israel have made decisions that concern the Electricity Sector, the principal elements of which are: 1) Decision dated May 28, 1995 (and subsequent decisions on August 13, 1997 and on November 4, 2002) To open the electricity generation sector to independent power producers for 20% of electricity generation. As of the date on which these ﬁnancial statements were signed, the scope of the installed electricity generation capability for independent power producers comprises about 0.6% of the Company’s total installed electricity generation capability. Nonetheless, additional conditional approvals in principle were granted to independent producers with an aggregate volume of about 3,143.7 megawatts that, as of the date on which the ﬁnancial statements for the year of 2007 were signed, comprise nearly 28% of the installed electricity generation capability of the Company. Should the entrepreneurs comply with the conditions of the Electricity Sector Law and the timetables set up for them, on the dates of the aforesaid commercial operation they will be provided with private electricity producer

F-45 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) d. Government Decisions regarding the Electricity Sector Law (continued) licenses. These projects are at the stage of the examination of suitability, and initial examinations have been performed at the Company regarding the ways to connect them to the Company’s transmission network; however, as of the date on which the financial statements were signed, the Company has not yet signed agreements with these entrepreneurs, and a specific timetable for links to the Company’s transmission network have was not been set. 2) Decision dated August 13, 1997 To adopt the principles of the policy appearing below in the electricity generation sector. – Independent power producers will be permitted to sell electricity directly to final customers, while using the transmission services of the national and regional grids. – Tenders to independent power producers will be made and published by the Government. 3) Decision dated August 12, 1998 – To act in a manner that will promote the Government’s policy to integrate independent power producers into the electricity sector. – To enable the sale of electricity in bulk to malls and office buildings while making the adjustments required by law, regulations or rules. – To prescribe Government policies, pursuant to the Electricity Sector Law, such that additional parties will be able to engage in the distribution of and/or commerce in electricity and to act toward arranging the terms of the transactions between the essential service license holders. 4) Decision dated March 11, 2002 To encourage the establishment and operation of power and heat facilities (‘‘co-generation facilities’’) for the generation of electricity by independent power producers. Transmission of electricity from the co-generation facility will be done primarily through the Company’s transmission grid. It was also determined in the decision that generation by co-generation will not be included in the generation quota intended for independent producers (20% of the generation of electricity). The Electricity Sector Regulations (Transactions with the Holder of an Essential Service Provider License), 2000, will apply to sales to the holder of an essential service provider license. The methods of sale will be according to the method for the sale of energy, or the available output and energy, as defined in the electricity sector regulations. 5) Decision dated November 4, 2002 Independent power producers, which are interested in selling electricity to parties other than the Company, will be able to obtain a license to produce electricity privately, without a tender, in accordance with the conditions that will be determined by the Minister. This is on condition that the plans will be

F-46 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) d. Government Decisions regarding the Electricity Sector Law (continued) approved pursuant to the Planning and Building Law. In the framework of the conditions, the Minister will be able to determine that transactions for the purchase of electricity between the Company and the holder of a private producer license can only be possible on the basis of the free will of the parties. Generation by independent power producers, who received generation licenses, as stated above, will not be included in the generation quota designated for independent power producers within the borders of Israel. 6) Decision dated September 12, 2006

The structure of the electricity sector and the Company’s structure will be changed as described below, and insofar as it will be required, the Electricity Sector Law will be changed: a) The Company will be a Government owned holding company (‘‘the holding company’’). Companies will be spun-off from the holding company in the generation, distribution and transmission of electricity sectors and system management, as will companies in the sectors for additional services as detailed below. b) The Company’s management, and the Company’s entire operational sector that will not be incorporated separately, as detailed below, will remain a part of the holding company. Electricity generation

c) The generation of electricity will be based on four subsidiaries, where each company will be coal-based with additional units, with a proﬁle of consumption of similar fuels. Additional coal-powered generation units that will be established will be the basis for additional generation companies, or will be added to the aforesaid four companies. d) Each generation company can also be engaged in the sale of electricity to end consumers (supply of electricity). e) These generation companies will be incorporated as subsidiaries of the holding company by March 1, 2007. f) By January 1, 2012, the holding percentage of the holding company in each of the generation companies will have declined to 51%, including through offerings to the public. g) In the framework of the reduction in the holding company’s holding percentage, as stated in section f, the employees will be entitled to compensation from the holding company or from the generation companies, as applicable, in accordance with employee compensation procedures in privatization by the Companies Authority. In addition, the employees will be eligible to compete for the purchase of additional holdings in these companies under equal terms. h) Once competition has been established, the generation and supply segment will progressively be released from rate regulation by the Electricity Authority.

F-47 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) d. Government Decisions regarding the Electricity Sector Law (continued) i) The ministers will be entitled to approve the sale of holdings in the generation companies exceeding what is stated in section f. In the absence of agreement between the ministers, the Prime Minister will resolve the matter, without derogating from the provisions of the Government Companies Law. j) Upon the sale of 49% of the holding company’s holdings in the generation company, that company will be authorized to engage in water desalination. This activity will be carried out pursuant to the principles of regularization customary in those segments.

Electricity transmission and system management

k) On March 1, 2007, operation will commence of the transmission and system management company, the function of which will be to operate and develop the electricity transmission network. A profit center will be set up in that company separate from the transmission activities that will be involved in system management, long-range planning of the electricity system and the management of and the commerce in electricity. This profit center will have authorities vis-à-vis the companies operating in the electricity sector, in a manner that, among others, will assure the level of development and maintenance required in the electricity sector, this under Government supervision. The activities of the transmission and system management company will be performed under supervision, including the rate for supplying transmission services. Thereafter, the need for creating a separate company for managing the system and the commerce will be evaluated. l) The transmission and system management company will be obligated to provide services upon equal terms to all parties in the electricity sector. m) The transmission rates will be linked to a fair rate of return on capital for the purpose of financial stability of the transmission and system management company.

Electricity distribution

n) The Company’s distribution segment will be split into four separate distribution companies that, from the aspect of the costs structure, will be similar and, insofar as is possible, will be similar in size. o) These distribution companies will be incorporated as subsidiaries of the holding company by March 1, 2007. p) By January 1, 2012, the holding company’s holding percentage in each of the distribution companies will decline to 51%, including by means of offerings to the public. q) In the framework of the reduction in the holding company’s holding percentage, as stated in section p., the employees will be entitled to

F-48 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) d. Government Decisions regarding the Electricity Sector Law (continued) compensation from the holding company or from the distribution companies, as applicable, in accordance with employee compensation procedures in privatization by the Companies Authority. In addition, the employees will be eligible to compete for the purchase of additional holdings in these companies under equal terms. r) The ministers will be entitled to approve the sale of holdings in the generation companies exceeding what is stated in section p. below. In the absence of agreement between the ministers, the Prime Minister will resolve the matter, without derogating from the provisions of the Government Companies Law. s) The distribution companies will act to operate and develop the existing regional electricity grid, and it will be operated under regulation, including the rate for transmission service. t) The transmission companies will be obligated to provide services at equal terms to all parties in the electricity sector. u) The distribution rates will be linked to a suitable rate of return on capital for the purpose of the ﬁnancial stability of the companies. Additional services v) By March 1, 2007, the Company’s planning, construction and performance, information technologies and logistics divisions will operate as separate divisions in the framework of holding companies. w) By January 1, 2009, each of the divisions will be incorporated as separate subsidiaries under a ‘‘holding company’’. x) By January 1, 2012, the holding company’s holding percentage in each of the service companies will decline to 51%, including by means of offerings to the public. y) Subsequent to January 2012, all of the holding company’s holdings in each of the service companies will be sold. z) In the framework of the reduction in the holding company’s holding percentage, as stated in sections x. and y. above, the employees will be entitled to compensation from the holding company or from the additional service companies, as applicable, in accordance with employee compensation procedures in privatization by the Companies Authority. In addition, the employees will be eligible to compete for the purchase of additional holdings in these companies at equal terms. aa) The ministers will be empowered to prescribe in the regulations, despite of the provisions of the Mandatory Tenders Law, that the generation, distribution and transmission companies that were spun-off from the Company will give preference to commitments with the service companies, for periods and at terms that will be determined by the ministers. Further, these companies will also be entitled to compete on other tenders outside of the electricity sector.

F-49 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) d. Government Decisions regarding the Electricity Sector Law (continued) bb) Upon the sale of 49% of the holding company’s holdings in the distribution and generation companies, the holding company will be allowed to establish subsidiaries that will be involved in other activities segments. These activities will be carried out pursuant to the regularization procedures customary in these areas. Negotiations concerning the structural change cc) It was decided to empower the representatives of the Companies Authority, the budget division oft the Ministry of Finance and the Ministry of National Infrastructure to negotiate with the Company’s management and the representative employees organization concerning the change in the electricity sector’s structure and in the Company’s structure. The agreements to be reached by the parties in the context of these negotiations will be presented for approval to the ministerial committee for social and economic affairs, as will be required in order to amend the Electricity Sector Law. dd) It was decided to establish a team that will include representatives from the Companies Authority, the budget division at the Ministry of Finance, the supervisor of the payroll division at the Ministry of Finance, the Ministry of National Infrastructures and the Company’s management to negotiate with the Company’s representative employees organization, regarding employee rights in the context of the structural change. The recognized costs for the change in structure will be expressed in future electricity rates. 7. Decision dated February 18, 2007 It was decided to approve the principles of the draft Electricity Sector Law (Amendment No. 5) (see a. above) regarding the amendment to the Electricity Sector Law in order to allow the restructuring in the electricity sector and accordingly, extend the licenses that will expire in March 2007. To add an addendum to the clause regarding the generation licenses in a manner that will assure that there will be no harm to competition in the electricity sector, including with independent manufacturers. In furtherance to the Government’s decision of September 12, 2006 (see 6 above), to continue to act to protect the employees’ rights under the customary rules prescribed by the labor laws. 8. Decision dated September 23, 2007 According to the policy for increasing the generation capacity in order to cut down on demand in the electricity sector, it was decided as follows: a) To require the team established by the Minister of Finance to notify the ministers of the status of negotiations with OPC in the matter of the tender for erecting a power station in the Rotem Plain site. The ministers will decide on a policy based on these ﬁndings. b) To require the Accountant General in the Ministry of Finance to appoint a tender committee, to publish an international tender for the construction of two solar power stations in the Eshelim compound.

F-50 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) d. Government Decisions regarding the Electricity Sector Law (continued) c) To establish that the Government’s objectives for reducing demand for electricity in times of shortage in the coming years will be in addition to cutting down current demands and to instruct the Electricity Authority to formulate a position with regard to setting an apparatus by December 31, 2007, in the context of its legal powers, to reduce electricity demand in times of shortage while adhering to Government policy. d) To assign to the Ministry of National Infrastructures the task of acting in accordance with its authority for promoting the Government’s objectives for the contraction of demand using the devices under its authority by virtue of the Electricity Sector Law, 1996 and the Energy Sources Law, 1989. 9. The decision of the ministers’ committee cabinet for economics dated November 13, 2007 It was decided to allow the Company to issue foreign debentures through Goldman Sachs International, pursuant to Article 11(a)(9a) to the Government Companies Law, 1975. e. The Payment of Dividends The Government Companies Law prescribes that the decision by the Board of Directors of a Government company regarding the designation of earnings, including with regard to a distribution as it is defined in the Companies Law, requires the approval of the Companies Authority. If the Companies Authority differs with the Board of Directors’ decision, then a company of the Company’s type (as long as it is not a company in the process of privatization) will act pursuant to the Electricity Authority’s decision, as approved by the Government. The present policy of the Companies Authority (which may change from time to time), from 1995 and thereafter concerning the designation of earnings for the payment of dividends, determines: 1. In public utilities companies, the dividends from current earnings will be paid at a rate of 60% of the annual current net income before bonus payments to the employees from such profits. 2. The dividends from accumulated profits will be determined specifically for every company, taking into consideration relevant data and factors. The provision for dividends was recorded in light of the stipulations of section 3 of the Companies Authority circular, 97/1-2c, dated February 9, 1997, and the clarifications of the Companies Authority, pursuant to which when dividends are recorded, reference should be made to all components of net income prior to the payment of a bonus to employees out of the earnings. According to an opinion from the Company’s attorneys, there is nothing in the above entry that derogates from or impairs the position of the Board of Directors with respect to the actual distribution. The Company’s Board of Directors is of the opinion that according to criteria in section 302 of the Government Companies Law and the Authority’s circulars, it would be appropriate to determine the amount of distributable dividends solely according to the criteria that are stated in the Companies Law.

F-51 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) f. Restrictive Trade Practices On January 5, 1999, the Restrictive Trade Practices Commissioner (‘‘the Commissioner’’) by force of his authority pursuant to the Restrictive Trade Practices Law, 1988 (‘‘the Restrictive Law’’) declared that the Company has a ‘‘monopoly’’ in the electricity supply sector (the generation and sale of electricity), the transmission and distribution of electricity and the provision of back up services to consumers and producers of electricity. There is nothing in the declaration in and of itself that changes the Company’s status as having a monopoly, or to apply obligations to it. The statutory tools prescribed in the Restrictive Trade Practices Law grant the Commissioner, inter alia, the right to require submitting new standard form contracts for his approval and the right to intervene in the Company’s affairs that are likely to harm the public or competition, including the right to apply to the Restrictive Trade Tribunal (‘‘the Tribunal’’) to divide the monopoly into two or more separate business entities. On May 4, 1999, the Company filed an appeal with the Tribunal, subsequent to which the Company arrived at an agreement with the Commissioner, which received validity as a ruling, as follows: 1. The Company is a monopoly in the electricity sector that includes, among others, the following components: the supply of electricity—the generation of electricity and its sale, the transmission of electricity and its distribution, providing backup services to consumers and producers of electricity. 2. The provisions of chapter d of the Restrictive Law apply to the Company as the owner of a monopoly, both as to the electricity sector in general, and as to each of its components. As of the date on which the financial statements were signed, the declaration of the Company being a monopoly did not have a material effect on its operations, profitability or financial position. In light of the existing degree of supervision by the Electricity Authority and other authorities to which the Company is subject and in view of the structural changes required pursuant to the provisions of the Electricity Sector Law, including the incorporation of the generation units in the framework of separate subsidiaries, the Company is unable to assess what would be the future implications of the aforesaid declaration on the Company’s operations, profitability and financial position, although it is possible that there will be material implications. In addition to the above, the Company is subject to a composite of the provisions of the Restrictive Law, including with respect to restrictive arrangements and mergers. It should be pointed out that, by force of the Company being a monopoly, its merger with any company whatsoever, is subject to the provisions of the Restrictive Law regarding the merger of companies. The Company is implementing an internal enforcement program with regard to restrictive trade activities. g. Environmental Quality The Company’s activities are subject to environmental laws and regulations regarding various matters such as air pollution, water resources, noise, storage, freight and disposal of poisonous waste, hazardous materials and others. Recently, several proposed environmental bills and regulations were brought before the Israeli Parliament and are in various stages of approval hearings. The Company is

F-52 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) g. Environmental Quality (continued) studying the economic, legal, operating and technical implications of the above. These proposed bills and regulations might have a serious economic impact on the Company yet the Company believes that these costs will be recognized within the rate. On January 1, 2006, the Non-Ionizing Radiation Law, 2006 was published in the official government gazette (‘‘the Law’’). The Law is also applicable to power plants used for electricity generation, transmission, distribution and supply up to the home distribution stage. The Law prescribes that a radiation installation is not to be constructed or operated other than by special authorization by the radiation supervisor in the Ministry of the Environment. The Law is effective as of January 1, 2007 with reference to new electric installations (electric installations for which a building permit or license had not been received by January 1, 2007) and as of July 1, 2008 with reference to existing installations. The Law constitutes a ‘‘framework law’’, which means that it prescribes taking ‘‘preventive precautionary measures’’ but does not stipulate what measures or determine the obligatory threshold yardsticks. These matters are supposed to be resolved in the regulations that will be enacted pursuant to the Law. Until such regulations are enacted by virtue of the Law, the Law adopted the Experts Committee Report of March 2005. This report enacts in Israel the World Health Organization’s position according to which the threshold value is 1,000 milligauss (‘‘mG’’) (and prescribes that there is no room to determine a lower threshold number than said value) together with prescribing that certain measures should be taken based on the precautionary principle (meaning the reduction to a minimum of reasonable costs and acceptable technical measures of the magnetic fields to which the public is exposed). It should be noted that pursuant to the Non-Ionizing Radiation Law, decisions, as well as regulations, which have a material effect on the electricity network, must be ratified by the consent of the ministers. The Company has obtained permits for a considerable part of the new electricity grid. The Company is currently acting to obtain a license for the remaining items of the new grid and a license for the existing grid. Based on the Company’s calculations and tests for various power lines and transformation installations, the Company believes that as a rule, it is complying with the directives of the International Commission on Non-Ionizing Radiation Protection. In August 2001, the radiation supervisor at the Ministry of the Environment issued a recommendation whereby electricity installations will be planned and operated in such a manner that the population will not be exposed to a magnetic field exceeding a daily average of 10 mG, in addition to the maximum value of 1,000 mG, which is the maximum value for a magnetic field. Following the publication of said Experts Committee Report, the Ministry of the Environment retracted the recommendation to plan and operate electricity installations so that the population is not exposed to electromagnetic radiation exceeding a daily average of 10 mG and cancelled this recommendation. The Ministry of the Environment provided guidelines for those who contact it that are also integrated into measurement reports conducted of the Ministry and of private surveyors. According to these guidelines, the threshold value of 1,000 mG is for a short period of time only whereas prolonged exposure to over 2 mG is a potential cause of cancer, yet the average levels in residential space in Israel do not exceed 0.4 mG.

F-53 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 1: OPERATIONS OF THE COMPANY AND THE LEGAL ENVIRONMENT (continued) g. Environmental Quality (continued) Recently, while handling a customer’s complaint, it was revealed that in the guidelines sent by the Ministry of the Environment to private surveyors or customers, the recommended average 24-hour consecutive exposure level is 2 mG, the recommended level for a consecutive 12-hour exposure is 3 mG and for a consecutive 8-hour exposure —4 mG. Such statements raise claims and arguments against the Company on the part of the public and local authorities. Moreover, several zoning authorities have incorporated a condition in the building permits regarding electricity installations according to which the installation’s magnetic ﬁeld levels must not exceed 2 mG. The inclusion of the above condition prevents the Company from connecting installations to the electricity grid. The Company has submitted its reservations regarding this position to the Ministry of the Environment and the Ministry of National Infrastructures and has argued that the above guidelines are interpreted by both the public and by some of the local authorities as a binding standard which the Company is unable to meet. This issue has not yet been settled between the government ministries and the Company.

With respect to the magnetic field requirements, several lawsuits have been filed against the Company in courts of law, certain of which have been stricken or rejected and certain are pending. The Company is studying the economic, legal, operational and technical ramifications of the above. The Company estimates that the costs that will be incurred as a result of adjustments required in order to comply with the provisions of the Law and/or regulations will be covered by the electricity rates.

h. Establishment of subsidiaries

On December 13, 2007, the Company’s Board of Directors resolved in the matter of establishing four subsidiaries as follows:

1. To approve in principle the proposed outline and initiate the process of setting up the subsidiaries for expanding the Company’s business and entrepreneurial activities in the presented areas as part of the Company’s business strategy.

2. To guide the Company’s management to act vis-à-vis the entities whose approval is required for promoting this move.

3. Detailed proposed decisions regarding the establishment of the companies will be brought before the Company’s Board of Directors, including contractual contexts, articles of association, ofﬁcers and required approvals.

The workers’ association has announced that it opposes the establishment of the subsidiaries and has forbidden all the employees to cooperate in drafting summaries and producing any information with this respect (see Note 21.c below).

F-54 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 2: SIGNIFICANT ACCOUNTING POLICIES

a. General 1. The Company presents its financial statements in accordance with Israeli Securities Regulations (Preparation of Annual Financial Statements)—1993 (as amended) and in accordance with Israeli generally accepted accounting principles, in addition to what is stated in section (3) below. 2. The Electricity Sector Law prescribes that a holder of a license to supply an essential service shall prepare its financial reports as determined by the Ministers in consultation with the Minister of Justice with regard to the level of their detail, the accounting principles applied in their preparation, and the declarations and notes attached. Such directives and obligations applicable to the Company’s financial statements as of December 31, 2007, have not yet been determined by the Ministers (See also Note 1.b.2 above). 3. In accordance with section 33.a of the Government Companies Law (see Note 1.c above), the Minister of Finance, in consultation with the Minister of Justice, and with reference to a public company in consultation with the Securities Authority, is entitled to prescribe, according to the recommendation of the Companies Authority, rules for the preparation of a Government company’s financial statements in respect of which he determined that it provides an essential service to the public, including the matter of the details to be incorporated, the accounting principles for their preparation, and the declarations and notes to be attached to them. On September 14, 2004, the Minister of Finance enacted the Government Companies Regulations (Principles for the Preparation of Financial Statements of the Israel Electric Corporation Ltd.) (Temporary Order), 2004, (‘‘the Government Companies Regulations’’), in accordance with his authority pursuant to the aforesaid law. Under the Government Companies Regulations, it was determined that during the period commencing January 1, 2004 and ending December 31, 2005 (‘‘the transition period’’), the Company will prepare its financial statements adjusted for the changes in the general purchasing power of the NIS, in accordance with principles prescribed in Accounting Opinion No. 36, including the provisions that were prescribed in Accounting Opinions Nos. 40, 50 and 56 of the Institute of Certified Public Accountants in Israel. The notes to these financial statements will include the details of the disclosure of the Company’s operations, which is required in accordance with the directives of the Companies Authority pursuant to section 33.b to the Government Companies Law, which were provided to the Company on March 2, 2004 and on September 14, 2004 (see Note 1.c.3 above), as well as additional provisions under section 33.b to the aforesaid, concerning the Company’s operations, as they will be given from time to time (‘‘the Companies Authority directives’’), provided that the Companies Authority has found that the Company implemented its directives. If the Company did not implement the Companies Authority directives, the Company shall not prepare its financial statements as adjusted for the changes in the general purchasing power of the NIS. On June 12, 2006, the Minister of Finance enacted regulations that extend the above transition period until December 31, 2007 and, in addition, the following regulations were prescribed:

F-55 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 2: SIGNIFICANT ACCOUNTING POLICIES (continued) a. General (continued) a) ‘‘The Company will prepare for the transition to reporting in accordance with International Accounting Standards, will report on same, as required in the Authority’s circulars, and will submit draft financial statements to the Companies Authority for the period commencing January 1, 2007 and ending June 30, 2007. In those financial statements, subject to the directives of the Authority, it will implement International Accounting Standards in accordance with the decision of the professional committee of the Israel Accounting Standards Board dated November 15, 2005, or in accordance with the detailed standard that the aforesaid Board will promulgate. Attached to the draft will be an opinion of the auditor that will include information in accordance with the Authority’s requirement’’. b) ‘‘Should the Company not complete the preparation for the transition to reporting in accordance with International Accounting Standards by August 31, 2007, the Company will not prepare, during the transition period, the financial statements as of September 30, 2007 and thereafter in accordance with the provisions that were prescribed in the Accounting Opinions’’. Based on the opinion of the Company’s legal advisors, if the Company fails to meet the conditions described above, it will have to cease implementing Accounting Opinion No. 36 in its financial statements effective July 1, 2007 and present nominal reporting from that date forward (the implications of this inability are similar in nature to the implications of the adoption of International Financial Reporting Standards (‘‘IFRS’’) as stated in Note 3.b(10). Following conversations and meetings with the representatives of the Companies Authority, while presenting the difficulties relating to the report mentioned in a) above, the Company received clarifications regarding the nature of the Authority’s directives stated in a) above and the Company filed reports for June and September 2007. The Company has finished preparing for the transition to reporting according to IFRS (see Note 32 below). 4. In accordance with section 33.b of the Government Companies Law, in the event that the Companies Authority will see that it is so required by the public interest, it will instruct the Government company as to how to present items in the financial statements, or in any other report that the Company is required to file pursuant to any law, provided that the directives in this matter are not prescribed in its rules, by law or in generally accepted accounting principles and generally accepted reporting principles. Regarding the Electricity Authority’s directives deriving from the aforesaid, see Note 1.c.3.a above and Note 34 below.

b. The Effects of the Electricity Authority’s Regulation over the Accounting Policies The Company’s rates are determined in accordance with the decisions reached by a public regulatory authority—the Electricity Authority (see Note 1.a.5 above). In Israel, special accounting principles regarding companies of this nature (‘‘regulated companies’’) have not yet been determined and, accordingly, the Company applies the

F-56 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 2: SIGNIFICANT ACCOUNTING POLICIES (continued) b. The Effects of the Electricity Authority’s Regulation over the Accounting Policies (continued) standard of the Financial Accounting Standards Board in the U.S., Standard No. 71, which deals with accounting for the effects of certain types of regulation on accounting policies (‘‘the Standard’’). The objective of issuance of the Standard is to establish and define how to apply generally accepted accounting principles to regulated companies and how to reflect the decisions of the regulating authority in the financial statements of those companies. The Standard allows, if certain criteria are met, an accounting treatment which is different from what is commonly practiced regarding the timing for recording income and expenses to the statement of operations, the objective of which is to reflect and devise adequate matching between the expenses and revenues that will result to the Company in the electricity rate according to the dates on which they are recognized. In addition, the Standard prescribes regulations concerning the impairment of the value of assets that is measured according to the future cash flow, which is based on the electricity rate as determined by the Electricity Authority. These regulations are different from the regulations that apply to an unregulated company. The Standard is applied when the following three cumulative criteria exist: 1. Rate regulation—the rates for regulated services or products provided to its customers are established by or are subject to approval by an independent, third party regulator or by a committee empowered by power of attorney or subject to their approval, this in accordance with statute or contract to establish rates to be charged to customers. 2. A specific coverage of costs—the regulated rates are designed to cover the specific costs (including the required return on capital) of providing the regulated services or products. 3. Competition and the likelihood of collection from customers—in view of the demand for the regulated services or products and the level of competition, direct and indirect, it is reasonable to assume that rates so set will cover the costs, are able to be charged and to be collected from customers. These criteria may also be applied to separable portions of operations, such as the generation of electricity, or its transmission, or to a specific segment of customers. A company meeting the above criteria will capitalize expenses that would otherwise be recorded to operations with the regulatory body setting a rate which will cover these expenses in the future. The aforesaid capitalized expense is a regulatory asset. In addition, such a company could also record regulatory liabilities, according to the circumstances. The Standard requires that regulatory bodies reassess the probability of recovering their regulatory assets at each date that financial statements are issued. If a conclusion is reached that the company is no longer meeting the criteria for applying the Standard, or that the coverage of the assets, or a portion thereof, is no longer highly probable, then the regulatory asset or a portion thereof, must be erased from the balance sheet and impairment losses should be evaluated according to Standard No. 15. With respect to the Company meeting the criteria of the Standard, see Note 3.c.2 below.

F-57 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 2: SIGNIFICANT ACCOUNTING POLICIES (continued) c. Deﬁnitions

In these ﬁnancial statements:

1. Affiliated Company—a company over which the Company has significant influence and that is not a subsidiary, and the investment in which is included in the Company’s financial statements on the equity basis.

2. Investee Company—a subsidiary or afﬁliated company.

3. Controlling Shareholders—until January 1, 2007, according to the deﬁnition in the Israeli Securities Regulations (Presentation of Transactions between a Corporation and a Controlling Interests Therein in the Financial Statements)— 1996. As of January 1, 2007, as deﬁned in Accounting Standard No. 23 of the Israel Accounting Standards Board.

4. Interested Parties—according to the deﬁnition in the Israeli Securities Regulations (Preparation of Annual Financial Statements)-1993.

5. Related Parties—as deﬁned in Opinion No. 29 of the Institute of Certiﬁed Public Accountants in Israel.

6. $—U.S. dollar.

7. CPI—the Consumer Price Index published by the Central Bureau of Statistics in Israel.

8. CPI for a speciﬁc month—the CPI relevant to a speciﬁc month which is published during the following month.

9. Known CPI on a speciﬁc date—the latest known CPI on any date during a speciﬁc month.

d. Financial Statements in Adjusted Values

1. As stated above in section a, the Company prepares its ﬁnancial statements on the basis of historical cost, adjusted for changes in the general purchasing power of the new Israeli shekel (‘‘NIS’’). The nominal ﬁnancial statements that form the basis on which the adjusted statements were prepared appear in Note 30.

2. The adjusted values of non-monetary assets do not necessarily represent the market value of these assets or their value to the Company, but only their cost adjusted for changes in the general purchasing power of the NIS.

3. In the adjusted statements, the term ‘‘cost’’ shall be deemed as ‘‘adjusted cost’’.

4. The comparative ﬁgures in these ﬁnancial statements are presented in adjusted NIS of December 2007 purchasing power.

F-58 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 2: SIGNIFICANT ACCOUNTING POLICIES (continued) d. Financial Statements in Adjusted Values (continued) 5. The following are data of the CPI and exchange rates of the NIS/U.S. dollar and the rates of change therein for the periods indicated:

Consumer Price Index * Exchange Known rate of the For the CPI for the U.S. dollar month of month of on the the balance the balance balance sheet sheet sheet date Points NIS As of December 31, 2004 ...... 180.74 180.56 4.308 December 31, 2005 ...... 185.05 185.41 4.603 December 31, 2006 ...... 184.87 184.87 4.225 December 31, 2007 ...... 191.15 190.03 3.846

Rates of change in the reported period %% % For the year ended December 31, 2005 .... 2.38 2.69 6.85 For the year ended December 31, 2006 .... (0.1) (0.29) (8.21) For the year ended December 31, 2007 .... 3.4 2.79 (8.97)

* The index on an average basis of 1993 = 100.

e. Principles Used for the Adjustments 1. Balance Sheet a) The amounts for the non-monetary items (items for which the amounts appearing in the balance sheet reflect their historical values when purchased or incurred-see below) are adjusted according to the changes in the CPI from the month in which each transaction was carried out to the CPI for December 2007. The following items were treated as non-monetary items: fixed assets and accumulated depreciation, expenses of raising capital, inventory, prepaid expenses, receipts and disbursements for unfinished contracts, perpetual debentures, capital reserves and share capital. b) The equity of the investments in investee companies is determined on the basis of the adjusted financial statements of those companies. c) Monetary items (those items for which the amounts appearing in the balance sheet reflect updated values as of balance sheet date) are presented in the adjusted balance sheet as of December 31, 2007, in amounts identical to their nominal amounts as of that date (the comparative numbers were adjusted to NIS of December 2007). 2. Statement of Operations a) The statement of operations items (except financing) which express transactions carried out during the reported year—income, expenses,

F-59 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 2: SIGNIFICANT ACCOUNTING POLICIES (continued) e. Principles Used for the Adjustments (continued) etc.—were adjusted according to the changes in the CPI from the month in which they were recorded out and through the month of the end of the reporting period. The erosion of monetary balances connected to those transactions, are included in financing, net. b) The statement of operations items related to non-monetary items (such as depreciation and amortization, changes in inventory, prepaid expenses and accrued income) have been adjusted on the same basis as the related balance sheet items. c) The statement of operations items related to provisions included in the balance sheet (such as provisions for pension and severance pay, vacation pay, etc.) are determined on the basis of the changes in the balances of the relevant balance sheet items after taking into account the relevant cash flows. d) The company’s share in the results of operations of investee companies is determined based on the adjusted financial statements of those companies. e) The net financial item reflects real financial income and expense, as well as the erosion of monetary items during the year. 3. Statements of Changes in Shareholders’ Equity Dividends declared and paid during a reported year have been adjusted according to the CPI in effect on the actual date of payment. Dividends proposed as of the date of approval of the financial statements and which is to be distributed from the earnings for the reported year and, as of the balance sheet date, has not been paid, is included without adjustment. The amount presented as erosion of dividends represents the erosion in the real value of the dividend proposed in prior years that was actually paid subsequently (the erosion relates to the adjustment from the beginning of the year and until the actual date of payment). f. Cash Equivalents Cash equivalents are considered by the Company to be highly liquid investments that include short-term bank deposits with maturities not exceeding three months from the investment date and that are not restricted by a lien. g. Short-term Investments Short-term bank deposits are deposits made with original maturities of more than three months from the investment date. h. Customer Discounts Current customer discounts are recognized in the financial statements upon being granted and are recorded in revenues. i. Allowance for Doubtful Accounts The financial statements include an allowance for debts for which collection is doubtful based on information available regarding the financial position of the consumers and on a statistical analysis of the consumers’ debt balance.

F-60 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 2: SIGNIFICANT ACCOUNTING POLICIES (continued) j. Inventory—Fuel

On January 1, 2007, the Company adopted the provisions of Accounting Standard No. 26, ‘‘Inventories’’ (‘‘Standard 26’’) of the Israel Accounting Standards Board regarding the accounting treatment of inventories.

This Standard applies to all types of inventories, except work in progress arising from construction contracts, which is subject to the provisions of Accounting Standard No. 4, ‘‘Construction-type Contracts’’, inventory of buildings for sale, which is subject to the provisions of Accounting Standard No. 2, ‘‘Construction of Buildings for Sale’’ and ﬁnancial instruments.

Inventories are measured at the lower of cost or net realizable value. The cost of inventories is determined based on the weighted average cost method.

When inventories are purchased under credit terms whereby the arrangement involves a financing element, the inventories are presented at cost reflecting the cash purchase price and the financing element is recognized as a financial expense over the period of the financing.

If in a particular period production is not at normal capacity, the cost of inventories should not include an allocation of ﬁxed overhead costs in excess of the amount that would have been allocated based on normal capacity. Such unallocated overhead costs are recognized as an expense in the statement of operations for the period in which they are incurred. Furthermore, cost of inventories does not include abnormal amounts of materials, labor and other costs resulting from inefﬁciency.

The initial adoption of Accounting Standard No. 26 had no material effect on the ﬁnancial statements.

Inventory of coal purchased by the National Coal Supply Company Ltd. (‘‘the Coal Company’’) (a subsidiary of the Company) for the Company from different foreign suppliers was recorded in the Company’s books as inventory in transit (see Note 7 below).

k. Inventory—Stores

The inventory is valued according to the cost determined by the adjusted moving average method.

l. Investments in Investee Companies

1. Investments in the Company’s investee companies are included on the basis of the adjusted equity method of accounting.

2. The Company recognizes its share of losses of investee companies in excess of its equity investment if the Company has an obligation towards them.

3. The Company does not consolidate its ﬁnancial statements with those of the Coal Company because of the lack of materiality.

F-61 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 2: SIGNIFICANT ACCOUNTING POLICIES (continued) m. Investments in Debentures

Investments in long-term debentures are presented at market value since they form part of the Company’s liquid means of redeeming its obligations due to employee- employer relationships.

n. Fixed Assets

1. The Company records all of the costs (including, among other things, direct wages and related expenses, materials, contractors and overheads) relating to their construction to ﬁxed assets under construction as well as real ﬁnancing costs accrued up to the date of their operation (see also v.4 below).

2. The useful lives and depreciation rates used in the calculation of depreciation are as follows:

Useful life Depreciation (years) rates (%) Power stations ...... 30-50 (mainly 30 years) 2-3.33 Industrial gas turbines...... 25 4 Jet gas turbines ...... 15 6.67 Transmission system ...... 30 3.33 Distribution system ...... 20-30 (mainly 30 years) 3.33-5 Meters ...... 14 7.1 Inventories (including ofﬁce equipment), mobile mechanical equipment and telecommunications...... 10 10 Computers and auxiliary equipment ...... 3-5 20-33.33 Motor vehicles ...... 5-7 14.3-20 Buildings ...... 30 3.33

Additions to the existing generation systems are depreciated over the remaining depreciation period of their original cost.

3. On January 1, 2007, the Company adopted the provisions of Accounting Standards No. 27, ‘‘Fixed Assets’’ and No. 28, ‘‘Amendment to the Transition Provisions of Accounting Standard No. 27, ‘‘Fixed Assets’’ of the Israel Accounting Standards Board (‘‘the Standards’’). The principal changes promulgated by these Standards in contrast to the principles applied prior to January 1, 2007 are:

a) The Standards allow an entity to choose measurement of fixed assets after the initial recognition at the cost model or the revaluation model, based on the fair value of the fixed asset upon the revaluation and to carry the revaluation to a capital reserve. According to the cost model, a fixed asset item will be presented at cost less accumulated depreciation and less any accrued impairment losses. The Company has elected to measure fixed assets according to the cost model.

F-62 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 2: SIGNIFICANT ACCOUNTING POLICIES (continued) n. Fixed Assets (continued) b) The component method—significant parts of fixed assets with a different useful life will be depreciated separately according to the component method. In order to implement this method, the Company is evaluating just which are the significant components with different useful lives using outside advisors, and also what is the appropriate useful life and depreciation method for each component. This examination includes, among other things, work meetings with various department representatives of various engineering units of the Company in order to gather relevant information, gather and process international information and adapt it to the Company’s unique characteristics and ultimately, to determine a representative useful life. From the examination of the provisions of the Standard and the analysis of all of the effects of the (retrospective) re-measurement of the depreciated cost of fixed assets pursuant to the provisions of the Standard and mainly as a result of the abovementioned component method, the Company’s tests concluded that depreciated cost according to Standard 27 will be higher than the depreciated cost included in the Company’s financial statements prior to the adoption of this Standard. The Company is a regulated company applying SFAS 71 to its fixed assets used in its activities under regulation since, under such accounting principles for regulated companies, a regulated company must write off the amount of the investment in fixed assets which will most probably not be recognized for rate purposes. In view of the above, the Company believes that, among other things for cost—effectiveness reasons, it will not be required to re-measure the opening balance of fixed assets on the one hand or write them down to the cost in the books prior to the adoption of Standard 27 on the other hand (by an identical amount). Accordingly, fixed assets are included at depreciated cost prior to the adoption of Standard 27. o. Dividend Declared Subsequent to Balance Sheet Date Dividends declared subsequent to the balance sheet date and prior to the approval of the financial statements are not recorded as a liability in the financial statements and are presented in the financial statements as a separate item in the statement of changes in shareholders’ equity.

p. Deferred Taxes Except as described in Note 19.j.(4), the Company attributes taxes in respect of temporary differences between the value of assets and liabilities in the ﬁnancial statements and their tax base and in respect of losses for tax purposes whose realization can be expected. The deferred taxes, net, are classiﬁed as current assets or liabilities and long-term assets or liabilities, according to their expected time of utilization. The deferred tax liability includes a liability for the element of adjustment to the CPI of depreciable assets that are non-deductible for tax purposes (except for immaterial buildings), whose depreciation is recorded over at least 20 years from their initial

F-63 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 2: SIGNIFICANT ACCOUNTING POLICIES (continued) p. Deferred Taxes (continued) operation. The Company is of the opinion that the accounting treatment as above is required in order to create proper correlation between carrying the depreciation on these assets and their respective tax expenses. The taxes that would apply in the event the investments in investees were realized were not taken into account in the calculation of the deferred taxes, as long as it is more likely than not that the investments in the investees are not expected to be sold in the foreseeable future. In addition, the deferred taxes on distribution of earnings by investees as dividends were not taken into account, since the distribution of dividends does not involve an additional tax liability. q. Spreading of Actuarial Gains and Losses The Company allocates actuarial gains and losses (‘‘actuarial changes’’) similarly to the provisions of International Accounting Standard 19. In each reporting year, a portion of 1:15 of the remaining actuarial changes at the beginning of that year is depreciated to cost of salaries and pension accruals (the average expected employment term of active employees is at least 15 years). Thus, the amounts of the expenses that are charged to salary and pension costs are the amount of the calculated interest at the beginning of the reported period on liabilities as of that date (‘‘interest on obligation’’), as well as the amount that accrued from the addition of seniority during the reported period (‘‘current service cost’’), less expected interest on the funded amounts as of the beginning of the reported period. Actuarial changes deriving primarily from the difference between the actuarial assumptions, that are long-term assumptions, and the behavior of those variables during the reported year (such as, the expected rate of increase in salaries, the capitalization interest rate, the rates of early retirement and mortality and from the difference between the effective return on the funded amounts during the reported year, and the expected return as of the beginning of the year) and from the changes in the actuarial assumptions themselves (see Note 17.a.1.b). r. Liability for Vacation Pay The liability with respect to the redemption and utilization of vacation days accumulated by the employees is calculated based on their salaries in the month of the balance sheet and is classiﬁed as either a short-term or long-term liability in accordance with its anticipated utilization. s. Revenue Recognition 1. On January 1, 2006, the Company adopted the provisions of Accounting Standard No. 25 of the Israel Accounting Standards Board regarding revenues (‘‘Accounting Standard No. 25’’). Accounting Standard No. 25 deals with the recognition of revenue from three types of transactions: sale of goods, rendering of services and revenue from interest, royalties and dividends and prescribes the required accounting treatment (recognition, measurement, presentation and disclosure) regarding these three types of transactions. The initial adoption of Accounting Standard No. 25 had no material impact on the ﬁnancial statements.

F-64 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 2: SIGNIFICANT ACCOUNTING POLICIES (continued) s. Revenue Recognition (continued) 2. Revenues from the sales of electricity are included upon the consumption of electricity by the customers according to meter readings. The revenues for the amount consumed, during the period between the last meter reading and the balance sheet date, are included according to estimates.

3. Revenues from interest are accrued over time, taking into consideration the principal for repayment, while using the effective interest method.

t. Intangible Assets, Excluding Goodwill

1. As of January 1, 2007, the Company applies the provisions of Accounting Standard No. 30, ‘‘Intangible Assets’’ of the Israel Accounting Standards Board (‘‘Accounting Standard No. 30’’) that prescribes the accounting treatment, recognition, measurement and the disclosure requirements regarding intangible assets.

An intangible asset is an identifiable non-monetary asset without physical substance. The definition of an intangible asset requires that such an asset be identifiable in order to distinguish it from goodwill. An asset is identifiable when it complies with one of the following criteria: it is separable—it is capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, related asset or related liability; or the asset arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.

The Company adopted the provisions of this Standard retrospectively. As a result of the initial adoption of the provisions of the Standard, the Company reclassiﬁed computer software whose depreciated cost amounted to approximately NIS 789 million and NIS 835 million as of December 31, 2007 and 2006, respectively, and had previously been included in ﬁxed assets and presented it under intangible assets, net. 2. The useful lives and depreciation rates used in the calculation of depreciation are as follows: Useful life Depreciation (years) rates (%) 5-12 8.33-20

F-65 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 2: SIGNIFICANT ACCOUNTING POLICIES (continued) u. Deferred Charges in respect of Credit Raisings Until December 31, 2005, deferred charges with respect to the issuance of debentures and loans were presented in other assets at cost less accumulated amortization. Expenses attributed to debentures offerings were amortized using the straight-line method over the period of the loans. As of January 1, 2006, with the application of Accounting Standard No. 22, ‘‘Financial Instruments: Disclosure and Presentation’’, the cost of issuing debentures is offset from the outstanding liability with respect to the debentures and is amortized to operations systematically over the term of the liability. This amortization is not essentially different from the effective interest method (*) prescribed by Accounting Standard No. 22.

(*) The effective interest method is a method for computing the amortized cost of a financial instrument and of the attribution of interest income or expense over the relevant period. The effective interest rate is the rate that accurately discounts the expected flow of future cash payments or receipts over the expected life of the financial instrument or a shorter period, if appropriate. The change in amortization method as above had no material impact on the Company’s financial position and results of operations. v. Financial Instruments and Financial Expenses, Net 1. Currency swap and forward transactions for the hedging of accounting exposure It is the Company’s practice to utilize swap transactions in order to convert a portion of the exposure of its liabilities denominated in U.S. dollars to exposure to the CPI or to the exchange rates of other currencies in order to adjust them to its electricity rate. The Company reflects in its financial statements only the net balance of swap transactions as of the reporting date. According to the book value, the balance is presented as part of the loans when it is in credit, and in long-term receivables when it is in debit (see Notes 8 and 18). The results of the transactions are recorded on a basis corresponding to the financial expenses of the long-term loans that they hedge (see Note 28). 2. Forward transactions to hedge the cash flows The results of forward transactions that are carried out by the Company are presented at their fair value as of the balance sheet date, and their results are recorded to financial expenses (income). 3. Swap transactions of fixed interest rates on loans to floating interest rates and floating interest rates on fixed interest loans These transactions are presented at market value as of the balance sheet date, and the results are recorded to financial expenses (income). 4. Capitalization of borrowing costs The Company applies Accounting Standard No.3 with regard to the capitalization of borrowing costs. The borrowing costs of specific liabilities incurred with

F-66 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 2: SIGNIFICANT ACCOUNTING POLICIES (continued) v. Financial Instruments and Financial Expenses, Net (continued) respect to an investment in qualifying assets, as defined by this Standard, were capitalized to that investment. The capitalization of borrowing costs related to investments in qualifying assets, which were not financed by specific liabilities, is calculated by using a percentage which is the weighted average of credit cost rates on the Company’s non-specific liabilities (see Note 28.a). During the reported period, the Company did not capitalize its non specific borrowing costs beyond the amount of those borrowing costs.

In addition, according to the decisions of the Electricity Authority, the Company capitalizes borrowing costs to assets used in constructing ﬁxed assets (see also Note 3 below).

5. Fair value of ﬁnancial instruments

The fair value of the financial instruments traded in active markets is based on the quoted market prices as of the balance sheet date. The fair value of financial instruments that are not traded in an active market is based on market prices of similar financial instruments and, if none available, on a variety of other methods of evaluation.

The Company uses various evaluation techniques accompanied by assumptions that are based on the prevailing economic conditions at each balance sheet date.

The evaluation methods used include the present value of cash ﬂows, economic option pricing models and other accepted evaluation methods. See also Note 23 below.

6. Offsetting ﬁnancial instruments

Financial assets and liabilities are presented in the balance sheet at their net amounts only when the Company has a legal enforceable offset right and there is intent to settle the asset and the liability on a net basis or realize the asset and settle the liability simultaneously.

7. Perpetual debentures

The Company issued unlinked, perpetual debentures to the State of Israel, valued at about NIS 15 million, which were included until December 31, 2005 in the Company’s shareholders’ equity at an adjusted value of about NIS 2 billion, and on which interest and linkage differences on the interest are paid, in an amount aggregating to about NIS 100 million per annum. These perpetual debentures are presented at their adjusted value as a liability, and the interest on them is carried as ﬁnancial expenses in the statement of operations.

F-67 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 2: SIGNIFICANT ACCOUNTING POLICIES (continued) w. Presentation of Transactions between a Corporation and a Controlling Shareholder Therein Until December 31, 2006, transactions between the Company and a controlling shareholder were presented in accordance with the Israeli Securities Regulations (Presentation of Transactions between a Corporation and a Controlling Shareholder Therein in the Financial Statements), 1996 (‘‘the Regulations’’). As of January 1, 2007, the Company applies the provisions of Accounting Standard No. 23, ‘‘Accounting Treatment of Transactions between an Entity and its Controlling Shareholder’’ of the Israel Accounting Standards Board (‘‘the Standard’’). The Standard prescribes that the basis for assessing the transactions between an entity and a controlling shareholder is fair value. Transactions that have the characteristics of shareholders’ investment or distribution to shareholders are carried to shareholders’ equity and should not be included in the controlled entity’s operating results. The differences between the proceeds that were received in the transactions between an entity and a controlling shareholder therein and the fair value of those transactions will be carried to shareholders’ equity. Current taxes and deferred taxes relating to items carried to shareholders’ equity with respect to transactions with controlling shareholders will also be carried directly to shareholders’ equity (see Note 13 below). x. Earnings per Share The Company applies the provisions of Accounting Standard No. 21, ‘‘Earnings per Share’’, according to which companies whose Ordinary shares or potential Ordinary shares are not listed for trade or are in the process of being listed for trade on public markets are not required to provide disclosure of earnings per share. Pursuant to the above, no earnings per share were disclosed in the financial statements. y. The Use of Estimates When preparing the financial statements in accordance with generally accepted accounting principles, management of the Company is required to use estimates and assumptions which affect the amount of the assets and the liabilities as of the date of the financial statements, the presentation of assets and contingent liabilities as of the date of the financial statements and the amount of revenues and expenses for the period of the financial statements. Actual results are liable to be different from these estimates. z. Work In Progress The Company performs numerous jobs that are carried out during a short period of time (less than a year). The receipts for these jobs are calculated according to the planned scope of the job, and according to the labor rates that are determined by the Electricity Authority, and their objective is to cover the actual costs resulting to the Company for these jobs. In accordance with Accounting Standard No. 4, the Company defers the revenue recognition for these jobs until it finishes performing the job. This deferral does not result in a distortion of the business results. The Company also performs contracts whose duration exceeds one year and recognizes gains or losses from such contracts pursuant to Accounting Standard No. 4 at each balance sheet date. aa. Investments in Finance Leases The investments in finance leases are presented at the amount of the lease fees receivable, in accordance with the amounts that are invested and the remainder of the lease period.

F-68 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 2: SIGNIFICANT ACCOUNTING POLICIES (continued) bb. Costs with Respect to Environmental Quality Current costs for the operation and maintenance of the facilities for the prevention of the pollution of the environment and the anticipated provisions for costs, which refer to environmental restoration deriving from current or past operations, are recorded to the statement of operations. Costs for prevention of environmental pollution that increase the life or efficiency of the facility, or that decrease or prevent environmental pollution, are charged to the cost of fixed assets and are depreciated over the economic life of the facilities. cc. The Effect of a New Accounting Standard in the Period prior to its Implementation Accounting Standard No. 29—Adoption of International Financial Reporting Standards (IFRS) In July 2006, the Israel Accounting Standards Board published Accounting Standard No. 29, ‘‘Adoption of International Financial Reporting Standards (IFRS)’’ (‘‘Accounting Standard No. 29’’). International Financial Reporting Standards comprise standards and interpretations adopted by the International Accounting Standards Board, and include: a) International Financial Reporting Standards (IFRS) b) International Accounting Standards (IAS) c) Interpretations issued by the International Financial Reporting Interpretations Committee (IFRIC) or by its predecessor, the Standing Interpretations Committee (SIC). Pursuant to this Standard, companies that are subject to the provisions of the Securities Law, 1968, and that are required to report according to the regulations published thereunder, will be required to prepare their financial statements in accordance with IFRS starting from periods commencing on January 1, 2008. These companies, as well as other companies, may adopt IFRS earlier and prepare their financial statements in accordance with IFRS starting with financial statements that are issued subsequent to July 31, 2006. For transition purposes, companies that prepare their financial statements in accordance with IFRS will be required to adopt the provisions of IFRS 1, ‘‘First-time Adoption of IFRS’’. A company that adopts IFRS commencing from January 1, 2008, and that has elected to include comparative data for only one year (2007) will be required to prepare an opening balance sheet as of January 1, 2007 (‘‘Opening Balance Sheet’’). Adjusting the Opening Balance Sheet to IFRS will require the following actions: – Recognition of all assets and liabilities whose recognition in the balance sheet is required by IFRS. – De-recognition of assets and liabilities if IFRS do not permit such recognition in the balance sheet. – Classification of items of assets, liabilities and shareholders’ equity according to IFRS. – Application of IFRS in the measurement of all recognized assets and liabilities.

F-69 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 2: SIGNIFICANT ACCOUNTING POLICIES (continued) cc. The Effect of a New Accounting Standard in the Period prior to its Implementation (continued) In order to ease ﬁrst-time adoption, a number of subjects have been stipulated as to which the requirement of retrospective application in the Opening Balance Sheet does not apply with the possibility of election of exemptions to be utilized, in whole or in part. Exceptions have also been established regarding the retrospective application of certain aspects of IFRS.

According to Accounting Standard No. 29, the Company is required to include in a note to the annual ﬁnancial statements as of December 31, 2007, a balance sheet data as of December 31, 2007, and a statement operations for the year then ended, that have been prepared based on the recognition, measurement and presentation criteria of IFRS.

There are differences between IFRS and generally accepted accounting principles in Israel in the recognition and measurement of assets and liabilities and in the reporting format and in disclosure requirements. These differences could have a material impact on the Company’s ﬁnancial position and results of operations.

See Note 32 for the adjustments to be made during the transition to IFRS reporting and the exemptions elected by the Company according to the provisions of IFRS 1.

F-70 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power) NOTE 3: DECISIONS OF THE ELECTRICITY AUTHORITY a. The Current Electricity Rate On July 5, 2002, the bases of the electricity rates and criteria for 2002-2005 and the manner for their updating came into force (‘‘the rate document’’). In that decision, it was determined that in the event that as of December 31, 2005, new electricity rate bases shall not be determined with regard to January 1, 2006 and thereafter, then the Electricity Authority’s decisions will remain in force until the date on which new electricity rate bases are determined. As of the date on which the financial statements were signed, the Electricity Authority had not yet determined new electricity rate bases. The Electricity Authority’s decisions with respect to the structure and level of the rates are detailed in the rate document for the Company’s activities segments—generation, transmission, the high-voltage distribution and the low-voltage distribution are detailed in the rate document. The rate document determines, among others, the following principles: 1) The recognized active assets base, which is adjusted pursuant to Accounting Opinion 36 of the Institute of Certified Public Accountants in Israel, serves in determining the coverage of depreciation and financial expenses and the return on capital. This base was calculated for each of the four segments as follows: a) The generation segment—The scope of the recognized active assets was determined based on analyses of the scope of the active assets in the Company’s financial statements during 1995-1999 as the representative period (which, in the opinion of the Authority, constitutes the development cycle that ends with the full utilization of the advantage of size of the units that are fired by coal) in prices of December 31, 2000. In addition, during the rate period, the Electricity Authority will recognize the additional costs of the combined cycle gas turbines (‘‘CCGT’’) that will become operable during the rate period, in excess of the cost of the open gas turbines that were reflected in the rate for the years of 1995-1999, and the additional costs for modifying the existing units for the use of natural gas. b) The transmission segment—The scope of the recognized active assets was determined, based primarily on the average active assets according to the financial statements for 2000, with certain adjustments. c) The high-voltage and low-voltage and distribution segments—The scope of the recognized active assets was determined based primarily on a model that was developed by the Electricity Authority and that, pursuant to which, the balance of the recognized active assets matches the averaged active assets according to the Company’s financial statements for 2000. In addition, the Authority recognized additional costs for burying cables beginning in 2002, which is a consequence of the policy of the Ministry of National Infrastructures for underground cables in urban areas. 2) The recognized costs of the rate bases will reflect: i. The ratio between shareholders’ equity and the foreign capital of one-third and two-thirds, respectively (for purposes of the rate, the Electricity Authority refers to deferred taxes as part of shareholders’ equity);

F-71 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 3: DECISIONS OF THE ELECTRICITY AUTHORITY (continued) a. The Current Electricity Rate (continued) ii. Linkage of the composition of foreign capital linked to the CPI or the basket of currencies (whose composition is determined by the Bank of Israel), as stipulated by the Electricity Authority similar to the manner in which the basket was determined in the past by the Bank of Israel; iii. The variable interest rates on foreign capital and the rates of return on shareholders’ equity according to the segments, as specified below: a) The foreign capital component—As of July 5, 2002 (‘‘the starting point’’), the percentage of the foreign capital linked to the basket of currencies out of the total recognized foreign capital will be reduced progressively on an annual basis, from 70% in 2002 to 50.61% in 2007. The recognized foreign capital balance which is not foreign capital linked to the basket of currencies, will be linked to the CPI. In addition, the Electricity Authority determined that the Company will need to hedge NIS 1.3 billion in the framework of hedging insurance in excess of the above mentioned while the recognized cost of this hedging insurance for the purpose of the rate will be 1.15%. The Electricity Authority has, as it did in the past, once again decided that the Company’s accounting exposure for part of its loans and debentures denominated in or linked to foreign currency, which finance fixed assets in use exclusively, will be passed on to the electricity consumers through the electricity rate. In its decision, it stipulated that the amount of the exposure will be determined according to the recognized percentage of foreign capital linked to the basket of currencies, as aforesaid, where it is linked to rate of the change in the exchange rate for the basket and to the change in the annual amount of manufactured electricity. The balance of the amount of the exposure as of the balance sheet date amounts to approximately NIS 15.48 billion. As the result of the aforesaid decision, the Company generates a regulatory asset for the financial expenses. The decision determines that the differences between the changes in the basket of currencies, as calculated by the Company and the Electricity Authority, and the changes in the CPI for the amount stated above will be passed on to the electricity consumers. These differences will be repaid to the Company or the consumers on a current basis, at a rate of one fifth of the net balance of the differences (the declining balance method). As a result of this, and following the decision of the Electricity Authority dated February 3, 1997 during the reported period, the Company recorded income during the reported period by decreasing the provision in the amount of approximately NIS 9 million (presented in the other expenses (income) item). b) The interest rates on the foreign capital—The annual interest on foreign capital linked to the CPI for the starting point was set at 4.72% and the annual interest on the foreign capital, linked to the basket of currencies for the starting point was set at 6.99%.

F-72 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 3: DECISIONS OF THE ELECTRICITY AUTHORITY (continued) a. The Current Electricity Rate (continued) These interest rates will change once annually, at the time of the annual rate update, taking into consideration the market interest rates (on a weighted basis) and, accordingly, the Electricity Authority determined that, beginning April 23, 2007, the recognized interest rates on the foreign capital linked to the CPI will be 4.81%, and the annual interest on the foreign capital linked to the basket of currencies for 2007 will be 6.75%. c) The rate of return on shareholders’ equity—The annual rate of return on the shareholders’ equity, will be 7% on the generation segment, 5.5% on the transmission segment and 6.2% on the distribution segment at low and high voltage. 3) Fuels The electricity rate includes a component to cover the Company’s fuel expenses. This component was determined by an estimated mixture of the use of the various power stations (that consume various types of fuel and that each of which 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. The fuel prices are updated on a current basis. In addition, the Electricity Authority determined that part of the fuel cost savings that will be derived as a result of the switch to the use of natural gas will remain with the Company as an incentive. In 2005, the rate of the incentive amounted to 20% of the aforesaid savings, and in 2006, the rate of the incentive amounted to 15%, while beginning in 2007 and thereafter, there will not be an incentive. The Company recently applied to the Electricity Authority with a request to continue to retain 20% of the savings in fuel costs from the use of natural gas in 2007 and afterwards as well. In August 2007, the Electricity Authority resolved that in the context of determining the next rate base for the generation segment in 2008, the Electricity Authority will examine determining an incentive mechanism for the Company for promoting the use of natural gas. 4) Amortization factors Amortization factors for a sold kWh sold were determined which are supposed to result in efﬁciency for the Company and to reﬂect advantages of size at cumulative annual rates that are gradually accumulated. The annual rates are 2.1% (until April 2004—2.6%) on inputs of the generation segment, excluding fuel; 1.3% (until April 2004—1.5%) on inputs of the transmission and transformer segment;—2.5% (until April 2004—2.9%) on inputs of the high-voltage distribution segment; 3.7% (until April 2004—4.1%) on inputs of the low-voltage distribution segment. 5) Times for updating rate bases The electricity rates will be examined biweekly (upon the publication of the CPI and upon the publication of fuel prices). The rates will effectively be updated in

F-73 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 3: DECISIONS OF THE ELECTRICITY AUTHORITY (continued) a. The Current Electricity Rate (continued) the event that the inputs basket net of the amortization coefficients will change by at least 3.5%, or with the passage of six months from the last update, whichever is sooner. The differences that arise between the biweekly update (as stated above) and the actual update of the rate to the consumers will be included in the rate beginning from the date of the upcoming annual update on which the Electricity Authority updates the rate base. As the result of the foregoing, the Company generates a regulatory asset or liability with relation to the dates for the updating of the rates. In the reported period, the Company generated a liability that reduced the Company’s revenues by an amount of approximately NIS 79 million, the balance of which as of the balance sheet date amounts to NIS 151 million. Each year, in April, the Electricity Authority will carry out an annual update of the various components of the recognized costs. The components to be updated are: interest on foreign capital, the fuel mix, the web and cable burying component, compensation for delaying updates, costs for purchasing electricity from independent producers and miscellaneous differences. (In 2007, the update was carried out on April 23, 2007; the updated rates came into effect as of May 3, 2007). 6. The Electricity Authority decisions reached in 2006 and the Company’s position that disagrees with them: During June 2006, the Electricity Authority reached several decisions with which the Company disagrees, that, for the most part, concern the annual update of the rate with which the Company disagrees. Below is a brief description of the principal decisions and the Company’s position regarding them: a) Fuel mixture—After having decided to accept the Company’s model as the desired methodology for determining the fuel mixture and for the purpose of calculating the saving on fuel costs as a result of the introduction of natural gas, the Electricity Authority set the parameters to be included in the calculation of the recognized fuel mixture for 2006 as follows: 1) The Equivalent Forced Outage Rates (EFOR) of the generation units for 2006 according to the recommendation of the Advisor to the Electricity Authority and contrary to the Company’s stance and contrary to what is acceptable in NERC member states. 2) The operation regime for F type CCGT at the Eshkol Power Station, as taken into consideration in the basket of fuels for 2005, contrary to changes made by the Company in the operation regime for the purpose of calculating the fuel basket. The Electricity Authority has accepted the Company’s position and did not include real data of the demand curve in the first five months of 2006 in the calculation of the fuel basket in order to maintain the principle of recognizing normative costs.

F-74 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 3: DECISIONS OF THE ELECTRICITY AUTHORITY (continued) a. The Current Electricity Rate (continued) b) Reading power station—The Electricity Authority decided that the 2006 fuel basket (that, in effect, was included in the rate for the year commencing in April) will be updated taking into consideration the fact that the Reading power station in Tel-Aviv was operated with fuel oil during the first of 2006, and that only beginning in the second half of the year will it be operated with natural gas. In spite of this, and despite the fact that during the entire year of 2005 and the first half of 2006 the power station was operated with fuel oil, the Electricity Authority did not agree to retrospectively correct the 2005 fuel basket, a basket that was determined assuming that the Reading power station began operating with natural gas during the second half of 2005. In the Company’s assessment, not correcting the fuel mixture for 2005 resulted in an impairment of the Company’s profitability by an amount of about NIS 200 million (about NIS 150 million net of the tax effect). In addition, during the period between March and June 2006, the Reading power station was closed by order of the authorized authority— the Ministry of the Environment. From that date, in order to provide a solution to the demand for electricity, the Company was forced to produce electricity with more expensive fuels. The Electricity Authority did not consent to the Company’s request to recognize this cost. From an examination made by the Company, as a result of this decision the Company’s profitability was impaired by an amount of about NIS 170 million (about NIS 125 million net of the tax effect). c) Electricity consumption for the Company’s facilities—The Company is of the opinion that under the method for calculating the rate, the electricity consumption of the Company’s facilities used to carry out ongoing activities is not covered by the electricity rate (representing impairment in the Company’s profitability of approximately NIS 30 million a year). In its decision of June 2006, the Electricity Authority indicated that the cost of the electricity consumption of the Company’s facilities forms part of the Company’s operating costs. Nevertheless, in a discussion held in January 2007, the Electricity Authority stated that it would re-examine this issue. d) Recognition of financing costs—The Electricity Authority rejected the Company’s request to recognize actual amounts of interest costs in their actual amounts; in other words, the rate of return on State debentures and a margin of up to 1.98% for the latest offerings, and left the margin at 0.73%. The Company disagrees with this decision of the Electricity Authority as it conflicts with reality. The effect of this decision increased with each new offering executed by the Company. e) Loss from the collection of an average rate—The Electricity Authority determined annual revenues that the Company is allowed to collect, subsequent to which various electricity rates are determined for the various groups of consumers that are designated for the purpose of collecting these revenues. The various rates were determined according to a forecast of electricity consumption for each of the consumer groups

F-75 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 3: DECISIONS OF THE ELECTRICITY AUTHORITY (continued) a. The Current Electricity Rate (continued) as they were in 2000. In the Company’s assessment, subsequent to the transition of consumers to load and time rates (‘‘LTR’’), and supply margins at high-voltage and very high-voltage that derive from the change in consumer habits during the last few years, as well as the flexibility granted to electricity consumers, primarily the larger ones, to change the hours of their consumption, the Company is not collecting the revenues that are due to it, and it bears major losses each year. According to the Company’s calculations, due to the above revenues in an amount of about NIS 309 million were obviated in 2007 and about NIS 249 million in 2006. The Company applied to the Electricity Authority to correct the rates structure, so that it will be able to collect the full amount of revenues due to it and receive compensation for the years in which the Company did not collect the full amount of recognized income. The Electricity Authority does not intend to adjust the revenue at the base of the current rate but in discussions held in early 2007, it did indicate that it is currently acting to update the clusters of demand hours, including updating the segmentation of consumption, in the context of its efforts to calculate the new rate bases. 7. The Electricity Authority decisions reached in 2007 and the Company’s position that disagrees with them: In April 2007, the Electricity Authority updated the rate in the context of the annual update and determined a decrease of 6.7% in recognized costs arising mainly from: a) A decrease in recognized costs in the fuel mixture. b) The termination of the collection of the consumers’ package regulatory asset. The Company disputes several of the Electricity Authority’s determinations under the rate update as follows: a) The discontinuance of the gas incentive—the gas incentive ended in 2006. b) The Gezer combined cycle gas turbine—in the calculation of the fuel mixture for 2007, the transition to natural gas at the Gezer combined cycle gas turbine in October 2007 was already taken into consideration. The Company applied to the Electricity Authority because the date for the recognition of the gas at the Gezer A combined cycle gas turbine in the fuel basket will be March 2008, at which time the Company anticipates the gas will arrive at this station. The operation of the Gezer combined cycle gas turbine using natural gas is contingent on the completion of all the projects, when most of the projects are not under the Company’s responsibility and the Company has no influence on their progress. The projects are not expected to be finished during the course of 2008, until which time the Company will continue operating the station using diesel oil.

F-76 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 3: DECISIONS OF THE ELECTRICITY AUTHORITY (continued) a. The Current Electricity Rate (continued) Following a preliminary examination of the substance of revising the date of the arrival of the gas, the Company believes that the rate’s update will have a material impact on the profits for 2007 (a decrease of NIS 200 million before the tax effect) and an even greater impact on cash flows. c) The Company’s recognized fuel basket for 2007: On November 12, 2007, the Company published an Immediate Report in which it warned of a loss in the reported period that results from the actual increased demand for electricity during the summer that exceeded projections. Consequently, the Company was forced to use a more expensive fuel mix including diesel oil and fuel oil for which it has not yet been reimbursed by the rate. On November 18, 2007, the Company applied to the Electricity Authority requesting to update the fuel basket that the Company is entitled to following the increase in the demand in excess of the demand on which the fuel basket is based. Total annual revenues due to this increment are estimated by the Company at approximately NIS 690 million. The Company has applied to the Electricity Authority requesting this increment for 2007. On March 19, 2008, the Electricity Authority informed the Company that it was dismissing the Company’s claims regarding the absence of rate coverage in the fuel basket. The Electricity Authority argues that the fuel basket recognition mechanism presupposes that there might be changes between the forecasted demand curve and the actual demand curve. The Electricity Authority’s examination revealed that the Company’s losses resulting from the change in the demand curve in 2007 approximate the Company’s profits for 2005-2006. Furthermore, towards the next trial period, the Electricity Authority intends to determine a defense mechanism against errors in forecasting the demand curve. The Company is evaluating all of the implications of the rate update and will consider its steps accordingly. Regarding the implications of the Company’s disputes with the Electricity Authority concerning these decisions, also see section c below.

b. The Future Electricity Rate 1. The models for the recognition of costs in establishing the distribution network As stated above in section a.1, the recognized costs for the distribution segments in 2000 were determined based on models that were developed by the Electricity Authority for the reassessment of the distribution assets. The Company disputes the principles of these models, and in June 2002 it submitted its approach in respect to them. The chairman of the Electricity Authority clariﬁed to the Company that the Electricity Authority will study the model to be recommended by the Company, and that until a decision is reached regarding this matter, the extent of the

F-77 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 3: DECISIONS OF THE ELECTRICITY AUTHORITY (continued) b. The Future Electricity Rate (continued) Company’s investments in the distribution segment will be studied (to be recognized in the framework of the determination of the next rate) based on the rate principles; that is, in accordance with the growth in the sales of electricity (kWh). On February 29, 2004, the Company submitted the aforesaid model. In November 2005, the Authority appointed a consultant who will examine the models for the development of the distribution system that were suggested by the Company. The letter received by the professional team at the Electricity Authority in October 2006 stated that in principle, it is adopting the models formulated by the consultant for examining the development in the high and low voltage distribution network and it intends to recommend before the Electricity Authority’s plenum to adopt said models in order to determine the level of recognition of the costs of the development in the distribution networks in the base of the new rates. The model that was formulated in order to examine the development of the high voltage distribution networks differs from the model suggested by the Company whereas the model suggested for examining the development of the low voltage distribution networks is identical to the model suggested by the Company. The Company has reservations regarding the suggested models and has requested to hold a joint discussion attended by the professional teams of both the Electricity Authority and the Company, before the models are adopted by the Electricity Authority. According to accounting principles for regulated companies, a regulated company must write off the amount invested in ﬁxed assets that most probably will no be recognized for it for rate purposes. At this stage, the Company cannot assess the extent of assets not recognized in the context of the base of the next rate, if at all, and has not recorded any provision for this matter. 2. Depreciation of fuel oil power stations Following the change in the estimated economic life of the fuel oil power stations effected by the Company in 2001, on March 14, 2004, the Electric Authority decided that the accumulated difference in the depreciated costs for the fuel oil power stations, during the period between July 2002 and the date for the next update in the rate basis, will not be recognized in the framework of the recognized costs in the electricity rates that the Electricity Authority will determine at that time. The balance of the regulatory liability that the Company recorded with respect to the aforesaid amounts to approximately NIS 237 million as of December 31, 2007. 3. Liability for pension On March 25, 2004, the Company applied to the Electricity Authority requesting that it recognize the amount of about NIS 1,146 million as a recognized expense that will be covered in the electricity rate, spread over no more than 10 years. This amount constitutes an increase in the actuary liability that was included in the Company’s ﬁnancial statements in 2003, and which originates from the adoption of the principles for calculating the actuarial liability that are prescribed

F-78 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 3: DECISIONS OF THE ELECTRICITY AUTHORITY (continued) b. The Future Electricity Rate (continued) by the supervisor of the capital markets and savings division at the Finance Ministry, and other decisions the effect of which is exogenous on the amount of the actuarial liability. In reply to this request, the Electricity Authority notified the Company that, in view of the complexity and importance of the issue, it appointed a team of outside consultants in the accounting and actuary sectors (‘‘the consultants team’’), in order to coordinate the required findings and calculations, including a rate approach to the implications of the setting up of a central pension fund. The issue in its entirety will be presented for discussion and a decision by the Electricity Authority plenum. During 2004 and 2005, the Company received draft reports from the consultants team for review and comments. What emerges, among others, from an examination of the draft committee reports, is that the consultant team accepts the change in the actuarial assumptions made by the Company in 2003, however in its opinion it is necessary to change additional actuarial assumptions regarding the increase in salaries and pension, so that the differences will offset one another, and no additional recognized expense will be added to the electricity rate. The actuarial assumptions that the consultant team recommended changing are to the forecasted real increase in pension pay to pensioners from an average of 2% per year to an average of 0% per year. The Company studied these recommendations, and based on the opinion of its outside actuary, it decided that it is unnecessary to change the assumptions regarding pensioners, based on an examination of actual data regarding the past, based on the evaluation of the head actuary at the Ministry of Finance and of an external actuary and also of the examining actuary of the Company (according to which, an assumption of a real increase in pension at a rate of 2% per year, where the pension is updated according to the rate of augmentation of the employee’s rank at the time of his retirement is reasonable on its face), and in consideration of the Company’s labor agreements, the existing assumption of a real increase in pension at an average rate of 2% per year is very reasonable. In the evaluation of the Company’s outside actuary, the determination of the real increase in pension at a lower rate will result in an undervaluation of the liability, and will not reflect the extent of the Company’s actuarial liability. On February 26, 2006, the Company presented its comments on the consultant team’s draft report to the chairman of the Electricity Authority. For various reasons, both legal and actuarial, in its comments, the Company in its comments disputes the principal conclusions of the consultant team, including the mater of forecasted real growth for pension pay to the pensioners. During 2005 through 2007, the Company applied several times to the Electricity Authority, with the objective of obtaining recognition in the rate for the as yet unamortized actuarial losses which have been recorded pursuant to allotment provisions of International Accounting Standard No. 19 (‘‘IAS 19’’). As of the balance sheet date, the balance of the unamortized actuarial losses amounts to about NIS 2.93 billion, and in the Company’s opinion, this amount is intended to be covered by the rate according to is the progress of amortization in the

F-79 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 3: DECISIONS OF THE ELECTRICITY AUTHORITY (continued) b. The Future Electricity Rate (continued) financial statements, that is, over a period of 15 years. As of the date on which these financial statements were signed, the matter is under discussion and no final decision has as yet been reached. 4. a) In 2004, before it was decided to enact IFRS in Israel, the Company filed a request with the Electricity Authority to be notified of the Authority’s policy, if and when the Company would be required to adopt Accounting Standard No. 12 of the Israel Accounting Standards Board (‘‘Discontinuance of Adjustment of Financial Statements’’). The Electricity Authority’s decision with respect to the Company’s request was as follows: 1) The capital costs recognized in the electricity rates to cover the costs of the assets operated until December 31, 2003, will continue to be determined based on the annual return and depreciation linked to the Consumer Price Index, with the addition of real return. 2) The capital costs recognized in the electricity rates that will in effect from January 1, 2004, will be determined based on the unlinked annual return (depreciation) with the addition of the nominal return. The amount of the recognized capital costs will be determined subsequently. The method for determining capital costs in the electricity rate will not change until the annual update for 2004 that will be carried out in 2005. 3) In accordance with the explanations to the decision, it was clarified that the capital costs to cover the assets that will be operated as of January 1, 2004, will be attributed to the increase in output in excess of the level of output in 2003. b) The Minister of Finance, pursuant to his authority, enacted regulations pursuant to section 33.a to the Government Companies Law, and pursuant thereto the Company will continue to prepare its financial statements on the conventional basis of the historical cost convention adjusted for the changes in the general purchasing power of the shekel from January 1, 2004 through December 31, 2007 (see Note 2.b.3 above). See also 10) below. 5. On February 20, 2005, the Electricity Authority reached the following decision: ‘‘The Authority wishes to express its concern regarding the scope of investments planned by the Company, and that will be financed in the framework of the capital offerings which the Company intends to carry out in the very near future. The cost of these planned investments to be made by the Company is not covered in the current rate outline that the Authority approved. Therefore, these expenditures are liable to be made without future rate coverage, despite the fact that the current rate structure integrates coverage for future costs deriving from an increase in electricity demand (including a reserve for generation and a special addition for the new combined cycles). The Authority, as a professional body with special authority and expertise in the cost aspects of

F-80 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 3: DECISIONS OF THE ELECTRICITY AUTHORITY (continued) b. The Future Electricity Rate (continued) the electricity sector, feels obliged to express this position before an irreversible situation is created through the publication of a prospectus and actual capital offerings by the Company.’’ The Company is acting according to development plans that were and will be approved by the responsible Minister. The Company believes that all of the investments detailed in the Company’s investments plans are for the purpose of development of the electricity sector and, therefore, are appropriate and essential. Nonetheless, with respect to part of the plans that were not yet approved by the Minister, discussions will be held with the Ministry of National Infrastructures regarding their approval. 6. On March 15, 2005, the Electricity Authority reached a decision that calls on the Company to react to the recommendations of the Electricity Authority’s professional team concerning the controls of costs in the generation segment, for 2004. The professional team displayed a rate approach that is derived from an accounting policy that is different from the Company’s policy concerning the additional investments in the operational generation systems that are operated, and in the construction costs for power stations of the combined cycle generation type as follows: a) In the opinion of the professional team, only investments that resulted in additional output, an increase in efficiency and an extension of the life of the generation units constitute an investment in operational generation units. The professional team studied the additions to the Company’s assets for 2004, which, in the opinion of the professional team, reveal that an amount of about NIS 134 million (out of the about NIS 700 million that was studied) that was invested in existing power stations does not meet the above criteria. The Company disputes the professional team’s findings regarding the criteria that were cited by the Electricity Authority, as stated above. Further, the Company pointed out that its accounting policy is consistent over the years and, accordingly, an investment is defined for it as any expenditure that results in a future economic benefit to the Company. b) The professional team argued that in contrast with the normative data that were furnished in the past by the Company, as they emerged from the costs control, the actual costs data for power stations of the combined cycle generation type are higher by approximately 12%. In addition, the length of time for building the Company’s generation units is relatively protracted, which results in the capitalization of interest costs for a relatively lengthy period. In its response dated March 23, 2005, the Company disputes this position of the Electricity Authority, and gave detailed reasons for the gaps between the normative prices to the actual costs, where the principal factor is the devaluation of the exchange rate of the dollar in relation to the Euro. The Company is unable to assess which costs the professional team is referring to.

F-81 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 3: DECISIONS OF THE ELECTRICITY AUTHORITY (continued) b. The Future Electricity Rate (continued) In addition, the Company requested to deliberate the professional issues with the Electricity Authority.

On March 29, 2005, the chairman of the Electricity Authority addressed the Company’s response and explained the professional team’s decision. In his remarks, he notiﬁed the Company that the discussion it requested will be held and, for that purpose, he requested that the Company furnish additional data regarding the investments in the generation system.

Regarding the matter of the costs for establishing combined cycle generation units, the Electricity Authority in its letter of March 2006 (further to the decision from December 2005) had recommended principles for the methodology for recognizing the costs in establishing combined cycle generation units. Pursuant to the principles of the Electricity Authority, the average cost per kilowatt that will be recognized for the Company will be lower than the average cost forecasted by the Company.

During October and November 2005, the Company received several letters from the supervisor of the Electricity Authority’s accounting and methodology division mostly relating to the construction of a combined cycle generation unit, and including a proposed decision of the Electricity Authority that is based on these letters. It was clariﬁed in these letters that, in accordance with the position of the supervisor of the accounting and methodology division, there are exceptional costs that arose at the time the combined cycle unit was constructed that will not comply with the conditions of costs controls. Therefore, he intends to recommend to the Electricity Authority to recognize the costs for this power station (as well as for other stations of this type) in an amount that will not exceed the amount budgeted by the Company for this station, with this amount including the addition for the capitalization of interest and general expenses over the average period for constructing the project.

Nevertheless, speciﬁc additional costs that are required in the Company’s opinion regarding a speciﬁc station will be approved by the Electricity Authority on an individual basis. After studying the issue, the Company does not agree with the content of the above letters. In the Company’s opinion, the construction period involves the granting of statutory approvals that are not under the Company’s control and this is the reason why the statutory procedure lasts much longer than what is customary.

In March 2006, the Company received an additional letter from the supervisor of the Electricity Authority’s accounting and methodology division regarding the same matter, in which there are details regarding the foremost principles for recognizing costs, as follows:

a) Planned basic cost—the basic cost on which he relied is the cost that was planned for the project according to the Company’s data, adjusted for the dates on which the decisions for constructing the stations were reached.

F-82 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 3: DECISIONS OF THE ELECTRICITY AUTHORITY (continued) b. The Future Electricity Rate (continued) b) Euro-dollar differences—the Electricity Authority recognizes the Company’s currency exposure of foreign capital in the normative capital structure and in the hedging of the Company. Beyond this recognition by the Authority, the Company needs to hedge the rest of the currency exposures at its risk by itself c) Capitalization of interest during the construction—the customary construction period, from the aspect of the rate, for constructing a cogeneration unit is approximately two and a half years. d) Exceptional expenses—for the purpose of recognizing these costs in the rate, the head of the accounting and methodology division recommends that the Electricity Authority will specifically recognize exceptions of up to 6% of the Company’s total planned costs with regard to the stations under construction. In cases of exceptions arising from ‘‘force majeure’’, there could be a possibility for recognition during a construction period longer than two and a half years, and all which that implies, from the aspect of the recognition of the capitalization of financing costs. In May 2006, the Electricity Authority held a hearing regarding this matter at which the Company presented its position. As of the date on which these financial statements were signed, the Electricity Authority had not yet reached a decision on this matter. In the Company’s assessment, as emerges from the above letters, the cost for constructing the above generation units is expected to exceed the recognized costs appearing in the letters described above by about $ 245 million. Pursuant to accounting principles for regulated companies, a regulated company must deduct the amount invested in fixed assets that most probably will not be recognized for it for purposes of the rate. The Company is of the opinion in view of the above that it has good arguments and that they will be accepted by the Electricity Authority. 7. On August 11, 2005, the Company received a document from the Electricity Authority’s professional team (‘‘the professional team’’) titled ‘‘Recommendation for Discussion Regarding the Accounting and Financial Principles for the Basis of the Next Electricity Rate’’. The document includes recommendations for changing the manner by which the Electricity Authority will recognize the Company’s investments in fixed assets in the future. The professional team’s position is that part of the construction costs that include salary, financing, depreciation, maintenance and general costs will be charged to the statement of operations instead of being recorded to the cost of assets, as was the practice until now, where 80% of these costs will be recognized in the electricity rate base in the framework of the coverage of the Company’s operating costs. The ramification of this position, pursuant to the professional team’s estimate, is an increase in the Company’s expenses by an amount of about NIS 350 million in the initial year, and up to about NIS 900 million from the third year and thereafter, to the basis of this recommended electricity rate, which will be covered accordingly in the amount of 80% annually through the operational

F-83 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 3: DECISIONS OF THE ELECTRICITY AUTHORITY (continued) b. The Future Electricity Rate (continued) component in the rate. The remaining balance of 20%, for which there is no electricity rate coverage, will serve as the efficiency factor in the construction of fixed assets. Following the receipt of the above recommendations of the professional team, the matter was discussed with the Electricity Authority, and there was also an exchange of correspondence concerning the issue between the Electricity Authority and the Company. The Company rejects the professional team’s recommendations, among others, based on the comments and calculations that it conveyed to the Electricity Authority with respect to the above recommendations. As of the date on which these financial statements were signed, a decision has not yet been reached by the Electricity Authority regarding the above recommendations. 8. On December 18, 2005, the Electricity Authority reached a decision regarding the principles for determining the bases for the new electricity rates and the costs for cogeneration units, as follows: a) The Electricity Authority hereby determines the foundations for the work plan for determining the bases for the new rates. b) The foundations: 1) Determination of rate bases on the basis of normative costs for the long-term. 2) Definition and clear distinction between the various operating segments in the electricity chain and the definition of the reciprocity between them. c) The stages and principles for handling the work plan: 1) Individual definition of the various activities segments in the electricity chain and a reallocation of the recognized costs to these segments based on the costs that the Electricity Authority determined in its decision of July 2002. In this context, it should be clarified that the manner for allocating the costs will be based on the principle of ‘‘ownership versus use’’, in a manner that the recognized rates for each segment will indeed reflect the segment’s physical assets, the services provided by the segment to its consumers inside and outside of the Company and the payments to another segment. In the decision dated July 10, 2006, the Electricity Authority defined the various activities segments in the electricity chain and reallocated the recognized costs to these segments on the basis of costs that were determined by the Authority in the rate basis in July 2002. These costs were attributed pursuant to the ‘‘use versus ownership’’ principle. 2) Determination of a new rate basis for the generation segment (including consumer costs—fixed payment): The Electricity Authority intends to update the format of the recognized costs for the distribution segment. The format will set

F-84 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 3: DECISIONS OF THE ELECTRICITY AUTHORITY (continued) b. The Future Electricity Rate (continued) limits for the level of investments allowed per year in order to maintain the level of services to the consumer, including the reliability of supply and connections to the grid. To accomplish this, the Electricity Authority appointed a consultant who will examine the models for the development of the distribution system that were suggested by the Company. At this stage, he is studying the quantitative aspects. 3) Determination of a new rate basis for the transmission segment: The Electricity Authority views the accurate and updated definition of the activities of the transmission segment prior to determining its costs as being of great importance. This is due to its being a unique segment that provides essential services both to the Company and to private parties that operate in the electricity sector. In light of this, the Electricity Authority feels that it is necessary that the Company will act immediately to organize itself administratively in order to effect the activities in this segment as a distinct and consolidated segment in the framework of the license as a an essential service supplier. The costs involved in the aforesaid preparations will be included in the framework of the recognized costs for the segment, subject to execution of the organization process. d) The principles for determining the level of the recognized costs: 1) Defining the level of the capitalizations that will be recognized in capital costs. 2) Reexamination of the mechanism for rate hedging for the Company’s foreign currency liabilities. 3) Implementation of the Authority’s decision regarding Accounting Standard No. 12 (see section 10) below). In this decision, the Electricity Authority indicated that, to begin with, it intends to determine a new rate for the generation system, afterwards for the distribution system, and only at the end for the transmission system. The Company believes that the sequence for determining the aforesaid rates, in which the Electricity Authority determines the rate in the initial stage particularly for the most profitable system and only in the last stage for the system with the most losses is incorrect, and that it is necessary to start with the transmission rate. 9. Currency exposure On January 26, 2006, the Company received a request from the Electricity Authority to receive its remarks regarding the neutralization of the currency exposure in the electricity rate (see section 3.a2 above). In this request, the Electricity Authority presented several alternatives for dealing with this issue. In the Company’s assessment, changing the current mechanism is liable to result in changes in the Company’s exposure for to its financial liabilities.

F-85 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 3: DECISIONS OF THE ELECTRICITY AUTHORITY (continued) b. The Future Electricity Rate (continued) 10. Adoption of IFRS As stated in Note 2.cc above, in accordance with Accounting Standard No. 29, as of 2008, the Company will adopt IFRS (see also Note 34.j below). The Company is of the opinion that the Electricity Authority should adjust the electricity rates so that they cover the costs as reflected by the new accounting principles and has contacted the Electricity Authority in order to discuss with it any relevant change in reporting standards. In a letter of February 21, 2007, the director of accounting and methodology at the Electricity Authority announced that in view of the complexity of the accounting changes involving the integration of the IFRS principles, he intends to participate as an observer in the follow-up meetings to be held by the Company to evaluate the adoption of IFRS. Financial reporting according to IFRS requires the Company to recognize index and exchange rate linkage differences (in relation to nominal NIS and not adjusted NIS as currently applied) in the financial statements on net financial liabilities not in nominal NIS. On March 9, 2008, the Company applied to the Electricity Authority with an additional request to adjust the electricity rate in respect of IFRS and also announced that the transition to IFRS will lead to a reduction in shareholders’ equity of approximately NIS 2.5 billion as of December 31, 2007 (see Note 32 below) and beyond that will lead to a significant decline in the Company’s profits every year. Compared to the financial statements adjusted to the CPI as until December 2007, the Company’s financial expenses will increase by approximately NIS 390 million (before the tax effect), also causing an erosion of approximately NIS 130 million in shareholders’ equity, all in respect of every inflation percentage. In addition to the above, the Company will be exposed in its financial statements to a real devaluation/revaluation in the basket of currencies in respect of the amount hedged in the electricity rate, so that each real percentage of change in the basket of currencies will be expressed in the financial statements (and not neutralized by a mechanism for creating regulatory assets/liabilities) thereby leading to an increase/a decrease in financial expenses of approximately NIS 140 million. This erosion in profits arising from the transition to IFRS might harm the Company’s rating, lead to an increase in capital raising prices and make it difficult to continue raising capital for executing the development plan. In view of the above, and in order to prevent any injury to the Company’s financial stability, the Company is asking to adapt the electricity rate to the new monetary calculation pursuant to IFRS. On March 26, 2008, the Electricity Authority announced that the adoption of IFRS is expected to be a complex procedure that will be executed and studied over several years. In view of the Company’s demand for a massive electricity consumption rate increase due to the changes involving IFRS in its accounting reporting, the Electricity Authority’s professional team argues that the time is not yet right for determining the rate-regulatory position regarding these

F-86 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 3: DECISIONS OF THE ELECTRICITY AUTHORITY (continued) b. The Future Electricity Rate (continued) changes and since the team does not yet possess all the data to enable forming a rate policy, if required. In light of the above, the Electricity Authority will form a team of expert advisors to study this issue and all its aspects and particularly with respect to the implications on the electricity rates. Until this subject is studied in full, the Electricity Authority will continue preparing the rate bases as practiced to date. The Electricity Authority further clariﬁed that ‘‘a basic principle in the regulator’s work consists of the latter not being limited in his judgment to automatically recognize the Company’s costs as they appear in the books on its behalf or in its accounting records. In attempting to decide in this issue, as in any other issue, the Electricity Authority will weigh all the relevant considerations in this respect (see the High Court of Justice’s ruling regarding the Electricity Authority’s decision in the matter of applying Accounting Standard No. 12 on the Company, No. 7976/04) and will reach an educated decision in this case at the appropriate time’’. The Company intends to continue negotiating with all the relevant factors in order to address the implications arising from the Electricity Authority’s announcement. 11. Recognition of the costs for the natural gas transmission agreement—On October 19, 2006, the Electricity Authority reached a decision that replaces its previous decision on the matter dated July 10, 2006, to recognize the costs for the transmission agreement between the Company and Natural Gas Lines Ltd. (‘‘Natural Gas Lines’’) (see Notes 13 and 21 below). It further determined recognition of the costs of the volume of ordering to capacity, which will be made in accordance with the development of the transmission system and in accordance with the mechanism for recognizing costs of the Authority’s fuel basket. 12. On March 27, 2007, the Electricity Sector Law (Amendment No. 6) (Reduced Rates), 2007 was made public. According to the Law, a consumer who has reached legal retirement age and is entitled to income support from the State, will pay a reduced rate of 50% of the home consumption rate for the ﬁrst 400 kWh consumed on a monthly basis for home consumption only. It was further determined that the Minister, in consultation with the Minister of Welfare and with the Minister of Finance’s consent, may prescribe rules in the regulations regarding the entitlement to reduced electricity consumption rates according to quantities determined by quotas. These quotas will apply to home consumers based on their domestic status and economic and medical conditions. The Minister, in consultation with the Minister of Welfare, will also determine the criteria for establishing such entitlement as above and the manner of submitting the information to prove entitlement within 60 days from the publication of the Law. The Law came into effect on June 27, 2007. The Law further states that in determining the electricity rates for the general public of consumers, the Authority must take into consideration the reduction of electricity rates paid by those eligible for discounts according to said regulations so that the licensed electricity supplier’s revenues are not diminished as a result of the reduction and the entitlement to reduced rates is established

F-87 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 3: DECISIONS OF THE ELECTRICITY AUTHORITY (continued) b. The Future Electricity Rate (continued) so that the total reduction of electricity fees by law will not exceed an amount equal to 1.5% of total fees paid by the public of consumers for electricity consumption. The Law will be applicable within three months from its publication. As of the balance sheet date, the Company created a regulatory asset of NIS 36 million for electricity discounts to the needy that were not yet reflected in the electricity rate. On July 5, 2007, the Electricity Sector Regulations (Ways of Proving Entitlement to Reduced Fees), 2007 came into effect. These regulations arrange the implementation of the provisions of Section 31.a(a) to the Electricity Sector Law regarding granting reduced electricity consumption fee privileges to needy populations. The regulations contain provisions as to proving entitlement by the National Insurance Institute, ways of notification of entitlement and delivering the information regarding entitlement to the essential service provider. In order to complete the overall arrangement, in July 2007, the Electricity Authority published a decision under which it executed changes in the covenants for the adoption of the provisions of Section 31.a to the Electricity Sector Law regarding consumers’ entitlement to reduced rates. The Company estimates that the amendment to the Law will not affect its revenues. 13. The Electricity Authority is negotiating with the Company concerning the formation of a new generation segment rate base. c. Disputes between the Company and the Electricity Authority 1. Further to the disputes regarding the Electricity Authority’s previous decisions, the Company disputes the Electricity Authority’s decisions described above in sections a.6) through a.7) regarding the update of the current rate, the positions of the Electricity Authority and the professional team at the Authority regarding the upcoming rate, as described above in section b., and the Company also expressed its opinion to the Electricity Authority, among other things, on the need to reduce the amortization factors in the rate and the need to continue receiving a gas incentive in future years and for the coverage of the exogenous expenses. In addition, and according to what was stated above, the Company is unable to estimate the implication of the Electricity Authority’s decision regarding the upcoming rate on its financial position in the event that no adjustment is made in the context of the anticipated adjustments in the electricity sector, but the Company is of the opinion that in not raising the electricity rates at the time the upcoming rate basis is determined together with the Electricity Authority’s decisions regarding the current rate that are described above in sections a.6) and a.7), will lead to a material impairment of the Company’s profitability and lead to losses. Since the Company is still unable to assess what the Electricity Authority’s decision would be regarding the rate basis that will be in force following the end of the current rate period (including the decisions described above in section b), the Company is unable to estimate the implications of the above on the financial statements and its financial position.

F-88 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 3: DECISIONS OF THE ELECTRICITY AUTHORITY (continued) c. Disputes between the Company and the Electricity Authority (continued) In light of the serious implications that are liable to derive from the aforesaid, since August 2006, the Company has applied to the ministers on numerous occasions, requesting that an urgent discussion be held regarding the Company’s matters. On April 23, 2007, the Electricity Authority decreased the average rate by about 6.7% as stated in section a.7) above. The Company applied to the chairman of the Electricity Authority and expressed its concerns that since the Electricity Authority has not yet determined a new rate base despite the termination of the trial period in 2005, the issue weighs heavily on the Company from a financial standpoint. Therefore, it is asking the chairman of the Electricity Authority to determine a new rate base for the Company as soon as possible. On April 29, 2007, the Chairman of the Company’s Board of Directors approached the ministers requesting to convene an urgent discussion in order to remove limitations and restrictions imposed on the Company with regard to raising capital, this so as to deliberate the Company’s demands regarding the decisions of the Electricity Authority. Following this appeal, several discussions were held, attended by all the relevant Government organizations, including the Companies Authority and the Electricity Authority with the intention of evaluating various ways of resolving the gamut of problems described above. On May 28, 2007, Ma’alot, the Israeli Securities Rating Company Ltd. (‘‘Ma’alot’’), announced that it was ranking debentures totaling up to NIS 2.5 billion that the Company intends to issue in 2007 and 2008 as AA+/negative. This ranking is identical to the ranking granted to the Company’s outstanding debentures. On July 18, 2007, the Electricity Authority resolved to increase the rate by about 4.7%. On July 10, 2007, the Chairman of the Company’s Board of Directors approached the chairman of the Electricity Authority detailing a series of streamlining measures that the Company intends to take and demanded that the Electricity Authority would concurrently decide on another rate increase. On August 8, 2007, the Electricity Authority published a decision regarding the Company’s financial strengths with the following major points: a) To publish for public reference its proposal to determine a rate base for the generation segment no later than by January 1, 2008. b) In the context of determining the next rate base for the generation segment, the Electricity Authority will look into establishing an incentive mechanism for the Company to advance the use of natural gas in the Company’s generation stations. c) In furtherance to the commitment of the Company’s Board of Directors and management with respect to an efficiency program, the Company

F-89 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 3: DECISIONS OF THE ELECTRICITY AUTHORITY (continued) c. Disputes between the Company and the Electricity Authority (continued) will submit to the Electricity Authority, no later than by September 1, 2007, a term sheet for a comprehensive efficiency program, approved by the Board of Directors. A detailed document specifying the steps required to implement the efficiency program and the relevant time schedules and milestones will be presented to the Electricity Authority by November 1, 2007. In determining the next rate base, the Electricity Authority will take into account, among other things, the streamlining plan presented to it. d) As of September 8, 2007, the recognized cost will increase by 5% (in relation to the recognized cost as of July 16, 2007). The consumer rate update will be determined after examination of the overall changes in recognized cost as of that date and in particular this increment and the changes resulting from the current update. The increment to recognized cost will represent advance recognition of investment cost at the following terms: 1) On the date of establishing a new rate base for the generation segment or at the end of one year from the date of effecting the increment to recognized cost (September 8, 2007), whichever is sooner, the special increment will cease. The accrued increment will be deducted from the rate bases of the recognized assets as determined by the Electricity Authority. 2) Until September 8, 2007, the Electricity Authority will determine a supervision mechanism ensuring that said increment as discussed in d)1) above will only be designated for financing development needs. e) The increment to recognized cost will be distributed pro rata to the division of the recognized assets of the various segments in the electricity chain as relevant for the recognized cost on July 16, 2007. The Company records this increment as an offset of the investments in fixed assets under construction. The total reduction of fixed assets under construction with respect to this increment as of the balance sheet date amounts to approximately NIS 293 million (of which approximately NIS 135 million not yet attributed to projects). In January 2008, the Electricity Authority announced that it will postpone the publication of the new generation segment rate base for the public’s reference until April 2008. On September 8, 2007, the Electricity Authority’s decision to increase the rates at about 7.91%, including a current update of about 2.9%, came into force. Recently, the Company’s management and Board of Directors have been conducting an ongoing dialogue with the relevant Government bodies in an attempt to remove certain obstacles which in the past have made it difficult for different capital raising conduits, as well as with the Electricity Authority in order to advance the discussions regarding issues in dispute as to the electricity

F-90 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 3: DECISIONS OF THE ELECTRICITY AUTHORITY (continued) c. Disputes between the Company and the Electricity Authority (continued) rate. In this regard, on August 8, 2007, the Electricity Authority made the abovementioned decision, which constitutes a positive indication of the future actions of the Electricity Authority, including, among other things, in the matter of updating the rate base. In the event that this positive indication is not realized in the future, the Company’s management will be required to take significant efficiency steps, cut back on vital operating expenses and development costs and carry out structural and organizational changes in order to prevent damage to its ability to serve its debts. On March 9, 2008, the Company applied to the Minister of Finance requesting to inject shareholders’ equity of approximately NIS 2.5 billion into the Company in order to prevent any injury to the Company’s capital raising ability such as the erosion of capital arising from the transition to IFRS, this so as to prevent any damage to the Company’s financial stability and allow the continued development of the electricity sector. 2) Application of SFAS 71 The Company applies the accounting principles for companies whose rates are regulated (SFAS 71) that enable, under certain conditions, an accounting treatment that is different from what is generally accepted with respect to the timing of the recording of expenses and income to the statement of operations (see Note 2.b above). One of the conditions for applying this SFAS 71 prescribes that the regulated rates are structured so that they will cover the specific costs (including the required return on capital), in connection with the supplying of a regulated service or product. d. Details of the amounts of the regulatory assets (liabilities), net as of the balance sheet date December 31, 2007 2006 NIS in millions With respect to the erosion of the Company’s liabilities in foreign currency passed on to the electricity consumers (see section a.2a above) ...... (1,420) (331) With respect to the frequency for updating the electricity rates (see section a.5 above) ...... (151) (168) With respect to depreciation for fuel oil power stations ...... (237) (239) With respect to other regulatory assets ...... 36 35 Total...... (1,772) (703)

As stated in Note 32, the Company will no longer apply SFAS 71 and will not record new regulatory assets/liabilities after the adoption of IFRS.

e. Service criteria Pursuant to the Electricity Sector Law, one of the functions of the Electricity Authority is to ‘‘set criteria for the level, attributes and quality of the services rendered by the holder of an essential service provider’’. In August 2002, a service criteria manual was

F-91 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 3: DECISIONS OF THE ELECTRICITY AUTHORITY (continued) e. Service criteria (continued) ﬁrst published in the Ofﬁcial Gazette. The criteria are periodically updated by the Electricity Authority and currently supersede the majority of the provisions in the arrangement that existed in the principles for the supply of electricity to consumers and connections.

In addition, in its decision of June 26, 2002, the Electricity Authority determined the level of reliability underlying the electricity rate, as follows:

1. The rate bases were intended to achieve a comprehensive level of reliability for the low-voltage consumer of an average of 100 minutes of supply failure to the average consumer annually (‘‘the goal’’).

2. a) Until February 2003, the Electricity Authority will determine a plan obligating achievement of the goal (as of the date on which the ﬁnancial statements were signed, such a plan has not yet been determined).

b) The Authority will not recognize investments in the DMS project (a project of the Company with the goal of improving the reliability of the electricity) other than in the framework of the aforesaid plan to be approved.

3. On the basis of the existing operations system, the Company is required to reduce the variation between the level of reliability in the various administrative regions and the general average from 100% to 50%.

In the Company’s estimation, the changes in the criteria as they were published in the rate document, as opposed to the previously applicable arrangements, have no material implications for the Company. The Company’s assessment is that it is meeting the aforesaid criteria, except as detailed below regarding the determination of the level of reliability of supply.

As for the determination of the aforesaid level of reliability, the Authority has not yet determined a binding program to achieve the goal. The Company acted in the past to convince the Electricity Authority to accept its position that it will not be possible to implement the Authority’s decision but that it is possible to achieve an annual level of overall reliability for the low voltage consumer of approximately 141 minutes of average lack of supply to the average consumer, only in the year following the completion of the DMS project (that, according to the current timetable, is due to end during 2010). The Company assumes that it will be able to achieve this target in those years when the weather will be average.

The Company is unable to estimate what the impact on the Company would be if the aforesaid targets that were determined by the Electricity Authority are not met, although it is possible that not meeting the targets by the dates that will be determined in the plan, when they are determined by the Electricity Authority, could be expressed by the non-recognition of certain costs in the distribution segment.

F-92 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 4: SHORT-TERM INVESTMENTS

December 31, 2007 2006 NIS in millions Short-term deposits ...... — 218

NOTE 5: TRADE RECEIVABLES FOR SALES OF ELECTRICITY

December 31, 2007 2006 NIS in millions Customer debts for electricity bills that were issued ...... 2,040 2,010 Allowance for doubtful accounts...... (190) (186) 1,850 1,824 Income receivable(1) ...... 1,212 1,145 3,062 2,969

(1) Income with respect to the relative portion of the electricity bills issued after the balance sheet date that, according to an estimate, are attributable to the related reported period.

NOTE 6: OTHER ACCOUNTS RECEIVABLE—UNBILLED

December 31, 2007 2006 NIS in millions Current maturities of: (see Note 8) Loans to employees...... 21 30 Chartering of tugboats ...... 6 6 Deposits securing swap transactions...... 544 501 Total current maturities ...... 571 537 Institutions...... 9 9 Prepaid expenses ...... 45 30 Other receivables ...... 147 124 772 700

NOTE 7: INVENTORY—FUEL

December 31, 2007 2006 NIS in millions Fuel oil...... 286 348 Diesel oil ...... 861 593 Coal ...... 564 392 Coal in transit...... 538 342 2,249 1,675

F-93 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 8: LONG-TERM RECEIVABLES

a. Composition of long-term receivables:

December 31, 2007 2006 NIS in millions Loans to employees (see section b below) ...... 82 91 Chartering of tugboats (see section b below) ...... 104 124 186 215 Natural Gas Lines—gas transmission project (see Note 13.h below) . . . 1,010 1,056 Receivables for currency swap transactions (see Note 18 below) ...... 35 16 Deposits to secure swap transactions (see Note 23 below) ...... 544 501 Excess of amounts funded over provision for pensions, net (see Note 17 below)...... 778 1,263 Other ...... 3 3 Total long-term receivables ...... 2,556 3,054 Less—current maturities (see Note 6 above) ...... 571 537 1,985 2,517

b. Loans to employees and chartering of tugboats

1. Linkage basis:

December 31, 2007 December 31, 2006 Linked Linked Linked Linked to the to the to the to the Unlinked CPI Dollar Total Unlinked CPI Dollar Total NIS in millions Interest rates (in percentages) . . 2-6 4.5 7.9-8.4 2-6 4.5-5 7.9-8.4 Loans to employees...... 80 2 — 82 88 3 — 91 Chartering of tugboats...... — — 104 104 — — 124 124 80 2 104 186 88 3 124 215

2. Maturity dates:

December 31, 2007 Loans to Chartering employees of Tugboats Total NIS in millions First year—current maturities ...... 21 6 27 Second year ...... 19 6 25 Third year...... 17 6 23 Fourth year...... 13 7 20 Fifth year ...... 11 8 19 Sixth year and thereafter ...... 1 71 72 Total ...... 82 104 186

F-94 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 9: INVESTMENTS IN INVESTEE COMPANIES

December 31, 2007 2006 NIS in millions The National Coal Supply Company Ltd. (‘‘the Coal Company’’) (see Note 13.b) Cost of shares ...... 41 41 Retained earnings ...... 23 18 64 59

a. The Company does not consolidate its ﬁnancial statements with those of the Coal Company due to the lack of materiality. The investment in the Coal Company is presented on the equity basis (see also Note 13.b below).

b. The Company has inactive afﬁliated companies, where the balance of its investment in them is zero, as follows:

1. Two wholly-owned affiliated companies, Jordan Investments Co. Ltd. and Migrashei Hakablanim Ltd. (an inactive company). The entire property of these affiliated companies is reflected in the assets of the Company.

Jordan Investments Co. Ltd. has two wholly-owned inactive afﬁliated companies—Ma’abarot Hayarden Ltd. and the Palestine Construction Company Ltd.

2. PAMA Ltd., in which the Company holds 49.99% of the share capital, terminated its operations in 2000.

NOTE 10: INVESTMENTS IN DEBENTURES

The investments in debentures reﬂect the Company’s deposits in a trust account, which are intended to cover provisions for the termination of the employee-employer relationship (see Note 17 below), and are composed of Government debentures that are presented at market value.

F-95 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 11: FIXED ASSETS COST ACCUMULATED DEPRECIATION NET BOOK VALUE Balance on Balance on Balance on Change in Balance on December 31, Additions December 31, December 31, depreciation December 31, December 31, December 31, 2006 net 2007 2006 net 2007 2007 2006 NIS in millions FIXED ASSETS IN USE Power plants (including land, buildings and machinery) ...... 48,688 2,373 51,061 25,859 1,516 27,375 23,686 22,829 Switching and transformer stations ...... 9,875 435 10,310 4,700 323 5,023 5,287 5,175 Overloading control center ...... 753 15 768 665 22 687 81 88 Telecommunications ...... 1,062 65 1,127 729 61 790 337 333 Switching stations and 400 KV voltage lines.... 6,693 183 6,876 2,242 221 2,463 4,413 4,451 High voltage transmission lines...... 4,722 128 4,850 2,273 121 2,394 2,456 2,449 F-96 Distribution networks ...... 31,169 1,026 32,195 15,096 881 15,977 16,218 16,073 Installations, etc. – East Jerusalem district ..... 118 — 118 118 — 118 — — Meters ...... 1,737 68 1,805 1,260 64 1,324 481 477 Land, office buildings ...... 2,554 (12) 2,542 1,103 32 1,135 1,407 1,451 Office equipment and tools ...... 1,163 29 1,192 968 41 1,009 183 195 Computers *)...... 766 2 768 *)672 21 693 75 *)94 Motor vehicles...... 559 (19) 540 305 40 345 195 254 Mobile mechanical equipment ...... 483 (1) 482 414 5 419 63 69 Emergency equipment ...... 50 — 50 34 2 36 14 16 Various projects ...... 38 15 53 14 2 16 37 24 110,430 4,307 114,737 56,452 3,352 59,804 54,933 53,978 Less: receipts for extension of the electricity network ...... (7,978) 12 (7,966) (5,082) (200) (5,282) (2,684) (2,896) 102,452 4,319 106,771 51,370 3,152 54,522 52,249 51,082 Spare parts for power plants and substations . . . 1,117 28 1,145 293 4 297 848 824 Total fixed assets in use ...... 103,569 4,347 107,916 51,663 3,156 54,819 53,097 51,906

*) Reclassiﬁed. THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 11: FIXED ASSETS (continued) COST ACCUMULATED DEPRECIATION NET BOOK VALUE Balance on Balance on Balance on Change in Balance on December 31, Additions December 31, December 31, depreciation December 31, December 31, December 31, 2006 net 2007 2006 net 2007 2007 2006 NIS in millions FIXED ASSETS UNDER CONSTRUCTION Power plants, buildings and other installations...... 5,424 (1,707) 3,717 6 — 6 3,711 5,418 Switching and transformer stations and high voltage lines...... 973 (91) 882 31 — 31 851 942 Switching stations and 400 KV voltage lines ...... 215 (120) 95 1 — 1 94 214

F-97 Payments on account of equipment ...... 92 1 93 — — — 93 92 Materials and payments on account of materials designated for investments in fixed assets ...... 529 5 534 — — — 534 529 Consumers’ participation in construction of fixed assets not yet attributed to projects ...... — (135) (135) — — — (135) — Total fixed assets under construction ..... 7,233 (2,047) 5,186 38 — 38 5,148 7,195 Total fixed assets ...... 110,802 2,300 113,102 51,701 3,156 54,857 58,245 59,101 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power) NOTE 11: FIXED ASSETS (continued) a. Investments in land (before amortization), which are included under fixed assets include NIS 680 million for long-term leaseholds (until 2048) and NIS 569 million for land owned by the Company. A substantial portion of the landed property, in which the Company has rights, is not registered in the Land Registry and the status of such properties has not been settled for various technical reasons, such as the absence of parcelization in a portion of those areas, the requirements of planning authorities to assemble master plans, and disputes with the various authorities, including the tax authorities, regarding the receipt of confirmation of having made mandatory payments had occurred, and those disagreements prevent the procurement of the receipt of authorizations for registration in the Land Registry. Due to the great complexity of the matter, it is not possible to estimate the period of time which will be required to conclude registering the land, but, in the Company’s opinion, this cost of registering the land, as aforesaid, is not liable to be substantial. There are capitalized contracts with respect to the majority of the land leased by the Company from the Israel Land Administration. b. As of the date of the expiration of the Concession (March 5, 1996), the Company had fully written off the cost of acquiring land in the amount of NIS 494 million as to which the Company’s right to receive compensation at the expiration of the Concession was unclear. Land purchased in late 1995 at a cost of NIS 303 million, as to which the Company received confirmation that it would receive adequate compensation, was not written off (see Note 1.a.6). The Company does not amortize the cost of land bought after the end of the Concession. c. See Note 18.c for pledges related to fixed assets. d. See Note 21.a.4 for fixed asset investment commitments. e. Accumulated financial expenses, net, capitalized as part of the cost of fixed assets (before depreciation) were NIS 3,173 million and NIS 3,146 million as of December 31, 2007 and 2006, respectively (see Note 28.a). f. The Company’s financial statements include assets, primarily networks and lines located within Judea, Samaria and the Gaza Strip (including the Palestinian Authority territories) (‘‘the territories’’) with a net book value of approximately NIS 827 million as of December 31, 2007. In the opinion of the Company’s management, the utilization of these assets for the purpose of electricity supply will continue and they will remain in the possession of the Company. In the event that the possession of the balance of the assets, as a whole or partially, located in the territories is taken from the Company, the Company’s management estimates, based on the terms of the interim agreement signed between Israel and the Palestinians on September 28, 1995, and based on the principles prescribed in the Disengagement Law, that the Company will be indemnified in an amount equal to at least the net book value of the assets as reflected in the financial statements, and that the Company will not suffer losses as a result thereof. The Company has user’s rights in the land and to what is connected to this land in the region of Gaza and northern Samaria (whose depreciated cost as of the balance sheet date amounted to about NIS 25 million) and from which Israelis were evacuated in accordance with the Law for the Implementation of the Disengagement Plan, 2005, that

F-98 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 11: FIXED ASSETS (continued) was passed in the Knesset on February 16, 2005 (‘‘the Disengagement Law’’). In accordance with the provisions of this law, the rights for the use of the land were nullified as of the date of the evacuation, while providing rights to demand compensation for the infrastructure facilities that were installed by the Company. During the reported period, the Company filed a claim with the Disengagement Authority for compensation for its assets that remained in the evacuated areas. In the Company’s assessment the amount of the compensation, when received, will not be less than the value of the assets that are presented in its financial statements. g. Pursuant to a directive from the Ministry of Infrastructures, new lease agreements will include a condition, pursuant to which, should the designation of the land cease serving its original objective (that is, electricity services), the agreement will be nullified and the land returned to the Israel Land Authority, while refunding the balance of the lease fees that were paid. h. On December 31, 2005, based on an opinion of outside consultants, the Company studied the need for a provision for the impairment of value of its assets, which was based on Accounting Standard No. 15. This examination was performed even though the Company is studying the need for a provision for impairment of value pursuant to SFAS 71 (according to the recognition of assets for the purpose of rates, see Note 2.n. above). For the purpose of the engagement, three cash generating units were determined (generation, transmission and distribution) and a forecast was made of the future cash flows that are expected to result from these units, where this forecast was made based, among others, on assumptions that represent the economic conditions that will prevail during the useful life of the units’ assets, of which the principal ones are: 1. Coverage in the framework of the rate for the assets of the units according to their value in these financial statements. 2. Coverage in the framework of the rate for the operating expenses expected for these units. 3. Coverage in the framework of the rate for the fuel expenses the Company will bear. 4. The discount rate as of the balance sheet date, based on the CAPM model for calculating the return on shareholders’ equity, and for determining the weighted discount rate (WACC). The weighted average cost of capital was calculated for the Company as one unit, and was split into cash generating units according to what is in place in the current electricity rate for each cash generating unit, which due to its being the general calculated discount rate that is very close to the capital cost recognized in the rate. The discount percentage rates are: 5.63% for a generating unit, 5.13% for a transmission unit and 5.36% for a distribution unit. These values, as aforesaid, reflect the time value of the money, and the specific risks for each cash-generating unit. In order to calculate the recoverable amount, the implications that are likely to result from the decisions and letters of the Electricity Authority described above in Note 3.b., were not taken into account due to the reasons indicated in that Note. Pursuant to the above calculations, it appears that the recoverable amount for all of the assets of the cash generating units stated above as of December 31, 2005, is not lower than their value in the financial statements as of December 31, 2005.

F-99 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 12: INTANGIBLE ASSETS, NET

Balance as of Balance as of December 31, Disposals Additions December 31, 2006 in 2007 in 2007 2007 NIS in millions Cost of software ...... 2,880 (36) 201 3,045 Accumulated amortization of software .... (2,045) 3 (214) (2,256) Intangible assets, net ...... 835 (33) (13) 789

NOTE 13: RELATED AND INTERESTED PARTIES a. The State of Israel and companies and other entities controlled by it (including Government companies, local authorities and Government ministries) (and other corporations in which the Government has a certain percentage of ownership in them), constitute related and interested parties of the Company. The Company’s income from those transactions carried out with interested parties, during its ordinary course of business, are: sales of electricity and electricity connections. In the framework of its purchases, the Company primarily buys natural gas, transmission, water and land leasehold services from the above interested parties. Payments to the State and its authorities as a sovereign entity, namely payments pursuant to law, such as taxes and fees, do not exceed the Company’s ordinary course of business. The transactions with the interested parties during the reported period were as follows: 1. Revenues a) Revenues from the State and its authorities (in accordance with invoices that were issued, and not including income receivable)—approximately NIS 492 million. b) Revenues from interested and other parties—approximately NIS 917 million (primarily revenues from Mekorot Ltd.—about NIS 528 million). 2. Expenses a) Expenses for natural gas transmission to Natural Gas Lines in Israel Ltd. (‘‘Natural Gas Lines’’)—about NIS 131 million (see section g below). b) The remaining expenses (primarily leasehold fees, pumping of fuels and water)—about NIS 90 million. With regard to State guarantees, see Note 18.g. below. b. The Coal Company The Coal Company is a subsidiary in which the Company holds 100% of the share capital. 1. On July 15, 2004, the Company signed an agreement with the Coal Company for the purchase and supply of coal for the Company’s power stations that consume coal—Orot Rabin in Hadera and Rutenberg in Ashkelon. The agreement is in force from December 31, 2003 and will remain in force for as long as the Company shall have generation licenses for the aforesaid power stations. The Company reserves the right to cancel the agreement with one year’s advance notice. The consideration that is paid is calculated based on cost in addition to an agreed upon proﬁt and is subject to the coal price approved for the Company by the Electricity Authority.

F-100 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 13: RELATED AND INTERESTED PARTIES (continued) b. The Coal Company (continued) In accordance with the aforesaid agreement, the ownership of the coal inventory is transferred directly to the Company from the supplier, where the Coal Company continues to handle the shipment of the coal to the Company’s power stations and see to appropriate insurance (in favor of the Company), in the case of any loss or damage to the coal. 2. In the year ended December 31, 2007, the Company received dividends in the amount of NIS 5 million from the Coal Company (in 2006—NIS 5 million). In May 2007, the Company reached an agreement with the Coal Company for increasing the suppliers’ credit extended to the Company by the Coal Company by another month. The additional credit will be linked to the U.S. dollar and bear interest of about 6% a year. The total added credit facility approximates $ 84 million. 3. In 2007, the Company acquired coal from the Coal Company at a cost of approximately NIS 4,468 million, included in fuel expenses. c. State of Israel (Chartering of Tugboats) In 1997, the Company chartered two tugboats that it had purchased from the Israel Shipyards Ltd. according to a contract signed in the past between it and the Ministry of Communications, to the Hadera Port Authority for periods of twenty years each, pursuant to the charter agreement entered into between the Company and the Hadera Port Authority in 1995. The balance for the charter as of December 31, 2007 was approximately NIS 46 million. The amount is linked to the U.S. dollar with the addition of interest at customary rates (see Note 2.aa above). d. The Eilat Ashkelon Pipeline Company Ltd. (‘‘EAPC’’) Pursuant to an agreement between the Company and EAPC, EAPC allocated an area that it owns to the Company for the purpose of building a pier for the unloading of coal for the Rutenberg power plant. In the context of this agreement, the Company entered into an agreement for the building of two tugboats by the Israel Shipping Ltd. In 2000, the tugboats were chartered to the Ashkelon port for periods of 240 months each, from the date of their delivery, in accordance with the charter agreement reached between the Company and EAPC. The balance of the amount of the charter fees as of December 31, 2007 was approximately NIS 58 million. The amount is linked to the U.S. dollar with the addition of interest at customary rates (see Note 2.aa above). e. Oil Infrastructures Ltd. (‘‘Oil Infrastructures’’) Pursuant to an agreement signed in the past between the Company and Oil Infrastructures., Oil Infrastructures constructed an oil distillate line (‘‘the oil distillate line’’) to the Gezer site and, through which oil distillates are pumped for 50 years. In exchange for Oil Infrastructures’ commitment to pump oil distillates through the line during the aforesaid period, the Company bears 64% of the value of the investment in the oil distillate line by way of the payment of 25 annual installments linked to the CPI. The Company recorded this transaction as a ﬁnancial lease in the amount of approximately NIS 22 million. f. The Israel Lands Administration The Company reached an agreement with the Ministry of National Infrastructures and the Israel Lands Administration, pursuant to which, the Israel Lands Administration

F-101 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 13: RELATED AND INTERESTED PARTIES (continued) f. The Israel Lands Administration (continued) will allocate alternative land to the Company in place of the land the Company vacated at the Reading C site for the purpose of a switching station, a substation, etc., in an identical area of land, one dunam for each dunam, at no cost, at a location required by the Company at its discretion, this without accepting the Company’s claim regarding its rights to the Reading C site. (The land at the Reading C site was depreciated in full—see Note 11.b above.) It was further determined that a negotiating team would be set up with the participation of representatives of the Company, the Israel Lands Administration, the Prime Minister’s Office and the budget division of the Ministry of Finance in order to determine the amount of compensation for the Company with respect to structures at the site being vacated. As of the date on which the financial statements were signed, the proceedings have not yet been finalized and the land has not yet been delivered to the Company.

g. Commitment for the transmission of natural gas In June 2006, the Company and Natural Gas Lines signed an agreement for the transmission of natural gas according to the version published by the Natural Gas Authority, which is applicable to all gas consumers who enter into a transmission agreement with Natural Gas Lines. The agreement is designed to regulate the commercial, technical and legal principles regarding natural gas transmission for a period of 15 years. This agreement was signed with respect to the Eshkol and Reading sites and the Company had several reservations regarding the agreement. On May 31, 2007, the Natural Gas Authority published a general draft of the transmission agreement between Natural Gas Lines and the sector’s transmission consumers. In February 2008, The Company’s Board of Directors approved a permanent agreement for the transmission of natural gas between the Company and Natural Gas Lines, replacing the agreement of June 2006. The Company was granted certain ﬂexibility with respect to capacity ordering by way of a right to divert capacity at a scope of up to 15% of the ordered capacity, and by way of a right to order short-term capacity (for at least a full month). This agreement is in effect for a period of 15 years, to apply to all the sites to be connected to the gas transmission system.

h. Project for the establishment of a natural gas transmission system (‘‘the project’’) In accordance with the agreement that was reached in November 2004, and the addendum to that agreement dated December 19, 2005, between Natural Gas Lines, the Government of Israel (on behalf of the State of Israel) and the Company (‘‘the tripartite agreement’’), it was imposed on the Company to ﬁnance, order and manage the works for constructing part of the natural gas transmission system in Israel as detailed below (‘‘the project’’). In addition, it was agreed that the Company will not serve as or be considered to be the chief contractor or the contractor executing the project, unless the aforesaid responsibility was imposed by law on the person ordering the works. The project includes the establishment of a marine system for the transmission of natural gas, a marine segment from Ashdod to the Reading site, a reception terminal and metering terminal at Reading, a marine segment from Reading

F-102 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 13: RELATED AND INTERESTED PARTIES (continued) h. Project for the establishment of a natural gas transmission system (‘‘the project’’) (continued) to the ‘‘Dor’’ coast, connection to the Hadera coast, including an overland segment from the Dor coast to the Hagit site and a reception terminal at the Hagit site.

The principal elements of the tripartite agreement are as follows:

– The Company’s duties are to ﬁnance the project, to manage it and to order the works that are related to its construction (including, but without derogating from the totality of the aforesaid, the selection of contractors, the commitments with contractors, full coordination between the contractors regarding the execution of and the compliance with timetables, managing the execution and supervision over the works, taking those actions that are required in order to assure the existence and enforcement of the obligations of the contractors, to carry out all of the actions that are required for the purchase and arrangement of all the rights to land that are required in order to construct the system, to obtain building and additional permits, as well as the handling and payment of compensation to the owners of the land and doing everything that is required to assure the integrity of the system during the warranty period).

– The Company will not be the owner of the system and it will not have any rights in it or in part of it, and the system shall be owned by the State.

– In exchange for the execution of the project, the Company will be entitled to receive all of the expenses (including financial expenses—as detailed in the tripartite agreement) that it expended for the project and that were approved by the authorized party, as defined in the tripartite agreement (the Accountant General at the Ministry of Finance, the managing director of the Ministry of National Infrastructures and the CEO of Natural Gas Lines—‘‘the authorized party’’), as well as management fees in the amount of between $ 10 million and $ 14 million, so that the Company does not anticipate a material profit or loss from this project. The authorized party is entitled to offset from the expenses to be reimbursed to the Company any cost or damage that was sustained by the State and/or Natural Gas Lines as a result of negligence or violation of the agreement by the Company. This liability of the Company is limited to $ 20 million during the warranty period, and $ 20 million following this period (even if the limits of the warranty period were fully or partially utilized). Should the damages that were caused by the Company’s negligence exceed $ 20 million, the aforesaid surplus damages shall be offset against the management fees that are to be paid to the Company. Insurance was taken out for the project that covers damages that are likely to be caused to the project and damages that are likely to be caused to third parties. In addition, there is coverage for the Company for professional liability in the framework of the Company’s general third party liability policy.

F-103 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 13: RELATED AND INTERESTED PARTIES (continued) h. Project for the establishment of a natural gas transmission system (‘‘the project’’) (continued) With regard to the reimbursement of the approved expenses, it was determined as follows: 1. Natural Gas Lines will pay all of the amounts to the Company that the Company must pay according to the payment schedule (‘‘the repayment amounts’’) of the loans that the Company has received and will receive from Citibank for the financing of the project’s costs (see below), this on the date on which each payment is made for each of the repayment amounts according to the payment schedule (back-to-back). 2. The repayment amounts will also include actual payments by the Company to the State for State guarantee commissions and other commissions and expenses that the Company paid for taking out the aforesaid loan. The settling of accounts regarding the approved expenses and the reimbursement shall be denominated in U.S. dollars. The Company’s responsibility for the project is derived from the obligations and the duties imposed on it in the tripartite agreement. In addition, these duties are liable to impose on it responsibility by law, including responsibility pursuant to the labor safety laws. The Company’s responsibility regarding the integrity of the system, as defined in the tripartite agreement, is limited to the warranty period, provided to the Company by the contractors with which it entered into agreements, and on condition that it will not be less than the minimal period detailed in the agreement—up to the end of 18 months from the date on which confirmation was granted for the completion, or by the end of 12 months from the date on which the system began to operate, whichever is earlier. (Nonetheless, it should be pointed out that the Company does not receive any general warranty for the system from the contractors; rather, each contractor is responsible only for the work he carried out). In January 2005, the ocean section of the pipeline suffered damage. This damage was repaired by the supplier in light of his warranty, in accordance with the agreement between him and the Company. In the Company’s opinion, the repair was successful, and the Company has confirmation to that effect from regulatory bodies. While the repair was being made, Natural Gas Lines directed the Company to repair it differently. However, consenting to these requests would have resulted in an additional expense of tens of millions of dollars, not to mention the fact that the Company was instructed by the Minister to make the repair as it was carried out. Should the Company be required in the future to make the repair by a different method, the anticipated expense will be about $ 30 million. According to the decision of the Board of Directors of October 2006, should the Company be required to perform the repair, it will finance the cost of the repair in an amount not exceeding NIS 30 million, when 50% of the financing will be done in the context of the project’s recognized increased budget and the other 50% will be refunded to the Company by the end of three years from the finalization of the repair, unless otherwise determined in an arbitration proceeding. The State disagrees with the Company’s position and demands that the Company finance 50% of the costs of the repair from its own sources. The Company and its legal counsel do not believe any loss is expected to incur from this issue.

F-104 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 13: RELATED AND INTERESTED PARTIES (continued) h. Project for the establishment of a natural gas transmission system (‘‘the project’’) (continued) In the Company’s assessment, the possibility that the Company will be required to make the repair a second time by another method is theoretical and the Company does not believe that it will materialize. In 2006, several disputed issues were raised between the Company and representatives of the State regarding the project as follows: a) On April 10, 2006, the authorized body rejected several requests made by the Company to increase the project’s budget in connection with works already expended by it or that will be expended in the future, amounting to about $ 20 million. b) In addition, it is the authorized body’s opinion that expenses relating to the project that had been or will be expended by others in a total of about $ 10 million should be borne by the Company. c) Furthermore, certain claims were raised against the Company by the Ministry of Defense arguing that the Company had violated its obligation to place the gas pipe at a certain depth as specified in the claims. Based on the opinion of its legal counsel, the Company believes that as far as issues a) and b) above are concerned, it has solid arguments based on which it is highly likely that the Company will be awarded the amounts that it had expended or had committed to spend for additional jobs and tests of the gas pipeline. Nevertheless, it should be noted that the Company has not yet received information regarding the specific claims raised by the authorized body and their foundation, if any, and no legal proceedings have been initiated by any of the parties. With respect to issue c) above, other than the fact of the making of the claim by the Ministry of Defense, no specific allegations have been made by the Ministry and certainly no claims have been made regarding damages or the necessary costs of repair. Therefore, despite tests conducted by the Company’s technical staff, it is not possible to assess the Company’s exposure in this matter, if there should be any. It should be clarified that the Company is continuing its preparation for the arbitration proceeding as above and, with the help of technical persons, is examining the statements made by the project’s managers. It should be pointed out that the Company had approached the Attorney General of the Government requesting that arbitrators (legal and technical) be appointed to deliberate the various disputes between the Company, the State and other bodies in connection with this project. The Attorney General responded to the Company’s request stating that he does not intend to appoint an arbitrator and that an expert in engineering technical disputes should be appointed in coordination with the parties. The Company has rejected this proposal and re-addressed the Attorney General announcing that it intends to initiate legal proceedings to appoint an arbitrator according to the terms of the tripartite agreement. A response to the Company’s second application has not yet been received. Until the date of signing the financial statements, said arbitrators have not been appointed. A provision of NIS 31 million was included in 2006.

F-105 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 13: RELATED AND INTERESTED PARTIES (continued) i. Letter of indemniﬁcation to the State of Israel

The Company furnished a letter of indemnification to the State of Israel (the Ministry of Defense) in connection with the damages likely to be caused to the State due to passage of the gas transmission line through security areas that belong to the State, and the Company’s liability for indemnification to the Ministry of Defense for any damage. An expense, payment or loss that will be borne by the Ministry as a result of the positioning of an underwater pipe that is not in accordance with the provisions of the coordination agreement that was signed with the Ministry of Defense in this matter. The force of the letter of indemnification has expired and, as of the date on which these financial statements were signed, the Company is not aware of any event whatsoever that might create responsibility and/or liability in accordance with the letter of indemnification. j. Establishment of a desalination facility at the Orot Rabin site

On September 7, 2004, an agreement was signed between the State and the Company, pursuant to which the Company will grant the State, or a developer on its behalf, the right to use land with an area of about 71 thousand sq. m. in the proximity of the Hadera power station, for the purpose of constructing a sea water desalination facility. The right of use of the land will commence on the date determined by the Government (‘‘the record date’’) and will extend for 24 years and 11 months. In consideration for granting the aforesaid use of the land, the Company is entitled to a non-recurring sum of NIS 7.5 million for covering the costs of evacuating the buildings on the designated plot designated to be assigned to the concessionaire and relocating them to another place at the power station. Furthermore, from the record date to the end of license, the Company will be entitled to an amount of NIS 1,140 thousand per year (linked to the CPI). As of the date of generating desalinated water in the facility, the Company will be entitled to a payment of 0.24 cents for each one cubic meter of desalinated water that the operator will sell to the State (the facility is intended to supply about 100 million cubic meters of desalinated water a year) in respect of additional services provided to the operator. In 2007, the Company is entitled to receive a non-recurring sum in respect of planning and supervision services in a total of approximately NIS 762 thousand. On December 10, 2007, the State announced that the above date is the record date.

k. The Advanced Study Fund of the Israel Electric Corporation Employees Ltd. (‘‘the Advanced Study Fund’’)

The Company holds 50% of the Advanced Study Fund’s management shares and rights to nominate directors (excluding a right to share proﬁts). The Company makes deposits to the Advanced Study Fund for employees entitled to such deposits pursuant to labor agreements. Following are the amounts funded during the periods:

NIS in millions

For the year ended December 31, 2007 ...... 61 For the year ended December 31, 2006 ...... 71

The Advanced Study Fund does not invest in the Company’s securities.

F-106 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 13: RELATED AND INTERESTED PARTIES (continued) l. Beneﬁts to Interested Parties Group Year Ended December 31, 2007 2006 2007 2006 Number of Individuals NIS in millions 1. Interested parties employed by the Company (including directors employed during part of the year) (*) ...... 2 2 1.4 (*)1.4 2. Directors not employed by the Company ...... 14 12 0.6 0.7

(*) The Chairman of the Board retired on August 9, 2006. No new paid Chairman had been appointed by December 31, 2006.

NOTE 14: CREDIT FROM BANKS AND OTHERS

December 31, 2007 December 31, 2006 Stated in Stated in or linked Linked or linked Linked Not to foreign to the Not to foreign to the linked currency (**) CPI Total linked currency (**) CPI Total NIS in millions Current maturities of loans and debentures (*) .... 111 (866) 2,424 1,669 1,816 (1,497) 2,476 2,795 For forward transactions . . 308 (294) — 14 2,135 (3,598) 1,564 101 Total...... 419 (1,160) 2,424 1,683 3,951 (5,095) 4,040 2,896

(*) With respect to interest rates for current maturities, see Note 18. (**) As for currency types, see Note 18.

NOTE 15: CUSTOMER ADVANCES, NET OF WORK IN PROGRESS Represents receipts from customers, net of work in progress with respect to attachments to buildings and works for others.

Connections to Work paid buildings for by others Total December 31, December 31, December 31, 2007 2006 2007 2006 2007 2006 NIS in millions Receiptsfromcustomers...... 145 130 652 583 797 713 Less: expenses with respect to work in progress ...... 72 73 479 384 551 457 73 57 150 199 223 256 Policy deductible with respect to insured damages...... — — 1 23 1 23 73 57 174 222 247 279

F-107 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 16: OTHER CURRENT LIABILITIES December 31, 2007 2006 NIS in millions Employees ...... 382 325 Institutions ...... 136 215 Interest and expenses accrued ...... 1,185 1,135 Current maturities of obligations due to employee-employer relationships (Note 17)...... 37 38 Regulatory liabilities (Note 3.d) ...... 1,772 703 Other current liabilities ...... 114 165 3,626 2,581

NOTE 17: OBLIGATIONS DUE TO EMPLOYEE-EMPLOYER RELATIONSHIPS, NET

December 31, 2007 2006 NIS in millions Accruals in the Company’s pension plan Provision for pensions managed in the central provident fund for ...... 17,077 17,438 Less: amounts funded in the central pension provident fund..... (16,702) (16,281) Balance to be deposited ...... 375 1,157 Additional provisions for retirement of employees ...... 1,774 1,585 2,149 2,742 Unamortized actuarial losses (see Note 2.q above)...... (2,927) (4,005) Total provisions for pensions and retirement grants in the Company’s pension plan, net ...... (778) (1,263) Other provisions: Retirement grants to employees ...... 177 169 Grants for non-utilization of sick leave and others ...... 419 399 Severance pay to employees under a special contract ...... 24 43 Vacation pay ...... 163 164 Total other provisions ...... 783 775 Total provisions, net...... 5 (488) Presented as follows: Current liabilities – other liabilities...... 37 38 Long-term liabilities – obligations due to employee-employer relationships, net...... 746 737 Long-term receivables ...... (778) (1,263) Total provisions, net...... 5 (488)

F-108 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 17: OBLIGATIONS DUE TO EMPLOYEE-EMPLOYER RELATIONSHIPS, NET (continued) a. The Company’s Pension Plan 1. Provisions a) Summary of the Company’s pension regulations, the salary components for calculating the pension and the principal actuarial assumptions applicable to the Company’s permanent employees that were hired prior to June 12, 1996 (‘‘the employees in the pension plan’’) The pension regulations that apply to all of the Company’s employees that are included in the pension plan. Pension rights result from one of the following: 1) Compulsory retirement that, by law, was ﬁxed at the age of 67. 2) After at least 30 years of service and conditional upon the employee reaching 55 years of age (women—50 years), and he wishes to retire, or that the Company is interested in his retiring, and the workers organization agrees, and on condition that the general number of those retiring according to this section in any year whatsoever will not exceed 20% of all retirees in that year. However, if an employee should wish to retire in accordance with this section and the Company is interested in his continued employment, the Company shall take into account the workers organization’s recommendation into account. 3) Dismissal after at least ten years of service and age of 40 or higher. 4) Disability retirement. 5) Survivors of workers/pensioners are entitled to rates of pension as detailed in pension regulations. Pension rates: 1) After 10 years of service—25% of last salary. 2) After each additional year of service, up to 30 years—2% of last salary for each additional year. 3) From the 31st to the 35th year of service—1% of the last salary for each additional year. 4) On retirement after more than 35 years of service, the employee receives on retirement, his last year’s monthly salary for each year of service exceeding 35 years. 5) For disability retirement of a permanent employee the rates of pension will be determined in accordance with the pension regulations. b) In order to evaluate the monetary liability for pensions, the Company uses actuarial calculations prepared by an outside actuary (in the amount of about NIS 18,848 million at balance sheet date). The liability calculation is made in reliance on the pension regulations, using personal data of permanent employees who are entitled to a pension and that is supplied to the actuary.

F-109 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 17: OBLIGATIONS DUE TO EMPLOYEE-EMPLOYER RELATIONSHIPS, NET (continued) a. The Company’s Pension Plan (continued) The evaluation of the actuarial liability is based on a forecast of future expected cash flows according to a system of actuarial assumptions. In effect for better or for worse, these cash flows could vary from what is expected due to the possible difference between future reality (actual flow) and the forecasts. Also the system of assumptions on which the actuarial balance sheet is based is subject to changes that are likely to occur to it in the future, such as—with the accumulation of updated information on factors that have an effect on the continued force of these assumptions. For example: changes in the development of life expectancy, regulatory changes, economic changes, etc. Such possible changes will (if they occur) affect the amount of the obligation due to employee—employer relationships.

The following are the main assumptions according to which the actuarial liability is calculated:

1) The liability is calculated for the pension salary components included in the last wages as of the date of the ﬁnancial statements with the addition of a provision of 0.5% with respect to the salary agreement for 2005 and as yet unpaid as well as another 1% based on management’s assessment (based on past experience) for the expected future salary agreement for 2006 and 1% for 2007.

2) The liability is calculated on the basis of the life tables published by the capital markets insurance and savings division of the Ministry of Finance, which includes dynamic improvement in life expectancy in the future, in accordance with the interim results of a study that was made by the capital market, insurance and savings division at the Ministry of Finance (‘‘the capital market division’’) and published on October 17, 2004, pursuant to which the rate of increase in the lifespan is greater than what was assumed in previous calculations. According to what was stated in the publication, the study is not ﬁnal and, in the future, it is possible that there will be changes and adjustments (see update in 5) below).

3) The actuarial liability takes into account severance pay (according to law) whose future effects on the funded amounts are not material.

4) On August 21, 2006, the Company received a letter from the supervisor of wages announcing the decision regarding the salary terms of the Company’s employees and pensioners whereby, among other things, several salary components had been paid to the Company’s employees and pensioners in contrast to the Budget Law, 1985 and accordingly, the supervisor of wages has

F-110 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 17: OBLIGATIONS DUE TO EMPLOYEE-EMPLOYER RELATIONSHIPS, NET (continued) a. The Company’s Pension Plan (continued) decided to cancel and/or change those components and has instructed the Company to claim refunds from its employees and pensioners. It also decided that the grade of the Company’s pensioners will be enhanced every three years instead of every two years as at present. On October 3, 2006, the supervisor of wages contacted the Company in another letter instructing it, among other things, to immediately stop/change the payments made to certain senior pensioners and employees (‘‘the seniors’ group’’) and the supervisor of wages expressed his consent to hold a supplementary hearing to allow the future implementation of other salary components. Following the court hearing dated November 12, 2006, the Histadrut, the workers’ association, the Company and the supervisor of wages agreed on the following, among other things: – The employees will remove the sanctions and the Company will adopt the supervisor’s decision regarding the seniors’ group. – For a period of one month, talks will be held regarding the supervisor’s decision as to salary excesses in the Company. – Until the talks have been exhausted, the Company will not act to implement the decisions of the supervisor of wages in the matter of the ﬁling of refund claims for the past. The Company believes that the implications of the letters of the supervisor of wages regarding pension and salary costs are not expected to be material. As for the decision regarding the pensioners’ rate of promotion, which might lead the Company to change its actuarial evaluations (in the direction of a decrease in pension liabilities), the Company believes that there is no room for changing its pensioner promotion policy from every two years to every three years at this stage, as stated in the letter of the supervisor of wages. The Company is deliberating the issue with the supervisor of wages and it believes that its current policy will be accepted. Accordingly, the Company has not changed any relevant actuarial assumptions (see also Note 21.c below). 5) In May 2007, the capital market, insurance and savings division in the Ministry of Finance published a circular regarding the manner of calculating the actuarial liabilities of pension funds. In view of this publication, the Company’s actuary concluded that the Company should adopt the actuarial schedules detailed in the Finance Ministry’s circular the principal ones being pensioners’ mortality schedules, disabled mortality schedules and marital rate

F-111 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 17: OBLIGATIONS DUE TO EMPLOYEE-EMPLOYER RELATIONSHIPS, NET (continued) a. The Company’s Pension Plan (continued) schedules, this because these schedules best suit the Company. This update has increased the actuarial liability by approximately NIS 226 million (this update has no material effect on the Company’s balance sheet and statement of operations as of the balance sheet date due to the adoption of the allocation principles similarly to the principles of IAS 19). 6) The early retirement agreement signed on February 4, 2008 constitutes a ﬁrst step in the scheme of a planned retirement agreement in the context of which, some 700 additional regular employees are expected to retire next. This retirement agreement is part of the Company’s preparations for the planned restructuring pursuant to the Electricity Sector Law. Accordingly, the costs of the early retirement agreement signed arise from the planned restructuring. Pursuant to the above, the effect will be included in the interim ﬁnancial statements of March 2008 in a total of approximately NIS 450 million (before the tax effect). 7) The interest rate for the capitalization of the liability is set in accordance with what is published by Interest Rates Company Ltd. that is determined based on the return until redemption of Government debentures. 8) The liability is calculated pursuant to the compulsory retirement age of 67 for men and women, and in accordance with the actuarial guidelines for retirement prior to the above ages (such as: disability, early retirement and death), and as to the early retirement of employees under special terms, the actuarial assumption is based on the Company’s decision that in future years, no more that 40 employees per year will retire in this framework. 9) The liability is accrued uniformly (linearly) over the expected term of the employees’ employment. 10) As for the re-examination of the assumptions underlying the actuarial liability, see Note 34 below. 2. Amounts funded Central Provident Fund for Pension Pay a) Since March 8, 2005, the Company has been depositing the funds to cover the liability for pension of the employees under the pension plan, to the Central Provident Fund for Pension Pay (‘‘the fund’’). b) The fund operates by force of the Income Tax Regulations (Principles for Approving and Managing Pension Funds), 1964 (‘‘the income tax regulations’’). The fund’s management by the management company (‘‘KFI’’) is performed accordingly.

F-112 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 17: OBLIGATIONS DUE TO EMPLOYEE-EMPLOYER RELATIONSHIPS, NET (continued) a. The Company’s Pension Plan (continued) c) The fund calculates the Company’s actuarial liability for employees in the pension plan in order to determine the amount that must be deposited by the Company to cover this liability. The fund’s actuary makes these calculations according to what is stated in the income tax regulations referred to above, which prescribe that the amount of the liability will be calculated with respect to the qualifying wage components, in the manner indicated by the supervisor of the capital market at the Ministry of Finance (‘‘the supervisor’’), in accordance with the Company’s liabilities, pursuant to the applicable labor agreements and according to all law. Among others, the calculation will refer to interest rate for capitalization, the rate of increase of the qualifying wage components, the linkage method for pensions and the mortality tables. The Company’s current deposits with the fund must reach the amount of its actuarial commitment; however, it is possible to deposit the amounts within 90 days or within 12 months, according to the changes that were used for the purpose of the deposits with the fund. d) In 2007, the Company deposited an amount of approximately NIS 436 million in the fund. e) Based on the fund’s calculations, the Company’s actuarial liability amounts to about NIS 17,077 million. f) The actuarial assumptions according to which the fund calculates the amount of the Company’s actuarial liability are similar in principle to the Company’s actuarial assumptions. Should the Supervisor instruct the fund to modify a certain actuarial assumption, there may be a gap between the liability presented in the Company’s ﬁnancial statements and the amount the Company is required to deposit in the fund. 3. The amounts of the pension expenses that were included in salary and pension costs for the reported year are as follows: 2007 2006 NIS in millions Current service cost ...... 443 407 Interest on the liability ...... 778 651 Expected return on the funds...... (647) (592) Actuarial losses that were written down...... 399 225 Expenses that were included in the cost of salary and pensions ...... 973 692

4. The provision for pension covers all of the Company’s liabilities toward its employees under the pension plan, assuming that the employees will retire according to the acceptable actuarial estimates. In the event that all of the employees under the pension plan should be dismissed immediately, the amount of the liability to these employees will be signiﬁcantly greater that the amount of the liability that is presented in the

F-113 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 17: OBLIGATIONS DUE TO EMPLOYEE-EMPLOYER RELATIONSHIPS, NET (continued) a. The Company’s Pension Plan (continued) ﬁnancial statements. In the assessment of the Company’s management, a situation like this is not expected. b. Pension for Employees Not Under the Pension Plan The Company’s other employees, who are not included in the pension plan, are insured by a comprehensive pension through a new cumulative outside pension fund, up to the cap amount permitted by law, and by a provident fund for pension with respect to the other relevant components. The Company deposits its full liabilities for these employees. The amounts that are deposited in the aforesaid pension fund are recorded in the name of the employees, and the liabilities for them are not presented in the Company’s balance sheet, since they are not controlled or managed by the Company. c. Other Provisions 1. Retirement grants An employee who has served for 10 to 35 years is entitled, on his retirement (compulsory, voluntary or disability), to a grant of 10% for each year of service multiplied by his last salary. The liability for retirement grants is calculated based on the last salary of the employee and relative to the period of their service with the Company. 2. Compensation for non-utilization of sick leave allowance and others The grant for non-utilized sick leave allowance, which comprises the material part of this category, is paid to employees who are retiring as pensioners based on the last salary of the employee for sick leave, as follows: – An employee who utilizes during the period of employment in the Company less than 36% of all sick leave days that he was entitled to, will receive a grant at the rate of 26.66% of the balance accumulated all years of employment. – An employee who utilizes during the period of employment in the Company between 36% and 65% of all sick leave days that he was entitled to, will be receive a grant at the rate of 20% of the balance accumulated during all years of employment. – An employee who utilizes more than 65% of all sick leave days will not receive any grant. 3. Severance pay to employees under special contract The Company is obligated to pay severance pay to employees who are not included in the framework of the Company’s pension plan, and in whose respect the Company transfers a portion of its liabilities for severance pay to the pension funds. The liability is calculated based on the employees last salary as of the balance sheet date, and represents the Company’s total liability according to the Severance Pay Law or other agreements, which exceeds the amounts to the credit of the employees in the external pension funds.

F-114 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 17: OBLIGATIONS DUE TO EMPLOYEE-EMPLOYER RELATIONSHIPS, NET (continued) d. Trust Account to Covering Various Provisions

To cover various provisions for which the Company does not make deposits to the Central Provident Fund for Pensions, because of the Fund’s by-laws, the Company deposits funds into a trust account (see Note 10 above).

F-115 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 18: LONG-TERM AND EXTENDED-TERM DEBENTURES AND LIABILITIES, NET

a. Composition of the long-term and extended-term debentures and liabilities and swap transactions, net

December 31, December 31, 2007 2006 Unlinked Linked to In U.S. In Swiss In Japanese In other Linkage Basis: NIS the CPI dollars In Euro francs Yen currencies Total Total NIS in millions (1) Debentures Interest rates (%)...... 8.5 2.5–6.5 7.0–8.9 2.8–4.1 Effective interest rates (%)...... 6–6.5 4.0–5.6 7.1–9.2 3.3–4.3 Debentures traded on the Israel Stock Exchange (1) ...... — 6,538 — — — — — 6,538 6,715

F-116 Debentures not traded in Israel ...... 657 5,703 — — — — — 6,360 4,592 Debentures issued abroad...... — — 9,307 — — 2,919 — 12,226 14,678 657 12,241 9,307 — — 2,919 — 25,124 25,985 Less: deferred charges ...... — (25) (25) — — (27) — (77) (92) (Discount)/premium...... 49 977 (24) — — (7) — 995 922 706 13,193 9,258 — — 2,885 — 26,042 26,815 Current maturities: Debentures ...... — 40 — — — — — 40 1,121 Deferred charges ...... — (4) (6) — — (3) — (13) (13) (Discount)/premium...... 4 118 (4) — — — — 118 93 4 154 (10) — — (3) — 145 1,201 Total of long-term debentures, net...... 702 13,039 9,268 — — 2,888 — 25,897 25,614 Extended-term debentures issued in the United States ...... — — 481 — — — — 481 546 Less: Deferred charges ...... — — (7) — — — — (7) (6) (Discount) ...... — — (1) — — — — (1) (1) Extended-term debentures, net ...... — — 473 — — — — 473 539 Total debentures, net...... 702 13,039 9,741 — — 2,888 — 26,370 26,153 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 18: LONG-TERM AND EXTENDED-TERM DEBENTURES AND LIABILITIES, NET (continued) a. Composition of the long-term and extended-term debentures and liabilities and swap transactions, net (continued)

December 31, December 31, 2007 2006 Unlinked Linked to In U.S. In Swiss In Japanese In other Linkage Basis: NIS the CPI dollars In Euro francs Yen currencies Total Total NIS in millions (2) Liabilities to banks Interest rates (%)...... 6.7 4.9–7.4 4.2–6.2 3.3–4.2 6.7 Effective interest rates (%) ...... 4.0–5.7 5.5–8.2 4.9–6.9 3.3–5.0 7.6 Loans from banks ...... — 890 5,981 4,396 59 — 26 11,352 13,301 Less: Deferred charges...... — — (58) (157) — — — (215) (255)

F-117 — 890 5,923 4,239 59 — 26 11,137 13,046 Current maturities: Loans from banks ...... — 154 280 647 29 — 6 1,116 1,208 Less: Deferred charges...... — — (7) (31) — — — (38) (42) — 154 273 616 29 — 6 1,078 1,166 Bank Liabilities, net...... — 736 5,650 3,623 30 — 20 10,059 11,880 Total transferred to next page ..... 702 13,775 15,391 3,623 30 2,888 20 36,429 38,033 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 18: LONG-TERM AND EXTENDED-TERM DEBENTURES AND LIABILITIES, NET (continued) a. Composition of the long-term and extended-term debentures and liabilities and swap transactions, net (continued)

December 31, December 31, 2007 2006 In Unlinked Linked to In U.S. In Swiss Japanese In other Linkage Basis: NIS the CPI dollars In Euro francs Yen currencies Total Total NIS in millions Brought forward from previous page . . 702 13,775 15,391 3,623 30 2,888 20 36,429 38,033 (3) Other liabilities Interest rates (%)...... 6.5–8.1 5.2–5.9 Effective interest rate (%) ...... 2.7–6.8 7 5.4–5.9 Loans from provident funds and F-118 insurance companies ...... — 1,825 227 — — — — 2,052 2,267 Loans from suppliers ...... — — 4 161 — — — 165 241 Liabilities for ﬁnance leases ...... — 22 — — — — — 22 23 Total ...... — 1,847 231 161 — — — 2,239 2,531 Less: deferred charges...... — (3) — — — — — (3) (4) — 1,844 231 161 — — — 2,236 2,527 Current maturities: Other liabilities ...... — 174 4 50 — — — 228 247 Less: deferred charges...... — (1) — — — — — (1) (1) — 173 4 50 — — — 227 246 Other liabilities, net ...... — 1,671 227 111 — — — 2,009 2,281 Total debentures and liabilities, net ... 702 15,446 15,618 3,734 30 2,888 20 38,438 40,314 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 18: LONG-TERM AND EXTENDED-TERM DEBENTURES AND LIABILITIES, NET (continued) a. Composition of the long-term and extended-term debentures and liabilities and swap transactions, net (continued)

December 31, December 31, 2007 2006 In Unlinked Linked to In U.S. In Swiss Japanese In other Linkage Basis: NIS the CPI dollars In Euro francs Yen currencies Total Total NIS in millions Brought forward from previous page . . 702 15,446 15,618 3,734 30 2,888 20 38,438 40,314 (4) Hedging transactions Deposits ...... — — (5,826) (1,588) (94) (1,463) (390) (9,361) (10,548) Loans...... 2,373 5,338 231 1,626 — — 1,269 10,837 11,674 Total swap transactions...... 2,373 5,338 (5,595) 38 — (1,463) 879 1,476 1,126 F-119 Forward transactions...... 101 — (6) 212 (94) (138) (156) 13 83 Total hedging transactions ...... 2,474 5,338 (5,601) 250 (94) (1,601) 723 1,489 1,209 Current maturities of swap transactions ...... 104 1,944 (1,065) (674) (94) — — 216 180 Current maturities of forward transactions ...... 101 — (6) 212 — (138) (156) 13 83 Total current maturities ...... 205 1,944 (1,071) (462) (94) (138) (156) 229 263 Total hedging transactions, net ...... 2,269 3,393 (4,530) 712 — (1,463) 879 1,260 946 Total debentures, liabilities and swap transactions, net...... 2,971 18,839 11,088 4,446 30 1,425 899 39,698 41,260 Transfer of swap transactions to long-term receivables, net (see Note 8)...... — (512) (231) 263 — 515 — 35 16 Total ...... 2,971 18,327 10,857 4,708 30 1,940 899 39,733 41,276 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 18: LONG-TERM AND EXTENDED-TERM DEBENTURES AND LIABILITIES, NET (continued)

a. Composition of the long-term and extended-term debentures and liabilities and swap transactions, net (continued) 1. Series 21-22 of debentures which were issued on the Tel-Aviv Stock Exchange, are linked (principal and interest) to the known CPI, and are due for redemption through the years until 2015. 2. During the reported year, the Company issued non negotiable debentures as follows: ‘‘2018 Linked Electric’’, ‘‘2008 NIS Electric’’, ‘‘2015 Linked Electric’’ and ‘‘2012 Linked Electric’’. In the framework of these series, debentures were issued at a nominal value of NIS 1,790 million, at annual interest of 6.5% (for the linked debentures) and 8.5% (for the NIS debentures). The proceeds from the aforesaid offerings, with the addition of premium and net of issuance expenses in the amount of NIS 173 million, amounted to NIS 1,963 million.

b. Maturity dates subsequent to the balance sheet date are as follows:

Liabilities Other Debentures to banks liabilities Total NIS in millions First year – current maturities ...... 40 1,345 228 1,613 Second year...... 4,271 1,147 220 5,638 Third year ...... 246 1,017 174 1,437 Fourth year ...... 2,830 1,373 97 4,300 Fifth year...... 2,437 1,093 68 3,598 Sixth year and thereafter ...... 15,781 7,128 1,225 24,134 25,605 13,103 2,012 40,720

The payments that mature in subsequent years are on account of the principal and linkage only. c. To secure all full and accurate payments of the aforementioned debentures (principal, interest and linkage differences) and to secure proper compliance with the other terms of the debentures, the Company pledged all its assets (including fixed assets under construction) in a floating charge and all of its rights to those assets of any type and sort whatsoever, which currently exist or will exist in the future, ranking equally with all other floating charges granted by the Company proportionately (pari passu) to the amounts of liabilities which will be secured, from time to time, by each of these charges. At the time of operating the fixed assets under construction for which a generation license must be obtained are operated, the Minister is entitled to determine restrictions on the transfer, encumbrance or attachment of that property (see also Note 1.a.3.b). The Company is of the opinion that these restrictions cannot apply to existing encumbrances. d. The fair value of the debentures traded on the Israel Stock Exchange is approximately NIS 7,199 million. This sum reflects the market value of these debentures. As to the fair value of other debentures, see Note 23.c below.

F-120 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 18: LONG-TERM AND EXTENDED-TERM DEBENTURES AND LIABILITIES, NET (continued) e. In addition to the charge stated above in section c, the lenders were granted the right to offset or place a lien regarding all of the cash, notes, securities and other negotiable instruments that the Company delivers to them for collection, security, safekeeping or other activities.

f. Terms of the Company’s loan agreements that might result in immediate repayment 1. According to the loans agreements, the Company is not required to comply with any financial covenants whatsoever. Nonetheless, there are general provisions in the loans agreements that provide the lender with the right to demand immediate repayment of the loan on the occurrence of an event that, in the lender’s opinion, could materially adversely affect the Company’s ability to repay the loan. 2. As is customary in loan agreements, events such as a material violation of the Company’s liabilities, the granting of a liquidation order or the appointment of a receiver for material assets of the Company, provide the lenders with the right to demand immediate repayment. When such events occur, a lender in whose favor the Company recorded a floating charge is entitled to realize his charge. 3. The terms of the loan agreements are not identical. As is common for such agreements, loan agreements include one or more of the events detailed in them as events that enable the lenders to demand immediate repayment. 4. All loan agreements with foreign lenders are subject to the laws of foreign states, such as the U.S., England, Germany, Switzerland, Canada, France, etc., and the courts in those countries have the exclusive authority to hear and decide disputes between the parties, except for the authority to hear and decide claims with respect to the realization of liens that the Company recorded in favor of the lenders, which is exclusively provided to the District Court at Haifa. The law in Israel applies to all liens. The Company is unable to estimate how the court in a foreign state will relate to the provisions of these loan agreements. 5. In all of the loan agreements, the failure to pay principal or interest on time (or after a period of deferral of repayment as defined in the agreement) constitutes a breach that provides the lender with the right to demand immediate repayment. In all of the loan agreements denominated in foreign currency, the Company is obligated to pay the principal and interest in the denominated currency. The Company’s inability to purchase foreign currency at the required time and in the required amount constitutes a breach that provides the lender the right to demand immediate repayment. 6. In most loan agreements, if the Company shall breach its liabilities toward a certain lender, where the cash value exceeds a certain amount defined in the agreement, and that lender demands immediate repayment as a result of that breach, the matter will result in a ‘‘cross violation’’, whereby a lender with whom an agreement was not breached is entitled to demand immediate repayment. The majority of the loan agreements determine that nonpayment pursuant to a ruling against the Company in excess of a certain amount (in the majority of cases, $ 25 million or more) provides the lender with the right to demand immediate repayment. Here as well, the reference is to a cross violation clause.

F-121 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 18: LONG-TERM AND EXTENDED-TERM DEBENTURES AND LIABILITIES, NET (continued) f. Terms of the Company’s loan agreements that might result in immediate repayment (continued) 7. In all loan agreements where the Company’s liabilities are secured by a State guarantee, the cancellation of the State guarantee or the insertion of changes to it without the lender’s consent constitutes a breach that provide the lender with the right to demand immediate repayment.

8. The transfer of Company assets: In part of the loan agreements, there is a blanket prohibition against the transfer of assets that are the subject of the speciﬁc loan. In other loan agreements, the Company has the right to transfer assets subject to conditions/restrictions included therein, including obtaining the lender’s consent. Certain agreements allow the transfer of assets to subsidiaries of the Company, on condition that these assets constitute less than 5% of the Company’s assets. Certain loan agreements prescribe that the Company is entitled to transfer assets on condition (1) that the transfer is made at market value (according to the determination of an appraiser or the Company), (2) at least 75% of the proceeds was received in cash or cash equivalents, (3) that the Company shall invest the proceeds in active assets. In the framework of the capital offerings plan in the U.S. (‘‘the capital offerings plan’’), the Company is entitled to use the proceeds in order to pay part of the amounts it owes to the holders of debentures that were issued in the framework of this plan.

9. The transfer of the Company’s liabilities: In part of the loans agreements, the Company was provided the right to transfer its liabilities that are the subject of the loan, conditional upon the receipt of the lender’s consent. It should be pointed out that pursuant to Israeli law, it is not possible to assign a charge without the creditor’s consent. An action by the Company contrary to these provisions constitutes a breach that provides the lender with the right to demand immediate repayment.

10. In the majority of loan agreements, the Company has exhibited presentations of various matters, such as the accuracy of its ﬁnancial statements, its right to use its assets and/or its ownership of them, the existence of the required licenses and their timely renewal, etc. In a case where it will be determined that the Company’s representations were materially misleading (or incomplete), the lender has the right to demand immediate repayment. In addition, nondisclosure of material details that are liable to result in a materially adverse change in the Company’s business activities or its ability to repay provide the lender with the right to demand immediate repayment.

11. In certain loan agreements, the Company is obligated to provide the lender with current updates regarding events (including a change in legislation and decisions by the Government, and including structural changes in general) that affect or are likely to adversely affect the Company’s operations and/or ﬁnancial strength. The lender is granted the right to decide, at his discretion, if there is anything to these changes that endanger the Company’s ability to repay the loan (principal and interest). Should the lender decide that that is the case, he is provided with the right to demand immediate repayment.

F-122 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 18: LONG-TERM AND EXTENDED-TERM DEBENTURES AND LIABILITIES, NET (continued) f. Terms of the Company’s loan agreements that might result in immediate repayment (continued) 12. In the framework of the debentures that the Company issued to the public and institutional investors in Israel, beginning with the debentures (Series 19) through the debentures (Series 21) inclusive, it was determined in the trust deeds that the Company will be entitled to sell, lease, assign, deliver or transfer, in any way, its assets, or any part of them, during the ordinary course of business. Carrying out an action other than in the ordinary course of business could provide the lenders (through the trustees) the right to demand immediate repayment.

13. In the signed trust deeds in connection with the debentures (Series 19 through Series 22 inclusive) that the Company issued to the public and institutional investors in Israel, it was determined that the trustee will be entitled to require immediate repayment of the entire undischarged balance of the debentures and will be obligated to do so if so requested by a special decision made in a general meeting of the holders of the debentures, or by the written demand of holders of debentures owning at least 20% of the aggregate par value of the outstanding debentures, on the occurrence of one or more of the events listed below: (1) if the holders of the charges on the Company’s assets will realize the charges that they have on the Company’s assets, in whole or in part (that is, a cross violation); (2) if a court shall grant a ﬁnal order or if a valid decision will be made to liquidate the Company (excluding a liquidation for objectives of a merger with another company or a change in the Company’s structure). It was determined in the aforesaid trust deed that the end of the validity of the generation and/or generation licenses held by the Company (at the time these ﬁnancial statements were signed) in connection with the debentures (Series 22) does not constitute an immediate repayment event.

14. In some of the loan agreements, the lenders have the right to change the conditions of the loan or to demand immediate repayment, due to a decline in the State’s holding percentage in the Company to below 51%.

The Company is of the opinion that it is complying with its liabilities by force of the loans agreements and credit allotted to it and, to the best of its knowledge, at the time these ﬁnancial statements were signed, none of the grounds exist that provide the lenders with the right to present credit for immediate repayment exists.

g. Government guarantees (for which the balance as of balance sheet date amounts to approximately NIS 6,762 million) have been given to various ﬁnancial institutions with relation to certain loans given to the Company.

NOTE 19: INCOME TAXES

a. Beneﬁts under the Law for the Encouragement of Industry

The Company is an ‘‘Industrial Company’’ as defined by the Law for the Encouragement of Industry (Taxes), 1969 and, accordingly, is entitled to certain tax benefits, the most significant of which is depreciation at enlarged rates.

F-123 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 19: INCOME TAXES (continued) b. Taxation under inflationary conditions The provisions of the Income Tax (Inflationary Adjustments) Law, 1985 apply to the Company. According to the law, the results for tax purposes are measured based on the changes in the Israeli CPI. On February 26, 2008, the Knesset (Israeli Parliament) passed by third reading the Income Tax (Inflationary Adjustments) Law (Amendment No. 20) (Limitation of Effective Period), 2008, according to which the provisions of said law will no longer apply, save the transition provisions that aim to prevent tax miscalculations. According to the amendment, starting 2008 and thereafter, the adjustment of income for tax purposes to a real measurement basis will no longer be calculated. Furthermore, the linkage to the CPI of the depreciation on fixed assets and of carry-forward losses for tax purposes will be discontinued such that these amounts will be adjusted up to the CPI of the end of 2007 and their linkage will stop as of that date. c. Tax loss carry-forward to future years The tax loss available for carry-forward to future years was NIS 17,607 million.. The tax loss carry-forward to future years is linked to the CPI in accordance with the law mentioned in section b above. The Company recorded a deferred tax asset with regard to the loss carry-forward in the aggregate amount of NIS 4,402 million as of December 31, 2007, and NIS 4,059 million as of December 31, 2006 (section j.1 below), based on management’s estimation that it is there is a high level of probability that the loss carry-forward will be utilized (including realization against deferred tax reserves, see section j.2 below). d. Effect of the change in the tax rate On July 25, 2005, the Knesset (Israeli Parliament) passed the Law for the Amendment of the Income Tax Ordinance (No. 147), 2005, which prescribes, among others, a gradual decrease in the corporate tax rate in Israel to the following tax rates: in 2007 –29%,in2008–27%,in2009–26% and in 2010 and thereafter – 25%. e. Reform in the Israeli tax system In 2003, the provisions of the Law for Amendment of the Income Tax Ordinance (No. 132), 2003, became effective (‘‘the reform law’’) which deal with a comprehensive reform in certain aspects of the Israeli tax system. It is expected that the application of the law will result in a gradual decrease in the companies’ tax liabilities, since a certain portion of the companies’ income derives from gains which are subject to capital gains tax. According to the provisions of the reform law, tax at a reduced rate of 25% will apply on capital gains accrued after January 1, 2003, instead of the regular tax rate. In case of the sale of properties purchased before the effectiveness of the reform law, the reduced tax rate will apply only to the portion of the gain which accrued after the adoption of the law, as computed according to the law’s stipulations. Further, the reform law states that capital losses carried forward for tax purposes may be utilized against capital gains for an indefinite period. The reform law also provides for the possibility to offset capital losses from sales of properties outside Israel against capital gains in Israel. f. The tax that will apply to the shareholders due to the payment of dividends by the Company is not expected to be material since almost all of the Company’s shares are held by the State of Israel.

F-124 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 19: INCOME TAXES (continued) g. Tax assessments

The Company received ﬁnal tax assessments through and including the 2003 tax year.

h. Theoretical tax

Below is a reconciliation between the theoretical tax on adjusted income before income taxes (computed as a result of the application of statutory tax rates) and the income taxes included in the statements of operations:

Year Ended December 31, 2007 2006 2005 NIS in millions Income (loss) before income taxes ...... (147) 344 626 Statutory tax rate ...... 29% 31% 34% Computed tax per statutory rate ...... (42) 107 213 Expenses disallowed net (including depreciation) ...... 4 5 9 Effect of inﬂationary tax law ...... (4) — 4 Effect of change in the tax rate ...... — — (865) Effect of the difference between the statutory tax rate and the tax rate according to which the deferred taxes were calculated. . . 5 (21) (56) (36) 91 (695)

i. Composition of deferred income taxes in the statement of operations

Year Ended December 31, 2007 2006 2005 NIS in millions Decrease (increase) in deferred tax assets ..... (446) (254) 1,686 Increase (decrease) in deferred tax liabilities. . . 410 345 (2,410) Less: Effect of transfer of tax beneﬁt related to interest on perpetual debentures to shareholders’ equity ...... — — 28 (36) 91 (695)

F-125 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 19: INCOME TAXES (continued) j. Deferred taxes

1. Deferred tax assets consist of the following Allowance Customer Accrued Loss carry- Accrued for doubtful advances, pension forward vacation pay accounts net pay, net Total NIS in millions Balance at December 31, 2005...... 3,905 25 49 1 1,804 5,784 Changes during 2006 ...... 154 3 1 (1) 97 254 Balance at December 31, 2006...... 4,059 28 50 — 1,901 6,038 Changes during 2007 ...... 343 — — — 103 446 Balance at December 31, 2007 (a) ...... 4,402 28 50 — 2,004 6,484

(a) Composed as follows: Short-term ...... — 6 — — 1 7 Long-term ...... 4,402 22 50 — 2,003 6,477 4,402 28 50 — 2,004 6,484

The deferred taxes are calculated according to tax rates of 25% (the tax rates that are expected to apply at the time they are realized).

2. Deferred tax liabilities consist of the following

Adjustment of depreciable ﬁxed assets, depreciation and other Fuel assets inventories Total NIS in millions Balance at December 31, 2005 ...... 10,250 2 10,252 Changes during 2006 ...... 347 (2) 345 Balance at December 31, 2006 ...... 10,597 — 10,597 Changes during 2007 ...... 400 10 410 Balance at December 31, 2007 (a)...... 10,997 10 11,007

(a) Composed of: Short-term ...... 3 10 13 Long-term ...... 10,994 — 10,994 10,997 10 11,007

F-126 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 19: INCOME TAXES (continued) j. Deferred taxes (continued) 3. Composition of deferred taxes

December 31, 2007 2006 NIS in millions Long-term Deferred tax liabilities ...... 10,994 10,595 Less: deferred tax assets ...... (6,477) (6,032) Advances for non deductible expenses ...... (84) (79) 4,433 4,484 Short-term Deferred tax liabilities ...... 13 2 Less: deferred tax assets...... (7) (6) 6 (4) 4. Permanent differences The balance of the depreciated cost for certain depreciable assets, includes amounts that, as regards temporary differences these amounts, the liability for deferred taxes on the adjustment component for these assets that will not be allowed as a deduction was not recognized, and it is viewed as a permanent difference in accordance with the provisions of Accounting Standard No. 19. The amounts treated as permanent differences are as follows: NIS in millions The aggregate amount that will not be deductible as of the beginning of the year...... 29 Decrease for 2007...... (4) The aggregate nondeductible amount at the end of the year..... 25

5. Tax provisions for assets whose depreciation period exceeds 20 years (included in section 3 above), see Note 2.p above)

NIS in millions Balance as of December 31, 2006 ...... 345 Decrease for 2007...... (51) Balance as of December 31, 2007 ...... 294

NOTE 20: PERPETUAL DEBENTURES FROM THE STATE OF ISRAEL Pursuant to the Company’s arrangement with the Ministry of Finance, perpetual debentures in a nominal amount of about NIS 15 million (the adjusted amount as of the balance sheet date is approximately NIS 2 billion) were issued in previous years. The principal in respect of these debentures is unlinked and they bear annual interest at a rate of 5% and 5.75%, fully linked to the known CPI as of balance sheet date. Other than a pledge in a nominal amount, the perpetual debentures are not superior to any other loans extended to the Company.

F-127 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power) NOTE 21: COMMITMENTS, CLAIMS AND CONTINGENT LIABILITIES a. Commitments 1. Commitment for the supply of natural gas On July 21, 2005, the Company’s Board of Directors approved the agreement that was reached by the Company with EMG for the supply of natural gas. According to the agreement, the amount of gas to be purchased (about 25 billion cubic meters), will be at an average annual pace of 1.7 billion cubic meters over 15 years. The estimated financial scope of the agreement is about $ 2.5 billion for 15 years. The projected date for beginning the flow of the gas is during April 2008. The agreement is for a period of 15 years, with an option for the Company to extend it by five additional years at the same terms and annual amounts. The exercise of the option is conditioned on the advance notice of the Company 36 months prior to the end of the base period. On July 31, 2005, the Government approved the above decision of the Board of Directors, in accordance with sections 11(a) and 9a to the Government Companies Law. 2. Agreement for the transmission of natural gas with a related party In June 2006, the Company and Natural Gas Lines signed an agreement for the transmission of natural gas, see Note 13.g above. 3. Purchase of natural gas at spot prices On August 15, 2006, the Company and Tetis Sea Group entered into an agreement to purchase natural gas at spot prices in effect from July 1, 2006 through March 31, 2008. This agreement regulates the cost of the additional gas which the Company will purchase from the Tetis Sea Group for the above period in an amount exceeding the maximum (hourly) quantity stipulated in the basic supply contract signed between the parties. The purpose of the agreement is to exploit gas quantities that are in excess of the above quantity during peak demands that the Company needs. According to the agreement, the Company is not obligated to purchase gas and the Tetis Sea Group is not obligated to supply gas pursuant to the spot transaction. Prior to signing the agreement, the approval of the Restrictive Trade Practices Commissioner was obtained and the Company will be forced to readdress the Commissioner if it wishes to extend the agreement or deviate from the spot based gas quantities in excess of one billion cubic meters. The spot price is lower than the price of fuel oil and higher than the price of gas under the basic contract. As for the Electricity Authority’s decision in this matter, see Note 3.a.7.e above). 4. As of December 31, 2007, the Company has entered into commitments to purchase equipment and services and to construct facilities, which are not disclosed in the financial statements, as follows: a) Ordering, planning, consulting and equipment from suppliers in various currencies expressed in U.S. dollars at their exchange rates as of balance sheet date amounting to approximately $ 167 million and u 113 million. These orders will be financed, among others, by existing long-term credit lines from banks and foreign suppliers.

F-128 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 21: COMMITMENTS, CLAIMS AND CONTINGENT LIABILITIES (continued) a. Commitments (continued) b) Contracts regarding construction, equipment supply, purchase of fuels and current activities with local suppliers amounting to approximately NIS 3,242 million. b. Claims and contingent liabilities The Company is involved in pending claims during the ordinary course of its business. The Company is of the opinion, based on the opinion of its legal and professional advisors with respect to these claims, that ultimately, nothing will result from these claims that will materially affect the financial position as of December 31, 2007 or the results of operations for the year then ended. Based on the aforesaid opinions, a provision was recorded in the financial statements in the amount of NIS 378 million (as of December 31, 2006—NIS 336 million) which is adequate to cover the losses that may possibly result from: (1) Insured claims as to which a provision was recorded up to the amount of the deductible component (a total provision of NIS 51.6 million). (2) Uninsured claims (that do not include claims for bodily injury) and as to which no provision was recorded at all, or for which only a partial provision was recorded (total provision of NIS 302.6 million). (3) Uninsured claims for bodily injury as to which a full provision was recorded (total provision of NIS 8.9 million). (4) Uninsured claims for bodily injury that, as is customary, are not specified by amount (total provision of NIS 14.9 million). The total claims pending against the Company in items 1-4 above amount to nearly NIS 14,515 million, of which about NIS 12,137 million is for claims that were requested to be recognized as class actions. 1. Claims requested to be recognized as class actions On March 1, 2006, the Class Actions Law, 2006 (‘‘the Class Actions Law’’) was enacted by the Knesset, which replaces the sections on class actions in the primary legislative articles. The Company, in collaboration with its attorneys, is studying the law that was enacted and its implications, insofar as the aforesaid implications exits, on the claims that are detailed below. a) On June 4, 2003, a claim was filed against the Company, to which was attached a request to recognize the claim as a class action pursuant to the Restrictive Trade Practices Law and according to the Consumer Protection Law, 1981. The claim deals with the collection of interest on the delinquent payment of electricity bills. The amount of the ‘‘group’’ claim was estimated by the claimants to be approximately NIS 150 million. On November 21, 2007, the representative of the plaintiffs filed with the District Court a motion to order the rejection of the motion for a class action without issuing an order for expenses, at the Company’s consent. The court’s decision was rendered on the same day and stipulates that the

F-129 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 21: COMMITMENTS, CLAIMS AND CONTINGENT LIABILITIES (continued) b. Claims and contingent liabilities (continued) representative of the plaintiffs must produce an affidavit for the court revealing, by fair disclosure, all the substantial details pertaining to the plaintiffs’ request to withdraw the lawsuit, as required by the Class Action Law. On March 3, 2008, the court rendered its decision in the case of striking the motion in view of the plaintiffs’ failure to meet the requirements of the Class Action Law pertaining to the terms required for their withdrawal from the lawsuit at this hearing stage, thereby bringing the proceedings in this case to a close. b) A request was filed in the past with the District Court against the Company and the State to approve a claim as a class action. The claim dealt with the collection of the special surcharge to the electricity rate. The claimant claims, inter alia, as detailed in the claim, that the special surcharge is a ‘‘hidden tax’’ that is being unlawfully collected, and that the Company must return it, together with interest and linkage, in the amount of approximately NIS 2,847 million in values of the date on which the claim was filed. The Company had collected a total of NIS 8,831 million on account of the special surcharge. The claimant filed a request to amend his claim in light of the legislation of the Class Actions Law. On June 5, 2007, the court granted the amendment request. Nevertheless, the court has refrained, at this stage, from deciding on the Company’s arguments with respect to the amendment request and has made it clear that the Company will be able to raise its allegations in its response to the amended class action request. The Company’s legal advisors believe that the Company has good defense arguments against the class action motion and believe that it is most probable that it will be rejected. c) On May 25, 2006, a request was received at the Company that was filed against the Company for approval as a class action pursuant to the Class Actions Law and the Law for the Prevention of Environmental Hazards (Civil Actions), 1992, which, according to the claimant’s estimate, amounts to nearly NIS 200 million. The substance of the claim is bodily injuries (asthma) that were caused, as alleged, to the claimants since childhood as a result of the air pollution that is caused by the smokestacks of the Orot Rabin power station at Hadera. On June 24, 2007, the parties signed a settlement agreement according to which all the legal proceedings will be stricken and the plaintiffs have undertaken not to file another claim in this matter. It was further agreed that the Company would reimburse the plaintiffs for legal fees. On June 27, 2007, the court approved the settlement agreement and granted it the validity of a verdict thereby concluding the proceedings in this case. Regarding the Company’s compliance with environmental regulations see Note 1.g above.

F-130 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 21: COMMITMENTS, CLAIMS AND CONTINGENT LIABILITIES (continued) b. Claims and contingent liabilities (continued) d) On June 8, 2006, the Company received a motion that was filed against the Company to approve a class action pursuant to the Class Actions Law. The substance of the claim is that damages that were caused, pursuant to what is alleged, as a result of the initiated power stoppages that, according to the claimant’s estimate, amount to about NIS 87 million. The Company is of the opinion that the power stoppages were in accordance with the law and were caused by excessive electricity demands that occurred as a result of unpredictable events and that production malfunctions and power stoppages are inevitable. On October 17, 2007, the Tel-Aviv District Court rejected by a well founded verdict the motion for a class action and accepted the Company’s position. The Court also ordered the appellants to reimburse the Company for its expenses and legal fees in a total of NIS 60,000. On December 2, 2007, the appellants filed an appeal to the District Court’s verdict. Pursuant to the Supreme Court’s decision, the appellants were required to deposit collateral in the amount of NIS 30,000 in order to secure the reimbursement of the Company’s expenses should the appeal be rejected but failed to do so on the stipulated date. On January 15, 2008, the Supreme Court instructed the appellants to produce a reason within seven days to why the appeal should not be dismissed for failure to deposit collateral. The appellants did not act in accordance with said decision and filed on January 31, 2008 a request for dismissing them from paying the collateral. This request was rejected on February 10, 2008, without soliciting the Company’s response, either with respect to the substance of the request or with respect to the delay in its submission. The Court ordered the appellants to deposit within 10 days the determined collateral or the appeal would be rejected without further notice. Simultaneously with said developments, the Company concurred that the appellants withdraw the appeal without issuing an expense order by the Supreme Court and agreed to relinquish half the amount of expenses awarded in its favor by the District Court. On February 14, 2008, the appellants moved to strike the appeal. On February 20, 2008, the Supreme Court granted the request and ordered striking the appeal as requested by the appellants, thereby terminating the proceedings in this case. e) On May 15, 2007, a lawsuit and a motion to approve the lawsuit as a class action according to the Class Actions Law were received by the Company according to the Class Actions Law, in a total of approximately NIS 116 million. The lawsuit concerns the Company’s alleged unlawful collection on the following levels: collection of VAT on arrears interest, charging consumers for arrears interest in case of spreading of debt, charging consumers requesting to spread their debt over installments in order to repay their current debt sooner than scheduled, collecting payment in civil leap years according to a calculation of 365 days a year instead of 366 days, charging a fixed payment for periods of power disconnection, charging for extended services according to rates prevailing

F-131 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 21: COMMITMENTS, CLAIMS AND CONTINGENT LIABILITIES (continued) b. Claims and contingent liabilities (continued) on the date of charge and not according to the rate on the date of providing the service, tax withholding on interest paid by the Company to consumers at a higher rate than required, over charging due to meter deviations of the ‘‘Aleg’’ type. The claimant further requests that a mandatory injunction be issued for the immediate replacement of all ‘‘Aleg’’ type meters as well as a declaratory relief stipulating that all meter tests will be executed by an independent external entity within the State budget with the budget source being fees imposed on the Company. The Company’s legal advisors believe that the chances of granting the motion for a class action are not high both for procedural reasons and for substantive considerations. In any event, the Company’s overall exposure with respect to this motion is immaterial. f) On December 5, 2007, a claim and a motion for approval as a class action were filed with the District Court against 13 defendants, among which the Company. The individual claim amounts to NIS 1,403 whereas the damage estimated by the plaintiff in the motion for the class action as damage to the group aggregates NIS 3,179 million as of December 31, 2007. The claim argues that plaintiffs 1 through 12 (collectively: ‘‘the companies’’) are manufacturing companies that manufacture, among other things, equipment for electricity generation and transmission power stations, which starting in 1988, formed a global cartel that until the first half of 2004 engaged in manufacturing power station equipment worldwide while geographically allocating the countries between the companies, coordinating quotes in bids and mutually assisting each other in tenders by submitting fictitious quotes in elevated amounts in order to allegedly present genuine competition and competitive prices while in advance, coordinating the winning bid between the companies at 20% higher than the competitive price. According to what was claimed, the Company had purchased equipment from the above companies to set up electricity generation and transmission power stations in the knowledge that the companies were operating under a cartel and that the price paid by the Company was a cartel prices that was higher than the market’s competitive price, while rolling the elevated price onto the consumers. The plaintiff is asking to hold the Company responsible by virtue of the Restrictive Trade Practices Law for having allegedly known of the existence of the cartel and having allegedly acted as a party to the binding arrangement created by the companies. The plaintiff further wishes to hold the Company responsible by virtue of Section 29a to the Restrictive Trade Practices Law for allegedly taking advantage of its status as a declared monopoly in the generation, transmission and supply of electricity by purchasing equipment for the generation and transmission of electricity at excessive prices in the framework of a cartel with no competition and while rolling the elevated prices onto the consumers, as

F-132 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 21: COMMITMENTS, CLAIMS AND CONTINGENT LIABILITIES (continued) b. Claims and contingent liabilities (continued) above. The Company is requested to submit its response for the motion by March 10, 2008. A pre-hearing in the motion was scheduled for March 23, 2008. The Company’s legal advisors believe that the Company has good defense arguments against both the motion and the claim. Nevertheless, at these early stages of the proceedings, they are unable to estimate the chances of the claim. 2. Claims in respect to the pollution of the Kishon River a) In the context of a class action that was filed against ‘‘Fertilizers and Chemical Materials Ltd.’’ and ‘‘Haifa Chemicals Ltd.’’ for granting an injunction and a mandamus with respect to the pollution of the Kishon river, the above companies filed in 2002 two third party notices against the Company. On April 16, 2007, the class action was dismissed ab limine by the Magistrate Court. On May 17, 2007, an appeal was filed with the Haifa District Court. A hearing has not yet been scheduled. b) In the framework of claims filed against Haifa Chemicals Ltd., Oil Refineries Ltd., the Association of Municipalities (Haifa region— Sewage) and the municipality of Haifa that were filed by 95 soldiers of the IDF or their estates for allegedly becoming ill with various types of cancer as a result of their exposure to the water of the Kishon river, Haifa port, Shemen coast and surrounding waters during their military service, in 2005, a joint notice was filed on behalf of the defendants against multiple third parties, among whom the Company. This notice is aimed at consolidating individual notices filed by certain of the defendants. As in the claim discussed in a) above, the Company was added as one of the third parties since it is alleged that its power station in Haifa contributed to the pollution of the Kishon’s waters. As of the date of signing these financial statements, the aggregate number of plaintiffs in these claims amounts to 76 after several claims have been rejected both at the request of the defendants and third parties due to the failure to comply with the court’s decisions and at the request of the plaintiffs. In 2007, another claim was filed, consolidating 17 claims by soldiers or estates against the same defendants in the existing claims and against their insurers. In these claims also, a joint notice was filed by the defendants, Haifa Chemicals Ltd., Oil Refineries Ltd., the Association of Municipalities (Haifa region—Sewage) and the municipality of Haifa against multiple third parties, among whom the Company. This claim will be heard separately from the remaining soldiers’ claims, and will focus on the origination of the damage issue. The plaintiffs allege that they contracted cancer and other diseases and some of them, as aforesaid, passed away with the passage of time. Among others, the claimants have attached to their claim a research results report that was prepared by the Greenpeace Global Organization, pursuant to which the waters of the Kishon contain high concentrations of heavy metals that are hazardous to one’s health; an environmental standard for the quality of the Kishon’s waters that was prepared in

F-133 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 21: COMMITMENTS, CLAIMS AND CONTINGENT LIABILITIES (continued) b. Claims and contingent liabilities (continued) February 2000, on which the plaintiffs wish to rely; a medical opinion that was prepared by Professor Hod, who considers himself to be an academic expert on Oncology, and which determines that there is a high probability of a direct causal—scientific—medical connection between each of the pollutants found in the water of the Kishon river and the outbreak of the diseases contracted by the plaintiffs. About one third of the plaintiffs are estates and dependents of soldiers who passed away over the years at different ages (part of them passed away 20-30 years ago). It should be noted that in light of the recent ruling of the Supreme Court in the Ettinger case, an estate is eligible for compensation for the loss of earnings for the missing years. In view of this practice, it appears that it is already possible to estimate that the amounts of the compensation for each estate are liable to increase by tens of millions and perhaps hundreds of millions of shekels, each case specifically and according to its circumstances. Since the case involves bodily injury claims, in the framework of which no defined aggregate cash amount was asserted on the date that the claims were filed, as the different parameters of which are the basis for the calculation of the damage for each plaintiff are determined in a clarification procedure of the claim, it is not possible to know at this initial stage what the damage that was caused to each of them is, all the more so what the relative part of each defendant and third party being sued in this claim is. In order to assess the amounts asserted in this claim (as distinguished from the real damage caused to the plaintiffs as stated above, that can not be estimated at this stage), it is necessary to distinguish between the claims by the estates and the claims of the living plaintiffs. With respect to estates, defined amounts are being claimed in the letter of claim in a total of about NIS 110 million. As for living plaintiffs, the letter of claim includes defined amounts for special damage components (loss of earnings in the past, third party assistance in the past, and past expenses) that were caused to the plaintiffs and that, together, amount to about NIS 36 million. On the other hand, the general damages components, which are the principal damages when referring to the living victims (future loss of earnings, future third party assistance, and future expenses), are unknown at this stage, and in the evaluation of the Company’s attorneys, the amounts being claimed amount to between an additional NIS 250 million and NIS 400 million. The amount of non-monetary damage (pain, suffering, and shortened lifespan) asserted in the letter of claim, in spite of it being general damage, is about NIS 2 million per each plaintiff, such that the aggregate amount for all of the living plaintiffs for this damage component amounts to about NIS 126 million. It follows that, in the assessment of the Company’s attorneys, the aggregate amount for the claim is in the range of between NIS 650 million and NIS 800 million, including legal fees and court expenses. The Company’s attorneys point out in their opinion that the reference is only

F-134 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 21: COMMITMENTS, CLAIMS AND CONTINGENT LIABILITIES (continued) b. Claims and contingent liabilities (continued) to a general estimate, based on the assumptions that they make in the absence of data at this stage, that could turn out to be erroneous when the real data are obtained, in a manner that might significantly change this assessment as to the amount of the claim (since, for example, they assume for the purpose of the estimate of the amount claimed for loss of earnings and future earning capability, that the plaintiffs are among a socio-economic level that is higher than the average, and that they earned double the average wages in the market. In addition, they disregard the various benefits that the plaintiffs are receiving and/or will receive in the future from third parties, such as the National Insurance Institute, the Ministry of Defense, etc., where at this preliminary stage, the value of the benefits cannot be estimated). It should be pointed out that the reference is to an assessment of the amount of the claims and not to the assessment of the risk of defendants and third parties in general and the Company in particular, since at this stage data are unavailable that would enable making such an assessment. The Company rejects the above claims and, according to the opinion of its attorneys, it believes that the Company’s claims present it with a good defense against the claims. As stated above, the claims are in the initial stages and in view of their complexity and uniqueness, primarily in everything concerning the types of pollutants that it is alleged that each of the defendant and third party discharged into the Kishon river’s waters and environment, their concentration and the mix created from their being combined and, in addition, the variety of diseases of the plaintiffs and the medical problems in determining the causal relationship between each disease and the Kishon river’s waters, the Company’s attorneys will be able to update their assessment only in the future when they obtain additional data in the course of clarification of the case. In the Company’s opinion, based on the opinion of its attorneys, data that would enable evaluating the Company’s risk are unavailable at this stage. 3. Claims for payment of municipal taxes from the Municipality of Yavne The municipality of Yavne has made several claims demanding the payment of general property tax for 2000 in an amount aggregating NIS 32 million for occupied land located, as alleged, under high voltage and primary power lines. The Company disputes these demands. The dispute is, in principle, significant, and very likely will impact the manner in which the Company is charged general property tax by all of the local authorities, since the line infrastructure for transmitting electricity is located all across the country. The Company filed a counterclaim against the municipality of Yavne, and a hearing on this claim was scheduled as a preliminary court hearing in the District Court at Tel-Aviv. In addition, the municipality of Yavne sent several additional demands concerning the same matter for the years 2001 and 2002, for an additional amount of approximately NIS 78 million. Subsequent to the Company’s application, on September 16, 2003, the Attorney General announced that he would join this procedure.

F-135 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 21: COMMITMENTS, CLAIMS AND CONTINGENT LIABILITIES (continued) b. Claims and contingent liabilities (continued) On October 9, 2003, the Company filed a request to consolidate the hearings on this case with those of two additional cases (in the amount of about NIS 186 million), which also involve in the unlawful charging for electric lines, one by the municipality of Rosh Ha’ayin and the other—by the Givat Shmuel local council. The court ordered the consolidation of the aforesaid cases. On October 12, 2003, the position of the Attorney General, which supports the position of the Company, was furnished to the Company, according to which the electric lines, land beneath them and around them are exempt from the payment of general property tax. The summations were finalized in August 2007 and the parties are now awaiting the verdict. The Company is of the opinion, based on an opinion of its legal advisors and based on the position of the Attorney General, that its claims are grounded from a legal and factual perspective and that its chances for succeeding in the claim are reasonable. 4. Other contingent liabilities The Company held and is holding discussions with the Israel Lands Administration (which commenced in July 2000) with respect to the lease fees for certain real estate properties at the Reading power plant site that it uses and as to which, at this stage, no comprehensive request has been received for the amount of usage fees in their respect, and the Company is unable to estimate if it will be required to pay usage fees for the past, and in case it is so requested, what the amount will be (the Company has not paid such usage fees for at least approximately 20 years). In addition, the Company is unable to estimate the amount which will be determined as lease fees for future use, and if they will be paid as capitalized lease fees or as current lease fees. The Company has not recorded any provisions in the financial statements with respect to the claims described above. 5. Other claims for payment of municipal taxes The Company received demands for municipal taxes for periods prior to the balance sheet date, in amounts exceeding the relevant provision that was recorded in the financial statements by about NIS 878 million. These demands derive from the changes in classification and the increase in the areas being billed. In the Company’s assessment, ultimately it will not ultimately be required to pay these amounts. 6. The Planning and Building Law The Planning and Building Law prescribes that the holders of rights in land who were adversely affected by a zoning plan, are entitled to indemnification from the local committees to the sectors of which this zoning plan applies. In order to set up 400 kilovolt lines, zoning plans are required. The Company undertook to indemnify the local committees to the sectors of which these zoning plans apply for the full amounts that the committees will be obliged to pay to the landowners who will be adversely affected, as stated above (aside from one plan, in which

F-136 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 21: COMMITMENTS, CLAIMS AND CONTINGENT LIABILITIES (continued) b. Claims and contingent liabilities (continued) the burden of indemnification will be divided among the institutional bodies that are involved in the plan). These undertakings for indemnification were delivered after it was made clear to the Company that not providing them would result in the failure to approve the plans or their suspension. As of the balance sheet date, claims are pending against several local committees in an amount of about NIS 522 million, in excess of the provisions that were recorded in the Company’s financial statements. In the Company’s opinion, based on the opinion of its attorneys, which takes into consideration the opinion of the real estate assessor advising the Company with regard to the above claims, if all of its arguments shall be rejected and the Company shall be forced to expend funds for these claims, then the Company’s exposure for these claims will not exceed the provision that was recorded in the financial statements. The Company is of the opinion that should any amounts whatsoever be paid, they will be part of the cost for setting up the relevant transmission lines, and due to the indispensability of the transmission lines, and based on the opinion of its attorneys, if and when the Company pays indemnification with respect to the indemnity letters, the Electricity Authority will be obligated to recognize them in the electricity rate. 7. Contingent assets In January 2005, there was a malfunction at one of the generation units at the Eshkol power station which is operated by natural gas. The repair of the malfunction was completed in June 2005, and during this period the Company used alternative fuels that resulted in an increase in fuel expenses in the amount of about $ 24 million. According to the Company’s insurance policy that covers the Company for cases such as these, the Company filed a claim with the insurance company in an amount of about $ 22 million, which constitutes the cost to the Company in excess of its deductible. The Company did not record a provision for income receivable for this insurance claim. In view of the insurance company’s refusal to pay any kind of compensation, an arbitrator agreed upon by the parties has been appointed. c. Labor disputes 1. In the past, the Company’s workers’ association gave notice of several labor disputes and strikes. The grounds for the labor disputes concern the salary agreements and the intention to carry out structural changes in the electricity sector. The sanctions imposed by the employees as of the date on which these financial statements were signed are: a) Lack of cooperation with the requests by the Company’s management, according to which it is necessary for arrangements to be made for the preparation of separate financial statements for each activity, as required by the directives of the Companies Authority. b) Lack of cooperation with the servicing and operation of the Company’s computer systems (CRM, EMS, DMS, ERP). In view of the above, in April 2007, the Company initiated a collective dispute against the employees in the Haifa Regional Labor Court. This dispute only

F-137 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 21: COMMITMENTS, CLAIMS AND CONTINGENT LIABILITIES (continued) c. Labor disputes (continued) concerned the launching of the fixed assets’ module (AA) in relation to the other computer systems On July 4, 2007, the employees received a warning that if they do not stop their sanctions, the Company will appeal to court with regard to these matters as well. On June 29, 2007, the Haifa Regional Labor Court ruled on the Company’s motion regarding the fixed assets’ module. Pursuant to the ruling, the employees must continue cooperating with the Company’s management for the utilization of the system, testing it and all other data and action that will not allow management to independently operate the system without the employees’ cooperation. The Company filed an appeal with the National Labor Court with respect to the ruling. On October 10, 2007, the National Labor Court rejected the Company’s appeal thereby allowing the employees to continue to desist from operating the fixed assets’ module. The Company is considering its steps in view of this ruling. 2. a) On February 15, 2006, a labor dispute was announced, and on July 5, 2006 notification was made of a strike under the Labor Dispute Settlement Act. The matters under dispute were defined as follows: (1) Structural changes at the Company that are being carried out by the contraction of the Company’s activities, in a manner that presents the employees’ representatives with a fait accompli concerning those changes. (2) Although the structural changes have ramifications on the employees in all aspects, including but not exclusively working conditions, rights, status, occupational security, pension rights and the status of the employees organization, and despite the fact that negotiations between the parties have not been exhausted, unilateral steps are being employed to implement the changes. (3) The demand of the representative employees organization to conduct negotiations and to sign a legally ratified collective agreement that will ensure the safeguarding of the employees and their rights. b) On March 11, 2007, the coordinating and executing committee of the Histadrut approved the labor dispute of July 2006 and as such, this dispute is valid and stands even subsequent to amending the law. c) On March 13, 2007, a notification of strike or a shutdown according to the Labor Dispute Settlement Act was delivered. The matters pertaining to the dispute are as follows: (1) A dead-end in the negotiations for signing a salary agreement for the period from January 1, 2006.

F-138 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 21: COMMITMENTS, CLAIMS AND CONTINGENT LIABILITIES (continued) c. Labor disputes (continued) (2) Undermining collective labor relations due to the Company’s attempts to transfer the workers employed under the collective labor agreement to personal contracts while infringing on the right of organization and on the collective agreement’s status. (3) An exceptional work load imposed on the employees as a result of the Company’s refusal to fill vacant posts. (4) A unilateral freeze of personal definitions of employees by the Company. (5) The employer’s unilateral decision not to grant tenure. (6) ‘‘Foot dragging’’ by the Company’s management with respect to the organization’s demand for transferring employees of the national security department center employed as workers of contractors to the status of Company employees. (7) The organization’s demand for rewarding the tractor employees at the Orot Rabin power station with the unique compensation of shift employees. (8) The employer has acted in mala fide and outside the acceptable work relations while harming the status of the workers organization by making unilateral decisions regarding work conditions. (9) With respect to all the grounds stipulated in (2) through (8) above, the employer refuses to conduct collective negotiations and disregards the organization’s demands to settle the disputes through a collective agreement. The strike was scheduled for March 28, 2007 and thereafter. 3. On October 7, 2007, a notice of a strike in accordance with the Labor Dispute Settlement Act was delivered. The matters in dispute are as follows: a) The employees’ representatives’ demands to secure by contract the risk increment to employees working at the Rutenberg power station and in the settlements around Gaza. b) The employees’ representatives’ demands to receive additional shifts for supervisors in the Southern district. c) The employees’ representatives’ demands to receive a bonus for all Company employees for 2004-2006. d) The employer’s undermining of the organized work by dismissing regular employees in the security department and replacing them by massive hiring of contractual service employees. e) Hindering employee promotion by stopping tenders and consequently imposing additional tasks and duties on employees without adequate compensation. f) The employer’s undermining the status of the representative employees’ organization and the workers’ committee by rescinding understandings and attempting to hinder moves designed to benefit the employees’ wellbeing.

F-139 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 21: COMMITMENTS, CLAIMS AND CONTINGENT LIABILITIES (continued) c. Labor disputes (continued) g) The employees’ representatives’ demands to equalize the terms of professional advancement fund A for administrative employees with professional advancement compensation of similar Government service employees. h) Acting in mala fide and in an unacceptable manner—the employer is undermining the employees’ organization’s status by ignoring and making unilateral decisions that are liable to project on collective work relations and the employees’ terms of employment, wages and rights. Management of the Company believes that even in the event that these labor disputes are not resolved and strikes will commence, the Company’s financial position will not be adversely affected. As for the matter of the restructuring, see section 1.a above. In addition to the above, in the past few months, several legal proceedings have been taking place between the Company’s management, the State, the workers’ representatives and the Histadrut concerning the restructuring in the Electric Corporation. The latest significant verdict granted in this matter, which is still valid and binding to all the parties, is a verdict granted with the consent of the parties on March 18, 2007 by the National Labor Court, stipulating the following: (a) the State, the Company and the Histadrut are willing to enter into negotiations regarding the implications of the restructuring on the employees’ rights and working conditions; (b) an outline was determined for the negotiations and related proposals; (c) at this stage, the employees are not obligated to cooperate in delivering the data required unless they find it appropriate for advancing the negotiations; the employees will continue to collaborate in all matters pertaining to the development of the ERP, EMS and DMS systems but will not be forced to operate them; (d) beyond the above, no organizational steps that might disrupt the Company’s operations will be taken; (e) the pending legal proceedings in the Regional Labor Court and National Labor Court regarding the restructuring have all been stricken. As of the date of issuance of these financial statements, the status of the negotiations between the State, the employees’ representatives and the Company is as follows: the State filed a proposal on its behalf for negotiations and the approval of the authorized bodies for conducting the negotiations on its behalf. The employees have not yet filed a proposal on their behalf and have not submitted their response to the Government’s proposal and are to do so in the coming weeks. Their proposal may also relate to the substance of the restructuring. Concurrently, in the past few months, several hearings have been held in the Regional Labor Court in an attempt to push a different outline for the negotiations between the parties. In the context of a hearing held in the Haifa Regional Labor Court on June 5, 2007, it was decided to hold meetings between the parties in two simultaneous channels (specified in 1(a) above). In view of disagreements regarding the salary negotiations, the employees began sanctions at the natural gas project in Gezer. The Company’s request for an injunction against the sanctions from the Haifa Regional Labor Court was

F-140 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 21: COMMITMENTS, CLAIMS AND CONTINGENT LIABILITIES (continued) c. Labor disputes (continued) rejected and the Company ﬁled an appeal with the National Labor Court. On January 31, 2008, a verdict was rendered in the National Labor Court instructing the employees to begin the gold welding work at the Gezer site without having to ﬁnish the welding work at the site. The Court ordered the parties to continue negotiations on the salary agreement and redirected the case to the Regional Court to discuss the main proceeding in the case. At this stage, the sanctions are maintained on the other hand and on the other, the parties are continuing to negotiate in order to reach agreement as to the wage agreement. 4. Sanctions by the engineers, practical engineers and technicians in the engineering planning department: a) On August 14, 2005, the union of engineers, architects and academics in the technological professions in Israel, gave notice of a labor dispute and notice of a strike to commence on September 4, 2005. The matters under dispute according to the notice are: • An attempt to harm the community of engineers by not including the engineers union in the discussions concerning matters that are related to that community. • The deliberate and bad faith impairment of the scope of work required from the engineers. • That a wage agreement for 2000 and thereafter has not been signed with the engineers. • An attempt to prevent the engineers from receiving relief, consultation and treatment from the engineers committee, through the prevention of the physical conditions that are required. • Discrimination of the engineers by acting differently toward the engineers committee as compared with other workers committee. • All of the grounds in the notice of a labor dispute dated January 30, 2005 that was delivered by the Histadrut, all of which apply to the engineers. b) On September 6, 2005, the engineers and technicians union in the Histadrut gave notice of a strike as of September 21, 2005. The issues involved in the dispute are: • A demand by the representatives of the employees for sincere and good faith negotiations with the engineers union and with the professional union that represents them concerning the anticipated dismissals of tens of technicians and engineers in the planning division. • The lack of an agreement for the transfer of employees from the rank of management to the rank of engineers and technicians. • The disregarding of the engineers union in the holding of negotiations on everything concerning the employees in that sector.

F-141 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 21: COMMITMENTS, CLAIMS AND CONTINGENT LIABILITIES (continued) c. Labor disputes (continued) The Company claims that the reference is to illegal sanctions. Among the actions that were taken in the context of the sanctions: not carrying out top-level controls; disruptions in delivering engineering planning programs to the division for execution of projects; non participation in meetings; shutdown of the computer systems in the engineering planning division.

As the result of the sanctions, on September 21, 2005, the Company notiﬁed the supervisor of labor relations at the Ministry of Industry, Trade and Labor of a protective shutdown of the civilian segment, the mechanical segment, the electrical segment and the sub-stations in the Company’s engineering planning division.

The engineers’ sanctions are still in effect and are manifested by occasional work disruptions.

The protective shutdown has not been activated.

Management of the Company believes that even in the event that these labor disputes are not resolved and strikes will commence, the Company’s ﬁnancial position will not be adversely affected in a material manner. Until the date of signing the ﬁnancial statements, no strikes were initiated arising from these labor disputes. The dispute and strike announcements are still in effect.

NOTE 22: CAPITAL RESERVES December 31, 2007 2006 NIS in millions Capital reserve according to the Securities Regulations – transactions with controlling shareholders: From the sale of land to the Ports and Railway Authority ...... 61 61 From the purchase of the Coal Company (see Note 13.b) ...... (2) (2) Company’s assets renewal reserve (1) ...... 721 721 Capital redemption reserve fund ...... 44 44 Premium on shares ...... 25 25 Reserves from realization of assets ...... 31 31 880 880

(1) The assets renewal reserve represents proﬁts in excess of amounts permitted for payment of dividends under the Concession for 1985 and 1986, which has been designated by the Minister of Energy for the renewal of assets.

The Company has established various reserves pursuant to applicable laws or at the discretion of the Minister responsible for the Company at the time of their establishment. Such reserves, other than the reserves from realization of assets, cannot be distributed as dividends.

F-142 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 23: FINANCIAL INSTRUMENTS

a. Risk Management Purposes and Policies The Company’s activities expose it to various financial risks such as market risk (including foreign currency risk, fair value risk for interest rates and price risk), credit risk, liquidity risk and cash flow risk with respect to interest rates. The Company’s comprehensive risk management plan focuses on activities that reduce to a minimum any possible adverse effects on the Company’s financial performances. The Company utilizes derivative financial instruments in order to hedge against certain exposures to risks. Risk management is performed by Mr. Moshe Bachman, the Acting Vice-President of Finances and Economics (on February 28, 2008, Mr. Harel Ze’ev Belinda was appointed as the Company’s CFO. Mr. Belinda will commence his actual term in the coming weeks. Until he commences his term, Mr. Moshe Bachman will remain in his office as Acting Vice-President of Finances and Economics). Risk management is performed in accordance with the policies approved by the Board of Directors. The risk management department identifies, estimates and hedges financial risks in collaboration with the Company’s operating units. The Board of Directors provides written policies for the overall management of these risks as well as the specific policies regarding certain exposures to risks such as foreign exchange risk, interest rate risk, credit risk and the use of derivative financial instruments and non-derivative financial instruments and investments of excess cash. 1. Currency risk a) The amount of real exposure for linked liabilities denominated in foreign currency that have been assigned to the electricity consumers—the Company will enter into foreign currency hedging transactions (mainly swap and forward transactions) in order to adjust the structure of expenses to the recognized structure of revenues (composition of the Bank of Israel’s basket of currencies). The swap transactions will be undertaken for a period of at least two years while taking into consideration the interest rate gaps between the different currencies with an allowed exposure of up to 15% of the balance of loans in the same currency. b) As for the balance of the Company’s exposure in for liabilities in foreign currency (after the adoption of section a above), the Company will swap its foreign currency liabilities for CPI-linked liabilities by carrying out foreign currency-CPI hedging transactions (mainly swap and forward transactions) and, should the market conditions justify it, foreign currency-NIS transaction in order to reduce its foreign currency exposure. The swap transactions will be performed for a period of at least two years while taking into consideration the inflation rates in Israel and the Western countries and the interest rates in the capital markets. As a rule, transactions will be entered into to cover at least 85% of the remaining exposure so that the exposure amount for each currency will not exceed a cumulative 15% of the balance of loans in same currency. c) In order to allow dynamic implementation of the policy discussed in section b above, and in order to avoid random technical irregularities, the vice president of finances and economics instructed that the amount of

F-143 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 23: FINANCIAL INSTRUMENTS (continued) a. Risk Management Purposes and Policies (continued) exposure for each currency, both for the hedged amount and for the balance of the exposure, will not be above or below 5% of the outstanding loan balance in same currency with the addition of 2% of the remaining loans for each 1% interest gap, even if it is negative, that is to the Company’s debit. d) An irregularity in excess of 15% will be allowed if the amount of the irregularity does not exceed $ 10 million or an equivalent sum in another foreign currency, each currency taken separately. 2. Cash flow risk in respect of interest rates Transactions such as options and IRS transactions in currencies and interest rates will be executed if market conditions indicate profitability/risk reduction. The Company has entered into swap transactions of currencies that are designed to partially reduce the Company’s exposure resulting from the difference between the actual level of liabilities and the structure of the electricity rate (see b below and Note 2.v above). The Company also carries out foreign currency forward transactions for periods of up to 12 months (see Note 18.a above). 3. Credit risk The Company’s cash and cash equivalents are deposited with banking institutions and accordingly, the Company does not anticipate any credit losses from them. The exposure to credit risks from customers is limited given the large number of the Company’s customers and the fact that the Company supplies an essential ongoing service. The Company included allowances for doubtful accounts, which management believes are adequate. Transactions with financial instruments are carried out with banking institutions and the Company does not anticipate any losses resulting from credit risks from them. The Company does not hold or sell financial instruments for trading purposes. 4. Fair value risk in respect of interest rates The Company’s interest rate risk is mainly derived from long-term loans. Loans bearing variable interest rates expose the Group to interest rate risk from cash flows. Loans bearing fixed interest rates expose the Group to interest rate risk from fair value. a) The Company has an interest mix (fixed/variable) dependent on the status of liabilities. The Company has entered into interest swap hedging transactions for swapping fixed interest with variable interest and it reviews the interest trends in capital markets to decide on the timing and scope of these transactions. b) Cash flow due to variable interest rates The variable interest risks (other than the changes in exchange rates discussed above) are immaterial to the Company’s cash flows.

F-144 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 23: FINANCIAL INSTRUMENTS (continued) a. Risk Management Purposes and Policies (continued) 5. Liquidity risk

The Company’s goal is to raise long-term ﬁnancial resources in capital markets in order to be able to ﬁnance the development plans for the electricity sector while maintaining a current cash reserve and credit balances within single borrower limitations of the Israeli bank system.

b. The following are details of open commitments for carrying out foreign currency swap transactions and forward transactions designed to reduce exposure resulting from differences between linkage terms of the commitments and the structure of the electricity rate as of December 31, 2007 and 2006

Swap Forward Transactions (1) Transactions (2) 2007 2006 2007 2006 NIS in millions Purchase of: U.S. dollars ...... 5,826 9,014 7 3,246 Euro ...... 1,588 959 144 1,175 Japanese Yen ...... 1,463 — 138 1,826 Pound Sterling ...... 390 475 156 173 Swiss francs ...... 94 100 — — NIS...... — — 358 1,407 9,361 10,548 803 7,826 In exchange for: Linked NIS ...... 5,338 4,059 — — NIS...... 2,373 4,266 461 5,107 Euro ...... 1,626 1,670 356 116 Pound Sterling ...... 1,269 1,416 — — U.S. dollars ...... 231 263 — 2,705 10,837 11,674 817 7,928

(1) The majority of swap transactions are for a period of up to 10 years.

(2) The majority of forward transactions are for a period of up to 12 months.

– The book value of the above transactions as of December 31, 2007 and 2006 is liabilities of about NIS 1,490 million and about NIS 1,228 million, respectively.

– The fair value of the above transactions as of December 31, 2007 and 2006 is liabilities of about NIS 1,312 million and about NIS 1,293 million, respectively.

– The loss from the ﬁnancial instruments in this item amounts to NIS 886 million and NIS 1,252 million in 2007 and 2006, respectively and the gain from ﬁnancial instruments in 2005 amounts to about NIS 499 million.

F-145 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 23: FINANCIAL INSTRUMENTS AND LINKAGE TERMS OF MONETARY BALANCES (continued)

c. Fair value of ﬁnancial instruments

Book Value Fair Value December 31, December 31, 2007 2006 2007 2006 NIS in millions Financial assets Investments in debentures (1) ...... 1,136 867 1,136 866 Financial liabilities Long-term loans at ﬁxed interest (2)...... 7,584 9,009 8,164 9,724 Other long-term loans at variable interest (3). . 5,789 6,564 5,789 6,564 Marketable debentures (1) ...... 6,780 7,095 7,199 7,535 Non-marketable debentures (2) ...... 19,735 20,259 20,197 21,588 39,888 42,927 41,349 46,277

(1) The fair value is based on quoted market prices in an active market as of the balance sheet date.

(2) The fair value is based on fair interest rates as of the balance sheet dates (the fair value of a long-term loan received, bearing ﬁxed interest is based on the calculation of the present value of cash ﬂows at an interest rate acceptable for a loan of similar characteristics).

(3) The book value approximates fair value.

The carrying amount of cash and cash equivalents, short-term investments, receivables, other current assets, payables and accrued expenses is equivalent to or approximates their fair value.

F-146 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power) NOTE 23: FINANCIAL INSTRUMENTS AND LINKAGE TERMS OF MONETARY BALANCES (continued) d. Report of linkage bases December 31, 2007 Linked to Linked Linked to other to the Linked to Japanese foreign Linked to Non- U.S. dollar the Euro Yen currency the CPI Unlinked monetary Total NIS in millions Assets: Cash and cash equivalents ...... — 1 — — — 455 — 456 Short-term investments ...... — — — — — — — — Trade receivables for sales of electricity ..... — — — — — 3,062 — 3,062 Other current assets...... 550 — — — — 183 39 772 Long-term receivables (not including current

F-147 maturities) ...... 1,409 (263) (515) — 513 838 3 1,985 Long-term deposits ...... — — — — — 1,136 — 1,136 Total ...... 1,959 (262) (515) — 513 5,674 42 7,411 Liabilities: Short-term credit from banks and other credit providers ...... (784) 23 (138) (214) 2,429 419 (52) 1,683 Liabilities to suppliers and service providers. . 181 70 — 1 — 2,252 — 2,504 Other current liabilities ...... 223 61 23 1,772 340 1,207 — 3,626 Obligations due to employee-employer relationships, net ...... — — — — — 746 — 746 Deferred taxes, net ...... — — — — — (85) 4,518 4,433 Long-term liabilities (not including current maturities) (1) ...... 10,934 4,834 1,964 928 18,352 2,971 (250) 39,733 Perpetual debentures ...... — — — — 2,156 — — 2,156 Total ...... 10,554 4,988 1,849 2,487 23,277 7,510 4,216 54,881 Net Total ...... (8,595) (5,250) (2,364) (2,487) (22,764) (1,836) (4,174) (47,470)

(1) a. A portion of the costs for the exposure in or linked to foreign currency is covered by the current electricity rate. b. A portion of the costs for long-term liabilities is capitalized to ﬁxed assets under construction (see Note 28). THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 23: FINANCIAL INSTRUMENTS AND LINKAGE TERMS OF MONETARY BALANCES (continued) d. Report of linkage bases (continued)

December 31, 2006 Linked to Linked Linked to other to the Linked to Japanese foreign Linked to Non- U.S. dollar the Euro Yen currency the CPI Unlinked Total monetary Total NIS in millions Assets: Cash and cash equivalents ...... — — — — — 746 746 — 746 Short-term investments ...... — — — — — 218 218 — 218 Trade receivables for sales of electricity ..... — — — — — 2,969 2,969 — 2,969 Other current assets...... 508 — — — 1 158 667 33 700 Long-term receivables ...... 923 (271) — (133) 134 1,861 2,514 3 2,517 F-148 Long-term deposits ...... — — — — — 866 866 — 866 Total ...... 1,431 (271) — (133) 135 6,818 7,980 36 8,016 Liabilities: Short-term credit from banks and other credit providers ...... (2,458) (345) (1,827) (468) 4,098 3,953 2,953 (57) 2,896 Liabilities to suppliers and service providers. . 195 102 — 1 — 1,232 1,530 — 1,530 Other current liabilities ...... 269 58 25 555 274 1,401 2,582 — 2,582 Obligations due to employee-employer relationships, net ...... — — — — — 737 737 — 737 Deferred taxes, net ...... — — — — — (79) (79) 4,563 4,484 Long-term liabilities (1)...... 12,592 5,206 3,115 1,273 16,223 3,108 41,577 (301) 41,276 Perpetual debentures ...... — — — — 2,169 — 2,169 — 2,169 Total ...... 10,598 5,081 1,313 1,361 22,764 10,352 51,469 4,205 55,674 Net Total ...... (9,167) (5,352) (1,313) (1,494) (22,629) (3,534) (43,489) Total average balance sheet balances, net (2)... (11,183) (6,490) (1,588) (1,237) (21,155) (1,804)

(1) a. A portion of the costs for the exposure in or linked to foreign currency is covered by the current electricity rate. b. A portion of the costs for long-term liabilities is capitalized to ﬁxed assets under construction (see Note 28). (2) The average balance sheet balance is calculated based on quarterly frequency during the reported year. THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 24: REVENUES

Year ended December 31, 2007 2006 2005 NIS in millions Residential ...... 6,583 6,434 6,530 Commercial...... 7,291 6,985 6,973 Agricultural...... 666 660 671 Industrial...... 3,803 3,708 3,849 Water pumping...... 894 871 900 Revenues from the sale of electricity, gross ..... 19,237 18,658 18,923 Add (less): Consumers’ participation in ﬁxed assets ...... (293) — — Collection of pension component ...... — — (992) Collection and provision for regulatory assets . . . 190 (581) (695) Revenues from the sale of electricity, net ...... 19,134 18,077 17,236 Other income ...... 130 111 81 19,264 18,188 17,317

NOTE 25: SALES AND MARKETING EXPENSES

Year ended December 31, 2007 2006 2005 NIS in millions Wages...... 546 518 485 Consumer services...... 129 144 146 Depreciation...... 123 127 114 798 789 744

NOTE 26: ADMINISTRATIVE AND GENERAL EXPENSES

Year ended December 31, 2007 2006 2005 NIS in millions Wages...... 404 397 343 Allowance for doubtful accounts ...... 33 48 74 Allowance for Gas Project...... — 57 — Depreciation and amortization ...... 129 136 108 Others ...... 144 151 135 710 789 660

F-149 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 27: WAGE COSTS

Year ended December 31, 2007 2006 2005 NIS in millions Total wage costs * ...... 4,318 4,211 3,920 Less – wages charged to works at expense of others...... 120 119 89 Less – wages charged to ﬁxed assets under construction ...... 1,595 1,604 1,629 Total wage costs included in statement of operations items, net...... 2,603 2,488 2,202

* Includes a provision for a bonus in the amount of ...... —3157

F-150 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 28: FINANCIAL EXPENSES (INCOME), NET

a. Financial expenses (income), net

Year Ended December 31, 2007 Year Ended December 31, 2006 Year Ended December 31, 2005 Other Other Other financial Erosion of financial Erosion of financial Erosion of expenses liabilities Total expenses liabilities Total liabilities liabilities Total NIS in millions Financial expenses (income) on Debentures (1) ...... 1,819 (1,719) 100 1,906 (1,537) 369 1,797 366 2,163 Loans (2) ...... 830 (836) (6) 878 (437) 441 911 (282) 629 Swap transactions ...... — 886 886 14 1,252 1,266 (6) (493) (499) Loss (gain) from marketable securities ...... (37) 11 (26) (56) (33) (89) (2) — (2) F-151 Others, net...... (117) 71 (46) (191) (36) (227) (208) 49 (159) 2,496 (1,587) 908 2,551 (791) 1,760 2,492 (360) 2,132 Capitalization of financial income (expenses) (3) ...... (405) 378 (27) (394) 214 (180) (423) 177 (246) Transfer of financial expenses (income) to a regulatory asset .... — 1,202 1,202 — 668 668 — 91 91 Financial expenses (income), net ... 2,091 (7) 2,083 2,157 91 2,248 2,069 (92) 1,977

(1) Other ﬁnancial expenses (income) for debentures include amortization of the issuance and related costs, discounts and premiums of debentures in 2007, 2006 and 2005 totaling NIS (87) million, NIS (65) million and NIS 33 million, respectively.

(2) Financial expenses for loans include amortization of the capital raising costs of NIS 43 million, NIS 47 million and NIS 49 million in 2007, 2006 and 2005, respectively.

(3) a. The capitalization rate of the non speciﬁc liabilities during December 31, 2007 is -0.2562%.

b. The capitalization rate of the non speciﬁc liabilities during December 31, 2006 is 1.6283%.

c. The capitalization rate of the non speciﬁc liabilities during December 31, 2004 is 6.7646%. THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 28: FINANCIAL EXPENSES (INCOME), NET (continued) b. Loss (gain) from the erosion of liabilities, net:

Year Ended December 31, 2007 2006 2005 NIS in millions Loss (gain) resulting from the change in CPI for...... (19) — 17 Loss (gain) resulting from differences in the change between the known CPI and the CPI for the balance sheet dates...... (99) (35) 33 Loss from devaluation (gain from revaluation) of foreign currency, net (1) ...... (1,540) (720) (459) Others ...... 71 (36) 49 (1,587) (791) (360)

(1) Net after effect of swap transactions and after the offset of the erosion of deposits of the proceeds from private raisings of capital and other loans deposited in banks.

NOTE 29: OTHER EXPENSES (INCOME), NET

Year Ended December 31, 2007 2006 2005 NIS in millions Capital losses ...... 86 1 41 Provisions for regulatory assets (see Note 3 above) ..... (9) (2) (19) Other income, net ...... (13) (6) (14) Total of other expenses (income), net ...... 64 (7) 8

NOTE 30: NOMINAL FINANCIAL STATEMENTS a. Condensed Balance Sheets

December 31, Note 2007 2006 NIS in millions Current assets...... 7,453 6,952 Long-term receivables...... 612 1,946 Investments in investee companies (excess of losses over investments in investees) ...... 64 55 Fixed assets, net...... 42,776 42,487 50,905 51,440 Current liabilities...... 6,283 6,371 Long-term and extended-term liabilities, net .... 41,635 41,878 Perpetual debentures ...... 2,156 2,098 Shareholders’ equity ...... 30c 831 1,093 50,905 51,440

F-152 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 30: NOMINAL FINANCIAL STATEMENTS (continued) b. Condensed Statements of Operations Year Ended December 31, 2007 2006 2005 NIS in millions Revenues ...... 18,891 17,745 16,549 Cost of operating the electricity system ...... 14,119 12,392 11,538 Profit from operating the electricity system...... 4,772 5,353 5,011 Sales and marketing expenses ...... 776 746 696 Administrative and general expenses ...... 688 752 627 Expenses due to liabilities to pensioners, net ...... 186 139 99 1,650 1,637 1,422 Income from current operations ...... 3,123 3,716 3,589 Financial expenses, net ...... 3,449 2,357 3,110 Other expenses (income), net ...... 36 (12) (6) Income (loss) from current operations before income taxes ...... (362) 1,371 485 Income tax expenses (benefit): deferred ...... (86) 380 176 Income (loss) from current operations after income taxes ...... (276) 991 309 Equity in earnings of affiliated company, net ...... 14 9 8 Net income (loss) ...... (262) 1,000 317

c. Statements of Changes in Shareholders’ Equity

Retained Paid-up earnings share Capital Dividend (accumulated capital reserves provided deﬁcit) Total NIS in millions Balance at January 1, 2005 ..... 12 195 1,461 192 1,860 Net income...... — — — 317 317 Dividends provided for 2005.... — — 736 (736) — Balance at December 31, 2005 . . 12 195 2,197 (227) 2,177 Reclassiﬁcation of perpetual debentures (see Note 2.c.3). . . — (2,084) — — (2,084) Net income...... — — — 1,000 1,000 Dividends provided for 2006.... — — 160 (160) — Balance at December 31, 2006 . . 12 (1,889) 2,357 613 1,093 Net loss...... — — — (262) (262) Balance at December 31, 2007 . . 12 (1,889) 2,357 351 831

F-153 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 31: INFORMATION IN NOMINAL VALUES a. Share Capital Composed as follows:

December 31, December 31, 2007 2006 Issued and Issued and Authorized paid-up paid-up NIS 80,167,387 Ordinary shares of NIS 0.1 par value each (issued and paid-up – 80,164,986 Ordinary shares) ...... 8,016,739 8,016,739 8,016,739 40,053,252 Ordinary ‘‘B’’ shares of NIS 0.1 par value each...... 4,005,325 4,005,325 4,005,325 39,531 unclassiﬁed shares of NIS 0.1 par value each...... 3,953 — — Total ...... 12,026,017 12,022,064 12,022,064

b. Shareholders’ Rights 1. Upon distribution of dividends:

The first five percent – Ordinary shareholders only. to the Ordinary shareholders The next five percent – Ordinary and Ordinary ‘‘B’’ shareholders— equal to the Ordinary percentages, until the cumulative sum of dividends shareholders paid to Ordinary shareholders reaches 10% and Ordinary ‘‘B’’ shareholders reaches 5% annually. The next five percent – Ordinary ‘‘B’’ shareholders—twice the percentage to the Ordinary of Ordinary shareholders, until the cumulative sum shareholders of dividends paid to Ordinary shareholders reaches 15% and Ordinary ‘‘B’’ shareholders reaches 15% annually. The following – Ordinary and Ordinary ‘‘B’’ shareholders—equal percentages percentages.

In the Company’s opinion, shareholders’ rights to dividends relate to the par value of the adjusted share capital. 2. Upon liquidation: The surplus after refund of paid-up share capital to shareholders, ﬁrst to Ordinary shareholders and then to Ordinary ‘‘B’’ shareholders, isto be allocated among shareholders on a proportional basis to the paid-up capital of shares held by each of them at the start of the liquidation. 3. On the date of the ﬁnancial statements, the State of Israel held 120,033,262 Ordinary shares, which represent 99.8% of the paid-up capital of the Company.

F-154 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued)

NOTE 32: FINANCIAL REPORTING PURSUANT TO INTERNATIONAL FINANCIAL REPORTING STANDARDS (‘‘IFRS’’) a. General Following the publication of Accounting Standard No. 29, ‘‘Adoption of International Financial Reporting Standards (IFRS)’’, in July 2006, the Company intends to adopt IFRS starting January 1, 2008. Pursuant to the provisions of IFRS 1, discussing the first-time adoption of IFRS, and given the date on which the Company elected to first adopt these standards, the financial statements that the Company must prepare in accordance with IFRS are the financial statements as of December 31, 2008 and for the year then ended. The date of the Company’s transition to reporting according to IFRS, as defined in IFRS 1, is January 1, 2007 (‘‘the transition date’’), and the opening balance sheet is the balance sheet as of January 1, 2007 (‘‘the opening balance sheet’’). The Company’s interim financial statements for 2008 will also be prepared in accordance with IFRS, including the comparative data. This Note was prepared in accordance with currently known International Accounting and Financial Reporting Standards and their Interpretations, which have been published and will come into effect or can be early adopted on the Company’s first annual reporting date pursuant to IFRS, December 31, 2008. Accordingly, the Company’s management has made assumptions regarding the accounting policies that are expected to be implemented upon preparing the Company’s first annual financial statements pursuant to IFRS for the year ended December 31, 2008. The IFRS that will be in effect or that can be adopted in the financial statements for the year ended December 31, 2008 are subject to changes and the publication of additional interpretations. Consequently, the accounting policies to be implemented in respect of the presented periods will only be finally determined when preparing the Company’s first financial statements pursuant to IFRS as of December 31, 2008. In the context of the opening balance sheet, the Company provided the following disclosures: – Recognition of all assets and liabilities whose recognition is required by IFRS. – De-recognition of assets and liabilities if IFRS do not permit such recognition. – Classification of assets, liabilities and components of equity according to IFRS. – Application of IFRS in the measurement of all recognized assets and liabilities. IFRS 1 further prescribes that the adoption of IFRS in the opening balance sheet will be done retrospectively. Nevertheless, IFRS 1 includes 13 exemptions in respect of which there is no retrospective application requirement. As for the exemptions applied by the Company, see items e.3, e.4 and e.6 below. Changes in the accounting policies retrospectively adopted by the Company in the opening balance sheet pursuant to IFRS compared to the accounting policies prescribed by generally accepted accounting principles in Israel (‘‘Israeli GAAP’’) were recognized directly in retained earnings. Following are the Company’s balance sheets as of January 1, 2007 and December 31, 2007, a statement of operations for the year ended December 31, 2007 and the reconciliations to the Company’s shareholders’ equity, all prepared in accordance with International Accounting Standards. The material reconciliations required for the transition from reporting according to Israeli GAAP to reporting according to IFRS are also disclosed.

F-155 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued)

NOTE 32: FINANCIAL REPORTING PURSUANT TO INTERNATIONAL FINANCIAL REPORTING STANDARDS (‘‘IFRS’’) (continued) b. Balance sheets

December 31, 2007 January 1, 2007 Israeli Israeli GAAP in GAAP in NIS of NIS of Dec’ 2007 Changes IFRS Dec’ 2007 Changes IFRS Note NIS in millions ASSETS CURRENT ASSETS: Cash and cash equivalents . . 456 — 456 721 — 721 Short-term investments ..... — — — 211 — 211 Trade receivables for sales of electricity...... 3,062 — 3,062 2,871 — 2,871 Other accounts receivable – unbilled ...... 2,3a 772 14 786 678 2 680 Inventory – coal and fuel oil...... 1 2,249 (41) 2,208 1,620 1 1,621 Inventory stores ...... 1,6 216 (6) 210 206 — 206 6,755 (33) 6,722 6,307 3 6,310 NON-CURRENT ASSETS: 1,3b, LONG-TERM DEBTS ..... 3c,4,7 1,985 (443) 1,542 2,433 (893) 1,540 INVESTMENTS IN INVESTEES ...... 5 64 (1) 63 57 (1) 56 INVESTMENTS IN DEBENTURES ...... 3a 1,136 (21) 1,115 838 (10) 828 FIXED ASSETS, NET ..... 1,6 58,245 (1,909) 56,336 57,158 (396) 56,762 INTANGIBLE ASSETS, NET ...... 1 789 (1) 788 806 (7) 799 68,974 (2,408) 66,566 67,599 (1,304) 66,295 LIABILITIES AND EQUITY CURRENT LIABILITIES: Credit from banks and others ...... 3d 1,683 18 1,701 2,801 (2) 2,799 Liabilities to suppliers and service suppliers ...... 2,504 — 2,504 1,480 — 1,480 Customer advances, net..... 1 247 (4) 243 270 1 271 Accounts payable and credit balances ...... 4b,8 3,626 (1,560) 2,066 2,497 (540) 1,957 8,060 (1,546) 6,514 7,048 (541) 6,507

F-156 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued)

NOTE 32: FINANCIAL REPORTING PURSUANT TO INTERNATIONAL FINANCIAL REPORTING STANDARDS (‘‘IFRS’’) (continued) b. Balance sheets (continued) December 31, 2007 January 1, 2007 Israeli Israeli GAAP in GAAP in NIS of NIS of Dec’ 2007 Changes IFRS Dec’ 2007 Changes IFRS Note NIS in millions LONG-TERM AND VERY LONG-TERM LIABILITIES, NET: Accrued severance pay, net . 4 746 2,849 3,595 712 2,787 3,499 DEBENTURES AND LIABILITIES TO BANKS: 3d Long-term debentures, net . . 25,897 8 25,905 24,772 8 24,780 Liabilities to banks...... 11,354 (200) 11,154 12,419 71 12,490 Other long-term liabilities. . . 2,009 — 2,009 2,206 — 2,206 Very long-term debentures, net...... 473 2 475 521 1 522 39,733 (190) 39,543 39,918 80 39,998 DEFERRED TAXES, NET 2 4,433 (876) 3,557 4,337 (910) 3,427 PERPETUAL DEBENTURES ...... 2,156 — 2,156 2,098 — 2,098 SHAREHOLDERS’ EQUITY ...... 13,846 (2,645) 11,201 13,486 (2,720) 10,766 68,974 (2,408) 66,566 67,599 (1,304) 66,295

F-157 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued)

NOTE 32: FINANCIAL REPORTING PURSUANT TO INTERNATIONAL FINANCIAL REPORTING STANDARDS (‘‘IFRS’’) (continued) c. Statement of operations Year ended December 31, 2007 Israeli GAAP in NIS of Dec’ 2007 Changes IFRS Note NIS in millions REVENUES...... 1,9 19,264 (468) 18,796 Cost of operating the electricity system: Wages ...... 1,10 1,653 (107) 1,546 Fuels...... 1 9,861 (176) 9,685 Purchases of electricity ...... 1 113 (2) 111 Operation of the generation system ...... 1,11 534 12 546 Operation of the transmission and distribution system...... 1 259 (5) 254 Depreciation and amortization ...... 1,6 3,106 (49) 3,057 15,526 (327) 15,199 Profit from operating the electricity system...... 3,738 (141) 3,597 Sales and marketing expenses Services to consumers – other ...... 1 129 4 133 Wages ...... 1,10 546 (25) 521 Depreciation and amortization ...... 1,6 123 (1) 122 798 (22) 776 Administrative and general expenses Administrative and general – other ...... 1 177 6 183 Wages ...... 1,10 404 (16) 388 Depreciation and amortization ...... 1,6 129 (5) 124 710 (15) 695 Expenses (income) from liabilities to pensioners, net ...... 4 230 (222) 8 1,738 (259) 1,479 Income from current operations ...... 2,000 118 2,118 Financial expenses, net Financial expenses ...... 12 908 1,095 2,003 Capitalization of financial expenses ...... 6,7 (27) (416) (443) Transfer of financial income to a regulatory asset...... 8 1,202 (1,202) — Financial expenses, net ...... 2,083 (523) 1,560 Other expenses, net ...... 64 (64) — Income (loss) before income taxes ...... (147) 705 558 Income taxes: deferred ...... (36) 166 130 Income (loss) from current operations after income taxes ...... (111) 539 428 Equity in earnings of affiliated company, net...... 10 (3) 7 Net income (loss)...... (101) 536 435

F-158 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued)

NOTE 32: FINANCIAL REPORTING PURSUANT TO INTERNATIONAL FINANCIAL REPORTING STANDARDS (‘‘IFRS’’) (continued) d. Reconciliation to equity

Paid share Capital Dividend Retained capital reserves provided earnings Total NIS in millions At January 1, 2007 Israeli GAAP in NIS of December 2006 ...... 940 851 2,358 9,337 13,486 Discontinuance of the adjustment to the CPI of December 2003 ...... (32) (29) — 61 — Derecognition of asset in respect of unamortized actuarial gains and losses ...... — — — (2,905) (2,905) Obligations due to employer-employee relationships ...... — — — (254) (254) Derecognition of regulatory liabilities ...... — — — 557 557 Long-term liabilities and swap transactions ..... — — — (65) (65) Discontinuance of adjustment to the CPI of assets, net ...... — — — (17) (17) Adoption of IAS 17 regarding leased lands ..... — — — (36) (36) IFRS...... 908 822 2,358 6,678 10,766 At December 31, 2007 Israeli GAAP in NIS of December 2007 ...... 972 880 2,358 9,636 13,846 Discontinuance of the adjustment to the CPI of December 2003 ...... (64) (58) — 122 — Derecognition and update of asset in respect of unamortized actuarial gains and losses ...... — — — (2,639) (2,639) Obligations due to employer-employee relationships ...... — — — (241) (241) Derecognition of regulatory liabilities ...... — — — 1,329 1,329 Long-term liabilities and swap transactions ..... — — — 107 107 Discontinuance of adjustment to the CPI of assets, net ...... — — — (1,495) (1,495) Burdening of ﬁxed asset costs ...... — — — 312 312 Burdening of software costs...... — — — 20 20 Adoption of IAS 17 regarding leased lands ..... — — — (38) (38) IFRS...... 908 822 2,358 7,113 11,201

e. Additional information 1. Functional currency Pursuant to IAS 21, ‘‘Effects of Changes in Foreign Currency Exchange Rates’’, the Company was required to determine its functional currency based on the economic environment in which it operates according to the criteria prescribed by IAS 21. The Company’s management has concluded that the Company’s functional currency and the presentation currency of its ﬁnancial statements is the New Israeli Shekel (‘‘NIS’’). Hence, there has been no change in the Company’s functional currency. As for the presentation currency, see below.

F-159 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued)

NOTE 32: FINANCIAL REPORTING PURSUANT TO INTERNATIONAL FINANCIAL REPORTING STANDARDS (‘‘IFRS’’) (continued) e. Additional information (continued) The Company has presented its financial statements in accordance with the Securities Regulations (Preparation of Annual Financial Statements), 1993 and according to Israeli GAAP. On September 14, 2004, the Minister of Finance enacted the Government Companies Regulations (Principles for the Preparation of Financial Statements of the Israel Electric Corporation Ltd.) (Temporary Order), 2004, (‘‘the Regulations’’), in accordance with his legal authority, as above. Under the Regulations, it was determined that during the period commencing January 1, 2004 and ending December 31, 2005 (‘‘the transition period’’), the Company will prepare its financial statements adjusted for the changes in the general purchasing power of the NIS, in accordance with principles prescribed in Opinion No. 36, including the provisions that were prescribed in Opinions Nos. 40, 50 and 56 of the Institute of Certified Public Accountants in Israel. On June 12, 2006, the Minister of Finance enacted regulations that extend the above transition period until December 31, 2007. Accordingly, the Company measured its assets, liabilities and operating results in NIS adjusted for the changes in the general purchasing power of the NIS through December 31, 2007. According to IFRS, the adjustment of the financial statements was discontinued in December 2003. Consequently, in reporting non-monetary items in the financial statements (balance sheet and statement of operations) pursuant to IFRS, there will be a change owing to the discontinuance of the adjustment to inflationary changes. As for the date of the discontinuance of the adjustment of fixed assets, see 6 below. 2. Deferred taxes According to Israeli GAAP, deferred tax assets and liabilities were presented in the short term under other accounts receivable. Upon the transition to IFRS, according to IAS 12, ‘‘Income Taxes’’, deferred tax balances are presented as non-current assets and non-current liabilities. As a result of the above, deferred taxes previously presented in other accounts receivable were reclassified to deferred taxes under non-current liabilities. 3. Financial assets and liabilities a) Investments in marketable securities According to accepted accounting principles in Israel, the investments in marketable securities were presented at market value. Upon the transition to IFRS, the Company has decided to adopt the exemption prescribed by IFRS 1 in the matter of designating transactions in financial instruments even though such designation was not performed upon initial recognition. Consequently, a portion of the remaining debentures was classified as held to maturity and was presented at amortized cost. The remaining investment in securities is presented at market value. Accordingly, the balance of other accounts receivable in respect of current maturities of premium and interest receivable on held-to-maturity debentures as of January 1, 2007 and December 31, 2007

F-160 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued)

NOTE 32: FINANCIAL REPORTING PURSUANT TO INTERNATIONAL FINANCIAL REPORTING STANDARDS (‘‘IFRS’’) (continued) e. Additional information (continued) increased by approximately NIS 6 million and NIS 8 million, respectively. The change as of January 1, 2007 was partly carried to retained earnings in the amount of approximately NIS 5 million and partly against deferred taxes in the amount of NIS 1 million. Furthermore, the balance of investments in debentures as of January 1, 2007 and December 31, 2007 decreased by approximately NIS 10 million and NIS 21 million, respectively. The change as of January 1, 2007 was partly carried to retained earnings in the amount of approximately NIS 7 million and partly against deferred taxes in the amount of NIS 3 million. b) Swap and forward transactions According to Israeli GAAP, the Company presented swap transactions at their liability value. Upon the transition to IFRS, the swap transactions are presented at fair value and their results are carried to profit and loss. Consequently, the balance of long-term receivables in respect of swap transactions as of January 1, 2007 and December 31, 2007 decreased by approximately NIS 13 million and NIS 27 million, respectively. The change as of January 1, 2007 was partly carried to retained earnings in the amount of approximately NIS 10 million and partly against deferred taxes in the amount of NIS 3 million. c) Embedded derivatives According to Israeli GAAP, the Company did not separate embedded derivatives from compound contracts. Upon the transition to IFRS, the Company separated the embedded derivatives from the compound contracts and measured them at fair value. The changes in fair value were carried to the income statement. As a result of the separation of the embedded derivatives in loan contracts, the balance of long-term receivables increased as of January 1, 2007 and December 31, 2007 by approximately NIS 8 million and NIS 13 million, respectively. The change as of January 1, 2007 was partly carried to retained earnings in the amount of approximately NIS 6 million and partly against deferred taxes in the amount of NIS 2 million. d) Debentures and liabilities to banks According to Israeli GAAP, the Company presented swap and forward transactions at their liability value. Upon the transition to IFRS, the swap and forward transactions are presented at fair value and their results are carried to profit and loss. Furthermore, according to Israeli GAAP, the Company presented deferred charges in respect of credit raising as adjusted for the CPI until December 31, 2007. Upon the transition to IFRS, the Company discontinued the adjustment of data to inflationary changes (see 1 above). Consequently, the balances of debentures and liabilities to banks increased as of January 1, 2007 by approximately NIS 80 million and decreased as of December 31, 2007 by approximately NIS 190 million. Also, as a result of the above, the balances of credit from banks and other

F-161 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued)

NOTE 32: FINANCIAL REPORTING PURSUANT TO INTERNATIONAL FINANCIAL REPORTING STANDARDS (‘‘IFRS’’) (continued) e. Additional information (continued) credit providers decreased as of January 1, 2007 by approximately NIS 2 million and increased as of December 31, 2007 by approximately NIS 18 million.

The change as of January 1, 2007 was partly carried to retained earnings in the amount of approximately NIS 59 million and partly against deferred taxes in the amount of NIS 19 million.

e) Index-linked ﬁnancial assets and liabilities

The Company has Consumer Price Index (CPI)-linked financial assets and liabilities that are not measured at fair value through profit or loss. For those assets and liabilities, the Company determines the effective interest rate as a real rate plus linkage differences according to the actual changes in the CPI up to the balance sheet date. This is the same approach taken under Israeli GAAP in the past. As of the balance sheet date, the Company had such CPI-linked financial liabilities in a total of NIS 15,422 million.

A different interpretation of IFRSs exists that would require the effective interest rate for such assets and liabilities to include the anticipated inﬂation through the applicable payment dates (as opposed to accruing the real interest plus linkage differences based on the actual changes in the CPI up to the balance sheet date).

In Israel, the vast majority of medium and long term loans and borrowings are CPI-linked. Therefore, the Israel Accounting Standards Board is submitting an inquiry to the International Financial Reporting Interpretations Committee (IFRIC) to clarify the method that should be applied for measuring the effective interest rate for such assets and liabilities under IFRSs. It is not possible to reliably predict IFRIC’s response to this issue and its implications. If IFRIC’s response will show that the current practice followed in Israel (as described in this Note) is not appropriate under IFRSs, the Company would then be required to change the measurement of such assets and liabilities, possibly through a restatement to its ﬁnancial statements. In the current circumstances, the Company is unable to reliably assess the potential impact on its ﬁnancial statements should that be the case.

4. Employee beneﬁts

a) In the absence of a speciﬁc accounting standard in Israel that addresses the accounting treatment of unrecognized actuarial gains and losses, the Company previously adopted the deployment principle of IAS 19 concerning the date of recognizing actuarial changes only and did not adopt the full provisions of IAS 19, including in the matter of calculating the assets and liabilities in respect of employee beneﬁts.

Upon the transition to IFRS, the Company is implementing the provisions of IAS 19 in full.

F-162 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued)

NOTE 32: FINANCIAL REPORTING PURSUANT TO INTERNATIONAL FINANCIAL REPORTING STANDARDS (‘‘IFRS’’) (continued) e. Additional information (continued) The principal changes arising from the transition to the full adoption of IAS 19 are as follows:

1) Actuarial calculation of employee benefits in respect of whom a liability was previously included without an actuarial calculation and presenting them at their current value, and adding the reduced electricity rate benefit at the full value of the benefit compared to only carrying marginal cost in the past. Consequently, the balance of liabilities in respect of employer-employee relationships, net increased as of January 1, 2007 and December 31, 2007 by approximately NIS 257 million and NIS 235 million, respectively.

2) The liabilities in respect of redeeming and utilizing vacation days accumulated by the employees were calculated based on the employees’ salaries for the balance sheet month and presented under obligations due to employer-employee relationships, net. Upon the transition to IFRS, the liabilities are presented in other accounts receivable. Consequently, the balance of this item increased as of January 1, 2007 and December 31, 2007 by approximately NIS 240 million and NIS 249 million, respectively.

Upon the transition to IFRS, the Company resolved to adopt the exemption prescribed by IFRS 1 allowing it to accumulate actuarial gains and losses from the transition date only instead of recalculating the accumulated balances as of the date of transition by adopting IAS 19 retrospectively. Consequently, as of January 1, 2007 and December 31, 2007, the Company wrote off an asset in respect of unrecognized actuarial gains and losses of approximately NIS 3,873 million and NIS 3,518 million, respectively.

As a result of the above, the balance of long-term receivables decreased as of January 1, 2007 and December 31, 2007 by approximately NIS 1,221 million and NIS 778 million, respectively and the balance of liabilities in respect of employer-employee relationships, net increased as of January 1, 2007 and December 31, 2007 by approximately NIS 2,787 million and NIS 2,849 million, respectively. The change as of January 1, 2007 was partly carried to retained earnings in the amount of approximately NIS 3,006 million and partly against deferred taxes in the amount of NIS 1,002 million.

b) According to the provisions of IAS 19, the discount rate for the calculation of pension liabilities is determined by using market returns at the end of the reported period on high quality corporate bonds. In countries where there is no deep market for such high quality bonds, the market returns on government bonds are used. Until the date of the approval of these ﬁnancial statements, the examination (conducted by government authorities) of the existence or absence of a deep market for high quality corporate bonds is still underway.

F-163 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued)

NOTE 32: FINANCIAL REPORTING PURSUANT TO INTERNATIONAL FINANCIAL REPORTING STANDARDS (‘‘IFRS’’) (continued) e. Additional information (continued) In the calculation of pension liabilities, at this stage, the Company utilized the appropriate discount rate for market returns on government bonds (as previously performed by the Company prior to the transition to IFRS reporting). If said examination does not determine that there is no deep market in Israel for high quality corporate bonds, the Company will have to restate its pension liabilities by using the appropriate discount rate for market returns on AA rated corporate bonds. In Israel, there are currently no special publications of data required for the specific calculation of pension liabilities according to market returns on corporate bonds. According to data published by Interest Rates (which was selected by the Capital Markets and Savings Division of the Finance Ministry to quote interest and return data for the benefit of institutional entities), with respect to every future range of time there is a different margin between the rate of return on AA rated corporate bonds and the rate of return on government bonds. With respect to the Company’s pension liabilities, said weighted average margin data for the end of 2007 are between 2% and 2.4% and the average effect of each 0.1% of this margin is a reduction of pension liabilities of approximately NIS 270 million and an increase in shareholders’ equity of approximately NIS 180 million. At the beginning of this year, the weighted average margin data are between 1.5% and 1.9% and the average effect of each 0.1% of this margin is a reduction of pension liabilities of approximately NIS 280 million and an increase in shareholders’ equity of approximately NIS 210 million. 5. Investments in investee companies The Company does not consolidate the financial statements of the Coal Company due to immateriality. The investment in the Coal Company will continue to be presented at equity. The investment was calculated based on the financial statements of the Coal Company following the adoption of IFRS. 6. Fixed assets According to Israeli GAAP, the accounting treatment of fixed assets included, among other things, the following principles: • Measuring fixed assets and presenting them in NIS adjusted for the changes in the general purchasing power of the NIS up to December 31, 2007 (see 1 above). • Capitalizing borrowing costs pursuant to the provisions of Accounting Standard No. 3. • Capitalizing salary costs to fixed assets under construction. Upon the transition to IFRS, the accounting treatment of fixed assets includes, among other things, the following principles: • The discontinuance of the adjustment of data in the financial statements to inflationary changes. Consequently, the balance of fixed assets as of December 31, 2007 decreased by approximately NIS 1,898 million.

F-164 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued)

NOTE 32: FINANCIAL REPORTING PURSUANT TO INTERNATIONAL FINANCIAL REPORTING STANDARDS (‘‘IFRS’’) (continued) e. Additional information (continued) • The capitalization of borrowing costs pursuant to IAS 23 according to which all the exchange rate and interest differences in respect of loans in foreign currencies should be capitalized as long as these expenses do not exceed the alternative financing costs in the local currency and at least, the amount of interest expenses in the relevant period. In 2007, the Company capitalized to fixed assets a minimal amount of interest expenses incurred in the period in respect of loans in foreign currencies. Consequently, the balance of fixed assets as of December 31, 2007 increased by approximately NIS 390 million. • Recording salary costs in investments pursuant to IAS 19 and all their components (salary components, various grants etc.) both for costs arising from post-retirement obligations and for costs arising from obligations during the employment period. Consequently, the balance of fixed assets as of December 31, 2007 decreased by approximately NIS 62 million. • Due to additional changes, the balance of fixed assets as of December 31, 2007 increased by approximately NIS 88 million. • As for lased lands, see 7 below. The change as of January 1, 2007 was partly carried to retained earnings in the amount of approximately NIS 1,432 million and partly against deferred taxes in the amount of NIS 477 million. Upon the transition to IFRS, the Company has opted for the exemption allowed by IFRS 1 according to which it may present fixed assets at fair value, as explained below, instead of at cost. Article 17 to IFRS 1 stipulates that upon the initial adoption of IFRS, the value of fixed assets can be determined according to previously accepted accounting principles on or prior to the transition date as deemed cost provided that said value (on such date) was broadly comparable to the depreciated cost pursuant to IFRS, retrospectively revalued according to previously accepted accounting principles. The Company’s examination revealed that the depreciated cost that would have been received under IFRS as of January 1, 2007 is higher than the depreciated cost in the financial statements prepared in accordance with Israeli GAAP. Accordingly, as a result of the test of the impairment of assets performed at December 31, 2006 pursuant to the provisions of IAS 36, the value in use of the assets approximates the depreciated cost in the books on that date. Hence, the amount of depreciated cost in the books as of December 31, 2006 can be established as deemed cost on that date. As of January 1, 2007, the Company manages the data pursuant to IFRS based on the provisions of IAS 16 and all of the above. 7. Land leased from the Israel Lands Administration According to Israeli GAAP, land leased from the Israel Lands Administration was presented under fixed assets in the amount of the capitalized lease fees paid. The Company did not depreciate this amount.

F-165 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued)

NOTE 32: FINANCIAL REPORTING PURSUANT TO INTERNATIONAL FINANCIAL REPORTING STANDARDS (‘‘IFRS’’) (continued) e. Additional information (continued) Upon the transition to IFRS, according to IAS 17, leases of land where there is no transfer of ownership over the real estate at the end of the lease period will be classiﬁed as operating leases under intangible assets. The balance of leased lands was calculated retrospectively according to the capitalization fees paid and depreciated over the lease period, including the option period, if any.

As a result of the discontinuance of said measurement and depreciation, as of January 1, 2007 and December 31, 2007, the balance of ﬁxed assets decreased by approximately NIS 396 million and NIS 427 million, respectively and the balance of long-term debts increased by approximately NIS 333 million and NIS 349 million, respectively. The change as of January 1, 2007 was partly carried to retained earnings in the amount of approximately NIS 47 million and partly against deferred taxes in the amount of NIS 16 million.

8. Regulatory liabilities

In the absence of a speciﬁc accounting standard in Israel relating to companies whose rates are regulated, the Company previously applied the provisions of the American accounting standard SFAS 71 allowing, under certain conditions, a different accounting treatment than the accepted accounting treatment with respect to the timing of recording expenses and revenues in proﬁt and loss.

Upon the transition to IFRS, the Company ceased applying the provisions of SFAS 71 and derecognized the remaining regulatory liabilities (and will not create new regulatory assets/liabilities in the future).

Consequently, as of January 1, 2007 and December 31, 2007, the balance of other accounts receivable decreased by approximately NIS 743 million and NIS 1,772 million, respectively. The change as of January 1, 2007 was partly carried to retained earnings in the amount of approximately NIS 557 million and partly against deferred taxes in the amount of NIS 186 million.

9. Revenues

The main effects on this item result from a decrease of approximately NIS 358 million resulting from the discontinuance of the adjustment to the CPI (see 1 above) and writing off approximately NIS 190 million recorded as collection and provision for regulatory liabilities (see 8 above), offset by an increase in revenues arising from revenues from reduced electricity rates to employee totaling approximately NIS 80 million (see 4 above).

10. Salaries

A decrease in salary costs in the income statement of approximately NIS 148 million in the period. This change arises from cross effects in respect of the discontinuance of the adjustment to inﬂation and from changes in liabilities in respect of employee retirement and writing off an asset in respect of unamortized actuarial gains and losses (see 4 above) on the one hand and recording the full beneﬁt of electricity at reduced rates for employees on the other.

F-166 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued)

NOTE 32: FINANCIAL REPORTING PURSUANT TO INTERNATIONAL FINANCIAL REPORTING STANDARDS (‘‘IFRS’’) (continued) e. Additional information (continued) 11. Operation of the generation system

An increase in this item arises mainly from the classiﬁcation of capital losses from the sale of ﬁxed assets that were previously disclosed under Israeli GAAP under other expenses, net.

12. Financial expenses

According to Israeli GAAP, the Company recorded real ﬁnancial expenses. Upon the transition to IFRS, the Company records nominal ﬁnancial expenses.

13. Subsequent events

Subsequent to balance sheet date, there was a revaluation of the NIS in relation to the U.S. dollar to which the Company is exposed in its net liabilities, which generated ﬁnancial income in respect of these liabilities in the period from balance sheet date through March 25, 2008 in an amount of approximately NIS 723 million.

NOTE 33: SUBSEQUENT EVENTS

The following events took place subsequent to the balance sheet date, beyond what is disclosed in the above notes:

a. Capital Raisings

1. On January 17, 2008, the Company issued debentures through Goldman Sachs International and Dexia Credit Local to foreign investors in a total of $250 million. The debentures were listed for trade on the Singapore Stock Exchange. The principal of the issued debentures will be repaid in one installment at the end of ten years from the issuance date. Moreover, in the context of the transaction, Goldman Sachs International and Dexia Credit Local were granted a right to demand that the Company issue additional debentures for periods of either ten or twenty years in an overall amount not exceeding another $750 million, this for a period commencing at the end of three months and terminating at the end of nine months from the initial issuance date under agreed upon terms.

2. On March 18, 2008, the Company issued to institutional investors by way of private placement CPI-linked non-marketable debentures of the ‘‘2014 Linked Electric’’ series with an overall par value of approximately NIS 170 million in consideration of approximately NIS 181 million for a period of six years under standard interests for the Company’s capital raising rounds.

b. In February 2008, an agreement was signed for the special early retirement of up to 300 employees, see Note 17.a above.

F-167 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued)

NOTE 34: ADDITIONAL INFORMATION REQUIRED UNDER THE PROVISIONS OF THE GOVERNMENT COMPANIES AUTHORITY Pursuant to the provisions of the Companies Authority published in the Financial Statements Circular 2007 – 1, the Company is required by the Companies Authority, in accordance with its authority pursuant to the Government Companies Law (see Note 1.c above), among other things, to include additional information (beyond the information required in the financial statements according to generally accepted accounting principles) as follows: a. According to the Government’s decision of August 5, 2004, with respect to the general accounting standards for Government companies is the same as for the private sector. The unique standards for Government companies aim to supplement the private sector’s standards or to elaborate or highlight certain issues regarding Government companies as detailed in the Companies Authority’s circulars. The unique standards for Government companies will be executed in accordance with the law. b. The Companies Authority determined targets for the Company whereby the Company will include in its financial statements material financial information that is relevant to the State and the other users of the financial statements in order to reach economic decisions in a manner that the information will more adequately reflect the economic essence of the events and transactions in carrying out the set targets and will include comparable and consistent information for prior periods. The Company will report the following issues: 1. The targets established (see section 2.a(7), P. 6 of the Circular) whether by legislation, the Government’s decisions or by an authority qualified by law to set targets and by agreements between the State or any of its institutions and the Company. 2. The monetary execution of the targets established, including the performance rate in the event that the targets and related rate can be quantified according to a reasonable estimate. 3. Financial restrictions and difficulties that arose in the course of achieving the targets and the monetary implications of these restrictions and difficulties. 4. In the event that the Company grants a right that is to limit the State, as discussed in Section 11.a(9)(a) to the Law, it will specify the limitations, the reasons and feasibility for creating such limitations and the description of the approvals granted pursuant to the Law. If not, the proper disclosures and explanations will be provided. 5. In the event that the targets established for the Company contain financial targets, including targets for meeting recognized normative costs, they will be disclosed, including the normative costs and differences between these costs and actual costs as they are presented in the financial statements. – As for compliance with minutes of supply failure, see Note 3.e below. – As for targets established by the Government’s decisions, the policy document and Amendment No. 5 to the Law (see Note 1.a), these were designated by their issuers to allow, among other things, the following: – The transmission and distribution rates will permit a suitable rate of return on capital and the financial stability of the transmission, system management and distribution companies. – To cause that by January 1, 2012, the holding company’s holding percentage in each of the generation companies will decline to 51% by way of offerings to the public.

F-168 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued)

NOTE 34: ADDITIONAL INFORMATION REQUIRED UNDER THE PROVISIONS OF THE GOVERNMENT COMPANIES AUTHORITY (continued) – Upon the sale of 49% of the holding company’s holdings in the generation companies, the holding company will be allowed to engage in water desalination according to the Company’s accepted rules for this line of business.

– The recognized costs of the restructuring will be expressed in the future electricity rates.

– The sale of the assets to the new companies will be done such that the assets and revenues that the Company will have subsequent to the restructuring, both directly and indirectly, through its holdings in the subsidiaries to be established, will allow the repayment of its debts to creditors.

The Minister, in consultation with the Electricity Authority, may demand that a holder of such license submit a development plan, integral or segmented, for his approval for the purpose of its activities as provided by the license and if such a development plan is not submitted to the Minister’s approval, such a plan will be designed for the licensee in consultation with the Electricity Authority and the licensee will have to abide by it.

The Minister is entitled to enact regulations concerning the responsibility of the holder of a transmission license for developing the electricity sector, pursuant to the development plan, including planning the electricity network.

– Following are data on ﬁnancial targets that have been set:

a) Financial leverage

The Electricity Authority has determined a normative financial leverage ratio (for the financing of assets without assets under construction) between the shareholders’ equity and the foreign capital of 1:2 (for the purpose of the rate, the Electricity Authority refers to the deferred taxes as being part of the shareholders’ equity). The ratio that is reflected in the financial statements as of December 31, 2007 is similar to the ratio that was determined by the Electricity Authority—1: 2.01. The payment of the dividend that was provided for and not yet distributed from the Company’s earnings in the amount of NIS 2.35 billion would change this ratio to one of 1:2.31.

b) Meeting the target determined in the electricity rate regarding the ratio of the exposure between the foreign currency liabilities and the NIS liabilities

The Electricity Authority determined that the composition of the foreign capital linked to the basket of currencies out of the total recognized foreign capital, will be reduced annually from 70% in 2002, down to 50.61% in 2007. The ratio that is reﬂected in the ﬁnancial statements as of the balance sheet date is 56.07% (net after hedging transactions— 34.60%).

F-169 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued)

NOTE 34: ADDITIONAL INFORMATION REQUIRED UNDER THE PROVISIONS OF THE GOVERNMENT COMPANIES AUTHORITY (continued) c) The rate of return on shareholders’ equity

According to the rate policy, the Electricity Authority decided that the annual rate of return on the shareholders’ equity will be 7% for the generation segment, 5.5% for the transmission segment and 6.2% for the high and low voltage distribution segments. As of the balance sheet date, the annual rate of return on shareholders’ equity amounts to a return of 3.4% for the generation segment, a negative return of 0.67% for the transmission segment and a negative return of 7.48% for the high and low voltage distribution segment, see Note 3.b below (this is in accordance with Company’s ﬁnancial statements according to the generation, transmission and distribution operating segments, see Note 35 below).

d) The Company was required to meet certain deadlines for ﬁling an annual and multi-annual work plan and budget with the ministers and the Companies Authority (pursuant to Sections 32, 33.b and 34(a1) to the Government Companies Law, that include, among other things, the implications of the restructuring in the electricity sector. Due to employee sanctions, at this stage, the Company is unable to prepare any business plan that will include the structural changes as required and it intends to prepare such a plan as soon as it becomes possible.

The Company’s Board of Directors has discussed a preliminary draft of a business plan that includes assumptions that do not coincide with the effects of the adoption of Amendment No. 5 and the Government’s decisions regarding the restructuring and does not include the information required as above.

c. A Government company will provide disclosure in its ﬁnancial statements regarding the Companies Authority’s policies as to the distribution of dividends out of the Company’s earnings (as for the disclosure in accordance with the requirements of this item, see Note 1.e above).

d. A company is required to perform full reconciliation of the balances with the State, its authorities, other Government companies and interested parties. If written balance conﬁrmations were not received from the authorized parties, as stated above, the company will provide disclosure regarding this in its ﬁnancial statements, subject to materiality.

At the end of 2007, the Company filed applications for balance confirmations from 130 customers and 91 suppliers which meet the above criteria, of which it did not receive confirmations from 30 customers and did receive confirmations from 30 suppliers, all corresponding to the balances in the Company’s books. The Company also received one confirmation from a customer and one confirmation from a supplier that did not match the balances in its books. The Company is holding inquiries in order to match the balances. Reconciliations were made with the Coal Company and with Natural Gas Lines as of the balance sheet date.

F-170 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued)

NOTE 34: ADDITIONAL INFORMATION REQUIRED UNDER THE PROVISIONS OF THE GOVERNMENT COMPANIES AUTHORITY (continued) e. A company will provide disclosure regarding assets (attached and detached) in its financial statements as specified below: 1) The company will provide proper disclosure in the financial statements of its rights to material assets (land and attached), which it holds or that are operated/held by it for the State or others , including assets that are or were in dispute with any of the Government authorities regarding the rights to them. This disclosure shall include the details of the Company’s rights to those assets (freehold, leasehold and respective dates, in trust or other rights) as well as conditions, limitations or commitments that the Company has in connection with the above assets (the obligation to transfer the assets to the State, the obligation to receive approval for transferring the rights thereto etc.). 2) Details of the State’s rights to the above assets. 3) Details of others’ rights to the above assets. 4) The dates on which the rights discussed in a) through c) above were created. 5) The status of records or approvals granted or received with respect to these rights, such as registration or confirmation of ownership or lease or trust, protected lease, or license, orders for seizing/closing/other, recording caveats with the Land Registry Bureau or any other relevant place and pursuant to any law. 6) Any existing disputes over the assets and rights attached thereto. 7) A company will provide disclosure in the financial statements of the implementation of the directives of the Companies Authority regarding control and reporting rules for land and attached assets in Government companies in accordance with the Financial Statement Circular 2006-3 of September 17, 2006. The information required above is not included in the financial statements due to employee sanctions (see Note 21). In a letter to the director of the Companies Authority dated January 10, 2007, the Company’s CEO states that back in 1998, the Company stated that it was preparing to collect the extensive amounts of material required. Furthermore, in 1998, a list of the Company’s assets was transferred to the Ministry of Finance as of the date of the expiration of the concession and since then and to date, the list of added assets is immaterial in relation to total assets and is irrelevant with relation to the assets arrangement prescribed by the Electricity Sector Law. In addition, the Company does not possess all of the required information as of today due to various problems in registering the many assets that have been accumulated by the Company over tens of years and due to the considerable costs and duration required to issue assessments, current measurements and other planning information for the thousands of assets held by the Company, as required by the Companies Authority. The CEO also mentioned that in meetings held with the Companies Authority and representatives of the Company’s management in negotiations regarding the restructuring, the representatives of the workers committee announced that they would not allow giving out information to the State or transferring any documents in connection with the Company’s assets, etc.

F-171 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued)

NOTE 34: ADDITIONAL INFORMATION REQUIRED UNDER THE PROVISIONS OF THE GOVERNMENT COMPANIES AUTHORITY (continued) 8) A company will provide proper disclosure in the financial statements of the existence of real estate properties that are not economically used for the Company’s operations and their use in relation to potential is partial and/or the consideration for them is partial and does not reflect adequate real proceeds. To the best of the Company’s knowledge, it will not sustain any material financial losses as above. Regarding certain assets (mostly administrative buildings), which are not populated, the Company has taken measures to realize them by way of sale or lease. 9) A company will provide proper disclosure in the financial statements and the directors’ report regarding the actions involved in the location, identification and registration of the assets during the reported period and of the aforesaid actions that are to be taken and were not yet carried out. At the Company’s initiative, during the last few years, an intensive, focused and continuous procedure was begun to gather and coordinate all of the information on all of the Company’s assets, which were scattered among departments and districts, including the transformation stations, mobile/temporary/leased facilities, etc., and to organize them as to everything related to establishing an assets ledger, registration of rights (including caveats, insofar as is relevant), administration and oversight, including the evacuation of squatters from the Company’s properties, or to arrange the status of those squatters on the Company’s properties. The Company has a complete principal assets ledger (some 334 main sites), as well a ledger of less important assets (about 12,636 sites, primarily transformation stations) which is currently being completed. In addition, the Company is acting to register its rights in its assets, both with regard to the principal assets and with regard to the less important assets. During the reported period, the Company registered its rights with the Land Registry Office with respect to 61 sites, and with respect to 76 other sites, caveats were recorded, 21 lease contracts were signed with the Israel Lands Administration, 20 contracts were signed for the acquisition of transformation rooms, 5 easements were recorded and 201 other assets were identified. 10) A company will provide proper disclosure in the financial statements of significant assets for which it believes there is a material gap between their fair value and their carrying amount in the financial statements, which are not recorded at their full amounts as above in the Company’s books, including on the basis of appraisals or evaluations performed, or insurance appraisals, if performed. The electricity rate basis includes full coverage (depreciation and return on capital) for all of the fixed assets presented in the Company’s financial statements during the base period (see Note 3.a). At this stage, the Company does not have any additional valuations, outside and independent, economic or for insurance purposes; however, the Company did perform an examination of the value of its assets as of December 31, 2005 pursuant to the principles of Accounting Standard No. 15 of the Israel Accounting Standards Board (‘‘Accounting Standard No. 15’’), and pursuant to which, the Company did not need to reduce the reduce the value of its assets (see Note 3.c).

F-172 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued)

NOTE 34: ADDITIONAL INFORMATION REQUIRED UNDER THE PROVISIONS OF THE GOVERNMENT COMPANIES AUTHORITY (continued) 11) Significant appraisals or evaluations have been performed and will be delivered to the Board of Directors, to the Companies Authority along with all other relevant details in order to insure their reasonableness, accuracy, reliability and independence of those performing, providing a reasonable time frame prior to the discussion of the draft of the financial statements by the Company’s Board of Directors meeting. The Board of Directors will examine their reasonableness and ascertain that they do not include material misstatement. f. If appraisals or evaluations have been performed and the appraisals or evaluations are material, as above, to the value of the details in the financial statements, these material appraisals or evaluations will be attached to the financial statements and disclosure will be provided, among others, in an appendix of the matters described in the Companies Circular 2007 – 1. As for the disclosure required in this section, see the actuary’s opinion attached to the financial statements. g. In connection with the matters mentioned in Note 1.a(3) above regarding the position of management and the Board of Directors as to the restructuring and in connection with the matter discussed in Note 3.c regarding the decisions of the Electricity Authority, the Companies Authority’s stance is as follows: 1) ‘‘Following the enactment of Amendment No. 5 to the Electricity Sector Law, 2007, the Company is bound by its provisions, including the time schedules specified therein and must act accordingly subject to any law’’. 2) ‘‘The Company’s reference to the decisions of the Electricity Authority and its implications is inaccurate. Therefore, we wish to examine the accuracy of the presentation of the implications of the Electricity Authority’s decision and the manner of presentation in the note, including after receiving the Electricity Authority’s reference to this note with relation to its decisions and their implications pursuant to the Authority’s Circular 2007 – 1 and we request that presentations in a Government company’s financial statements regarding the State and its institutions (including the Electricity Authority) will be provided, as much as possible, in coordination with them and after granting them an opportunity to deliver their comments’’. h. With respect to pension liabilities and the capitalization rate, in its letter of March 12, 2008, the Government Companies Authority announced, among other things, its position according to which ‘‘disclosure must be provided in the capitalization rate for the risk and uncertainty components underlying the pension liabilities’’. i. Transactions with the State of Israel, its institutions and other Government companies: A Government company will provide proper disclosure in its financial statements regarding transactions and balances with the State of Israel, its authorities and other Government companies, including the accounting treatment of these transactions and balances. The company is to insure that the presentation of the transactions correlates their substance (transactions with the State as a sovereign, as an interested party etc.). If there is a lack of clarity involving a matter, disclosure should be provided in the financial statements and actions should be takenin coordination with the Companies Authority and the other State entities to remove said lack of clarity. The Company believes that such disclosure has been provided in Note 13.

F-173 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued)

NOTE 34: ADDITIONAL INFORMATION REQUIRED UNDER THE PROVISIONS OF THE GOVERNMENT COMPANIES AUTHORITY (continued) j. Disclosure of the transitional preparations to implement International Financial Reporting Standards (IFRS): A Government company will provide condensed disclosure in its financial statements of the status of the preparation process according to the list of topics as follows in 1 – 6 below: 1. Diagramming and identifying all the subjects and items in the financial statements that might be affected by the transition to IFRS. 2. Disclosing the existing treatment in the current financial statements. 3. The existing treatment alternatives for them pursuant to IFRS. 4. The alternative which the Company’s management intends to suggest. 5. The effect of the proposed alternative and of other alternatives on the financial statements compared to the current status. 6. A condensed clarification of management’s intention to opt for said alternative. Adopting IFRS: In July 2006, the Israel Accounting Standards Board published Accounting Standard No. 29, ‘‘Adoption of International Financial Reporting Standards (IFRS)’’. 1. The Company has defined the adoption of IFRS as a project of the utmost importance and has found that identifying the differences between IFRS and current standards and the accounting principles applied in the past necessitates considerable time and resources. Consequently, the preparations included appointing a senior chief of department to head the project, appointing a work team headed by the project manager to convene once a week to discuss and report the project’s progress, setting up a steering committee headed by the director of accounting and economics to convene every two weeks and receive project updates, regular reporting to the CFO, CEO and report Board of Directors. 2. In principle, the IFRS adoption project was divided into three stages: a) Diagramming and identifying the differences between the current accounting principles implemented by the Company those applied in the past as compared to IFRS. b) Identifying the required changes in business processes and work methods, solution finding and analysis, analyzing the different treatment possibilities pursuant to IFRS and implementing the solutions, including the required changes in the information system, writing procedures etc. c) Implementing the changes, preparing an opening balance as of the date of transition and re-preparing the financial statements for 2007 on a quarterly level. The Company has completed its preparations for adopting IFRS, see Note 32 above. k. Disclosure of internal control reports: According to the directives of the Government Companies Authority published in regulations of December 2007, all government companies, among which the Company,

F-174 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued)

NOTE 34: ADDITIONAL INFORMATION REQUIRED UNDER THE PROVISIONS OF THE GOVERNMENT COMPANIES AUTHORITY (continued) will be obligated to attach to their annual and interim financial statements, starting those published as of December 31, 2009, an additional report of the actions taken in order to assure proper disclosure in the financial statements and the directors’ report, including setting up an entire array of internal controls, examining the processes affecting the Company’s records of transactions, in order to assure the existence of controls and their effectiveness and in order to ascertain with a reasonable degree of certainty that the Company’s receipts and expenses are only performed in accordance with the authorization of the qualified factors in the Company. In the transitional period commencing from the publication of the regulations until the date on which the Company will be obligated to attach the additional statement, as above, the Company must report the progress of its preparations, including stages and time schedules, for submitting the additional report.

As of the date of the publication of these ﬁnancial statements, the Company has reported that it is studying these regulations and preparing for the required adoption.

l. Pursuant to the Government Companies Regulations (Additional Report Regarding the Measures Taken and Exhibits Presented to Assure the Accuracy of the Financial Statements and Directors’ Report), 2005, these ﬁnancial statements include letters of representation on P.4–7.

m. The Finance Committee of the Company’s Board of Directors and the Government Companies Authority have discussed the need to re-examine all the assumptions underlying the obligations with respect to employee-employer relations. As a result, the Company decided to set up a sub committee for the application of the above. Among other things, the link between the assumptions underlying the calculation of the actuarial liability of pension funds, the assumptions of the Capital Markets Division and the actuarial calculations presented in the Company’s books will be investigated. On November 22, 2007, the Finance Committee decided to exchange the roles of the Company’s actuary and the examining actuary starting from the ﬁnancial statements as of December 31, 2007. The sub-committee has commenced its work. Several meetings were held between the Company and the outside actuaries.

n. The non-inclusion of material misstatements in the ﬁnancial statements and accompanying information of Government companies:

1) Government companies are required to verify that the ﬁnancial statements and accompanying information submitted by them do not include any misstatement, including information that might mislead a reasonable reader of the ﬁnancial statements and related information.

2) The ﬁnancial statements will clearly state that the presentations included in the ﬁnancial statements and in the related information are solely the responsibility of the Company and are not binding to the State of Israel.

The Company asserts that, to the best of its knowledge, the disclosures in the ﬁnancial statements, other than disclosures of the positions of the various Government authorities, are the sole responsibility of the Company’s management and Board of Directors and are not binding to the State of Israel.

F-175 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 35: INFORMATION REGARDING THE ATTRIBUTION OF THE STATEMENT OF OPERATIONS AND THE BALANCE SHEET ACCORDING TO ACTIVITY SEGMENTS: GENERATION, TRANSMISSION AND DISTRIBUTION (SEE NOTE 1.c ABOVE) According to the provisions of the Companies Authority, whose principal points are published in the Circular of March 2, 2004, the Company is required by the Companies Authority, under its authority by the Government Companies Law, to include additional information (beyond the information included in the ﬁnancial statements according to generally accepted accounting principles) regarding the attribution of the statement of operations and balance sheet to the generation, transmission and distribution activity segments. a. Statement of operations for the year ended December 31, 2007:

Distribution Transmission Generation Total segment segment segment Company NIS in millions Required revenues...... 3,156 1,777 15,348 20,281 Adjustment for segment revenues...... (687) (225) (235) (1,147) Revenues from electricity...... 2,469 1,552 15,113 19,134 Other revenues...... 110 — 20 130 Total revenues ...... 2,579 1,552 15,133 19,264 Cost for operating electricity system ...... 1,225 943 13,358 15,526 Proﬁt from operating electricity system.... 1,354 609 1,775 3,738 Sales and marketing expenses ...... 798 — — 798 Administrative and general expenses ...... 242 115 353 710 Expenses from liabilities to pensioners, net...... 86 17 127 230 1,126 132 480 1,738 Income from current operations ...... 228 477 1,295 2,000 Financial expenses, net ...... 612 488 983 2,083 Other expenses, net ...... 19 18 27 64 Operating income (loss) before income taxes ...... (403) (29) 285 (147) Income taxes...... (98) (7) 69 (36) Income (loss) from current operations after income taxes ...... (305) (22) 216 (111) Equity in earnings of afﬁliates, net ...... — — 10 10 Net income (loss)...... (305) (22) 226 (101)

F-176 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

Total PEP and generation Orot Rabin Rutenberg others segment NIS in millions Required revenues...... 3,693 3,443 113 15,348 Adjustment for segment revenues...... (57) (54) — (235) Revenues from electricity...... 3,636 3,389 113 15,113 Other revenues...... 5 4 — 20 Total revenues ...... 3,641 3,393 113 15,133 Cost for operating electricity system ...... 3,212 2,782 113 13,358 Proﬁt from operating electricity system.... 429 611 — 1,775 Sales and marketing expenses ...... — — — — Administrative and general expenses ...... 90 74 — 353 Expenses from liabilities to pensioners, net...... 39 29 — 127 129 103 — 480 Income from current operations ...... 300 508 — 1,295 Financial expenses, net ...... 232 362 — 983 Other expenses, net ...... 6 12 — 27 Operating income before income taxes .... 62 134 — 285 Income taxes ...... 14 32 — 69 Income from current operations after income taxes ...... 48 102 — 216 Equity in earnings of afﬁliates, net ...... 5 5 — 10 Net income ...... 53 107 — 226

F-177 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 35: INFORMATION REGARDING THE ATTRIBUTION OF THE STATEMENT OF OPERATIONS AND THE BALANCE SHEET ACCORDING TO ACTIVITY SEGMENTS: GENERATION, TRANSMISSION AND DISTRIBUTION (SEE NOTE 1.c ABOVE) (continued) b. Details of the generation sites statement of operations for the year ended December 31, 2007: (continued) Gezer Eshkol Reading Haifa NIS in millions Required revenues...... 1,125 1,560 542 845 Adjustment for segment revenues...... (17) (24) (8) (13) Revenues from electricity...... 1,108 1,536 534 832 Other revenues...... — 3 1 3 Total revenues ...... 1,108 1,539 535 835 Cost for operating electricity system ...... 953 1,353 477 788 Proﬁt from operating electricity system.... 155 186 58 47 Sales and marketing expenses ...... — — — — Administrative and general expenses ...... 12 54 33 26 Expenses from liabilities to pensioners, net...... 2 21 10 11 14 75 43 37 Income (loss) from current operations..... 141 111 15 10 Financial expenses, net ...... 101 86 14 13 Other expenses net ...... 3 2 — — Operating income (loss) before income taxes ...... 37 23 1 (3) Income taxes...... 9 6 0 (1) Income (loss) from current operations after income taxes ...... 28 17 1 (2) Equity in earnings of afﬁliates, net ...... — — — — Net income (loss)...... 28 17 1 (2)

F-178 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 35: INFORMATION REGARDING THE ATTRIBUTION OF THE STATEMENT OF OPERATIONS AND THE BALANCE SHEET ACCORDING TO ACTIVITY SEGMENTS: GENERATION, TRANSMISSION AND DISTRIBUTION (SEE NOTE 1.c ABOVE) (continued) b. Details of the generation sites statement of operations for the year ended December 31, 2007: (continued) Alon Ramat Other gas Hagit Tavor Hovav Zafit turbines NIS in millions Required revenues ...... 1,881 460 1,043 425 218 Adjustment for segment revenues ...... (29) (7) (16) (7) (3) Revenues from electricity ...... 1,852 453 1,027 418 215 Other revenues ...... 1 1 1 — 1 Total revenues ...... 1,853 454 1,028 418 216 Cost for operating electricity system ...... 1,729 405 979 378 189 Profit from operating electricity system ...... 124 49 49 40 27 Sales and marketing expenses ...... — — — — — Administrative and general expenses ...... 18 11 18 9 8 Expenses from liabilities to pensioners, net.... 4 2 5 2 2 22 13 23 11 10 Income from current operations ...... 102 36 26 29 17 Financial expenses, net ...... 84 27 27 24 13 Other expenses, net ...... 2 1 — 1 — Operating income (loss) before income taxes . . 16 8 (1) 4 4 Income taxes ...... 4 2 0 2 1 Income (loss) from current operations after income taxes ...... 12 6 (1) 2 3 Equity in earnings of affiliates, net ...... — — — — — Net income (loss) ...... 12 6 (1) 2 3

F-179 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 35: INFORMATION REGARDING THE ATTRIBUTION OF THE STATEMENT OF OPERATIONS AND THE BALANCE SHEET ACCORDING TO ACTIVITY SEGMENTS: GENERATION, TRANSMISSION AND DISTRIBUTION (SEE NOTE 1.c ABOVE) (continued) c. Details of the transmission sites statement of operations for the year ended December 31, 2007 Total Haifa Northern distribution District District segment NIS in millions Required revenues ...... 379 614 3,156 Adjustment for segment revenues ...... (82) (135) (687) Revenues from electricity ...... 297 479 2,469 Other revenues ...... 10 22 110 Total revenues ...... 307 501 2,579 Cost for operating electricity system ...... 151 235 1,225 Proﬁt from operating electricity system ...... 156 266 1,354 Sales and marketing expenses...... 93 154 798 Administrative and general expenses ...... 30 47 242 Expenses from liabilities to pensioners, net ...... 11 17 86 134 218 1,126 Income from current operations...... 22 48 228 Financial expenses, net...... 69 123 612 Other expenses, net ...... 2 4 19 Operating loss before income taxes ...... (49) (79) (403) Income taxes ...... (12) (19) (98) Loss from current operations after income taxes ..... (37) (60) (305) Equity in earnings of afﬁliates, net ...... — — — Net loss ...... (37) (60) (305)

Southern Dan Jerusalem District District District NIS in millions Required revenues ...... 1,092 654 417 Adjustment for segment revenues ...... (237) (142) (91) Revenues from electricity ...... 855 512 326 Other revenues ...... 49 17 12 Total revenues ...... 904 529 338 Cost for operating electricity system ...... 418 244 177 Proﬁt from operating electricity system ...... 486 285 161 Sales and marketing expenses...... 290 167 94 Administrative and general expenses ...... 87 46 32 Expenses from liabilities to pensioners, net ...... 30 17 11 407 230 137 Income from current operations...... 79 55 24 Financial expenses, net...... 211 132 77 Other expenses, net ...... 7 4 2 Operating loss before income taxes ...... (139) (81) (55) Income taxes ...... (34) (20) (13) Loss from current operations after income taxes ..... (105) (61) (42) Equity in earnings of afﬁliates, net ...... — — — Net loss ...... (105) (61) (42)

F-180 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 35: INFORMATION REGARDING THE ATTRIBUTION OF THE STATEMENT OF OPERATIONS AND THE BALANCE SHEET ACCORDING TO ACTIVITY SEGMENTS: GENERATION, TRANSMISSION AND DISTRIBUTION (SEE NOTE 1.c ABOVE) (continued) d. Balance sheet as of December 31, 2007: Distribution Transmission Generation Total segment segment segment Company NIS in millions Current assets ...... 772 541 5,442 6,755 Long-term receivables ...... 752 143 2,226 3,121 Investments in investee companies ..... — — 64 64 Fixed assets, net...... 15,803 13,746 28,696 58,245 Intangible assets, net...... 230 184 375 789 17,557 14,614 36,803 68,974 Current liabilities...... 2,029 813 5,218 8,060 Long-term and extended-term liabilities . 10,183 9,544 22,912 42,635 Deferred taxes, net ...... 1,296 1,033 2,104 4,433 Shareholders’ equity ...... 4,049 3,224 6,573 13,846 17,557 14,614 36,803 68,974

F-181 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 35: INFORMATION REGARDING THE ATTRIBUTION OF THE STATEMENT OF OPERATIONS AND THE BALANCE SHEET ACCORDING TO ACTIVITY SEGMENTS: GENERATION, TRANSMISSION AND DISTRIBUTION (SEE NOTE 1.c ABOVE) (continued) e. Details of the generation segment balance sheet as of December 31, 2007: Total PEP and generation Orot Rabin Rutenberg others segment NIS in millions Current assets ...... 1,258 1,198 43 5,442 Long-term receivables ...... 433 256 1,011 2,226 Investments in investee companies ...... 35 29 — 64 Fixed assets, net ...... 5,629 8,911 397 28,696 Intangible assets, net ...... 83 132 — 375 7,438 10,526 1,451 36,803 Current liabilities ...... 1,513 1,416 78 5,218 Long-term and extended-term liabilities. . 3,994 6,042 1,373 22,908 Deferred taxes, net...... 468 745 — 2,104 Shareholders’ equity...... 1,463 2,323 — 6,573 7,438 10,526 1,451 36,803

Gezer Eshkol Reading Haifa NIS in millions Current assets ...... 428 532 181 308 Long-term receivables...... 18 181 89 100 Investments in investee companies ...... — — — — Fixed assets, net ...... 3,811 2,110 346 1,651 Intangible assets, net ...... 44 33 5 5 4,301 2,856 621 2,064 Current liabilities ...... 322 403 146 331 Long-term and extended-term liabilities . . . 2,966 1,724 356 1,623 Deferred taxes, net ...... 246 177 29 26 Shareholders’ equity ...... 767 552 90 84 4,301 2,856 621 2,064

Alon Ramat Other gas Hagit Tavor Hovav Zaﬁt turbines NIS in millions Current assets ...... 705 172 383 154 80 Long-term receivables ...... 39 21 43 14 21 Investments in investee companies ...... — — — — — Fixed assets, net ...... 2,711 1,426 689 666 349 Intangible assets, net ...... 40 10 10 9 4 3,495 1,629 1,125 843 454 Current liabilities ...... 410 167 242 111 79 Long-term and extended-term liabilities. . 2,152 1,237 657 526 258 Deferred taxes, net...... 226 54 55 54 28 Shareholders’ equity...... 707 171 171 156 89 3,495 1,629 1,125 843 454

F-182 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

Total Haifa Northern distribution District District segment NIS in millions Current assets ...... 89 152 772 Long-term receivables ...... 96 151 752 Investments in investee companies ...... — — — Fixed assets, net...... 1,761 3,220 15,803 Intangible assets, net...... 25 47 230 1,971 3,570 17,557 Current liabilities...... 242 399 2,029 Long-term and extended-term liabilities ...... 1,126 2,092 10,183 Deferred taxes, net ...... 146 262 1,296 Shareholders’ equity ...... 457 817 4,049 1,971 3,570 17,557

Southern Dan Jerusalem District District District NIS in millions Current assets ...... 273 157 101 Long-term receivables ...... 263 148 94 Investments in investee companies ...... — — — Fixed assets, net...... 5,485 3,343 1,994 Intangible assets, net...... 80 49 29 6,101 3,697 2,218 Current liabilities...... 720 423 245 Long-term and extended-term liabilities ...... 3,533 2,135 1,297 Deferred taxes, net ...... 448 276 164 Shareholders’ equity ...... 1,400 863 512 6,101 3,697 2,218

F-183 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

Distribution Transmission Generation Total segment segment segment Company NIS in millions Required revenues ...... 3,520 1,423 13,742 18,685 Adjustment for segment revenues ...... (933) (56) 381 (608) Revenues from electricity ...... 2,587 1,367 14,123 18,077 Other revenues...... 87 — 24 111 Total revenues ...... 2,674 1,367 14,147 18,188 Cost for operating electricity system ...... 1,407 735 11,762 13,904 Proﬁt from operating electricity system...... 1,267 632 2,385 4,284 Sales and marketing expenses ...... 789 — — 789 Administrative and general expenses...... 297 110 382 789 Expenses from liabilities to pensioners, net.... 47 7 67 121 1,133 117 449 1,699 Income from current operations ...... 134 515 1,936 2,585 Financial expenses, net...... 759 423 1,066 2,248 Other expenses (income), net ...... 6 — (13) (7) Operating income (loss) before income taxes .. (631) 92 883 344 Income taxes ...... (166) 24 233 91 Income (loss) from current operations after income taxes ...... (465) 68 650 253 Equity in earnings of afﬁliates, net ...... — — 9 9 Net income (loss) ...... (465) 68 659 262

F-184 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 35: INFORMATION REGARDING THE ATTRIBUTION OF THE STATEMENT OF OPERATIONS AND THE BALANCE SHEET ACCORDING TO ACTIVITY SEGMENTS: GENERATION, TRANSMISSION AND DISTRIBUTION (SEE NOTE 1.c ABOVE) (continued) h. Details of the generation segment statement of income for the year ended December 31, 2006: Total PEP and generation Orot Rabin Rutenberg others segment NIS in millions Required revenues ...... 3,575 3,183 86 13,742 Adjustment for segment revenues ...... 100 89 — 381 Revenues from electricity...... 3,675 3,272 86 14,123 Other revenues ...... 6 6 — 24 Total revenues ...... 3,681 3,278 86 14,147 Cost for operating electricity system ...... 3,064 2,483 86 11,762 Proﬁt from operating electricity system ...... 617 795 — 2,385 Sales and marketing expenses ...... — — — — Administrative and general expenses ...... 101 86 — 382 Expenses from liabilities to pensioners, net ...... 21 15 — 67 122 101 — 449 Income from current operations...... 495 694 — 1,936 Financial expenses, net...... 273 415 — 1,066 Other expenses, net ...... (3) (4) — (13) Operating income before income taxes ...... 225 283 — 883 Income taxes...... 60 75 — 233 Income from current operations after income taxes . 165 208 — 650 Equity in earnings of afﬁliates, net...... 5 4 — 9 Net income ...... 170 212 — 659

Gezer Eshkol Reading Haifa NIS in millions Required revenues ...... 838 1,719 596 994 Adjustment for segment revenues ...... 23 48 17 28 Revenues from electricity...... 861 1,767 613 1,022 Other revenues ...... 1 4 2 2 Total revenues ...... 862 1,771 615 1,024 Cost for operating electricity system ...... 688 1,510 539 932 Proﬁt from operating electricity system ...... 174 261 76 92 Sales and marketing expenses ...... — — — — Administrative and general expenses ...... 19 58 29 34 Expenses from liabilities to pensioners, net ...... 1 11 6 7 20 69 35 41 Income from current operations...... 154 192 41 51 Financial expenses, net...... 89 98 16 16 Other expenses (income), net...... (1) (1) — (1) Operating income before income taxes ...... 66 95 25 36 Income taxes ...... 17 25 6 10 Income from current operations after income taxes . 49 70 19 26 Equity in earnings of afﬁliates, net...... — — — — Net income ...... 49 70 19 26

F-185 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 35: INFORMATION REGARDING THE ATTRIBUTION OF THE STATEMENT OF OPERATIONS AND THE BALANCE SHEET ACCORDING TO ACTIVITY SEGMENTS: GENERATION, TRANSMISSION AND DISTRIBUTION (SEE NOTE 1.c ABOVE) (continued) h. Details of the generation segment statement of income for the year ended December 31, 2006: (continued) Alon Ramat Other gas Hagit Tavor Hovav Zafit turbines NIS in millions Required revenues ...... 1,186 300 871 199 195 Adjustment for segment revenues ...... 33 8 24 6 5 Revenues from electricity...... 1,219 308 895 205 200 Other revenues ...... 1 — 1 — 1 Total revenues ...... 1,220 308 896 205 201 Cost for operating electricity system ...... 1,069 247 807 175 162 Profit from operating electricity system ...... 151 61 89 30 39 Sales and marketing expenses ...... — — — — — Administrative and general expenses ...... 17 8 16 5 9 Expenses from liabilities to pensioners, net ...... 2 1 2 — 1 19 9 18 5 10 Income from current operations...... 132 52 71 25 29 Financial expenses, net...... 67 31 32 13 16 Other expenses (income), net...... (2) — (1) — — Operating income before income taxes ...... 67 21 40 12 13 Income taxes...... 17 6 11 3 3 Income from current operations after income taxes . 50 15 29 9 10 Equity in earnings of affiliates, net...... — — — — — Net income ...... 50 15 29 9 10

F-186 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 35: INFORMATION REGARDING THE ATTRIBUTION OF THE STATEMENT OF OPERATIONS AND THE BALANCE SHEET ACCORDING TO ACTIVITY SEGMENTS: GENERATION, TRANSMISSION AND DISTRIBUTION (SEE NOTE 1.c ABOVE) (continued) i. Details of the distribution segment statement of operations for the year ended December 31, 2006: Total Haifa Northern distribution District District segment NIS in millions Required revenues ...... 432 704 3,520 Adjustment for segment revenues ...... (114) (187) (933) Revenues from electricity ...... 318 517 2,587 Other revenues ...... 8 22 87 Total revenues ...... 326 539 2,674 Cost for operating electricity system ...... 174 290 1,407 Proﬁt from operating electricity system ...... 152 249 1,267 Sales and marketing expenses...... 93 145 789 Administrative and general expenses ...... 44 69 297 Expenses from liabilities to pensioners, net ...... 6 9 47 143 223 1,133 Income from current operations...... 9 26 134 Financial expenses, net...... 87 152 759 Other expenses, net ...... 1 1 6 Operating loss before income taxes ...... (79) (127) (631) Income taxes ...... (21) (33) (166) Loss from current operations after income taxes ..... (58) (94) (465) Equity in earnings of afﬁliates, net ...... — — — Net loss ...... (58) (94) (465)

Southern Dan Jerusalem District District District NIS in millions Required revenues ...... 1,209 724 451 Adjustment for segment revenues ...... (320) (192) (120) Revenues from electricity ...... 889 532 331 Other revenues ...... 33 15 9 Total revenues ...... 922 547 340 Cost for operating electricity system ...... 470 277 196 Proﬁt from operating electricity system ...... 452 270 144 Sales and marketing expenses...... 293 167 91 Administrative and general expenses ...... 95 53 36 Expenses from liabilities to pensioners, net ...... 17 9 6 405 229 133 Income from current operations...... 47 41 11 Financial expenses, net...... 261 165 94 Other expenses, net ...... 2 1 1 Operating loss before income taxes ...... (216) (125) (84) Income taxes ...... (57) (33) (22) Loss from current operations after income taxes ..... (159) (92) (62) Equity in earnings of afﬁliates, net ...... — — — Net loss ...... (159) (92) (62)

F-187 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

Distribution Transmission Generation Total segment segment segment Company NIS in millions Required revenues ...... 3,640 1,030 13,167 17,837 Adjustment for segment revenues ...... (610) (197) 207 (600) Revenues from electricity ...... 3,030 833 13,374 17,237 Other revenues...... 75 — 5 80 Total revenues ...... 3,105 833 13,379 17,317 Cost for operating electricity system ...... 1,491 498 11,203 13,192 Proﬁt from operating electricity system...... 1,614 335 2,176 4,125 Sales and marketing expenses ...... 744 — — 744 Administrative and general expenses...... 232 92 336 660 Expenses from liabilities to pensioners, net ...... 46 4 60 110 1,022 96 396 1,514 Income from current operations ...... 592 239 1,780 2,611 Financial expenses, net...... 750 282 945 1,977 Other expenses (income), net ...... 2 4 2 8 Operating income (loss) before income taxes .. (160) (47) 833 626 Income taxes ...... (373) (136) (186) (695) Income (loss) from current operations after income taxes ...... 213 89 1,019 1,321 Equity in earnings of afﬁliates, net ...... — — 7 7 Net income (loss) ...... 213 89 1,026 1,328

F-188 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 35: INFORMATION REGARDING THE ATTRIBUTION OF THE STATEMENT OF OPERATIONS AND THE BALANCE SHEET ACCORDING TO ACTIVITY SEGMENTS: GENERATION, TRANSMISSION AND DISTRIBUTION (SEE NOTE 1.c ABOVE) (continued) k. Details of the generation segment statement of income for the year ended December 31, 2005: Total PEP and generation Orot Rabin Rutenberg others segment NIS in millions Required revenues ...... 3,736 3,431 75 13,167 Adjustment for segment revenues ...... 60 55 — 207 Revenues from electricity...... 3,796 3,486 75 13,374 Other revenues ...... 2 0 — 5 Total revenues ...... 3,798 3,486 75 13,379 Cost for operating electricity system ...... 3,192 2,699 75 11,203 Proﬁt from operating electricity system ...... 606 787 — 2,176 Sales and marketing expenses ...... — — — — Administrative and general expenses ...... 96 74 — 336 Expenses from liabilities to pensioners, net ...... 21 13 — 60 117 87 — 396 Income from current operations...... 489 700 — 1,780 Financial expenses, net...... 261 390 — 945 Other income, net...... 0 4 — 2 Operating income before income taxes ...... 228 306 — 833 Income taxes ...... (46) (79) — (186) Income from current operations after income taxes . 274 385 — 1,019 Equity in earnings of afﬁliates, net...... 4 3 — 7 Net income ...... 278 388 — 1,026

Gezer Eshkol Reading Haifa NIS in millions Required revenues ...... 667 1,560 756 724 Adjustment for segment revenues ...... 10 25 12 11 Revenues from electricity...... 677 1,585 768 735 Other revenues ...... 1 1 — 1 Total revenues ...... 678 1,586 768 736 Cost for operating electricity system ...... 556 1,377 699 668 Proﬁt from operating electricity system ...... 122 209 69 68 Sales and marketing expenses ...... — — — — Administrative and general expenses ...... 19 49 28 31 Expenses from liabilities to pensioners, net ...... 1 9 5 6 20 58 33 37 Income from current operations...... 102 151 36 31 Financial expenses, net...... 54 75 14 11 Other income, net...... 0 (1) (1) (1) Operating income before income taxes ...... 48 77 23 21 Income taxes ...... (17) (17) — (1) Income from current operations after income taxes . 65 94 23 22 Equity in earnings of afﬁliates, net...... — — — — Net income ...... 65 94 23 22

F-189 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

Alon Ramat Other gas Hagit Tavor Hovav Zafit turbines NIS in millions Required revenues ...... 909 279 650 195 185 Adjustment for segment revenues ...... 14 4 10 3 3 Revenues from electricity ...... 923 283 660 198 188 Other revenues ...... — — — — — Total revenues ...... 923 283 660 198 188 Cost for operating electricity system ...... 791 227 589 179 151 Profit from operating electricity system...... 132 56 71 19 37 Sales and marketing expenses ...... — — — — — Administrative and general expenses...... 14 5 9 3 8 Expenses from liabilities to pensioners, net. . . 2 1 1 — 1 16 6 10 3 9 Income from current operations ...... 116 50 61 16 28 Financial expenses, net...... 61 28 30 7 14 Other income, net ...... 1 — — — — Operating income before income taxes ...... 54 22 31 9 14 Income taxes ...... (12) (6) (4) (1) (3) Income from current operations after income taxes ...... 66 28 35 10 17 Equity in earnings of affiliates, net ...... — — — — — Net income...... 66 28 35 10 17

F-190 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 35: INFORMATION REGARDING THE ATTRIBUTION OF THE STATEMENT OF OPERATIONS AND THE BALANCE SHEET ACCORDING TO ACTIVITY SEGMENTS: GENERATION, TRANSMISSION AND DISTRIBUTION (SEE NOTE 1.c ABOVE) (continued) l. Details of the distribution segment statement of operations for the year ended December 31, 2005 Total Haifa Northern distribution District District segment NIS in millions Required revenues ...... 437 714 3,640 Adjustment for segment revenues ...... (73) (120) (610) Revenues from electricity ...... 364 594 3,030 Other revenues ...... 8 20 75 Total revenues ...... 372 614 3,105 Cost for operating electricity system ...... 182 302 1,491 Proﬁt from operating electricity system ...... 190 312 1,614 Sales and marketing expenses...... 88 139 744 Administrative and general expenses ...... 31 44 232 Expenses from liabilities to pensioners, net ...... 6 9 46 125 192 1,022 Income from current operations...... 65 120 592 Financial expenses, net...... 87 150 750 Other expenses, net ...... — — 2 Operating loss before income taxes ...... (22) (30) (160) Income taxes ...... (44) (73) (373) Loss from current operations after income taxes ..... 22 43 213 Equity in earnings of afﬁliates, net ...... — — — Net income ...... 22 43 213

Southern Dan Jerusalem District District District NIS in millions Required revenues ...... 1,267 763 459 Adjustment for segment revenues ...... (212) (128) (77) Revenues from electricity ...... 1,055 635 382 Other revenues ...... 28 12 7 Total revenues ...... 1,083 647 389 Cost for operating electricity system ...... 514 297 196 Proﬁt from operating electricity system ...... 569 350 193 Sales and marketing expenses...... 271 160 86 Administrative and general expenses ...... 84 42 31 Expenses from liabilities to pensioners, net ...... 17 9 5 372 211 122 Income from current operations...... 197 139 71 Financial expenses, net...... 255 166 92 Other expenses, net ...... 1 1 — Operating loss before income taxes ...... (59) (28) (21) Income taxes ...... (130) (80) (46) Income from current operations after income taxes .. 71 52 25 Equity in earnings of afﬁliates, net ...... — — — Net income ...... 71 52 25

F-191 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 35: INFORMATION REGARDING THE ATTRIBUTION OF THE STATEMENT OF OPERATIONS AND THE BALANCE SHEET ACCORDING TO ACTIVITY SEGMENTS: GENERATION, TRANSMISSION AND DISTRIBUTION (SEE NOTE 1.c ABOVE) (continued) m. General 1. As previously stated, based on section 33.b. of the Government Companies Law, and in accordance with the provisions of the Companies Authority circular dated March 2, 2004 (see Note 1.c above), the Company is required to provide disclosure in the form of a note to the primary financial statements. It will include statements of operations, condensed balance sheets related to the various activities segments and details of assumptions and the principal details that were used in their preparation. Disclosure will also be provided of the financial targets, including targets to meet normative recognized costs in the various activities segments that were (or will be) determined by the Electricity Authority, and the differences between them and the effective costs, as stated in the Companies Authority’s circular on financial statements (see Note 1 above). 2. The Company’s activities are composed of three principal segments: a) Generation—activities of the power plants producing electricity. b) Transmission—the transmission and transformation system for high- voltage electricity over long distances. c) Distribution—the electricity grid and the transformer stations system that brings electricity to the end consumer (except for a small number of customers who purchase high-voltage electricity and are directly connected to the transmission system), as well as the customer service and collection system of the Company. These segments are called the electricity chain (‘‘the electricity chain’’). 3. The rate basis that came into force in July 2002 initially included various rates for four segments in the electricity chain: generation, transmission, distribution and supply. The different rates were intended to enable the private producers and customers to trade in electricity through a partial usage of the Company’s system. 4. The Company manages one accounting system that includes all of the activities of the electricity chain. The internal controls principles that exist for everything concerning the internal trade between the activities of the electricity web are not compatible those required for separate audited financial statements. 5. Under the basic rate that was in effect until June 30, 2006, 80.7% of the expenses relating to the substations were diverted from the transmission segment to the distribution segment and expenses relating to connections in the transmission segment were diverted to the generation and distribution segments. As of July 1, 2006, the Electricity Authority reallocated the costs recognized with respect to the segment rates without fundamentally changing the recognized costs for the entire Company. The reallocation was carried out while adhering to the principle of ownership over the properties in relation to use of properties. In

F-192 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 35: INFORMATION REGARDING THE ATTRIBUTION OF THE STATEMENT OF OPERATIONS AND THE BALANCE SHEET ACCORDING TO ACTIVITY SEGMENTS: GENERATION, TRANSMISSION AND DISTRIBUTION (SEE NOTE 1.c ABOVE) (continued) m. General (continued) view of the decision of the Electricity Authority to reallocate costs as above, the Company made a corresponding adjustment of the allocation of costs and property. The Company also recorded ‘‘usage fees’’ based on the above principles between the segments.

n. The principles used in attributing the statements of income are as follows 1. General a) The principles that the Electricity Authority used for determining the rate for the aforesaid activities segments, will be implemented in these statements of operations. b) Since the Company is one legal entity, complete separate entries are not actually recorded for the segments of the electricity chain. The attribution of the expenses and income of the statement of operations to the level of the segments is performed as applicable, as will be described below. The statements of operations as they are presented in this note do not necessarily reﬂect the results of operations of the various segments if they had been managed as separate economic entities, as signiﬁed by generally accepted accounting principles. 2. Below are the principles for attributing the income between the various segments a) Revenues from the sale of electricity The gross revenues for the segment are calculated based on the rate for the segment published by the Electricity Authority, multiplied by the quantity sold (kWh) for that segment. 1) Amount sold per segment The amount sold in each segment is calculated based on data of the amount of sales to the end customers according to the type of the customer (quantity measured in a systematic way for each segment), with the addition of the quantity purchased from private producers (known quantity for each segment) and their adjustment to the generation data, net (continuous measured quantity), by adding the quantity of normative loss for each segment and standardizing it according to the actual amount of loss. Adjustment of the quantities between the segments is required since there is a gap between the quantity sold and the quantity generated and purchased. The gap derives from losses in the systems that are primarily caused by weather conditions, system load and the distance of transmission.

F-193 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 35: INFORMATION REGARDING THE ATTRIBUTION OF THE STATEMENT OF OPERATIONS AND THE BALANCE SHEET ACCORDING TO ACTIVITY SEGMENTS: GENERATION, TRANSMISSION AND DISTRIBUTION (SEE NOTE 1.c ABOVE) (continued) n. The principles used in attributing the statements of income are as follows (continued) Since there is no continuous quantitative measurement of KWhs transferred between the transmission segments and the distribution segment, it is not possible to estimate the scope of losses in each segment. For that purpose, they are aided by normative loss coefficients that the Electricity Authority determined for calculating the quantity of sales between the segments. The total losses in the system are added to segments according the ratio of normative losses that were determined by the Electricity Authority. 2) Rate for the segment The electricity rates that were determined by the Electricity Authority are divided into two main categories: (a) Rates according to load and time (‘‘LTR’’)—rate that varies according to the season of the year and the time of day, where it is split to each of the segments of the electricity chain (a total of nine rates at the segment level). (b) A uniform rate according to type of consumer that is supposed to reflect over an entire year, the LTR rate according to the expected level of demand by those paying that same rate during the various seasons and time of day (a total of five types of uniform rates at the segment level). The uniform rate, in accordance with the various types of consumers, is calculated for the various segments, in accordance with the model that was used by the Electricity Authority in determining the rates for the Company. 3) Calculation of the income for the electricity chain segments The income for the segment is calculated by multiplying the amount of sales calculated for each segment by the various types of consumers at the appropriate rates. The difference, which derives from the Company’s actual income and the calculated income obtained, is distributed among the segments according to the amount of their calculated income. 4) In addition, in view of the matter discussed in m.5 above, as of July 1, 2006, revenues from usage fees are calculated for substations and connections. These revenues are collected through the generation and distribution segment rates and transferred to the transmission segment for the usage fees for the segment’s

F-194 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 35: INFORMATION REGARDING THE ATTRIBUTION OF THE STATEMENT OF OPERATIONS AND THE BALANCE SHEET ACCORDING TO ACTIVITY SEGMENTS: GENERATION, TRANSMISSION AND DISTRIBUTION (SEE NOTE 1.c ABOVE) (continued) n. The principles used in attributing the statements of income are as follows (continued) properties. Revenues from usage fees of substations are calculated at a rate per kWh multiplied by the quantity transmitted by the segment. Revenues from usage fees for connections are calculated at a rate per kWh multiplied by the installed transformation capacity. b. Collection of regulatory assets − are added or subtracted, based on their inclusion in the rate, since their collection does not constitute income in the statement of operations. c. Other income – is attributed to the appropriate segment, according to its nature. 3. Below are the principles for attributing the expenses to the various segments The specifically identifiable expenses are charged directly to the appropriate items. Certain indirect expenses are recorded for those items according to distribution bases that, in the Company’s assessment, constitute a reasonable estimate for the attribution of those expenses. a) Cost for operating the electricity system – reflects in the Company’s financial statements the operating expenses for the generation, transmission and distribution segments. b) Selling and marketing expenses – include the expenses for services to consumers that are attributed to the distribution segment. c) General and administrative expenses (includes salary, depreciation and other expenses) The basis for attributing the general and administrative expenses items to segments was determined in accordance with the nature of the activities of the Company’s various units, whose costs are attributed to general and administrative expenses; see the following details: 1) The general administrative expenses, the accounting and economic division and asset maintenance expenses—are presented according to the ratio of the division of the operating expenses in the electricity chain during the reported period. 2) The expenses for the human resources department are presented according to the ratio of the division of the salary expenses to the electricity chain during the reported period. 3) Doubtful accounts and bad debts—are presented according to the ratio of the gross revenues from electricity sales of the electricity chain during the reported period. 4) Communications, electronics and quality control, planning and technological development expenses—are presented according to the activities of the relevant unit.

F-195 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 35: INFORMATION REGARDING THE ATTRIBUTION OF THE STATEMENT OF OPERATIONS AND THE BALANCE SHEET ACCORDING TO ACTIVITY SEGMENTS: GENERATION, TRANSMISSION AND DISTRIBUTION (SEE NOTE 1.c ABOVE) (continued) n. The principles used in attributing the statements of income are as follows (continued) d) Expenses (income) from liabilities, net, to pensioners – These expenses (income) are presented according to the ratio for allocating the salary expenses to the electricity chain during the reported period. e) Financial expenses (income), net – Primarily derive from the operated fixed assets and, therefore, they were attributed according to the average ratio of the operated fixed assets, net in the electricity chain during the reported period. f) Other expenses (income), net – were attributed to the electricity chain according to substance. 4. Taxes on income − deferred The deferred taxes are presented according to the ratio of the income before tax for all of the various segments, out of the total pre-tax income of all of the segments. 5. Equity in earnings of affiliated companies This income derives from the earnings of a subsidiary—the National Coal Supply Company Ltd. and, therefore, it was attributed entirely to the generation segment. Income from taxes—and deriving from the effect of the change in tax rates on deferred taxes are allocated to the various segments according to the net operated fixed assets. o. The principles used in attributing the aforesaid balance sheet items are as follows 1. The Company is one legal entity and, in effect, the balance sheet balances are not separated according to the Company’s activities segments in its accounts (except for direct fixed assets). Therefore, the Company is reallocating the balance sheet balances for purpose of this note, in every reporting period, based on allocation keys, as described below. 2. The balance sheets as they are presented in this note do not necessarily reflect the financial position of the various segments, if they would have been managed as separate economic entities, as signified by generally accepted accounting principles. 3. Below are the principles for attributing the balance sheet balances to the various segments: a) Working capital items: The working capital items were attributed to the segments in accordance with those principles that the Electricity Authority used in determining the electricity rates (principally for the purpose of determining the coverage of the working capital’s financial expenses) where the principal allocation keys are:

F-196 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 35: INFORMATION REGARDING THE ATTRIBUTION OF THE STATEMENT OF OPERATIONS AND THE BALANCE SHEET ACCORDING TO ACTIVITY SEGMENTS: GENERATION, TRANSMISSION AND DISTRIBUTION (SEE NOTE 1.c ABOVE) (continued) o. The principles used in attributing the aforesaid balance sheet items are as follows (continued) Fuel inventories and balance for fuel suppliers—were fully attributed to the generation segment. The trade receivables balance allocated according to the ratio for distributing revenues. Trade payables and other items were allocated primarily according to the ratio of the operating expenses and salary for the segments.

b) Fixed assets:

Fixed assets that are speciﬁcally identiﬁable are included in the appropriate segment. Joint assets (about 4% of the entire assets) were distributed according to distribution keys that, in management’s opinion, constitute a reasonable estimate for attributing these assets.

c) Shareholders’ equity and deferred taxes:

Shareholders’ equity and deferred taxes are allocated according to the ratio of the active ﬁxed assets, net.

d) Loans and debentures:

The loans and debentures were allocated to the segments in accordance with the other balance sheet items, and principally according to the distribution ratio of ﬁxed assets to segments, pursuant to the nature of the ﬁnancing for the Company’s assets under the rate principles.

e) The remaining balance sheet items were distributed according to distribution keys that, in the Company’s estimation, constitute a reasonable estimate for attributing these items.

p. Information regarding the attribution of the income statement and balance sheet according to 18 reporting units

1. General

In addition to the aforesaid in section m.1 above, the Company was required to provide disclosure in the form of a note that is to include condensed statements of operations and a balance sheet, in reference to 18 activities that are included in the three electricity chain segments, as follows:

F-197 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 35: INFORMATION REGARDING THE ATTRIBUTION OF THE STATEMENT OF OPERATIONS AND THE BALANCE SHEET ACCORDING TO ACTIVITY SEGMENTS: GENERATION, TRANSMISSION AND DISTRIBUTION (SEE NOTE 1.c ABOVE) (continued) p. Information regarding the attribution of the income statement and balance sheet according to 18 reporting units (continued) Generation segment 11 generation sites: Rutenberg, Orot Rabin, Haifa, Reading, Eshkol, Gezer, Hagit, Alon Tavor, Ramat Hovav, Zaﬁt and the other gas turbines. In addition, it also reports on activities for acquiring electricity from private producers.

Transmission segment The electricity transmission and transformation system.

Distribution segment The Company’s ﬁve districts: Northern, Haifa, Jerusalem, Dan, Southern. Below, the 18 operations segments will be called: ‘‘reporting units’’.

2. Below are the primary principles for attributing the income The income at the level of the reporting unit is calculated by stages since presently there is no electricity rate at the reporting unit level, and the Authority’s current rates, at the level of the electricity chain’s segments, do not allow for their attribution to a level that is lower than the segment level. The income is calculated based on the following principles: a) Calculation of the income from electricity at the level of the electricity chain segments, which is based on the electricity rates and agrees with the total of all revenues from electricity at the total Company level. b) Determination of the required revenues at the reporting unit level for each reporting period. Required income—cover for the actual costs during the reported period (operating costs including fuel and depreciation) neutralized by the various other income and expenses, and with the addition of normative ﬁnancing costs and the normative rate of return on capital. The required revenues are structured based on the principal elements of the rules and principles that served the Electricity Authority for determining the electricity rate for the various segments. c) The difference between the total required revenues for the reporting unit in the segment and the revenues of the appropriate segment was distributed among the reporting units according to the ratio of required revenue of the segment. d) The revenues from electricity at the reporting unit level were not designated in order to estimate the revenues that will be obtained from the electricity if and when electricity rates are determined at the

F-198 THE ISRAEL ELECTRIC CORPORATION LIMITED NOTES TO THE FINANCIAL STATEMENTS (continued) (Adjusted NIS in December 31, 2007 purchasing power)

NOTE 35: INFORMATION REGARDING THE ATTRIBUTION OF THE STATEMENT OF OPERATIONS AND THE BALANCE SHEET ACCORDING TO ACTIVITY SEGMENTS: GENERATION, TRANSMISSION AND DISTRIBUTION (SEE NOTE 1.c ABOVE) (continued) p. Information regarding the attribution of the income statement and balance sheet according to 18 reporting units (continued) reporting unit level and, therefore, statements of operations according to the 18 reporting units do not necessarily reﬂect the results of their operations if they were managed as separate economic entities, as signiﬁed by generally accepted accounting principles.

3. The principles for the attribution of expenses are as follows:

The principles for attributing the expenses at the level of the reporting units agree with the principles that were applied in the reporting according to the three electricity chain segments (see section n. above).

Joint expenses for a segment (such as management of the segment) were attributed to the reporting units, generally on the basis of the direct operating costs for each reporting unit.

Other expenses that are not allocated in the Company’s books of account (such as general and administrative and ﬁnancial) were attributed to the reporting units in accordance with the loading bases use in the reporting according to the electricity chain segments.

4. Equity in earnings of afﬁliated companies

The income was attributed to the reporting units included in the generation segment according to the coal consumption ratio.

5. Principles that were used in attributing the balance sheet items according to 18 reporting units

According to what is stated in section o. above, the Company is one legal entity and, in effect, the balance sheet balances are not segregated in the Company’s books according to the segments of the Company’s activities. Therefore, the Company reattributes the balance sheet balances for the purpose of this note for each reported period based on allocation keys, as described above in section o., while providing additional details for the 18 reporting units.

F-199 Project13 14/7/06 8:25 am Page 1

[THIS PAGE LEFT INTENTIONALLY BLANK] AUDITORS’ REPORT FOR THE YEAR ENDED DECEMBER 31, 2006 Ernst & Young Deloitte • Kost Forer Gabbay & Kasierer Brightman Almagor & Co. 2 Palyam Blvd, Haifa 33095, Israel • Phone : 972-4-8654000 Fax: 972-4-8654022

Auditors’ Report

To the Shareholders of The Israel Electric Corporation Limited We have audited the accompanying balance sheet of The Israel Electric Corporation Limited (the ‘‘Company’’) as of December 31, 2006, and the related statements of income, changes in shareholders’ equity and cash flows for the year ended December 31, 2006. These financial statements are the responsibility of the Company’s Board of Directors and its management. Our responsibility is to express an opinion on these financial statements based on our audit. The financial statements as of December 31, 2005 and 2004 and for each of the years then ended were audited solely by Kost, Forer, Gabbay and Kasierer, Certified Public Accountants, whose report dated March 29, 2007 included an unqualified opinion. We conducted our audit in accordance with generally accepted auditing standards in Israel including those prescribed by the Israeli Auditors’ Regulations (Auditor’s Mode of Performance)—1973. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the Company’s Board of Directors and its management, as well as evaluating the overall financial statements presentation. We believe that our audit provides a reasonable basis for our opinion. As described in Note 2.a.3, the Minister of Finance prescribed in the regulations principles for the preparation of the Company’s financial statements, in accordance with his authority in section 33.a to the Government Companies Law. Pursuant to these principles, the Company shall continue reporting in values adjusted for the changes in the purchasing power of the Israeli currency pursuant to the provisions of Opinion No. 36 (including the provisions prescribed in Opinions No. 40, 50 and 56) of the Institute of Certified Public Accountants in Israel, until December 31, 2007. In our opinion, the financial statements referred to above present fairly, in conformity with generally accepted accounting principles in Israel and in accordance with the matter discussed in the preceding paragraph, in all material respects, the financial position of the Company as of December 31, 2006 and the results of its operations, the changes in its shareholders’ equity and its cash flows for the year ended December 31, 2006. Furthermore, in our opinion, the financial statements referred to above are prepared in accordance with the Securities Regulations (Preparation of Annual Financial Statements)-1993. Notes 2.ee and 33 include additional information that is required pursuant to provisions of the Government Companies Authority (by virtue of section 33.b to the Government Companies Law), excluding information regarding land rights as discussed in Note 2.ee.5. Without qualifying our above opinion, we draw attention to the following matters: 1. To Note 1.a to the financial statements regarding the stance of the Company’s management and Board of Directors with respect to the restructuring in the Company. The Company’s management and Board of Directors believe the Company’s restructuring cannot be executed and implemented (in accordance with Amendment No. 5 to the Electricity Sector Law) without reaching an agreement with the Company’s employees and the holders of its debentures as well as with the Company’s remaining creditors, in a manner that will insure that the Company will be able to meet all its existing

Exhibit 1-1 obligations towards them by law and the agreements entered into by the Company. The above Note also states that the Company’s management and Board of Directors believe that it is the State’s responsibility to act to implement Amendment No. 5 in a manner that will guarantee that the Company will be able to meet its obligations, including to its creditors.

2. To Notes 3.b.9 and 3.c to the financial statements according to which if the electricity rates are not updated as required by the changes that have occurred subsequent to the establishment of the previous rate base and as required by the transition to International Financial Reporting Standards (IFRS), this could have a material adverse effect on the Company’s financial position, its economic rating and ability to repay its debts, with all the grave sectorial and national ramifications involved.

3. To Note 1.a.4 to the ﬁnancial statements regarding the assets acquisition.

4. To Note 21.b (subsections 1, 2 and 3) to the ﬁnancial statements regarding class action lawsuits and other material claims that were ﬁled against the Company.

5. To Notes 2.p and 19.j.5 to the ﬁnancial statements according to which the ﬁnancial statements include a deferred tax liability in respect of the adjustment to the Israeli Consumer Price Index that is non-deductible for tax purposes of depreciable assets (except for immaterial buildings), whose depreciation is carried over at least 20 years from their initial operation. The Company is of the opinion that the accounting treatment as above is necessary in order to create an adequate correlation between carrying the depreciation in respect of these assets and their respective tax expenses.

March 29, 2007

Kost Forer Gabbay & Kasierer Brightman Almagor & Co.

A Member of Ernst & Young Global Certiﬁed Public Accountants

March 29, 2007

Exhibit 1-2 AUDITORS’ REPORT FOR THE YEAR ENDED DECEMBER 31, 2005

Ë Kost Forer Gabbay & Kasierer Ë Phone: 972-4-8654000 2 Palyam Blvd. Fax: 972-4-8654022 Haifa 33095, Israel

AUDITORS’ REPORT

To the Shareholders of The Israel Electric Corporation Limited

We have audited the accompanying balance sheet of The Israel Electric Corporation Limited (the ‘‘Company’’) as of December 31, 2005 and the related statements of income, changes in shareholders’ equity and cash flows for each of the years ended December 31, 2005 and 2004. These financial statements are the responsibility of the Company’s Board of Directors and its management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing standards in Israel including those prescribed by the Israeli Auditors’ Regulations (Auditor’s Mode of Performance) — 1973. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the Financial Statements are free of material misstatement. An audit includes examining on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the Company’s Board of Directors and its management, as well as evaluating the overall financial statements presentation. We believe that our audits provide a reasonable basis for our opinion.

As described in Note 2.a.3, the Minister of Finance prescribed in the regulations principles for the preparation of the Company’s ﬁnancial statements, in accordance with his authority in section 33.a to the Government Companies Law. Pursuant to these principles, the Company shall continue reporting in values adjusted for the changes in the purchasing power of the Israeli currency pursuant to the provisions of Opinion No. 36 (including the provisions prescribed in Opinions No. 40, 50 and 56) of the Institute of Certiﬁed Public Accountants in Israel, until December 31, 2007.

In our opinion, the financial statements referred to above present fairly, in conformity with generally accepted accounting principles in Israel and in accordance with the matter discussed in the preceding paragraph, in all material respects, the financial position of the Company as of December 31, 2005 and the results of its operations, the changes in its shareholders’ equity and its cash flows for each of the years ended December 31, 2005 and 2004. Furthermore, in our opinion, the financial statements referred to above are prepared in accordance with the Securities Regulations (Preparation of Annual Financial Statements) — 1993.

Notes 2.ee and 33 include additional information that is required pursuant to provisions of the Government Companies Authority (by virtue of section 33.b to the Government Companies Law), excluding information regarding land rights as discussed in Note 2.ee.5.

Without qualifying our above opinion, we draw attention to the following matters:

1. To Note 1.a to the ﬁnancial statements regarding the stance of the Company’s management and Board of Directors with respect to the restructuring in the Company. The Company’s management and Board of Directors believe the Company’s restructuring cannot be executed and implemented (in accordance with Amendment No. 5 to the Electricity Sector Law) without reaching an agreement with the Company’s employees and the holders of its debentures as well as with the Company’s remaining creditors, in a manner that will insure that the Company will be able to meet all its existing obligations towards them by law and the agreements entered into by the Company. The above Note also states that the Company’s management and Board of Directors believe that it is the State’s responsibility to act to implement Amendment No. 5 in a manner that will guarantee that the Company will be able to meet its obligations, including to its creditors.

Exhibit 2-1 2. To Notes 3.b.9 and 3.c to the financial statements according to which if the electricity rates are not updated as required by the changes that have occurred subsequent to the establishment of the previous rate base and as required by the transition to International Financial Reporting Standards (IFRS), this could have a material adverse effect on the Company’s financial position, its economic rating and ability to repay its debts, with all the grave sectorial and national ramifications involved.

3. To Note 1.a.4 to the ﬁnancial statements regarding the assets acquisition.

4. To Note 21.b (subsections 1, 2 and 3) to the ﬁnancial statements regarding class action lawsuits and other material claims that were ﬁled against the Company.

Kost Forer Gabbay & Kasierer A Member of Ernst & Young Global Haifa, Israel March 29, 2007

Exhibit 2-2 ANNEX A CONDITIONS IN ISRAEL The following information regarding the State of Israel has been extracted from the most recent Annual Report of the State of Israel (for the year ended December 31, 2006) and has not been independently verified in connection with this offering of Notes. The State of Israel has not published a more recent Annual Report. When such Annual Report is published the information for the year ended December 31, 2007 will be different from the 2006 information and such differences may be material. The Company has not sought to update such information and the following information does not otherwise reflect any changes that have occurred since December 31, 2006. The information provided is included for the convenience of investors and is not intended to be a complete description of all information about the State of Israel that may be material to investors. General The State of Israel (the ‘‘State’’ or ‘‘Israel’’) is a highly developed, industrialized democracy. Since 1990, Israel has seen improvements in most economic indicators. GDP increased on average by 5.4% annually from 1990 through 2000. A number of negative factors converged in the last quarter of 2000 and during 2001 and 2002, including the ongoing security unrest in Israel, which negatively affected tourism, the global technology slump, which slowed investments in high-tech companies, and the global economic slowdown, which negatively affected Israeli exports. As a result, GDP decreased by 0.6% in 2001 and by 0.9% in 2002. An economic recovery began in 2003 and accelerated during 2004, 2005 and 2006. In 2006, in spite of the Second Lebanon War during July and August, GDP increased by 5.1%, following an increase of 5.2% and 4.8% in 2005 and 2004 respectively. This accelerated growth rate was the result of several factors: increased macroeconomic stability, which resulted from firm fiscal policy aimed at reducing the fiscal deficit and public debt burden; fast growth of global economic activity, particularly, global trade; increased activity in high-tech sectors; and relatively low real interest rates. The Israeli economy is export-oriented. Following two years of recession during which a decrease in exports was measured, exports recovered in 2003 and continued to grow in 2004, 2005 and 2006. By 2006, exports constituted 44.5% of GDP. In 2006, exports rose by 4.9% in real terms. In recent years, Israel has made substantial progress in opening its economy, and major trade barriers and tariffs have been removed. Israel has entered into free trade agreements with its major trading partners, and Israel is one of the few nations that is a party to free trade agreements with both the United States and the European Union. Israel has also signed free trade agreements with the European Free Trade Association (‘‘EFTA’’) countries, as well as with Canada, Turkey and Mexico. Since 1990, Israel’s fiscal and monetary policies have been formulated and coordinated with the goals of reducing Israel’s high tax burden, narrowing the Government’s fiscal deficit, attaining levels of inflation similar to those in other industrialized countries and enhancing economic growth. As part of its economic policies, the Government has pursued a policy of privatizing state-owned enterprises, including banks. In contrast to periods of high inflation in the early 1980s, inflation has been reduced and stabilized. Between 1992 and 1999, the annual average inflation rate was 9.5%. Throughout that period, inflation gradually decreased. Since 1999, the annual average inflation rate has been close to zero, with the exception of 2002 when the annual average inflation rate rose to 5.7% mainly attributable to a one-time increase in prices due to currency depreciation that adjusted the currency rate to domestic and external events. The annual average inflation rate was 0.7% in 2003, negative 0.4% in 2004, 1.3% in 2005 and 2.1% in 2006. The total budget deficit (excluding net lending and the realized profits of the Bank of Israel) averaged 3.1% of GDP per year between 1995 and 2000. The total budget deficit increased to 4.2% of GDP in 2001, 3.6% of GDP in 2002 and 5.4% of GDP in 2003, mainly as a result of a decline in GDP and in tax revenue. The 2004 total budget deficit was reduced to 3.7% of GDP. The 2005 and 2006 total budget deficits were 1.9 % and 0.9% of GDP, respectively, mainly reflecting higher than expected government revenues. The implementation of a decisive fiscal policy starting in mid-2003, backed by the loan guarantees provided by the U.S. government, contributed significantly to macroeconomic stability by raising fiscal credibility and lowering economic uncertainty.

A-1 The current account deficit of the balance of payments that existed between 1995 and 2002 transitioned into a small surplus in 2003 and has been growing ever since 2004, primarily due to the growing expansion of exports, as compared with the expansion in imports during that period. Another factor that contributed to the growing surplus is the significant expansion of financial investments of Israeli residents abroad, which produced higher interest and dividend income, partially because of higher interest rates abroad. These surpluses reflect a high degree of external stability both by international standards and relative to the situation that existed in Israel in the mid-1990s. The unemployment rate increased from 9.4% in 2001 to 10.4% in 2004. In 2005, the average unemployment rate decreased to 9.0%, and in 2006 it dropped to 8.4% (in the last quarter of the year it reached 7.7%). Both the number of Israeli employees and the labor participation rate rose in 2005 and in 2006. The rate of participation in the civilian labor market (as a percentage of the population aged 15 and above) rose to 55.6% in 2006, compared with 55.2% in 2005 and 54.9% in 2004. In the last quarter of 2006, the number of employed Israelis increased by 62,400 from the last quarter of 2005. Israel’s productive and highly educated population remains a principal strength of the economy. Based on 2005 statistics, approximately 41% of the Israeli population over the age of 15 has had 13 or more years of schooling. In addition, from 1990 through 2006, approximately 1.2 million immigrants arrived, increasing Israel’s population by more than 25%. The new immigrants are generally highly educated and include a high percentage of scientific, academic, managerial, technical and other professional workers. Although this wave of immigration initially placed strains on the economy by raising the budget and trade deficits and contributing to a relatively high level of unemployment, these immigrants have been successfully integrated into the economy. Today, the employment rate of immigrants who came to Israel in the first half of the 1990s is similar to that of native-born Israelis. Over the past three decades, Israel has made progress in reducing the hostilities that have existed with Arab countries in the region since the establishment of the State in 1948. Nevertheless, the unrest in the areas administered by the Palestinian Authority, which began in September 2000 and intensified during 2001 and 2002, has been a major setback in the peace process. Since 2003 there has been an improvement in the security situation, as it relates to the Israeli-Palestinian conflict, which is reflected by the relative decline in the number of terrorist attacks and security incidents. The first peace agreement between Israel and its neighbors was the 1979 Camp David peace accord with Egypt. In September 1993, Israel and the Palestinian Liberation Organization (‘‘PLO’’) signed a Declaration of Principles, a turning point in Israeli-Arab relations. Israel signed a peace treaty with Jordan in 1994. Further agreements have also been signed between Israel and the PLO. In 2005, Israel implemented the disengagement plan, in which it dismantled all Israeli communities in the Gaza Strip, four Israeli towns in the northern West Bank and all of its military installations in those areas. In July and August 2006, Israel was engaged in a war against the Lebanese terror organization Hezbollah in Lebanon (the ‘‘Second Lebanon War’’). See ‘‘International Relations’’ below. Geography Israel lies on the western edge of Asia bordering the Mediterranean Sea. It is bounded on the north by Lebanon and Syria, on the east by Jordan, on the west by the Mediterranean Sea and Egypt, and on the south by Egypt and the Gulf of Eilat. Israel has a total land area (excluding the Gaza Strip and the West Bank) of approximately 21,500 square kilometers or 8,305 square miles, approximately the size of the State of New Jersey. Jerusalem is the capital of Israel. Population Israel’s population, including Israeli citizens residing in the West Bank, but not including foreign nationals residing in Israel for employment purposes, was estimated to be 7.11 million as of December 31, 2006, up from 6.99 million as of December 31, 2005. During the period from 1990 through 2006, Israel’s population grew by 47.5%, largely as a result of immigration. At the end of 2005, approximately 10% of the population was 65 years of age or older, 30% was between the ages of 35 and 65, 32% was between the ages of 15 and 34, and 28% was under the age of 15. Approximately 91% of the population lives in urban areas. 20% of the population lives in Israel’s three largest cities: Jerusalem (population 719,900), Tel-Aviv (population 378,900) and Haifa (population 268,300).

A-2 The Israeli population is composed of a variety of ethnic and religious groups. At the end of 2005, 76.0% of the total Israeli population was Jewish, 16.3% was Muslim, 2.1% was Christian, 1.6% was Druze and 3.9% were not classiﬁed by religion. Israel’s Declaration of Independence and various decisions by Israel’s Supreme Court guarantee freedom of worship for all Israeli citizens. Hebrew and Arabic are the ofﬁcial languages of Israel and English is commonly used.

Immigration Israel has experienced a continuous flow of immigrants, in part due to Israel’s Law of Return which provides that any Jewish immigrant is entitled to become a citizen of Israel. Between 1990 and 2001, the flow of immigrants has increased dramatically. The substantial influx of immigrants during these years totaling 1.1 million increased Israel’s population by more than 23% over this period. Over the same period, total population growth was 42.5%. Approximately 91% of all immigrants to Israel since 1990 have come from the former Soviet Union. Many of these immigrants are highly educated. Of the immigrants who arrived since 1990 who were over 15 years of age, 58% had over 13 years of schooling. Of the immigrants who arrived between 1990 and 2003, approximately 62% held scientific, academic, managerial, technical or other skilled jobs. This influx of highly skilled workers has contributed to the growth of the Israeli economy since 1990.

Form of Government and Political Parties The State of Israel was established in 1948. Israel is a parliamentary democracy, with governmental powers divided among separate legislative, executive and judicial branches. Israel has no formal written constitution. Rather, a number of basic laws govern the fundamental functions of the State, including the electoral system, the government, the legislature and the judiciary. These laws are given special status by Israeli courts relative to other laws and, in some cases, cannot be amended except by an absolute majority vote of the Knesset, Israel’s parliament. All citizens of Israel, regardless of race, religion, gender or ethnic background, are guaranteed full democratic rights. Freedom of worship, speech, assembly, press and political affiliation are embodied in the State of Israel’s laws, judicial decisions and Declaration of Independence. The President is the head of state and is elected by the Knesset for a single seven-year term. The President has no veto powers and the duties of the office are mainly ceremonial. The President selects one of the Knesset members to form the government, after consulting with different parties’ representatives. This Knesset member becomes Prime Minister. The current President, Shimon Peres, was elected on June 13, 2007. The Prime Minister is the head of Israel’s Government and appoints a cabinet to assist in governing the State of Israel. The legislative power of the State resides in the Knesset, a unicameral parliament that consists of 120 members elected by universal suffrage under a system of proportional representation. The entire State of Israel constitutes a single electoral constituency. Each party receiving more than 2.0% of the total votes cast is assigned membership in the Knesset in proportion to its percentage of the total national vote. Knesset elections are held every four years, unless the Knesset votes for elections to take place earlier or if the Knesset fails to pass the annual budget by the end of March. If a 61-vote majority of the Knesset subsequently passes a vote of no confidence in the government and proposes an alternate candidate, the government will dissolve and the President will select the alternate candidate to form a new government. If the alternate candidate fails to form a new government, new elections will be held. The Prime Minister, with the approval of the President, also has the authority to dissolve the Knesset. However, a majority of Knesset members may require the President to appoint another Knesset member to form a new government. If this Knesset member fails to form a new government, new elections will be held. Since the establishment of the State of Israel in 1948, the Government has been a coalition government led by Avoda or Likud and supported by a majority of the members of the Knesset. Currently, Israel has two major political parties, Kadima and Avoda (Labor)-Meimad. Following the March 2006 elections, the former President Moshe Katsav selected Ehud Olmert to form a government.

A-3 Prime Minister Olmert formed a new coalition government, consisting of the Kadima party, the Avoda-Meimad party, the Shas party and Gil party. International Relations Over the past three decades, Israel has made progress in reducing the hostilities that have existed between Israel and the region’s Arab countries since the establishment of the State of Israel in 1948. As a result of the historic visit to Israel by the President of Egypt in 1977 and the intensive negotiations held by the two countries, Egypt and Israel signed a peace treaty on March 26, 1979, which was the first between Israel and one of its neighboring countries. The Madrid Conference in 1991 marked the start of a broader peace process in the Middle East. The mutual recognition and the signing of a Declaration of Principles between Israel and the PLO in September 1993 was a turning point in Israeli-Arab relations. A number of interim agreements were signed, and the Palestinian Authority (the ‘‘PA’’) was established. As part of the 1994 Gaza Strip and Jericho Agreement signed in Cairo and the 1995 Interim Agreement on the West Bank and the Gaza Strip signed in Washington, D.C., Israel withdrew from Jericho, most of the Gaza Strip and six additional West Bank towns. The PA has gradually taken responsibility for administering those areas of the West Bank and Gaza Strip designated as self-rule areas. Several rounds of negotiations were held between Israel and the PLO in 2000, aimed at achieving a permanent agreement and an end to the conflict. Unfortunately, those negotiations did not result in an agreement. Since September 2000, relations between Israel and the PA have deteriorated due to violence and terror attacks conducted by Palestinian terror organizations against Israeli citizens and targets in violation of all bilateral agreements signed since 1993. In April 2003, a performance-based, multi-phase plan to end the Israeli-Palestinian conflict, known as the Road Map, was released by the United States, the United Nations (the ‘‘UN’’), the European Union and Russia. The first phase of the Road Map requires the immediate cessation of violence by the Palestinians, the implementation of comprehensive political reforms by Palestinians, the withdrawal from Palestinian areas controlled by the Israeli Defense Forces since September 28, 2000, and action by Israel in relation to settlements, in particular the dismantling of settlement outposts erected since March 2001. The second phase of the Road Map, which would begin upon satisfactory performance of the first phase, contemplates the creation of a temporary Palestinian state with provisional borders and an elected government. The third and final phase of the Road Map would include the negotiation of a final agreement to end the Israeli-Palestinian conflict and fulfill the vision of two states, Israel and Palestine, living side by side in peace and security. While the Road Map has been officially accepted by both the Israeli and the Palestinian sides, its implementation encountered a number of serious obstacles. In light of the obstacles facing implementation of the Road Map, the Government of Israel initiated the disengagement plan, which included the evacuation of all civilians and withdrawal of all military forces from the Gaza Strip and parts of the northern West Bank. Implementation of the disengagement from Gaza was completed in August 2005 and included the formal dismantling of Israel’s military government in the Gaza Strip and withdrawal of all Israeli troops from the ‘Philadelphi Route’ along the border between the Gaza Strip and Egypt. The withdrawal brought an end to Israeli presence and authority over the area, which began after the Six-Day War in June 1967. Disengagement from parts of the northern West Bank was completed in September 2005. On September 20, 2005, representatives of the United States, Russia, the European Union and the UN issued a joint statement, declaring that they ‘‘welcomed the successful implementation of the disengagement plan and the moment of opportunity that it brings to renew efforts on the Roadmap.’’ The Israeli government had expected that its unilateral steps will advance the peace process and the implementation of the Road Map. The election of the Hamas terrorist organization to head the PA in January 2006, and its refusal to accept the conditions for legitimacy set out by the international community, namely, the renunciation of terrorism and violence, the recognition of Israel’s right to exist and the acceptance of previous agreements and obligations, including the Road Map, have disrupted the efforts to renew the peace process. In June 2007, increasing violent clashes between the Hamas forces and the Fatah movement led by Palestinian President Abbas, have resulted in the Hamas de facto taking control of the Gaza Strip. Consequently, a new Palestinian Government was formed by Abbas. The

A-4 Palestinian internal violent political conflict has increased further uncertainty regarding the potential renewal of the peace process. The renewal of the Palestinian violence also resulted in significant damage to economic relations, primarily in bilateral trade, which suffered heavily during the past seven years. In his inaugural address to the Knesset, the elected Prime Minister Olmert outlined the policies of the new government which included a preference for negotiations with a Palestinian partner committed to ‘‘the principles of the Roadmap, which fights terror, dismantles terrorist organizations, abides by the rules of democracy and upholds, practically and thoroughly, all agreements which have thus far been signed with the State of Israel.’’ However, in the absence of such a partner, Prime Minister Olmert declared that the government would act ‘‘without an agreement with the Palestinians to create an understanding which will, first and foremost, be founded on a correct definition of the desired borders for the State of Israel.’’ The new Prime Minister also stated that Israel would work to reach understandings with the United States and Europe on its future steps. On October 26, 1994, Israel and Jordan signed a peace treaty. After resolving issues relating to borders and water, Israel and Jordan entered into negotiations to promote economic cooperation and planning of regional economic development initiatives. In addition to political and economic discussions between Israel, Egypt and Jordan, in recent years, Israel has begun to establish economic and political relations with other Arab countries in the region, both in Africa and the Gulf states. On October 28, 1999 Israel and Mauritania established full diplomatic relations. Mauritania is the third country after Egypt and Jordan with whom Israel exchanged ambassadors. Although Israel has entered into various agreements with Arab countries and the PLO, and various declarations have been signed in connection with the efforts to resolve some of the economic and political problems in the Middle East, no prediction can be made as to whether, and under what terms, a full resolution of these problems will be achieved. To date, Israel has not entered into a peace treaty with either Lebanon or Syria. On May 23, 2000 the Israeli military forces withdrew from South Lebanon, in accordance with a government decision to implement United Nations Resolutions 425, as confirmed by the Security Council and Secretary General of the United Nations. In July 2006, an attack of the Lebanese terror organization Hezbollah on Israeli military patrol within the Israeli border led to the Second Lebanon War, which included heavy fighting during July and August 2006. The war ended with UN resolution 1701, which called the government of Lebanon to take full control of Lebanon, called for the deployment of UNIFIL soldiers throughout the South of Lebanon and prohibited the presence of paramilitary forces, including Hezbollah, south of the Litani River. Since 1948, the members of the Arab League have maintained a trade boycott of Israel. The primary tier of the boycott prohibits the importation of Israeli- origin goods and services by member states. The secondary tier of the boycott prohibits individuals in Arab League states from engaging in business with foreign firms that contribute to Israel’s military or economic development, and the tertiary tier of the boycott prohibits business dealings with firms that do business with blacklisted entities. In September 1994, the Gulf Cooperation Council (which includes Qatar, Oman, Bahrain, United Arab Emirates, Saudi Arabia, and Kuwait) declared their intention to lift the secondary and tertiary trade boycotts of Israel, signifying a major shift in Israel’s relations with several Arab nations in the region. In addition, four other Arab League members (Algeria, Djibouti, Mauritania and Somalia) do not enforce the secondary and tertiary boycotts of Israel. Prior to the recent security unrest, Israel and its Arab neighbors had taken several initiatives to encourage the development of economic relations among the countries of the region. The formation of additional regional economic organizations was proposed to enhance cooperation between Israel and other countries of the region. Among these, the most important are the Middle East Development Bank (MEDB), the Middle Eastern-Mediterranean Tourist and Travel Association (MEMTTA) and the Regional Business Council (RBC). Israel maintains a close economic, diplomatic and military relationship with the United States. Israel receives economic and military assistance from the United States in amounts that have averaged approximately U.S.$3 billion per year since 1987. In 1992, the United States approved up to U.S.$10 billion of loan guarantees during U.S. fiscal years 1993 through 1998 to help Israel absorb the recent influx of immigrants. In April 2003, the United States approved up to U.S.$9 billion in loan guarantees for the State

A-5 of Israel to be issued during U.S. government fiscal years 2003 through 2005. This program was extended until 2011. The amount of guarantees that shall be issued to Israel under the loan guarantee program may be reduced by an amount equal to the amount extended or estimated to have been extended by Israel for activities that the President of the United States determines are inconsistent with the objectives and understandings reached between the United States and Israel regarding the implementation of the loan guarantee program. For United States fiscal year 2003, the amount of this reduction was U.S.$289.5 million. For United States fiscal year 2006, a reduction of U.S.$795.8 million was made. The proceeds of the guaranteed loans may be used to refinance existing debt (see ‘‘Public Debt-External Public Debt’’ below). In May 2003, as part of the aid package, the United States formally granted Israel U.S.$1 billion in military aid. The Government of Israel and the United States have agreed to reduce foreign assistance to Israel. This reduction involves a phase-out of U.S. Economic Support Fund (‘‘ESF’’) assistance to Israel through incremental annual reductions in the level of such annual assistance over a ten-year period that began in fiscal year 1999. Over the same time period, the United States will increase annually the level of its Foreign Military Financing (‘‘FMF’’) assistance to Israel in amounts equal to half the amount of the annual reduction in ESF assistance. Subject to Congressional appropriations, from U.S. fiscal year 1999 through 2008, each year the level of ESF assistance will be reduced by U.S.$120 million and the level of FMF assistance will be increased by U.S.$60 million. The level of ESF assistance for U.S. fiscal year 2007 is U.S.$120 million. Israel currently maintains diplomatic relations with more than 160 countries. Israel has established or re-established commercial, trade and diplomatic relations with several republics of the former Soviet Union, nations of Eastern Europe, and other countries that had been aligned politically with the former Soviet Union. Furthermore, the developments toward peace in the region in the last decade have facilitated the growth of commercial, trade and diplomatic relations with several Asian countries, including Japan, South Korea, China and India. Membership in International Organizations and International Trade Agreements Israel is a member of a number of international organizations, including the United Nations, the World Bank Group (including the International Finance Corporation), the International Monetary Fund (the ‘‘IMF’’), the European Bank for Reconstruction and Development, and the Inter-American Development Bank. Israel has been a signatory to the General Agreement on Tariffs and Trade (‘‘GATT’’) of 1947 and 1994 (the World Trade Organization Agreement (the ‘‘WTO’’)), which provides for reciprocal lowering of trade barriers among members. Under the WTO, Israel is eligible to receive a number of trade preferences that are available only to certain participants, including duty-free treatment of its exports to certain countries pursuant to the Generalized System of Preferences. Israel is one of the founding members of the WTO. In March 1996, the Council of Ministers of the Organization for Economic Cooperation and Development (‘‘OECD’’) approved Israel’s request to participate in the organization’s activities, and Israel has accordingly joined certain OECD committees as an observer. Since February 2000, Israel has been in a dialog with OECD leadership in order to promote Israel’s admission to the organization as a full member. In May 2007, OECD countries invited Israel to begin discussions on its accession to the organization. Israel has an extensive network of free trade agreements with most of its trading partners: United States, European Union, EFTA, Turkey, Canada, Mexico and Jordan. Approximately 75% of Israel’s foreign trade is conducted under its bilateral free trade agreements, which provide duty free access and other preferential treatment schemes. Israel is currently negotiating a free trade agreement with the MERCOSUR block (Brazil, Argentina, Paraguay and Uruguay) which is scheduled for signing by the end of 2007. In 1975, Israel established a free trade agreement with the European Economic Community (EEC) that provided for the gradual reduction and ultimate elimination of tariffs on manufactured goods and certain agricultural products. In July 1995, Israel signed an Association Agreement with the European Union, which came into force in June 2000. The 1995 agreement, which replaced the 1975 agreement,

A-6 addresses issues relating to services, competition, government procurement, and cooperation in many areas including research and development. It also expands the liberalization in agricultural products. At the end of 2004, Israel and the European Union approved an Action Plan (within the European Neighborhood Policy) to address several issues including but not limited to services, dispute settlement for trade matters and standardization. Since 1996, Israel has participated in the EU Framework Programs for Research and Development, which allow Israeli firms and academic institutions to participate in European Union research and development projects. Israel is the only country outside Europe to enjoy this special status, a status granted to Israel largely in recognition of its role as a key technological player in the global arena. Under the Fifth Research and Development Program, more than 500 Israeli projects have been implemented, with a total value of more than EUR150 million. In November 2002, Israel was admitted to the EU’s Sixth Research and Development Program and gained access to EUR17 billion in research and development tenders from European Union countries. Israel is currently negotiating its admission to the Seventh Research and Development Program. In addition, in 2004 Israel joined the EU GALILEO program for the development of a space navigation system. In 1985, Israel and the United States entered into a free trade agreement that resulted in the elimination of all tariffs on all industrial products effective January 1, 1995. The free trade agreement with the United States also resulted in the elimination of certain non-tariff barriers to trade between the two countries. In recent years, Israel, with the assistance of the United States, has developed new regional trade agreements that stimulate economic cooperation between Israel and its neighbors in the Middle East. Israel signed a Qualified Industrial Zones (‘‘QIZ’’) agreement with Jordan in 1997 and a separate QIZ agreement with Egypt in December 2004. The above mentioned agreements allow Egypt and Jordan to export products to the United States free of export duties if the products contain inputs from Israel (8% of input from Israel in the Israeli-Jordanian QIZ agreement, 11.7% of input from Israel in the Israeli-Egyptian QIZ agreement). The purpose of this trade initiative has been to support prosperity and stability in the Middle East by encouraging regional economic integration. In order to promote its international economic cooperation, and, in particular, to promote Israeli investments in emerging markets, Israel has signed 32 bilateral investment treaties. The treaties provide investors from countries that are party to the treaties with basic security and protection rights when investing in another party’s country. Some of those rights include repatriation of investments and returns, a prohibition on expropriation or nationalization other than for public purposes, prompt, adequate and effective compensation, and no less favorable treatment as compared with investors from countries that are not party to the treaties. Israel is also a party to 44 conventions for the avoidance of double taxation that cover most aspects of income tax and capital gains tax. Three more tax treaties were signed but have not yet been ratified. Most of Israel’s tax treaties are based on the OECD Model Tax Convention on Income and on Capital. Some of the treaties also include provisions from the UN Model Double Taxation Convention between Developed and Developing Countries. The conventions provide investors from countries that are parties to the conventions with greater certainty when investing in another party’s country and contribute to economic cooperation between the countries that are parties to the conventions.

The Economy

Overview Israel’s economy is industrialized and diversified. GDP per capita in 2006 was U.S.$19,917. From 1990 through 2006, real GDP growth averaged 4.5% per year (1.8% per capita). From 1990 through 2000, GDP increased on average by 5.6% annually, which had been, to a large extent, a product of the increased domestic demand due to the large volume of new immigrants during that period and the growth of high value-added industries, such as electronics and high-tech medical equipment. A number of negative factors converged in the last quarter of 2000 and during 2001 and 2002, including: security unrest with the Palestinian Authority, which negatively affected tourism and contributed to the fiscal deficit; the global technology slump, which slowed investments in high-tech companies; and the global economic slowdown,

A-7 which negatively affected Israeli exports. As a result, GDP decreased by 0.6% in 2001 and by 0.9% in 2002. There was a recovery in economic activity in 2003, as evidenced by a 1.5% increase in GDP. The recovery gained momentum in 2004 and 2005, as expressed by a 4.8% and 5.2% increase in GDP, respectively. Despite the Second Lebanon War, this rapid GDP growth continued in 2006 with a 5.1% increase. The recovery during the years 2003 through 2006 was related to: the improvement in the global economy, as manifested by the expansion of global trade and demand for high-tech products; the adoption of a firm fiscal policy; a relatively calm security situation (apart from the Second Lebanon War); and a less restrictive monetary policy. The year 2006 was characterized by a rapid growth of all components of the GDP. In 2006, exports of goods and services increased by 4.9%, private consumption increased by 4.8% and investments in fixed assets increased by 6.4%. The composition of Israel’s trade sector reflects the industrialized nature of its economy. In 2006, exports consisted primarily of manufactured goods, in particular high-tech goods, while raw materials and investment goods comprised 88.6% of imported goods. Especially since 1992, exports have played a significant role in Israel’s economic growth. During the period from 1992 to 2006, exports of industrialized goods (excluding diamonds) grew by an annual average of 9.7% (in volume terms). In 2000, due to rapid growth in the United States and European Union economies, Israel’s exports of industrialized goods (excluding diamonds) increased by 27.0%, while total exports of goods and services increased by 22.7%. However, total exports of goods and services decreased by 11.2% in 2001 and by 2.3% in 2002. The main factors behind the contraction in exports of goods were the global slowdown, which dampened global trade, and the decline in demand for high-tech goods. Exports of services were severely affected by the large decline in exports of tourism services caused by the security and political unrest during those years, and the decline, to nearly zero, of start-up exports (sales of start-up companies to international buyers) due to the global high-tech crisis. In 2003, exports began to recover, growing by 8.2%. The recovery in exports gained momentum in 2004, as exports rose sharply, by 18.2%. The expansion in exports continued in 2005 and 2006 as well, albeit at a lower rate than in 2004 (5.1% and 4.9% in real terms, respectively, including a 8.1% and 8.7% rise in exports excluding diamonds and start-ups). High-tech and traditional industries took part in the rise in exports of goods; the exports of services also rose, in particular the sharp increase in tourism, recovering from a slump that began in late 2000. The growth in exports during the years 2003-2006 was a result of the global economic recovery, the expansion of global trade and increased demand for high-tech products, the depreciation of the NIS in real effective terms during the period from 2002 through 2004, the decrease in real wages during 2002 and 2003, improved efficiency of business enterprises in Israel, and lower interest rates. Exports of services grew by 5.3% in 2006, despite a decline of 3.7% in the tourism sector that was associated with the Second Lebanon War. The decline in tourism measured in the summer of 2006 followed an increase of 28.4% in 2005, and was followed by a fast recovery during the remainder of 2006. Exports of agricultural products remained stable in 2006, with an increase of 0.4%, following a sharp increase of 14.1% in 2005. Historically, the Government has had a substantial involvement in nearly all sectors of the Israeli economy. In the past decade, however, a central aim of the Government’s economic policy has been to reduce its role in the economy and to promote private sector growth. In order to advance these goals, the Government has pursued a policy of privatizing State-owned enterprises, including banks. See ‘‘Role of the State in the Economy.’’ The Government has also pursued stability-oriented monetary and fiscal policies. These policies build upon the economic stabilization program established by the Government in 1985 (the ‘‘Economic Stabilization Program’’). The 1985 economic stabilization program was a comprehensive plan designed mainly to reduce Israel’s high inflation rates and chronic deficits in the balance of trade that resulted from high levels of defense expenditures, rising Government spending and rising oil prices. Since 1985, Israel has made significant progress in stabilizing inflation through effective implementation of monetary policy by the Bank of Israel, fiscal restraint and trade liberalization by the Government. In 1986, the Government succeeded in reducing inflation to 19.6%. During the period of 1987 through 1991, inflation stabilized to an annual average rate of 17.8%. During the period of 1992 through 1999, the annual average inflation rate decreased to an average of 9.5%. The average rate of inflation dropped to a mere 1.1% in each of 2000 and 2001, but rose in 2002 to an average of 5.7%, mainly as the result of the currency depreciation during the first half of 2002. Since then, inflation has dropped back again, to an average

A-8 annual rate of 0.7%, negative 0.4% and 1.3% in 2003, 2004 and 2005, respectively. In 2006, the average annual inﬂation rate was 2.1%. The Government’s inﬂation target for 2007 and onwards is 1% to 3%.

Main Economic Indicators Year 2002 2003 2004 2005 2006 (in millions of NIS unless noted) Growth (Percentage Change) ...... Real gross domestic product ...... -0.9% 1.5% 4.8% 5.2% 5.1% GDP per capita...... -2.9% -0.3% 3.0% 3.4% 3.2% Inﬂation (change in CPI — annual average) 5.7% 0.7% -0.4% 1.3% 2.1% Industrial production...... -2.4% -0.4% 7.1% 4.7% 8.9% Constant 2005 Prices GDP...... 520,103 527,935 553,258 582,290 611,819 Business sector product ...... 362,403 370,352 395,374 421,704 448,591 Current Prices GDP...... 517,975 524,187 548,936 582,291 626,015 Business sector product ...... 359,172 368,663 390,508 421,706 457,212 GNP...... 498,904 506,368 532,898 570,572 619,441 Net national income (at market prices). . . 411,482 416,977 440,723 475,755 520,508 Permanent Average Population (thousands) ...... 6,570 6,690 6,809 6,930 7,053

Source: Central Bureau of Statistics.

Gross Domestic Product GDP is defined as gross national product (‘‘GNP’’) minus income of Israeli residents from investments abroad, earnings of Israeli residents working abroad, and other income from work and leases abroad, less corresponding payments made abroad (after deduction of payments to foreign companies with respect to production facilities located in Israel). GDP growth averaged 5.6% annually between 1990 and 2000. From October 2000 until the beginning of 2003, the GDP growth rate declined mainly due to: the global economic slowdown, which dampened demand for high-tech products on which a significant percentage of the Israeli economy relies; the decline of the NASDAQ index, which reduced investments in Israeli start-up companies and in the high-tech industry in general; and the adverse effects of Palestinian terrorism on tourism, construction, agriculture and exports to the Palestinian Authority areas. Growth was negative 0.6% and negative 0.9% in the years 2001 and 2002, respectively. The recovery process began in 2003 and gained momentum in 2004 and 2005 with GDP growth rate increasing to 4.8% and 5.2% in 2004 and 2005, respectively. The GDP growth continued in 2006 with a 5.1% increase. Contributing factors to the rate of GDP growth include: the improvement in the global economy, as manifested by the expansion of global trade and demand for high-tech products; the adoption of a firm fiscal policy; a relatively calm security situation (apart from the Second Lebanon War); and relatively low real interest rates. In 2006, economic improvement was reflected in rapid growth of all components of GDP except for tourism, which constitutes 1.3% of GDP.

Savings and Investments In 2006, gross national savings increased to 22.5% of GDP (in current prices), compared with 20.6% in 2005 and 19.1% in 2004. Gross domestic investment, the sum of investments in ﬁxed assets and the change in inventories, totaled 17.6% of GDP in 2006 and has remained relatively stable in the past few years. In 2006, total gross domestic investment increased by 4.1% in real terms following increases of 11.5% and 1.2% in 2005 and 2004, respectively. Investment in ﬁxed assets increased by 6.4% in 2006, following a 2.9% increase in 2005 and a 0.3% decrease in 2004.

A-9 Investment in machinery, equipment and transport vehicles increased by 10.7% in 2006. Investment in residential construction in 2006 increased by 1.7%, following a decrease of 1.3% in 2005 and a decrease of 2.6% in 2004. The residential construction sector has contracted since 1998 as a result of the decrease in demand following the slowdown in the wave of immigration and in response to the recession during the years 2001-2002.

Business Sector Product Business sector product in Israel equals GDP less general government services, services of private non-proﬁt institutions and housing services (representing the imputed value of the use of owner-occupied residential property). Business sector product grew at an average annual rate of 6.8% in real terms from 1990 through 2000, but decreased by 1.9% and by 2.8% in 2001 and in 2002, respectively. Since 2003, business sector product began to grow again, increasing by 2.2%, 6.8%, and 6.7% in 2003, 2004 and 2005, respectively. In 2006 it grew by 6.4%.

Prices In the early and mid-1980s, Israel’s economy experienced high rates of inflation, reaching a peak of 445% in 1984. In response to this crisis, in 1985, the Government implemented the Economic Stabilization Program, which succeeded in reducing the rate of inflation to 19.6% in 1986, and maintaining the annual rate of inflation during the period from 1987 through 1991 at an annual average of 17.8%. As a result, price controls that were introduced as part of the Economic Stabilization Program were largely eliminated by mid-1988. The inflation rate, measured by the CPI, averaged 9.5% during the period from 1992 to 1999, with fluctuations between 9.0% and 12.3% on an annual average basis. Inflation since 1999 has been close to zero. The inflation rate in 2002 (an annual average of 5.7%) was an exception and reflected a one-time increase in prices due to currency depreciation after several years of high interest rates that had delayed the exchange-rate adjustment. The average annual inflation rate was 0.7% in 2003, -0.4% in 2004, 1.3% in 2005 and 2.1% in 2006. Both the Ministry of Finance and the Bank of Israel have stated that maintaining low rates of inflation is one of their main priorities. Since the end of 1991, the Government has announced annual inflation targets as part of its effort to further reduce inflation. The Bank of Israel has adopted a restrictive monetary policy in recent years. As a result, since 1999, inflation has been below government targets most years. Since November 1993, the Bank of Israel has adjusted its key rate of interest on lending to banks on a monthly basis. Beginning in June 2003, the Bank of Israel lowered the key interest rate at an accelerated rate, reaching 5.2% by the end of 2003. In 2004, the key interest rate was lowered to 3.9% and by September 2005, the interest rate reached 3.5%. Subsequently, the Bank of Israel increased the interest rate gradually up to 4.5% in December 2005, and to 5.0% in April 2006. A cautionary reaction to the deterioration in security led the Bank of Israel to increase the rate to 5.5% in August 2006. Since November 2006 the interest rate has been gradually decreased and was set at 3.5% in June 2007. Real interest rates, derived from the Bank of Israel’s key interest rate, have fallen from more than 6% in mid-2003 to about 2.9% in March 2007. The public’s inflation expectations are calculated as the difference between nominal yields (on unindexed Government bonds) and real yields to maturity (on CPI-indexed Government bonds). During 2006, the public’s inflation expectations for one year and two years ahead, as derived from the capital market, were near the lower end of the inflation target range of 1-3%.

Employment and Labor One of Israel’s most important resources is its experienced and highly educated work force. In 2005, approximately 41.3% of the Israeli population over age 15 had 13 or more years of schooling. With this highly-educated population, Israel has developed an export-oriented, technology-based industrialized economy. In 2005, 29% of the Israeli work force consisted of scientiﬁc, academic, professional, technical

A-10 and related workers, while 24% consisted of administrative or managerial workers. These percentages compare favorably with the percentages of such workers found internationally. The employment qualifications of recent immigrants have been consistent with the high quality of the Israeli work force, with two-thirds of immigrants from the former Soviet Union having been employed there as professionals, scientists, engineers or technical staff. The wave of immigrants since 1990 led to significant growth in the Israeli labor force. In 2006, Israel’s civilian labor force averaged a total of 2.8 million people compared with 1.9 million in 1992. The recession that began in late 2000 caused the unemployment rate to increase from 8.8% in 2000 to 10.3% in 2002. Despite the economic recovery that began in 2003, the unemployment rate continued to climb in 2003 to a rate of 10.7%. The unemployment rate decreased to 10.4% in 2004, 9.0% in 2005 and 8.4% in 2006 (7.7% in the last quarter of 2006). The number of Israeli employees, and, the rate of civilian labor force as a percentage of the population over the age of 15 (the ‘‘labor participation rate’’) rose in 2006. In Israel, the labor participation rate is negatively affected by the relatively large number of soldiers. The average labor participation rate increased from 54.1% in 2002 to 55.6% in 2006. Compared with the last quarter of 2004, the number of employed Israelis increased by 74,400 in the last quarter of 2006. The increase in the participation rate and the number of Israelis employed is attributed, among other factors, to the successful implementation of government policy of cutting transfer payments and reducing the number of foreign workers. In 2006, business sector employment increased by 65,000 (compared with an increase of 63,000 in 2005) and employment in public services increased by 15,000, compared with a decrease of 30,000 in 2005 and a decrease of 3,000 in 2004 (year-on-year averages). The unemployment rate among immigrants in 2005 was 8.5%, even less than that of the native-born population (9.0%). Surveys undertaken by the Israeli Central Bureau of Statistics indicate that immigrant unemployment declines with length of stay in the country. Immigrant participation rate in the labor force stood at 58.2% in 2005 compared with 55.2% for the working age population as a whole. Despite the initial difficulties experienced by many of the professional and other highly skilled immigrants in finding suitable employment, statistical data regarding employment in Israel suggest that immigrants have moved from their original jobs into jobs better suited to their education and other employment qualifications. One important factor in this transition has been the professional requirements of Israel’s high-tech companies, which have matched well with the educational and professional background of many of the immigrants. Role of the State in the Economy Historically, the Government has been involved in nearly all sectors of the Israeli economy, particularly in defense-related and monopolistic businesses. Before the privatization process, ownership of industry in Israel was divided between the Government, the Histadrut and the private sector, with the Government and the Histadrut owning prominent interests in several key industries. In recent years, the Government has made significant progress towards the privatization of state-owned enterprises. As part of this process, the Government has implemented structural reforms aimed to enhance competition in some essential monopolistic sectors such as the communication sector, oil refineries and the seaports. In addition, the Government has begun the process of introducing competition to additional sectors and industries, such as the electricity sector and capital markets. As of June 2007, there are 99 state-owned enterprises, 40 of which are business-oriented enterprises. The remaining state-owned enterprises include funds established as vehicles for employee savings or educational institutes. State-owned enterprises are divided, by law, into two main categories: Government Companies (including their subsidiaries) and Mixed Companies. In addition to state-owned enterprises, the Government is also involved in some sectors through statutory authorities. Government Companies (a category that excludes state-owned banks acquired pursuant to the Bank Shares Arrangement, see ‘‘Privatization’’ below) are those where the Government owns more than 50% of the voting shares and which are subject to the provisions of the Israeli Government Companies Law and the regulations promulgated thereunder (collectively, the ‘‘GCL’’), as well as the directives of the

A-11 Government Companies Authority (see ‘‘Privatization’’ below). The GCL regulates the management and operation of Government Companies and the circumstances under and procedures by which the Government may sell shares in Government Companies or reorganize Government Companies. Mixed Companies are companies in which the State owns 50% or less of the voting shares. Under the GCL, Mixed Companies are not subject to the same degree of regulation as Government Companies. However, Mixed Companies are subject to certain limited provisions of the GCL, including the Government’s appointment and qualification of certain directors. Government Companies play a significant role in the Israeli economy. Although they employed only 1.8% of the Israeli work force, in 2005 Government Companies accounted for 8% of total exports and 8% of investment in fixed assets. These companies include several public service monopolies and a number of companies that either engage in activities considered crucial to Israeli national security or provide important services to the Government. To increase competition in the markets in which these companies participate and thus prepare them for privatization, the Government has initiated a number of regulatory arrangements with the major Government Companies. Nevertheless, the pace of privatization may be affected by the need for further regulatory and structural reforms and formulation of policies that will define the post-privatization environment in which these companies will operate. The development and implementation of some of these policies and reforms may take a considerable period of time. Privatization An essential element of the broader structural reforms initiated by the Government over the past several years to promote the growth of the private sector and to enhance competition is the Government’s move towards privatizing its business holdings. Privatization efforts have included the full or partial sale of state-owned companies and banks and the transfer of activities that were previously performed by the Government or statutory authorities to private entities. From 1986 through June 2007, 91 companies changed their status as Government Companies and the Government’s proceeds from privatization from 1986 through April 2007 were approximately U.S.$14.2 billion. In 2006, proceeds from privatization totaled NIS4.7 billion. Balance of Payments General As a small country with a relatively limited domestic market, Israel is highly dependent on foreign trade. International trade (exports plus imports) of goods and services amounted to 88.3% of GDP (at current prices) in 2006. Following a goods and services trade deficit of U.S.$3.5 billion in 2002 and U.S.$1.0 billion in 2003, the goods and services trade balance in 2004 was a surplus of U.S.$0.7 billion, which balanced (U.S.$0.0 billion) in 2005 and increased to a surplus of U.S.$0.9 billion in 2006. This improvement in the trade balance was the result of a significant increase in exports of goods and services, and a moderate increase in imports of goods and services. Economic and military assistance furnished by the United States, German reparations and personal and institutional remittances increased by 23.8% in 2006 to U.S.$7.4 billion, following decreases of 4.9% in 2005 and 2.1% in 2004. Official reserve assets increased during 2006 by 3.8% to U.S.$29.4 billion, compared with U.S.$28.3 billion in 2005 and compared with U.S.$6.9 billion at the end of 1994. As of December 31, 2006, Israel’s net external debt was negative U.S.$31.7 billion (negative 23.4% of GDP), as compared with positive U.S.$11.1 billion (8.6% of GDP) at the end of 1995. Balance of Payments Israel’s balance of payments consists of two parts: (i) the current account, which measures the trade balance (receipts and payments derived from the sale of goods and rendering of services), the balance of

A-12 income payments and transfer payments; and (ii) the capital and ﬁnancial account, which reﬂects borrowing by the Government and the private sector, foreign direct investment in Israel and investment by Israeli residents abroad and assets and liabilities of commercial banks.

In the second half of the 1990s, the current account deficit steadily decreased, due mainly to an improvement in Israel’s terms of trade and a greater increase in exports than the increase in imports. In 2002, the current account deficit was 0.6% of GDP. Israel’s current account deficit of the balance of payments transitioned into a small surplus in 2003, which grew in 2004, 2005 and 2006. In 2003 and 2004, the current account surplus was U.S.$1.4 billion and U.S.$2.9 billion, respectively. In 2005, the current account surplus was U.S.$4.3 billion and in 2006 it grew to U.S.$6.8 billion. The surplus in the last four years attests to the high external stability both by international standards and relative to the deficits of the mid-1990s. Year 2002 2003 2004 2005 2006 (In millions of dollars)(1) Current account balance ...... U.S.$ (976) U.S.$ 1,371 U.S.$ 2,926 U.S.$ 4,295 U.S.$ 6,841 Balance of trade and income payments(2) ..... (7,761) (5,039) (3,351) (1,677) (553) Exports(2) ...... 41,788 46,321 55,629 63,136 69,217 Imports(2) ...... (49,549) (51,360) (58,980) (64,813) (69,770) Transfer payments (net) ...... 6,785 6,411 6,277 5,972 7,394 Government sector ...... 4,420 4,115 3,519 3,221 4,385 Other sectors ...... 2,366 2,296 2,759 2,751 3,009 Of which: personal restitutions from Germany. . 760 770 946 750 736 Capital and financial account balance ...... (1,867) (1,851) (3,666) (7,999) (6,730) Capital transfers ...... 207 535 667 727 893 By the public sector ...... (120) 191 173 163 197 By the private sector ...... 328 344 494 564 696 Financial account...... (2,074) (2,386) (4,333) (8,726) (7,623) Direct investments...... 734 1,803 (2,460) 1,431 517 Abroad ...... (982) (2,065) (4,544) (3,323) (13,633) In Israel ...... 1,715 3,868 2,084 4,754 14,150 Portfolio investment ...... (2,496) (1,344) 4,495 (3,653) (204) Assets ...... (3,219) (3,155) (2,376) (8,208) (8,792) Equity securities ...... (711) (1,088) (810) (3,631) (5,144) Debt securities...... (2,509) (2,067) (1,567) (4,577) (3,647) Liabilities...... 723 1,812 6,871 4,555 8,587 Other investments ...... (1,087) (1,775) (6,042) (4,592) (7,547) Assets ...... (1,133) (1,543) (6,212) (5,075) (9,326) Government ...... 110 140 84 1,295 315 Private sector...... (1,583) (275) (2,568) (1,662) (3,066) Banks...... 340 (1,255) (3,658) (4,718) (6,587) Liabilities...... 45 (232) 171 483 1,779 Government — long-term ...... (10) (68) (218) (273) (590) Government — short-term ...... 25 — (25) — — Private sector — long-term ...... 25 139 749 233 1,109 Private sector — short-term ...... (112) 255 785 655 40 Banks...... 117 (558) (1,120) (132) 1,219 Reserve assets (net) ...... 776 (1,068) (301) (1,940) (369) Financial derivatives (net)...... (11) (4) (26) 29 (21) Net Errors and Omissions...... (2,843) (480) (740) (3,704) 111

(1) Many of the Balance of Payments ﬁgures are based on temporary estimations, and therefore are subject to signiﬁcant adjustments over time.

A-13 (2) Includes exports and imports of goods, services and income payments. The data on exports and imports of goods is based on current foreign trade statistics, adjusted for the balance of payments deﬁnitions established by the International Monetary Fund. The value of imports and exports is recorded on a f.o.b. basis. Defense imports, which are not included in the foreign trade statistics, are included in the Balance of Payments table. Source: Central Bureau of Statistics.

Foreign Investment Net foreign investment in Israel totaled U.S.$24.4 billion in 2006, significantly higher than the U.S.$9.9 billion invested in 2005, and the highest level ever. These figures include direct foreign investment, investment in Israeli securities traded on the TASE and on foreign exchanges, direct credit to the public sector and to residents (excluding trade finance and credit to suppliers), and deposits by nonresidents in Israeli banks. Net Foreign Direct Investment (‘‘FDI’’) increased significantly from U.S.$4.8 billion in 2005 to approximately U.S.$14.2 billion in 2006. This growth was backed by the materialization of several large transactions, primarily the acquisitions of non-tradable Israeli companies, mainly in the hi-tech sector. The macroeconomic improvement and a global trend of record flows into emerging markets (a category in which financial investments in Israel are sometimes included) also had a positive influence on portfolio investments. Because the timing and scale of these kinds of investments often result from non-recurring, one-time opportunity, 2006 figures do not necessarily represent a sustainable level. Unlike in recent years, when the most significant sector that attracted FDI to Israel was the hi-tech sector, in 2006, a substantial share of FDI was in traditional industries, most notably the purchase of Iscar, a leading metalworking company, for U.S.$4 billion. Other significant investments were made through two other transactions, where non-residents purchased financial asset management companies for a total of U.S.$0.7 billion. FDI in tradable companies totaled U.S.$0.7 billion, compared with a record U.S.$1.4 billion in 2005, mostly as a result of privatizations during 2005. A significant share of the FDI in Israel is made in start-up companies, real estate and reinvestment of accumulated profits in Israeli companies. These transactions comprise a rather stable component of total FDI, which is otherwise generally considered to be volatile. In 2006, FDI in start-up companies totaled about U.S.$0.9 billion. The pace of investments in start-ups has been rather stable in the last few years and seems to be high, relative to the global trend. In 2006, investment in real estate totaled a record U.S.$1.4 billion, compared with U.S.$1.2 billion in 2005. The most gainful sectors were communications, software and life science. Free investable capital, which is the sum of investors’ obligations to the investment funds, also has been stable and measured U.S.$1.3 billion in 2006. Net portfolio investment totaled U.S.$8.6 billion, compared with U.S.$4.6 billion recorded in 2005. The major share of these investments was made through one large Israeli corporate issuance abroad for Cellcom Israel Ltd. of U.S.$5.5 billion in equity and U.S.$2.6 billion in bonds. There was also a U.S.$2.2 billion investment by non-residents in domestic government bonds, primarily in the last quarter of 2006, as a consequence of the Primary Dealership Reform (see ‘‘The Financial System—Capital Markets’’ below). Other than the aforementioned issuance, the scope of issuance abroad by Israeli companies slowed down during 2006. In addition, non-residents liquidated a net U.S.$0.1 billion of equity traded on the TASE, compared with a net investment of U.S.$2.1 billion in 2005. Other foreign investments, comprised of deposits in local banks and credit allocation, totaled U.S.$1.8 billion in 2006, compared with U.S.$0.6 billion in 2005. There was a major increase in foreign-currency-denominated deposits, from U.S.$0.3 billion in 2005 to U.S.$1.5 billion in 2006.

Public Debt Public sector debt (‘‘public debt’’) in Israel consists of the local currency and foreign currency debt of the public sector. Net public debt as of December 31, 2006 was NIS470.2 billion (75.9% of GDP), of which NIS11.3 billion was net foreign currency debt. As of December 31, 2005, the net public debt was NIS484.4 billion. Following four years of increases, in the last two years, net public debt as a percentage

A-14 of GDP declined, marking a return to the pre-2001 trend. The main factors that contributed to the decrease of the public sector debt in 2006 were the low government deﬁcit, the high proceeds from privatizations, and the depreciation of the U.S. dollar as compared with the NIS.

Ratio of Net Public Debt to GDP Year 2002 2003 2004 2005 2006 (percentage of GDP at end-of-year prices) Local Currency...... 80.5% 86.4% 84.5% 78.6% 74.1% Foreign Currency ...... 3.3 3.3 3.7 2.6 1.8 Total ...... 83.8 89.8 88.2 81.2 75.9

Source: Bank of Israel.

Net Public Debt Year 2002 2003 2004 2005 2006 (at end-of-year current prices in billions of NIS)(1) Local Currency ...... NIS416.4 NIS444.7 NIS464.9 NIS468.9 NIS458.9 Foreign Currency(2) ...... 17.2 17.1 20.1 15.5 11.3 Total ...... 433.6 461.8 485.0 484.4 470.2

(1) The net public debt includes debt of local authorities, except the local authorities’ debt to the Government.

(2) Net foreign currency public debt equals the Government’s foreign currency liabilities minus foreign reserves.

Source: Bank of Israel.

Energy

Israel’s main sources of energy are oil and coal. Israel is almost totally dependent on imported fuel for its energy requirements, since domestic production of crude petroleum is negligible and Israel has no domestic production of coal. Most of Israel’s foreign oil is purchased in the open market. Pursuant to the Oil Supply Arrangement, the United States has agreed to supply Israel with oil in the event of a failure of Israel’s oil supply. In 2000, a substantial amount of natural gas was discovered near Israel’s Mediterranean shore. The discovery of the natural gas could reduce Israel’s dependence on imported oil.

Israel has succeeded in significantly reducing its dependence on oil for the production of electricity by switching to coal-fired power stations located along Israel’s coastline, and by expanding a coal facility in Ashkelon. All of the coal used in Israel is imported. Israel purchases the majority of its coal from South Africa, the United States, Colombia and Australia. Smaller amounts of coal are purchased from other countries, including China. The shift to coal has not had a significant environmental impact in Israel, because most of the coal used is low-sulfur coal.

In 1997, the Government decided to establish a natural gas infrastructure in Israel. In August 2003, the Government founded Israel Natural Gas Lines Ltd. (‘‘INGL’’), a Government-owned company that was established to supervise, control and operate the natural gas transportation system. In March 2004, the ﬁrst natural gas power station in Israel was inaugurated in Ashdod. Currently, this power station has the ability to produce approximately 10% of Israel’s total energy capacity.

A-15 In April 2004, INGL, IEC and the State signed an agreement for the ﬁnancing, construction and operation of a natural gas transportation system that would be state-owned. Under the agreement, IEC will build the 100 kilometer underwater gas pipeline route, and INGL will construct the continental route. The underwater pipeline construction is expected to be completed in 2007. INGL has begun building the continental segment between Ashdod and Ashkelon. This segment is scheduled to be completed by July 2007. In 2005, the Government decided to build two more continental segments: one between Kiryat-Gat and Sdom, scheduled to be completed in 2008, and the other between Haifa and Alon-Tavor.

A-16 ANNEX B Form of Pricing Supplement

[Attached to, and part of, Terms/Syndication Agreement or Principal Purchase Letter, if any]

Pricing Supplement [and Supplemental Offering Circular]

The Israel Electric Corporation Limited

[Title of Issue of Notes]

[Dealer Name(s)]

The date of this Pricing Supplement is . This document (the ‘‘Pricing Supplement’’) is issued to give details of an issue by The Israel Electric Corporation Limited (the ‘‘Company’’) under its Global Medium-Term Note Program [and to provide information supplemental to the Offering Circular referred to below]. This Pricing Supplement supplements the Description of the Notes in, and incorporates by reference, the Offering Circular dated April 23, 2008, and all documents incorporated by reference therein (the ‘‘Offering Circular’’), and should be read in conjunction with the Offering Circular. Unless otherwise deﬁned in this Pricing Supplement, terms used herein have the same meaning as in the Offering Circular. [Notes offered and sold outside the United States have not been and will not be registered under the United States Securities Act of 1933, as amended, and are subject to U.S. tax law requirements. Accordingly, subject to certain exceptions, Notes may not be offered, sold or delivered within the United States or to U.S. persons. [Include the preceding sentence if Regulation S restrictions are applicable.]] [Date]

The Israel Electric Corporation Limited [Title of relevant Series of Notes (specifying type of Notes)]issued pursuant to the U.S.$2,000,000,000 Medium-Term Note Program

(Terms used herein shall be deemed to be deﬁned as such for the purposes of the Description of Notes in the Offering Circular.)

[Include whichever of the following apply or specify items as ‘‘not applicable’’.]

Type of Notes 1 Interest/Payment Basis: Fixed Rate Note/Floating Rate Note/ Zero Coupon Note/Original Issue Discount Note/Indexed Note/Dual Currency Note/Partly-Paid Note/Amortizing Note/ Combination/Other 2 If Amortizing Note, insert Installment [] Amount(s)/Installment Date(s): 3 If Partly-Paid Notes, insert amount of each installment [Insert details] (expressed as a percentage of the nominal amount of each Note)/due dates for any subsequent installments/consequences of failure to pay subsequent installments/rate of interest to accrue on ﬁrst and any subsequent installments:

B-1 4 If Dual Currency Notes, insert the Rate of [The Rate(s) of Exchange is the exchange Exchange/calculation agent/fall back provisions/person rate(s) or basis of calculating the exchange(s) at whose option Specified Currency is to be payable to be used in determining the amounts of and notice period: principal and/or interest payable in the Specified Currencies] Description of the Notes 5 Form of the Notes: Registered Notes 6 Exchange: (a) Notes to be represented on issue by: [Euroclear/Clearstream Global Registered Note/Restricted Global Note—[insert principal amount]/Regulation S Global Registered Notes—[insert principal amount]/Definitive Registered Notes—[insert principal amount]] (b) Global Registered Note exchangeable for [No] [Yes] [If yes specify circumstances of Definitive Registered Notes at the request of the exchange] holder: 7 (a) [Reserved.] (b) [Reserved.] 8 (a) Series Number: [ ] (b) Tranche Number: [ ]] (c) Details (including the date, if any, on which the [Number and other details]] Notes become fully fungible) if forming part of an existing Series: 9 (a) Principal amount of Notes to be issued: [ ] (b) Aggregate principal amount of Series (if more [] than one issue for the Series): (c) Specified Currency (or Currencies in the case of [] Dual Currency Notes): (d) Specified Denomination(s): 10 Issue Price: [ ] 11 Issue Date: [ ] 12 Interest Commencement Date: [Issue Date/other] 13 Automatic/optional conversion from one [Insert details] Interest/Payment Basis to another: Provisions Relating To Interest (If Any) Payable Fixed Rate Note 14 (a) Rate(s) of Interest: [ ] percent per annum/zero (b) Interest Payment Date(s) [ ] (c) Initial Broken Amount per Specified [Specify amounts] Denomination (d) Final Broken Amount per Specified [Specify amounts] Denomination (e) Other terms relating to the method of calculating [] interest (e.g., day count fraction and Interest Determination Dates) Zero Coupon Notes 15 (a) Accrual Yield: [Insert details] (b) Reference Price: [Insert details] (c) Other formula or basis for determining [Insert details] Amortized Face Amount:

B-2 Floating Rate Notes 16 Calculation Agent (if not the Fiscal Agent) [ ] appointed pursuant to [ ] 17 (a) Interest Period(s) or specified Interest Payment [NB: specify either a period or periods or a Date(s): specific date or dates] (b) Minimum Interest Rate (if any): [ ] (c) Maximum Interest Rate (if any): [ ] (d) Business Day Convention: [Floating Rate/Following Business Day/Modified Following Business Day/Preceding Business Day/other convention — insert details] (e) Additional Business Centers: [ ] (f) Applicable definition of Business Day (if [] different from that set out in the Terms and Conditions): (g) Principal Financial Center: [ ] (h) Other terms relating to the method of calculating [Condition 5(a)(ii)(B) applies/other — insert interest (e.g., day count fraction, rounding up details] provision and if different from Condition 5(a)(ii)(B) denominator for calculation of interest): (i) Calculation Agent (if other than the Fiscal [] Agent): 18 (a) Interest Rate Basis: [EURIBOR/ LIBOR Reuters/ISDA Rate/CD Rate/ Commercial Paper Rate/Prime Rate/Federal Funds Rate/Treasury Rate/ Eleventh District Cost of Funds Rate/ OTHER] (b) Spread: [Plus/minus] [ ] percent per annum (c) Spread Multiplier: [ ] percent (d) Interest Reset Period: [daily/weekly/monthly/quarterly/semi-annually/ annually] (e) Reset Date(s): [ ] (f) Index Maturity: [ ] (g) If ISDA Determination: (i) Floating Rate Option: [ ] (ii) Designated Maturity: [ ] (iii) Reset Date(s): [ ] (h) If Rate of Interest to be calculated otherwise [] than by reference to LIBOR or EURIBOR or (g) above insert details, including Rate of Interest / Spread / fall back provisions: Indexed Notes 19 Index/Formula: [Insert details of the index to which amounts payable in respect of interest are linked and/or the formula to be used in determining the rate of interest, together with details of the calculation agent and the fallback provisions] Provisions Regarding Payments 20 Definition of ‘‘Payment Business Day’’ for the purpose [Insert details] of Conditions if different to that set out in Condition 9(c):

B-3 Provisions Regarding Redemption/Maturity 21 Maturity Date: [ ]/The Interest Payment Date falling [on or nearest to] 22 Amortizing Notes: Installment Dates Installment Amounts 23 (a) Redemption at Company’s option: [No/Yes] [If yes, insert optional redemption date(s)/optional redemption amounts:] (b) Redemption at Noteholder’s option: [No/Yes] [If yes, insert optional redemption date(s)/optional [] redemption amounts:] (c) Minimum Redemption Amount/ Higher [] Redemption Amount: (d) Other terms applicable on redemption: [ ] 24 Final Redemption Amount for each Note, including [Insert amount or details including party the method, if any, of calculating the same: responsible for calculation (NB — fall back provisions must be inserted)] 25 Early Redemption Amount for each Note payable on [Insert amount or details including party redemption for taxation reasons or on an Event of responsible for calculation] Default or Acceleration Event and/or the method, if any, of calculating the same: General Provisions Applicable to this Issue of Notes 26 Other terms or special conditions: [Insert details] 27 Details of additional/alternative clearance system [Insert details] approved by the Company and the Fiscal Agent: 28 Additional or variations to selling restrictions: [Insert details] 29 Method of distribution: [Non-syndicated] [Syndicated — please insert management group details here] 30 Stabilizing Agent: [Insert details/None] 31 (a) Notes to be listed: [No/Yes] (b) Stock Exchange(s): [Singapore Stock Exchange] [Other — insert details]

ISIN: ...... [ ]

CUSIP: ...... [ ]

B-4 REGISTERED AND HEAD OFFICE OF THE COMPANY

The Israel Electric Corporation Limited 1 Netiv Ha’or Street Post Ofﬁce Box 10 Haifa 31000, Israel

PRINCIPAL PAYING AGENT AND REGISTRAR CHARGE AGENT The Bank of New York, London Branch The Bank of New York, New York Branch One Canada Square 101 Barclay Street London E14 5AL New York, New York 10286

PAYING AGENTS AND TRANSFER AGENTS The Bank of New York, London Branch One Canada Square London E14 5AL

FISCAL AGENT The Bank of New York, London Branch One Canada Square London E14 5AL

LEGAL ADVISERS To the Company as to United States law: To the Company as to Israeli law: Arnold & Porter LLP Herzog, Fox & Neeman 399 Park Avenue Asia House New York, New York 10022 4 Weizmann Street Tel Aviv 64239 Israel To the Dealers as to United States law: To the Dealers as to Israeli law: Weil, Gotshal & Manges LLP Meitar Liquornik Geva & Leshem Brandwein 767 Fifth Avenue 16 Abba Hillel Road New York, New York 10153 Ramat Gan 52506 Israel

AUDITORS TO THE COMPANY Kost Forer Gabbay & Kasierer Brightman Almagor & Co (a member practice of Ernst & Young Global) (a member ﬁrm of Deloitte International) 2 Pal Yam St. Haifa 33095 Israel Haifa Branch 5 Ma’aleh Hashichrur St. P. O. B. 5648 Haifa 31055 Israel LISTING AGENT Wong Partnership LLP One George Street #20-01 Singapore 049145 U.S.$1,000,000,000

THE ISRAEL ELECTRIC CORPORATION LIMITED

7.250% Notes due 2019

FINAL PRICING SUPPLEMENT May 1, 2008

Citi Lehman Brothers JP Morgan Merrill Lynch & Co. Morgan Stanley