The Israel Electric Corporation Ltd.

Transcription

1 The Israel Electric Corporation Ltd. Financial Reports For The Three Months Ended March 31, 2018 FILES INDEX The financial reports, for the three months ended March 31, 2018, are presented in a primary order. Each chapter is numbered separately by its internal sequence. Section Description Page Chapter A Description of the Company s Business Affairs 2 Chapter B Supplement Chapter C Board of Directors' Report on the Status of the Company's Affairs Additional Report Regarding the Effectiveness of the Internal Control Over Financial Reporting Condensed Consolidated Interim Financial Statements Annex 1 Actuarial Valuation

2 The Israel Electric Corporation Ltd. Updated Chapter A (Description of the Company s Business Affairs) for the 2017 Annual Report For the Period Ended March 31, 2018

3 Prominent Disclaimer This English translation of the Updated Chapter A (Description of the Company s Business Affairs) for the 2017 Annual Report for the period ended March 31, 2018 ("English Translation") is provided for information purposes only. In the event of any conflict or inconsistency between the terms of this English Translation and the original version prepared in Hebrew, the Hebrew version shall prevail and holders of the Notes should refer to the Hebrew version for any and all financial or other information relating to the Company. The Company and its Directors make no representations as to the accuracy and reliability of the financial information in this English Translation, except that the Company and its Directors represent that reasonable care has been taken to correctly translate and reproduce such information, yet notwithstanding the above, the translation of any technical terms are, in the absence of generally agreed equivalent terms in English, approximations to convey the general sense intended in the Hebrew version. The Company reserves the right to effect such amendments to this English Translation as may be necessary to remove such conflict or inconsistency. 2

4 Updated Chapter A (Description of the Company s Business Affairs) for the 2017 Periodic Report ("the Periodic Report") 1 of the Israel Electric Corporation Ltd. ( The Company or The Electric Company ) According to Regulation 39A to the Securities Regulations (Periodic and Immediate Reports), 1970, the following are details of material developments or changes in the Company s business affairs, in any matter that should be described in the periodic report during the three months that ended on March 31, 2018 and up to the publication date of this report, according to the order of the sections in the Chapter of Description of the Company s Business Affairs in the periodic report. This chapter of the quarterly report was prepared under the assumption that its reader possesses the Chapter Description of the Company s Business Affairs of the periodic report. It should be noted that the terms in this chapter will have the same meaning as presented in the Chapter Description of the Company s Business Affairs of the periodic report, unless explicitly stated otherwise. 1. The Company s operation and description of the development of its business affairs 1.1. General: As of the first quarter of 2018, the Company's Chief Operating Decision Maker separately reviews the operating results of the system management and consumer supply services down to the profit and loss for the relevant period. Consequently, the Company is presenting two new segments: (a) the system management segment; and (b) the consumer supply services segment. For additional details, including with regard to the circumstances that led to presentation of the two new segments as aforesaid, see Note 11 to the Company s financial statements as at March 31, 2018 (the Financial Statements ) The nature and results of any material structural change, merger or acquisition Further to the details in section 1.3 in the Chapter of Description of the Company s Business Affairs in the periodic report in connection with the outline of principles relating to the structural change in the Company, following further discussions and negotiations between the relevant government entities, the Company, the employees representatives and the Histadrut, on May 10, 2018, the aforesaid parties reached consents regarding the outline of principles with respect to the structural change for a period of 8 years (the structural change outline"). For additional details regarding the structural change outline and the collective agreement signed on May 17, 2018, following the structural change outline (the Collective Agreement ), see Note 1e and Note 5f to the Financial Statements. The Company estimates that the expected costs in connection with the structural change, to the extent that it will be implemented in accordance with the structural change outline, are at an estimated amount of approximately NIS 7 billion, which will be spread over ten years from the approval date of the structural change outline. Subject to the required regulation and as a condition on the part of the Company to implement the reform, the costs due to implementation of the reform outline will be fully recognized for the Company, subject to cost control. In accordance with the consents with respect to the structural change outline, on May 10, 2018, the Board of Directors of the Company approved a business plan that constitutes the basis for the financial model that was presented to the Board of Directors on the date of approval which is based on the principles of the structural change outline formulated during the reform discussions, including the following financial objectives: (a) The ratio of total liabilities to total assets of the Company, will be no more than 68% until the end 2021, while the net financial debt to adjusted EBITDA of the Company, as defined in the understandings, will be no more than 5.5 until the end of As published on March 15, 2018 (reference number: ) 3

5 (b) The ratio of total liabilities to total assets of the Company, as defined in the understandings, will be no more than 66% until the end of 2025, while the net financial debt to adjusted EBITDA of the Company, as defined in the understandings, will be no more than 4.6 until the end of Within the framework of the policy principles regarding structural changes in the electricity sector and in the Company published by the Minister of Energy on May 17, 2018, and in accordance with the response of the Electricity Authority as part of the obligation to consult which applies to it, it was clarified that the costs of implementation of the reform are estimated at approximately NIS 7.1 billion which are composed of approximately NIS 6.4 billion for increasing efficiency in the Electric Company and increasing managerial flexibility in accordance with the collective agreement and approximately NIS 0.7 billion with respect to additional reform costs. In accordance with the provisions of section 31 (b) of the Electricity Sector Law, in implementing the cost principle for the purpose of setting rates, the Electricity Authority will recognize costs deriving from the policy principles set by the Minister of Energy. The aforesaid policy principles will enter into effect upon receipt of a government resolution and necessary legislative amendments. The information included in this report and within the financial statements of the Company, regarding the manner of implementation of the structural change outline and its cost, within which inter alia, the Company s operation in the generation segment will be reduced and existing Company gasoperated generation sites will be sold, a subsidiary fully owned by the Company will be established and it will construct two new combined cycle gas turbines, the system management operation will be removed from the Company and will be sold to a separate government company, a new transmission supervision will be established by the Company, the supply segment will be gradually opened to competition, compliance with the principles of financial stability that will be determined and a material process of organizational change and an efficiency program in the Company will be carried out, recognition of the costs of implementation of the reform and compliance with the financial targets detailed above, and the information included in this report and within the Company's financial statements regarding decisions of the Company's Board of Directors and the regulatory entities required in connection with all of the aforesaid, are forwardlooking information, as defined in the Securities Law, This information is based on future data, whose materialization is not certain and not controlled by the Company, but depends on receiving regulatory approvals and consents, and relevant legislation changes and based on the Company s estimates as at the date of the report. Said estimates may not materialize or materialize partially or in a different manner than expected, inter alia, if the regulatory approvals and consents and the required legislation amendments as aforesaid will not be received, or if they will be received in a manner or format different that that described above, all of which are not under the control of the Company. 2. Generation Segment 2.1. Section 7.4: Competition Section 7.4.1: General; the Company as a monopoly; private electricity production government policy and decisions of the Electricity Authority Private electricity producers private electricity producers with renewable energy Further to that stated in section (d) of the Chapter Description of the Company s Business Affairs in the Periodic Report, with respect to several decision proposals for a hearing published by the Electricity Authority on December 4, 2017, aimed at ensuring compliance with a production target of 10% energy of renewable energy from the total production in the electricity sector until the end of 2020, on May 6, 2018, the Company received decisions of the Electricity Authority, which include four arrangements aimed at ensuring compliance with the said production target, combined with competitive procedures in these agreements published by the Electricity Authority, are intended to bring about the establishment of 1,900 megawatts in photovoltaic solar plants by 2020, 300 megawatts completion for net meter and 1,600 megawatts in new quotas. 4

6 2.2. Section 7.7: Development of the electricity sector the generation segment Section 7.7.5: Emission reduction plan For details regarding the approval of the Ministry of Environmental Protection to postpone the shutdown date of unit 4 at the Rutenberg power station, to reduce emissions, until October 1, 2018, subject to certain terms, see Note 1g to the financial statements Section : Coal ash Following the details in section of the Chapter of Description of the Company s Business Affairs in the periodic report with respect to the use of coal ash, on March 26, 2018, the Ministry of Environmental Protection, after a public hearing was held in this matter, published an opinion for comments by the public under which the manner of distributing the ash created in Israel should remain unchanged. Furthermore, in March 2018, the Ministry of Environmental Protection announced that it is prohibiting the continued use of coal ash in soil applications filling and infrastructure as well as treating sewage sludge. The Company applied to the Ministry of Environmental Protection and requested that the cancellation will be suspended until a hearing is held in the matter, in view of the implications the decision may have on the operation of its coalfired power stations Section 7.9: Raw Materials and Suppliers Section The table below presents the generation distribution rate in the Company (in percentage) according to types of fuels used in the generation segment for generating electricity in the three months ended on March 31, 2018 and March 31, 2017: For the Three Months Ended March in percent Coal Natural Gas * Liquid Gas * Diesel Oil Crude Oil Total * The estimate of the distribution of the electricity generation through natural gas according to its sources (Tamar reserve and LNG) was calculated based on the respective relative gas quantities (tons), assuming that the gas from the two sources have identical lower heating values Section 7.9.3: The table below presents the total fuel costs (including attributed wages) used to generate electricity in the generation segment in the three months ended on March 31, 2018 and on March 31, 2017: For the Three Months Ended March in NIS millions Coal Natural Gas ,055 Liquid Gas Diesel Oil Crude Oil Movement in provision for crude oil impairment... 1 (12) Costs of maintaining diesel oil for emergencies for the electricity sector... 2 Total... 1,911 2, Section 7.11: Restrictions on and control of the operations of the Company in the generation sector For updates and changes regarding the rate see Note 3 of the Financial Statements. 5

7 2.5. Section : Land and water Following the details in section in the Chapter of Description of the Company s Business Affairs in the periodic report with regard to filing an indictment against the Company and a number of Company employees following a diesel oil leak at the Hagit site, on May 8, 2018, the Haifa Magistrate's Court decided to adopt the plea bargain with the Company, whereby the Company and a former manager of the Company admitted to the facts of an amended indictment and the commission of offenses under the Water Law and the Maintenance of Cleanliness and Sanitation Law, 1984, and a fine of NIS 350 thousand was imposed on the Company. In addition, the Company signed an undertaking for three years in the amount of NIS 700 thousand under which the Company will refrain from committing the offenses in which it was convicted 2.6. Section : Asbestos Following the details in section in the Chapter of Description of the Company s Business Affairs of the periodic report pertaining to the removal of brittle asbestos from all its sites, on March 31, 2018, the generation units at Haifa C were permanently shut down for the removal of brittle asbestos from them. 3. Matters Relating to the Operations of the Company as a Whole 3.1. Section 13: Human capital Section 13.2: Employee roster by areas of operation As of March 31, 2018, the Company employs 11,893 employees Section 13.9: Labor disputes For details regarding the labor dispute with respect to promoting the outline of reform in the Company, see Note 9c to the Financial Statements Section 18: Financing For details of material raisings and repayments, publication of a shelf prospectus, credit rating during the report period, see Note 7 to the Financial Statements Section 21: Restrictions and control over the operations of the corporation Section : Restrictive trade practices For details regarding an appeal filed by the Company and officer serving in the Company, pertaining to the determination of the Acting GeneralDirector of the Antitrust Authority under which the Company abused its monopolistic position, and for details regarding a consent decree signed by the Company and the Antitrust Authority for payment of NIS 3 million by the Company following a demand for data which was not fully complied with by the Company, see Note 1h to the financial statements Section 22: Material Agreements Section 22.2: The Palestinian PETL Company and the negotiations for sale of electricity at ultrahigh and high voltage For details of initialing the draft agreement with the Palestinian Electricity Transmission Limited, see Note 4b1 to the Financial Statements. 6

8 4. The Supply Segment 4.1. General information regarding the supply segment Structure of the area of operation and changes occurring therein The electricity supply operation is carried out under a license received by the Company in 1996 for transmission, distribution, supply, sale and trade in electricity, which the Company calls a general license (the General License ). The validity of the General License, including all the activities included therein, including the supply of electricity, was extended along with other licenses held by the Company until November 15, For further details regarding the General License, see section in the Chapter of Description of the Company s Business Affairs. The supply segment includes the collection and service system of the Company, which include editing and producing invoices and collection actions, as well as consumer services including customer call center, customer reception and customer account coordinators. Under the Outline of Structural Change, insofar as it will be implemented, the Electric Company will be a default supplier in the supply segment and will operate in a separate profit center. The supply of electricity to consumers of high voltage, ultrahigh voltage and extrahigh voltage will be open to full competition The Company will not be permitted to act as a competitive factor. The supply of electricity to lowvoltage consumers will be opened to competition as will be decided by the competent government entities and on the date determined. At the opening of the market to competition, the Company will not be permitted to act as a competitive factor in this consumer segment. Accordingly, the Electricity Authority will determine a mechanism in accordance with the policy that will be determined, according to which the State will open the low voltage segment to competition gradually so that the Company's market share is not expected to be less than 60% of the number of customers in the segment during the reform period. If the number of the Company s low voltage customers will drop below 60%, the Company will be given the opportunity to compete in this household consumer segment in a fair manner and subject to regulation that will be determined. For additional details regarding the Outline of the Structural Change, including in relation to the supply segment, see Note 1e to the Financial Statements Restrictions, legislation, standards and special constraints that apply to the area of operation The Company s operation in the supply segment, similarly to the other areas of its operation, is subject to legislation restrictions, such as those set in the Electricity Sector Law and the Government Companies Law, and to constraints related to licensing issues and requirements for permits from authorities and various government ministries such as the Electricity Authority, the Companies Authority, the Ministry of Energy and the Ministry of Environmental Protection, and to emergency and development plans in the electricity sector. As aforesaid, the electricity supply operation is carried out under the General License Changes in the volume of operation in the field and its profitability The Company estimates that the major factors that may affect the volume of the Company s operation in the field of supply are the Company s compliance with the efficiency goals detailed in the rate that entered into effect as of 2018, the structure of the rate that will be determined in future which may affect the profitability of the segment, and the terms of competition that will be determined in the market in accordance with criteria to be determined by the Electricity Authority Critical success factors in the field of operation and the changes occurring therein The Company estimates that the business success of the supply segment mainly depends on the Company's ability to improve efficiency both in terms of the Company's costs and structurally and in the professionalism of its employees by providing quality service to its customers. In addition, fair competition conditions are required, including an effective rate structure. 7

9 Main entry and exit barriers of the field of operation and the changes occurring therein Entry barriers: The Company estimates that the main entry barrier to the field of operation is receipt of a supply license. Exit barriers: The regulation regulates the Company s operation and it being an essential service supplier, pursuant to the Electricity Sector Law and the provisions of its licenses, which obligates it to supply electricity to the general public, reliably and efficiently, according to the conditions of its license, are the main exit barriers from the field of operation. For details of the outline of the structural change, under which, inter alia, changes will be made in the supply segment, see Note 1e to the Financial Statements Products and services The main services in the supply segment include preparation and Issue of invoices and collection actions, customer call center, reception and customer account coordinators Segmentation of revenues products and services For details of the Company s revenues from electricity sales that were attributed to the supply segment see Notes 11 and 12 to the Financial Statements Competition There are private electricity producers who hold a supply license in addition to the production license granted to them, and therefore they also serve as suppliers to end consumers who engage with them directly and receive electricity from them and not from the Company. In 2017, the Electricity Authority announced that it intends to also distribute supply licenses to private suppliers who do not own production assets, which could significantly harm the Company's market share in the supply segment. As aforesaid, private electricity producers who also operate as suppliers and sellers of electricity to endcustomers have an impact on the Company s scope of operation in the supply segment. However, the Company s revenues in the supply segment presently constitute approximately only 2% of its total revenues and are collected from the Company s customers by a fixed payment that is not dependent on consumption. The opening of the supply segment to competition, as expected in the grid rate which is in effect from 2018, may affect the entire electricity sector. For details regarding the outline of the structural change, including with regard to competition in the supply segment, see Note 1e to the financial statements. The Company's estimates regarding the possible implications of the transfer of customers to other suppliers and the opening of the supply segment to competition constitute forwardlooking information, as defined in the Securities Law. These estimates are based on information available to the Company at the date of the report, and may not materialize or materialize partially or in a different manner than expected, inter alia, in light of the fact that their materialization depends on various factors, some of which are not under the Company's control, such as: the volume of entry of other suppliers into the electricity sector, the manner in which the rate will be determined, and the costs that will be recognized for the Company in practice Environmental risks and manner of their management supply segment For details of environmental risks that the Company s operation is exposed to in the supply segment see section 7.12 in the Chapter of Description of the Company s Business Affairs in the periodic report Legal Proceedings For details regarding legal proceedings, including proceedings with respect to the supply segment, see Note 9b to the Financial Statements. 8

10 5. System Administration 5.1. General information regarding the system administration segment Structure of the field of operation and the changes occurring therein The operation of the system administration unit is carried out by the Company according to the wording of the general license, even though the Company was not granted a designated license for this purpose. The administration of the system includes, inter alia, the administration for the electricity system in the generation and transmission segments, including a constant balance between the supply and demand of electricity, ensuring the survivability of the electricity generation and transmission array, managing the transfer of energy from power stations through the electricity grids or substations with the required reliability and quality, scheduling the execution of maintenance work in the generation units and the transmission system, managing trade in electricity under competitive, equal and optimal conditions, including execution of agreements for the purchase of available capacity and energy from electricity producers, planning the development of the transmission and transformation system, and integrating private producers into the electricity sector, from the initiation stages, through the construction of the power stations, their testing until the commercial operation stages. Under the provisions of the Electricity Sector Law, an entity which is granted a license to manage the system constitutes an essential service provider. The system administration unit is responsible for the ongoing administration of the generation, transmission and transformation system at the national and regional levels, while directing the generation of electricity in the various generation units and distributing their loads, while ensuring the system's survivability at a reasonable level of risk and maintaining optimal safety, reliability, quality of electricity and its costs. In addition, the unit is a partner in determining the development plan for the short, medium and long term of the generation, transmission and transformation system, and is responsible for managing the operation of gas contracts with gas suppliers and the INGL, and managing the activities of private electricity producers in high voltage and private suppliers from the commercial, operational and project aspects, as well as demand administration. In recent years there has been a significant change in the aspect of securing the survivability of the electricity system with an emphasis on the growth of the volume of electricity generation in the sector. In addition, as part of the operation of the system management unit and in order to meet the electricity demands while maintaining the system s survivability, the system management unit executes daily risk management which takes into account the limitations associated with the fact that at present there is only one gas pipeline which transports the natural gas from one gas supplier, and that there is a limitation of minimum production in the coal units in accordance with the instructions of the Minister of Energy. For details of the Minister of Energy s directives with regard to the coal units see Note 1g (Directives of the Minister of Energy reduction of the use of coal) to the Annual Financial Statements. According to the outline of the structural change, insofar as will be implemented, within 18 months from the date the Government passes a resolution regarding the reform in the electricity sector, a separate government company for system management will begin to operate ( System Administration Company ), provided that during this period, the required legislative amendment was passed. The functions of the new company will be defined by the State in a license to be granted by the Electricity Authority with the approval of the Minister of Energy. Employees from the System Management Unit, the Planning, Development and Technology Division, the Department of Statistics, and employees from other units, in accordance with the needs of the sector and in a manner that will enable the functioning of the new company, will be transferred to the system management company, except for employees or functions from those units with regard to which it was agreed between the parties that they will remain with the Electric Company. For additional details regarding the outline of the structural change, including in connection with the system administration segment, see Note 1e to the financial statements Restrictions, legislation, standards and special constraints that apply to the area of operation The System administrator operates according to the Electricity Sector Law, Electricity Sector Regulations, decisions and criteria of the Electricity Authority, instructions from the Ministry of Energy such as a generation restriction in the coal units, restrictions by the Ministry of Environmental Protection such as operating the electricity sector routinely and at times of emergency with alternative fuels, decisions by the Gas Authority regarding gas distribution in times of shortage in the gas sector. 9

11 Changes in the volume of operation in the field and its profitability The operation of the system administration unit in the operating and commercial areas is increasing each year. The change is mainly due to the increase of private producers and suppliers in the electricity sector. As of the date of publication of the report, the production share of the private producers constitutes approximately 30% of the total energy produced in the sector, and the suppliers share is even higher. Additional changes are expected, deriving from regulatory requirements: continuous adaptation of the computerized tools and the computer systems, the integration of renewable energies according to the government's goals, and more Developments in the markets of the segment of operation, or changes in the characteristics of its customers The main development that affects and will affect the operation of the system management in future is a reform in the electricity sector. The future system administrator will have to provide a solution for all customers of the electricity sector, including the Company independently. When taking into consideration the increase of generation in the sector and the increase of the various means of generation (wind, pumped energy, and more) and changes in the customer profile, the system manager has to take into account many parameters. For details see section above Critical success factors in the field of operation and the changes occurring therein The Company estimates that the business success of the system management segment depends mainly on management of the electricity system while maintaining the system's survivability and proper commercial activity with all the producers and consumers in the sector, in accordance with the regulatory conditions Main entry and exit barriers of the field of operation and the changes occurring therein Entry barriers: The Company estimates that the main entry barrier into the field of operation is receiving a system administration license. Exit barriers: The regulation that regulates the Company's operation and its being an essential service supplier, according to the Electricity Sector Law and the provisions of its licenses, which obligates it to provide full services during the whole period of the licenses of the Company, are the main exit barriers from the field of operation. For details regarding the outline of the structural change, including as regards the system administration segment, see section above and Note 1e to the financial statements Products and services The services provided in the field of the system management mainly include maintenance of a proper electricity supply and the survivability of the electricity system in the generation and transmission segments, coordination and execution of maintenance plans in the generation and transmission segments and the gas system. Execution of gas orders with gas suppliers and the INGL Company for generation units of the Company. Approval of production and consumption plans and issuing a load program for all the players in the electricity sector. Computation of the electricity sector with private producers, production of various reports according to the reporting requirement of the system administrator regarding operation in the electricity sector, accompanying entrepreneurs (in the field of generation) up to the stages of commercial operation Customers The Electric Company, private producers and suppliers, entrepreneurs in the electricity sector, various government ministries, and the Electricity Authority, are among the customers attributed to the system management segment Segmentation of revenues products and services The revenues of the system administrator are anchored in the decisions of the Electricity Authority and are defined as system costs that are collected from all the consumers of the sector. These costs include services to balance the system, backup services, accompanying arrangements in the electricity sector, and administrative costs. For details regarding Company revenues attributed to the system management segment, see Note 12a to the Financial Statements. 10

12 5.5. Fixed assets, real estate and facilities A facility in Haifa and a facility in Ramat Hasharon Development of the electricity sector system administration segment The longterm development of the electricity sector under the responsibility of the Planning, Development and Technology Division (PDT) includes, inter alia, preparation and submission of multiyear plans for approval by the Minister of Energy, which include plans for the development of the generation, transmission and transformation systems derived from the plans of absorption of private producers and other units of the Company and to initiate, develop and implement the technological and research infrastructure and to evaluate which are the most suitable technologies that will provide affordable, reliable and environmentally friendly electricity. Additionally, the Divisions is responsible to conduct a general gas survey, to prepare outline plans for the transmission lines, switching stations and substations, to manage a preproject stage and to manage the environmental and statutory aspects of all the projects in the generation, transmission and transformation system. One of the main activities of the Planning, Development and Technology Division in recent years is handling the absorption of private producers/consumers who connect to the transmission grid Human capital For details of the outline of structural change, under which the employees from the system management unit, PDT, the Department of Statistics and employees from additional units according to sector needs and in a manner that will enable the functioning of the new Company, will be transferred to the system administration company, see Note 1e to the Financial Statements Restrictions on and control of the operations of the Company in the system administration segment For details of the general license under which the Company executes the system management operation, see section above. The Electricity Sector Law determines that the Minister, upon consultation with the Electricity Authority or pursuant to its proposal, may set provisions with respect to the duty of a system administrator license owner to execute actions to be decided by the Minister to secure the development level required in the electricity generation system. As of the date of the report, such regulations have not been set. For details of the regulation that applies to the Company, including to the system management segment, see section 21 in the Chapter of description of the Business Affairs of the Company in the Periodic Report Environmental risks and manner of their management system administration segment In accordance with the Clean Air Law and the emission permits issued to the generation units of the Electric Company, a loading order has been defined for the generation units according to the requirements of the grid. These environmental guidelines also define the removal of generation units for renovations and repair of malfunctions due to environmental considerations that override economic considerations. This situation limits the flexibility of the system management in dealing with the demand for electricity and requires strict management of the generation array. In addition, in order to maintain electromagnetic field levels in certain transmission lines in accordance with the Ministry of Environmental Protection's instructions, the system management unit is required to ensure that the current levels in these lines do not exceed a predefined threshold, which limits the flexibility of the system management in the transmission of the output Restrictions on and control of the operations of the Company in the system administration segment The rate for system administration services (system rates) includes, inter alia, administrative system management costs, service costs for balancing the system, costs with respect to backup services and related arrangements. Pursuant to the decisions of the Electricity Authority 2, in which it was determined that the rates for the system administration services will be applied from June 1, 2013, on August 6, 2015, the Electricity Authority's decision 3 was published, under which the system administration rate (system rates) will be imposed on supply license holders and independent producers, in a manner designed to lead to a more equal allocation of the burden of costs between the various electricity producers in the sector. On December 4, 2017, the Electricity Authority 2 Decision number 3 from meeting 400 of May 6, 2013, and decision number 4 of meeting 401 of May 13, Decision number 4 from meeting 471 of the Electricity Authority of August 6, 2015, regarding Determination of rates for management services of the electricity system (system rates). 11

13 published a hearing on setting rates for management services of the electricity system. According to the hearing, every consumer consuming electricity from an installation with the ability to generate electricity using renewable energy or natural gas, will be debited with the rate for the system administration services with respect to the electricity consumed from the said generation facility. These rates were applied retrospectively as from September 13, The decision also determined that a private producer that commenced operation prior to the adoption of this decision will pay its debt, so that for each KWH that it provided from June 1, 2013 until the date of the decision, it will pay 90% of the annual system rate. For additional details, see Note 3k to the Financial Statements. A number of private electricity producers, including independent producers, petitioned the High Court of Justice against the Electricity Authority and against the Electric Company regarding the decision of the Electricity Authority to charge them with a payment of a system costs rate, including payment with respect to a past debt as from June 1, For additional details, see Note 3k to the Financial Statements. On January 8, 2018, the Electricity Authority reached a decision regarding 2018 electricity rate annual update for the electricity rates for the consumers of the Electric Company. In the decision, the Electricity Authority set final system costs for 2016 in the amount of approximately NIS 3.4 billion (approximately 5.58 agorot per kwh) and advance costs for 2017 and 2018 based on a forecast of approximately NIS 3.8 billion and NIS 3.6 billion, respectively (about 6.26 and 5.83 agorot per kwh). Costs for 2017 and 2018 will be determined definitively in the next annual update. For additional details regarding the rate base for the system administration services (system rates), see Note 3 to the Financial Statements Forecast of development in the coming year In 2018, additional private producers are expected to enter commercial operation in the electricity sector at a capacity of approximately 854 megawatts using various technologies, and accordingly, the operating and commercial operations of the system administration unit are expected to grow. The Company s estimate regarding the entry of additional private producers into commercial operation as aforesaid constitutes forward looking information, as this term is defined in the Securities Law. This information is based on data and forecasts that exist in the Company as of the date of the report and which may not materialize or may materialize in a different scope than the Company s expectations, and this, inter alia, in light of the fact that their materialization depends on various factors that are not under the control of the Company. Ofer Bloch Chief Executive Officer Yiftah RonTal Chairman of the Board of Directors Date of approval: May 24,

14 The Israel Electric Corporation Ltd. Chapter B Board of Directors Report on the Status of the Company's Affairs For the Three Months Ended March 31, 2018

15 Prominent Disclaimer This English translation of the "Company's Board of Directors' Report on the Status of the Company's Affairs" for the three months ended March 31, 2018 ("English Translation") is provided for informational purposes only. In the event of any conflict or inconsistency between the terms of this English Translation and the original version prepared in Hebrew, the Hebrew version shall prevail and holders of the Notes should refer to the Hebrew version for any and all financial or other information relating to the Company. The Company and its Directors make no representations as to the accuracy and reliability of the financial information in this English Translation, save that the Company and its Directors represent that reasonable care has been taken to correctly translate and reproduce such information, yet notwithstanding the above, the translation of any technical terms are, in the absence of generally agreed equivalent terms in English, approximations to convey the general sense intended in the Hebrew version. The Company reserves the right to effect such amendments to this English Translation as may be necessary to remove such conflict or inconsistency. 2

16 BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE COMPANY'S AFFAIRS FOR THE THREE MONTHS ENDED MARCH 31, 2018 The Board of Directors of the Israel Electric Corporation (the Company") hereby presents the Directors Report on the status of the Company's affairs for the three months ended on March 31, 2018, ("The Report Period") according to the directives of the Securities Regulations (Periodic and Immediate Reports) 1970 ("The Securities Regulations") and the provisions of the Government Companies Authority ("The Companies Authority"). a. Explanations of the Board of Directors on the Business Condition of the Company 1. Brief Description of the Company and its Business Environment a) General The Company operates as one combined and coordinated system that deals in supplying electricity to consumers, starting from the electricity generation stage through the transmission, distribution, supply and trading electricity stages, all in accordance with licenses granted to each type of activity, which are effective up to November 15, 2018, as of the date of approval of the financial statements. The Company also deals in the construction of infrastructures required for these activities. The operations of the Company include five main areas: electricity generation, transmission and transformation of electricity, electricity distribution, supply of electricity, and the Company also functions as the Electricity Grid Administrator. The Company provides electricity to most of the electricity consumers in the country. The Company is owned by the State of Israel which holds about 99.85% of its share capital, therefore the Company and its operations are subject, inter alia, to the directives of the Government Companies Law 1975 (hereinafter: the Government Companies Law ). As of March 5, 1996, the Company operates according to the Electricity Sector Law 1996 (hereinafter: the Electricity Sector Law ) and the regulations thereunder. The Electricity Sector Law replaced the Electricity Concessions Order and the Electricity Authority was founded in accordance with this ordinance. The duties of the Electricity Authority are, inter alia, to set electricity rates and define rate amendment processes, to award licenses and to supervise the compliance with the instructions specified in the licenses (which in certain cases require the approval of the Minister of Energy). For further details of the Electricity Sector Law, including the details and role of the Electricity Authority, inter alia, in accordance with the amendment to the Electricity Sector Law, see Note 1 to the Financial Statements of March 31, 2018 (hereinafter: Financial Statements ), and Note 1 to the Financial Statements as of December 31, 2017 (hereinafter: the Annual Financial Statements ). b) Condensed Review of the Changes in the Business Environment during the Report Period 1) For details regarding material legislated provisions applicable to the Company in the field of environmental protection, including details and developments regarding the emission reduction project, see Note 1g to the Financial Statements. 2) For details regarding examinations and decisions by the Director of the Antitrust Authority pertaining to the Company's operations, see Note 1h to the Financial Statements. 3) For details of publication of a shelf prospectus on April 26, 2018, and of raisings and repayments of debentures and loans in the report period and after the date of the Statement of Financial Position, see Note 7 to the Financial Statements. 4) For details regarding rate updates including a decision for the base rate for the grid s segments, as well as decisions of the Electricity Authority during the report period see Note 3 to the Financial Statements. 5) For details regarding the consents in principle reached with regard to an agreed outline for structural change see Note 1e to the Financial Statements. 6) For details regarding class actions and other material actions, see Note 9b to the Financial Statements. 7) For details regarding the outline and agreements reached with respect to the assets arrangement, see Note 1f to the Financial Statements. 8) For details regarding a collective agreement signed subject to completion of the reform outline, see Notes 5f and 9c to the Financial Statements. 3

17 BOARD OF DIRECTORS' REPORT ON THE STATUS OF THE COMPANY'S AFFAIRS FOR THE THREE MONTHS ENDED MARCH 31, 2018 a. Explanations of the Board of Directors on the Business Condition of the Company (continued) 1. Brief Description of the Company and its Business Environment (continued) b) Condensed Review of the Changes in the Business Environment during the Reporting Period (continued) 9) For details of the Palestinian debt and the draft agreement with the PETL Company, see Note 4 to the Financial Statements. 10) For details on the indictment filed following the leak of diesel oil at the Hagit site, see section 2.5 in the Report on Description of Company's Business as of March 31, c) Information Required in Accordance with the Directives of the Government Companies Authority Major financial targets Following are the goals for the end of the fiveyear financial planning period ( ): 1) Real net financial debt ratio to EBITDA: the target is a ratio of 5.5. In practice, as of March 31, 2018, the ratio is approximately 5.73 (the ratio is based on the real net financial debt of the Company as of March 31, 2018, in the amount of NIS 41,535 million and on EBITDA for the last four quarters, in the amount of NIS 7,250 million). 2) Total debt to total assets ratio (leverage) will gradually decrease to 75%. In practice, as of March 31, 2018, the ratio stands at approximately 76%. 3) Maintaining an international rating of at least 'BBB'. For details of the Company s credit rating see Note 19f to the Annual Financial Statements. 4) The safety cushion will be of a monetary value of no less than NIS 3 billion, of which the balance of cash and shortterm deposits will be no less than NIS 1.7 billion and the balance will be in unused secured credit lines valid for a period exceeding one year. As of March 31, 2018, the Company is meeting the objective. 5) According to the fiveyear financial plan, the target for decreasing real net financial debt is by at least NIS 0.5 billion per year. Adjustment of financial targets following the structural change: Subsequent to the statement of financial position date, on May 10, 2018, the Company's board of directors approved the Company s undertakings concerning the outline of the structural change, subject to receiving permits and the completion of the necessary procedures. For details see Note 1e to the Financial Statements and section 1.2 in the Report of Update of Description of the Business Affairs of the Corporation of March 31, In addition, on the same date, the Company's board of directors approved a business plan that constitutes the basis for the financial model, which is based on the principles of structural change established during the Reform discussions, including the following financial targets (revising targets no. 1, 2 and 5 above): 1) The ratio of total liabilities to total assets, as defined in the understandings between the parties will be no more than 68% until the end of 2021, while the net financial debt to adjusted EBITDA as defined in these understandings will be no more than 5.5 until the end of ) The ratio of total liabilities to total assets, as defined in the understandings between the parties will be no more than 66% until the end of 2025, while the net financial debt to adjusted EBITDA as defined in these understandings will be no more than 4.6 until the end of The resolution of the Company's board of directors and compliance with the Company's commitments as aforesaid, are subject to and contingent on the Government's decision in accordance with the understandings, and provided they are incorporated in primary legislation and/or secondary legislation and/or administrative decisions and/or regulations of the Israeli Electricity Authority, and in licenses provided by the competent institutions in Israel and the appropriate arrangements and procedures, all as required by the relevant law. 4