ANNUAL REPORT Year 2009 The Israel Electric Corporation Ltd. / Annual Report 2009

BOARD OF DIRECTORS MANAGEMENT as of 31.12.2009 as of 31.12.2009

Mordechai Friedman – Chairman Amos Lasker Shlomit Barnea-Farago President & Chief Executive Officer Izhak Elyashive Moshe Bachar Shulamit Eshbol Executive Senior Vice President Generation & Transmission Dorit Inbar Blanche Kay Yigal Ben-Arieh Michael Lazer Senior Vice President of Marketing & Communication & Advisor to the CEO on Strategy & Philip Mandelker Special Tasks Amit Oberkovich Ziv Reich Dr. Adrian Bianu Senior Vice President Aura Sova-Gindin Strategic Resources Yossef Vadana Yaffa Vigodsky Harel Blinda Senior Vice President Finance & Economics

Asher Dahan Senior Vice President Customers

Auditors: Yacov Hain Brightman Almagor & Co. Senior Vice President Certified Public Accountants (Isr.) Engineering Projects A Member Firm of Deloitte Touché Tohmatsu 1 Azrieli Center Tzvi Harpak Tel-Aviv 67021, ISRAEL Senior Vice President Organization, Logistics, Security & Emergency Representative of Government Companies Authority: Aharon Goldman

General Counsel & Company Secretary: David Yahav, Adv.

Company Auditor & Ombudsman: Shay Rosenstock Registered Office: Secretary to the Board of Directors: 1 Netiv Ha'or St. Shlomi Tsarfati Haifa 31000, ISRAEL

Introduction Board Directors and Management 2 Summary of the Statistical Report 25 Company Organization Structure 3 Summary of the Environmental Report 37 Selected Data as of December 31, 2009 4 Development of the Electricity Market 49 Strategy and Objectives 5 Summary of the Financial Statements 59 CEO & Chairman's Review 7

2 Company Organization Structure

Company Organization Structure

* S.V.P Generation & Transmission serves as Executive Vice President

3 The Israel Electric Corporation Ltd. / Annual Report 2009

Selected Data as of 31.12.2009

Annual Change 2008 2009 (%) Generation System Installed Capacity (MW) 11,675 11,824.0 +1.3 Peak Demand (MW) 10,200 9,882 -3.1 Electricity Production (million KWH) 54,504 53,179 -2.4 Load Factor (%) 63.0 61.5 -2.3 Fuel Consumption (thousand tons) Fuel Oil 401 165 -58.8 Coal* 12,882 12,331 -4.3 Gas Oil 690 173 -75.0 Gas 2,408 2,649 +10.0 Average Fuel Consumption (gr/KWH) Fuel Oil 232 229 -1.1 Coal* 364 359 -1.4 Gas Oil 214 219 +2.6 Gas 170 153 -10.0 Electricity Consumption by Sector (million KWH) Total Consumption 50,161 48,947 -2.4 Residential 15,201 15,117 -0.6 Public & Commercial 15,499 15,625 +0.8 Agricultural 1,827 1,690 -7.5 Industrial 11,218 10,329 -7.9 Water Pumping 2,749 2,404 -12.5 E. Jerusalem & P.A. 3,666 3,783 +3.2 Income from Sales of Electricity by Sector (million NIS) Total Consumption 22,316.6 20,802.4 -6.8 Residential 7,419.8 7,001.7 -5.6 Public & Commercial 7,345.5 7,022.0 -4.4 Agricultural 755.9 665.6 -11.9 Industrial 4,443.3 3,925.2 -11.7 Water Pumping 932.8 779.5 -16.4 E. Jerusalem & P.A. 1,419.4 1,408.4 -0.8 Average Electricity Prices by Sector (agorot/KWH) Total Consumption 44.49 42.50 -4.5 Residential 48.81 46.32 -5.1 Public & Commercial 47.39 44.94 -5.2 Agricultural 41.38 39.39 -4.8 Industrial 39.61 38.00 -4.1 Water Pumping 33.93 32.42 -4.5 E. Jerusalem & P.A. 38.71 37.24 -3.8 Consumers by Sector (thousands) Total 2,417.6 2,450.7 +1.4 Residential 2,125.5 2,155.8 +1.4 Public & Commercial** 246.3 248.9 +1.1 Agricultural 9.6 9.5 -1.0 Industrial 32.4 32.6 +0.6 Water Pumping 3.8 3.9 +0.0 Permanent Employees 9,641 9,712 +0.7 Electricity Generated per Permanent Employee (thousands/KWH) 5,653 5,476 -3.1

* Nominal quantity of coal. ** Including consumers in E. Jerusalem & P.A.

4 Strategy and Objectives

Strategy and objectives

Vision The Company will continue to ensure reliable supply of good quality electricity, at a competitive price, while working for optimization of production elements, according to the requirements imposed on it by law, as an essential service provider, and to the business environment in which it operates, to the full satisfaction of its customers.

Main objectives 1. Maintain the Company’s financial strength, including a fair yield for shareholders. 2. Develop optimal systems along the electricity chain with suitable reserves. 3. Put the emphasis on environmental quality, in all areas, along the electricity chain. 4. Achieve excellence in quality of customer service. 5. Reduce the average number of minutes of non supply to consumers.

Means of achieving these objectives

Development 1. Implement criteria for optimal reliability when developing the production system, to maintain balance between the cost of unsupplied energy and the cost of adding means of production. 2. Optimal integration of production means using natural gas into the development work in the current decade. 3. Planning and developing transmission and transformation systems at standards that ensure the transmission of generated energy to consumption centers at the required level of reliability and quality, and maintaining system survivability. 4. Developing the distribution system in line with customer demand while minimizing costs.

Operation 1. Assimilating a policy of environmental operation and development. 2. Optimal operation of means of production. 3. Implementing a policy of optimal operation and maintenance, to ensure availability during peak demand, and renovations at the lowest possible cost. 4. Using the optimal mix of fuels to operate the generation system.

Customers 1. Developing new products and services for customers (reducing frequency agreements, reliability rates, and so on). 2. Providing service with reference to the needs of different market segments, including strategic customers, making use of a special model. 3. Fostering links with Company customers as part of management policy. 4. Strengthening the Company’s links with the community through initiated activities, cooperation with environmental bodies, etc.

Resource management 1. Maintaining, optimizing and fostering the human resource by developing tracks for advancement and professional and managerial training. 2. Pursuing a policy of intelligent purchases of fuels, as required by operations, with attention to fuel quality, environmental issues, reliability of electricity supply and varying the sources of fuel. 3. Adapting the structure of Company liabilities to the structure as recognized in the electricity rates. 4. Financial management that facilitates retaining the Company’s rating and consequently its ability to raise funding for its development plans.

5

CEO and Chairman's Review for the 2009 Annual Report

CEO and Chairman of the Board of Directors Review for the 2009 Annual Report

Mordechai Friedman Amos Lasker Chairman of the Board President & CEO

Introduction

The Israel Electric Corporation (IEC) was founded 87 years ago. At the beginning, the Company’s generating capacity totaled no more than a few hundred kilowatts; today the IEC is among the largest industrial companies in Israel’s economy with an installed capacity of more than 12,000 MW.

Since its establishment and up to today, Israel Electric works as an integrated and coordinated system, generating, transmitting and supplying electricity to almost all consumers, reliably and at all times. The Company sets an example to the economy in its professional standard, excellent service in supplying electricity to Israel’s citizens, and in its abilities to construct the required electricity infrastructure, a must for the continued development of the economy.

We aspire to continue being the leading business company in its field in Israel; adapting ourselves to changes in economic conditions, economic values, social and technological changes locally and globally; promoting development of renewable energies and encouraging energy saving; as well as breaking into new international markets.

To this end, • we will develop and supply products and services to satisfy our customers’ needs – with dignity, fairly, reliably and with transparency towards our customers, workers, suppliers and stock holders; • we will supply excellent service, while ensuring availability, quality and safety; • we will strive for excellence, innovation and maximum efficiency – managerial and technological; • we will acknowledge that our workers are our primary asset and will support their promotion, while striving to create a feeling of pride and belonging, encouraging creativity and commitment.

7 The Israel Electric Corporation Ltd. / Annual Report 2009

All these will be accomplished legally, according to appropriate management regulations, striving for sustainable development and social and environmental responsibility.

In the last few years, there has been erosion in the Company’s financial strength which has manifested itself in low rates of return on capital and profits. Internal company sources have sustained the repayment of debts, but do not suffice to fund the entire scope of investments necessary to execute the development plans of the electricity sector to fulfill the growing economy needs.

We regard the Company’s financial strength to be of foremost importance. To this end, Israel Electric strives to increase its income, among other things from business entrepreneurship, and by ongoing activities with the Public Utilities Authority – Electricity (PUA) in an attempt for electricity tariff to reflect the Company’s operating and capital costs, bringing the Company appropriate return as determined by legislation. We also endeavor to minimize cost of service, taking the necessary steps to increase efficiency and savings in various sectors.

This review details IEC activities during 2009.

2009 – Main Activity and Development

As already stated, the IEC operates as a single integrated and coordinated system dealing with electricity supply along the electricity chain starting from generation, transmission, distribution and supply to consumers. At the same time, the company operates to erect the required infrastructure to enable these activities. The continuing annual increase in demand for electricity creates the need for planning of the electricity sector in advance and in depth study of alternative future development scenarios. Decisions for projects are reached keeping costs to minimum, on one hand; while on the other hand, adhere to the criteria of reliability and environmental requirements. The proposed development plan is presented for approval to the Ministry of National Infrastructures and implemented according to the authorization of the Minister of Infrastructures.

The Generation System As of the end 2009, IEC maintains and operates 17 power plants, with an installed capacity of 11,664 MW. One or more units generate electricity in each and every one of the Company power plant sites. At the end of 2009, there were 59 generating units, of which 20 were steam generated and 39 were gas turbine units.

Most of the electricity is generated in units fired by coal or by natural gas. Marginal quantity of electricity is required mainly during peak hours, and is fueled by fuel or diesel oil. The Company’s steam generation units generate electricity by steam turbines and include coal-fired units and/or fuel oil, and additional steam units fired by natural gas and/or fuel oil. The gas turbine units include jet gas turbines fueled by diesel oil and industrial gas turbines fired by natural gas and/ or diesel oil.

In the era of natural gas, most of the power plants can be dual-fueled, and operated by natural gas and/or diesel oil, to maintain the ability to generate electricity during a shortage of natural gas supply, or as a result of a supply failure.

During 2009, a 118 MW unit at the Ramat Hovav site near Beer-Sheva was added to the IEC generation system. The capacity of the combined-cycle power plant at Hagit in Wadi Milik increased by 48 MW as a result of transition to natural gas. Two units at the Haifa Power Plant totaling 144 MW were scrapped, and the installed capacity of the generation unit in Eilat decreased by an additional 7 MW due to topographic conditions. In 2009, the generation of the IEC units totaled 53,062 thousand MWh, a decrease of 2.4% compared with the previous year. Israel Electric implements optimal operating policies for the units in the generation process. These policies are based on minimizing generation costs, when the primary cost is the cost of fuels per KHh produced. According to these policies, coal and natural gas, less costly fuels, are used as the main fuels for electricity generation, followed by diesel

8 CEO and Chairman's Review for the 2009 Annual Report

oil and fuel oil, the most expensive. Therefore, in 2009, the Company generated about 65% of its total electricity with coal, about 33% with natural gas, and the remainder, with fuel oil and diesel oil.

In addition to electricity generated in the power plants, in 2009 the Company acquired small quantities of electricity (about 0.5% of the total electricity supplied by IEC) from Independent Power Producers (IPPs). Some sold their entire production to IEC, while other producers that generate electricity for their customers, sold only production surplus to the Company.

Together with the decreased electricity sold to consumers in 2009, system peak demand also decreased. After the annual peak demand for 2008 occurred during the winter period and reached 10,440 MW (of which 10,200 MW was supplied by IEC), the annual peak demand for 2009 occurred during the summer period and stood at 10,280 MW (of which 9,882 MW was supplied by IEC). The decrease in demand for electricity is the result of the economic crisis and has not occurred since the founding of the State of Israel.

In 2010, the peak demand record of 2008 was broken when a heat wave hit the country in June and peak demand reached 10,700 MW, of which 10,050 was supplied by the IEC. The remainder was supplied by IPPs and by lowering demand via existing arrangements with consumers. Thanks to advanced preparation and readiness of the Company for exceptional weather conditions, it succeeded in meeting demands and supplied available and reliable electricity without abnormal failures.

The IEC generation system development plan The development plans for the generation system define the additional generating units required, their types, their installed capacity and dates of operation. The authorized development plans permit erection of combined-cycle generation units, open-cycle gas turbines, and coal-fired power plant.

According to the plan, by 2012, IEC is expected to complete the construction of three combined-cycle units, with an installed capacity of 1,112 MW: two units at Haifa site will be commissioned in 2011 and another at Zafit site is planned for 2012. These three units are currently in different stages of planning and construction. The construction of Zafit site gas turbines have been completed and connected to natural gas since the beginning of May 2010, all in addition to the combined-cycle units that have already begun operation in Eshkol, Hagit, Gezer, and Alon Tavor sites.

Electricity sector emergency plan As a consequence of the low reserves anticipated in the years to come, which puts the reliability of the electricity supply at risk, and the non-realization of the expected entry of IPPs into the electricity sector, the government, via the Minister of National Infrastructures, has imposed on the IEC to execute an emergency plan,. Within the scope of the plan, the Company will construct aside of the ordinary development plan, additional generating units with a total installed capacity of 1,765 MW. The Company has made great efforts to construct the project with an accelerated process and pressing timetable.

Throughout 2009 and the beginning of 2010, two gas turbines in Ramat Hovav site with a total installed capacity of 249 MW (part of the first stage of the emergency plan) were commissioned and another four combined-cycle units with a total installed capacity of 1,525 MW are expected to be put into operation:

During the summer of 2010, gas turbines in Eshkol and Hagit sites (part of the first stage of the plan); and towards the end of 2010, the gas turbines in Ramat Hovav will be commissioned; plus the gas turbines in Alon Tavor in the summer of 2012. During the second stage of the plan, steam turbine additions will be erected to enable operation of the combined-cycle units in Eshkol, Ramat Hovav, Hagit, and Alon Tavor to be commissioned in the summer of 2013.

9 The Israel Electric Corporation Ltd. / Annual Report 2009

Presently, IEC is working with different government officials to ensure appropriate funding sources to enable completion of the above mention plan. With the completion of project, these units, together with the units erected under the ordinary development plan, are expected to increase the Company’s generation capacity by 2,877 MW fueled by natural gas (assuming natural gas reaches the generation sites on schedule).

Project D With the fast tracked penetration of natural gas for electricity generation, professionals in the economy believe that a need exists for another coal-fired power plant, to diversify energy sources and prevent too high a dependency on natural gas, as this may endanger the reliability of electricity supply. Therefore, together with the natural gas-fueled additions to the generation system given in details above, a request for approval for the construction of a coal-fired power plant lies on the government’s table – Project D at the Rutenberg site south of Ashkelon. Nevertheless, the effect of the new discovery of natural gas reservoirs off Israel’s shores on the proposed coal-fired power plant and the entire electricity sector’s fuel basket is presently being examined.

Independent Power Producers (IPPs) As of 1996, the Electricity Sector Law has enabled IPPs to enter into electricity generation area, but to date, only few have ventured into this field. At the beginning of 2009, IPPs operated in electricity market with a total installed capacity of only 179 MW. The largest producer, “IPP Ashkelon Fuel Ltd.”, with an installed capacity of 87 MW, started operating in 2008. During 2009, the IPP “Paz Oil Refinery -Ashdod Ltd.”, with an installed capacity of 49 MW, was commissioned, so that by the end of 2009, the contractual scope between IEC and active IPPs totaled 228 MW (approximately 1.9% of the market’s installed capacity). In addition, an IPP, “Nesher Ramle” with an installed capacity of 48 MW, began negotiating with IEC and is expected to start selling electricity to IEC during 2010.

During 2009, about 80% of the active IPPs sold electricity to consumers and the surplus to the IEC, and about 20% of the active IPPs sold electricity only to IEC. The total scope of sales to IEC in 2009 was fairly low and reached about 285 million KWh, about 0.5% of the total electricity generated.

By the end of 2009, the PUA had granted conditional licenses to entrepreneurs in a power production area for a total capacity of about 3,400 MW; some licenses are already invalid. During February 2010, conditional licenses were awarded to “Dalia”, “Dorad”, and “IPM Be’er Tuvia” producers for a total scope of 2,150 MW. In addition, an agreement for the purchase of electricity from the installation in Mishor Rotem of 400 MW was signed with “Rotem IPC”.

These private generation installations are expected to be constructed during the next decade, but at present, IEC cannot forecast which will actually be constructed and granted permanent generating licenses.

Regulating IPPs During 2008-2009, the PUA published a number of decisions to regulate the activity of IPPs in the electricity sector. In 2009, the chapters concerning IPPs in the Standards Book (applicable to the electricity sector) were updated. Furthermore, the sections on financing for IPPs were published, as well as the tariffs for the producers operating with conventional technologies, cogeneration, pump-storage technology, and renewable energies.

It is important to note that IEC is interested in doing everything possible to assist IPPs to enter the electricity sector, with the understanding that additional IPP generation will help IEC share the heavy load of electricity sector development that is currently IEC’s sole responsibility. This is subject to the IPPs receiving all the necessary permits from the various government authorities involved in the process including the Ministry of National Infrastructures, the Israel Antitrust Authorities, etc.

The Transmission and Transformation System The IEC transmission and transformation system (delivery system) is spread throughout the entire country. This system is responsible for the transmission of electricity produced in the different generation units and for transformation of the

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The Israel Electric Corporation Ltd. / Annual Report 2009

electricity to substations spread throughout the country (electricity is transferred from substations to consumers via the distribution system). The transmission system includes ultra-high voltage (161KV) and high voltage (400 KV) lines (the antiquated 115 KV system remains in a few isolated locations). The transformation system includes switching stations, which are connect transformers from 400 KV to 161 KV voltages, and substations, transformers that reduce the voltage from 161 KV to medium voltage (the distribution system begins from the substations exits).

Transmission In 2009, the transmission system of 161 KV voltage overhead lines was expanded. Thirteen kilometers of new overhead circuit were added, resulting in the completion of a number of line-uprating projects. By the end of the year, the length of 161 KV voltage overhead and underground lines in operation totaled 4,267 kilometers, and the 115 KV voltage lines totaled 123 kilometers. The length of 400 KV extra-high voltage lines reached 736 kilometers.

Transformation By the end of 2009, the transformation system consisted of the nine switching stations and 189 substations, of which 42 are privately owned. The transformation capacity of 161/400 KV switching stations remained unchanged and totaled 10,000 MWA. The transformation capacity from high to medium voltage in permanent, temporary, and mobile substations owned by the Company, expanded, and by the year’s end, stood at 14, 365 MWA.

To meet the requirements of the electricity sector, new projects and projects for expansion and upgrading of the existing transmission and transformation system are being planned for the coming years.

The Distribution System The function of the distribution system is to distribute electricity from the substations to consumers via medium and low voltage lines, and supplying and selling electricity to consumers. IEC is the sole distributor, supplier and seller of the electricity in the State of Israel.

The IEC distribution system consists of medium and low voltage grids, and distribution transformers. Most of our customers consume low voltage electricity. Large customers consume medium voltage electricity. There are also customers connected directly to the transmission system and consume electricity at high voltage level.

At the end of 2009, the medium voltage distribution grid included 24,531 km. of lines, 45,552 distribution transformers with a total installed capacity of 21,539 MWA, and low voltage lines extended to a total of 19,260 km.

In the coming years, the development of the distribution system is planned to meet the needs of the electricity economy according to techno-economic planning criteria. This is manifested in the operation of new substations, the development of existing substations, additional consumers, the increase in demand forecast from existing consumers and aging of the grid.

By the end of 2009, IEC had 2.45 million customers, about 35,000 customers more than the previous year. Nevertheless, electricity consumption decreased by 2.4%, mainly due to the global economy crisis during this period.

Project for preventing the climbing of electricity poles Israel Electric has installed protection and signposts on medium and low voltage electricity poles in populated areas, due to the danger involved in climbing electricity poles by children and unauthorized climbers. It has installed new climbing prevention protection and large and visible warning signs on the poles. By the end of 2009, 70% of the project was completed, and 100% will be completed by the end of 2010; 130,000 poles will be protected against climbing.

12 CEO and Chairman's Review for the 2009 Annual Report

The Natural Gas Project In 2009, IEC expanded the “Natural Gas Revolution” when approximately 40% of the total generation production could be produced by natural gas. The company reached that ability only within five years . This is an unprecedented achievement when compared with other developed countries and considering the complexity of the Israeli economy.

Natural gas is virtually pollutant-free and when burned, releases carbon-dioxide emissions lower by tens of percent than coal, so its use enables cleaner burning processes and it is considered the cleanest and most environmentally- friendly fuel.

In February 2004, natural gas was initially introduced to the fuel mix at the Eshkol Power Plant in Ashdod. As of July 2006, the Reading Power Plant in Tel-Aviv operates on natural gas, replacing fuel oil, after it was converted during 2006 to burn natural gas and was connected to the natural gas national transportation system. In July 2008, operation of the combined-cycle and open-cycle units at Gezer site fueled by natural gas, replacing diesel oil, began gradually. In July 2009, the first combined-cycle at the Hagit site started using natural gas instead of diesel oil, and two additional combined-cycle units began operation with natural gas. At the beginning of May 2010, Zafit Power Plant was also connected to natural gas. As of December 31, 2009, generation capacity fueled by natural gas totaled 1,285 MW at Eshkol, 428 MW at Reading, 1,064 MW at Gezer, and 1,019 MW at Hagit site by three combined-cycle units.

Since the introduction of natural gas to the generation system, there has been a significant improvement in pollutant emissions: a decrease of more than 90% in sulfur dioxide emissions and particle matter and a decrease of 20% - 30% in nitrogen dioxide emissions in installations fueled by natural gas.

Furthermore, since the arrival of natural gas in Israel, there has been a significant decrease in the cost of generating electricity, as the cost of the natural gas fuel component in the electricity generation process is much cheaper than the cost of electricity generation by diesel and fuel oil. Indeed, as of the arrival of natural gas and until the end of 2009, IEC has saved the national economy about NIS 23.5 billion in the cost of fuel basket, as a consequence of the transfer to natural gas. In 2009 alone, the Company saved NIS 7.5 billion by conversion to natural gas. Almost 100% of this saving has been passed onto consumers by reducing the electricity tariff.

The Natural Gas Transportation System The construction of the natural gas transport project is very important to the national economy in general, and for the development of the electricity sector, in particular. The 2002 Natural Gas Industry Law (Gas Industry Law) defined the natural gas transportation system connecting gas supply terminals to the high-pressure gas centers, such as power plants, by underground piping and surface installations. This system is constructed (except for the sections constructed by IEC, as detailed further on) and operated by the Israel Natural Gas Lines, Ltd. (INGL or “Natural Gas Lines”), a monopoly supervised by the National Gas Authority located within the Ministry of National Infrastructures.. Natural Gas Lines was specially established by the Gas Industry Law to construct the natural gas transportation system.

Up to the date of this review, the following sites have been connected to the natural gas transport system: IEC sites at Eshkol, Reading, Gezer, Hagit and Zafit; Oil Refinery Ashdod Ltd.; Hadera Paper Ltd., Dead Sea Works and an IPP in Ashkelon.

The Natural Gas Transportation Agreement IEC has a 15-year agreement for the transportation of natural gas with INGL. The agreement regulates natural gas services to IEC power plants, and among other things includes the regulations regarding delivery capacities to each IEC sites and the obligations and rights of each party. The cost of transporting natural gas is fixed by the Natural Gas Authority, and includes the delivery capacity component, energy component, and one-time connection fees. In 2009, the Company paid INGL delivery capacity and energy fees totaling some NIS 180 million.

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CEO and Chairman's Review for the 2009 Annual Report

Natural Gas Suppliers During 2009, about 63% of natural gas was supplied by the Yam Thetys group that owns the “Mari” field natural gas production platform reserve, located about 24 kilometers offshore from Ashkelon, in accordance with the natural gas supply agreement between the Company and the Yam Thetys group signed in June 2002 and July 2009. Egyptian Eastern Mediterranean Gas (EMG) supplied 37% of the gas supply in 2009 through an offshore pipeline from El-Arish to Ashkelon, in accordance with the agreement signed in August 2005.

Letter of Intent to supply natural gas from the Tamar field and natural gas storage services in the Mari B field During the process for the purchase of natural gas, which began in 2007, IEC reached an understanding with the companies owning holdings in the Tamar field, situated about 90 kilometers offshore west of Haifa, regarding supply of natural gas from 2013 for a period of 15 years. This non-binding letter of intent, signed between the parties on December 13, 2009, specifies the scope of quantity and the price formula.

Furthermore, according to the non-binding letter of intent with the Yam Thetys group, producing natural gas from the Mari B field offshore Ashkelon, the group is to provide IEC with natural gas storage services in this field. The date of start of storage will be agreed in a detailed contract so that as IEC begins to receive a regular gas supply from Tamar field, it will retain a gas reserves at Mari B field, and thus will be able to take advantage of those reserves in the event of a supply disruption from regular sources or during periods of peak demand.

The Electricity Tariff On February 1, 2010, the PUA reached a decision to apply a new tariff base for 2010-2014 for the generation sector only. The tariff became valid on February 15, 2010, but the tariff base update for the generation sector did not include any reference to IEC employees’ retirement costs. The PUA has experienced lengthy difficulty reaching a decision on this issue. Following the determination of the new tariff base for the generation sector, the PUA also updated some of the components of the transmission and distribution segments.

From a preliminary analysis of the tariff base, it appears that it will not contribute to the hopeful improvement of the Company’s financial situation as it does not fully cover all the Company’s anticipated expenses for the coming years. IEC has sent the PUA its initial comments and requested a review of the new tariff base.

Financing Stage B of the electricity sector emergency plan Due to the financial difficulties IEC had to face in the last few years, it has decided not to take upon itself additional financial obligations above and beyond those that already exist to fund the second stage of the emergency plan imposed on it by the government. The Company requested that the PUA fund the execution of the project by granting an advance via the tariff, similar to the advance in payment received to fund the first stage of the project. To date, no reply to Company’s request has been received from the PUA.

Business Development As a consequence of the introduction of IPPs into the economy, the IEC has adopted a strategy to increase income from activity not related to the sale of electricity. As part of this strategy, it decided to exploit its relative advantage in planning and execution of large-scale projects in the global energy field. IEC makes use of extensive expertise, experience and capability accumulated over the years, such as computerized infrastructure, engineering and managerial personnel. In 2007, Israel Electric began activities to sell its capabilities to construct projects for clients both locally and overseas.

Within this context, the Corporation aspires to exploit its extensive and wide ranging fields of expertise: planning, erection and operation of coal-fired power plants; planning, erection, and operation of combined-cycle power plants; transmission and transformation projects; planning, erecting, and operation of environmental installations such as monitoring and emission-reducing systems; upgrade of installations, energy efficiency; and solar energy. IEC also offer additional services such as sales by means of the existing infrastructure: optical fibers for communication, rental of space and equipment, expansion of activities related to the construction of water desalination plants and cogeneration installations.

15 The Israel Electric Corporation Ltd. / Annual Report 2009

IEC is preparing for the provision of an overall response to customer demands, One-Stop-Shop, to execute all project stages and components, including: management services, planning, purchasing and erection (EPCM – Engineering, Procurement, Construction and Management). The Company has cooperated in a number of projects in Israel and abroad, in South Africa, Greece and Spain, and is investigating the possibility to participate in additional projects in various countries.

Integration into the communications market IEC has infrastructure which can be exploited to supply communication services to the public. Therefore, as the Company wishes to diversify its sources of income by appropriate business ventures, and with the encouragement of the Minister of Communication, Israel Electric has submitted a request for a special permit to supply communication services nation- wide. In December, the Minister of Communication authorized two technological experiments: one, the erection of an optical fiber infrastructure to customer homes in Kiryat Shemona; and two, erection of cellular infrastructure for a cellular company, including communication connection to the operator’s switch.

Company activities in energy efficiency Israel Electric is active in integrating the national effort to encourage energy efficiency in institutions and factories, to develop solar energy and exploit renewable energy sources - green energy – to generate electricity (especially biomass). Due to the limitations of the Company licenses, these activities take place in cooperation with private entrepreneurs. IEC offers its clients, locally and overseas, comprehensive solutions for maximizing energy efficiency in their installations.

Company activities in the electric vehicle market IEC is active in creating business opportunities with entrepreneurs involved in the electric vehicle market in Israel and that are interested in constructing the infrastructure to charge these vehicles. The Company is preparing to build nation-wide thousands of charging stations for the electric vehicles.

Technological Incubator In 2009, IEC established the KARAT Unit for promoting technological concepts. This venture unit is a technological incubator with the objective of identifying, promoting and developing ideas in the energy field, including green energy, with commercial potential.

The Company reaches out to entrepreneurs, “innovators”, inventors and others to submit ideas and proposals to the KARAT selection committee via the internet. Preference is given to the following subjects: treatment of greenhouse gases, reduction of electromagnetic fields, increase of energy transmission by high and medium voltage lines, improvement in photovoltaic cell technology, and decrease of energy loss – the smart grid.

The entrepreneurs whose concepts are accepted are invited to join KARAT as a company for a period of two years. For two years, they will benefit from the rich experience of the IEC as the largest energy supplier in the economy, from professional, theoretical and practical expertise, laboratories and business know-how, and the extensive areas of activity in which the IEC is involved. They will receive financial support, accompanied by a large professional team of energy experts, and the use of company infrastructure and its connections in Israel and overseas. At the time of writing this review, two companies are active in the photovoltaic field within the framework of KARAT, and negotiations are presently conducted with a number of additional companies.

Additional Current Activities Together with its principal activities – generation, transmission and supply of electricity – the Company, in 2009, is continue to be engaged in activities, which are no less important, that included: on-going dialog with its consumers, constantly striving to improve service; preservation of the environment, landscape and nature; involvement in the community in many diverse areas, etc.

16 CEO and Chairman's Review for the 2009 Annual Report

Development of Activities and New Products to Improve Customers Service IEC has made the provision of excellent service its motto and aspires to continually improve customer satisfaction. In 2009, the Company was awarded, for the eleventh time, first place in the customer satisfaction survey among public and private authorities that provide service to the public.

One of the most important tools the Company uses to provide service to its customers is the 103 Call Center. In October 2009, Globes Newspaper published survey results that compared the waiting time among customer service call centers of 14 companies. IEC was awarded first place for the shortest waiting time.

The marketing strategy promotes managing the IEC as a competitive and customer-focused business entity of the highest possible level. In line with this strategy, the Company invests considerable resources to improve the level of service to its customers and to provide a response for their changing needs.

The following are a few of the Company’s activities to improve and promote better service during the year under review:

“Business Customer Lounge” To improve service for the business customer, the “Business Customer Lounge” was established. This is a unique module located on the company website, which enables large customers to see, in full transparency, data related to their electricity demand and accounts at any given place and time. Information can also be found on the Business Customer Lounge related to diverse subjects, such as: efficient/intelligent use of electricity, professional information, etc. To date, a quarter of all customers which defined as "Customers Business" have subscribed to this service (about 500 customers).

Expansion of payment points for electricity bills IEC has expanded service at its points of sale, providing a code for prepayment meters (PM), enabling all customers to pay their electricity bills at external points of payment, including convenience stores and supermarkets. This service, which is to start operating in 2010, will reduce billing costs and improve service in the Company’s offices.

Transfer of information to customers by message system: Email/SMS/fax A computerized process has been developed to enable transmission of information and messages to customers by electronic mail, SMS or fax, according to the customer’s choice. The information transmitted to clients include: messages to those customers who pay by standing order or by credit card for bills above NIS 10,000; messages about issuing new invoices; and sending forms for bank authorization to establish payment of the electricity bill by standing bank order.

Prepayment meter (PM) During 2009, IEC continued to promote to increase the use of prepayment meters. The prepayment meter is aimed at low-income customers that accumulate debts as they are unable to pay their electricity bills and for consumer locations characterized by numerous changes in the customer base. The prepayment meter is a tool which allows to reduce disconnections from the source of electricity as a measure to enforce payment of the electricity bill.

To enable customers easy access in their vicinity to purchase the code to charge the PM smart card, without visiting the Company’s offices, IEC contracted with two service suppliers to charge the PM smart card at nationwide sale points, (“Top up online” and the Postal Bank). To date, prepayment meters have been installed for some 10,500 customers.

Customer Relationship Management Project (CRM) and Establishment of Contact Centers IEC continued its customer service strategy and began implementing the Customer Relationship Management Project (CRM) as of 2007. According to this strategy, when the customer calls the company contact center, they receive a complete response from the company representative with a single call. In this way, the customer experiences a comprehensive and high-quality service at every call to the company contact center. To this end, all district service centers have had to be connected and backed-up by each other, enabling operational flexibility during periods of peak demand, exploiting the economies of scale.

17 The Israel Electric Corporation Ltd. / Annual Report 2009

The service center technology enables customer identification by his telephone number or by his billing number. It is possible to find customer information, analyze data and direct the customer to the menu of his choice and then to the appropriate service representative. The service representative answering the call can see background information pertinent to the customer’s call and relevant data on the computer screen.

The transfer to district contact centers enables to exploit the economies of scale by using technology that shortens the time for customer service, enables a single, complete and rapid response to the customer, providing the customer with a service experience of the highest standard.

Additional Strategic Projects In 2009, the IEC promoted additional strategic marketing projects to improve service, efficiency, save costs, and improve its image to position the company as a business, competitive and customer-focused company.

Smart Metering Project “Smart Metering” is a term that evolved with the development of the metering system from “Remote Meter Reading” to “Advanced Meter Infrastructure.” This development turned the meter from a means of registering consumption as a basis for issuing an electricity bill, to a source of data and information, for both the customer and IEC. The smart- metering system includes: advanced electronic meters, data collection system, storage and processing of information distributed to the relevant bodies, and a two-way communication system that transmits data from the meter to the information system and back to the customer.

IEC has followed innovations in meters area, especially among large strategic customers, and has examined the different methods for remote meter reading for a number of years. This activity has been recognized as a strategic project, and a steering committee and administration have been appointed and certified to examine the continuation of this activity also for residential customers. Increased interest in the smart grid contributed to the importance of this project, as smart meters are a cornerstone for the smart grid.

Among the many applications of smart meters is control of household appliances by the customer in the home, enabling a significant saving in electricity, while IEC will maintain a better control of generation resulting in a significant saving of electricity and preservation of the environment. In 2009, within the framework of this project, the IEC signed contracts with software and communication suppliers to construct a smart-metering system for 6,000 locations, which have a high consumption rate and medium and low-voltage business customers.

Distribution Management System Project (DMS) The DMS system supports the remote control of the power disconnectors (disconnects and connects) which are installed in the distribution grid at critical intersections and includes their control. Its main purpose is to improve the management tool that District uses to supervise in order to minimize the times of non-supply of electricity, and to achieve a better control of the distribution lines. The system has three main components: the control and monitoring system at the District level, end units (monitors of remote-operated controls of the power disconnectors in the grid), and the communication systems that unite the first two components. When operated, the system is expected to control some 5,000 power disconnectors, of which there are more than 2,800 disconnectors to be controlled by end units developed during this project.

By the end of 2009, the development of the District control and monitoring system and quality control checks in the supplier’s factory were completed; the control rooms were built at the District dispatch centers and the systems were installed; the inspection upon receipt in all sites (five districts and Beer-Sheva sub-district ) were completed and the communication system was checked; some 600 power disconnectors and five systems began operating: the Northern, Dan, Jerusalem, Haifa Districts, and Beer-Sheba sub-district.

Enterprise Resource Planning Project (ERP) The ERP system is a software package providing a comprehensive and integrated computerized solution to manage

18

The Israel Electric Corporation Ltd. / Annual Report 2009

organizational resources. The ERP system can manage the computer network in one database system, one application and one user interface.

The ERP package is a SAP application, integrated into the IEC by Ness Technologies with the assistance of our information system personnel and Company representatives which are the users of the system. To date, the new system serves about 4,000 different end-users and replaced 19 existing systems for resource management.

The first modules of the package were already commissioned in 2007 and since then, the Company has continued to develop and improve them. Additional planned modules are in varying stages of development and installation. By the completion of the project, some 5,000 end-users will be served, replacing 27 different computer information systems.

Corporate Environmental Policies The importance of environmental protection and conservation is taking an ever increasing role in the priorities of governments and countries all over the world. The requirements for environmental protection and conservation are becoming ever more extensive. IEC is aware of the significance of environmental issues and has decided to take responsibility for its part, as has become common in large organizations in the world. It has even taken the decision to become a world leader in the field. Therefore, it has adopted the principle of “ sustainable development” that responds to present needs, balancing environmental, social and economic considerations, without compromising future generations’ abilities to respond to future needs.

Israel Electric has invested significant resources in the transition to modern technologies to minimize environmental hazards resulting from generating, transmitting and supplying electricity. In 2009, it invested about NIS 113 million in its generating installations, in projects relating to environmental issues, and an additional NIS 35 million to comply with environmental regulations.

IEC strictly follows all national environmental standards, laws and regulations that involve company activities and in those cases where legislation does not exist, it adopts appropriate measures. The Company operates in complete transparency towards the authorities and the public regarding environmental information applicable to IEC activities and takes an active role in promoting environmental legislation. Furthermore, IEC constantly follows current trends in the world in regards to technological and new methods developments relating to environmental issues and looks into implementing them in its installations.

Reduction of pollutant emissions Thanks to IEC activities, there has been a significant reduction in pollutant emissions from electricity generation installations over the last few years. Existing power plants, previously fueled by fuel oil, have been converted by IEC to natural gas and the Company has expanded the use of natural gas in the installation of new combined-cycle power plants generating additional electricity without extra fuel. In coal-fired power plants, an improved coal basket decreases sulfur-dioxide emissions. Israel Electric continuously operates generating units equipped with stack gas scrubbers to clean sulfur dioxide from emitted gas and uses advanced burning systems to decrease nitrogen oxides. In the few generation units where fuel oil is still used, very low-sulfur fuel oil is used.

To further reduce particle emissions into the air, the Company has implemented a project to install FGD systems to decrease sulfur dioxide and nitrogen oxides emissions from all coal-fired power plants. The total cost of purchasing and installing the special FGD equipment is about USD 2 billion. New planned coal-fired power generating units will be constructed with the very best available technology and will include all the equipment required to maintain low levels of emissions. In spite of the anticipated increase in electricity generation in the years to come, a continuous reduction in particle emissions is anticipated.

20 CEO and Chairman's Review for the 2009 Annual Report

Additional activities for environmental conservation • IEC is preparing to implement the recently legislated Clean-Air Law, and cooperates with the Environmental Protection Ministry in implementation. • IEC promotes energy efficient processes and intelligent use of electricity in a variety of fields, in cooperation with the Ministry of National Infrastructures and the Environmental Protection Ministry. • IEC promotes implementation of “smart grids” to adjust the electricity-demand curve and reduce consumption in peak demand hours. • IEC is active in efficient use of water at its sites, develops use of low quality water, and increase workers’ awareness to save water. • IEC deals with waste products, applying Total Waste Management (TWA) approach, including separating and recycling all types of waste products created as a result of current operations. • IEC is active in recycling by-products of the electricity generation process, primarily coal ash. Recycling saves the economy the cost of excavation or import of raw materials and reduces pollutant emissions, as well as contributes to company income. • IEC invests much effort in implementing “green computerization – Green IT” that contributes to reducing the ecological footprint of computers and reduces electricity demand. • IEC holds courses for its managers in environmental protection, to raise awareness to environmental issues linked to company activities and providing up-to-date information. • IEC holds an annual inter-company competition among its workers and managers, called “Green-Blue-Orange: IEC President and CEO’s Pledge to the Environment.” The aim of the competition is to mark and honor staff committed to the environment, show initiative to improve the environment, and contribute personally to the environment, instilling in the company workers and managers the values of environmental conservation.

It is possible to obtain additional information regarding company activity relating to the environment in the “IEC Environmental Report”, attached to this review and can be viewed on the company website.

Responsibility and Community Involvement As one of the largest industrial companies in Israel, IEC believes that its duty is not only to be an essential service provider, but that it has a responsibility to contribute to the community and expose its professional and humanitarian face. The Company uses available tools and means permitted by law, to foster long-term relationships with the community, on the basis of dialogue, involvement, cooperation, and reciprocity.

IEC community activities are unique in a way that they take place in areas where the Company’s operations are integrated in its core business and expertise. These are woven into a practical and enriching fabric in education, science and technology, culture, art, environment and heritage, and include relevant and functional activities involving diverse groups of people of all ages. Joint activities grant the IEC the opportunity for direct interchange with the community and enable the Company to expose the community to issues of nationwide importance.

Via these activities, IEC presents its initiatives and operations on an environmental and communal level. It is these continuous, long-term activities that reflect Company’s long-standing and continual commitment to the community.

Visitor centers The Company operates four visitor centers throughout the country. Three are located at the generation sites: Haifa, Orot Rabin and Rutenberg Power Plants. Another center is at the Heftziba site and represents the story of an agricultural farm since the beginning of settlement in Israel.

During a visit to these centers, the public becomes acquainted with the challenges that the IEC faces, a behind-the-scenes look at the world of electricity generation, and can receive answers to many questions. The visitor centers are open to the general public, by appointment, and are free of charge. During 2009, the centers enjoyed more than 182,000 visitors.

21 The Israel Electric Corporation Ltd. / Annual Report 2009

Additional community relation projects • The “Nativ Haor” project, which operates in hundreds of schools across the country, continued to be developed. The project’s aim is to educate the younger generation, via their parents, in how to behave safely with electricity inside and outside of the home, to use energy intelligently and efficiently, and to protect the environment.

• The educational-community project “Yedid Haholot” (Friends of the Dunes), which deals with preservation of beaches and their surroundings, was the result of cooperation between IEC and the Israel Nature and Parks Authority, and adopted the Sharon Beach, the Sorek estuary, the Poleg Reserve, and the Palmachim Nature Reserve.

• The interactive play, “Against the Current”, was a result of cooperation with the Bloomfield Science Museum in Jerusalem. The play is presented to school pupils, who are asked to participate in a discussion by asking questions on quality of life and the dilemma between development versus the environment.

Training in IEC An entire training formation exists in the IEC to provide support for the improvement of employee performance and to increase the level of human and professional capital of company employees. Company employees require a specialized skilled particular to the electricity industry and are unable to acquire the necessary skills outside the work place.

The training section provides education in a wide variety of professions in the main occupations of the IEC, and provides the necessary certification for these occupations, according to the law and regulations. The training staff prepares training programs and instructs workers and managers during their professional lifetime in the Company, retraining them for career changes and implementation of new technologies. The training formation consists of five schools and a national training staff. All the courses that take place in the Company are managed by the training staff of the different schools, and by company workers, who have acquired the knowledge and expertise to teach course participants. Moreover, the training section promotes and handles formal studies for the following professions: technicians, practical engineers and engineers, needed in the Company especially in the technological field, and in studies for a Masters degree in business. The training section is involved in building study programs to ensure as much compatibility as possible between the material studied in academic institutions and the anticipated occupation of the participant.

There are 20-25 daily courses being taught in parallel, an average of 350-400 workers studying every day. About 200 workers are also studying at academic institutions at any given time. In total, about 400 different training activities and over 600 study days take place every year.

The “Atid Naor” Project “Atid Naor” is a social project which “adopts” students from outlying towns. IEC fosters 30-40 honor students in the final year of their Bachelor degree in different subjects required by the Company under its wings. These students participate in the Company’s work, are accompanied professionally by IEC managers and professionals, and are awarded a monthly scholarship and fully-paid tuition fees. When they complete their degree, they can be integrated into the Company’s workforce.

In 2008-2009, 38 students participated in the first “Atid Naor” class, and all were accepted as company workers. In the second class of 2009-2010, 17 students have enrolled.

The importance and uniqueness of this program is in granting a professional employment opportunity to the outstanding population from outlying towns and the possibility of allowing them to study without economic pressure. Another no- less important advantage is the creation of a reserve of quality professionals for the IEC.

22

The Israel Electric Corporation Ltd. / Annual Report 2009

Structural Change in the Electricity Sector

On March 5, 1996, the Electricity Sector Law – 1996 came into effect. Its main objective being to organize the activity of the Electricity Sector for the public good, ensuring reliability, availability, quality and efficiency, creating conditions for competition and minimizing costs.

During the years since the Law came into effect, it has undergone many changes, but the complex question of structural change in the electricity sector remains.

In the beginning of May 2009, IEC Management agreed, together with different national bodies, the National Workers’ Union, and the IEC Workers’ Union, to enter into negotiations regarding structural and organizational changes and to increase efficiency. The process, which began in the beginning of 2010, still continues to the date of the writing of this review, to attempt to reach agreement on these issues. We believe that advancement of this subject, together with the process of organizational change and increased efficiency in the Company, are the most important steps for the IEC and the electricity sector. We call all government bodies responsible for this process to assist Israel Electric in promoting these issues quickly and effectively.

Summary

Since its establishment and up to date, IEC has come a long way which has trained it to deal with the tasks it faces. We live in a period of changes – in the business and in the economic environment – and we have to prepare and plan carefully for the Company’s future.

We believe that we are able to build a strong and stable company that will succeed in adapting to the new conditions being created in the electricity sector and will be able to integrated into a competitive world. At the same time, we will work towards securing the Company’s financial strength by increasing its income, by promoting an electricity tariff that reflects the costs of the electricity chain, and by expanding activities in areas not included in the electricity tariff. In addition, we will continue to strive to increase efficiency and economy in different areas of operation.

In the coming years, we will maintain a high professional standard and will continue supplying millions of customers with high-quality electricity, at a fair price and maximum availability.

We would like to express our appreciation to the Company managers and workers that perform their work professionally, faithfully, with diligence, and with aspiration for achievements. In this way they contribute to the Company success and bring us all a feeling of pride and respect. We believe that with their help we will be able to fulfill successfully all tasks set before us.

Furthermore, our thanks to all the members of the Board of Directors who participated in the many Board meetings and acted in the various Board committees, and by that they took part in the execution and were partners in decision-making that led the Company to the welcome achievements in many performance areas.

Michael Lazer, CPA. Amos Lasker Acting Chairman of the Board President & CEO of Directors

24

2009 Developments in the Electricity Economy

2009 Development in the Electricity Economy

Electricity Consumption 2000-2009 µµ

50.2 µ∞ 49.3 48.9

46.2 ¥µ 44.3 42.9

Billion Kw H Kw Billion 41.7 39.9 ¥∞ 38.7 37.8

≥µ ≤∞∞∞ ≤∞∞± ≤∞∞≤ ≤∞∞≥ ≤∞∞¥ ≤∞∞µ ≤∞∞∂ ≤∞∞∑≤∞∞∏ ≤∞∞π

Electricity Consumption Per Capita by Country, 2007

≥∞¨∞∞∞ 24,643 ≤µ¨∞∞∞

≤∞¨∞∞∞ 16,541 14,873

±µ¨∞∞∞ 13,426 KwH

±∞¨∞∞∞ 8,159 7,600 7,542 6,978 6,725 6,645 6,620 6,525 6,481 6,220 6,045 6,032 5,674 5,433 5,414 4,915 4,568 4,280

µ¨∞∞∞ 4,009 3,803 3,359 2,222 2,027

∞

UK

Italy

eden

Israel

yprus

urkey

oland

Spain

T

France

P

C

Ireland

Greece

ortugal

Finland

Austria

Sw

Norway

Belgium

Bulgaria

Slovenia

P Slovakia

Hungary

Romania

Germany

Denmark

witzerland

Czech Rep. Czech

Luxemburg

S Netherlands

Source: Energy Information Administration, EI 30, 1000 Independence Avenue, SW, Washington, DC 20585 (Internet website)

≤∑ The Israel Electric Corporation Ltd. / Annual Report 2009

Electricity Consumption by Sector 2000-2009 ∂ 5.3 µ

¥ ent

≥ 2.7 Perc

≤ 1.9% 1.2 1.2 ± 0.6 0.4 ∞ Household Commercial-public Industry PA Water pumping Agriculture

Annual Demand Peaks 1990-2009 ±≤¨∞∞∞ 10,200 10,070 9,882

±∞¨∞∞∞ 9,450 9,030 8,750 8,570 8,550 7,900 ∏¨∞∞∞ 7,850 7,150 7,041 6,518 6,000 5,600

∂¨∞∞∞ 5,490 MW 5,090 5,010 4,540

¥¨∞∞∞ 3,800

≤¨∞∞∞

∞ ±ππ∞ ±ππ± ±ππ≤ ±ππ≥ ±ππ¥ ±ππµ ±ππ∂ ±ππ∑ ±ππ∏ ±πππ ≤∞∞∞ ≤∞∞± ≤∞∞≤ ≤∞∞≥ ≤∞∞¥ ≤∞∞µ ≤∞∞∂ ≤∞∞∑ ≤∞∞∏ ≤∞∞π

Winter peak demand Summer peak demand

≤∏ 2009 Developments in the Electricity Economy

Load Curve on Seasonal Peak Demand Days

±∞¨∞∞∞

∏¨∞∞∞ MW

∂¨∞∞∞

¥¨∞∞∞ ±≥µ∑π±±±≥±µ±∑±π≤±≤≥

Winter - March 1, 2009 Summer - July 29, 2009

Record Monthly Demand ±±¨∞∞∞

±∞¨∞∞∞

π¨∞∞∞

∏¨∞∞∞ MW

∑¨∞∞∞

∂¨∞∞∞

µ¨∞∞∞ July June May April March August January October February December November September

Record demand in 2008 Previous record demand

≤π The Israel Electric Corporation Ltd. / Annual Report 2009

התפתחות†משק†החשמל†בשנת†∑∞∞≥†©המשך®

Average Price of Electricity - Household Sector in Selected Countries, 2007

28.50 ≥∞ 25.80 24.40 ≤µ 23.10 21.90 21.40 21.30 18.80 18.80 ≤∞ 15.80 15.10 14.50 14.40 ±µ 13.60 13.20 12.20 12.07 10.64

±∞ Cents/kWh, including taxes including Cents/kWh, µ

∞

UK

Italy

USA

Israel

urkey

oland

T

France

P

Ireland

ortugal

Finland

Austria

Holland

Norway

P

Slovakia

Hungary

witzerland

Chech Rep. Chech

Luxemburg S

Source: Energy Information Administration, EI 30, 1000 Independence Avenue, SW, Washington, DC 20585 (Internet website)

Average Price of Electricity - Industrial Sector in Selected Countries, 2007

≥∞

23.70 ≤µ

≤∞ 14.90 13.70 ±µ 13.40 13.40 12.80 11.50 10.90 9.47 ±∞ 8.40 8.20 8.10 6.36 Cents/kWh, including taxes including Cents/kWh, 5.60 4.80 µ

∞

Italy

USA

Israel

urkey

oland

T

France

P

Ireland

ortugal

Finland

Austria

Norway

Slovakia

P

Hungary

witzerland

Chech Rep. Chech S

Source: Energy Information Administration, EI 30, 1000 Independence Avenue, SW, Washington, DC 20585 (Internet website)

≥∞ 2009 Developments in the Electricity Economy

Distribution of Electricity Generation and Installed Capacity by Type of Fuel

Installed Capacity

±πππ ≤∞∞¥ ≤∞∞π

30.9% 11.6% 34.4% 40.9% 29.0% 49.0%

43.6%

25.5% 19.7% 10.4% 5.0%

Coal Fuel oil Diesel oil Gas

Generation

±πππ ≤∞∞¥ ≤∞∞π

3.9% 9.1% 3.2% 26.3% 32.6% 10.0%

1.6% 1.1% 69.8% 77.7% 64.7%

Coal Fuel oil Diesel oil Gas

≥± The Israel Electric Corporation Ltd. / Annual Report 2009

Distribution of daily load curve by fuel type

Winter Peak Day ±≤¨∞∞∞

±∞¨∞∞∞

∏¨∞∞∞

∂¨∞∞∞ MW

¥¨∞∞∞

≤¨∞∞∞

∞ ±≥µ∑π±±±≥±µ±∑±π≤±≤≥

Installed capacity Available capacity DIesel oil Fuel oil Gas Coal

Summer Peak Day ±≤¨∞∞∞

±∞¨∞∞∞

∏¨∞∞∞

∂¨∞∞∞ MW

¥¨∞∞∞

≤¨∞∞∞

∞ ±≥µ∑π±±±≥±µ±∑±π≤±≤≥

Installed capacity Available capacity DIesel oil Fuel oil Gas Coal

≥≤ 2009 Developments in the Electricity Economy

Growth in Electricity Capacity

≤µ¨∞∞∞ 21,539

≤∞¨∞∞∞ 17,015 17,227

±µ¨∞∞∞ 13,201 11,824 MW 9,882 ±∞¨∞∞∞ 9,129 7,900

µ¨∞∞∞

∞ ±πππ ≤∞∞π±πππ ≤∞∞π ±πππ ≤∞∞π ±πππ ≤∞∞π Generation system Transformation system Distribution system Peak demand (MVA) (MVA)

Electricity Capacity Growth Rate 2000-2009

≥µ 29.5 ≥∞ 28.9 25.0 ≤µ Peak demand 25.1%

≤∞ ent

Perc ±µ

±∞

µ

∞ Generation system Transformation system Distribution system

≥≥ The Israel Electric Corporation Ltd. / Annual Report 2009

Israel’s Electric Economy - Selected Historic Data

Year Installed Electricity Annual Electricity Total Total Average Capacity Generation Peak Consumption Number Population* per Capita (MW) (in million Demand (in million Consumers (thousands) Consumption kWh) (MW) kWh) (thousands) (Kwh)

±π≤≥ 0.30 779.0 ±π≤¥ 0.30 0.5 2.0 805.0 0.62 ±π≤µ 1.15 1.9 1.5 4.4 847.2 1.77 ±π≤∂ 2.25 3.0 2.3 6.5 898.2 2.56 ±π≤∑ 2.25 3.1 0.95 2.5 7.4 917.3 2.73 ±π≤∏ 2.25 3.9 1.02 3.0 8.5 936.0 3.21 ±π≤π 2.25 4.9 1.16 3.6 11.2 960.0 3.75 ±π≥∞ 3.35 7.2 1.78 6.2 13.3 992.6 6.25 ±π≥± 4.20 11.5 2.65 9.5 15.7 1,033.3 9.19 ±π≥≤ 16 16.6 5.60 12.7 19.5 1,073.8 12 ±π≥≥ 16 29.1 8.20 21.5 27.7 1,140.9 19 ±π≥¥ 22 47.5 14.2 36.6 42.5 1,210.6 30 ±π≥µ 40 71.9 22.5 53.6 61.9 1,308.1 41 ±π≥∂ 40 90.4 26.1 69.9 76.3 1,366.7 51 ±π≥∑ 52 101 31.2 76.9 87.0 1,401.8 55 ±π≥∏ 76 103 32.3 78.8 92.9 1,435.3 55 ±π≥π 76 116 33.9 91.4 98.6 1,501.7 61 ±π¥∞ 76 122 34.1 101 100.0 1,544.5 66 ±π¥± 76 133 37.5 111 98.1 1,585.5 70 ±π¥≤ 76 157 41.7 134 99.6 1,620.0 82 ±π¥≥ 76 190 50.0 162 103.4 1,676.6 96 ±π¥¥ 76 220 51.7 188 109.7 1,739.6 108 ±π¥µ 73 250 55.1 216 117.2 1,810.0 119 ±π¥∂ 74 289 62.6 252 131.8 1,887.2 133 ±π¥∑ 75 343 73.3 303 151.2 1,967.0 154 ±π¥∏ 69 309 65.2 261 147.9 879.0 296 ±π¥π 99 373 76.3 329 170.6 1,173.9 280 ±πµ∞ 99 517 110 464 203.4 1,370.1 339 ±πµ± 129 604 111 558 232.0 1,577.8 354 ±πµ≤ 129 737 137 669 257.2 1,629.5 410 ±πµ≥ 179 862 178 759 289.2 1,669.4 455 ±πµ¥ 229 1,073 222 896 322.2 1,717.8 521 ±πµµ 229 1,246 242 1,047 358.1 1,789.1 585 ±πµ∂ 249 1,343 263 1,143 390.0 1,872.4 610 ±πµ∑ 266 1,341 276 1,113 425.8 1,976.0 563 ±πµ∏ 360 1,683 317 1,411 466.1 2,031.7 694 ±πµπ 410 1,874 357 1,568 507.1 2,088.7 751 ±π∂∞ 410 2,209 420 1,857 551.3 2,150.4 864 ±π∂± 485 2,437 458 2,054 595.0 2,234.2 919 * At the end of the year (starting in 1949).

≥¥ 2009 Developments in the Electricity Economy

Israel’s Electric Economy - Selected Historic Data (cont.)

Year Installed Electricity Annual Electricity Total Total Average Capacity Generation Peak Consumption Number Population* per Capita (MW) (in million Demand (in million Consumers (thousands) Consumption kWh) (MW) kWh) (thousands) (Kwh)

±π∂≤ 560 2,807 508 2,370 635.7 2,331.8 1,016 ±π∂≥ 645 3,042 561 2,569 675.7 2,430.1 1,057 ±π∂¥ 720 3,543 632 2,991 719.8 2,525.6 1,184 ±π∂µ 727 4,061 693 3,450 758.9 2,598.4 1,328 ±π∂∂ 727 4,461 718 3,823 793.6 2,657.4 1,438 ±π∂∑ 1,009 4,632 789 3,968 821.0 2,776.3 1,429 ±π∂∏ 1,019 5,327 882 4,595 849.5 2,841.1 1,617 ±π∂π 1,019 5,903 944 5,069 882.1 2,929.5 1,730 ±π∑∞ 1,233 6,610 1,115 5,697 911.5 3,022.1 1,885 ±π∑± 1,411 7,330 1,285 6,328 948.6 3,120.7 2,028 ±π∑≤ 1,451 8,167 1,453 7,117 994.1 3,225.0 2,207 ±π∑≥ 1,606 8,401 1,436 7,443 1,038.5 3,338.2 2,230 ±π∑¥ 1,914 8,837 1,443 7,749 1,083.4 3,421.6 2,265 ±π∑µ 2,182 9,349 1,479 8,255 1,103.1 3,493.2 2,363 ±π∑∂ 2,157 9,969 1,575 8,759 1,139.2 3,575.4 2,450 ±π∑∑ 2,385 10,696 1,810 9,334 1,171.5 3,653.2 2,555 ±π∑∏ 2,613 11,471 1,980 10,176 1,209.1 3,737.6 2,723 ±π∑π 2,653 11,995 2,070 10,635 1,239.0 3,836.2 2,772 ±π∏∞ 2,737 12,097 2,070 10,796 1,271.1 3,921.7 2,753 ±π∏± 3,041 12,666 2,160 11,191 1,296.8 3,977.7 2,813 ±π∏≤ 3,361 13,362 2,240 11,790 1,318.4 4,063.6 2,901 ±π∏≥ 3,711 14,047 2,460 12,557 1,346.8 4,118.6 3,049 ±π∏¥ 4,061 14,347 2,500 12,856 1,370.4 4,199.7 3,061 ±π∏µ 4,061 15,010 2,570 13,516 1,395.8 4,266.2 3,168 ±π∏∂ 4,061 15,503 2,820 13,957 1,419.4 4,331.3 3,222 ±π∏∑ 4,061 17,102 3,240 15,419 1,445.5 4,406.5 3,334 ±π∏∏ 4,061 18,760 3,510 16,920 1,498.7 4,476.8 3,637 ±π∏π 4,295 19,827 3,760 17,951 1,521.3 4,559.6 3,792 ±ππ∞ 5,065 20,279 3,800 18,333 1,557.9 4,821.7 3,652 ±ππ± 5,885 20,856 4,540 18,781 1,582.9 5,058.8 3,556 ±ππ≤ 5,885 24,020 5,010 21,821 1,629.0 5,195.9 4,013 ±ππ≥ 6,115 25,240 5,090 22,956 1,692.5 5,327.6 4,110 ±ππ¥ 6,345 27,610 5,490 25,186 1,749.9 5,471.5 4,360 ±ππµ 6,920 29,504 5,600 26,986 1,804.3 5,612.3 4,540 ±ππ∂ 7,736 31,291 6,000 28,588 1,865.4 5,757.9 4,687 ±ππ∑ 7,854 33,607 6,518 30,822 1,937.3 5,900.0 4,925 ±ππ∏ 8,324 36,378 7,041 33,025 1,999.0 6,041.4 5,148 ±πππ 8,579 37,656 7,150 34,298 2,069.9 6,209.1 5,182 ≤∞∞∞ 9,129 41,355 7,900 37,791 2,120.5 6,369.3 5,559 * At the end of the year (starting in 1949).

≥µ The Israel Electric Corporation Ltd. / Annual Report 2009

Israel’s Electric Economy - Selected Historic Data (cont.)

Year Installed Electricity Annual Electricity Total Total Average Capacity Generation Peak Consumption Number Population* per Capita (MW) (in million Demand (in million Consumers (thousands) Consumption kWh) (MW) kWh) (thousands) (Kwh)

≤∞∞± 9,679 42,209 7,850 38,665 2,159.8 6,508.8 5,585 ≤∞∞≤ 9,902 43,867 8,750 39,920 2,209.2 6,631.1 5,673 ≤∞∞≥ 9,969 45,608 8,570 41,721 2,251.4 6,748.4 5,819 ≤∞∞¥ 9,869 46,989 8,550 42,933 2,294.3 6,869.5 5,871 ≤∞∞µ 10,010 48,379 9,030 44,309 2,319.9 6,990.7 5,929 ≤∞∞∂ 10,487 50,372 9,450 46,175 2,353.8 7,116.7 6,053 ≤∞∞∑ 11,323 53,613 10,070 49,323 2,384.1 7,243.7 6,332 ≤∞∞∏ 11,675 51,273 10,200 50,161 2,417.6 7,372.3 6,307 ≤∞∞π 11,824 52,391 9,882 48,947 2,549.8 7,546.1 5,985

* At the end of the year (starting in 1949).

Peak Demand and Installed Capacity, 1948-2009

±≤¨∞∞∞

π¨∞∞∞

MW ∂¨∞∞∞ אחוזים

≥¨∞∞∞

∞ ¥∏ µ± µ¥ µ∑ ∂∞ ∂≥ ∂∂ ∂π ∑≤ ∑µ ∑∏ ∏± ∏¥ ∏∑ π∞ π≥ π∂ ππ ∞≤∞µ ∞∏

Annual peak demand Installed capacity

≥∂ Environmental Report Summary

37

Environmental Report Summary

Environmental quality - generating segment a) The activities of the Company, including the generating segment are subject to environmental laws and regulations regarding various matters such as air pollution, water sources, noise, storage, transportation and disposal of toxic substances, hazardous materials and others. Many of these laws and regulations were introduced a long time ago, while others are at various stages of regulation and standardization. b) These laws include among others: the Nuisance Prevention Law, 1961, the Planning and Construction Law, 1965, the Business Licensing Law, 1968, the Water Law, 1959, the Prevention of Sea Pollution from Mainland Sources Law, 1988, the Hazardous Materials Law, 1993, the Coastal Environment Preservation Law, 2004, Non-Ionizing Radiation Law, 2006 and Non-Ionizing Radiation Regulations, 2008,Clean Air Law, 2008, Environment Protection Law (the polluter pays) (amendments), 2008, Freedom of Information Law, 1998 and Freedom of Information Regulations (making information on the environment available to the public, 2009 and other laws and regulations (hereinafter: “environmental legislation”). Environmental legislation stipulates permitted levels for air pollution, noise, contaminants in sewage and other waste from power stations and the Company’s other facilities, as well as mechanisms for handling toxic substances (the Hazardous Materials Law), restrictions and procedures for erecting facilities (the Planning and Construction Law) and so on. c) In addition, the Business Licensing Law, 1968, the regulations drawn up by virtue of it and the licenses issued according to it include various environmental conditions which must be met as a condition for operating a business (including the Company’s power stations - since 1995). The Company expects that possible changes in the policy of the Ministry for Environmental Protection and/or changes in the Company’s generating sites will add additional environmental obligations/ conditions to its business licenses, including conditions that require adaptation of some of the Company’s facilities. d) Several environmental bills that have been placed recently on the Knesset agenda, including a bill on rehabilitating contaminated lands and a bill on reducing emission of hot house gases. The current Knesset did not open debates on approving these bills. These bills, if and insofar as approved could have significant economic implications for the Company. The Company estimates that the expenses, if any, that it would incur for the adjustments necessary in order to comply with any laws and/or regulations will be covered by the electricity rates. e) In the framework of planning and licensing procedures, the Company makes assessments of the environmental effects of its activities. The Company prepares surveys and opinions on the environmental effects for its facilities, according to the rules and instructions given by the planning and environmental authorities. In these documents it presents its environmental assessments and proposed steps for dealing with any problems found. The environmental documents are submitted to the relevant authorities for approval. f) Industrial waste from the power stations is drained into storage facilities on each site. In coastal power stations the waste is treated in dedicated purification plants. If possible, the purified (liquid) waste is recycled for use by the station. Other liquid waste is discharged into the sea according to permits given to each power station site by the Interdepartmental Committee for Permits for Sea Discharge, which operates by virtue of the Prevention of Sea Pollution from Mainland Sources Law, 1988. Power stations close to municipal sewage systems send their sanitary waste to these systems. In power stations that are not close to such sewage systems, independent plants have been set up to treat the waste. Liquid treated waste is used to irrigate landscaped gardens on these sites, in accordance with the irrigation with liquid waste permits issued to each site by the Ministry of Health, by virtue of the Public Health Regulations, 1981 (Amendment 1990). g) The Company has removed all transformers and cables containing PCB from its power stations and other external facilities. h) Atmospheric emissions from power stations include sulfur dioxide, nitrous oxide, carbon dioxide and particles. Specific emission values have been set for each power station. The Haifa, Reading (see paragraph (l) below) and Eshkol sites are subject to “personal orders” - provisions to prevent air pollution from the power stations according to the Nuisance Prevention Law, 1961. National outline plans, at the detailed level, were recently approved for Eshkol and Haifa and the outline plan for Reading is in the approval process. At the Company’s other generating sites there are provisions based on the Planning and Construction Law, 1965 and/or the Business Licensing Law, 1968. The Company is continually implementing measures to reduce polluting emissions. These measures include

39 The Israel Electric Corporation Ltd. / Annual Report 2009

Environmental quality - generating segment (cont.)

using low sulfur fuel oil at the Haifa site until natural gas reaches this site (and closing the Haifa B generation units). The coal power stations run on low sulfur coal. In many of the industrial gas turbines the Company has installed means to reduce nitrous oxide during use of natural gas or diesel. The installations were done on the basis of European requirements for large combustion installations, which are stricter than the provisions and requirements on this matter in Israel, in order to complete the project that began in 2005 for industrial gas turbines.

In the large fuel oil power stations, Haifa C, Eshkol C and D, the Company installed preliminary means to reduce nitrous oxide in the years 2002-2006 at a total cost of about 96 million dollars.

The Company operates systems to monitor and control emissions from its facilities in the air, in the sea and on land. The data are submitted to the regulating authorities and other relevant agencies.

i) About 64% of the electricity in Israel is generated by the large units operating on coal in the Orot Rabin and Rutenberg sites. Imports of coal have risen over the years and are expected to continue to rise in future if erection of the additional units of project D will be approved. Coal consumption produces coal ashes in a quantity of about 1.2 million tons per year. In the past surplus ashes that were not required were discharged into the sea, in accordance with legally granted permits, but after the Barcelona Treaty on protection of the Mediterranean was amended, disposal of ashes in the sea stopped in 1999. Since disposal of coal ashes into the sea stopped, the entire quantity of ashes produced by the Company was shipped for exploitation in the construction, infrastructures and agriculture industries. Usage in the construction industry (manufacture of cement and concrete) is most profitable, economically. In 2006-2009, over 90% of the produced ashes was sold to the construction industry and only a relatively small quantity, mainly bottom ashes, was delivered for use in infrastructures and agriculture.

Surplus seasonal ashes are stored at internal sites within the Orot Rabin and Rutenberg power stations until they are used for infrastructures. The quantity of coal ashes, stored in the power stations decreased significantly, following an increased demand for the ashes. At the same time, the Company wishes to improve its ability to store coal ashes, so as to market the ashes in an optimal manner and to be prepared for crisis conditions. On June 23, 2008, the Radiation Officer announced that as of July 23, 2008, coal ashes, which are a product of coal burning in power stations operated by coal of the Company are “Radioactive Waste”. The Company filed a detailed objection to this decision, in which the Company claimed that without referring to the very authority of the Officer to decide that coal ashes are “Radioactive Waste”, the fact of the matter is that there is no basis for classifying the ashes as “Radioactive Waste”, in view of the fact that the ashes are not treated as waste but rather as an industrial raw material: secondary material, used throughout the world as reclaimable material. In the Officer’s statement, dated July 21, 2008, the Officer rejected the objection of the Company.

This statement determines that coal ashes will be considered as radioactive waste as of July 23, 2008, and yet, despite this classification, “the radioactivity rate of coal ashes is insufficient in order to justify its burial in Dimona.” Due to the rejection of the objection of the Company to classifying coal ashes as “Radioactive Waste”, the Company applied recently to the General Manager of the Ministry of Environment and to the Manager of the petitions to the High Court of Justice Department in the Ministry of Justice with the request to bring about the suspension of the Officer’s decision, with the purpose of granting the parties sufficient time to resolve the disagreement. In his October 2, 2008, the Company received a letter from the Deputy Director General of the Ministry of the Environment stating that the Ministry is interested in making maximum usage of coal ashes, under supervision of the radioactive contents of building materials containing coal ashes.

In November 4, 2008, the Company received the letter of the State Advocate of the Ministry of Justice stating that it finds the position of the Ministry of the Environment acceptable. The Company believes that in view of the fact that even the Ministry of the Environment is not interested in terminating the useful utilization of coal ash, the parties will resolve the disagreement and the disagreement can be resolved through talks. To date, the announcement of the Officer did not affect ashes sales by the Company. The Company received in February 2009 a letter from the deputy general manger of the Ministry of the Environment requesting the Company to send a concluding report on use of ashes in 2008, detailing all the industrial companies that receive these ashes. A similar report will be sent every quarter and at the end of every calendar year. The Standards Institute is currently revising IS 5098 standard and is interested in applying a standard that will not affect concrete production and uses of ash in concrete.

40 Environmental Report Summary

Environmental quality - generating segment (cont.)

A specialists committee on behalf to the Standards Institute is revising since the beginning of 2009 the standard IS 5098 “Contents of Natural Radio-Active Elements in Building Materials”. The standard was approved upon completion of the process and was published on January 1, 2010. The standard is expected to conform to the requirements of the Ministry of the Environment to supervise the radioactive radiation of all building materials produced in Israel, including those containing coal ashes.

On January 3, 2010, the Radiation Officer addressed the Company, claiming that the Company transfers coal ashes to concrete plants which operate without a regulated business permit, from aspects of using ashes. The Company is currently studying this claim, but responded that it is supplying coal ashes for concrete production according to the permits as required by law and only to companies that declared that they hold a valid business license, which includes special terms for holding and using coal ashes. j) In February 2004 the Company began using natural gas (see section 2.1.10(h) of this report), which gradually replaced liquid fuel in the large steam driven units and in some of the industrial gas turbines. Use of natural gas considerably reduces sulfur dioxide and particle emissions, and also reduces carbon dioxide emissions (greenhouse gas). At the time of signing this report, the Eshkol power station in Ashdod and Reading power station in Tel Aviv, Gezer in Gezer regional council and Hagit operate on natural gas. A natural gas delivery infrastructure is currently being built for the Tsafit, Ramat Hovav, Haifa and Alon Tavor sites. k) In spite of the change to natural gas as the fuel in power stations, and the plan for significant reduction in the use and storage of liquid fuels (fuel oil and diesel), issues of preventing land and water pollution are expected to occupy the Company for quite some time.

Although the change to natural gas is indeed expected to reduce operational leakage of fuel that contaminates the ground, as older fuel infrastructures (containers and pipes) are emptied, shut down and dismantled, it becomes necessary to deal with past contamination (which occurred inadvertently during normal operation in accordance with work practices that were acceptable many years ago).

For example, the subject of the old fuel infrastructures in the Reading area has occupied the Company for several years, at this stage mainly at the theoretical level, to plan and examine options for orderly shut down of these infrastructures that are mostly in urban areas, underneath roads and close to residential buildings.

Shutting down fuel installations is expected to involve expenditure of tens of millions of dollars for environmental issues and treating polluted ground. l) Nuisance Prevention Regulations (Prevention of Air Pollution by Electricity Generation) 2009: The proposed regulation bill, by force of the Nuisance Prevention Law was submitted for approval by the Interior and Environmental Protection Committee of the Knesset in the previous Knesset session (2007). This bill sets out a specific and gradual timetable for implementing the new provisions on the subject of limiting emission of air pollutants to the environment at each of the Company’s generating sites. An inter-ministerial team, convened to review the implementation and execution of emissions reduction set by the regulations draft, defined implementable timetables, to ensure that a reliable electricity supply will not be affected. Details of continued approval of the regulations during the current Knesset session were not concluded as yet.

According to the version submitted to the approval of the Knesset in its previous session, by 2016 all the Company’s generating sites should be operating in accordance with the provisions of the new regulations. New generating facilities must be erected in accordance with these provisions. Accordingly, the Company will be required to install SCR (for treating nitrous oxides), FGD (to deal with sulfur dioxide) and Primary Measures (PM) (to handle nitrous oxides) in eight coal fired generating units, and also SCR (to handle nitrous oxides). In the last two coal units (Project C) that came on line in 2000-2001 PM and FGD were installed in advance. New coal units (D) will be built with PM, FGD and SCR. The Company is studying the estimated investments required to implement future requirements.

41 The Israel Electric Corporation Ltd. / Annual Report 2009

Environmental quality - generating segment (cont.)

m) According to the Tel Aviv Power Station Law (Cancellation), 1994, the National Council for Planning and Construction was authorized to set a timetable for ending the operation of Reading power station and its facilities. In July 1996 the National Council ordered the preparation of an outline plan to regulate continued use of the site. In June 2007 the National Council for Planning and Construction decided to distribute the outline plan for comments of the districts committees and public reservations. The plan determines the continued operation of the power station to the end of 2020 and decides, as authorized by the law which facilities will be eliminated, which will be relocated, environmental development and public designation of some of the cleared areas. This actions have a considerable financial cost of tens millions of dollars.

According to decisions of the National Council for Planning and Construction, Reading D will operate on natural gas, with liquid fuel backup up to 2011, subject to TASHAL approval. Operation of the station beyond 2020 will require a change in the national outline plan. The outline plan that enables operation of Reading D until 2020 was recently published for comments and reservations of the public and the district committees.

Pursuant to the decision of the Natural Gas Licensing Authority of Tel Aviv District and conclusions with the Municipality of Tel Aviv, the Company undertook to build a shore promenade, including a bridge over the station’s cooling water pool area.

n) The Clean Air Law, 2008 was published in the code on July 31, 2008, This law is intended to constitute the basic law designated to regulate air pollution in Israel from mobile and stationary sources. The law obliges the Government to prepare a national multi-annual plan that will include objectives for preventing air pollution and also require the establishing of a national air monitoring system and the publishing monitoring and sampling data provided by plants to the public. The law states that a large stationary emission source cannot be built or operated without obtaining an emission license from the Officer at the Ministry of the Environment. The emission license will cancel part of other current mandatory documents on the subject of air pollution, e.g., personal order and business license. The law defines a regulation and supervision system on the subject and includes an extensive chapter that grants enforcement and penalizing authorities, including the option to subject plants to financial sanctions due to violating the instructions of the law, authority to enter plants and issue orders to stop using the whole emission source or part thereof. The law states that granting an emission license involves a participation of the public process and requires payment of a fee under the application to receive an emission license and also required the Minister to set a levy on emission of contaminants, imposed on the owner of the emission source. The law is a “framework” law, since it sets a regulation system and a procedure for issuing an emission license but does not set mandatory threshold values. These issues and also details that must be specified in the request for an emission license, fees and levies rates and more will be included in regulations regulated by force of the law.

The law will come into force on January 1, 2011. The last date for filing a request for an emission license for current power stations is March 1, 2015, where a current power station will also include a new, inactive unit, if it is operated by natural gas and an outline plan with a survey on its environmental effects was approved for that unit.

The Company studying the economical, legal and operational implications arising from the law.

o) In 2009, the Company made investments of about NIS 113 million on environmental matters at its generating facilities. In addition to the investments, in 2009, as part of the costs of operating power stations and associated costs for fuel, the Company spent about NIS 35 million to meet environmental requirements.

The Company believes that overall its generating facilities currently comply with all the requirements of environmental legislation, of the Business Licensing Law and of the licenses that it received. Most of the Company’s power stations have business licenses, and some of the facilities are still in the final stages of obtaining licenses. Under the terms of the licenses, some of the facilities must be adapted pursuant to terms that were added later. The Company believes that it will be able to complete the necessary work for the additional adaptations at insignificant additional expense. The Company is discussing the subject of the radioactive radiation fees rate with the Ministry of Environment, and pays the fees required by the Ministry of Environment to obtain the licenses for its sites under protest.

42 Environmental Report Summary

Environmental quality - generating segment (cont.)

In order to comply with environmental legislation and terms, the Company allocates funds both for operating and fuel budgets and for development plans. For 2010, in the Company’s budget for regular operations and fuel, it has allocated about NIS 806 million for compliance with environmental requirements. This includes dealing with coal ash, handling kindlers, preservation activities, coastal cleaning and dealing with sewage, separate drainage for industrial waste, prevention of environmental nuisance, etc.

In the Company’s development budget it has allocated the sum of about $1,710 million (including interest incurred during construction) for reducing emissions (initial estimate only), in the years 2012-2017 (the reduction will be performed up to 2016, but operation will continue in 2017, see paragraph (g) above) as follows:

The plan includes: (a) Installing “preliminary measures” to reduce nitrous oxide in eight existing carbonic generating units at Orot Rabin and Rutenberg (installed in Rutenberg B). These “preliminary measures” reduce the production of nitrous oxide in the combustion process, as distinct from secondary means that reduce nitrous oxide after the combustion process. (b) Installation of devices to remove sulfur dioxide in eight coal operated generation at Orot Rabin site and at Rutenberg site. (c) Installation of catalytic devices to further reduce nitrogen oxides in ten coal driven generation units at Orot Rabin Rutenberg sites. Catalytic devices (SCR) are secondary means to reduce nitrogen oxide after the burning process.

The main additional environmental projects performed by the Company are as follows: 1) Improvements were made in the system for transporting flying ash in units 1 and 2 in the Rutenberg power station, at a cost of some NIS 22 million. 2) Projects for installing ongoing monitoring of stacks, started in 2009, at a total amount of approximately NIS 37 million. These projects will be performed at Haifa, Reading, Eshkol, Orot Rabin and Rutenberg sites. 3) Installation of silencers in jet gas turbines in an approximate amount of NIS 20 million. 4) Upgrade of a sanitary sewage treatment facility at Orot Rabin in an amount of approximately NIS 7 million. The current facility was built in the late 1980’s and the purpose of the upgrade is to ensure long term, reliable quality of the effluents. 5) An annual expense of approximately NIS 8 million to implement a “Smart Avoidance” policy to reduce electromagnetic fields. This policy provides a solution for treating existing facilities according to the Non- Ionizing Radiation Law. p) Various claims - criminal and civil - have been filed against the Company and its managers in connection with the activity of the generating segment, arguing breaches of environmental legislation. The criminal claims refer in principle to sea and air pollution, and those that have been investigated did not involve significant penalties for the Company or its managers, except for a criminal complaint regarding air pollution from Reading power station for which the Company was fined NIS 300,000. For more information, see note 24.b.2 to the financial statements. q) The Company expects the existing laws and regulations regarding the environment to be stricter in the future and that new laws will be adopted. This estimate is forward looking in nature, based on existing trends in the western world for stricter demands on environmental issues. A change in these trends would mean that this prediction would not materialize. The Company believes that it materially complies with all the existing environmental laws and regulations as of the date of this report. The Company is also studying the implications of the laws and regulations proposed on environmental subject, and has allocated funds in its electricity sector development plan and its operating budget to comply with existing and expected regulations. Nevertheless, that there is no certainty that the costs and obligations connected with existing and expected legislation will not be higher than described above, but even then the Company believes that it will be entitled to reimbursement of the costs involved in the adjustments necessary to comply with environmental legislation in the electricity rates.

The Company’s estimates given above are forward looking in nature. The financial data are based on the Company’s past experience and its forecasts, based on the degree of environmental effect caused by the Company’s current generating activity, and the environmental provisions in their current format. These forecasts may not materialize, if there are any future changes in the regulations referring to the environment or if the pollution caused by the Company changes as a result of changes in the scope of its activity. In addition, recognition of the costs as exogenous expenses is in the hands of the Electricity Authority.

43 The Israel Electric Corporation Ltd. / Annual Report 2009

Environmental quality

a. Background

The modern lifestyle is characterized by huge consumption of electricity, which makes possible much convenient and safe usage. Electricity is the main source of energy in most households, industry and businesses.

The electricity current creates an electrical field and magnetic field around it. The level of these fields depends on the voltage or the current, respectively, the structure of the line, the arrangement of phases on it and the distance from it.

These fields influence other electrical loads around them. They change their direction with a frequency of 50 cycles per second (50Hz), a frequency that is considered extremely low.

The energy linked to this low frequency is very low and in practice negligible. Over the last 30 years, there has been thorough investigation worldwide of the question of whether there is a link between extended exposure to the magnetic fields found in residences that are close to main electricity facilities or domestic electric appliances and the incidence of certain diseases, in particular leukemia in children. The studies include dozens of health surveys and thousands of laboratory tests.

A brief summary of research to date shows that the findings of some health surveys indicated a link between magnetic fields and leukemia in children (these findings were attacked by other researchers, since they are based entirely on estimates and since the statistic link that was found is extremely weak and cannot indicate the existence of a causal, scientific link between magnetic fields and infantile leukemia), while other health surveys and laboratory tests found nothing to indicate any link whatsoever.

The World Health Organization (WHO) and the International Radiation Protection Association (IRPA) in 1990 published guidelines on exposure to electrical and magnetic fields. The purpose was to prevent the known effects of magnetic fields, that is, induction of currents in the body that can affect the function of muscles and the nervous system. According to these guidelines, the maximum value for a magnetic field exposed to humans is 1,000 milligauss, and the maximum value for an electrical field is 5kw per meter. These values are based on the known effects of magnetic fields - induction of the electrical currents in the body. The values were published again in 1998, by the International Committee for Non Ionizing Radiation Protection (ICNIRP) as environmental threshold values, intended to ensure that the limit set for current induction flow in a body is not exceeded. According to ICNIRP, environmental thresholds for an electrical or magnetic fields may be exceeded, as long as the limit of the induced current in a body is not exceeded.

44 Environmental Report Summary

Environmental quality (cont.) a. Background (cont.)

With reference to epidemiological findings, that there could be other health effects of extended exposure to magnetic fields at lower levels than the threshold stated above, the Committee said that there was insufficient information to set threshold values lower than 1,000 milligauss.

The guidelines of the ICNIRP were adopted by the European Union and many western countries, as well as by Israel, through the Ministry for Environmental Protection and the Electric Corporation.

The International Association for Research into Cancer (IARC) in mid 2001 categorized magnetic fields as a “possible carcinogen”. According to the grading system of this Association, these fields are classified as a third degree risk (for comparison, this grade of risk also includes, for example, coffee). The ICNIRP mentioned above examined this definition and stated, at the end of 2001, that it did not affect the maximum value of 1,000 milligauss determined by it as aforesaid. This position reflects the policy of the WHO.

As a response to the possibility that there are long term effects, the WHO and many institutions and countries worldwide support the “principle of caution”, which means that even in the absence of certainty regarding the existence of any risk, and its scope - if any, there is justification for adopting certain preventive measures - not too far-reaching - on all aspects of exposure to magnetic fields.

This policy was validated once again in a comprehensive policy document from the WHO in June 2007, which states that there should be no new threshold lower than 1,000 milligauss, that magnetic fields will continue to be defined as “possible carcinogens”, and with a recommendation to use precautions that are low cost or without cost. It also recommended further research on the subject.

In July 2009, the ICNIRP committee published an updated draft guidelines document for low frequency magnetic and electrical fields. According to this document, the threshold value for the populations remains 1000 milligauss. The document also refers to the recommendations of WHO on all matters related to implementing the principle of caution to the , unproven, possible long term effects on the population. b. In February 2002, the Director General of the Ministry of the Environment appointed an advisory expert committee to define an Israeli standard for the magnetic field from the electricity grid, with reference to the actions of other countries and international bodies. On March 17, 2005, the committee submitted its recommendations to the Director General of the Ministry, including setting an upper threshold for exposure of 1,000 milligauss, applied to short term effects, while also operating the principle of preventive precautions for the magnetic field from the electricity grid, a principle that means adopting the accepted technical measures at reasonable cost, to reduce the level of exposure, as far as possible. Regarding implementation of the precaution principle, the report of the expert committee stipulates planning measures to be adopted when planning new facilities, and also states that for existing facilities a public committee will be set up, to determine the order of actions and the manner of dealing with facilities in the framework of the defined budget of $2 million per year. The committee adopted the position of the WHO, that it should not define a threshold lower than the maximum value given above.

The Ministry of the Environment published the report on its Internet site, and its recommendations were incorporated in the Non Ionizing Radiation Law, in 2006, as the basis for decisions by the Radiation Officer on matters concerning the terms for permits covering the electrical grid, until regulations for the electrical grid are introduced.

45 The Israel Electric Corporation Ltd. / Annual Report 2009

Environmental quality (cont.)

c. Although the Ministry of the Environment retracted the recommendation to plan and operate electricity facilities in a way that will prevent exposure of the population to electromagnetic radiation that exceeds an average of 10 milligauss per day and cancelled this recommendation even before the experts committee published its report, the Company adopted a policy of “smart avoidance” as part of its environmental policy. In this framework, the Planning, Development and Technology (PDT) Division and the Consumers Implementation Division carry out engineering work on limiting magnetic fields in all kinds of electrical installations. For new installations, the principles of smart avoidance are implemented right from the design phase. In high voltage facilities, the principle is implemented as part of the Company’s development plan. For high voltage lines, phase lines and arrangements are defined that restrict the levels of magnetic fields in populated buildings as much as possible. For high voltage and low voltage facilities, planning is based on keeping conductors away from occupied rooms, and improving mutual setoff between phases. These principles are also gradually being implemented in existing facilities that create relatively high fields in adjacent buildings (on this matter see below, the section above on the report of the experts committee). At the same time research is taking place on the development of further reduction methods. The expenses recorded for the smart prevention project in 2009 is approximately NIS 6.3 million.

d. On January 1, 2006, the Non Ionizing Radiation Law, 2006 was published in the Government records. The Law defines a source of radiation as any device, installation or technological system which in the course of its operation creates or may create non ionizing radiation, i.e. it emits electromagnetic waves whose energy level is less than 5 electrons per volt. The Law was also applied to electrical facilities used for generation, transmission, distribution and supply, as far as supply to homes. The Law stipulates that no radiation facility can be set up or operated without a permit from the Radiation Officer in the Ministry of the Environment. It is also possible to obtain a permit to cover the erection and operation of several facilities of the same type. The Law gives the Radiation Officer in the Ministry of the Environment wide powers, including: canceling or suspending permits, powers to enter places where radiation sources are located, appointment of inspectors, the ability to issue an order to remove a facility, informing the public of the existence and location of radiation sources, and so on. The Law came into force on January 1, 2007 with respect to new electrical facilities (those facilities for which no building permit or authorization was received by January 1, 2007), and is intended to come into force for existing facilities on July 15, 2008. This is a “framework” law, that is, it states that “preventive precautions” must be adopted but does not specify what they are or any binding threshold values. These matters, like the imposition of fees for radiation permits, must be included in the regulations to be promulgated by January 1, 2007. Up to the publication of the said regulations, the law adopted the aforementioned report of the experts committee, published on March 3, 2005. It should be noted that pursuant to the Non Ionizing Radiation Law, decisions that have an effect on the costs for the electricity sector and regulations that have a direct and material effect on these costs, must be approved by the Minister of National Infrastructures and the Minister of Finance.

In January 19, 2009 “Non-Ionizing Radiation Regulations – 2009” were published. The regulations require payment of fees for radiation permits to electricity facilities and for every new facility built by force of these permits. The phrasing of these regulations is not quite clear and unequivocal, therefore there is no final estimate, as yet, of the total annual amount which the Company will be required to pay with respect to the fees. It should be noted that since the law came into force, the Company requested and received permits to set up and operate electrical installations but has not yet been asked to pay the fees.

e. The Company is studying the economic, legal, operational and technical implications of the foregoing. It estimates that the costs of the adaptations required to comply with the provisions of the Law and/or the regulations will be covered by the electricity rates. This estimate is predictive in nature. Regarding the assumptions underlying this estimate and the factors that could prevent its realization.

f. In order to implement the Law, the Company set up teams with representatives of the relevant divisions, and discussions began through the Ministry of National Infrastructures with the Ministry of the Environment.

46 Environmental Report Summary

Environmental quality (cont.) g. The Company submitted applications for most of the new facilities on the grid and for all the existing facilities on the grid. So far, the majority of permits required to build new electricity facilities and continued operation of existing facilities were received. A limited number of permits stipulate conditions that the Company will have difficulty complying with. The Ministry of the Environment refused to grant permits for some of the applications while other applications are still waiting for a permit. The Company is in continual negotiations with the Ministry of the Environment to find reasonable solutions to these problems. h. As stated, the Law does not set threshold values for lengthy exposure to electrical and magnetic fields with a frequency of 50Hz. However, and as stated in paragraph (a) above, back in 1990 and later on under the report of the experts committee of March 2005, the Ministry of the Environment adopted the position of the WHO that recommended a threshold value of 1,000 milligauss for short exposure to magnetic fields.

According to the calculations and tests carried out by the Company itself, for various electricity lines and transformation facilities, the Company believes that in general it is complying with the ICNIRP guidelines. There are special cases where there may be a limited local deviation from the ICNIRP threshold for a magnetic field close to a few existing facilities, yet the Company estimates that there is no deviation from the ICNIRP limit for induced current in the body. The Company is working to plan new facilities so as to avoid deviations from the aforesaid threshold.

47 The Israel Electric Corporation Ltd. / Annual Report 2009

Environmental quality (cont.)

i. The Ministry of the Environment prepared an explanation for sending to anyone who inquired and also for incorporation in the survey reports of the Ministry and of private surveyors. According to this explanation, the threshold value of 1,000 milligauss is for a short time only, while extended exposure to levels above 2 milligauss is a possible carcinogen, and the average levels in residential rooms in Israel are no higher than 0.4 milligauss. Recently, while handling a customer complaint, it was found that the explanation sent by the Ministry to private surveyors or customers includes a recommendation that the average level for continuous 24 hour exposure should be 2 milligauss, for 12 hours continuous exposure - 3 milligauss, and for 8 hours continuous exposure - 4 milligauss. These statements aroused complaints and claims against the Company from the public and the authorities. Moreover, several planning authorities have incorporated into the building permits for electrical facilities a condition stating that it is forbidden for the level of the magnetic field from the facility to be greater than 2 milligauss. The inclusion of this condition prevents the Company from connecting facilities to its electrical grid. The Company submitted an objection to this position to the Ministry of the Environment and the Ministry of National Infrastructures, arguing that this explanation has been interpreted by the public and by some of the authorities as a binding standard, which the Company cannot meet. In the proposed plan for national infrastructures dealing with electrification of the railway, the committee for national infrastructures has incorporated a provision stating that the maximum threshold for radiation from railway electrical facilities will be 10 milligauss. If this value is indeed adopted in the plan, it could lead to the adoption of a similar threshold in other national plans. The Company objected to determining this value in the proposed plan. There is still no agreement between the Ministries and the Company on this issue.

j. Many inquiries on this subject of the existing magnetic fields around electrical facilities are received from the public, some of an informative nature, and others framed as requests or demands for measurements and other actions to reduce the level of the magnetic fields deriving from these facilities. The Company responds to every inquiry.

To date, a number of complaints were filed in court against the Company in connection with the magnetic field, but were deleted or dismissed. A decision that dismissed the claims states, inter alia, that the valid standard in Israel is 1,000 milligauss. Six claims against the Company are pending currently. One of the claims is a claim (and a request to be recognized as a class action) of NIS 100,000,000, stating that the Company does not fulfill the obligation of disclosure and informing the public on the radiation emitted from its facilities and the position of the Ministry of the Environment.

48 Developing the Electricity Sector

49

Developing the Electricity Sector

Developing the electricity sector - the generating segment a) Method of determining the plan

The main purpose of the development plan for the generating segment is to serve as a basis for reaching practical decisions on additional generating units required, their type, capacity, dates of commencement of operation and their location, while defining the optimal fuel mixture required for their operation. The plan contends mainly with uncertainty in all input aspects: demand for electricity, fuel prices, techno-economical data of candidates for developing the generation system and more. For these reasons, the planning is usually performed through different future scenarios, aimed at reviewing the scope of uncertainty in order to contend with future possible realizations of the planning parameters. In light of the above, there is a perpetual need for the development plans to be updated periodically.

Section 19(a) of the Electricity Sector Law states that the Minister, in consultation with the Electricity Authority may require an essential service license holder to submit for his approval, in the required format and time, a development plan, as a whole or in parts, needed to fulfill the obligations provided by the license; after the Minister, in consultation with the Electricity Authority approves the plan, the essential service license holder will act only according to the approved plan.

The aforesaid requirement is specified in section 28a of the generation license, stipulating, inter alia, that the license holder will submit a development plan regarding its operations according to the license to the Minister, every five years.

The Company submitted only specific projects for the approval of the Minister in recent years and did not submit a multi-annual development plan for approval. b) Main assumptions and constraints underlying the development plan and its implications on reserve level and reliability of the generation system:

1) Development in electricity consumption is affected by economical, climatic and demographical factors. The link between electricity consumption and the influential factors is expressed with the help of an econometric model, developed by Economical Models Ltd., (“Economical Models”) jointly with the Company. It should be noted that energy efficiency in electricity consumption over the years was included in the calculations in the future demand forecasts and subsequently in planning the generation system.

Since the long term planning of the generation system is especially long and includes a high uncertainty rate about the future economical development of the State and climatic conditions, it is highly important to conduct an extensive risk analysis during the optimization of the generation system development, with due consideration of distributed demand forecasts.

Consequently, demand forecasts up to 2030 were prepared in three economical scenarios (describing three combinations of weighting a reasonable economical scenario with a basic and accelerated economical scenarios) and two climatic summer scenarios (difficult, extreme), which together create six possible scenarios. All these are performed with the purpose of enabling system planners to expand the risk analysis and thereby reduce the risk involved in decision making.

The global economical crisis that started in 2008, affects the demand for electricity forecast. The Company, jointly with Economical Models and the Ministry of National Infrastructures is in an on-going process of reviewing the changes in the demand for electricity, to adapt the demand forecasts to trends indicated by the local and global changes. Therefore, possible updates may still be required in the long term demand forecast.

51 The Israel Electric Corporation Ltd. / Annual Report 2009

Developing the electricity sector - the generating segment (cont.)

b) Main assumptions and constraints underlying the development plan and its implications on reserve level and reliability of the generation system: (cont.)

2) Forecast of gaps between peak demand and generating capacity for the years 2011-2014: The following table summarizes the expected available capacity of the Company’s generating units (including existing small private electricity producers) compared to the weighted summer peak demand forecast for 2011- 2014 in megawatts (negative numbers in brackets).

It should be noted that the following forecast data are based on the most recent update of long term demand for electricity forecast, conducted in July 2009 and includes the estimated effects of the global economical crisis up to that date.

Year Forecast Installed Available capacity Available Available Available peak capacity in summer reserve in capacity in reserve in demand considering summer summer, summer, stoppages for assuming a assuming performing emission fault in the fault in the reduction projects largest unit largest unit in existing coal power stations Megawatts 2011 10,858 13,221 12,495 1,637 11,920 1,062 2012 11,358 13,484 12,728 1,370 12,153 795 2013 12,054 13,966 12,617 563 12,042 (12) 2014 12,662 14,081 12,728 66 12,153 (509)

Assumptions used in preparing the table (a) The Company’s forecast of weighted peak demand for electricity is based on the scenario that assumes reasonable economical development and extreme climate in summer. (b) The forecast for installed capacity is based on the expected start of operation of new generating units according to the Company’s development plan, including the emergency plan for 2010-2013, scrapping of old generating units, and stoppage of current generation units in order to implement environmental projects. (c) In the summer the available capacity is obtained after deducting reduced output of industrial gas turbines and CCGT units from the available capacity caused by the effect of the high ambient temperature. (d) A fault in the largest unit - a fault in the largest carbonic unit would cause a reduction of about 575 megawatts, and therefore the available capacity is reduced by 575 megawatts each year. (e) Available capacity does not include the entry of new private producers.

It should be noted that according to the data presented in the table above, the reserve of the generation system may be significantly lower than the values required by planning reliability criteria, from which a reserve of 20% of the generation capacity is derived.

3) Expected development of additional generating capacity According to the development plan, the Company is expected complete the construction of a further 3 new combined cycle units with a total capacity of 1,112 MW by 2012, which have been approved by the Ministry of National Infrastructures for the sites at Gezer, Tsafit and Haifa. These 3 units are at various stages of planning and construction, and so far the construction of the gas turbines at Tsafit was completed and is currently operated on diesel, with a capacity of 248 MW. Gas is expected to reach Tsafit in 2010.

In addition, in light of the risks to reliability of electricity supply, the Minister of National Infrastructures approved the addition of generation units with a total capacity of 1,775 MW, under the framework of an emergency plan. Under the plan, two gas turbines with a total capacity of 250 MW are operated at Ramat Hovav and four combined cycle gas turbines with a total capacity of 1,525 MW wil be operated: • In the first stage, gas turbines - for the summer of 2010, gas turbines in Eshkol, Ramat Hovav and Hagit sites and for the summer of 2011 in Alon Tavor site. • Second stage - Additional steam driven units will be built, enabling operation of the units in a combined cycle at Eshkol, Ramat Hovav and Hagit and Alon Tavor in the summer of 2013.

52 Developing the Electricity Sector

Developing the electricity sector - the generating segment (cont.) b) Main assumptions and constraints underlying the development plan and its implications on reserve level and reliability of the generation system: (cont.)

3) Expected development of additional generating capacity (cont.)

It should be noted that the capacities stated above are the capacities of the units when operating on natural gas, which assumes that natural gas will reach all the electricity generating sites during the period mentioned above.

In addition to these natural gas driven generation additions, the Company plans to operate a coal operated power station, Project D, already included in the development plan by the Minister of National Infrastructures in 2001. This power station comprises two generation units of 630 megawatts each, at Rutenberg site in Ashkelon (“Project D”). The earliest possible operation date of this project is 2015 and 2016. The power station is currently in the planning process at the National Planning Committee, that recently heard with an investigator acting on its behalf the comments of the district committees and the public. The recommendation of the investigator after hearing the objections was not published as yet. Planning processes of the project are subject to legal proceedings, as detailed in section 2.1.15 herein. c. Forecast of Investments Required to Implement the Development Plan of the Generation Segments

The investments forecast required by this plan is currently being prepared by the Company. In view of the average volume of previous annual investments in developing the generation segment, (approximately NIS 2 billion per year) and in consideration of the development plans specified above, the Company estimates that the investments required to implement the development plan will amount to approximately NIS 4.6 billion per year. d. Forward Looking Information

The detailed estimates of the Electricity Sector development plan – the generation segment is forward looking in nature, based on the aforementioned forecasts and assumptions. Upon completion of the updated investments plan or pursuant to instructions issued to the Company (as a critical service supplier) on the development plan it must implement, the Company may require investments in different volumes than aforementioned. This information contains subjective forecasts, valuations, estimates and other plans of the Company for the report date, regarding work assumptions used to prepare the forecast and realization date of those assumptions. This information is based on future data, the realization of which is uncertain by nature and outside the sole control of the Company.

The main factors which may prevent this forward looking information from materializing or change the estimated implementation timetable of the development plan and the subsequent investments according to the aforementioned outline are, inter alia, changes in the expected increase in demand for electricity; implementation of the future restructuring of the Electricity Sector and the Company (see paragraph 1.7.1 in this report) and the effect of the restructuring on the implementation of the Company’s development and investments plan; difficulties in receiving licenses and/or changes in the regulations relating to the environment and to licensing; lack of appropriate rate coverage (see Note 3(b) to the Financial Statements); the ability of the Company to raise the funds required to implement the development plan.

53 The Israel Electric Corporation Ltd. / Annual Report 2009

Developing the Electricity sector - Transmission and Transformation Segment

a) Method of defining development plans for the transmission and transformation segment

The development plan for the transmission and transformation system for the years 2010-2014, at a total investment of approximately NIS 4 billion, for the said period and approximately NIS 800 million per year. The plan includes construction of new projects and projects to enlarge and improve the existing system, in order to adapt it to the needs of the electricity sector, taking into account the availability of sites and the Company’s ability to realize the projects. This development plan was submitted to the Ministry of National Infrastructures for approval, after consultation with the Electricity Authority, as required by section 19(a) of the Electricity Sector Law, regulation 43(b) of the Electricity Sector Regulations (Conditions and Procedures for Granting a License and Obligations of the License Holder), 1997 and by section 34(a) of the transmission, distribution, delivery, sale of and trade in electricity. As of the date of this report, the Company did not receive the approval of the Minister of National Infrastructure, although it acts according to this plan.

The main projects in the transmission and transformation segment for 2009 are: a. Erection of stationary secondary station – Maalot, Kfar Saba east. b. Building mobile secondary stations – Netivot, Sodom north, Nahal Zofin and Atarot. c. Additional transformation in existing secondary stations – Shprintsak, Beit Shean, Kabri, Caesarea, Sharon, Shderot temporary, Anilevitch and Yarkon.. d. Construction of an 62.8 km long overhead line and 2.8 km underground cable (cable moving). e. Hundreds of relatively small projects and advanced multi-annual projects that will begin operation in 2010.

b) Main Assumptions and Constraints Underlying the Development Plan

The development plan is based on: 1) Geographical spread of load, matching the forecast of national demand. 2) Development plan for the generating system. 3) Planning criteria. 4) Implementation of advanced and proven technologies in the transmission and transformation system. 5) Analysis of chances of realizing the projects.

The purpose of the development plan is to adapt the transmission and transformation system to the needs of the national economy while reducing costs and minimizing land resources, according to the defined standard of reliability and quality of electricity. The plan was prepared taking account of uncertainty as well as planning, land, environmental and economic constraints and their implications for the ability to implement the plan.

The development plan meets the following needs: (1) Ensuring optimal operating conditions for the generating system, taking account of the expected geographical breakdown of loads and according to various reasonable scenarios regarding the load on generating units. (2) Ensuring system survivability. (3) Ensuring proper reliability of supply to consumers in the event of faults in generating units, transmission circuits, secondary stations, connection transformers and transformers in secondary stations. (4) Maintaining the quality of electrical energy supplied. (5) Consideration of the ability to implement the projects.

The development plan for the transmission and transformation segment is the product of techno-economic optimization of various alternatives that meet these needs. The projects described in the development plans are examined with respect to their chances of implementation, which depend on the availability of sites and the Company’s ability to realize them. Revised operation dates are set based on these assessments. In accordance with the Government decision to generate electricity from renewable energy at a 10% rate by 2020, the Company is acting to implement this plan. As part of these actions, the Company published numerous surveys on possible integration of the different initiatives (the surveys are conducted in accordance with the decisions of the Electricity Authority).

54 Developing the Electricity Sector

Developing the Electricity sector - Transmission and Transformation Segment (cont.) b) Main Assumptions and Constraints Underlying the Development Plan (cont.)

Regarding the subject of the Government tender for a solar power station in Ashalim, the Company is completing the plans related to the environmental document and a planning scheme for a 161 kWh facility and a 161 kWh line in the site. Regarding the private power station Ktura, the Company is completing the material for an environmental survey for the required 161 kWh line.

At the same time, it should be noted that the Company will not be able to contain the initiatives for building a power station based on renewable energy of a material capacity without completing the new 161 kWh line to Eilat, especially without running a section in Machtesh Ramon area. c) Development of the transmission system

In the years 2010-2014 it is planned to add about 134 km of circuit to the ultra high voltage (400 kwh) transmission system, conditional on the conclusion of statutory procedures for approval of the lines. This plan does not take into account the option of connecting 400 kwh lines with neighboring countries: Egypt and Jordan. As of the report date, the Company acts to receive licenses. A 400 kWh gas turbine (unit 6) in Ramat Hovav was connected to the system during 2009. In addition, multi-annual projects will be advanced to commence operation in 2010. As of the report date, the Company conforms to the timetable set in the development plan.

During the period 2010-2014 it is planned to add about 762 km of circuit to the high voltage (161 kwh) transmission system. In addition about 505 km. of circuit will be upgraded/ re-erected/ relocated. Addition of another 32 km. of underground cable circuits are also planned for 2010-2014. d) Development of the 400/161 kwh transformation system

The development plan includes the addition of a connection transformer with a capacity of 575 megavolts at the Zevulun switching station, setting up the Ganot switching station with two connection transformers with a total capacity of 1,300 megavolts in 2014 - conditional on the conclusion of statutory procedures for approval of the aforesaid sites. At the end of 2014 the Company expects to have 10 switching stations with a total capacity of 11,875 megavolts. e) Development of 161 kwh transformation capacity

The development of secondary stations in the transmission and transformation segment is based on long term planning, taking account of the geographical dispersion of demand. This forecast is expressed by setting up new fixed secondary stations, temporary and mobile secondary stations, plus adding transformation in existing secondary stations.

There are two types of secondary stations: internal and external. The trend is to erect external secondary stations wherever possible, for economic reasons.

In the years 2010-2014 the Company expects to add about 13 permanent secondary stations with total transformation capacity of 1,420 megawatts. By the end of 2014 there should be some 144 secondary stations (stationary, temporary and mobile) with total transformation capacity of about 16,270 megawatts.

55 The Israel Electric Corporation Ltd. / Annual Report 2009

Developing the Electricity sector - Transmission and Transformation Segment (cont.)

f) Forecast of investments required to implement the development plan for the transmission and transformation segment

According to investment data from previous years, an average investment of about NIS 700 million is required for the transmission and transformation system each year over the years, from 2010 to 2014, to implement the development plan.

This information includes forecasts, subjective estimates and other plans of the Company as of the date of this report, regarding work assumptions used to prepare the forecasts and realization schedules of these assumptions. The said information is based on future data of an uncertain realization nature, that are not fully controlled by the Company. The main factors that could affect the actual realization of this predictive information or that could cause changes in the estimated timetable for execution, as described above, include the following:

Changes in the expected rate of growth in demand for electricity, implementation of the future organizational change in the electricity sector and the Company (see section 1.7.1 of this report) and the implications of the structural change for realization of the Company’s development and investment plans; any development plan that may be defined by the Minister for National Infrastructures for the transmission and transformation segment; difficulties obtaining licenses and/or changes in legislation affecting environmental issues and licensing; absence of suitable rate cover; the Company’s ability to raise the required funding for its development plan.

Development of the electricity sector - distribution

a. Method of defining development plans for the distribution segment

The development plan for the distribution system includes the three main components of the distribution grid: the high voltage grid, distribution transformers, and the low voltage grid. Each of these elements are referred to individually with respect to building and replacement. The distribution grid also includes the component of electricity meters and improvements in connections to homes. The development plan is intended to adapt the distribution system to the needs of the electricity sector in view of the introduction of new sub-stations and development of existing sub-stations, additional consumers, expected growth in load of existing consumers and aging of the current grid, in accordance with techno-economic planning criteria.

Section 19(a) of the Electricity Sector Law states that the Minister, in consultation with the Electricity Authority may require an essential service license holder to submit to his approval, in the required format and time, a development plan, as a whole or in parts, needed to fulfill the obligations provided by the license; after the Minister, in consultation with the Electricity Authority approves the plan, the essential service license holder will only act according to the approved plan.

The aforesaid requirement is specified in section 34a of the transmission, distribution, delivery, sale and trade in electricity license, stipulating, inter alia, that the license holder will submit a development plan in accordance with the law and the regulations, as instructed by the Minister in accordance with the operations of the license holder according to the license.

Regulation 43(b) of the Electricity Sector Regulations (Terms and Procedures for Granting a License and Obligations of the License Holder), 1997, also stipulates the a transmission or distribution license holder should submit a multi- annual development plan to the Minister.

56 Developing the Electricity Sector

Development of the electricity sector - distribution (cont.) a. Method of defining development plans for the distribution segment (cont.)

According to the aforementioned, the Company submitted to the Minister, three years ago, a development plan for the distribution segment. At that time, the Minister forwarded the plan for consultation with the Electricity Authority, as required by section 19a of the Electricity Sector Law. Intensive discussions on the subject of models for developing the distribution grid were conducted at the time, mainly with the Electricity Authority and also with the Ministry of National Infrastructures. No final decision was reached as yet on the models that will be used for recognizing the development costs of distribution grids.

In light of the prolonged discussions on the subject of this development plan, the Company was not requested as yet by the Minister to submit another development plan. b. Main Assumptions and Constraints Underlying the Development Plan

The development plan for the distribution grid is based on the following data and assumptions: 1) Forecast number of domestic and small business connections, obtained from the department of statistics and market research. 2) Forecast number of large businesses connections bases on average performance in previous years (data is derived from the infrastructure system and the orders system). 3) Data on high voltage consumers, from the orders system. 4) Technical guidelines for planning the distribution grid. 5) Guidelines from the Ministry of National Infrastructures, local authorities, statutory authorities for planning and executing national infrastructures, such as instructions from the Ministry of National Infrastructures on construction of an underground grid in urban and industrial areas characterized by high population density. c. Expected development of additional distribution capacity

1) High voltage During the period 2010-2015 some 4,247 km of high voltage above ground and underground lines are expected to be added. In addition, about 1.015 km of grid will be replaced. As of the date of this report, the Company conforms to the timetable as stipulated in the plan. About 690 km over ground and underground high voltage lines are expected to be added in 2010. At the end of this period, the total length of high voltage lines is expected to be about 29,563 km.

2) Low voltage During the period 2010-2015 some 4,191 km of low voltage over ground and underground lines are expected to be added. In addition, about 1,720 km of grid will be replaced. About 646 km above ground and underground low voltage lines will be added in 2010. At the end of this period, the total length of low voltage lines is expected to be about 23,747 km.

3) Distribution transformers During the period 2010-2015 some 7,831 distribution transformers are expected to be added. In those years about 2,707 transformers are scheduled for replacement. About 1,251 new transformers are scheduled to be added in 2010 and about 308 transformers are scheduled for replacement At the end of this period, the Company expects to have at its disposal about 53,621 distribution transformers.

57 The Israel Electric Corporation Ltd. / Annual Report 2009

Development of the electricity sector - distribution (cont.)

d. Forecast of investments required to implement the development plan for the distribution segment

The annual average investment forecast for each of the years 2010 up to 2014 stands at some NIS 1.2 billion per year. This forecast also includes the investment in special projects, as specified below: 1. Implications of the radiation law: changes in the new and existing grid to adapt it to the requirements of the radiation law. The annual investment forecast includes an estimate of the additional costs due to changes in planning and execution required by the radiation permits obtained. However, there are costs that cannot be estimated at present. Realistic estimates will only be possible when practical experience has been gained of at least one year following operation of the radiation law. Regarding existing facilities, to which the law will apply starting on July 1, 2008, the expert committee is supposed to set criteria. 2. Privatization of kibbutzim and the changeover from bulk supply to individual supply. 3. Burial of existing grids in populated areas: bringing forward investments in line with opportunities to excavate in city centers. 4. Moving pylons from roads. 5. Entry of private producers, for which the Company will have to built additional grid.

However, this estimate is predictive in nature, and when the updated investment forecast is prepared, the investments required by the Company may differ from the foregoing. This information includes forecasts, subjective estimates and other plans of the Company as of the date of this report, regarding work assumptions employed by the Company to prepare the forecast and its realization dates. The said estimates are based on future data that may not materialize or materialize partially or not as expected, which are outside the Company’s control The main factors that could affect the realization of the predictions or lead to changes in the estimated timetable for implementation of the development plan as described above include: 1) Non realization of special projects. 2) Changes in the forecast rate of growth in the number of connections. 3) Implementation of changes in the future organizational structure of the electricity sector and of the Company (see section 1.7.1 of this report) and their implications for the Company’s development and investment plans; difficulties in obtaining licenses and/or changes in legislation in the area of environmental quality and licensing; absence of suitable rate cover (see note 1(c) to the financial statements); the Company’s ability to raise the finance required for the development plan.

The electrical vehicle project - The Company, as a critical service supplier, is obliged to erect the charging posts in public areas - roads and sidewalks. The condition for performing the project is ensuring coverage of the critical service supplier costs for the erection and maintenance of the charging system in public areas. Costs of the charging post and its connection to the grid and also its current operation and maintenance costs will be covered separately through the electricity rates, as a payment component that will apply to the electrical vehicles owners sector and not to the general public. It is proposed to set a rate in two parts, comprised of a fixed payment for each charging (to cover costs of the charging posts installed by the Company and specific fixed costs) and a price per kWh (to cover actually consumed electricity costs).

e. Expected development of electricity pylons protection

The Company is taking steps to prevent the danger of minors and unauthorized people climbing electricity pylons. In this framework it was decided to install new protective measures and signs on high voltage and low voltage pylons in residential areas. Following the ruling of the Magistrates Court in Tel Aviv on December 20, 2005, in which the Company was found guilty of causing the death of a minor who climbed an electricity pylon, it was decided to accelerate this plan. Pylons will be mainly protected by new climbing shields, with much longer and denser spikes than the existing climbing shields. Pylons will be marked with large and clear warning signs, designed by a consulting company, following a survey of a representative sample of children, which found that these signs are the most effective from the aspect of deterring children from climbing on pylons. The plan calls for protection of some 130,000 electricity pylons, the majority of them in populated areas and a small number in open areas. This project is scheduled to end up to the end of 2010. Budgeted cost of the aforementioned protection is approximately NIS 295. Protection was installed and signs posted on about 90,688 pylons up to December 31, 2009, completing about 70% of the project 58

Financial Report Summary Consolidated Statements of Financial Position

Consolidated Statements of Financial Position Adjusted to NIS of December 2009, in Millions

December 31, Note 2009 2008* 2007* CURRENT ASSETS Cash and cash equivalents 4 3,885 3,670 492 Trade receivables for sales of electricity 5 3,219 3,487 3,302 Other current assets 6 875 950 968 Inventory- fuel 7 1,659 2,898 2,426 Inventory- stores 223 234 233 9,861 11,239 7,421

NON-CURRENT ASSETS Long-term receivables 8 1,237 1,563 1,285 Advance payments on leasing real estate 9 398 404 401

Assets with respect to benefits after employment termination: Excess pension plan assets over pension liability 19 4,968 4,897 4,622 Funds in trust 10 1,736 1,591 1,202 6,704 6,488 5,824

Fixed assets, net Fixed assets in use, net 55,223 56,633 56,405 Fixed assets under construction 5,314 4,119 5,470 11 60,537 60,752 61,875

Intangible assets, net 12 782 789 800

79,519 81,235 77,606 * Restated (see Note 35 in the complete financial report on IEC website). The accompanying notes are an integral part of the Financial Statements.

Mr. Harel Zeev Blinde Mr. Amos Lasker Mr. Michael Lazer Dr. Ziv Reich Senior Vice-President of Chief Executive Officer Chairman, Finance External Director Finances and Economics Committee

Date of approval of the financial statements: March 31, 2010

61 The Israel Electric Corporation Ltd. / Annual Report 2009

Consolidated Statements of Financial Position (cont.) Adjusted to NIS of December 2009, in Millions

December 31, Note 2009 2008* 2007* CURRENT LIABILITIES Credit from banks and other credit providers 14 1,727 6,705 2,397 Trade payables 1,457 1,376 2,104 Other current liabilities 15 1,372 1,813 1,587 Regulatory liabilities, net 20 2,258 128 687 Customer advances, net of work in progress 16 441 307 254 Provisions 17 803 817 755 8,058 11,146 7,784

NON CURRENT LIABILITIES Debentures 18 30,375 29,160 28,446 Liabilities to banks 18 10,195 10,229 12,005 Liabilities with respect to other benefits after employment termination 19 2,456 2,385 2,270 Regulatory liabilities, net 20 1,529 1,447 1,225 Provision for refunding amounts arising from restatement of the financial statements 21 1,950 1,863 1,780 Deferred taxes, net 22 3,894 4,968 4,751 Debentures to the State of Israel 23 2,338 2,341 2,326 Others 18 1,895 2,105 2,198 54,632 54,498 55,001

SHAREHOLDERS’ EQUITY Share capital 33 1,048 1,048 1,048 Capital reserves 26 950 950 950 Retained earnings 14,831 13,593 12,823 16,829 15,591 14,821

79,519 81,235 77,606 * Restated (see Note 35 in the complete financial report on IEC website). The accompanying notes are an integral part of the Financial Statements.

62 Financial Report Summary Consolidated Statements of Operations and Comprehensive Income

Consolidated Statements of Operations and Comprehensive Income Adjusted to NIS of December 2009, in Millions

Year Ended December 31, Note 2009 2008* 2007* REVENUES 28 18,704 24,142 20,870

Cost of operating the electricity system: Wages 1,365 1,442 1,508 Fuel 8,674 12,825 10,618 Purchases of electricity 135 155 122 Operation of the generation system 646 596 547 Operation of the transmission and distribution system 333 318 329 Depreciation 3,635 3,515 3,383 14,788 18,851 16,507 Profit from operating the electricity system 3,916 5,291 4,363

Sales and marketing expenses 29 749 779 773 Administrative and general expenses 30 816 674 711 Expenses (income) from liabilities to pensioners, net 19 (215) 292 (102) 1,350 1,745 1,382

Income from current operations 2,566 3,546 2,981

Financial expenses, net: Financial expenses 2,141 1,842 838 Capitalization of financial expenses (240) (259) (255) Transfer of financial income to a regulatory liability 489 965 1,297 Financial expenses, net 32 2,390 2,548 1,880

Income before income taxes 176 998 1,101

Income taxes: Income from adjustments of deferred tax balances arising from changes in future tax rates (1,108) - - Other deferred taxes 22 46 228 278 (1,062) 228 278

Net income (loss) 1,238 770 823

Total comprehensive income 1,238 770 823 * Restated (see Note 35 in the complete financial report on IEC website). The accompanying notes are an integral part of the Financial Statements.

63 The Israel Electric Corporation Ltd. / Annual Report 2009

Consolidated Statements of Changes in Shareholders' Equity Adjusted to NIS of December 2009, in Millions

Paid-up Capital Retained Total share capital reserves earnings* Balance as of January 1, 2007 1,048 950 12,000 13,998

Changes during 2007 Net income 823 823 Balance as of December 31, 2008 1,048 950 12,823 14,821

Changes during 2008 Net income 770 770 Balance as of December 31, 2008 1048 950 13,593 15,591

Changes during 2009 Net income 1,238 1,238 Balance as of December 31, 2009 1,048 950 14,831 16,829 * Restated (see Note 35 in the complete financial report on IEC website).

a. The Government Companies Law, 1975, (“Government Companies Law”) states, inter alia, that the decision of the Board of Directors on the appropriation of profits of a Government company, including, a distribution, as defined by the Companies Law, 1999, (“The Companies Law”), is subject to the approval of the Government Companies Authority. If the Government Companies Authority disputes the decision of the Board of Directors, then a company that is classified like the Company (provided that it is not a company in privatization process) will act according to the decision of the Government Companies Authority, as approved by the Government. The current policy of the Government Companies Authority (which may change from time to time) on appropriating profits for dividends distribution, as of 1995, states: 1) Dividends from current income of public utility companies will be distributed at a rate of 60% of the current net annual income, before profit-based bonus payments to employees. 2) Dividends from accumulated profits will be determined specifically for each company, with due consideration of several relevant data and factors. The provision for dividends is recorded in accordance with the stipulations of section 3 of the Government Companies Authority in Circular c 1-2/97, dated February 9, 1997 and the clarification of the Government Companies Authority according to which, when recording dividends, reference should be made to net income including all its components, before profit-based bonus payments to employees. According to the opinion of the legal advisors of the Company, such recording does not derogate or damage the position of the Board of Directors regarding the actual distribution every year. The Company’s Board of Directors believes, that according to the tests specified in section 302 of the Government Companies Law, which according to the legal advisors of the Company overrides the stipulations of the Government Companies Law and the circular of the Public Utilities Authority - Electricity (“The Electricity Authority”), the amount of the dividends available for distribution should properly be determined solely in accordance with the tests specified in the Government Companies Law.

b. The amount of the dividends according to this policy and before the restatement for 2004 was about NIS 1,546 million, for 2005 - about NIS 762 million and for 2006 - about NIS 166 million. No dividends were calculated for 2007, since according to the former reporting standards, the Company recorded a loss in that year. According to this policy, the dividends for 2008 amount to about NIS 342 million (before the restatement). The dividend amount for 2009, is NIS 743 million.

c. The Company’s Board of Directors decided in 2005 to recommend to the General Meeting the distribution of dividends in the amount of NIS 118 million with respect to earnings for 2004, because in its opinion, dividends should not be distributed out of the earnings deriving from an accounting change and from an amount deriving from a decrease in the tax rate.

d. The Company applied to the Director of the Companies Authority to receive his approval of the above recommendation for 2004 and as of the date of signing these Financial Statements, has not yet received his reply.

64 Financial Report Summary Consolidated Statements of Changes in Shareholders' Equity

Consolidated Statements of Changes in Shareholders' Equity (cont.) Adjusted to NIS of December 2009, in Millions e. For the time being, the Board of Directors does not recommend the distribution of dividends for 2005, 2006, 2008 and 2009. f. The Company requested the approval of the Director of the Companies Authority for not recommending payment of a dividend with respect to 2008 and did not receive a reply up to the signing date on these Financial Statements. g. On March 26, 2008, the response of the Director of the Companies Authority was received regarding the examination of the appropriation of earnings for 2006-2005 stating that “in 2008, the Companies Authority does not intend to require dividend distributions with respect to 2006-2005”. h. No reaction was received as yet from the Government Companies Authority regarding the effect of the restatement of the Financial Statements on dividends. i. Bonus payments to employees: under the bonus policy in Government Business Companies, as stipulated in the Government Companies Authority circular, dated July 15, 2008, is not allowed when no dividends were paid for the year for which the bonus is requested, unless by an exceptional approval of the Director of the Government Companies Authority and subject to advance approval of the Management and the Board of Directors. At this stage, the Company did not submit any request to the Director of the Government Companies Authority.

The accompanying notes are an integral part of the Financial Statements.

65 The Israel Electric Corporation Ltd. / Annual Report 2009

Consolidated Statements of Cash Flows Adjusted to NIS of December 2009, in Millions

Year Ended December 31, 2009 2008* 2007* Cash flows from operating activities: Net income according to the statements of operations and comprehensive income 1,238 770 823 Adjustments required to present cash flows from operating activities (Annex A) 5,453 1,575 3,272 Net cash provided by (used for) operating activities 6,691 2,345 4,095

Cash flows from investing activities: Purchase of fixed assets less consumers’ participation in assets (3,702) (2,374) (3,525) Purchase of intangible assets (170) (178) (257) Investments in funds in trust (40) (286) (282) Proceeds from sale of fixed assets 42 48 67 Collection of long-term debts, net 61 2 61 Deposit of redeemed deposits in banks - - 235 Net cash used in investing activities (3,809) (2,788) (3,701)

Cash flows from financing activities: Issuance of long-term debentures, net 2,595 4,808 2,157 Other long-term loans received, net 901 320 164 Long-term debentures repayment (4,470) (43) (1,125) Repayment of long-term loans from provident funds (187) (187) (187) Repayment of other long-term loans (1,077) (1,176) (1,367) Deposit (repayment) of hedging transactions, net 92 (231) (550) Short-term credit from banks, net (521) 130 197

Net cash provided by (used in) financing investing activities (2,667) 3,621 (711)

Increase (decrease) in cash and cash equivalents 215 3,178 (317)

Balance of cash and cash equivalents at beginning of the period 3,670 492 809

Balance of cash and cash equivalents at end of period 3,885 3,670 492

Additional information about cash flows: Actual interest payments, net 2,860 2,670 2,787 Actual tax payments, net 12 6 4 * Restated (see Note 35 in the complete financial report on IEC website). The accompanying notes are an integral part of the Financial Statements.

66 Financial Report Summary Consolidated Statements of Cash Flows

Consolidated Statements of Cash Flows (cont.) Adjusted to NIS of December 2009, in Millions

Annex A - Adjustments Required to Present Cash Flows from Operating Activities

Year Ended December 31, 2009 2008* 2007* Income and expenses not affecting cash flows: Depreciation and amortization 3,927 3,638 3,719 Deferred taxes, net (1,069) 222 287 Decrease in liabilities with respect to employees benefits, net - (99) (310) Erosion of loans and debentures, net, including hedging transactions (894) (857) (1,878) Increase in differences with respect to increased provisions for refunding amounts arising from restatement of the Financial Statements 87 83 81 Increase of Company exposure to changes in foreign currency transferred to consumers 102 277 1,098 Decrease (increase) in other regulatory liabilities 2,109 (614) (5) Revaluation (erosion) of collectible debts 14 (1) 20 Capital loss (gain) on sale of fixed assets (24) 8 94 Decrease (increase) in value of funds in trust, net (105) (103) 2 4,147 2,554 3,108

Changes in assets and liabilities: Decrease (increase) in trade receivables for sales of electricity 268 (185) 29 Decrease (increase) in other receivables 47 (28) (54) Decrease (increase) in inventory- stores 11 (1) (3) Decrease (increase) in inventory- fuel 1,239 (472) (619) Increase (decrease) in customer advances, net of work in progress 134 53 (42) Increase (decrease) in liabilities to suppliers 81 (729) 854 Increase (decrease) in other current liabilities (474) 383 (1) 1,306 (979) 164

5,453 1,575 3,272 * Restated (see Note 35 in the complete financial report on IEC website). The accompanying notes are an integral part of the Financial Statements.

67