Open Letter to Israel’s Petroleum Commissioner

November 13, 2012

Dr. Uzi Landau
Minister of Energy and Water Resources

Mr. Alexander Varshavsky
Petroleum Commissioner

Ministry of Energy and Water Resources
234 Yafo Street
P. 0. Box 13106
Jerusalem 91130, Israel

Re: Zion Oil & Gas, Inc.’s Comments to the Ministry’s Performance Guarantee Guidelines

Dear Dr. Landau and Commissioner Varshavsky,

On behalf of Zion’s Board of Directors and our over 25,000 stockholders, many of whom are evangelicals and Christian Zionists who support the company because of their deep love for the State of Israel, Zion Oil & Gas, Inc. (“Zion”) hereby submits its comments to the Ministry’s Proposed Guidelines regarding Licensee Performance Guarantees published on the Ministry’s website on 29 October 2012.

Zion has been engaged in onshore oil and gas exploration in Israel since 2000 when we were first granted the small 28,800 acre Ma’anit License. Our mission, then as now, is to find and produce oil and gas, helping to make Israel politically and economically independent. Today, Zion holds three onshore licenses comprising 218,000 acres. Over the years, we have expended over $85 million dollars directly into the Israeli economy by drilling several deep wells, opening and maintaining an office with over 10 Israeli employees in Caesarea, employing outside legal counsel and multiple third party consultants such as the Geophysical Institute of Israel, Geologic Survey of Israel, Lapidoth, Ecolog, various oil service companies, construction companies, security companies, caterers, hotels, rental car companies, etc.

Requiring a 10% performance guarantee on each license, including drilling obligations, represents a tremendous financial obligation that will discourage, not encourage, additional exploration in Israel, particularly with regard to companies the size of Zion. Believe me when I say that it is much easier to seek and find oil and gas in Texas (with its abundant resources and streamlined regulations) where Zion’s headquarters are than in Israel but we love Israel and its people and that is what has motivated us to remain here for over 12 years.

With this as background, Zion offers our comments and requests:

  1. The financing of onshore exploration and drilling activities by exploration companies requires heavy and significant expenditures and financing. The proposed performance guarantee is a tremendous burden to impose on onshore companies, given the fact that all onshore operators and companies are relatively small as compared to those operating offshore. The financial burden and risk can lead to an end of exploration activity for the few onshore companies that are currently active and will certainly discourage any potential new companies from considering entry into Israel.
  2. A discount on the performance guarantee percentage should be applied to onshore exploration companies that operate from overseas and finance their operations in Israel. Such companies that inject capital directly into the Israeli economy should be incentivized by providing them with a separate guarantee base scale and some exemptions. Zion recommends the following: “New Onshore Licenses- Prior to granting a new onshore license one must deposit at the offices of the Petroleum Unit -Natural Resources Department a performance guarantee to the amount of -W% 5% of the cost of the work program including the first drilling as per the form attached herein.”
  3. Zion recommends that incentives be provided based on a proven record of conducting exploration activities and drilling in Israel. Respectfully, we recommend that for this reason alone, there should be no performance guarantee on existing licenses for companies like Zion who can prove a record of tangible expenditures above a certain threshold in Israel.
  4. Beyond this practical reason, there is also a most compelling legal rationale for a complete exemption of performance guarantees for existing licensees. Current licensees, such as Zion, are grandfathered, under the law because the original legal requirements, including budget, work plans and terms at the time the Ministry granted the license absolutely did not require frozen cash as a performance guarantee. Seeking to apply a significant financial performance guarantee retroactively is wholly contrary to the sanctity of contracts and the rule of law that otherwise promotes commercial certainty for company owners seeking to do business in Israel.
  5. If, however, the Ministry decides to impose a performance guarantee for existing licensees, onshore companies should not be subject to a more burdensome percentage than our offshore counterparts. Here, both parties should be treated equally. Zion recommends the following: “Existing Onshore and Offshore Licenses- All owners of existing licenses are obligated to deposit at the offices of the Petroleum Unit- Natural Resources Department a performance guarantee to the amount of -W% 5% of the balance of the cost of the future work program regarding onshore licenses and 5% of the balance of the cost of the future work program regarding offshore licenses … “
  6. Once a licensee has begun exploration activities, a structured and prorated release of the guarantee should occur. For example, when a license holder completes 20% of the work plan budget (such as for a required seismic acquisition project) the Commissioner should release 20% of the original guarantee.
  7. With regard to the request for an updated budget by the end of November, 2012, Zion argues that a thorough updated budget simply cannot be done within a few weeks. We propose: “For the purpose of determining the guarantee amount the operator of existing licenses is to submit an updated budget of the cost of the work program by three months after the guidelines become final no later than November 30, 2012, which updated budget is subject to the examination and approval by the Petroleum Commissioner.”
  8. As drafted, the guarantee states that it may be exercised if the license holder “has violated or breached any provision of the law, terms of right or instructions of the Commissioner.” However, the Petroleum Commissioner has stated that if a license holder has violated the license terms, the Petroleum Commissioner is entitled to revoke the license. Revoking a license would in and of itself result in an extensive loss of time and investment and collecting the guarantee would further impose an unfair, unnecessary, and unreasonable penalty on the license holder for not fulfilling the license terms. The government should encourage and promote companies to pursue hydrocarbon exploration in Israel while at the same time protecting the public from damages resulting from the industry. Accordingly, we submit that the guarantee should only be exercised to cover actual damages caused by the license holder. If, however, the Ministry adopts the concept of exercising performance guarantees for violation of license terms, due process requires that advanced warning in writing be given with an adequate opportunity to cure any defect. For example, when Gil is out of country, it has often taken Zion months to complete our seismic acquisition work plan obligation. Therefore, Zion recommends that the Petroleum Commissioner warn the lease holder in writing with regard to the defects and deficiencies for a period of time it would reasonably take to cure the work program defect.

Thank you for the opportunity to voice our significant concerns regarding the negative path that Israel’s oil and gas regulatory direction has recently taken. I trust that this path can be reversed before irreparable harm to the bright future of Israel’s energy independence occurs.

Respectfully submitted,

John Brown, Chairman/CEO
Zion Oil & Gas, Inc.

cc: Zion Board of Directors
Victor G. Carrillo, President/COO
llan Sheena, CFO

To be hand delivered to Prime Minister Netanyahu