Oil Refineries Ltd.
Periodic Report
as of December 31, 2008
This translation of the financial statement is for convenience purposes only. The only binding version of the financial statement is the Hebrew version.
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Contents
Chapter A - Description of the Business of the Company
Chapter B - Directors' Report on the State of the Company's Affairs
Chapter C - Financial Statements as of December 31, 2008
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Contents
Chapter A Description of the Business of the Company 1.1 Company Operations and Description of the A-1 Development of its Business 1.2 Segment Reporting A-4 1.3 Investments in the Company’s Equity and Share A-6 Transactions 1.4 Distribution of a Dividend A-11 1.5 Financial Information concerning the Company’s A-12 Operations 1.6 Refining Operations A-13 1.7 Petrochemicals Operations – Polymers A-94 1.8 Petrochemicals Operations – Aromatics A-146 1.9 Trade Operations A-165 1.10 Risk Factors A-168
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Chapter A – Description of Company’s Business
Part A - General
1.1 Company Operations and Description of the Development of its Business 1.1.1 Establishment of the Company and Principal Stages in its Development Oil Refineries Ltd. (“Company” or “ORL” was incorporated and registered in Israel in August 1959 under the name Haifa Refineries Ltd. On June 6, 1972, the name of the Company was changed to Oil Refineries Ltd. The Company was set up as a result of a government decision to acquire and receive the rights of an English petroleum company under the franchise granted to it, and the ownership of the Haifa refinery, which had up until then been under the control of foreign shareholders. As part of a private placement of the shares of the Company conducted by the State of Israel on February 12, 2007 and a public offering of the shares of the Company under a prospectus dated February 13, 2007 (the “Prospectus”), the State of Israel sold the entire issued and paid up share capital of the Company, such that following the sale, the Company ceased being a government company, and the shares of the Company were listed for trade on the stock exchange. As part of the aforementioned public offering, the Israel Corporation Ltd. (“Israel Corporation”) (36.8%) and Petroleum Capital Holdings Ltd. (“PCH”) (9.2%) together purchased 46% of the issued share capital of the Company. As of the date of the report, the Israel Corporation holds 45.08% of the shares of the Company, and PCH holds 15.76% of the shares of the Company. The Company, together with its subsidiaries, are industrial companies operating in Israel, which deal mainly in the production of refined products, raw materials for the petrochemical industry, and materials for the plastics industry. The facilities of the subsidiaries are integrated with those of the Company. Until September 28, 2006 (the “Effective Date”), the Company operated a refinery at Haifa and a refinery at Ashdod. As part of the privatization process of the Company, on September 28, 2006, the Company’s operations were split in such a way that the Ashdod refinery was sold to a subsidiary of the Company, Oil Refineries-Ashdod Ltd. (“ORA”), which was sold on the Effective Date to Paz Oil Company Ltd. (“Paz”). At the date of the report, the Company operates the Haifa refinery only.
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1.1.2 Chart setting out the structure of the Company’s holdings as at the date of the report
Israel PCH Company
45.08% 15.76%
The Company
100% 50%31.25% 50% 25% 25% 25% 23.15% 12.29%
Gadot Gadiv Mercury Tanker PAMA (Energy The United Oil Petrochemical Carmel Basic Oils Biochemical Petrochemical Aviation (4) Services Development Export Industries in Olefins Ltd. Haifa Ltd. (4) (5) (4) Industries Ltd. (1) Industries Ltd. Ltd. Ltd. Resources) Ltd. Company Ltd. (1)(4) Israel Ltd.
50% 100% 100% 100% 100% 100% 100% Carmel Carmel Carmel Olefins Colland Habol Trade Olefins Collins Olefins (UK) (Marketing) Polymers & Insurance Investmetns Ltd. (3) Ltd. (2) Ltd. 1990 B.V. (6) Ltd. (2) 2007 Ltd.
49%
Domo Chemicals M.V. (6)
1. A public company. Details of the holdings of these public companies are not material to the Company, except for the holdings of Israel Petrochemical Enterprises Ltd. 2. A company registered in Bermuda. 3. A company registered in Guernsey and held by Carmel Olefins via foreign trust companies. 4. The Company’s commencement of operations in the field of retail and wholesale marketing of refined products could be subject to proceedings under the Antitrust Law with respect to the Company’s joint holdings with companies that market petroleum.
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5. At the date of the report, Pama is inactive. 6. Companies registered in the Netherlands.
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1.1.3 The Company’s operations by virtue of the franchise and thereafter On October 18, 1933, a treaty was signed between the Mandatory Government of Palestine and the Anglo-Iranian Oil Company, under which the Anglo-Iranian Oil Company would have a franchise to transport petroleum and for that purpose to build, operate and maintain all of the related facilities for such, including refineries, for a term of 70 years. On April 7, 1960, all of the assets and rights of the Anglo-Iranian Oil Company were transferred to the Company under an arrangement that was approved by the court and the Ministers of Justice and Finance. The original franchise period ended in October 2003. On December 2, 2002, an agreement was signed between the Company, the Government of Israel and the Israel Corporation1, covering the Company’s operations after the end of the term of the franchise (the “Original Asset Agreement”), under which the Company would be entitled to continue holding assets that it held prior to the end of the franchise, for a term of 25 years, with the Company having the right to extend the term of such arrangement by another 25 years in return for a fee for use. On January 24, 2007, a new asset agreement (the “New Asset Agreement”) was signed and according to which the land that was owned by the Company or in which it had long-term lease rights prior to the date of expiration of the franchise, would be held by the State and would be leased to the Company for 49 years, with an option for the Company to extend the term of the lease under the same conditions for an additional 49 years. In the event there is a conflict between the two agreements, the new asset agreement shall prevail. For details of the Original Asset Agreement, see section 1.6.30.1 of this report and for the New Asset Agreement, see section 1.6.30.2 of the report. 1.1.4 The decision to privatize the Company 1.1.4.1 During 2004, the Ministerial Committees for Socio-Economics and Privatization passed resolutions to effect the split and privatization of the Company during the years 2004-2005, such that at the first stage, the Ashdod refinery would be sold as a "going concern". In the second stage, immediately thereafter, there was to be a public issue of the Company (together, “Privatization Decision”). According to the privatization resolution, ORA was set up and all of the assets and rights relating to the Ashdod oil refinery and were transferred to it. The shares of ORA were sold to Paz, and all for a consideration in the amount of NIS 3,251,409 thousand. According to the same resolution, following the sale of ORA, the State of Israel sold all of its shares in the Company through a private placement and a public offering on the Tel Aviv Stock Exchange. For further details with respect to the transfer of the assets to ORA and the sales contract of ORA shares to Paz, see sections 1.6.30.3 and 1.6.30.5 to the report. For details relating to the Government Companies (Declaration of Essential Interests of the State in Oil Refineries Ashdod Company Ltd.) Order, 5766-2006, see section 1.6.28.11 of this report. 1.1.4.2 As part of the privatization resolution aforesaid, it was held that as part of privatization of the Company, expression would be given to conditions set out in the position taken by the Antitrust Commissioner (the “Commissioner”), in his notices as attached to the Privatization Resolution, the main points of which were allowing vertical integration between distillate manufacturers and importers of distillate and refined products marketing sector and a framework for removing the supervision of prices for refined products sold at the refinery gate, under certain conditions. For details of the main points of the Commissioner’s notices, see section 1.6.26.5 of this report. 1.1.4.3 In addition, under the Privatization Resolution, the Ministerial Committee on Privatization issued instructions that under certain circumstances the Supervision of Prices of Commodities
1 In 1971, the Israel Corporation purchased shares in the Company, granting it 26% of the capital and voting rights in the Company until their sale to the State in February 2006 for NIS 677.5 million.
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and Services (Maximum Ex-Refinery Prices for Refined Products at the ORL Gates) Order2, 5753-1992 (the “Supervision Order”), should be amended such that following the split and privatization of ORA, supervision of the ex-refinery prices of refined products at the gates of the refineries would be removed. In connection with LPG, the method of supervision over the price will be changed at the end of the twelve month period following the date of completion of the process of selling ORA and the transfer of ownership. According to the same decision, supervision over the prices of most fuels was removed commencing on January 1, 2007 and the method of price supervision regarding LPG, was changed commencing on October 1, 2007. For further particulars regarding the Supervision Order over the prices of fuels and LPG, see sections 1.6.26.12 and 1.6.26.3 of the report.
1.2 Company’s areas of operation Through the end of 2007, the Company was engaged in three areas of operation, reported as business segments in its financial statements (refining, polymers (through Carmel Olefins Ltd.) and Aromatics (through Gadiv Petrochemical Industries Ltd.)). On November 6, 2007, the board of directors of the Company adopted a strategic plan whereby it decided to adapt the organizational structure of the to the strategic plan, by setting up three managerial – business segments as detailed below in order to facilitate the rapid growth of the Company in its core areas and in additional tangential areas. For information regarding said strategic plan, see section 1.6.32 of the report. In accordance with said resolution, as of the first quarter of 2008, the Company has three areas of operation, reported as business sections in its financial statements, as follows: 1.2.1 Refining: The Company’s principal field of operations accounted for 84% of the Company’s consolidated revenue in 2008. As part of its operations in this field, the Company purchases crude oil and interim materials, refines and separates them into various products, some of which are end products and others of which are raw materials for the manufacture of other products. This operations is performed directly by the Company (see section 1.6 of the report). As part of its refining operations, the Company sells end and interim fuel products to its customers in Israel and abroad, and provides power and steam to industrial customers in the Haifa Bay, as well as infrastructure services (storage, pumping and truck loading of fuel products). 1.2.2 Petrochemicals: This area of operations accounted for approximately 13% of the Company’s consolidated revenue in 2008. The petrochemical segment is divided into polymer and aromatic activities, in which the Company is engaged through Carmel Olefins Ltd. (“Carmel Olefins”), a private company that is proportionally consolidated with the Company (see section 1.7 of the report), and which deals in the production of polyethylene and polypropylene, which are the principal raw materials in the plastics industry. It is noted that Carmel Olefins management and board of directors are separate from those of the Company and operate independently and the aromatics segment, which is performed by Gadiv Petrochemical Industries Ltd. (“Gadiv”), a private company that is wholly-owned by the Company, produces aromatic materials, mainly benzene, paraxylene, orthoxylene, and toluene, which are used as raw materials in the manufacture of other products (see section 1.8 of the report). 1.2.3 The trade segment: This area of operations accounted for approximately 3% of the Company’s consolidated revenue in 2008. In its operations in this field, the Company is engaged in trading of crude oil and related products and aromatic products, not for other areas of activity and in long-term leasing of tankers for transport of fuel products.
2 Gate of ORL - the Company’s facilities where fuel products are sold upon exit from the Company.
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1.2.4 Additionally, the Company has investees engaged in additional operations, which are not material to the Company. 1.2.5 The facilities of the subsidiaries are downstream facilities of the Company’s, so that they receive the feedstock that they require entirely or mostly from the Company on an ongoing basis via pipelines, and return the products of their facilities or part thereof to it, as well as the feedstock not used in their operations. The Company’s refinery operations are integrated with its operations in the fields of petrochemicals. The following is a diagram setting out the integration between the various operations of the Company:
In the Company’s opinion, the integration and synergy between the various fields of operation leads to an increase in the aggregate margins flowing to the Company from all of its fields of operation, and a reduction in fluctuations of the Company’s profitability, since business turnover in the areas of the Company’s operations and those of its subsidiaries do not necessarily overlap. Carmel Olefins has a material dependency on receipt of feedstocks from the Company. In addition, a cessation or significant reduction in the supply of feedstocks to Carmel Olefins due to their non-receipt by Carmel Olefins, may have an impact on the profits of the Company in the refining activity. In addition, the joint management of the Company and Gadiv streamlines the companies’ operations and reduces expenses.
1.3 Investments in the Company’s equity and share transactions During the two years preceding this report, no investments were made in the Company’s equity, apart from the capitalization of capital funds and surpluses in the sum of NIS 1,645,839,307 (nominal) into share capital, in accordance with the resolution of the general shareholders’ meeting held on February 7, 2007 and February 8, 2007. On February 12, 2007, the State of Israel executed a private tender to institutional investors from Israel and abroad. As part of the tender, the State of Israel sold to the institutional investors 880,000,000 ordinary shares, par value NIS 1 each, constituting 44% of the issued and paid-in capital of the Company. The price per share that was set in the private placement was NIS 2.702. The sale of the shares under the private placement to the institutional investors was contingent upon the registration of the Company’s shares for trade on the stock exchange and for this purpose, a prospectus was issued. The terms of the private placement set
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forth a mechanism for adjusting the price per unit (comprised of 1,000 ordinary shares), whereby if the price per unit to be determined in the public offering under the prospectus exceeds the price per unit determined in the private placement, the price per unit in the private placement will be adjusted such that an amount equal to 80% of the difference between the price determined in the public offering under the prospectus and the price determined in the private placement would be added, but such adjustment shall not exceed in shekels an amount equal to 15% of the per unit price determined in the private placement. On February 13, 2007, the Company and the State of Israel issued a prospectus for a public offering whereby the State of Israel offered the public 1,120,000,000 ordinary shares, par value NIS 1 each of the Company, constituting 56% of the issued and paid-in share capital of the Company. The public tender was held on February 19, 2007 and as part of which all of the shares offered to the public were sold, at a price per share of NIS 3.3. Accordingly, the price per share was determined for the institutional investors as part of the private placement, using the price adjustment mechanism set out above, at NIS 3.1073. The total consideration received by the State of Israel for the sale of all of the shares that comprise the issued and paid-in capital of the Company amounted to NIS 6,430,424 thousand. On March 26, 2007, The Commissioner granted approval for the merger of the Company with the Israeli Corporation and PCH, under conditions that obligate the Company and Carmel Olefins not to discriminate against ORA and other customers in the purchase or sale of specific products, which the Company does not expect to have a material impact (if at all) on its operations and business results. 1.3.1 Memorandum of understanding between PCH and the Israel Corporation regarding the purchase of the shares of the Company3 1.3.1.1 On February 18, 2007, the Israel Corporation entered into a binding memorandum of understand with Scailex Corporation Ltd. ( (“Scailex”) and PCH (Scailex and PCH will be jointly referred to as: “Scailex Group”) in the binding memorandum of understanding, under which the Israel Corporation and the Scailex Group will submit a joint proposal for the purchase of the shares of the Company as part of a proposal to the public for the sale of the shares of the Company ( “memorandum of understanding”). Additionally, it was agreed that decisions to purchase additional shares of the Company after the public offering, as aforementioned, would be done with the agreement of the parties. Furthermore, the memorandum of understanding included, among other things, arrangements between the Scailex Group and the Israel Corporation regarding control of the Company. 1.3.1.2 Control and operation of the means of control in the Company are subject to the approval of the Prime Minister and the Finance Minister, in accordance with the the Government Companies (Declaration of the State’s Vital Interests in Oil Refineries Ltd.) Order, 5767-2007 ( “approval of the ministers” or "control permit" and “interests order”, respectively) and to the Antitrust Commissioner’s approval of the merger (received on March 26, 2007). On May 10, 2007, the Israel Corporation and the Scailex Group agreed to cancel the memorandum of understanding. Further to the cancellation of the memorandum of understanding, the Israel Corporation received the permit for the control and holding of the means of control of the Company on June 27, 2007. For more details on the control permit, see section 1.6.26.1. For more information regarding the interests order, see section 1.6.28 of the report. 1.3.1.3 Concurrent with the cancellation of the memorandum of understanding, the Israel Corporation undertook towards Scailex Group as part of an irrevocable promissory note ( “first promissory note”), which stipulated, inter alia, that if PCH ad Scailex receive the approvals required to hold the means of control in the Company, including any approval other permit required under the provisions of the law, up to and no later than May 15, 2009 (in this section, “effective date”), then in such a case the Company will enter into an agreement with them for joint control over the Company (in this section, “first control agreement”) in accordance with the
3 The details in this item are to the best of the Company's knowledge.
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wording attached to the first promissory note, in which it was stipulated, inter alia, that PCH amended the call option to buy and receive by transfer from Israel Corporation shares that will increase its share of the core control shares (50.25% of the Company’s share capital, the “core control shares”) to 45% of the core control shares. 1.3.1.4 Following the execution of the agreement between Israel Petrochemical Enterprises ("IPE"), Scailex and Suny Telecom Ltd. (“Suny”), described in section 1.3.3.4 below, under which IPE purchased all of PCH’s issued capital from Scailex, the Israel Corporation gave Israel Petrochemical Enterprises (“IPE Group”) on June 1, 2008, another irrevocable promissory note (“second promissory note”) which replaced the first irrevocable promissory note. Attached to the second promissory note was the wording to the joint control agreement of the Company, which may enter into effect under the terms agreed upon between the parties (“second control agreement”). The second promissory note is designed to set forth the relations between the Israel Corporation and the IPE Group, following execution of said agreement. In the second promissory note, it was agreed that subject to compliance with the certain dependent conditions, the following provisions, among others, shall apply: 1.3.1.4.1 If IPE Group receives all of the permits required by law for the engagement through the control agreement, including the permit for control of the Company, up to and no later than May 10, 2009, then the Israel Corporation and IPE Group, or whoever will purchase the company's shares from IPE Group, will sign the second control agreement, the principles of which are set out in Section 1.3.2 below. 1.3.1.4.2 The sale of the current core shares (constituting 11.1% of the company's shareholders' equity held by PCH) and sale of the direct control in PCH to a third party is subject to the Israel Corporation’s right of first refusal. Should control of IPE be transferred, the Israel Corporation will have the right to purchase the existing core shares from PCH, provided that they constitute most of IPE’s assets in return for a payment to be fixed according to a formula based on the market price of the company's shares with an additional 15% as premium. 1.3.1.5 On August 3, 2008, the Israel Corporation signed another promissory note in favor of the IPE Group ("third promissory note") regarding entering into an agreement for the joint control of the Company. The third promissory note replaced the first and second promissory notes, which were cancelled, and two draft joint control agreements of the Company were added to it, which will take effect subject to the conditions prescribed in the third promissory note. The third promissory note was signed pursuant to an agreement from June 24, 2008 between IPE and the Company for the acquisition of IPE's holdings (50%) in Carmel Olefins by the Company, as specified in par. 1.7.1.3 to the Report (in this section: "Carmel Olefins agreement"). The third promissory note and attached draft agreements arrange the IPE Group's joining control of the Company, as well as in the event that the Carmel Olefins agreement is annulled or it expires (each of the aforementioned ("cancellation of the Carmel Olefins agreement"). For further details regarding the Carmel Olefins agreement, see par. 1.7.1.3 to the Report. The third promissory note stipulated that if the Carmel Olefins agreement is canceled prior to May 10, 2009, for reasons which are not due to an act, omission or action by IPE, the second promissory note will then become valid once again together with the second draft control agreement, and the third promissory note will be deemed null and void. On December 31, 2008, the Carmel Olefins agreement expired as a result of the failure to meet the preliminary conditions required for its execution. 1.3.1.6 Until the Control Agreement is signed, and after obtaining the ministers' approval, the Israel Corporation will be entitled to exercise its power of control in the Company at its discretion and without restriction. 1.3.2 Principles of the second control agreement
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The Control Agreement between the Israel Corporation and the IPE Group will be signed upon receipt of the required approvals by the parties to the agreement and it regulates the joint control relationship between the Israel Corporation and the IPE Group, including: defining the core control shares in the Company – the core control shares will account for 50.25% of the Company's issued and paid-up share capital; the granting of a Call option to PCH to acquire and receive by transfer from the Israel Corporation shares that increase its share of the control core shares to 45%; a 6-month freeze period to begin on the date of signing the control agreement, during which none of the parties will be permitted to transfer shares in the control core; the right of first refusal for acquiring shares in the control core; the right of any party to tag along on the sale of shares in the control core; the right to participate in the purchase of the Company's securities by one of the parties, depending on the other party's share of the control core; setting a BMBY mechanism for the purchase of the control core shares by one of the parties; the manner of voting regarding the appointment of directors, appointment of the Company's CEO, auditors and attorneys; the manner of voting on certain issues prescribed in the control agreement; setting dividend policy as specified in par. 1.4.1 of the Report. The second control agreement also stipulates that a sale of the current core shares and a sale of the direct or indirect control of IPE shall confer on the Israel Corporation the right to acquire from IPE the control core shares in the Company that are held by PCH at that time, should they account for most of IPE's assets in consideration for payment as specified in par. 1.3.1.4.2 above. The control agreement will terminate at either: (a) pursuant to its provisions; or (b) from such date as any party no longer holds at least 10% of the Company's issued, paid-up share capital, the earlier of the two. The agreement includes other provisions that are generally accepted in agreements of this kind, including confidentiality clauses, remedies, non-waiver of rights, arbitration, venue, and the like. 1.3.3 Moves to obtain a control permit and holds the means of control in the Company, by PCH 1.3.3.1 On February 21, 2008, Scailex published an immediate report, stating that on the same day, a response was received by the attorneys of its subsidiary, PCH, from the proper authority to the request of PCH to receive a control permit in respect of the Company. The immediate report stated that the authority indicated that it would be possible to consider the request of PCH for joint control with the Israel Corporation over the Company, only if the influence of the Alder Group on the direct and indirect control over PCH was totally removed, both as a material shareholder in Modgal Industries Ltd. (the controlling interest in PCH, through companies under its control) ("Modgal Industries") and as a creditor. . On July 1, 2008, IPE acquired from Scailex all the issued capital of PCH for payment of USD 57.2 million and sold its entire holding in Scailex to a third party. Subsequent to completion of the transactions, Scailex is no longer an interested party (indirectly) in the Company. 1.3.3.2 On August 12, 2008, IPE announced that PCH had accepted the position in principle of the proper authority, whereby, if the transaction materializes by which PCH will no longer be indirectly held by the Alder Group and the Alder Group will cease to be a creditor of the controlling shareholders in PCH, the Attorney General will inform the Prime Minister and Minister of Finance (who are empowered to issue the control permit), that there is no legal impediment to issuing the permit for control of the Company to PCH together with the Israel Corporation. On March 22, 2009 IPE published an immediate report whereby Modgal Industries notified it that it had signed an agreement to sell the entire holding of Group Menatep Ltd. ("Menatep") of the Alder Group, to Modgal Ltd. (which, as at the reporting date, holds 50.1% of Modgal Industries shares). At the time of signing the agreement, the Alder Group holds 26.83% of the shares in Modgal Industries. The aforesaid purchase agreement was contingent upon PCH
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receiving the permit for control of the Company and becoming part of the controlling group of the Company (according to the promissory note from Israel Corporation) by May 10, 2009. As a result of the execution of this agreement, Menatep will cease to be a shareholder in Modgal Industries and will no longer be its creditor, while Modgal Ltd.'s holdings in Modgal Industries, directly or indirectly, shall exceed 76.97%. In addition to the sales contract, Modgal Ltd. and Modgal Industries signed option agreements with Menatep (indirectly), whereby Menatep was granted Call option to acquire Modgal Ltd.'s entire holding in Alder and alternatively, to acquire from Modgal Industries shares, which constitute, as at the report date, 10.72% of the shareholders' equity in IPE (fully diluted). The option agreements will become effective only upon conclusion of the abovementioned sales agreements, and shall be annulled should the sales agreement expire, pursuant to its provisions. The options agreements determine that, so long as Modgal Industries controls IPE and IPE holds the Company's shares, requiring a control permit with respect thereof, the exercise of the options shall be subject to not harming the receipt of the control permit and to the receipt of any permits relating thereto. The option period was set until April 1, 2015 with an automatic extension mechanism in the event that Menatep assigns its rights in accordance with the option agreements. 1.3.4 On June 24, 2008, the Company entered into agreement with IPE to acquire IPE's remaining holdings (50%) in Carmel Olefins for consideration of 20.53% of the Company's issued share capital and voting rights therein. Completion of the agreement was made contingent on meeting several pre-conditions by December 31, 2008. As not all the pre-conditions were met by this date, the transaction which was the subject of the agreement was not completed. Nonetheless, as the main considerations on which the Company's board of directors' approval of the transaction was based are still valid, the Company and IPE agreed to continue to cooperate with the aim of trying to complete the said transaction. 1.3.5 On May 29, 2008, the Company published a shelf prospectus based on the Company's financial report at December 31, 2007 for the issue of shares, convertible bonds, debentures, share options, bond options, and an expansion of the Company's existing series of debentures (Series A to C). At the reporting date, the Company has not yet issued the securities according to the said shelf prospectus. 1.3.6 On August 13, 2008, the Company's general meeting approved an increase in the Company's registered share capital by NIS 1,000,000,000, divided into 1,000,000,000 ordinary shares, par value NIS 1 each, such that after this increase, the Company's registered share capital will be NIS 3,000,000,010 divided into 3,000,000,010 ordinary shares, par value NIS 1 each. As part of the said decision of the general meeting, the prohibition on acquiring shares of the Company by a subsidiary or company that it controls was cancelled.
1.4 Dividend Distribution 1.4.1 Dividend distribution policy The Company's board of directors has no established dividend distribution policy. According to the second promissory note in force, the second control agreement which is expected to be signed by the Israel Corporation and IPE Group, if and when IPE Group receives a control permit in accordance with the interests order, the parties will work towards reaching a control agreement subject to any law, such that the Company and its subsidiaries will adopt a dividend policy whereby a distribution will be made of at least 75% of the distributable annual profit. 1.4.2 The following details the cash dividends that the Company paid during the two years preceding the date of this report: Sum of Dividend Distribution Date in USD 000’s January 2, 2007(1) 4,734
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October 22, 2007 69,410 May 20, 2008 71,599 December 16, 2008 49,726 (1) For details about the Company's assessment of the absence of a tax liability in respect of distribution of the dividend on December 27, 2006 and January 2, 2007, see section 1.6.23.4 of the report. For details about the financial covenants that the Company undertook towards credit providers, which may restrict the distribution of a dividend by the Company, see paragraph 1.6.23.6. 1.4.3 On August 13, 2008, the Company's general meeting approved a change in the Company's articles in a manner that any resolution passed regarding a distribution of dividends shall be within the power of the Company's board of directors (and not of the general meeting as was the case until this date).
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1.5 Financial information concerning the Company’s operations The following are details of the Company’s consolidated financial data, in USD 000’s:
Income segment of activities Costs segment of activities Income from Inter-sectional Inter-sectional Operating Operating Total Segment external entities sales Other Costs sales (loss) profit margin assets 2008 Refinery 6,911,565 706,988 7,682,901 57,033 (121,381 ) (1)1.8% (2)2,078,211 Aromatics 487,409 57,033 85,396 451,212 7,834 1.6% 222,995 Petrochemicals Polimers 475,193 - 269,583 257,308 (51,698) - 10.9% 545,413 Trade 383,291 - 371,912 - 11,379 3% (2) Adjustments - - (1,532 ) - 1,532 - (438,571 ) Total 8,257,458 764,021 8,408,260 765,553 (152,334) - 2,408,048 2007 Refinery 4,416,518 593,438 4,742,077 45,574 222,305 (1) 5% 2,753,083 Aromatics 475,416 45,574 93,325 393,660 34,005 7.2% 276,845 Petrochemicals Polimers 342,549 - 121,773 194,064 26,712 7.8% 542,633 Trade ------Adjustments - - 1,406 - (1,406) - (521,086) Total 5,234,483 639,012 4,958,581 633,298 281,616 5.4% 3,051,475
(1) In refining operations, profitability is determined through profit from refining, as specified in par. 1.6.2 of the Report. The rate of gross profit, calculated in relation to turnover (revenues from this area of operations), is affected principally by the prices of the oil products, and an increase or decrease in these prices does not necessarily indicate an increase or decrease in the profitability they entail, for the Company. For a detailed analysis of the factors and trends that affect the refining margins, see par. 1.6.2.4 to the Report. (2) The assets and liabilities for the refineries and the trade segment is included in the refineries segment For details concerning the developments that in the above financial data, see the Board of Directors' explanations on the state of the Company's business at December 31, 2008, chapter 2 of the Periodic Report.
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Part B – Refining Operation Area
1.6 Refining Operation Area 1.6.1 General – Refining Processes The refining of oil is a process that consists of a number of stages, the purpose of which is to separate out the various components in crude oil, and to turn them into useful products such as: gasoline, naphtha, diesel fuel, kerosene, fuel oil, liquefied petroleum gas (LPG) and bitumen. There are four main production processes: 1.6.1.1 Separation by distillation - processes that result in groups of products, according to the differences in their boiling points. The refining of crude oil leaves an unrefined residue that is used to make asphalt and fuel oil. 1.6.1.2 Cracking and reformation - which alter the chemical composition of some of the materials separated out, so as to give rise to products of a higher added value. 1.6.1.3 Refining - a finishing-off process, the purpose of which is to purify and cleanse the products of the separation processes, and to improve the qualities of such (such as reduction of sulphur content). 1.6.1.4 Finishing - the products undergo finishing, in order to meet the requisite parameters. The prices of the crude oil purchased by the Company, which constitute the majority of its costs, are dictated by the prices in international markets. The prices of the products of the Company are also set on the basis of prices set by international trade. The central factors impacting on the results of operations in the refining segment are the price levels in international markets, the selection of the optimal mix of the types of crude oils and the operational accessibility of the refining facilities. At the date of this report, the Company’s entire refining operations are carried out at the Company’s refinery at Haifa (“ORL”). The interim materials that are produced by the Company’s facilities and that are not wholly processed at the Company’s downstream facilities may be sold to ORA and/or to customers outside of Israel. The volume of these operations accounts for approximately 10% of the quantity of petroleum products sold by the Company on the local market. Interim products required by the Company and/or subsidiaries, which are not supplied by the Company’s own refinery facilities, may be purchased from ORA and/or from suppliers outside of Israel. The volume of these operations accounts for approximately 8% of the materials used in the Company’s refinery facilities. 1.6.2 Structure and changes in area of operations 1.6.2.1 General The main factor affecting the results of refining operations is the refining margin. The refining margin is the margin between revenues from sales of the basket of products that the Company sells, and the cost of raw materials purchased by the Company (mainly crude oil) at the refinery gate. The prices of crude oil and refined products around the world are subject to considerable fluctuations, and are determined, among other things, based on international supply and demand, and are also affected by geopolitical events which are not directly related to the production of fuel, but are seen by markets as having a possible effect on future output. The level of the refining margin is a result of the market forces that act on two different planes – one the supply and demand of crude oil and the other the supply and demand for end products.
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1.6.2.2 Factors affecting the supply and demand of crude oil The supply of crude oil is first and foremost influenced by the existence and location of oil fields under ground, or under the sea bed. At present, the rate at which new oil fields are being discovered is diminishing, and it is widely thought that the rate of discovery is going to continue to fall, despite the continued improvement in the technology used to discover and evaluate new fields. In addition, the supply of oil depends on a very large number of factors, such as the ability to extract crude oil and pump it from the oil fields to ports, the assessments of the fuel producers as to future prices, the ability of the production company to store the fuel produced for long periods of time, international geopolitical events, etc. Crude oil is a commodity, the price of which is quoted on various commodity markets around the world. The following is a graph setting out fluctuations in the price of crude oil between 2007 until close to the date of this report (dollars per barrel)4:
Based on statistical data published by OPEC5, as of the end of 20076, approximately 78% of worldwide oil reserves are concentrated in the eleven OPEC countries (of which some 62% are concentrated in OPEC companies in Middle-Eastern countries), which are responsible for approximately 45% of the crude oil produced in the world. A decision by the OPEC states to increase or reduce their fuel production also affects the fluctuation of crude oil prices around the world. The demand for crude oil is primarily influenced by the global refining capacity, also taking into consideration the refining margins. 1.6.2.3 Factors and trends in supply and demand of refined products The supply of refined products is mainly influenced, aside from the supply of crude oil, by international refining capacities, which dictate the ceiling of world supply for end products, which varies in accordance with the changes that occur from time to time in the capacities of the existing facilities (such as construction of new facilities, closure of refineries around the world, etc.) and in accordance with variable factors such as breakdowns, renovation of facilities, etc. Consumption of refined products is influenced, mainly, by the following factors: the rate of growth of large economies, increases and decreases in standards of living, mainly in highly- populated countries, increasing seasonality in cases of extreme weather conditions and substitute energy products (such as nuclear energy, natural gas and coal). There is a long standing global trend of consistently increasing demand for refined oil products. With the deterioration of the global economic crisis in the latter part of 2008, the
4 The prices of the various types of crude oil purchased by the Company are generally priced relative to dated Brent crude oil (an oil that is produced in the North Sea). 5 www.opec.org 6 As at the date of the report, the data for 2008 were not yet published.
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global demand for crude oil and refined products decreased and renewed demand depends on the rate at which the global economy exits the crisis. There is also an international trend towards constantly improving the qualities of fuel products (such as: reducing levels of sulfur and improving combustion qualities), the purpose of which is to burn cleaner materials more efficiently which reduces the burden on the environment in terms of levels of emission of the pollutants generated in the process of combustion of fuel substances. As at the date of this report, there is a strong international trend of manufacturing fuel components for transportation from renewable (plant) resources, such as ethanol and bio- diesel. The goal of this trend is to reduce the dependency on petroleum and to reduce the emission of greenhouse gasses. This trend is increasing around the world, and according to forecasts, in the next decade we should see an increase in the use of ethanol and bio-diesel, which are not crude oil derivatives, as a substitute for refined products for transportation. Vehicles which are powered by electricity or hydrogen may reduce the consumption of fuel and its products, since they can be produced also from other sources of energy. As at the date of this report, the transition to use of vehicles powered by alternative energy is relatively small, but is on the rise. This trend might increase with the development and manufacture of cheaper hybrid vehicle models. 1.6.2.4 Factors and trends affecting refining margins The factors that affect demand and supply for crude oil and refined products, as reviewed above, give rise to fluctuations and cyclicality in the levels of profitability of the refining industry. From 2004, surplus production capacity for refined products began to fall as a result of increased demand for refined products (mainly in developing economies in Asia, and in the USA) on the one hand, as opposed to stringent production and refining supply on the other hand. Other objective difficulties in the supply of crude oil and refined products - hurricanes in the Gulf of Mexico (in the third quarter of 2005) which shut down the production of oil and gas in that region and caused the closure of refineries, as well as conflicts with the Iranian government regarding nuclear issues, caused a continuous increase and great volatility in refining margin, commencing in 2004 until the third quarter of 2008. At the beginning of 2008, the price of crude oil was some 97 dollars per barrel and reached around 140 dollars per barrel by the beginning of the third quarter. During the third quarter its price started to drop drastically as a result of a worsening of the global recession to a price of approximately 36.5 dollars per barrel at the close of 2008. The following is a graph setting out the Company’s refining margins (including the operations of the Ashdod Refinery until 2006), and the average margin publicized by "Reuters" for a sample oil refinery with cracking abilities in the Mediterranean for Ural crude7 from 2002 to the end of 2008:
7 Ural crude is refined in many refineries in the Mediterranean, including the Company’s refinery.
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Please note that there are differences in a number of parameters between the refining margin of the Company and the refining margin publicized by "Reuters", including the composition of the crude oil (the Company also refines crude oil types that are not "Ural"), the composition and quality of the products produced by the Oil Refineries and the difference created as a result of the fact that the quote takes into account purchase and sale on the same day, while in practice, there is a gap between the date of the purchase of the crude and the date of the sale of the distillates made therefrom. Accordingly, the comparison to the “Reuters” margin could provide an understanding of the development trends of the refining margin of the Company, and is not an accurate measure to estimate the short-term refining margin of the Company. As of 2007, the neutralized refining margin also reflects the refining margin according to the results of the Company's operations less the impact of derivatives due to the transition to recording according to international standards, the impact of purchasing and selling timing difference and impairment of the value of inventory. For information relating to refining margins of the Company in 2007 and 2008, and relating to the developing trends at the beginning of 2009, see the board of directors’ explanations on the status of the Company's business as of December 31, 2008, in Chapter B of the periodic report. 1.6.3 The local market for refined products, impact of the split and privatization processes and changes in regulation 1.6.3.1 Until proximate to the date of the split of ORA from the Company, the Company estimates that it supplied approximately 85% of the refined products market in Israel via the refineries at Haifa and Ashdod. The remaining 15% were supplied by competing imports of refined products from energy corporations and international trade. After the split was completed, the market share of the Company decreased. In the Company’s opinion, the local refined product market is part of the Mediterranean market to which frequent changes are applicable, according to the changes in international markets. In the Company’s assessment, refined product imports to Israel dropped in 2008. 1.6.3.2 Commencing on January 1, 2007, supervision over the ex-refinery prices of most oil products was removed. Previously, a supervision order set out the maximal prices at which the Company could sell refined products. On October 1, 2007, the method of supervision over the price of LPG was changed. For more details, see paragraphs 1.6.26.1 of the report. Cancellation of the maximum price for most of the oil products sold by the Company and the change in method of supervision over LPG prices, provide the Company with greater business flexibility and improve its ability to contend with competition in the fuel product market. Commencing from those dates, the Company continued setting prices of the fuel products on the basis of international prices, with adjustments made for the developments in the Mediterranean Basin and the Israeli market. For more information, see paragraph 1.6.26.12 in the report. 1.6.3.3 Prior to the date of the Split, Paz was one of the Company’s major customers. The acquisition of ORA by Paz affects the volume of its purchases from the Company. However, taking into account the reduction of the Company’s production capacity following the Split, this change will not have a material impact on the Company. 1.6.3.4 Whereas prior to the split and privatization, Company operations were subject to provisions and restrictions set out in the Government Companies Law, following the split and privatization, the Company ceased being a government company and, therefore, is not subject to such provisions and restrictions.8
8 Except for the applicability of the Interests Order. For information regarding this matter, see paragraph 1.6.28.1 of the report.
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1.6.3.5 Upon completion of the split and privatization of the Company, a significant part of the restrictions on its ability to deal in the marketing segment were removed. The Company was prohibited from conducting such activity prior to the privatization. 1.6.3.6 The Company and its subsidiaries, Gadiv and Carmel Olefins, are, regarding some of the products sold by them, monopolies under the Antitrust Law. The contents of section 1.6.3 above, regarding the possible effects of changes in regulation and conditions of competition and of the market constitutes forward-looking information and is based on the Company’s assessments regarding the possible effect of all of the factors and circumstances described above in this section. In light of the changes expected to take place in the basic structure of the refined products market in Israel, in terms of competition and removal of regulation (should such be removed and to the extent that such exists in the future), it is not possible, as of the date of this report, to assess the scope and nature of the effect of these changes on the Company and its results, but it is possible, in general terms, that these might have a substantial effect on the results of the Company’s operations. For details of the limitations imposed on the Company, including in the field of refinery operations, see section 1.6.26 of this report.
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1.6.3.7 The following is a chart setting out the structure of the Israeli fuel sector:
Import of crude / interim materials / refined products (ORL/ORA)
Discharge, Storage and transportation of crude (PEI – Tashan ) (EAPC – Katza )
Import of refined products Ashdod Haifa Import, heavy oils, coal and natural gas (Fuel companies) (Israel Electric Co.) Refinery1 Refinery
Storage and supply Refined Oil dock and (PEI, EAPC and Pi Gliloth- 2 ) products customer terminals
Fuel companies (Paz, Delek , Sonol , Dor Alon , others)
Trade Power Ports Airports Fuel Stations Agriculture Industry and Services Stations (Bunkering)
1 Owned by Paz – 2 Owned by Delek
1.6.3.8 The following table presents the Company's assessment of domestic consumption of Israel's oil products in 2005-2007: (1)
Fuel Petrochemical Year Bitumen Oil Gasoil Diesel Gasoline LPG Kerosene Feedstock Total 2006 187 1,970 855 2,620 2,252 513 775 841 10,013 2007 222 1,746 1,109 2,727 2,363 545 830 1,142 10,684 2008 207 1,675 911 2,627 2,433 539 841 1,195 10,428 (1) Data was taken from publications of the Ministry of National Infrastructures and does not include military use and the Company's own consumption. 1.6.4 Critical success factors Throughout the years, the Company has employed methods for ensuring its own placement among and differentiation from its competitors. Among other things: 1.6.4.1 Creating a reputation as a reliable company, in terms of its commercial relations with suppliers and customers and in the field of product quality and compliance with standards. 1.6.4.2 Assembling teams of employees and executives who are highly professional and motivated. 1.6.4.3 Up-to-date technological capabilities enabling use of a wide variety of types of crude oil (the Company makes use of over 10 different kinds of crude oil), the highly efficient manufacture of refined products in various mixes, and the adherence to the requirement for stringent quality controls. 1.6.5 Entry barriers In the Company’s assessment, the following factors constitute barriers to entry into the field of refining operations: 1.6.5.1 The need for large capital investments; 1.6.5.2 The relatively long time required for setting up a plant;
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1.6.5.3 The requirement for obtaining necessary regulatory approvals to set up and operate a refinery, and compliance with the conditions thereof. 1.6.5.4 Dependence upon port, transportation and suppliance infrastructures; 1.6.5.5 Knowledge and experience in the fields of crude oil and refined products, which is a complex and dynamic field that requires considerable skill and expertise. For further details on competition in the field of refining and the Company’s risk factors, see sections 1.6.13 and 1.9.10 of this report. 1.6.6 Alternatives to and changes in products of area of operations 1.6.6.1 The trend of substituting refined products with natural gas is global. Natural gas is becoming a significant source of energy in the Israeli market, and is expected, in a few years, to replace most of the fuel oil, gasoil, and industrial LPG in use, thereby requiring the Company to take steps in order to deal with substitutes for the crude oil and gasoil markets, although the limitations on construction of the infrastructure necessary for transporting natural gas to the various customers are delaying the introduction of natural gas and the extent of its use. 1.6.6.2 According to the Natural Gas Economy Law – 2002, anyone who refines more than 10% of the total quantity of refined oil in Israel (hereinafter – an "Oil Refiner"), and anyone who is a controlling shareholder in an Oil Refiner, shall not engage in the sale or marketing of natural gas. By virtue of the aforementioned law, the Company, as an Oil Refiner, is prohibited from engaging in the sale or marketing of natural gas. For information regarding the position of the Antitrust Commissioner, see paragraph 1.6.26.5 of the report. 1.6.6.3 The following are the possible steps that the Company could take with respect to the fuel oil and gasoil market: A. Enlarging the portion of light crude oil used by the Company's refinery facilities, the fuel oil content of which is small, making the necessary modifications to existing facilities for the purpose of refining these kinds of crude, at an investment of approximately $ 50 million (see section 1.6.33 of this report). B. Expanding the diesel manufacturing capacity, while maintaining the flexibility to export gasoil. C. Setting up a complex refining system to turn fuel oil into refined products of a higher value, or using the residue as a source of energy in a facility for generation of electricity, at an investment of hundreds of millions of dollars. 1.6.6.4 The Company is examining the various substitute fuels, with the aim of dealing with such changes as may take place following the introduction of natural gas into use in Israel, and in particular, the Company is working towards advancing the possibility of purchasing natural gas for use as a combustible material instead of fuel oil. Use of natural gas at the Haifa Refinery is conditional upon signing an agreement to purchase it and completion of a natural gas transmission system from the Israel-Egypt border to the Haifa Bay. The transmission system is being planned and constructed by Natural Gas Lines Ltd. which estimates and has notified the Ministry of National Infrastructures that the natural gas is expected to reach Haifa Bay at the beginning of 2010. In January 2009, a report about a natural gas reserve discovered in the Mediterranean Sea off the coast of Haifa was published. At this stage, in light of the newness of the findings, it is not possible to estimate whether and to what extent it will impact the Company. The Company believes that the transition to the use of natural gas at the Haifa Refinery will give rise to increased operational efficiency, and will assist the Company in dealing with environmental requirements. In addition to making natural gas a significant source of energy in Israel, the introduction of substitute fuels from renewable sources such as ethanol and bio-diesel, which are not derived from crude oil, may be a substantial competitive threat to the Company’s products, as set out in section 1.10.2.5 of this report. Nevertheless, the Company’s ability to sell diesel containing
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bio-diesel to the European market, as its sells at the date of this report, could give it a marketing advantage when similar products are introduced into the Israeli market. The information contained in this section regarding the introduction of natural gas and fuel substitutes from renewable sources, the scope of its use and the influence thereof on the Company is forward-looking information, based on the assessment of Natural Gas Lines Ltd. and the announcements of the Ministry of National Infrastructures as to the rate of introduction of natural gas into use in Israel, the availability and feasibility of types of crude oil for purchase by the Company, the fuel oil and gas-oil market in the regions of the Company’s operations outside of Israel and other factors; and on the Company’s assessment as to the rate of introduction of components that are not products of crude oil, for use as transportation fuels. There is no certainty that the Company’s assessments as to each of these factors will come to fruition, in particular, the rate of development of use of natural gas in Israel, which involves considerable uncertainty, and there is no certainty as to the way in which the Company will handle this, or the costs involved. 1.6.7 Company's products of the area of operations A large number of substances can be produced from crude oil. The oil is usually separated out into a number of groups of substances, each of which includes several chemical compounds: 1.6.7.1 Light gasses - for energy and industry. 1.6.7.2 Liquefied petroleum gas (a compound of propane and butane) – for home cooking and as a raw material for industry. 1.6.7.3 Naphtha - as a raw material for industry. 1.6.7.4 Various kinds of gasoline – for combustion in gasoline engines. 1.6.7.5 Kerosene - fuel for jet airplanes, and for heating. 1.6.7.6 Various kinds of gasoil- for combustion in diesel engines, heating homes and use in the industry. 1.6.7.7 Various kinds of fuel oil - heavy fuel used as fuel for industrial furnaces and in the production of electricity. 1.6.7.8 Waxy substances - substances that bind at relatively high temperatures, and that are used as raw materials in the manufacture of lubricants for lubricating moving parts in machines, and for manufacturing wax (candles and other uses), and as feedstocks for catalytic and hydrocracker. 1.6.7.9 Bitumen - solid at ordinary temperatures, is used for tarring roads and manufacturing sealing products.
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1.6.8 Segmentation of revenues from products and rate of gross profit The following is segment data regarding the Company’s revenues based on its principal product groups in the field of refining, which constitute 10% or more of the Company’s revenues: Component Product 2008 2007 Diesel 2,417 1,380 Gasoline 2,643 1,922 Fuel oil 841 860 Revenue (NIS millions) Kerosene 845 541 Gasoil 441 - Others 814 308 Total 8,001 5,011 Diesel 32% 28% Gasoline 34% 38% Fuel oil 19% 19% Ratio of total Company sales Kerosene 11% 11% Gasoil 6% Others 6% 4% Total 100% 100% Cost of sales* (NIS millions) 8,056,335 4,710,311 Gross profit* (NIS millions) (54,491) 299,645 * Since the Company’s production process is a continuous process in which all of the products are manufactured from raw materials in joint processes that are unable to be allocated based on the end products, it is not possible to allocate costs according to classes of products. The Company also generates revenues from the sale of steam, electricity and infrastructure services (see section 1.2.1 of this report). The Company’s revenues from the supply of these services in the years 2008 and 2007 were (in dollar millions): 35 and 28 respectively. The prices of storage infrastructure, pumping and production services provided by the Company are fixed in the Supervision of Prices of Commodities and Services (Infrastructure Tariffs in the Fuel Industry) Order, 5756-19959. In order to determine the types of crude oil that are to be purchased by the Company, and the composition of the products that are to be produced by it, the Company, among other things, uses a computerized system of linear planning based on a multiple variable mathematical model which takes into account commercial data such as: the prices of various kinds of crude oil and the prices of various refined products, customer orders, and technical data with respect to the production capacity of the facilities. The recommended production function (the mix of crude oil, and the mix of products produced using it) is optimized to maximize the Company’s profitability. This system is used by the Company for the purpose of long-term planning and as part of its ongoing operations. Please note that the various kinds of crude oil and refined products are commodities, the prices of which are set in sophisticated international markets and are quoted on various commodities exchanges around the world, over which the Company has no influence. The purchase price of crude oil paid by the Company is set on the basis of international prices, with adjustments
9 This Order sets out a list of infrastructure services the rates of which are under supervision, and defines service standards for such services. The service standards define the system of rights and obligations of the providers and recipients of infrastructure services, including rules regarding service quality, liability for the quality of refined products and provision of services on an equal basis.
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for each transaction and to the extent possible, identification of spot opportunities in order to reduce costs. The prices for the sale of refined products by the Company to its customers are based on international prices. The prices for marine transportation of crude oil and refined products which are paid for by the Company are also fixed on the basis of international prices over which the Company has no influence. Long-term leasing of ships as set out in section 1.6.11.2 of this report reduces the Company’s exposure to fluctuations in marine transportation prices. Long-term leasing of ships by the Company as set out in paragraph 1.9.1 of this report reduces the Company’s exposure to sea freight price fluctuations. 1.6.9 New Products At the beginning of 2009, standards for transportation fuels matching Euro 5 came into force in Israel. The Company manufactures and markets products that comply with these standards. 1.6.10 Customers 1.6.10.1 Most of the refined products produced by the Company are sold on the local market to fuel and gas marketing companies, registered with the Fuel Administration, or licensed as gas supply licenses by the Ministry of National Infrastructure. Commencing July 2007, the Company sells its products to end-users from time to time. At the beginning of the same year, the Company started varying its sales methods for products on the local market, enabling its customers to contract with the Company for various periods (month, year or parts of a year as negotiated with the customer). For details as to the price of the products sold on the local market, see sections 1.6.26.1 and 1.6.26.3 of this report. The balance of sales is exported to various customers around the world (mainly in the Mediterranean area). 1.6.10.2 Export sales are partially made pursuant to spot contracts between the Company and foreign fuel companies or traders, and partially on the basis of one-year contracts. The export prices of the Company’s products are set in accordance with a price formula that is based on the level of market prices at the time of delivery of the products. The Company exports mainly to close markets in the Mediterranean Basin various products, some of similar quality to the products that are sold by it on the local market, and other products of a lower quality. Lower quality of product does not necessary mean low profitability from its sales. The differences in prices between sale to the local market and export sale for products of a similar quality sold at the same time stem mainly from the cost of transportation to export targets. The Company is close to and has access to growing markets such as Turkey, Greece and Cyprus, which import transportation fuels. Of the quantity of products exported by the Company in the past two years, the Company exported to the principal markets as follows: in 2008, 40 to Cyprus, 19 to Italy, and 14 to Turkey, and in 2007, 36% to Cyprus, 8% to Italy and 22% to Turkey. Below is a schematic drawing of the consumption and manufacture of distillates in the eastern Mediterranean basin:
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Thessaloniki (72 kb/d / 6.7) 638 Izm it (231 kb/d / 6.2 ) 486 429 443 Kirikale (100 kb/d / 6.3)
Izm ir (201 kb/d / 7.7) Greece Turkey Batman (22 kb/d / 1.8)
Aspropyrgos (147 kb/d / 10.6) Elefsina (100 kb/d / 1.5) Corinth (105 kb/d / 11.4)
Banias (133 kb/d 5.8) Homs (107 kb/d / 3.9) 52 Cyprus 105 260243 Lebanon Syria Haifa (180 kb/d / 7.4)
Ashdod 90 kb/d / 7.5) El Mex (100 kb/d / 3.0) 106 270 82 Libya Amiriyah (78 kb/d / 6.2) 220
Midor (100 kb/d / 10.1) 655 581 Israel Ras Lanuf (220 kb/d / 1.1) Jordan 357 244 Tanta (35 kb/d / 1.0) Egypt
Product Refined Product Domestic production Refinery (2) Sales Consumption (kb/d)(1) (kb/d)(1)
(1) Source: Energy Information Agency (Annual International Energy Convention 2004), PFC Energy. (2) The data for each of the refineries include location (refining capacity / Nelson complexity index). Source: for refineries in Israel – the Company. For other refineries, various data, including information conveyed to the Company by third parties, since it was collected from reports or presentations of relevant companies, the professional press, analytical reports, etc. The above data are indicative, and meant for an understanding on a general scale, as opposed to detailed and precise data, since except for data for which the Company is the source, they are cited from external sources as noted above, and the Company has not verified their accuracy. 1.6.10.3 Set forth below are the Company’s local and export product sales by segment, out of the Company’s total revenues. 2008 2007 Percentage of Percentage of Revenue Company Revenue Company (In $ 000’s) revenue (In $ 000’s) revenue Local market 5,689,943 74% 3,595,164 72% Export 1,983,047 26% 1,416,164 28% Total 7,672,990 100% 5,011,328 100%
The breakdown of the Company’s revenues between sales to the local market and sales for export changes from time to time according to the Company’s analysis of its optimal mode of operation in relation to the product mix that will be manufactured and their market objectives.
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1.6.10.4 The following are details of the Company’s product sales in the local and export market, according to quantities sold (in thousands of tons). 2008 2007 Ton Ton thousands % thousands % Local market 6,391 71% 5,587 69% Export 2,645 29% 2,547 31% Total 9,036 100% 8,134 100%
1.6.10.5 The Company’s revenues from customers, which accounted for 10% or more of the Company’s total sales turnover, are as set out below: Billions of NIS Customer 2008 2007 Paz Petroleum Company Ltd. 1,124 607 Fuel company B 948 * Fuel company C 904 * Fuel company D 511 *
Percentage of total revenues Customer 2008 2007 Paz Petroleum Company Ltd. 14.05% 12.11% Fuel company B 11.84% * Fuel company C 11.30% * (*) Less than 10% of the sales turnover.
1.6.11 Marketing and distribution 1.6.11.1 Marketing and distribution in Israel Under the reform of the fuel industry which took place in 1988, the Company sold refined products only to companies approved to market fuel and gas. The sale of the Company’s products is effected at the Company’s gate, with the fuel and gas marketing companies “extracting” the products by pipelines belonging to the infrastructure companies, or in road tankers from the Company’s dispensing terminal, and they resell the fuel products wholesale for industry and transportation, and retail to the public at large, mainly via fuel pumping stations located around the country. Commencing July 1, 2007, the Company sells its fuel products also to customers which are not fuel companies. The Company has an operational dependency on infrastructure companies through whose pipes the Company's products flow from the Company's production facilities. For the position of the Antitrust Commissioner regarding the marketing and distribution of refined products to customers which are not fuel companies, see section 1.6.26.5 of the report. 1.6.11.2 International marketing and distribution The marketing and distribution of the Company’s products internationally is done by the Company’s marketing division as part of the refining activity field. Principal marketing operations are in the Mediterranean basin, to save on shipping costs. The Company has a
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reputation for the quality of its products and their compliance with the requirements of the customers. In general, the Company’s marketing and distribution expenses are not substantial. For the purpose of its operations overseas, the Company leases tankers for maritime shipping of refined products (and crude oil) under long-term leases. For details about tanker leasing activities for transportation of refined products (and crude oil), see section 1.9.1 of this report. 1.6.12 Backlog of orders The Company's backlog of orders from its local and foreign customers as of December 31, 2008 amounts to USD 1.3 billion, expected to be spread out more or less uniformly over the entire 2009. The backlog of orders derives mainly from 2009 annual sales of transportation fuel, gasoline and kerosene. As at the date of this report, the backlog of orders amount to approximately one billion dollars. The rest of the Company’s sales in Israel are done on the basis of monthly orders, which are supplied in the calendar month following the order month. The rest of the foreign sales are effected on the basis of spot sales contracts, and are supplied within a short period of time after the date of contracting. 1.6.13 Competition 1.6.13.1 Until the effective date, the Company’s portion of the local market for refined products amounted to approximately 85%. The balance of refined products was imported by the large fuel companies, and large customers such as the Israel Electric Corporation and El Al Israel Airways Ltd. 1.6.13.2 The spin-off of ORA from the Company, and its operations as a competitor of the Company, increased competition for manufacturing and marketing of refined products on the local market. In 2007, there was a decrease in the Company's share in the local market, which reflected – in the opinion of the Company – an increase in imports when compared with the previous year and the sale of the Ashdod refinery to Paz. The Company estimates that in 2008 its share in the local market grew in relation to its share in 2007 as a result of a reduction in imports for 2007. In the opinion of the Company, over time, the competition will reflect the conditions in the international market for oil products in the Mediterranean Basin. 1.6.13.3 The Company estimates, based on public information published by the Fuel Administration, that the Company's share of the local market in 2008 was approximately 60%10: 1.6.13.4 Costs of transportation of those of the Company’s products that are designated for export have a substantial impact on the profitability of sales. Therefore, the Company has an advantage in supplying its products to customers who request supply of the products in the Mediterranean basin. 1.6.13.5 The purchase of the Pi Glilot terminals, and mainly the purchase of the storage and supply terminal in Ashdod (which is the heart of the flow and supply system in the center and south of the country) by the Delek Group, may have an impact on the ability of the Company to compete in those areas. In the Company’s opinion, its operations in areas of the terminals were not affected during the reported period as a result of these purchases. 1.6.13.6 The Company’s operations in Israel and overseas take place under conditions of international competition. The Company’s share of the international market is minor. 1.6.13.7 The products sold by the Company are commodities the price of which is quoted in international publications, and which cannot be distinguished from competing products of a similar level of quality. Therefore, competition in the field of refining operations focuses on maintaining the quality of these products over time, adaptation of the products to comply with changing standards, and the upholding a high level of reliability with regard to complying with dates of supply and payment practices to suppliers.
10 For information pertaining to the volume of the entire market, see 1.6.10.2 of the report.
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1.6.14 Seasonal fluctuations The Company manufactures various refined products based on standards that fluctuate according to the seasons. The standards are intended to make the qualities of the products comply with changing environmental conditions, in accordance with seasonal climates. In addition, there are seasonal fluctuations in consumption of the Company’s products which impact on the relative prices of the various products. The effect of seasonal fluctuations, as set out above, is relatively small compared with the effect of other factors (such as: the status of facilities, the Company’s general refining capacity, the viability of refining and competing imports), on the scope of product sales by the Company, and on the mix of products sold by it.
1.6.15 Production capacity 1.6.15.1 As set out in section 1.6.16.1 of the report, the plant facilities at Haifa include, among other things, initial distillation units (crude refining), catalytic cracking units and catalytic reformer units (responsible for refining and finishing fuel products), other production units (for production of isomert, which is used as one of the components of gasoline, and asphalt), and facilities for treatment of sulfur. The following is a flow chart of the production process:
Petrochemical LPG Refinery Treatment GAS LPG to Market
Light Isomerization Gasoline Blend Naphtha
Naphtha Naphtha Naphtha Feed to CCR Aromatic Stabilizer HDS Splitter Aromatic
Hydrogen Kerosene Kerosene to Market HDS
H.P. Gas Oil
Crude Oil Crude Gas Oil to Market
Distillation HDS Atmospheric
HVGO Gasoline FCC Gasoline Blend HDS HDS Propylene IC4 Feed to LPG LPG MTBE LPG to Market Treatment Splitter Vacuum C4 feed to Petrochemical Distillation Petrochemical Lube Oil Plant
Visbreaker Fuel Oil Blend
Bitumen Bitumen
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1.6.15.2 Refining capacity is measured in tons of crude oil per day. The maximum production capacity of the Haifa refinery is approximately 24,800 tons per day. Actual refining capacity is determined based on the type of crude oil that is processed, and in accordance with the Company’s needs. The following data reflects the Company’s yields (the Haifa Refinery) for its principal product groups in the area of refining (in thousands of tons): Product 2008 2007 Transportation diesel 1,848 1,723 Gasoline 1,664 1,627 Kerosene 831 751 Fuel oil 1,367 1,392 Vacuum diesel 738 706 Other 1,143 915 Total 7,591 7,114
1.6.15.3 The plant is in operation 24 hours a day every day of the year, apart from planned shutdowns of various facilities for the purposes of ongoing maintenance, based on the Company’s work plan and on account of malfunctions. As a rule, each of the plant’s principal facilities is shut down once every four years with the aim of effecting periodic maintenance which takes between 30 and 45 days, depending on the facility and the amount of work needed, and during those periods, no operations are performed in the facilities that are shut down. The Company tends to produce inventory in advance of such shut-down periods, so as to enable it to supply customer orders during these periods. For the costs of such periodic maintenance see section 1.6.15.9 of the report. In addition, the Company has an ongoing maintenance plan for its facilities (see section 1.6.15.8 of the report). 1.6.15.4 The average utilization ratio of the crude oil refining capability of the refinery (actual yield to maximum production capacity) was 83.3% in 2006, 86.2% in 2007 and 91% in 2008. Despite the fact that the mechanical availability of the refinery installations for these years is approximately 96%, actual utilization is lower as a result of use of a different crude oil mix from that on the basis of which the refinery facilities were planned, due to maximization of profits. As at the reporting date, the Company is upgrading its large crude refining facility at an investment of USD 50 million (which was approved by the board of directors on August 16, 2007), in order to expand the variety of crudes that the facility can refine. Completion of the upgrade is expected for the first half of 2009. As a result of the project, it will be possible to refine heavy crudes during periods in which their refining margin is higher and to focus on the refining the lighter crudes when their margins are higher, switching between the crudes without the need to shut down the facility and lose operating days. Increasing this flexibility will improve the utilization rate of the facility. (For more information, see also paragraph 1.6.33 of the report.) Approximately 8.5% of the crude oil refined by the Company is used by it for its own consumption. 1.6.15.5 On October 15, 2008, the Company’s board of directors made a decision on setting up a hydro-cracking facility with a capacity of 25,000 barrels per day that will produce interim distillations (diesel and kerosene), at an investment of 670 million dollars, as part of Company’s strategy, which is set out in section 1.6.32.3 of this report. The facility is expected to be operational in 2011. As part of the board of directors’ decision, the Company management was given the responsibility of completing credit arrangements with the Export Credit Agency, in the framework of which the Company will receive financing to purchase key items of equipment from suppliers abroad, as well as acting to receive the long-term credit required for the project from various sources. As at the date of this report, the Company is working towards formulating the said credit arrangements. Once it is operating, the facility
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will significantly increase the complexity of the Haifa refinery in so much as it will enable producing more distillations with higher added-value from every barrel of oil. The facility will also increase the refinery’s flexibility in selecting raw materials and product mix in order to adapt them to the variable market conditions. For details relating to the board of directors' guidelines for reducing ther hydro-cracking facility establishment costs see section 1.6.32.3 below. The Company’s assessment of the expected time of completion of the project and the scope of the investment therein is forward-looking information, based on plans prepared by the Company management and data received from external professional authorities. There is no certainty that these assessments will come to fruition, since it is a most complex project the implementation of which is subject, inter alia, to external factors, the receipt of the various relevant approvals and completion of the fund-raising necessary to set it up, factors which could change according to developments in the relevant markets.
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1.6.15.6 The following are details of the capacity of the facilities set out in section 1.6.16 of the report: Days of operation in Year of Date of last Date of last the year construction upgrade maintenance Production capacity (2) Facility (barrels per day) 2006 2007 2008 Crude refining(4/ 3/ 1) 180,000 344/317/363 364/344/365 361/366/366 '39/’44/’85 ‘91/’93/'95 (04'/ 05'/ 05') Refining Vacuum(4/ 3/ 1) 90,000 344/317/363 364/343/365 361/366/366 ’39/ ’79/‘85 ’91/’93/'95 (04'/ 05'/ 05') Visbreaking (3/4) 43,500 290/321 338/365 349/366 ’39/’85 70/ None (05'/ 04') Fluid catalytic cracking 25,000 327 335 366 ’79 ’82, ‘00, ‘04 2005 Continuous catalytic reformer 27,000 363 361 366 ’95 none 2004 Isomerization 11,300 314 347 2006 none None Catalytic hydrotreating: Naphtha 40,000 361 348 366 ’95 none 2004 Kerosene 21,000 356 328 361 62(3) '07(5)/’96 2004 Gasoil 60,000 350 358 341 ’02 none 2004 FCC gasoline 15,300 339 296 366 ’02 '07(5) 2004 HVGO 25,000 298 355 366 64(4) ’93, ‘95, '06(5) 2004 Hydrogen purification (6) 1,680 (KNM3/D) (1) 0 0 10 ’02 none None
(1) Thousands of standard cubic meters per day. (2) A portion of the time in which the FCC and the catalytic hydrotreaters of gasoil, FCC gasoline and HVGO were not operational during 2006 was due to the constraints of the war in the summer of 2006. (3) Set up as naphtha catalytic hydrotreater. (4) Set up as gasoil catalytic hydrotreater. (5) Replacing reactors. (6) The facility is ready for use, when necessary.
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1.6.15.7 The Company has a cogeneration station which supplies 40 megawatts of electricity and 350 tons of steam per hour for its own use. The electricity and steam produced at the station are used to operate the Company’s plant, and are in part sold to other companies in the Haifa Bay. The Company purchases the rest of the electricity that it requires from the Israel Electricity Corporation. The refinery’s ability to produce refined products with a high added value by using complex refinery facilities is measured using the Nelson Complexity Index (the “Nelson Index”) which, for refineries in the Mediterranean Basin, fluctuates in the range of 5-10. The higher the Index, the more the refinery is capable of producing products of higher added value and/or of refining types of crude oil of lower quality. The Company’s refinery is ranked at 7.4 on the Nelson Index. To the best of the Company’s knowledge, this level of complexity is among the highest in the Mediterranean basin. 1.6.15.8 The Company has established a maintenance program for its facilities. The costs of maintenance in 2007 amounted to 25 million dollars and in 2008 to 21 million dollars. 1.6.15.9 The costs of periodic maintenance of the Company’s facilities amounted, in 2007 to 13 million dollars and in 2008 to 19 million dollars. Please note that the cost of periodic maintenance is depreciated on the Company’s financial statements over the period until the subsequent periodic maintenance. 1.6.15.10 In addition to the current maintenance plans and the periodic maintenance of the Company’s facilities, the Company acts to upgrade, improve and expand its facilities in accordance with plans approved from time to time. This is done in order to meet market requirements which change in accordance with technology, and to enable the production of products that comply with strict quality requirements. In 2007 the Company invested an amount of USD 8 million and in 2008 approximately USD 77 million in large-scale projects. 1.6.16 Facilities and fixed assets11 1.6.16.1 The Company’s facilities in Haifa include initial distillation units (distillation of crude), catalytic cracking facilities and catalytic reformer units (which effect refining and finishing of fuel products), additional production units (for the manufacture of isomert which is one of the components of gasoline, and asphalt), facilities for treatment of sulfur, infrastructure (buildings, storage facilities, pipelines, etc.) and service facilities (power stations, wastewater treatment, fire-fighting equipment). In 2007 an opinion was received from an external expert with regard to the expected shelf life of the facilities, and according to which the management re-estimated the life expectancy of certain production facilities. The depreciated cost of these facilities as of December 31, 2008, based on said opinion is approximately USD 565 million. For details regarding the various kinds of fixed assets, including the depreciation accrued thereupon, see Note 11 to the financial statements of the Company. For the production capacity of the Company’s facilities, see section 1.6.15.4 of the report. For details of current maintenance plans, upgrades and improvements, see sections 1.6.15.3, 1.6.15.6 - 1.6.15.10 of the report. 1.6.16.2 Under the New Asset Agreement signed on January 24, 2007, the Company is entitled to be registered as a lessee from the State of Israel of 213.3 hectare of land (most of which is registered in the name of the Company) in the Haifa Bay, under a capitalized lease for a period of 49 years from the date of execution of the agreement, and at its election, for a period of a further 49 years. Of this land, the Company holds possession of approximately 160 hectare of land. The rest of the land is leased to Carmel Olefins, Gadiv, HBO and to a third party or is used for various uses necessary for the Company’s operations, and is not held in the exclusive possession of the Company. In addition, the Company leases an area of approximately 5.6 hectare of land from the Israel Lands Administration in the region of Jalma (near Kiryat Tivon). The New Asset Agreement also applies to that land. For further details regarding
11 For a description of the Company’s rights in assets, see also section 1.6.30.1.
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execution of the New Asset Agreement, and the implications of such to the Company’s rights in its land, see section 1.6.30.2 of this report. 1.6.16.3 On December 17, 2006, the Minister of National Infrastructures appointed an inter-ministerial committee to examine the question of the location of factories in the Haifa area. The committee was required to formulate a position regarding the location of factories in the Haifa Bay area in light of examination of the risks that those factories pose, including levels of pollutants emitted from them, and the need for them. If necessary, the committee is to come up with suggestions for alternative sites and recommendations for operative actions. The committee is required to complete its work and to submit its recommendations to the Minister of National Infrastructures by June 28, 2007. The Company does not know whether the committee began its work and it is unable, at this stage, to assess the implications of this matter on the Company. 1.6.16.4 A portion of the quantities of water consumed by the Haifa refinery are pumped by the Company from wells in the Jalma region, and are transported by underground pipeline. These operations are conducted under an agreement between the High Commissioner and the United Refineries Company Ltd. (which the Company has replaced) and under a production license granted by the Water Commission to the Company each year. 1.6.16.5 The municipal regime that applies to the land on which the plant is situated On March 28, 2005, the Minister of the Interior adopted the decision of the committee set up to handle the matter, and decided to annex the area of the petrochemical plants in the Haifa Bay area, including the area of the Company (hereinafter – the "area of the plants") to the municipal boundaries of the Haifa Municipality, on condition that the area of the plants is managed jointly by all of the relevant local authorities and the representatives of the plants which will act as an regional administration.. The Company and Gadiv appealed this decision to the High Court of Justice to prevent implementation of the decision of the Minister, claiming that the recommendation of the committee and the decision of the Minister created a municipal administrative mechanism that does not exist in law and that is unreasonable, and that the best way of achieving the goals set down by the committee is by setting up an industrial local council in the area of the plants. On December 29, 2005, the area of the plants was incorporated into the municipal boundary of Haifa, including the property of the Company. On August 23, 2006, the Company, Gadiv, Carmel Olefins and another plant entered into an agreement with the Haifa Municipality and other adjacent municipal authorities, designed to regulate the municipal regime that will apply to the area of the plants (hereinafter – the “authorities agreement”). The authorities agreement stipulates that a municipal corporation will be set up (hereinafter – the “Municipal Corporation”), in which all of the rights in capital and most of the voting rights will be held by the authorities, with the balance being held by the plants, and the goal of which is to provide municipal services in the area of the plants, including the setting of guidelines, planning and development. The agreement stipulated that the Haifa Municipality, as the licensing authority in the area of the plants, shall handle the request for a business permit submitted by the Company and that it shall not add additional conditions to the business permit beyond those conditions stipulated by the relevant government ministries for the business permit of the Company. For more information on the business permit of the Company, see section 1.6.26.8 of the report. It was further stipulated in the agreement, that in the area of the plants, the by-laws of the city of Haifa shall apply, and such laws shall be applied in an equal manner to the other areas of Haifa, as well as the provisions for cooperation, with the goal of having the Interior Minister set up a "joint committee" in accordance with the provisions of the Planning and Construction Law, the members of which shall be members of the board of directors of the municipal corporation. On January 6, 2009, the National Planning and Building Council held a meeting with regard to the Minister of Interior’s recommendation to set up a joint planning committee for the yard of the Company plant, most of the members of which will be government representatives and the others will be representatives of the bordering authorities, to grant the
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it local committee and local licensing authority powers only. As of the date of the prospectus, the Interior Minister notified that he has accepted the aforementioned National Council recommendations. On April 6, 2008, the Director General of the Ministry of Interior approved the authorities agreement and the setting up of the municipal corporation. As of the date of this report, the municipal corporation was not yet incorporated. Once registration of the municipal corporation is complete, the appellants will withdraw their appeal. As of the end of the concession period, the Company did not receive construction permits relating to the construction in most of the area of the plant. In 2004, the Company and additional plants located in the area of the plants submitted a detailed plan for the area to the Haifa Regional Planning and Construction Council. During the report period, the regional planning and building committee approved submission of the plan under conditions set in its decision. At the same time the regional committee also cancelled its previous decision concerning not granting certain building permits until approval of the survey regarding the impact on the environment. For additional details, see paragraph 1.6.25.5 of the report. Construction permits cannot be received for buildings constructed before the end of the concession period until the detailed plan for the yard of the plants is approved. Commencing at the end of the concession period, the Company has been requesting and receiving construction permits in respect of every new building constructed in its yard. Until the end of the concession period toward the end of 2003, the Company did not have to pay municipal taxes for the vast majority of the area of its plant. The Company has received the rate notices from the Haifa Municipality from 2005 onwards. Following a dispute between the Company and Haifa Municipality, the Company, Gadiv and Haifa Municipality reached an agreement during the period of this report concerning municipal tax sums which the Company will pay up to and including 2009, which was validated in a court ruling. 1.6.16.6 The Company holds rights in offices in Ramat Gan, in an area of approximately 210 m2. The new asset agreement signed on January 24, 2007 also applies to these offices (for no additional consideration beyond that set out in the New Asset Agreement, as set out in section 1.6.30.2.3 of the report). The Company signed a rental contract for these offices, commencing on April 1, 2008 at rentals which are not significant to the Company. 1.6.16.7 In addition, according to an agreement dated July 24, 2007, the Company rented offices covering an area of 765 m2 in the Azrieli Tower in Tel Aviv from a third party. The rental period is until December 31, 2012, with the Company having an option to extend the rental period for an additional period of 60 months. 382 m2 of this area was sublet to Carmel Olefins, as detailed in paragraph 1.7.9 of the report. The rentals are not significant to the Company. 1.6.17 Research and development The Company does not perform any significant research and development operations of its own, but rather, purchases the knowledge that it requires for the purposes of its operations from external suppliers, which are international companies that specialize in developing and selling know-how for the refinery industry. The Company purchases a license to use know- how and pays royalties to the supplier of the know-how in a fixed sum or in variable sums, depending on the volume of annual production at the licensed facility. The licenses to use know-how under which the facilities were set up are necessary for the operation thereof, and were granted to the specific facilities for which they were purchased. Under the know-how agreements, even where the agreement terminates, the Company is entitled to continue making use of the know-how for the purpose of production, to the extent for which the license was granted, and for which royalties are paid by the Company. The Company has non-exclusive agreements to purchase rights to use know-how with, among others, the following companies: UOP (Universal Oil Product Company), Lonza, Merichem
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Company, Exxon Mobil Research and Engineering Company, and BASF. The total sum of royalties paid by the Company as aforesaid is not substantial to the Company’s operations. The Company also purchases know-how that it requires for the purpose of reducing emissions into the environment from its production facilities from specialist suppliers. For additional details, see section 1.6.25.2 of the report. 1.6.18 In the refinery operations field, the Company has no rights to any substantial intangible assets. In December 2008, the Company was granted a license according to the Israel Petroleum Law, 5712 – 1952 to carry out experiments on the production of oil from oil shale on an area of some 300 hectare in the Nahal Efah region in the Negev. The period of the license is three years.
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1.6.19 Human resources For details of employees at Carmel Olefins and Gadiv, see sections 1.7.12 and 1.8.16 of this report. 1.6.19.1 The following is a diagram of the organizational structure of the Company as of the date of this report:
Chairman
CEO
CEO CEO Refining CEO Trade Petrochemical Segment Segment Segment
VP Headquarters and Human VP Finance VP Technical Resources Development
Secretary of the Legal Internal Board of Counsel Auditor Directors
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1.6.19.2 The following table presents the number of employees of the Company, broken down into segments (for details regarding Gadiv and Carmel Olefins, see sections 1.7.12 and 1.8.16 of the report):
Number of employees per day 31.12.2008* 31.12.2007 Company management Senior Management 5 5 Management – Business Development, Legal Department and Internal Auditing 15 16 Technological and information development 46 27 Finance 40 43 Information systems 23 25 Total Company management 129 116
Refining segment Refining segment management 7 5 Plant management office 4 3 Production 258 255 Maintenance 157 153 Quality 51 43 Human resources and organization 45 36 Purchasing and agreements 27 25 Technical services 13 9 Security 18 27 Total refining segment 580 556 Total trade segment 28 32 Company total 737 704 * As of December 31, 2008 until proximate publication date of the report, there were no significant changes to Company's workforce. The above table does not include 61 employees of the Company who work at Carmel Olefins (for details see section 1.7.12 of the report). In addition to the aforesaid, 60 temporary employees are employed at the Company (most of whom are part-time security employees) and 58 employees are employed via human resource companies in various positions of a temporary nature, most in projects, set-up and overhauling. Approximately 29% of the employees of the Company are engineers and academics, 41% are practical engineers and technicians and 30% have secondary school education. In the assessment of Company management, the Company is not dependent upon any particular employee. Employment relations at the Company are in good order. 1.6.19.3 Instruction and training The Company provides its operations and maintenance staff with professional training in their areas of operations, and all employees of the Company receive training in the fields of safety and fire safety, as required by law. Professional employees participate in courses in their fields of operations for the purpose of refreshment and development of knowledge, and for the purpose of increasing knowledge prior to the receipt of new equipment. The Company’s expenses for provision of these training courses are not substantial.
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1.6.19.4 Provisions relating to the conditions of employment of employees that applied to the Company as a government company Until the date of the public issue under the prospectus dated February 13, 2007, by virtue of the Company being a government company, the wages and other conditions of employment of the employees, including social conditions, benefits and grants, were subject to the rules prescribed by the Companies Authority and to its approval, by virtue of the provisions of the Government Companies Law. Commencing with the sale of the shares of the State under the prospectus dated February 13, 2007, the Company ceased being a government company and the aforementioned provisions no longer applied to it. 1.6.19.5 Pursuant to the resolutions of the board of directors of the Company of March 19, 2008, the Company paid bonuses to its employees (including the Chairman of the Board, the Company CEO 12and Officers), NIS 28,500 in respect of its annual income for 2007. According to the board of directors’ decision, the bonuses are granted differentially, in accordance with criteria set out by the board of directors at the recommendation of the Company CEO. 1.6.19.6 Employment agreements Of all of the employees of the Company, as of the date of this report, 61 senior employees are employed under personal employment contracts for senior employees, 37 employees are employed under the conditions of the special collective bargaining agreements to which the Company is a party, and 38 employees are employed under special personal employment contracts. The following are details of the conditions of employment of these groups of employees. 1.6.19.7 Senior employees employed under personal contracts Most of the senior employees, from the rank of department manager and upwards, are employed under personal employment contracts. A number of department managers are employed under collective bargaining agreements. The personal employment contracts of senior employees include pension and insurance coverage and social benefits and conditions that do not deviate from the norm, except for the entitlement of part of the senior employees to a surplus severance grant of up to 200% and the option of other senior employees to elect an early retirement track or an enhanced severance package in the event of dismissal. 1.6.19.8 Employee stock option plan 1.6.19.8.1 On September 5, 2007, the board of directors approved a stock option plan of 30,000,000 options (the “Option Plan”). 1.6.19.8.2 As part of the option plan, the Company allotted to Mr. Yossi Rosen, Chairman of the Board, and to Mr. Yashar Ben Mordechai, the CEO of the Company, 4,500,000 options each, exercisable into 4,500,000 shares of the Company, par value NIS 1, and which constitute 0.224% of the capital of the Company (full dilution), at an exercise price of NIS 3.25 per option. In November and December of 2007, the board of directors also allotted 17,900,000 options to officers and senior employees exercisable into the same number of Company shares, part at an exercise price of NIS 3.174, and part at NIS 3.486. 1.6.19.9 Collective bargaining agreements The Company is a party to special collective bargaining agreements which regulate the conditions of employment of those of the Company’s employees who are not employed under personal contracts. The following are details of the major conditions of the collective bargaining agreements that apply to the Company.
12 For details of the bonuses paid to the Chairman of the Board and the Company CEO, see Chapter D of the periodic report.
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Employee wages are determined based on rankings set for each class of employee. Under the collective bargaining agreement, once a year, the employee committee may submit to Company Management a list of employees who, in its opinion, are worthy of a raise in ranking. The collective bargaining agreement contains no undertaking by management of the Company to approve the list or any part of it. Wage increases as a result of an increase in ranking amount to approximately 15% on average. In addition, employees are entitled to a seniority supplement of 1% for every year of employment, up to a ceiling of 30 years’ employment at the Company and 0.75% for each year thereafter, up to a ceiling of 40 years’ employment at the Company. The Company enables those of its employees who so wish, to join the education fund, the employer’s participation in which amounts to 7.5% of the employee’s salary. Employees who are engineers, academics in social science and the arts, practical engineers and technicians are entitled to study remunerations as is common practice in public service. An employee who retires from employment with the Company having reached retirement age shall be entitled to a grant on the basis of the number of sick days accumulated to his credit, up to a ceiling of 250 days. All of the employees of the Company to whom the provisions of the collective bargaining agreement apply shall be members of a comprehensive pension fund. The Company makes provisions for the employer's share and deducts employee contributions from the employees’ salaries at the rates set out in the uniform articles. Under the agreement with employees, the Company’s provisions as aforesaid, plus payment of surplus compensation, based on the employee's most recent salary, are to be in substitution for severance pay in accordance with section 14 of the Severance Pay Law, 5723-1973. In respect of tenure in excess of 20 years, employees are entitled to surplus severance of 50% and in respect of tenure in excess of 30 years, employees are entitled to surplus severance of 100%. Approximately 300 of the Company's employees are employed in day and night shifts, entitling them to various bonus payments, as set out in the agreement. As of the date of this report, the Company has been making current payments into the pension fund for approximately 137 pensioners of the Company who retired under early retirement schemes, until they reach the legal retirement age. The total pensions paid by the Company in 2008 and 2007 amounted to USD 3,880 thousand and USD 2,771 thousand, respectively. As of the date of this report, the Company estimates that the balance of all payments that the Company is required to pay into the pension fund for such pensioners amounts to USD 11,515,000. In addition, the Company gives its employees and retirees gifts for festivals and a sum of money to purchase the Company’s products in sums which are not significant to the Company (see Note 18 to the financial statements). 1.6.19.10 Changes following the split and sale of ORA and privatization of the Company – special collective bargaining agreements dated June 14, 2006 Under the Split Agreement, as of the Effective Date ORA is to be the employer of the employees of the Ashdod refinery who moved to work at ORA after the Split (the “Transferred Employees”). The Company undertook to continue to bear all pension payments to pensioners who retired early, including those who worked at the Ashdod refinery. As part of the split and sale procedures of ORA, three special collective bargaining agreements were signed between the Company and the New General Employees Trade Union (the “Trade Union”), as set out below, the purpose of which was to regulate the issue of continuity of the rights of the Transferred Employees, the rights of the employees remaining at the Company under the privatization proceedings (the “Remaining Employees”), the rights of new employees accepted for employment at the Company after the Effective Date and an agreement to regulate the early retirement of employees of the Company. These agreements were approved by the Minister of Finance, as required under the Budgetary Foundations Law,
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5745-1985, and by the Companies Authority as required under section 32(a)(4) of the Government Companies Law. The following are details regarding the aforesaid agreements. All of the agreements below have been registered with the Registrar of Collective Bargaining Agreements. 1.6.19.10.1 Special collective bargaining agreement - transfer of employees from Oil Refineries Ltd. To Oil Refineries Ashdod Ltd. and privatization of Oil Refineries Ltd., dated June 14, 2006 (the “Transfer Agreement”) In respect of the Transferred Employees, the Company paid a split grant of NIS 70 thousand per employee and a privatization grant equal to five monthly salaries. The Remaining Employees received the privatization grant. The total cost of the split grant paid by the Company was NIS 72,701 thousand. The total cost of the privatization grant paid by the Company to the Transferred Employees amounted to NIS 23,808 thousand. The privatization grant was paid to the Remaining Employees by the State (through the Company). The Government Companies Authority applied the entitlement to the privatization grant also to employees of Carmel Olefins and HBO, on a pro rata basis to the share of the Company (directly and indirectly) in each of those companies. The privatization grant received from the State, in an amount of NIS 118.6 million13, was recorded as an expense (the net after-tax amount was NIS 106 million). The gross receipt from the State was carried to a capital reserve. The employees are in discussions with the taxation authorities regarding classification of the privatization and split grants as capital income (according to the employees’ claim) or income from employment (as the tax authorities claim). As part of a procedural agreement between the tax authorities, the employees and the Company, all of the sums in dispute were deposited with a trustee, and if the final tax sum is greater than the sums accrued to the trust account, the Company shall be liable to pay the difference (in the event that the total amount of the sums in dispute, plus index linkage differentials, is higher than the total amounts deposited in trust plus yields accrued thereupon). In addition, the Company undertook that pending the ruling on the dispute it shall not sue for recognition of such grant payments as an expense for tax purposes. Exhaustion of claims regarding transfer– The agreement prescribes that it constitutes final exhaustion of all of the claims of Company and the Trade Union regarding the consequences of the split and privatization of the Company. The period of the Transfer Agreement starts on the Effective Date and ends on the date of termination of the last of the old employees. 1.6.19.10.2 Special collective bargaining agreement - employment agreement of June 14, 2006 (the “Employment Agreement”) The Employment Agreement applies to 699 employees who were employed by the Company immediately prior to the effective date. The term of the Employment Agreement is five years, at the end of which the term of the Employment Agreement shall be extended for a period of a further two years, unless both of the parties agree otherwise. Dismissal of veteran employee s - the employment agreement prohibits management of the Company from dismissing veteran employees (in general, employees who were employed by the Company prior to the effective date), except with the consent of the employee committee of the Company or the chairman of the Professional Association Division of the Trade Union whose ruling shall be final. In any event, the provisions of the early retirement agreement, set out below, shall apply to any veteran employee who is dismissed. Voluntary retirement - the employment agreement provides that in each of the three years following the effective date, 45 veteran employees shall be entitled to retire from the
13 Of which an amount of NIS 97.2 million was in respect of benefits to the employees of the Company, NIS 8.8 million in respect of benefits to employees of Gadiv, NIS 11.9 million to employees of Carmel Olefins, and NIS 0.7 million to employees of HBO.
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Company early in accordance with the retirement conditions set out in the retirement agreement as set out below. The Company estimates that the cost to the Company of the retirement of 45 employees as aforesaid will amount to approximately NIS 81 million and provided for the amount in its books. Salary supplements - All of the veteran employees and the new employees shall be entitled to a salary supplement, to be paid to them until January 2011, the timing of part of which is contingent upon Company profits. However, in any event, by that time, all veteran employee s will have received an aggregate salary supplement of 10% of his 2006 salary. The Annual salary supplements shall be in addition to the salary supplements paid to employees, including for promotion of ranking under the collective bargaining agreements and arrangements in place, and the procedures in place at the Company prior to the effective date. The Company estimates the cost of the aforesaid salary supplement to the Company in each of the years 2009 through 2010 as follows: Supplement to salary cost Year (in dollar 000’s) 2009 1,290 2010 1,954 2011 1,054
Notwithstanding the foregoing, the Company and the employees' representatives reached an agreement, whereby salary costs (in NIS) for 2009 in relation to 2008 will be frozen unless the Company presents profits for 2009. Conditions of employment of New Employees - new employees shall be accepted for employment at the Company at a lower salary than that of veteran employees, at lower ranks than those received by the veteran employees, their promotion up the ranks shall be slower than the rate of promotion of the veteran employees and maximum rankings have been determined for every position. Dismissal – Under the agreement, it will be possible to dismiss a new employee with seniority of more than five years only with the consent of the employee committee or the Trade Union, and in the absence of consent, upon the ruling of an arbitrator, to be appointed by the parties. Personal agreements - under the employment agreement, management of the Company shall be entitled to employ an employee under a personal agreement only from the ranking of department manager and upwards. Labor peace - The parties have undertaken to maintain industrial quiet up until the end of five years following the effective date regarding the matters set out in the employment agreement. However, this undertaking shall not derogate from the rights of the employees to take part in any strike that may be declared by the Trade Union on a national level regarding employees of the public sector, or the entire country. 1.6.19.10.3 Special collective bargaining agreement - early retirement agreement of June 14, 2006 (the “Early Retirement Agreement”) Entitlement to early retirement - under the Early Retirement Law, 45 employees agreed upon by the employee committee and management of the Company14 shall be entitled to early retirement from the Company under the conditions set out below, as well as any veteran employee who is to be dismissed within six years of the date of privatization of the Company, the age and seniority of such employee which meet the stipulated guidelines
14 As at the date of this report, early retirements in between 2007 and 2009 has been agreed upon between the Company and 45 employees. Of this group, 39 employees have retired from the Company as at the date of this report.
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(“Employees entitled to Early Retirement”). Employees who are not entitled to early retirement shall be entitled to increased severance pay, as set out below. After the end of six years following the date of privatization of the Company, termination of the employment of an employee meeting the age and seniority criteria set out in the agreement shall only be by way of retirement for early pension, under terms to be set out in the agreement to be signed between the Company and the Trade Union. During the report period, a special collective bargaining agreement was signed between the Company and representatives of the employees which extended the aforesaid six year period to ten years from the date of privatization of the Company and enforced the provision concerning termination of employees after the said period for the list of veteran employees included in the work agreement of June 14, 2006. Retirement into early pension and acquisition of rights – the Company has undertaken to purchase for those employees entitled to early retirement, rights to early pension as pensioners of the Mivtachim Employee Social Insurance Institute Ltd. (under Special Administration) (the “Fund”) from the Fund, paying the full cost of the early retirement in accordance with the actuarial value on the date of early retirement, in the amount of the rights accrued by the employee as of the date of retirement, plus up to 10% of the employee’s determining salary, but no more that 70% and no more than the pension percentage the employee is entitled to in retirement according to age. To secure the Company’s undertakings to purchase the rights to early pension under the Early Retirement Agreement, a loan agreement was signed between the Company and the Haifa Early Pension Company Ltd. (the “HEP”), a special company set up for the purpose of the loan agreement. Under the loan agreement, the Company provided HEP with a loan in the sum of NIS 300 million. In the event that the Company does not meet its undertakings to purchase the pension rights for the employees entitled to early retirement, HEP shall be entitled to purchase the pension rights for such employees, using the loan monies provided by the Company to HEP. Repayment of the principal of the loan by HEP shall commence no later than in January 2010. The loan shall be repaid to the Company in full, on the assumption that use shall not be made of the loan monies for the purchase of employee pension rights up until the retirement of the employees eligible for early retirement into pensions or early pensions. During the report period, a letter of agreement was signed between the Company, representatives of the employees and HEP according to which the Company will be entitled to provide other security as replacement for the loan which it provided to HEP in order to secure the purchase of the pension rights for employees entitled to such, under conditions summarized in the letter of agreement. Additional rights to employees retiring early - The employees retiring under early retirement in accordance with the early retirement agreement shall be entitled to the following rights: (a) 11 month adjustment grant; (b) prior notice payment - a one-time grant in the sum equivalent to twice the employee’s monthly salary. Until shortly prior to publication of the report, 39 employees terminated their employ with the Company under early retirement terms in accordance with the early retirement agreement and 6 additional employees (in total 45 employees as decided upon in the agreement between the Company management and the employees committee, as stipulated in the employment agreement) will terminate their employment under the terms of the early retirement agreement. As at the report date, 630 of the Company's employees are eligible, or will be eligible until September 2016, for the early retirement terms as set forth above, should they be dismissed in accordance with the procedures set up in the employment agreement. According to the agreement, said employees who will retire after 2016, will be eligible for early retirement terms to be agreed upon. Increased severance pay on retirement - veteran employees whose employment is terminated by the Company during the ten years following the date of privatization of the Company, and who are not entitled to early retirement, shall be entitled to increased severance
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pay of 150%, for employees whose tenure at the Company is less than five years, and of 230% for employees whose tenure is longer than five years. Any employee under the increased severance pay track, shall be entitled to a 6 month adjustment grant and a prior notice payment in an amount equivalent to twice the employee’s monthly salary. 1.6.20 Raw materials and suppliers 1.6.20.1 The Company’s raw materials are crude oil and interim materials produced in the processes of separating out crude oil, and which are intended for processing in downstream facilities. Around the world, a wide variety of types of crude oil is traded, each of which is different from the others with regard to qualities. The crude oil market and its products is a commodities market This market is a sophisticated one, which is characterized by a high level of trading, including derivatives and futures contracts on the commodities exchange or with large international bodies. The Company purchases its crude oil from various suppliers around the world, mostly on the basis of spot transactions, the remainder (about 30%) being under contracts for periods of one year, based on price formulas. The combination of early purchasing and purchasing under spot transactions enables the Company to create a fixed basis for regular supply of crude oil on the one hand, and to enjoy opportunities for purchasing crude oil at attractive prices on the other hand For a graph of the behavior of the prices of crude oil, see section 1.6.2.2 of the report. The main source of crude oil purchased by the Company is from countries around the Black Sea and the Caspian Sea, the relative proximity of which to the Company’s plant reduces the costs of transportation. Likewise, the Company makes use of the crude oil pipeline from Baku to Southern Turkey. Other available sources are West African nations, Northern European nations, Mexico and Egypt. The following table presents data regarding the segmentation of the purchases of crude oil by the Company (the Haifa Refinery) from various countries around the world (in thousands of tons): Source 2008 2007 Caspian Sea 6,100 4,246 Russia 910 2,650 Africa 800 324 North America 190 194 Others 30 333 Total 8,030 7,747
In the Company’s assessment, it is not dependent upon any one single supplier of crude oil. 1.6.20.2 There are crude oil suppliers and trading companies which do not sell crude oil to Israeli companies, which to an extent limits the possibilities for the Company to contract with crude oil suppliers, and even causes an increase in the Company’s transportation expenses. Likewise, the availability of tankers to transport crude oil to Israeli ports is limited and a number of international shipping companies do not contract with the Company, which causes additional costs. For tankers that the Company leases for long-term periods, see section 1.9.1 of this report. 1.6.20.3 Petroleum and Energy Infrastructure Ltd. ("PEI"), which supplies the Company with: unloading services for crude oil at the Kiryat Haim terminal, storage services for crude oil and refined products, port infrastructure at the Kishon Port, which is used for unloading interim materials and refined products, and for loading products intended for export. PEI has been providing these services to the Company for decades and the price that the Company pays PEI for its services is supervised under the Supervision of Prices Order, which sets a fixed price for these services. In the Company’s assessment, should PEI cease providing services to the
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Company, the Company's operations might be materially adversely affected. In the Company’s assessment, should PEI cease providing services to the Company, the Company's operations might be materially adversely affected. In the Company’s assessment, the possibility that PEI might cease to provide services is remote, among other things, due to the fact that PEI is a government company and in light of its being a monopoly in the field of the services that it provides, and taking into account the dependence of PEI upon the Company as its primary customer PEI has informed the Company that following findings as to the status of a segment of the maritime pipeline owned by it in the Haifa Bay, which is used for the unloading of crude oil and for pumping it to the Company’s refinery, it intends to replace the segment. Subsequent to talks between the Company and PEI, the expected date for completing the replacement of the pipeline segment is August 2009. Following a letter from the Company in this regard, PEI has given notice that the unloading services at the Kiryat Haim Terminal are operating in an orderly fashion and that the marina is available for the Company’s use, without any restrictions regarding the pumping of crude oil. To the best of the Company’s knowledge, the replacement process is expected to take about one month and the Company will be prepared to minimize the effect of closure of the pipeline during the pre-planned period on the scope of refining, as far as possible, but in any event, some reduction in the scope of refining during this period is to be expected. If and to the extent that it is not possible to use this segment until it is replaced, or in the event that the process of replacing the pipeline segment extends for longer than the expected time frame, the Company will not be able to receive crude oil supplies from the Kiryat Haim Terminal, and will be required to reduce the scope of its refining activities by approximately 30%, so long as it is not possible to make use of the pipeline. On the possibility that the date of replacement of the segment of PEI’s pipeline might overlap with the date of entry into force of the closure order regarding EAPC’s transmission pipeline, and the implications of such, see section 1.6.20.4 of this report. In Addition PEI and the Israeli Ports Company notified the Company that the Israeli Ports Company intends on renovation the pier of the Kishon fuel port which serves the Company for unloading interim products and fuel products and loading products for export. Notwithstanding the fact that the Israeli Ports Company expressed its willingness to take into consideration the needs of the Company, the Company cannot under the present circumstances, in which a plan for the renovation of the pier has not yet been prepared, assess the impact of the renovation of the pier on the Company. The Company’s total payments to PEI during 2007 and 2008 amounted to approximately USD 23 million and USD 21 million (of which USD 7 million is for purchases), respectively. In a letter dated December 11, 2006 sent to the Company by PEI, PEI sought to draw the Company’s attention to two environment-related issues in which, in PEI’s opinion, requires discussion between PEI and the Company. One issue raised in the letter, arises out of an annual report by the Ministry of Environmental Protection dated 1997, which states that in the area of the fuel pipelines corridor near the fuel port at Haifa, there is massive pollution of the soil and the ground water, originating out of leaks from the old pipelines, or from when the old pipelines were replaced by new ones (the corridor where the Company’s pipelines are laid). The second issue is that of PEI’s alleged claim of pollution emanating from several sources within the tank farms at Kiryat Haim terminal and at El-Ro'I, (these two tank farms were operated by the Company, according to PEI’s claim, until the middle of the 1990's). According to PEI, it is difficult to assess the financial and other implications of this problem, and PEI demands that these issues be discussed soon, in order to reach an agreed solution. The Company has not replied to this letter. An initial examination conducted by the Company of its records with respect to the aforesaid allegations has shown that during the 15 years prior to PEI's letter, no reports were found of leaks from any pipes owned by the Company in the pipeline corridor to which PEI referred, and that the Company did not operate the two tank farms during the entire period alleged by PEI. On May 12, 2008 a hearing was held in the Haifa offices of the Ministry of Environmental Protection. The hearing was attended by
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Petroleum and Energy Infrastructure Company Ltd. ("PEI"), Eilat Ashkelon Pipeline Company Ltd. ("EAPC") and the Company, after the Ministry of Environmental Protection alleged that it discovered findings that could indicate pollution near the fishing harbor in the PEI strip where Haifa Refinery and EAPC pipeline works are carried out, and that soil suspected as polluted was removed from the area to the Haifa Refinery. At the hearing, the Company stated that it patrols the strip, the pipeline has cathode protection and the pipeline is tested before any inflow. The test results indicate that there was no leakage from the pipeline. Notwithstanding the aforesaid, the Company cannot rule out the possibility that there is exposure on this matter, in amounts that it cannot estimate at this stage, inter alia, because the scope of the pollution, if it exists, is unknown. In addition, the Company does not know if there is any pollution, when it was created and who is responsible. 1.6.20.4 The Company is operationally dependent upon Petroleum & Energy Infrastructures Ltd. (hereinafter: ("EAPC") which provides the Company with: crude oil unloading and storage services at its facilities at Ashkelon and Eilat, transportation services for crude oil, and at times, products in the pipeline infrastructure that belongs to EAPC. The tariffs for the services provided by EAPC to the Company, and other conditions relating to such services are prescribed from time to time by negotiations between the parties. In the Company’s assessment, should PEI cease providing services to the Company, the Company's operations might be materially adversely affected, including among other things, the quantity of crude oil refined by the Company and an increased dependence upon the Haifa Bay infrastructure for the uploading and transportation of crude oil. In the Company’s assessment, the possibility that EAPC might cease to provide services as aforesaid is remote, among other things, due to the fact that EAPC is a company in which the Israeli government holds 50% of the means of control and in light of its being a monopoly in the field of the services that it provides, and taking into account the dependence of EAPC upon the Company as its primary customer. Following the split and sale of ORA, the tariffs for the services provided by EAPC to the Company have been concluded again On October 18, 2006, the court issued a closure order against EAPC in respect to a segment of EAPC’s transmission pipeline which passes through Haifa. The closure order was meant to come into effect as of May 1, 2007, unless EAPC obtains a business license to operate the pipeline inside the city of Haifa. Most of the crude oil used by the Company is transmitted via this pipeline. On February 19, 2007, the Company was notified by EAPC that it received a temporary business license until February 28, 2009 for the operations of EAPC within the boundaries of Haifa. As at the reporting date, EAPC's temporary business license has not yet been extended. The Company cannot at present determine whether this temporary license will be extended or whether EAPC will be granted a permanent business license to operate said pipeline. Furthermore, the Company will not be able to extend it if the closure order is enforced. If the closure order comes into force, the Company will prepare itself for increased operations from the Kiryat Haim terminal in order to reduce the effect of closure of the EAPC line on its refinery operations. In the Company’s assessment, entry of the closure order into force could substantially harm the Company’s financial results, among other things, due to a reduction in the quantities refined by the Company by up to 50% of its refining capacity. In the event that the closure order issued for the segment of EAPC’s pipeline is put into effect on a date that overlaps the date on which the segment of PEI’s marine pipeline is being replaced as set out in section 1.6.20.3 above, the Company’s ability to receive crude oil for refining will be severely harmed, and it is expected that this will reduce its operations to the point of cessation of operation of its facilities during the overlap period, which shall have a considerable effect on the Company’s financial results. The Company’s total payments to PEI during 2007 and 2008 amounted to approximately USD 22 million and USD 28 million, respectively. 1.6.21 Working capital: 1.6.21.1 Inventory holding policy
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The Company’s policy is to hold crude oil inventory and product inventory at levels that will ensure the refinery’s ongoing operation, continuous supply of refined products to the Company’s customers in the local market and performance of its undertakings to overseas customers. The Company’s inventory as of December 31, 2008 was approximately 1,041 thousand tons of crude oil and 545 thousand tons of products. As a matter of course, the Company holds crude oil inventory sufficient for approximately one and a half months' production and inventory of finished products sufficient for approximately three weeks. This policy is examined from time to time by the Company's board of directors The principal factors that affect the amount of stock are: 1.6.21.1.1 The need for stock for filling the bottoms of tanks and pipelines. 1.6.21.1.2 The need to hold a large number of types of crude oil for distilling various compounds. 1.6.21.1.3 The need to import crude oil to Israel from great distances. 1.6.21.1.4 The availability of tankers for transportation of the crude oil and refined products. 1.6.21.1.5 The state of the crude oil and refined products market, expectations and future trade 1.6.21.1.6 The weather conditions at ports in Israel and overseas, including transition times for maritime transfers. 1.6.21.2 Supplier and customer credit The following is data regarding the average amounts of supplier credit and customer credit in the period 2007 to 2008 (in USD millions). Average amount of credit Average days of credit 2008 2007 2008 2007 Trade receivables 257 366 26 26 Suppliers 384 498 30 30
1.6.21.3 Credit policy 1.6.21.3.1 Customer credit: In general, the Company's policy regarding customer credit in Israel is approximately 30 days and 15 days for customers overseas. 1.6.21.3.2 For further information relating to the Company's policy on provisions for doubtful debts, see Note 2E to the financial statements. For details regarding the matter of collateral for credit, see also Note 30.6 to the financial statements. 1.6.21.3.3 Supplier credit: As stated above, crude oil, and refined and interim products constitute the Company’s principal raw materials (approximately 96%). Crude oil is purchased by the Company from foreign suppliers overseas at supplier credit of about 30 days. The prices of raw materials are set in foreign currency (US Dollars). 1.6.22 Investments 1.6.22.1 With the exception of the following, the Company has no significant investment operations that are not subsidiaries. 1.6.22.2 On June 30, 2008 the Company signed an agreement with a third party, that is not a related party of the Company or its controlling shareholders, to purchase 31.25% of the shares of Mercury Aviation (Israel) Ltd. ("Mercury") in consideration of NIS 2.705 million. Mercury is a refueling company operating at Ben Gurion Airport under a franchise agreement with the Airports Authority, which terminates on December 24, 2012. Mercury's operations constitute a total of 50% of the refueling services at Ben Gurion Airport. The controlling shareholder in Mercury (37.5%) is the Mercury Air Group, a company incorporated in the US and operating
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in aircraft refueling at numerous airports. The transaction was completed on September 23, 2008. The acquisition of Mercury shares is the Company's entry into the fuel products infrastructure segment outside of its plants and it is part of the Company's strategy in operations that overlap its core business to create an additional channel for the expansion of the Company's operations outside of Israel. 1.6.23 Credit and financing: The Company finances its operations via loans from banks and non-bank loans, among other things, by issuing debentures to institutional entities, from the cash flow from its current operations and from shareholders’ equity, which, as of December 31, 208, amounted to approximately NIS 552 million, which finances approximately 26% of the total assets of the Group (the Company’s shareholders’ equity as of December 31, 2007 financed approximately 30% of the total assets of the Company). 1.6.23.1 During 2003-2004, the Company raised long-term financing from institutional entities in the amount of approximately NIS 1,385 million (USD 364 million) by way of issue of nine (9) series of non-tradable debentures registered on the unlisted securities system of the Stock Exchange Clearing House ( the "Debentures"). The balance of the Company’s debt to the debenture holders, as of December 31, 2007 (including current maturities) amounted to approximately NIS 534 million (USD 143 million). The following are additional particulars regarding the Company’s Debentures as of December 31, 2007 (in NIS 000’s): Debt balance as at Effective Date of issue of December 31, Type of Interest Date of termination Debentures 2008 linkage Fixed Interest rate rate of payment term 03/2004 57,414 CPI 5.50% 5.61% December 31, 2013 05/2004 13,766 CPI 5.50% 5.61% December 31, 2013 03/2004 1,994 USD 3 months LIBOR 3.40% December 31, 2013 +1.90% 03/2004 1,076 USD 3 months LIBOR 3.40% December 31, 2013 +1.90% 03/2004 USD 3 months LIBOR 3.40% December 31, 2013 1,385 +1.90% 03/2004 33,162 CPI 5.70% 5.82% December 31, 2019 11/2004 CPI December 31, 2013 22,858 5.35% 5.46% 11/2004 8,873 CPI 5.56% December 31, 2019 5.45%
1.6.23.2 On November 28, 2007, the Company issued a prospectus for the issuance to the public of debentures (series A-C) for an amount of NIS 1,816 million (USD 472 million). The following are particulars regarding the debentures issued by the Company (in USD 000’s): Debt balance as Fixed Effective at December 31, Type of Interest Interest Date of termination Series 2008 linkage rate rate of payment term Series A 130,537 CPI 4.80% 4.86% June 30, 2020 Series B 232,648 CPI 4.60% 4.65% June 30, 2015 Series C 131,510 Unlinked 6.50% 6.61% June 30, 2014
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1.6.23.3 Credit rating The debentures (series A – C) issued by the Company under the prospectus dated November 28, 2007, as well as the debentures issued by the Company proximate to the date of the prospectus, were rated by Standard and Poor's Maalot Ltd. ("Maalot") – on November 12, 2008, at A/Negative, a decline of three ratings from the previous rating for the Company's debentures. 1.6.23.4 For additional information regarding the long-term loans from banking institutions and other entities, see Note 16 to the financial statements of the Company in Chapter C of the periodic report. For information pertaining to the revolving credit from banking institutions and credit providers, see Note 16 to the financial statements of the Company During the months of December 2006 and January 2007, the Company obtained credit facilities from banking institutions in the sum of approximately NIS 480 million which is to be repaid over a period of 5 to 9 years, at variable interest linked to Libor plus a margin (on the date of the report, the Libor rate is 2.5%). Some of this credit was used by the Company to refinance its short term debt. During October 2006, the Board of Directors of the Company resolved to distribute a dividend of NIS 2,700 million, which the Company paid on December 27, 2006 (NIS 2,680 million) and on January 2, 2007 (NIS 20 million). The Company believes, based on an opinion it received from the law firm of Eitan, Mehulal, Papo, Kugler & Co. on February 13, 2007, that the Company will have no tax liability in respect of non-recognition of the full amount of the financing expenses, the source of which is these loans, since they were used to generate income and were designated for financing the Company's current operations not for financing payment of the aforementioned dividend. The opinion relies on the facts set out in it, such as the fact that the Company customarily and from time to time raises long-term financing in order to convert short-term loans; the taking of the loans which are the subject of the opinion did not constitute an addition to the Company's liabilities and does not affect the overall scope of the financial liabilities of the Company; the Company approved the distribution of the dividend based on its compliance with all of the tests set out in the Companies Law; and the overall assessment of the structure of the Company's capital, which includes a high level of profitability, a high level of liquidity, a positive cash flow, high debt coverage ratios and high surplus balances. Based on the above, the authors of the opinion conclude that the loan was intended for financing current operations and therefore there is no direct and close link between the loans and the distribution of the dividend, to which the court was referring in the decision in the matter of Civil Appeal 6557/01 PazGas Marketing Co. Ltd. v. The Assessment Officer for Large Plants, as a parameter for the purpose of non-recognition of the financing expenses as expenses used to generate income. Pursuant to the resolution of the Board of Directors of the Company on February 12, 2007, the Company undertook to indemnify the authors of the opinion in respect of any sum required to be paid to third parties, including expenses incurred by the authors of the opinion in respect of an allegation related to reliance on the opinion in connection with the purchase of the Company's shares pursuant to the Prospectus of the Offer for Sale. 1.6.23.5 Financial covenants To secure the credit received by the Company for the non-marketable debentures, the Company undertook not to create charges over its assets ( ("Negative Charge"). In addition, the deeds of trust signed in respect of the debentures include stipulations that allow the holders of them, under certain circumstances, to demand immediate payment of the balance of the loans pursuant to the debentures, including a notice calling for immediate payment of one of the debenture series will be grounds for demanding immediate payment of other debenture series and a notice calling for immediate payment of the debentures if the Company violates or fails to comply with any of the terms or material undertakings, obligating it under the deed of trust and its appendices .
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In addition, the Company undertook to meet financial covenants, failure of which will result in the immediate call of the balance of the credit as follows: If the ratio of the Company’s total liabilities plus guarantees to third parties less crude oil and refined product inventories to the Company’s shareholders’ equity plus reserves for the allocation of income taxes (the "Expanded Capital") is greater than 2:1. As of December 31, 2008, this ratio is 1:77 if the ratio of current assets to current liabilities (the current ratio) is less than 1:1. As of December 31, 2008, this ratio is 1:6 1.6.23.6 To secure the long-term bank credit that the Company received from banking institutions (the "Creditors"), which, at the date of this report, amounts to approximately USD 324 million, the Company has undertaken, in addition to the causes for immediate payment which do not deviate from the norm, to comply with financial covenants, the failure to comply with which would enable the Creditors to make the balance of the credit immediately repayable. The main points of such covenants are as follows: If the expanded shareholders’ capital of the Company falls below NIS 1,700,000,000 (the "Expanded Shareholders’ Capital") meaning – funds and surpluses as appearing on the annual audited balance sheets of the Company, in reported amounts, plus reserves for allocation of income taxes; 1.6.23.6.1 If the ratio between the Company’s total long-term liabilities and its current liabilities plus guarantees to third parties, less inventory of crude oil and refined products, to the expanded shareholders capital of the Company is greater than 2:1; as of December 31, 2008 it was 1:77 1.6.23.6.2 If the ratio between the Company’s current assets (less spare parts, maintenance and chemicals) and the Company’s current liabilities is less than 1:1; as of December 31, 2008, it was 1:6 1.6.23.6.3 If the Company pays a dividend, the recording of which in the last periodic financial statements prior to the payment, causes a breach of any of the financial ratios set out in sub- sections 1.6.23.6.1 - 1.6.23.6.2; In addition to the aforesaid, the Company has undertaken, inter alia, financial covenants with banking institutions as follows, as at the reporting date the Company complies with them; 1.6.23.6.4 That it shall not sell and/or transfer and/or lease to any other or others any assets in the sum of more than the value of 10% of the Company’s fixed assets as will be in existence at the time of performance of the transaction, not in the ordinary course of the Company’s business and not under market conditions, without the prior written consent of the banking institutions to such; 1.6.23.6.5 That it shall not lend its shareholders amounts which would entitle the banking institution to demand immediate repayment of the loans, were it to pay such as a dividend, so long as it has not paid the amounts owing to the banking institution on account of the loan in full, without the prior written consent of the banking institution; 1.6.23.6.6 The negative charge signed in favor of the banking institutions by the Company shall remain in force; 1.6.23.7 Causes for the immediate repayment of the debentures (Series A – C) of the Company listed for trade on the stock exchange, as set out in the trust notes in connection with each of the series of the above debentures, were set out in the prospectus of the Company dated November 28, 2007. As part of the undertaking of the Company towards the trustees and the holders of the debentures (series A – C), the Company did not undertake to comply with financial covenants or certain financial ratios. As at December 31, 2008 and the reporting date, the Company complies with all the foregoing covenants. 1.6.23.8 Credit facilities
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The Company finances its current needs using short-term bank financing (on call loans) and short-term non-bank credit from institutional entities. The volume of its short-term credit is adjusted from time to time to the changing requirements of the Company. Shortly prior to the reporting date, the Company's short-term credit balances totaled an overall amount of approximately USD 108 million. In addition, at the beginning of 2009, the Company signed for a line of credit with on of the banks in an amount of USD 50 million, until the end of 2009. 1.6.23.9 Variable interest credit The following are details regarding credit at variable interest (short term and long term) received by the Company in 2007-2008, as set out in section 1.6.23 of the report. Interest range Sum of credit in Variance Interest prior to USD millions as of mechanism 2008 2007 the report date December 31, 2008
Dollar, LIBOR + 1.0-6.7 5.70-7.46 1.3-3.1 360 Prime + % 3.75-4.85 4.0-4.85 1.6 49
1.6.23.10 Raising additional resources From time to time, the Company raises funds for the purpose of the ongoing operation of its business and for investment in its plant, in such amounts as is determined by the board of directors of the Company in accordance with its needs. 1.6.24 Taxes For details regarding the taxation laws that apply to the Company and principal benefits thereunder, see Note 17 to the financial statements of the Company. 1.6.25 Environmental protection 1.6.25.1 General Environmental protection laws which regulate the levels of emission of pollutants that are permitted for the Company in its operations apply to the Company, including, mainly, the Prevention of Hazards Law, 5721-1961 ("Prevention of Hazards Law"), the Hazardous Substances Law, 5753-1993 (the "Hazardous Substances Law"), the Business Licensing Law, 5728-1968, the Prevention of Land Originating Sea Pollution Law, 5748-1988 and the Water Law, 5719-1959. In addition to these statutory provisions, the Company is also subject to provisions contained in permits and licenses, given to the Company and necessary for it to operate in its area of operations. The Company invests considerable resources in order to comply with all of the regulatory provisions that apply to it. In August 2007, the Company's board of directors set up a committee on environmental quality and safety, which discusses and monitors the performance of the Company and its investments in the area of environmental quality. As part of the strategic plan adopted by the Company's board of directors in November 2007, as set forth in section 1.6.25.7, an amount of NIS 270 million was earmarked for projects in the area of environmental quality, safety and security, and the enhancement of operational reliability. As of the date of the report, in the Company’s assessment, the Company is in compliance with all statutory provisions, permits and licenses that apply to it with respect to environmental matters, unless otherwise expressly stated in this section 1.6.25.2.4 below. In respect of the period from January 1, 2006 through the date of the report, the Company has not received warnings or demands relating to non-compliance with the provisions of the law, permits, and licenses applying to it with regard to environmental quality, which in the opinion of the Company, would impact in a material manner.
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The following are details of the licenses in the field of environmental protection which have been granted to the Company as part of its operations: Type of license Licensing authority Expiration of license Permit to pump brine into the sea (1) Ministry of Environmental September 30, 2009 Protection Toxin permit Ministry of Environmental January 1, 2010 Protection Additional conditions in business Ministry of Environmental (2) license Protection - Ministry of the Interior (see also section 1.6.26.8) --- Business license to transport gas and Haifa Municipality May 1, 2009 fuel Regulations for the prevention of air Ministry of Environmental --- pollution from the refinery in Haifa Protection (1) With respect to the pumping of brine into the Kishon River, see also section 1.6.25.3 below. (2) The additional conditions of the business license do not constitute a license. Proximate to the expiration date of the various licenses, the Company takes steps in order to renew all of the licenses that it requires in order to be able to operate, so as to maintain continuity of licensing. 1.6.25.2 Air quality 1.6.25.2.1 The Company has been informed that the policy of the Ministry of Environmental Protection is that it shall not allow any addition to the existing pollution of the air in the Haifa Bay, which, in the opinion of the Ministry of Environmental Protection, is abundant in air pollutants, and future development of this area will be restricted in accordance with air pollution levels. 1.6.25.2.2 Clean Air Law, 5768-2008 The Clean Air Law, 5768-2008 (in this section – the "Law") which becomes effective as of January 1, 2011, is intended to regulate treatment of the air pollution problem in Israel in an extensive and comprehensive manner. The law is expected to tighten the monitoring of emissions and require plants emitting substances into the air to receive an emissions permit for their operation. In addition, the law will introduce harsher criminal and administrative sanctions that could be imposed on any party contravening the provisions of the law and causing excessive or unreasonable air pollution. The issues covered by the law include: (1) Prescribing maximum levels for the presence of pollutants in the air; (2) Integrating the air monitoring systems into a single system and controlling publication of monitoring data in the media, as well as publishing air quality forecasts; (3) The authority of local councils to take the necessary actions to reduce the pollution levels within their jurisdiction and the authority of the Environmental Minister to order the heavily-polluted councils to prepare and execute a plan for reducing the pollution within their jurisdiction; (4) The obligation to obtain an emissions permit, inter alia, for any person who installs, owns, operates or uses a source of emissions that requires such a permit. The Environmental Minister shall lay down regulations, rules and criteria with respect to the issue of emissions permits, whereby such criteria will include, inter alia, guidelines relating to the best available techniques on which the conditions of such emissions permit will be based. Such emissions permit will be issued for a period of seven years; (5) The law prescribes interim provisions which stipulate timetables for the required treatment by factories, by sector, for the first five years that the law will be in force;
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(6) The authority to impose financial sanctions and provisions with respect to civil lawsuits against persons violating the provisions of the law, as well as terms of imprisonment and fines. Pursuant to the interim provisions of the law, a plant operating in the Company’s area of operations and which operated a source of emissions pursuant to the provisions of the personal order it received, may continue to operate without a permit under the law until September 30, 2016 or until a decision is made on its application for an emissions permit, the earlier of the two, provided that application is made for an emissions permit no later than March 1, 2014. Furthermore, the secondary legislator was certified by law to formulate material and key provisions relating to implementation of the law, including provisions defining excessive or unreasonable air pollution and steps and means to prevent such pollution. These provisions have not yet been formulated. In view of the foregoing, the Company is unable to assess the implications for it, from the enforcement of the law and its secondary legislature when it will be adopted. 1.6.25.2.3 On April 20, 1998, the Company voluntarily joined as a party to the Treaty to Implement Standards regarding Emission of Pollutants into the Air, signed on January 12, 1998 between the Manufacturers Association of Israel and the Ministry of Environmental Protection. The Treaty sets out standards for concentrations of emissions of hazardous substances from factory stacks. Nonetheless, the Ministry of Environmental Protection administration is gradually reducing its reliance on the treaty by prescribing new regulations that are not based on the criteria set in the treaty. 1.6.25.2.4 Personal order of May 25, 2006 On May 25, 2006, a personal order was imposed upon the Company15 under the provisions of the Prevention of Hazards Law, 5721-1961, which replaced the previous personal order. The personal order imposes air emission standards on the Company from every emissions source, separately, as well as air emission standards from the entire plant area, including provisions regarding the kinds of fuels that may be combusted in the Company’s plant, for the period up until November 25, 3008 and for the subsequent period. The Ministry formulated an amendment to the provisions of the personal order, based on the assumption that the Company's facilities will burn only natural gas, and published it for public review. The Company gave notice to the Ministry of Environmental Protection that it has started to act in accordance with the provisions of the amendment that was formulated. Under the personal order, the Company is also required to monitor the plant’s stacks on a constant basis. In addition, the order provides that the Company must conduct a survey of unfocused emissions from its facilities (i.e. emissions into the air, not from stacks, vents, flares or designated emission sources, but rather from pipeline connections, faucets, pools, etc.) and plan and execute a program for reducing unfocused emissions and continuous monitoring of them. With respect to those matters, the order stipulated that the Company is to submit implementation plans for approval by the Ministry of Environmental Protection. Under the provisions of the personal order, the Company was required to appoint a public complaints officer and to publicize the way to contact such person. The Company was also required to handle any complaint regarding any odor hazard reported to it. According to the Ministry of Environmental Protection, complaints that it has received from the public show that the odor nuisance problem has not yet been resolved and the Company’s site causes a great deal of odor nuisance. In accordance with the above, the Company provided the Ministry of Environmental Protection with a notice regarding set-up of a system to receive complaints from the public regarding odor nuisances and the treatment thereof and also the training and certification of an odor assessment team by the Ministry of Environmental Protection.
15 Any duty applying to the Company under the personal order also applies to its directors.
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Following receipt of the personal order, the Company is formulating a plan for operations and investments (the "Investment Plan") which, in the assessment of management of the Company, will enable the Company to comply with the provisions of the personal order on the target dates determined therein. The following is the assessment of management of the Company as to the investments and current costs required for implementation of the provisions of the personal order: Estimated cost Implementation Description (in USD millions) Time (years) Stack gas treatment unit (1) 150 2.5 Treatment of emissions from catalytic cracker to particle 10 levels of less than 40 mg / m3 In final stages Permanent roofs for tanks for storing volatile substances 27 10 Others 7 2 Total 194
(1) The updated draft of the personal order is meant to be approved in the foreseeable future, making the USD 150 investment in the stack gas treatment unit superfluous. Instead of this investment, an investment of USD 29 million was approved, in coordination with the Ministry of Environmental Protection, for a natural gas reception system at the Company, which will enable compliance with the terms of the personal order also without the stack gas treatment unit. Preparations for receiving natural gas are in the final stages. In January 2009, the Company received from the Ministry of Environmental Protection a warning and summons to a hearing relating to violations and apparent defective application of the provisions of the personal order (the "Warning"). The warning described the apparent violations which referred, inter alia, to the time tables set forth in the order, the results of the stack samples, the submission of certain plans as required in the order and the manner in which information is sent to the Ministry, as stipulated in the order. Prior to the date of the hearing, ORL submitted its response to the warning it received, in which it detailed its arguments and responses to the issues included in the warning. At the conclusion of the hearing, goals and timetables were set for actions to be taken by the Company for the purpose of reducing the pollution emitted by its facilities. The Company is preparing to implement the mandatory actions under the personal orders issued to it and is conducting talks with the Ministry of Environmental Protection regarding additional actions that the Ministry has required it to execute. The Company estimates that if it is required to carry out the mandatory actions under the personal orders it received, this will not cause it additional costs beyond its planned expenses. The Company's aforesaid estimates regarding the extent of investments and actions it is required to take and the timetables it will be required to meet, constitute forward looking information. These estimations are based on the personal orders issued to the Company and on the plans prepared by the Company's management, based on these estimations. There is no certainty that these estimations will be realized since the conclusion of the talks with the Ministry of Environmental Protection have not yet concluded and it is possible that the Company will be required to take actions and make investments greater than its estimations. 1.6.25.2.5 The Company is looking forward to the possibility of purchasing natural gas for its plants in Haifa as a replacement for combustible material instead of fuel oil. Use of natural gas will allow the Company to meet the emission standards set out in the new personal order, while significantly reducing the volume of the investments required to treat emission gases. The supply of natural gas to the Company's plants is contingent upon an agreement with a natural gas supplier.
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1.6.25.2.6 The Company contracted with Israel Natural Gas Lines Ltd. ("ING"), which is setting up the national transmission system and signed an agreement for the construction of the transmission infrastructure and the absorption of natural gas at its Haifa facilities. ING finished the planning of the gas pipeline to the facilities of the Company, submitted requests for the required construction permits and has even received some of the permits. Completion of the transmission infrastructure to Haifa Bay is contingent upon receipt of the rest of the required permits and licenses. Based on ING estimates the Ministry of National Infrastructure notice, the natural gas is expected to reach Haifa bay by the end of 2009. The anticipated date for the arrival of the natural gas to Haifa Bay is based on the assessment of ING as set forth below, and it constitutes forward looking information and is dependent, inter alia, upon the completion of settlements with landowners along the route of the pipeline and the completion of the laying of the pipeline and there is no certainty regarding the said date. 1.6.25.2.7 The Company is preparing to implement the provisions of the new personal order and for this purpose it is investing an amount of approximately USD 29 million which is expected to be completed by the time the natural gas reaches Haifa bay. Furthermore, the following environmental projects relating to the provisions of the personal order have been approved and the company has started implementation: (1) A facility for the reduction of particles from the catalytic cracker at a cost of USD 9.5 million. (2) A facility for the reduction of the emission of nitrogen oxides from the power plant at a cost of USD 13.6 million. (3) A multi-year project for the addition of a fixed roof above the floating roof of the volatile materials tanks – to date, investments have been approved through the end of 2008 at a cost of USD 16.4 million, and in coming years, additional investments are approximated at USD 10.6 million. (4) Projects to reduce the emission of odors from Company facilities, at a cost of NIS 5 million. (5) A number of additional projects at a total cost of NIS 9 million The formulation of an investment plan is based on the evaluations of experts, technology suppliers, equipment manufacturers, and equipment installers. It is uncertain whether the Company will be able to put this plan into effect within the timetable determined in the personal order and which are dependent upon, among other things, entities outside of the Company (e.g. ING)s, or that the cost of the Investment Plan will not deviate beyond expected costs, as of the report date. Failure to meet the timetables set out in the investment plan and/or in the investment plan budget might cause substantial harm to the business results of the Company. 1.6.25.2.8 In a number of stack examinations conducted at the Company’s catalytic cracker facility, it was found that particle emissions were possibly above the quantities determined in the personal order as applicable to the Company at present. The Company is implementing a number of steps in order to ensure that the scope of particle emissions from all of its facilities is no more than that determined in the personal order as follows: in the short term, the Company has reduced, according to an understanding reached with the Haifa Area Municipal Union for the Environment which is the supervisory authority for the personal order, emissions of particles from other facilities by using “super low-sulfur” fuel oil at the refinery. In March 2008 a facility was installed to further reduce the emission of particles from the catalytic cracker stack. The Company presumes that even though the Ministry of Environmental Protection gave notice on January 1, 2007 that it had not given approval for the Company to deviate from the provisions of the personal order, if the above understanding is upheld, it will not be required to expend substantial monetary sums in respect of the findings of the tests described above. 1.6.25.2.9 An indictment was filed against the Company, eight directors of the Company, and against Carmel Olefins and its directors, containing two charges regarding two events of emission of a black cloud from the Company’s flares, which, in each event, lasted a few hours, and which, under the indictment, constitute offenses under the Prevention of Hazards Law, 5721-1961 and
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the regulations thereunder. Under a plea bargain, the Company admitted guilt, and a fine of NIS 1.6 million was imposed upon it, as was an undertaking to avoid committing any of the offenses it was convicted for, for a period of two years as of the date of the judgment (March 26, 2006), in a further sum of NIS 1.6 million. Under the plea bargain, all of the directors of the Company were struck from the indictment, apart from the CEO who undertook to perform 150 hours of community service, without being convicted. Carmel Olefins and its officeholders were acquitted by the court on March 25, 2007, nonetheless an appeal was filed against the ruling which, at the end of the day, was brought before the Supreme Court where Carmel Olefins and the State reached a plea bargain according to which Carmel Olefins admitted to amended allegations, paid a fine of NIS 600,000 and undertook a commitment in the amount of NIS 400,000 to avoid committing the violation it was convicted of under the plea bargain, for a period of two years. Carmel Olefins directors were acquitted of the charges brought against them. For further information see section 1.7.23.3 to the report. 1.6.25.2.10 The Company and Carmel Olefins were summoned to a hearing in the offices of the Regional Manager of the Ministry of Environmental Protection on August 19, 2007, in connection with an alleged emission of black smoke from the flare that is located on the premises of Carmel Olefins. The minutes of the hearing did not include any operative decisions in the matter of the Company or Carmel Olefins. In the protocol, the Regional manager noted that another deviation from the permissible emission level would result in the opening of an investigation of the Ministry of Environmental Protection. 1.6.25.2.11 Apart from the above section 1.6.25.2.9, no indictments based on events that might have occurred in the five years preceding the date of this report have been filed against the Company. In the past, a number of indictments were filed against the Company regarding events that constituted alleged offenses under environmental protection laws. In each of these proceedings, the Company reached a plea bargain under which the Company admitted the offenses ascribed to it and fines in non-substantial sums were imposed upon it. 1.6.25.2.12 On January 31, 2007, the chairman of the Haifa Area Municipal Union for the Environment (the Union) sent a letter to the Director of the Companies Authority and the chairman of the board of directors of the Company regarding the privatization of the Company. According to the letter, the Union is acting to adopt the best available technologies rules (BAT) with respect to setting standards for emissions of pollutants into the atmosphere from industrial factories. The letter further states that according to the findings of research done by a foreign company which compares the emission of atmospheric pollutants between various refineries in Europe and in Haifa, the level of emission of atmospheric pollutants from the refineries in Haifa is in the top 10% of emissions from other refineries, and that in order to reach the levels of emission of the refineries in Europe, the refineries in Haifa must reduce their current emission levels by 70%. The chairman of the Union warns in his letter that despite the fact that the Ministry of Environmental Protection refuses to include the BAT standards proposed by the Union in the personal order that applies to the Company, it is not certain that this situation might not change when the land on which the refineries stand is transferred into the municipal jurisdiction of the municipal authorities that are members in the Union, which supports the BAT project. According to the letter, the cost of implementing the BAT standards is estimated at approximately USD 150 million over 15 years, approximately USD 30 million more than the cost of implementing the requirements set out in the personal order. In a letter dated February 4, 2007, the Mayor of Haifa notified the Companies Authority that he intends to demand, within the framework of the Company's business license, a reduction of 70% in the level of air pollution emission, in comparison to the current level, according to the Union's position as stated above. The Ministry of Environment's position with regard to the Union's claims, as set forth in a letter from the manager of the Haifa region dated December 7, 2006, is that the personal order is in accordance with European standards, including the BAT standards. As of the date of the report, the Company is operating in accordance with the requirements set out in the personal order and is unable to assess whether, in light of the Union’s position, an amendment might be made to the provisions of the personal order, nor what amount may be required to be invested if and to the extent that such amendment is made. For details regarding the declaration on the inclusion of the land of the plant in the jurisdiction of the Municipality
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of Haifa, and the stipulation in the Authorities Agreement to the effect that Haifa Municipality, as licensing authority over the plant, will not impose additional conditions on the Company’s business license over and above those prescribed by the relevant government Ministries, see section 1.6.16.5 to this report. It should be noted that on June 9, 2009 the Local Council (Environmental Enforcement – Inspector Authority) Law, 5768-2008 will come into force. This law certifies the local councils to supervise and enforce numerous environmental laws. The provisions of the said law includes provisions allowing the local councils to take a stronger stand than the provisions of the existing environmental legislature under a by-law. Notwithstanding, in the agreement signed with the council on August 23, 2006 the Haifa municipality undertook not to include additional conditions to the business license over the conditions prescribed by the relevant government ministries that issue the Company's licenses and that the Haifa municipal by-laws would be uniformly enacted in the Company's compound as in the rest of the areas in Haifa. The implications of this law on the Company cannot at this stage be estimated. 1.6.25.2.13 The draft version of the new personal order (which has not yet concluded), contains a requirement for performing a Gap Analysis, in accordance with the IPPC method currently in practice in the EU countries. The demand includes the examination of the process that have a potential impact on the environment and the adaptation thereof to the best possible available technologies ("BAT") as set out under the IPPC method. The Company began conducting the analysis and after approval of the analysis by the Ministry of Environmental Protection, the investment plan was amended to complete the existing gaps compared with the BAT, however at this stage we are unable to assess the impact of the requirement on the Company. 1.6.25.2.14 According to the provisions of the additional conditions terms of the business license, which were issued to the Company by the Ministry of Environment, in 2005, the Company began to dismantle and remove asbestos from the area of the plant. The dismantling and removal of the asbestos requires the consent of the Technical Hazardous Dust Committee of the Ministry of Environmental Protection. The costs of the above are not material to the Company’s business 1.6.25.3 Effluent quality and the Kishon River Industrial effluent generated during the Company’s manufacturing operations is treated by it and pumped as brine into the Kishon River. The Ministry of Environmental Protection is looking into a number of alternatives in order to resolve the brine issue. The issue of the quality of the brine pumped by the Company is regulated under the provisions of the Permit for Pumping Brine into the Sea. Likewise, the plant constantly monitors the quality of the brine prior to pumping it into the Kishon River. As of the date of this report, the Company is in compliance with the aforementioned permit, with regard to the quality of the waste water being pumped by it into the Kishon River. A Standardization Committee - Quality Standards for Waste Water headed by Dr. Yossi Inbar, Deputy Director General of the Ministry of Environmental Protection (the "Inbar Committee") has published its recommendations regarding the standards for the quality of the waste water. The Inbar Committee’s conclusions were adopted by the Ministerial Committee on the Environment, and a government decision was passed with respect thereto on May 1, 2005, the force of which is conditional upon the passing of a further government decision regarding the burden of the costs, which was passed on August 9, 2005. In order to implement the Inbar Committee’s conclusions, it will be necessary for regulations to be made under the relevant statutes, the Ministry of Health and the Ministry of Environmental Protection having been instructed to implement the aforesaid standard pending the enactment of such regulations, via conditions in business licenses. As of the report date, the decision of the committee has not yet been formalized in the regulations. On April 10, 2006, the Director of the Haifa District of the Ministry of Environmental Protection gave notice to the Company that factories wishing to continue to pump waste water into the Kishon River will need to comply with the standards prescribed by the Inbar Committee as of January 1, 2007. In that letter, the Company was requested to submit an immediate application for an order permitting pumping into the river under section 20K of the
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Water Law, 5719-1959, in compliance with the waste water quality standard as set out below. The Company did not submit such an application. On May 9, 2006, a meeting was held at which representatives of the Chemical, Pharmaceutical and Environmental Society of the Manufacturers’ Association of Israel and representatives of the Ministry of Environmental Protection were present. At that meeting, Manufacturers’ Association representatives asked for clarifications regarding the letters issued by the Ministry of Environmental Protection to industrial factories regarding the intention to make conditions for pumping treated factory effluent into the sea more stringent. Among other things, the manufacturers’ representatives claimed that the conclusions of the Inbar Committee should not be applied to factories required to pump into the Kishon River, since those conclusions were with respect to waste water from municipal effluent purification plants, without regard to industrial effluent, which was not examined by the Inbar Committee. Representatives of the Ministry of Environmental Protection argued that some of the factories emit high levels of nitrogen, and therefore the Ministry had decided that they must pump their effluent into the sea rather than into the river. The minutes of the meeting also states that it was agreed that the factories should be given more time than that set out in the letter from the District Director, and that the timetable for continued treatment would be set during the course of negotiations with the Ministry of Environmental Protection. On October 31, 2006, the Ministry of Environmental Protection held a public hearing to solve the issue of brine being pumped into the Kishon River. This hearing dealt with the possibility of a marine outlet pipe and the possibility of injecting the brine into the saltwater aquifers by way of deep drilling. During the visit of the Director General of the Ministry of Environmental Protection with the Kishon River authority on December 26, 2006, it was decided that that pumping the factories’ waste water, including that of the Company, would be by way of a marine outlet pipe, and after the BAT standards are adopted16, and not via the Kishon river. The timetable expected for commencement of the work to lay the marine outlet pipe is, according to the Ministry’s notice, the end of 2007. As at the report date, work on laying of the proposed marine pipeline has not commenced and in so far as the Company is aware, an alternative date has not yet been set for commencement. In the Company’s assessment, if and to the extent that the decision of the Director General of the Ministry of Environmental Protection is implemented as aforesaid, the Company shall not be required to make its brine comply with the Inbar Committee’s standards. According to deliberations which took place in June 2007 and thereafter with senior persons in the Ministry of Environmental Protection and in accordance with the public announcements of the administration of the Ministry, the guidelines of the minister and the director general of the ministry are to pump the wastes of the plants near the Kishon into the sea, through a pipeline. In the opinion of the Company, this makes the requirement to bring the brine content into line with the standards of the Inbar Committee redundant. The Ministry of Environmental Protection decided to have experts from abroad carry out a reassessment of the standards for pumping out to sea. Until the report date, the Company is unaware that a path has been stipulated for the outlet pipe to the sea or that any progress has been made on the reassessment discussed above. In the Company’s assessment, if and to the extent that it is resolved that the Inbar Committee standards also bind persons that are not institutes that deal in the purification of effluents, the Company shall be required to make considerable investments in order to comply with these standards. If a decision is made to pump the waste water of the factories via a marine outlet pipe, then in the Company’s assessment, the costs that it shall bear in respect of this will not be substantial to the Company.
16 BAT means the best available technology financially applicable.
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On July 18, 2006, the Minister of the Environment sent a letter to the Minister of Finance regarding the privatization of the Company. The letter sets out the preliminary findings of a survey examining the extent of pollution of the Kishon River, which states that there is a polluted layer of river bed several meters deep and several kilometers along the River’s course. The Minister of the Environment adds that having received the findings of the survey, he intends to order that those factories which the results of the survey prove have contributed to this pollution be required to bear the costs of removal of the pollutant sediments from the river, their treatment, and subsequent removal to an appropriate site. The initial assessment of the Minister of the Environment is that these costs could be as great as hundreds of millions of Shekels in total. In his letter, the Minister of the Environment claims that some of the pollution that has accrued over many years originates from the petrochemical industry on the banks of the Kishon River including the Company's refineries. On January 7, 2007, the Ministry of Environmental Protection gave notice that it had recently received the interim findings of the above survey conducted by the Kishon River Authority to the effect that the findings show that the riverbed is contaminated with heavy metals and organic materials originating from fuel products (petroleum hydrocarbons). The letter stated that according to the survey, approximately 450,000 tons of contaminated ground must be removed and that the initial cost assessment for doing so is approximately USD 50 million. According to the letter, the Kishon River Authority will now examine whether a connection can be drawn between the industrial processes at the factories on the banks of the river and the components of the sludge which polluted it. During the reporting period the Company received, for its review, draft findings of the study attributing the Company's contribution to the contamination at the bottom of the Kishon River at 0.21 % of the heavy metal contamination and 87.2 % of the organic materials originating from fuel products (petroleum hydrocarbons) contamination. The Company requested all the information used for conducting the study and received part of the material it requested. Based on the material received, the Company has some doubts about the findings of the study and it is in contact with the Ministry of Environmental Protection in this regard. As at the date of the report, management of the Company cannot assess what the final findings of the survey will be; the extent to which the findings prove the level of the Company’s liability, if at all, for the pollution, if any; whether and under what legal authority the Company might be required to take the actions set out in the Minister’s letter, or other actions, as a result of the above; and what the costs involved in this to the Company might be. For claims relating to the Kishon River, see section 1.6.31.1 of the report, and Note 20(2) of the financial statements. 1.6.25.4 Toxins The Company has a toxin license under the Hazardous Substances Law, which makes provisions regarding the amounts of hazardous substances that the Company is permitted to handle, and provisions regarding the manner of storing and treating such toxins. The license also includes requirements regarding the location of facilities that might be harmed by an earthquake, and which might cause danger, and requirements for protecting any facility so located in accordance with a protection plan submitted to the Ministry of Environmental Protection, for its review. Discussions are being held with the Ministry of Environmental Protection pursuant to comments made on the plan. In accordance with the provisions of the law, toxic waste is removed to the National Waste Disposal site at Ramat Hovav, and solid waste, such as polluted earth, is removed and taken to burial sites, in accordance with specific permits obtained from the Ministry of Environmental Protection. The costs involved in protecting these facilities as aforesaid are not substantial to the Company. 1.6.25.5 Suspicion of seepage of fuels into soil and groundwater From time to time, the Company is required to check claims regarding seepage of fuels and other pollutants into the soil and groundwater in the area of the plant. In 2005, following a finding of groundwater pollution in the upper section and a fuel pocket, the Company began drilling monitor bores into the shallow layer of groundwater underneath one of the Company’s facilities. In addition, the Company drilled several extraction wells in order to contain the pollution and to extract the polluted layer and remove it from the groundwater. Based on an external survey conducted by an external expert, the results of which were provided to the
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Company on January 21, 2007, the Company assesses that it is unlikely that the groundwater in the aquifer in the area in which the Company’s plant is located, which flows in a general south-westerly direction, will contribute to pollution of the groundwater to the west and to the south of the area of the Company’s plant. Based on this survey, in the Company’s estimation, pollution of the groundwater in the area of the plant is not expected to spread into adjacent areas where it could cause pollution of water sources used for drinking or irrigation. However, taking into account the aforesaid regarding the position taken by the Ministry of Environmental Protection, there is also a danger of finding pollution in the soil and in the groundwater. In this regard, there is uncertainty as to the scope of treatment that might be required if this pollution is located, and the Company is unable to assess the possible implications of these developments. Based on the Ministry of Environmental Protection's position as it was expressed to the Company on January 1, 2007 in the guidelines to the environmental impact survey (for further details see section 1.6.16.5 of the report), the plants in the petrochemical site are required to conduct a land survey in accordance with the Ministry's guidelines, which stipulate that the “Ministry of Environmental Protection shall add supplementary requirements as necessary and in accordance with the findings of the survey, including requirements to repair faults and to rehabilitate any pollution that may be found.” The survey is supposed to set out the extent and location of such pollution. In July 2007, the Company received the results of the aforementioned hydrogeological survey, which indicate that there is no danger to the groundwater sources in the areas outside of the plants boundaries as a result of the activities of the plant. However, a number of sites were found to contain polluted earth. The recommendation of the party that carried out the survey is (and to the best of the knowledge of the Company the recommendation is also acceptable to the Ministry of Environmental Protection) that upon completion of the processing of the results of the ground survey, a risk assessment should be performed using the RBCA or a similar method and to act in accordance with the results thereof. According to the position of the Ministry, after receipt of the results of the survey, the Ministry of Environmental Protection should define the goals of the rehabilitation of the land and the water (if water pollution is also found), taking into consideration that the existing operations are expected to remain at the site. On January 25, 2009 a hearing was held at the Ministry of Environmental Protection for the Company and PEI regarding two specific sites, located along the pipeline corridor close to the refinery, where the Ministry of Environmental Protection claims petroleum hydrocarbon contamination of soil and water were found. Subsequent the hearing, the Company and PEI were required to close the two pipelines along which leakage was found; to put them back to use following repair and/or replacement; to test impermeability of all the pipelines and to submit the results to the Ministry of Environmental Protection. In the hearing, the Company and PEI were warned that if the repair and rehabilitation process does not commence within 7 days after the hearing, including the removal of the contaminated soil, the Ministry would issue a toxin cleanup and removal order. The Ministry gave notice that it was requesting that the Green Police begin investigations of the events, including the Company's lack of taking steps to minimize damage and prevent further contamination of the river and its environs. On March 1, 2009 the Company received a toxin removal order, pursuant to section 16A of the Hazardous Substances Law, 5753-1993 and a clean-up order, pursuant to section 13B of the Maintenance of Cleanliness Law, 5744-1984, demanding that the Company, PEI and their CEOs submit plans to the Ministry of Environmental Protection for conducting soil and water gas surveys, to fence off the contaminated areas, to conduct the survey in accordance with the approved plans and to submit a report for the Ministry's approval of the findings of the survey which will include recommendations for carrying out the clean-up and rehabilitation of the contaminated soil and water and for returning the condition of the site to its former state, based on the findings of the survey, while noting a short-term and obligating timetable for carrying out the recommendations of the survey, until all the waste and toxins are removed from the soil and the water. The Company has submitted its plan for conducting a soil gas survey of the soil and water for the Ministry of Environmental Protection's approval.
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As at the report date, the Company is unable to assess the outcome of the survey, the actions which may be required according to the outcome and the extend of the expenses which will be incurred by the Company for carrying out such actions, if any. At the beginning of 2009, the Company and EAPC were required, under the terms added to their business licenses, to conduct soil surveys along the pipeline corridor connecting the Haifa refinery to the fuel port and along which, inter alia, the fuel pipelines serving the Company and EAPC are laid, and to apply the survey recommendations according to the suggested timetable which will be approved by the Ministry of Environmental Protection. The Company is appealing against these terms in its business license via the procedure set up by the law. 1.6.25.6 Quality standards The Company has obtained Israeli Standard ISO 14001:2004 certification in the field of manufacturing and dispatch of energy products and raw materials for the petrochemical industry. This standard is an international standard, and was adopted as an Israeli standard by the Israeli Standards Institute in February 1997. The Standard itself sets out the requirements of an organized environmental management system that is integrated into total management operations. In addition, the Company has authorization for Israeli Standard ISO 18001 in the areas of safety and risks, which is similar in format to Israeli Standard ISO 14001. Similarly, the Company has received a standard certificate for Israeli Standard ISO 9001:2000. The Company’s laboratories were given an official certificate of authorization by the National Authority for Laboratory Authorization (ISO/IEC 17025/2005) for environmental tests and various chemical tests. 1.6.25.7 Investments in environmental protection As part of the strategic plan approved by the board of directors on November 6. 2007, the goal of which is the achievement of rapid growth of the Company and the enhancement of its competitive capabilities in the coming years, accompanied by massive investments in increasing the share of high added value products in the Company's product mix as well as in areas of environmental protection, safety and security and the enhancement of operational reliability, the Company expects to make investments in the areas of environmental quality, safety and security and the enhancement of operational reliability in an amount of USD 270 million. As part of this plan, the board of directors has approved investments of USD 104 million which include, among other things, infrastructure and preparations of the absorption of natural gas at the Haifa refinery, a system for the reduction of particle emissions, a system for the reduction of nitrogen oxides from the oil refinery, expansion of the ability to exhaust Mercaptans and upgrading the oven protection. In 2008, the Company invested approximately USD 50 million in environmental, safety and increased operational reliability projects. For additional information, see section 1.6.33 below. In addition, in recent years, a proposal to make new regulations that will apply to fuel tank farms has been discussed. Following consent, in principle, to the wording of the statute between representatives of the authorities and representatives of the fuel industry, it is anticipated that these regulations will come into force after approval by the Knesset Economics Committee. If the regulations are approved in a form similar to the above, the Company assesses that this will not have significant consequences for it. Moreover, recently, and especially since the Bali Environmental Quality Conference took place, it has become more apparent that the State of Israel will also demand that emissions of CO2 be reduced, on the basis of standards being formulated since the Bali Conference. The Company cannot predict whether Israel will pass such restrictions and cannot assess the impact thereof on the Company.
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1.6.26 Restrictions on and Supervision of Operations 1.6.26.1 The control permit for holding means of control in the Company17 1.6.26.1.1 On June 27, 2007, the Israel Corporation received the Approval of the Ministers for control and the holding of the means of control in the Company. The Control Permit is subject to the fulfillment of the requirements, conditions and undertakings set out therein, by the Israel Corporation and the permit owners, as set out in the permit (Mr. Idan Ofer, Mr. Eyal Ofer, and Mr. Ehud Angel) (hereinafter the Permit Owner), including preserving the existing holding structure of the Company and the Israel Corporation and the prohibition to transfer control in the Company or to change the holdings in the means of control and the composition of control in the Israel Corporation, without the approval of the Ministers. 1.6.26.1.2 According to the Control Permit, the permit owner is allowed to be the controlling shareholder of the Company and hold 24% or more of the means of control in the Company, as long as the direct holder of the control and means of control in the Company is the Israel Corporation alone and that the control over the Company is exercised at the sole and absolute discretion of the Israel Corporation. 1.6.26.1.3 In addition, as long as the Israel Corporation is the controlling shareholder of the Company, and Paz is the controlling shareholder of ORA, and Bank Leumi Ltd. (hereinafter BLL) has the right or the ability to appoint, recommend or prevent the appointment of a director in the Israel Corporation and in Paz, certain restrictions were set down, among others, in connection with the appointment of a director on behalf of Bank Leumi in the Israel Corporation, in Paz, in connection with the involvement of Bank Leumi or anyone acting on its behalf in the appointment of directors in the Company and in discussions and decisions of the Israel Corporation regarding the Company and ORA, and in connection with the transfer of information from the Israel Corporation to Bank Leumi regarding the Company. 1.6.26.2 Government price supervision Until January 1, 2007, ex-refinery fuel prices were regulated under the Supervision Order. The Supervision of Prices for Commodities and Services (Maximum Ex-refinery Price for LPG) Order -200018 prescribes a maximum price for LPG sold by the Company at the refinery gate. Following the privatization decision, the order was amended so that as of October 2007, the regime of supervision of LPG prices changed so that Chapter G of the Supervision (Reporting on Profits) Law applies, and in cases where it becomes apparent that a refinery sold LPG at a price exceeding the import price in the month prior to the month of the sale (as defined in the order), or that a refinery supplied LPG to various consumers at a different price at the same time, Chapter F of the Supervision (Application to Raise Prices) Law shall apply. As at the report date, this amendment is in force. On April 8, 2008 the Company expressed its position before the price committee, as part of the discussion on the application to the committee to reinstate the maximum LPG price, according to which the LPG price supervision should be removed completely. As at the report date, the Company has no knowledge of whether the price committee concluded its discussions and whether it has adopted any recommendations. The prices of storage infrastructure, fuel dispensing and loading services provided and consumed by the Company (other than the infrastructure services purchased by the Company from EAPC) are determined in the Supervision of Prices for Commodities and Services (Tariffs for Infrastructure in the Fuel Industry) Order, 5756-1995.
17 The details in this section are to the best of the Company's knowledge. 18 The amendment of the Order as aforesaid prescribes that the name of the Order is to be changed such that the words "at the refinery gate” shall replace the words “at the Gate of ORL”, and wherever the word “ORL” appears in the Order, it shall be replaced by the word “refinery”. This definition amendment shall come into force within 12 months of completion of the sale and transfer of ownership of ORA.
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1.6.26.3 Amendment of the Supervision of Fuel Prices Order As part of the spin-off and privatization of the Company, a supervisory order was enacted and in it, it was stipulated that commencing on the date on which two refineries operate independently in Israel, the supervision of the prices of fuel will be removed, except for a reporting requirement. The supervision over maximum prices at the refinery gate shall once again apply in the event that the refinery does not uphold the reporting obligations that apply to it with respect to the amounts and prices of refined products, or in the event that the share of one refinery is more than 50% of the volume of consumption of the product on the local market and less than 15% at the other refinery. 1.6.26.4 Supervision of monopolies On February 27, 1989, the Antitrust Commissioner declared that the Company is a monopoly in the field of fuel distillation services. To date and for many preceding years, the Company no longer supplies fuel distillation services, but rather, sells refined products such that the conditions set out in the declaration are not relevant to the Company’s current operations. However, until the effective date, the Company was a monopoly in the field of sale of refined products. The Company estimates that in the foreseeable future, the Company will continue to be a monopoly over most of the refined products sold by it. Under the Antitrust Law, 5748-1988, the provisions of that law which regulate the operations of monopolies, including the prohibition against unreasonable refusal to supply the asset or service in the monopoly, the prohibition to abuse market status in such a way as to reduce competition in business or harm the public, etc., apply to the Company. 1.6.26.5 Commissioner’s notice regarding rules to be applied to the Company after the Split Within the framework of the aforesaid privatization decision, it was determined that as part of privatization of the Company, the position of the Antitrust Commissioner (the "Commissioner") in his notices which were attached as annexes to the privatization decision (the "Commissioner’s Notice"). The Commissioner’s Notice, to the extent that it relates to the Company following the sale of the Ashdod refinery relates to the following issues: the splitting up of the monopoly, restrictions as to the identity of the purchaser of a refinery as part of the privatization, restrictions on the vertical activity of a refinery, determining rules for the commercial behavior of a refinery, the purchase of transmission infrastructure, engaging in natural gas for the production of electricity and in desalination. The Commissioner also addressed the removal of supervision over the ex-refinery prices of fuel, subject to the terms set out afterward in the Supervisory Order (see section 1.6.26.3 of the report). In the Commissioner's ruling of September 27, 2006, authorizing the purchase of ORA by Paz, the Commissioner stated that full separation is to be maintained between ORA’s operations and the operations of any other refinery in Israel, and also, that no arrangement may be implemented regarding the joint purchase of raw materials, cooperation in sale or marketing of products, or use of production, storage, pumping or dispensing infrastructure, or port or unloading infrastructure, without the prior consent of the Commissioner, except for the transfer of feedstock where needed to provide an immediate solution to a production malfunction. In that decision, it was clarified that the Interim Materials Agreement between ORA and the Company, signed as part of the Split Transaction, did not require the consent of the Commissioner as aforesaid. For additional details see section 1.6.30.4 of this report. Likewise, the decision also provided provisions that require ORA to supply customers in the LPG market equally and without discrimination. On March 26, 2007, the Company received the decision of the Antitrust Commissioner to approve, subject to certain conditions, the merger between the Company, the Israel Corporation and PCH. Among other things, certain stipulations were set out in the approval decision, requiring the Company, Carmel Olefins, and Rotem Ampart Ltd. to provide for the equal and non-discriminating supply of customers versus ORA.
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1.6.26.6 Memorandum and proposed bill for Fuel Industry Law On January 1, 2007, the Ministry of National Infrastructure published a memorandum of the Fuel Industry Law 5767-2007 ( the "Fuel Industry Law" or the "Law"), the purpose of which is to regulate operations19 in the fuel industry, among other things in order to ensure regular, continuous and reliable supply of refined products, to ensure an adequate level of service in all sectors of the fuel industry, maintenance of competition, advancement of competition and generation of conditions for competition, ensuring supply during emergencies, and public welfare. The main points of the memorandum which will affect the Company’s operations, if passed, are, among others: The Company’s continued operations following enactment of the Law being conditional upon the obtaining of licenses under it; assurance of adequate service and conditions of competition; restrictions on holding of license and on activities of licensee; fuel pumping stations; definition of a refinery as an essential service, and the implications thereof. The memorandum of the Law grants broad powers to the Minister of National Infrastructures, to the Director of the Fuel Administration and to other persons to prescribe conditions and provisions in the above areas, which are not set out in detail in the memorandum itself. As of the date of this report, it is not possible to know what conditions and provisions may be made by virtue of the Law, or the extent to which these might alter the situation in place in the fuel industry at present. Therefore, the Company does not have the information necessary for assessing the extent of the affect that the memorandum of the Law as aforesaid will have on its operations and business. The complete wording of the memorandum of the Fuel Industry Law may be viewed on the website of the Ministry of National Infrastructures, at www.mni.gov.il. 1.6.26.7 Standards There are official standards in Israel with respect to some of the refined products sold by the Company. For others of the refined products there are Israeli standards or provisions regarding the quality of those products in orders made under the Vehicle Operation (Motors and Fuel) Law, 5721-1961, and at times, the specifications under which the Company supplies its products are determined under agreement between the Company and the customer. Refined products that are manufactured and sold by the Company meet the European standards based on EURO-5, which were intended to reduce the effect of motor vehicle emissions on the environment. 1.6.26.8 Licenses Towards the end of the franchise term, the Company applied to obtain a business license for the refinery at Haifa. Due to the lack of an outline plan for the land on which the Haifa refinery is situated, and as a result, a lack of building permits for the buildings constructed in the past on that land, the District Officer of the Ministry of the Interior does not view himself authorized to issue a business license for the plant. In January 2003, the District Commissioner at the Ministry of the Interior informed the Company that in exercise of the discretion afforded to him with regard to the institution of legal proceedings against factories operating without a license, the continued compliance of a factory with the conditions presented to it by the relevant licensing authorities, and the factory’s operation for the purpose of arranging a building permit for buildings in its territory shall be taken into account. The District Commissioner also noted that the various licensing authorities have confirmed that the Company is complying with all of the requirements made of it for the purpose of obtaining the business license. The Company is unable to assess the date on which it will be issued a business license, in light of the requirement for completion of the processes of planning and constructing the site on which the refinery is situated, in its entirety. In the Company’s assessment, in light of the above, it is not expected that the lack of a business license will give rise to the institution of proceedings against the Company.
19 (1) refining; (2) importation of fuel; (3) marketing of fuel; (4) export of fuel; (5) provision of infrastructure service; (6) activities in the industry prescribed by the Minister (the Minister of National Infrastructures);
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Likewise, the Company holds the following licenses: Type of license Licensing authority Expiration of license Business license to transport gas and Haifa Municipality May 30, 2009 fuel License to manufacture fuel Ministry of Finance - Taxation December 31, 2009 Authority Approval of place of fuel manufacture Ministry of Finance - Taxation December 31, 2009 Authority Gas supplier license Ministry of National Infrastructure November 10, 2010 Electricity production license(1) Ministry of National Infrastructure - Electricity Authority May 8, 2015 (1) Under the conditions of the license and the Electricity Market Law, 5756-1996, control of a company (which is a licensee) may only be transferred with the consent of the Minister of National Infrastructures. The Company does not expect any difficulty to arise in obtaining such consent for transfer of control of the Company, to any person who receives a control permit under the Essential Interests Order. In addition, the license holder is not entitled to transfer, charge or encumber, directly or indirectly, the power station or the electricity facility without the prior written approval of the Minister of National Infrastructures. In view of the receipt of the control permit under the Critical Interests Order, the Company sent a relevant request on this matter to the Minister of National Infrastructures. Proximate to the date of expiration of the licenses it requires to operate, the Company takes steps to renew all of the licenses. The Company does not foresee any difficulty in renewing these licenses. 1.6.26.9 Regulations regarding sale of LPG The State Economy Arrangements (Legislative Amendments) (Sale of Gas by Gas Manufacturers) Regulations, 5766-2006 provide that the Company (and Carmel Olefins when it is subject to such regulations) shall not discriminate between the various gas suppliers in supplying LPG. Similarly, various provisions intended to regulate the method of supply of LPG by the Company to the various gas suppliers in general and in times of LPG shortages apply to the Company as well. On February 8, 2007, the State Economy Arrangements (Legislative Amendments) (Provision of Equal Service) Regulations, 5766-2006, which are intended to regulate the provision of equal services in the field of LPG by any refinery operating in Israel, were publicized. The regulations contain punitive provisions in respect of breaches of the obligations set forth therein. The regulations do not substantially alter the Company's LPG sale operations. 1.6.26.10 Special permit to employ employees on the Sabbath The Company’s facilities are in operation every day of the year. The Company has a special permit for employing employees on weekly days of rest, in accordance with the provisions of the Hours of Work and Rest Law, 5711-1951, which is in force until December 31, 2009. 1.6.26.11 Declaration of essential enterprise The Company has been declared an essential enterprise under the Employment Service in an Emergency Law, 5727-1967, which regulates the Company’s operations in times of emergency. An essential enterprise is an enterprise declared by the government ministries so authorized as performing operations that are essential to the existence and supply of essential services. The Law authorizes the Minister of Labor and Welfare to require employees of the Company, and persons who are not employees of the Company, to present themselves for work at the Company’s plant under an emergency. 1.6.26.12 Registration as a fuel company Under the State Economy Arrangements (Legislative Amendments to Achieve Budgetary Targets and Economic Policy for the 2001 Financial Year) Law, 5761-2001 ( the "Budget
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Targets Law"), the Company is required to be registered with the Fuel Administration at the Ministry of National Infrastructures as a fuel company, as a condition of its operations in the field. The Company is so registered. 1.6.26.13 Performance of function as Firefighting Authority Due to the status of the Company's land during the franchise period, the Company has been appointed to perform the functions of a firefighting authority within the boundaries of its plant under section 15 of the Firefighting Services Law, 5719-1959. As of the date of the report, the Minister of the Interior decided, on the recommendation of the Firefighting and Rescue Commission to cancel the Company's status as an independent firefighting authority within the boundaries of its plant. In the Company’s assessment, it shall not bear substantial costs due to the cancellation of its aforesaid appointment and the transfer of the land on which the factory is situated into the jurisdiction of the Haifa Firefighting Cities Union. 1.6.26.14 Regulation of Safety in Public Bodies Law, 5758-1998 The Company is listed in the Second Schedule to the Regulation of Safety in Public Bodies Law, 5758-1998 and therefore, is subject to the provisions of that law which provide special safety arrangements for the Company’s facilities. The Law requires the Company to appoint a security officer and an essential computer systems officer, grants the security officer various powers to perform security operations at the Company, and requires the Company to act in accordance with the instructions of the Police with respect to physical security operations, and with the instructions of the General Security Services with respect to information security operations. 1.6.26.15 For details of permits and licenses relating to environmental protection and hazardous substances see section 1.6.25.1 of the report. 1.6.27 The Company’s status Since February 19, 2007, the Company is no longer a Government company and, therefore, the provisions of the Government Companies Law, 5735-1975 (the "Government Companies Law") no longer applies to it. For further information relating to the Interest Order published under the Government Companies Law, see section 1.6.28 to the report. Under section 9(5) of the State Comptroller Law [Consolidated Version], 5718-1958 the Company is subject to audit by the State Comptroller with regard to the period during which the Company was a government company, for the three years from the date on which the Company ceased being a government company. Under this framework, the Company transfers information to the State Comptroller, if and when it is required to do so. 1.6.28 Protection of the essential interests of the State in the Company - Provisions of the Government Companies Law and of the Essential Interests Order made under it Chapter H.2 of the Government Companies Law ( "Chapter H2") authorizes the Prime Minister and the Minister of Finance to declare, in an order, that the State has essential interests with respect to a company being privatized and to make provisions in an order for the purpose of protecting the vital interests of the State with regard to a company under privatization. 1.6.28.1 Government Companies (Declaration of Essential Interests for the State in Oil Refineries Ltd.) Order, 5767-2007 (in this section: the Order) 1.6.28.1.1 General On February 1, 2007, an order was published protecting the special interests of the State in the Company. The order sets out the essential interests that the State has with regard to the Company: (1) retention of the nature of the Company as an Israeli Company the center of whose business and administration shall be in Israel; (2) prevention of exposure or disclosure of confidential information on grounds of state security; (3) promotion of competition and prevention of centralization in the fuel industry; (4) prevention of the creation of a situation in which the
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Company is influenced by hostile entities or that might harm the security of the State, or its foreign relations; (5) assurance of the continuous existence of crude oil refinery operations, production of products thereof and their supply in Israel. In order to ensure the existence of the above interests, the Order sets out various restrictions and obligations, the principal ones being: 1.6.28.1.2 Restrictions on holding of control or means of control (a) Prohibition against acquisition or holding control of the Company without the prior written consent of the Prime Minister and the Minister of Finance (in this Section – the "Ministers"); (b) Prohibition against holding means of control of any particular kind in the Company in the rate of 24% or more without the prior written consent of the Ministers or increasing his holdings beyond what is stipulated in the approval; (c) Setting restrictions regarding the identity of a controlling shareholder or a person holding 5% or more of the means of control of the Company, in connection with the prohibition against cross-holdings in the Company and in a company that holds one of the following: ORA, infrastructure for storage, flow, or supply, port infrastructures, and a company engaging in natural gas, as well as in an entity that is registered or has operations in an enemy country. (d) The Company must make immediate notification should a person hold control or means of control in percentages requiring consent under the Order, without having received prior consent to such, including due to exercise of a charge or means of control or exercise of some other right afforded to him. (e) Requirement of any person who holds control or means of control without approval to sell his holdings, and there shall be no validity towards the Company to exercise any right by virtue of deviant holdings. 1.6.28.1.3 Delivery of information (a) The Company shall deliver to the Fuel Administration on a regular basis and to the Ministers, at their demand, such information regarding matters relating to the refining of crude oil, production of the products thereof and supply their in Israel. (b) Should the Minister of National Infrastructure be of the opinion that the Company has ceased to provide an essential service or that there has been a substantial disruption in the provision thereof, or that such disruption is expected, he may give notice to the Ministers that in his opinion the conditions of exercise of their powers under section 59N of the Government Companies Law have come into existence. 1.6.28.1.4 Confidentiality and information security (a) The Company is obliged under the order to fulfill all of the professional guidelines pertaining to data security. (b) A director who has not been vetted shall not be entitled to take part in a meeting of the board of directors which discusses a subject marked as “classified”, “secret” or “top secret”, as the Company’s security officer may so classify such, and shall not be entitled to receive information nor peruse any document relating to such classified subject; the Company shall not be entitled to provide information or documents regarding security issues to any director who has not been vetted. -The general meeting shall not be entitled to take, delegate, transfer or exercise security (ג) related powers that are vested in another organ of the Company. 1.6.28.1.5 Center of business and current management (a) The Company shall at all times be a company, incorporated and registered in Israel, the current operations of which and the center of whose business shall be in Israel.
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(b) The majority of the directors of the Company, including the chairman of the board of directors, shall be citizens and residents of Israel and shall have security clearance and security compatibility for their position, as determined by the General Security Service (the "Vetted Directors"), unless the General Security Service consents in writing and in advance to deviate from such, under such conditions as may be prescribed. (c) To maintain the requirements set forth in sub-section (b) above, no director who is not a vetted director may be appointed or selected and his or her appointment as aforesaid shall not be valid if, as a result thereof, the number of vetted directors is lower than the majority of the members of the board of directors; and if the terms of any of the vetted directors are ended or were terminated so that the total number of vetted directors is less than the majority of the members of the board, the directors who are not vetted may not participate in the Company's board meetings until the number of vetted directors have been appointed as required under sub-section (b) above. (d) The appointed officers of the Company, as stipulated below, shall be citizens or residents of Israel and shall have security clearance and security compatibility for their position, as determined by the General Security Service ( the CEO and his or her substitute, the VPs of Engineering, Operations and Information Systems, the attorney and his or her deputies and substitute, the internal auditor; chief security officer and his or her staff, the officer in charge of the essential computer systems and his or her staff, other officeholders and senior officers and Company service providers, including consultants who receive security classified information or who work on security organization projects such as may be set up in coordination with the Company's chief security officer and CEO. (e) The appointment or employment by the Company of an officeholder who does not comply with the provisions in subsection (d) above shall not be valid and his or her appointment or employment, as the case may be, will be cancelled. 1.6.28.1.6 Changes in the Company’s structure The following acts shall require the prior written consent of the Ministers, following consultation with the Minister of National Infrastructures: Voluntary winding-up of the Company; settlement or arrangement between the Company and its creditors or shareholders; merger of the Company with another company; split of the Company, except for a split that only relates to transfer of the Company’s assets which are not used in the refining of crude oil and production of the products thereof, and supply thereof in Israel. 1.6.28.1.7 Company’s operations in the field of marketing of distillates at gas stations (a) The Company shall not be entitled to hold any right in fuel pumping stations constituting 20% or more of all of the fuel pumping stations in Israel; however, after December 31, 2011, the Ministers shall be entitled, upon consultation with the Minister of National Infrastructures and the Antitrust Commissioner, to permit the Company to hold a right in fuel pumping stations at a higher rate than the aforesaid, noting the status of competition in the fuel and refinery industries. (b) The Company shall not purchase rights in fuel pumping stations from any one person during a period of three years, if such constitute more than 7.5% of all of the gas stations in Israel. (c) Where the Company has a right in fuel stations constituting 10% or more of all of the fuel stations in Israel, it shall not be entitled to enter into an arrangement to receive a right in a gasoline station which is an “adjacent station”20, without the consent of the Antitrust Commissioner. 1.6.28.1.8 Additional restrictions on Company operations
20 “Adjacent station” for this purpose shall be a fuel pumping station situated at the distance set out below from a place where another station in which the Company holds rights in the station is situated: on a city road - one kilometer as the crow flies, and on any other road - ten kilometers measured along the lengths of the relevant roads.
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(a) The Company shall not purchase control or 5% or more of the means of control of a corporation whose business is the marketing of distillates at gas stations, which operations the Antitrust Commissioner has determined to be nationwide, unless the Ministers prescribe, upon consultation with the Antitrust Commissioner, that such shall promote competition in the fuel industry. (b) The Company shall not hold control and shall not be the owner, holder or operator, directly or indirectly, including via a corporation under its control or in which it holds 5% or more of the means of control, of port infrastructure for the import or export of refined products in Israel, unless one of the following exists: (1) The aforesaid infrastructure was owned by it prior to the date of publication of the Order. (2) The aforesaid infrastructure was erected by the Company on the strip of land on which, as at the date of publication of the Order, the infrastructure under sub-section (1) above existed. (c) The Company shall not have a monopoly under the definition of section 26 of the Antitrust Law, whether declared or otherwise, in the dispensing, pumping or storage of refined products in Israel, including via a corporation under its control or in which it holds 5% or more of the means of control, unless the conditions set out in the order are fulfilled. (d) The Company shall not hold control or 5% or more of the means of control of ORA or any of the entities. 1.6.29 Insurance The Company maintains customary insurance coverage against risks related to its nature of activities. The material insurance policies maintained by the Company as of the date of the report are as follows: 1.6.29.1 Property and loss of profit Insurance - the policy covers direct physical loss or damage and consequential loss thereof, the scope of coverage under this policy is above USD 5 million and up to USD 1.2 billion, whereas the maximum indemnity term is 30 months. Notwithstanding the above, the coverage in respect of machine breakdown is USD 190 million and the insurance coverage in respect of earthquake damage is USD 500 million. The deductible according to the policy is USD 2.5 million for physical loss or damage and the participation period in cases of consequential damage is 60 days. 1.6.29.2 Terrorism insurance - provides certain coverage for direct physical injury and consequential loss as a result of terror acts. The coverage for property damages and consequential loss is USD 250 million for an indemnity period of 30 months. The deductible according to the policy is USD 5 million for physical loss or damage and the participation period in cases of consequential damage is 30 days. The Company's insurance policies do not cover acts of war, except for a few exceptions. 1.6.29.3 Public, Products and pollution Liability and excess employers liability Insurance - provides coverage for statutory liability in respect of: physical loss or damage to a third party’s tangible property due to operational activity and products supplied by the Company; bodily injury to third parties due to operational activity and products supplied by the Company; accidental pollution; and bodily injury to the Company's employees. The coverage under this policy is USD 100 million, excluding in respect of employer liability for which the coverage is USD 19 million. This policy excepts, inter alia, claims relating to pollution of the Kishon River. 1.6.29.4 Aviation products liability - provides coverage for the Company's legal liability in respect of the supply of aviation petroleum products. The coverage under this policy is USD one billion (including the above mentioned product liability insurance). 1.6.29.5 Prolonged pollution legal liability insurance - provides coverage for the Company's legal liability in respect of continuous environmental pollution arising from certain events. The
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coverage under this policy is up to USD 40 million. This policy excepts, inter alia, claims relating to pollution of the Kishon River. 1.6.29.6 Marine cargo insurance - covers loss or damage to cargo shipments in international cargo. The coverage under this policy is USD 125 million and cover in the amount of USD 25 million for cargo stored around the world that is not part of continuous transport. 1.6.29.7 Charters liability - provides coverage for the Company's liability in respect of chartered vessels. The coverage under this policy is USD 750 million, with a deductible of USD 750 thousand per incident. 1.6.29.8 Crime insurance - provides coverage for losses sustained as a result of fraud or dishonesty committed by any employees or any other person. The coverage under this policy is USD 10 million. 1.6.29.9 Directors’ and Officers’ Liability Insurance – The company holds a joint policy for directors' and officers' liability insurance with a liability limit of USD 130 million per claim and per period, which also covers the public offering of debentures that the Company issued in November-December 2007. In addition, in the reporting period, the Company purchased a run-off policy with liability limit of USD 130 million for a period of six to seven years to cover lawsuits that may be filed during the insurance period with respect to events that occurred to date. The insurance coverage under each of the policies set out above is subject to the conditions and exceptions set out in each such policy. 1.6.30 Substantial agreements 1.6.30.1 The asset agreement between the State and the Company, dated December 2, 2002 (the “Original Asset Agreement”) On December 2, 2002, an agreement was signed between the Company, the State of Israel and the Israel Corporation, regulating the Company’s operations after termination of the franchise (which ended as aforesaid on October 18, 2003). The original asset agreement provided that the State’s position is that at the end of the franchise term, all of the Company’s assets would revert to the ownership of the State for no consideration (the "State’s Position"), and that the Company and the Israel Corporation disputed the State’s Position (the "Dispute"). The following are the main points of the original Asset Agreement: 1.6.30.1.1 At the end of the term of the franchise, the Company shall be entitled to continue to hold assets that it held immediately prior to termination of the franchise (the "Assets") for a period of 25 years commencing on October 18, 2003, the Company having a right to extend the term of the arrangement by an additional 25 years, without any change being made to registration of the Assets (which are mostly registered in the Company’s name). 1.6.30.1.2 During the period of the original asset agreement, the Company undertook to pay the Government a fixed annual permit fee and additional annual sums that depend upon the annual profit of the Company before tax, and before payment of the permit fee. Upon the sale of ORA, the annual fee was reduced accordingly. 1.6.30.2 The new asset agreement between the State and the Company, dated January 24, 2007 (the “New Asset Agreement”) Pursuant to a decision of the Ministerial Committee on Privatization made on January 7, 2007, on January 24, 2007, the State and the Company entered into an amended asset agreement (the "Date of Execution"), which settles the dispute between the Parties with respect to the rights in the Company’s assets (in this section, the "Company’s Assets"). The following are the main points of the new asset agreement: 1.6.30.2.1 General – the Company agrees to the State’s Position in the Dispute, as defined in the Original Asset Agreement, and waives any claim stemming from the Dispute (as defined in section 1.6.30.1 of the report).
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1.6.30.2.2 Rights in assets other than real-estate - the Company has rights in each and every one of the Company's assets other than real estate assets, that it would have had but for the State’s Position in the Dispute. 1.6.30.2.3 Rights in the Company's Land 21 as defined in the agreement (a) The rights of the State - with respect to any land in which the Company was the owner or lessor but for the State's Position in the Dispute, the State is the owner and the Company does not and will not have any claim against the State with respect to the State's rights. With respect to such land – the Company has a long-term lease22 in accordance with the terms of the New Asset Agreement, and the Company does not and shall not have any claim against the State with respect to such rights. The term of each Lease Agreement shall be 49 years, commencing on the Date of Execution, the Company being given the option of extending such term for an additional 49 years ( the "Option Term"), subject to the compliance with all of its undertakings under the Lease Agreements and the New Asset Agreement. At the end of the term of the lease, including the Option Term, if exercised, the Company shall transfer possession of all of the land leased, including any structure thereupon or any fixture thereto, to the State. (b) With respect to the Company’s land not covered in section (a) above, the Company has such right that it would have had, but for the State’s Position in the Dispute. (c) In consideration of the Company’s rights under the New Asset Agreement, the Company will pay the State of Israel, every year, an annual fee comprised of a fixed amount of USD 2.25 million and additional annual amounts, that are contingent on the annual income of the Company before taxes and before the annual payment (in this section, annual income) , as follows: 8% of the annual income up to USD 30 million; plus, 10% of the annual income, in the range of USD 30 – USD 52.5 million; plus, 12% of the annual income, in the range of USD 52.5 – USD 67.5 million. In any event, the amounts paid to the State in respect of the annual payment (including the fixed component) shall not exceed USD 8.7 million. All amounts shall be translated into shekels at a rate of NIS 4.80 per dollar and are linked to the Consumer Price Index of May 2002. The purpose for the leasing of the land is refining of oil23 only for part of the land and fuel pumping stations or downstream industry24 and an infrastructure facility25 which wholly or mainly serves for petroleum refining facilities or downstream industry;
21 The land that the New Asset Agreement relates to is detailed in schedules attached to the New Asset Agreement. 22 The Company’s rights regarding the land shall be restricted to the layers of land and air reasonably required for the purpose of use and exploitation of the Company’s land in the context of the purposes of the Lease Agreements as per subparagraph (d) below, and shall not be construed as being from the heavens to the center of the earth, the scope of such layers being in accordance with that required in order to meet acceptable engineering requirements and acceptable safety standards. 23 “Refining of oil” for the purpose of the Agreement means production of refined products, including supply thereof. 24 “Downstream industry” for the purpose of this Agreement – an industry in which the principal raw material originates in refined products produced at the refinery. 25 “Infrastructure” for the purposes of the Agreement means a facility for desalination of water, any other infrastructure facility for water, a power station, any other infrastructure facility for electricity, a gas and fuel storage facility, any other infrastructure facility for fuel, facilities for the transmission of gas, any other infrastructure facility for the transmission of gas, or infrastructure lines or connection facilities as defined in section 274B(c) of the Municipalities Ordinance. The agreement provides that an infrastructure facility shall be deemed to be a change in zoning or exploitation, however, if the Directors-General are of the view that a facility is indeed used in whole or in part for the refining of petroleum or for a downstream industry, the Directors-General (as defined in section 1.6.30.2.3(e)) or either of them shall not object to the Notice of Change of Zoning or Exploitation given by the Company in respect thereof. In any event, to the matter of infrastructure facility, the agreement states that it is subject to the payment for the increase in value as set forth in section 1.6.30.23 (i).
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(d) The Company is not entitled to sell and/or assign and/or charge and/or mortgage its rights in the land leased in whole or in part, nor to enter into any other transaction in such land, and is not allowed to change the zoning of the land, unless prior written consent of the State to such is obtained, except in order to charge and/or mortgage its rights in the land leased in favor of a financial institution only for the purpose of obtaining financing for its operations during the ordinary course of its business. Should the Company breach any of its undertakings under section 1.6.30.2.3 of the report with respect to particular land, all of the Company’s rights in such land and all of the rights in land as aforesaid shall be cancelled and shall revert to the State ( the "Reverting Land"), in addition to any possible compensation. 1.6.30.2.4 Distillate pipelines (a) On the Date of Execution, the Company shall return all of its rights in or with respect to the Distillate Pipelines26, including any right that the Company had in the land on which the pipe system is laid as aforesaid prior the Date of Execution. (b) During the period between the Date of Execution and February 28, 2010 ( the "Interim Period"), the Company shall have the right to operate and use the distillate pipeline in accordance with and subject to the instructions of the State regarding the manner of operation and use of the Distillate Pipelines, as may be in effect from time to time ( the "Right to Operate"). (c) The Company shall not be entitled to collect any payment from other persons for their permitted use of the Distillate Pipelines, other than in accordance with the State’s instructions from time to time. (d) No later than February 28, 2010, the Company shall transfer possession of the Distillate Pipelines to the State, these being: free and vacant of any person, clean; in compliance with all of the requirements of any law, especially laws relating to environmental protection. The Company shall be liable for and shall indemnify the State, upon the State’s demand, for any damage and/or expense incurred and/or that may be incurred to the State as a result of breach of the Company’s undertakings under this sub-section. In addition, the Company has undertaken that throughout the entire term of the lease, including the Option Term, it shall operate and use the infrastructure used to pump to the El-Ro'i tank farm, in such a way as to enable a free and equal right of use of such infrastructure for any person wishing to use such to pump petroleum products. 1.6.30.2.5 Exhaustion of Claims - the new asset agreement shall constitute final conclusion of all allegations and claims by the State or the Company against each other with respect to the dispute and supersedes any other agreement signed between the parties with respect to the company's assets. 1.6.30.2.6 At the end of the concession period and in accordance with the original asset agreement, and subsequently in accordance with the amended asset agreements, the Company commenced payment of the annual fee to the State. In 2007 the annual fee paid by the Company to the State amounted to USD 11 million and for 2008, to date advance payments have been made in the amount of USD 10 million.. 1.6.30.3 Agreement for the Transfer of Assets and Liabilities to ORA (the Split Agreement) On March 9, 2006, the Company signed the Split Agreement with ORA, which was amended on May 25, 2006, on June 25, 2006 and on July 27, 2006. The split agreement provides that the Company would transfer and assign to ORA, on the effective date rights, assets, liabilities (including liabilities to credit providers) and employees ( the Transferred Property).
26 For purposes of this section, "Distillates Pipeline" means – the system of pipelines for the flowing of oil distillates between the Haifa port and the Haifa Oil Refinery, in the area known as "Corridor F".
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In consideration, the Company received shares of ORA, which were sold to Paz as part of the sales agreement as set out in paragraph 1.6.30.5 of the report. Subject to the rest of the provisions of the agreement, all of the income and expenses flowing from the transferred property and the operations of the Ashdod refinery up to the effective date belong to the Company and from the effective date onwards, belong to ORA. Under the Agreement, the Company declared and undertook, among other things, in connection with the rights to the transferred property, to furnish the various required approvals and permits, and to comply with the environmental laws. Under the Agreement, ORA waived all claims against the Company with regard to the transferred property and the transferred rights and it undertook to receive it on the Effective Date as is and where is, without any representation or liability on the part of the Company, with the exception of the Company’s obligation to indemnify, as set out below. The agreement included the Company's undertaking to indemnify ORA, its shareholders and officeholders for damages caused to them as a result of the incorrectness of any of the Company’s representations. This undertaking expired, except for the indemnification requirement relating to an environmental matter, for which the final date for delivery of an indemnification demand shall be seven years after the effective date. In any event, the Company shall not be required to pay on account of this indemnification undertaking, a sum of more than NIS 975,423 thousand. As at the report date, no such indemnification demand has been received. In the event of breach of the Agreement by the Company, ORA shall be entitled to rescind the Agreement for compensation only. 1.6.30.4 Agreement for the transfer of interim materials On March 9, 2006, the date of execution of the Split Agreement, the Company executed an agreement for the transfer of interim materials with ORA ( the "Interim Materials Agreement") which set out a mechanism for the submission and receipt of bids for purchase and/or sale of a number of interim materials intended for the parties’ use only, during the course of their distillation operations. The prices of the interim materials are set in accordance with the price formulas based on international publications. The interim materials agreement remains valid until the end of the third quarter of 2009, when the parties have the option to extend the term for additional terms of one year each, by mutual consent under the mechanism prescribed in the agreement. On March 8, 2006, the Antitrust Authority gave notice that the interim materials agreement was not an arrangement in restraint of trade, and did not require submission of an application for an exemption from the Commissioner. 1.6.30.5 Agreement for the sale of shares in ORA to Paz (the Sale Agreement) As set out above, under the privatization proceedings, Paz signed an agreement for the purchase of ORA’s shares from the State and from the Company, which was implemented on September 28, 2006, contemporaneously with implementation of the Split Agreement. In return for purchase of all of ORA’s shares from the State and the Company, the Company was paid the sum of NIS 3,251,409,000. 1.6.30.6 Distribution agreement On February 13, 2007, the Company and the State entered into a distribution agreement with international distributors for purposes of marketing and distributing the shares of the Company being offered by the State to institutional investors in Israel and abroad as part of a private placement (the "Private Placement"). In accordance with the instructions given to the Company by the Government Companies Authority pursuant to article 59E of the Government Companies Law pertaining to the indemnification by the Company of international distributors, the Company undertook to
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indemnify the international distributors, including companies related thereto, senior officers thereof, their agents and their employees ("Recipients of Indemnification"), without any ceiling being stipulated, in respect of any loss, liability, demand, damage, monetary debt, or expense of any kind and type placed upon them (severally and jointly), in connection with the existence of a misleading detail (as defined in the Securities Act) in the private placement documents, or due to an inaccuracy in the English translation of the draft prospectus of the sales offer or of the sales offer prospectus in a total amount not exceeding the proceeds of the private placement received from the foreign institutional investors. On February 8, 2007, pursuant to the instruction of the Government Companies Authority by virtue of article 59E of the Government Companies Law, the Company’s board of directors approved the granting of indemnification to the attorneys who handled the sale offer of the Company's shares by the government with regard to the confirmation granted by the law firm to the international distributors in the matter of the translation of the sales offer prospectus in respect of any amount it would be required to pay to the international distributors in respect of the incorrectness of the aforementioned confirmation. 1.6.31 Legal proceedings The following are the Company’s substantial legal proceedings that are pending in courts and/or the outcomes of substantial proceedings that have ended. 1.6.31.1 The Kishon River Claims A. During the period 2001 – 2005, monetary suits were filed with the Haifa District Court against the Company, Gadiv, Carmel Olefins and a series of other defendants (including the State of Israel), by 50 people suffering from illnesses (or their heirs or dependents), mostly fisherman who allegedly work in the past in the Kishon fishing port. According to the plaintiffs, the discharge of effluents into the Kishon by each of the chemical plants operating on the banks of the Kishon River caused the cancer (and other illnesses) from which they suffer. Dozens of other factories were added to the suits as third parties, including Gadiv, Carmel Olefins and authorities. During the course of the investigation of the suits, nine of the plaintiffs withdrew their suits and were removed. Since the suits involve claims of bodily damage, the plaintiffs are not required to quantify the total amount being claimed. As of the date of the preparation of the report, the quantified damages in the suit amount to NIS 137 million, together with an amount of NIS 3 million in respect of pending litigation which overlaps the main damages, for a total of NIS 140 million, in terms of their value on the date the suit was filed, plus linkage differentials and interest from the date of the illness or the date of the filing of the suit, as well as punitive damages and additional expenses such as treatments and third party assistance (a small part of which have not been quantified), attorney fees and expenses. Please note that these refer to the arithmetic sum of the quantified amounts in the statements of claim and not a risk assessment of the defendants, and certainly not the risk to which the Company, Gadiv and Carmel Olefins are exposed. As of the report date, these suits are in the evidentiary phase. In the first phase, the court deliberated on the causal relationship in the narrow sense of the term, i.e. the relationship of the materials claimed to have been in the fishing port and the alleged illnesses. We are dealing with a very complicated factual framework which lasted for dozens of years and in which more than a hundred litigants (plaintiffs, defendants and third parties) and with legal issues that are unprecedented, both from the standpoint of the body of the claim and regarding the issue of a breakdown of the liability between the defendants and the third parties. The defendants, including the Company, Gadiv, Carmel denied their responsibility for the damages of the plaintiffs and claimed, among other things, that the statute of limitations pertaining to the plaintiff's claim has already passed, that the materials stipulated in the claim were not discharged and/or the materials that were discharged were not carcinogenic and are not harmful to human health, and that in the event that the plaintiffs indeed contracted illnesses and that in the event that the water and riverbed of the Kishon
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River caused or contributed to their illnesses and in the event that the plaintiffs' illnesses derive from human acts of commission or omission (when all of the above has been denied), then the illnesses were caused by the negligence of the plaintiffs and/or by a breach of the requirements of the law on the part of the plaintiffs themselves. In addition, the defendants filed a joint notification to third parties against fifty different entities, including additional plants, employers, local counsels, and government bodies, most of which have filed defense motions and have denied responsibility for the damages sustained by the plaintiffs. The Company and Gadiv also sent third party notifications against insurance companies which over the years have issued various insurance policies, claiming that should the court find them responsible for the damages of the plaintiffs and should they have to pay compensation in respect of such responsibility, then the insurance companies will have to indemnify and/or compensate them. For their part, the insurance companies claim, among other things, that the policies expressly exclude bodily damages caused to third parties as a result of pollution; that such pollution is a continuous phenomenon and did not occur all of a sudden and, therefore, is not covered by the policies; that the acts of commission and omission of the Company and Gadiv are not covered by the policies, etc. In addition, the Company issued a third party notification against Gadot Biochemical Industries Ltd. ("Gadot"), pursuant to an agreement whereby the Company purchased Gadiv, Gadot's petrochemical division, from Gadot. Pursuant to the aforementioned notification, in the event that the court enters judgment against the Company and/or Gadiv in respect of acts of commission or omission that occurred in whole or in part in the petrochemical division of Gadot and/or in respect of any damages that were caused in whole or in part and/or that were uncovered in whole or in part in the period prior to January 31, 1994, then Gadot, by virtue of its commitments under the aforementioned agreement, will have to indemnify the Company and Gadiv in respect of any amounts they are required to pay to the plaintiffs. Notwithstanding the above, based on the opinion of legal counsel, in view of the complexity of the suits, from both a factual and a legal standpoint, the preliminary stage in which matters stand, and the many parties involved, the Company is unable to assess the risks involved and did not provide for these suits in its financial statements. B. During the period 2000 – 2007, suits were filed in the Haifa District Court against a series of defendants including the Company, Gadiv and Carmel Olefins by former soldiers (and their heirs and dependents). The plaintiffs claim that they contracted cancer and/or other illnesses as a result of contact with poisonous materials in the Kishon River and its environs. As of the date of the report, 19 of the plaintiffs withdrew their claims and they were removed. As of the date of the report, 93 plaintiffs remained with the court in respect of 91 soldiers, for an amount NS 276 million (nominal, as of the date of the filing of the claim) – the amount of the damages that was quantified (special/general damage), NIS 81 million pending claims (which partially overlap the special damage) and NIS 138 million in punitive damages (all amounts are as of the date the suit was filed). Since the suits involve claims of bodily damage, the plaintiffs are not required to accurately quantify the total amount being claimed. Additional principal damages, which were not quantified monetarily in the statements of claim, also include loss of future earnings, medical expenses, in some of the cases, loss of earnings in the lost years, etc., as well as interest and linkage differentials, attorney fees and expenses. Please note that these refer to the arithmetic sum of the quantified amounts in the statements of claim and not a risk assessment of the defendants, and certainly not the risk to which the Company, Gadiv and Carmel Olefins are exposed. The defendants filed third party notifications against dozens of factories and authorities, including the State of Israel. As at the reporting date, the suits of 76 plaintiffs are also conducted in proceedings similar to those in which the suits described in section a above are conducted, while with
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respect to the suits of another 17 plaintiffs, the court decided that the question of the estimated damages will first be clarified and only afterwards will the other issues in question be argued. The organization filed an appeal against the decision in the Haifa District Court and in the reporting period, a ruling was handed down, whereby the appeal was dismissed with the consent of all the parties, without the Company and Gadiv being required to bear any monetary or legal obligations with respect thereto and without this preventing the filing of another motion on the subject. These suits are in the preliminary stages of deliberations. Therefore, the factual details related to the plaintiffs and to the circumstances of the alleged exposure are for the most part unknown to the defendants and the third parties, including the Company, Gadiv and Carmel Olefins. We are dealing with a very complicated factual framework which lasted for dozens of years and in which more than a hundred litigants (plaintiffs, defendants and third parties) and with legal issues that are unprecedented, both from the standpoint of the body of the claim and regarding the issue of a breakdown of the liability between the defendants and the third parties. The defendants, including the Company, Gadiv and Carmel Olefins denied their liability to compensate the plaintiffs and claimed, among other things, that the statute of limitations pertaining to the claim of the soldiers has expired; the soldiers received payments and/or other benefits under the Law for the Handicapped (Annuities and Rehabilitation) – 1959 (integrated version) and/or under the Law for the Families of Soldiers who Fell in Battle (Annuities and Rehabilitation) – 1950 and, therefore, are not entitled to claim damages; the defendants did not commit any act of negligence and/or breach of their legal duties toward the soldiers; it was the fault of the soldiers and/or other people or entities that caused the alleged damages, if at all, and it was especially the fault of the State of Israel, including the defense establishment, and their negligence that caused the illnesses of the soldiers. The Company and Gadiv (which was added to the proceedings as a third party) also sent third and fourth party notifications to insurance companies which, over the years, issued insurance policies in their favor and which they claim will have to indemnify and/or compensate them in the event that the court finds them liable for the damages of the plaintiffs and they have to pay compensation in respect of such liability. The insurance companies filed defense motions and reiterated the claims they made in section 1.6.31.1 (a) above. In addition, the Company filed a third party notification against Gadot in respect of the claims mentioned in section 1.6.31.1 (a) above. Notwithstanding the above, based on the assessment of its legal counsel, in view of the complexity of the suits, from both a factual and legal standpoint, the preliminary stage in which matters stand, and the many parties involved, the Company is unable to assess the risks involved and did not provide for these suits in its financial statements. C. The Haifa Rowing Club filed a class action in the Haifa Magistrate's Court under the Prevention of Environmental Hazards Law (Civil Claims), 57521992 against a number of factories along the banks of the Kishon River. The claim is petitioning for an injunction to stop the flow of effluents into the Kishon, and an order to restore the river to it to its former state. Dozens of factories were included in the claim as third parties, including the Company, Gadiv and Carmel Olefins, as well as authorities, including the State of Israel. On March 29, 2007, the court summarily rejected the suit and allowed the authorities to exercise their discretion concerning granting permits for discharge of effluents into the Kishon, noting the practical steps taken by the authorities and the defendants to improve the condition of the Kishon and the considerable improvement in recent years in the quality and condition of the river’s water. The Society appealed the decision of the Haifa District Court and in the reporting perio, a ruling was handed down, whereby the appeal was dismissed, with the consent of all the parties, without the Company or Gadiv being required to bear any monetary or legal obligations with respect thereto and without this preventing the filing of another motion on the subject.
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D. The Company, together with 11 other parties, including Gadiv and Carmel Olefins, was sued by Israel Shipyards Ltd. The plaintiff claimed that its plants, located at the mouth of the river, had been damaged by the defendants’ polluting of the Kishon River. The lawsuit amounts to NIS 21 million (as of the date of filing - January 2004) and an undefined amount is claimed for future damages and compensation. As of the report date, the lawsuit is in the stage of pretrial and hearing of evidence in a case that is expected to commence in 2009. On March 18, 2008 the plaintiff and Carmel Olefins signed a settlement agreement according to which the lawsuit against Carmel Olefins will be dismissed and all proceedings relating exclusively to Carmel Olefins will be eliminated from the expert opinion on behalf of the plaintiff. For further details relating to the settlement and the risk assessment, see section 1.7.23.2 of the report 1.6.31.2 On November 9, 2004, a charge sheet was issued against the Company and the CEO of the Company for an alleged violation of the Law for Control of Prices of Goods and Services – 1996, with the State claiming that the Company sold low-sulfur diesel fuel at a price that exceeded the maximum price stipulated in the law. The Company claims that the price of the product was not under price control during the relevant period and that the price at which the Company sold the product to its customers was known to all parties, including those charged with setting the prices of products under control. As part of a plea bargain, an amended indictment was filed, which indictment included fewer charges against the Company than those included in the original indictment that was filed on November 9, 2004. In addition, the amended indictment did not include the CEO of the Company as a defendant. On January 6, 2008, the Company was convicted, on its own admission, of violating the Law for Control of Prices of Goods and Services – 1996 and was fined an amount of NIS 5 million. 1.6.31.3 In 2006, Sonol and Delek, two of the company's partners in Haifa Basic Oils Ltd. (“HBO”), filed suit against the Company in an amount of NIS 165 million and filed a petition to have the suit approved as a derivative claim of Haifa Basic Oils. The major claim of the plaintiffs is that the Company has been abusing its power and has not been acting in the best interests of Haifa Basic Oils. It has been confining the operations of the company and undermining its activities and development. According to the plaintiffs, the facility for the preparation of feedstocks, which is under the sole authority of the Company is an obsolete facility, is maintained on a very low level and has been suffering from recurring problems which seriously hamper the work of Haifa Basic Oils. It was also claimed that the Company does not supply the proper feedstock, neither in the quality nor the quantity needed for the operations of Haifa Basic Oils and over the years, the quality of the transferred feedstocks has declined significantly, contrary to the obligations of the Company. The claim does not point to any concrete and express commitment on the part of the Company to carry out the demands of the plaintiffs. However, it is claimed that the void of formal agreement, to the extent that it exists, should be filled by various legal tools. The plaintiffs requested that their suit be approved as a derivative suit, claiming that due to the equality between the two blocks in control of Haifa Basic Oils, Haifa Basic Oils cannot exhaust its rights against the Company. In its response, the Company claimed, among other things, that it never undertook to supply HBO with specific feedstocks of a quantity and composition that would maximize the profits of HBO and that it acts in this matter as a supplier which takes into consideration commercial criteria. The Company also claimed that, as opposed to what was claimed in the petition, HBO currently receives a much larger quantity of feedstocks than it received in the past, and that the quality of the feedstocks is of a customary level and as agreed upon, while HBO, as opposed to the past, refrains from paying for more suitable feedstock when it is available; and that the Company is not required, as a shareholder in HBO, to prefer the interests of HBO over its own interests. The Company further claimed that it is under no obligation, either contractual or by law, to upgrade at its
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own expense the facility for preparing feedstock for HBO. In addition, the Company claims that the damages being sued for are exaggerated and baseless. t the hearing that took place in court on the request to approve the suit as a derivative suit, it was decided that the board of directors of HBO would discuss the upgrading of the facility for the preparation of feedstock, and that the parties should submit their dispute to a bridging process. On May 27, 2007, the Company was notified that the board of directors of HBO decided to approve the investment in the upgrade of the feedstock preparation facility subject to an agreement with the Company for the supply of feedstocks over the long term, at prices to be agreed upon and at quantities required for the operation of the feedstock preparation facility at full output. The parties went to arbitration, which failed, and therefore the suit will be continued in court. In the reporting period, the Company notified the plaintiffs and the General Security Services that the prices of feedstocks and derivatives will be updated, as of the beginning of 2009. according to their real value and invited them to conduct fair negotiations for updating the prices in accordance with the market price. After extended disregard, the plaintiffs and the General Security Services denied the Company's right to update the prices, as aforesaid. In the Company’s assessment, based on advice from its legal counsel, it is more reasonable to assume that the petition to approve the suit as a derivative claim, insofar as it relates to a monetary suit against the Company relating to the past, will be rejected rather than accepted. 1.6.31.4 On March 26, 2005, two plaintiffs (the "Plaintiffs") filed suit with the Haifa District Court against the Company, Carmel Olefins, the CEO of the Company and the CEO of Carmel Olefins ("the Respondents"). The Plaintiffs filed a petition to have the suit approved as a class action under the Law for Class Action Suits – 2006 (the "Petition for Approval"). In the Petition for Approval, the Plaintiffs requested to represent a group of 30,000 residents of Kiryat Tivon and surrounding towns (Members of the Group). The plaintiffs claim that smoke emissions from the respondents that occurred on September 15, 2003 and on October 5, 2003 provided them and the Members of the Group with a basis for a claim under the Torts Ordinance (New Version) against the respondents, especially for negligence, breach of statutory obligation, and a nuisance to an individual, and such claims should be adjudicated as part of a class action suit. The plaintiffs claim that each member of the group should be compensated for non-monetary damages allegedly caused to him, in an amount of NIS 5,000. For purposes of the claim, the Plaintiffs set the total amount at NIS 150 million. As of the date of the report, a settlement agreement was submitted for court approval and the court issued instructions to move forward on the proceedings set out in the Law for Class Actions – 2006, to approve the settlement. As part of the settlement, if it is approved, the Company will invest in financing an educational program on an environmental issue, in an amount of NIS 650,000 (including legal fees). The procedure for approval of a settlement in a class action is set out in the Class Actions Law. As part of the settlement approval procedures, the Attorney General requested that an evaluator be appointed to examine all the aspects of the settlement and its applicability. The Company estimates, based on its legal counsel and its insurers' method of operating, that the suit is covered by an insurance policy (with the exception of a deductible) and the Company operates, in this matter, in conjunction with its insurers. For this suit, the Company made provisions in the amount of USD 200,000. 1.6.31.5 On October 28, 2008 Carmel Olefins was presented with a request to approve a class action pursuant to the Class Actions Law 5766-2006, filed on October 5, 2008 at the district court in Tel Aviv with respect to the matter noted in section 1.6.31.4 above and due to the removal of Carmel Olefins from the suit noted in section 1.6.31.4 above. For further details, see section 1.7.23.5 below. 1.6.31.6 In addition, the Company is a defendant in suits being handled by insurance companies which insured the company for the risks covered by the suits, except for a deductible amount. The amount of the total deductible in respect of these suits is immaterial to the Company.
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The companies record provisions in their accounting records in respect of suits which in the opinion of the managements of the companies, based on their legal counsels, have good chances of coming to fruition. The provisions are made on the basis of the estimated amounts that will have to be paid to settle the liabilities. 1.6.32 Business Strategy and Objectives Many energy companies in the modern world are integrated companies. This integration can be vertical: production of oil and gas, manufacture of fuel products, wholesale and retail marketing; or horizontal, exploiting synergies in the field of crude oil refining and the manufacturing of petrochemical products, manufacture of electricity. On November 6, 2007, the board of directors of the Company passed a strategic plan designed to achieve rapid growth and an increase in the competitive capability of the Company in the coming years, with a massive investment of approximately $1.1 billion in increasing the share of high added value products in the Company’s product mix as well as in the areas of environmental quality, safety and security and in enhancing operational reliability. 1.6.32.1 The vision of the Company as publicized by it is: To be a leading firm in the field of energy and petrochemicals – in Israel, regionally, and internationally. To be a green and environment-friendly company, making investments, performing current operations and training. To be an efficient company, profitable, growing, and generating returns for its shareholders. Ready to execute vigorous investment plans. 1.6.32.2 In the field of refining, the plan is designed to improve assets so as to maximize their value for the Company, even in periods in which margins decrease, by investing in existing assets and looking for opportunities around the globe. In the field of petrochemicals, the plan is designed to expand activity in Israel and abroad, through development and enhancement of the capabilities of existing assets; looking for expansion opportunities abroad; focusing on specialty products with high added value in order to moderate industrial volatility. In this context, on June 24, 2008, an agreement was signed between the Company and IPE according to which the Company would acquire the remaining 50% of IPE's Carmel Olefins shares against the allocation of 20.53% of the Company's shares and the sale by the Company to IPE of 12.39% of IPE's shares held by the Company for a consideration of USD 40 million. The agreement was contingent on compliance with a number of preconditions by December 31, 2008. The preconditions were not met by said date and therefore the transaction was not completed. Nonetheless, as the main considerations on which the Company's board of directors' approval of the transaction was based are still valid, the Company and IPE agreed to continue to cooperate with the aim of trying to complete the said transaction. The strategic plan is also designed to develop areas that are tangential to the present areas of Company operations: electricity production, international trade activity, and shipping of fuel and chemicals. Environmental protection is also a business interest of the Company and, accordingly, as part of the strategic plan, the Company intends on increasing production of products that improve environmental quality in contrast to products currently marketed in Israel today, and to invest in reducing the environmental impact of the Company's facilities. 1.6.32.3 The strategic plan will be implemented, inter alia, through an investment plan according to the following: 1.6.32.3.1 Accelerated investments in the area of refining ,which is the core business of the Company, mainly in increasing the complexity and efficiency of the Haifa Oil Refinery and in tangential areas, at an estimated amount of USD 850 million, of which an amount of USD 600 million is
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in respect of the expansion of the cracking capability of fuel products having a high added value, as well as identifying business opportunities outside of Israel. For further information relating to the establishment of a hydrocracker for an investment of USD 670 million see section 1.6.15.5 above. In 2008, the Company invested in the execution of its strategic plan in the refinery segment an amount of USD 117 million, primarily in upgrading the Company's large crude refining facility, as stipulated in section 1.6.15.4 to this report. 1.6.32.3.2 Expansion of the Company’s petrochemical activity, by focusing on high added value products, in Israel and abroad; 1.6.32.3.3 Expansion of commercial and logistics operations relating to oil products; 1.6.32.3.4 Investment of estimated USD 270 million in environmental quality, safety and security and in improving operational reliability. In 2008, the Company invested in the execution of its strategic plan in these areas and amount of approximately USD 50 million. 1.6.32.3.5 In view of the global economic crisis, the board of directors instructed the Company management to take the necessary steps to lower the costs of establishing the hydrocracker as stated in section 1.6.32.3 above. Furthermore, the board of directors requested to re-examine and reschedule the balance of the financial investments as set forth in this section. 1.6.32.4 Furthermore, the board of directors of the Company resolved to update the organizational structure of the Company to comply with and support the new strategic plan, with a breakdown into three segments: refining, trade and petrochemicals. as set forth in section 1.2 above. As of the first quarter of 2008 the Company acts according to this blueprint. 1.6.32.5 The board of directors instructed management to formulate plans and projects as part of the strategic plan and to present them for approval to the board when each one matures, including the means to finance such projects. 1.6.33 Forecast for developments in the coming year 1.6.33.1 As part of the implementation of the Company's strategic plan (see section 1.6.32 above), the board of directors decided to approve investments in the areas of refining, environmental quality and safety as set out below, and the Company expects to commence execution of the investments during the coming year. 1.6.33.1.1 An investment of USD 66 million in a project for the replacement of the diesel desulfurization facility and the conversion of the HVGO desulferization facility from heavy vacuum gas oil to moderate catalytic hydrodesulfurization, in order to increase the quantity of diesel produced by the Haifa refinery, at the expense of HVGO, and to crack part of the quantity of HVGO produced by the Haifa refinery. The Company estimates that the interim phase of the project is expected to end during the second quarter of 2009 and the completion of the entire project is expected for the second half of 2010. 1.6.33.2 In addition, the board of directors approved additional investments integrated with its strategic plan, as follows: 1.6.33.2.1 An investment of USD 50 million in a plan to upgrade the large crude refining facility at the Haifa refinery ("MZG"), which will allow the Company to expand the range of crude oil products (from the lightest to the heaviest) that can be refined at its large refining facility. This is expected to increase the rate of utilization of the facility. The Company estimates that the upgrading project will be completed by the middle of 2009. 1.6.33.2.2 Investments of USD 104 million in respect of environmental issues, security, safety and enhancement of operational reliability, including, among other things, infrastructure and preparations for the absorption of natural gas at the Haifa refinery, a system for the reduction of particle emissions, a system for the reduction of nitric oxides from the refinery, expansion of the exhaustion capability of Mercaptans and upgrading the oven protection. 1.6.33.3 The Company's estimations regarding the expected times for project completion and the scope of the investments constitute forward looking information. These estimations are based on plans prepared by the Company’s management and on information received
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from independent professional parties. There is no certainty that these assessments will come to fruition, since they involve very complex projects, the execution of which is contingent upon, among other things, factors that are outside of the Company and on the receipt of regulatory approvals. 1.6.34 Information pertaining to an extraordinary change in the Company's business The Company is unaware of any extraordinary changes in its business, including during the course of its ordinary operations, during the period following the balance sheet date through the publication of this report. For further information relating to significant events during the reporting period after the balance sheet date, see Note 34 to the financial statements. 1.6.35 Events or matters deviating from the normal business of the Company To the best of the Company's knowledge there are on events or matters that were not covered in sections 1.6.1 through 1.6.34 of the report, that deviate from the normal course of the Company's business as to their quality, scope or possible outcome, and which have or will have a material impact on the corporation.
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Part C – Petrochemical activity
Pursuant to a Board of Directors decision from November 6, 2007 concerning a strategic plan for the Company, at which it was decided to restructure the Company and create new business segments that would correspond with the aforesaid strategic plan, from 2008 the petrochemical area of operations and the aromatic area of operations were unified to form a single area of operations – the petrochemical area of operations (for further details about the strategic plan, see par. 1.6.3.2 above). Accordingly, the petrochemical area of operations is divided into polymer activity, in which the Company, through Carmel Olefins produces raw materials for the plastics industry (as detailed at length in section 1.7 below) and aromatic activity, in which the Company, through Gadiv, produces aromatic substances that are used as raw materials for producing other products (as detailed at length in section 1.8 below).
1.7 Polymer activity 1.7.1 General information 27 1.7.1.1 General As mentioned above, the Company operates in the polymers industry through its holdings in Carmel Olefins. Carmel Olefins was established in 1988 under the Companies Ordinance, 5743-1983 [New Version] as a private, limited share company, and by virtue of an agreement from July 20, 1988 between the Company and IPE. From the date of its incorporation and up to the date of this report, the shareholders of Carmel Olefins are IPE and the Company, in equal parts. Series A debentures of Carmel Olefins were registered for trade according to a prospectus from December 24, 2008, on the Tel Aviv Stock Exchange Ltd., and accordingly, from this date, Carmel Olefins is a reporting corporation, as this term implies in the Securities Law, 5728-1968. A t the Reporting Date, the Company holds 12.29% of IPE's issued share capital. According to an agreement between the Company and IPE from February 26, 2000, as long as the Company does not sell more than 10% of its shares in IPE (as they were on the date of the parties signing the agreement) and so long as Modgal Industries (99) Ltd., the controlling shareholder of IPE, holds at least 40% of the shares in IPE,28 the parties shall vote in any election or appointment of directors of IPE such that in any event, one member of the board of directors, to be determined by the Company, shall be appointed, and such director may be replaced by another director determined by the Company, whenever the Company so resolves. A general meeting to appoint or elect a director, as aforementioned, shall be convened immediately upon the request of either party. At the Reporting Date, Carmel Olefins operates in the petrochemical industry and manufactures and markets polymers (mainly low-density polyethylene29 and polypropylene30 )
27 The financial data in the description of the polymer area of operations that is attributed to Carmel Olefins, reflect all Carmel Olefins' operations, while the Company's relative share of Carmel Olefins is 50%. 28 At the reporting date, Modgal Industries (99) Ltd., as far as the Company is aware, holds 60.91% of IPE's share capital. 29 Polyethylene – a polymer that belongs to the thermoplastic group of materials. Polyethylene is created through the polymerization of ethylene, and it can be polymerized in many diverse ways, each of which creates polyethylene with different properties. There are several types of polyethylene (low-density polyethylene, high-density polyethylene, and linear polyethylene), differentiated by their level of density which directly affects the properties of the final material. 30 Polypropylene – a polymer that belongs to the thermoplastic group of materials. It is used for a broad range of applications, including: packaging, textiles, office equipment, plastic parts and different types of containers, laboratory equipment, and more. The process of manufacturing polypropylene is based on the polymerization of the monomer propylene.
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("the Carmel Olefins Products" or "products in this area of activity"), that are used principally as raw materials in the plastics industry. Carmel also manufactures monomers (ethylene31 and propylene32 ) used as raw materials for the manufacture of polymers. In April 2008, Carmel Olefins completed the acquisition, through a wholly owned company, of 49% of the shares of a company registered in Holland that produces and markets polypropylene (for details see par. 1.7.1.2.2 below). Carmel Olefins is also engaged, through one of its subsidiaries, in the importing and marketing of other polymers that it does not manufacture, such as linear polyethylene and high-density polyethylene. Where necessary and through a subsidiary, Carmel Olefins also imports, low-density polyethylene and polypropylene to supplement shortages in its own production. Imported products account for 5% of the volume of Carmel Olefin's sales, taken as a multi-year average. In 2007, sales of imported products accounted for 4% of Carmel Olefins sales, due to the introduction of the expansion plan (as defined in par. 1.7.1.2.1 below) and the acquisition of a subsidiary in Holland (as detailed in par. 1.7.1.2.2 below). In 2008, the sale of imported products accounted for 0.2% of Carmel Olefins sales. Carmel Olefins products are marketed in the domestic market through its sales offices. For sales outside Israel, see par. 1.7.1.5.4 below. 1.7.1.2 Sale, acquisition or transfer of assets on a significant scale during the normal course of business 1.7.1.2.1 The Expansion Plan (A) During the period 2004-2007, Carmel Olefins implemented a plan to substantially expand production capacity for polypropylene by erecting plants to produce propylene ("OCU plant") and polypropylene at an overall investment of USD 350 million ("Expansion Plan"), excluding discounting the credit costs. On July 4, 2007, the new plants erected as part of the Expansion Plan became operational. (B) The purpose of the Expansion Plan was to significantly increase the existing production capacity for polypropylene, enabling Carmel Olefins to meet demand for this product in the domestic and the global market and thus enhance its position. (C) Following the operation of the plants that were erected as part of the Expansion Plan, the output of polypropylene increased. For further details, see par. 1.7.1.5.6 below. 1.7.1.2.2 Acquisition of Domo On January 23, 2008, a wholly owned subsidiary of Carmel Olefins entered into an agreement with Domo Chemicals N.V. ("Domo Chemicals"), to acquire 4% of Domo's shares ("Domo Agreement"). At the same time, the subsidiary was given a Call option to acquire the remainder of Domo's shares and Domo Chemicals was given a Put option to sell the remainder of Domo's shares. As far as the Company is aware, Domo Chemicals is registered in Belgium and is controlled by Domo N.V. As far as the Company is aware, Domo N.V. is registered in Belgium and is controlled (indirectly) by the family of Mr. Jan De Clark. For further details concerning the Domo Agreement, see par. 1.7.22.9 below. 1.7.1.3 Investments in the corporation's equity and transactions in its shares On June 22, 2007, Carmel Olefins allotted to IPE and the Company, in equal parts, for no consideration, 400,000 ordinary shares each at par value NIS 10, that is: 200,000 shares each ("the allotted shares"). The allotted shares account for 1.3% of Carmel Olefins' issued share capital.
31 Ethylene – is a simple organic compound. Ethylene is used in the chemicals industry as a starting material for numerous compounds such as plastics. Connecting numerous units of ethylene gives the polymer polyethylene, the most common plastic in the world. 32 Propylene - a colorless, odorless gas at room temperature. Propylene is a raw material used in the petrochemical industry, and it is used principally as a monomer for the production of polypropylene.
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The allotted shares were allocated for the purpose of complying with the conditions of approval as an Approved Enterprise under the Encouragement of Capital Investments Law, 5719-1959. For details about an agreement reached between the Company and IPE to acquire 50% of Carmel Olefins' shares held by IPE, and the expiry of the said agreement, see par. 1.3.1.5 to the Report. 1.7.1.4 Distribution of dividends On June 21, 2007, Carmel Olefins distributed a cash dividend to its shareholders in the amount of NIS 110 million (USD 26 million. External restrictions apply to Carmel Olefins that affected its ability to distribute a dividend over the last two years, and may even affect its ability to distribute a dividend in the future. On the subject of these restrictions, that apply on account of agreements between Carmel Olefins and banking corporations, see par. 1.7.17.3.2 below. Concerning the said restrictions that apply on account of the trust deed and Carmel's commitment towards the investors who purchased the Series A debentures, see par. 1.7.17.6 to the Report. On March 15, 2004, the Company, IPE and Carmel Olefins signed an agreement ("2004 agreement") arranging the principles of the Company's fixed dividend policy as follows (for further details regarding the 2004 agreement, see par. 1.7.17.5.6 to the Report): (1) Carmel Olefins will distribute the balance of the distributable cash flow to its shareholders each year as follows, and without derogating from the binding provisions of the law regarding all aspects of the distribution of dividends. "Balance of the distributable cash flow" – the cash flow less the self-funded investments. "Cash flow" – net cash flow stemming from Carmel Olefin's on-going operations in a particular fiscal year. "Self-funded investment" – part of the volume of investment in fixed assets, which according to lenders' restrictions to be defined or which were defined between Carmel Olefins and its lenders, cannot be financed using foreign capital or in which the lenders refused to participate. (2) Carmel Olefins will make every effort to renew the loans that were taken, under reasonable conditions, in the view of Carmel's Board of Directors', under the circumstances at that time. If Carmel Olefins is unable to renew the loans that were taken, and the cash flow from financing activity, excluding the dividend distribution from Carmel Olefins to its shareholders in a particular year is negative, the negative balance will be offset against the balance of the distributable cash flow. (3) If, based on Carmel Olefin's budget, the cash flow for the coming year is expected to be negative, the negative balance will be offset against this year's positive distributable balance. (4) The distribution will take place, where possible, in the most effective, economical manner with respect to the tax liability of Carmel Olefin's shareholders. (5) Notwithstanding the aforementioned, the dividend distribution shall be limited to an amount in respect of which the overall tax rate is no more than 15%. Should the tax rate in respect of a dividend distributed from income from an approved enterprise increase, the aforesaid restriction shall be amended in accordance with the new tax rate prescribed, provided that the overall tax rate is no more than 20% (see par. 1.7.22.4 below). (6) Carmel Olefins will distribute a dividend pursuant to the principles prescribed in this section, as soon as the annual financial statements for a particular fiscal year are approved, with respect to that fiscal year, and under no circumstances any later than the end of the first quarter following the end of that fiscal year.
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(7) Notwithstanding that mentioned above in this section, Carmel will distribute to its shareholders each year, a dividend of at least 35% of the annual profit presented in its audited financial statements for the year in respect of which the dividend is distributed ("the annual profit"), and no more than 70% of the annual profit. 1.7.1.5 Structure of polymer operations 1.7.1.5.1 As noted above, Carmel Olefin's products are used as raw material in the plastics industry. These products are considered to be commodities, purchased at more or less the same price from all manufacturers. Feedstock prices, naphtha33 in particular, as well as the products manufactured at Carmel Olefins' plants, fluctuate and are affected, in part, by the cyclical nature of supply and demand worldwide. The increase in demand for plastic products worldwide is affected by developments in the standard of living and changes in the economic situation. In contrast, changes in supply are dependent on the timing of operating new plants. The dynamics between demand and supply create a ten-year cycle, on average, of boom and slump in demand and in the prices of Carmel Olefins' products. There are hundreds of plastics plants in Israel that purchase the products they require from Carmel Olefins and from import. The prices at which the products are purchased in Israel and overseas are derived, as aforementioned, from the prices of these products on the global market. In the wake of the global financial crisis, there has been a general slowdown in the commodities' markets, including that of feedstock (naphtha and LPG), and in Carmel Olefins products. During the fourth quarter of 2008, there was a marked drop in the feedstock price and in the price of the polymers sold by Carmel Olefins. For example, according to figures published by ICIS (an international organization that provides information and data about petrochemical products (www.icis.com/StaticPages/AboutUs.htm), at the end of the third quarter the price of polypropylene was USD 671 per ton, and at the end of 2008, the price of polypropylene had dropped to USD 870 per ton. Prices of Carmel Olefins' products fell against the backdrop of sharp declines in the price of the feedstock that Carmel uses to manufacture its products. For example, according to information published by Platts (an international organization that provides information and data about the prices of petrochemical products, for details see www.platts.com), at the end of the third quarter, the price of naphtha was USD754 per ton, and at the end of 2008 the price of naphtha had fallen to USD 251 per ton. These drastic reductions in the prices of Carmel Olefins' products and feedstock had a double impact on Carmel Olefins, and in turn on the Company. First, the market value of the inventory held by Carmel Olefins fell substantially. Second, Carmel Olefins suffered further loss due to the time gap between the date on which the price of the feedstock was set and the date on which the sale price of Carmel's products that are manufactured from the feedstock was fixed. This damage is the direct result of an exceptional drop in prices that occurred within a short period in product prices and the price of the feedstock. 1.7.1.5.2 Through IPE, the Antitrust Commissioner declared Carmel Olefins a monopoly in the supply of low-density polyethylene (see par. 1.7.20.8 below). Until February 1, 2007, the price of low-density polyethylene was regulated under the Control of Goods and Services Prices (Price of polyethylene) Order, 5763-2003 ("Polyethylene Control Order"). On December 1, 2007, the Polyethylene Control Order was abolished. As at January 11, 2009 there was also an 8% import tax on polyethylene from countries with which there are no trade agreements (during the period from November 29, 2006 and up to
33 Naphtha – one of the refined products of crude oil which at room temperature and atmospheric pressure is in a liquid state. It is used in industry as a raw material for producing ethylene, propylene and butylene.
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December 31, 2007, the customs rate was 4%). As of the same date, the aforesaid import tax was cancelled. 1.7.1.5.3 Carmel Olefins has three main groups of plants: the monomer group of plants (cracker and OCU plant which was added as part of the Expansion Plan), the polyethylene group of plants, and the polypropylene group of plants (which includes a polypropylene plant that was added as part of the Expansion Plan, as specified in par. 1.7.1.2.1 above) (together: "Carmel Olefins plants"). All the Carmel Olefins plants operate as a single concern, and are connected to one another directly by pipes and receive joint services such as electricity, steam, water, storage and other services from a central service system, partially backed up by the Company's service framework. The cracker is fed principally by naphtha purchased from the Company. It produces ethylene, propylene and other by products. Ethylene is the raw material used by the polyethylene plant as well as by the OCU plant, which mainly produces propylene. The propylene and quantities of ethylene are the feedstock for the polypropylene plants. The ethylene and propylene that are fed into designated plants become polyethylene and polypropylene following a catalytic process.34 The feedstock required to produce Carmel Olefins' products are purchased from the Company 35and from ORA, and the fuel required to heat the boilers is purchased from the Company. Domo has a plant that produces polypropylene to which propylene is piped continuously according to a long-term agreement that was signed in 2001 between Domo and Basell Polyolefins Company N.V. For further details, see par. 17.15 below. In 2007, approximately 60% of Carmel Olefin's products were sold in Israel to hundreds of plants manufacturing plastic products. The rest of the quantity was sold mainly to Europe. The output produced by the monomer group of plants is used as raw material for the polyethylene and polypropylene group of plants. In 2008, approximately 35% of the group's products was sold in Israel and 65% was sold outside Israel (including Domo. For further details about Domo, see par. 1.7.22.9 above). 1.7.1.5.4 The products are marketed in the domestic market through Carmel Olefins' marketing division. Sales outside Israel are handled from Carmel Olefins' offices in Israel and Holland as well as through local agents in each of the countries in which Carmel Olefins has substantial operations. In England, Carmel Olefins markets its products through the subsidiary Carmel Olefins (UK) Ltd. In addition to production, Carmel Olefins imports and markets related products that it does not manufacture itself, and utilizes Carmel Olefins' existing infrastructure to market them. 1.7.1.5.5 The technology for the production of ethylene and polymers is developing slowly, and newly erected facilities for manufacturing ethylene and polymers are not substantially different, in terms of the production process, from the plants built in the past Most of the change in the new plants is increased production capacity which provides economies of scale, and in more efficient equipment installed in the plants. Nevertheless, production economics is not only measured by production capacity and efficiency of the equipment, but also by the variety of products manufactured, the availability of raw materials and the availability of markets near the production plants. 1.7.1.5.6 Further to that mentioned in par. 1.7.1.2.1 above, following completion of the Expansion Plan, the annual production capacity of polypropylene at Carmel Olefins' plants increased by 250,000 tons to an overall, potential production capacity of 450,000 tons of polypropylene a year. At the date of this report, Carmel Olefins produces an average of 85% of its maximum production capacity. Most of the quantity of propylene required as raw material for the
34 Catalytic process – a process integrating a catalyst as a substance capable of speeding up chemical reactions. 35 Until June 2007, Carmel Olefins' monomer plants were fed with naphtha purchased from the Company through fuel marketing companies.
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production of polypropylene at the new plant which was set up as part of the Expansion Plan, approximately 180,000 tons a year, is produced at the OCU plant which was erected in close proximity to Carmel Olefins' cracker plant. The rest of the propylene required to produce polypropylene at the new plant is supplied by the Company and ORA, as well as from the increased production capacity, as part of the Expansion Plan, at the cracker that existed before implementation of the Expansion Plan. The Expansion Plan also included an expansion of infrastructures, for example: the electricity system, water cooling towers, upgrading of the sewage treatment plant, flame, etc. As part of the Expansion Plan, Carmel Olefins undertook to operate in accordance with the requirements and conditions of the Ministry of Environmental Protection on subjects such as air quality, particle emissions, the transportation of hazardous materials, and sewage treatment. 1.7.1.5.7 Following is a flow chart of the production process:
Industry תעשייתPlastic כרמל .Olefins Ltd אולפינים בע"מCarmel בתי Refineries הזיקוקThe הפלסטיק Monomers plant Polymers plant
פוליאתילן Ethylene מתקניNaphtha Polyetyhy plant פוליאתילןlene מתקן LPG" Crude Cracker Ethylene Plastic הפיצוח נפט Propylene Polypropylene Polypropylene Products מתקןoil plant OCU Unit מוצרי C4 C4 OCU Plant פלסטיק Propylene גולמי
Polypropylene Propylene Polypropylene מתקן plant מתקן
פוליפרופילן Propylene
Before Expansion Project After Expansion Project
1.7.1.6 Legislative and standards-related restrictions that apply to the polymer operations The Company's polymer operations are governed by laws, regulations and various orders pertaining to price control, the licensing of businesses, antitrust, environmental and safety regulations. Following are the main points of the relevant laws that apply to Carmel Olefins' operations: Prevention of Hazards Law, 5721-1961; Business Licensing Law, 5729-1968; Antitrust Law, 5748-1988; Planning and Building Law, 5725-1965; the Dangerous Substances Law, 5743-1993; Prevention of Land-Originating Sea Pollution Law, 5748-1998; Control of Goods and Services Prices Law, 5756-1996; the Clean Air Law, 5768-2008. Moreover, various regulations, orders and provisions by virtue of these laws also apply. Various laws pertaining to environmental protection and safety also apply to Domo's activity. For details concerning restrictions and supervision of this area of activity, see par. 1.7.20 of the Report. 1.7.1.7 Changes in volume of the operations and in profit for this area of activity
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The expansion of operations depends on the general growth of industry in Israel and worldwide. Factors such as: GDP, private consumption, and output in the agricultural, vehicle, construction and plastics industries affect sales and profit in this area of activity. Based on a report prepared by Chemical Market Associates Inc. ("CMAI"36), in September 2008, global demand for polymers manufactured by Carmel Olefins (low-density polyethylene and polypropylene) increased by 2%-6% annually over the last five years, according to the different categories, and in 2008, it amounted to 65 million tons a year. According to CMAI's forecasts in this report, long-term demand in the global polymers market during the period 2008-2013 is expected to increase by 2.9% - 5.6%. It is worth noting that this is the forecast of an external entity and naturally there is no certainty that it will materialize. The price of the feedstock forms a material component of the production costs in the polymers industry (for details see graph of behavior of naphtha prices in recent years, par. 1.7.7 of the report). Consequently, investments in new polymer production plants are made mainly in countries where cheap feedstock is readily available. 1.7.1.8 Developments in the polymer operations markets In the developed countries' markets, demand expands and is influenced by economic developments (GDP) in those countries. In the developing countries, market demand is influenced by the extent of penetration of relevant products to these countries, where the level of consumption has not yet reached that of the developed countries. In general, the increase in demand for plastic products worldwide is affected by developments in the standard of living and changes in the economic situation. Plastic products are a cheap, user-friendly and high-quality substitute in many cases replacing the use of wood, aluminum, glass, paper, fabric, other types of plastic and more. In contrast, changes in supply depend largely on the timing of the operation of new production plants worldwide. Carmel Olefins believes that due to the global crisis, demand has shrunk and there is now a supply surplus. Carmel Olefins estimates that some of the producers around the world will have to cut back production and postpone investments in new plants, particularly in those areas where there is a surplus of production capacity. This is forward-looking information. These assumptions stem principally from the uncertainty of the overall outcome and impact of the economic crisis and to the manner and intensity of the response of polymer producers to the crisis.
1.7.1.9 Technology changes that may significantly affect polymer activity 1.7.1.9.1 The polypropylene production technology used by Carmel Olefins is relatively new and the new plant set up as part of the Expansion Plan is an up-to-date development of this technology that has recently been introduced. Using this new technology, new improved types of polypropylene can be manufactured that cannot be produced using the previous technology. This plant is similar in size to the new plants currently being set up in other countries. As far as Carmel Olefins is aware, the new polypropylene production plant that was set up as part of the Expansion Plan is one of the most advanced plants of its type in the world. The manufacture of polypropylene by Domo is based on BASF's Novolene technology. This technology is accepted worldwide and facilitates the production of types of polypropylene that are high quality and meet international standards. 1.7.1.9.2 The technology for producing polyethylene has not changed significantly in recent years, although new plants being erected in different parts of the world are fitted with different
36 For details about CMAI, see: www.cmaiglobal.com
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reactors from those present at Carmel Olefins, and their output is higher than that of Carmel Olefins. The propylene production technology used at the OCU plant is innovative and has been in operation for several years in various countries, including the US and Japan. It is based on a process called metathesis (the OCU plant was successfully operated as part of the Expansion Plan). Contrary to the traditional technology, in which propylene is produced by cracking naphtha and LPG,37 in this technology propylene is produced from ethylene and components from the flow of C4,38 which is a by-product from the monomer plants and the Company's catalytic cracker plant (FCC). In this way, the new technology facilitates maximum and efficient utilization of the products and by-products of the refineries and petrochemical industry. 1.7.1.9.3 The process of manufacturing ethylene has not changed significantly for many years. Development has mainly been an increase in the production capacity of new facilities compared with existing ones. Before implementing the Expansion Plan, the Carmel Olefins cracker was relatively old, although much of the equipment was replaced with newer, more efficient equipment during the Expansion Plan and within the framework of a comprehensive investment to prolong the life of the facility. 1.7.1.10 Critical factors for success in the polymers area of operations The critical factors for success in the manufacture of Carmel Olefins' products stem from its ability to operate the production facilities at full output for long periods of time with minimum down time, the availability of raw materials as well as the presence of streamlined production facilities and advanced technologies. The critical factors for success in the sale of Carmel Olefins' products stem from the economic situation in Israel and worldwide, from the demand for Carmel Olefins' products, the presence of a developed domestic market, reliability of supply, quality of the supplied products, the technical support that customers receive, as well as the holding of an available supply of products at Carmel Olefins' plant, enabling customers in the domestic market to keep low levels of operating inventory at their own plants. 1.7.1.11 Changes in the network of suppliers and raw materials The manufacturing companies worldwide realize that the availability of raw materials is critical to competitive ability. New plants around the world are therefore erected in close proximity to raw materials' sources. From this perspective, Carmel Olefins is well placed. Most of the raw materials for manufacturing polymers are produced at Carmel Olefins' monomer facilities, while most of the naphtha required for their operation is piped directly from the Company's plants located nearby. Supply is extremely reliable and Carmel Olefins does not anticipate any significant changes in coming years due to a long-term supply agreement that was revised as part of the 2004 agreement (see par. 1.7.22.3 below). In June 2006, the Company assigned to ORA part of its commitments and rights in connection with the supply of feedstock to Carmel Olefins, from the time of operating the plants that were set up as part of the Expansion Plan.
37 LPG – liquefied petroleum gas, also known as cooking gas. A mixture of hydrocarbon gases used for heating purposes and automotive fuel. Commercial mixtures of LPG are varied and include mixtures in which the main component is propane, mixtures in which the main component is butane, and mixtures with similar percentages of propane and butane. 38 C4 – a fraction of LPG which contains butane and isobutane, from the alkane family that are used mainly as a source of energy for heating and automotive fuel. C4 fraction also contains non-saturated hydrocarbons, butane-1 and butane-2 (olefins) that are used principally as the raw materials in chemical processes such as metathesis to produce propylene.
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Regarding Domo's agreement with Basell Polyolefins N.V. for the supply of propylene, see par. 1.7.15 below). 1.7.1.12 Principal entry barriers to the polymer area of operation The main entry barriers to the business of polymer production are the availability of feedstock, the amount of capital required to erect new plants, and the relatively long time period required to erect a new plant. 1.7.1.13 Substitutes for polymer products Polymers are convenient and cheap substitutes for wood, glass, aluminum, expensive plastics, etc. . The Company’s believes that the use of polymers in general, and of polypropylene in particular, will continue to be used as a substitute for these and other materials for many years. This is forward-looking information. The view that polymers will continue to replace numerous uses is based mainly on the price differences between polymers and the products they replace. If polymers stop replacing these products, the polymers market will grow at a different rate than currently anticipated.
1.7.1.14 Structure of competition in the polymer area of operations The polymer market exhibits behavior similar to that of the commodities market and it therefore follows that competition in this market relates mainly to price, and to a lesser extent to other advantages such as quality, customer service, and the like. For further details, see: par. 1.7.7 below. As Israel's sole producer of polyethylene and polypropylene, Carmel Olefins enjoys a competitive advantage in Israel over importers of similar products. This is reflected in a high level of accessibility and close physical proximity to customers, in available supply that allows customers to keep low levels of operating inventory on their own premises and to save on expenses associated with holding inventory, as well as the ability to provide customers with hands-on technical assistance due to its proximity to these customers. In contrast with its advantages in the domestic market, Carmel Olefins faces relative disadvantages in the international markets due to its limited production capacity and distance from target markets. The Domo share acquisition agreement (see par. 1.7.1.2.2 to the Report) should help eliminate these relative disadvantages to some extent. 1.7.2 Principal products in this area of operations Carmel Olefins manufactures and markets low-density polyethylene and polypropylene that form the raw material for the plastics industry. These products are sold in sacks on palettes or in bulk in highway tankers. Polypropylene is made from propylene gas, and its main use is in engineering, for making consumables (such as diapers, toys, bottles, containers, household plumbing, tool boxes), home and garden storage sheds, garden furniture, fibers and threads for making carpets, for use in the vehicle industry (such as bumpers, carpets, upholstery, dashboards), and substitutes for substances such as aluminum, wood, glass and other kinds of plastics Polyethylene is made from ethylene gas, and its main use is for agriculture (such as sheeting used for greenhouses), for making flexible and hard packaging (such as bags and bottles), insulation products and household implements Carmel Olefins' sales are divided between sales in Israel and those outside Israel (mainly to Europe). Until the new plants became operational, approximately 70% of sales were to the Israeli market. In 2007, approximately 60% of Carmel Olefins products were sold in Israel to hundreds of plants manufacturing plastic products. The rest of the quantity was exported, mainly to Europe. Output from the monomer group of plants is used as raw material for the polyethylene and polypropylene group of plants. In 2008, approximately 35% of Carmel Olefins' products were sold in Israel and 65% were sold outside Israel (including sales by Domo).
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The following table details the breakdown of sales of Carmel Olefins' products by principal product groups (in thousands of tons): Product 2008 2007 Polyethylene 150 172 Polypropylene 440(1) 248 (1) The increase in sales in 2008 stems from the acquisition of Domo and an increase in the quantities produced. 1.7.3 Breakdown of revenues and profitability of products At the reporting date there is no single polymer product that accounts for more than 10% of the company's total consolidated revenues. The costs of manufacturing the polymers consist of the costs of the raw materials (monomer), other variable expenses (conversion, chemicals and packaging), and fixed costs (labor, depreciation, maintenance, etc.). The raw material component is the most dominant and accounts for 80-85% of the production cost. As the production process for this group is continuous in which all the products are manufactured from raw materials in shared processes that cannot be attributed to the final products (polyethylene, polypropylene), it is impossible to allocated cost precisely by type of product. 1.7.4 Customers 1.7.4.1 General Carmel Olefins' customers are mainly plastics factories that purchase the company's products, which are used to manufacture various plastics products. Carmel Olefins has a customer base of approximately 300 customers in Israel and 400 customers overseas, mainly in Europe. Most of these customers, both in Israel and Europe, are regular customers that purchase polymers from Carmel Olefins on a regular basis. 1.7.4.2 Carmel Olefins' agreements with its customers in the domestic market are generally master agreements for periods of one year, which set out a formula for calculating the price paid by the customer for the products that it purchases. Customers place their orders, usually on a daily basis, based on these master agreements. At the reporting date, Carmel Olefins has no single customer that accounts for more than 10% of the Company's consolidated sales, and Carmel Olefins is not dependent on any individual customer. 1.7.4.3 The following table details the breakdown of revenues from the sale of polymer products in Israel and overseas, and their rate of Carmel Olefins total revenues (in thousands of dollars): 2008 2007 Revenues In % Revenues In % In Israel 331,203 35% 397,774 58% Outside Israel 619,182 65% 287,324 42% Total 950,385 100% 685,098 100%
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1.7.4.4 The following table details the rates of profit from the sale of polymers in Israel and overseas for the years 2007 through 2008 (in thousands of USD):
2008 2007 Israeli Market Israeli Market market outside Israel market outside Israel Amount Amount Amount Amount USD thousands USD thousands USD thousands USD thousands Sales of polymers 1 313,234 19,182 357,417 287,324 Cost of sales 2 326,831 682,788 309,002 242,520 Gross profit (loss) (13,597) (63,606) 48,415 44,804 Rate of profit (loss) 3 (4.3%) (10.3%) 13.5% 15.6% Transportation and agents' costs 4 2,711 22,596 1,994 13,501 Gross profit (loss) less identified costs (16,308) (86,202) 46,421 31,303 Return on sales 3 (5.2%) (13.9%) 13% 10.9% Quantity of sales (in tons)5 190,686 398,666 235,349 184,713
(1) The sales revenues presented above are for the sale of polymers manufactured by Carmel Olefins and do not include revenues from the sale of by-products, imported products, and other revenues. Export prices are similar to those of the domestic market, where the main difference is the result of transportation costs and identified marketing expenses. An increase in sales outside Israel is not expected to result in a higher return on sales as the export return rates after transportation and agents' costs are lower than those of the domestic market. (2) The cost of sales was presented according to a volume ratio. (3) The changes in gross profit, and as a consequence in the return on sales, are mainly affected by the margin between revenues from the sale of polymers by Carmel Olefins and the cost of the feedstock (naphtha and LPG) that Carmel Olefins purchases. (4) Transportation costs and agents' fees are not uniform in different countries and range from USD 20-80 / ton. There was no allocation by marketing, sales, general and administrative expenses. (5) As mentioned above, following the operation of the new plants that were erected as part of the Expansion Plan and the acquisition of Domo, sales directed to exports as a percentage of Carmel Olefins' total revenues has increased. 1.7.4.5 In September 2007, in December 2007 and in March 2008, Carmel Olefins entered into agreements with a banking corporation (in this section – "the Bank") to sell certain of the debts of its customers. These agreements stipulate that the liabilities reflected in invoices to be received by the Bank for discounting are assigned from Carmel Olefins to the Bank pursuant to the Assignment of Debt Law, 5729-1969. The assignment is absolute, final, and complete, and unconditional, by way of the sale. The assignment is unconditional and cannot be changed or cancelled without the prior written consent of the bank. Customers' debts that were sold correct at December 31, 2008 totaled USD 17 million. 1.7.5 Marketing and distribution 1.7.5.1 Marketing in Israel Sales in Israel take place according to orders received directly from customers at the sales offices, and the products are supplied from Carmel Olefins' warehouses in Haifa Bay. Sales in the domestic market are based on ex-works from Carmel Olefins' warehouses and the supply is therefore made by trucks which are sent by the customers to Carmel Olefins' warehouses. Customers in Israel usually receive their supplies immediately.
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1.7.5.2 Marketing overseas Overseas sales take place directly from Carmel Olefins' offices in Israel and Holland, through agents abroad and through a subsidiary in England Carmel, Olefins (U.K.) Ltd. (100%), which also functions as an agent. Most of the overseas sales are handled by agents by area of sales. Carmel Olefins' dependence on these marketing channels is not great, and as noted there is considerable trade in polymers of the type sold by Carmel Olefins through numerous entities (agents and distributors). Carmel Olefins has direct contact with all the customers, and the commission paid to the agents is the accepted rate in this sector. 1.7.6 Backlog of orders 1.7.6.1 Carmel Olefins' backlog of orders amounted to approximately USD 19,800 at March 16, 2009, USD 18,000 thousand at December 31, 2008, and USD 22,800 thousand at December 31, 2007. At the reporting date, all the orders are scheduled for supply during the following quarter. Most of the backlog of orders is for export 1.7.6.2 Based on Carmel Olefins' past experience, the customer cancellation rate is negligible. 1.7.6.3 Supply dates for Carmel Olefins' products to its customers vary from one customer to another, and are between three business days (mainly to customers in Israel) and up to 30 business days (mostly for overseas customers) from the date of receiving the order. Supply dates are set jointly by Carmel Olefins and the customer, based on Carmel Olefins' estimate of the dates of production and stock availability. 1.7.6.4 The volume and dates of exercising the backlog of orders may change, in part if customers' orders change substantially and/or there is a change in Carmel Olefins' ability to supply the orders and/or in macro-economic data and/or other facts over which Carmel Olefins has no control and that it is unaware of at the date of this report. 1.7.7 Competition Carmel Olefins is the sole producer of low-density polyethylene and polypropylene in Israel (and has even been declared a monopoly in the low-density polyethylene industry, as noted in par. 1.7.20.8 below). Carmel Olefins' competitors in Israel are the agents of foreign manufacturers and local distributors. As of January 11, 2009, there is no import duty on polyethylene. Until November 29, 2006 and from January 1, 2008, 8% import duty applied to imported low-density polyethylene from countries with which Israel has no trade agreement (during the period from November 29, 2006 and up to December 31, 2007, the import duty was 4%). The cancellation of import duty is not expected to have material impact on Carmel Olefins' financial results or sales. Imports into Israel take place on a random basis from various sources, depending on the export prices prevailing in each of the principal sources of supply (Europe, the US, and the Far East). The Company estimates that Israel accounts for 40%-60% of the polypropylene market. The disparity in the Company's estimates stems from reviewing the situation in Israel in two different ways: based on a summary of reports for customers in the group regarding their consumption of polypropylene in 2008, the company estimates that its share of the polypropylene market in Israel is 40%, whereas based on customs data regarding the import of polypropylene, as published together with sales figures for this group, the Company estimates that it accounts for 60% of the market in Israel. The Company estimates, based on the import duty information for the import of polyethylene as it was publicly published, together with Carmel Olefins' sales data, that it accounts for 80% of the domestic market for low-density polyethylene in 2007 and 70% in 2008. In the export markets, Carmel Olefins accounts for an insignificant share of each of the markets in which it sells. As most of the products are defined as commodities, for which there are international prices, competition mainly concerns the prevailing prices in Israel or in the region in which the customer wishes to receive the goods.
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The following graph shows price conduct for Carmel Olefins' products as published by the ICIS39 for the period between January 2002 and February 2009:
Behavior of polyethylene and polypropylene price $/ton Weekly quotes in W. Europe including shipping fees 2,400
2,200
2,000
1,800
1,600
1,400
1,200
1,000
800
600
400 01/02 04/02 07/02 10/02 02/03 05/03 08/03 12/03 03/04 06/04 09/04 01/05 04/05 07/05 11/05 02/06 05/06 08/06 12/06 03/07 06/07 10/07 01/08 04/08 07/08 11/08 02/09
HomoPolypropylene Low-Density Polyethylene
The following graph shows the prices of naphtha that Carmel Olefins purchases, as published by Platt's,40 for the period between January 2002 and February 2009:
Behavior of polyethylene feedstock prices $/ton Naphtha 1,200
1,100
1,000
900
800
700
600
500
400
300
200
100 01/02 04/02 07/02 10/02 02/03 05/03 08/03 12/03 03/04 06/04 09/04 01/05 04/05 07/05 11/05 02/06 05/06 08/06 12/06 03/07 06/07 10/07 01/08 04/08 07/08 11/08 02/09 Naphtha
As noted, in the domestic market, Carmel Olefins has in-built advantages compared to its overseas competitors, mainly due to reliability of supply, product quality, technical support available to customers, as well as available stock that helps customers in the local market maintain a low level of operating supply, thus saving them the associated financing costs.
39 An international organization that provides information and data about the prices of petrochemical products. For details see: http://www.icis.com/StaticPages/AboutUs.htm 40 An international organization that provides information in the energy industry, including data about the price of petrochemical products. For details see: http://www.platts.com
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Abroad, Carmel Olefins must confront the disadvantage of remote markets by low transportation prices and by selling to countries (mainly Turkey, Italy and England) which are unable to supply all their own consumption and are therefore forced to import polymers. Acquisition of the Domo shares (see par. 1.7.1.2.2 above and par. 1.7.22.9 below) should, among other things, eliminate these relative disadvantages to some extent. In the wake of the global financial crisis, there has been a general slowdown in the commodities markets, including in feedstock (naphtha and LPG) and in Carmel Olefins' products. Feedstock prices and the price of the polymers sold by Carmel Olefins fell sharply during the last quarter of 2008. 1.7.8 Production capacity Carmel Olefins' production plants operate as a single concern and are mutually dependent on the full, continuous operation of each of the other facilities. The polyethylene plants have a production capacity of 165,000 tons / year. Following the completion of the Expansion Plan, and based on the data in Carmel Olefins' possession at the reporting date, the Company estimates, that the annual production capacity of polypropylene has increased by 250,000 tons / year to overall potential production capacity of 450,000 tons / year. At the date of this report, Carmel Olefins produces, on average, 85% of its potential production capacity. The quantity produced at the date of this report reflects, in Carmel Olefins' opinion, the maximum production capacity for the initial operating period following completion of the Expansion Plan, and Carmel Olefins intends to further increase this quantity, however it is uncertain that it will reach its full potential production capacity. The Company's estimates regarding the increase in production capacity are based, among other things, on Carmel Olefins' cumulative experience from the date of completion of the Expansion Plan and on the demand for polypropylene. This estimate may materialize only partially due to a decline in the availability of raw materials or due to a decline in the volume of demand for polypropylene. Domo's polypropylene facilities have a production capacity of 180,000 tons / year. At the date of this report, Domo produces, on average, 90% of its potential production capacity. The plants operate continuously without a break, excluding instances of breakdown and to perform periodic maintenance work. The production plants are shut down once in four years for periodic maintenance work that lasts 4-6 weeks. It should be emphasized that the sales prices in the markets, compared with Carmel Olefins' production costs, generally justify full operation of all its plants. Production is partially or fully suspended only in the event of breakdowns or planned shutdowns for maintenance work on Carmel Olefins' facilities. At the reporting date, Carmel Olefins is therefore running the polymer production facilities at maximum possible output (90% of its potential production capacity). Output from the monomer plants corresponds with the needs of the polymer plants. Output from the monomer plants is produced in fixed proportions, allowing for flexibility of output and adaptability to changes in the ratios between the existing products, although on a more limited scale. Consequently, it is impossible to significantly change the mix of the polymer production, which is based on the raw materials supplied mainly from the monomer facilities. Furthermore, since Carmel Olefins' facilities operate as a single concern, a slowdown in the activity of one of its plants will cause a slowdown of activity in the other plants. Consequently, if operations in one of the monomer plants slows, and the polymer plants continue to operate at full output, the intermediate materials in the storage tanks will run out within a short time, and operations at the polymer facilities will be forced to slow down due to a shortage of raw materials. If operations at any of the polymer plants slows down, and the monomer plants continue to operate at full output, the raw materials storage tanks will be filled within a short time and the monomer plants will be forced to slow their operations. A slowdown of activity at the
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monomer plants will lead to reduced output of both ethylene and propylene, such that both the polyethylene plants and the polypropylene plants will be forced to slow their operations. In view of the above, most of the periodic maintenance work at the other facilities is performed when the monomer plants are shut down, although shorter shut downs and breakdowns are utilized for small, planned repairs. Carmel Olefins manufactures stocks of products in advance for the periods in which maintenance work is performed, in an effort to enable it to supply customers' orders during this period. The last planned shutdown for periodic maintenance work was in June 2006. As far as the Company is aware, the number and duration of the shutdowns of the Carmel facilities is lower than average when compared with other similar facilities around the world 1.7.9 Fixed assets and plants Carmel Olefins is located on a 390-dunam site situated in the Haifa Bay area, immediately to the south east of the Company's compound. Carmel Olefins has the right to be registered as the owners of approximately 38 hectare of the aforesaid land, and the Company owns the right to be registered as the lessee of the rest (rest of the land, ("Other Land"), in consideration for the use of which, Carmel Olefins pays the Company sums that are not substantial. The rights to Carmel's land on which its plants are located, are conferred on Carmel Olefins under transfer agreements and irreversible powers of attorney from IPE and the Company from its date of establishment, and the subsequent purchase of land from IPE and the Company. Ownership of these lands is not registered in the Lands Registry in Carmel Olefins' name, due to problems of parcellation. Carmel Olefins has recorded caveats in its favor with the Land Registry Office The Company is of the opinion that the fact that ownership of these lands is not registered in Carmel Olefins' name does not create material exposure. 95 dunam of the Carmel Olefins compound was purchased from IPE in February 2006 in consideration for the sum of NIS 31.5 million (approximately USD 6,674 thousand) plus VAT. Prior to purchase of this land, most of it was leased to Carmel Olefins by IPE (parallel to the purchase of the site, in February 2006 Carmel Olefins and IPE signed a leasing agreement arranging the use made by Carmel, for no consideration, of various areas within the acquired site during different periods. The agreement specified that in return for leasing the property during the various periods, Carmel Olefins paid IPE USD 1 million , plus VAT). The area was sold to Carmel Olefins as is, including environmental hazards, if any, where it was agreed that IPE shall bear no liability in connection with the environmental hazards in the area sold, and Carmel Olefins shall bear all the liability in connection with the environmental hazards in the area sold. Carmel Olefins' rights in the Other Land are based on two agreements between Carmel and the Company, whereby the Company granted Carmel Olefins the right to erect plants for its operations. One agreement is for an unlimited period, although according to the terms of the agreement and by giving 24 months advance notice, the Company is entitled to ask that the land be vacated. The second agreement is for a period of 24 years and 11 months (until September 2024), with an option for earlier termination pursuant to the conditions of this agreement. Carmel's plants operate on its site, centering on the monomer facilities which supply ethylene and propylene to the polypropylene and low-density polyethylene plants. Carmel Olefins' facilities are interconnected and a pipe also connects them to the Company's plants, through which feedstock flow and by products are returned. In addition to Carmel's plants, the following are also located on the site: offices, laboratories, production service facilities (steam, cooling water, compressed air, nitrogen, etc.), finished goods warehouses, raw materials storage, employee services (dining room, showers, etc.), workshops for maintenance, gate, etc. In addition to the aforementioned land, Carmel Olefins leases an auxiliary facility from the Ports and Railways Authority for the import and storage of ethylene on a 6-dunam site in the Kishon Port. The lease period is due to end in 2011, and consideration for the lease is an annual fee of approximately NIS 1.6 million. Up to 2,000 tons of ethylene can be stored at the storage facility and up to 100,000 tons of ethylene annually can be moved through it. A
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pipeline connects the storage facility directly to Carmel Olefins' plants, and ethylene imported in liquid form is piped from the ships to the storage plant and from there as gas directly to Carmel Olefins' production facilities. For more information on the plan to expand the Carmel plants, see par. 1.7.1.7 of the Report. In August 2007, Carmel Olefins entered into agreement to sublet from the Company 382 sq.m. of office space in the Azrieli Tower in Tel Aviv. This sub-lease is valid until December, 31, 2012. The rent and the other conditions of the lease, taking note of Carmel Olefins' relative share of the leased property, are the same as those applicable to the Company under the lease agreement with the lessor. The annual rent is USD 158 thousand. Domo's facilities are located on a 127-dunam site in Rotterdam port, Holland ("Domo site"). Under an agreement from February 1994, between BASF Nederland BV and Rotterdam municipality, Rotterdam port leases the Domo site to Domo. According to this agreement, the lease is for a 25-year period ending February 2019, where the lessee has an option to extend the lease for 3 additional periods of 25 years each. The annual lease is 328 thousand euros. It is possible that when the lease comes to an end, Domo may be asked to return the land clean of any pollution. In view of the partial indemnity that a wholly owned subsidiary of Carmel Olefins received from Domo Chemical (see pars. 1.7.1.2.2 and 1.7.22.9 below), the Company believes that Carmel does not anticipate any material exposure from such a request. The Company's estimate regarding its aforesaid exposure is forward-looking information. Among other things, the Company's view is based on the partial indemnity paid to Carmel Olefins' subsidiary and on the findings of the environmental consultant. The Company's estimate may not materialize, in part if there is any change in Domo Chemical's status and/or should there be any disagreement with Domo Chemicals and/or if any errors are found in the environmental consultant's findings. The following table details the fixed assets owned by Carmel Olefins at December 31, 2008 (in thousands of USD):
Retained cost of Accrued Total depreciated purchase depreciation cost Land (*) 39,736 890 38,846 Machines & equipment (*) 773,332 81,582 691,750 Vehicles 112 74 38 Office furniture and equipment 3,466 2,396 1,097 Spare parts inventory 43,196 0 43,196 Catalysts 14,534 3,827 10,707 Total 874,376 88,742 785,634
(*) After a valuation at January 1, 2007 that Carmel Olefins received at its request in April 2007, regarding Carmel's production plants and its land. 1.7.10 Product development and new technologies In recent years, Carmel Olefins has invested in two key areas through its development department – product engineering and the development of new technology: 1.7.10.1 Product engineering The development department adapts existing products, develops special types of polypropylene and deals with product development, as follows: 1.7.10.1.1 Updates existing products and adapts them to the requirements of Carmel Olefins' customers. Carmel's development department reviews developments in the market, the variety of existing products and the activity of its competitors. By developing its own products and on the basis of know-how agreements to which Carmel Olefins is a party, it is constantly up to date regarding the products available in its field of operations, so that it is able to compete with the other products available on the market. Carmel Olefins also offers its customers technical support and helps them develop new products.
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1.7.10.1.2 Develops special types of polypropylene, quality types for special industries which provide a higher product contribution, price stability and regular customers Carmel Olefins intends to expand such activity in view of the new technologies applied in the new propylene plant, which was set up as part of the Expansion Plan, and the possibility of producing new, improved quality polypropylenes. The Company's estimate in connection with product development is based, in part, on Carmel Olefins' decisions to continue to update existing products and to develop new types of polypropylene. It is possible that Carmel Olefins' intentions will not materialize if there are changes in the demand for products and/or if development costs exceed their benefit. Consequently, depending on the information available to Carmel Olefins from time to time, Carmel may decide not to realize its aforementioned intentions. 1.7.10.2 Development of new technologies In addition, Carmel Olefins' development department is involved in research and development of new technologies in conjunction with academic research institutions. This R&D activity takes place by way of the occasional participation by Carmel in consortiums of industrial corporations and research institutions, and in such instances, Carmel Olefins receives small amounts of financing from the Ministry of Industry and Trade and from the European Union. Carmel's investment in the R&D projects is insignificant with respect to its business. 1.7.11 Intangible assets 1.7.11.1 The know-how for the manufacture of Carmel Olefins products is purchased from local and overseas companies under license agreements. Under the provisions of some of the license agreements, Carmel Olefins undertook to pay royalties of amounts that are not material to Carmel. On the subject of the manufacturing technologies for Carmel's products, see par. 1.7.1.1 above. 1.7.11.2 The know-how and the technology required to implement the Expansion Plan, was acquired mainly from Basell Poliolefine Italia S.p.A. ("Basell") as part of the agreements signed between Carmel Olefins and Basell in the years 2004-2005 ("Basell Agreements"). This know-how and technology are material and critical to Carmel's operations. The know-how and technology applications are not limited in time and the right to use them is not exclusive. Under the Basell agreements, in return for the aforesaid know-how and technology, Carmel Olefins paid Basell 6 million euros and also undertook to pay royalties at a rate of 1.7% of the sale of Carmel's products manufactured at the new plant, up to an overall sum of royalties of 12 million euros, plus 7% annual interest. During 2007, Carmel Olefins decided to pay the entire amount of the royalties in advance, and transferred to Basell a final amount of 13.5 million euros. Carmel Olefins and Basell further agreed that should Carmel decide to expand production capacity at the new polypropylene facility by more than 20% of the production capacity prescribed in the Basell agreement, or alternatively, should Carmel Olefins record an increase of more than 20% in the actual production of polypropylene, compared with the production capacity defined in the Basell agreement, and this over a period of 12 consecutive months, Carmel will pay Basell an additional amount to be calculated according to the formula set forth in the Basell agreement. Carmel is of the opinion that the additional amount will not be prohibitive to its expansion of production capacity at the new propylene plant. 1.7.11.3 As a result of the surplus acquisition costs allocated by Carmel Olefins in respect of the Domo acquisition, 1 million euros was allocated in respect of an agreement with Basell's principal raw materials supplier, and 3 million euros in respect of the facilities that were purchased. See also pars. 1.7.15 above and 1.7.22.8 below. 1.7.11.4 The unamortized balance of the know-how in respect of Carmel Olefins' plants and Domo's plants amounted to USD 29 million at December 31, 2008. 1.7.11.5 Carmel Olefins has one registered trademark: Carmelstat. Carmel Olefins has registered two patents in connection with the development of its products. The patents are registered in many countries. The patents are not material to Carmel Olefins' operations.
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1.7.12 Human capital 1.7.12.1 Organizational structure The organizational structure of Carmel Olefins is as follows:
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1.7.12.2 The number of employees according to the organizational structure Close to the reporting date, Carmel Olefins has 534 employees, 304 are permanent employees, 168 temporary employees and with individual employment contracts, 61 Company employees on loan to Carmel Olefins, and one person employed on a daily basis through a manpower company. Close to the reporting date, Domo has 75 employees. 1.7.12.3 The following table details the number of employees in Carmel Olefins' various units: Department / occupation 31.12.2008 31.12.2007 31.12.2006 Production, operations, maintenance and 411 421 361 purchasing (including the employees on loan from the Company Labs, technology, R&D 53 48 47 Management, finance, HR and marketing 70 68 67 Total 534 537 475
The manager of the monomer plants, the managers of the polymer plants and the production services manager (laboratory and safety) are accountable to the VP Operations. All the plants have one maintenance manager who is accountable to the VP Operations. The company's structure is generally accepted in this type of industry and it is built on a study and examination of activity in other, similar industries. 1.7.12.4 Carmel Olefins' investments in training and instruction As part of the instruction courses, training sessions, exercises and internal training take place at the production plants and maintenance units. The training programs include operations, maintenance, annual safety and environmental programs, and quality assurance. Refresher courses are also held on specific professional subjects to improve know-how as well as in computer-related training. Emergency and fire-fighting drills, safety instruction for specific plants and professional training are also held at the production plants. 1.7.12.5 Employment agreements and compensation plans 1.7.12.5.1 General All employees, whether employed according to a collective labor agreement or by personal contract, are entitled to pension insurance pursuant to the provisions of the various agreements on this subject, and also enjoy progressive social benefits. Carmel Olefins has a policy of awarding performance-based bonuses as decided by the company's Board of Directors. 1.7.12.5.2 Collective labor agreements Carmel Olefins is party to several special collective labor agreements some of which arrange the work and employment conditions of the company's tenured employees ("tenured employees") and some of which arrange the rights of the newer, next-generation employees ("next-generation employees') who are not employed through personal contracts and that give employees benefits beyond the requirements of the various labor laws. From time to time changes and supplements are added to the special collective labor agreement from May 5, 1965 ("the original agreement") that applies to the tenured employees, and additional, special collective labor agreements have been signed (together – the collective labor agreements"). The original agreement was signed by IPE, however subsequent to the establishment of Carmel Olefins, Carmel adopted these agreements onto the changes that had been made in them, and periodically extended their validity. Among other things, the collective labor agreements set out the salary table and ranks, which are revised from time to time according to the class of employees, order of increasing rank, and a 48-month trial period until a decision is made regarding tenure (60 months for a younger-generation employee).
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Among other things, the collective labor agreements set out benefits over and above the rights granted by law to Carmel Olefins employees, the most important of which are a seniority supplement, an enlarged overtime bonus, on-call compensation and a call-out allowance. The collective labor agreements provide a special bonus for employees in the following positions: Plant supervisor, professional supervisor, shift manager, and group leader. These employees will be compensated by payment of a salary one rank higher, a special seniority supplement for shift workers, enlarged holiday and convalescence pay for shift workers and facility-based employees, sick leave with enlarged accrual, enlarged convalescence pay, insurance for work injury, a loan fund for employees, insurance through the Mivtachim pension fund. For an employee who is insured in the old pension fund – the employee will set aside 5% and Carmel Olefins 13.5% (6% for severance pay and 7.5% for pension); for an employee who is insured through the new pension funds – the employee will set aside 5% and Carmel Olefins 12% (6% for severance pay and 6% for pension); after 10 years of employment 2.33% will also be set aside for severance pay, entitlement to receive the severance pay money excluding cases of an employee who resigns, a bonus for redeeming unutilized sick leave for a worker who retires at retirement age at the rate of a day of convalescence multiplied by 20% of unused sick leave up to a maximum of 250 days ( for younger-generation employees – up to a maximum of 90 days). Over the years, the following benefits have also been added: personal accident insurance, education compensation, supplementary health insurance, tuition fee grants for kindergartens, high school and post high-school education for the children of employees, as well as the option to join an education fund (employees' participation is 2.5% and the company's share is 7.5% of the ordinary wage). Criteria were established for giving loans to employees, including to buy an apartment, housing for children, entitlement to join a leasing arrangement. Arrangements were also prescribed with regard to maintaining the continuity of employees' rights in the event of a merger, share sale, spin off, transfer of the plant or change of control of Carmel Olefins, subject to the provisions of the supplementary agreement to the special collective labor agreement from February 16, 2007, that was signed on April 17, 2007 ("special collective labor agreement" and "supplementary agreement", respectively). The employees' representatives undertook not to declare a labor dispute only in respect of those issues arranged in the special collective labor agreement or the supplementary agreement, and to preserve industrial peace in connection with them. Nevertheless, this undertaking will remain in force until September 28, 2011, and will not include extensions of the collective labor agreement under its provisions. Within the framework of the supplementary agreement, it was agreed that 42 employees would voluntarily retire gradually over a three-year period. At the reporting date, a plan has been outlined for the early retirement of 23 employees, at a cost of NIS 16 million. At the date of this report, the conditions for the retirement of the other employees have not yet been determined, and it is therefore impossible at this stage to estimate the cost of such retirement for Carmel Olefins. At the date of this report, 8 employees have retired not on the basis of a defined plan. Within the context of the state's privatization of the Company, the Government Companies Authority also applied the entitlement to a privatization grant to Carmel Olefins employees, relative to the rate of the Company's holdings (direct and indirect) in Carmel Olefins, such that Carmel Olefins employees received a bonus (through Carmel Olefins) of 2.815 salaries from the state. The work conditions of Company employees who are on loan to Carmel Olefins are regulated under the collective labor agreement that applies to the Company's employees. For details, see par. 1.6.19.9 above.
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1.7.12.5.3 Individual employment agreements The employment agreements specify the employee's salary as well as the number of vacation days, sick leave and convalescence days to which each employee is entitled and any restrictions that apply to the accumulation of such days. The individual employment contracts include the employee's entitlement to an education fund. These contracts also include instructions concerning provision for managers' insurance, pension fund and provident fund. Carmel Olefins is also committed to making provision for work disability. Under the individual contracts, employees are entitled to a clothing allowance. Furthermore, employees who are employed according to an individual employment contract are also entitled to three months advance notice, excluding instances of a serious breach of trust or termination of their employment in exceptional circumstances in which they are not entitled to severance pay. In the individual employment contracts, the employees undertake to maintain the confidentiality of Carmel Olefins' business and not to make use of any information that comes into their possession during the course of their work. Employees also undertake that for one year after their employment with the Company ends, they will not engage in any occupation that competes with Carmel Olefins or that is contrary to Carmel's interests, without Carmel Olefins' consent. 1.7.12.5.4 Senior officers and directors Carmel Olefins has eight senior management employees who have personal employment contracts and are entitled to full social benefits as well as bonuses, in accordance with the decisions of the Board of Directors. Carmel also has ten BOD members (4 of whom serve as members of the executive committee) who are entitled to payment of directors' compensation, excluding the Chairman of the Board of Directors who is entitled to a salary. 1.7.13 Raw materials and suppliers 1.7.13.1 The main feedstock in the manufacture of ethylene and propylene are naphtha (one of the products of the distillation of crude oil) and LPG (liquefied petroleum gas). Polyethylene production mainly requires ethylene, and polypropylene production mainly requires propylene. Carmel Olefins purchases from the Company41 and ORA the main feedstocks (mainly naphtha and LPG). Due to regulatory restrictions applicable until June 30, 2007, the purchase of feedstocks from the Company was carried out through the fuel companies. As of July 1, 2007 this regulatory restriction was annulled and therefore as of same date, the Company purchases feedstocks directly from the company. Purchase of feedstock from the Company is governed by a contract from 1997, extended under an agreement between Carmel Olefins, the Company and IPE dated March 15, 2004 (see section 1.7.22.4 below) until December 2010, in accordance with agreed-upon changes that went into effect in the middle of 2006. The agreement for the supply of feedstocks for the manufacture of polypropylene at the new facility is valid for 10 years, from the date of commencement of operations of the new facilities erected by Carmel Olefins under the expansion plan, that is until July 4, 2017. In addition, as part of the merger agreement from 1988 between the Company and IPE through which Carmel was founded (see paragraph 1.7.20.1 of the report), it was agreed that the Company will make every effort to ensure the production and availability of the feedstocks needed by Carmel Olefins to manufacture at full output. Notwithstanding, it was agreed that in the event it becomes necessary to make structural changes in the production line of the Company which cause a shortage in the feedstocks needed by Carmel, the Company and Carmel will take steps to find the best solution from a technical and economic standpoint to obtain the missing quantity of feedstocks for Carmel.
41 Until June 30, 2007, the Company was allowed to sell fuel products only to companies authorized to market fuel and gas, and feedstocks were sold by the Company to Carmel through fuel companies. As of July 1, 2007, the Company sells feedstocks directly to Carmel, not through fuel companies.
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In June 2006, further to the split of the Company, the Company gave notice to Carmel Olefins that it had assigned part of its obligations and rights regarding supply of feedstock to Carmel Olefins to ORA. Under the Company’s notice, as of the date of commencement of operation of the new facilities erected by Carmel Olefins under the Expansion Plan, Carmel Olefins would purchase 60,000 tons of propylene per annum from ORA. 1.7.13.2 Carmel Olefins produces most of its ethylene itself (from Naphtha and LPG) Carmel Olefins has a terminal for unloading ethylene at the Kishon Port which enables the importation of ethylene from overseas where necessary due to a malfunction or ongoing maintenance work. Carmel Olefins has an annual agreement that renews once a year with an overseas supplier regarding the importation of ethylene where necessary, at prices derived from the prices in Europe. Carmel Olefins produces most of its propylene itself at its cracking plant (from Naphtha and LPG) and at its OCU plant (from ethylene and C4 stream components). The balance of the required propylene is purchased from the Company and ORA. 1.7.13.3 Since most of the naphtha needed for the monomer facility is supplied from the Company, Carmel Olefins is dependent on the Company. In the past, when there was a shortage of naphtha at the Company, Carmel Olefins imported part of its light Naphtha consumption from overseas and in the future, the Company may import light and/or full naphtha. In 2007 and 2008, feedstock purchased from the Company directly and/or indirectly constituted about 90% and 70%, respectively, of Carmel Olefins total purchase of feedstocks. The share of sales deriving from the direct and/or indirect purchases from the Company in 2007 and 2008 constituted approximately 54% and 58% respectively, of Carmel Olefins total sales. 1.7.13.4 On March 27, 2008 Carmel Olefins obtained a permit from the Ministry of Environmental Protection to import about 30,000 tons of C4 via the Eilat Ashkelon Oil Pipeline Ltd. (EAPC) port in Ashkelon. The permit is for a period of one year. At the beginning of April 2008, Carmel Olefins imported approximately 1,600 tons. 1.7.14 Commencing from the end of 12 months from the completion of the ORA sale (i.e. as of October 2007), the supervision mechanism of LPG prices that Carmel Olefins purchases from the Company and from ORA changed to supervision by reporting only (the price ceiling was cancelled). For further details relating to the supervision regime change see section 1.6.26.2 of the report. 1.7.15 In May 2001 Basell Polyolefins Company N.V. ("Basell") signed a contract with Domo to supply propylene in an annual quantity of up to 187,000 tons (the "Secured Quantity") for polypropylene production at the Domo plant (the "Basell Contract"). Under the terms and conditions set forth in the Basell contract, Domo has the option of increasing the secured quantity. Subject to the terms and conditions of the Basell contract, the annual quantity of propylene ordered will not deviate by more than 20,000 tons from the quantity supplied in the preceding year. The Basell contract period is for 10 years and Domo has the unilateral option to extend the Basell contract period for two additional periods of 5 years each, subject to the terms and conditions that will be agreed upon by the parties. The Basell contract allows Basell the right to cancel the contract in the event of a change in control at Domo. 1.7.16 Working capital: 1.7.16.1 Policy regarding holding inventories in the polymer area of operation Carmel Olefins holds an inventory of raw materials in relatively low quantities due to the ongoing supply from its suppliers (which is primarily carried out via transfer by means of a pipeline) and the lack of the significant storage capacity. Carmel Olefins' policy is to hold in stock quantities of finished product sufficient for sales for a period of 30 days, in the event of a shutdown of the Carmel Olefins plants for repair, if any, without harming supply to the customers. The average finished product inventory days in 2007 and 2008 amounted to approximately 35 days and about USD 58 million and USD 95 million, respectively.
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1.7.16.2 Credit policies Credit terms for local customers are an average of EOM + 90 and to the export market EOM + 40 days. Average export terms were EOM+ 25 days. The credit extended to customers is covered by credit insurance or cash or letters of credit or surety approved by Carmel Olefins' credit committee. Exceptions are brought to the board of directors for approval. A review conducted by Carmel Olefins over several quarters found that about 10% of the total receivables in the balance sheet are due to customers exceeding the credit terms (days) set for them. As at December 31, 2008 the rate of receivables from customers exceeding the credit terms (days) set for them is about 13%. The average credit terms received from suppliers is EOM + 25 days. Letters of credit are opened for part of the transactions with suppliers abroad. The following are details of the average amount of credit that Carmel Olefins gave its customers: 2008 2007 Average amount of credit (in NIS millions) 201 166 Average credit days for customers in Israel 115 106 Average credit days for overseas customers 40 54
The difference is the credit days extended to customers in Israel and the credit days to customers abroad stems from the fact that most of the sales in Turkey are in cash. The following are details of the average amount of credit that Carmel Olefins received from its suppliers for 2007 and 2008:
2008 2007 Average amount of credit (in NIS millions) 122 65 Average credit days 40 40
The increase in amount of credit was mainly due to an increase in the quantity of feedstocks purchased as a result of the increased production capacity at Carmel Olefins and the initial merger of Domo, and of the increase in feedstock prices. 1.7.17 Financing 1.7.17.1 General Carmel Olefins’ operations are funded by shareholders’ equity, debentures, bank and non- banking credit (Debentures (Series A)) and supplier credit. 1.7.17.2 Short-term credit 1.7.17.2.1 During the course of the first quarter of 2007, Carmel Olefins repaid all the short-term credit extended to it up to that time by banks, by way of the credit it received from the issue of Debentures (Series A), as set forth in section 1.7.17.6 to the report. 1.7.17.2.2 Carmel Olefins has short-term lines of credit from banks, which is updated from time to time. As at the report date, these amounted to a total of USD 180 million. As at December 31, 2008, Carmel Olefins utilized a total of USD 94 million of these lines of credit. As at March 16, 2009, Carmel Olefins utilized credit totaling an amount of USD 105 million. 1.7.17.3 Long-term bank credit 1.7.17.3.1 In 2005 and 2006, Carmel Olefins signed agreements with several banking institutions (the "Banks") for the purpose of received financing for the expansion project, in an amount of USD 318 million (the Bank Loans). These included a long-term loans extended to Carmel Olefins in the amount of USD 37 million during 2007, USD 115 million in 2006 and USD 166 million in 2005. Of the total amount of the bank loans, an amount of USD 138 million was taken from
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foreign banks for periods between seven to eight and a half years, and this as of December 31, 2006, and loans from local banks in the amount of USD 180 million as set forth below. Within the framework of the bank loans, Carmel Olefins has undertaken not to pledge any of its properties and assets (apart from the pledge created by Carmel Olefins for the purpose of securing its debts in an accrued amount that does not exceed USD 1 million to any third party) and that it will not to provide collateral in favor of a third party (apart from guarantees that are given by Carmel Olefins to third parties as part of its normal course of business) as long as it still has debts and liabilities in respect of the credit received from the banks, without obtaining their prior consent. Furthermore, several financial covenants were set for Carmel Olefins, including compliance with certain finances as stipulated in section 1.7.17.5 to the report. As at December 31, 2008 Carmel Olefins has not complied with these covenants. For further details see section 1.7.17.5 to the report. 1.7.17.3.2 In March 2007, Carmel Olefins signed an agreement with the local banks to restructure the bank loans received from them (the Restructure Agreement), as set forth hereunder: (a) A loan in the amount of USD 100 million (extended by one of the banks) will be spread over a period of 17 years instead of 8.5 years and will be repaid in equal quarterly installments over this period. (b) Loans totaling USD 80 million (extended by two other banks) will be repaid in equal quarterly installments calculated over a period of 17 years, whereby the actual final repayment of the loans was set for December 30, 2016 when the unpaid balance of the loans will be repaid in a lump sum.
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1.7.17.4 The table below presents details of the unpaid balances of bank loans as at December 31, 2008:
Amount of Currency of original principal Variance Average interest Average interest Date of final Balance of principal as loan (in US$ 1000’s) mechanism rate in 2007 rate in 2008 repayment of December 31, 2008 USD 80,000 LIBOR 6.2% 5% December 31, 2016 70,588 USD 100,000 LIBOR 6.3% 5.1% December 31, 2023 88,236 USD 22,500 LIBOR 5.8% 5.2% December 20, 2013 16,071 USD 30,189 LIBOR 4.7% 3.9% June 30, 2015 23,364 Euro 18,118 LIBOR 5.1% 5.3% June 30, 2015 15,636 Euro 63,910 Fixed 3.6% 3.6% June 30, 2015 52,867 Total 314,717 266,762
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1.7.17.5 Credit limits As stated above, in the agreements with the banks a number of financial covenants were stipulated for Carmel Olefins, (the "Original Covenants") the main points of which are as follows: 1.7.17.5.1 Carmel Olefins' tangible shareholders' equity shall not fall below than NIS 636 million. Tangible shareholders’ equity is defined as equity less deferred expenses and other intangible assets. 1.7.17.5.2 Tangible shareholders’ equity as a percentage of the total balance sheet will not fall below 33%. 1.7.17.5.3 The current ratio shall be no less than 1.1. 1.7.17.5.4 The average debt coverage ratio over eight quarters being no less than 1.1 and the ratio of debt coverage for each of the previous four quarters being no less than 1. Debt coverage ratio means the ratio between the operating profit for the relevant period, plus depreciation and amortizations, and the sum of principal payments for such period, plus interest payments on long-term loans, interest payments on short-term credit and current taxes during the period. 1.7.17.5.5 The ratio between total liabilities to banking entities and financial institutions and the tangible shareholders’ equity on the last day of each quarter shall be no more than 1.5. Furthermore, the Company undertook additional covenants, the main points of which are as follows: 1.7.17.5.6 Distribution of dividends to shareholders shall not be allowed if such distribution does not comply with the 2004 agreement, or if such distribution is expected to make the ratio of debt coverage expected for each of the two subsequent half years fall below 1:1, or if the average debt coverage ratio for the past four consecutive quarters prior to the date of the declaration and/or distribution or payment of the dividend will fall below 1:1 or if, up to the date of the declaration and/or distribution and/or payment of the dividend, grounds arise for a bank to recall for immediate repayment of the amounts that Carmel Olefins owes and/or it will owe the banks or if such distribution may cause a breach of the other financial ratios. 1.7.17.5.7 Carmel Olefins shall give notice, no more than 7 days from the date on which it receives knowledge, of any lawsuit or legal proceedings and provided that the amount claimed in such legal proceedings against the Company exceeds an amount of USD 1 million. 1.7.17.5.8 Carmel Olefins undertook to insure, all the times, all its assets and properties, at their full value, against the usual risks and to pay all insurance premiums in full. 1.7.17.5.9 Carmel Olefins declared that it complies with all the standards and environmental rules required by law and that it holds all the licenses required by law to operate its operations. 1.7.17.5.10 Carmel Olefins undertook that the management fees paid to its shareholders shall not exceed an amount of five million dollars per year and provided that on the payment date to the shareholders no grounds will arise to recall for immediate repayment of the amounts that the Company owes and/or it will owe to the banks. 1.7.17.5.11 Carmel Olefins is entitled to pay to its shareholders amounts as per the existing agreements with them as at December 2005 provided that such payments to the shareholders under these agreements are not given priority in their terms and conditions and that by their nature these agreements will allow the signing of agreements at market conditions between the Company and an individual who is not a shareholder in the Company. 1.7.17.5.12 Carmel Olefins is allowed, after December 2005, to enter agreements with its shareholders provided that such agreements will not give priority to the shareholders in their terms and conditions and that by their nature, these agreements will allow the signing of agreements at market conditions between the Company and an individual who is not a Carmel Olefins shareholder.
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1.7.17.5.13 Carmel Olefins undertook towards the banks that one of the grounds for immediate recall is if the 2004 agreement, in whole or in part, will be amended and/or modified and/or annulled in any way without receipt of prior written consent from the bank. 1.7.17.5.14 In any event whereby Carmel Olefins breaches or does not comply with any of its commitments towards the banks or if it transpires that any statement is incorrect or inaccurate, the bank will be entitled to recall for immediate repayment of the amounts extended as part of the banks services or any part thereof and to take any means it deems necessary to collect them. 1.7.17.5.15 As of December 31,2006, Carmel Olefins did not comply with part of the original financial covenants specified in sections 1.17.5.1 – 1.17.5.5 above. Carmel Olefins received a letter from the banks confirming its compliance with the various financial covenants up until June 30, 2007, specified below. After this date Carmel Olefins was required to repay and comply with the original financial covenants set as aforesaid in sections 1.7.17.5.1 – 1.17.5.5 above. 1.7.17.5.16 Up until December 31, 2007, Carmel Olefins was examined by the banks according to its shekel financial statements, which were prepared in accordance with the Israeli standards and not according to the dollar statements of the international standards. In view of the fact that Carmel Olefins reporting currency changed to the dollar and that it adopted the IFRS accounting standards as of the first quarter of 2008, the banks agreed during March 2008 to amend part of the original financial covenants which Carmel Olefins undertook, which became effective as at January 1, 2008 (the "New Financial Covenants"). A. The definition of the debt coverage ratio was changed as follows: The ratio between the operating profit in the period with the addition of depreciation and amortization and the amount of the fund payments for that period with the addition of payments of interests on long-term loans (less the difference for the funds and interest swap currency transactions42 for the period) and short term loans and the current taxes for that period. B. The tangible equity shall not fall from USD 138 million (the tangible equity as at December 31, 2008 was USD 268 million). C. The ratio of the tangible equity to the total balance sheet shall not be less than 29% (the ratio of tangible equity to total net balance sheet as at December 31,2008 was 25%). D. The ratio between all the liabilities to banks and financial institutions less moneys due from short- and long-term principal and interest swap currency transactions and the tangible shareholders’ equity on the last day of each quarter shall not exceed 1.8. (the ratio between the total liabilities to banks and financial institutions and tangible shareholders equity as at December 31, 2008 was 2.1) E. The average debt coverage ratio in the last eight quarters shall not fall below 1.1 in relation to the four consecutive quarters prior to the assessment date. . The debt coverage ratio shall not fall below -1, with the exception of a quarter in which there is periodic treatment of facilities, the debt coverage ratio in that quarter will not fall below -0.75 (the above debt coverage ratio as at December 31, 2008 was 0.9). F. Subject to the amendments in the new financial covenants, all other liabilities of Carmel Olefins towards banks, as set forth above, will continue to apply, as aforesaid. 1.7.17.5.17 As at December 31, 2008 Carmel Olefins has not complied with the new financial covenants and therefore, in the Company's financial statements as at December 31, 2008, the bank loans are presented as short-term loans. Carmel Olefins is currently negotiating with the banks to reach a settlement, by which new financial criteria will be set and/or it will receive from the banks letters of waiver for a fixed period, according to which Carmel Olefins will not be required to comply with the new financial covenants during the aforesaid fixed period (the "Letters of Waiver").
42 SWAP Currency – the agreement to swap an asset or liability fixed in a certain currency to an asset or liability fixed in another currency.
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In view of the progress of these negotiations, Carmel Olefins estimates, as at the report date, that it will probably receive such letters of waiver from all the banks. As of December 31,2008 and until the receipt of all the letters of waiver, if and when they will be received, the banks will have the right to recall the bank loans for immediate repayment. As at the report date, Carmel Olefins has not received from any bank a demand recalling the loan extended to the Company for immediate repayment. Carmel Olefins' assessment with respect to the receipt of the aforesaid letters of waiver constitutes forward looking statements, which may not materialize and is not under Carmel Olefins' exclusive control and therefore, it is uncertain whether they will materialize. 1.7.17.5.18 The costs of raising long-term loans from banks decrease over the loan period. 1.7.17.6 Issuance of debentures 1.7.17.6.1 During the first quarter of 2007, Carmel Olefins issued Debentures (Series A) as part of a private placement to institutional investors, in an amount of NIS 850 million. The debentures are linked to the Israel Consumer Price Index and bear annual interest at a rate of 4.69%. As stipulated in section 1.7.17.2 above, the Debentures (Series A) primarily replaced short-term bank credit. Debentures (Series A) are redeemable in eight equal annual installments as of March 31, 2013. Debentures (Series A) bore additional annual interest at 0.25% (the "Additional Interest") as of their issue date (March 15, 2007) until June 30, 2008 (inclusive). Debentures (Series A) bore temporary interest of 1.25% (the "Temporary Interest") as of July 1, 2008 until December 31, 2008, based on 365 days per year. 1.7.17.6.2 The debentures issued by Carmel Olefins were rated A1 stable by Midroog Ltd. 1.7.17.6.3 During the period prior to listing of the debentures on the TASE, Carmen Olefins undertook to comply with certain financial conditions most of which expired on the date the debentures were listed for trade on the TASE. From the date of listing of the debentures for trade, the following financial conditions are applicable to Carmel Olefins: 1.7.17.6.4 No dividend distribution shall take place, unless at the date of the distribution, Carmel Olefins has adequate cash balances to make the next payment to the holders of debentures (Series A) after the dividend distribution date. 1.7.17.6.5 The rating of the debentures will not fall below A. As of December 31, 2008, Carmel Olefins was in compliance with the aforementioned financial covenants. 1.7.17.7 Additional credit limits 1.7.17.7.1 Based on Bank of Israel's Proper Conduct of Banking Business Regulations no. 313, Limitations on the Indebtedness of a Borrower and a Group of Borrowers, (the "Bank of Israel Regulation"), Carmel Olefins is may be considered part of a group of borrowers together with its controlling shareholders and whoever is controlled by them. Therefore, should Carmel Olefins apply to the Bank of Israel to receive credit, it is liable to encounter difficulties if the ratio of the group of borrowers that it belongs to indebtedness to the Bank's equity exceeds the ratios set in the aforesaid Bank of Israel regulations. This may limit the ability of Carmel Olefins to receive credit from certain Israeli banks as well as the extent of the credit that Carmel Olefins will be able to receive. 1.7.17.7.2 As at the report date, these limitations have not affected Carmel Olefins' ability to receive bank credit nor the extent of the bank credit that it has actually received. 1.7.17.8 Credit rating The debentures (Series A) issued by Carmel Olefins were rated A1 stable by Midroog Ltd. 1.7.18 Taxation For details regarding the taxation laws that apply to Carmel Olefins and principal benefits thereunder, see Note 17 to the financial statements of the Company.
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1.7.19 Environmental quality 1.7.19.1 General Carmel Olefins, as an industrial plant, is obligated to comply with the relevant environmental laws. This primarily include: The Prevention of Hazards Law, 5721-1961; the Business Licensing Law, 5728-1968; Planning and Building Law, 5725-1965; the Dangerous Substances Law, 5753-1993; the Prevention of Sea Pollution from Land Sources Law, 5748- 1998, Regulations for the Prevention of Hazards of Air Pollution, Noise and Odors from Carmel Olefins Plant under the Prevention of Hazards Law, 5721-1961, The Clean Air Law, 5768-2008 and their regulations. As part of its regular operations, Carmel Olefins is preparing to comply with the laws and regulations applicable to its operations. As of the date of the report, except for the items described in paragraphs 1.7.19.3, 1.7.19.4, 1.7.19.5, and 1.6.25.2.6 to the report. Carmel Olefins has not received any warnings or demands relating to non-compliance with the provisions of the law, its permits, and licenses that were in effect during said period, in connection with environmental issue, which in the opinion of the Company are expected to have a material impact on Carmel Olefins. 1.7.19.2 For further details relating to the Clean Air Law 5768-2008 see section 1.6.25.2.2 of the report. 1.7.19.3 Treaty to implement standards regarding pollutant emissions Carmel Olefins is also subject to a treaty to implement standards regarding emission of pollutants into the air signed between the Ministry of Environmental Protection and the Manufacturers Association of Israel, of which Carmel Olefins is a member since 1999 (the Treaty). For further details relating to the treaty see section 1.6.25.2.3 of the report. 1.7.19.4 Pumping permit Carmel Olefins has a pumping permit under the Prevention of Sea Pollution from Land Sources Law, 5748-1988, in force until March 31, 2010. Brine from the polymer facilities is pumped into the Kishon River under this permit, while brine from the monomer facility is transferred for further treatment to the Company’s effluent treatment facility. The pumping permit sets out provisions regarding the permitted amounts of brine for pumping into the Kishon River from each of Carmel Olefins’ facilities, and provisions regarding the treatment of brine permitted for pumping, the composition of the brine, methods of monitoring and the reports that are required to be given. To the best of Carmel Olefins' knowledge, the Ministry of Environmental Protection is looking into a number of alternatives in order to resolve the brine issue. Based on the stipulations in the pumping permit, the criteria for the removal of brine are liable to be changed by the Ministry of Environmental Protection if no agreed and final joint solution for the removal of the brine is found and Carmel Olefins will request continuing pumping the brine into the Kishon River and it will be required to comply with the environmental water quality standards for the Kishon River (Kishon River Water Quality Standard, Summary Report of the inter-ministerial environmental commission set up to formulate water quality standards for the Kishon River) (the River Standard and Inbar Commission, respectively), at a date that will be fixed by the Ministry of Environmental Protection. To the best of Carmel Olefins' knowledge, the ministerial environmental committee resolved to adopt the recommendations of the Inbar Commission report and its said resolution received the validity of a government resolution in 2005, and it is being formulated into a draft bill. As of the report date, the decision of the committee has not yet been formalized in the regulations. Carmel Olefins estimates that if it is decided that the Inbar Commission's standards are also mandatory for entities which are not defined as operating in the purification of effluents (and this also includes Carmel Olefins), Carmel Olefins will be required to invest an amount of USD 10 million in order to comply with the Inbar Commission's standards.
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The foregoing, with respect to the expected scope of the investments constitute forward looking information. The Company's assessment with respect to the aforesaid scope of investment is based on the decision of the Inbar Commission in its current format and on Carmel Olefins forecasts based on current data relating to Carmel Olefins' environmental pollution. It is possible that the Company’s forecast may not materialize, among other tings, if in the future changes will be introduced to the regulatory regulations with regard to the Inbar Commission's conclusions or if Carmel Olefins environmental pollution will change. During January 2008, Carmel Olefins updated the coordinator of the pumping permit committee at the Ministry of Environmental Protection regarding the upgrade project of its effluent system. The update stated that Carmel Olefins had carried out a significant part of the project and it expected to complete it within a few months. During October 2008, the Company completed the upgrade project and the effluent system is in operation. 1.7.19.5 Toxins permit under the Hazardous Materials Law 5753-1993 Carmel Olefins has a toxin permit pursuant to the Hazardous Materials Law 5753-1993, valid until January 3, 2010. Carmel Olefins operates in accordance with the special terms set out in the permit which deal with, among other things, the removal and storage of the toxic waste, and the treatment of wastes. According to the provisions of the permit, the toxic waste is collected and stored temporarily at a plant waste site, from where it is transferred on a regular basis to the toxic waste site at Ramat Hovav. 1.7.19.6 Prevention of Air Pollution, Noise and Odors 1.7.19.6.1 Carmel Olefins is subject to Directives for the Prevention of Hazards of Air Pollution, Noise and Odors from Carmel Olefins Plant under the Prevention of Hazards Law, 5721-1961, issued in 1998 and updated in November 2007 ( the "Personal Order"). The personal order sets out provisions regarding the prevention of air pollution, noise and odor hazards from Carmel Olefins’ facilities, which include: A. Carmel Olefins is required to take the necessary operational and technological means to prevent causing excessive or unreasonable air pollution from its facilities, whereby in this matter any of the following cases will be deemed unreasonable air pollution originating from specific emission sources at Carmel Olefins: (a) the concentration of pollutants in the gases emitted exceed the maximum concentrations set forth in the personal order; (b) emission of black smoke. B. Notwithstanding the foregoing, the maximum concentration or emission of black smoke shall not be considered unusual, among other things, in the following cases: Emissions of nitrogen oxides during ignition and shutdown of a fuel burning facility that is not equipped with secondary means for duration that does not exceed the duration set by the supervising authority for exceptions to ignition and shutdown times; emissions of black smoke during ignition of a fuel burning facility which does not have secondary means for reducing emissions of particles, for duration that does not exceed a cumulative period of 6 minutes per hour; emissions of black smoke when sending gases for burning to a burner during a malfunction requiring the emission of large quantities of gases in a short time for a duration that does not exceed a cumulative period of 6 minutes per hour or does not exceed the permitted duration of exceptions for black smoke from a burner as prescribed by the Ministry of Environmental Protection after professional examination (Orders for Emissions in the event of a Malfunction); emissions of black smoke when emitting soot for duration that does not exceed that set by the supervising authority for exceptions to soot emitting times. C. Carmel Olefins is required to submit a plan for the Ministry of Environmental Protection's comments and for review by the supervising authority, for conducting a non- specific emissions survey for the purpose of mapping all the non-specific sources of emissions and to quantify the emissions.
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D. Carmel Olefins is require to submit a plan for the Ministry of Environmental Protection's approval and review by the supervising authority, to locate and repair non-specific leakages from equipment components. The measurement for locating leakages will be carried out using the method specified in the US Federal Code of Regulations, Title 40, Part 60, Appendix A Reference Method 21. Carmel Olefins will amend the plan within three months from receipt of the Ministry's comments to the plan and will carry out the plan as it will be approved. Carmel Olefins disputes the regulations for emissions in the event of breakdown, since it claims that the regulations cannot be implemented and that it is not able to comply with them. Carmel Olefins is working opposite the Ministry of Environmental Protection to change the orders for emissions in the event of a malfunction and a Ministry of Environmental Protection ministerial committee has been set up to examine Carmel Olefins' claims. The said ministerial committee's report was given to Carmel Olefins in December 2008. In its conclusions, the committee wrote that limiting the duration of black smoke emission to 6 minutes per hour is not practicable in emergency situations for which purpose the burner has been installed and is long (compared with the US Federal environmental authority's requirements) for operating in routine situations. Accordingly, the committee's main recommendation is the creation of clear distinction between routine situations and an incident or emergency situation. With respect to the various situations, the committee recommended adopting the relevant US regulation package on this issue, which is based on the following principles: a. examination of the plans for the burner system and adapting it to treat pollutants in routine and in emergency situations; b. limiting the duration for the emission of black smoke in routine situations to a minimum; c. strict monitoring of the operation of the burner in routine and malfunction situations; d. consistent reduction of the amounts of gases sent to the burner; e. investigation of events and malfunctions to locate the causes and prevent their recurrence. In order to examine the practical implications of the changes in the regulations, the committee recommended that a temporary regulating framework be set up that will operate for about two years and will form the basis for the application of the regulatory principles stipulated above. 1.7.19.6.2 On May 1, 2008 a hearing was held for Carmel Olefins (the "hearing") at the Haifa office of the Ministry of Environmental Protection district director (the "district director") at which Carmel Olefins representatives were present. The hearing was held following the district director's letter claiming that on April 9, 2008 black smoke was emitted from Carmel Olefins’ ethylene flare for periods of time, which when accumulated, exceeded six minutes per hour , which, according to the district director, constitutes breach of the provisions of the personal order. On May 6, 2008 Carmel Olefins sent a letter to the district director requesting that a professional committee be set up to examine the matter of the time permitted for the emission of black smoke from the Carmel Olefins flare during a breakdown, and this under the district director's authority under the directives covering emission in the event of breakdown This authority allows the district director, after a professional examination, to make changes in the directives covering the emission of smoke for cumulative periods of 6 minutes per hour. In the same letter, Carmel Olefins requested that until the decision of the professional committee is reached in this matter, the time permitted for the emission of smoke be an annual cumulative period of 25 hours as set forth in Carmel Olefins' previous personal order or that another temporary solution be decided that is appropriate for the existing technological means. In response to the above letter, the district manager noted in his letter dated May 11, 2008 that until decided otherwise, Carmel Olefins is obligated to the cumulative duration of 6 minutes and that as part of adapting the Carmel Olefins plant to the BAT criteria, which is being carried out by the Ministry of Environmental Protection in collaboration with Carmel Olefins, it will be possible to also examine the performance of the Carmel Olefins flare, including
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criteria for the duration of black smoke emissions deriving from the application of BAT for the flare. On May 19, 2008 Carmel Olefins received the minutes of the hearing. In the minutes of the hearing, the district director states that he was of the opinion that the provisions of the personal order and the Prevention of Hazards Law were contravened. During the hearing, Carmel Olefins disputed the district director's opinion when it claimed that no black smoke was emitted from the flare and that in any event, the emission orders in the event of breakdown are not capable of being implemented. In the minutes, the district manager demanded the following from Carmel Olefins: A. That Carmel Olefins submit to the Ministry for Environmental Protection and the Haifa Municipal Union, within one week from receipt of the minutes, a list of all breakdowns since 2004 up to the present during which black smoke was emitted into the environment and all actions taken by Carmel Olefins to prevent recurrence of such breakdowns; B. The Ministry of Environmental Protection will act to enforce the personal order, including demanding the prohibition of emission of black smoke, as written by them in their own words; C. Every pollution event in the future will force the district manager to demand that criminal investigations be started against Carmel Olefins and its directors; D. To discontinue operations in the monomer facility immediately until the installation of everything that is required in accordance with Best Available Technique (hereinafter; "B.A.T."), including the back-ups that are required in order to prevent mishaps, and all this at the satisfaction of the Ministry and the Haifa Municipal Union. E. Carmel Olefins is to establish an information center for public complaints and to publish it to the local communities to allow for providing information to the residents directly. Subsequent to the hearing and the hearing minutes received at Carmel Olefins on May 19, 2008 as aforesaid, Carmel Olefins shut down its facilities for nine days (the "temporary shutdown"). During the temporary shutdown which commenced from May 25, 2008 for a period of nine days, Carmel Olefins took various steps to ensure that BAT technologies that are installed in the flare, will be operated at the optimal functioning levels for the processes, including the back-ups that are required in order to prevent breakdowns. Carmel Olefins believes that with the termination of the temporary shut-down, it is in compliance with all of the requirements that were raised by the district director in relation to the flare. However, Carmel Olefins emphasized to the district manager that this will not solve the matter of the emission orders in the event of a breakdown, as specified in sections 1.7.19.6.1 and 1.7.16.6.2 above, and requested the appointment of a professional committee to study the matter. Furthermore, Carmel Olefins notified the district director that it had appointed a representative for handling public complaints and that this person can be contacted, inter alia, via Carmel Olefins website. 1.7.19.6.3 It is noted that in the hearing held on August 19, 2007 following a similar event of smoke emission, Carmel Olefins was informed that any further deviation from the provisions of the personal order will result in an investigation by the Ministry of Environmental Protection. For further details, see section 1.7.19.6.5 below. 1.7.19.6.4 On May 16, 2008 in the afternoon hours, a breakdown occurred in one of the polyethylene facilities at the Carmel Olefins plant. This resulted in a controlled explosion in the facility which caused a shutdown of the facility. No material damage was caused to the Carmel Olefins facility and it was reactivated on March 18, 2008. 1.7.19.6.5 On July 6, 2008, another hearing was held for Carmel Olefins at the district director office at the Ministry of Environmental Protection with respect to alleged emissions of black smoke from the Carmel Olefins plant on June 21, 2008. In the minutes of this hearing, the district director ordered Carmel Olefins, inter alia, to shut down one of its polyethylene plants until tests are completed and conclusions drawn, and ordered a test by a German expert within two
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weeks from the date of the hearing. The district director further ordered that the conclusions of the German expert’s report will be applied within one month of the hearing. Carmel Olefins implemented the requirements that appear in the minutes of the said hearing and shut down one of its polyethylene facilities, whose operations were renewed with the completion of the examination on July 18, 2008. On July 27, 2008, Carmel Olefins sent a letter to the district director to which the written confirmation of the German expert was attached, attesting to the ethylene facilities turbine system being in operating properly. 1.7.19.6.6 Domo is subject regulations concerning air, soil and noise pollution hazards from its facilities. Domo has a permit from 1995 under the Environmental Control Act (the "ECA permit"). As of October 31, 2007 Domo is required to also comply with the requirements of the European Union Directive for pollution control and prevention which, according to examinations, it does comply with. Furthermore, pursuant to the terms of the ECA permit, Domo is required to comply with the stringent requirements relating to noise from its industrial operations. As at the report date, Domo does not comply with some of these requirements, however Domo has prepared a plan with the approval of the authority certified to implement the required modifications of the systems in an amount of euro 150 thousand, which is expected to begin during the course of 2009. Furthermore, pursuant to the terms of the ECA permit, Domo is required to comply with various requirements relating to the storage of hazardous materials. In 2006, Domo complied with the requirements for the maximum storage of 25 tons of hazardous materials, though to the best of the Company's knowledge, based on the information received from Carmel Olefins, as at the report date, the certified authority has not taken any enforcement steps against Domo in this matter. To the best of the Company's knowledge, based on the information received from Carmel Olefins, as at the report date Domo is in compliance with the requirements of the ECA permit with respect to the storage of hazardous materials. Domo has a permit for pumping wastewater (the "WWD permit"). In 2004-2005 Domo breached the WWD permit due to the release of zinc above the permitted quantity set in the WWD permit, which apparently spilt from a truck and the wheels of a forklift. Due to the foregoing, the certified authority reduced the permitted maximum quantity of zinc for pumping as set in the WWD permit. In January 2008, the reference to the permitted level of zinc was lifted from the WWD permit after it became clear that the release of zinc was linked to the logistics process and not to the production chemical process. 1.7.19.6.7 In order to conclude the Domo agreement (see section 1.7.1.2.2 above and section 1.7.22.9 below) the consultant on environmental quality matters (the "environmental consultant") conducted various tests on the soil and groundwater in the region in which Domo's plant is located. These tests indicated that the soil is contaminated, inter alia, with various oils and metals. The environmental consultant believes that the source of part of the pollution is, apparently, the result of the preparations carried out in the area in which the Domo plant is located between 1961-1971 and its adaptation for industrial needs by using contaminated sand and mud. Since the Rotterdam Ports Authority developed the area for industrial use after 1971, the foregoing historic pollution of the soil is probably not connected to industrial activities. The environmental consultant concluded, based on the results of the tests he conducted, that there is no reason to determine that Domo polluted the soil and the groundwater as a result of its industrial activities and in his opinion, the pollution level is not high enough for the certified authorities to demand soil treatment. The environmental consultant found an unusual result with respect to TPH contaminated compounds in a specific spot at the site which most probably originates from industrial activities from prior to 1992 and which he estimates is not linked to Domo's industrial activities. For further information relating to the Domo agreement and the Carmel Olefins' subsidiary's rights to indemnification from Domo Chemicals for the soil pollution claims, see section 1.7.22.9 below. 1.7.19.7 Material investment in environmental issues for the expansion plan
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As part of the preparations for the execution of the expansion plan (see section 1.7.1.2.1 of the report) and the need for compliance with the Ministry of Environmental Protection requirements with respect to said plan, as at the report date Carmel Olefins has invested an amount of USD 11 million. 1.7.20 Restrictions and supervision on Carmel Olefins’ operations 1.7.20.1 The laws applicable to the operations of Carmel Olefins In addition to the provisions of section 1.7.19 above, as with any industrial plant, the company is subject to laws relating to work safety. The Company is also subject to the laws specified below. 1.7.20.2 Price control Under section 6 of the Supervision of Prices of Commodities and Services Law, 5756-1996 ( Supervision Law), supervision under Chapter F of the Supervision Law was imposed on prices for polyethylene and the storage of ethylene. Under the provisions of Chapter F of the Supervision Law, in the event that Carmel Olefins wishes to increase the price of the products under supervision, it must submit a detailed application, and the Supervisor of Prices may require additional details in order to investigate the matter. The application shall be deemed to be approved if the Supervisor of Prices does not give notice of rejection of the application, or does not respond to the application within 30 working days of the date of its delivery to the Supervisor. Reduction of prices is also subject to supervision under the Supervision Law, through the temporary imposition of Chapter E of the Supervision Law on Carmel Olefins. Up until February 1, 2007, the prices of low density polyethylene for the local market were supervised under the Supervision Order. On February 1, 2007, the above Order was repealed. 1.7.20.3 Business licenses Under the law, Carmel Olefins’ business requires a business license in respect of its manufacture operations and in respect of the storage of dangerous substances at the Kishon Port and the transporting of hazardous materials through pipes. Business license for production facilities On December 29, 2005, the Minister of the Interior published a declaration regarding the municipal attachment of the land on which the production facilities of Carmel Olefins' are situated to the jurisdiction of the Municipality of Haifa. Up until that date, Carmel Olefins’ Land was not attached to any local authority and, as such, no business licenses were granted to businesses located within this compound. In August 2006, Carmel Olefins applied for a business license. Carmel Olefins has a temporary business license which is valid until September 30, 2009, to enable the plant to promote the rezoning and building permits. The temporary license is subject to the Ministry of Environmental Protection terms and conditions. Business license for storage facility The ethylene storage facility has been within the jurisdiction of the Haifa Municipality since 1995, however due to regulatory difficulties and since there is no outline plan for the land and to date the Municipality has not issued a business license for the storage facility. However, in September 2004, Carmel Olefins was issued a temporary permit containing conditions for a business license with respect to the storage facility, in accordance to which Carmel Olefins operates. 1.7.20.4 License to transport dangerous substances Carmel Olefins has a license from Haifa Municipality to transport dangerous substances in pipelines. The license is in force until May 30, 2009. 1.7.20.5 As at the report date, Carmel Olefins has firefighting authority certification valid until June 30, 2009. 1.7.20.6 Special permit to employ employees on the Sabbath
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Carmel Olefins facilities operate continuously in three shifts a day, every day of the year. Under the provisions of the Hours of Work and Rest Law, 5711-1951, Carmel Olefins has a special permit for employing employees during the weekly rest day, which is in force until December 31, 2009, and Carmel Olefins acts to renew such permit every year. 1.7.20.7 Declaration as essential enterprise Carmel Olefins has been declared an essential enterprise under the Work Service in an Emergency Law, 5727-1967, which is in force until December 31, 2009. For details of the significance of the declaration of Carmel Olefins as an essential enterprise, see section 1.6.26.11 of the report. 1.7.20.8 Antitrust On April 9, 1995, the Antitrust Commissioner declared that Carmel Olefins is a monopoly in the field of supply of ethylene. On July 5, 1989, prior to the commencement of its operations, the Company, through IPE, was declared to be a monopoly in the field of low density polyethylene and polystyrene in Israel, by the Antitrust Commissioner. As of August 1999, Carmel Olefins does not manufacture polystyrene. As a monopoly in these areas, Carmel Olefins is subject to the supervision of the Antitrust Commissioner, including the provisions of the Antitrust Law, 5748-1988, regulating the actions of monopolies, and providing, among other things, that supply of the asset or service under the monopoly must not be unreasonably refused, and that its status in the market must not be abused in such a way as to reduce competition in business or to harm the public. For restrictions issued as part of the decision of the Commissioner regarding the merger request of the Company, the Israel Corporation and PCH, see section 1.6.26.5 above. 1.7.20.9 Quality control Carmel Olefins conducts quality control in accordance with the usual measures in its field of operations, and in accordance with international quality standards. Carmel Olefins' quality management system was examined nd surveyed by the Israel Standards Institute and was found to comply with the requirements of the Israeli and international Standard ISO 9001 version 2000 (in force until May 31, 2010) in the area of content, development and manufacture of polyolefins, ethylene and by-products and project management. In addition, Carmel is certified for Israeli Standard ISO 27001 in the field of data security in the management system of Carmel, valid until August 31, 2008. In addition, Carmel Olefins is also authorized under Israeli and International Environmental Management Standard ISO 14001 (in force until May 31, 2009). and Israeli Standard IS18001 for Management of Occupational Safety and Hygiene (International Standard – OHSAS 18001, valid until July 1, 2010). In 2008 the Company received certification of its compliance with the Israeli Standard IS 10,000 (valid until February 28, 2009), after it was found in compliance with the guidelines of the Israeli Standards Institute for social responsibility of organizations. As of the date of the report, these certifications are valid and are conditional upon constant maintenance and performance of periodic follow-ups by the Israel Standards Institute. The Company's quality assurance falls under the responsibility of the Quality Assurance manager. Domo is certified under the International Environmental Management Standard ISO 14001, which is in force until January 8, 2010. 1.7.21 Insurances 1.7.21.1 Carmel Olefins maintains customary insurance coverage against risks related to its nature of activities. The material insurance policies maintained by the Company as of the date of the report are as follows: 1.7.21.1.1 Property and loss of profit insurance policy – Carmel Olefins is covered by a property and loss of profit insurance policy which also includes earthquake coverage. The limit of liability in this policy is USD 1,000 million, subject to a deductible in the event of loss of profit for 48
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days for 48% of the coverage and 60 day waiting period for the balance of the coverage, and in the event of property damages, an amount of USD 5 million. The earthquake policy is up to a limit of liability of USD 750 million and the deductible in the event of an earthquake is 5% of the damage. The insurance peri0d is meant to end on May 1, 2010. 1.7.21.1.2 Terrorism and hostilities insurance policy – Carmel Olefins has insurance cover damages caused by terror acts or as a result of an event defined as a war. The limit of liability in this policy is USD 200 million, subject to a deductible in the event of loss of profit for 60 days and in the event of property damages, an amount of USD 1 million. The insurance period is meant to end on May 1, 2009. 1.7.21.1.3 Third party and product liability insurance policy – the limit of liability in this policy is USD 100 million, subject to a deductible in the event of product liability of USD 35 thousand and in the event of a third party claim in an amount of USD 10 thousand The insurance policy also covers legal costs. The insurance period is meant to end on June 1, 2009. 1.7.21.1.4 Employer liability insurance policy – the limit of liability in this policy is USD 50 million, subject to a deductible in the amount of USD 10 thousand. The insurance period is meant to end on June 1, 2009. 1.7.21.1.5 Directors’ and officers’ liability insurance policy – Liability limit for directors and officeholders at Carmel Olefins is up to an amount of USD 25 million per claim and per period, subject to the terms of the policy and its restrictions. The insurance cover under each of the policies set out above is subject to the conditions and exceptions set out in each such policy. 1.7.21.1.6 Domo maintains customary insurance cover against risks related to its nature of activities. The material insurance policies maintained by Domo as at the report date are as follows: A property insurance policy with limit of liability of Euro 116, million for the value of the property and Euro 60 million for loss of profits for a period of 24 months, subject to a deductible of Euro of 1 million for material damages and a 7 day waiting period for loss of profits, when the minim loss of profit is Euro 250 thousand. The insurance period ends on June 30, 2009. Third party, product liability, employer liability and accidental environmental damage insurance policy – the limit of liability for the policy is Euro 12.5 million, subject to a deductible of Euro 12.5 thousand in the event of product liability and employer's liability and of Euro 1.25 thousand in the event of a third party claim. The insurance period ends on December 31, 2009. Insurance against mechanical breakdown – the limit of liability in this policy is Euro 82 million, subject to a deductible in the amount of Euro 100 thousand. The insurance period ends on June 30, 2009. An insurance policy against loss of profits resulting from a mechanical breakdown – the limit of liability in this policy is Euro 75 million, subject to a deductible in the amount of Euro -7 thousand. The insurance period ends on June 30, 2009. The insurance cover under each of the policies set out above is subject to the conditions and exceptions set out in each such policy. 1.7.22 Substantial agreements Material agreements between Carmel Olefins and its shareholders 1.7.22.1 Founders’ agreement On July 20, 1988, the Company and IPE entered into a founder's agreement under which the parties agreed to cooperate in the field of polymers, by way of a new company that would be jointly owned by them ( the "Founders Agreement:). Under the provisions of the Founders’ Agreement, the Company’s ethylene facility and IPE’s polyethylene facilities were merged into Carmel Olefins, as were other assets connected with the area of operations.
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Under the provisions of the Founders’ Agreement, the board of directors of Carmel Olefins is comprised of eight directors, four appointed by the Company and four appointed by IPE. On August 16, 2007, the articles of association of Carmel were changed whereby the number of directors of the company would be set by the general shareholders meeting (on condition that it is made up of an even number of directors and no less than 8) and that any shareholder who holds 50% of the share capital of the company will be entitled to appoint half of the directors. The general meeting also determined that the number of directors of Carmel would be ten. On August 28, 2007, each of the Company and IPE appointed an additional director on its behalf to the Carmel board such that the board was then comprised of ten directors. In addition, Carmel Olefins has an executive committee made up of four directors, two of whom are appointed by the Company and two of whom are appointed by IPE. The chairman of the board of directors of Carmel Olefins is appointed by IPE, and the Company appoints the chairman of the executive committee of the board of directors (the chairman of the board of directors of Carmel Olefins and the chairman of the executive committee do not have a casting vote in the case of a hung vote). The board of directors of Carmel Olefins is the entity that appoints the CEO of Carmel Olefins. The articles of association of Carmel Olefins provide that the powers of the executive committee are similar to those of the board of directors of Carmel Olefins, except in that the executive committee is not authorized to approve financial statements, to declare dividends and/or bonus shares, to pass a decision regarding the employment and/or termination of the employment of the CEO of Carmel Olefins, and is not authorized to cancel and/or amend resolutions passed by the board of directors of Carmel Olefins. The Agreement also provides that in the event that one party seeks to sell its shares in Carmel Olefins, the other party will have a right of first refusal to purchase the shares of the selling party. The Founders’ Agreement also provides that so long as the parties hold shares in Carmel Olefins in equal shares, they will not compete with Carmel Olefins' business. 1.7.22.2 Management agreement: In 1995, Carmel Olefins entered into a management agreement with the Company and IPE (the "management agreement") Under the provisions of the Management Agreement, the Company and IPE provide Carmel Olefins with management and consultancy services which include, among other things, handling contacts with authorities, consultation and assistance with development plans, expansion and investments, consultation on the establishment of new facilities, assistance in contacts with banks, consultation and direction on professional issues such as environmental quality, dangerous substances, firefighting and assistance and consultation in preparation of budgets. In consideration for such management services, Carmel Olefins undertook to pay each of the parties an annual management fee of USD 750,000, plus VAT (the “fixed management fee”). The fixed management fee was updated from time to time, and as of the date of the report, it is a maximum of USD 2.5 million to each party (for the parties’ decision regarding update of the management fee in the years 2003 – 2006 in light of the increased scope of the services, see section 1.7.22.4 of this report). The initial period of the Management Agreement was set for one year, with the Management Agreement renewing automatically at the end of each calendar year for an additional term of one year each time, unless one of the parties gives notice to the other of non-extension of the Agreement, at least 60 days prior to the end of such year. The parties further agreed under the Management Agreement that all documents, plans and other material that may be prepared by the Company and/or IPE for Carmel Olefins under the Management Agreement shall be the exclusive property of Carmel Olefins. 1.7.22.3 Feedstock supply agreement In 1997, an agreement was signed between the Company and Carmel Olefins under which the Company undertook to supply 600,000 tons a year of light naphtha and LPG to Carmel Olefins’ monomer facility, at those prices set out in the agreement. The term of the agreement was set for 5
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years from the date of execution. As set out in section 1.7.22.4 of the report, under an agreement signed in March 2004, the term of this agreement was extended to the end of 2010. 1.7.22.4 Shareholders’ agreement On March 15, 2004, an agreement was signed between the Company, IPE and Carmel Olefins, regarding the relationship between Carmel Olefins and its shareholders (the Company and IPE), and setting out the framework conditions for expansion of Carmel Olefins’ polypropylene facility and for the supply of feedstock by the Company to Carmel Olefins (the "2004 Agreement"). The following are the main points of the agreement: Dividends – with respect to the provisions of the 2004 Agreement on the matter of the distribution of dividends by Carmel Olefins, see section 1.7.1.4 of the report. Management fee - in view of expansion of the services provided by the parties to Carmel Olefins in 2003 – 2006, it was agreed that in addition to the fixed management fee paid to the parties under the management fee agreement (see section 1.7.22.2 of the report), Carmel Olefins shall pay each of the parties, between the years 2003 and 2006, the sum of 0.5% of all of Carmel Olefins’ revenues, up to the sum of USD 1.25 million to each of them. On November 20, 2006, the board of directors of Carmel Olefins decided that since the scope of management services expected to be given to Carmel Olefins by the Company and by IPE will not decrease and is even expected to increase in the coming years compared with the scope of services provided in recent years, Carmel Olefins shall continue to pay the parties the increased management fee as aforesaid, so long as the Shareholders' Agreement is in force. Supply of feedstock - the Company undertook to supply Carmel Olefins with the raw materials used to manufacture propylene at its facility after its expansion, for a period of 10 years, on the conditions set out in the agreement. The parties further agreed that the term of the agreement for supply of feedstock of 1997 (see section 1.7.22.3 of the report) would be extended until the end of 2010 (the “additional term”). In addition, conditions were stipulated regarding the amounts and prices for purchase of feedstock from the Company during the Additional Term. The agreement also set down conditions and prices for the return of by- products to the Company. In June 2006, the Company gave notice to Carmel Olefins that it had assigned part of its obligations and rights with respect to supply of feedstock to Carmel Olefins to ORA, as of the date of commencement of operation of the facilities set up under the Expansion Plan. Waiver of claims - upon entry of the Shareholders Agreement into force, the parties finally and absolutely waived any claim and/or cause of action, if any, against each other, in the present and in the past. This waiver applies to any claim and/or suit, whether known to the parties on the date of execution of the agreement or not. 1.7.22.5 Agreement for the purchase of property from IPE in 2006, as described in 1.7.9 of this report. 1.7.22.6 Agreements for the receipt of necessary know-how to set up and operate the new polypropylene plant and facilities that will manufacture the raw materials for this facility, as detailed in paragraph 1.7.11.2 of the report. 1.7.22.7 Credit agreements with banking institutions, as detailed in section 1.7.17.5 of the report. 1.7.22.8 With regard to the agreement between Domo and Basell with respect to the purchase of propylene, see section 1.7.14 above. 1.7.22.9 Investment agreement in Domo On January 23, 2008, Carmel Olefins entered into an agreement, through a wholly-owned subsidiary Colland Polymers B.V. ("Colland") with Domo Chemicals N.V. ("Domo Chemicals") (the "Domo Agreement") for the acquisition of 49% of the shares in Domo Polypropylene B.V ("Domo"). To the best of the Company's knowledge, Domo Chemicals is incorporated in Belgium and is controlled by Domo N.V. To the best of the Company's knowledge, Domo N.V. was incorporated in Belgium and is controlled (indirectly) by the
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family of Mr. Jan De Clark. To the best of the Company's knowledge, Domo is a company incorporated in the Netherlands, which prior to the conclusion of the transaction as set out in the Domo agreement, was wholly owned (100%) by Domo Chemicals, which was incorporated in Belgium. Domo operates in the petrochemical industry and engages in the manufacture and marketing of polypropylene, which is used as raw material in the plastics industry for a range of uses and products. Domo owns one polypropylene manufacturing plant in Rotterdam in the Netherlands, with an output of 180,000 tons of polypropylene per year. In consideration for the acquisition of 49% of Domo's share capital, Colland paid to Domo Chemicals on May 6, 2008 (in this section – the "conclusion date") an total amount of Euro 20 million in cash. In addition, commencing 2013, Domo Chemicals. may be entitled to additional compensation, not exceeding an amount of Euro 1 million a year for a five-year period, in accordance with the terms set out in the agreement. The Domo agreement stipulates that Domo Chemicals will be liable and will indemnify Colland for any damages deriving from existing soil pollution on the land on which the Domo plant is located prior to Decembe4r 31,2007 and including the tests carried out by the environmental consultant (see section 1.7.19.6.7 above). The Domo agreement also stipulated that Colland is liable and will indemnify Domo Chemicals for any third party claim against Domo Chemicals relating to soil pollution that does not appear in the tests carried out by the environmental consultant and which cannot be proven that it was caused mainly by Domo during the period when Domo Chemicals or Basell Europe Holdings B.V. were the controlling shareholders of Domo. Under the agreement, upon completion of the transaction, Colland will enter into a joint venture agreement with Domo Chemicals N.V(the "joint venture agreement") which terms and conditions were agreed upon by the parties and are attached as an appendix to the agreement. Carmel, through Colland, will have a call option until December 31, 2016, for the purchase of the balance of the shares (51% of the remaining Domo shares) for an additional amount of Eur10 million less the dividends to be distributed to Domo Chemicals N.V., plus interest at a rate of 5% per annum, commencing from the date of completion and up to actual payment. Domo will have a put option, exercisable commencing on July 1, 2011 until December 31, 2016 for the sale of the remaining 51% to Carmel Olefins under the same terms. Under the joint venture agreement, as of the completion date until the call or put option exercise date mentioned above, it they will be exercised, the Domo board of directors will be equally representative of Colland and Domo Chemicals, and Domo will be run according to the business plan which the parties will agree upon. Furthermore, Colland will be entitled to appoint one of the three executive directors at Domo. Under the joint venture agreement, Colland will be entitled to propose, at its sole discretion, what dividend amounts will be paid by Domo to its shareholders and Domo Chemicals will be obligated to support such dividend distribution, provided that they do not put Domo's financial stability at risk and subject to any law. The joint venture agreement also stipulates that both Colland and Domo Chemicals will provide Domo with various services and will be entitled to receive payment for these services as agreed upon in the Domo agreement. As at the report date, Colland's acquisition of Domo shares has been financed by a short-term loan extended to Carmel Olefins, and this is up until Colland signs the loan documents with the banks. On May 5, 2008, Carmel Olefins extended a loan in the amount of Euro 20 million to Colland. The loan period is up until November 5, 2008 and the loan bears annual interest of Euribor + 0.7% (cumulative once per quarter). This loan was extended until November 5, 2009 and bears annual interest of Euribor + 1.5% (cumulative once per quarter). As at the report date, Colland has not yet signed on the loan agreements with the external financing organizations and the terms have not yet been agreed.
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The acquisition of Domo shares was part of Carmel Olefins strategy to examine opportunities to acquire companies abroad operating in its area of operation and their enhancement through Carmel Olefins know-how, services and support. As at the date of this report, Colland has no intention of changing Domo's specialty nor that of the polypropylene production facility and Colland is not committed to invest in Domo after its acquisition. The transaction was completed on May 6, 2008, after all the pre-conditions in the acquisition agreement were fulfilled. 1.7.23 Legal proceedings Except as disclosed below, Carmel Olefins is not party to any legal proceedings that are material to the Company: 1.7.23.1 Claims for bodily injury and damage to property allegedly incurred by the plaintiffs as a result of pollution of the Kishon River have been field against Carmel Olefins and other persons (including the Company), neighboring plants and authorities of the State. For details of the proceedings in these claims, see section 1.6.31.1.1 of the report. For the Company’s assessment regarding the risks to Carmel Olefins as a result of the above proceedings, see section 1.6.32.1.1 of this report. The Company’s assessment as aforesaid is based on the opinion of Carmel Olefin’s legal counsel. 1.7.23.2 A claim was filed against Carmel Olefins and other entities (including the Company), by Israel Dockyards Ltd., alleging that pollution of the Kishon River by the defendants caused various damage to the plaintiff’s facilities, situated at the mouth of the river. The lawsuit amounts to NIS 21 million (as of the date of filing - January 1, 2004) and an undefined amount is claimed for future damages and compensation. Carmel Olefins filed a statement of defense in which it claims that it acted and continues to act in accordance with the permits from the certified authorities and that the materials pumped by it into the Kishon River did not cause the damaged claimed in the suit. Carmel Olefins filed a third party notice to the relevant parties, jointly with the other three defendants in this case. On March 18, 2008 the plaintiff and Carmel Olefins signed a compromise agreement according to which the lawsuit against Carmel Olefins will be dismissed and all procedures relating exclusively to Carmel Olefins will be deleted from the expert opinion on behalf of the plaintiff. In the compromise agreement, Carmel Olefins undertook that if a compromise is achieved with the consent of most of the defendants and third parties, which will end all proceedings in the lawsuit, it will participate in 2.8% of the amount paid to the plaintiff under the compromise agreement. On March 26, 2008 this compromise agreement was given the validity of judgment. Carmel Olefins is negotiating with the plaintiffs so that it will not be served a third-party notice therefore its final status in the case has yet to be clarified. In the current situation, the legal counsels of Carmel Olefins estimate that Carmel Olefins will not be charged a material amount for this suit, if at all. 1.7.23.3 Indictments have been filed in the Local Court at Haifa against Carmel Olefins, and five of its officers, due to two events of emission of black smoke from two flares. The defendants were acquitted and an appeal was filed against the acquittal to the district Court (for details see section 1.6.25.2.8 of the report). On October 16, 2007, the Haifa District Court partially accepted the appeal of the State of Israel regarding the previous decision of the Magistrates Court and convicted Carmel Olefins of the criminal indictments lodged against it in respect of air pollution in connection with the events of the black smoke emission that occurred on September 15, 2003 and October 5, 2003. Notwithstanding, the District Court sustained the acquittal of the executives of Carmel Olefins from the charges filed against them in the same matter. The District Court returned the case to the magistrates court to pass sentence on Carmel Olefins. On November 19, 2007, Carmel Olefins filed a request for permission to appeal to the Supreme Court, the decision of the District Court to convict Carmel Olefins of the criminal
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indictments filed against it. On September 7, 2008 a hearing was held in the Supreme Court, during which Carmel Olefins and the State presented the plea bargain reached by them to the court (the "plea bargain"). According to the plea bargain: (a) the rulings handed down by the Magistrates and District Courts will be repealed; (c) the indictment will be amended so that the Company's officers will be struck from the indictment. In addition, the aggravated grounds will be eliminated; (c) the Company will plead guilty to the amended indictment; (d) a fine of NIS 600,000 will be imposed on the Company; (e) the Company will undertake a commitment of NIS 400,000 to avoid committing another violation of the type noted in the indictment for a period of two years On September 17, 2008, a ruling confirming the aforesaid plea bargain was handed down and the State amended the indictment. It should be noted that the Company's undertaking within the framework of the plea bargain was given subject to correspondence with the Attorney General in which the Ministry of Environmental Protection assured that there were no contingent and pending criminal investigations against the Company for violations of environmental laws and that it will not file environmental related indictment against the Company, and this with respect to the events in which the Company was involved and was known to the Ministry on July 24, 2008. The Company's undertakings within the framework of the plea bargain were also given subject to the agreement of the Ministry of Environmental Protection that the professional committee to discuss the six minute limit set forth in the personal order for the Company will convene and take a decision soon. 1.7.23.4 For further information relating to the suit filed against the Company, Carmel Olefins, the CEO of the Company and the CEO of Carmel Olefins and the petition to approve it as a class action, see section 1.6.31.4 above. 1.7.23.5 On October 28, 2008 Carmel Olefins was presented with an application for the certification of a class action pursuant to the Class Actions Law 5766-2006, filed on October 5, 2008, with the Tel Aviv District Court (the "Bernstein Lawsuit"). The Bernstein lawsuit was filed for undisclosed damages caused, according to the applicant's claims, following the events mentioned in section 1.6.31.4 above. In the petition, the applicant asks to represent the residents of the Haifa Bay area and those who were present in the area ("a member of the group") and were exposed to the smoke emissions on the said dates. The applicant claims that each of the members of the group is to be compensated NIS 1,000 for the damage allegedly caused. The petition for approval does not quote the estimated number of the group’s members and does not quote the total amount that the application claims should compensate the group. The applicant claimed that he filed the application following the results of the criminal procedure against Carmel Olefins (see section 1.6.25.2.8 above), under which Carmel Olefins was convicted, at its own admission, in a revised indictment relating to the events in the plea bargain. In Carmel Olefins' opinion, based on the opinion of its legal counsel, inter alia, due to the early stages of the proceedings, the complexity of the proceedings, the need to study the suit in depth and the fact that the applicant did not mention the overall amount that in his opinion the members of the group should be compensated, it is unable to assess at this stage the chances of the outcome of the petition and it also cannot at this stage estimate Carmel Olefins financial exposure relating to it. 1.7.23.6 Among other things, since the Bernstein lawsuit was filed with respect to the same events and damages as the suit mentioned in section 6.31.4 above (the "Reichin Lawsuit") and in view of he great similarity and overlap between the two lawsuits, Carmel Olefins filed a petition on December 16, 2008 with the Tel Aviv District Court to transfer the hearing in the Bernstein lawsuit to the Haifa District Court, in order that the Bernstein lawsuit will be brought before the Hon. Judge Yitzhak Cohen (sitting on the Reichin lawuit), together with the Reichin lawsuit. At the same time, as at the report date, negotiations are currently underway between the Applicants in the Reichin lawsuit and Carmel Olefins with the purpose of examining the possibility of including Carmel Olefins in a complementary compromise settlement to the compromise agreement arrived at in the Reichin lawsuit, between the applicants and the Company, as set forth in section 1.6.31.4 above. 1.7.23.7 As part of its regular operations, Carmel Olefins is the subject of lawsuits that are not material to the Company. In the opinion of the management of Carmel Olefins, in reliance on the opinions of its legal counsel, the provisions made on its books on account of these claims are sufficient.
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1.7.24 Forecast for developments in the coming year 1.7.24.1 Within the working plans for 2009, Carmel Olefins board of directors approved on January 18, 2009 Carmel Olefins decision regarding streamlining steps to be taken in a variety of sectors, including in production, logistics, procurements, contractors and human resources, and this against the background of the global financial crisis and its implications on the Israeli market. 1.7.24.2 As part of the aforesaid decision, the Chairman of Carmel Olefins board of directors and other officers gave notice to Carmel Olefins, on their own initiative, of their decision to waive 5%- 11% of the remunerations they are entitled to receive, individually, during the course of 2009 (with the exception of the issue of provisions and related conditions) and, similarly, the directors serving at Carmel Olefins, gave notice on their own initiative of their decision to waive 10% of the directors fees they are entitled to receive during 2009. 1.7.25 Business Strategy and Objectives Carmel Olefins periodically assesses its business strategy and goals. The strategy includes, among other things, self manufacture of most of the raw materials and expansion of its activities abroad, in view of its having exhausted the potential for feedstocks in Israel. In order to carry out this strategy, Carmel takes the following steps (among others): • Operation of the propylene and polypropylene facilities that were set up as part of the expansion plan, so as to exhaust and take advantage of the increased production capacity of polypropylene, in order to supply the demand for this product, using the new technology that facilitates the production of new types of polypropylene with improved quality, which could not be manufactured using the previous technology. • Finding opportunities to acquire foreign companies whose primary operations are Carmel Olefins core business. As part of this, Carmel Olefins signed a contract , through Colland, with Domo Chemicals N.V. For details see sections 1.7.1.2.2 through 1.7.22.9 above. • Activities in the areas of social responsibility, the community and environmental quality. The goals set out above reflect Carmel's strategy as of the date of the report. By their very nature, such goals are subject to changes on the basis of developments in Carmel, the polymer industry in Israel and abroad, in the target markets and demand characteristics of the products sold by the Company. Materialization of such strategy is uncertain and involves among other things circumstances and factors that are beyond the control of Carmel Olefins and/or the Company, including the risk factors set out in section 1.10 above.
1.8 Aromatics Segment 1.8.1 General As noted above, as part of the petrochemical business segment, the Company operates in the manufacture and marketing of aromatic products. Gadiv, which was founded in 1978, and which has been under the full ownership of the Company since 1994, is engaged in the manufacture and sale of aromatic products. The products manufactured by Gadiv are interim products or components of the raw materials used in manufacturing other products, and are not intended for consumption by end users. The aromatic products are used as raw materials in the manufacture of clothing, drugs, packaging, cosmetics, computers, paints, vehicle spare parts, home maintenance products, etc. 1.8.2 Agreement with the Company for the processing and purchase of raw materials 1.8.2.1 The raw materials required for the manufacture of Gadiv’s products are supplied to it by the Company under an agreement signed between parties on August 12, 2001, and amendments thereto, the purpose of which is to optimize the integration of the joint operation of the parties’ production systems ( the “Processing Agreement”). Under the provisions of the Processing Agreement, the parties are to act as follows:
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1.8.2.1.1 The Company is to provide Gadiv with reformat43 produced by the Company and dripolene44 which the Company purchases from Carmel Olefins in such amounts as may be determined in the production plan by the Company, the VP Commerce and Marketing at the Company’s headquarters having responsibility for this, following consultation with Gadiv ( the “Production Plan”) and Gadiv will then process and separate the benzene, toluene and xylene in them. 1.8.2.1.2 Gadiv shall retain and purchase the benzene, toluene and xylene separated out in its facilities, as well as quantities of C9 and refinate. All other materials pumped to Gadiv for processing, and quantities of toluene and xylene determined in the production plan as being required to be returned to the Company shall be returned to the Company by Gadiv. 1.8.2.2 The following is a flow chart of the process of pumping raw materials and return of certain materials to the Company:
לפיטייSolvents ם ממיסיאםAliphatic Aliphatic בPoolנ זין מבלהלRefinate 30,000 Gasoline אליפטייםSolvents 145,000 בנזןBenzene 125,000 בPoolנ זין מבלהלGasoline PMax Toluen 70,000 טולואן Pyrolysis e Rich Aromatic Stream דריפולן Gasoline 60,000
א 70,000 ש י
נהדרידAnhdride פטאליאקPhthalic ת מ י ה 23,000 צ ו י Intermediates פ יניים מוצרבי אורתוקסילןOrthoxylene ר ד Extraction רפורמטReformate ז י רה Aromatic split
SA,DSS,FA ק ו 900,000900,000 1,500 ק
Refining Ortho Depleted Xylene אורתוקסילןOrthoxylene 30,000
פאראקסParexילן Parex 170,000
Toluene and Xylene סיXyleneל ן ממיקסstreams Solvent 10,000 איזומריזציהIsomerization Virgin Xylene
בדיםSolventsמ מיסיכםHeavy ולUnitג ד מתקסןSolgad 30,000
בPoolנ זין מבלהלHeavy Solvents (C9) Gasoline Streams returned to the Company 295,000 Per year in tons in the data sheet
1.8.2.3 The processing fee paid by the Company to Gadiv is based on a formula which takes into account a refund of a proportional part of the total fixed and variable expenses of Gadiv in accordance with Gadiv’s income statements for each year of the agreement, as a ratio of the amount of substances returned by Gadiv to the Company to the total amount of the substances processed by Gadiv. The total processing fees paid by the Company to Gadiv in 2008 and in 2007 were USD 49 million and USD 41 million respectively. 1.8.2.4 The consideration for the materials retained by Gadiv and purchased by it from the Company, as set out above, is determined in accordance with price formulae agreed upon by Gadiv and the Company, and based on international prices. The total payments made by Gadiv for the aforesaid purchase in 2008 and in 2007 were USD 400 million and USD 390 million respectively. 1.8.2.5 For the purpose of settling accounts between the parties, Gadiv undertook to provide the Company, once a month, with all of the data relating to the total variable expenses, quantities
43 A high-octane substance produced in the Company’s catalytic reformer, which contains high concentrations of aromatic materials. 44 A by-product of the cracking of naphtha in Carmel Olefins' facilities, which contains a high concentration of benzene.
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of fluids and quantities returned, etc., all such data being verified and checked against the Company’s data. 1.8.2.6 The payments made under the Processing Agreement are made in US dollars on the 15th day of the month following the account month. 1.8.2.7 The Processing Agreement is in force until the earlier of December 31, 2009 and the date on which the Company ceases to be the sole owner of Gadiv. 1.8.3 General information regarding the area of operations in aromatics Most of the aromatic products are commodities, and the market is a competitive market of supply and demand. The awakening of developing markets in recent years, headed by the Chinese market, has caused an increase in demand for many products which are used to manufacture downstream products, including aromatic products, and as a result, additional plants are being set up around the world which operate in the field of aromatics. As set out above, the aromatic products are mostly interim products or components in the raw material used in manufacturing other products, and are not intended for consumption by end consumers. Therefore, the principal customers for aromatic products are manufacturing companies in the fields of chemistry and plastics. The standards and legislative restrictions set out in section 1.8.24 of this report apply to aromatic products. 1.8.4 Critical success factors Over the years, Gadiv has used a number of methods for positioning itself in the market and setting itself apart from its competitors. These include: 1.8.4.1 Over the years, Gadiv has established a reputation as a reliable company that meets its supply times and maintains a high and uniform level of quality of its products. 1.8.4.2 A high technological ability and long-term experience enable Gadiv to obtain high yields of raw materials and to implement unique methods of for optimizing energy consumption, which enable a reduction in the costs of manufacturing products. 1.8.4.3 The proximity to the Company’s facilities, reduces the cost of transportation of the raw materials for Gadiv’s products. In addition, the relationship between the Company and Gadiv enables manufacture of the aromatic products or gasoline (which are at the expense of one another), and where demand for aromatic products falls, Gadiv pumps more raw materials back to the Company, and vice versa. 1.8.4.4 Strict compliance with quality standards - Gadiv continuously invests resources and funds in improving the quality of its products and in maintaining its position as a company with a high quality line of products. 1.8.5 Barriers to entry into the aromatics production business In the Company’s assessment, the following factors are barriers to entry into the area of Gadiv’s operations: 1.8.5.1 Dependence upon supply of raw materials and the need to have a refinery near the plant; 1.8.5.2 The need for large capital investments, the scope of the investment being influenced by the requisite production line yield and production quality; 1.8.5.3 Obtaining the regulatory approvals required in order to set up and operate facilities for the production of aromatic products, and to comply with the conditions thereof; 1.8.5.4 The need for broad technological knowledge and experience; 1.8.5.5 The relatively lengthy period required to establish a plant (two to three years); 1.8.5.6 The need to establish strong marketing and distribution channels appropriate for dealing with customers and potential customers for the purpose of competing with Gadiv’s competitors.
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For additional details regarding competition in the aromatics field, and the risk factors involved in Gadiv’s operations, see sections 1.8.11 and 1.10 of this report. 1.8.6 Products Gadiv’s principal products, which are produced from raw materials purchased from the Company as set out in the Processing Agreement in section 1.8.2 of the report, are as follows: 1.8.6.1 Benzene - benzene is used as a basic chemical in the manufacture of a broad variety of products used in day-to-day life, such as polystyrene, polycarbonate, etc., but it is not used as an end product consumed directly by end consumers. 1.8.6.2 Toluene - is a component in the manufacture of polyurethane, which is used to prepare foam for insulation or coating, and is common in the vehicle, furniture, construction and other industries. Toluene is also used in the production of paraxylene and benzene. 1.8.6.3 Xylene - is used as a raw material in the production of paraxylene, and as an organic solvent in the paint industry. 1.8.6.4 Paraxylene - is an important component in the production of polyester, which is a component used in the clothing industry. It is also used as a raw material in the production of beverage packaging. This is Gadiv’s main product. 1.8.6.5 Orthoxylene - is used as a raw material for the production of phthalic anhydrides. 1.8.6.6 Phthalic anhydrides - used in the production of softener for the plastics industry and in the production of various polyesters. 1.8.6.7 Solvents - the principal demand for solvents comes from the paint and coatings industries. In addition, solvents are used as a raw material in agriculture, in the area of pesticides, weed killers, etc., and in the ink printing industry. They are also used as a raw material in the cleaning industry. The following data relates to the quantities of products manufactured by Gadiv (in thousands of tons): Product 2008 2007 Benzene 130 127 Toluenes 22 27 Xylenes 171 204 Others 107 103 Total 430 461
1.8.7 Revenue Segmentation and profitability of the products For details of total revenues in the area of aromatics in 2007 and 2008, see section 1.5 of this report. In the total area of operation of aromatic products, there is no one group of products which accounts for 10% or more of the Company’s total revenues. The following are details regarding Gadiv’s gross profits (in USD 000’s). 2008 2007 Gross profit % Gross profit % 35 6% 62 12%
The factors that caused a decline of USD 27 million in the gross profits are primarily the reduction in the product mix margin of USD 17 million, a decrease in the turnover of USD 4 million and a rise in production expenses, particularly energy costs, of USD 17 million less the rise in other income from processing fees and steam of USD 11 million.
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1.8.8 Trade receivables 1.8.8.1 As of the date of this report, most of Gadiv’s sales (approximately 94.5% in 2007 and 94.7 % in 2008) were to overseas customers, mainly in the Mediterranean Basin and Western Europe, Asia and the USA. Gadiv’s principal customers are manufacturing companies in the chemical and plastics industries. 1.8.8.2 Since Gadiv’s products are used as raw materials in the production of other products and are supplied mainly to industrial companies, Gadiv’s customers view the regular supply of the raw materials that they require (i.e. Gadiv’s products) and Gadiv’s reliability with regard to supply of its products as being very important. As a result, this is a relatively conservative industry which prefers to act in long-term cooperation with its various suppliers, such as Gadiv. 1.8.8.3 Therefore, Gadiv has annual contracts with most of its customers, most of which are renewed annually. The prices of the products are determined in accordance with established formulas and/or prices that are published in international publications. Most of the agreements set out fixed quantities and dates of supply and Gadiv is required to manufacture the products and supply them in accordance with acceptable international specifications. Gadiv’s commercial relations with its principal customers are long-term. 1.8.8.4 Gadiv has no customers that account for more than 10% of the Company’s sales. 1.8.8.5 Neither the Company nor Gadiv are dependent upon any one of Gadiv’s principal customers. In the Company’s assessment, if any of its above principal customers terminates its contract with Gadiv, it will require a period of up to two months to find a replacement customer. 1.8.9 Marketing and Distribution As set out above, Gadiv does not sell to end users. Most of its customers are manufacturing companies that purchase Gadiv’s products as raw materials for their own products. Therefore, Gadiv’s marketing operations are aimed at manufacturing companies in the chemical and plastics industries. Under the service agreement executed between the Company and Gadiv, as set out in section 1.8.24.2 of the report, the Company supplies Gadiv with the marketing services that Gadiv requires, and consideration for the service agreement includes Gadiv’s marketing and sales expenses. Gadiv’s marketing operations are based on the following components: (1) Retention of customers for the long-term and identification of new potential customers. (2) Sales mix comprised of spot sales and periodic contracts. (3) Commercial transactions - on the basis of Gadiv’s business opportunities. (4) Conducting swap transactions with various customers, who contribute to savings on transportation costs. 1.8.10 Order Backlog Customer orders for aromatic products are mainly placed on an annual calendar year basis. As of December 31, 2005, the backlog for 2006 amounted to NIS 1,710 million. As at December 31, 2007 the order backlog amounted to USD 380 million and as at December 31, 2008 to USD 104 million and proximate to the report date, the balance of Gadiv's orders amounted to USD 90 million. The Company estimates that the decline in order backlog as at December 31, 2008 compared with December 31, 2007 stems from the eruption of the global economic crisis during the last quarter of 2008 and the consumers' preference to defer annual purchase commitments to a certain period, as well as from a decrease in the reporting period in the prices of the products sold. Based on Gadiv's past experience the rate of order cancellations by customers is negligible.
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1.8.11 Competitors and competition 1.8.11.1 As discussed above, Gadiv operates in a very competitive market. It competes with international manufacturers such as: BP Plc., Exxon Mobile, Repsol YPF, S.A., and Polimeri. Gadiv is a small player in the international manufacture of aromatic products, as are most of its competitors in the Mediterranean Basin and Western Europe. However, in the Mediterranean Basin, Gadiv is a significant participant both as a manufacturer of aromatic products and as a party active in commercial operations including various kinds of time swaps, geographic swaps, etc. In the Company’s assessment, Gadiv’s share of operations in the Mediterranean Basin is around 16% of the market. 1.8.11.2 The market in which Gadiv operates places considerable importance on the reliability of the suppliers of aromatic products, and Gadiv views its reputation as a reliable supplier, along with the quality of its products, as being the main factors that assist it in dealing with its competitors. For details of the Company’s principal competitive strengths and methods of handling its competitors, see section 1.8.4 of the report. 1.8.11.3 Gadiv is the only manufacturer of aromatic products in Israel, and has been declared a monopoly under the Antitrust Law. As set out in section 1.8.23.1 of the report, the vast majority of Gadiv's sales are to overseas customers. 1.8.12 Production capacity Gadiv has the capacity to process approximately 900,000 tons of reformat and approximately 100,000 tons of pygas (an aromatic fluid received from Carmel Olefins) a year. Of these amounts, Gadiv can manufacture approximately 520,000 tons a year of various aromatic products The type of products change in accordance with economic optimization and is integrated with the Company’s considerations. The production lines are based on continuous operation and operate 24 hours a day. 1.8.13 Fixed Assets and Facilities Gadiv’s facilities for the manufacture of aromatic products are integrated into the Company’s facilities at Haifa Bay, and constitute a downstream plant. The facilities were erected on land of approximately 8.6 hectare in area, of which approximately 8.0 hectare are leased to Gadiv by the Company under a capitalized long-term lease. Such lease is registered in Gadiv’s name. An additional 0.6 hectare were leased to Gadiv by the Company until August 30, 2006. As of the date of the report, the parties are continuing to act under that lease agreement. The following are details regarding the principal fixed assets owned by Gadiv as of December 31, 2008 (in USD thousands): Machinery Office Inventory Facilities Real and furniture and and spare under Estate equipment Vehicles equipment parts construction Total Balance of purchase 1,895 185,216 99 1,003 3,475 10,160 201,848 cost Accumulated 793 111,846 95 879 - - 113,613 depreciation Total depreciated 1,102 73,370 4 124 3,475 10,160 88,235 cost
1.8.14 Research & Development Gadiv does not engage in independent research and development, but rather purchases the know-how that it needs for its operations from external suppliers of know-how, which are international companies that specialize in the development of know-how for the aromatics
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industry. Gadiv purchases a license to use such know-how and pays royalties to the supplier of the know-how in a fixed or variable sum, depending on the amount of annual production in the facility under the relevant license. The licenses to use the know-how under which Gadiv’s facilities have been set up are essential for their operation, and have been granted in respect of the specific facilities for which they were purchased, are not exclusive and are not limited as to time. Under the know-how agreements, even in the case of termination of the agreement for any reason, Gadiv shall remain entitled to continue making use of the know-how for the purpose of production in the amounts in respect of which the license was granted and in respect of which royalties were paid by Gadiv. Gadiv has non-exclusive purchase agreements for rights to use know-how. Total royalties paid by Gadiv as aforesaid is not material to Gadiv’s operations. In the Company’s assessment, Gadiv is not dependent upon any supplier of such know-how. In addition, Gadiv examines the possibilities of developing new aromatic products, mainly in the field of specialty chemicals by cooperating with other raw materials manufacturers. Gadiv has a multi-function pilot facility which it uses for developing processes based on aromatics and their derivatives and for manufacture of new products for the purpose of market development in cooperation with know-how companies. With respect to Gadiv’s targets and commercial strategies, see section 1.8.27 of the report. Gadiv’s investments in the field of research and development are not material to the Company. 1.8.15 Intangible assets The Company has no rights in intangible assets in the field of aromatic products. 1.8.16 Human Capital 1.8.16.1 Work force As at the date of this report, Gadiv has 92 employees working the field of aromatics. The following is the breakdown of employees by department: Proximate to Department / Position the report date 31.12.2008 31.12.2007 Management 4 4 4 Production 62 62 58 Quality, ecology, safety 12 13 10 Maintenance 14 14 12 Total 92 93 84 The Company has no material dependence on any particular employee. 1.8.16.2 The following is a diagram of Gadiv’s organizational structure:
* Production Management, management of inventory and marketing of products are effected via employees of the Company, see section 1.8.24.2 of the report.
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1.8.16.3 The group of officers and senior management of Gadiv Senior management is made up of three employees: the Deputy CEO, the Research and Development Manager, and the Overall Quality and Gadiv Laboratory Manager who are employed under personal contracts that are similar, for the most part to the conditions of the personal employment contracts of senior employees of the Company, as set out in section 1.6.19.6 of the report. Under the agreement between the Company and Gadiv, the Company supplies Gadiv with production management, marketing, maintenance, finance, purchasing, security, human resources and office [management, legal consultation, computing and other services. For additional details see section 1.8.24.2 of the report. 1.8.16.4 Collective agreements Those of Gadiv’s employees who are not part of its senior management are employed under identical collective bargaining agreements to those that apply to the Company’s employees, as set out in sections 1.6.19.7 and 1.6.19.9 of the report. As at the report date, Gadiv regularly pays a pension for the retirement for 8 pensioners who took early retirement, until these pensioners reach legal pension age. The total amount of pension that Gadot paid out in 2008 and 2007, amounted to USD 252 thousand and USD 249 thousand respectively. As of the date of this report, Gadiv estimates that the balance of all payments that it is obligated to pay into the pension fund for such pensioners amounts to approximately NIS 898 thousand. Based on the number of employees employed at Gadiv as of the date of the report, who are entitled to salary supplements as set out in section 1.6.19.9 of the report, and the conditions of their employment, Gadiv estimates the cost of the aforesaid salary supplement to Gadiv in each of the years 2009 through 2011 as follows: Supplement to salary cost Year (in USD 1000’s) 2009 134 2010 203 2011 146
Notwithstanding the foregoing, Gadiv and the employees' representatives reached an agreement whereby salary costs will be frozen (in NIS) for 2009 in relation to 2008, unless the company reports profits for 2009. As of the report date, 74 of Gadiv’s employees are entitled, if dismissed under the provisions of the employment agreement, to early retirement terms, all as set out in section 1.6.19.9 of the report. 1.8.16.5 Training Gadiv conducts safety training courses, according to the law, for all its employees including firefighting subjects. Gadiv invests resources in professional training for its operations and maintenance employees in the fields of their work, and in the area of safety for all of its employees, in accordance with the law. In the area of operations, professional qualification and refresher courses, and in the area of technical professions, increasing knowledge prior to receiving new equipment, including training carried out via technology companies who sold their technology for production of paraxylene at Gadiv’s plant. 1.8.16.6 Employment relations at Gadiv are in good order. In recent years, there have been no work disputes or strikes at Gadiv. 1.8.16.7 Gadiv’s undertakings to pay severance pay are covered by payments to pension funds and executive insurance policies, and the provisions made by the Company on an ongoing basis (see Note 18 to the financial statements of the Company).
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1.8.17 Raw materials, suppliers As set out above, Gadiv’s operations are integrated with those of the Company, which is the only supplier of Gadiv’s raw materials. The raw materials required by Gadiv are very sensitive raw materials, and there are significant difficulties in transferring them from one place to another. Therefore, Gadiv and the Company are co-dependent. A change in the Company’s status and/or relationship with Gadiv might cause substantial differences in Gadiv’s financial situation and in the results of its operations. For details of the agreement regarding processing and purchase of Gadiv’s raw materials, see section 1.8.2. of the report. 1.8.18 Working capital: 1.8.18.1 Inventory holding policy Gadiv’s policy is to hold a minimum level of inventory of raw materials that is sufficient for between two weeks and one month of production among other reasons, in light of the fact that it has no problem receiving the raw materials that it requires for its ongoing operations immediately. Where there is a fear that a raw material might not be available, or that there might be some difficulty in acquiring it, Gadiv purchases additional inventory. Gadiv produces most of its products under contracts and advance orders, however, some of its output is sold on the free market. Gadiv’s policy is to hold product inventory sufficient for approximately one month’s sales in order to provide an immediate response to changes in timing or size of orders. Average finished product inventory days in was approximately 29 days and NIS 36 million in 2007, and approximately 12 days and NIS 17 million in 2008. 1.8.18.2 Supplier and customer credit The following table represents the average supplier and customer credit (in NIS millions): Million USD Average days of credit 2008 2007 2008 2007 Customers 55 67 29 37 Suppliers 34 58 30 31
1.8.18.3 Credit policies Payment to suppliers As disclosed above, Gadiv purchases its raw materials mainly from the Company. As a rule, Gadiv is not required to provide security for supplier credit. The prices of raw materials are mostly fixed in foreign currency. The majority of purchases are effected in USD (including US Dollar-linked transactions), or in NIS. In general Gadiv's supplier credit is 30 days. Customer payments Gadiv’s customer credit policy is generally for payment within 30 days. With respect to collateral for credit, Gadiv insures its sales with credit insurance, or receives appropriate collateral from its customers. 1.8.19 Investments On September 25, 2007, Gadiv signed a memorandum of intent (the "Memorandum of Intent") which replaced a previous memorandum of intent on the same topic, for the purchase of 50% of the registered share capital of a Chinese company (the "Acquired Company") which benefits in China from the status of a wholly-foreign owed company (WFOE) and which will manufacture Tri-Mellitic Andydride (TMA), a product used mainly as a softener in the polymer industry and as a component in powder colors, and Para Diethyl Benzene (PDEB), a product used mainly in the production of paraxylene.
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The shares of the acquired company will be purchased by the Company from a foreign company, registered in Hong Kong, which is not a related party to the Company or a controlling shareholder therein (the "Seller") and which is the owner of all of the share capital of the acquired company. According to the memorandum of intent, a company under the control of the Seller will transfer to the acquired company, for no consideration, an existing plant in China (excluding the land of the plant which will be leased to the acquired company for no consideration), which manufactures TMA and PDEB (the "Existing Plant") and all of the intellectual property, know-how and technology regarding the existing plant. In addition, the acquired company is taking steps to set up another plant to house facilities for the manufacture of TMA and PDEB through the know-how and technology that were transferred to its ownership. The additional plant will be set up in China on land in which the acquired company has usage rights. According to the assessments of the Seller and the acquired company that were furnished to Gadiv, the new PDEB facility commenced production and sales operation as of the end of February 2008, and the new TMA facility is expected to start its commercial production during the first half of 2009. The validity period of the memorandum of intent expired and the negotiations underway by the parties have not reached as at the report date the signing of a binding transaction. The primary terms and conditions of the Memorandum of Understanding are as follows: 1.8.19.1 The memorandum of intent is subject to the completion of a due diligence to the complete satisfaction of Gadiv and to the signing of a detailed agreement, the wording of which was approved by the boards of directors of the Seller and Gadiv (the "Detailed Agreement"), by October 31, 2007 or by a later date to be agreed upon by the parties. On November 15, 2007, the parties agreed to extend the validity of the memorandum of intent until November 25, 2007. 1.8.19.2 At the closing of the detailed agreement, Gadiv will purchase from the Seller 50% of the shares of the acquired company for an amount of USD 33,500,000 (the "Purchase Price"). 1.8.19.3 The purchase price shall be paid in three payment, as follows: (a) 60% of the purchase price shall be paid at the closing of the detailed agreement; (b) 20% of the purchase price shall be paid within 14 days after the new PDEB facility successfully completes its test run; (c) 20% of the purchase price shall be paid within 14 days after the new TMA facility successfully completes its test run. 1.8.19.4 The closing of the detailed agreement will be subject to pre-conditions, including the receipt of the necessary approvals from the Chinese authorities; the signing of accompanying agreements (including an agreement for the transfer of the existing plant to the acquired company, employment agreements with key personnel and a non-competition agreement); receipt of an undertaking by Chinese banks to furnish a loan to the acquired company in an amount of at least $13 million, for the completion of construction of the new TMA plant and the new PDEB plant, without demanding guarantees from the shareholders. 1.8.19.5 The memorandum of intent includes arrangements pertaining to the joint management of the acquired company and to the relationship between its shareholders, which shall be included as part of the detailed agreement, including a clause regarding mutual purchase (BMBY) that shall go into effect following a seven year period after the consummation of the agreement.
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1.8.20 Financing 1.8.20.1 Gadiv independently finances its operations using banking credits (short-term and long-term credit, including current maturities) and credit from the Company at market terms. The following are details of the average rate of interest on loans taken by Gadiv: 2008 2007 USD USD Long-term loans 4.5% - - - Banking sources 4.3% - 6.3% - The Company (ORL) - - 5.8% - Short-term credit 4.5% - - -
1.8.20.2 Credit facilities The scope of its short-term credit is adjusted from time to time to Gadiv’s changing requirements. 1.8.20.3 Conditions for immediate repayment To secure the long-term bank credit that Gadiv received from a banking institution, Gadiv has undertaken to comply with certain financial covenants, the failure to comply with which would enable such banking institution to make the balance of the credit immediately repayable. The bank credit will be immediately repayable in the event that: 1.8.20.3.1 An attachment order is imposed over Gadiv’s assets which is not cancelled within 15 days, the total sum of which is greater, at any time, than USD 2,000,000. 1.8.20.3.2 A substantial portion (25%) of production works are shut down for a period of more than 60 days, except for a shut down for the purpose of maintenance. 1.8.20.3.3 The Company does not meet the financial covenants set out in section 1.6.23.5 - 1.6.23.6 of the report. 1.8.20.3.4 As of December 31, 2007, Gadiv was in compliance with these financial covenants. 1.8.20.4 Variable interest credit 1.8.20.4.1 The following are details regarding credit at variable interest received by Gadiv in 2007 – 2008 and as of December 31, 2008: Credit in Interest USD millions as prior to of the report December 31, Range of Interest date 2008
Variance mechanism 2008 2007
US Dollar, LIBOR + 3.2%-5.3% 5.7%-6.4% 1.7% 2.7
1.8.21 Taxation For details regarding the taxation laws that apply to Gadiv and principal benefits thereunder, see Note 17 to the financial statements of the Company. 1.8.22 Environmental quality Gadiv is under the supervision of environmental authorities, with respect to its compliance with the environmental laws that relate to its operations. Gadiv has to deal with a variety of environmental regulations relating to its plant, similar to what the Company has to deal with.
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The main areas relate to the binding instructions that the authorities give Gadiv, by virtue of their powers under law, in the following areas: (a) air quality; (b) quality of liquid effluent; (c) solid / toxic waste; (d) prevention of pollution of ground and groundwater by fuels. These provisions are expressed in a series of documents that are similar to those described with respect to the Company in section 1.6.25.1 of the report. Gadiv treats its liquid effluents in its plant, and effects supplementary treatment of them using the effluent treatment system at the Company’s refinery. In January 2009, Gadiv received from the Ministry of Environmental Protection a warning and summons to a hearing relating to violations and apparent defective implementation of the provisions of the personal order (the "Warning").. The warning described the apparent violations which referred, inter alia, to the time tables set forth in the order, the results of the stack samples, the submission of certain plans as required in the order and to the way information is sent to the Ministry, as stipulated in the order. Prior to the date of the hearing, Gadiv submitted its response to the warning it received, in which it detailed its arguments and responses to the issues included in the warning. At the conclusion of the hearing goals and timetables were set for actions to be taken by Gadiv for the purpose of reducing the pollution emitted by its facilities. Gadiv is preparing to implement the mandatory actions under the personal order issued to it and is conducting talks with the Ministry of Environmental Protection regarding additional actions that the Ministry as required it to implement. The Company estimates that if Gadiv is required to take the mandatory actions under the personal orders it received, this will not cause it further expenses beyond its planned expenses. The Company's said preparations regarding the scope of the investments and actions Gadiv is required to take and the time tables Gadiv will be required to meet, constitute forward looking information. These estimations are based on the personal orders issued to Gadiv and on the plans prepared by Gadiv's management, based on these estimations. There is no certainty that these estimations will be realized since the conclusion of the talks with the Ministry of Environmental Protection have not yet concluded and it is possible that Gadiv will be required to take actions and make investments greater than its estimations. Similar to the Company and Carmel Olefins, Gadiv is also a signatory to the treaty to implement standards regarding the emission of pollutants, signed on January 21, 1998 between the Manufacturers’ Association of Israel and the Ministry of Environmental Protection, as set out in section 1.6.25.2.2 of the report. As part of its ongoing operations, Gadiv is acting to comply with the above statutory provisions. The Ministry of Environmental Protection gave notice to Gadiv that it was looking into taking administrative steps including rescission / non-renewal of the toxin permit granted to it, if and to the extent that the conditions set out in the toxin permit, with regard to preparations in the event of earthquake, are not implemented. Gadiv submitted a plan to examine whether its facilities would withstand the risks of earthquake, and to effect improvements if required. Gadiv was summoned to a hearing in this regard before the Director of the Haifa District of the Ministry of Environmental Protection in order to present its position. At the hearing, Gadiv presented a short term and long term protection plan, and was required to begin inspections, and were needed, the gradual protection of facilities, according to their level of risk. Furthermore, Gadiv was required to submit, by December 31 2006, its recommendations for the timetable of the reinforcement plan and to implement the protection in a short-term schedule, which was to be determined after the approval of the recommendations. Gadiv
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immediately commenced inspections of different facilities, and several elements that were found to require reinforcement, were reinforced during December 2006. As of the report date, Gadiv completed its inspections according to the plan it presented to the Ministry of Environmental Protection and the detailed planning of the reinforcement that has to be done in accordance with the plan. It has completed 30% of the reinforcements and is planning to do the rest of the reinforcements that do not require a shutdown of the facilities during the course of 2009. Reinforcements that require the shutdown of the facilities are planned for 2009. In the reporting year, Gadiv submitted supplementary planning to the Ministry of Environmental Protection and after receiving its comments, completed the detailed planning that also included dynamic examination of all the primary pipelines connected to the transportation equipment. Gadiv is certified under an Environmental Quality Management Standard (Israeli Standard ISO 14001:2004). See also section 1.8.23.2 of the report. For claims regarding environmental issues, see section 1.6.31.1. of the report. Gadiv is in compliance with the environmental requirements as aforesaid (except for the possibility that proceedings might be instituted with respect to the personal order and to its toxins permit as set out above). Notwithstanding, the findings of the survey at Gadiv, which are in the final stages, indicate that Gadiv will be required to make investments in order to comply with the BAT requirements, although these costs were taken into account as part of the investment plant and therefore are not expected to cause it costs over and above the costs planned by it. 1.8.23 Limitations on and supervision of Gadiv’s operations 1.8.23.1 Gadiv has been declared a monopoly in the field of benzene, toluene and xylene, and therefore, the provisions of the Antitrust Law regarding monopolies apply to it. Due to the fact that the vast majority of Gadiv’s produce is sold outside of Israel (approximately 95%), these provisions have no significant bearing on the Company’s business. 1.8.23.2 Quality standards for Gadiv's facilities and production processes of its products Gadiv has received certifications under the following quality management standards: Israeli Standard ISO 9001:2000 regarding product quality assurance, Israeli Standard ISO 14001:2004 for environmental protection management, Israeli Standard ISO 17025 for laboratory management, Israeli Standard ISO 18001 for safety management and GMP standard for proper production conditions. 1.8.23.3 Business license In 2001, Gadiv applied for a business license for its plant. Upon publication of the order annexing the land of Gadiv’s plant to the territory under the jurisdiction of Haifa Municipality, treatment of Gadiv’s business license was transferred to the Haifa Municipality. For the agreement with the Haifa Municipality see section 1.6.16.5 of the report. In addition, Gadiv holds the following licenses: Type of license Licensing authority Expiration of license Toxin permit Ministry of Environmental January 5, 2010 Protection Additional conditions in business Ministry of Environmental --- license Protection – Ministry of the Interior Approval for purchase of fuel Israel Tax Authority – Finance December 31, 2009 exempt from excise tax for 2008 Ministry License to manufacture fuel Israel Tax Authority – Finance December 31, 2009 Ministry Approval of location for production Israel Tax Authority – Finance December 31, 2009 of fuel Ministry
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1.8.24 Substantial agreements The material agreements not in the ordinary course of business signed by Gadiv, to which Gadiv is a party or under which, to the best of its knowledge, it has rights, during the period described in the report or which affected its operations during such period are: 1.8.24.1 An agreement with the Company to process reformat and dripolene, and for the purchase of benzene, toluene, xylene, naphtha and refinate and C9, see section 1.8.2 of the report. 1.8.24.2 There is an agreement between the Company and Gadiv (the “Service Agreement”) under which, in order to exploit the fact that the parties’ production systems operate in integration, and in order to increase the efficiency and to improve the results of the operations of both parties, the Company agreed to provide Gadiv with production management services, marketing, maintenance, finances, purchasing, security, human resources and office management, legal consultation, computing etc. (the “Services”) in consideration for an annual payment of USD 1.6 million, paid on a quarterly basis. The term of the Service Agreement will terminate on the date on which the Company ceases to be the sole owner of Gadiv. The Service Agreement set out the format for the provision of Services, criteria for ensuring the quality of the Services and the mutual undertakings of the parties with respect to the method of effecting and consuming the Services. 1.8.24.3 If the Service Agreement is rescinded due to a fundamental breach on the part of either of the parties, the Company has undertaken to transfer all of the Services given by it up to the date of rescission to Gadiv in an orderly fashion, and the agreement sets out a mechanism enabling Gadiv to provide itself, independently, with the Services that had previously been provided by the Company. 1.8.25 Joint venture agreements For details of the processing agreement signed by the Company and Gadiv, see section 1.8.2 of the report. 1.8.26 Legal proceedings Except for the claims described regarding the Kishon River and set out in section 1.6.31.1. of the report, there are no legal proceedings pending in court against Gadiv which are material to the Company. Gadiv is also the subject of lawsuits that are handled by the insurance companies that have insured it against the risks under the claims, apart from the policyholder’s deductible. The total sum of the policyholder’s deductibles on account of these claims is not material to Gadiv. As part of its regular operations, Gadiv is the subject of lawsuits that are not material to the Company. In the Company’s opinion, in reliance on the opinions of its legal counsel, the provisions made on its books on account of these claims are sufficient. 1.8.27 Business Strategy and Objectives 1.8.27.1 The strategic plan adopted by the Company includes the expansion of the Company's petrochemical activities, focusing on high added value products in Israel and abroad. As part of this plan, Gadiv expects to advance various projects, including: 1.8.27.1.1 Expanding production of phthalic anhydride., currently manufactured by Gadiv, by 55%, in two phases; the first phase in which $9 million will be invested to expand the quantity produced by 30%, has been approved and the Company expects it to be completed in 2009. 1.8.27.1.2 Expanding the volume of production of paraxlyne, toluene and benzene produced by the company. 1.8.27.1.3 The establishment of a cyclohexane facility (used as a raw material in the chain of production of nylon).
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1.8.27.1.4 Establishment of a facility for the production of normal Hexane (used in the pharmaceutical industry, pesticides, agricultural materials, and home cleaning aids). 1.8.27.2 In addition, and as part of the Company's strategic plan, Gadiv will continue and try and identify business opportunities for activities abroad in its area of operations and in tangential areas. 1.8.27.3 For further details, see sections 1.6.32 and 1.8.19 above. The above goals and plans and the information regarding the aromatic product market reflect Gadiv’s view of the market, and its status as of the date of this report, and naturally, there may also be further developments at Gadiv, in the international aromatic market, in Gadiv’s target markets and in the characteristics of demand for such products. The Company's preparations regarding the expected times for project completion and the scope of the investments constitute forward looking information. These estimations are based on plans prepared by the Company’s management and on information received from independent professional parties. There is no certainty that these assessments will come to fruition, since they involve very complex projects, the execution of which is contingent upon, among other things, factors that are outside of the Company and on the receipt of regulatory approvals. 1.8.28 Forecast for developments in the coming year As of the date of this report, Gadiv has no plans that deviate from the ordinary course of its business, which it has decided to implement during the coming year, which might have a substantial influence on the state of its business and the results of its operations or which have not been set out in detail in this report. 1.8.29 Exceptional changes to Gadiv’s business The Company is not aware of any extraordinary changes in the business of Gadiv, including during the ordinary course of its business, during the period from the date of the financial statements until the date of publication of this report. 1.8.30 Event or matter deviating from the ordinary course of Gadiv’s business To the best of the Company’s knowledge, there are no events or matters not set out in sections 1.8.1 through 1.8.29 of this report which are in deviation from the ordinary course of the Company’s business due to their nature, scope or possible outcome, and which have or might have a substantial affect on the Company.
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Part D – Trade Area of Operation
1.9 Trade Area of Operation 1.9.1 General information on the area of operation As set out in section 1.6.32 above, based on the board of directors’ decision of November 6, 2007 concerning the Company’s strategic plan, it was decided, inter alia, to expand the commercial activities and logistics for oil products. Commencing from the first quarter of 2008, the Company started to operate in the trade segment as set out below. As part of its commercial activities, the Company trades in crude oil and its products and oil price derivatives (such as options and forward contracts), as well as leasing tankers based on opportunities in the market. As a result of the board of directors’ decision, a cutting-edge trade center was set up and implementation of data systems for trade management of oil products began. The Company also leases tankers under long-term leases (usually between one to five years) to transport crude oil and/or refined products and/or chemicals, and also uses them to ship the products that it purchases and sells. Additionally, it subleases the tankers to various entities based on voyage leases. The trading activities in products for use in the Company’s facilities or those of its subsidiaries are an integral part of the relevant operations and are not integrated into the trade segment. 1.9.2 The segment structure and the changes which apply The trade segment is affected by the volatility of crude oil prices and its products, and the price differentials between the various markets (arbitrage). World prices of crude oil and its products fluctuate greatly and are set, inter alia, according to global supply and demand. They are also affected by geopolitical events that are not directly connected to oil production, but are perceived in the markets as having a possible impact on future yields. For details on the factors that influence the supply of crude oil and its products, and the factors and trends in refined product consumption, see sections 1.6.2.2 and 1.6.2.3 of this report. The crude oil market and its products is a commodities market. This market is sophisticated and characterized by extremely high negotiability, including derivative and forward contracts carried out in various commodities exchanges or large multinational organizations. Therefore, the viability of the segment could change drastically from time to time. 1.9.3 Critical success factors Due to the nature of the market for trading in crude oil and its products, as well as the multitude of participants therein (such as speculators who do not actually use the oil that they purchase), the Company estimates that the key critical success factor is professional staff experienced in the purchase and sale of crude oil and its products and risk hedging. 1.9.4 Entry barriers In the Company’s opinion, physical activity in crude oil and refined products, and financial strength are significant entry barriers in the oil trading sector, inter alia, because of the need for significant volumes of working capital and the willingness of suppliers in the sector to trade under adequate credit conditions. Additionally, familiarity with the market players and their requirements could also constitute a significant advantage. 1.9.5 Products All types of crude oil and refined products are likely to be included in the segment. The Company also trades in oil price derivatives such as options and forward contracts.
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Additionally, the Company leases tankers under long-term leasing contracts to ship refined products (also crude oil). These tankers could be used to transport products purchased or sold by the Company outside of Israel or subleased. 1.9.6 Segmentation of revenues and profitability of products and services For information on the total revenues of the trade sector in 2008, see section 1.5 of this report. There is no group of products or services in the trade sector whose rate is 10% of more of the Company’s total revenues. In 200845, the gross profit of the trade sector amounted to some NIS 13 million. 1.9.7 Customers The sales in the area are carried out in spot contracts between the Company and entities active in the market. At times, the contracting is made forward contract transactions for the sale and purchase of oil and its products. As part of the electronic trade in oil, the Company sells and purchases derivatives without any interaction at all with the buyer or seller. None of the sales to any of the Company’s customers in this field constitutes 10% or more of the Company’s total revenues. 1.9.8 Marketing and distribution As aforesaid, transactions in the field are carried out in spot contracts according to opportunities identified by the Company in the market. The Company’s familiarity with the oil market and its key players and their requirements helps the Company in identifying said opportunities. 1.9.9 Backlog of orders Since, as at the date of this report, the Company’s contacts in this area are made on the basis of spot contracts and are supplied within a short time period after the date of contracting, there is no significance to backlog of orders in the area of operation. 1.9.10 Competition Competition in the field is extensive, mainly due to the multitude of players in the global market and the variety of commercial opportunities, from electronic trading in oil derivatives to back-to-back sales in which any entity operates to match the demands of the customer with the supply of the suppliers. In back-to-back sales, it is important to be familiar with the oil area of operation in general and particularly with the players in this field, including familiarity with the variable requirements of the customers in this area on the one hand and familiarity with inventory holders and manufacturers on the other hand. 1.9.11 Seasonality The seasons of the year have no impact on the trade sector. 1.9.12 Fixed assets and facilities All of the trading activities are carried out in the Company’s offices at the Haifa refinery. 1.9.13 Human resources The trade segment activities are carried out by the Company’s trade sector employees, and are integrated into their activities of purchasing and selling crude oil, refined products and aromatic products for the company’s other sectors. For additional information, see section 1.6.19 of this report.
45 Activities in the sector began in the first quarter of 2008.
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1.9.14 Raw materials and suppliers The Company purchases the crude oil from various suppliers worldwide, pursuant to spot transactions, and therefore, it is not dependent on any supplier whatsoever.
1.9.15 Working capital Credit days for suppliers and customers in the trade segment are similar to the credit days for customers and suppliers in the refining segment.
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Part E - Risk Factors
1.10 Risk Factors: The Company’s operations, in all areas, involve external risks which might have a substantial adverse affect on the Company’s business operations. In 2009, the Company conducted a
1.10.1 Macro risks 1.10.1.1 Economic slow-down – the global economic crisis – the demand for fuel products is affected by various factors, as set out in section 1.6.2 of the report. A market slow-down might substantially and adversely affect the refining margins, due to a reduction in purchases of fuel products and surplus refining capacity. As of the fourth quarter of 2008, the markets have felt the effects of the economic crisis, which first appeared in the financial markets and is today felt in the real markets as well. In the refinery segment this crisis is expressed by a steep drop in crude oil prices (see section 1.6.2.4 of the report) and the drop in fuel product prices. In the petrochemical segment (the polymers and aromatics), the crisis is expressed in significant reduction in demand and substantial drop in price. As a result of the recession and economic slowdown, the profits as well as the scope of the Company's turnover may be impaired. Nonetheless, the decrease in the price of oil reduces the operating capital needs of the Company. The continuing global financial crisis makes it difficult to raise capital effecting the financial system on the local market. Notwithstanding the uncertainty and instability of the financial markets, the Company estimates that it will be able to raise the capital required for its ongoing operations.
1.10.1.2 Economic slow-down – the local market recession – the demand for the Company's products is affected by various factors, as set out in section 1.6.2 of the report. A market slow- down might substantially and adversely affect the Company's revenues due to a reduction in purchases of the Company's products. The above situation could affect the scope of orders received by the Company from the local market and the level of prices paid to the Company in respect of sales of its products, as well as on the level of the Company’s operations as a whole. As of the fourth quarter of 2008, signs of recession became evident on the local market as a result of the crisis that first appeared in the financial markets and is today also evident in the real market. During the fourth quarter, a decline was evident in the local demand for petrochemical products and if the crisis deepens a further decline in the demand and/or further price drop of the products sold by the Company are possible, which are liable to have adverse impact on the outcome of the Company's activities and the scope of its operations. In addition, such a slow-down or recession could cause the Company to be exposed to increased risks with respect to the financial condition of its customers. The Company keeps track of its customers’ financial status, and adjusts its sales turnover, the collateral, discounting settlements of customers' debts and the required manner of collection in accordance with the risk level that it ascribes to its customers.
1.10.1.3 Difficulties raising credit due to the global financial crisis – The Company finances its operations, inter alia, by means of banking and/or non-banking finance. Due to the grave global economic crisis which increased towards the end of 2008, banks in Israel and/or abroad are liable to take a harder line regarding their requirements from corporations with respect to extending banking finance. Furthermore, the global economic crisis affected the capital markets is such a way that activity on the markets as at the reporting date is minimal, making it harder to raise non-banking finance. In view of the foregoing, should the Company require additional sources of finance, it may encounter difficulties receiving banking and/or non- banking finance.
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1.10.1.4 Geopolitical Risk – Security, political and economic conditions in Israel directly affect the Company’s business. Over the past several decades, a number of armed conflicts have taken place between Israel and its Arab neighbors and between Israel and Palestinian elements in Judea, Samaria and the Gaza Strip. The escalation of events with Israel’s neighbors, particularly Lebanon, Syria or Iran, could give rise to renewed hostilities with Lebanon or other states, which might force the Company to shut down its facilities in whole or in part, or may incur physical damage to the Company’s facilities. In addition, terrorist attacks originating in Israel directed at the Company’s assets may force the Company to suspend activities or shut down facilities. Any such attacks could have a material adverse effect on the Company’s business, financial performance and operations. The Company’s insurance policies provide limited coverage for war damage (see section 1.6.29.2 of the report). The Property Tax Authority provides compensation for losses arising from acts of war. However such compensation may not cover losses of income. The Company’s operations are dependent upon the importation of crude oil from various countries. There are a number of countries, mainly in the Middle East, that prohibit doing business with Israel or Israeli companies. Negative public opinion with regard to Israel or expansion of the boycott imposed upon Israel to other countries that trade with Israel could harm the Company’s ability to purchase crude petroleum or other inputs and the Company’s ability to transport such crude oil to Israel. In addition, geopolitical developments could give rise to a reduction or cessation of flights to and from Israel, which might bring about a reduction in demand for the Company’s products, particularly in the field of demand for fuel in the airline industry.
1.10.1.5 Exposure to fluctuations in exchange rates – The Company operates in a dollar market, and therefore, a considerable portion of its current assets and liabilities are in dollars or are linked to the dollar, and most of its long-term credit is dollar credit. Part of the sales of the Company and a significant part of its operating and maintenance are denominated in shekels and create an economic exposure for the Company to risks deriving from changes in the exchange rate of the shekel to the dollar. This is due to, among other reasons, the timing differences between the date the selling prices of are set in shekels and the date of actual payment, in the event that between the two dates, an upward revaluation of the shekel takes place. Upon the transition to IFRS, the Company will start reporting in US dollars, which has been defined as the functional currency of the Company and, therefore, the accounting exposure of the Company to changes in the shekel/dollar exchange rate will be significantly reduced, except in respect of part of the liabilities and assets of the Company that are shekel- denominated.
1.10.1.6 Exposure to inflation – the Company finances a substantial part of its operations by way of Israeli CPI linked shekel debentures, and it also has CPI linked assets. The Company has surplus liabilities over assets in CPI link shekel and therefore it is exposed to inflation in Israel.
1.10.1.7 Exposure to changes in interest rates – the Company has loans and liabilities in dollars that bear variable interest (mostly every 3 and 6 months) based on LIBOR plus bank margins. An increase in the variable interest rates will give rise to an increase in the Company’s financing expenses. The Company occasionally makes use of interest rate substitution (IRS) transactions and of interest options in order to reduce its exposure to fluctuations in interest rates. (For details see Note 30(5)(A) to the financial statements).
Risk hedging - The Company uses various financial instruments in order to partially hedge against the economic exposure in respect of fluctuations in exchange rates (see section 1.10.1.4 of the report); inflation (see section 1.10.1.5 of the report); and interest rates (see section 1.10.1.6 of the report). For additional information regarding the hedging policy, see section 1.10 of this report, and
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Note 30(A) to the financial statements. The hedging effected by the Company as aforesaid, being partial, does not cover the Company’s entire exposure for each of the risks set out above. Until December 31, 2007 and in accordance with accounting principles generally accepted in Israel, the shekel was the functional currency of the financial statements of the Company. Accordingly, exposures were created between the rate of the shekel and the rates of the other currencies in which the Company operates. Commencing on January 1, 2008, upon the adoption of IFRS, the functional currency of the Company was defined to be the U.S. dollar. Accordingly, the exposures of the Company will be measured between changes in the rate of the dollar and the other currencies in which the Company operates (mostly the shekel). The major risks are: exposure in respect of long-term shekel credit balances, investments in marketable securities denominated in shekels, operating and maintenance expenses in shekels, and Company sales to its customers in shekels. The Company uses financial instruments including derivative financial instruments, in order to reduce its exposure to currency and interest risks. Under IFRS, in order for a transaction in financial instruments to be considered as an accounting hedge transaction, it has to meet certain conditions, including conditions in respect of the designation of the instrument, compliance with strict documentation requirements, and high hedging effectiveness at the beginning of and during the course of the entire hedge. According to IFRS, changes in the fair value of derivative financial instruments that do not fulfill the conditions required for hedge accounting are immediately carried to the income statement in each period. The transactions conducted by the Company in financial instruments to reduce this exposure do not comply with the hedge conditions set out in international standards and, therefore, in the transition to IFRS, these financial instruments are measured at fair value, with the changes in the fair value immediately carried to the income statement.
1.10.1.8 Strikes and lock-outs – The vast majority of the employees of the Company belong to labor unions and are employed on the basis of special collective agreements. Strikes and lock outs in Israel, and in particular closure of the ports and/or lock-outs in fuel pumping infrastructure companies and/or strikes at the Company's facilities, which could be part of public sector strikes, may prevent the receipt of raw materials, thereby harming the Company's ability to manufacture its products and supply of orders on time, thereby harming the Company’s ability to meet its obligations towards its customers, which could harm the Company’s income and the goodwill that the Company has generated for itself. Moreover, delays in arrival of imported products could cause a complete stoppage of the production process, causing the Company significant costs.
1.10.2 Segment Risks 1.10.2.1 Exposure to changes in prices of raw materials and products – the Company’s operations in the purchase of raw materials, the sale of refined products on the local market and on the international market, the sale of polymer and aromatic products, both for the purposes of the refining and petrochemical segment and for trading purposes only, and the need for the Company to at all times hold stock of crude oil (including base inventory for which the Company does not hedge) and refined products in significant quantities, requires management of the Company and of its subsidiaries to take market risks stemming from changes in prices of raw materials and the products produced from them (for additional details about the changes in crude oil prices see section 1.6.2 of the report). The Company’s policy is to protect itself against such exposure by determining hedged positions by using the appropriate derivatives for protection purpose. It is not possible to fully hedge against risks stemming from price fluctuations. For further information relating to this matter see section 10.1 of the report. Since there are no sophisticated futures markets for products in the petrochemical segment (polymers and aromatics), but only for crude oil and refined products, it is not possible to fully hedge against operating margins in those areas. In the event of a significant increase in the prices of crude oil, the amount that the Company will need to raise in the
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working capital for the purchase of all of the oil required for its current operations will increase, and there might be an impairment in the conditions for raising such working capital. In the event of a significant decrease in the prices of crude oil, the Company is liable to record a loss with respect to the unprotected inventory of crude oil that it holds.
1.10.2.2 Erosion of refining margins – The Company is exposed to the risk of an erosion in the refining margins which may be the result of a similar global trend. In the event that crude oil prices increase, without a parallel increase in the prices of oil products, or in the event that the demand for products remains fixed or decreases, the refining margins, which constitute the basis for the Company's profit, may erode. In a case of erosion of refining margins, and as the market structure does not usually allow active hedging of refining margins, the financial and business results of the Company may be impaired. For more information regarding the trends in refining margins, see section 1.6.2 of the report.
1.10.2.3 Memorandum of Fuel Industry Law – if the Fuel Industry Law is enacted in accordance with the Memorandum published by the Ministry of National Infrastructure on January 1, 2007 as set out in section 1.6.26.6 of the report, the Company shall be required to obtain the licenses required for its operations under that Law. These licenses may be contingent to additional terms over and above those applicable to the Company as at the report date. In addition, the Company shall be subject to various provisions as set out in the Memorandum of the Law, which relate, among other things, to the guaranteeing of adequate service and ensuring a competitive environment; restrictions on the holding of licenses and on the activities of a licensee; the definition of a refinery as an essential service and the implications of such. It is not possible to assess whether and when the Law will be passed, what the final wording of it will be and what the conditions will be for obtaining the licenses, or the restrictions thereunder. For further details on the affect of the Fuel Law on the Company, see section 1.6.26.6 of this report.
1.10.2.4 Regulations and standards regarding environment, health and safety – companies engaged the Company's area of operation are subject to comprehensive regulation with respect to storage, manufacture, transportation, use and removal of their products, their components and by-products. The Company’s production facilities are subject to environmental standards with respect to air pollution, effluent removal, use and treatment of dangerous substances, method of waste removal and purification of existing environmental pollution. Over the years, there has been a continued increase in the stringency of environmental requirements, including through new environmental legislature, the interpretation given to laws in this area, and in the enforcement of environmental standards. Further increases in the stringency of regulation and/or interpretation and/or enforcement as aforesaid that might be imposed upon the Company’s area of operations or upon the Company specifically, could cause the Company large-scale expenses and investments, over and above the Company's existing investment plans, and might even harm the results of its operations. For details regarding PEI's alleged claims regarding the alleged existence of pollution in tank farms at the Kiryat Haim terminal, see section 1.6.20.3 of the report. The Company has various environmental permits and licenses which define the conditions for management of the Company’s operations. The construction of new facilities or the expansion of existing facilities requires receipt of permits and new or additional licenses and in the future the Company may require new permits, including permits under the Clean Air Law, 5768- 2008. The terms and conditions of the permits and licenses are liable to be modified by the relevant regulators. Likewise, breach of the conditions of the licenses, permits or other regulatory provisions might give rise to the imposition of fines, criminal sanctions, cancellation of licenses and restrictions on the operation of facilities, including closure of facilities. Non-approval of new permits required by the Company, or revocation, aggravation or modification of the permits, licenses or conditions might adversely affect the financial status of the Company and the results of its operations.
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As of the report date, deliberations are taking place regarding a number of proposed laws, in their preliminary stages, dealing with more stringent regulation and enforcement of environmental issues. For additional details of the issue of environmental protection and the regulations that apply in this area, including the possible impact of future legislation, see section 1.6.25 of the report.
1.10.2.5 Transition to alternatives for refined products – the Company’s products are used mainly for land and air transportation, and for industry. Innovations and inventions in the field of engines and vehicles, including electric powered vehicles, or the transition of many consumers to the consumption of alternative fuels and substitute products to those of the Company, such as fuels based on ethanol, bio-diesel or natural gas, could reduce the demand for the Company’s products. In addition, a change in Israeli driver preferences towards increased use of public transport might also bring about a reduction in the demand for petroleum based fuels for transportation and might also harm the Company’s business results. For additional details on alternative petroleum products, see section 1.6.2.3 of the report.
1.10.2.6 Reinstatement of price regulation for the Company's products – at the present time there is no maximum prices supervision for the Company's products. However, the Supervision of Prices Order sets out conditions which, if fulfilled, would give rise to the reintroduction of supervision of refined oil products prices. If such supervision is reintroduced, as aforesaid, and/or price control is instituted in respect of products not under supervision as at the report date, this is liable to harm the Company's ability to compete in such a competitive and open market and as a result, the business and financial results of the Company may be harmed (see section 1.6.26.3 of the report).
1.10.2.7 Dependence on infrastructure companies –In order to carry out the Company's operations, the refining companies in Israel are dependent upon receiving services from the infrastructure companies, EAPC and PEI, which own essential infrastructure for the unloading, transportation, storage and dispensing of crude oil and refined products. They will also be dependent upon Natural Gas Lines Ltd., once the laying of the natural gas line infrastructure has been completed by the expected date, allowing the supply of natural gas to the plants of the Company and receipt of continuous and reliable transport services thereafter. In the event that the Company is unable to receive such services from one or more of these companies, the results of the Company’s operations might be substantially harmed. (See sections 1.6.20.3 and 1.6.20.4 of the report).
1.10.2.8 Exposure due to unexpected events and malfunctions in production facilities – the Company’s production facilities and those of neighboring plants operate continually, under difficult physical and chemical conditions, and are exposed, from time to time, to events and malfunctions that might cause physical harm to persons and property of the Company or third parties, harm to the environment, to a shut-down of the faulty facility and a shut-down of other production facilities which operate in combination with or nearby the facility where the event or malfunction occurred. Since the Company’s production facilities are located on a single site, an event or malfunction might give rise to damage causing termination of all of the operations of the Company and its facilities. The Company's production activity is controlled through an advanced information system and a malfunction in these systems may impair the Company's ability to carry out its production activity. The Company insures itself against such risks (see section 1.7.21.1 to the report), however the relevant policies set deductibles and it is possible that the compensations paid by the insurers under these policies may not cover and/or may not fully cover the damages which may be caused to the Company due to aforesaid event or malfunction.
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1.10.3 Company-specific risks 1.10.3.1 Raising credit – the Company is part of a group of borrowers together with the companies of the Ofer Brothers Group and the Israel Corporation Group with respect to the Israeli banking system. In view of this, the Company is liable to be restricted in the extent of banking credit it can raise from banks in Israel. As at the report date, this restriction has not had any material impact on the Company's operations.
1.10.3.2 Increased competition in the fuel market – two refineries operate in the Israeli market (ORL and ORA), competing with one another and with importers of oil products. Both refineries are dependent upon storage and distribution terminals owned by infrastructure owners who offer these products on the local market. The increasing competition is liable to erode the Company’s market share and will adversely affect the scope of its operations and its profitability.
1.10.3.3 Liability for failure to comply with statutes or regulations regarding the environment, health and safety - the Company may be subject to significant liability (including heavy fines) for deviations and/or breaches of statutes and regulations in the areas of environmental protection, health and safety. Other environmental laws impose responsibility for cleaning up pollution and therefore, might expose the Company to expenses for cleaning and purifying land and/or waterways. The Company’s insurance policies provide only partial coverage. In addition, the Company may become subject to claims alleging bodily injury or damage to property as a result of exposure to dangerous substances. 1.10.3.4 Proceedings with respect to the Kishon River - the Company, Carmel Olefins and Gadiv, together with many other plants and authorities and other entities, have been sued in a number of proceedings for compensation for bodily injury which the plaintiffs alleged were caused due to the pollution of the Kishon River. Furthermore, third party notices have been served against the Company and Carmel Olefins regarding the issue of an injunction to terminate the pumping of their effluents into the Kishon River forthwith, and the issue of a mandamus order to restore the river to its prior state. If the Company is charged with paying compensation to the plaintiffs in the Kishon claims for bodily injury, or if these injunctions or orders are put into effect, this may impose a severe economic burden on the Company. Should a lawful order be given requiring the Company to cease pumping brine into the Kishon River over a shorter time-table than that required for finding an alternative solution, the Company shall suffer damage to its current operations and its business results. For further details regarding the status of claims against the Company with respect to the Kishon River, and for the Company’s assessments regarding its exposure to such claims, see section 1.6.31.1 of the report. If the final findings of the survey conducted by the Kishon River Authority indicate that the riverbed is polluted and in the opinion of the authorities the Company is found responsible in whole or in part for the pollution, the authorities may demand that the Company cover the costs of cleaning the river. For further details relating to the treaty see section 1.6.25.3 of the report.
1.10.3.5 Closure order regarding part of EAPC’s transmission pipeline - entry into force of a closure order for part of EAPC’s transmission pipeline which passes through the jurisdiction of the Municipality of Haifa, through which most of the crude oil used by the Company is transported to it, might substantially harm the Company’s financial results, among other things, due to a reduction in the quantities distilled by the Company of up to 50% of its refining capacity. For further details relating to the treaty see section 1.6.20.4 of the report.
1.10.3.6 Plan to replace a section of the marine pipeline in Haifa Bay that is owned by PEI - PEI gave notice to the Company that following findings regarding the status of a section of the
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marine pipeline owned by it in Haifa Bay, which is used for the unloading of crude oil and pumping of it to the Company’s refinery, it intends to replace the said section in May 2009. Recently PEI notified the Company that the date of the replacement will be postponed, but no new date has been set. If and to the extent that it is not possible to use that section of the pipeline until it is replaced, or if the process of replacing it goes on for longer than the expected period of time, the Company will not be able to receive supplies of crude oil from the Kiryat Haim terminal, which will reduce the refining performed by it by about 30%, so long as it is not possible to use the pipeline. For further details relating to the treaty see section 1.6.20.3 of the report. In the event that the closure order issued for the segment of the EAPC pipeline enters into force as set out in section 1.6.20.4 of the report during a period overlapping the period during which PEI’s maritime pipeline is being replaced as set out in section 1.6.20.3 of the report, the Company’s ability to receive crude oil for refining will be seriously harmed, and this will probably reduce the scope of its operations or even cause the operations of the facilities to terminate during the overlapping period.
1.10.3.7 Receipt of Order under Section 59N of the Government Companies Law – under the aforesaid section, the Prime Minister and the Minister of Finance may, with the consent of the Ministerial Committee on Privatization, and after consultation with the Government Companies Authority, instruct the Company by way of an Order to continue operations or to provide services for such period and under such conditions as may be prescribed, in the event that the Company ceases to perform operations or provide essential services as set out in section 2(5) of the Essential Interests Order issued to the Company, or in the event that the Ministers are of the opinion that there is a reasonable suspicion that the Company might cease to provide such, and it is necessary to ensure the continued provision of the service or operations as aforesaid. In the event that the Company does not fulfill the provisions of the additional order as aforesaid, the Ministers shall be entitled to appoint, by order, a person to be responsible for ensuring the continued provision of the service and the operations, and for management of the Company’s facilities and assets, and to give such person instructions in that regard. In such a case, if the conditions set out in section 59N as aforesaid exist, the Company may be required to perform operations or to provide services under non-economic or non-commercial conditions, and such operations might affect the Company’s business results. The Company is unable to anticipate whether such an additional order will be made, under what conditions and accordingly it is unable to anticipate what the affect of such on the Company might be. For further details relating see section 1.6.28 of the report.
1.10.4 The following table sets out the Company’s risk factors according to their nature and effect on the Company’s business, according to management of the Company: It is noted that in the Company's assessments below regarding the extent of the impact of a risk factor on the Company reflects the level of impact of such risk factor presuming manifestation of the risk factor, and this shall not be interpreted as an assessment nor shall it give any weighting to the chances of the manifestation of such factor.
Risk factor Major Moderate Minor Macro risks Economic slowdown – global economic financial crisis √ Economic slowdown or recession in the local market √ Deterioration in Israel's political situation √ Difficulties in raising finance due to the global financial √ crisis Exposure to changes in the currency exchange rate. √
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Risk factor Major Moderate Minor Exposure to changes in inflation √ Exposure to changes in interest rates √ Strikes and lock-outs in the Israeli economy and at the √ Company's plants Sectoral Risks Exposure to changes in prices of raw materials and √ products Erosion in refining margins √ Memorandum of the Fuel Economy Law √ Regulations regarding the environment, health and safety √ Transition to alternatives to the Company's products √ Reintroduction of regulation regarding prices of √ Company's products Dependence upon infrastructure companies √ Exposure for unexpected events or malfunctions in √ production facilities Company-specific risks Capital Raising √ Increase in competition in the fuel market √ Liability in respect of non-compliance with the laws and √ regulation on the environment, etc. Proceedings regarding the Kishon River √ Closure order regarding section of the EAPC √ transmission pipeline Replacement of section of the marine pipeline at Haifa Bay that belongs to PEI and which will take longer than √ one month. Receipt of Order under section 59N of the Government √ Companies Law.
A-145 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Directors’ Report on the State of the Company’s Affairs for the year ended December 31, 2008
The board of directors is pleased to present the Directors' Report on the state of the Company’s affairs for the year ended December 31, 2008.
1. Description of the Company and its Business Environment
1.1 General Oil Refineries Ltd. (“the Company” or “ORL”) and its subsidiaries are industrial companies involved in three synergetic fields of operations organized in three segments: refinery, petrochemicals and trade. The Company’s primary operations are the production of oil products, feedstock for the petrochemical industry and materials for the plastics industry. In addition, the Company is involved in the trading of crude oil and its products and distillates other than for operational purposes, logistics and infrastructure services, and the supply of electricity and steam to neighboring plants. The Company’s petrochemicals operations are made up of two operations: aromatics, through Gadiv Petrochemical Industries Ltd. (“Gadiv”) (100%) and polymers, through Carmel Olefins Ltd. (“Carmel Olefins”) (50%). The plants of these companies are downstream facilities of the Company and they receive the required feedstock entirely or mostly from the Company on an ongoing basis through pipelines and return all or part of products of their facilities to the Company, as well as the feedstock not used in their operations. The Company’s refinery operations are integrated with its petrochemical operations. In the Company’s opinion, the integration and synergy between the various fields of operations led to an increase in aggregate margins flowing to the Company from all of its fields and a reduction in fluctuations of the Company’s profits, since business turnover in the areas of the Company’s operations and those of its subsidiaries do not necessarily overlap. In addition, the joint management of Gadiv streamlines the operations of the companies and reduces expenses. The Company, Carmel Olefins and Gadiv have no significant dependency on customers or suppliers, except for the dependency of the subsidiaries on the supply of feedstocks from the Company. The Company has an operating dependency on government companies – Petroleum and Energy Infrastructures Ltd. (“PEI”) and Eilat Ashkelon Pipeline Company Ltd. (“EAPC”) which provide it with crude oil transportation services at terminals and in pipelines. The Company has holdings in other companies, each which are not on a scope that is material for the Company. The Company’s strategic plan, which was launched in September 2007 in a scope of $1.1 billion, focuses on achieving growth and increasing in the competitive capacity of the Company in the coming years, as well as expanding the share of high added-value products in the Company’s product mix and emphasizing environmental quality. The blueprint of the strategic plan includes the following: (1) accelerated investments in refining, mainly in increasing the complexity and efficiency of the refinery and in synergetic areas. The investment is estimated at $850 million, of which $600 million is for the expansion of the cracking capacity of oil products with high added value; (2) identification of business opportunities relating to refineries and petrochemicals in Israel and abroad; (3) expansion of petrochemical operations, by focusing on high added-value products, in Israel and abroad; (4) expansion of commercial and logistics operations for oil products; (5) investment of an estimated $270 million in environmental quality, safety and security and in enhancing operational reliability; (6) reorganization, with a division into three segments: refining, trade and petrochemicals.
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1.2 Business environment and Company profitability The refining margin is the major factor affecting the results of operations in the refining segment. This margin is the difference between the revenue from the sale of the basket of products sold by the Company and the ex-refinery cost of the raw materials purchased by the Company (mainly crude oil). The level of the margin is based on the index of the products and their prices in the reporting period, compared to the composition of the crude oil index and its prices in the same period, depending on different market forces. Global prices of crude oil and distillates are highly volatile and are set, inter alia, by global supply and demand. Prices are also affected by geopolitical events which are not directly connected to oil production, but which are viewed by the markets as having a potential impact on future production. The size of the refining margin is a result of the market forces active on two different planes: one, supply and demand of crude oil and the other, supply and demand of end products. The factors affecting the supply and demand of crude oil and oil products, as described above, generate fluctuations and seasonality in the profitability level of the refining industry. In the reporting period, there was great fluctuation in the price of crude oil and its distillates. The price of oil was $97/barrel at the beginning of the year, rose to $140/barrel at the beginning of the third quarter of 2008 and fell to $36/barrel at the end of the year. Concurrently, there was a decrease in the prices of fuel products that the Company produces from crude oil and sells. Accordingly, the accounting results of the Company’s operations and refining margins were primarily affected by: a loss of $81 million due to timing differences between purchase and selling prices and unhedged basic inventory of 600,000 tons, for which changes its value do not generate cash flow exposure for the Company; (2) a provision of $183 million for impairment of inventory; (3) changes in fair value of derivatives on prices of goods, due to the transition to international financial reporting standards (IFRS) in the amount of $5 million (profit). In the refining segment, operating income, EBITDA and the refining margin after neutralizing these three impacts is $139 million, $180 million and $41.4 per ton, respectively. The operating loss, EBITDA and refining margin, as reflected in the financial statements (without neutralizing these impacts) is $120 million (loss), $79 million (negative) and $9.9 per ton, respectively. In the reporting period, neutralized refining margins fell to $41.4 per ton, compared to $44.2 per ton in the corresponding period last year. The margins publicized by Reuters for an example of a Mediterranean refinery having the capability of cracking Ural-type crude oil (Reuters margin), amounted to $40.1 per ton in the reporting period compared to $38.7 per ton last year. See section 3.1.2 for further information. It is noted that there are differences in a number of parameters between the refining margin of the Company and the Reuters margin. These include the composition of the crude oil (the Company also refines crude oil types that are not Ural), the composition and quality of the products produced by the refineries and the difference generated as result of the fact that the quote takes into account purchase and sale on the same day, while in practice, there is a gap between the purchase date of the crude and the selling date of distillates produced from the crude oil. Accordingly, the comparison to the Reuters' margin is likely to provide insight in relation to the trends of the development of the Company's margin, and does not constitute an exact criterion for estimating the Company's refining margin in the short term.
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The following table summarizes the comparison of the refining margins with the refining margin in the Mediterranean.
2008 2007 Ural margin in the Mediterranean (dollar/barrel) 5.5 5.3
Neutralized margin (dollar/barrel) 5.7 6.1
Neutralized margin (dollar/ton) 41.4 44.2 Neutralization of the impact of the accounting method for derivatives according to IFRS 0.7 (2.6) Buying and selling timing differences (9.9) 16.1 Provision for impairment of inventory as of the balance sheet date (22.3) -- Accounting margin (dollar/ton) 9.9 57.7
Consolidated operating loss amounted to $152 million in the reporting period, compared to operating income of $282 million in the corresponding period last year, a decrease of $434 million. The following table presents a description of the main reasons for the changes in consolidated operating income (in USD million):
2008 compared to 2007 Increase in sales turnover 29 Increase in other revenue 18 Profit from the trade segment 13 Decrease in losses for derivative transactions – see section 6.3 26 Provision for impairment of inventory (198) Buying and selling timing differences – in the refining segment (206) Decrease in margins and buying and selling timing differences – in the segment (89) Decrease in margins in the refining segment (22) Increase in production expenses, mainly energy (36) Increase in selling and administrative expenses (14) Decrease in other expenses 45 (434)
Consolidated EBITDA amounted to a loss of $76 million in 2008, compared to a profit of $354 million in 2007, a decrease of 430%. For further details on the results of operations, including a breakdown by segment, see section 3. Production volumes The refining volume in the Company amounted to 8,245,000 metric tons (in 2007 – 7,759,000 metric tons) with usage of 92%. It is noted that this is a record level of usage.
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The following table presents the breakdown of the Company’s output (refineries) by the main product groups in the refinery segment (in thousands of tons):
2008 2007 Diesel fuel 2,367 1,996 Gasoline 1,664 1,627 Kerosene 831 751 Fuel oil 1,367 1,392 Vacuum diesel 738 706 Others 624 642 Total 7,591 7,114
The following table presents the breakdown of the output of the consolidated companies (in thousands of tons):
2008 2007 Gadiv Petrochemical Industries Ltd. 430 461 Carmel Olefins Ltd. (the Company’s share – 50%) 307 219
1.3 Summary of Company developments during and subsequent to the reporting year 1.3.1 Corporate developments 1.3.1.1 Credit rating of the Company’s debentures On November 11, 2008 Standard & Poor's Maalot announced that it has downgraded the Company’s debentures (Series A, B and C as well as untraded debentures) from AA/Stable to A/Negative. Immediately before the rating was downgraded, the Company published an immediate report, emphasizing that when the debentures (Series A-C) were issued in December 2007 and were rated AA/Stable by Maalot, the Company, as well as Maalot, took into account the Company’s investment forecast to implement its strategic plan in the coming years, and accordingly, under the terms of the debentures (Series A-C), the majority of the payments will start from 2012 onwards, during which time the Company expects to generate large cash inflows on these investments. From the time of the rating in November 2007 and up to the date of the downgraded rating, there were positive changes affecting the Company, as described below: 1. Improved operational availability of the facilities and increased production and sales capacities 2. Improved liquidity and available cash flow, following the sharp decline in crude oil prices 3. Substantial increase in the forecasted future margins for the products produced by the hydrocracker (mainly diesel oil and kerosene) since approval of the strategic plan 4. Continued investment in strengthening the Company’s core businesses, while increasing the refining complexity and flexibility of the facilities as well as adding other margin components, to increase its profits and reduce risk in the long term The Company examined its steps in detail when preparing the strategic plan. Reassessment of the chosen directions indicates that the market changes
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strengthen these directions. This plan emphasizes the Company’s strengths, including human resources, which are among the highest in terms of technological aptitude worldwide, integration of the petrochemical and refining industries, excellent strategic location with accessibility to a wide selection of crude oils, close proximity to growing markets, and strong modern infrastructure in its main Haifa facility. The Company estimates that its strategic plan, the ensuing investments, and the organizational changes and efficiency measures adopted, strengthen the Company as compared to its position at the time of the rating issuance before the debenture offering in 2007. 1.3.1.2 Credit rating of Carmel Olefins In December 2008, Midroog downgraded the rating of Carmel Olefins debentures from Aa2 with a negative outlook to A1 with a stable outlook. The downgrade was due to the failure of Carmel Olefins to meet the leverage goals set at the initial rating date, inter alia, due to fluctuations in raw material prices alongside an increase in the financial debt in 2007-2008 to complete the investment plan and finance the acquisition of a company. On December 31, 2008, the debentures were listed for trading on the TASE. 1.3.2 Corporate developments 1.3.2.1 Strategic plan On October 12, 2008, the Company’s board of directors decided, as part of the strategic plan it adopted in November 2007, to establish a hydrocracker in the Haifa refinery. The hydrocracker, which is expected to be operational in 2011, will produce middle distillates (diesel oil and kerosene), following an investment of $670 million (including an investment of $37 million approved by the board of directors in November 2007 to advance the project). In addition, the plant will increase the flexibility of the refinery in terms of ability to select the raw materials and product mix, adapting them to the changing markets. The Company’s board of directors instructed management to complete the long- term credit arrangements to finance the project.. Accordingly, the Company is taking steps to complete arrangements for the credit facility through Export Credit Agency to finance the purchase of equipment from foreign suppliers, and to receive the additional long-term credit from various sources, which is vital for completion of the project. It is noted that the Company raised part of the sum required to finance the strategic plan in December 2007, pursuant to a prospectus published by the Company on November 28, 2007. In view of the global economic crisis, the board of directors of the Company gave instructions to reduce the cost of the hydrocracker. The board of directors also asked to reassess the balance of financial investments. As of the approval date of the financial statements, the Company has no financial liabilities for the purchase of fixed assets that are not covered by secured financial financing. 1.3.2.2 Implementation of the strategic plan by segment 1. Refining: Completion of organization in the segment. An internal compliance plan was adopted for environmental quality, health and safety. In addition, the following investments were made as part of the strategic plan: A. Increased flexibility of refining at crude refining terminal 4 is in process. Operation is expected to be renewed after shutdown for renovation in the third quarter of 2009. The upgrade will allow refining of a very wide range of crude oil types common in the region, such that
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utilization of the plant will increase and it will be possible to take advantage of more opportunities of good margins B. Conversion of the desulfurization facility from heavy vacuum gas oil (HVGO) to moderate catalytic hydrosulfurization is in process. Stage A is expected to be operational in the second quarter of 2009 and stage B in the third quarter of 2010. Operation of stage A is expected to produce an additional 1.5% of diesel fuel for refining output. Stage B is expected to produce a similar additional output. The Company is acting to advance the implementation of stage B. C. Establishment of a hydrocracker: To advance the project approved by the board of directors when adopting the strategic plan, reactors were ordered and planning is underway. On October 12, 2008, the Company’s board of directors approved the establishment of the hydrocracker. See section 1.3.2.1 above. Projects related to environmental quality in the scope of $50 million were implemented in 2008. D. Establishment of a power station: The configuration testing stage has been completed. 2. Trade: A modern commercial center was established and the information system for managing trade in oil products was implemented. Trade operations in the segment commenced in the first quarter of 2008. 3. Petrochemicals A. Agreement for the purchase of the remaining Carmel Olefins shares In June 2008, the board of directors approved a transaction for the acquisition of the remaining 50% of Carmel Olefins shares from Israel Petrochemical Enterprises Ltd. (“IPE”) in return for the allotment of 20.53% of the Company’s shares (after the allotment). This transaction is part of the Company's business strategy, which aims, inter alia, to realize the full synergy potential in the refinery, polymers and aromatics segments. On June 24, 2008, the Company signed an agreement with IPE. The general meeting of the Company's shareholders approved the agreement on August 13, 2008 On September 28, 2008, the Company and IPE signed an addendum to the agreement. Under the agreement, IPE will sell the Company all the shares it owns in Carmel Olefins, comprising 50% of the issued share capital of Carmel Olefins (“the acquired Carmel Olefins shares”) such that following the acquisition, the Company will hold the full issued share capital of Carmel Olefins. In consideration for the allotment of the Company’s ordinary shares, representing (after the allotment and without dilution) 20.53% of the Company’s issued share capital and its voting rights. It was also agreed that the Company would sell IPE all of the Company’s shares in IPE (“the acquired IPE shares”), representing 12.29% of the share capital of IPE, in consideration for $40 million. On December 31, 2008, the agreement for the purchase of Carmel Olefins expired, without the fulfillment of all the preconditions defined in the agreement and therefore the transaction was not completed. However, as the main reasons underlying the decision of the board of directors to approve the merger of Carmel Olefins with the Company are still valid today, the Company and IPE agreed to continue to cooperate in an attempt to complete the merger, and if the conditions ripen, the issue will be brought to the organs of the Company.
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B. Increased production capacity of paraxylene and benzene is expected to be completed in the fourth quarter of 2009. C. Increased production capacity of phthalic anhydride is expected to be completed in the fourth quarter of 2009. D. Acquisition of a company by Carmel Olefins On April 25, 2008, Carmel Olefins acquired, through Colland Polymers B.V. (“Colland”), Domo Chemicals N.V. ("Domo”) pursuant to an agreement entered into on January 23, 2008. Colland is a wholly-owned subsidiary of Carmel Olefins. Domo is a petrochemical company incorporated in the Netherlands that manufactures and markets polypropylene used as raw material in the plastics industry for a range of uses and products. The main terms of the agreement are as follows: Carmel Olefins purchased 49% of the shares of Domo for €20 million. In addition, commencing from 2013, the shareholders of Domo who sold Carmel Olefins the Company’s shares (“the sellers”) could be entitled to additional compensation, not to exceed an amount of €1 million a year for a five-year period, in accordance with the terms set out in the agreement. Carmel Olefins, through Colland, has a call option from the purchase date until December 31, 2016, for the purchase of the balance of the shares for an additional €10 million, net of the dividends to be distributed to Domo, plus interest at a rate of 5% per annum. The sellers have a put option, exercisable commencing on July 1, 2011 for the sale of the remaining 51% in Domo to Carmel Olefins at the same terms. Commencing May 1, 2008 Carmel Olefins fully consolidates Domo results due to the options, and the minority interests for the shareholders’ balance in Domo are not included. E. TMA project On September 25, 2007, Gadiv signed a memorandum of intent (“the memorandum of intent”) for the purchase of 50% of the registered share capital of a Chinese company (“the acquired company”) which benefits in China from the status of a wholly-foreign owed company (WFOE) and which will manufacture Tri-Maleic-Anhdrid (TMA), a product used mainly as a softener in the polymer industry and as a component in powder colors, and Para Diethyl Benzene (PDEB), a product used mainly in the production of paraxylene. On November 25, 2007 the validity of the memorandum of understanding expired, and the negotiations conducted by the Company on this matter ended without the parties reaching the required agreements for consummation of a binding transaction. At the reporting date, the parties are continuing to examine the options for advancing the project. 4. Company administration A. The Company is examining ways to take advantage of business opportunities outside of Israel, primarily in Mediterranean countries. B. Internal enforcement plans for antitrust issues, securities laws and environmental quality and safety were adopted and assimilated. 5. Environmental quality Alongside the implementation of environmental, reliability and safety projects in the scope of $50 million in 2008, out of the comprehensive
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investment plan in these issues, which was included in the strategic plan, and the assimilation of an internal compliance plan for environmental quality and safety, the Company invested effort to raise public awareness of its activity in these areas. In the reporting period, the Company launched a media campaign regarding the use of environmentally-friendly fuels in compliance with the Euro-5 standard, while emphasizing the slogan: ORL – Energy of Change. This is in addition to the great effort invested in hosting representatives of green organizations and the media at the Company’s plants, presentation of environmental activities and planned investments on the subject, and an environmental exhibition held in Haifa during the week of the Succoth holidays in October. See section 20.2 below for details of the hearing held for the Company in respect of the personal order under which it operates. 1.3.2.3 The Company’s preparation for 2009 and organizational changes As part of the 2009 work plan, which was approved by the board of directors, the Company is implementing efficiency measures in a number of areas, including production, logistics, purchasing, contractual work and human resources, with the aim of ensuring the realization of its strategic plan and its long-term strength and prosperity, against the background of the global economic crisis and its implications on the Israeli economy. As part of these measures, there were organizational changes at the beginning of 2009, which included incorporation of the activities of the business development unit into other units in the Company. In this context, the Company’s vice president for business development and capital market ended his employment at the Company. In addition, the Company appointed a vice president for administration and human resource development. A. In this context, the chairman of the board, CEO and other officers in the Company have announced their intention to take a 10% reduction on the salary due to them in 2009 (with the exception of provisions and incidental conditions). B. Additionally, the Company’s directors, including the outside directors, announced their intention to take a 10% reduction on the directors’ remuneration due to them in 2009. C. On January 1, 2009, CFO Jacob Hirsh announced his resignation. Igal Salhov, who had served up to that date as CFO at Carmel Olefins (held 50% by the Company) was appointed in his place. 1.3.3 Developments in the economic environment and in financial markets and their impact on the Company In 2008, there was dramatic fluctuation in the price of crude oil and its products, in the exchange rate and in the financial markets in Israel and the world. The board of directors of the Company, the board of the trade segment and the finance committee of the board of directors discussed these changes during the reporting period and made decisions designed to adapt the operations in the Company to the changing marketing conditions. The price of crude oil was $96/barrel at the end of 2007, rose to $140/barrel at the beginning of the third quarter of 2008 and fell to $94/barrel at the end of that quarter. By the end of the fourth quarter, the price of crude oil had fallen to $36.5/barrel. On the approval date of the financial statements, the price of crude oil was $50/barrel. In the same period, there was also a decrease in the prices of fuel products produced by the Company from crude oil and sold by the Company. There was no full correlation between the dates of the changes in product prices and the scope of these changes and the dates of the changes in the prices of crude oil and the scope of changes, which resulted in fluctuation in the refining margin.
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A rise in the price of crude oil leads to an increase in the volume of working capital required by the Company to finance its purchases and to an increase in the inventory value in the Company's books. On the other hand, a drop in the price of crude oil leads to a reduction in the volume of working capital required by the Company to finance its operations and a reduction in the inventory value in the Company’s books. The Company’s exposure to changes in the price of crude oil is hedged in the futures and derivatives markets. The decrease in the price of crude oil and its products in the reporting period has a material impact on the fourth quarter results, as described in the section below describing the main factors for the decrease in gross profit. It is noted that the Company does not hedge against the basic inventory value of 600,000 ton. The impact of the changes in the value of the inventory value is not economical therefore, the Company reports its operating results after removing these impacts and other impacts in respect of changes in the value of derivatives in accordance with IFRS. In 2008, there was significant fluctuation in the dollar exchange rate. Although the Company’s functional currency is the dollar, the Company has assets and liabilities denominated in the shekel (mainly due to salaries, payments to suppliers and subcontractors in Israel and payments to institutions and authorities. From the beginning of 2008 until the end of the fourth quarter, there was an appreciation of 12%, while from the beginning of the fourth quarter until the end of 2008, there was a depreciation of 11%. The impact of the fluctuation in exchange rates on the business results in the reporting period amounts to an expense of $13 million. The CPI rose by 3.8% in the reporting period. The Company finances its operations, inter alia, through a public placement of CPI-linked debentures. To reduce the Company’s exposure to changes in the rate of inflation, the Company entered into a currency swap, converting most of its long-term index-linked shekel debentures into dollar loans (see section 6.5 below). Parallel to the Company's index- linked liabilities that were not converted to dollars, the Company holds assets linked to this index. As a result of the crisis in the financial markets in the fourth quarter, the fair value of the financial derivatives held by the Company decreased by $39 million, which was recognized in the Company’s financing expenses. In view of the crisis in the financial markets and in order to reduce the exposure to financial assets, at the end of the third quarter, the Company decided to update its investment policy to further reduce the risks in most of the components of the investment portfolio. The crisis in the financial markets led to heavy losses in pension and compensation funds holding funds deposited by the Company to cover its severance liabilities. In accordance with IFRS, losses from actuarial changes net of tax amounting to $7 million were recognized directly in retained earnings. See section 20 below for the implications of the increase in prices subsequent to the balance sheet date and the implications of the economic crisis on the Company’s financial position.
2. Financial position
2.1 Current assets On December 31, 2008, consolidated current assets amounted to $1,104 million, representing 46% of the total assets, compared to $1,902 million, representing 62% of total assets on December 31, 2007. The change in current assets is mainly due to a decrease in the cash balance of $244 million, a decrease in the Group’s inventory value, mainly due to the decrease in prices amounting to $473 million, reduction in trade receivables (after offsetting the discount and advance payments of $108 million in 2008 and $139 million last year), of $141 million, mainly due to the decrease in prices, offset by an increase of $39 million in other receivables, mainly due to the income tax asset from
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surplus current tax payment of $25 million and recognition of tax benefits of $45 million for prior years for a beneficiary enterprise, offset by a tax return of $37 million, an increase in derivatives for inventory of $9 million, an increase from the investment in financial assets stated at fair value and a short-term deposit of $14 million and an increase in current assets due to consolidation for the first time of Colland results. The decrease in the price of crude oil and oil products reduced the operating capital requirements for commercial operations, customers and inventory, including derivatives for inventory less trade receivables by $317 million.
2.2 Investments and long-term loans As of December 31, 2008, investments and long-term loans amounted to $193 million, representing 8% of the assets, compared to $148 million, representing 5% of the assets as of December 31, 2007. The increase is mainly due to an increase of $60 million in financial derivatives in 2008, due to the impact of the change in interest on the fair value of derivatives for hedging on debentures offset by a decrease in the balance sheet value of investments in investees of $18 million.
2.3 Current liabilities Consolidated current liabilities as of December 31, 2008 amounted to $736 million, representing 40% of total liabilities, compared to $882 million, representing 39% of total liabilities as of December 31, 2007. The decrease is mainly due to the decrease in trade payables of $289 million resulting from the decrease in the price of crude oil and distillates, a decrease in current maturities of $83 million for repaying debentures, offset by an increase in short-term credit from banks of $130 million and reclassification of a long-term bank loan at Carmel Olefins for $117 million to a short- term loan, due to non-compliance with financial covenants.
2.4 Long term financial liabilities Consolidated current liabilities as of December 31, 2008 amounted to $960 million compared to $1,169 million as of December 31, 2007. The decrease of $209 million is mainly due to repayment of loans and debentures and reclassification of Carmel Olefin’s long-term bank loans to short-term, due to non-compliance with the financial covenants. See section 2.3 above.
2.5 Shareholders’ equity Shareholders’ equity amounted to $552 million, representing 23% of the balance sheet, compared to $800 million, representing 26% of the balance sheet as of December 31, 2007. The decrease in shareholders’ equity is mainly due a loss of $109 million in the reporting period and from the distribution of a dividend of $121 million.
B-10 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd. 3. Results of the Group’s operations 3.1 The following tables present selected information compared to last year Petrochemicals Adjustments to Refining Trade Polymers Aromatics consolidated Consolidated Year ended December 31 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 Revenue 6,913 4,416 383 - 475 342 487 476 - - 8,258 5,234 Inter-company operations 707 594 - - - - 57 45 (764) (639) - - Total sales 7,620 5,010 383 - 475 342 544 521 (764) (639) 8,258 5,234
Cost of sales 7,629 4,665 370 - 256 100 61 65 - - 8,316 4,830 Inter-company operations 57 45 - - 255 194 449 394 (761) (633) - - Total cost of sales 7,686 4,710 370 - 511 294 510 459 (761) (633) 8,316 4,830
Gross profit (loss) (66) 300 13 - (36) 48 34 62 (3) (6) (58) 404
Selling, general and administrative expenses 54 54 2 - 30 19 26 25 (4) (4) 108 94 Other (income) expenses - 23 - - (14) 3 - 2 - - (14) 28 Operating profit (loss) (120) 223 11 - (52) 26 8 35 1 (2) (152) 282
Financing income (expenses) (61) (102) Share in the profit (loss) of investees (3) 7
Profit (loss) before taxes on income (216) 187 Tax benefits (income tax) 107 (45)
Net profit (loss) (109) 142
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3.1.1 Sales turnover The sales turnover of the refining segment (carried out through the Company) amounted to $7,619 million in 2008, compared to $5,010 million last year. The increase was mainly due to the increase in the average price of oil products of $1,900 million and an increase in sales turnover of $700 million. The average price per ton of the product index in the Mediterranean area, similar to the product index produced by the Company (“the Company’s product index”) amounted to $850 in 2008, compared to $613 in 2007. Revenue from the sale of products with a volume of over $500 million in the reporting period were as follows: gasoline - $2,643 million, diesel fuel - $2,417 million, kerosene - $845 million, and crude oil - $841 million. There was a decrease of 2% in consumption of distillates in the local market compared to 2007, which included an increase of 3% in the consumption of gasoline offset by a decrease of 4% in diesel oil mainly due to an increase in private consumption of gasoline in 2008 and the slump in operations in the economy. Additionally, there was a decrease of 9% in the consumption of fuel oil compared to 2007 due to the conversion of the Israel Electric Corporation’s power station to production of electricity using natural gas. The turnover of the trade segment (which commenced operations this year and is carried out through the Company) amounted to $383 million. Sales turnover in the petrochemical sector Sales turnover of polymer operations (carried out through Carmel Olefins) increased by $133 million in 2008 compared to the turnover in 2007. The increase is mainly due to the increase in turnover of $155 million, following the operation of the new facilities in July 2007, from inclusion of the sales of Domo, which was consolidated for the first time in 2008, and from the increase in product prices amounting to $15 million. Sales turnover of aromatics operations (carried out through Gadiv) increased by $23 million in 2008 compared to turnover in 2007. . The increase is due to an increase in the sales prices of $33 million and an increase in other revenue of $11 million as a result of the increase in energy and steam prices, offset by a decrease in turnover of $21 million. 3.1.2 Gross profit The following table presents a description of the main reasons for the decrease in gross profit in the refining and trade segments in 2008 compared to 2007 (in USD millions):
2008 compared to 2007 Increase in volume of refining and sales 18 Increase in other revenue 7 Profit from the trade segment 13 Increase in profits for derivative transactions – see section 6.3 26 Provision for impairment of inventory (183) Buying and selling timing differences (206) Decrease in margin neutralized by refining operations (22) Increase in production expenses (6) (353) The margin from refining operations is the difference between the revenue from sales of the products that the Company sells and the cost of raw materials that it purchases, ex- refinery (dollars per ton). The cost of raw materials includes the hedging transactions for the inventory of crude oil and distillates, as described below in the section referring to risk management.
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WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
The following table describes the Company’s refining margins, offset by the impact of impairment of inventory, buying and selling timing differences and recording of derivatives in accordance with IFRS in UDS/ton. Q1 Q2 Q3 Q4 Year 2008 17.7 48.9 58.9 40.3 41.4 2007 74.8 48.0 29.6 26.1 44.2
In the first half of 2008, there was a decrease in refining margins in the Mediterranean area and in the Company, mainly due to speculator demands in the crude oil market following the crisis in financial markets. This resulted in an increase in oil prices but not a corresponding increase in prices of oil products. In the second half of the year, in particular in the fourth quarter, there was a decrease in margins due to the global slowdown. The increase in other income was mainly due to the sale of energy and water utilities in 2008 compared to 2007, mainly due to the increase in sales turnover. The increase of $6 million in production expenses in 2008 compared to 2007 was mainly due the impact of the depreciation in the exchange rate on shekel expenses, mainly payroll expenses and an increase in expenses for energy and water utilities, resulting mainly from the increase in prices, offset by a decrease in maintenance expenses resulting from a decrease in the scope of maintenance works and a decrease in depreciation and amortization after renovation of one of the Company’s plants which was completed in August 2008. Gross loss in polymers operations amounted to $36 million in 2008, compared to gross profit of $48 million in 2007. The following table presents a description of the main reasons for the decrease is gross profit (in USD millions): 2008 compared to 2007 Increase in sales turnover 15 Provision for impairment of inventory (15) Decrease in products index margin and buying and selling timing differences (72) Increase in production and other expenses (12) (84)
Gross profit in aromatics operations amounted to $34 million in 2008, compared to $62 million in 2007. The following table presents a description of the main reasons for the decrease in gross profit (in USD millions): 2008 compared to 2007 Decrease in sales quantities (4) Increase in processing fees 11 Decrease in products index margin (17) Increase in production expenses, mainly energy (18) (28)
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WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
3.1.3 Selling, general and administrative expenses Selling, general and administrative expenses include mainly payroll, insurance, taxes and authorization fees. Consolidated selling, general and administrative expenses amounted to $108 million in 2008, compared to $94 million in 2007. The increase in expenses is mainly due to an increase in payroll expenses as a result of the impact of the appreciation in the exchange rate on payroll expenses, an increase in the selling costs of Carmel Olefins as a result of the increase in exported quantities and consolidation of Domo for the first time. 3.1.4 Operating income and EBIDTA (earnings before interest, taxes, depreciation and amortization) Refining and trade segment The neutralized operating income in the refining and trade segments amounted to $150 million in 2008, compared to an income of $118 million in 2007. The accounting operating loss in the refining and trade segments amounted to $110 million in 2008, compared to an income of $223 million in 2007. The change in the accounting operating income of $333 million is due to the decrease in gross profit of $354 million as explained above, an increase of $2 million in selling, general and administrative expenses and a decrease in other expenses of $23 million, due to the privatization grant for employees in 2007. . In the context of the State’s completion of the Company’s privatization process, the Government Companies Authority applied the right to a privatization grant on the Company’s employees and the employees of proportionally consolidated companies, pro rata to its holdings. Neutralized EBITDA of the refining and trade segment amounted to $191 million in 2008 compared to $162 million in 2007, an increase of $29 million. Accounting EBITDA amounted to a loss of $68 million in 2008 compared to a profit of $237 million in 2007, a decrease of 335%. Petrochemicals segment Operating loss in the polymers operations amounted to $52 million in 2008, compared to operating income of $26 million in 2007. The decrease was due to a decrease in gross profit of $84 million, as described above, an increase in sales, general and administrative expenses of $11 million, offset by an increase in other revenue of $17 million, mainly due to earnings for negative goodwill created upon the acquisition of Domo. EBITDA of the polymers operation amounted to a loss of $25 million in 2008 compared to a profit of $47 million in 2007. Operating income of the aromatics operations amounted to $8 million in 2008 compared to operating income of $35 million in 2007, a decrease of $27 million. EBITDA of the aromatics operations amounted to $15 million in 2008, compared to $42 million in 2007. The consolidated accounting operating loss amounted to $152 million in 2008 compared to a profit of $282 million in 2007. Consolidated accounting EBITDA amounted to a loss of $76 million in 2008, compared to a profit of $354 million in 2007.
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WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
3.1.5 Financing expenses In the reporting period, net consolidated financing expenses amounted to $61 million in 2008 compared to $102 million in 2007. The following table presents details of the principal changes in financing expenses (in USD millions):
2008 compared to 2007 Impact of the appreciation on shekel and linked debentures 4 Impact of debenture derivatives following the appreciation (54) Increase in the cost of short-term credit mainly due to the increase in volume offset by a decrease in the interest rate including the impact of appreciation 15 Increase in interest expenses on long-term debentures and loans mainly due to an increase in the volume of debentures offset by a decrease in the interest rate 14 Impact of the appreciation on the financial items, net (27) Increase in value of securities and loan to Haifa Early Pensions Ltd., including the impact of appreciation 7 (41)
3.1.6 Income tax In 2008, tax revenue in the Group amounted to $107 million due to a loss in the year and from tax revenue in respect of prior years in the amount of $47 million following the draft approval for a beneficiary enterprise. 3.1.7 The Company’s share in earnings of investees The Company’s share in the earnings of investees amounted to a loss of $3 million in 2008 compared to earnings of $7 million in 2007. The change is mainly due to the our share in losses of IPE $6 and Gadot $4 million
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WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Consolidated quarter results of the reporting period and the prior year
Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 2008 2007 USD millions Revenue 1,276 2,625 2,471 1,886 1,567 1,288 1,298 1,081
Cost of sales, refinery and services 1,576 2,574 2,340 1,834 1,470 1,192 1,184 970 Revaluation of open transactions in derivatives on prices of goods and margins, net - (31) 13 11 (8) 34 (45) 33 1,576 2,543 2,353 1,845 1,462 1,226 1,139 1,003
Gross profit (loss) (300) 82 118 41 105 62 159 78
Selling expenses 9 11 11 10 11 9 7 8 General and administrative expenses 8 18 26 15 12 14 14 19 Reduction of negative goodwill created upon acquisition - (1) (14) - - - - - Privatization grant ------28 Profit (loss) from operations (317) 54 95 16 82 39 138 23
Financing income (expenses), net 29 (52) (21) (17) (59) (21) (15) (7)
Company’s share in profits (losses) of investees (net of tax) (4) (3) 9 (5) 6 (6) 5 2 Profit (loss) before income tax (292) (1) 83 (6) 29 12 128 18
Tax benefits (taxes on income) 110 1 (12) 8 (11) 6 (33) (7) Net profit (loss) for the year (182) - 71 2 18 18 95 11
3.2 Fourth quarter results compared to the corresponding quarter last year 3.2.1 Sales turnover The dollar sales turnover in the refining and trade segment in the fourth quarter decreased by $269 million compared to the corresponding quarter last year, mainly due to a decrease in product prices. The sales turnover of polymer operations decreased by $17 million in the fourth quarter compared to the corresponding quarter last year, due to a decrease in sales volume and a decrease in selling prices. The increase in volume is mainly due to consolidation of Domo results for the first time. The sales turnover of aromatics operations decreased by $59 million in the fourth quarter compared to the corresponding quarter last year. The decrease is due to a decrease in prices and selling quantities. Revenue from sales of products of over $200 million in the fourth quarter: diesel fuel - $414 million, gasoline – $271 million.
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WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
3.2.2 Gross profit Gross loss in the refining and trade segments amounted to $232 million in the fourth quarter compared to a profit of $77 million in the corresponding quarter last year. The following table presents a description of the main reasons for the changes (in USD millions): 10-12.2008 compared to 10-12.2007 Increase in volume of refining and sales (2) Profit from the trade segment 4 Decrease in margin from refining operations (29) Impairment of inventory (1) (115) Selling and buying timing differences (2) (235) Decrease in losses for derivative transactions – see section 6.3 (1) Decrease in production expenses 11 (309)
(1) As a result of the volatility in the prices of crude oil and its distillates, the Company recognized a loss of $115 million for impairment of inventory in the quarter, out of the total $183 million as of December 31, 2008 (the balance of $68 million was recognized in the third quarter of 2008). (2) In the fourth quarter of 2008, buying and selling timing differences amounted to a loss of $170 million compared to a profit of $65 million in the corresponding period last year. The loss reflects the exposure and hedging policy for changes in prices of the Company's inventory, according to which the Company does not hedge against basic operational inventory of 600,000 metric tons. Changes in the value of this inventory do expose the Company to cash flow risks. Gross loss in the polymers operations amounted to $57 million in the fourth quarter of 2008 compared to a profit of $14 million in the corresponding quarter last year. The following table presents a description of the main reasons for the increase in gross loss (in USD millions): 10-12.2008 compared to 10-12.2007 Decrease in sales quantities (7) Impairment of inventory (15) Decrease in products index margin and buying and selling timing differences (48) Increase in product expenses, net (1) (71)
Gross loss in the aromatics operations amounted to $11 million in the fourth quarter of 2008 compared to a profit of $16 million in the corresponding quarter last year.
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WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
The following table presents a description of the main factors of the impact of the gross loss in the aromatics segment (in USD millions): 10-12.2008 compared to 10-12.2007 Decrease in products index margin (22) Decrease in sales quantities (5) (27)
3.2.3 Operating income and EBIDTA Neutralized operating income in the refining and trade segment amounted to $47 million in 2008, compared to a loss of $5 million in 2007. Operating loss in the refining and trade segment amounted to $236 million in the fourth quarter of 2008 compared to operating income of $64 million in the corresponding period last year, representing a decrease of 300%. The decrease in operating income in the refining and trade section is due to a decrease in gross profit of $310 million as explained above, which was partially offset by a decrease in administrative and selling expenses of $9 million. Neutralized EBITDA in the refining and trade segment amounted to a profit of $56 million in the fourth quarter of 2008 compared to a profit of $6 million in the corresponding quarter last year. Accounting EBITDA in the refining and trade segment amounted to $227 million in the fourth quarter of 2008 compared to a profit of $75 million in the corresponding quarter last year. Operating loss in the polymers operations amounted to $67 million in the fourth quarter compared to operating income of $6 million in the corresponding quarter last year. The decrease was due to a decrease in gross profit of $71 million, as described above, and an increase in general and administrative expenses of $2 million. EBITDA of the polymers operations amounted to a loss of $60 million in the fourth quarter of 2008 compared to a profit of $12 million in the corresponding quarter last year. Operating loss in the aromatics operations amounted to $16 million in the fourth quarter of 2008 compared to profit of $10 million in the corresponding quarter last year. EBITDA of these operations amounted to a loss of $14 million in the fourth quarter of 2008 compared to a profit of $12 million in the corresponding quarter last year. Consolidated accounting operating loss amounted to $317 million in the fourth quarter of 2008 compared to operating income of $82 million in the corresponding quarter last year. Consolidated accounting EBITDA amounted to a loss of $299 million in the fourth quarter of 2008 compared to a profit of $63 million in the corresponding quarter last year.
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WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
3.2.4 Financing Net consolidated financing expenses amounted to $30 million in the fourth quarter, compared to an expense of $59 million in the corresponding quarter last year. The following table presents details of the principal changes in financing expenses (in USD millions): 10-12.2008 compared to 10-12.2007 Impact of the devaluation on shekel and linked debentures 120 Impact of debenture derivatives (48) Decrease in the cost of short-term credit mainly due to the increase in the scope offset by an decrease in the interest rate, including the impact of depreciation 26 Impact of the appreciation on the financial items, net 30 Decrease in value of securities and loan to Haifa Early Pensions Ltd., including the impact of the devaluation (40) 88
3.2.5 Income tax In the fourth quarter of 2008, tax revenue in the Group amounted to $110 million due to a loss in the quarter and from tax revenue in respect of prior years in the amount of $44 million following the draft approval for a beneficiary enterprise. 3.2.6 Company’s share in earnings of investees The Company’s share in the earnings of investees amounted to a loss of $4 million in 2008, compared to earnings of $6 million in 2007. The change is mainly due to the our share in losses IPE $6 million and Gadot $4 million.
4. Liquidity Total current assets less current liabilities as of December 31, 2008 amounted to $368 million compared to $1,021 million as of December 31, 2007. The current ratio as of December 31, 2008 is 1.5 compared to 2.1 on December 31, 2007. Consolidated cash flows from operating activities in the reporting period amounted to $223 million, mainly due to the accounting loss less adjustments of non-cash activities and a decrease in current assets and liabilities. Cash flows used in investment activity amounted to $182 million in the reporting period, used mainly to finance investments in fixed assets in the Company and Carmel Olefins and the acquisition of a subsidiary by Carmel Olefins. Cash flows used in financing activity amounted to $287 million in the reporting period mainly from short-term credit received in the amount of $128 million offset by repayment of debentures and long- term loans of $218 million, $77 million in interest paid, and payment of a dividend of $121 million. The total cash flows from operating activities less cash used for financing and investment operations led to a decrease of $246 million in cash balances in the reporting period.
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WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
5. Sources of financing
Composition of the Group’s source of financing: 2008 2007 USD millions Sources Reduction in the period 246 - Cash from operating activities (prior to changes in working capital) - 163 Receipt of short-term credit and deposits from customers 129 - Decrease in working capital, net 307 - Privatization grant - 28 Long-term loans and debentures - 623
682 814
Uses Cash used in operating activities (before changes in operating capital) 162 - Repayment of short-term credit - 134 Increase in cash - 63 Increase in operating capital - 214 Payment of dividend 121 74 Investments in fixed and other assets 142 100 Loan to Haifa Early Pensions Ltd. - 72 Investment in affiliates, in negotiable securities 40 - Repayment of long term loans and debentures 217 157
682 814
Long-term loans and debentures Long term loans and debentures as of December 31, 2008 (after deduction of current maturities) amounted to $960 million, representing 40% of the balance sheet, compared to $1,169 million, representing 38% of the balance sheet on December 31, 2007. The proceeds of the loans are used to finance investments in fixed assets and to finance working capital. Financial leverage (long term loans and debentures for shareholders’ equity plus long term loans and debentures) is 64% compared to 59% as of December 31, 2007. Total financial liabilities Current financial liabilities plus long-term loans and debentures amounted to $1,340 million on December 31, 2008, representing 56% of the balance sheet compared to $1,385 million, representing 45% of the balance sheet as of December 31, 2007. Financial leverage of total financial liabilities to banks and other credit providers is 71% compared to 63% as of December 31, 2007. Long-term financial debt (long-term loans and debentures, including current maturities) amounted to $1,092 million in the reporting period: in the Company $955 million (including $118 million in current maturities); in Carmel Olefins $134 million (including $14 million in current maturities); and in Gadiv $3 million.
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WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Average volume of sources of finance in the reporting period Long term loans (including current maturities) – $1,306 million; short term credit – $216 million; trade payables – $553 million; trade receivables – $462 million.
6. Exposure to market risk and risk management methods
6.1 Parties responsible for management of market risks in the Group 6.1.1 The parties responsible for market risks deriving from changes in prices of crude oil and distillates and prices of aromatic products and polymers: In the Company and Gadiv: CEO of the trade segment - Mrs. Rivka Brookman. In Carmel Olefins: Exposure committee headed by the CEO - Mr. Charlie Sheffer. 6.1.2 The parties responsible for market risks deriving from changes in exchange rate of the dollar to foreign currencies, changes in interest rates, inflation, securities, and credit risks: In the Company: CFO - Mr. Jacob Hirsh, in the reporting period. Commencing from January 6, 2009, Mr. Igal Salhov, who was appointed as CFO of ORL on that date, and Mrs. Eti Gutman, who was appointed as head of risk management commencing from 2009. In Gadiv: Head of the Finance and Accounting Department at the company - Mr. Yehuda Nirenfeld. In Carmel Olefins: CFO – in the reporting period, Mr. Igal Salhov. Commencing from January 6, 2009, Mr. Zeev Ginor, who was appointed acting CFO at Carmel Olefins at that date. According to its management’s recommendation, the Company’s board of directors resolved to carry out a comprehensive risk survey during 2009. 6.1.3 The board of directors of Gadiv and the Company, through the finance and investment committee and the trade segment council, discuss and set market risk management policy, receive reports from the management members responsible for management of market risks and monitor management’s implementation of the policy. At Carmel Olefins, the exposure policy is implemented in accordance with the policy approved by its board of directors.
6.2 Description of market risks and the Group’s risk management policy: 6.2.1 General The Group is engaged in the purchase and refining of crude oil and the sale of distillates and petrochemical products to local and export markets. This involves market risks due to changes in the prices of crude oil, distillates and petrochemical products, changes in the shekel and dollar exchange rates and changes in interest and inflation rates. The Group’s risk management policy is designed as a tool for management to achieve the Company’s business objectives, by assessing and limiting the possible results of exposure in accordance with criteria set by the Company’s board of directors. Reporting and monitoring subsequent to the implementation of the policy is carried out by the board committees. The Group uses financial instruments, including derivatives (“derivatives”), to minimize its exposure to these risks. The Company does not issue or hold financial instruments for trading purposes. Derivative transactions are carried out with banking institutions and multinational corporations, with attention to the financial strength of these entities, and, therefore, the
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WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Company estimates that there is no material credit risk in respect of such derivatives. The Company does not demand or provide guarantees in respect of these derivatives, with the exception of short transactions involving crude oil and products traded on international exchanges, for which the Company provides guarantees (margin) as is customary in these markets. 6.2.2 Exposure to changes in the price of crude oil and the Group’s products The exposure is generated for the Company at the time that the price of the crude oil purchased by the Company is set and exists until the sales price of the refined products is set. In accordance with Company policy, it does not hedge against the base crude oil inventory of 600,000 tons. The Company hedges its crude inventory balance mainly by selling futures contracts and at times fixes its future refining margins through swap transactions. In the absence of sophisticated futures markets suited to their products, the Company’s subsidiaries do not hedge on the prices of their products. 6.2.3 Exposure to exchange rate fluctuations Commencing from January 1, 2008, upon adoption of IFRS, the Company’s functional currency was defined as the US dollar. Accordingly, measurement is mainly of the Company’s exposure to changes in the dollar exchange rate and the other currencies in which the Company operates. The Company’s financial Statements are prepared and stated in US dollars. The Group operates in the fuel and petrochemicals market, which are markets based on the US dollar, therefore most of the Company's current assets and liabilities are dollar- denominated or dollar-linked and part of the long-term credit is dollar-denominated. Group policy is to hedge against exposure to changes in exchange rates which are reflected in current cash flows. The Group has financial and operational assets and liabilities denominated in the shekel (mainly due to salaries, payments to suppliers and subcontractors in Israel, payments to institutions and part of the sales to customers denominated in the shekel). The companies in the Group use financial instruments to reduce the exposure at the level of current and long-term assets and liabilities. The finance committee of the Company's board of directors decided to hedge on shekel- denominated operating and maintenance expenses commencing from 2008, based on the criteria formed in the committee. The exposure committee of Carmel Olefins, headed by the CEO, discussed the exposure and different financial instruments were used in accordance with the decisions of the committee. 6.2.4 Exposure to changes in interest rates The Group companies have loans and liabilities bearing variable interest based on LIBOR interest plus a banking margin. Changes in the variable interest rate are the source of the exposure. The Group companies use of interest rate swap transactions (IRS) to minimize part of this exposure. 6.2.5 Credit risks The Group companies sell at credit to customers in Israel and abroad. To reduce the exposure to risks from providing this credit, the companies obtain proper collateral in cases they consider as having a high risk and sells debts to customers in discount arrangements.
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WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
6.2.6 Fair value of financial instruments 6.2.6.1 The financial instruments of the Group companies include mainly cash and cash equivalents, trade receivable, investments in marketable securities, short-term credit, trade payable, long-term bank loans, and debentures. The fair value of the current financial instruments is not materially different from their value in the Company’s books. 6.2.6.2 The Company has long-term assets and liabilities with a fair value that differs from their book value. See Note 31 to the financial statements for disclosure of these assets and liabilities. 6.2.6.3 The fair value of derivative financial instruments is based on their listed market price. If a listed market price is not available, then fair value is estimated by analyzing the discounted cash flows using an appropriate interest rate for the residual maturity of the instruments. For derivatives including options, models for pricing options are used. 6.2.7 Adoption of International Financial Reporting Standards (IFRS) In accordance with the provisions of the accounting standard referring to the adoption of IFRS, commencing with the financial statements for the first quarter of 2008, the Group prepares its financial statements in accordance with IFRS. See Note 33 to the financial statements. Until December 31, 2007, in accordance with generally accepted accounting principles in Israel (Israeli GAAP), the shekel was the functional currency of the financial statements of the Group and the financial statements of the Group were prepared in the shekel. Accordingly, exposure was created between the rate of the shekel and the rates of the other currencies in which the Group operated. Commencing from January 1, 2008, upon adoption of IFRS, the Group’s functional currency was defined as the US dollar. Accordingly, the Group measures its exposure to changes in the rate of the dollar compared to the other currencies in which the Group operates (including the shekel). The major risks are the exposure in respect of the long-term shekel credit balance, investments in marketable securities denominated in shekels, operating and maintenance expenses in shekels, and shekel denominated sales made by the Company to its customers.
6.3 Implementation of derivative transactions 6.3.1 General In accordance with Israeli GAAP, which was used as the basis for the preparation of the Company’s financial reports until December 31, 2007, the conditions for hedge accounting were based primarily on financial criteria that generated an accounting comparison between the results of the hedged item and the results of the hedging instrument. In accordance with IFRS, before a transaction in financial instruments is recognized as hedge accounting, it has to fulfill certain conditions, including conditions relating to the purpose of the instrument, compliance with strict documentation requirements, and high hedging effectiveness at the beginning of and during the course of the entire hedge. Changes in the fair value of derivative financial instruments that do not meet the conditions required for hedge accounting are immediately recognized in profit or loss in each period, however the results of the hedging instrument are only recognized in profit or loss statement at the exercise date. The transactions conducted by the Company in financial instruments to reduce this exposure do not comply with the hedge conditions set out in IFRS, even though their financial objective is purely hedging, and therefore, in the transition to IFRS, these financial instruments are measured at fair value, with changes in fair value immediately recognized in profit or loss, as described below.
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WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
6.3.2 Transactions in derivatives on the prices of goods and margins In the reporting period, following the transition to IFRS accounting (compared to Israeli GAAP), the Company recorded profits for derivative transactions on the prices of goods and refining margins of $6 million, deriving from recording the derivatives in accordance with IFRS in 2007, while according to Israeli GAAP, they were deferred for realization in 2008, compared to a loss of $20 million in the corresponding period last year (before tax). The loss in the reporting period is mainly due to derivatives on refining margins due to the Company at a future date defined in the agreement, a fixed amount equal to the margin between the cost of raw materials and the consideration for certain refining products, as determined in the agreement. The increase in fair value at the end of the reporting period compared to the beginning of the reporting period reflects the decrease in the refining margin for the refining products in the agreement, compared to the fixed margin in the hedging transaction and is recognized in profit or loss in the reporting period. The absence of comparison is mainly accounting, as financially the Company is not expected to be affected by these changes, since at the future date determined in the transaction, the Company is expected to receive the margin determined in the transaction. While in accordance with Israeli GAAP (prior to implementation of IFRS), the loss was recognized as incurred, while recognizing profit from the physical transaction. In accordance with IFRS, the company will recognize the changes in the fair value of the hedging transactions in profit or loss at each reporting period until completion of the transaction. In accordance with IFRS, should the crude oil prices increase, the Company would record losses for realization of hedging positions on crude oil previously attributed to inventory based on accounting principles prior to full adoption of IFRS. Recognizing the loss in the profit or loss instead of in inventory does not create accounting parallelism for the income when income from sales of inventory is expected to be recognized in profit or loss subsequent to the reporting period. At the end of 2008, the prices of crude oil dropped and therefore, this situation did not arise. 6.3.3 Transactions in derivatives on principal and interest 6.3.3.1 In the reporting period, following the transition to accounting according to IFRS, the Group recorded a net profit of $38 million for derivative transactions on exchange rate and interest rate swap transactions in a net amount of NIS 43 million. The profit is attributed to financial hedging by the Group to reduce currency exposure resulting from issuance of shekel or shekel CPI-linked debentures in December 2007 ("the 2007 debentures”). As part of the hedging transaction, the Group converted its shekel liabilities to dollar liabilities at the same repayment dates as those of the 2007 debentures, and exchanged the fixed linked interest with variable dollar interest. 6.3.3.2 In the fourth quarter of 2007, the Group increased the scope of IRS transactions to long-term transactions to hedge the replacement of fixed interest on debentures with variable interest. In the reporting period, following the transition to IFRS, the Company recorded losses of $6 million for the swap transactions 6.3.4 Forward currency transactions To hedge against exposure from the Group’s credit sales to its customers in shekels, the Group purchases dollars in forward transactions for the expected dates of customer intake. In the reporting period, following transition to IFRS, the loss of $1 million was recognized immediately in the income statement and offset the impact of the changes in the exchange rate against the shekel for these sales. To hedge forecasted cash flows for the purchase of fixed assets in euro, the Company entered into forward transactions to purchase euro. In the reporting period, following the
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WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
transition to IFRS, the Company recognized a loss of approximately $1 million in the income statement as a result of changes in the fair value of the derivative.
6.4 Supervision over the market risk management policy and how it is realized A finance committee is a permanent part of the Company’s management. This committee is made up of the CEO, VP trade, CFO, and in the reporting period, VP business development and capital market, and VP finances, who meet once a week to discuss and decide on various financial issues. This committee and the board of directors' finance committee discussed the Company's exposure to exchange rate fluctuations. The board of directors’ finance committee received reports from the management and held six meetings to discuss the Company's exposure to the impact of exchange rate fluctuations. The resolutions of the finance committee on this subject are designed to reduce the Company’s exposure to changes in the shekel exchange rate and included the following issues: the replacement of most of the Company’s shekel debentures with long-term dollar loans, reduction of the exposure for the Company’s sales to customers with shekel credit through forward transactions, short-term credit management in dollars and investment of the balance of the current moneys in dollar, and conversion of part of the index- and CPI-linked investments portfolio into the dollar. In the reporting period, it was decided to enter into hedging transactions for operating and maintenance expenses denominated in the shekel according to the criteria that were determined. In the reporting period, the board of directors has held four meetings to discuss the Company's exposure to exchange rate fluctuations. In these meetings, the board received reports from the management and approved the reports and decisions of the finance committee as above.
6.5 Sensitivity analysis of exposure to market risks – the Group Index-linked debentures Index-linked debentures floated by the Company bear fixed interest. The debentures are presented at fair value which reflects the future cash flows discounted at a real interest rate, based on index-linked corporate debentures rated by the Company for the appropriate term, plus a margin as of the balance sheet date The sensitivity analysis was made for the following risk factors: changes in exchange rates, changes in real and nominal shekel interest and changes in the index. Interest rate swaps (IRS) The Group entered into interest rate swap transactions in which it undertook to pay fixed interest against a receipt of variable interest. The swap transactions are presented at fair value based on the estimated future discounted cash flows at LIBOR interest using conventional commercial software. The sensitivity analysis was made for the change in dollar interest. Principal and interest swap transactions In December 2007 and January 2008, as part of its preparation for operations in the functional currency – the dollar – the Company executed a swap of index-linked debentures at fixed interest against a dollar loan at variable interest under the same terms of repayment. The swap transactions are presented at fair value using assessment techniques based on discounting the future cash flows, as follows: Discounted unlinked shekel payments based on the interest rate derived from unlinked shekel government bonds, discounted index-linked payments – based on the
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WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd. interest rate derived from index-linked government bonds, and discounted dollar payments based on the interest rate derived from LIBOR interest plus a customary commercial margin. The sensitivity analysis was made for the following risk factors: exchange rate fluctuations, changes in risk-free dollar, real and nominal shekel interest and changes in the index. Forward transactions The Group conducted hedging transactions, using forward transactions on the exchange rate for the short term and dollar-euro exchange rate for the long term. The value of the forward transactions are presented at fair value at the balance sheet date. The fair value of the transactions is based the use of commercial software routinely quoting the market prices, according to forward rates as of December 31, 2008. The sensitivity analysis was made for the following risk factors: exchange rate fluctuations and changes in risk-free dollar, shekel and euro shekel interest rates. Futures To reduce the exposure created from the date the price of crude oil is set until the date the selling prices of the distillates are set, the Company sold marketable contracts for the future sale of crude oil at fixed prices. Parallel to setting the selling price of products produced from the hedged inventory, the Company purchases contracts on the futures market, thereby fixing the price of the inventory and reducing the risk of changes in market prices. Long positions are purchased as part of the fixing of the value of the inventory in some instances to neutralize the base risk of a discrepancy between the price of the physical load and the futures contract. The hedging results are recognized in the results of operations immediately on disposal of the inventory. The contracts are presented at their fair value, based on market price quotes as of the balance sheet date. The sensitivity analysis was made for changes in the inventory price. Swap hedging To hedge its future cash flows, the Company fixed refining margins for specific refining quantities for periods subsequent to the reporting period. The Company fixes the refining margins by using swap transactions which are not traded over the counter and adapts the hedging activity to the production mix the Company plans to produce, to the extent possible. The hedging results are recognized in profit or loss at the same time as the results of the transactions they were intended to hedge. The swap transactions are presented at their fair value which reflects the future cash flows discounted at the appropriate LIBOR interest. The sensitivity analysis was made for the following risk factors: changes in the dollar interest rate for the appropriate periods, and changes in the future prices of products included in the SWAP transactions. Crude oil and Group products The value of the inventory intended for sale on the local market in the following month based on the realization value. The balance of the inventory is presented at fair value, on the basis of the quote on the balance sheet date. The sensitivity analysis was made for changes in the inventory price.
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Trade receivables and trade payables The balances of trade receivables and trade payables were included on the same cumulative basis as the fair value. The fair value is the market value at the balance sheet date. The sensitivity analysis was made for changes in the exchange rate. Securities portfolio The securities portfolio is broken up into various investment tracks, on the basis of the average life span of the investment in each track. The fair value is the market value at the balance sheet date. The sensitivity analysis was made for the risk factors that characterize the composition of the portfolio: exchange rate fluctuations, and changes in the dollar, shekel and real interest rates. The following tables describe sensitivity to the Company’s exposure to market risks
6.5.1 Summary of the differences in fair value in view of the sensitivity analysis of the dollar-shekel exchange rate
Profit (loss) Fair value Profit (loss) December 10%+ 5%+ 31, 2008 5%- 10%- Exchange rate fluctuations 4.1822 3.992 3.802 3.612 3.422 USD thousands (23,710) Long-term linked shekel debentures 40,954 21,452 (450,490) (50,054) 6,743 Long-term shekel debentures 11,647 6,101 (128,117) (14,235) 4,540 Trade receivables (NIS) (7,842) (4,108) 86,267 9,585 (2,975) Trade payables (NIS) 5,139 2,692 (56,525) (6,281) 1,658 Inventory balance (NIS) (*) (2,864) (1,500) 31,500 3,500 4,478 Securities (NIS) (7,734) (4,051) 85,077 9,453 (3,239) Forward contracts 5,596 2,931 (1,058) (6,839) Swapping principal and interest (50,333) (26,365) 48,512 29,140 61,518 (5,438) (2,849) 3,149 6,647
* Inventory denominated in NIS
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6.5.2 Summary of the differences in fair value in view of the sensitivity analysis of the euro-dollar exchange rate
Profit (loss) Fair value Profit (loss) December 10%+ 5%+ 31, 2008 5%- 10%- Exchange rate fluctuations 1.532 1.462 1.393 1.323 1.254 USD thousands Forward contract 1,819 910 (796) (910) (1,812)
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6.5.3 Summary of the differences in fair value in view of the sensitivity analysis of the dollar interest rate Profit (loss) Fair value Profit (loss) December 10% + 5% + 1%+ 0.5%+ 31, 2008 0.5%- 1%- 5%- 10% - USD thousands Interest rate swaps (IRS) 1,231 601 5,867 2,971 (6,900) (3,052) (6,176) (669) (1,309) Swap hedging (12) (3) (24) (9) 5,946 9 24 3 12 Dollar-linked securities (54) (27) - - 15,033 - - 27 54 Forward contract 53 26 6 3 (1,854) (3) (5) (26) (52) Swapping principal and interest 674 337 2,105 1,063 48,512 (1,090) (2,204) (338) (678) 1,891 934 7,954 4,028 (4,136) (8,361) (1,003) (1,974)
6.5.4 Summary of the differences in fair value in view of the sensitivity analysis of the price of crude oil and distillates Profit (loss) Fair value Profit (loss) December 50% + 20% + 10%+ 5%+ 31, 2008 5%- 10%- 20%- 50% - USD thousands Inventory (*) 80,795 32,318 16,159 8,079 161,589 (8,079) (16,159) (32,318) (80,795) Futures (94,062) (37,618) (18,803) (9,395) 6,765 9,418 18,826 37,641 94,085 Swap hedging 10,455 4,182 1,241 620 5,946 (620) (1,241) (4,182) (10,455) (2,812) (1,118) (1,403) (696) 719 1,426 1,141 2,835
(*) Excluding inventory with a fixed price (**) Assuming product index prices are unchanged
`
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6.5.5 Summary of the differences in fair value in view of the sensitivity analysis of shekel interest in real terms: Profit (loss) Fair value Profit (loss) December 10% + 5% + 1%+ 0.5%+ 31, 2008 0.5%- 1%- 5%- 10% - USD thousands CPI-linked securities (553) (276) (55) (28) 49,611 28 55 276 553 Long-term CPI-linked shekel debentures 14,057 7,114 19,828 10,082 (450,490) (10,434) (21,235) (7,291) (14,765)
Swapping principal and CPI- linked interest (5,938) (2,984) (21,090) (10,736) 37,991 11,137 22,693 3,015 6,063 7,566 3,854 (1,317) (682) 731 1,513 (4,000) (8,149)
6.5.6 Summary of the differences in fair value in view of the sensitivity analysis of nominal shekel interest Profit (loss) Fair value Profit (loss) December 10% + 5% + 1%+ 0.5%+ 31, 2008 0.5%- 1%- 5%- 10% - USD thousands Securities (NIS) (322) (161) 32 16 35,467 (16) (32) 161 322 Forward contracts 13 6 - - (1,058) - - (6) (13) Unlinked shekel debentures 3,510 1,722 4,789 2,425 (128,117) (2,490) (5,046) (1,806) (3,649) Swapping principle and non- linked interest (1,621) (814) (5,322) (2,694) 10,521 2,763 5,597 820 1,647 1,580 753 (565) (285) 289 583 (831) (1,693)
6.5.7 Summary of the differences in fair value in view of the sensitivity analysis of euro interest Profit (loss) Fair value Profit (loss) December 10% + 5% + 1%+ 0.5%+ 31, 2008 0.5%- 1%- 5%- 10% - USD thousands Forward contracts (50) (25) (5) (3) (796) 3 5 25 50
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6.5.8 Summary of the differences in fair value in view of the sensitivity analysis of the CPI
Profit (loss) Fair value Profit (loss) December Change in the CPI 10%+ 5%+ 31, 2008 5%- 10%- USD thousands CPI-linked securities 4,961 2,481 49,611 (2,481) (4,961) Long-term CPI-linked shekel debentures ()45,049) ()22,524 (450,490 22,524 (45,049) Swapping principal and interest 40,357 20,178 37,990 (20,178) (40,357)
269 135 (135) (269)
6.5.9 Summary of the differences in fair value in view of the change in price of marketable securities
Profit (loss) Fair value Profit (loss) December Change in the CPI 10%+ 5%+ 31, 2008 5%- 10%- USD thousands CPI-linked securities portfolio 10,151 5,075 101,509 (5,075) (10,151)
Sensitivity analysis of the exposure to market risks at Carmel Olefins 6.5.10 Summary of the differences in fair value in view of the sensitivity analysis of the dollar-shekel exchange rate
Profit (loss) Fair value Profit (loss) December 10%+ 5%+ 31, 2008 5%- 10%- Exchange rate fluctuations 4.1822 3.992 3.802 3.612 3.442 USD thousands Long-term linked shekel debentures 12,038 6,019 (120,381) ( 6,019) (12,038) Trade receivables(NIS) (1,761) (881) 17,609 881 1,761 Trade payables (NIS) 1,596 798 (15,960) (798) (1,596) Forward contracts 361 189 (164) (209) (441) Swapping principal and interest (7,947) (3,974) 15,857 3,974 7,947 4,287 2,151 (2,171) (4,367)
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6.5.11 Summary of the differences in fair value in view of the sensitivity analysis of the euro-dollar exchange rate
Profit (loss) Fair value Profit (loss) December 10%+ 5%+ 31, 2008 5%- 10%- Changes in exchange rates 1.532 1.462 1.393 1.323 1.254 USD thousands Trade receivables- euro (1,301) (650) 130,004 650 1,301 Trade payables - euro 967 484 (9,670) (484) (967) Other long-term liabilities - euro 740 370 (7,394) (370) (740) Long-term loans - euro 3,425 1,713 (34,251) (1,713) (3,425) Forward contract (2,030) (1,015) (1,287) 1,015 2,030 1,801 902 (902) (1,801)
6.5.12 Summary of the differences in fair value in view of the sensitivity analysis of the GBP- dollar exchange rate
Profit (loss) Fair value Profit (loss) December Exchange rate fluctuations 10%+ 5%+ 31, 2008 5%- 10%- USD thousands Trade receivables- GBP (527) (263) 5,263 263 527 Forward contracts 302 151 101 (151) (302) Other long-term liabilities - euro (225) (112) 112 225
6.5.13 Summary of the differences in fair value in view of the sensitivity analysis of euro interest
Profit (loss) Fair value Profit (loss) December Change in interest 10%+ 5%+ 31, 2008 5%- 10%- USD thousands Fixed interest euro loan 278 140 (26,434) (141) (283)
6.5.14 Summary of the differences in fair value in view of the sensitivity analysis of dollar interest
Profit (loss) Fair value Profit (loss) December Change in interest 10%+ 5%+ 31, 2008 5%- 10%- USD thousands Principal and interest swap (1,420) (711) 15,857 711 1,422
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6.5.15 Summary of the differences in fair value in view of the sensitivity analysis of shekel interest in real terms:
Profit (loss) Fair value Profit (loss) December Change in interest 10%+ 5%+ 31, 2008 5%- 10%- USD thousands Principal and CPI-linked interest swap (2,959) (1,497) 15,857 1,533 3,103 Long-term CPI-linked shekel debentures 4,731 2,431 (66,378) (2,572) (5,295) 1,772 934 (1,039) (2,192)
6.5.16 Summary of the differences in fair value in view of the sensitivity in the consumer price index:
Profit (loss) Fair value Profit (loss) December Change in interest 10%+ 5%+ 31, 2008 5%- 10%- USD thousands Debenture swap transactions 9,533 4,767 15,857 (4,767) (9,533) Debentures (6,638) (3,319) (66,378) 3,319 6,638 2,895 1,448 (1,448) (2,895)
6.5.17 Summary of the differences in fair value in view of the changes in polymer prices:
Profit (loss) Fair value Profit (loss) December Change in interest 10%+ 5%+ 31, 2008 5%- 10%- USD thousands Debenture swap transactions 1,772 934 (1,039) (2,192)
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6.6 Consolidated linkage-based report 6.6.1 Consolidated linkage-based report As of December 31, 2008 (in USD thousands) Foreign- Index- currency Non- linked linked(*) Unlinked monetary Total Assets Cash - 14,194 646 - 14,840 Short-term deposit - 25,000 - - 25,000 Short term derivatives at fair value through profit or loss - 15,374 - - 15,374 Future purchase - 78,684 - - 78,684 Investment in other financial assets at fair value through profit or loss 49,612 16,432 35,465 - 101,509 Trade receivables - 173,759 79,456 - 253,215 Other receivables 20,724 9,729 24,159 25,852 80,464 Inventory of fuel products - 494,013 34,298 41,096 569,407 Current tax assets 42,047 - - - 42,047 Affiliates - - - 36,005 36,005 Loan to Haifa Early Pensions Ltd. 86,047 - - - 86,047 Deposits and loans (**) - 463 3,014 - 3,477 Long-term derivatives at fair value through profit or loss 499,951 - 150,092 - 650,043 Employee benefit plan assets - - 5,007 - 5,007 Property, plant and equipment - - - 1,083,446 1,083,446 Other assets - - - 25,170 25,170 Total assets 698,381 827,648 332,137 1,211,569 3,069,735
Liabilities . Short-term credit and loans - (81,645 ) (48,774 ) - (130,419) Trade payables - (243,107 ) (27,487 ) - (270,594) Other payables (1,422) (31,395 ) (32,431 ) - (65,248) Provisions - (18,908 ) (61,629 ) - (80,537) Future sales - (585,674 ) - - (585,674) Long term derivatives at fair value - (2,202 ) (10,748 ) - (12,949) through profit or loss Debentures (**) (619,875) (4,455 ) (131,510 ) 3,270 (752,570) Long-term loans(**) - (459,736) - 2,083 (457,653) Liabilities for finance lease (8,448) - - - (8,448) Other long-term liabilities - (7,394) - - (7,394) Long-term future sale - (6,900) (73,653) - (6,900) Employee benefits - (644 ) (70,598 ) - (73,653) Deferred taxes - - - (65,827) (65,827) Total liabilities (629,745) (1,441,876) (385,771) (60,474) (2,517,866) . Net balance 68,636 (614,228) (53,634) 1,151,095 551,869
(*) Primarily dollar (**) Including current maturities The Company’s management views the product inventory, consisting of commodities with a turnover of a month, as a financial item. Accordingly, it is included in the table above.
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6.6.2 Consolidated linkage-based report As of December 31, 2007 (in USD thousands) Foreign- Index- currency Non- linked linked(*) Unlinked monetary Total Assets Cash - 236,710 22,615 - 259,325 Short-term derivatives at fair value - 6,513 - - 6,513 through profit or loss Future purchase - - 77,006 - 77,006 Investment in financial assets at fair 63,509 6,395 43,131 - 113,035 value through profit or loss Trade receivables 10,486 244,644 149,826 - 394,470 Other receivables 19,958 2,868 41,647 10,977 - Inventory of fuel products - 557,897 439,450 45,198 1,042,545 Current tax assets 10,153 - - - 10,153 Affiliates - - - 53,958 53,958 Loan to Haifa Early Pensions Ltd. 80,038 - - - 80,038 Deposits and loans (**) - 302 2,655 - 2,957 Long term derivatives at fair value 307,257 - - - 307,257 through profit or loss Employee benefit plan assets - - 7,519 - 7,519 Property, plant and equipment - - - 978,722 978,722 Other assets - - - 22,614 22,614
Total assets 480,915 1,055,329 783,849 1,111,469 3,431,562
Liabilities Short-term credit and loans - (948) - - (948) Trade payables - (422,905) (136,790) - (559,695) Other payables (1,421) (28,340) (55,183) - (84,944) Future sales - (77,000) - - (77,000) term derivatives at fair value through - - (1,595) - (1,595) profit or loss Provisions - (4,039) (11,638) - (15,677) Debentures (**) (680,083) (5,504) (130,005) 3,421 (812,171) Long-term loans(**) - (575,173) - 2,815 (572,358) Liabilities for finance lease (7,763) - - - (7,763) Long-term derivatives at fair value - (303,081) - - (303,081) through profit or loss Employee benefits - - (71,240) - (71,240) Deferred taxes - - - (125,287) (125,287)
Total liabilities (689,267) (1,416,990) (406,451) (119,051) (2,631,759) Net balance (208,352) (361,661) 377,398 992,418 799,803 (*) Primarily dollar (**) Including current maturities The Company’s management views the product inventory, consisting of commodities with a turnover of a month, as a financial item. Accordingly, it is included in the table above.
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7. Additional information contained in the auditors’ report to shareholders Without qualifying their opinion, the auditors of the Company drew attention to: 7.1 The contents of Note 20 (B), sections 2(a), 2(b), 2(e), 3, 7, 15, 16 and 17 to the financial statements regarding the suits filed against the Company, a subsidiary and a proportionally consolidated company (“the investees”), the legal proceedings, supervision by government authorities, other contingencies, laws and bills relating to the fuel and gas industry and infrastructure facilities. Based on the opinion of the legal counsels of the Company and its investees, the Company estimates that, at this stage, it is not possible to assess the aforementioned impact on the financial statements, if any exists, and therefore, no provision regarding this matter was included in the financial statements. 7.2 The contents of Note 20(C)(11) regarding the dependency of the Company on services from infrastructure companies.
8. Disclosure of the process for approving the Company's financial statements The board of directors appointed an audit and balance sheet committee and instructed it, among its other duties, to discuss and make recommendations to the board in connection with the approval of the financial statements Among the members of the audit committee are Mr. Ori Slonim, Mr. Avisar Paz and Mrs. Daphne Schwartz, the directors having accounting and financial expertise, as well as other directors. The audit committee discusses the financial statements at its meeting at which senior officers of the Company and the external auditor of the Company are in attendance. The committee hears a detailed presentation made by the senior officers and others at the Company, including the CEO and CFO. The presentation includes the material issues contained in the financial reports, including material transactions not conducted in the normal course of business (if any), the significant assessments and critical estimates applied in the financial statements, the accounting policy applied and changes thereto (if any), and the implementation of the fair disclosure principle in the financial statements and accompanying information. The committee assesses the various aspects of the control and risk management of the Company, both those reflected in the financial statements (for example, reporting on financial risks) and those affecting the reliability of the financial statements. The opinion of the external auditor is also heard at the meeting. The committee presents its recommendations regarding the reports to the board of directors. After receiving the recommendation of the audit committee regarding the financial statements, the board of directors investigates the material issues included in the financial statements, including material transactions not conducted in the normal course of business (if any), the significant assessments and critical estimates applied in the financial statements, the accounting policy applied and changes thereto (if any), and the implementation of the fair disclosure principle in the financial statements and accompanying information. The committee assesses the various aspects of the Company’s control and risk management, both those reflected in the financial statements (for example, reporting on financial risks) and those affecting the reliability of the financial statements. The board of directors also studies the recommendations of the audit committee regarding the financial statements being discussed, hears the opinion of the external auditor, and where necessary, requests that other matters be reviewed by the board, at its discretion. The financial statements are submitted to the members of the audit committee and the board of directors a few days prior to the meetings at which they are discussed for purposes of approval. During the course of the deliberations of the board of directors, questions are raised by the members of the board on various issues, including issues that arose during the audit. The goal of the entire
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process is to ensure that the financial statements faithfully present the financial position of the Company. The questions and issues raised are addressed when necessary by both Company management through the CEO or CFO and by the external auditor of the Company. Following a discussion, the chairman of the board calls for a vote on the approval of the financial statements, after ensuring that members of the board have no further questions and there are no unanswered issues. The financial statements as of December 31, 2008 were discussed at the audit and balance sheet committees on March 22, 2009 in the presence of the audit and balance sheet committee members Uri Slonim (chair), Yachin Cohen, Avisar Paz, Nechama Ronen, Daphne Schwartz and Ran Coral, and in participation with the Chairman of the Board Yossi Rosen, and were discussed and approved in full at the board of directors of the Company on March 29, 2009 in the presence of all members of the board of directors.
9. Directors with accounting and financial expertise The minimum number of directors with accounting and financial expertise appropriate for the Company was set at four directors, taking into account the nature of the accounting and finance issues that arise when preparing the financial statements of the Company and its subsidiaries, in view of the Company’s operations, and taking into account the composition of the board of directors in general. The members of the board of directors having accounting and financial expertise and the facts that enable them to be deemed to be such, are Mr. Yossi Rosen - Mr. Rosen’s extensive professional experience, the senior positions he has held, including his tenure from 1998 - 2007 as the CEO of the Israel Corporation Ltd. and chairman of the board and board member of its subsidiaries, as well as his education in economics and business administration Mr. Uziel Netanel - Mr. Netanel's professional experience, including membership on the boards of various companies, as well as his education in economics and international relations Adv. Uri Slonim - Mr. Slonim possesses legal, accounting and economic expertise based on his professional experience, including many years on the boards of companies having a high degree of accounting and financial complexity, as well as his legal education Mr. Avisar Paz - Mr. Paz’s professional experience, including his tenure as VP - Finance of the Israel Corporation Ltd. and board member of its subsidiaries, as well as his being a certified public accountant. Mr. Ran Carroll - Mr. Carroll’s professional experience, including his tenure as CEO of Etgal Holdings Ltd. and chairman of the boards of a number of companies and government committees, and various positions in the Israeli Ministry of Finance, as well as his economics education Dr. Daphne Schwartz - Dr. Schwartz's professional experience, including membership on various boards of directors and her tenure as a senior lecturer of business administration at Ben Gurion University, as well as her academic education in the field of economics
10. Peer review Further to the directive of the Israel Securities Authority dated July 28, 2005, requiring fair disclosure as to consent to perform a peer review, the purpose of which was, as set out in the directive, to start a process of monitoring the operations of CPA firms, the board of directors, on January 8, 2007 approved the granting of the Company's consent to the peer review.
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11. Disclosure regarding the internal auditor in a reporting corporation
11.1 Name of auditor: Yehuda Meirovitch, in office since 1988 Qualifications: MBA, CIA 11.2 The auditor is an employee of the Company.
11.3. Scope of employment during the reporting period: Full time + 3 audit employees + the engagement of two outside officers for internal audits in a scope of 2,00 hours
11.4. The audit plan is based on a multi-year plan to cover the main issues of the Company every three years. Other issues once every four or five years and the management’s routine audit requirements
11.5. The internal audit plan includes audit issues at Gadiv, which constitutes a material holding of ORL, and refers also to commercial and other connections with companies in which ORL has holdings.
11.6. The internal auditor conducts the audit in accordance with professional standards generally accepted in Israel and other countries.
11.7. The internal auditor reports directly to the chairman of the board of directors.
11.8. The audit reports were presented and discussed at the following meetings of the audit committee: 11.8.1 The annual work plan for 2008 was approved at the February 2008 meeting of the audit committee. 11.8.2 In March 2008, the committee approved the engagement of two accountant offices to assist the internal audit in the preparation of the audit. 11.8.3 At the meeting of the audit committee in July 2008, the 2007 annual report was discussed as well as the follow-up report for the correction of faults found in the 2006 audit. At the end of the meeting, decisions were made regarding these reports and instructions for submitting the management's responses to the audit findings. 11.8.4 At the meeting of the audit committee at the beginning of December 2008, selected issues from 2007 and 2008 were discussed. There was also another discussion of the status of implementation of the recommendations and decisions from the annual reports for 2006-2007. In this meeting, the report on the progress of the 2008 audit work plan was also discussed. 11.8.5 In December 2008, the audit committee also discussed the interim report of the internal audit for 2008. The report covered eight subjects some of which were discussed in this meeting and others in anther meeting held at the beginning of 2009. The committee made various decisions regarding the findings raised in the audit.
11.9 The nature and continuity of operations and the internal auditor’s work plan are reasonable under the circumstances, in the Company’s estimation, and will serve to achieve the purposes of the corporation’s internal audit. The internal auditor has free access, as set out in section 9 of the Internal Audit Law, 1992, including constant and direct access to the corporation’s information systems, including financial data.
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12. Liability certificates of the corporation held by the public
12.1 As of the date of the periodic report (December 31, 2008), three series of debentures are in circulation. The debentures were issued by the Company and offered to the public in a prospectus, as follows:
Par value of Par value of debentures Total debentures in circulation accrued Fair value of in plus linkage interest the series in circulation TASE differences as of the financial TASE value Par value of date as of price as of as of Decemb reports as of as of Interest Linkage basis and Date of of issue (NIS December December December er 31, December December type and Principal payment Interest payment terms (principle Series issue thousands) 31, 2008 31, 2008 31, 2008 2008 31, 2008 31, 2008 rate dates dates and interest) Series A December 473,000,000 473,000,000 88.84 496,300,493 - 420,213,320 420,213,320 4.8% 14 equal semi-annual June 30 and Linked to the CPI of 3, 2007 linked to payments on June 30 December 31 of October 2007 CPI the CPI and December 31 of each of the years each of the years 2008-2019 2013-2020 (inclusive) and on (inclusive) June 30, 2020 Series B December 843,000,000 843,000,000 96.71 844,527,094 - 815,265,300 815,265,300 4.6% 6 equal semi-annual June 30 and Linked to the CPI of 3, 2007 linked to payments on June 30 December 31 of October 2007 the CPI and December 31 of each of the years each of the years 2008-2014 2012-2015 (inclusive) and on (inclusive) June 30, 2015 Series C December 500,000,000 500,000,000 98.51 500,000,000 - 492,550,000 492,550,000 % 6.5 6 equal semi-annual June 30 and Unlinked 3, 2007 payments on June 30 December 31 of and December 31 of each of the years each of the years 2008-2013 2011-2014 (inclusive) and on (inclusive) June 30, 2014
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12.2 Trustees of the debentures (Series A-C) The trustees of the Company’s debentures (Series A-C) and their details are as follows: (1) The trustee of the Company’s debentures (Series A) is Ziv Haft Trusts Company Ltd. To the best of the Company’s knowledge, the trustee’s details are as follows: Contact person (person in charge): Rami Sabati; Address: 46-48 Menachem Begin Avenue, Tel Aviv; telephone: 972-3-6386868; fax: 972-3-6374344; email [email protected]. (2) The trustee of the Company’s debentures (Series B) is Reznik Paz Nevo Trusts Ltd. To the best of the Company’s knowledge, the trustee’s details are as follows: Contact person (person in charge): Liat Bachar Segal; address: 14 Yad Harutzim Street, Tel Aviv; telephone: 972-3-6393311; fax: 972-3-6393316 ; email [email protected]. (3) The trustee of the Company’s debentures (Series B) is Hermetic Trust (1975) Ltd. To the best of the Company’s knowledge, the trustee’s details are as follows: Contact person (person in charge): Adv. Dan Avnon; email: 113, Hayarkon St; telephone: 972- 3-5272272; fax: 972-3-5271736; email: [email protected].
12.3 Debenture rating The table below describes the rating of the debentures in circulation:
Date and reference of Rating on the Rating immediate report on the Rating date of the proximate to Date of updated rating1 company periodic report date of issue issue Series November 13, 2008, ref. no. S&P Maalot A/Negative AA/Stable December Series A 2008-01-316449 3, 2007 November 13, 2008, ref. no. A/Negative AA/Stable December Series B 2008-01-316449 S&P Maalot 3, 2007 November 13, 2008, ref. no. S&P Maalot A/Negative AA/Stable December Series C 2008-01-316449 3, 2007
In accordance with the deeds of trust for the debentures (Series A-C), the trustees have the right to call the debentures for immediate redemption under certain conditions. From the issuance date up to December 31, 2008, the Company was in compliance with all the conditions and liabilities towards the deeds of trust for each of the debenture series (Series A-C), there were no grounds for calling the debentures for immediate redemption and no notice was received from the trustees in contradiction of the aforesaid. On December 23, 2008, the general meeting of the holders of the debentures (Series C) approved the appointment of Hermetic Trust (1975) Ltd. as a trustee of the Company’s debentures (Series C), commencing from the date of the resolution by the general meeting, such that it shall have the same powers, authorities and other authorizations and shall be able to take any and all action as though such trustee was appointed as trustee of the debentures (Series C) from the outset.
1 The immediate reports included in this position are presented as a reference.
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12.4 Securities of the debentures (Series A-C) The debentures issued by the Company and offered to the public as set forth in this report are not secured by any charge. The Company may encumber all or part of its assets, under fixed liens of any degree, in favor of any third party, without requiring any consent from the trustee and/or the debenture holders.
13. Use of estimates and judgments The preparation of the financial statements in conformity with IFRS requires management of the Group companies to make judgments, estimates and assumptions that affect the application of accounting policies and the reported amounts of assets, liabilities, income and expenses. Actual results may differ from these estimates. When preparing the accounting estimates used to prepare the Group’s financial statements, management was required to make assumptions regarding the circumstances and events involving substantial uncertainly and relied on past experience, various facts, external factors and reasonable assumptions according to the circumstances appropriate for each estimate. Estimates and underlying assumptions are reviewed on an ongoing basis. Adjustments in the accounting estimates are recognized in the period in which they are made and in any other affected period in the future.
13.1 Estimates identified by the Company as critical Information about the critical estimates, prepared on the basis of IFRS with material impact on the financial statements:
13.1.1 Contingent liabilities: When assessing the possible outcomes of legal claims that were filed against the Company and its investee companies, the companies relied on the opinions of their legal counsel. The opinions of their legal counsel are based on the best of their professional judgment, and take into consideration the current stage of the proceedings and the legal experience accumulated with respect to the various matters. As the results of the claims will ultimately be determined by the courts, they may be different from such estimates. Additionally, the Group estimates, based on the opinion of its legal counsel in view of the complexity of the proceedings, that for some cases the Group’s financial exposure cannot be assessed, therefore no provisions were made for them in the financial statements. (*) See Note 19 to the financial statements. 13.1.2 Impairment of assets: The Company examines on every balance sheet date whether there have been any events or changes in circumstances which would indicate impairment of one or more non-monetary assets. When there are indications of impairment, it examines whether the carrying amount of the investment can be recovered from the discounted cash flows anticipated to be derived from the asset, and if necessary, it records an impairment provision up to the amount of the recoverable value. The estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. The estimates regarding cash flows are based on past experience with respect to this asset or similar assets, and on the best possible assessments of the Company regarding the economic conditions that will exist during the remaining useful life of the asset. The Company uses the estimates of an appraiser when determining the net selling price of part of the assets. With respect to real estate, the estimates also take into consideration the situation of the market where the asset is located. Changes in these estimates may result in material changes to the carrying amounts of the assets and to the results of operations.
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13.1.3 Provision for doubtful debts: At every balance sheet date, the Group assesses the amount of the provision for doubtful debts. The provision for doubtful debts is determined on a specific basis for debts which the Group management believes to be doubtful. 13.1.4 Measuring employee benefits: The present value of the Group’s liability to pay employee benefits is based on various data, which are determined on the basis of an actuary assessment, using many assumptions, including the discount rate. Changes in actuarial assumptions could affect the book value of the Group‘s liabilities for paying severance compensation and pension. The Group assesses the discount rate once a year, based on the discount rate of government bonds. Other key assumptions are defined on the basis of market conditions, and on the basis of accumulated experience in the Group. For further information of the assumptions used by the Group, see Note 3(J) to the financial statements. 13.1.5 Useful life of property, plant and equipment - The Group management examines the estimated useful life of property, plant and equipment once a year. In the reporting period, the management determined that there was no change in the useful life of property, plant and equipment. 13.1.6 Measuring inventory: Inventory is stated at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less the estimated costs of completion and estimated costs required for selling as known as of the date of the financial statements. 13.1.7 Tax benefits: The Company and the companies in the Group claimed tax benefits under laws for the encouragement of capital investments and therefore the management of each of the companies is required to apply significant deliberation to determine its right to benefits, the scope of the benefits and the provision included for the taxes. Changes in these assumptions could lead to significant differences in the book value of the assets and provisions and in the operating expenses. 13.1.8 Financial derivatives: The Group holds financial derivatives to hedge its foreign currency, inflation and interest risks. The derivatives are recognized at fair value. The fair value of the derivative financial instruments is calculated using quoted prices, when available. When these prices are unavailable, calculation is by using assessment techniques based on the analysis of discounted cash flow using the appropriate yield rate for the useful life of the instruments. The fair value of transactions including options is calculated using commercial software based on the Black and Scholes model, taking into account the internal value, standard deviation and interest. Changes in the economic assumptions and calculating model could result in material changes in the fair value of the assets, liabilities and outcomes of the operations. 13.1.9 Business combinations: The acquisition of a subsidiary is measured through the acquisition method. The Group allocates the cost of the identifiable assets that were acquired and the liabilities undertaken at fair value at the acquisition date. To estimate the amount in the event that it is not possible to replace and asset or dispose of a liability, in a transaction between a willing buyer and a willing seller in an arm’s length transaction, the Company used the assessment of an external assessor to determine the fair value. In accordance with the allocation of the cost of acquisition made by the Company as a result of the acquisition, a surplus cost was created at the fair value of the assets and liabilities acquired on the cost of the business combination. This surplus was recognized as a one-time profit in other revenue.
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14. Corporate governance In the reporting period, the board of directors adopted a procedure based on the recommendations of the Goshen Committee and the recommendations regarding their implementation as submitted to the Company by Adv. Dr. Yoram Danziger. On December 30, 2008, the Company added a provision in its regulations whereby as long as the Company has a controlling shareholder or a holder of a control block, at least one third of the members of the board of directors will be independent directors, as defined in the section 219 of the Companies Law. As of the reporting date, the audit committee has not discussed and determined the identity of the independent directors.
15. Insignificant transactions in the Company’s financial statements In the course of its business, the Company engages in transactions with related parties, including companies controlled by the controlling shareholder, primarily in purchase and selling agreements of industrial and logistics products and services that are part of the operations of the Company's plants. In general, these transactions are not material for the Company, both quantitatively and qualitatively, and they are conducted under market conditions. Therefore, the board of directors of the Company determined that an interested party transaction that is not an irregular transaction will be deemed to be insignificant under the following conditions: A. An agreement for the purchase of products, including raw materials and materials used for production or services, which is for the benefit of the Company, made during the regular course of the Company’s business and under market conditions, with annual expenses that do not exceed 1% of the annual selling cost (cost of sales, refining and services) or operating expenses (sales and marketing expenses and administrative and general expenses), as relevant, in the Company’s consolidated financial statements of the year preceding the date of the agreement, provided the total annual expense from this acquisition does not exceed 3% of the expense. B. An agreement for the sale of products, including raw materials and materials used for production or services, which is for the benefit of the Company, made during the regular course of the Company’s business and under market conditions, with annual revenue that does not exceed 1% of the annual revenue in the Company’s consolidated financial statements of the year preceding the date of the agreement, provided the total annual revenue from this sale does not exceed 3% of the revenue. C. An agreement for the joint purchase of services or products from a third party, together with the controlling shareholder, with controlled companies, which is for the benefit of the Company, made during the regular course of the Company’s business and under market conditions, and the audit committee of the Company determined that distribution of the costs and expenses in the agreement is fair and equal under the circumstances, and the total annual expense for the agreement does not exceed 1% of the selling cost or annual operating expenses, as relevant, in the Company’s consolidated financial statements of the year preceding the date of the agreement, provided the total annual expense from this sale does not exceed 3% of the expenses. The board of directors further decided that the market conditions in respect of these transactions will be compared to other transactions that are as similar as possible to those in which the Company engages and to the same type of transactions that are made in the market.
16. Meetings of the board of directors During the reporting period, there were 30 board meetings and 36 meetings of board committees.
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17. Salaries of senior officers and the considerations on which the board of directors bases such salaries Management estimates that the remuneration of the senior officers are appropriate, fair and reasonable, taking into consideration the size of the Company, scope and complexity of its operations and business, the tasks and degree of responsibility of the senior officers who dedicate their effort and time to promote the affairs of the Company and their contribution to the development of the Company's affairs. In determining the salaries of senior officers, as well as bonuses paid to them, the Company takes into consideration achievements in the areas of business and finance, degree of responsibility, specific contribution, and compliance with targets and work plans. The Company has a policy of granting bonuses to its senior officers, at the discretion of the CEO and the approval of the relevant organs, which, inter alia, is conditional to the Company’s results. At the beginning of 2009, the chairman of the board, CEO and other officers in the Company announced their decision to waive 10% of their salary (with the exception of provisions and incidental conditions) in 2009. This is part of the 2009 work plan to ensure implementation of the Company’s strategic plan and its long-term strength and prosperity, against the background of the global economic crisis and its implications on the Israeli economy.
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18. Auditor’s fees
December 31 2008 2007 2006 USD USD USD Hours thousands Hours thousands Hours thousands 18.1 At the Company: Fahn Kanne & Co., CPAs (Isr.) KPMG Somekh Chaikin & Co., CPAs (Isr.) (1) Fee for audit services 9,000 700 9,068 618 9,600 381 Other fees 5,300 483 4,511 307 4,800 213 14,300 1,183 13,579 926 14,400 595 18.2 At Gadiv: Chaikin Cohen Rubin & Gilboa, CPAs (Isr.) KPMG Somekh Chaikin & Co., CPAs (Isr.)(1)(3) Fee for audit services 1,100 84 1,845 93 1,331 47 Other fees 290 42 60 3 138 7 1,390 126 1,905 96 1,469 54 18.3 At Carmel Olefins - Fahn Kanne & Co., CPAs (Isr.) and Brightman Almagor & Co, CPAs (Isr.) joint accountants (2) Brightman Almagor & Co, CPAs (Isr.) (3) Fee for audit services 1,775 100 1,450 71 1,750 79 Other fees 1,250 108 1,250 61 - - 3,025 208 2,700 132 1,750 79
(1) Commencing from November 2007, KPMG are the Company’s auditors. (2) The Company’s share (3) Until the end of November 2007, Fahn Kanne & Co., CPAs (Isr.) and Brightman Almagor were the joint accountants at Carmel Olefins. Commencing from November 2007, Brightman Almagor are the accountants at Carmel Olefins.
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19. Contributions to the community in the reporting period In 2008, the Company’s consolidated expenses for contributions amounted to $1,560 thousand (the Company: $1,470 thousand and Carmel Olefins, $90,000) The contributions were made to various organizations. The contributions are made to worthy causes, focusing on advancing education and community welfare in Israel and other countries.
20. Subsequent events
20.1 Impact of changes in exchange rates and prices of crude oil and distillates Changes in exchange rates: From the end of the reporting period and up to the approval date of the financial statements, there was a devaluation of 9% in the shekel-dollar exchange rate. The Company, as part of its exposure management policy, uses hedging transactions to neutralize part of this exposure. The effect of the depreciation on the Group’s business results, after the results of the hedging transactions, is estimated at $3 million in financing income. Changes in prices of crude oil and its distillates: As a result of the changes in the economic environment subsequent to the balance sheet date, there were significant fluctuations in the price of crude oil and its distillates. The price of crude oil, which was $36.5/barrel as of the balance sheet date, rose to $50/barrel close to the publication date of the financial statements. As a result of these changes, the Company is expected to recognize a profit of $85 million) before tax, for the inventory balance as of the balance sheet date, which was mainly realized in January and February 2009.
20.2 Disclosure of the expected cash flow for financing the repayment of Carmel Olefins liabilities As reflected in the financial statements of Carmel Olefins, as of December 31, 2008, the company has an operating capital deficit of $254 million, mainly due to reclassification of a long-term loan of $235 million to short term, as a result of non-compliance with the financial covenants set with the banks, as well as a deficit in cash flow from operating activities due to the loss in the fourth quarter of 2009. The management of Carmel Olefins estimates that the results of the fourth quarter were unusually dramatic. Management does not expect such results to be repeated in the near future and does not expect the continuation of the direction of negative cash flow from operating activities. On the other hand, the working capital is expected to continue to be negative until the financial covenants are arranged with the banks. Carmel Olefins is currently negotiation with the banks to reach an arrangement. In view of the progress of the negotiations, Carmel Olefins estimates that, as of the reporting date, it will receive letters of waiver from all the banks. This is forward-looking information and as such may not materialize and is not under the control of Carmel Olefins alone. Therefore there is no certainty that it will materialize.
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The following table describes the expected cash flow of Carmel Olefins for repayment of its liabilities for its debentures: First year Second year USD thousands Sources Cash flow from operating activities (before interest) 97,200 44,800 Cash flow from prior year 4,941 3,608 Total sources 102,141 48,408
Uses Investments in fixed assets 12,000 12,000 Liability for repayment of debentures (interest) 11,272 11,272 Liability for repayment of loans (principle + 35,261 35,261 interest) Repayment (receipt) of short-term credit 40,000 (12,500 ) Total uses 98,533 46,033 Cash balance at end of period 3,608 2,375
1. As of the approval date of the financial statements, the board of directors of Carmel Olefins examined the market situation, business forecasts of Carmel Olefins and its cash flow forecast. The board of directors of Carmel Olefins estimates that, based on this information, it is able to repay its liabilities. 2. Carmel Olefins estimate of its cash flow is based on the forecasted margins, implementation of the planned efficiency measures and reduction of fixed expenses, including the early retirement plan that led to a reduction of human resources, gross payroll expenses and employee benefits. The board of directors of Carmel Olefins examined the expected cash flow for repayment of the liabilities for its debentures and believes that, based on the information that was examined, Carmel Olefins is able to repay its liabilities. The cash flow statement of Carmel Olefins is based on its assessments and forecasts of prices and costs. This forecast is forward looking information, the realization of which is not certain and is not under the control of Carmel Olefins alone. Therefore, there is no certainty that the information, assessments or forecasts will materialize, in full or in part, and this could result in a cash flow that differs from the forecast.
20.3 Environmental quality In January 2009, the Company and Gadiv received from the Ministry of Environmental Protection a warning and summons to a hearing relating to violations and alleged defective application of the provisions of the personal order (“the warning"). The warning described the alleged violations which referred, inter alia, to the time tables set forth in the order, the results of the stack samples, the submission of certain plans stipulated in the personal order and to the way information is sent to the Ministry, as stipulated in the order. Prior to the date of the hearing, the Company submitted its response to the warning it received, in which it detailed its arguments and responses to the issues included in the warning. At the conclusion of the hearing, goals and timetables were set for actions to be taken by the Company to reduce the
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pollution emitted by its facilities. The Company is preparing to implement the mandatory actions under the personal orders and is holding discussions with the Ministry of Environmental Protection regarding additional actions that the Ministry requires. On January 25, 2009, a hearing was held at the Ministry of Environmental Protection for the Company and PEI regarding two specific sites where, according to the Ministry, soil and groundwater were contaminated by fuel products. After the hearing, the Company and PEI were required to close the two pipelines along which leakage was found; to return them to operation following repair and/or replacement; to test impermeability of all the pipelines and to submit the results to the Ministry of Environmental Protection. In the hearing, the Company and PEI were warned that if the repair and rehabilitation process does not commence within seven days after the hearing, including the removal of the contaminated soil, the Ministry would issue an order for cleanup and removal of the toxic substances. The Ministry gave notice that the Green Police of the Ministry of Environmental Protection would investigate the events, including the Company's failure to act to minimize damage and prevent further contamination of the river and its environs. On March, 1, 2009, the Company received a removal order for toxic substances, pursuant to section 16(A) of the Hazardous Substances Law - 1993 and a clean-up order, pursuant to section 13(B) of the Maintenance of Cleanliness Law -1984, demanding that the Company, PEI and their CEOs submit plans to the Ministry of Environmental Protection for soil gas, soil and groundwater surveys and to fence off the contaminated areas and to conduct the survey in accordance with the approved plans. The parties are further required to submit to the Ministry a report of the survey findings, including recommendations for the clean-up and rehabilitation of the contaminated soil and groundwater and the restoration of the river and its banks to their former condition, based on the findings of the survey. The parties will also define a short-term and binding timetable for implementing the recommendations of the survey, until all waste and toxins are removed from the soil and groundwater. The Company has submitted its plan for the soil gas, soil and groundwater survey to the Ministry of Environmental Protection for approval. As of the reporting date, the Company is unable to assess the outcome of the survey, the actions required according to the outcome and the expenses arising for the Company when implementing these measures. At the beginning of 2009, the Company and EAPC were required, under the terms added to their business licenses, to conduct soil surveys along the pipeline corridor and to apply the survey recommendations according to the suggested timetable approved by the Ministry of Environmental Protection. The Company appealed this condition in its business license through the procedure set up by the law.
Yossi Rosen Yashar Ben Mordechai Chairman of the board of directors CEO
March 29, 2009
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WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Financial Statements as of December 31, 2008
Contents Page
• Auditors’ Report for the Shareholders ...... C-1
• Financial Statements as of December 31, 2008
• Balance Sheets...... C-2
• Statements of Income ...... C-4
• Statements of Recognized Income and Expense ...... C-5
• Statements of Cash Flows...... C-6
• Notes to the Financial Statements...... C-8
Appendix A: Consolidated Financial Statements as of December 31, 2008 Translated into New Israeli Shekels WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Auditors Report to the Shareholders of Oil Refineries Limited We have audited the accompanying consolidated balance sheet of Oil Refineries Limited (“the Company”) as of December 31, 2008 and 2007, and the consolidated statements of income, recognized income and expenses and cash flows for the year then ended. These financial statements are the responsibility of the management and board of directors of the Company. Our responsibility is to express an opinion on these financial statements based on our audit. We did not audit the financial statements of a proportionately consolidated subsidiary, the consolidated assets of which constitute approximately 23% and 18% of the total consolidated assets as of December 31, 2008 and December 31, 2007, respectively, and the consolidated revenues of which constitute approximately 6% and 7% of the total consolidated revenue for the year ended December 31, 2008 and December 31, 2007, respectively. In addition, we did not audit the financial statements of investees accounted by the equity method, the investment in which amounts to $36,005 thousand and $53,958 thousand as of December 31, 2008 and December 31, 2007, respectively, and the share of the Group in their profits is $(3,111) thousand and $6,913 thousand for the year ended December 31, 2008 and December 31, 2007, respectively. The financial statements of those companies were audited by other auditors, whose reports have been furnished to us, and our opinion, insofar as it relates to amounts included for those companies, is based on the reports of the other auditors. We conducted our audit in accordance with generally accepted auditing principles in Israel, including those prescribed by the Israeli Auditors’ Regulations (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 board of directors and management, as well as evaluating the overall financial statement presentation. We believe that our audit and the reports of the other auditors provide a reasonable basis for our opinion. In our opinion, based on our audit and the reports of the other auditors, these financial statements present fairly, in all material respects, the financial position of the Company and its subsidiaries as of December 31, 2008 and 2007, and the results of their operations and cash flows for each of the years then ended, in conformity with International Financial Reporting Standards (IFRS) and Securities Regulations (Preparation of Annual Financial Statements) – 1993. We call attention to: 1. The contents of Note 20(B), sections 2(a), 2(b), 2(e), 3, 7, 15, 16 and 17 and Note 34(B) to the financial statements regarding the suits filed against the Company, a subsidiary and a proportionally consolidated company (“the investees”), the legal proceedings, supervision by government authorities, other contingencies, laws and bills relating to the fuel and gas industry and infrastructure facilities. Based on the opinion of the legal counsels of the Company and its investees, the Company estimates that, at this stage, it is not possible to assess the aforementioned impact on the financial statements, if any exists, and therefore, no provision regarding this matter was included in the financial statements. 2. The contents of Note 20(C)(11) regarding the dependency of the Company on services from infrastructure companies. Somekh Chaikin Certified Public Accountants March 29, 2009
1 C-1 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Consolidated Balance Sheets As of December 31 USD thousands
Note 2008 2007
Assets
Cash and cash equivalents 14,840 259,325 Short-term deposit 5 25,000 - Derivatives at fair value through profit or loss 31 15,374 6,513 Investments in other financial assets at fair value through profit or loss 5 101,509 113,035 Trade receivables 6 253,215 394,470 Other receivables 6 82,642 76,381 Inventory 7 569,407 1,042,545 Current tax assets 17 42,047 10,153 Total current assets 1,104,034 1,902,422
Investments in investee companies accounted by the equity method 8 38,005 53,958 Loan to Haifa Early Pensions Ltd. 18 84,740 80,038 Long term loans and debit balances 10 2,606 2,026 Derivatives at fair value through profit or loss 31 64,369 4,176 Employee benefit plan assets 18 5,007 7,519 Fixed assets 11 1,083,446 978,722
Intangible assets and deferred expenses, net 12 25,170 22,614
Total non-current assets 1,301,343 1,149,053
Total assets 2,405,377 3,051,475
The accompanying notes are an integral part of these financial statements.
2 C-2 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Consolidated Balance Sheets as of December 31 in USD thousands
Note 2008 2007
Current liabilities Bank overdrafts 16 28,973 948 Loans and credit 16 351,366 215,073 Trade payables 13 270,594 559,695 Other payables 14 70,056 88,820 Derivatives at fair value through profit or loss 31 1,853 1,595 Provisions 15 12,949 15,677 Total current liabilities 735,791 881,808
Non-current liabilities Debentures 16 726,554 717,302 Bank loans 16 233,749 452,154 Liabilities for finance lease 16 8,448 7,763 Other long-term liabilities 9 7,394 - Derivatives at fair value through profit or loss 31 6,900 - Employee benefits 18 68,845 67,358 Liabilities for deferred taxes 17 65,827 125,287 Total non-current liabilities 1,117,717 1,369,864 Total liabilities 1,853,508 2,251,672
Shareholders’ equity 21 Share capital 472,478 472,478 Capital reserves 20,953 29,036 Retained earnings 58,438 298,289 Total equity attributed to equity holders of the Company 551,869 799,803
Total liabilities and capital 2,405,377 3,051,475
______Yossi Rosen Yashar Ben Mordechai Igal Shahov Chairman of the Board CEO CFO
Date of approval: March 29, 2009
The accompanying notes are an integral part of these financial statements.
C-3 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Income Statements For the year ended December 31 in USD thousands
Note 2008 2007
Revenue 22 8,257,458 5,234,483
Cost of sales, refinery and services 23 8,324,149 4,816,511 Revaluation of open positions in derivatives on prices of goods and margins, net (7,465) 13,626 Total cost of sales 8,316,684 4,830,137
Gross profit (loss) (59,226) 404,346
Selling expenses 24 40,582 35,010 General and administrative expenses 25 67,061 59,360 Reduction of negative goodwill created upon acquisition 9 (14,535) - Privatization grant 20 - 28,360
Operating profit (loss) (152,334) 281,616
Financing revenue 26 64,979 (12,361 Financing expenses 26 (126,034) (114,284) Financing expenses, net (61,055) (101,923)
Company’s share in profits (losses) of investees (net of tax) 8 (3,111) 6,913
Profit (loss) before taxes on income (216,500) 186,606
Tax benefits (taxes on income) 17 107,292 (44,937)
Net profit (loss) for the year (109,208) 141,669
Earnings (loss) per share
Net basic and diluted earnings (losses) per ordinary share (in USD) 27 (0.055) 0.071
The accompanying notes are an integral part of these financial statements.
C-4 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Statements of Recognized Income and Expense For the year ended December 31 in USD thousands
2008 2007
Actuarial gains (losses) from a defined benefit plan, net of tax (9,318) 5,231 Capital reserve for translation differentials (1,078) - Group’s share in other comprehensive income of equity accounted - investees (10,433)
Other total income for the period, net of tax (20,829) 5,231
Income for the period (109,208) 141,669
Total income for the period attributed to the equity holders of the (130,037) 146,900 Company
The accompanying notes are an integral part of these financial statements.
C-5 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Consolidated Statements of Cash Flows For the year ended December 31 in USD thousands
2008 2007 Cash flows from operating activities Profit (loss) for the period (109,208) 141,669 Adjustments: Depreciation and amortization 75,699 72,258 Negative goodwill created upon acquisition (14,535 ) - Financing expenses, net 60,998 103,923 Changes in fair value of derivatives (10,456 ) 11,151 Changes in the fair value of the loan to Haifa Early Pensions Ltd. (6,009 ) (8,408) Share in the (profits) losses of equity accounted investees net of dividends received from investees 4,064 4,007 Gain on securities classified as held-for-trading 13,164 (14,870) Proceeds from sale of fixed assets - (10) Employee benefits, net (8,715 ) (4,837) Share-based payment expenses 3,428 558 Income tax benefit expenses (revenue) (107,292) 44,937 10,346 208,709
Change in inventory 485,795 (387,889) Change in trade and other receivables 156,575 115,914 Change in trade and other payables (335,603) 58,029 306,767 (213,946)
Income tax received (paid), net 15,212 (128,833)
Net cash flows provided by operating activities 223,117 7,599
Cash flow for investing activities Interest received 1,867 2,062 Investment in deposit (25,000) - Proceeds from sale of fixed assets - 28 Acquisition of a subsidiary consolidated for the first time (*) (14,462) - Loan to Haifa Early Pensions Ltd. (71,621) Investment in investee companies (796) - Repayment (granting) of long-term loans from others, net 41 (472) Purchase of securities held for trading (150,000) - Sale of securities held for trading 148,362 - Purchase of fixed assets (140,221) (89,021) Purchase of intangible assets and deferred expenses (1,789) (11,458) Net cash used for investing activities (181,998) (170,482) (*) See Note 9(1).
The accompanying notes are an integral part of these financial statements.
C-6 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Consolidated Statements of Cash Flows For the year ended December 31 (cont’d) in USD thousands
2008 2007 Cash flow from financing activities Receipt (repayment) of short-term credit 127,668 (62,850) Receipt of deposits from customers, net 989 8,032 Interest paid in cash (85,162) (68,672) Proceeds from transactions in derivatives 9,259 1,494 Proceeds from issuing debentures - 573,697 Repayment of debentures (104,421) (22,529) Payment of issuance expenses for interested parties - (1,046) Bank loans received - 48,684 Repayment of bank loans (113,825) (134,090) Privatization grant - 28,360 Dividends paid (121,325) (74,144)
Net cash from (used for) financing activities (286,817) 296,936
Net increase (decrease) in cash and cash equivalents (245,698) 134,053 Effect of fluctuations in exchange rate on cash and cash equivalents 1,213 1,351 Cash and cash equivalents at the beginning of the year 259,325 123,921
Cash and cash equivalents at the end of the year 14,840 259,325
The accompanying notes are an integral part of these financial statements.
C-7 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 1 – GENERAL
A. Reporting entity 1. Oil Refineries Ltd. (“the Company” or “ORL”) is a company domiciled and incorporated in Israel. The Company is located in the Haifa Bay and its official address is: PO Box 4, Haifa 31000, Israel. The Company and its subsidiaries are industrial companies which operate in Israel and are engaged primarily in the production of oil products, feedstock for the petrochemical industry and materials for the plastics industry. The facilities of the subsidiaries are integrated with those of the Company. In addition, the Company provides water treatment and power generation services (primarily electricity and steam) to a number of industries adjacent to the Haifa refinery. 2. Until the date of sale of the Ashdod Oil Refinery, the Company had two operational sites: one in the Haifa Bay area and the other in Ashdod. On September 28, 2006, the Company sold all of its shares in Ashdod Oil Refinery (“ORA”) to Paz Oil Company Ltd. On February 21, 2007, as part of implementation of the privatization that was decided upon on December 26, 2007, the State sold all the shares it held in Company in a private and public offering. The Israel Corporation Ltd. acquired 36.8% of the Company’s shares and Petroleum Capital Holdings Ltd. (“PCH”) acquired 9.2% of the Company’s shares. Subsequently, The Israel Corporation Ltd. and PCH acquired additional shares, and as of the date of the financial statements, hold 45.08% and 15.76%, respectively. 3. The Group’s consolidated financial statements as of December 31, 2008 include the statements of the Company and its subsidiaries (“the Group)” and the Group’s interests in affiliates. The Company's shares are traded on the Tel Aviv Stock Exchange (“TASE”). At the balance sheet date, the Israel Corporation Ltd. and Petroleum Capital Holdings Ltd. (“ PCH”) hold 45.08% and 15.76% of the Company's shares, respectively B. Definitions In these financial statements - (1) International Financial Reporting Standards - Standards and interpretations that were adopted by the International Accounting Standards Board (IASB) and which include international financial reporting standards and international accounting standards (IAS) along with the interpretations to these standards of the International Financial Reporting Interpretations Committee (IFRIC) or interpretations of the Standing Interpretations Committee (SIC), respectively (2) The Company – Oil Refineries Ltd. (3) The Group – Oil Refineries Ltd. and its subsidiaries (4) Subsidiaries – Companies, including a partnership or joint venture, the financial statements of which are fully consolidated, directly or indirectly, with the financial statements of the Company (5) Investees – Subsidiaries and companies the Company's investment in which is stated, directly or indirectly, on the equity basis (6) Related party – Within its meaning in IAS 24, Related Party Disclosures (7) Interested parties – Within their meaning in Paragraph (1) of the definition of an “interested party” in Section 1 of the Securities Law - 1968 (8) CPI – The consumer price index as published by the Israeli Central Bureau of Statistics
C-8 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 2 - BASIS OF PREPARATION
A. Statement of compliance The consolidated financial statements have been prepared by the Group in accordance with International Financial Reporting Standards (IFRS). These are the Group’s first IFRS annual financial statements and IFRS 1, First-time Adoption of International Financial Reporting Standards has been applied. In addition, the financial statements have been prepared in accordance with the Securities Regulations (Preparation of Annual Financial Statements) - 1993. An explanation of how the transition to IFRS has affected the reported financial position, financial performance and cash flows of the Company is provided in Note 33. The consolidated financial statements were authorized for issue by the Company’s board of directors on March 29, 2009. B. Functional and presentation currency The financial statements are presented in the US dollar, which is the Company’s functional currency, and have been rounded to the nearest thousand. The US dollar is the currency that represents the principal economic environment in which the Group operates. These financial statements are translated into Israeli shekel, as required by the Securities Regulations, in accordance with IAS 21, and are included in Appendix A to these financial statements. C. Basis of measurement The financial statements have been prepared on the historical cost basis except for the following assets and liabilities that are stated at fair value: the loan to Haifa Early Pensions Ltd. and the assets of the employee benefit plans. The value of non-monetary assets and equity items that were measured on the historical cost basis was adjusted to changes in the CPI until December 31, 2003, since until that date Israel was considered a hyperinflationary economy. D. Use of estimates and judgments The preparation of the financial statements in conformity with IFRS requires management to make judgments, estimates and assumptions that affect the application of accounting policies and the reported amounts of assets, liabilities, income and expenses. Actual results may differ from these estimates. The preparation of accounting estimates used in the preparation of the Company’s financial statements requires management to make assumptions regarding circumstances and events that involve considerable uncertainty. Management of the Company prepares the estimates on the basis of past experience, various facts, external circumstances, and reasonable assumptions according to the pertinent circumstances of each estimate. Estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the period in which the estimates are revised and in any future periods affected. In 2007, management reassessed the useful life of certain manufacturing facilities.
C-9 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 2 - BASIS OF PREPARATION (CONTD.)
D. Use of estimates and judgments (contd.) The impact of the change on the consolidated financial statements is as follows:
Balance in the Balance before financial statements change in Effect of change (after change in estimate in estimate estimate) USD thousands Year ended December 31, 2008
Depreciation and amortization expenses 85,408 (9,709) 75,699 Loss before taxes on income (226,209 ) 9,709 (216,500 ) Loss for the period (116,490 ) 7,282 (109,208 ) Earnings per share (dollar) (0.058 ) 0.004 (0.055 )
Year ended December 31, 2007
Depreciation and amortization expenses 81,967 (9,709) 72,258 Earnings before taxes on income 176,897 9,709 186,606 Net profit for the period 134,508 7,161 141,669 Earnings per share (dollar) 0.067 0.004 0.071
The effect of the change in estimate on the results of operations of the Group for each one of the next 28 years is a decrease in depreciation expenses in the amount of $9.7 million per annum, compared to the depreciation expenses that were included on the basis of the previous estimate. See Note 33(E)(6) for further information on the change in estimates. Critical estimates Presented hereunder is information about critical estimates, made while implementing accounting policies and which have a most significant effect on the financial statements:
• Contingent liabilities: When assessing the possible outcomes of legal claims that were filed against the Company and its investees, the companies relied on the opinions of their legal counsel. The opinions of their legal counsel are based on the best of their professional judgment, and take into consideration the current stage of the proceedings and the legal experience accumulated with respect to the various matters. As the results of the claims will ultimately be determined by the courts, they may be different from such estimates. In addition, for a number of suits, the Group estimates, based on the opinion of its legal counsel in view of the complexity of the proceedings, that at this stage the Group’s financial exposure cannot be assessed, therefore no provisions were made for them in the financial statements.
C-10 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 2 - BASIS OF PREPARATION (CONTD.)
D. Use of estimates and judgments (contd.) Critical estimates (contd.)
• Impairment of assets: The Company examines on every balance sheet date whether there have been any events or changes in circumstances which would indicate impairment of one or more non- monetary assets. When there are indications of impairment, it examines whether the carrying amount of the investment can be recovered from the discounted cash flows anticipated to be derived from the asset, and if necessary, it records an impairment provision up to the amount of the recoverable value. The estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. The estimates regarding cash flows are based on past experience with respect to this asset or similar assets, and on the best possible assessments of the Company regarding the economic conditions that will exist during the remaining useful life of the asset. The Company uses the estimates of an appraiser when determining the net selling price of part of the assets. Changes in these estimates may result in material changes to the carrying amounts of the assets and to the results of operations. • Employee benefits: The present value of the Group’s liability to pay employee benefits is based on various data, determined on the basis of an actuarial assessment, using several assumptions, including the discount rate. Changes in the actuary assumptions could affect the book value of the Group‘s liabilities for paying severance compensation and pension. • The Group assesses the discount rate once a year, based on the discount rate of government bonds. Other key assumptions are defined on the basis of market conditions, and on the basis of accumulated experience in the Group. For further information of the assumptions used by the Group, see Note 3(J) and Note 18 to the financial statements. • Useful life of Fixed assets: The Group reviews the estimated useful life of Fixed assets in each annual period. In the reporting period, management determined that there was no change in the useful life of Fixed assets. • Measuring inventory: Inventory is stated at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less the estimated costs of completion and estimated costs required for selling as known as of the date of the financial statements. • Provision for doubtful debts: At every balance sheet date, the Group assesses the amount of the provision for doubtful debts. The provision for doubtful debts is determined on a specific basis for debts the collection of which Company management believes to be doubtful. • Tax benefits: The Company and the companies in the Group claimed tax benefits under laws for the encouragement of capital investments and therefore the management of each of the companies is required to apply significant deliberation to determine its right to benefits, the scope of the benefits and the provision included for the taxes. Changes in these assumptions could lead to significant differences in the book value of the assets and provisions and in the operating expenses.
C-11 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 2 - BASIS OF PREPARATION (CONTD.)
D. Use of estimates and judgments (contd.)
• Financial derivatives: The Group holds financial derivatives to hedge its foreign currency, inflation, interest and price risks. The derivatives are recognized at fair value. The fair value of the derivative financial instruments is calculated using quoted prices, when available. When these prices are unavailable, calculation is by analysis of discounted cash flow using the appropriate yield rate for the useful life of the instruments. The fair value of transactions including options is calculated using commercial software based on the Black and Scholes model, taking into account the internal value, standard deviation and interest. Changes in the economic assumptions and assessment techniques could result in material changes in the fair value of the instruments. • Business combinations: The acquisition of a subsidiary is measured through the acquisition method. The Group allocates the cost of the identifiable assets that were acquired and the liabilities undertaken at fair value at the acquisition date. To estimate the amount in the event that it is not possible to replace an asset or dispose of a liability, in a transaction between a willing buyer and a willing seller in an arm’s length transaction, the Company used the assessment of an external assessor to determine the fair value. E. Capital management – objectives, procedures and processes Management’s policy is to maintain a strong capital base in order to maintain the ability of the Company to continue operating so that it may provide a return on capital to its shareholders, benefits to other holders of interests in the Company such as credit providers and employees of the Company, and sustain future development of the business. The Board of Directors monitors the level of dividends to ordinary shareholders. The Company and the subsidiary Carmel Olefins Ltd. (“Carmel Olefins”) are subject to compliance with financial covenants, including a minimum balance of equity. At the balance sheet date, Carmel Olefins is not in compliance with some of the financial covenants. See Note 16(C).
NOTE 3 - SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements have been prepared on the basis of International Financial Reporting Standards and their related interpretations (IFRS) in issues that are effective or available for early adoption at the Group’s first IFRS annual reporting date, December 31, 2008, and were the basis for the Group’s accounting policy. The preparation of the consolidated financial statements in accordance with IFRS resulted in changes to the accounting policies as compared with the most recent annual financial statements prepared under generally accepted accounting principles in Israel (Israeli GAAP). The accounting policies set out below have been applied consistently to all periods presented in these consolidated financial statements. They also have been applied in preparing an opening IFRS balance sheet as on January 1, 2007 for the purposes of the transition to IFRS, as required by IFRS 1. The impact of the transition from Israeli GAAP to IFRS is explained in Note 33.
C-12 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 3 - SIGNIFICANT ACCOUNTING POLICIES (CONTD.)
The accounting policies in accordance with IFRS have been applied consistently throughout the Group companies. A. Basis of consolidation The consolidated financial statements include the financial statements of the Company and a subsidiary (100%) Gadiv Petrochemical Industries Ltd. (“Gadiv”), as well as the proportionate consolidation (50%) of Carmel Olefins Ltd. (“Carmel Olefins”), a jointly controlled company. Commencing from May 1, 2008 the consolidated financial statements include proportionate consolidation (50%) of Domo Chemicals N.V. (see Note 8). See Note 9(1). (1) Subsidiaries Subsidiaries are entities controlled by the Group. Control exists when the Group has the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities. In assessing control, potential voting rights that are exercisable immediately are taken into account. The financial statements of subsidiaries are included in the condensed consolidated financial statements from the date that control commences until the date that control ceases. The accounting policies of subsidiaries have been changed when necessary to align them with the policies adopted by the Company. (2) Jointly controlled entities (accounted by the proportional consolidation method) Jointly controlled entities are those entities over whose activities the Group has joint control, established by contractual agreement and requiring joint consent with the other investors for strategic financial and operating decisions. Jointly controlled entities are accounted for on a proportionate consolidation basis from the date that joint control commences until the date that joint control ceases. The consolidated financial statements include the Group’s proportionate share of the jointly controlled company’s assets, liabilities, revenue and expenses, which are accounted for on the proportionate consolidation basis, on the basis of the rate of holding in those entities, after adjustments to align the accounting policies with those of the Group. (3) Affiliates (accounted for using the equity method) Affiliates are those entities in which the Group has significant influence, but not control, over their financial and operating policy. The consolidated financial statements include the Group’s share of the revenues and expenses of affiliates on an equity accounted basis, after adjustments to align the accounting policies with those of the Group, from the date that significant influence commences until the date that significant influence ceases. When the Group’s share of losses exceeds its interest in an entity accounted for by the equity method, the book value of those interests is reduced to nil (including any long-term investments) and recognition of further losses is discontinued except to the extent that the Group has an obligation to support the entity or has made payments on its behalf. (4) Transactions eliminated on consolidation Intra-group balances and any unrealized income and expenses arising from intra-group transactions, are eliminated in preparing the consolidated financial statements. Unrealized gains arising from transactions with affiliates are eliminated against the investment to the extent of the Group’s interest in the affiliates. Unrealized losses are eliminated in the same way as unrealized gains, but only to the extent that there is no evidence of impairment.
C-13 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 3 - SIGNIFICANT ACCOUNTING POLICIES (CONTD.)
A. Basis of consolidation (contd.) (5) Early adoption of IFRS 3, IFRS 5 and IAS 27, revised The Group elected to implement early adoption of IFRS 3 Business Combinations, IFRS 5 Discontinued Operations and IAS 27 Consolidated and Separate Financial Statements, revised (“the Revisions”) commencing from January 1, 2007. Business combinations are measured through the acquisition method. The cost of the business combination is measured at the fair value of the transferred assets, the liabilities used in favor of the former owners and the capital instruments issued by the Group in consideration for achieving control in the acquisition. Transaction costs are recognized in profit or loss as incurred. Contingent consideration resulting from a business combination and constituting a financial liability as defined in IAS 32 is first measured at fair value. Changes in fair value in subsequent periods are recognized in profit or loss. Implementation of the Revisions mainly affected the recognition of transaction costs in profit and loss in the transactions for acquisition of subsidiaries and is expected to affect the revaluation of the original investment in Carmel Olefins on the basis of fair value in profit or loss, subject to completion of the merger transaction and achieving control in Carmel Olefins. See Note 9 (2). (6) Acquisition of non-controlling interests in subsidiaries The surplus cost created in transactions of non-controlling interests in subsidiaries are recognized directly in capital. (7) Put option for the minority shareholders A put option that was issued by the Group to the minority shareholders is recognized as a liability at fair value, recognized as a contingent purchase cost of the minority interest. Changes in the fair value in the subsequent periods are recognized in profit or loss. The Company’s share in the earnings of the acquired company includes the share of the other shareholders that were allotted put options by the Company. B. Foreign currency (1) Foreign currency transactions Transactions in currencies other than the functional currency of the Group (foreign currencies) are translated into the functional currency of the Group at exchange rates at the dates of the transactions. Monetary assets and liabilities denominated in foreign currencies on the reporting date are translated to the functional currency at the exchange rate at that date. The foreign currency gain or loss on monetary items is the difference between the cost in the functional currency at the beginning of the period, adjusted for payments during the period, and the amortized cost in foreign currency translated at the exchange rate at the end of the period. Non- monetary assets and liabilities denominated in foreign currencies that are measured at fair value are retranslated to the functional currency at the exchange rate at the date that the fair value was determined. Foreign currency differences arising on retranslation are recognized in profit or loss.
C-14 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 3 - SIGNIFICANT ACCOUNTING POLICIES (CONTD.)
B. Foreign currency (contd.) (2) Foreign operations Foreign operations are defined in IAS 21 as a subsidiary, associate, joint venture, or branch whose activities are based in a country or denominated in a currency other than that of the reporting enterprise. The assets and liabilities of foreign operations, including fair value adjustments arising on acquisition, were translated to the dollar at exchange rates at the reporting date. The income and expenses of foreign operations were translated at the Company to the dollar at exchange rates at the dates of the transactions, or at Carmel Olefins at the average exchange rates. Foreign currency differences are recognized directly in equity commencing January 1, 2007, the Group’s date of transition to IFRS. In accordance with IFRS 1, the Group chose to reset the cumulative translation differences against the retained earnings item for all foreign activities at the date of transition to IFRS. When a foreign operation is sold, in part or in full, the relevant amount in the foreign currency translation reserve (FCTR) is transferred to profit or loss C. Financial instruments (1) Non-derivative financial instruments Non-derivative financial instruments comprise investments in equity and debt securities, trade and other receivables, cash and cash equivalents, loans and borrowings, and trade and other payables. Non-derivative financial instruments are recognized initially at fair value plus, for instruments not at fair value through profit or loss, any directly attributable transaction costs. Subsequent to initial recognition, non-derivative financial instruments are measured as described below. A financial instrument is recognized when the Group accepts the contractual conditions of the instrument. A financial asset is derecognized when the Group’s contractual rights to receive the cash flows deriving from the financial asset expires, or the Group transfers the financial asset to others without maintaining control of the asset or transfers all the risks and rewards deriving from the asset. Regular way purchases and sales of financial assets are recognized on the trade date, meaning on the date the Group undertook to purchase or sell the asset. A financial liability is derecognized when the Group's obligation specified in the contract is discharged, cancelled or expired. a. Cash and cash equivalents Cash comprises cash balances for immediate use. Cash equivalents include highly liquid investments, including short-term investments that can be easily converted into known amounts of cash and that are exposed to an insignificant risk of changes in value. b. Financial assets at fair value through profit or loss Investments in securities stated at fair value through profit or loss are investments in securities held for trading.
C-15 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 3 - SIGNIFICANT ACCOUNTING POLICIES (CONTD.)
C. Financial instruments (contd.) (1) Non-derivative financial instruments (contd.) b. Financial assets at fair value through profit or loss (contd.) The Group manages such investments and makes purchase and sale decisions based on their fair value in accordance with the Group’s documented risk management or investment strategy. Upon initial recognition, attributable transaction costs are recognized in profit or loss when incurred. Financial instruments at fair value through profit or loss are measured at fair value, and changes therein are recognized in profit or loss. c. Loans and receivables Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not traded on an active market. After initial recognition, the loans and receivables are measured at amortized cost using the effective interest method, while taking into consideration transaction costs and deducting any impairment losses. The sale of customer debts is recognized as a sale when the control over the financial asset was fully transferred to an independent third party and all of the risks and rewards involved in the asset were transferred to the independent third party. (2) Derivative financial instruments The Group holds derivative financial instruments to hedge its foreign currency, inflation and interest rate risk exposures. A transaction in financial instruments will be considered an accounting hedge if it meets certain conditions, including conditions regarding designation of the instrument, strict documentation requirements and high effectiveness of the hedge at the beginning and throughout the hedge. The Company’s transactions in financial instruments that reduce economic exposures, as aforementioned, do not meet the accounting hedge conditions of IFRS, and therefore the financial instruments are measured at fair value with the changes in fair value being recognized immediately in profit or loss Derivative financial instruments are recognized initially at fair value and the changes in fair value are recognized in profit or loss when incurred. Transaction costs are recognized in profit or loss as incurred. Changes in fair value of derivatives on prices of commodities and refining margins are classified in cost of sales whereas changes in fair value of derivatives on foreign currency and interest rates are classified as financing expenses. (3) Embedded derivatives Embedded derivatives in financial instruments or any other host contract are separated from the host contract, if the economic characteristics and risks of the embedded derivative are not closely related to the economic characteristics and risks of the host contract, unless the instrument (including the embedded derivative) is recognized as a financial asset or a financial liability at fair value through profit or loss. Changes in the fair value of separable embedded derivatives are recognized immediately in profit or loss at each period.
C-16 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 3 - SIGNIFICANT ACCOUNTING POLICIES (CONTD.)
C. Financial instruments (contd.) (4) Index-linked assets and liabilities that are not measured at fair value The value of the index-linked financial assets and liabilities, which are not measured at fair value, is revaluated in each period according to the actual increase in the index. The CPI and exchange rate of the dollar.
As of December 31, 2008 2007 Index (2000 average basis) 117.95 113.63 Representative dollar/NIS exchange rate 3.802 3.846
The rate of change in the CPI and the exchange rate of the dollar in the reported periods.
Year ended December 31, 2008 2007 Index 3.80% 3.39% Representative exchange rate of $1 (1.14)% (8.97)%
(5) Share capital Incremental costs directly attributable to the issue of ordinary shares and share options are recognized as a deduction from equity. D. Inventory Inventory is stated at the lower of cost and net realizable value. Cost is determined on the basis of the moving average method, and it includes the costs incurred in acquiring the inventory and bringing it to its existing location and condition. In the case of finished goods, cost includes the attributable portion of overheads based on normal operating capacity. Net realizable value is the estimated selling price in the ordinary course of business, less the estimated costs of completion and estimated costs required for selling. E. Fixed assets (1) Recognition and measurement Fixed asset items are measured at cost less accumulated depreciation and any accumulated impairment losses. Cost includes expenditure that is directly attributable to the acquisition of the asset. The cost of self-constructed assets includes the cost of materials, direct labor, finance costs any other costs directly attributable to bringing the assets to a working condition for their intended use. The cost of purchased software that is integral to the functionality of the related equipment is capitalized as part of that equipment. Investment grants were deducted from cost. Maintenance and repairs, other than periodic maintenance of facilities, is included in profit or loss as incurred.
C-17 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 3 - SIGNIFICANT ACCOUNTING POLICIES (CONTD.)
E. Fixed assets (contd.) (1) Recognition and measurement (contd.) When major parts of a fixed asset item (including costs of major periodic inspections) have different useful lives, they are accounted for as separate items (major components) of Fixed assets. Gains and losses on disposal of a fixed asset item are determined by comparing the proceeds from disposal with the carrying amount of the asset, and are recognized net within “other income or expenses” in profit or loss. The cost of certain fixed asset items of Carmel Olefins was determined at fair value on January 1, 2007, the date of transition to IFRS (“deemed cost”). See section 8 below. (2) Subsequent costs - The cost of replacing part of an item of fixed assets is recognized when that cost is incurred if it is probable that the future economic benefits embodied within the item will flow to the Group and the cost of the item can be measured reliably. The book value of the replaced part is derecognized. The costs of day-to-day servicing are recognized in profit or loss as incurred. (3) Depreciation Depreciation is recognized in profit or loss on a straight-line basis over the estimated useful lives of each part of a fixed asset item. Leased assets are depreciated over the shorter of the lease term and their useful lives. Real estate is not depreciated. The estimated useful lives for the current and comparative periods are as follows:
4-5 years Refining and cracking facilities 50 Storage facilities 50 Sulfur installations 15 Facilities for manufacturing aromatic materials 15 - 49 Facilities for manufacturing polymer products 4 - 33 (primarily 33) Other equipment 25 - 50 Buildings 50 Computers 3 - 5 Furniture and equipment 3 - 17 Vehicles 5 - 7
Depreciation methods, useful lives and residual values are reviewed at least at the end of each reporting year. Estimates in respect of the useful lives of certain Fixed assets were revised in 2007 (see Note 2D above).
C-18 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 3 - SIGNIFICANT ACCOUNTING POLICIES (CONTD.)
E. Fixed assets (contd.) (4) Catalysts are presented at cost less accumulated depreciation. The catalysts are depreciated over the period of their expected useful lives (2-10 years). (5) Costs actually incurred in respect of the periodic maintenance of facilities are amortized over the period until the next planned maintenance (approximately 4 years). Costs and expenses incurred by shutting down the facilities during maintenance are recognized in profit or loss. (6) Spare parts are valued at cost, using the moving average method. The spare parts are depreciated on the basis of the average useful lives of the machinery and equipment (20 years). At Carmel Olefins, spare parts that remain in stock for five years are amortized in full. (7) Advance payments for the purchase of Fixed assets are recognized in Fixed assets. (8) At the beginning of 2007, Carmel Olefins elected to adopt the exemption of fair value as deemed cost under Israeli Accounting Standard 28 (Revision to the Transition Standard in IFRS 27, Fixed assets), for fixed asset items as follows: land, buildings, machinery and equipment. At the date of initial implementation, the useful life of part of the assets was changed. The balance of the useful life of the polyethylene plants prior to reassessment was up to 8 years. Subsequent to reassessment, the period was extended from 8 to 12 years. No obligation has been created for Carmel Olefins in respect of the costs of dismantling or removing the fixed asset items or restoring on which they are located, therefore, no amounts whatsoever have been added or deducted from the costs of the fixed asset items during the current period. The fair value of the property and buildings of Carmel Olefins is based on the appraisal of an outside real estate assessor and the fair value of the production facilities is based on the appraisal of an outside industry assessor. The value of the real estate of Carmel Olefins is based on the comparative method, and its value is compared to similar real estate in the same area or in areas that are comparable. The value of the buildings of Carmel Olefins is based on the amortized replacement cost approach, taking into consideration accepted market prices of construction of buildings on different levels of standard, depreciation and the useful life of the buildings. The useful life of the buildings takes into consideration the projected benefit from the buildings. The production facilities were assessed in accordance with the estimate that was determined in view of the basic assumptions, the main ones being as follows: a. A list of the facilities at the plant, including the cost of their reconstruction, addition for administration, planning, acquisition and establishment expenses, which were not included in the establishment cost and the projected useful life of each facility, based on the information provided by the company establishing the facility, or as valuated based on the known condition of the site. b. The projected useful life of the item in the facility is based on the useful life of the item itself, or that of the entire facility, whichever is shorter. c. The scrap value of the facilities and the estimated costs for dismantling or removal of the fixed asset item is not included in this estimate, as Carmel Olefins estimates that the value is not material.
C-19 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 3 - SIGNIFICANT ACCOUNTING POLICIES (CONTD.)
F. Intangible assets (1) Intangible assets that are acquired by the Group and have a definite useful life are stated at cost less accumulated amortization and impairment losses. Amortization is recognized in profit or loss on a straight-line basis over the estimated useful lives of intangible assets, from the date that they are available for use, as follows: a. Prepaid royalties in respect of know-how are amortized over the agreement period, usually 8 years. b. Water and electricity rights are amortized over 25 years. Subsequent expenditure is recognized as an intangible asset only when it increases the future economic benefits embodied in the specific asset to which it relates. All other expenditure is recognized in profit or loss as incurred. The estimates regarding the amortization method and useful life are reassessed at each reporting date. (2) Goodwill Goodwill and negative goodwill arise on the acquisition of subsidiaries and affiliates (including acquisitions of additional interests in affiliates). The goodwill represents the excess of the cost of the acquisition over the Group’s interest in the net fair value of the identifiable assets, liabilities and contingent liabilities of the acquired entity. When the excess is negative (negative goodwill), it is recognized immediately in profit or loss See Note 9 (1) below. Subsequent measurement: Goodwill is measured at cost less accumulated impairment losses. In respect of equity accounted investees, the carrying amount of goodwill is included in the carrying amount of the investment. (3) Intangible assets acquired as part of business combinations at Carmel Olefins Identifiable intangible assets acquired in the context of business combinations are recognized separately from goodwill when they meet the definition of an intangible asset and their fair value can be measured reliably. The cost of these intangible assets is the fair value at the date of the business combination. In the periods subsequent to initial recognition, intangible assets acquired in the context of business combinations are presented at cost less amortization and losses from cumulative impairment. Amortization of intangible assets with an indefinite useful life is calculated on a straight-line basis over their expected useful life (expertise is amortized over 15 years and the supplier agreement is depreciated over 37 months). he estimates regarding the amortization method and useful life are reassessed at each reporting date. The impact of the change in the assessment is accounted for from now onwards. See Note 9(1).
C-20 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 3 - SIGNIFICANT ACCOUNTING POLICIES (CONTD.)
G. Leased assets Leases, where the Group assumes substantially all the risks and rewards of ownership, are classified as finance leases. Upon initial recognition, the leased asset is measured at an amount equal to the lower of its fair value and the present value of the future minimum lease payments. Subsequent to initial recognition, the asset is accounted for in accordance with the accounting policy applicable to that asset. Other leases are operating leases and the leased assets are not recognized on the Group’s balance sheet. Leases of land from the Israel Land Administration (ILA) that are not accounted for as investment property, are operating leases. Lease fees are paid routinely to the ILA and are recognized in profit or loss. H. Capitalization of credit costs Specific and non-specific credit costs were capitalized to qualifying assets as defined in IAS 23, Borrowing Costs, throughout the period required for completion and construction until they are ready for their intended use. Non-specific credit costs are capitalized in the same manner to the same investment in qualifying assets, or portion thereof, which was not financed with specific credit by means of a rate which is the weighted-average cost of the credit sources which were not specifically capitalized. Other credits are recognized in profit or loss as incurred. I. Impairment of assets (1) Financial assets A financial asset is tested for impairment when objective evidence indicates that one or more events have had a negative effect on the estimated future cash flows of that asset. An impairment loss in respect of a financial asset measured at amortized cost is calculated as the difference between its carrying amount, and the present value of the estimated future cash flows discounted at the original effective interest rate. Individually significant financial assets are tested for impairment on an individual basis. All impairment losses are recognized in profit or loss. An impairment loss is reversed if the reversal can be related objectively to an event occurring after the impairment loss was recognized. For financial assets measured at amortized cost, the reversal is recognized in profit or loss. (2) Non-financial assets The book value of the Group’s non-financial assets, other than inventories and deferred tax assets, are reviewed at each reporting date to determine whether there is any indication of impairment. If any such indication exists, then the asset’s recoverable amount is estimated. The recoverable amount of an asset or cash-generating unit is the greater of its value in use and its fair value less costs to sell. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset.
C-21 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 3 – SIGNIFICANT ACCOUNTING PRINCIPLES – (CONTD.)
I. Impairment of the value of Fixed assets (contd.) (2) Non-financial assets (contd.) For the purpose of impairment testing, assets are grouped together into the smallest group of assets that generates cash inflows from continuing use that are largely independent of the cash inflows of other assets or groups of assets (the “cash-generating unit”). An impairment loss is recognized if the carrying amount of an asset or its cash-generating unit exceeds its estimated recoverable amount. Impairment losses are recognized in profit or loss. Impairment losses recognized in prior periods are assessed at each reporting date for any indications that the loss has decreased or no longer exists. An impairment loss is reversed if there has been a change in the estimates used to determine the recoverable amount. An impairment loss is reversed only to the extent that the asset’s carrying amount does not exceed the carrying amount that would have been determined, net of depreciation or amortization, if no impairment loss had been recognized. J. Employee benefits (1) Post-employment benefits The Group has a number of post-employment benefit plans. The plans are usually financed by deposits with insurance companies or with pension funds and they are classified as defined contribution plans and defined benefit plans. (a) Defined contribution plans The Group’s obligations for contributions to defined contribution pension plans are recognized as an employee benefit expense in profit or loss when they are created. (b) Defined benefit plans The Group’s net obligation in respect of defined benefit pension plans is calculated separately for each plan by estimating the amount of future benefit that employees have earned in return for their service in the current and prior periods. That benefit is recognized at its present value and the fair value of any plan assets is deducted. at the balance sheet date on government debentures denominated in the same currency and having maturity dates approximating the terms of the Group’s obligations. When the benefits of a plan are improved, the portion of the increased benefit relating to past service by employees is recognized as an expense in profit or loss on a straight-line basis over the average period until the benefits become vested. To the extent that the benefits vest immediately, the expense is recognized immediately in profit or loss. The Group immediately recognizes all actuarial gains and losses arising from defined benefit plans directly in retained earnings.
C-22 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 3 – SIGNIFICANT ACCOUNTING PRINCIPLES – (CONTD.)
J. Employee benefits (contd.) (2) Other long-term employee benefits The Group’s net obligation in respect of long-term employee benefits other than post- employment plans is the amount of future benefit that employees have earned in return for their service in the current and prior periods. That benefit is discounted to determine its present value, and the fair value of any related assets is deducted. The discount rate is the yield on the reporting date on government debentures denominated in the same currency and having maturity dates approximating the terms of the Group’s obligations. The calculation is performed using the projected unit credit method Any actuarial gains or losses are recognized in profit or loss in the period in which they arise. (3) Severance benefits Severance benefits are recognized as an expense when the Group is demonstrably committed, without realistic possibility of withdrawal, to a formal detailed plan to terminate employment before the normal retirement date. Severance benefits for voluntary redundancies are recognized as an expense if the Group has made an offer encouraging voluntary redundancy (comprising a benefit for dismissal), it is probable that the offer will be accepted, and the number of acceptances can be estimated reliably. The loan to Haifa Early Pensions Ltd. constitutes a right to indemnification that the Group will receive for payment of liabilities for early pension. The right to indemnification does not constitute a benefit plan asset for severance and is presented as a separate asset in the balance sheet. The right to indemnification is measured at fair value. Changes in the fair value in each period are recognized directly in profit or loss. (4) Short-term benefits Short-term employee benefit obligations are measured on an undiscounted basis and are expensed as the related service is provided. A liability is recognized for the amount expected to be paid under short-term cash bonus plans if the Group has a present legal or constructive obligation to pay this amount as a result of past service provided by the employee and the obligation can be estimated reliably. (5) Share-based payments The fair value on the grant date of options granted to employees is recognized as an employee expense with a corresponding increase in equity (capital reserve) over the period during which the employees become unconditionally entitled to the options. The amount recognized as an expense is adjusted to reflect the actual number of share options that are expected to vest.
C-23 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 3 – SIGNIFICANT ACCOUNTING PRINCIPLES – (CONTD.)
K. Provisions The provisions recognized in the financial statements for legal and contingent claims. A provision for claims is recognized if, as a result of a past event, the Company has a present legal or constructive obligation and it is more likely than not that an outflow of economic benefits will be required to settle the obligation and the amount of obligation can be estimated reliably. When the value of time is material, the provision is measured at its present value. However, in rare cases in which the outcome of the contingency cannot be assessed, no provision is included in the financial statements. L. Revenue Revenue from the sale of goods is measured at the fair value of the consideration received or receivable, net of returns, trade discounts and volume rebates. The credit period is usually short and constitutes the accepted credit in the industry, so that accordingly the future consideration is not discounted. Revenue is recognized when the significant risks and rewards of ownership have been transferred to the buyer, recovery of the consideration is probable, the associated costs and possible return of goods can be estimated reliably, there is no continuing management involvement with the goods, and the amount of revenue can be measured reliably. Transfers of risks and rewards vary depending on the individual terms of the contract of sale. For sales of products in Israel, transfer usually occurs when the product is delivered to the customer. For international shipments, transfer occurs upon loading the goods onto the relevant carrier. However, for some international shipments, transfer occurs when the goods reach the destination port. Revenue from services rendered is recognized in profit or loss upon rendering the service if it is certain that the economic benefits associated with the service will flow to the provider of the service. M. Lease payments Payments made under operating leases are recognized in profit or loss on a straight-line basis over the term of the lease. Minimum lease payments made under finance leases are apportioned between the financing expense and the reduction of the outstanding liability. The financing expense is allocated to each period during the lease term so as to produce a constant periodic rate of interest on the remaining balance of the liability. N. Financing income and expenses Financing income comprises interest income on funds invested, dividend income, changes in the fair value of financial assets recognized at fair value through profit or loss, and changes in fair value of the loan to Haifa Early Pensions and of assets of employee benefit plans. Foreign currency gains and gains on hedging instruments are recognized in profit or loss. Interest income is recognized as it accrues in profit or loss, using the effective interest method. Dividend income is recognized on the date that the Group’s right to receive payment is established which in the case of quoted securities is the ex-dividend date. Financing expenses comprise interest expense on borrowings, changes in time value of provisions, dividends on preference shares classified as liabilities, changes in the fair value of financial assets at fair value through profit or loss, impairment losses recognized on financial assets, and losses on hedging instruments that are recognized in profit or loss. All borrowing costs, which are not discounted, are recognized in profit or loss using the effective interest method. Gains and losses in exchange rate differences are reported on a net basis.
C-24 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 3 – SIGNIFICANT ACCOUNTING PRINCIPLES – (CONTD.)
O. Income tax expenses Income tax expense comprises current and deferred tax. Income tax expense is recognized in profit or loss except to the extent that it relates to items recognized directly in equity, In these cases, the tax expense is charged to shareholders’ equity. Current tax is the expected tax payable on the taxable income for the year, using tax rates enacted or substantively enacted at the balance sheet date, and any adjustment to tax payable in respect of previous years. Deferred tax is recognized using the balance sheet method, providing for temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. The Group does not recognize deferred tax for the following temporary differences: the initial recognition of assets or liabilities in a transaction that is not a business combination and that affects neither accounting nor taxable profit, and differences relating to investments in subsidiaries and jointly controlled entities and affiliated companies to the extent that it is probable that they will not reverse in the foreseeable future. Deferred taxes are measured according to the tax rates that are expected to apply on the temporary differences at the date they are realized, based on the applicable laws at the balance sheet date. Deferred tax assets and liabilities are offset if there is a legally enforceable right to offset current tax liabilities and assets, and they relate to income taxes levied by the same tax authority on the same taxable entity, or on different tax entities, but they intend to settle current tax liabilities and assets on a net basis or their tax assets and liabilities will be realized simultaneously. A deferred tax asset is recognized to the extent that it is probable that future taxable profits will be available against which the temporary difference can be utilized. The deferred tax assets are reviewed at every balance sheet date, and if it is not expected that the attributed tax benefits will be realized, they are reduced. The Group may be liable for additional tax in the event of a distribution of a dividend from certain investee companies. This additional tax was not included in the financial statements in view of the Group's policy not to initiate dividend distributions that generate additional tax liabilities in its subsidiaries and in view of the existence of agreements that stipulate that the profits of affiliated companies would not be distributed as dividends. Additional income taxes that arise from the distribution of dividends by the Company are recognized in profit or loss at the same time as the liability to pay the related dividend is recognized. Deferred tax in respect of intra-company transactions in the consolidated financial statements is recorded according to the tax rate applicable to the buying company. P. Earnings per share Diluted EPS is determined by adjusting the profit or loss attributable to ordinary shareholders and the weighted average number of ordinary shares outstanding for the effects of all dilutive potential ordinary shares, which include share options and share options granted to employees.
C-25 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 3 – SIGNIFICANT ACCOUNTING PRINCIPLES – (CONTD.)
Q. Segment reporting A segment is a distinguishable component of the Group that is engaged either in providing related products or services (business segment), or in providing products or services within a particular economic environment (geographical segment), which is subject to risks and returns that are different from those of other segments. Segment information is presented in respect of the Group’s business segments and it is based on the Group’s management and internal reporting structure. Inter- segment pricing is based on transaction prices during regular business. Segment results, assets and liabilities include items directly attributable to a segment as well as those that can be allocated on a reasonable basis. R. Environmental costs Current costs of operating and maintaining installations used in preventing environmental pollution and expected liabilities for costs relating to existing conditions deriving from current operations are recognized in profit and loss. Costs of constructing installations used in preventing environmental pollution are recorded as Fixed assets and are depreciated in accordance with the Company’s depreciation policy pertaining to the Fixed assets to which the costs relate. S. Separate reporting The Company elected to implement early adoption of Revised IAS 27, Consolidated and Separate Financial Statements, and IFRS 1, First-time Adoption of International Financial Reporting Standards (“the Standards”). In accordance with the revised Standards, a company that chooses the cost method for measuring its investments in subsidiaries, jointly controlled companies and affiliated companies, in the separate financial statements (stand-alone financial statements) is permitted to measure these investments on the date of transition to IFRS at their fair value in accordance with IAS 39 or at their carrying value in accordance with previous GAAP. The Company chose to measure the investments at the transition date to IFRS at their carrying amount in accordance with previous GAAP. Furthermore, a dividend received from subsidiaries, jointly controlled companies and affiliated companies shall be recognized as income in the separate financial statements of the holding company. It was further provided that under certain circumstances the receipt of a dividend indicates impairment of the investment in the investee company. T. New standards and interpretations not yet adopted
• IFRS 8, Operating Segments (“the Standard”) determines that the “management approach” should be used in segment reporting, meaning in accordance with the format of the internal reports provided to the decision makers of the entity. Currently the Company presents segment information in respect of its business segments. Under the management approach, the Group will present segment information in respect of the refining, petrochemicals and trade operations. The Standard is effective for annual periods beginning on or after January 1, 2009. Management of the Group estimates that implementation of the Standard will not have an effect on the financial statements of the Group. • Revised IAS 23, Borrowing Costs (“the Standard”) removes the option to recognize credit costs as an expense in profit and loss and requires that an entity capitalize credit costs directly attributable to the acquisition, construction or production of a qualifying asset as part of the cost of that asset. The Standard is effective for annual periods beginning on or after January 1, 2009 and will constitute a change in accounting policy for the Group.
C-26 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 3 – SIGNIFICANT ACCOUNTING PRINCIPLES – (CONTD.)
T. New standards and interpretations not yet adopted (contd.) In accordance with the transitional provisions, the Group will apply the Standard to qualifying assets for which capitalization of credit costs commences on or after the effective date. Management of the Company evaluates that implementation of the Standard will not have an effect on the financial statements of the Group. • Revised IAS 1, Presentation of Financial Statements (“the Standard”) requires the aggregation in the financial statements of information having common characteristics and the presentation of a statement of comprehensive income. The Standard allows the presentation of income and expense items and components of other comprehensive income either in a single statement of comprehensive income with subtotals, or in two separate statements (a separate income statement followed by a statement of comprehensive income). The titles of some of the financial statements were changed in order to reflect their function more clearly (for example, the balance sheet is renamed a statement of financial position). The Standard will come into effect for annual periods beginning on or after January 1, 2009. Early adoption is permitted. Management of the Group estimates that implementation of the Standard will not have an effect on the financial statements of the Group. Implementation of the Standard is expected to have an effect on the presentation of the consolidated financial statements. The Group will ask to present a statement of comprehensive income (which will replace the consolidated statement of recognized income and expenses) and a statement of changes in equity, as part of the financial statements. • Revised IFRS 2, Share-Based Payments (“the Standard”). The Standard provides that vesting conditions determine whether the parent company is receiving the services that entitle the other party to a share-based payment, and they are restricted to service and performance conditions. Non-vesting conditions will be reflected in the fair value of the share-based payment on the grant date, and after the grant date the company shall not adjust the fair value in respect of these conditions. Furthermore, the Standard specifies the accounting treatment of non-compliance with non- vesting conditions. The Standard will apply retroactively to annual periods beginning after January 1, 2009. Early adoption is permitted, with disclosure. Management of the Group estimates that implementation of the standard will not have an effect on the financial statements of the Group. • IFRIC 18, Transfers of Assets from Customers (“the Interpretation”). The interpretation addresses the accounting treatment for the transfer of an item of fixed assets from a customer to the reporting entity that the entity must then use either to connect the customer to a network or to provide the customer with ongoing access to a supply of supply of goods or services, or both. The interpretation clarifies the recognition of the asset and the measurement of its cost on initial recognition, and the recognition of revenue relating to receiving the asset. The interpretation applies to transfer of assets from customers received by the reporting entity on or after July 1, 2009 from now onwards. Early application is permitted under certain conditions. The management of the Group is assessing the impact of the Interpretation on its financial statements. In the framework of the Improvements to IFRS project, in May 2008 the IASB published and approved 35 amendments to various IFRS on a wide range of accounting issues. The amendments are divided into two parts: (1) amendments that result in accounting changes for presentation, recognition or measurement purposes without accounting implications and (2) terminology or editorial amendments that are expected to have either no or only minimal effects on accounting. Most of the amendments shall apply to periods beginning on or after January 1, 2009 and permit early adoption, subject to the specific conditions of each amendment and subject to the transitional provisions relating to a first-time adopter of IFRS. The Group estimates that implementation of the standards will not have a material impact, if at all on the Group. However, the following revisions could be relevant for the Group:
C-27 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 3 – SIGNIFICANT ACCOUNTING PRINCIPLES – (CONTD.)
T. New standards and interpretations not yet adopted (contd.) IAS 19, Employee Benefits, revised (“the Standard”). Under IAS 19 (revised), other long-term benefits will include benefits for employees that are short term but they are expected to be used one year after the eligible period, such as benefits for accumulated vacation and sick days that are expected to be used one year after the balance sheet date. From now onwards these benefits will be recognized in the financial statements on the basis of actuarial calculation of future salary and discounted present value. The revised Standard is effective retroactively for accounting periods commencing on or after January 1, 2009. Early adoption is permitted. The Group estimates that implementation of the revision will not have a material impact, on the financial statements. • IAS 28, Investments in Associate, revised (“the Standard”). In accordance with IAS 28 (revised), impairment of an investment in an associate is calculated for the entire investment. Accordingly, the recognized impairment loss is not allocated specifically to the goodwill in the investment, but to the entire investment. Therefore, the full impairment loss recognized in the past can be cancelled if the required conditions exist under IAS 36. The revised Standard may be applied retroactively or from now onwards, for accounting periods beginning on or after January 1, 2009, with disclosure. • Management of the Group estimates that implementation of the Standard will not have an effect on the financial statements.
NOTE 4 - DETERMINATION OF FAIR VALUES
A number of the Group’s accounting policies and disclosures require the determination of fair value, for both financial and non-financial assets and liabilities. Fair values have been determined for measurement and / or disclosure purposes based on the following methods. Further information about the assumptions made in determining fair values is disclosed in the notes specific to that asset or liability. A. Investments in equity and debt securities The fair value of financial assets at fair value through profit or loss, held-to-maturity investments and available-for-sale financial assets is determined by reference to their quoted closing bid price at the reporting date. B. Trade and other receivables The fair value of trade and other receivables is estimated as the present value of future cash flows, discounted at the market rate of interest at the reporting date. In periods subsequent to initial recognition, the fair value of trade and other receivables is determined for disclosure purposes only. The credit period is usually short and constitutes the accepted credit in the industry, so that accordingly the future consideration is not discounted. C. Derivatives The fair value of derivative financial instruments is based on their listed market price, if available. If a listed market price is not available, then fair value is estimated by analyzing the discounted cash flows using an appropriate interest rate for the residual maturity of the instruments. The interest rates are defined in relation to the quotations received for similar transactions and include a commercial margin above the accepted market rate (LIBOR). For derivatives including options, models for pricing options are used.
C-28 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 4 - DETERMINATION OF FAIR VALUES (CONTD.)
D. Non-derivative financial liabilities Fair value, which is determined for disclosure purposes, is calculated based on the present value of future principal and interest cash flows, discounted at the market rate of interest at the reporting date. E. Share-based payment expenses The fair value of employee share options and of share appreciation rights is measured using the Black-Scholes formula. Measurement inputs include share price on measurement date, exercise price of the instrument, expected volatility (based on weighted average historic volatility adjusted for changes expected due to publicly available information), weighted average expected life of the instruments (based on historical experience and general option holder behavior), expected dividends, and the risk-free interest rate (based on government debentures). Service and non-market performance conditions attached to the transactions are not taken into account in determining fair value. F. Business combinations Business combinations: The acquisition of a subsidiary is measured through the acquisition method. The Group allocates the cost of the identifiable assets that were acquired and the liabilities undertaken at fair value at the acquisition date. To estimate the amount in the event that it is not possible to replace and asset or dispose of a liability, in a transaction between a willing buyer and a willing seller in an arm’s length transaction, the Company used the assessment of an external assessor to determine the fair value.
NOTE 5 – INVESTMENTS
A. Short-term deposits In December 2008, a short-term deposit bearing 2.7% was deposited for six months. B. Investments in other financial assets at fair value through profit or loss
December 31 2008 2007
Mutual fund certificates for joint investment fund trusts - 11,191 Government debentures 69,911 66,709 Corporate debentures 14,211 28,486 Convertible debentures - 209 Short-term loan - 2,800 Other 17,387 3,640 101,509 113,035
C-29 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 6 – TRADE AND OTHER RECEIVABLES
Trade receivables (1) Composition:
December 31 2008 2007
Open accounts 249,946 390,423 Checks receivable 5,675 6,359 255,621 396,782 Net of provision for doubtful debts (2,406) (2,312) 253,215 394,470 Including related parties and interested parties (1) 45,031 46,541
Sale of customer debts as part of a securitization transaction In the reporting period, the Company and Carmel Olefins entered into an agreement with banks (“the banks”). As part of the agreement, it was stipulated that the liabilities reflected in invoices to be received by the bank for securitization are endorsed from the Company to the bank pursuant to the Law for the Endorsement of Charges - 1969. The endorsement is absolute, final, and complete, and unconditional, by way of a sale. The endorsement is independent and cannot be changed or cancelled without the prior written consent of the bank. Customer debts that have been sold as of the reporting date amount to $108 million (in December 2007 – $26 million). Other receivables Composition:
December 31 2008 2007
Employees 22 158 Current maturities of loans (see Note 10) 872 931 Interest to receive (see Note 18) 1,307 - Institutions 21,883 39,210 Deposits from derivative instruments 1,714 3,753 Advance expenses 25,852 10,978 Others 32,299 21,351 82,642 76,381
The exposure of the Group to credit and currency risks and losses in respect of impairment relating to trade and other receivables is described in Note 31 - Financial Instruments.
C-30 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 7 – INVENTORY
Composition: December 31 2008 2007
Crude oil and middle fuel products for refining * 305,172 627,422 Fuel products 221,757 355,777 Raw materials in the petrochemicals sector 4,640 7,256 Petrochemical products 15,768 33,839 Accessory materials and chemicals 22,070 18,251 569,407 1,042,545 * Including inventory on the way 31,848 154,589
As a result of the dramatic fluctuations in the prices of crude oil and its products, the Group recognized a loss for impairment of inventory amounting to $198 million on December 31, 2008, which was partially offset by hedging transactions for inventory in the futures market in the amount of $14 million. The loss reflects the difference between the cost of inventory and the net value of its realization on the reporting date. The impairment was recognized in profit and loss under cost of sales, refinery and services.
NOTE 8 – EQUITY ACCOUNTED INVESTEES
A. Composition of the investments in the Group December 31 2008 2007
Haifa Basic Oils Ltd. 22,667 22,979 Gadot Biochemical Industries Ltd. (*) (***) 9,900 13,371 United Petroleum Export Co. Ltd. 2,322 1,544 Tanker Services Ltd. 343 326 Israel Petrochemical Enterprises Ltd. (**) (***) - 15,738 Mercury 773 - 36,005 53,958
(*) Gadot issued convertible debentures and allotted options to senior employees. In the event that all of the debentures are converted into shares and all of the options granted to senior executives are exercised, the Company’s holdings in Gadot will decrease to 20.34%. (**) As of December 31, 2008, IPE holds 50% of the ownership and control in Carmel Olefins Ltd. and indirectly holds 15.76% of the company’s shares. (***) As of December 31, 2008, based on the market price of the shares on the TASE, the market value of the investments of the Company is IPE - $6 million and Gadot - $3 million. As of December 31, 2007, the recoverable value of the investment is $10 million. In view of the aforementioned, the Company recorded a loss from impairment of the investment in the amount of $25 million. The market value of the investment proximate to the approval of the financial statements is $10 million. In view of the substantial decrease in the market value of the investment in Gadot, the Company examined the need for impairment of the investment. Based on the valuation by external assessors, Prof. Yitzhak Suary & Co., as of December 31, 2008, the recoverable amount of the investment is $10 million. Therefore, the Company recognized a loss from investment impairment of $2.7 million.
C-31 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 8 – EQUITY ACCOUNTED INVESTEES (CONTD.)
B. Composition of investments and the Group’s share in the profits (losses) December 31 2008 2007 Cost of shares - original 7,064 6,268 Group’s share in earnings at the acquisition date 55,363 58,474 Dividends (16,252) (10,920) Capital reserve – privatization grant 168 168 Capital reserve - Adjustments arising from translation from the acquisition (10,338) date (32) 36,005 53,958
C. Change in investment during the year based on the equity method
December 31 2008 2007 Balance at the beginning of the year 53,958 57,829 Changes during the year: Company’s share in earnings (3,111 ) 6,913 Investment in investees 796 - Company’s share in capital reserves in an investee (10,306 ) 136 Dividend received (953 ) (10,920) Dividend declared (4,379) - Balance at the end of the year 36,005 53,958
D. Further information about the material acquisitions and sales in the reporting period Mercury Aviation (Israel) Ltd. acquisition transaction On June 30, 2008, the Company signed an agreement to purchase 31.25% of the shares of Mercury Aviation (Israel) Ltd. (“Mercury”) in consideration of $796,000. The transaction was completed on September 24, 2008. Mercury is a refueling company operating at Ben Gurion Airport. The consideration of the acquisition included the surplus cost for an intangible asset attributable to the concession granted to Mercury by the Israel Airport Authority, commencing from December 31, 2007. The balance of the surplus cost amortization period commencing from the acquisition date is 4.25 years. E. Dividends received from investees
Year ended December 31 2008 2007 From a proportionately consolidated subsidiary - 13,136 From affiliates 5,332 10,920 5,332 24,056
F. Revenue from investees Year ended December 31 2008 2007
For a proportionately consolidated subsidiary Fees for management and services 1,250 1,250
C-32 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 8 – EQUITY ACCOUNTED INVESTEES (CONTD.)
G. Condensed financial information for equity accounted investees
Current Non-current Total Current Non-current Profit assets assets assets assets assets Total assets Revenue Expenses (loss)
2008 139,809 154,507 294,316 103,160 73,110 176,270 478,145 (465,642) 12,503
2007 740,195 588,675 1,328,870 195,966 691,446 887,412 664,872 (672,630) (7,758)
H. Condensed information for equity accounted investees
Current Non-current Total Current Non-current Profit assets assets assets assets assets Total assets Revenue Expenses (loss)
2008 232,849 855,739 1,088,588 486,613 320,104 806,717 950,385 (1,027,458 (77,073)
2007 291,080 791,870 1,082,950 140,237 579,304 719,541 685,098 (672,272) 12,826
C-33 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 9 - ACQUISITION OF SUBSIDIARIES AND MINORITY INTERESTS
1. On January 23, 2008, Carmel Olefins entered into an agreement with Domo Chemicals N.V. through a wholly-owned subsidiary, Colland Polymers B.V. Domo is a petrochemical company incorporated in the Netherlands. The main points of the agreement are as follows: Carmel Olefins will purchase 49% of the shares of Domo Polypropylene B.V. (Domo) for €20 million. In addition, commencing from 2013, Domo Chemicals N.V. may be entitled to additional consideration, not to exceed an amount of €1 million a year for a five-year period, in accordance with the terms set out in the agreement. The contingent liability for the additional consideration was measured at fair value. Carmel Olefins, through Colland, has a call option from the purchase date until December 31, 2016, for the purchase of the balance of the shares for an additional €10 million, net of the dividends to be distributed to Domo, plus annual interest at a rate of 5%. Domo Chemicals N.V. has a put option, exercisable commencing on July 1, 2011 for the sale of the remaining 51% to Carmel Olefins at the same terms describe above in relation to the call option. Domo is a petrochemical company incorporated in Holland engaging in the manufacture and marketing of polypropylene, which is used as raw material in the plastics industry for a range of uses and products. The transaction was completed on April 25, 2008. A. Analysis of the acquired assets and liabilities (as of the acquisition date):
Carrying Adjustment to Fair value at amount fair value acquisition According to the Company’s holding in Carmel Olefins (50%)
Current assets (*) 32,339 - 32,339 Non-current assets 4,212 29,897 34,109 Current liabilities (18,241) - (18,241) Non-current liabilities (779) (7,624) (8,403)
B. On May 6, 2008, Carmel Olefins paid €20 million in cash for the acquisition of 49% of Domo shares. C. The tax rate for calculation of deferred taxes on the attributable surplus cost is 25.5%. D. Assets (including intangible: expertise and the commercial agreement with the main raw material supplier) and liabilities of Domo were included in the consolidated balance sheet on the basis of the fair values on the date the transaction was completed. E. In the consolidated statements of income, Domo’s Fixed assets are depreciated over 15 year, expertise is depreciated over 15 years and the supplier agreement is depreciated over 37 months. F. In accordance with the allocation of the acquisition cost that Carmel Olefins carried out as a result of the acquisition, there is negative goodwill of $29 million (the Company’s share is $14.5 million). A one-time profit for this negative goodwill was recorded in the consolidated statements of income. As of the date of the financial statements, Carmel Olefins has completed attribution of the surplus cost of assets on the recognized liabilities. Attributed surplus cost was depreciated on the basis of section E. above.
C-34 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 9 - ACQUISITION OF SUBSIDIARIES AND MINORITY INTERESTS (CONTD.)
1. (contd.) G. Carmel Olefins recognized a financial liability for the call option, against increase of the cost of the acquisition in the amount of $14.6 million (the Company’s share is $7.3 million). As the call option is exercisable immediately, and as the call option confers on Carmel Olefins access to the economic benefits incorporated in ownership of Domo shares, Domo results were fully consolidated and no minority interests were included for the share of the other shareholders in Domo commencing May 1, 2008 in their financial statements. Carmel Olefins recognizes a financial liability for future payments contingent on margins between the price of propylene and polypropylene, as an embedded derivative in the Domo acquisition transaction. For accounting of embedded derivatives, see Note 3(C)(3). H. Net cash flow on acquisition:
Year ended December 31, 2008 Total value of acquisition 25,269 Less non-cash proceeds (9,527)
Proceeds paid in cash 15,742 Less cash and cash equivalent (1,280) 14,462
(*) See section G. I. Impact of the purchase on the Group’s results The loss in 2008 included a profit of $6,433 thousand, and revenue of $77,019 thousand attributable to the subsidiary in Holland. Were the acquisition to be effected at the beginning of 2008, the total revenues of the Group would have amounted to $8,307,909 thousand and the Group losses would have amounted to $105,724 thousand. 2. Carmel Olefins merger transaction On June 24, 2008, the Company signed an agreement with IPE. The general meeting of the company's shareholders approved the agreement on August 13, 2008. Under the agreement, IPE will sell the Company all the shares it owns in Carmel Olefins, comprising 50% of the issued share capital of Carmel Olefins (“the acquired Carmel Olefins shares”) such that following the acquisition, the Company will hold the full issued share capital of Carmel Olefins, in consideration for the allotment of the Company’s ordinary shares, representing (after the allotment and without dilution) 20.53% of the company’s issued share capital and its voting rights. It was also agreed that the Company would sell IPE all of the Company's shares in IPE (“the acquired IPE shares”), representing 12.29% of the share capital of IPE, for $40 million. On December 31, 2008, the agreement for the purchase of Carmel Olefins expired, without the fulfillment of all the preconditions defined in the agreement and therefore the transaction was not completed. However, as the main reasons at the basis of the board’s resolution to approve the merger of Carmel Olefins with the Company are still valid today, the Company and IPE agreed to continue to cooperate with the aim of trying to complete the merger, and when the terms are ripe, the matter will be presented to the organs of the Company.
C-35 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 10 - LONG TERM LOANS AND DEBIT BALANCES
A. Composition:
(Weighted *) December 31 % 2008 2007
Loans to employees - unlinked 2.7% 2,730 2,655 Less: current maturities (see Note 6) (758) (817) 1,972 1,838
Loans to customers – dollar linked - 188 302 Less: current maturities (see Note 6) (114) (114) 74 188 Long-term trade receivables 2,946 - Net of provision for doubtful debts (2,386) - 560 2,606 2,026
* The interest rate refers to balances as of December 31, 2008. B. Loans which mature in the coming years
December 31, 2008
Second year 1,105 Third year 726 Fourth year 357 Fifth year and thereafter 418 2,606
C-36 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 11 – FIXED ASSETS
A. Composition and changes:
Machinery Computers, Constructio Real and office furniture n work in Spare parts estate Buildings equipment and equipment Vehicles progress inventory Total (B)(3) (B) (C) (D) (E) (*) Cost Balance on January 1, 2007 13,355 19,584 1,449,939 62,091 1,271 168,235 28,704 1,743,179 Additions during the year - 2,138 216,080 1,481 10 - 11,495 231,204 Disposals during the year - - - - (30) (142,105) - (142,135)
Balance on December 31, 2007 13,355 21,722 1,666,019 63,572 1,251 26,130 40,199 1,832,248
Additions during the year - 3,789 36,589 2,114 - 99,854 6,189 148,535
Consolidation - - 29,853 - - - - 29,853 Net differences from translation of foreign operations - - (3,103 ) - - - - (3,103 ) Disposals during the year - - (475) - - - - (475)
Balance on December 31, 2008 13,355 25,511 1,728,883 65,686 1,251 125,984 46,388 2,007,058
Depreciation Balance on January 1, 2007 - 7,042 719,987 56,504 1,124 - - 784,657 Depreciation for the year - 445 67,103 1,298 42 - - 68,888 Disposals - - - - (19) - - (19)
Balance on December 31, 2007 - 7,487 787,090 57,802 1,147 - - 853,526
Depreciation for the year - 607 67,977 1,564 35 - - 70,183 Net differences from translation of foreign operations - - (48 ) - - - - (48 ) Disposals during the year - - (49) - - - - (49) Balance on December 31, 2008 - 8,094 854,970 59,366 1,182 - - 923,612
Carrying amount On January 1, 2007 13,355 12,542 729,952 5,587 147 168,235 28,704 958,522
On December 31, 2007 13,355 14,235 878,929 5,770 104 26,130 40,199 978,722
On December 31, 2008 13,355 17,417 873,913 6,320 69 125,984 46,388 1,083,446 (*) Net, less cumulative depreciation.
C-37 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 11 – FIXED ASSETS (CONTD.)
B. Real estate (1) According to the New Asset Agreement, signed on January 24, 2007, the Company is entitled to register itself as the lessee of land covering an area of 213.3 hectare in the Haifa Bay area, from the State of Israel, under a capital lease for 49 years from the date of the signing of the agreement, with the Company having an option at its discretion to extend the lease for an additional 49 years (see Note 20). Of this property, the Company is in possession of 160 hectares. The rest of the property is leased to Carmel Olefins, Gadiv, Haifa Basic Oils, and third parties, or serves various purposes needed for the operations of the Company, but are not specifically held by the Company. In addition, the Company leases an area of 5.6 hectares near Jalama from the Israel Lands Administration. The New Asset Agreement applies to this property as well. Under a note recorded in the Haifa Land Registry in 1958, the Company is registered as the owner of an easement in three strips of land that connect the Haifa oil refinery to three facilities held by an infrastructure company: a crude oil terminal in Kiryat Haim, a fuel port in the Haifa Port, and a fuel product terminal in Elroy (Kiryat Tivon). By virtue of the easement, the Company possesses underground pipes under the strips for the purposes of flowing crude oil and various fuel distillates. In the same note, an easement was mutually granted to the infrastructure company (then IPC, at present - Petroleum & Energy Infrastructures Ltd.) by virtue of which there are other underground pipes in the strip of land that constitute part of the property of the Company. This strip is located along the northern boundary of the Oil Refineries' compound and is connected to the aforementioned three strips. In accordance with the agreement with the State of Israel dated January 24, 2007, the Company restored to the State of Israel its rights in the distillates piping (see Note 20(C)1d). The implementation of this agreement had no impact on the balance sheet of the Company since these rights were not contained therein. See Note 19(B). (2) The Gadiv plant is built on eight hectares of land owned by the Company and leased under a 999 year capital lease. The lease is registered in Gadiv’s name. An additional six hectares for storage purposes is rented until August 30, 2006. As of the date of the financial statements, Gadiv continues to hold this real estate and pays rent in accordance with the agreement between the parties (see Note 12). (3) Carmel Olefins plants are on a tract of 39 hectares in the Haifa Bay area, adjacent to the compound of the Company, on the south-east side. Of this tract of land, Carmel Olefins has the right to register itself as the owner of 38.1 hectares, of which 0.86 hectares were sold to Carmel by the Company. The remainder of the tract (0.9 hectares) which is owned by the Company was leased to Carmel Olefins at market terms. C. Buildings In addition to the buildings detailed above, the Company holds rights in offices in Ramat Gan, covering an area of 210 sq m. The New Asset Agreement as described in B(1) above also applies to these offices (without additional consideration in excess of what was set in the New Asset Agreement). D. Machinery and equipment The Group has fully-depreciated assets that are still operating. The original cost of the assets as of December 31, 2008 amounted to $318 million.
C-38 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 11 – FIXED ASSETS (CONTD.)
E. Agreements for establishment works and facilities As of the date of the financial statements, the balance of agreements for approved establishmnet works amounted to NIS 84 million. As of December 31, 2008, Fixed assets include advance payments made by the Group on account of the purchase of Fixed assets in the amount of $24 million. F. Credit acquisitions of Fixed assets In the year ended December 31, 2008, the Company acquired Fixed assets using credit in the amount of $13 million. As of the reporting date, the cost of acquisition is yet to be completed. G. Establishment of a hydrocracker On October 12, 2008, the Company’s board of directors approved the establishment of a hydrocracker at the Haifa refinery for a total investment of $670 million, (including an investment of $37 million approved by the board of directors in November 2007 in order to advance the project), as part of the strategic plan adopted in November 2007. The hydrocracker will produce middle distillates (diesel oil and kerosene) and is expected to be operational in 2011. The board of directors instructed the Company’s management to complete the organization of the credit facility through Export Credit Agency to finance the purchase of the main equipment from foreign suppliers, and to act to receive additional long-term credit required for the project, from various sources. As of the date of the financial statements, $32 million have been invested. As of the approval date of the financial statements, the Company has no financial liabilities for the purchase of Fixed assets that are not covered by additional financing. H. Capitalized costs
December 31 2008 2007
Credit costs 19,382 18,089
The capitalization rate used to determine the credit costs is as follows: 4.48% I. For the implementation of the exemptions of fair value as a deemed cost in Carmel Olefins, see Note 3(E)(8). J. Liens See Note 20(A).
C-39 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 12 – OTHER ASSETS AND DEFERRED EXPENSES
A. Changes in intangible assets during the year:
Real estate Royalties Electricity – advance and and other Supplier rental expertise rights agreement Total Cost Balance on January 1, 2007 2,024 18,209 692 - 20,925 Additions during the year - 10,845 - - 10,845
Balance on December 31, 2007 2,024 29,054 692 - 31,770
Additions during the year - 2,403 - - 2,403 Consolidation - 2,331 - 860 3,191 Net differences from translation of foreign operations - (241) - (89) (330)
Balance on December 31, 2008 2,024 33,547 692 771 37,034
Cumulative depreciation Balance on January 1, 2007 26 7,910 313 - 8,249 Additions during the year 2 880 25 - 907
On December 31, 2007 28 8,790 338 - 9,156
Additions during the year 2 2,513 26 167 2,708 Balance on December 31, 2008 30 11,303 364 167 11,864
Book value On January 1, 2007 1,998 10,299 379 - 12,676 On December 31, 2007 1,996 20,264 354 - 22,614
On December 31, 2008 1,994 22,244 328 604 25,170
B. See Note 11(B)(2). C. Amortization of intangible assets is recognized in cost of sale. D. For consolidation, see Note 9(1).
C-40 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 13 - TRADE PAYABLES
December 31, 2008 2007
Open accounts 270,594 559,695
Including related parties and interested parties (1) 917 409
(1) For further information of related parties and interested parties, see Note 28. For the Group's exposure to currency risk and liquidity for part of the trade balances, see Note 31 – Financial Instruments.
NOTE 14 – OTHER PAYABLES
December 31 2008 2007 Deposits from customers 30,930 29,941 Employees 26,633 44,330 Institutions 7,572 7,001 Others 4,921 7,548
70,056 88,820
For the Group's exposure to currency risk and liquidity for part of the payable balances, see Note 31 – Financial Instruments.
NOTE 15 - PROVISIONS
Claims and legal proceedings Balance on January 1, 2008 15,677 Provisions during the period 17,395 Provisions realized during the period (16,838) Provisions cancelled during the period (92) Impact of translation of currency (3,193) Balance on December 31, 2008 12,949
For details of claims and legal proceedings for which provisions were made, see Note 20(B).
C-41 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 16 – LOANS AND CREDIT FROM BANKS AND OTHER CREDIT PROVIDERS
This Note includes information of the contractual conditions of the Group's loans and credit bearing interest. Additional information about the Group’s exposure to interest, foreign currency, inflation and liquidity risks appears in Note 31 – Financial Instruments. Current liabilities
December 31 2008 2007 Credit from banks Bank overdrafts 28,973 948 Short-term loans 101,446 - 130,419 948 Current maturities of long-term liabilities Current maturities of bank loans 106,525 120,204 Current maturities of debentures 26,016 94,869 132,541 215,073
Classification of long-term loans to short-term loans at Carmel Olefins due to non- compliance with financial covenants (see Note B(5) below) 117,379 -
Total current liabilities 380,339 216,021
Non-current liabilities
December 31 2008 2007 Non-convertible debentures 755,840 815,645 Bank loans 459,736 575,664 1,215,576 1,391,309 Other long-term liabilities Liability in respect of financial lease 8,448 7,763
Classification of long-term loans to short-term loans at Carmel Olefins due to non- compliance with financial covenants (119,157) - Less deferred expenses for loans reclassified as short term 1,778 - (117,379)
Less current maturities (132,541) (215,073) Less deferred expenses (5,353) (6,780)
Total non-current liabilities 968,751 1,177,219
For guarantees and liens, see Note 20(A).
C-42 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 16 – LOANS AND CREDIT FROM BANKS AND OTHER CREDIT PROVIDERS (CONTD.)
A. Interest and linkage
December 31 2008 2007 Currency Interest Par value Book value Par value Book value Bank overdrafts Unlinked NIS - 948 948 Bank overdrafts Dollar 1.6% 28,973 28,973 - - Short-term bank loans Unlinked 3.75% NIS 48,774 48,774 - - Short-term bank loans Dollar 1.28% 51,352 51,352 - - Short-term bank loans Euro 4.5% 1,320 1,320 - - Non-convertible debentures Index linked 4.86% 569,719 619,875 666,950 680,136 Non-convertible debentures Unlinked 6.5% NIS 131,510 131,510 130,005 130,005 Non-convertible debentures Dollar 3.4% 4,455 4,455 5,504 5,504 Long-term bank loans Dollar 2.71% 326,354 326,354 533,630 533,630 Long-term bank loans classified as Dollar 2.71% short-term (*) 99,130 99,130 - Long-term bank loans classified as Euro 3.48% short-term (*) 34,252 34,252 42,034 42,034 Liability in respect of financial Index linked 7% lease NIS 8,448 8,448 7,763 7,763
Total loans and credit from banks and other credit providers 1,304,287 1,354,443 1,386,834 1,400,020 (*) See section (B)2(b) below
(1) Distribution by currency and linkage basis
December 31, 2008 Total liabilities Long-term loans Total liabilities before deduction of classified as short Total current less current current maturities term (*) maturities maturities Total non-current liabilities: Non-linked NIS 131,510 - 131,510 CPI-linked NIS 628,323 (25,174) 603,149 USD-linked or USD-denominated 429,939 (90,431) (101,841) 237,667 Euro-linked or euro-denominated 34,252 (28,726) (5,526) - 1,224,024 (119,157) (132,541) 972,326
(*) See section (B)2(b) below.
C-43 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 16 – LOANS AND CREDIT FROM BANKS AND OTHER CREDIT PROVIDERS (CONTD.)
B. Additional information about non-current liabilities (2) Balance by maturity dates a.
As of December 2008 2010 118,472 2011 140,356 2012 122,801 2013 170,967 More than five years 419,730 Total non-current liabilities less current maturities 972,326
b. As part of the loans extended to Carmel Olefins, a number of financial covenants were set, including the compliance with certain financial ratios. See Note 16(C). As of the date of the financial statements, Carmel Olefins is not in compliance with these conditions therefore the loans balance was reclassified as short term. Repayment dates of Carmel Olefins’ bank loans, prior to reclassification as short-term.
2010 14,224 2011 14,224 2012 14,224 2013 14,224 More than five years 62,261
Total liabilities to banks less current maturities 119,157 Less deferred expenses (1,778) 117,379
C-44 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 16 – LOANS AND CREDIT FROM BANKS AND OTHER CREDIT PROVIDERS (CONTD.)
B. Additional information about non-current liabilities (contd.) (3) Liabilities for financing lease Distribution by payment dates 2008 2007 Minimum Present value Minimum Present value future of minimum future of minimum rent Interest leasing fees rent Interest leasing fees Up to 1 year 472 444 28 433 408 25 From 1-5 years 2,671 2,487 184 2,454 2,286 168 More than five years 23,199 14,963 8,236 21,786 14,216 7,570 26,342 17,894 8,448 24,673 16,910 7,763
The Company leases land under an operating lease for 49 years (see Note 19). In accordance with the operating lease, the Company pays annual fees, including a fixed annual fee of $2.25 million (“the minimum leasing fees”). Of the minimum leasing fees capitalized for 49 years, a proportionate part of the buildings were attributed to building lease amortized over this period (including the financing and principle component). (4) Non-convertible debentures The Company Maalot - the Israel Securities Rating Company Ltd. rated debentures (Series A-C) issued by the Company in the prospectus of November 28, 2007, as well as the debentures issued for the prospectus, at AA/Stable. On November 11, 2008, Standard & Poor's Maalot announced that it has downgraded the Company’s debentures (Series A, B and C as well as non-marketable debentures) from AA/Stable to A/Negative. Carmel Olefins In the first quarter of 2007, Carmel Olefins issued index-linked debentures in a private offering to institutions, in the amount of NIS 850 million (approximately $202 million). The Company's share is NIS 425 million (approximately $101 million). The debentures mainly replaced a short- term bank loan. The debentures will be repaid in eight equal annual payments commencing from March 31, 2013. The debentures bear annual interest of 4.94%. In the period commencing on July 1, 2008, the debentures bore annual interest of 5.94%. On December 31, 2008, the debentures were listed for trading on the TASE. Commencing from this date, the debentures bear annual interest of 4.69%. In the context of the issuance, a number of financial covenants were defined for Carmel Olefins, including compliance with certain financial ratios. As of the date of the financial statements, Carmel Olefins is in compliance with these conditions. See section 1.2.3.2 below. These debentures were rated Aa2 by Midroog Ltd. In December 2008, Midroog downgraded the rating of Carmel Olefins's debentures from Aa2 negative to A1 stable. The downgrade was due to the failure of Carmel Olefins to meet the leverage goals set at the initial rating date, inter alia, due to fluctuations in raw material prices alongside an increase in the financial debt in 2007-2008 to complete the investment plan and finance the acquisition of a company.
C-45 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 16 – LOANS AND CREDIT FROM BANKS AND OTHER CREDIT PROVIDERS (CONTD.)
B. Additional information about non-current liabilities (contd.) (5) Bank loans The Company In December 2006 and January 2007, the Company obtained credit facilities from banks amounting to $480 million. As of December 31, 2008, the remainder of the repayment term is 4- 7 years. The loan is at variable interest, linked to LIBOR plus a margin. The Company used the credit to repay its short-term liabilities, and to finance the Company’s operating activities. Carmel Olefins Carmel Olefins has an agreement with banks to finance an expansion project in the amount of $318 million (the Company’s share is $159 million). The loans were received during 2005- 2007. Loans from foreign banking institutions are for 7-8.5 years commencing from December 31, 2006. Loans from local banks are described below. On March 30, 2007, Carmel Olefins signed an agreement with the local banks for a restructuring of the loans received from them. According to the agreement, the loan from one bank in an amount of $100 million will be spread out over a 17 year period instead of 8.5 years and will be repaid in equal quarterly installments over the entire period. In accordance with the agreement with two additional banks, the quarterly repayments in respect of the loans in amount of $80 million will be considered as if the loans were for seventeen years. However, the final date for the loans will be on December 30, 2016, at which time the balance of the loans will be paid in one amount. As part of the agreements with the banks providing the loans, Carmel Olefins undertook not to make any additional pledges on its property and assets as long as there were still debts and liabilities deriving from the credit taken from the banks without receiving prior approval from the banks. Moreover, a number of financial covenants were stipulated, including certain financial ratios. As of the date of the financial statements, Carmel Olefins is not in compliance with these covenants therefore the loans balance was classified as short term. See section C below for information on financial covenants. The costs for raising the long-term are amortized over the loan period. C. Contractual restrictions and financial covenants for the bank loans The Company To secure credit received by the Company from credit providers, negative pledges were furnished (undertakings not to create additional charges). Loan agreements with credit providers include conditions which enable the credit providers to demand immediate repayment of the loan balances. The major events which may trigger the demand of the credit providers (themselves and/or through their representatives) for such repayment are presented below: a. If the expanded shareholders' equity of the Company falls below NIS 1,700,000,000 (the expanded shareholders' equity), meaning - the capital reserves and surplus as appearing in the audited annual financial statements of the Company, in reported amounts, plus the provision for allocation of income taxes.
C-46 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 16 – LOANS AND CREDIT FROM BANKS AND OTHER CREDIT PROVIDERS (CONTD.)
C. Contractual restrictions and financial covenants for the bank loans (contd.) The Company (contd.) b. If the ratio between total long-term liabilities and current liabilities of the Company plus guarantees granted to third parties, less the inventory of crude oil and distillates to the expanded shareholders’ equity of the Company exceeds 2 to 1. As of December 31, 2008, the ratio is 1.8. c. If the ratio between the Company’s current assets (less maintenance spare parts and chemicals) to the Company’s current liabilities falls below 1. As of December 31, 2008, the ratio was 1.6. d. If the Company distributes a dividend in a manner that the recording of such a dividend in the periodic financial statements of the period preceding the distribution of the dividend would cause a breach of any of the financial ratios set out in subparagraphs a - c (inclusive). e. If the Company sells and/or transfers and/or leases to another/others any assets in a volume that exceeds the value of 10% of its Fixed assets as of the date of the execution of the transaction, except in the normal course of the Company’s business and not at market terms, without the agreement of the banking institutions in advance and in writing. f. If the Company lends its shareholders amounts that, had it distributed such amounts as a dividend, the banking institutions would be entitled to demand immediate repayment of the loans, as long as the Company has not repaid to the banking institution the amounts due in respect of the loans, in full, all without the consent of the banking institution in advance and in writing. g. The negative pledge signed in favor of the credit providers by the Company shall remain in effect. As of the date of the financial statements, Carmel Olefins is in compliance with these conditions. Carmel Olefins To secure the loans from the banks, Carmel Olefins undertook not to make any additional pledges on its property and assets as long as there were still debts and liabilities deriving from the credit taken from the banking institutions without the prior approval of the banking institutions. Moreover, a number of financial covenants were stipulated for Carmel Olefins, including certain financial ratios (the original financial covenants), as follows. 1. Carmel Olefins' tangible shareholders' equity shall not fall below NIS 636 million. Tangible shareholders’ equity is defined as equity less deferred expenses and other intangible assets. 2. Tangible shareholders’ equity as a percentage of the total balance sheet shall not fall below 33%. 3. The current ratio shall not fall below 1.1.
C-47 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 16 – LOANS AND CREDIT FROM BANKS AND OTHER CREDIT PROVIDERS (CONTD.)
C. Contractual restrictions and financial covenants for the bank loans (contd.) Carmel Olefins (contd.) 4. The ratio of average coverage of charges for eight quarters shall not fall below 1.1 and the debt cover ratio in each of the last four quarters shall not fall below 1. The debt coverage ratio" is defined as the ratio between the operating income of the same period, plus depreciation and amortization, and the amount of principal payments in the same period, plus interest on long-term and short-term loans and current taxes for the same period. 5. The ratio of total liabilities to banking entities and financial institutions versus tangible shareholders’ equity on the last day of each quarter shall not exceed 1.5. 6. No dividend declaration or distribution to shareholders will be allowed if such a distribution is expected to result in having a debt coverage ratio in each of the next two half years of less than 1.1 or will result in a breach of the other financial covenants. New financial covenants with the banks: a. In view of adoption of IFRS in the first quarter of 2008, in March 2008 Carmel Olefins and the banks and debenture holders agreed to amend some of the original financial covenants valid from January 1, 2008 (“the new financial covenants). The new financial covenants are described below. 1. The definition of the debt coverage ratio was revised as follows: The ratio between the operating profit in the period with the addition of depreciation and amortization and the amount of the principle fund payments for that period with the addition of payments of interest on long-term loans (less the difference for the principle and interest swap currency transactions for the period) and short term loans and the current taxes for that period. 2. Tangible shareholders’ equity shall not fall below $138 million. Tangible shareholders’ equity is defined as equity less deferred expenses and other intangible assets. 3. Tangible shareholders’ equity as a percentage of the total balance sheet shall not fall below 29%. 4. The ratio between the total liabilities to banks and financial institutions less moneys due from short- and long-term swap currency transactions and the tangible shareholders’ equity on the last day of each quarter will not exceed 1.8. 5. The average debt coverage ratio in the last eight quarters shall not fall below 1.1 in relation to the four consecutive quarters prior to the assessment date. The debt coverage ratio will not fall below 1, with the exception of a quarter in which there is periodic maintenance of the facilities, the debt coverage ratio in that quarter will not fall below 0.75. 6. Subject to revisions in the new financial covenants, all the other undertakings of Carmel Olefins towards the banks will continue to apply, as aforesaid. As of the date of the financial statements, Carmel Olefins is not in compliance with these conditions. Carmel Olefins is currently negotiating with the banks to reach a settlement by which new financial criteria will be set and/or it will receive deeds of waiver.
C-48 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 16 – LOANS AND CREDIT FROM BANKS AND OTHER CREDIT PROVIDERS (CONTD.)
C. Contractual restrictions and financial covenants for the bank loans (contd.) New financial covenants with the banks (contd.) a. (contd.) Carmel Olefins has not yet received deeds of waiver from all the banks in respect of the financial covenants, therefore from the date of the financial statements and until the date all the deeds of waiver are received, if received, the banks have the right to demand immediate repayment of the loans. As of the date of approval of the financial statements, Carmel Olefins has not received a request from any other banks for immediate repayment of the loan. Gadiv According to the loan agreement between Gadiv and a banking institution, Gadiv undertook to comply with a number of financial covenants, including compliance with certain financial ratios. As of the balance sheet date, Gadiv is in compliance with these covenants. D. Contractual restrictions and financial covenants relating to debentures The Company 1. In 2003-2004, the Company raised long-term financing from institutional entities by way of an issue of nine series of non-marketable debentures. The balance of the Company’s debt to the holders of the non-marketable debentures, as of December 31, 2008. is $140 million. 2. On November 28, 2007, the Company issued an IPO prospectus for debentures in the amount of $472 million. 3. To secure the credit received by the Company for the non-marketable debentures, the Company undertook not to create charges over its assets ("the negative charge"). In addition, the deeds of trust signed in respect of the debentures include stipulations that allow the debenture holders, under certain circumstances, to demand immediate payment of the balance of the loans under the debentures, including a notice calling for immediate payment of one of the debenture series will be grounds for demanding immediate payment of other debenture series and a notice calling for immediate payment of the debentures if the Company violates or fails to comply with any of the terms or material undertakings, binding it under the deed of trust and its appendices . In addition, the Company undertook to meet financial covenants, failure of which will result in the immediate recall of the balance of the credit as follows: If the ratio of the Company’s total liabilities plus guarantees to third parties less crude oil and refined product inventories to the Company’s shareholders’ equity plus reserves for the allocation of income taxes (“the expanded capital”) is greater than 1.2. As of December 31, 2008, the ratio is 1.8 4. The Company’s financial covenants for marketable debentures are described in section 16(C) above.
C-49 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 16 – LOANS AND CREDIT FROM BANKS AND OTHER CREDIT PROVIDERS (CONTD.)
D. Contractual restrictions and financial covenants relating to debentures Carmel Olefins In the first quarter of 2007, Carmel Olefins issued index-linked debentures. See also section B(4) above. As long as the debentures of Carmel Olefins are not listed for trading on the stock exchange, Carmel Olefins is required to comply with the following cumulative conditions: 1. The shareholders' equity of the company (excluding minority interests) shall not fall below NIS 600 million. 2. No dividend distribution may take place, unless at the time of such distribution the company will be in possession of adequate cash to make the next payment to the holders of the debentures due after the date of the dividend distribution. 3. Up to and including the financial statements for the third quarter of 2007, the ratio of the company’s net debt to the cumulative EBITDA for 2007 (annualized) shall not exceed 6 in any quarterly financial statement. Annualized means the cumulative EBITDA as of the date of the calculation, divided by the number of quarters elapsed in 2007, and multiplied by 4. Net debt means the company's long and short-term financial liabilities, less cash and cash equivalents. 4. Commencing from the financial statements for the fourth quarter of 2007, the ratio of net debt of the Company to its EBITDA of the last four quarters shall not exceed 5, in each quarterly financial statements. 5. The rating of the debentures shall not fall below Group A. New financial covenants for debentures In view of adoption of IFRS in the first quarter of 2008, in March 2008 Carmel Olefins and the banks and debenture holders agreed to amend some of the original financial covenants valid from January 1, 2008 (“the new financial covenants”). The new financial covenants are described below. (1) The shareholders’ equity of Carmel Olefins excluding minority interest) will not fall below $170 million. (2) Up to and including the financial statements for the second quarter of 2008, the ratio of the Company’s net debt to its cumulative EBITDA for the last four quarters will not exceed 6 in any quarterly financial statement. The definition of EDITDA was revised: EBITDA based on the Company’s consolidated quarterly financial statement in US dollars (and for the quarterly statements in 2007 - calculated at the representative dollar rate published by the Bank of Israel on the last day of the relevant quarter) with the addition of early retirement expenses of employees only. (3) Commencing from the financial statements for the third quarter of 2008, the ratio of the Company’s net debt to its EBITDA for the last four quarters will not exceed 5 in any quarterly financial statement. Net debt means the company's long and short-term financial liabilities, less cash and cash equivalents and debts of financial institutions for hedge/swap transactions.
C-50 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 16 – LOANS AND CREDIT FROM BANKS AND OTHER CREDIT PROVIDERS (CONTD.)
D. Contractual restrictions and financial covenants relating to debentures Carmel Olefins (contd.) (4) For the four consecutive quarters commencing from the first quarter subsequent to completing the transaction for the acquisition of Domo shares by the Company (see Note 9), the abovementioned conditions will be assessed without the accounting impact of acquisition of these shares. (5) Carmel Olefins will not distribute a dividend in the first and second quarters of 2008. In September 2008, the Company reached an agreement with the debenture holders to amend the financial covenants. The following amendments were approved: (1) Up to and including the financial statements for the second quarter of 2009, the ratio of the Company’s net debt to its cumulative EBITDA for the last four quarters will not exceed 6 in any quarterly financial statement. (2) Commencing from the financial statements for the third quarter of 2009, the ratio of the Company’s net debt to its EBITDA for the last four quarters will not exceed 5 in any quarterly financial statement. (3) Carmel Olefins will not distribute a dividend in the third and fourth quarter of 2008 and the first and second quarters of 2009. In December 2008, the debentures of Carmel Olefins were listed for trading on the TASE. Following the listing, only sections 2 and 5 of the original financial covenants apply. As of the date of the financial statements, Carmel Olefins is in compliance with the financial covenants that remained in effect subsequent to the listing for trade. Cause for immediate repayment of the debentures: If there is a demand for immediate repayment of a debt of Carmel Olefins that exceeds NIS 50 million, the debenture holders have cause to demand immediate repayment of the debentures. As of the date of approval of the financial statements, Carmel Olefins has not received notice from a bank regarding immediate repayment of the loan. E. Additional undertakings towards the banks Carmel Olefins make additional undertakings towards the banks, the main ones being as follows: (1) No distribution of a dividend to the shareholders will be permitted, if the distribution is not in accordance with the agreement from 2004 or where such a distribution is expected to render the forecast debt cover ratios for each of the following two semi-annual periods under 1.1, or if the average debt cover ratios for the last four consecutive quarters, that preceded the date of the declaration and/or the distribution and/or payment of the dividend fall, below 1.1, or if up to the time of the declaration and/or the distribution and/or payment of the dividend, grounds have arisen for the bank to make the amounts that Carmel Olefin owes and/or will owe to the bank repayable immediately, or if the distribution might cause a breach of the other financial covenants.
C-51 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 16 – LOANS AND CREDIT FROM BANKS AND OTHER CREDIT PROVIDERS (CONTD.)
E. Additional undertakings towards the banks (contd.) (2) Carmel Olefins is to make an announcement, no later than seven days from the time that it becomes aware of any action or legal process provided that the amount that is being claimed in the legal proceedings against Carmel Olefins exceeds an amount of $1 million. (3) Carmel Olefins has undertaken to ensure all of its assets and its property at their full value against the usual risks and to pay the insurance fees in full. (4) Carmel Olefins has undertaken to comply with any environmental rules and regulations, which are required under the law and to hold all of the licenses that are required under the law for the operation of its plant. (5) Carmel Olefins has made an undertaking that the management fees for its shareholders will not exceed an amount of $5 million dollars a year, and provided that at the time of the payment to the shareholders no grounds have arisen for the bank to make the amounts that the Company owes and/or will owe to the bank immediately repayable. (6) Carmel Olefins is entitled to pay its shareholders amounts of money, in accordance with the existing agreements between them as of December 2005, and provided that the payments in accordance with these agreements will not be preferable towards the shareholders, in their terms and in their nature to the agreements that could have been entered into under market terms between Carmel Olefins and a person who is not a shareholder in the company. (7) Carmel Olefins is entitled to enter into agreements with shareholders after December 2005, and provided that such agreements will not be preferable towards the shareholders, in their terms and in their nature to the agreements that could have been entered into under market terms between Carmel Olefins and a person who is not a shareholder in the company. (8) Carmel Olefins has made an undertaking to the banking institutions that one of the grounds for immediate repayment is that the 2004 agreement, in whole or in part, will not be amended and/changed and/or cancelled in any manner whatsoever, without the bank's prior written agreement. (9) In any event in which Carmel Olefins has breached or does not comply with any of its commitments towards the banking institutions or if it becomes apparent that any declaration whatsoever is not correct or is not accurate, the banking institution will be entitled to make the amounts that have been given within the framework of the banking services, or any part of them, repayable immediately and to employ any means that it sees fit for their collection.
NOTE 17 – INCOME TAX
A. The tax environment of the Group 1. General The Group companies are taxed in Israel in accordance with the provisions of the Israeli Income Tax Ordinance (New Version) -1961 (“the Ordinance”).
C-52 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 17 – INCOME TAX (CONTD.)
A. The tax environment of the Group (contd.) 2. Amendments to the Ordinance On July 25, 2005, the Knesset passed the Law for the Amendment of the Income Tax Ordinance (No. 147). Amendment 147 provides for a gradual reduction in the company tax rate in the following manner: in 2007 the tax rate will be 29%, in 2008 the tax rate will be 27%, in 2009 the tax rate will be 26% and from 2010 onward the tax rate will be 25%. Current and deferred tax balances for the periods reported in these financial statements are calculated in accordance with the tax rates specified in Amendment 147 as aforementioned. 3. Taxation under inflation The Income Tax Law (Adjustments for Inflation) – 1985 “the Law”) introduced the concept of measurement of results for tax purposes on a real basis. The various adjustments required by the aforesaid Law are designed to achieve taxation of income on a real basis. However, the adjusted income in accordance with tax laws is not always the same as the income reported in accordance with IASB standards. As a differences are created between the income reported in the financial statements and their tax basis. For deferred taxes for these differences, see Note 3(O). On February 26, 2008, the Knesset enacted the Income Tax Law (Adjustments for Inflation) (Amendment No. 20) (Restriction of Effective Period), 5768-2008 (“the Amendment”). In accordance with the Amendment, the effective period of the Adjustments Law will cease at the end of the 2007 tax year and as from the 2008 tax year the provisions of the law shall no longer apply, other than the transitional provisions intended at preventing distortions in the tax calculations. In accordance with the Amendment, as from the 2008 tax year, income for tax purposes will no longer be adjusted to a real measurement basis. Furthermore, the depreciation of inflation immune assets and carried forward tax losses will no longer be linked to the CPI, so that these amounts will be adjusted until the end of the 2007 tax year after which they will cease to be linked to the CPI. The effect of the Amendment to the Adjustments Law is reflected in the calculation of current and deferred taxes as from 2008. 4. Benefits under the Law for Encouragement of Industry (Taxes) - 1969 (1) The Group companies are industrial companies as defined in the Law for Encouragement of Industry (Taxes) -1969 and accordingly they are entitled to benefits, the main ones being as follows: a. Higher amortization rates. b. Reduced issuance expenses when listing the company’s shares for trading on the TASE. c. An 8-year period of amortization for patents and know-how serving in the development of the enterprise. d. The possibility of submitting consolidated tax returns by companies in the same line of business.
C-53 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 17 – INCOME TAX (CONTD.)
A. The tax environment of the Group (contd.) 4. Benefits under the Law for Encouragement of Industry (Taxes) – 1969 (contd.) (2) Since 2000, the Company and Gadiv have been filing a consolidated tax return to the tax authority pursuant to the Law for the Encouragement of Industry (Taxation), 5729-1969. 5. Benefits under the Law for the Encouragement of Capital Investments - 1959 (1) The Company notified the tax authorities of its election of 2005 as an base year, pursuant to article 51D of the Law for the Encouragement of Capital Investments - 1959 (the Law). In addition, the Company petitioned the director of the tax administration for a pre-ruling pursuant to article 51I(a) of the Law, regarding entitlement for tax benefits under the alternative track in respect of a beneficiary enterprise. In the event that the Company receives an affirmative reply to its request for a pre-ruling, and it is found that the Company is in compliance with the conditions set out in the law and the regulations regulated thereunder, the Company will be entitled to tax benefits pursuant to the provisions of the law in respect of income defined as beneficiary income. This income will be tax-exempt for a two year period, from the first year in which the Company has taxable income, and will be taxed at a reduced rate of 25% for an additional five year period, on condition that 12 years have not passed since the first day of the base year (2005). Following the draft approval received from the Tax Authorities in December 2008, the Company recorded a tax benefit for prior years in the amount of $42 million. The receipt of these benefits is contingent on the terms defined in the Law for the Encouragement of Capital Investments, the provisions promulgated thereunder and the decision of the Tax Authority regarding the Company's request for a pre-ruling as aforesaid. (2) Certain expansions carried out at the Gadiv plant were recognized as an approved enterprise pursuant to the provisions of the law. Gadiv elected the alternative benefits track, whereby income generated from the "approved enterprise" will be tax-exempt for the first four years from the first year in which the company has taxable income, and will be taxed at a reduced rate of 25% for another three years. Gadiv started utilizing the benefit for an approved enterprise in 2006. The aforementioned benefits are contingent upon fulfillment of the conditions set out in the law, in the directives thereunder, and in the letters of approval under which the investments in the approved enterprise were carried out. Failure to comply with the conditions may result in a cancellation of the benefits, in full or in part, and in the refunding of the amounts received in respect of the benefits, plus interest. Gadiv estimates that it is in compliance with the required conditions. Pursuant to section 51(D) of the Law for the Encouragement of Capital Investment – 1959, Gadiv notified the tax authorities of its election of 2005 as the base year of one beneficiary enterprise (the first expansion) and 2007 as the second base year of another beneficiary enterprise. (“the second expansion”). Gadiv received a pre-ruling from the tax authorities pursuant to section 51(H)(a) of the law, and is eligible for tax benefits on the alternative track for the first expansion. Income from the first expansion of the beneficiary enterprise are exempt from tax for two years and are subject to reduced companies tax for up to five years from the year the company’s first taxable year.
C-54 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 17 – INCOME TAX (CONTD.)
A. The tax environment of the Group (contd.) 5. Benefits under the Law for the Encouragement of Capital Investments – 1959 (contd.) (2) (contd.) Income from the second expansion of the beneficiary enterprise is exempt from tax for six years from the company’s first taxable year. The period of the tax benefits for the first expansion commenced in 2006-2007, while the period of the tax benefits for the second expansion has not yet commenced. The benefits are contingent on fulfilment of the conditions set out in the law (such as rate of export). To date, Gadiv is in compliance with these conditions. The dividend distributed from the income of a beneficiary enterprise is taxable at a rate of 15%. In the event of distribution of a dividend out of income that is exempt from companies tax, Gadiv will be taxed at a rate of 25%. (3) Carmel Olefins received approved enterprise status under the alternative track for two expansion plans, the benefit period of which has not yet ended. The income of Carmel Olefins arising from the first plan will be tax-exempt for four years and will be taxed at a rate of 25% for an additional two years. The benefit periods for this plan will end in 2008. The income of Carmel Olefins arising from the second plan will be tax-exempt for two years and taxed at a rate of 25% for another five years, commencing in the first year in which it earns taxable income. The benefit periods for this plan will end in 2010. The aforementioned benefits are contingent upon fulfillment of the conditions set out in the law, in the regulations regulated thereunder, and in the letters of approval under which the investments in the approved enterprise were carried out. Failure to comply with the conditions may result in a cancellation of the benefits, in whole or in part, and in the refunding of the amounts received in respect of the benefits, plus interest. Carmel Olefins is of the opinion that it is in compliance with the required conditions. Further to the amendment of the Law for the Encouragement of Capital Investments, benefits arising from the investment in the expansion of the polypropylene plant will be handled through the tax administration and not through the Investment Center. Carmel Olefins applied to the tax authorities for a pre-ruling on the election of 2004 as the base year for the expansion of the beneficiary enterprise, following the regulations for shortening the cooling-off period passed by parliament in November 2008. In addition, Carmel Olefins is planning another expansion of its beneficiary plant in the 2007 base year, on the basis of its investments in the period 2005 – 2007. Carmel Olefins applied for a pre-ruling on the election of 2007 as the base year. 6. The tax effects of the distribution of a dividend If a dividend is distributed from tax-exempt income of the plans set out above (or from tax- exempt income from approved plans, the benefit period of which has already ended) the Group companies will be taxed at a rate of 25%. The policy of the Group companies is not to distribute a dividend from this income. The dividend distributed from the income of a beneficiary enterprise is taxable at a rate of 15%.
C-55 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 17 – INCOME TAX (CONTD.)
A. The tax environment of the Group (contd.) 7. Accelerated depreciation On July 7, 2008, new directives were published for accelerated depreciation. Under the directors, a taxpayer will be eligible for accelerated depreciation (of 50%) for equipment used directly for qualifying operations in the building, agriculture and tourist industries, acquired during the period commencing June 1, 2008 until May 31, 2009, whichever is later. Carmel Olefins adopted this directive for investments in Fixed assets acquired during this period and claimed for depreciation for tax purposes accordingly. 8. Temporary differences for which deferred tax liabilities were not recognized The Company did not recognize deferred tax liabilities in respect of temporary differences in connection with investments in investees due to the fact that the Company controls the timing of the reversal of the temporary difference, so that it can be expected that the temporary difference will not be reversed in the foreseeable future. B. Income tax benefit expenses (revenue)
December 31 2008 2007 Current tax expenses (income) For the current period 1,574 42,781 Adjustments for prior years, net (46,650) 678 (45,076) 43,459
Deferred tax expenses (income) Generation and reversal of temporary differences (62,216) 1,478 Tax expenses (income) for income from ongoing operations (107,292) 44,937
C. Taxes on income (tax benefits) recognized directly in capital
December 31 2008 2007 Deferred taxes 3,188 1,743
C-56 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 17 – INCOME TAX (CONTD.)
D. Reconciliation between the theoretical tax on adjusted income before tax and the amount of tax included in the books
December 31 2008 2007
Profit (loss) before taxes on income and before the Company’s part of the subsidiaries’ net profits (losses), based on the statement of income (213,389) 179,693
The Company’s principal tax rate 27% 29%
Tax based on the Company’s principal tax rate (57,615) 52,111
Addition (saving) in tax liability for:
Income taxed at a special tax rate (benefits for an approved enterprise) (2,160) (6,355) Unrecognized expenses 1,038 5,357 Losses (benefits) for tax purposes for which deferred taxes were not generated 1,729 (227) Taxes for prior years (46,552) 678 Difference between accounting of income for tax purposes and accounting of net income in the financial statements (3,732) (6,627) (107,292) 44,937
E. Deferred tax assets and liabilities (1) Recognized deferred tax assets and liabilities Deferred taxes in respect of companies in Israel are calculated according to the tax rate anticipated to be in effect on the date of reversal as stated above. Deferred taxes in respect of foreign subsidiaries are calculated according to the relevant tax rates of each country. Deferred tax assets and liabilities are attributed to the following items: Losses to Fixed Employee transfer for assets benefits tax purposes Others Total
Deferred tax asset (liability) on January 1, 2007 (146,938) 26,954 226 (4,050) (123,808) Changes recognized in profit or loss (25,502) (1,493) 20,211 5,305 (1,479) Deferred tax asset (liability) On December 31, 2007 (172,440) 25,461 20,437 1,255 (125,287)
Consolidation (7,624) - 1,066 - (6,558) Net differences from translation of foreign operations 614 - - - 614 Changes recognized directly in capital - 3,188 - - 3,188 Changes recognized in profit or loss (22,921) (3,723) 94,912 (6,052) 62,216 Deferred tax asset (liability) on December 31, 2008 (202,371) 24,926 116,415 (4,797) (65,827)
C-57 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 17 – INCOME TAX (CONTD.)
E. Deferred tax assets and liabilities (contd.) (2) Unrecognized deferred tax assets Unrecognized deferred tax assets for the following items:
December 31 USD millions 2008 2007 Losses for tax purposes 10 -
As of the balance sheet date, the Group has tax losses and inflationary deduction carry-forwards in the amount of $464,000 (in 2007: $742,000). The carry-forward losses and deductions are linked to the CPI until the end of 2007 in accordance with the law mentioned in section A(3) above, except for those of the subsidiary, Carmel Olefins, which keeps its books in foreign currency and these items are linked to the exchange rate. The Group creates deferred taxes for all carry-forward losses for tax purposes in Israel. For carry-forward losses for tax purposes of the subsidiary of Carmel Olefins in Holland, deferred taxes were created for the expected cost of disposal (the Company’s share is $ 9 million). The balance of the losses for which deferred taxes were not recognized is $10 million. F. Tax assessments The Company has tax assessments that are considered as final up to and including 2003. Gadiv has final tax assessments up to and including 2003. Gadiv received a tax assessment for 2004- 2006 and filed a reservation for this assessment. Carmel Olefin has final tax assessments up to and including 2004. Carmel Olefin's subsidiary in Israel has final tax assessments up to and including 2005. The subsidiary of Carmel Olefin's subsidiary in Holland has final tax assessments up to and including 2003.
C-58 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 18 – EMPLOYEE BENEFITS
Employee benefits include post-employment benefits, other long-term benefits, termination benefits, short-term benefits and share-based payments. As regards post-employment benefits, the Group has defined benefit plans for which it makes contributions to central severance pay funds and appropriate insurance policies. The defined benefit plans provide the entitled employees a lump-sum amount based on a compensation agreement. The Company also has a defined contribution plan for some of its employees who are subject to Section 14 of the Severance Pay Law – 1963.
December 31 2008 2007
Present value of unfunded liabilities 29,594 25,588 Present value of funded liabilities 61,449 65,372 Total present value of liabilities 91,093 90,960 Fair value of plan assets (47,567) (62,000) Recognized liability for defined benefit liabilities 43,526 28,960
Liability for early retirement 23,181 33,174
Liability for other long-term benefits 1,670 1,586 68,377 63,720 Presented under the following items: Assets Non-current assets (5,007) (7,519) Liabilities Other payables 4,539 3,881 Long-term employees benefits 68,845 67,358 73,384 71,239
68,377 63,720
Fair value of right for indemnification asset for severance plan (loan to Haifa Early Pension Ltd.). See section B(2) below) 84,740 80,038
Plan assets are as follows:
2008 2007 Cash 2,641 3,517 Deposits and loans 1,376 2,028 Equity instruments 6,888 13,582 Debt instrument 23,102 28,903 Contributions to insurance companies 13,560 13,970 47,567 62,000
C-59 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 18 – EMPLOYEE BENEFITS (CONTD.)
A. Post-employment benefit plans – defined benefit plan (1) The liability of the Group companies in respect of pension payments is covered by regular contributions to pension funds. According to employment agreements, contributions to pension funds, plus payment of the supplemental severance pay will, in respect of most employees, replace the severance pay pursuant to section 14 of the Severance Pay Law - 1963. Under the agreements, the liabilities of the Company and Gadiv for severance is in the amount of the difference between the last salary of the employee multiplied by the number of months at the Company, and the last salary of the employee multiplied by the number of consecutive years of employment at the Company up to twenty years of service, plus one and a half months' salary for each year of service between 20 - 30 years at the Company, plus two months for every year of service in excess of 30 years at the Company. Some of the employees who are employed through personal contracts are entitled to double severance pay. Others are entitled to double severance pay for their years of employment up until 2008 and for severance pay of 150% from that time onwards. These liabilities are covered by regular payments to pension funds, provident funds, and insurance companies. The liabilities and a partial compensation for unused sick pay are covered by regular payments to provident funds, insurance companies and by the aforementioned liabilities. The amounts funded in provident funds include accrued profit that the Group companies are entitled to receive, subject to the provisions of the law. (2) In accordance with the salary agreements with employees, the Group companies undertook to compensate employees who reach retirement age, in respect of unused sick pay in the amount of the accumulated sick pay or a maximum of 50 days. The undertaking was based on an actuarial assessment. (3) Post-retirement employee benefits In addition to pension payments from the pension fund, retirees of the Group companies receive benefits, mainly gifts during holiday seasons and Company products. The liability of the companies for these costs is accrued during the employment period. The Group companies include in their financial statements the expected costs for the period following the employment period on the basis of actuarial calculations. (4) Change in the present value of the defined benefit obligations
December 31 2008 2007 Defined benefit obligation as at January 1 90,960 87,019 Benefits paid by the plan (8,421) (6,106) Current service costs and interest costs 9,667 8,233 Changes in respect of business combinations 602 - Changes in respect of foreign exchange differences 903 8,871 Actuarial gains recognized in equity (2,618) (7,057) Defined benefit obligation as at January 31 91,093 90,960
C-60 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 18 – EMPLOYEE BENEFITS (CONTD.)
A. Post-employment benefit plans – defined benefit plan (5) Change in plan assets
December 31 2008 2007 Fair value of plan assets as at January 1 62,000 55,973 Contributions paid into the plan 754 598 Benefits paid by the plan (3,698) (3,219 ) Changes in respect of foreign exchange differences 752 5,519 Expected return on plan assets 3,433 3,156 Actuarial losses recognized in equity (15,674) (27) Fair value of plan assets as at December 31 47,567 62,000
(6) Expense recognized in profit or loss
December 31 2008 2007 Current service costs 3,914 3,216 Interest costs 6,657 13,889 Expected return on plan assets (4,185) (8,675) 6,386 8,430
(7) The expense is recognized in the following line items in the income statement:
Year ended December 31 2008 2007 Cost of sales 3,206 2,664 Selling and marketing expenses 140 109 General and administrative expenses 568 443 Financing expenses 2,472 5,214 6,386 8,430
(8) Actual proceeds
Year ended December 31 2008 2007
Actual returns from plan assets (12,241) 3,129
(9) Actuarial gains and losses recognized directly in equity
Year ended December 31 2008 2007 Cumulative balance on January 1 (8,438) (15,468) Amounts recognized in the period (13,056) 7,030 Cumulative balance on December 31 (21,494) (8,438)
C-61 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 18 – EMPLOYEE BENEFITS (CONTD.)
A. Post-employment benefit plans – defined benefit plan (10) Actuarial assumptions Principal actuarial assumptions at the reporting date (expressed as weighted averages):
2008 2007 % % Discount rate as of December 31 5.5 6.2 Expected return on plan assets as on January 1 5.5 6.2 Future salary increases in the Company and Gadiv 4.2 5.7 Future salary increases in Carmel Olefins 3.9 3.6 Increase in pension 2.1 2.0 Unused sick pay in the Company, Gadiv and Carmel Olefins 2.0 2.0 Early retirement in the Company and Gadiv 3.8 3.7 Early retirement in Carmel Olefins 3.5 3.5 Retirement benefits in the Company and Gadiv 3.8 3.7 Retirement benefits in Carmel Olefins 3.5 3.5 Liabilities for tuition fees for employees’ children 3.5 3.5
Assumptions regarding future mortality are based on published statistics and mortality tables. B. Severance benefits – liability for early retirement 1. The Group companies undertook to pay a pension to employees whose employment was terminated before they reached retirement age, until they are eligible to receive pension payments from the pension fund. The allowance in respect of this commitment was based on the actuarial value of the anticipated early pension payments over the coming years, discounted at an annual rate of 4.16%. In accordance with a special collective agreement of June 14, 2006 over a period of three years following the effective date, 45 long-term employees will be entitled to retire from the Company under early retirement, in accordance with the terms of the retirement agreement, as detailed below, with fifteen employees being entitled to early retirement each year. The Company management and workers committee will select the identity of the employees who will be retiring from the list of employees who expressed their willingness to leave under early retirement. In the event of a dispute between the workers committee and Company management in respect of the composition of the list of employees retiring, the chairman of the Energy Workers Association in the Histadrut and the CEO of the Company will decide. If they cannot reach an agreement, the decision will rest solely with the chairman of the Professional Unions Division of the Histadrut and his decision shall be final. In 2006, the board of directors of the Company allocated NIS 81 million for implementation of the early retirement plan. In 2006- 2008, 36 employees retired under the early retirement plan. In addition, the Company signed early retirement agreements with another 13 employees who will retire in 2009. The Company is examining the retirement of other employees. The Company estimates that, as of the reporting date, the cost of retirement of the employees who have yet to retire amounts to NIS 26 million and the provision in the books is made accordingly (the balance of NIS 81 million allocated to implement the early retirement plan).
C-62 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 18 – EMPLOYEE BENEFITS (CONTD.)
2. Other benefits - loan to Haifa Early Pensions Ltd. Under the collective agreement for the early retirement and enhanced severance pay of Company employees, signed between the Company and representatives of the employees on June 14, 2006 (the Early Retirement Agreement), a loan agreement was signed between the Company and Haifa Early Pensions Ltd. (HEP) whereby the Company granted a loan in an amount of $80 million (approximately NIS 300 million), linked to the CPI, for purposes of purchasing pension rights for the employees, at any date or time, if HEP sees that the Company was in breach of the early retirement agreement. HEP will invest the loan in bank deposits or in debentures listed for trade on the stock exchange or in marketable government bonds. HEP will make payments in respect of interest and principal in accordance with the terms set forth in the loan agreement, with the first principal payment scheduled for the earlier of January 2010 or the date on which 75 employees retire under the early retirement agreement. See also Note 20(C)(4). The loan to Haifa Early Pensions Ltd. constitutes a right for indemnification that the Group will receive for payment of liabilities for early pension and is measured at fair value.
December 31 2008 2007 Loan to Haifa Early Pensions Ltd. 86,047 80,038 Interest to receive (*) (1,307) - 84,740 80,038 (*) Stated under other receivables
NOTE 19 – OPERATING LEASE
A. Leasing of tankers The Group charters a number of tankers under an operating lease. The lease agreements are usually for a period of five years, with an option to renew the contract at the end of the period. The lease fees are paid at the beginning of each month in accordance with the lease agreement. For some tankers, lease fees are fixed, and for others, lease fees are reduced over the period. The Group sub-leases the leased tankers. Lease and sub-lease payments are recognized in profit or loss:
Year ended December 31 2008 2007
Minimum lease payments recognized as an expense 42,871 32,674
Income for sub-lease 53,123 39,437
C-63 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 19 – OPERATING LEASE (CONTD.)
B. Lease fees On January 24, 2007 a new assets agreement was signed (“the new assets agreement"), which determined that real estate assets that were owned by the Company or had perpetual leasehold rights before expiry of the concession (which ended on October 28, 2003), with the exception of ORA assets, will be owned by the State and leased to the Company for 49 years, with an option to extend the lease period under the same terms for an additional 49 years. For further information, see Note 11(B)1. Operating lease expenses for the land component recognized in profit or loss during the year:
2008 2007 4,001 10,714
C. Real estate Gadiv’s facilities were built on land owned by the Company and leased under a 999 year capital lease. For further information, see Note 11(B)2 and Note 12.
NOTE 20 – CHANGES IN CONTINGENT LIABILITIES AND AGREEMENTS
A. Guarantees and liens (1) The Company placed a guarantee of $2,387 thousand with the customs collector in favor of payment of import taxes (a contingent exemption). See Note 20(18). (2) The Company placed a bank guarantee of $13,000 with the Haifa Region regional council for planning and construction to secure payment of a disputed betterment levy. (3) To guarantee lease payments to the Ports Authority, Carmel Olefins and Gadiv placed bank guarantees, renewable annually, of $440,000 (the share of the Company in this amount is $220,000) and Gadiv placed a bank guarantee of $0.8 million for five years, ending on February 28, 2009, extended on this date for an additional year. (4) In December 2008, the Company placed a bank guarantee of NIS 0.5 million with Natural Gas Lines Ltd. in respect of the natural gas pipeline (PRMS). (5) To secure compliance with the terms relating to the receipt of investment grants, investees registered floating charges on all of the assets in the approved plants, in favor of the State of Israel. In the event the investees cannot prove compliance with the terms of the grant, the Government Investment Center is entitled to demand repayment of the grants received, in addition to interest and linkage differentials from the date of receipt of the grants. In addition, the investees will also have to repay all tax benefits received. The investees are of the opinion that they are in compliance with the conditions of the approval letters. (6) To secure the rental of offices in the Azrieli Towers in Tel Aviv, the Company placed a bank guarantee of $78,000. (7) The Company gave Mercury a limited bank guarantee of $650 million for the full repayment of the liabilities to Bank Hapoalim. (8) A number of financial covenants were stipulated as part of the granting of the loans by the banking institutions and the issuance of the debentures. See Notes 16(C) and 16(D).
C-64 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 20 – CHANGES IN CONTINGENT LIABILITIES AND AGREEMENTS (CONTD.)
B. Contingent liabilities (1) Claim of the Movement for Quality Government in Israel (“the Movement”) against the agreement In January 2006, the Movement filed suit in the Tel Aviv - Jaffa Circuit Court against the State of Israel, the Company and the Israel Corporation for declaratory relief, whereby on October 18, 2003, the Company was required to transfer ownership to the State of Israel, without consideration, all of the assets the Company owned at that time. In the reporting period the suit was dismissed with the consent of all the parties and the plaintiff undertook not to renew the claim. (2) Claims pertaining to the Kishon River a. In 2001 - 2005, monetary suits were filed with the Haifa District Court against the Company, Gadiv, Carmel Olefins and other defendants (including the State of Israel), by 50 people suffering from illnesses (or their heirs or dependents), mostly fisherman who allegedly worked in the past in the Kishon fishing port. According to the plaintiffs, the discharge of effluents into the Kishon by each of the chemical plants operating on the banks of the Kishon River caused the cancer (and other illnesses) from which they suffer. Dozens of other factories were added to the suits as third parties, including Gadiv, Carmel Olefins and the authorities. During the course of the investigation of the suits, nine of the plaintiffs withdrew their suits and were removed. Since the suits involve claims of bodily damage, the plaintiffs are not required to quantify the total amount being claimed. As of the date of the preparation of the report, the quantified damages in the suit amount to NIS 137 million, together with an amount of NIS 3 million in respect of pending litigation which overlaps the main damages, for a total of NIS 140 million, in terms of their value on the date the suit was filed, plus linkage differentials and interest from the date of the illness or the date of the filing of the suit, as well as punitive damages and additional expenses such as treatments and third party assistance (a small part of which have not been quantified), attorney fees and expenses. Note that these refer to the arithmetic sum of the quantified amounts in the statements of claim and not a risk assessment of the defendants, and certainly not the risk to which the Company, Gadiv and Carmel Olefins are exposed. As of the balance sheet date, these suits are in the evidentiary stage. In the first stage, the court deliberated on the causal relationship in the narrow sense of the term, in other words, the relationship of the materials allegedly in the fishing port and the alleged illnesses. This is a very complicated factual framework which has continued for decades, with more than a hundred litigants (plaintiffs, defendants and third parties) and legal issues that are unprecedented, both from the standpoint of the body of the claim and as well as the breakdown of the liability between the defendants and the third parties.
C-65 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 20 – CHANGES IN CONTINGENT LIABILITIES AND AGREEMENTS (CONTD.)
B. Contingent liabilities (contd.) (2) Claims pertaining to the Kishon River (contd.) a. (contd.) The defendants, including the Company, Gadiv and Carmel Olefins, denied their responsibility for the damages of the plaintiffs and claimed, among other things, that the statute of limitations pertaining to the plaintiff's claim has already passed, that the materials stipulated in the claim were not discharged and/or the materials that were discharged were not carcinogenic and are not harmful to human health, and that in the event that the plaintiffs indeed contracted illnesses and that in the event that the water and riverbed of the Kishon River caused or contributed to their illnesses and in the event that the plaintiffs' illnesses derive from human acts of commission or omission (when all of the above has been denied), then the illnesses were caused by the negligence of the plaintiffs and/or by a breach of the requirements of the law on the part of the plaintiffs themselves. In addition, the defendants filed a joint notification to third parties against fifty different entities, including additional plants, employers, local counsels, and government bodies, most of which have filed defense motions and have denied responsibility for the damages sustained by the plaintiffs. The Company and Gadiv also served third party notifications against insurance companies which over the years have issued various insurance policies, claiming that should the court find them responsible for the damages of the plaintiffs and should they have to pay compensation in respect of such responsibility, then the insurance companies will have to indemnify and/or compensate them. For their part, the insurance companies claim, among other things, that the policies expressly exclude bodily damages caused to third parties as a result of pollution; that such pollution is continuous and did not occur all of a sudden and, therefore, is not covered by the policies; and that the acts of commission and omission of the Company and Gadiv are not covered by the policies. In addition, the Company issued a third party notification against Gadot Biochemical Industries Ltd. (“Gadot”), pursuant to an agreement whereby the Company purchased from Gadot its petrochemical division, Gadiv. Pursuant to the aforementioned notification, in the event that the court enters judgment against the Company and/or Gadiv in respect of acts of commission or omission that occurred in whole or in part in the petrochemical division of Gadot and/or in respect of any damages that were caused in whole or in part and/or that were uncovered in whole or in part in the period prior to January 31, 1994, then Gadot, by virtue of its commitments under the aforementioned agreement, will have to indemnify the Company and Gadiv in respect of any amounts they are required to pay to the plaintiffs. Notwithstanding the above, based on the assessment of its legal counsel, in view of the complexity of the suits, from both a factual and legal standpoint, the preliminary stage in which matters stand, and the many parties involved, the Company is unable to assess the risks involved and did not provide for these suits in its financial statements.
C-66 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 20 – CHANGES IN CONTINGENT LIABILITIES AND AGREEMENTS (CONTD.)
B. Contingent liabilities (contd.) (2) Claims pertaining to the Kishon River (contd.) b. In 2000 - 2007, suits were filed in the Haifa District Court against a series of defendants including the Company, Gadiv and Carmel Olefins by former soldiers (and their heirs and dependents). The plaintiffs claim that they suffered from cancer and/or other illnesses after being in contact with toxic materials in and around the Kishon River. As of the date of the report, 19 of the plaintiffs withdrew their claims. As of the date of the report, 93 plaintiffs remained with the court in respect of 91 soldiers, for an amount NS 276 million (nominal, as of the date of the filing of the claim) - the amount of the damages that was quantified (special/general damage), NIS 81 million pending claims (which partially overlap the special damage) and NIS 138 million in punitive damages (all amounts are as of the date the suit was filed). Since the suits involve claims of bodily damage, the plaintiffs are not required to accurately quantify the total amount being claimed. Additional principal damages, which were not quantified monetarily in the statements of claim, also include loss of future earnings, medical expenses, in some of the cases, loss of earnings in the lost years, etc., as well as interest and linkage differentials, attorney fees and expenses. Note that these refer to the arithmetic sum of the quantified amounts in the statements of claim and not a risk assessment of the defendants, and certainly not the risk to which the Company, Gadiv and Carmel Olefins are exposed. The defendants filed third party notifications against dozens of factories and authorities, including the State of Israel. As of the reporting date, 76 claims are under litigation, including the claims described in section (A) above. For an additional 17 claims, the court ruled that in the initial stage, the question of the amount of damage will be investigated, and only then, the other disputes will be investigated. These cases are in initial stages of hearing evidence or preliminary proceedings. Therefore, the factual details related to the plaintiffs and to the circumstances of the alleged exposure are for the most part unknown to the defendants and the third parties, including the Company, Gadiv and Carmel Olefins. This is a very complicated factual framework which has continued for decades, with hundreds of litigants (plaintiffs, defendants and third parties) and a legal issue that is unprecedented, both from the standpoint of the body of the claim and as well as the breakdown of the liability between the defendants and the third parties. The defendants, including the Company, Gadiv and Carmel Olefins deny their liability to compensate the plaintiffs and claimed, among other things, that the statute of limitations pertaining to the claim of the soldiers has expired; the soldiers received payments and/or other benefits under the Law for the Handicapped (Annuities and Rehabilitation) - 1959 (integrated version) and/or under the Law for the Families of Soldiers who Fell in Battle (Annuities and Rehabilitation) - 1950 and, therefore, are not entitled to claim damages; the defendants did not commit any act of negligence and/or breach of their legal duties toward the soldiers; it was the fault of the soldiers and/or other people or entities that caused the alleged damages, if at all, and it was especially the fault of the State of Israel, including the defence establishment, and their negligence that caused the illnesses of the soldiers.
C-67 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 20 – CHANGES IN CONTINGENT LIABILITIES AND AGREEMENTS (CONTD.)
B. Contingent liabilities (contd.) (2) Claims pertaining to the Kishon River (contd.) b. (contd.) The Company and Gadiv (which was added to the proceedings as a third party) also served third and fourth party notifications to insurance companies which, over the years, issued insurance policies in their favor and which they claim will have to indemnify and/or compensate them in the event that the court finds them liable for the damages of the plaintiffs and they have to pay compensation in respect of such liability. The insurance companies filed defense motions and reiterated the claims they made in section (a) above. Additionally, the Company filed a third party notification against Gadot in respect of the claims mentioned in section (a) above. Notwithstanding the above, based on the assessment of its legal counsel, in view of the complexity of the suits, from both a factual and legal standpoint, the preliminary stage in which matters stand, and the many parties involved, the Company is unable to assess the risks involved and did not provide for these suits in its financial statements. c. The Haifa Rowing Club filed a class action in the Haifa Magistrate's Court under the Prevention of Environmental Hazards Law (Civil Claims), 5752-1992 against a number of factories along the banks of the Kishon River. The claim is petitioning for an injunction to stop the flow of effluents into the Kishon, and an order to restore the river to it to its former state. Dozens of factories were included in the claim as third parties, including the Company, Gadiv and Carmel Olefins, as well as authorities, including the State of Israel. On March 29, 2007, the Court summarily dismissed the claim and permitted the authorities to exercise their discretion concerning granting permits for discharge of effluents into the Kishon, noting the practical steps taken by the authorities and the defendants to improve the condition of the Kishon and the considerable improvement in recent years in the quality and condition of the river’s water. The club appealed the ruling of the Haifa District court. In the reporting period, a ruling was handed down to strike the appeal, with the consent of all the parties, without the Company and Gadiv being required to bear and financial or constructive obligation. d. A claim was filed by Israel Shipyards Ltd. against the Company and 11 other parties, including Gadiv, Carmel Olefins and an affiliate, alleging that the defendants polluted the Kishon River, causing damage to the plaintiff’s facilities at the river mouth. The suit was in an amount of NIS 21 million as of the date of filing in January 2004. On the date of the financial statements, the lawsuit is in the stage of pretrial and hearing of evidence in a case that is expected to commence in 2009. On March 18, 2008, the plaintiff and Carmel Olefins signed a settlement arrangement according to which the lawsuit against Carmel Olefins will be dismissed and all procedures relating exclusively to Carmel Olefins will be deleted from the expert opinion on behalf of the plaintiff. In the settlement arrangement, Carmel Olefins undertook that if a settlement is achieved with the consent of most of the defendants and third parties, which will end all proceedings in the lawsuit, it will participate in 2.8% of the amount paid to the plaintiff under the settlement arrangement.
C-68 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 20 – CHANGES IN CONTINGENT LIABILITIES AND AGREEMENTS (CONTD.)
B. Contingent liabilities (contd.) (2) Claims pertaining to the Kishon River (contd.) d. (contd.) On March 26, 2008 this settlement arrangement was given the validity of judgment. Carmel Olefins is negotiating with the defendants so that it will not be served a third-party notice therefore its final status in the case has yet to be clarified. In the current situation, the legal counsels of Carmel Olefins estimate that Carmel Olefins will not be charged a material amount for this suit, if at all. e. On July 18, 2006 the Minister of Environmental Protection sent a letter to the Minister of Finance pertaining to the privatization of the Company. In his letter, the Minister of Environmental Protection described the initial findings of a survey that checked the extent of the pollution on the Kishon River riverbed. The initial findings indicate that there is a polluted layer a few meters thick and a few kilometers long, along the river. The Minister added that after receipt of the findings of the survey he intends on demanding from the plants whose involvement in the pollution has been proven by the results of the survey, to bear the costs of removal, treatment and transportation to an appropriate site. Based on the preliminary estimates of the Minister of Environmental Protection, such costs may reach hundreds of millions of shekels. In his letter, the Minister makes the claim that part of the pollution that accumulated over a period of many years derives from the petrochemical industry on the banks of the river, including the Oil Refineries. In the letter, the Minister of Finance was asked to inform the Company’s potential buyers by fair disclosure. On January 7, 2007, the Ministry for Environmental Protection announced that it recently received the interim findings of the survey taken by the Kishon River Authority, indicating that the riverbed is polluted with heavy metals and mainly organic materials from fuel products (oil carbons). The letter stated that, on the basis of the survey, it is necessary to remove 450 thousand tons of polluted earth at an initial estimated cost of $50 million. According to the letter, the Kishon River Authority will now try to ascertain whether there is a connection between the industrial processes that were carried out by the plants on the banks of the river and the components of the sludge that polluted it. In the reporting period, the Company and Gadiv were presented with the survey findings for their comments. The survey attributed 0.34% of the content of the heavy metals allegedly found in the sediments tested in the survey and 87.5% of the organic substances from fuel products to the Company and Gadiv. The Company requested the full information provided to the parties preparing the survey and received part of the requested material. Based on the material it received, the Company estimates that the findings survey do not stand up to the audit test and is discussing this with the Ministry of Environmental Protection. At this stage, management cannot assess the final findings of the survey; to what extent these findings will prove the degree of liability of the Company, if any, for the pollution, should any be found; whether and by virtue of what legal authority the Company will be made to take the steps set out in the letter of the Minister, or other actions as a result of the above; and what costs the Company will have to bear as a result thereof.
C-69 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 20 – CHANGES IN CONTINGENT LIABILITIES AND AGREEMENTS (CONTD.)
B. Contingent liabilities (contd.) (3) On May 12, 2008 a hearing was held in the Haifa offices of the Ministry of Environmental Protection. The hearing was attended by Petroleum and Energy Infrastructure Company Ltd. (PEI), Eilat Ashkelon Pipeline Company Ltd. (EAPC) and the Company, after the Ministry of Environmental Protection alleged that it discovered findings that could indicate pollution near the fishing harbor in the PEI strip where Haifa Refinery and EAPC pipeline works are carried out, and that soil suspected as polluted was removed from the area to the Haifa Refinery. At the hearing, the Company stated that it patrols the strip, the pipeline has cathode protection and the pipeline is tested before any inflow. The test results indicate that there was no leakage from the pipeline. Notwithstanding the aforesaid, the Company cannot rule out the possibility that there is exposure on this matter, in amounts that it cannot estimate at this stage, inter alia, because the scope of the pollution, if it exists, is unknown. In addition, the Company does not know if there is any pollution, when it was created and who is responsible. (4) On April 10, 2008, the Ministry of Environmental Protection sent a letter to Carmel Olefins claiming that on April 9, 2008 black smoke was emitted from the company’s polypropylene plant for cumulative periods of over six minutes an hour, which, according to the Ministry, constitutes breach of the provisions of the Personal Order. Following the alleged event, Carmel Olefins was summoned to a hearing on May 1, 2008 at the offices of the district director of the Ministry of Environmental Protection. It is noted that Carmel Olefins disagrees with the emission orders in the event of a malfunction in the Personal Order (which includes a provision according to which the smoke emission will not exceed a cumulative period of six minutes an hour), as it alleges the provisions are not applicable and Carmel Olefins cannot comply with them. Carmel is working with the Ministry of Environmental Protection to change the orders for emission in the event of a malfunction. It is noted that in the hearing held on August 19, 2007 following a similar event of smoke emission, Carmel Olefins was informed that any further deviation from the provisions of the Personal Order will result in an investigation by the Ministry of Environmental Protection. Carmel informed the Company that on May 19, 2008 it received the minutes of the hearing regarding the incident that led to a demand for the immediate shutdown of operations at the monomer plant until fulfillment of all the requirements according to best available technique (BAT), including the backup required to prevent malfunctions, to the satisfaction of the Ministry and the Haifa District Municipal Association (“the demand”). On May 25, 2008, Carmel Olefins shut down facilities (“the temporary shutdown”). In the context of the temporary shutdown, Carmel Olefins took various steps to ensure that the BAT technologies installed in the flare will be operated at the optimal functioning levels for the processes, including the back-ups that are required in order to prevent breakdowns. Carmel Olefins estimates that at the end of the temporary shutdown, it is in compliance with all the requirements presented by the district manager in relation to the flare. However, Carmel informed the district manager that this will not solve the matter of the emission directives in the event of a breakdown and requested the appointment of a professional committee to study the matter.
C-70 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 20 – CHANGES IN CONTINGENT LIABILITIES AND AGREEMENTS (CONTD.)
B. Contingent liabilities (contd.) (4) (contd.) On July 6, 2008, a hearing was held for Carmel Olefins with the district manager following the district manager's allegations of non-compliance with the provisions of the Personal Order and generation of unreasonable pollution regarding the smoke emission event from Carmel Olefin’s plant on June 21, 2008. In the minutes of this hearing, the district manager ordered Carmel Olefins, inter alia, to close one of its polyethylene plants until completion of the examination and drawing of conclusions, and ordered an examination by a German expert within two weeks from the date of the hearing. The district manager further ordered that the conclusions of the German expert’s report are to be implemented within one month of the hearing. Carmel Olefins has implemented the requirements in the minutes of the hearing and closed down of its polyethylene plants, which was reopened on completion of the examination on July 18, 2008. (5) On September 17, 2008, the Supreme Court ruled to approve the arrangement between Carmel Olefins and the State, according to which Carmel Olefins would be convicted at its own admission, in a revised indictment filed against it following two events of smoke emission in the fall of 2003. Following the conviction, Carmel Olefins received a fine of $175,000 and it undertakes not to commit another violation of this type for two years. Carmel Olefins paid this fine in the fourth quarter of 2008. (6) On March 26, 2005, two plaintiffs (“the plaintiffs”) filed suit with the Haifa District Court against the Company, Carmel Olefins, the CEO of the Company and the CEO of Carmel Olefins ("the respondents”). The plaintiffs filed an application for certification as a class action under the Law for Class Action Suits - 2006 ("the application for certification"). In the application for certification, the plaintiffs requested to represent a group of 30,000 residents of Kiryat Tivon and surrounding towns (“the members of the group"). The plaintiffs claim that smoke emissions from the facilities of respondents on September 15, 2003 and October 5, 2003 provided them and the members of the group with the grounds for a claim under the Torts Ordinance (New Version) against the respondents, especially for negligence, breach of statutory obligation, and a nuisance to an individual, and such claims should be adjudicated as part of a class action suit. The plaintiffs claim that each member of the group should be compensated for non-monetary damages allegedly caused, in an amount of NIS 5,000. For purposes of the claim, the plaintiffs set the total amount at NIS 150 million. The parties submitted to the court a petition to approve a settlement arrangement. If the agreement is approved, the Company will finance education program related to environmental quality in the amount of NIS 650,000 (including lawyers fees). The procedure for settlement in a class action is regulated by the Class Actions Law. In the context of the procedure to approve the settlement, the Attorney General requested the appointment of an examiner to assess all the aspects of the settlement arrangement and its implementation. The Company estimates, based on the opinion of its legal counsel and the method of the insurance company, that the claim is covered by an insurance policy (with the exception of deductibles) and the Company is working together with its insurers. The Company made provisions of $200,000 for this claim. After the Magistrates Court acquitted Carmel Olefins of all the events in the claim, the claim against Carmel Olefins and the CEO of Carmel Olefins was dismissed with the consent of the plaintiff. For this matter see also section (7) below.
C-71 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 20 – CHANGES IN CONTINGENT LIABILITIES AND AGREEMENTS (CONTD.)
B. Contingent liabilities (contd.) (7) On October 28, 2008 Carmel Olefins was presented with a request to approve a class action pursuant to the Class Actions Law 5766-2006, filed on October 5, 2008 at the district court in Tel Aviv (“the application”). The application was filed for non-monetary damages caused, according to the applicant, by two smoke emission events which occurred on September 15, 2003 and October 5, 2003 (“the events”). In a prior class action filed in the same matter against the Company and Carmel Olefins, the plaintiffs agreed to remove Carmel Olefins. In the application, the applicant asks to represent the residents of the Haifa Bay area and those who were present in the area (“the group”) and were exposed to the smoke emissions on the said dates. The applicant claims that each of the members of the group is to be compensated NIS 1,000 for the damage allegedly caused. The application does not quote the estimated number of the group’s members and does not quote the total amount that the application claims should compensate the group. The applicant claimed that he filed the application following the results of the criminal procedure against Carmel Olefins, under which Carmel Olefins was convicted, at its own admission, in a revised indictment relating to the events, by the Supreme Court. As the new claim was submitted in respect of these events and alleged damages, the claim described in section (6) above, and in view of the great similarity and overlap between the claims, Carmel Olefins filed an application at the Tel Aviv District Court to transfer the hearing of the new claim to the Haifa District Court, which is hearing the parallel claim. The applicant opposed Carmel Olefin's application, and as of the reporting date, the decision of the Tel Aviv District Court is pending. At the same time, negotiations are underway between the Carmel Olefins and the applicants in an administrative lawsuit in Haifa, to examine the possibility of including Carmel Olefins in a complementary settlement to the settlement agreement formed in the claim against the Company. Based on the opinion of the legal advisors of Carmel Olefins, in view of the early stage of the claim, the complexity of the process and the fact that no amount was quoted in the application, the Company is unable to evaluate the amount of the exposure, if any exists. (8) Two companies holding, together with the Company, shares in Haifa Basic Oils Ltd. (“Haifa Basic Oils”) filed suit against the Company in an amount of NIS 165 million and applied for certification of a derivative claim of Haifa Basic Oils. The major claim of the plaintiffs is that the Company has been abusing its power and has not been acting in the best interests of Haifa Basic Oils. It has been confining the operations of the company and undermining its activities and development. According to the plaintiffs, the facility for the preparation of feedstocks, which is under the sole authority of the Company is an obsolete facility, is maintained on a very low level and has been suffering from recurring problems which seriously hamper the work of Haifa Basic Oils. It was also claimed that the Company does not supply the proper feedstock, neither in the quality nor the quantity needed for the operations of Haifa Basic Oils and over the years, the quality of the transferred feedstocks has declined significantly, contrary to the obligations of the Company.
C-72 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 20 – CHANGES IN CONTINGENT LIABILITIES AND AGREEMENTS (CONTD.)
B. Contingent liabilities (contd.) (8) (contd.) According to the plaintiffs, by virtue of the agreements and procedures between the parties over the years, the Company is obligated to provide Haifa Basic Oils with a suitable quantity of feedstock at a suitable quality. The claim does not point to any concrete and express commitment on the part of the Company to carry out the demands of the plaintiffs. However, it is claimed that the void of formal agreement, to the extent that it exists, should be filled by various legal tools. The plaintiffs requested that their suit be approved as a derivative suit, claiming that due to the equality between the two blocks in control of Haifa Basic Oils, Haifa Basic Oils cannot exhaust its rights against the Company. As of the date of the balance sheet, the claim is yet to be certified as a derivative claim. The Company filed its response to the application and the plaintiffs responded. In its response, the Company claimed, among other things, that it never undertook to supply Haifa Basic Oils with specific feedstocks of a quantity and composition that would maximize the profits of Haifa Basic Oils and that it acts in this matter as a supplier which takes into consideration commercial criteria. The Company also claims that it is not required, as a shareholder in Haifa Basic Oils, to prefer the interests of Haifa Basic Oils over its own interests. The Company further claimed that it is under no obligation, either contractual or by law, to upgrade at its own expense the facility for preparing feedstock for Haifa Basic Oils. In addition, the Company claims that the damages being sued for are exaggerated and groundless. Subsequent to a change in the oil standard effective from August 2005, in June 2006, following an update of the price of fuel oil, the Company requested that the fuel companies and Haifa Basic Oils pays the Company the updated price of feedstock supplied to Haifa Basic Oils, commencing from the updated period. On April 30, 2007, the application for approval of the derivative suit was discussed, and it was decided that the board of directors of Haifa Basic Oils would discuss the upgrading of the facility for the preparation of feedstock, and that the parties should submit apply for arbitration. The Company was notified that the board of directors of Haifa Basic Oils decided to invest in the upgrade of the feedstock preparation facility subject to an agreement with the Company for the supply of feedstocks over the long term, at prices to be agreed upon and at quantities required for the operation of the feedstock preparation facility at full output. The arbitration between the Company and the plaintiffs did not produce results and therefore the claim will be heard in court. In the reporting period, ORL notified the plaintiffs and Haifa Basic Oils that the prices of feedstock will be updated, commencing from the beginning of 2009, in accordance with the real price and proposed fair negotiations regarding the update of the prices based on market prices. After a long period of disregard, the plaintiffs and Haifa Basic Oils denied the Company's right to update the prices. The Company estimates, based its legal counsel representing it in this case, that it is more likely than not that the monetary suit against the Company in respect of the past will be rejected.
C-73 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 20 – CHANGES IN CONTINGENT LIABILITIES AND AGREEMENTS (CONTD.)
B. Contingent liabilities (contd.) (9) Following the Company's application to the Ashdod municipality for permission to register in the land registry office the transfer of real estate from the Company to ORA as part of the split of the Company and the sale of Oil Refineries Ashdod, the Ashdod municipality issued a notice for payment of betterment tax for NIS 19 million and a demand for payment of levies and fees amounting to NIS 78.3. The Company filed an appeal, an administrative petition and other assessment for these demands. In the reporting period, there were discussions with an assessor to determine the betterment levies and the parties are engaged in an arbitration procedure for the fees and development levies. (10) In the reporting period, the Company and Gadiv reached an agreement with the Haifa municipality in respect of the amount of property tax due by the Company and the Company will paid the agreed amount of property tax by December 31, 2009. The Haifa municipality produced property tax appraisals for Carmel Olefins from 2005. In February 2008, Haifa municipality send Carmel Olefins an amended assessor notice for 2008 in the amount of $6 million (NIS 20 million). Pursuant to this notice, the details of the new assessment were updated from October 26, 2005 and an additional charge was added in the amount of $3 million (NIS 10.5 million) for the period from October 26, 2005 to December 31, 2007. The balance of the debt claimed by the Haifa municipality up to February 29, 2008 is NIS 11 million (NIS 38 million). The assessment has not yet been updated in the books of the Haifa municipality, therefore the information available on September 30, 2008 is not updated. The Haifa municipality and parties to the petition agreed that the reservations and appeals filed for charges in 2006 will also apply to the assessor notice for 2007. Carmel Olefins estimates, based on the opinion of its legal counsels, that the company will cover property taxes that are lower than the full amount charged by the Haifa municipality. Carmel Olefins believes that the provisions in its books for the demands of the municipality are sufficient. (11) Three fuel distribution companies sued the Fuel Administration of the Ministry of National Infrastructures, the Company, and an infrastructure company in the fuel industry, claiming that part of the crude oil inventory stored by the plaintiffs in the installation of the infrastructure company, some 38,000 tons, was not delivered to the plaintiffs upon their demand, claiming that it was sludge. The plaintiffs claim that the defendants are responsible toward them for delivery of the aforementioned quantity of crude oil or for payment of its value. The value of the suit on the date of filing (November 2002) was NIS 25.2 million. The State of Israel filed a countersuit against four fuel distribution companies, the Company, and an infrastructure company, for damages in an amount of NIS 121 million (on the date of filing - February 2004), for alleged losses caused to the State as a result of the amounts it paid over the years for maintaining emergency inventories of crude oil, which the distribution companies now claim is useless sludge. At the request of the State, its claim was combined with the claim of the fuel distribution companies. As part of the series of events at the base of the dispute between the parties, the State filed suit against the fuel distribution companies for payment of valuation differentials of the crude oil inventory that was held by the distribution companies as part of the emergency stocks of the State which the State ordered no longer be held as emergency stock.
C-74 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 20 – CHANGES IN CONTINGENT LIABILITIES AND AGREEMENTS (CONTD.)
B. Contingent liabilities (contd.) (11) (contd.) The Company and the infrastructure company were issued third party notifications by the fuel distribution companies. In this suit, the State claims that it is entitled to receive a payment of NIS 23 million as of the date of the filing of the suit August/2007). The suit is based on the Supervisory Order over Goods and Services (Arrangements in the Fuel Economy) - 1988 which set up an accounting mechanism between the State and the marketing companies, regarding the value of the emergency stocks which were held, at the demand of the State, by the fuel distribution companies. In the third party notification that was filed by the fuel distribution companies, they reiterated their claims against the Company, in a suit that was filed by them. The Company, for its part, filed a suit against the infrastructure company in the same matter, whereby the court was requested to declare that the crude oil reserves located in the facilities of the infrastructure company and appearing in its books as unowned crude oil, belong to the Company. Additionally, the Company was presented with a claim of the infrastructure company, which was filed against the fuel distribution companies and the Company, alleging that the defendants own storage fees for the disputed reserves, from September 2000 onwards, in the amount of NIS 33 million. The remedy against the Company was claimed as alternative remedy. The claim of the State for valuation differentials and the claim of the infrastructure company for storage fees is in the pre-trial phase. In respect of the other suits, the court issued instructions to complete the preliminary proceedings and the preparation of the main testimonial declarations. (12) Four companies engaged in the production of asphalt and a fuel distribution company sued the Company, the Fuel Administration of the Ministry of National Infrastructures, and fuel distribution companies, in two separate suits, claiming that beginning in 1986, the maximum price set for bitumen, and as a derivative, the price charged by the Company for the bitumen it sold, was U.S.$ 20 a ton more than the price that should have been charged. The value of one suit is NIS 28 million at the date of filing (December 2002) and the value of the second suit was NIS 5.4 million as at the date of filing (February 2005). The plaintiffs submitted as evidence a number of testimonial declarations and the expert opinion of a person who had filled various positions in the Fuel Administration, including the director of the Fuel Administration, according to which the price of bitumen in the periods relevant to the statement of claim tended to be higher by $20/ton. The expert witness for the plaintiff was cross examined by the lawyers of the defendant. On behalf of the State, testimonial declarations were submitted, including statements of the director of the Fuel Administration and other office holders in the Fuel Administration, supporting the Company's position, according to which the price of bitumen that was set is appropriate and within the law, and is not high. The Company submitted its statement supporting its claim of defense. Summations have been filed and the plaintiffs have the right to file their responses. Deliberation proceedings have been completed and a ruling is pending. (13) For information pertaining to the Company’s liability for severance pay, see Note 18.
C-75 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 20 – CHANGES IN CONTINGENT LIABILITIES AND AGREEMENTS (CONTD.)
B. Contingent liabilities (contd.) (14) Personal Order On May 25, 2006, the Company was served with a personal order pursuant to the provisions of the Law for the Prevention of Nuisances - 1961 which replaced the previous personal order. The personal order applies to the company emission standards from all sources of emissions individually and emission standards from the entire area of the plant, including provisions pertaining to the types of fuel that are permissible to burn at the Company's plant. These standards will become more stringent on November 25, 2008. The order stipulates that the company submit an action plan for compliance with the stringent standards for the approval of the Ministry for Environmental Protection. The Ministry formulated an amendment to the provisions of the specific order, based on the assumption that the Company's facilities will burn only natural gas, and published it for public review. The Company gave notice to the Ministry of the Environment that it has started to act in accordance with the provisions of the amendment that was formulated. As of the date of the financial statements, the amendment to the order has yet to be sealed. Pursuant to the personal order, the Company is also required to continuously monitor the stacks of the plant. The target date for the standards regarding emissions from the stacks and standards regarding emissions from the entire plant is November 25, 2008. In addition, the order stipulates that the Company must conduct a survey regarding unfocused emissions from its facilities (in other words, emissions to the air which do not come from stacks, vents, flames, or designated sources of emission, but from pipe joints, faucets, pools, etc.) and to plan and implement a plan for the reduction of unfocused emissions and the constant monitoring thereof. Regarding these issues, the Order stipulated that the Company submit an action plan for the approval of the Ministry of Environmental Protection. The plans were submitted but deliberations have not yet been completed. The Ministry notified the Company that the plans do not address the issue of reducing unfocused emissions from area sources. On February 7, 2007, the Company submitted a supplementary plan on this matter. As part of the provisions of the personal order, the Company was charged with appointing a public ombudsman and advertising the ways in which he can be contacted. The Company was also charged with handling any complaint regarding foul odors it receives. According to the Ministry, the public complaints it receives indicate that the problem of odor pollution has not been solved yet and the compound of the Company is a source of many odor nuisances. According to the above, the Company has set up a system for the receipt and handling of public complaints regarding odor nuisances. Further to the receipt of the personal order, the Company formulated an action and investment plan ("the investment plan") which, Company estimates will enable the Company to comply with the provisions of the personal order in accordance with the stipulated milestones. In January 2009, the Company and Gadiv received from the Ministry of the Environment a warning and summons to a hearing relating to violations and apparent defective application of the provisions of the personal order (“the Warning"). The warning described the apparent violations which referred, inter alia, to the time tables set forth in the order, the results of the stack samples, the submission of certain plans as required in the order and to the way information is sent to the Ministry, as stipulated in the order.
C-76 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 20 – CHANGES IN CONTINGENT LIABILITIES AND AGREEMENTS (CONTD.)
B. Contingent liabilities (contd.) (14) (contd.) Prior to the date of the hearing, the Company and Gadiv submitted its response to the warning it received, in which it detailed its arguments and responses to the issues included in the warning. At the conclusion of the hearing, goals and timetables were set for actions to be taken by the Company and Gadiv for the purpose of reducing the pollution at its facilities. The Company and Gadiv are preparing to implement the mandatory actions under the personal orders and are conducting talks with the Ministry of Environmental Protection regarding additional actions stipulated by the Ministry. The Company estimates that if the Company is required to take the mandatory actions under the personal orders it received, this will not cause it further expenses beyond its planned expenses. (15) On December 17, 2006, the Minister of National Infrastructures appointed an inter-ministerial committee to look into the question of the location of the plants in the Haifa Bay area. The committee was asked to formulate a position on the location of the plants in the Haifa Bay area in view of the assessment of the inherent risks in these plants, including the level of the pollutants released by them and the need for them. If necessary, the committee will compile proposals for alternative sites and recommendations for operational steps. The committee was given until June 28, 2007 to complete its work and submit its recommendations to the Minister of National Infrastructures. As of the date of the report, the Company does not know if the committee commenced its work and is unable at present to assess the ramifications of the matter on the Company. (16) In a letter dated December 11, 2006 sent by PEI to the Company, PEI drew the attention of the Company to two issues in the area of environmental quality which, in the opinion of PEI, required discussion by the two parties. One of the issues raised in the letter derives from the annual report of the Ministry for Environmental Protection from 1997, in which it was stated that in the area of the fuel pipe corridor near the Haifa oil port, there is massive pollution of the riverbed and the groundwater which derives from leaks that occurred in the old pipes or when the old pipes were replaced with new ones (a corridor in which the pipes of the Company are located). The second issue revolves around the claims of OEI that there are a number of focal points of pollution in the tanker farms at the Kiryat Chaim and Elroi terminals (these two tanker farms were operated by the Company, claims PEI,, until the middle of the 1990s). According to OEI, it is difficult to estimate the monetary and other consequences of this problem and OEI demands that these issues be immediately deliberated in order to reach an agreed-upon solution. The Company has still not yet replied to the aforementioned letter. An initial investigation of its records made by the Company regarding the aforementioned claims indicates that in the last 15 years there were no reports of leakage from pipes owned by the Company and located in the corridor to which OEI related and that the Company did not operate the two tanker farms during the entire period claimed by OEI. Notwithstanding the above, the Company cannot dismiss the possibility that it may be exposed in this matter, in amounts that it cannot estimate at present, since among other things, the scope of the pollution, if any exists at present, is unknown and in addition, the Company has no knowledge as to whether pollution exists, when it was created and who is responsible for it.
C-77 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 20 – CHANGES IN CONTINGENT LIABILITIES AND AGREEMENTS (CONTD.)
B. Contingent liabilities (contd.) (16) (contd.) Subsequent to the reporting period, on January 25, 2009 a hearing was held at the Ministry of Environmental Protection for the Company and PEI regarding two specific sites where, according to the Ministry, soil and groundwater had been contaminated by fuel products. On March 1, 2009, the Company and PEI received a removal order for toxic substances, pursuant to section 16(A) of the Hazardous Substances Law - 1993 and a clean-up order, pursuant to section 13(B) of the Maintenance of Cleanliness Law - 1984. The orders require the Company, PEI and their CEOs to submit plans to the Ministry of Environmental Protection for the implementation of soil gas, soil and groundwater surveys and to fence off of the contaminated areas and to conduct the survey in accordance with the approved plans. The parties are further required to submit to the Ministry a report of the survey findings, including recommendations for the clean-up and rehabilitation of the contaminated soil and water and restoration of the river and riverbank to their former state, based on the survey findings, and a short-term, binding timetable for implementing the survey recommendations, until all waste and toxins have been removed from the soil and groundwater. The Company has submitted its plan for the soil gas, the soil and groundwater survey to the Ministry of Environmental Protection for approval. At the report date, the Company is unable to assess the outcome of the survey, the actions required following the outcome and the extent of any expenses arising for the Company when implementing these actions. (17) Subsequent to the reporting period, the Company and EAPC were required, under the terms added to their business licenses, to conduct soil surveys along the pipeline corridor and to apply the survey recommendations according to the proposed timetable approved by the Ministry of Environmental Protection. The Company is appealing against these terms in its business license via the procedure set up by the law. The Ministry of Environmental Protection is yet to respond to the application. At the reporting date, the Company is unable to assess the outcome of the survey, the actions required following the outcome and the extent of any expenses arising for the Company when implementing these actions. (18) The tax authority served the Company an amended deficit notice for NIS 11 million (including linkage differences and interest up to the date of notice – May 2008) for the import of goods by the Company in the exemption under item 10 in the customers tariff, for the period from October 8, 2003 (the expiry date of the original concession). After examining numerous documents referring to the import of goods by the Company in the relevant period, the Company notified the tax authorities that, in the opinion of the Company, the majority of the tax deficit is fundamentally in error. The Company and the tax authority are negotiating to settle the dispute. (19) Subsequent to the reporting period, the Company filed a claim with the Haifa District Court alleging that Haifa Port Ltd. does not have the right to charge the Company for infrastructure fees in respect of crude oil unloaded at the Kiryat Haim sea terminal and that the port administration does not have the right to delay tankers that have unloaded crude oil for the Company and for which the Company did not pay infrastructure fees for the unloaded oil. In the court hearing on March 22, 2009, the parties agreed that the Company would place a bank guarantee for these infrastructure fees, until the court hands down its decision.
C-78 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 20 – CHANGES IN CONTINGENT LIABILITIES AND AGREEMENTS (CONTD.)
B. Contingent liabilities (contd.) (20) In the reporting period, the Haifa municipality served Gadiv an assessor notice for property tax for Gadiv facilities at the chemical terminal at the port, for 2001 onwards. The amount required for 2001-2009 (inclusive) is NIS 1.37 million. Gadiv filed a reservation against the charge. As of the reporting date, a decision is yet to be made on the reservation. (21) A major customer (in liquidation) of Carmel Olefins filed a number of claims against Carmel Olefins, as follows: a. Further to a demand letter previously submitted, the customer claimed NIS 30 million in damages (the share of the Company is NIS 15 million) which allegedly resulted from the shutdown and breakdowns at the ethylene plant and in respect of the added expense of having to import ethylene. Carmel Olefins filed its defense brief. The plaintiff requested to add Siemens, the supplier of the problematic turbine, as an additional defendant and the court approved the request. At the preliminary hearing on March 5, 2008, dates were set for the submission of the customer's affidavits and for the evidentiary hearings at which time the affidavits will be examined. In the opinion of the Company, based on the legal counsel of Carmel Olefins, Carmel Olefins has a good defense against the claim. Accordingly, no provision was made in respect of this matter. b. A former customer filed suit against Carmel Olefins in an amount of NIS 49 million (the share of the Company - NIS 24.5 million) in respect of amounts that Carmel Olefins allegedly overcharged for the supply of ethylene in 1993-2000. According to the customer, Carmel Olefins charged more than the maximum price set by the Ministry of Trade and Industry. The customer filed a motion to be exempted from payment of the fee. Carmel Olefins filed its response to the motion. According to the decision of the court from November 25, 2007, Carmel Olefins has to file its defense motion within 21 days after the court renders a decision on the request for the exemption. On February 2, 2008, the Registrar of the District Court granted the request from the customer to be exempt from payment of the levy. On February 27, 2008, Carmel Olefins appealed the decision of the Registrar and filed a request to grant an extension for the filing of its defense brief until ruling is handed down on the appeal. In the opinion of Carmel Olefins, based on its legal counsel, it has good claims against the claims of the customer. No provision was made in respect of this matter. (22) In addition to the contingent liabilities described above, there are claims that were filed against the companies during the course of their business, in immaterial amounts, to which the Company, Gadiv and Carmel Olefins do not admit. Some of these claims are covered by insurance, except for the deductible component. The total amount of the deductibles in respect of these claims is immaterial to the Company. The companies record provisions in their accounting records in respect of suits which in the opinion of the managements of the companies, based on their legal counsels, have good chances of coming to fruition. The provisions are made according to the estimated amounts of payments to remove the liabilities. There is an additional amount of $140 million for which no provisions were made (excluding the suits presented in Note 20(B)(2), a, b, e and 20(B)(3), 20(B)(4), 20(B)(6), 20(B)(7), 20(B)(16) and 20(B)(17).
C-79 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 20 – CHANGES IN CONTINGENT LIABILITIES AND AGREEMENTS (CONTD.)
C. Agreements (1) New assets agreement On January 24, 2007, the State of Israel and the Company entered into a new asset agreement which resolves the dispute between the parties regarding the rights to the assets of the Company (“assets of the Company”) and which replaces the previous agreement regarding this issue made in 2002. According to the agreement, the company agreed with the position of the State in the dispute as defined in the original asset agreement from 2002 and waives all claims deriving from the dispute or the position of the Company in the dispute or with regard to them. According to the new agreement, the rights of the Company in the assets of the Company are as follows: Rights to assets which are not real estate assets - Except for real estate assets, the Company has the same rights to all of the assets of the Company which it had notwithstanding the position of the State of Israel in the dispute. Rights in the property of the Company a. Rights of the State of Israel - Regarding each of the pieces of property of the Company in which the Company had ownership were in not for the position of the State of Israel in the dispute, including the right to be registered as the owner in the land registry - the State of Israel is the owner and the Company has and will have no claim against the State of Israel in respect of such rights. Regarding these pieces of property - the Company has perpetual leasehold rights (“the leasing agreements) and the Company has and will have no claim against the State of Israel in respect of the rights of the State of Israel. The period of each of the Leasing Agreements is 49 years, commencing on the date of signature (January 24, 2007), with the Company having an option to extend the period for an additional 49 years ("option period”), subject to the fulfillment of all of its obligations under the leasing agreement and the new asset agreement. At the end of the leasing period, including the option period should it be exercised, the Company will transfer possession of each piece of leased real estate to the State of Israel, including any construction and permanent appurtenances. b. Regarding each of the pieces of property of the Company which are not included in paragraph A above - the Company shall have the same rights it had in the pieces of property had it not been for the position of the State of Israel in the dispute. c. According to the agreement, the Company will pay the State of Israel, every year, an annual fee comprised of a fixed amount of $2.25 million and additional annual amounts, that are contingent on the annual income of the Company, as follows: 8% of the annual income before taxes and the annual payment, in the range of $0 - $30 million; plus 10% of the annual income before taxes and the annual payment, in the range of $30 - $52.5 million; plus, 12% of the annual income before taxes and the annual payment, in the range of $52.5 - $67.5 million. In any event, the amounts paid to the State in respect of the annual payment (including the fixed component) shall not exceed $8.7 million. All amounts shall be translated into shekels at a rate of NIS 4.80 per dollar and are linked to the CPI of May 2002. According to the asset agreement, the Company began paying the annual fee. In respect of 2008, the Company paid an annual fee $4 million to the State and in respect of 2007, the Company paid an advance of NIS $11 million.
C-80 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 20 – CHANGES IN CONTINGENT LIABILITIES AND AGREEMENTS (CONTD.)
C. Agreements (contd.) (1) c. (contd.) The new asset agreement set out the objectives of the leasing of the property and stipulated provisions regarding the need for the agreement of various parties for the transfer of the rights of the Company in the property (except for a lien and/or pledge of its rights in the leased property in favor of a financial institution only for purposes of obtaining financing for its operations in the normal course of business). The Company will not be entitled to make or initiate a change in the zoning or utilization of the leased property, including any part thereof, until it gives notice of its intention to do so in advance and in writing to the CEOs “the notice of change in zoning or utilization”) and subject to none of the CEOs notifying the Company of his objection to the Company's notice. In the event that the Company breaches any of its commitments in respect of any specific piece of property, all of the rights of the Company in the same property will be cancelled and all of the rights in that property will revert back to the State (“the returned property”), in addition to a possible liability in respect of compensation. d. Piping of distillates At the date of the signing, the Company shall restore to the State of Israel all of its rights in or related to the piping of distillates, leading from the Haifa oil refinery to the Haifa Port, including any right the Company had prior to the date of signing in the land in which the pipe network is located. During the period from the date of signing until February 28, 2010 “the interim period”), the Company shall have the right to operate and use the distillates piping, in accordance with and subject to the instructions of the State of Israel pertaining to the manner in which the piping should be operated and used, which instructions are issued from time to time (“the operating right”). No later than February 28, 2010, the Company shall transfer possession to the State of Israel of the distillates piping in such a state that it is free and clear of any person; clean; in compliance with the demands of any law, especially laws pertaining to environmental quality. (2) The municipal regime applicable to the area of the plant On March 28, 2005, the Minister of the Interior adopted the decision of the committee set up to handle the matter, and decided to annex the area of the petrochemical plants in the Haifa Bay area, including the area of the Company ("the area of the plants) to the municipal boundaries of the Haifa Municipality, on condition that the area of the plants is managed jointly by all of the relevant local authorities and the representatives of the plants which will act as an regional administration. The Company and Gadiv appealed this decision to the High Court of Justice to prevent implementation of the decision of the Minister, claiming that the recommendation of the committee and the decision of the Minister created a municipal administrative mechanism that does not exist in law and that is unreasonable, and that the best way of achieving the goals set down by the committee is by setting up an industrial local council in the area of the plants.
C-81 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 20 – CHANGES IN CONTINGENT LIABILITIES AND AGREEMENTS (CONTD.)
C. Agreements (contd.) (2) (contd.) On December 29, 2005, the area of the plants was incorporated into the municipal boundary of Haifa, including the property of the Company. On August 23, 2006, the Company, Gadiv, Carmel Olefins and another plant entered into an agreement with the Haifa Municipality and other adjacent municipal authorities, designed to regulate the municipal regime that will apply to the area of the plants (“the authorities agreement”). The Ministry of the Interior ratified the authorities agreement in the reporting period. The authorities agreement stipulates that a municipal corporation will be set up (“the municipal company”). The authorities agreement stipulates that a municipal corporation will be set up (“the municipal corporation”), in which all of the rights in capital and most of the voting rights will be held by the authorities, with the balance being held by the plants, and the goal of which is to provide municipal services in the area of the plants, including the setting of guidelines, planning and development. The agreement stipulated that the Haifa municipality, as the licensing authority in the area of the plants, shall handle the request for a business permit submitted by the Company and that it shall not add additional conditions to the business permit beyond those conditions stipulated by the relevant government ministries for the business permit of the Company. It was further stipulated in the agreement, that in the area of the plants, the by-laws of the city of Haifa shall apply, and such laws shall be applied in an equal manner to the other areas of Haifa, as well as the provisions for cooperation, with the goal of having the Interior Minister set up a "joint committee" in accordance with the provisions of the Planning and Construction Law, the members of which shall be members of the board of directors of the municipal corporation. Subsequent to the reporting period, the Minister of Interior adopted the recommendations of the planning institutions and ordered the establishment of a joint committee that will have the authorities of a local committee, made up of representatives of the local authorities and government ministries. The Company and Gadiv agreed, under the terms stipulated in the agreement, to bring the agreement to the attention of the court and to withdraw their petition and are expected to do so after the incorporation of the joint company and the establishment of the joint committee for planning and construction. Up to the end of the concession period, the Company did not receive construction permits relating to the construction in most of the area of the plant. In 2004, the Company and additional plants located in the area of the plants submitted a detailed plan for the area to the Haifa Regional Planning and Construction Council. As of the reporting period, the plans were discussed in the district committee and the district committee decided to deposit the plan, in the terms stipulated in the decision. Commencing at the end of the concession period, the Company has been requesting and receiving construction permits in respect of every new building constructed in its yard. Until the end of the concession period toward the end of 2003, the Company did not have to pay general rates for the vast majority of the area of its plant. The Company received property tax notices from the Haifa Municipality for part of 2005 and for 2006 - 2009 (inclusive). In the reporting period, the Company and Gadiv reached an agreement with the Haifa Municipality in respect of the amount of property tax due by the Company. The Company will paid the agreed amount of property tax by December 31, 2009.
C-82 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 20 – CHANGES IN CONTINGENT LIABILITIES AND AGREEMENTS (CONTD.)
C. Agreements (contd.) (3) Agreements with ORA Agreement for the transfer of feedstocks On March 9, 2006, the date of the signing of the spin-off agreement, the Company signed an agreement with ORA for the transfer of feedstocks (“the feedstocks agreement) whereby a mechanism was set up for the submission and receipt of proposals to purchase and/or sell a number of feedstocks, designed for the sole use of the parties during the course of their refining business. The prices of feedstocks are determined on the basis of price formulas that are based on international publications. The major feedstocks that are transferred from the Company to ORA are HVGO at a quantity of 300,000 tons a year, high-octane components of the gasoline composition at a quantity of 50,000 tons a year, as well as variable quantities of propane. The major feedstocks that are transferred from ORA to the Company are Naphtha (light and heavy) at a quantity of 190,000 tons a year, propylene (earmarked for Carmel Olefins) at a quantity of 60,000 tons a year, and intermixture components at variable quantities. The feedstocks that are transferred between the Company and ORA constitute 7% - 10% of the overall output of both refineries. The feedstocks agreement was signed for a period of twelve months from the effective date, with the parties having options to extend the agreement for additional periods of one year each upon mutual agreement, based on a mechanism set out in the agreement. As of the date of the report, the agreement was extended until September 30, 2009. On March 8, 2006, the Antitrust Authority announced that the feedstocks agreement is not a restrictive trade agreement and does not require submission of a request for exemption from the Commissioner. (4) Employee agreements The Company signed collective agreements with its employees that went into effect on the date of the consummation of the sale of ORA. These agreements include the following: a collective employment agreement for the period 2006 - 2010, an agreement for the transition of employees from the Company to ORA, an agreement for early retirement, and an agreement for the granting of a loan to Haifa Early Pension Ltd. which is designed to guarantee the Company's commitment under the early retirement agreement, see Note 18. In November 2008, the Company and its employees signed an amendment to the collective agreement, extending the period in which the Company’s employees will be eligible for early retirement and extended the security net to additional employees who were employed by the Company at the time of privatization, and who were included in the list of names attached to the agreements. In addition, it was agreed that the Company could provide other collateral as an alternative to the loan extended to Haifa Early Pensions, in accordance with the principles determined in the memorandum of understanding signed by the parties.
C-83 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 20 – CHANGES IN CONTINGENT LIABILITIES AND AGREEMENTS (CONTD.)
C. Agreements (contd.) (5) The commitment between Carmel Olefins and a major customer was terminated due to the customer's commencing liquidation and receivership proceedings, see Note 20(B)(21). These proceedings may have an impact on the reciprocal claims of the customer and Carmel Olefins. (6) Regarding commitments to perform plant construction work, see Note 11(G). (7) On September 25, 2007, Gadiv signed a memorandum of intent (“the memorandum of intent”) for the purchase of 50% of the registered share capital of a Chinese company (“the acquired company") which benefits in China from the status of a fully-foreign owed company (WFOE) and which will manufacture Tri-Maleic-Anhdrid ("TMA"), a product that is used as a softener in the polymer industry and as a component in powder colors, and Para Diethyl Benzene (PDEB), a product used mainly in the production of paraxylene. On November 25, 2007 the validity of the memorandum of understanding expired, and the negotiations conducted by the Company on this matter ended without the parties reaching the required agreements for consummation of a binding transaction. As of the date of the report, the parties are continuing to assess the options for advancing the project. (8) As part of the agreement signed between the State of Israel, the Company and foreign investment banks ("the international distributors”) regarding the private placement offer of the shares of the Company held by the State of Israel, the Company undertook to indemnify the International Distributors in respect of amounts that they may be required to pay to any third party as a result of a misstatement in the prospectus and/or as a result of an incorrect translation of the prospectus to English, up to an amount equal to the total receipts in respect of the sale of the shares sold through them. (9) In addition, the Company undertook to indemnify the attorneys of the issue - the law firm of Haim Samet, Steinmetz, Haring, & Co., in respect of amounts the law firm would be required to pay the International Distributors in connection with the aforementioned incorrectness of the approval of the translation that law firm gave to the International Distributors and the authorization that the law firm gave to the law firm of Carter Ledyard & Milburn LLP which rendered consulting services to the State of Israel and the Company regarding the reliance on the approval of the English translation from the standpoint of U.S. law, in connection with the private placement. The Company also undertook to indemnify the law firm in respect of reasonable litigation costs to be incurred in litigating the aforementioned suit. (10) The Company undertook to indemnify the law firm of Eitan, Mehulal, Pappo, Kugler & Co. in respect of any amount it may be required to pay to third parties, including expenses caused to the firm in respect of any claim in connection with the reliance on an opinion rendered to the Company in the matter of the tax aspects of the financing expenses relating to the loans taken by the Company. (11) To maintain the operations of the Company, the Company is dependent upon receipt of services from the infrastructure companies, PEI and EAPC which own crucial infrastructure pertaining to the unloading, shipping, storage, and issuance of crude oil and distillates. In August 2009, PEI is expected to carry out reinforcement works on the offshore pipeline used to unload crude oil in Haifa Bay.
C-84 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 21 – SHAREHOLDERS’ EQUITY
Capital and funds A. Reconciliation of changes in equity Additional changes in shareholders’ equity
Capital Capital Capital reserve reserve for reserve for for financial Capital Capital share-based translation assets available reserve in Retained reserve payment differentials for sale affiliates earnings Total Year ended December 31, 2008 Balance on January 1, 2008 472,478 558 - - 28,478 298,289 799,803 Total income for the period - - (1,078) (10,433) - (118,526) (130,037) Dividend declared and paid - - - - - (121,325) (121,325) Options issued to employees - 3,428 - - - - 3,428 Balance on December 31, 2008 472,478 3,986 (1,078) (10,433) 28,478 58,438 551,869 Year ended December 31, 2007 Balance on January 1, 2007 239,819 - - - - 454,504 694,323 Distribution of bonus shares 232,659 - - - - (232,659) - Company’s share in capital reserves of an affiliate - - - - (48) - (48) Payment of issuance expenses to controlling shareholders - - - - - (1,046) (1,046) Payment of privatization grant to employees of the - - - - 23,388 - 23,388 Company Payment of privatization grant to employees of investees - - - 5,138 - 5,138 Share-based payments 558 - - - 558 Dividend declared and paid - - - - - (69,410) (69,410) Total income for the period - - - - - 146,900 146,900 Balance on December 31, 2007 472,478 558 - - 28,478 298,289 799,803
C-85 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 21 - SHAREHOLDERS’ EQUITY (CONTD.)
B. Share capital and premium on shares a. At a general shareholders meetings of the Company on February 7, 2007 and February 8, 2007, it was resolved as follows: 1. To consolidate all of the registered and issued share capital of the Company into ordinary shares of par value NIS 1 each, such that the Company’s registered share capital would be comprised of 381,280,000 ordinary “A” shares, par value NIS 1 each, equal and identical in rights. 2. To increase the share capital of the Company from NIS 381,280,000 to NIS 2,000,000,010 by creating 1,618,720,010 new ordinary “A” shares. 3. To allot to the State of Israel 1,645,839,307 ordinary “A” shares, par value NIS 1 each, as bonus shares. For purposes of increasing the share capital, the Company transferred an amount of NIS 1,080 million from retained earnings. Following execution of these resolutions, the Company’s issued and paid in share capital amounts to 2,000,000,010 ordinary shares, par value NIS 1 each. b. On August 13, 2008 the general meeting of the Company approved an increase in the Company's registered capital by NIS 1,000,000,000 divided by 1,000,000,000 ordinary shares of NIS 1 par value each, such that after increasing the share capital, the Company's registered capital is NIS 2,000,000,010 divided by 2,000,000,010 ordinary shares of NIS 1 par value each. c. Restriction of distribution of retained earnings - see Note 16(D). d. Capital reserve for translation differentials The translation fund included the exchange rate differences deriving from the translation of the financial statements of the foreign operations. e. Capital reserve for financial instruments available for sale As of the reporting date, an affiliate reflected capital reserve for investment impairment of a subsidiary. Accordingly, the investment impairment of the affiliate was included in the investment of the affiliate in the capital reserves of the Company. See note 21 f. Capital reserve for share-based payment - allotment of options to employees and directors of the Company (1) On September 5, 2007, the board of directors of the Company approved an option plan comprised of 30,000,000 options in an equity track (with a trustee) pursuant to article 102 of the Income Tax Ordinance. As of December 31, 2007, the Company allotted options for the purchase of 26,900,000 ordinary shares par value NIS 1 each. As of December 31, 2007, 3,100,000 options to purchase ordinary shares remained. According to the decision of the board of directors from September 5, 2007, which was ratified by the general shareholders meeting of the Company on September 23, 2007, the Company allotted as part of the option plan 9,000,000 options to the chairman of the board and to the CEO of the Company to be split equally between the two of them, and which constitute 0.45% of the capital of the Company, under the assumption that all of the non-negotiable options are exercised. Each of the above options is exercisable into one ordinary share, par value NIS 1 each (subject to adjustments in accordance with the terms of the option plan), at an exercise price of NIS 3.25, which is the average price of the share of the Company on the stock market during the 30-day period preceding the decision of the board of directors. The aggregate economic value of all of the options allotted to the chairman of the board and the CEO of the Company (9,000,000 options), based on the above, is $7.5 million.
C-86 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 21 - SHAREHOLDERS’ EQUITY (CONTD.)
B. Share capital and premium on shares (contd.) f. Allotment of options to employees and directors of the Company (1) (contd.) According to the decision of the board of directors dated November 6, 2007, 10,950,000 options were allotted to nine officers who are not and will not become interested parties in the Company as a result of this placement through the option plan. The options are exercisable into 10,950,000 shares of the Company, par value NIS 1 each and constitute 0.55% of the capital of the Company, under the assumption that all of the non-negotiable options are exercised. Each options is exercisable into one ordinary share, par value NIS 1 (subject to adjustments in accordance with the terms of the option plan), at an exercise price of $0.80). The aggregate economic value of all of the options allotted to the office holders (10,950,000 options), based on the above, is $2.5 million. On December 31, 2007, the board of directors decided to allot 6,950,000 options to sixteen senior employees who are not officers in the Company as part of the option plan. The options are exercisable into 6,950,000 shares of the Company, par value NIS 1 each. Each option is exercisable into one ordinary share, par value NIS 1 each (subject to adjustments in accordance with the terms of the option plan), at an exercise price of $0.90. The aggregate economic value of all of the options allotted to the senior employees, based on the above, is NIS 1.9 million. As of the date of the report, the options to the 16 senior employees have not been allotted in practice. In the event of a termination of service, the right to exercise the options will be restricted to those options which have already vested by the date of termination of service and they will be exercisable during the 180 day period following the termination of service. (2) The option allotment plan was registered in accordance with article 102 of the Income Tax Ordinance, whereby the options will be deposited with a trustee for a period of at least two years from the date the options were granted. The recipients of the options will pay the tax to derive from the benefit, when the shares are sold.
C-87 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 21 - SHAREHOLDERS’ EQUITY (CONTD.)
B. Share capital and premium on shares (contd.) f. Allotment of options to employees and directors of the Company (3) The following table summarizes the terms of the grant of the options granted by the Company and the data used in determining the fair value of the benefit:
Vesting Contractual Share price as Total share No. of instruments period life of options Interest rate Expected Exercise a basis for value of benefit Grant date (thousands) (years) (years) (average) fluctuations supplement option price on grant date % NIS NIS thousands September 5, 2007 9,000 1-3 3-5 3.50 28 3.25 3.156 7,500 November 6, 2007 10,950 1-3 3-5 3.50 28 3.179 3.197 9,800 December 31, 2007 6,950 1-3 3-5 3.20 28 3.486 3.7 7,600 26,900
The price of the share was derived from the market price of the share. The expected volatility was determined on the basis of the historical volatility of the price of the share of the Company and the shares of companies operating in similar areas of operations to that of the Company. The lifespan of the option warrants was determined on the basis of management estimates regarding the period of time the employees will hold the option warrants, taking into consideration their positions at the Company and the Company's previous experience regarding the termination of employees. (4) `The risk-free interest rate was determined on the basis of the yield to maturity of shekel government bonds, with the time to maturity being equal to the expected lifespan of the option warrants.
C-88 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 21 - SHAREHOLDERS’ EQUITY (CONT’D)
Year ended December 31, 2008 December 31, 2007 Weighted No. of Weighted No. of average of options average of options exercise price (thousands) exercise price (thousands) (NIS) Allotted during the year - - 26,900 3.28
For the end of the year 26,900 3.28 26,900 3.28
(5) The following table summarizes the total payroll expenses recognized in the income statement in respect of the share-based payment transactions for the employees and directors:
Year ended December 31 2008 2007 USD thousands General and administrative expenses 1,471 411
(6) See Note 34(C) for allotment of options to senior employees subsequent to the balance sheet date. g. Dividends 1. In January 2007, the Company paid a dividend that was declared in 2006 in an amount of NIS 20 million ($5 million). 2. In October 2007, the Company paid a dividend of NIS 280 million ($69 million). 3. On April 28, 2008 the general meeting of the Company approved the distribution of a dividend in the amount of NIS 240 million ($71.6 million), which was paid on May 20, 2008. 4. On August 13, 2008 the general meeting of the Company approved an amendment to the Company Articles such that the Company’s board of directors will have the authority to resolve the distribution of a dividend (and not the general meeting, as was the case previously) and to approve the lifting of the prohibition for a subsidiary or company controlled by the Company to acquire the shares of the Company. 5. On November 23, 2008, the board of directors decided to distribute a cash dividend of NIS 200 million “”the dividend” ($50 million) out of the distributable retained earnings as of September 30, 2008. In accordance with the decision of the board of directors, following the implementation of the agreement dated June 24, 2008, between the Company and IPE for the acquisition of the balance of shares in Carmel Olefins, the dividend will be counted as part of the first dividend as defined in the agreement. See note 9(2). The dividend will be paid on December 16, 2008. h. On May 29, 2008, the Company published a shelf prospectus on the basis of the Company’s financial statements as of December 31, 2007, for the issuance of shares, debentures, convertible debentures, option warrants for ordinary shares and option warrants for debentures, as set forth in the prospectus.
C-89 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 22 - REVENUES
December 31 2008 2007 From the local market 5,150,513 3,201,002 From export 3,076,680 2,008,838
8,227,193 5,209,840 Supply of services to foreign parties and other revenue 30,265 24,643
8,257,458 5,234,483
NOTE 23 – COST OF SALES, REFINING AND SERVICES
December 31 2008 2007 Materials consumed 7,651,542 4,526,442 Impairment of inventory 198,062 - Wages and related expenses 97,881 83,691 Maintenance of plants, buildings and equipment * 40,239 46,614 Depreciation and amortization 65,534 64,801 Other production expenses 115,491 116,225 Decrease (increase) in inventories of products 155,400 (21,262)
8,324,149 4,816,511
* Including wages and incidental expenses
NOTE 24 – SELLING EXPENSES
December 31 2008 2007 Wages and incidental expenses 6,790 4,738 Transportation and storage 28,634 26,405 Others 5,158 3,867
40,582 35,010
C-90 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 25 – GENERAL AND ADMINISTRATIVE EXPENSES
December 31 2008 2007 Wages and incidental expenses 22,550 18,772 Insurance, taxes and levies 19,190 25,920 Depreciation 2,009 1,600 Doubtful and lost debts 2,437 (37) Others 20,875 13,105
67,061 59,360
NOTE 26 – FINANCING INCOME AND EXPENSES
December 31 2008 2007 Financing revenue Interest income from bank deposits 496 1,032 Change in fair value of loan to Haifa Early Pension Ltd. 5,489 2,141 Net change in fair value of financial assets held for sale 8,839 4,715 Net change in fair value of derivatives for exchanging currency and interest 47,676 2,328 Other income 2,479 2,145 Financing income recognized in profit or loss 64,979 12,361
Financing expenses Interest expenses on financial liabilities measured at amortized cost: Short-term loans (6,924) (3,261) Debentures (68,522) (35,869) Long-term loans (26,448) (29,137) Others (4,150) (2,613)
Net loss from change in exchange rate (9,860) (31,028) Net change in fair value of other derivatives (8,162) - Net interest expenses for working capital items (1,663) (13,882) Other financing expenses (1,598) (2,153) Financing expenses (127,327) (117,943)
Less discounted credit costs 1,293 3,659 Financing income recognized in profit or loss (126,034) (114,284)
Net financing expenses recognized in profit or loss (61,055) (101,923)
C-91 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 27 – EARNINGS PER SHARE
A. Basic earnings (loss) per share The calculations of the base loss per share as of December 31, 2008 was based on the loss attributed to the ordinary shareholders, in an amount of $109,208 thousand (in 2007, earnings of $ 141,669 thousand), divided by the weighted average of the number of ordinary shares (in thousands) in circulation (2,000,000 shares in 2008 and 2007). B. Diluted earnings (loss) per share The Company did not present data pertaining to the diluted earnings/loss per share due to the anti- dilutive effect of the employee options.
NOTE 28 – RELATED AND INTERESTED PARTIES
A. Until February 21, 2007, the Government of Israel held 100% of the share capital of the Company. Therefore, all government ministries, government authorities and companies in which the government holds at least 25% of the issued share capital or voting rights, are considered to be related parties. B. 1. Balances and transactions with governmental authorities and government companies, arising in the ordinary course of business, were not disclosed separately in the financial statements. 2. Regarding annual fees paid by the Company to the State of Israel, see Note 19(B). C. Transactions with related parties
Year ended December 31 2008 2007 2008 2007 Additional Transaction amounts Balance in balance sheet details Related/interested party Income (expenses) Assets (liabilities) Affiliates 167,160 104,362 15,662 21,704 Jointly-owned entities 262,329 115,976 29,362 24,668 Key officers (including directors) (4,233) (3,366) (108) (40) Other related parties (13,948) (3,348) (228,135 ) (71,721)
C-92 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 28 – RELATED AND INTERESTED PARTIES (CONTD.)
C. Transactions with related parties (contd.) Management fees from a related party The Company has an agreement for management fees with a proportionally consolidated company. See section J. below. Total revenue from management fees: Year ended December 31 2008 2007 USD thousands Proportionately consolidated subsidiary 1,250 1,250
Transactions with interested and related parties are made in the regular course of business. 1. Due to regulatory restrictions that were effective prior to privatization of the Company, the Company sold the main raw materials (mainly naphtha) to the fuel distribution companies. Commencing from July 1, 2007 these regulatory restriction were annulled and therefore as of same date, Carmel Olefins purchases feedstocks directly from the Company. 2. The price of the transactions were based on the Company's product pricelist. 3. The Company’s products were sold to related and interested parties under market conditions. 4. Carmel Olefins purchased most of the raw materials from the Company and therefore Carmel Olefins is dependent on the Company. D. Benefits for key management personnel (including directors) The directors and key manager in the Group are eligible, in addition to their salary, to non-monetary benefits, such as the use of a company car and health insurance. The Company contributes to defined post-employment benefit plans. Senior managers also participate in option plans for the Company’s shares. See Note 21 - Share Based Payments. Employment benefits for key management personnel (including directors) employed by the Company inlcude the following: Year ended December 31 2008 2007 No. of No. of people Amount people Amount Total employee benefits without share-based payments 5 2,762 6 (*) 2,955
Share-based payments (**) 5 1,471 5 411 4,233 3,345 (*) On June 28, 2007, the outgoing chairman of the board of directors, Mr. Ohad Marani, ended his term and Mr. Yossi Rosen was appointed as chairman of the board of directors. Key management personnel includes the outgoing and elected chairman of the board of directors. (**) For information on the allotment of options to employees, see Note 21(E).
C-93 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 28 – RELATED AND INTERESTED PARTIES (CONTD.)
D. Benefits for key management personnel (including directors) (contd.) Benefits for key management personnel (including directors) employed by the Company include the following:
Year ended December 31 2008 2007 No. of No. of people Amount people Amount Benefits for an external director 7 532 9 179
Compensation for directors and managers: 1. Up to December 31, 2007, the Company’s directors (including the external directors, and with the exception of the chairman of the board of directors) were eligible for directors compensation at the maximum permitted amount under the Companies Regulations (Rules for Remuneration and Expenses for Outside Directors) - 2000 “the remuneration regulations”, according to the grading of the company as defined in the revised remunerations regulations of March 2008. On February 6, 2008, this was approved by the general meeting of the shareholders after approval by the audit committee and board of directors. approved the amount of the remuneration for directors, with the exception of outside directors and the chairman of the board, effective from January 1, 2008. In addition, an additional fixed monthly remuneration equal to remuneration for participation in two meetings was determined for the chairman of the permanent committee of the board of directors, provided the chairman is not a director related to a controlling shareholder in the Company. At the same date, the general meeting approved that at the date the amendment to the compensation regulations come into effect, the annual remuneration and participation remuneration of the directors who are not outside directors will be updated to the maximum permitted amount in accordance with the revised remuneration regulations. In accordance with the decisions of the Company’s audit committee and board of directors, commencing from March 6, 2008, the outside directors are eligible for annual remuneration and participation remuneration at the maximum amount permitted under the revised remuneration regulations. In addition, two directors of the Company (with the exception of the chairman of the board of directors) serve on the board of directors of Carmel Olefins.
C-94 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 28 – RELATED AND INTERESTED PARTIES (CONTD.)
D. Benefits for key management personnel (including directors) (contd.) Compensation for directors and managers: (contd.) 2. On September 23, 2007 and April 28, 2008, the general meeting of the Company (after the approval of the Company’s audit committee and board of directors) approved the terms of employment of the chairman of the board of the Company, as follows: 1) His monthly salary will be NIS 75,000, commencing on July 1, 2007 and will be linked to the increase in the CPI. (2) the fringe benefits will be in line with those of the senior executives of the Company, including payment of an education fund and social benefits, vacation, convalescence, and reimbursement of telephone expenses; (3) the company will place at the disposal of the chairman of the board a car that is appropriate for his position at the Company, together with a driver; (4) the term of employment of the chairman of the board is for a period of three years. If the chairman requests to terminate his tenure, he will give six months notice. (5) At the end of this period, the employment agreement between the chairman and the Company will continue until either of the parties submits six months notice to the other. (6) After termination of his employment, the chairman will be entitled, in addition to possession of the compensation fund under the agreement, to additional severance compensation of 100% of his last salary. (7) The Chairman will be permitted to engage in other endeavors unrelated to his tenure at the Company (including for remuneration), provided that the number of hours he devotes to his work at the Company is not less than a 2/3 position. The employment agreement of the chairman includes his undertaking to confidentiality and non-competition for six months after severance. 3. From September – November 2007, the CEO of the Company, CEO of the trade segment, CEO of the refining segment and the CFO were employed under new employment agreements regulating their salary conditions and incidental conditions for the period of the employment, which is unlimited in time. 4. On January 1, 2009, CFO Jacob Hirsh announced his resignation. Igal Salhov, who had served up to that date as CFO at Carmel Olefins (held 50% by the Company) was appointed in his place. 5. At the beginning of 2009, as part of the Company’s efficiency plan, the chairman of the board, CEO and other officers in the Company have announced their intention to take a 10% reduction on the salary due to them in 2009 (with the exception of provisions and incidental conditions) in 2009. In addition, the Company’s directors, including the outside directors, announced their intention to take a 10% reduction on the directors’ remuneration due to them in 2009. E. In 2007, the Company allotted options warrants to officer holders for the Company’s ordinary shares. See Note 21(F) below. F. On October 8, 2007, the audit committee and board of directors of Carmel Olefins approved an amendment to the employment conditions of the chairman of Carmel Olefins. In accordance with this approval, the chairman will be entitled to a monthly salary of NIS 70,000 (linked to the CPI of August 2007), plus social benefits and reimbursement of expenses in the amount of NID 25,000 plus VAT. The chairman will also be entitled to a bonus as approved by the board of directors of Carmel Olefins and its certified organs. This agreement is effective retroactively from January 1, 2007. Between October and December 2007, these conditions were approved by all the relevant entities as required by the law.
C-95 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 28 – RELATED AND INTERESTED PARTIES (CONTD.)
G. The Company has an insurance policy covering indemnification of its directors and senior officers, with a liability limit of $130 million per event and per period. In addition, on June 28, 2007, the Company purchased a run-off policy with a liability limit of $130 million for a period of six to seven years to cover claims in respect of acts which took place until that date. The Company undertook in advance to indemnify directors and senior officers who served at the Company during the period commencing seven years prior to the publication of the procedure for the sale of the shares of the State of Israel and the Company in ORA or during part of that period, in respect of acts performed by them as part of their jobs deriving from the sale of ORA and in respect of environmental issues, in accordance with the terms set out in the undertakings given. On January 14, 2007, the board of directors approved and on February 7, 2007, the general shareholders meeting ratified the advance undertakings to indemnify directors and senior officers as set out above, for actions performed by them by virtue of their jobs in respect of the privatization of the Company, or by virtue of their being senior officers that were appointed by the Company to serve in other companies in which the Company has a holding of at least 20%. The total commitment to indemnify, as above, shall not exceed 25% of the Company’s shareholders’ equity as of December 31, 2005, linked to the CPI of December 2005. On November 8, 2007, following the approval of the audit committee and the board of directors, the general shareholders meeting of the Company decided to expand the coverage of the directors and senior officers liability policy such that the policy also covers the public placement of debentures. H. On October 24, 2007, the audit committee and the board of directors approved, and on November 8, 2007 the general shareholders meeting of the Company ratified the granting in advance of an exemption to directors and senior officers regarding their liability for damages as a result of a breach of their fiduciary duty towards the Company, subject to the provisions of the Companies Law, and the granting of a writ of undertaking to indemnify directors and senior officers of the Company, whereby, subject to the terms set out in the writ of undertaking and the Companies Law, the Company undertook to indemnify all senior officers for any indebtedness or expense as detailed below placed on them or incurred by them as a result of acts they performed or will perform by virtue of their being senior officers of the Company or senior officers of another company (including actions prior to the date of the writ of undertaking), connected directly or indirectly to one or more events set out in the addendum to the writ of undertaking, which the board of directors of the Company determined to be expected in view of the activity of the Company at the time of the granting of the writ of indemnification, or any part of them or anything related to them, directly or indirectly, on condition that the maximum amount of the indemnification does not exceed an amount of NIS 731.5 million. The undertaking to indemnify senior officers under this paragraph shall apply (a) in respect of any monetary indebtedness placed on a senior officer in Israel and/or abroad in favor of a person and/or other entity as the result of a court ruling, including a court ruling rendered as part of a compromise or the ruling of an arbitrator, approved by a court of law: (b) reasonable litigation expenses, including attorney fees expended by the senior officer as the result of an investigation or proceeding conducted against him by an authority authorized to conduct an investigation or proceeding and which ended without an indictment being served against him and without a monetary indebtedness being placed on him in lieu of a criminal proceeding, or ended without an indictment being served against him but with a monetary indebtedness being placed on him in lieu of a criminal proceeding for a crime which does not require proof of criminal intent, as detailed in article 260(1A) of the Companies Law; (c) and in respect of all reasonable litigation expenses including attorney fees that the senior officer expended or which a court found against him for costs as part of a proceeding instituted against him by the Company or on its behalf or by a person and/or another entity, or in a criminal indictment of which he will be acquitted or in a criminal indictment of which he was convicted for a crime that does not require criminal intent.
C-96 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 28 – RELATED AND INTERESTED PARTIES (CONTD.)
I. Agreement for management of Carmel Olefins In 2004, an agreement was signed among the Company, Israel Petrochemical Enterprises, and Carmel Olefins (“ the agreement"), the major provisions of which are as follows: (1) Investments: Carmel Olefins will expand its polypropylene plant. The Company undertook to supply Carmel Olefins with the raw materials needed for production at the polypropylene plant following the expansion, for a period of 10 years following commencement of operations, in accordance with the terms stipulated in the agreement. (2) Feedstock and returned material: an agreement regarding feedstock and by-products, from 1997, will continue to apply between the Company and Carmel Olefins, for an additional period of seven and a half years from June 1, 2003, in accordance with agreed-upon changes to commence in the middle of 2006. (3) Dividend: Commencing from 2003, Carmel Olefins’ permanent dividend policy will be to distribute annually the balance of its cash deriving from current operations during the same year, less self-financed investments, subject to the provisions of any applicable laws and to various restrictions stipulated in the agreement. Notwithstanding the above, it was stipulated in the agreement that Carmel Olefins would distribute a dividend every year, at a rate of between 35% and 70% of its annual income. (4) Management fees: Further to the existing management agreement, and in view of the expansion of services in the period 2003 - 2006, additional management fees will be added to the existing management fees of $1.25 million, in an amount equal to 0.5% of the revenues of Carmel Olefins, payable to each of the parties, but not to exceed the shekel equivalent of an additional $1.25 million to each of the parties. (5) Waiver of claims: The agreement settles all of the disputes that have arisen between the parties and stipulates that upon the agreement’s coming into force, the parties mutually waive all of the claims they have against each other. J. Agreement for the purchase of Carmel Olefins shares On June 24, 2008, the Company signed an agreement with IPE. The general meeting of the company's shareholders approved the agreement on August 13, 2008. Under the agreement, IPE will sell the Company all the shares it owns in Carmel Olefins, comprising 50% of the issued share capital of Carmel Olefins (“the acquired Carmel Olefins shares”) such that following the acquisition, the Company will hold the full issued share capital of Carmel Olefins. In consideration for the allotment of the Company’s ordinary shares, constituting (after the allotment and without dilution) 20.53% of the Company’s issued share capital and its voting rights. It was further agreed that the Company would sell IPE all of itd shares in IPE (“the acquired IPE shares”), representing 12.29% of the share capital of IPE, in consideration for $40 million. As the main reasons at the basis of the board’s resolution to approve the merger of Carmel Olefins with the Company are still valid today, the Company and IPE agreed to continue to cooperate with the aim of trying to complete the merger, and when the terms are ripe, the matter will be presented to the organs of the Company.
C-97 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 28 – RELATED AND INTERESTED PARTIES (CONTD.)
K. In the course of its business, the Company engages in transactions with related parties, including companies controlled by the controlling shareholder, primarily in purchase and selling agreements of industrial and logistics products and services that are part of the operations of the Company's plants. In general, these transactions are not material for the Company, both quantitatively and qualitatively, and they are conducted under market conditions. Therefore, the board of directors of the Company determined that an interested party transaction that is not an irregular transaction will be deemed to be insignificant under the following conditions:
1. An agreement for the purchase of products, including raw materials and materials used for production or services, which is for the benefit of the Company, made during the regular course of the Company’s business and under market conditions, with annual expenses that do not exceed 1% of the annual selling cost (cost of sales, refining and services) or operating expenses (sales and marketing expenses and administrative and general expenses), as relevant, in the Company’s consolidated financial statements of the year preceding the date of the agreement, provided the total annual expense from this acquisition does not exceed 3% of the expense.
2. An agreement for the sale of products, including raw materials and materials used for production or services, which is for the benefit of the Company, made during the regular course of the Company’s business and under market conditions, with annual revenue that does not exceed 1% of the annual revenue in the Company’s consolidated financial statements of the year preceding the date of the agreement, provided the total annual revenue from this sale does not exceed 3% of the revenue.
3. An agreement for the joint purchase of services or products from a third party, together with the controlling shareholder, with controlled companies, which is for the benefit of the Company, made during the regular course of the Company’s business and under market conditions, and the audit committee of the Company determined that distribution of the costs and expenses in the agreement is fair and equal under the circumstances, and the total annual expense for the agreement does not exceed 1% of the selling cost or annual operating expenses, as relevant, in the Company’s consolidated financial statements of the year preceding the date of the agreement, provided the total annual expense from this sale does not exceed 3% of the expenses. The board of directors further decided that the market conditions in respect of these transactions will be compared to other transactions that are as similar as possible to those in which the Company engages and to the same type of transactions that are made in the market.
C-98 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 29 – SEGMENT REPORTING
Up to the end of 2007, the Company was involved in three areas of operations, which are reported as business segments in the Company’s financial statements: refining, polymers (through Carmel Olefins) and aromatics (through Gadiv). On November 6, 2007, the board of directors of the Company adopted a strategic plan that includes a decision to adapt the Company’s organizational structure to the objectives of the strategic plan and to form three managerial-business segments as described below, designed to achieve rapid growth in the Company’s core businesses and additional synergetic businesses. In accordance with this decision, commencing from the first quarter of 2008, the Company has three fields of operations, reported as business segments in its financial statements, as follows: Refining: This is the Company’s principle field of operations. As part of its operations in this field, the Company purchases crude oil and interim materials, and refines and separates them into end products and raw materials for the manufacture of other products. These operations are performed directly by the Company. As part of its refining operations, the Company sells end and interim fuel products to its customers in Israel and abroad, sells electricity and steam to industrial customers in the Haifa Bay, and supplies infrastructure services (storage, pumping and distribution of fuel products). Petrochemicals: The petrochemicals sector is divided into polymers and aromatics operations. Polymers operations are carried out by Carmel Olefins, (a private company that is proportionally consolidated with the company). Carmel Olefins produces polyethylene and polypropylene, which are the principal raw materials in the plastics industry. It is noted that the management and board of directors of Carmel Olefins are separate from those of the Company and operate independently. Aromatics operations are carried out by Gadiv, (a private company that is wholly-owned by the Company). Gadiv produces aromatic materials, mainly benzene, paraxylene, orthoxylene, and toluene, which are used as raw materials in the manufacture of other products. Trade: In its operations in this segment, the Company is involved in trade in crude oil and its distillates and aromatics, other than for the other fields of operations, and long-term lease of tankers to transport fuel. In addition, the Company’s investees are involved in other operations that are not material to the Company. Most trade operations are integrated vertically into the refining segment. The external trade operations are presented commencing from the first quarter of 2008 as a separate business segment. Operations of the trade segment in prior periods are not material.
C-99 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 29 – SEGMENT REPORTING (CONTD.)
Petrochemicals Adjustments to Refining Trade Polymers Aromatics consolidated Consolidated
Year ended December 31 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 Income from external entities 6,911,565 4,416,518 383,291 - 475,193 342,549 487,409 475,416 - - 8,257,458 5,234,483
Income from sales between segments 706,988 593,438 - - - - 57,033 45,574 (764,021) (639,012) - -
Income from the segment 7,618,553 5,009,956 383,291 - 475,193 342,549 544,442 520,990 (764,021) (639,012) 8,257,458 5,234,483 Operating profit (121,381) 222,305 11,379 - (51,698) 26,712 7,834 34,005 1,532 (1,406) (152,334) 281,616 Financing expenses, net (61,055) (101,923) Company share in the profits (losses) of investees accounted by the equity (3,111) method 6,913 Tax benefits (taxes on income) 107,292 (44,937) Net income (loss), per (109,208) 141,669 annum
C-100 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 29 – SEGMENT REPORTING (CONT’D)
Petrochemicals Adjustments to Refining Trade Polymers Aromatics consolidated Consolidated
Year ended December 31 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 2008 2007 Segment assets 1,710,835 2,337,410 - - 545,413 542,633 222,995 276,845 (109,871) (159,371) 2,369,372 2,997,517 Investment in investees accounted by the equity method ------36,005 53,958 Total assets 1,710,835 2,337,410 - - 545,413 542,633 222,995 276,845 - (159,371) 2,405,377 3,051,475 Segment liabilities 1,523,671 1,953,236 - - 404,479 361,055 35,229 95,753 (109,871) (158,372) 1,853,508 2,251,672 Depreciation 42,114 44,161 - - 26,358 20,967 7,227 7,130 - - 75,699 72,258 Reduction of negative goodwill created upon acquisition - - - - (14,535) - - - - - (14,535) - Share-based payments 3,245 - - - - - 183 - - - 3,428 - Company share in the profits (losses) of investees accounted by the equity method (10,873) 6,913 Tax benefits (taxes on income) 107,292 (44,937) Net income (loss), per annum (116,970)141,669
(*) The assets and liabilities of the refining and trade segment are included in the refining segment.
C-101 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 30—FINANCIAL RISK MANAGEMENT
A. General To reduce the exposure to these risks, the Group uses derivative financial instruments, including forward transactions, interest swap transactions, and principle and interest swap transactions. This Note presents information about the Group’s exposure to each of the above risks, and the Group’s objectives, policies and processes for measuring and managing risk. The risk management of the Group companies is carried out as part of the ongoing management of the companies. The Group companies routinely monitor the scope of the exposure. The boards of directors of the companies discuss the hedging policy for all types of exposure. The board of directors in each of the Group companies has overall responsibility for the Group’s risk management. The board of directors appointed the CFOs of the Group Companies to manage the risks. The finance committee of each company discusses the Company’s risk management on an ongoing basis. The audit committee of the board of directors, in accordance wit6h the work plan defined from time to time, also oversees the management’s monitoring of implementation of the risk management policy of each company in the Group. B. Credit risk Credit risk is the risk of financial loss to the Group if a customer or counterparty to a financial instrument fails to meet its contractual obligations, and arises principally from the Group’s receivables from customers and from investments in securities and derivative transactions. Cash and cash equivalents, short-term deposits and the Group’s short-term marketable investments are mainly deposited in banks and financial institutes in Israel. Marketable securities held by the Group represent mainly corporate debentures in Israel and abroad and government debentures. The Group estimates that the credit risk for these balances is low. The risk management committee determines credit policy according to which the credit quality of each customer is examined separately. The test conducted by the Group includes external credit rating, if any exists, and in certain cases, receiving a reference from the bank. A purchase limit is set for each customer, reflecting the maximum open amount that does not require the approval of the risk management committee. Customers that do not comply with the criteria of the Group regarding credit quality can engage with the Group on the basis of advance payment only. The provision for doubtful debts impairment is determined on a specific basis for debts the collection of which Company management believes to be doubtful. At every balance sheet date, the Group assesses the amount of the provision for doubtful debts. C. Liquidity risk Liquidity risk is the risk that the Company will not be able to meet its financial obligations as they fall due. The Company’s approach to managing liquidity risk is to ensure, as far as possible, the degree of liquidity that is sufficient to meet its liabilities.
C-102 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 30—FINANCIAL RISK MANAGEMENT (CONTD.)
D. Market risks Market risk is the risk that changes in market prices, such as exchange rates, CPI, interest rates and prices of products that will affect the fair value or future cash flows of the financial instrument. In the regular course of business, the Group buys and sells derivatives and takes on financial liabilities to management market risks. The transactions are carried out in accordance with guidelines determined by the Company's board of directors. E. Currency risk The functional currency of the Group is the US dollar. The exposure of the Group companies is measured in relation to changes in the dollar rate and the other currencies in which it operates. The Group is exposed to currency risk due to sales, purchases, current expenses and liabilities denominated in the shekel and in currencies other than the functional currencies of the Group companies. The Group uses forward contracts on exchange rates to hedge currency risks, primarily in the short term, usually up to one year, in order to reduce the risk arising from operations in currencies other than the Company’s functional currency. The Group is exposed to currency risks in respect of the loans it took out and debentures it issued in currency other than the dollar. Principle and interest swap transactions are made for the principle amounts of the debentures and interest hedging to reduce exposure. F. Interest rate risk The Group is exposed to changes in interest rates for loans bearing variable interest and for swap transactions of liabilities in currency other than the dollar liabilities at variable interest. G. Inflation risk The Group companies issued shekel or index-linked debentures. To reduce part of the exposure to changes in the index, the Group uses interest and currency swap transactions (see exchange rate risk management). The Group also hedges against an increase in the index above the expected index at the transaction date by fixing the rate of change to the index. H. Other market price risks The Company uses derivative instruments to reduce exposure to risks of crude oil market prices in order to reduce the exposure to changes in fuel prices on the cash flow in respect of acquisition of fuels designated for ongoing operations in the coming year. The Company does not issue or hold financial instruments for trading purposes. Derivative transactions are carried out with banking institutions and international companies, with attention to the financial robustness of these entities, and therefore the Company believes that no material credit risk exists in respect of such derivatives.
C-103 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 31 - FINANCIAL INSTRUMENTS
A. Exposure to credit risk (1) The book value of the financial assets represents the maximum credit exposure. The maximum exposure to credit risk at the reporting date was:
December 31 2008 2007 USD thousands Current assets Cash and cash equivalents 14,840 259,325 Short-term deposit 25,000 - Derivatives at fair value through profit or loss 15,374 6,513 Investment in financial assets at fair value through profit or loss 101,509 113,035 Trade receivables 253,215 394,470 Other receivables 28,731 24,804 438,669 798,147 Investments and long-term loans Loans 2,606 2,026 Derivatives at fair value through profit or loss 64,369 4,176
66,975 6,202
505,644 804,349
The aforementioned balances are presented under the items of cash and cash equivalents, short- term deposit, trade receivables, other receivables and investments in other financial assets at fair value through profit or loss, loans and derivatives at fair value through profit or loss. (2) The maximum exposure to credit risk for trade receivables, at the balance sheet date, by geographic region was as follows
December 31 2008 2007 Local customers 162,335 263,076 Overseas customers 90,880 131,394 Total customers 253,215 394,470
C-104 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 31 - FINANCIAL INSTRUMENTS (CONTD.)
(3) Aging of debts and impairment losses
December 31 2008 2007 Gross Impairment Gross Impairment Not past due 175,761 - 375,697 - Past due up to six months 74,719 - 14,956 - Past due between six months and one 731 (472) 479 - year Past due more than one year 4,410 (1,934) 5,649 (2,311) 255,621 (2,406) 396,781 (2,311)
The change in the provision for impairment in respect of trade receivables, other receivables and loans granted during the year was as follows:
December 31, 2008 2007 Balance as of 1 January 2,311 1,562 Impairment loss recognized 95 749 Balance as of December 31 2,406 2,311
(4) The credit extended to customers is covered by credit insurance in letters of credit or other securities, such as advance payments, deposits and guarantees from customers. See Note 6 for the sale of the Group’s customer debts as part of the capitalization transaction.
C-105 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 31 - FINANCIAL INSTRUMENTS (CONTD.)
B. Liquidity risk The following are the contractual maturities of financial liabilities, including estimated interest payments. This aging does not include the impact of netting agreements.
December 31, 2008 Expected cash flows Carrying Up to 1 More than amount year 1-2 years 2-3 years 5 years USD thousands Non-derivative financial liabilities Bank overdrafts 28,973 30,712 - - - Loans and credits(*) 351,366 369,108 - - - Trade payables 270,594 270,594 - - - Other payables 57,676 57,676 - - - Debentures 729,824 8,439 37,758 372,334 434,135 Bank loans 235,832 - 97,232 123,374 25,435 Liability in respect of financial lease 8,448 629 629 1,886 23,199 Other long-term balances 7,394 - - 7,870 - 1,690,107 737,158 135,619 505,464 482,769
Financial liabilities - derivatives Forward exchange contracts 1,853 1,227 548 78 -
Interest swaps used for hedging 6,900 - - 6,900 - 8,753 1,227 548 6,978 -
Total 1,698,860 738,385 136,167 512,442 482,769
December 31, 2007 Non-derivative financial liabilities Bank overdrafts 948 986 - - - Loans and credits(*) 215,073 256,701 - - - Trade payables 559,695 559,695 - - - Other payables 77,943 77,943 - - - Debentures 720,723 2,818 34,421 227,255 585,474 Bank loans 454,969 - 134,819 279,889 96,518 Liability in respect of financial lease 7,763 577 577 1,733 21,786 2,037,114 898,719 169,817 508,877 703,778
Financial liabilities - derivatives Forward exchange contracts 1,595 1,595 - - -
Total 2,038,709 900,314 169,817 508,877 703,778
(*) Including current maturities
C-106 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 31 - FINANCIAL INSTRUMENTS (CONT’D)
C. Index and foreign currency risks Exposure to index and foreign currency risks The following table indicates the Group’s exposure to linkage and foreign currency risks, based on notional amounts:
December 31, 2008 NIS Foreign Unlinked CPI-linked currency (*) Total Current assets Cash and cash equivalents 646 - 14,194 14,840 Short-term deposit - - 25,000 25,000 Derivatives at fair value through profit or loss - - 15,374 15,374 Investment in other financial assets through profit or loss 35,465 49,612 16,432 101,509 Trade receivables 79,456 - 173,759 253,215 Other receivables 3,147 22,031 3,553 28,731
Non-current assets Long term loans and debit balances 2,143 - 463 2,606 Derivatives at fair value through profit or loss 150,092 499,951 (585,674) 64,369 Total assets 270,949 571,594 (336,899) 505,644
Current liabilities Bank overdrafts - - (28,973) (28,973) Loans and credit (48,774) (25,174) (277,418) (351,366) Trade payables (27,487) - (243,107) (270,594) Other payables (24,859) (1,422) (31,395) (57,676) Derivatives at fair value through profit or loss (61,629) - 59,776 (1,853)
Non-current liabilities Debentures (131,510) (594,701) (3,613) (729,824) Bank loans - - (235,832) (235,832) Liabilities for finance lease - (8,448) - (8,448) Other long-term liabilities - - (7,394) (7,394) Derivatives at fair value through profit or loss - - (6,900) (6900) Total liabilities (294,259) (629,745) (774,856) (1,698,860)
Net balance (23,310) (58,151) (1,111,755) (1,193,216)
(*) Primarily US dollar
C-107 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 31 - FINANCIAL INSTRUMENTS (CONTD.)
Exposure to index and foreign currency risks (contd.)
December 31, 2007 NIS Foreign Unlinked CPI-linked currency (*) Total Current assets Cash and cash equivalents 99,621 - 159,710 259,331 Derivatives at fair value through profit or loss - - 6,513 6,513 Investment in other financial assets through profit or loss 43,131 63,509 6,395 113,035 Trade receivables 149,826 - 244,644 394,470 Other receivables 1,978 19,958 2,868 24,804
Non-current assets Long term loans and debit balances 1,724 - 302 2,026 Derivatives at fair value through profit or loss - 307,257 (303,081) 4,176 Total assets 296,280 390,724 117,351 804,355
Current liabilities Bank overdrafts - - (948) (948) Loans and credit - (93,821) (121,253) (215,073) Trade payables (136,790) - (422,905) (559,695) Other payables (48,182) (1,421) (28,340) (77,943) Derivatives at fair value through profit or loss (1,595) - - (1,595)
Non-current liabilities Debentures (130,005) (586,262) (4,455) (720,723) Bank loans - - (454,969) (454,969) Liabilities for finance lease - (7,763) - (7,763) Total liabilities (316,572) (689,267) (1,032,870) (2,038,709)
Net balance (20,292) (298,543) (915,519) (1,234,354)
(*) Primarily foreign currency
C-108 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 31 - FINANCIAL INSTRUMENTS (CONTD.)
Information regarding the CPI and significant exchange rates:
Year ended 2008 2007 2008 2007 % of change Reporting date spot rate 1 US dollar 1% 9% 3.802 3.846 1 GBP 28% 7% 5.5481 7.7105 1 euro 6% 2% 5.2973 5.6592 CPI (in points) 4% 3% 117.95 113.63
C-109 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
Sensitivity test A strengthening of the NIS against the following currencies as at December 31, 2008 and an increase in the CPI would have increased (decreased) equity and profit or loss by the amounts shown below. This analysis assumes that all other variables, in particular interest rates, remain constant. The analysis is performed on the same basis for 2007.
Year ended December 31 2008 2007 Increase (decrease in profit for the period)/Increase (decrease) in equity 10% 5% -5% -10% 10% 5% -5% -10% Non-derivative instruments (55,810) (27,905) 27,905 55,810 (62,450) (31,225) 31,225 62,450 Debenture derivative hedging instruments 46,482 23,241 (23,241) (46,482) 30,566 15,283 (15,283) (30,566)
Exchange rate risk 4.1822 3.9921 3.6119 3.4218 4.2306 4.0383 3.6537 3.4614 Non-derivative instruments 60,898 31,899 (35,257) (74,431) 63,773 33,405 (36,921) (77,945) Currency swap USD/EUR (211) (105) 105 218 USD/NIS 5,957 3,120 (3,448) (7,281) (6,856) (3,591) 3,969 8,379
Swapping principal and interest (58,280) (30,339) 33,114 69,466 (27,932) (14,631) 16,171 34,140
A weakening of the NIS against the above currencies and a decrease in the CPI as at December 31 would have had the equal but opposite effect on the above currencies to the amounts shown above, on the basis that all other variables remain constant.
C-110 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
Interest rate risk
(1) Profile At the reporting date the interest rate profile of the Group’s interest-bearing financial instruments was:
Year ended December 31 2008 2007 Book value Book value Fixed rate instruments Financial assets 126,509 113,041 Financial liabilities (747,025) (728,486) (620,516) (615,445)
Variable rate instruments Financial assets 66,975 6,202 Financial liabilities (616,171) (670,990) (549,196) (664,788)
(2) Fair value sensitivity analysis for fixed rate instruments The Group does not account for any fixed rate financial assets and liabilities at fair value through profit or loss, and the Group does not designate derivatives (interest rate swaps) as hedging instruments under a fair value hedge accounting model. Therefore a change in interest rates at the reporting date would not affect profit or loss.
C-111 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 31 - FINANCIAL INSTRUMENTS (CONTD.)
(3) Cash flow sensitivity analysis for variable rate instruments A change of __% in interest rates at the reporting date would have increased (decreased) equity in the amount of $____ (2007: ...... _____). A change of __% in interest rates at the reporting date would have increased (decreased) equity and profit or loss by the amounts shown below. This analysis assumes that all other variables, in particular foreign currency rates, remain constant. The analysis is performed on the same basis for 2007.
December 31, 2008 Profit or loss Shareholders’ equity Increase in Decrease in Increase in Decrease in interest interest interest interest 1% 05% -05% -1%
Non-derivative instruments (6,136) (3,068) 3,068 6,136
Derivative instruments Swapping principal and interest 2,793 1,410 (1,446) (2,924)
December 31, 2007
Non-derivative instruments (66,896) (33,448) 33,448 66,896
Derivative instruments Swapping principal and interest 1,812 915 (938) (1,897)
Fair value compared to carrying amounts The carrying amounts of certain financial assets and liabilities, including cash and cash equivalents, trade receivables, other receivables, other short-term investments, derivatives, bank overdraft, loans and short-term credit, trade payables, other payables and proposed dividend are the same or proximate to their fair value. The fair values of financial assets and liabilities, together with the carrying amounts shown in the balance sheet, are as follows:
December 31 2008 2007 Carrying Carrying amount Fair value amount Fair value 729,824 700,373 720,723 826,462
The basis for determining fair value is disclosed in Note 2.
C-112 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 31 - FINANCIAL INSTRUMENTS (CONTD.)
Interest rates used for determining fair value The interest rates used to discount estimated cash flows, when applicable, are based on the government yield curve at the reporting date plus an adequate credit spread, and were as follows:
December 31 % 2008 2007 Non-current liabilities Debentures 2% - 8% 3% - 8%
C-113 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 32 - CONDENSED FINANCIAL DATA ON STAND-ALONE BASIS
Presented hereunder are condensed financial data based on the separate financial statements of the Company (“the stand-alone financial statements”), which are presented in accordance with FAQ 11 of the Securities Authority regarding the attachment of stand-alone financial statements to financial statements prepared in accordance with IFRS. The accounting policies described in Note 3 on the significant accounting policies were applied in the preparation of this condensed note, other than that described hereunder: A. Measurement of investments in investees The Company accounts for its investments in subsidiaries, jointly controlled entities and affiliates according to the cost model and according to IAS 27, by which a dividend received from subsidiaries, jointly controlled entities and affiliates will be recognized as revenue in the stand-alone financial statements of the holding company. B. Determination of the carrying value of investments in investees on the date of transition to IFRS. The Company has elected to implement the instruction of revised IFRS 1, by which a company that has elected the cost model for measuring investments in subsidiaries, jointly controlled entities and affiliates may measure these investments in the stand-alone financial statements on the date of transition to IFRS at deemed cost, which is the fair value or carrying value in accordance with previous GAAP. Accordingly, a company is required to reflect their value as suppliers in accordance with previous GAAP. Presented hereunder is the aggregate amount of investments in investees according to deemed cost:
January 1, 2007 Total investments presented at deemed cost – carrying value in accordance with previous GAAP 327,181
C-114 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 32 - CONDENSED FINANCIAL DATA ON STAND-ALONE BASIS (CONTD)
C. Balance sheet
December 31 2008 2007
Assets Cash and cash equivalents 10,755 240,333 Short-term deposit 25,000 - Derivatives at fair value through profit or loss 14,046 6,513 Investment in other financial assets at fair value through profit or loss 101,509 113,035 Trade receivables 188,448 327,625 Other receivables 72,279 71,285 Inventory 511,242 961,663 Current tax assets 44,114 10,486 Total current assets 967,393 1,730,940
Investments and long-term loans Investments in investees accounted by the equity method 315,195 325,258 Loan to Haifa Early Pensions Ltd. 84,740 80,038 Long term loans and debit balances 1,509 1,398 Derivatives at fair value through profit or loss 48,512 2,571 Employee benefit plan assets 2,595 3,264 452,551 412,529
Fixed assets 602,394 516,919
Intangible assets and deferred expenses, net 3,692 2,280
Total non-current assets 1,059,326 931,728
Total assets 2,026,030 2,662,668
C-115 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 32 - CONDENSED FINANCIAL DATA ON STAND-ALONE BASIS (CONTD.)
C. Balance sheet (cont’d)
December 31 2008 2007
Current liabilities Loans and credit 275,040 274,682 Trade payables 243,974 532,830 Other payables 58,832 75,702 Derivatives at fair value through profit or loss 1,853 - Provisions 8,991 13,643 Total current liabilities 588,690 896,857
Non-current liabilities Debentures 606,173 603,268 Bank loans 231,549 316,926 Liabilities for finance lease 8,448 7,763 Derivatives at fair value through profit or loss 6,900 - Employee benefits 54,990 56,162 Liabilities for deferred taxes 26,921 72,260 Total non-current liabilities 934,981 1,058,379 Total liabilities 1,523,671 1,953,236
Shareholders’ equity Share capital 472,478 472,478 Capital reserves 27,374 23,946 Retained earnings 2,506 213,008 Total equity attributed to equity holders of the Company 502,359 709,432
Total liabilities and capital 2,026,030 2,662,668
C-116 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 32 - CONDENSED FINANCIAL DATA ON STAND-ALONE BASIS (CONTD.)
D. Statement of Income
The year ended December 31 2008 2007
Revenue 8,001,844 5,009,956
Cost of sales, refinery and services 8,063,800 4,696,685 Revaluation of open positions in derivatives on prices of goods and margins, net (7,465) 13,626 Total cost of sales 8,056,335 4,710,311
Gross profit (loss) (54,491) 299,645
Selling expenses (4,671) (3,514) General and administrative expenses (50,840) (50,437) Privatization grant - (23,388) Other income 5,332 24,056 Other expenses (11,038) - Operating profit (loss) (115,708) 246,362
Financing revenue 62,243 9,787 Financing expenses (115,501) (90,730) Financing expenses, net (53,258) (80,943)
Profit (loss) before taxes on income (168,966) 165,419
Tax benefits (taxes on income) 88,272 (42,143)
Net profit (loss) for the period (80,694) 123,276
Earnings (loss) per share
Net basic and diluted earnings (losses) per ordinary share (in USD) (0.040) 0.062
E. Statement of Recognized Income and Expense
Year ended December 31 2008 2007
Actuarial gains (losses) from a defined benefit plan, net (8,482) 5,231
Other total income for the period, net of tax (8,482) 5,231
Income (loss) for the period (80,694) 123,276
Total income for the period attributed to the equity holders of the Company (88,176) 128,507
C-117 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 32 - CONDENSED FINANCIAL DATA ON STAND-ALONE BASIS (CONTD.)
F. Statements of cash flows
The year ended December 31 2008 2007
Cash flows from operating activities Profit (loss) for the period (80,694) 123,276 Adjustments: Depreciation and amortization 42,114 44,161 Financing expenses, net 59,733 90,108 Changes in fair value of derivatives (7,533) 12,157 Changes in the fair value of the loan to Haifa Early Pensions Ltd. (6,009) (8,408) Gain on securities classified as held-for-trading 13,164 (14,870) Employee benefits, net (11,982) (6,499) Share-based payment expenses 3,245 558 Income tax benefit expenses (revenue) (88,272) 42,143 Impairment of investment in an investee 11,038 - 15,498 159,350
Change in inventory 450,422 (364,498) Change in trade and other receivables 137,344 76,907 Change in trade and other payables (320,013) 83,228 267,753 (204,363)
Income tax received (paid), net 12,937 (125,989)
Net cash flows from operating activities 215,494 (47,726)
Cash flow for investing activities Interest received 1,810 3,066 Investment in deposit (25,000) - Investment in investees (796) - Repayment (granting) of long-term loans from others, net 3 (71,663) Repayment of loan from a subsidiary 1,921 2,559 Purchase of securities held for trading (150,000) - Sale of securities held for trading 148,362 - Purchase of fixed assets (117,517) (43,287) Purchase of intangible assets and deferred expenses (1,608) (1,043)
Net cash used for investing activities (142,825) (110,368)
C-118 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 32 - CONDENSED FINANCIAL DATA ON STAND-ALONE BASIS (CONTD.)
F. Statements of cash flows (contd.)
The year ended December 31 2008 2007
Cash flow from financing activities Receipt (repayment) of short-term credit 82,784 743 Receipt of deposits from customers, net 989 8,032 Interest paid in cash less proceeds from transactions in derivatives (62,858) (55,466) Proceeds from issuing debentures - 472,794 Repayment of debentures (104,184) (22,529) Payment of issuance expenses for interested parties - (1,045) Receipt (repayment) of loan from a subsidiary (203) 26,996 Bank loans received - 30,000 Repayment of bank loans (98,897) (119,720) Privatization grant - 23,388 Dividends paid (121,325) (74,144)
Net cash from (used for) financing activities (303,694) 289,049
Net increase (decrease) in cash and cash equivalents (231,025) 130,955
Effect of fluctuations in exchange rate on cash and cash equivalents 1,453 (11,766) Cash and cash equivalents at the beginning of the year 240,333 121,144
Cash and cash equivalents at the end of the year 10,755 240,333
C-119 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 32 - CONDENSED FINANCIAL DATA ON STAND-ALONE BASIS (CONTD.)
G. Changes in equity Capital reserve Capital share-based Capital Retained reserve payment reserve earnings Total Year ended December 31, 2008
Balance on January 1, 2008 472,478 558 23,388 213,008 709,432 Total income for the period - - - (89,176) (89,176) Dividend declared and paid - - - (121,325) (121,325) Share-based payment - 3,428 - - 3,428 Balance on December 31, 2008 472,478 3,986 23,388 2,507 502,359
Year ended December 31, 2007
Balance on January 1, 2007 239,819 - - 387,615 627,434 Total income for the period - - - 128,507 128,507 Payment of issuance expenses to controlling shareholders - - - (1,045) (1,045) Payment of privatization grant to employees of the Company - - 23,388 - 23,388 Distribution of bonus shares 232,659 - - (232,659) - Dividend declared and paid - - - (69,410) (69,410) Share-based payment - 558 - - 558 Balance on December 31, 2007 472,478 558 23,388 213,008 709,432
NOTE 33 – IMPACT OF TRANSITION TO IFRS
A. General As noted in Note 2(A) above, these are the first annual consolidated financial statements that the Group has prepared in accordance with IFRS. The accounting policy described in Note 3 was applied when preparing the consolidated financial statements for the year ended January 31, 2008, the comparative data for year ended December 31, 2007 and the opening balance sheet according to IFRS on January 1, 2007 (“the transition date”). This note was presented on the basis of IFRS principles as currently known, which were issued and will come into effect or that are subject to early adoption as of the first annual reporting date of the Group in accordance with IFRS, December 31, 2008, on the basis of which the Company's accounting policies were determined. An explanation of the effect of the transition from Israeli GAAP to IFRS on the financial position of the Group, the results of its operations and its cash flows is presented in the following tables and notes.
C-120 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 33 - EFFECT OF THE TRANSITION TO IFRS (CONTD.
B. Balance sheet
January 1, 2007 Impact of change of Israeli functional Impact of GAAP currency to USD transition IFRS NIS USD USD USD Note thousands thousands* thousands thousands Current assets
Cash and cash equivalents 523,570 123,921 - 123,921 Investment in financial assets at fair value - through profit or loss 414,749 98,165 98,165 Trade receivables 2,175,459 514,902 - 514,902 Other receivables 4,8 446,010 104,716 5,813 110,529 Income tax 8,691 2,057 - 2,057 Inventory 4 2,813,392 664,346 (9,658) 654,688
6,381,871 1,508,107 (3,845) 1,504,262 Investments and long-term loans
Investment in equity-accounted investees 13 191,002 52,864 4,826 57,690 Long term loans and debit balances 7,409 1,755 - 1,755 Employee benefit plan assets 2 45,458 10,759 (2,937) 7,822 243,869 65,378 1,889 67,267
Fixed assets, net 3,5,6,7 3,827,045 883,519 75,003 958,522
Intangible assets and deferred expenses, net 7 48,100 10,678 1,998 12,676
10,500,885 2,467,682 75,045 2,542,727 Current liabilities Credit from banking institutions and other - credit providers 899,142 212,815 212,815 Trade payables 2,214,883 524,233 - 524,233 Other payables 2,4 614,961 145,407 (12,570) 132,837 Provisions 87,785 20,778 - 20,778 Income tax 82,563 19,542 - 19,542 Dividend declared 20,000 4,734 - 4,734
3,919,334 927,509 (12,570) 914,939
Long term liabilities Debentures 854,799 202,319 - 202,319 Bank loans 2,205,647 522,047 - 522,047 Deferred taxes 8 498,352 112,827 11,309 124,136 Liabilities for finance lease 29,275 6,929 - 6,929 Employee benefits 2 278,801 65,988 12,046 78,034
3,866,874 910,110 23,355 933,465
Total liabilities 7,786,208 1,837,619 10,785 1,848,404 Shareholders’ equity Share capital 919,650 239,819 - 239,819 Adjustments for translation of financial 103 statements of autonomous units (435) (103) - Retained earnings 1,795,462 390,347 64,157 454,504 2,714,677 630,063 64,260 694,323
10,500,885 2,467,682 75,045 2,542,727
* See Note (E) (1) below
C-121 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 33 - EFFECT OF THE TRANSITION TO IFRS (CONTD.)
C. Balance sheet
December 31, 2007 Impact of change of Israeli functional Impact of GAAP currency to USD transition IFRS NIS USD USD USD Note thousands thousands* thousands thousands Current assets
Cash and cash equivalents 997,363 259,325 - 259,325 Derivatives at fair value through profit or loss 25,049 6,513 - 6,513 Investment in financial assets at fair value through profit and loss 434,734 113,035 - 113,035 Trade receivables 1,517,130 394,470 - 394,470 Other receivables 4,8 322,503 82,699 (6,318) 76,381 Income tax 39,046 10,153 - 10,153 Inventory 4 4,148,554 1,054,976 (12,431) 1,042,545
7,484,379 1,921,171 (18,749) 1,902,422
Investments and long-term loans
Investment in equity-accounted investees 13 160,066 49,143 4,815 53,958 Loan to Haifa Early Pensions Ltd. 307,827 80,038 - 80,038 Long term loans and debit balances 7,791 2,026 - 2,026 Derivatives at fair value through profit or loss 4 9,499 2,470 1,706 4,176 Employee benefit plan assets 2 37,089 9,644 (2,125) 7,519 522,272 143,321 4,396 147,717
Fixed assets, net 3,5,6,7 3,870,594 898,272 80,450 978,722
Intangible assets and deferred expenses, net 7 89,814 20,618 1,996 22,614
11,967,059 2,983,382 68,093 3,051,475 Current liabilities Credit from banking institutions and other credit - providers 830,818 216,021 216,021 Trade payables 2,152,587 559,695 - 559,695 Other payables 2,4 371,312 98,103 (9,283) 88,820 Provisions 60,294 15,677 - 15,677 Financial liabilities at fair value through profit or loss - - 1,595 1,595 3,415,011 889,496 (7,688) 881,808 Long term liabilities Debentures 2,758,742 717,302 - 717,302 Bank loans 1,738,983 452,154 - 452,154 Deferred taxes 8 563,569 116,884 8,403 125,287 Liabilities for finance lease 29,857 7,763 - 7,763 Employee benefits 2 222,703 57,905 9,453 67,358 5,313,854 1,352,008 17,856 1,369,864 Total liabilities 8,728,865 2,241,504 10,168 2,251,672
Shareholders’ equity Share capital 2,000,000 472,478 - 472,478 Capital reserves 114,564 29,036 - 29,036 Dividend declared subsequent to the balance sheet date 240,000 62,402 (62,402) - Retained earnings 883,630 177,962 120,327 298,289 3,238,194 741,878 57,925 799,803 11,967,059 2,983,382 68,093 3,051,475
* See Note (E) (1) below
C-122 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 33 - EFFECT OF THE TRANSITION TO IFRS (CONTD.)
D. Statements of income
December 31, 2007 Impact of change of Israeli functional Impact of GAAP currency to USD transition IFRS NIS USD USD USD Note thousands thousands* thousands thousands
Revenue 21,339,364 5,234,483 - 5,234,483
Cost of sales, refinery and services 2,4,5,6 19,843,713 4,813,786 2,725 4,816,511 Revaluation of open transactions in derivatives on prices of goods and margins, net - - 13,626 13,626 Total cost of sales 19,843,713 4,813,786 16,351 4,830,137
Gross profit 1,495,651 420,697 (16,351) 404,346
Selling expenses 137,077 35,010 - 35,010 General and administrative expenses 3 276,802 59,240 120 59,360 Privatization grant 9 - - 28,360 28,360
Operating profit 1,081,772 326,447 (44,831) 281,616
Financing revenue 4 25,537 23,416 1,706 25,122 Financing expenses 2 (75,090) (126,190) (855) (127,045) Privatization grant 9 (117,833) (28,360) 28,360 - Company's share in earnings of investees - - 6,913 6,913
Profit before income tax 2,4,5,6 914,386 195,313 (8,707) 186,606
Tax benefits (taxes on income) (241,653) (49,003) 4,066 (44,937)
Earnings after taxes on income 672,733 146,310 (4,641) 141,669
Company's share in earnings of investees 19,833 6,875 (6,875) -
Net profit for the year 692,566 153,185 (11,516) 141,669
Earnings per ordinary share
Basic and diluted earnings per ordinary share 0.346 0.077 (0.006) 0.071
* See NOTE E (1) below
C-123 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 33 - EFFECT OF THE TRANSITION TO IFRS (CONTD.)
E. Notes to IFRS reconciliation 1. In accordance with Israeli GAAP, functional currency can be other than the NIS only if most of the income is received and most of the assets are purchased in that other currency. In accordance with IFRS, the entity has to take into consideration, inter alia, the following factors when it determines its functional currency: The currency that affects mainly the sale price of goods and services (usually this will be the currency in which the sale prices are denominated and settled) and the currency of the country whose competitive and regulatory forces mainly determine the sale prices of goods and services. The currency that primarily affects mainly the costs of labor, materials, and other costs incurred in the supply of goods and services (this will usually be the currency in which the selling prices of the goods and services are denominated and settled). Furthermore, there are additional matters that may indicate the entity’s functional currency, such as the currency in which financial resources from financing activities are generated and the currency in which receipts from operating activities are normally retained. In accordance with Israeli GAAP, the functional currency of the Company is the NIS, whereas in accordance with IFRS its functional currency is the US dollar. 2. In accordance with Israeli GAAP, liabilities for employee severance benefits are recognized on the basis of the full liability, assuming that all the employees will be dismissed at conditions entitling them to the full amount of severance pay, without taking into account discount rates, future salary raises and future employee turnover. Furthermore, liabilities for paid vacation and sick leave are calculated on the basis of estimates of utilization and redemption, respectively. At the date of transition to IFRS, all of the net liabilities in respect of benefits to employees after termination and other long-term benefit plans are measured in accordance with the provisions of IAS 19 regarding employee benefits. on the basis of actuarial estimates and discounted amounts. The discount rate used is based on the interest rate of government bonds since the Company believes that there is no high quality deep market for corporate bonds in Israel. This issue will be subjected to an in-depth study by a task force of the Israel Securities Authority, so it is possible that a decision on the issue will be made that is different than the accounting in the financial statements. The Company elected to recognize actuarial gains and losses directly to shareholders' equity (retained earnings), pursuant to the existing alternatives in IAS 19, since under this alternative, the balance sheet reflects the proper fair value of the net liability to employees as of the cutoff date and, in accordance with this alternative, the income statement more fairly reflects the results of operations of the Company by avoiding volatility in respect of actuarial gains and losses. 3. In accordance with Israeli GAAP, buildings leased from the State were presented as a transaction with an interested party. The financial leasing transaction with a controlling shareholder was recorded as a long-term financial liability and, accordingly, the difference between the liability for minimum leasing fees and the cost of the buildings on the books was carried to a capital reserve. In accordance with IFRS, the leasing of the buildings was recognized as a financial lease. In accordance with IFRS, a finance lease liability is recorded against an asset - buildings (and not against capital reserve), in an amount equal to the present value attributed to the buildings. Therefore, the buildings were recorded in the books of the Company based on the minimum leasing fee.
C-124 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 33 - EFFECT OF THE TRANSITION TO IFRS (CONTD.)
E. Notes to IFRS reconciliation (contd.) 4. The Group companies use financial instruments, including derivative financial instruments, to reduce exposure to the risks of the prices of goods, currency risks and interest risks. In accordance with GAAP, the conditions for applying hedge accounting are based mainly on economic criteria. Furthermore, under certain circumstances, derivative financial instruments qualifying as an accounting hedge are not measured according to fair value and sometimes are not even recognized in the balance sheet. In accordance with IFRS, a transaction in financial instruments has to meet a number of conditions so that it may be considered an accounting hedge, including conditions regarding the designation of the instruments, compliance with strict documentation requirements and high effectiveness of the hedge at the beginning and during the entire hedge. Changes in the fair value of a financial instrument designated as a hedge for an asset or liability will be recognized in the statement of income concurrently with recognizing the changes in the fair value of the hedged asset or liability that are associated with the hedged risk. In addition, under IFRS, changes in the fair value of derivative financial instruments that do not fulfill the conditions required for hedge accounting are immediately charged to the statement of income in each period. The transactions the Company executes in financial instruments for the purpose of reducing exposure, as aforementioned, do not meet the hedge conditions provided in international standards, and therefore, upon the transition to IFRS, the said financial instruments are measured according to fair value and the changes in fair value are immediately recognized in profit or loss. Changes in the fair value of the derivatives on prices of goods and refining margins are classified in a separate item as part of cost of sales, whereas changes in the fair value of derivatives on exchange rates and interest rates are classified as financing expenses. 5. In accordance with the leniency permitted by the provisions of IFRS 1, Carmel Olefins elected to measure fixed asset items (property, buildings, machinery and equipment) at their fair value as of January 1, 2007 and to use the same fair value as deemed cost as of the transition date. The deemed cost was based on the opinion of an external expert. In addition, the useful life of some of the assets was changed (see paragraph 6 below).
6. Change in the estimate of the useful life of Fixed assets. IAS 16 Fixed assets stipulates that the useful life of an asset be reviewed at least at the end of each fiscal year and if the expectations are different from the previous estimates, the change should be handled as a change in accounting estimate in accordance with IAS 8 Accounting Policy, Changes in Accounting Estimates and Errors. In October 2007, the Israel Securities Authority issued decision 3-17 regarding a change in the estimate of the useful life of Fixed assets (“the Authority's decision”). The authority's decision applies to financial statements presented in accordance with IFRS. According to the Authority's decision, a change in estimate of the useful life of an asset may be based on the accumulated experience of the company regarding the same asset, if the company has concrete and reliable evidence in support of making such a change. In 2007, the companies of the Group, through an external appraiser of industrial matters, assessed the useful life of certain production facilities. According to the opinion of the appraiser, further to renovations and steps taken for purposes of extending the lifespan of the facilities, there was a change in the estimate of the economic life of those production facilities, and their average useful life was extended by 10 to 20 years.
C-125 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 33 - EFFECT OF THE TRANSITION TO IFRS (CONTD.)
E. Notes to IFRS reconciliation (contd.) 6. (contd.) The reason for the change in estimate rests with a basic change in the treatment by the companies of the Group for maintenance of their facilities and their approach to the periodic maintenance. To the extent that this deals with maintenance, the companies made a transition from maintenance that is basically corrective maintenance (repair) to maintenance that is basically preventive maintenance. Contrary to the past, in recent years extensive maintenance work is carried out in advance, on the basis of examinations conducted at the facilities, all in order to reduce to a minimum the cases in which facilities will be shut down due to malfunction As part of the maintenance work, tanks and major equipment are replaced when they appear to be "old" or may fail, or when the new equipment allows for significant technological improvement. Regarding periodic maintenance - most of the facilities of the Company undergo periodic maintenance every four years. In recent years, as part of the periodic maintenance, major equipment items were replaced, entire tanks were replaced in the facility instead of partial repairs to a tank that appeared to be damaged or "tired", and backup systems were pressed into service in the event of damage to a main system at the facility, as well as to improve the utilization or consumption of energy. The changes in the maintenance policy and in the manner in which the renovations are performed are material changes in the manner of operations of the companies of the Group, which improve the facilities and significantly change the estimate regarding the life that was estimated by the Company in the past (in 1997), based on the manner of treatment of the facilities at that time. 7. In accordance with Israeli GAAP, leased property is classified as Fixed assets and is not depreciated. In accordance with IFRS, in cases in which such property is not considered to be owned by the Company, the leasing payments are classified as a deferred expense and are amortized over the leasing period, including an option to extend the leasing period, if at the date of the leasing transaction it is reasonably certain that the option will be exercised. 8. In accordance with Israeli GAAP, deferred tax assets are classified as current assets or non- current assets, depending upon the classification of the assets for which the deferred taxes were generated. In accordance with IFRS, deferred tax assets are classified as non-current assets even if the date of utilization is expected to be in the short term. 9. In accordance with Israeli GAAP, earnings and losses on the sale of Fixed assets and expenses in respect of reorganization, early retirement and the privatization grant were not presented as part of operating income (as part of other income/expenses). In accordance with IFRS these items will be included as part of operating income. 10. According to the leniency permitted by the provisions of IFRS 1, translation differentials generated prior to the date of transition to IFRS in respect of foreign operations are carried to retained earnings on the date of transition to IFRS. 11. In the absence of specific instructions in IFRS, the Company elected to carry the increase in shareholders' equity in respect of the recording of share-based payment expenses to retained earnings.
C-126 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 33 - EFFECT OF THE TRANSITION TO IFRS (CONTD.)
E. Notes to IFRS reconciliation (contd.) 12. In accordance with Israeli GAAP, a dividend proposed subsequent to balance sheet date and before the date of authorizing the financial statements was presented under shareholders’ equity as a separate item “Dividend proposed or declared subsequent to balance sheet date” against a decrease in retained earnings. In accordance with IFRS, such a dividend only requires disclosure and does not require any equity classification.
13. Accounting of jointly-controlled entities: In accordance with Israeli GAAP, entities in which the Company has joint control are presented according to the proportionate consolidation method. In accordance with IFRS, the investments in such entities may be presented according to the proportionate consolidation method or on the equity basis. The Company has chosen to present its investments in jointly controlled entities on the equity basis, in order to fairly reflect the calculation of the assets and liabilities and the results of operations of the jointly-controlled entities.
14. Accounting of business combinations: The Company did not retroactively apply IFRS 3 Business Combinations. Therefore, goodwill and surplus cost generated by business combinations that occurred prior to January 1, 2007 were not accounted on the basis of IAS 3, but in accordance with Israeli GAAP. F. Material adjustments to the statement of cash flows for the year ended December 31, 2007 (1) In accordance with Israeli GAAP, interests received, interests paid and derivative transactions on interest rates were classified as operating cash flows. In accordance with IFRS and on the basis of the accounting policy adopted by the Company, interests received were classified as investing cash flows and interests paid and derivative transactions on interest rates were classified as financing cash flows. (2) In accordance with Israeli GAAP, the effects of exchange rate fluctuations on cash flows were presented as operating cash flows. In accordance with IFRS, the effects of exchange rate fluctuations on the cash balance were classified under a different item. There are no other material differences between the statement of cash flows presented in accordance with IFRS and the statement of cash flows presented in accordance with Israeli GAAP.
C-127 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
NOTE 34 – MATERIAL EVENTS SUBSEQUENT TO THE BALANCE SHEET DATE
A. The impact of the changes in the prices of crude oil and distillates As a result of changes in the economic environment subsequent to the balance sheet date, there were dramatic fluctuations in the price of crude oil and distillates. The price of oil, which was $36.5 per barrel on the balance sheet date, rose to $51 per barrel close to the date of approval of the financial statements. As a result of these changes, the Company expects recording a profit $ 85 million (before tax) for the inventory balance as of the balance sheet date, which is realized for the most part in January and February, 2009. B. Environmental quality In January 2009, the Company and Gadiv received from the Ministry of Environmental Protection a warning and summons to a hearing relating to violations and alleged defective application of the provisions of the personal order (“the warning"). The warning described the alleged violations which referred, inter alia, to the time tables set forth in the order, the results of the stack samples, the submission of certain plans stipulated in the personal order and to the way information is sent to the Ministry, as stipulated in the order. Prior to the date of the hearing, ORL submitted its response to the warning it received, in which it detailed its arguments and responses to the issues included in the warning. At the conclusion of the hearing, goals and timetables were set for actions to be taken by the Company to reduce the pollution emitted by its facilities. The Company is preparing to implement the mandatory actions under the personal orders and is holding discussions with the Ministry of Environmental Protection regarding additional actions that the Ministry requires. On January 25, 2009, a hearing was held at the Ministry of Environmental Protection for the Company and PEI regarding two specific sites where, according to the Ministry, soil and groundwater were contaminated by fuel products. After the hearing, the Company and PEI were required to close the two pipelines along which leakage was found; to return them to operation following repair and/or replacement; to test impermeability of all the pipelines and to submit the results to the Ministry of Environmental Protection. In the hearing, the Company and PEI were warned that if the repair and rehabilitation process does not commence within seven days after the hearing, including the removal of the contaminated soil, the Ministry would issue an order for cleanup and removal of the toxic substances. The Ministry gave notice that the Green Police of the Ministry of Environmental Protection would investigate the events, including the Company's failure to act to minimize damage and prevent further contamination of the river and its environs. On March, 1, 2009 the Company received a removal order for toxic substances, pursuant to section 16(A) of the Hazardous Substances Law - 1993 and a clean-up order, pursuant to section 13(B) of the Maintenance of Cleanliness Law -1984, demanding that the Company, PEI and their CEOs submit plans to the Ministry of Environmental Protection for soil gas, soil and groundwater surveys and to fence off the contaminated areas and to conduct the survey in accordance with the approved plans. The parties are further required to submit to the Ministry a report of the survey findings, including recommendations for the clean-up and rehabilitation of the contaminated soil and groundwater and the restoration of the river and its banks to their former condition, based on the findings of the survey. The parties will also define a short-term and binding timetable for implementing the recommendations of the survey, until all waste and toxins are removed from the soil and groundwater. The Company has submitted its plan for the soil gas, soil and groundwater survey to the Ministry of Environmental Protection for approval.
C-128 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3 Oil Refineries Ltd.
Notes to the Financial Statements as of December 31, 2008 NIS thousands
As of the approval date of the report, the Company is unable to assess the outcome of the survey, the actions required according to the outcome and the expenses arising for the Company when implementing these measures. At the beginning of 2009, the Company and EAPC were required, under the terms added to their business licenses, to conduct soil surveys along the pipeline corridor and to apply the survey recommendations according to the suggested timetable approved by the Ministry of Environmental Protection. The Company appealed this condition in its business license through the procedure set up by the law.
C-129 WorldReginfo - 8bb1089d-b977-4da7-87ec-bb115e6449c3